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Which economic indicators?

Despite the abundance and omnipresence of economic indicators in the media and in our professional outlets, the economics profession in the main failed to observe the approach of the Global Financial Collapse.  But what about that small minority of economists, many of whom were nominated for the Revere Award, who saw it coming and gave warning. From which indicators did they gain their foresight?  Given that there has been no major reform of financial systems, the same indicators that foretold approaching disaster last time will most likely also provide the means of doing so in the future.

The world needs a short list of such indicators with concise explanations of how to interpret them.  Ideas anyone?

  1. August 23, 2011 at 10:13 am

    We should stop using financial indicators, because they can be bubbled. Real indicators should be used. Real production, real number of unemployed.

  2. Merijn Knibbe
    August 23, 2011 at 10:45 am

    I recommend the Eurostat Household Investment Rate, which captures investments in existing and new houses and is not based (like comparable IMF statistics) on GDP but on disposable income. As Disposable Income increased less than GDP in most countries and will possibly continue to do so (surely in countries which try to decrease a deficit on the current account) and as income is more important to households than GDP, Income is a much better basis for such a metric than GDP.

    It´s easily accesible and well defined: http://epp.eurostat.ec.europa.eu/portal/page/portal/product_details/dataset?p_product_code=TEC00098

    – it clearly captures the Irish, Spanish and Estonian housing follies (yes, ireland was special)as well as the Dutch one, which is crashing at this very moment
    – it shows, despite some arguments indicating the opposite, that there is at this moment no bubble in Sweden and Germany
    – a level of this indicator above 9% is worrying, a level above 11% is alarming

    It´s main draw back: it´s too ´slow´ and a ´short´ indicator has to be developed, but that should not be too difficult, using existing statistics of house prices, new and existing house sales and guesstimates of disposable income.

  3. August 23, 2011 at 11:45 am

    This comment is from Michael Hudson, who currently is out of wifi range.

    from Michael Hudson

    Here’s the problem with looking for good indicators: Any accounting format reflects theoretical categories. Most indicators today are based on the GNP accounting format from the national income and product accounts (NIPA).
    The aim of these indicators was to track inflationary pressures, focusing on the production and consumption economy + government spending and taxation.
    Today’s major problem is financial in character. The indicators here are really in a mess. To track what is happening, the following adjustments are needed. (At least, these are the ones that I have begun to work on):

    (1) Add “capital gains” to national income to measure “total return”
    The name of the game in making money these days is capital gains – inflation of asset prices, as distinct from current earnings. The tax system encourages speculation on property already in place and financial securities already issued, by taxing capital gains at only a fraction of “earned income.”
    Some 80% of capital gains are in real estate – and so, they are basically land-price gains. In the first decade of the 2000s, these gains were in the trillions. So were stock-market gains in the 1990s. So when you add capital gains to national income or GDP, you find both the upsweep and the post-bubble crash moving much more sharply.

    (2) Derive a good measure of land valuation, as this is the largest category of capital gains and losses.
    To do this, one must replace the Federal Reserve’s “Balance sheet of the US Economy” (Table Z of its Flow of Funds report). The Fed uses a “land residual” method of calculation. As a result of real estate industry lobbying, it assumes that buildings “grow” in value each year by factoring in the construction-cost index. This is so large that it leaves little room for land as a residual.
    The process needs to be reversed, to use a building residual value.
    The overall real estate figures used by the Fed are taken from the Census Dept., and are acceptable at least in theory. The problem comes in the breakdown between land and capital improvements.

    (3) Use a measure of ebitda instead of earnings.
    Classical economics focused on the idea of economic surplus. The aim was to see which class got what: labor (in wages), land (groundrent), and tangible capital (profit). Obviously, we need to add interest and taxes – hence, ebitda.
    This too varies much more sharply than national income or GDP.

    (4) balance of payments
    As I have written for many decades, the pre-GDP format focused on actual payments FLOWS (the PAYMENTS associated with exports and imports), not merely the “as if” flows: foreign aid “export” credits, offset by government “outflows.”
    The government accounts should be separated from the private-sector account, and traced on a payments basis. When I did this for the 1950s and ‘60s, this showed that the entire US balance of payments deficit stemmed from military spending. Foreign aid actually generated a surplus.

