Unemployment and Undermployment, Stagflation and Monetary Policy

Unemployment and Underemployment, Stagflation and Monetary Policy

Carlos M. Pelaez

© Carlos M. Pelaez, 2010, 2011

The objective of this post is to analyze high unemployment and underemployment in relation to possible stagflation and monetary policy. The contents are as follows;

I Unemployment and Underemployment

II Stagflation

III Monetary Policy

Growth and Employment Outlook

Monetary Policy and Recovery

Pass-through of Commodity Prices to Inflation

IV Economic Indicators

V Interest Rates

VI Conclusion

References

I Unemployment and Underemployment. The Bureau of Labor Statistics (BLS) released on Fri, Mar 4 the employment report showing a decrease in the seasonally adjusted rate of unemployment, or unemployed as percent of the labor force, from 9.0 percent in Jan 2011 to 8.9 percent in Feb 2011 (http://www.bls.gov/news.release/pdf/empsit.pdf). The number of people in job stress is 24.7 million composed of 13.7 million unemployed (of whom 6.0 million, or 43.8 percent, unemployed for 27 weeks or more), 8.3 million employed part-time for economic reasons (who suffered reductions in their work hours or could not find full-time employment) and 2.7 million who were marginally attached to the labor force (who were not in the labor force but wanted and were available for work) (Ibid, 2). Additional information provides deeper insight. Table 1 consists of data and additional calculations using the BLS household survey, illustrating the possibility that the actual rate of unemployment could be 12.7 percent and the number of people in job stress could be closer to 30 million. The first column provides for 2006 the yearly average population (POP), labor force (LF), participation rate or labor force as percent of population (PART %), employment (EMP), the employment population ratio (EMP/POP %), unemployment (UEM), the unemployment rate as percent of labor force (UEM/LF Rate %) and the number of people not in the labor force (NLF). The numbers in column 2006 are averages in millions while the monthly numbers for Feb 2010 and Jan and Feb 2011 are in thousands, not seasonally adjusted. The average yearly participation rate of the population in the labor force was in the range of 62.0 percent minimum to 67.1 percent maximum between 2000 and 2006 with the average of 66.4 percent (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). The objective of Table 1 is to assess how many people have left the labor force because they do not think they can find another job. Row “LF PART 66.2 %” applies the participation rate of 2006, almost equal to the rates for 2000 to 2006, to the population in Feb 2010 and Jan and Feb 2011 to obtain what would be the labor force of the US if the participation rate had not changed. In fact, the participation rate fell to 63.9 percent by Jan 2011 and also 63.9 percent in Feb 2011, suggesting that many people simply gave up on finding another job. Row “∆ NLF UEM” calculates the number of people not counted in the labor force because they could have given up on finding another job by subtracting from the labor force with participation rate of 66.2 percent (row LF PART 66.2%) the labor force estimated in the household survey (row LF). Total unemployed (row “Total UEM”) is obtained by adding unemployed in row “∆NLF UEM” to the unemployed of the household survey in row “UEM.” The last row is the effective total unemployed “Total UEM” as percent of the effective labor force in row “LF PART 66.2%.” The results are that: (1) there are an estimated 5.484 million unemployed who are not counted because they left the labor force on their belief they could not find another job; (2) the total number of unemployed is effectively 20.026 million and not 14.542 million of whom many have been unemployed long term; (3) the rate of unemployment is 12.7 percent and not 9.5 percent, not seasonally adjusted, or 8.9 percent seasonally annualized; and (4) the number of people in job stress is close to 30 million because of the 5.484 million leaving the labor force because they believe they could not find another job. The employment population ratio “EMP/POP %” dropped from 62.9 percent on average in 2006 to 57.6 percent in Jan 2011 and 57.8 percent in Feb 2011 and the number of employed dropped from 144 million to 138 million. There are almost six million less people working in 2011 than in 2006 and the number employed is not increasing.

Table 1, Population, Labor Force and Unemployment, NSA

	2006	Feb 2010	Jan 11	Feb 11
POP	229	236,998	238,704	238,851
LF	151	153,194	152,536	152,635
PART%	66.2	64.6	63.9	63.9
EMP	144	137,203	137,599	138,093
EMP/POP%	62.9	57.9	57.6	57.8
UEM	7	15,991	14,937	14,542
UEM/LF Rate%	4.6	10.4	9.8	9.5
NLF	77	83,804	86,188	86,216
LF PART 66.2%		156,892	158,022	158,119
∆NLF UEM		3,698	5,486	5,484
Total UEM		19,689	20,423	20,026
Total UEM%		12.5	12.9	12.7

Pop: population; LF: labor force; PART: participation; EMP: employed; UEM: unemployed; NLF: not in labor force; ∆NLF UEM: additional unemployed; Total UEM is UEM + ∆NLF UEM; Total UEM% is Total UEM as percent of LF PART 66.2%.

Note: the first column for 2006 is in average millions; the remaining columns are in thousands; NSA: not seasonally adjusted

The last four rows are calculated by applying the labor force participation of 66.2% in 2006 to current population to obtain LF PART 66.2%; ∆NLF UEM is obtained by subtracting the labor force with participation of 66.2 percent from the household survey labor force LF; Total UEM is household data unemployment plus ∆NLF UEM; and total UEM% is total UEM divided by LF PART 66.2%

Sources:

ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf

http://www.bls.gov/news.release/archives/empsit_12032010.pdf

http://www.bls.gov/news.release/pdf/empsit.pdf

Total nonfarm payroll employment seasonally adjusted (SA) rose by 192,000 in Jan and private payroll employment rose by 222,000. Table 2 provides the monthly change in jobs in the prior strong contraction of 1981-1982 and the recovery in 1983 and in the contraction of 2008-2009 and in the recovery in 2009-2010. The data in the recovery periods are in relief to facilitate comparison. There is significant bias in the comparison. The average yearly civilian noninstitutional population was 174.2 million in 1983 and the civilian labor force 111.6 million, growing by 2009 to an average yearly civilian noninstitutional population of 235.8 million and civilian labor force of 154.1 million, that is, increasing by 35.4 percent and 38.1 percent, respectively (http://www.bls.gov/cps/cpsaat1.pdf). Total nonfarm payroll jobs in 1983 were 90.280 million, jumping to 94.530 million in 1984 while total nonfarm jobs in 2010 were 129.818 million declining from 130.807 million in 2009 (http://www.bls.gov/webapps/legacy/cesbtab1.htm ). What is striking about the data in Table 2 is that the numbers of monthly increases in jobs in 1983 are several times higher than in 2010 even with population higher by 35.4 percent and labor force higher by 38.1 percent in 2009 relative to 1983 nearly three decades ago and total number of jobs in payrolls rose by 39.5 million in 2010 relative to 1983 or by 43.8 percent. Professor Michael Boskin of Stanford, former Chairman of the CEA, provides analysis of growth in cyclical expansions in an article for the Wall Street Journal (http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html ). The critical historical perspective is that average quarterly rates of growth in the expansions after a severe recession were incomparably higher than during the current expansion: 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975, 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter in 1983 and only 3 percent in the first four quarters and 2.9 percent forecast in the first 12 quarters after the trough in the third quarter of 2009. GDP grew at the SA quarter-on-quarter yearly-equivalent rate of 1.7 percent in IQ2010, 2.6 percent in IIIQ2010 and 3.2 percent in IVQ2010. Growth has been mediocre in the six quarters of expansion beginning in IIIQ2009 in comparison with earlier expansions (http://cmpassocregulationblog.blogspot.com/2011/02/mediocre-growth-raw-materials-shock-and.html) and also in terms of what is required to reduce the job stress of at least 25 million persons but likely close to 30 million. Some of the job growth and contraction in 2010 in Table 2 is caused by the hiring and subsequent layoff of temporary workers for the 2010 census.

