Global Inflation, Seigniorage, Financial Turbulence and Valuations of Risk Financial Assets
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011
Executive Summary
I Global Inflation
II Seigniorage
IIA New economics and Great Inflation
IIB Seigniorage
IIC Government Finance and Base Money
III Financial Turbulence
IV Valuations of risk Financial Assets
V Economic Indicators
VI Conclusion
References
Executive Summary
Recent financial turbulence has appeared in corrections of valuations of risk financial assets, more sharply of commodity prices than of stocks. The appreciation of the dollar while the Swiss franc and the yen continue to be strong and the low yields of Treasury securities and German government securities suggest a flight to quality away from risk. Risk aversion originates in various factors that have been causing financial turbulence: (1) sovereign risk doubts in the euro area; (2) slower growth in China because of the tough tradeoff of inflation and growth; (3) accelerating inflation in the midst of fiscal/monetary accommodation inherited from the recession; (4) geopolitical events in the Middle East and subsequently the earthquake/tsunami in Japan; (5) mediocre growth, job stress, wage stagnation and fiscal/monetary imbalance in the US; and (6) increasingly the rise of inflation everywhere in the world that injects uncertainty in financial and economic decisions, or allocation disruptive effect, and redistributions of income and wealth, or income/wealth redistributive effect. The strongest impact of risk aversion occurred in Apr to Jul 2010 because of the sovereign doubts in Europe, recurring less strongly in Nov 2010 and again in Mar 2011.
Inflation has been rising throughout the production chain, worldwide trade, two-digit nominal percentage changes of nominal values and virtually everywhere. Monetary policy continues to be managed as if inflation were transitory with mean reversion of commodity prices that could even threaten deflation again. The central bank issues monetary liabilities or base money, which is composed of currency in circulation and reserves of depository institutions at the central bank. Governments need financing, which can occur through the Treasury or general government and also through the issue of base money. The use of base money for financing government is known as seigniorage. Section II explores the literature on the Great Inflation of the 1970 and on seigniorage to analyze base money management. Seigniorage currently is quite complex with financing via the traditional issue of money but also by low interest rates on the internal and foreign debt as well as capital gains.
I Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table 1, updated with every post, provides the latest yearly data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly-indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of the sovereign risk issues (http://www.ft.com/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1G67TzFqs). CPI inflation stabilized in China at 5.3 percent in the 12 months ending in Apr relative to 5.4 percent in the 12 months ending in Mar. Food prices in China soared by 11.7 percent in Mar after 11.0 percent in Feb, 10.3 percent in Jan and 9.6 percent in Dec (http://www.ft.com/cms/s/0/69aa5fcc-670d-11e0-8d88-00144feab49a.html#axzz1J7CmnPhC). Food prices rose 11.5 percent in China in the 12 months ending in Apr relative to 11 percent in the first quarter of 2011 relative to 2010 as analyzed by Jamil Anderlini in the Financial Times (China inflation edges lower to 5.3% http://www.ft.com/cms/s/0/09a22246-7b75-11e0-ae56-00144feabdc0.html#axzz1LqpStZfj
). New loans in local currency rose CNY (Chinese yuan) 740 billion (http://noir.bloomberg.com/apps/news?pid=20601087&sid=aolyrQHuzo4o&pos=4). The People’s Bank of China increased reserve requirements by 50 basis points to 21 percent for the largest lenders in the fifth increase this year and may use other measures of inflation control (http://noir.bloomberg.com/apps/news?pid=20601087&sid=aCS.hGGzvNMU&pos=2). Inflation in the euro zone accelerated to 2.8 percent in Mar relative to 2.4 percent in Feb (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-15042011-BP/EN/2-15042011-BP-EN.PDF). PPI inflation accelerated in Japan to 2.0 percent with new numbers being released on May 16. EUROSTAT provides a flash estimate of 2.8 percent inflation in the Monetary Union (euro area) Index of Consumer prices for Apr (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-29042011-BP/EN/2-29042011-BP-EN.PDF) and 0.7 percent in Apr for the PPI with 12-month rate of increase of 6.7 percent (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-03052011-CP/EN/4-03052011-CP-EN.PDF). The euro area unemployment rate is estimated at 9.9 percent (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/3-29042011-AP/EN/3-29042011-AP-EN.PDF). Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration. The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. There are six key interrelated vulnerabilities in the world economy that have been causing global financial turbulence: (1) sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings (see section IV in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html); (2) the tradeoff of growth and inflation in China; (3) slow growth (see http://cmpassocregulationblog.blogspot.com/2011/05/mediocre-growth-world-inflation.html http://cmpassocregulationblog.blogspot.com/2011_03_01_archive.html http://cmpassocregulationblog.blogspot.com/2011/02/mediocre-growth-raw-materials-shock-and.html), weak hiring (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html and section III Hiring Collapse in http://cmpassocregulationblog.blogspot.com/2011/04/fed-commodities-price-shocks-global.html ) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (http://cmpassocregulationblog.blogspot.com/2011/05/job-stress-of-24-to-30-million-falling.html http://cmpassocregulationblog.blogspot.com/2011/04/twenty-four-to-thirty-million-in-job_03.html http://cmpassocregulationblog.blogspot.com/2011/03/unemployment-and-undermployment.html); (4) the timing, dose, impact and instruments of normalizing monetary and fiscal policies (see http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies; (5) the earthquake and tsunami affecting Japan that is having repercussions throughout the world economy because of Japan’s share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) the geopolitical events in the Middle East.
Table 1, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 2.9 | 3.2 | 6.8 | 8.8 |
| Japan | 2.5 | 0.0 | 2.0 | 4.6 |
| China | 9.7 | 5.3 | 6.8 | |
| UK | 1.8 | 4.0* | 5.3* output | 8.0 |
| Euro Zone | 2.5 | 2.8 | 6.7 | 9.9 |
| Germany | 4.8 | 2.4 | 6.1 | 6.3 |
| France | 2.2 | 2.2 | 6.7 | 9.6 |
| Nether-lands | 3.2 | 2.0 | 10.8 | 4.2 |
| Finland | 5.2 | 3.5 | 8.8 | 8.2 |
| Belgium | 3.0 | 3.5 | 10.2 | 7.7 |
| Portugal | -0.7 | 3.9 | 6.9 | 11.1 |
| Ireland | -1.0 | 1.2 | 5.4 | 14.9 |
| Italy | 1.0 | 2.6 | 6.1 | 8.4 |
| Greece | -4.8 | 4.3 | 8.1 | 15.1 |
| Spain | 0.8 | 3.5 | 7.8 | 21.3 |
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
*Office for National Statistics
PPI http://www.statistics.gov.uk/pdfdir/ppi0511.pdf
CPI http://www.statistics.gov.uk/pdfdir/cpi0411.pdf
** Excluding food, beverage, tobacco and petroleum
http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/4-04042011-AP/EN/4-04042011-AP-EN.PDF
Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html
Headline consumer price index (CPI) inflation was 3.2 percent in the 12 months ending in Apr compared with 2.8 percent in Mar. Table 2 provides CPI percentage changes for the 12 months ending in Apr in column “∆% 12 months Apr 2011/Apr 2010 NSA” and what inflation would be in 12 months if it were repeated during the year in column “∆% Annual Equivalent Jan-Apr SA.” The 12 months inflation provides information on what the trend has been over a year while the extrapolation of Jan-Apr inflation provides an annual equivalent for the first four months of the year. Headline CPI inflation, or inflation of all items in the CPI, was at an annual equivalent of 5.5 percent in the first fourth months of 2011. Excluding food and energy, CPI inflation was 1.3 percent in 12 months and 2.1 percent annual equivalent. There is inflation in all major items of the CPI in Table 2 with the exception of apparel that rose only 0.1 percent in 12 months and is equivalent to decline of 0.6 percent on the basis of the first four months of the year. Apparel is only 3.6 percent of expenditures in the calculation of the CPI. The other minor increase in Table 2 is for shelter, which rose 1.0 percent in 12 months and 1.8 percent in annual equivalent. The highest increases are in food, 3.2 percent 12 months and 7.1 percent annual, and energy, 19.0 percent 12 months and 39.3 percent annual equivalent.