    Michael Hudson

  4. August 23, 2011 at 12:03 pm

    I would not look to a single indicator, as opposed to searching for unsustainable imbalances. In the 90s it was easy to see that there was a stock bubble that would eventually burst because price to earnings ratios were inconsistent with anyone’s projection of profit growth. If you get a PE of more than 30, which is what we were seeing at the market peak, then unless we think investors are willing to hold stock for a 3 percent real return, then we know that we have a bubble which will burst.

    The wreckage from that bubble was actually pretty severe, which is why the federal funds rate was at 1.0 percent for almost 3 years. Given this is as low the ECB rate ever went in the current crisis, we should have been talking about liquidity traps and the Fed’s lower bound in 2002-2004.

    The imbalance of the housing bubble was easy to recognize because house prices had diverged from a 100-year long trend with no remotely plausible explanation based on the fundamentals of the market. It was inevitable that this would burst and bring down much of the economy with it.

    I would look for a sector characterized by major imbalances. There is going to be a single formula that will tell you to how to recognize imbalances within a sector. It also matters that it is a major sector. Imbalances in the shoe lace market will not have major economic consequences.

    Anyhow, I don’t see any major sector producing the sort of imbalances that should cause major problems right now, the real concern is just continued slow growth. That seems quite likely for the foreseeable future.

    The one big issue is whether the clowns at the ECB can prevent a collapse of the euro. This should be a no-brainer since they can flood with as many euros as necessary to prevent a meltdown, and they must know that the consequences would be a disaster. But the cult of 2.0 percent inflation is still very powerful at the ECB. One cannot rule out the possibility that the bank heads will oversee a financial collapse and then pat themselves on the back for meeting their inflation target. After all, in their view, keeping the economic system functioning is a secondary issue.

  5. Jorge Buzaglo
    August 23, 2011 at 1:27 pm

    “I would look for a sector characterized by major imbalances.” (Dean Baker)

    I think a good candidate should be the US balance of trade, and the exploding debt associated to its permanent deficit. “The U.S trade deficit is a bigger threat to the domestic economy than either the federal budget deficit or consumer debt and could lead to political turmoil… Right now, the rest of the world owns $3 trillion more of us than we own of them” (Warren Buffett).

    In the global laissez faire context in which we live, it would seem that the only way for the US trade deficit to diminish is through economic recession. Yet the trade deficit is increasing again since 2009 is spite of very low growth.

    In the present neoliberal context, a much bigger recession should be necessary in order to bring balance. The alternative suggested among others by Godley, Papadimitriou and Zezza (2008:5) is “a drastic change in the institutions responsible for running the world economy—a change that would involve placing far less than total reliance on market forces.”

    Godley, W., D. Papadimitriou, and G. Zezza (2008) Prospects for the United States and the World: A Crisis That Conventional Remedies Cannot Resolve. Levy Economics Institute, Strategic Analysis, December.

  6. Jorge Buzaglo
    August 23, 2011 at 4:15 pm

    During the Latin American debt crises of the 1980s I read (in some academic paper whose title and author I don’t remember) that a critical threshold for the external debt to generate a payments’ crisis is three times annual exports. With annual exports around say 1.5 trillion, net external debt (net international investment position) around 3 trillion, and the debt annually increasing by a trade deficit of say 0.5 trillion, this would mean than within three years one should reach the threshold. But of course USA is not Latin America.

  7. August 23, 2011 at 7:58 pm

    Employment growth, U-6 unemployment rate, median real household income, private debt/GDP, Gini coefficient

    Full employment is the measure of a healthy economy. Median income growth is a good approximation of how productive the society is. Keen has shown dramatically and graphically that private debt/GDP expresses how much of the economy is unsustainable and the likelihood of major problems. The Gini coefficient, as a measure of income inequality, is in lock step with broader measures of economic and societal well-being, from obesity to incarceration rates to violence and across the board.

    What are bad indicators?