Table 2, Monthly Change in Jobs, Number SA

Month	1981	1982	1983	2008	2009	2010	Private
Jan	95	-327	225	-10	-779	14	16
Feb	67	-6	-78	-50	-1266	39	62
Mar	104	-129	173	-33	-213	208	158
Apr	74	-281	276	-149	-528	313	241
May	10	-45	277	-231	-387	432	51
Jun	196	-243	378	-193	-515	-175	61
Jul	112	-343	418	-210	-346	-66	117
Aug	-36	-158	-308	-334	-212	-1	143
Sep	-87	-181	1144	271	-225	-24	112
Oct	-100	-277	271	-554	-224	210	193
Nov	-209	124	352	-728	64	93	128
Dec	-278	-14	356	-673	-109	121	139
			1984			2011	Private
Jan			447			63	68
Feb			479			192	222

Source: http://data.bls.gov/PDQ/servlet/SurveyOutputServlet

http://www.bls.gov/webapps/legacy/cesbtab1.htm

http://www.bls.gov/schedule/archives/empsit_nr.htm#2010

http://www.bls.gov/news.release/pdf/empsit.pdf

Important aspects of growth of payroll jobs from Feb 2010 to Feb 2011, not seasonally adjusted (NSA), are provided in Table 3. Total nonfarm employment increased by 1,253,000, consisting of growth of total private employment by 1,522,000 and decline by 269,000 of government employment. Monthly average growth of private payroll employment has been 126,833, which is mediocre relative to 25 to 30 million in job stress while total nonfarm employment has grown on average by only 104,417 per month. Manufacturing employment increased by 189,000 while private service providing employment grew by 1,283,000. An important feature is that jobs in temporary help services increased by 245,000. This episode of jobless recovery is characterized by part-time jobs. An important characteristic is that the losses of government jobs have been highest in local government, 228,000 jobs lost, because of the higher number of employees in local government, 14.4 million relative to 5.2 million in state jobs and 2.8 million in federal jobs.

Table 3, Employees in Nonfarm Payrolls Not Seasonally Adjusted in Thousands

	Feb 2010	Feb 2011	Change
A Total Nonfarm	127,746	128,999	1,253
B Total Private	104,981	106,503	1,522
B1 Goods Producing	17,087	17,326	239
B1a Manu-facturing	11,340	11,529	189
B2 Private service providing	87,894	89,177	1,283
B2a Temporary help services	1,858	2,103	245
C Government	22,765	22,496	-269
C1 Federal	2,848	2,826	-22
C2 State	5,261	5,242	-19
C3 Local	14,656	14,428	-228

Note: A = B+C, B = B1 + B2, C=C1 + C2 + C3

Source:

http://www.bls.gov/news.release/pdf/empsit.pdf

The NBER dates recessions in the US from peaks to troughs as: IQ80 to IIIQ80, IIIQ81 to IV82 and IVQ07 to IIQ09 (http://www.nber.org/cycles/cyclesmain.html). Table 4 provides total annual level nonfarm employment in the US for the 1980s and the 2000s, which are different from 12 months comparisons. Nonfarm jobs rose by 4.853 million in 1982 to 1984, or 5.4 percent, and continued rapid growth in the rest of the decade. In contrast, nonfarm jobs are down by 7.779 million in 2010 relative to 2007 and fell by 989,000 in 2010 relative to 2009 even after six quarters of GDP growth. Monetary and fiscal stimuli have failed in increasing growth to rates required for mitigating job stress. Disruption of business models and decisions by onerous legislative restructuring and regulation prevented recovery of growth and employment as in earlier contractions.

Table 4, Total Nonfarm Employment in Thousands

Year	Total Nonfarm	Year	Total Nonfarm
1980	90,528	2000	131,785
1981	91,289	2001	131,826
1982	89,677	2002	130,341
1983	90,280	2003	129,999
1984	94,530	2004	131,435
1985	97,511	2005	133,703
1986	99,474	2006	136,086
1987	102,088	2007	137,598
1988	105,345	2008	136,790
1989	108,014	2009	130,807
1990	109,487	2010	129,818

Source: http://www.bls.gov/webapps/legacy/cesbtab1.htm

The highest average yearly percentage of unemployed to the labor force since 1940 was 14.6 percent in 1940 followed by 9.9 percent in 1941, 8.5 percent in 1975, 9.7 percent in 1982 and 9.6 percent in 1983 (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). The rate of unemployment remained at high levels in the 1930s, rising from 3.2 percent in 1929 to 22.9 percent in 1932 in one estimate and 23.6 percent in another with real wages increasing by 16.4 percent (Margo 1993, 43; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 214-5). There are alternative estimates of 17.2 percent or 9.5 percent for 1940 with real wages increasing by 44 percent. Employment declined sharply during the 1930s. The number of hours worked remained 29 percent in 1939 below the level of 1929 (Cole and Ohanian 1999). Private hours worked fell in 1939 to 25 percent of the level in 1929. The policy of encouraging collusion through the National Industrial Recovery Act (NIRA), to maintain high prices, together with the National Labor Relations Act (NLRA), to maintain high wages, prevented the US economy from recovering employment levels until Roosevelt abandoned these policies toward the end of the 1930s (for review of the literature analyzing the Great Depression see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 198-217).

The wage bill is the average weekly hours times the earnings per hour. Table 5 provides the estimates by the BLS of earnings per hour, increasing from $22.48/hour in Feb 2010 to $22.87/hour in Feb 2011, or by 1.7 percent. The number of average weekly hours rose from 34.0 in Feb 2010 to 34.2 in Feb 2011, or by 0.6 percent. The wage bill before taxes rose by 2.3 percent (1.017 times 1.006). Energy and food increases are similar to a “silent tax” that is highly regressive, harming the most those with lowest incomes. Market fears developed on Fr Mar 4 that the wage bill would deteriorate in purchasing power because of the raw materials shock in the form of increases in prices of commodities such as the 36.5 percent steady increase in the DJ-UBS Commodity Index from Jul 2, 2010 to Mar 4, 2011.

