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You are looking at a long term trend here and the trend is not good.

On the shorter term, lower retail sales in December may be giving us a better view of the current situation. Dropping sales during the Christmas shopping season is especially bad since US businesses depend on those sales to keep the business alive for the rest of the year. And some are projecting lower retail sales in January.

This in spite of lower gasoline prices which should have freed up some money for other spending.

Or maybe the fact that retail sales are falling in spite of lower gasoline prices is telling us that consumers are so hard pressed that any opportunity to save is taken up. Even during the Christmas shopping season.

And some of the current spending due to subprime lending.

Not good.

Hi Jim,
My line of attack is to figure out the potential of demand to determine the end of the business cycle. That is what effective demand is.
Retails sales gives a picture of current demand. Do you think that current month-to-month demand gives insight into potential demand?
I look at the graph for retail sales and real GDP growth(yoy).

My concern is that retail sales would simply neutralize the effect of growth in output in the effective demand equation.

You wrote: "Do you think that current month-to-month demand gives insight into potential demand?"

I do think that could be true now. Probably not enough that you could graph it, more of an interpretation of the circumstantial evidence.

I am not concerned when retail sales vary a little month to month.

But I am a little surprised when the US consumer gets cheaper energy and does not spend the savings. That has not been our history. In the past, consumers continued to spend even when they were rapidly running up debt. Especially during the Christmas shopping season.

Obviously something has changed and I doubt that it is from some new found change in their desire to spend.

I have been thinking more about deflationary pressures lately.

Consumers can not spend what they do not have, whether thru income or borrowing. That is more of an absolute brake now that consumers seem to have max'ed out their credit except for subprime loans with onerous rates. (In the aggregate.) That has to affect potential demand.

HI Jim,
I recently downloaded a book from the internet on deflation. I haven't had a chance to read it yet, but here is the link so that you can get it.


You have to wait and then click on the "download file" button. The other buttons are for advertisements.

Okay, I made it to page 33 before I gave up. From there I read conclusions and skimmed the rest. It is a different view of deflation.

But I believe that deflation is an effect not a cause. I am more interested in the cause.

These are just a few of my problems with the text:

On Page 86 he writes: “The main consequence of price deflation is, therefore, that buyers of goods and services will be better off than without the price decline of what they demand and sellers of goods and services will be worse off than without the price decline of what they sell. As almost every individual is both a buyer as well as a seller of goods and services on the market and prices fall to different degrees and at different times, one cannot say a priori who will be a net winner and who will be a net loser of a price deflation.”

But creditors would be worse off. Their borrowers would be harder pressed and much more likely to enter bankruptcy. Powerful bankers do not like that prospect. He probably pointed this out elsewhere but the overall impression is confused.

On page 155 “We have shown that from 1865 to 1896 there was a price deflation in the U.S. caused by economic growth. The price deflation did not pose any problems for fast economic growth.“

But there is a better explanation than fast economic growth. As immigration soared, wages would have been suppressed, so the number of customers soared but the prices that they could pay was less. And as more and more farmers automated, their production would go up, their prices would go down but their mortgages still had to be paid. The haves got richer and richer, leading up to the “Gay Nineties”. (See page 132 for his discussion of economic growth in the period.)

From: https://www.census.gov/history/www/through_the_decades/fast_facts/1870_fast_facts.html
The US population went from about 38.5 million in 1870 to about 63 million in 1890. This was a growth of about 24.5 million people or a 63% growth rate in twenty years.

On page 194, “The last fallacy about price deflation concerns the liquidity trap. When nominal interest rates are close to zero, deflationary expectations would lead to a high real interest rate increasing the real cost of borrowing. “

But the Great Depression and the Great Recession were both preceded by a rampage of borrowing. Then consumers were more concerned with paying down debt then borrowing more. And bankers were more concerned with collecting debt than increasing lending. The FED’s monetary policy was bound to be much less influential. I can not bring myself to believe in liquidity traps when there are better explanations.

The theoretical discussions of our economy become so abstract that they lose any real meaning. The definitions of deflation are so broad that they remind me of modern psychology.

Deflation is just one piece of the puzzle. Sure it is nice for demand when prices go down. And it is nice when sellers have the capability to drop prices too.
Money growth just could not keep up with the population growth back in the 1800's. And production had to increase because more people were producing. Relatively less money was available for the economy. Even though money was entering the economy through increased investment to increase production. Population was growing a few steps ahead.
Usually deflation hinders investment, but when the labor force is increasing, investment will increase because there are more consumers walking into town.
Different dynamics back in those days.