    Inflation. Low inflation can come from economic stagnation or a huge trade deficit resulting from importing the product of cheap labor. High inflation can come from commodity price speculation (as recently) or from healthy job growth and investment (as Minsky and Kalecki showed)

    Government deficits. High deficits can arise from a shift of income from future taxpayers to the wealthy or well-positioned (as under Bush) and from chronic inadequate revenues and poor safety nets (as in Japan), where governments have chosen to borrow rather than tax. They can also come from mobilization of the society’s economy (as in WWII or to redevelop and prepare for climate change). Government deficits today are only a good indicator because they show how much it takes to keep business in business when they are not doing business.

    Economic forecasts. Particularly the forecasts from the Fed. Bernanke made these public back when he was trying to do implicit inflation targeting. Any objective review puts them at the bottom. Consensus or blue chip economists are busy forecasting the past. Consumer confidence surveys routinely outperform 90 percent of economists.

  8. August 24, 2011 at 12:15 am


    The key indicator that alerted me to the fact that a crisis was approaching was the private debt to GDP ratio. This was growing at an exponential rate in the USA and Australia, and had reached levels that had never been encountered before. Having checked the data in December 2005, I therefore expected a crisis in the very near future.

    I expected that the crisis would hit when the rate of growth of debt suddenly slowed. From my Monetary Circuit Theory perspective, I define aggregate demand as income (GDP via the income measure) plus the change in debt, which is in turn expended on output (GDP via the production method) and net asset sales. The former peaked at about $18.5 trillion in 2007/8, with about $4.5 trillion coming from the increase in private debt (the change in public debt is also obviously a factor, but it works in the opposite direction to private debt).

    A simple slowdown in the rate of growth of debt was enough to seriously reduce aggregate demand–and thus expenditure on both commodities and assets. The first inkling was a drop in the annual rate of growth of debt from 4.5 to 2.5 trillion, which more than swamped the increase in GDP over the same period. By the time the depths in the rate of change of debt had been reached in 2009, the change in debt was about minus 1,5 trillion–thus reducing aggregate demand from 18.5 trillion at its peak to 12.5 trillion.

    A third indicator, which I’m still developing, is the Credit Accelerator (first called the Credit Impulse by Biggs, Meyer and Peck). This is the acceleration of debt (calibrated by GDP). It follows logically from “Aggregate demand equals income plus the change in debt” that the change in aggregate demand is the change in income plus the acceleration of debt. The acceleration of debt is thus related to both change in demand for goods and services and the change in asset prices.

    Finally, Minsky argued cogently that there were two price levels in capitalism–one for assets and the other for consumer prices. A simple comparison of the ratio of asset prices to consumer prices is thus another good indicator of both a bubble and the likelihood of a crash.

    I’ll put a post on these issues up on my Debtwatch blog shortly: http://www.debtdeflation.com/blogs

    This is also a good point to announce that I am forming the Center for Economic Stability (www.cfesi.org) to attempt to raise funds to support non-neoclassical research into economic and financial instability. If you would like to help develop an alternative to neoclassical economics, please consider joining CfESI.

    Cheers, Steve Keen

  9. August 25, 2011 at 8:49 am

    Economic foresight or what indicators are really helpful is mainly a question of how we explain real markets or to be precise, how evolving markets are explained. It ist evident, however, that real markets, and societies as well, permanently evolve. The neoclassical growth model has failled as a solid basis for explaniation in this respect. Dependig on the state of this process, changes (or shifts) in the set of indicators and the way they have to be interpretated seems to be unavoidable. Perhaps we´ll have to go back to e.g. Schumpeters early work and his theory of economic change. I have tried some theoretical work on this, eventually leading me to a new theory of competition, one of the kind that helps understanding why and how markets change. Especially concerning the question of appropriate indicators, I guess we urgently need some more work in this direction, although I don´t see this really happens.