Table 5, Earnings per Hour and Average Weekly Hours

Earnings per Hour	Feb 10	Dec 10	Jan 11	Feb 11
Total Private	$22.48	$22.77	$22.86	$22.87
Goods Producing	$23.97	$24.20	$24.40	$24.27
Service Providing	$22.13	$22.44	$22.50	$22.54
Average Weekly Hours
Total Private	34.0	34.2	34.2	34.2
Goods Producing	39.0	39.7	39.6	39.8
Service Providing	33.0	33.1	33.1	33.1

Source: http://www.bls.gov/news.release/pdf/empsit.pdf

II Stagflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table 6, updated with every post, provides the latest yearly data for GDP, consumer price index (CPI) inflation, producer price index (inflation) and UNE (unemployment) for the advanced economies, China and the highly-indebted European countries with sovereign risk issues.

Table 6, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates

	GDP	CPI	PPI	UNE
US	2.7	1.6	3.6	8.9
Japan	2.6	0.0	1.6	4.9
China	9.8	4.9	6.6
UK	1.5	4.0	8.5	7.9
Euro Zone	2.0	2.4	6.1	9.9
Germany	4.0	2.0	5.5	6.5
France	1.5	1.8	5.5	9.6
Belgium	1.8	2.9	9.0	8.0
Portugal	1.2	3.64	5.7	11.2
Ireland		1.7	4.0	13.5
Italy	1.3	2.1	4.6	8.6
Greece	-6.6	5.2	6.7	12.4
Spain	0.6	3.3	6.8	20.4

Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier

Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html

Wall Street Journal Professional Factiva

Critical information on the flow of shocks of raw materials and commodities through the production chain is provided by purchasing managers indexes (PMI). The Institute for Supply Management (ISM) calculates closely-watched indexes based on responses to questionnaires in two surveys of industrial and nonindustrial companies. The ISM explains the information in a diffusion index as (http://www.ism.ws/ISMReport/content.cfm?ItemNumber=10706):

“A diffusion index measures the degree to which a change in something is dispersed, spread out, or "diffused" in a particular group.

All the ISM indexes are "diffusion indexes" and are indicators of month-to-month change. The ISM indexes are calculated by taking the percentage of respondents that report that the activity has increased ("Better") and adding it to one-half of the percentage that report the activity has not changed ("Same") and adding the two percentages. Using half of the "Same" percentage effectively measures the bias toward a positive (above 50 percent) or negative index. As an example of calculating a diffusion index, if the response is 20 percent "Better," 70 percent "Same," and 10 percent "Worse," the Diffusion Index would be 55 percent (20% + [0.50 x 70%]). A reading of 50 percent indicates "no change" from the previous month.

Economists and statisticians have determined that the farther the index is away from the amount that would indicate "no change" (50 percent), the rate of change is greater. Therefore, an index of 60% indicates a faster rate of increase than an index of 55% (increased activity is becoming more dispersed), and an index of 35% indicates a faster rate of decrease than an index of 40% (decreased activity is becoming more dispersed). A value of 100 indicates all respondents are reporting increased activity while 0 indicates that all respondents report decreased activity.”

The ISM PMI for manufacturing prices in the US rose from 81.5 in Jan to 82.0 in Feb in the 20^th month in which it has been trending up (http://ism.ws/ISMReport/MfgROB.cfm). The second highest sub-index in the PMI is new orders rising 0.2 from 67.8 in Jan to 68.0 in Feb. While in Nov 2010 48 percent of respondents reported higher prices, 49 percent no change in prices and 3 percent lower prices, in Feb 2011 an overwhelming 66 percent reported higher prices, 32 percent the same prices and 2 percent lower prices. The nonmanufacturing PMI of the ISM for the US rose 0.3 from 59.4 in Jan to 59.7 in Feb (http://ism.ws/ISMReport/NonMfgROB.cfm). The price index of the nonmanufacturing ISM report rose 1.2 from 72.1in Jan to 73.3 in Feb. While in Nov 2010 28 percent reported higher prices, 67 percent unchanged prices and 5 percent lower prices, in Feb 2011 46 percent reported higher prices, 50 percent unchanged prices and 4 percent lower prices. Inflation and not deflation is moving through the production chain in the US. The valuable summary of worldwide factory activity by the Wall Street Journal on the basis of PMI indexes by Markit and the ISM find expansion in all countries except one but cautions that inflation is everywhere in the world because of pressure of increasing costs of inputs (http://blogs.wsj.com/economics/2011/03/01/world-wide-factory-activity-by-country-14/). The Food and Agriculture Organization (FAO) world food price index has risen 34.1 percent in the 12 months ending in Feb 2011 with increases in meat of 19.7 percent, dairy 20.4 percent, cereals 54.9 percent, oils and fats 65.1 percent and sugar 15.8 percent (http://www.fao.org/worldfoodsituation/wfs-home/foodpricesindex/en/). The chart of four commodity price indexes by Bloomberg shows an unusually strong upward trend of all indexes since the moderation of the sovereign risk issues in Europe around the beginning of Jul 2010 (http://noir.bloomberg.com/markets/commodities/cfutures.html). The DJ-UBS Commodity index has increased 36.5 percent since a low on Jul 2, 2010 (see Table 10 below in the section on valuation of risk financial assets). According to market data from the Financial Times, Brent crude oil was last priced at $115.97/barrel and has increased by 46.8 percent in the past 52 weeks; the crude oil front month futures was priced in NYMEX at $104.91/barrel, increasing 30.1 percent in the past 52 weeks; COMEX gold 1 futures chain front month was last priced at $1430/ounce, increasing by 26.3 percent in the past 52 weeks; copper high grade front month futures was last priced at CMX at 447.30 cents, increasing by 33.1 percent in the past 52 weeks; and corn front month futures was priced at 721.25 cents at CBT, increasing 93.6 percent in the past 52 weeks (http://markets.ft.com/markets/commodities.asp).