Table 2, Consumer Price Index Percentage Change 12 Months Apr 2011/Apr 2010 and Annual Equivalent Change Jan-Apr 2011, %
| ∆% 12 Months Apr 2011/Apr 2010 NSA | ∆% Annual Equivalent Jan-Apr SA | |
| CPI All Items | 3.2 | 5.5 |
| CPI ex Food and Energy | 1.3 | 2.1 |
| Food | 3.2 | 7.1 |
| Food at Home | 3.9 | 9.7 |
| Food Away from Home | 2.1 | 3.0 |
| Energy | 19.0 | 39.3 |
| Gasoline | 33.1 | 65.2 |
| Fuel Oil | 35.1 | 89.9 |
| New Vehicles | 2.4 | 7.1 |
| Used Cars and Trucks | 3.3 | 5.5 |
| Medical Care Commodities | 3.1 | 6.8 |
| Services Less Energy Services | 1.6 | 1.8 |
| Apparel | 0.1 | -0.6 |
| Shelter | 1.0 | 1.2 |
| Transportation Services | 3.6 | 5.5 |
| Medical Care Services | 2.8 | 2.1 |
Source: http://www.bls.gov/news.release/cpi.nr0.htm
The relative importance or weights of the CPI are shown in Table 3. Food and transportation account for 32.1 percent of consumer expenditures and housing for 41.460 percent such that food, transportation and housing account for 73.56 percent of consumer expenditures. Housing is still in recession conditions and a significant part, 24.9 percent, consists of “owners’ equivalent rent,” which is a calculation of what the owner would pay she/he would rent their own house. The major categories are shown in relief. Motor fuel has risen sharply, 35.1 percent in 12 months and 89.9 percent in first four month annual equivalent, but accounts for only 5.079 percent of CPI expenditures.
Table 3, Relative Importance, 2007-2008 Weights, of Components in the Consumer Price Index, US City Average, Dec 2010
| All Items | 100.000 |
| Food and Beverages | 14.792 |
| Food | 13.742 |
| Food at home | 7.816 |
| Food away from home | 5.926 |
| Housing | 41.460 |
| Shelter | 31.955 |
| Rent of primary residence | 5.925 |
| Owners’ equivalent rent | 24.905 |
| Apparel | 3.601 |
| Transportation | 17.308 |
| Private Transportation | 16.082 |
| New vehicles | 3.513 |
| Used cars and trucks | 2.055 |
| Motor fuel | 5.079 |
| Gasoline | 4.865 |
| Medical Care | 6.627 |
| Medical care commodities | 1.633 |
| Medical care services | 4.994 |
| Recreation | 6.293 |
| Education and Communication | 6.421 |
| Other Goods and Services | 3.497 |
Source: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiri2010.txt
The 12-month rates of increase of PCE price indexes are shown in Table 4. Headline 12-month PCE inflation (PCE) has accelerated from slightly over 1 percent in the latter part of 2010 to 1.8 percent in Mar. The Fed uses PCE inflation excluding food and energy (PCEX) on the basis of research showing that current PCEX is a better indicator of headline PCE a year ahead than current headline PCE inflation. The explanation is that commodity price shocks are “mean reverting,” returning to their long-term means after spiking during shortages caused by climatic factors, geopolitical events and the like. Inflation of PCE goods (PCEG) has accelerated sharply, in spite of 12-month declining inflation of PCE durable goods (PCEG-D) while PCE services inflation (PCES) has remained around 1.2 to 1.3 percent. The last two columns of Table 4 show PCE food inflation (PCEF) and PCE energy inflation (PCEE) that have been rising sharply, especially for energy. The Fed expects these increases to revert with its indicator PCEX returning to levels that are acceptable for continuing monetary accommodation.
