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Hi, Edward. So, Prof, the chart from Mr Yglesias is almost an inversion of effective demand limit. http://www.talkmarkets.com/content/economics--politics-education/kashkari-reveals-dark-secret-fed-plan-for-wages?post=145383 This chart is interesting because it points to Fed procyclical behavior, the attempt to raise rates just when wages are starting to accelerate. Your study points to the inevitability of what happens when wages get too high. But Yglesias says it is the Fed that causes the pruning, implying that it is money supply rather than effective demand limit. I am wondering on some level if you are both right. The Fed must be looking at effective demand limit in secret all these years. And when capacity lags income they prune. What other sense can we make of all this?

Hi Gary,
Here is a graph of labor share with effective Fed funds rate.


The relationship that you are describing is just not seen. In most cases, increases in Fed rate precede increases in labor share.
From my look into Fed data, it does seem though that they have a primitive view of the effective demand limit. Like at the end of this post...

However, the Fed seems more to raise rates on the down side of the profit rate cycle...

So the Fed seems to want to reach their medium-term goal when they sense the business cycle winding down. They see an opportunity to raise rates, but mostly they are behind the curve and have to raise quickly near the end of the business cycle.

These dynamics are separate from the effective demand limit, which has its own timing in the profit rate cycle.


So, the first chart in your response is actually different than the chart supplied in my article regarding Yglesias. It appears that that FRED chart "share of gross domestic income" shows wages declining just prior to the recession hitting or just at the very beginning, while the chart you cited, "nonfarm business: labor share" shows wages not starting their declines until well into the recession periods. I don't understand the contradictory information coming from the two charts. But if your chart is more accurate, still, doesn't the rise in rates eventually cause the recession? Even if the rise in rates causes a short lived bump in wages, it still results in a decrease in wages after that. I don't think Kashkari is lying, meaning I think he sees people at the Fed wanting to get wages down. So, that fear of wage acceleration actually destroys the power of the Fed's fund rate, as you prove, as labor share continues to decline over time. One more thing, it is possible that because of interest on reserves, banks are kept from lending, and therefore inflation will be difficult to achieve. But if the Fed took away the excess reserves, how would it set rates if the Fed Fund rate is dead? Are they stuck with excess reserves until the end of time?

Hi Gary,
Yes, increases in the Fed rate can exacerbate the zero sum profit game around the effective demand limit. The higher Fed rate helps push the economy into recession.
The Fed wants to normalize rates to have some control over the economy into the next recession. But raising rates now is tricky I still see that there is room to raise rates without pushing a recession.
As far as Kashkari, I think you had a notion at the end of your post that maybe he was searching for reasons to not raise rates now. And using fairness of workers as an excuse. Yet the data does not really suit his story, so I don't think economists will follow the story.
As far as inflation, capacity utilization is low partly because of high profit rates. Low capacity utilization keeps inflation down.
Like in this post...

So lending is optimized. Firms are actually more in debt now than around the crisis. They have locked in low rates for a while so they are good. And with profit rates high and capacity utilization low, there is less need to invest in the macro sense.
As for excess reserves, I look at this chart.

Excess reserves have come down a bit as the Fed rate rises. So the future of excess reserves is linked to the future of the Fed rate. So if we get a recession in 6 months, the Fed rate goes back down to zero, and excess reserves are here to stay.

And inflation is not dependent on interest rates at the moment. It is much more a dynamic of high profit rates, low capacity utilization, increased inequality, weak labor power and weak effective demand from lower labor share.
This scenario applies to other countries like Japan and Europe.

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Data as of 1stQ-2018
Effective Demand = $17.386 trillion
Real GDP = $17.379 trillion
Productive Capacity = $23.479 trillion
UT index is at effective demand limit = +0.03%
Effective demand limit = 74.0%
TFUR = 74.0%
ED Fed rate rule = 3.4%
Estimated Natural Real Interest rate = 2.2%
Short-term real interest rate (fallen from 2.8% peak in 2014) = 2.4%

There is no recession for 1stQ-2018. Chance of recession is growing as economy heads toward 2nd effective demand limit in this business cycle. I am forecasting that economic conditions will begin to contract in the second half of 2018.

Click on Graphs below to see updated data at FRED.

UT Index (measure of slack):

The UT Index



z derivatives in terms of labor & capital:

z derivatives in terms of labor & capital

Effective Demand, real GDP & Potential GDP:

ED, real GDP & pot rGDP

ED Output Gap:

ED Output gap

Corporate profit rate over real cost of money:

Corp profit rate over real cost of money

Exponential decay of Inflation:

Corporate profits impact Inflation

Measures of Inflation:

Measures of Inflation

YoY Employment change:

YoY employment change

Speed of consuming slack: yoy monthly:

Speed of consuming slack

Speed of consuming slack: quarterly:

Speed of consuming slack quarterly

Real consumption per Employee:

real consumption per employee 2

Will real wages ever rise faster than productivity?:

Productivity & Real Wages

Real Wage Index:

real wage index



Productivity against Effective Demand limit:

Prod & ED limit

Bottom of Initial Claims?:

Initial claims

Tracking inflation expectations:

Fisher effect?

M2 velocity still falling:

Measures of Inflation

All in one:

All in one

Double checking labor share with unit labor costs & inflation:

My Photo
Edward Lambert: Independent Researcher on Effective Demand.
Some links for economic analysis
Fed Views - San Francisco Fed, around 10th of each month.
Well's Fargo monthly - around 10th of each month
Well's Fargo weekly
Well's Fargo Interest rate report
Well's Fargo Economic indicators
T. Rowe Price weekly market wrap-up
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