The current economic environment could have risk of repeating the stagflation of the 1970s. Table 7 provides the rate of yearly growth of GDP, CPI inflation and UNE (rate of unemployment) from 1969 to 1982. Double digit inflation rates plagued the 1970s with the economy running in “stop and go” episodes. The Fed raised the fed funds rate with the effective rate reaching 22.36 percent on Jul 22 of 1981 (http://www.federalreserve.gov/releases/h15/data/Daily/H15_FF_O.txt). The rate of unemployment rose to 9.7 percent in 1982. Several countries that had borrowed for financing balance of payments deficits declared moratoriums on their foreign debts, impairing balance sheets of money-center banks. The increase in interest rates to deal with stagflation caught the banking industry with short-dated funding and long-term fixed-rate assets. In a parallel of what could happen when the Fed abandons its near zero interest rates, 1150 US commercial banks, around 8 percent of the industry, failed, almost twice the number of banks that failed from establishment of the FDIC in 1934 until 1983 (Benston and Kaufman 1997, 139; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7). More than 900 savings and loans associations, equivalent to around 25 percent of the industry, had to be closed, merged or placed in conservatorship (Ibid). Taxpayer funds in the value of $150 billion were used in the resolution of failed savings and loans institutions. In terms of relative dimensions, $150 billion was equivalent to 2.6 percent of GDP of $5800 billion in 1990 and 3.6 percent of GDP of $4217 billion in 1985 (http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=5&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=1980&LastYear=1990&3Place=N&Update=Update&JavaBox=no). The equivalent in terms of 2.6 to 3.6 percent of US GDP in 2010 of $14,657 billion would be $381 billion to $528 billion (data from Ibid). Wide swings in interest rates resulting from aggressive monetary policy can wreck the balance sheets of families, financial institutions and companies while posing another recession risk. While it is true that the Fed can increase interest rates instantaneously, the increase from zero percent toward much higher levels to contain inflation can have devastating effects on the world economy. The Financial Times/Harris Poll finds that few respondents in the major economies of Europe and the US are not concerned of being affected by inflation (http://www.ft.com/cms/s/0/0354c278-3d0d-11e0-bbff-00144feabdc0.html#axzz1Ead9yEL8). About 40 percent of respondents in the UK, US and Germany expect strong or very strong effects from inflation and 60 percent in Spain and France.

Table 7, US Annual Rate of Growth of GDP and CPI and Unemployment Rate 1969-1982

	∆% GDP	∆% CPI	UNE
1969	3.1	6.2
1970	0.2	5.6
1971	3.4	3.3
1972	5.3	3.4
1973	5.8	8.7
1974	-0.6	12.3
1975	-0.2	6.9
1976	5.4	4.9	7.7
1977	4.6	4.7	7.1
1978	5.6	9.0	6.1
1979	3.1	13.3	5.8
1980	-0.3	12.5	7.1
1981	2.5	8.9	7.6
1982	-1.9	3.8	9.7

Note: GDP: Gross Domestic Product; CPI: consumer price index; UNE: rate of unemployment

Source: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=2&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=2009&LastYear=2010&3Place=N&Update=Update&JavaBox=no

http://www.bls.gov/web/empsit/cpseea01.htm

III Monetary Policy. Chairman Bernanke (2011Mar1) presented the Fed’s semiannual report to Congress on Mar 1-2 2011. This report is analyzed below in terms of three issues of current interest on the relation of monetary policy to the economy, employment and price stability: first, growth and employment outlook; second, monetary policy and recovery; and third, pass-through of commodity prices to inflation. The individual subsections present also alternative arguments and relevant data.

First, growth and employment outlook. Bernanke finds that after six consecutive quarters of growth the economy has reached the level of real GDP before the crisis. However, “job growth remains relatively weak and the unemployment rate is still high” (Bernanke 2011Mar 1, 2). Growth is actually mediocre relative to other historical expansions after deep contractions (see http://cmpassocregulationblog.blogspot.com/2011/02/mediocre-growth-raw-materials-shock-and.html) and the employment report for Mar analyzed above confirms that employment creation is much weaker than in past expansions. GDP is projected by members of the Federal Open Market Committee (FOMC) at 3.5 to 4 percent in 2011. The US lost 8.75 million jobs in 2008-2009 and regained only slightly more than 1 million in 2010 (Ibid, 3). The FOMC projects that the rate of unemployment would be in the interval of 7.5 to 8 percent by the end of 2012. These estimates can be used with the analysis in Table 1 above to calculate the number of unemployed and underemployed by the beginning of 2013. The civilian noninstitutional population (POP) would be around 242.451 million in Jan 2013 if the same rate of population growth continued. Under the current labor force participation rate of 63.9 percent, the civilian labor force (LF) would be 154.926 million and the unemployed would be 11.619 million with the rate of 7.5 percent or 12.394 million under the rate of 8 percent. If the labor force participation rate were 66.2 percent, the labor force (LF PART 66.2%) would be 160.503 million. Unemployment would be 12.038 million under the rate of 7.5 percent and 12.8 million under the rate of 8 percent. It is more difficult to estimate the underemployed. Assuming underemployment to be roughly 57 percent of unemployment, as currently, underemployment would be 6 to 6.4 million, for total in job stress under (LF PART 66.2%) of 18 to 19.3 million people. The US would continue in an unusual social drama with major stress on its social and health safety nets.

Second, monetary policy and recovery. Bernanke (2011Mar1) argues that there are two types of monetary policy that contributed to recovery. (1) Conventional measures consist of lowering the policy rate of the Fed, which is the fed funds rate. Under some form of the expectations hypothesis, the lowering of the fed funds rate creates expectations of lowering future short-term interest rates such as from 6 months to a 1 year, from 1 year to 1 ½ years, and so on along the term structure of interest rates. Lower costs of borrowing for all terms induce higher consumption of durable goods and increasing investment, or aggregate demand. Higher levels of aggregate demand cause higher rates of growth and increasing hiring. (2) Unconventional measures are used when the nominal interest rate approaches the lower bound of zero. The fed has engaged in two rounds of quantitative easing or purchase of long-term securities of $1.7 trillion in Dec 2008 to Mar 2009 with reinvestment of interest and maturing securities into Treasury securities after Aug 2010 and another program of purchasing $600 billion of Treasury securities after Nov 3, 2010. Bernanke (2011Mar1, 6-7) attributes to these policies the stabilization of financial markets and higher growth after Mar 2009 and again after Aug 2010 following a pause created by the sovereign risk issues in Europe between Apr and Jul 2010. A variety of indicators in 2009 and after Aug 2010 allegedly support this view: “for example, since August, when we announced our policy of reinvesting principal payments on agency debt and agency MBS [mortgage-backed securities] and indicated that we were considering more securities purchases, equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed and inflation compensation as measured in the market for inflation-indexed securities has risen to historically more normal levels. All of these developments are what one would expect to see when monetary policy becomes more accommodative, whether through conventional or less conventional means” (Bernanke 2011Mar1, 6-7; see also Dudley 2011NYUS, 3).

The explanation of recovery by monetary policy assumes that monetary policy has nearly instantaneous effects on output and prices. Romer and Romer (2004) measure the lag in effects of monetary policy based on a sample of the intended funds rate. Tightening monetary policy begins to reduce industrial production after five months and is processed in about two years. Monetary policy tightening does not have an effect on prices in the first 22 months and is processed fully over 48 months (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 102-3). The remainder of this subsection considers an alternative interpretation of the actual effects of monetary policy together with some data. The issues are (1) duration trap of lowering yields; (2) causes of the financial crisis and global recession; (3) effects of monetary policy on valuation of risk financial assets; and (4) competitive devaluation of the dollar by monetary policy.