Table 4, Percentage Change in 12 Months of Prices of Personal Consumption Expenditures
| PCE | PCEG | PCEG -D | PCES | PCEX | PCEF | PCEE | |
| 2011 | |||||||
| Mar | 1.8 | 3.0 | -1.6 | 1.3 | 0.9 | 2.9 | 15.3 |
| Feb | 1.6 | 2.1 | -1.4 | 1.3 | 0.9 | 2.4 | 11.1 |
| Jan | 1.2 | 1.2 | -1.9 | 1.2 | 0.8 | 1.7 | 6.7 |
| 2010 | |||||||
| Dec | 1.1 | 1.0 | -2.2 | 1.2 | 0.7 | 1.2 | 7.4 |
| Nov | 1.0 | 0.6 | -2.0 | 1.3 | 0.8 | 1.3 | 4.0 |
| Oct | 1.2 | 0.8 | -1.8 | 1.4 | 0.9 | 1.3 | 6.3 |
| Sep | 1.3 | 0.5 | -1.4 | 1.7 | 1.1 | 1.3 | 4.2 |
| Aug | 1.4 | 0.6 | -1.0 | 1.7 | 1.2 | 0.7 | 4.0 |
Notes: percentage changes in price index relative to the same month a year earlier of PCE: personal consumption expenditures; PCEG: PCE goods; PCEG-D: PCE durable goods; PCEX: PCE excluding food and energy; PCEF: PCE food; PCEE: PCE energy goods and services
Source: http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi0311.pdf
The role of devil’s advocate is played by data in Table 5. Headline PCE inflation (PCE) has jumped to 1.1 percent cumulative in IQ2011, which is equivalent to 4.5 percent annual, with PCEG jumping to 2.4 percent cumulative and 10.0 annual equivalent, PCEG-D rising 0.3 percent cumulative or 1.2 percent annual, and PCES, PCEX and PCEF all rising to 0.5 percent or 2.0 percent annual. PCEE has risen to 9.8 percent cumulative or 45.3 percent annual equivalent.
Table 5, Monthly and Quarterly PCE Inflation and Annual Equivalent IQ11 and IVQ10 %
| PCE | PCEG | PCEG -D | PCES | PCEX | PCEF | PCEE | |
| 2011 | |||||||
| IQ11 | 1.1 | 2.4 | 0.3 | 0.5 | 0.5 | 0.5 | 9.8 |
| IQ11 A | 4.5 | 10.0 | 1.2 | 2.0 | 2.0 | 2.0 | 45.3 |
| Mar | 0.4 | 0.8 | 0.0 | 0.2 | 0.1 | 0.1 | 3.7 |
| Feb | 0.4 | 0.8 | 0.2 | 0.2 | 0.2 | 0.2 | 3.5 |
| Jan | 0.3 | 0.8 | 0.1 | 0.1 | 0.2 | 0.2 | 2.3 |
| IVQ10 | 0.6 | 1.0 | -0.9 | 0.3 | 0.1 | 0.1 | 7.0 |
| IVQ10 A | 2.4 | 4.1 | -3.5 | 1.2 | 0.4 | 0.4 | 31.1 |
| Dec | 0.3 | 0.6 | -0.3 | 0.1 | 0.0 | 0.0 | 4.1 |
| Nov | 0.1 | 0.0 | -0.3 | 0.1 | 0.1 | 0.1 | 0.1 |
| Oct | 0.2 | 0.4 | -0.2 | 0.1 | 0.0 | 0.0 | 2.7 |
Notes: percentage changes in a month relative to the same month for the same symbols as in Table. 1Q11: cumulative for Jan-Mar 2011; 1Q11 A: 1Q11 annual equivalent rate; 4Q10: cumulative for Oct-Dec 2010; 4Q10: annual equivalent rate
Source: http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi0311.pdf
The headline producer price index (PPI) rose 6.8 percent in the 12 months ending in Apr and 13.0 percent in annual equivalent for the first four months, as shown in Table 6. Excluding food and energy, PPI inflation was 2.1 percent in the 12 months ending in Apr and 3.9 percent in annual equivalent. Headline PPI is driven by the high increases in intermediate and crude goods, in double digits in 12 months rates and in annual equivalent.