  10. August 25, 2011 at 4:59 pm

    Unless we expect a new bubble to rise from the ashes, the indicators that served the past will not be those which serve the future. The post-war economy that depended on private capital formation is over. The process of paper wealth destruction will likely be very disorderly. (Consider the certainty and conviction with which most politicians and economists proclaim austerity as the way out.) The liquidity trap which most of us see is evidence of the debt-deflation cycle in real assets, which cannot be solved by any of the policies currently in prospect. As Steve Keen has said elsewhere, the current private debt/GDP is enormously higher than anything relating to legitimate financing. As Michael Hudson has said, debts that cannot be repaid will not be repaid. Until that is over, looking at previously useful indicators will be something like looking at the RPM gauge on a car that has run off a cliff.

  11. Lucy Badalian
    October 21, 2011 at 7:05 pm

    i agree with Alan Harvey. There is a tendency to mix together two classes of economic problems and related indicators, which have nothing in common. Bubbles indicate inflationary shortages of supply, with economic development pointing upward, be it healthy or imbalanced/superficial. Slowdowns are their opposite, deflationary shortages of demand. The former can be compared with fever and were very visible prior to 2008 on indicators, including the noinlinear growth in debt/M++, mostly through derivatives, mentioned by others above. According to my research, inverted yield curve is also a very good warning sign. it appeared in the run-up both to the 1929 and 2008. for 2008, its appearance meant that the only real debt was in fact short-term, used for everything, including refinancing of the long-term debt, as it was the only way of repaying long-term debts. this indicates extremely low economic fundamentals. Just as Alan says, it is a debt that cannot be repaid under any conditions. That is why, a truly deflationary slowdown (especially on a stage of globalization — since I see globalization as an attempt to resolve low fundamentals through a dramatic increase in the scale) presents a push towards a total techno-economic restructuring. The prices must be lowered dramatically in order to attract the shrinking demand, while the old-time companies go belly-up. The main problem at that stage are the old institutions and asset inertia. The main thing that governments do now they try to support the old institutional order, which is unsupportable in principle because of its low fundamentals and its inability to feed itself w/out an outside help, such as Chinese debt, government handouts etc.

    To understand what is ahead, consider the difference between the 19th century and the 20th century: production, technology and institution-wise, then, multiply it by at least the factor of ten, considering the much larger size of the currrent Oikoumene and its complexity. Then, think of the fact that the period encompassed by two world wars was seen as a transition from coal to oil economies by a renowned British historian, John Roberts. After all was duly “restructured” breaking during the wars the immense institutional resistance, the world actually became better-off. Things that were luxury before, the car, the washing machine, the fridge etc became affordable to masses as economic fundamentals jumped, at least up to the 1980s..

  12. Dave Taylor
    October 24, 2011 at 10:10 am

    Lucy, it seems to me you are missing the point. Bubbles indicate not inflationary shortages of supply, but BELIEF in those and the so-called laws of supply and demand: beliefs manipulable by those on the make, including speculators in the stock exchanges, property markets and the marketing of “brands” – and especially those legally allowed to supply “out of thin air” and at interest the additional money required to pay the inflated prices. What are not good indicators of real shortages are stock market share prices and decline in trade which has become unnecessary. What is utterly disgusting is forcing financially weak people and nations into debt and destitution in order to encourage second-hand trade in the stock markets. People shouldn’t need to “occupy Wall Street”; their governments should take back constitutional responsibility for the issue of credit where living off the land is no longer possible, and they should either close down the stock markets or let them play their games in their “shadow economy” using only Monopoly money.

    • Lucy Badalian
      October 24, 2011 at 10:17 pm

      well, Dave, my point is that historically there were deflationary and inflationary periods, which require very different responses. Btw, the recent bubbles arose in an attempt to correct persistent demand shortages, which are, per se, deflationary, not inflationary. this was done by employing such superficial means as pumping monetary supplies into the economy (did you notice that I spoke of healthy or imbalanced/superficial inflation — may correspond to your notion of market-generated beliefs :-)). First this was done by the market (derivatives), now by governments (sovereign debt). Shortages of demandl persist even today, despite all these infusions. To make it short, I have advanced models of the process (a so called market pendulum model). If you wish, I could send some publications your way to help you in a better articulation of your critique :) cheers. Lucy

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