(1) Duration trap of lowering yields. Table 8, updated with every blog, provides in the second column the yield at the close of market of the 10-year Treasury on the date in the first column. The price in the third column is calculated with the coupon of 2.625 percent of the 10-year note current at the time of the second round of quantitative easing after Nov 3, 2010 and the final column “∆% 11/04/10” calculates the percentage change of the price on the date relative to that of 101.2573 at the close of market on Nov 4, 2010, one day after the decision on quantitative easing by the Fed on Nov 3, 2010. Prices with the new coupon of 3.63 percent in recent auctions (http://www.treasurydirect.gov/instit/annceresult/press/preanre/2011/2011.htm) are not comparable to prices in Table 8. The highest yield in the decade was 5.510 percent on May 1, 2001 that would result in a loss of principal of 22.9 percent relative to the price on Nov 4. The Fed has created a “duration trap” of bond prices. Duration is the percentage change in bond price resulting from a percentage change in yield or what economists call the yield elasticity of bond price. Duration is higher the lower the bond coupon and yield, all other things constant. This means that the price loss in a yield rise from low coupons and yields is much higher than with high coupons and yields. Intuitively, the higher coupon payments offset part of the price loss. Prices/yields of Treasury securities were affected by the combination of Fed purchases for its program of quantitative easing and also by the flight to dollar-denominated assets because of geopolitical risks in the Middle East. The yield of 3.494 percent at the close of market on Mar 4 would be equivalent to price of 92.7235 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price loss of 8.4 percent relative to the price on Nov 4, 2010, one day after the decision on the second program of quantitative easing. If inflation accelerates, yields of Treasury securities may rise sharply. Yields are not observed without special yield-lowering effects such as the flight into dollars caused by the events in the Middle East and continuing purchases of Treasury securities by the Fed. Important causes of the rise in yields shown in Table 8 are expectations of rising inflation and US government debt estimated to reach 75 percent in 2012 (http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html)

Table 8, Yield, Price and Percentage Change to November 4, 2010 of Ten-Year Treasury Note

Date	Yield	Price	∆% 11/04/10
05/01/01	5.510	78.0582	-22.9
06/10/03	3.112	95.8452	-5.3
06/12/07	5.297	79.4747	-21.5
12/19/08	2.213	104.4981	3.2
12/31/08	2.240	103.4295	2.1
03/19/09	2.605	100.1748	-1.1
06/09/09	3.862	89.8257	-11.3
10/07/09	3.182	95.2643	-5.9
11/27/09	3.197	95.1403	-6.0
12/31/09	3.835	90.0347	-11.1
02/09/10	3.646	91.5239	-9.6
03/04/10	3.605	91.8384	-9.3
04/05/10	3.986	88.8726	-12.2
08/31/10	2.473	101.3338	0.08
10/07/10	2.385	102.1224	0.8
10/28/10	2.658	99.7119	-1.5
11/04/10	2.481	101.2573	-
11/15/10	2.964	97.0867	-4.1
11/26/10	2.869	97.8932	-3.3
12/03/10	3.007	96.7241	-4.5
12/10/10	3.324	94.0982	-7.1
12/15/10	3.517	92.5427	-8.6
12/17/10	3.338	93.9842	-7.2
12/23/10	3.397	93.5051	-7.7
12/31/10	3.228	94.3923	-6.7
01/07/11	3.322	94.1146	-7.1
01/14/11	3.323	94.1064	-7.1
01/21/11	3.414	93.4687	-7.7
01/28/11	3.323	94.1064	-7.1
02/04/11	3.640	91.750	-9.4
02/11/11	3.643	91.5319	-9.6
02/18/11	3.582	92.0157	-9.1
02/25/11	3.414	93.3676	-7.8
03/04/11	3.494	92.7235	-8.4

Note: price is calculated for an artificial 10-year note paying semi-annual coupon and maturing in ten years using the actual yields traded on the dates and the coupon of 2.625% on 11/04/10

Source:

http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3020

(2) Causes of the financial crisis and global recession. The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

Table 9 shows the phenomenal impulse to valuations of risk financial assets originating in the initial shock of near zero interest rates in 2003-2004 with the fed funds rate at 1 percent, in fear of deflation that never materialized, and quantitative easing in the form of suspension of the auction of 30-year Treasury bonds to lower mortgage rates. The charts of risk financial assets show sharp rise in valuations leading to the financial crisis and then profound drops that are captured in Table 9 by percentage changes of peaks and troughs. World financial markets were dominated by Fed and housing policy in the US. Table 9 now has a row for the Chinese yuan (CNY) rate of exchange relative to the US dollar (USD). China pegged the exchange rate at a value that afforded significant competitive power in trade, at around 8.2798 CNY/USD, revalued it from 2005 to 2008 by 17.6 percent, pegged it again to the dollar to avoid loss of competitiveness during the global recession and then revalued it by 3.7 percent by Fri Mar 4, 2011. The first round of quantitative easing and near zero interest rates depreciated the dollar relative to the euro by 39.3 percent between 2003 and 2008, with revaluation of the dollar by 25.1 percent from 2008 to 2010 in the flight to dollar-denominated assets in fear of world financial risks and then devaluation of the dollar by 17.3 percent by Fri Mar 4, 2011. Between 2002 and 2008, the DJ UBS Commodity Index rose 165.5 percent largely because of the unconventional monetary policy of the Fed encouraging carry trade from low US interest rates to long leveraged positions in commodities and other risk financial assets.

Table 9, Volatility of Assets

DJIA	10/08/02-10/01/07	10/01/07-3/4/09	3/4/09- 4/6/10
∆%	87.8	-51.2	60.3
NYSE Financial	1/15/04- 6/13/07	6/13/07- 3/4/09	3/4/09- 4/16/07
∆%	42.3	-75.9	121.1
Shanghai Composite	6/10/05- 10/15/07	10/15/07- 10/30/08	10/30/08- 7/30/09
∆%	444.2	-70.8	85.3
STOXX EUROPE 50	3/10/03- 7/25/07	7/25/07- 3/9/09	3/9/09- 4/21/10
∆%	93.5	-57.9	64.3
UBS Com.	1/23/02- 7/1/08	7/1/08- 2/23/09	2/23/09- 1/6/10
∆%	165.5	-56.4	41.4
10-Year Treasury	6/10/03	6/12/07	12/31/08	4/5/10
%	3.112	5.297	2.247	3.986
USD/EUR	6/26/03	7/14/08	6/07/10	03/04 /11
Rate	1.1423	1.5914	1.192	1.3980
CNY/USD	01/03 2000	07/21 2005	7/15 2008	02/25 2011
Rate	8.2798	8.2765	6.8211	6.5670
New House	1963	1977	2005	2009
Sales 1000s	560	819	1283	375
New House	2000	2007	2009	2010
Median Price $1000	169	247	217	203
	2003	2005	2007	2010
CPI	1.9	3.4	4.1	1.5