Table 6, Producer Price Index Percentage Change 12 Months Apr 2011/Apr 2010 and Annual Equivalent Change Jan-Apr 2011, %
| ∆% 12 Months Apr 2011/Apr 2010 NSA | ∆% Annual Equivalent Jan-Apr SA | |
| Finished Goods | 6.8 | 13.0 |
| Finished Goods Except Food and Energy | 2.1 | 3.9 |
| Intermediate Goods | 9.4 | 19.9 |
| Crude Goods | 23.7 | 32.7 |
Source: http://www.bls.gov/web/ppi/ppi_dr.pdf
Nominal values jump sharply during acceleration of inflation, disguising much lower increases in physical volumes. This illusion is showing in short-term indicators that are increasing by high percentages, as shown in tables 7 to 11. Table 7 shows first quarter IQ2010 and IQ2011 nominal dollar values of merchant wholesalers. The economy grew at 1.8 percent in real seasonally-adjusted annual equivalent quarterly rate in IQ2011 but nominal merchant wholesalers quarterly sales rose 15.4 percent relative to IQ2010, 13.9 percent for durable goods and 16.4 percent for nondurable goods. A significant part of this nominal growth was simply inflation.
Table 7, First Quarter Sales of Merchant Wholesalers Except Manufacturers’ Sales Branches and Offices, Billions of Dollars and %
| IQ2010 $ B | IQ2011 $ B | ∆% | |
| US Total | 964 | 1112 | 15.4 |
| Durable | 429 | 489 | 13.9 |
| Not Durable | 535 | 623 | 16.4 |
Inflation is also showing in nominal dollar values of international trade. Table 8 provides Jan-Mar 2010 and Jan-Mar 2011 exports and imports in nominal dollar values and their percentage changes. Exports rose by 18.5 percent and imports by 20.0 percent. The only decline is for US exports of crude oil, which are $301 million and have share of only 0.08 percent in total exports of $354,734 million and the decline was caused by lower exported volume. All categories expanded by double digits percentages.
Table 8, First Quarter Exports and Imports of Goods, Not Seasonally Adjusted Millions of Dollars and %
| Jan-Mar 2011 $ B | Jan-Mar 2010 $ B | ∆% | |
| Exports | 354,734 | 299,404 | 18.5 |
| Manu- factured | 229,316 | 204,914 | 11.9 |
| Agricultural Commodities | 37,558 | 28,828 | 30.3 |
| Mineral Fuels | 27,360 | 16,747 | 63.4 |
| Crude Oil | 301 | 461 | -34.7 |
| Imports | 519,907 | 433,087 | 20.0 |
| Manu- factured | 372,479 | 315,623 | 18.0 |
| Agricultural Commodities | 24,173 | 20,103 | 20.2 |
| Mineral Fuels | 102,910 | 84,192 | 22.2 |
| Crude Oil | 75,191 | 60.046 | 25.2 |
Source: http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf
Inflation of prices of exports and imports in the 12 months ending in April and in annual equivalent for the first four months is shown in Table 9. There are major percentage changes in most categories with three exceptions: (1) consumer goods, which would affect the CPI, rose by only 0.6 percent in 12 months but by 2.7 percent in annual equivalent; (2) capital goods rose 1.0 percent in 12 months and only 1.2 percent in annual equivalent; and (3) autos increased 1.8 percent in 12 months but 3.3 percent in annual equivalent. There is inflation in prices of traded goods worldwide.