You wrote "Different dynamics back in those days."

In my opinion the similarities overwhelm the differences.

In back of your insufficient money supply scenario is the fact that very large numbers of immigrants were arriving and looking for work. Wages could be held down during that earlier period. And the phrase "Gay Nineties" was not referring to workers leading a life of opulence.

The law of supply and demand applies to labor just as much as it applies to other areas of the economy.

If business owners can replace unskilled workers with cheaper labor then they will. And even skilled workers can be replaced with just a little more trouble.

If modern economic theory defies that reality then it is in error.

We see the same general dynamic today. First thru the outsourcing of jobs overseas and then as the fallout of the Great Recession. If you want another job today, you should expect to take a pay cut.

Look at the labor participation rate and tell me that does not have consequences.

I am not championing deflation but I am beginning to accept that it is more than a remote possibility. There would be winners and losers, there always are. Savers have been the losers over the last 7 years.

You make a good point connecting the immigrants of the 1800's to the outsourcing of jobs overseas recently. There is wage suppression and that contributes to the deflation.
Yet, back in the 1800's, I do not think that banks were so likely to hold reserves or refrain from investing like banks do now.
Also, think about the increasing consumption in the 1800's. Total dollars spent was rising with the population increasing so much. As wages fell, so could prices.
An important question is whether labor share and unit labor costs held steady or fell.
For example, if labor share held steady, then with deflation, unit labor costs are reduced. Now if labor share was falling with the influx of immigrants, that would reduce effective demand which would put downward pressure on prices leading to deflation in an attempt to maintain effective demand.

I think this quote from wikipedia is revealing.
"The Long Depression is sometimes held to be the entire period from 1873–96."


That tells me that effective demand was constraining the economy for a long time. Labor share must have been falling. Monetary policy probably could not be loose enough. and deflation could not raise effective demand enough.

The labor struggles of those times imply that labor share was falling.


You wrote: “Yet, back in the 1800's, I do not think that banks were so likely to hold reserves or refrain from investing like banks do now.”

Back then deposits were not insured and any sign of weakness could bring on a run on the bank. In that environment, bankers must have been more conservative in their lending. Everything that I have read said that it was impossible to get a home loan without a very large down payment. FDIC and Fannie Mae changed the dynamics of home ownership. I expect that the same dynamics were at work in getting business loans.

You wrote: “Also, think about the increasing consumption in the 1800's. Total dollars spent was rising with the population increasing so much. As wages fell, so could prices.”

With the very high levels of immigration, there was increasing consumption. But most of those immigrants were poor and unlikely to go on spending binges and the competition for jobs must have been brutal and wage suppressing. I do not believe that lower wages would automatically push prices down. Capital would just have accumulated windfall profits. (The Gay Nineties were the result.) Prices could fall as a result of increased mechanization, even as capital accumulation continued.

You wrote: “An important question is whether labor share and unit labor costs held steady or fell. “

Agreed. The ideas about the “Long Depression” mesh nicely with some of the ideas in “In Defense of Deflation” which you cited above. The author of that piece saw a long period of price deflation and fast economic growth. Here we have two visions of the period between 1873 and 1896. We do not have to accept one over the other, both could be true. Just as the conclusion in the Gay Nineties was undeniably true.

Deflation moderated the impact of the “Long Depression” on labor. Consumers could not spend what they did not have, so producers had to produce at cheaper prices, if they were to maintain acceptable economic growth and profits.

Capitalism forces consumers and producers to face reality. Thus my curiosity about the likelihood of deflation in our future. Deflation seems unlikely in the current environment but another severe recession could provide an opening.

Very interesting reply by you. You shed good light on the issue of the possibility of deflation. We may not have strong deflation, but you are describing forces that lead to falling inflation.

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Data as of 3rdQ-2018
Effective Demand = $18.433 trillion
Real GDP = $18.671 trillion
Productive Capacity = $24.872 trillion
UT index is at effective demand limit = -0.92%
Effective demand limit = 74.1%
TFUR = 75.1%
ED Fed rate rule = 4.0%
Estimated Natural Real Interest rate = 2.3%
Short-term real interest rate = 2.8%

There is no recession for 3rdQ-2018. Chance of recession is growing as economy has now reached 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



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. Graduate of Atlantic International University where independent research was developed.
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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