Sources: http://online.wsj.com/mdc/page/marketsdata.html

http://www.census.gov/const/www/newressalesindex_excel.html

http://federalreserve.gov/releases/h10/Hist/dat00_eu.htm

ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm

http://markets.ft.com/ft/markets/currencies.asp

(3) Effects of monetary policy on valuation of risk financial assets. The trends of valuations of global risk financial assets are dominated by the carry trade from near zero interest rates in the US to take long positions in risk financial assets. Investors and financial professionals learned from losses or how to avoid them. The carry trade is now more opportunistic in quickly realizing profits to avoid losses during periods of risk aversion resulting from events such as the European risk issues, fears of the tradeoff of growth and inflation in Asia and slow growth with high unemployment and underemployment in the US together with expectations of increases in taxes and interest rates. When risk aversion is subdued, the combination of near zero interest rates of fed funds and quantitative easing creates again the dream of traders of “the trend is my friend” without as strong a belief in the Bernanke-put, or floor on risk financial asset valuations set by Fed monetary policy, as in earlier periods. Table 10 captures in the fourth column “∆% to Trough” the decline of risk financial assets resulting from the European sovereign risk issues after Apr and the sharp recovery in the last column “∆% Trough to 3/ 4/11” that was not interrupted by the second round of Ireland in late Nov. The final column “∆% Trough to 3/ 4/11” shows that after Jun there is repetition of the trend of high valuations of risk financial assets with the exception of the dollar that devalued by 17.3 percent. A major risk of world capital markets is in sustained increases in oil prices that could cause another downturn of risk financial assets similar to the one that occurred in the European sovereign risk event after Apr 2010. That risk could be significant as shown by the decline of valuations of risk financial assets in column “∆% to Trough” with high double-digit losses. The column “∆% Week 3/4/11” shows mixed recovery from the decline of stock market indexes by two percentage points or more in most cases in the prior week ending on Feb 25.

Table 10, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 3/ 4/11	∆% Week 3/ 4 /11	∆% Trough to 3/ 4/11
DJIA	4/26/ 10	7/2/10	-13.6	8.6	0.3	25.6
S&P 500	4/23/ 10	7/20/ 10	-16.0	8.5	0.1	29.2
NYSE Finance	4/15/ 10	7/2/10	-20.3	-1.9	-1.1	23.2
Dow Global	4/15/ 10	7/2/10	-18.4	5.4	0.3	29.2
Asia Pacific	4/15/ 10	7/2/10	-12.5	8.7	1.9	24.2
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-6.1	1.6	21.2
China Shang.	4/15/ 10	7/02 /10	-24.7	-7.0	2.2	23.4
STOXX 50	4/15/10	7/2/10	-15.3	-1.9	-1.2	15.9
DAX	4/26/ 10	5/25/ 10	-10.5	13.4	-0.1	26.6
Dollar Euro	11/25 2009	6/7 2010	21.2	7.6	1.7	-17.3
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	16.7	2.4	36.5
10-Year Tre.	4/5/ 10	4/6/10	3.986	3.494

T: trough; Dollar: positive sign appreciation relative to euro (less dollars paid per euro), negative sign depreciation relative to euro (more dollars paid per euro)

Source: http://online.wsj.com/mdc/page/marketsdata.html.

Table 11, updated with every post, provides the percentage changes of the DJIA and the S&P 500 since Apr 26, around the European sovereign risk issues, from current to previous selected dates and relative to Apr 26. Chairman Bernanke (2010WP) first argued on Nov 4, 2010 that quantitative easing was also designed to increase the valuations of stocks with the objective of creating a wealth effect that would motivate consumption. The problem is that the Fed does not control effects over multiple asset classes including riskier financial assets such as commodities and exchange rates. The decline of major US stock indexes in the week of Feb 25 without full recovery in the week ending on Mar 4 reduced the valuations of the DJIA and S&P 500 to single digit increases since the effects of the European sovereign risk event beginning around Apr 26.

Table 11, Percentage Changes of DJIA and S&P 500 in Selected Dates

2010	∆% DJIA from earlier date	∆% DJIA from Apr 26	∆% S&P 500 from earlier date	∆% S&P 500 from Apr 26
Apr 26
May 6	-6.1	-6.1	-6.9	-6.9
May 26	-5.2	-10.9	-5.4	-11.9
Jun 8	-1.2	-11.3	2.1	-12.4
Jul 2	-2.6	-13.6	-3.8	-15.7
Aug 9	10.5	-4.3	10.3	-7.0
Aug 31	-6.4	-10.6	-6.9	-13.4
Nov 5	14.2	2.1	16.8	1.0
Nov 30	-3.8	-3.8	-3.7	-2.6
Dec 17	4.4	2.5	5.3	2.6
Dec 23	0.7	3.3	1.0	3.7
Dec 31	0.03	3.3	0.07	3.8
Jan 7	0.8	4.2	1.1	4.9
Jan 14	0.9	5.2	1.7	6.7
Jan 21	0.7	5.9	-0.8	5.9
Jan 28	-0.4	5.5	-0.5	5.3
Feb 4	2.3	7.9	2.7	8.1
Feb 11	1.5	9.5	1.4	9.7
Feb 18	0.9	10.6	1.0	10.8
Feb 25	-2.1	8.3	-1.7	8.9
Mar 4	0.3	8.6	9.0	0.1

Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3004

(4) Competitive devaluation of the dollar by monetary policy. The issue of capital controls is actually an issue of exchange rate policy. Table 12, which is updated with every post, shows in the last three rows the Chinese yuan (CNY) to US dollar (USD) exchange rate or number of CNY required to buy one USD. China fixed the rate at around 8.2765 CNY/USD for a long period until Aug 2005. That rate afforded a competitive edge to Chinese products in world markets and in competition of internally-produced goods with foreign-produced imports. China then strengthened the yuan by 17.6 percent until Jul 2008 when it fixed it to the dollar in an effort to prevent the erosion of its competitiveness in world markets and at home to protect the economy from the global recession. China resumed the revaluation of the yuan in 2010, with revaluation by 3.7 percent by Mar 4, 2011. Table 12 shows the sharp appreciation relative to the dollar of most currencies in the world, which is far higher than the Fed’s objective of attaining by quantitative easing “a moderate change in the foreign exchange value of the dollar that provides support to net exports,” as revealed for the first time by Yellen (2011AS, 6). Bernanke (2002FD) states:

“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”

Many countries have complained that Fed “nonconventional policy” of near zero interest rates and quantitative easing is designed to cause, or at least results in, a competitive devaluation of the dollar that would export US unemployment to other countries.

Table 12, Exchange Rates

	Peak	Trough	∆% P/T	Mar 4 2011	∆% T Mar 4 2011	∆% P Mar 4 2011
EUR USD	7/15 2008	6/7 2010		3/4/ 2011
Rate	1.59	1.192		1.398
∆%			-33.4		14.7	-13.7
JPY USD	8/18 2008	9/15 2010		3/4 2011
Rate	110.19	83.07		82.27
∆%			24.6		0.1	25.3
CHF USD	11/21 2008	12/8 2009		3/4 2011
Rate	1.225	1.025		0.926
∆%			16.3		9.6	24.4
USD GBP	7/15 2008	1/2/ 2009		3/4 2011
Rate	2.006	1.388		1.627
∆%			-44.5		15.6	-23.3
USD AUD	7/15 2008	10/27 2008		3/4 2011
Rate	1.0215	1.6639		1.014
∆%			-62.9		40.7	3.5
ZAR USD	10/22 2008	8/15 2010		2/25 2011
Rate	11.578	7.238		6.87
∆%			37.5		5.1	40.7
SGD USD	3/3 2009	8/9 2010		2/25 2011
Rate	1.553	1.348		1.267
∆%			13.2		6.0	18.4
HKD USD	8/15 2008	12/14 2009		2/25 2011
Rate	7.813	7.752		7.786
∆%			0.8		-0.4	0.3
BRL USD	12/5 2008	4/30 2010		3/4 2011
Rate	2.43	1.737		1.656
∆%			28.5		4.7	31.9
CZK USD	2/13 2009	8/6 2010		3/4/ 2011
Rate	22.19	18.693		17.34
∆%			15.7		7.2	21.9
SEK USD	3/4 2009	8/9 2010		3/4 2011
Rate	9.313	7.108		6.343
∆%			23.7		10.8	31.9
CNY USD	7/20 2005	7/15 2008		3/4/ 2011
Rate	8.2765	6.8211		6.567
∆%			17.6		3.7	20.7

Symbols: USD: US dollar; EUR: euro; JPY: Japanese yen; CHF: Swiss franc; GBP: UK pound; AUD: Australian dollar; ZAR: South African rand; SGD: Singapore dollar; HKD: Hong Kong dollar; BRL: Brazil real; CZK: Czech koruna; SEK: Swedish krona; CNY: Chinese yuan; P: peak; T: trough

Note: percentages calculated with currencies expressed in units of domestic currency per dollar; negative sign means devaluation and no sign appreciation

Source: http://online.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000

http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm

http://markets.ft.com/ft/markets/currencies.asp

Third, pass-through of commodity prices to inflation. The Fed follows inflation by means of the price index of personal consumption expenditures (PCE) excluding food and energy that rose only 0.1 percent in Jan and 0.8 percent relative to a year earlier (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm). In Dec 2010, the PCE price index rose less than 0.1 percent and gained 0.7 percent relative to a year earlier. Fed policy would be required because “both headline and core inflation remain below levels consistent with our dual mandate objectives—which most members of the FOMC consider to be 2 percent or a bit less on the PCE measure” (Dudley 2011NYUS, 4). There are two critical issues considered by Dudley 2011NYUS, 2011NYUC). (1) There could be “speed limit” effects such that even with the unemployment rate above the non-inflation accelerating rate of unemployment (NAIRU) much higher prices and wages would be required to divert capital and labor to activities growing at high rates. Dudley (2011NYUS, 6) uses the example that “in the rebound from the comparably deep early 1980s recession, the annualized growth rate exceeded 7 percent for five consecutive quarters” while the economy is growing slowly in the current expansion. The discussion should center in similar events such as the 1980s instead of the fascination with the Great Depression that has little in common to current economic conditions. (2) Commodity prices have risen sharply in the past year, causing headline inflation higher than core inflation. Dudley (2011NYUS, 6) argues that core inflation has been more effective in predicting future headline inflation than commodity prices. In this view, commodity price increases may be temporary and reversed when production responds with higher commodity output. The amount of slack is higher in the US than in other economies. Commodities account for a lower proportion of consumption than in other countries such that “pass-trough” of commodity prices into core inflation indexes has not been high in the US during “several decades” (Ibid, 7).

These arguments do not explain the stagflation of the 1970s characterized by the legacy of deficits of war, large domestic projects, two sharp oil price increases, stop-and-go fiscal/monetary policies, lending for financing balance of payments deficits that ended with the debt crisis of 1983, the banking crisis of the 1980s and so on. The “virtuous circle” pursued by current monetary policy may well turn into a Volcker instead of a Roosevelt moment, with sharp increases in interest rates as in 1981. The last fear of deflation with fed funds rates of 1 percent was followed by CPI inflation rising from 1.9 percent in 2003 to 4.1 percent in 2007, as shown in the last row of Table 9, and the fed funds rate increasing from 1 percent in Jun 2004 to 5.25 percent in Jun 2006 (http://www.federalreserve.gov/monetarypolicy/openmarket.htm#2004). The increase of interest rates by 25 basis points in 17 consecutive meetings of the FOMC did not stop initially the financing of everything indexed to overnight interest rates until nonprime mortgages financed with adjustable rate mortgages defaulted. Monetary policy with intransigent deflationist view justifying exotic “unconventional” policy impulses can be as pernicious as with tolerance of high inflation.

In the period 1857-1906 of high growth and trade, British export prices declined at the rate of 0.5 percent per year while the world economy grew rapidly (Imlah 1958, Pelaez, 1976a). In 1860-1900, Brazil’s inflation was 1.6 percent per year likely because of sustained fiscal profligacy (Pelaez and Suzigan 1978, 143; see Pelaez 1974, 1975, 1976b, 1977, 1979; Pelaez and Suzigan 1978, 1981). High inflation also coexisted with abundant slack in the economy in the second half of the 1980s (Pelaez 1986, 1987). We know much less about inflation than simple analysis that inflation only occurs and accelerates when the economy is moving to full capacity utilization.

The line “reserve bank credit” in the Fed balance sheet on Mar 2 was $2528 billion, or $2.5 trillion, with portfolio of long-term securities of $2303 billion, or $2.3 trillion, composed of holdings of nominal Treasury notes and bonds of $1157 billion, inflation-indexed notes and bonds of $54 billion, federal agency debt securities of $143 billion and $949 billion of mortgage-backed securities; and reserves balances with Federal Reserve banks of $1296 billion, or $1.3 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The Fed continues to insist that it can exit monetary policy with several instruments such as increasing interest paid on excess reserves deposited at the Fed and open market operations broadened to various types of securities. There may not be a smooth exit from zero fed funds rate, high-duration bonds and $2.3 trillion portfolio of long-term securities, raising the possibility of another Volcker moment in the form of sharp rise in interest rates that may flatten the expansion path of the economy. There is no such thing as a science or art of monetary policy that permits the Fed to maintain inflation in a neighborhood of a point of 2 percent inflation while promoting economic growth. Aggressive monetary policy may have again the adverse unwinding effects on financial market stability and the global economy as the experiment with deflationist view in 2003-2004.

There are warnings both from Europe and within the Fed about the perils of current US monetary policy. The president of the European Central Bank (ECB), Jean-Claude Trichet, is quoted by Bloomberg as concerned with secondary effects of commodity prices on inflation and the pledge to act firmly at the right moment (http://noir.bloomberg.com/apps/news?pid=20601087&sid=auUD1rgy5E.c&pos=3). The euro gained 0.9 percent after this statement, the highest gain since Nov (Ibid, http://professional.wsj.com/article/SB10001424052748703300904576178050889801460.html?mod=WSJPRO_hpp_sections_markets). The president of the ECB used the phrase “strong vigilance,” which was used by the ECB in 2005-2007 when it increased interest rates in the next meeting (http://www.ft.com/cms/s/0/457bec8e-4588-11e0-bc94-00144feab49a.html#axzz1FFUcDuuA). The ECB faces a difficult choice in returning to normal monetary policy with inflation rising above the 2 percent target to 2.4 percent and the need for faster growth in the countries with sovereign risk issues in order to recover lost government revenue (http://www.ft.com/cms/s/0/8435c4fa-45c3-11e0-acd8-00144feab49a.html#axzz1FFUcDuuA). The President of the Federal Reserve Bank of Richmond, Jeffrey Lacker, believes inflation may be trending up (http://blogs.wsj.com/economics/2011/03/03/qa-feds-lacker-sees-inflation-trending-up/). The President of the Federal Reserve Bank of Kansas City, Thomas Hoenig, finds that monetary policy plays a role in the surge of commodity prices (http://blogs.wsj.com/economics/2011/03/02/feds-hoenig-policy-plays-role-in-commodity-price-surge/).

IV Economic Indicators. The Fed Beige Book finds that “reports from the twelve Federal Reserve Districts indicated that overall economic activity continued to expand at a modest to moderate pace in January and early February” (http://www.federalreserve.gov/fomc/beigebook/2011/20110302/fullreport20110302.pdf i). Personal income rose 1.0 percent in Jan relative to Dec and disposable personal income (DPI) rose 0.7 percent in Jan but 0.4 percent in inflation-adjusted terms; personal consumption expenditures rose 0.2 percent in Jan and declined 0.1 percent in real terms (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm). The Bureau of Economic Analysis (BEA) finds that the change of DPI in Jan was influenced by two factors: (1) the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 increased DPI in Jan by reducing employees’ rates of contribution to Social Security; and (2) DPI was reduced by the expiration of the Making Work pay provisions of the American Recovery and Reinvestment Act of 2009 (ARRA), which increased personal current taxes. Excluding these factors, DPI rose 0.1 percent in Jan after increasing 0.4 percent in Dec (Ibid). The purchasing managers’ index (PMI) of the Institute for Supply Management (ISM) rose 0.6 to 61.4 in Feb from 60.8 in Jan, which was the highest reading since May 2004. The employment index rose above 60 percent for only the third time in a decade; growth of exports drives new orders and production that sustain the PMI (http://ism.ws/ISMReport/MfgROB.cfm). Continuing growth in the nonmanufacturing sector is found by the ISM nonmanufacturing index that rose 0.3 in Feb to 59.7 relative to 59.4 in Jan (http://ism.ws/ISMReport/NonMfgROB.cfm). Construction spending fell by 0.7 percent in Jan 2011 relative to Dec 2010 and 5.9 percent relative to Jan 2010 (http://www.census.gov/const/C30/release.pdf). New orders for manufacturing industries rose 9.6 percent in Jan 2011 relative to Jan 2010, 11.7 percent excluding transportation and 10.8 percent excluding defense (http://www.census.gov/manufacturing/m3/prel/pdf/s-i-o.pdf). The pending home sales index of the National Association of Realtors (NAR) fell 2.8 percent in Jan relative to Dec and is 1.5 percent below the level in Jan 2010 (http://www.realtor.org/press_room/news_releases/2011/02/phs_mod). Initial claims for unemployment insurance, seasonally adjusted, fell 20,000 in the week ending on Feb 26 to 368,000 relative to 388,999 a week earlier; the decline in initial claims without seasonal adjustment was 30,029 to 351,076 relative to 471,256 a year earlier (http://www.dol.gov/opa/media/press/eta/ui/current.htm). US crude oil inventories were slightly lower at 346.4 million barrels in the week ending on Feb 25 relative to 346,7 in the week ending on Feb 18 (http://www.eia.doe.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCESTUS1&f=W).

V Interest Rates. Yields of Treasury securities are not observed without the influence of the flight to safety because of geopolitical events in the Middle East and continuing purchases of long-term securities by the Fed. The 10-year Treasury note traded at yield of 3.49 percent on Fr Mar 4, which was higher than 3.43 percent a week earlier but lower than 3.64 percent a month earlier. The 30-year Treasury bond traded at yield of 4.60 percent, higher than 4.51 percent a week earlier but was lower than 4.73 percent a month earlier (http://markets.ft.com/markets/bonds.asp?ftauth=1299369385245). The 10-year government bond of Germany traded at 3.27 percent for negative spread relative to the comparable Treasury of 23 basis points. The US Treasury paying coupon of 3.63 percent and maturing in 02/21 traded at yield of 3.49 percent for equivalent price of 101.09, which is not comparable to the price of 92.7235 in the last line of Table 8, which is for coupon of 2.625 percent for a security maturing in exactly 10 years used for comparisons with prices relative to Nov 4, 2010 a day after the decision of additional quantitative easing of $600 billion.

VI Conclusion. There is continuing stress of the social and health safety net from the plight of 25 to 30 million people unemployed or underemployed and an unemployment rate that could be as high as 12.7 percent if labor force participation were at levels before the global recession. Stagflation as in the 1970s with the adverse repercussions of the 1980s is more relevant than the deflationist conventional view justifying intransigent unconventional policy impulses as if the monetary authorities were engaged in laboratory experiments. The return to normal interest rates is not as painless as claimed. The growth path of the economy may be dampened, perpetuating the social stress of unemployment and underemployment, by tax increases to adjust four consecutive years of deficits exceeding one trillion dollar that bring the national debt to 75 percent of GDP by 2012 and interest rate increases starting from zero interest rates burdened by the weight of $2.3 trillion of long-term securities in the Fed’s portfolio together with the risk of stagflation. (Go to http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10 http://cmpassocregulationblog.blogspot.com/ http://sites.google.com/site/economicregulation/carlos-m-pelaez)

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