Table 9, Prices of Exports and Imports 12 Months Apr and Annual Equivalent First Four Months 2011, %
| 12 Month ∆%Apr 2011 | Annual ∆%Equivalent 4 Month 2011 | |
| Imports | 11.1 | 26.8 |
| Fuel | 34.8 | 106.1 |
| Nonfuel | 4.3 | 7.8 |
| Capital Goods | 1.0 | 1.2 |
| Autos | 1.8 | 3.3 |
| Consumer Goods | 0.6 | 2.7 |
| Durables Manufactured | -0.7 | 3.9 |
| Non-Manufactured Consumer Goods | 7.4 | 17.8 |
| Exports | 9.6 | 17.1 |
| Agricultural | 35.3 | 36.3 |
| Non-Agricultural | 6.9 | 14.0 |
Source: http://www.bls.gov/news.release/ximpim.nr0.htm
Inflation is also in nominal retail sales, as shown in Table 10. Total retail and food services rose 8.1 percent in the 12 months ending in Apr and retail sales rose 8.4 percent.
Table 10, Sales for Retail and Food Services 12-month Percentage Changes Not Adjusted for Seasonality and Price Changes, %
| 12 Months ∆% Apr 2011 | |
| Retail/food services total | 8.1 |
| Total excluding motor vehicles and parts | 6.7 |
| Retail | 8.4 |
| Motor vehicle & parts dealers | 14.6 |
| Gasoline stations | 16.9 |
| Clothing and accessories | 5.4 |
| Food services and drinking | 5.2 |
Source: http://www.census.gov/retail/marts/www/marts_current.pdf
There are also two-digit percentage changes in nominal sales values of business as shown in Table 11. Total business sales rose 11.8 percent in the 12 months ending in Apr. Manufacturers sales rose 11.4 percent and merchant wholesalers sales 15.4 percent with retail sales increasing only 8.2 percent. Retailers may be experiencing a profit squeeze.
Table 11, Twelve Month Percentage Changes for Sales of Manufacturers, Retailers and Merchant Wholesalers Unadjusted for Seasonality and Price Changes, %
| 12 Months ∆% Apr 2011 | |
| Total Business | 11.8 |
| Manufacturers | 11.4 |
| Retailers | 8.2 |
| Merchant Wholesalers | 15.4 |
Source: http://www.census.gov/mtis/www/data/pdf/mtis_current.pdf
DeLong (1997, 247-8) shows that the 1970s were the only peacetime period of inflation in the US without parallel in the prior century. The price level in the US drifted upward since 1896 with jumps resulting from the two world wars: “on this scale, the inflation of the 1970s was as large an increase in the price level relative to drift as either of this century’s major wars” (DeLong, 1997, 248). Monetary policy focused on accommodating higher inflation, with emphasis solely on the mandate of promoting employment, has been blamed as deliberate or because of model error or imperfect measurement for creating the Great Inflation (http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). As DeLong (1997) shows, the Great Inflation began in the mid 1960s, well before the oil shocks of the 1970s (see also the comment to DeLong 1997 by Taylor 1997, 276-7). A counterfactual of the 1970s immediately rises out of Table 12, which consists of simulating current monetary and fiscal policies in doses much more aggressive than in the 1960s and 1970s proposed as a true rose garden without thorns (http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html). What would have been the Great Inflation and Unemployment if the Federal Reserve would have lowered interest rates to zero in 1961, in fear of deflation because of 0.7 percent CPI inflation, and purchased the equivalent of 30 percent of the Treasury debt in long-term securities, subsequently engaging in quantitative easing II in 1964 after CPI inflation of 1.0 percent? The counterfactual would not be complete without including the unknown path of the US debt, tax and interest rate increases to exit from unsustainable debt and the largest monetary accommodation in US history. In one of his multiple important contributions to the Great Inflation, Meltzer (2005) distinguishes between one-time price jumps, such as by oil shocks, and a “maintained” inflation rate. Meltzer (2005) uses a dummy variable to extract the one-time oil price changes, resulting in a maintained inflation rate that was never higher than 8 to 10 percent in the 1970s. There is revealing analysis of the Great Inflation and its reversal by Meltzer (2005, 2010a, 2010b).
Table 12, US Annual Rate of Growth of GDP and CPI and Unemployment Rate 1960-1982
| ∆% GDP | ∆% CPI | UNE | |
| 1960 | 2.5 | 1.4 | 6.6 |
| 1961 | 2.3 | 0.7 | 6.0 |
| 1962 | 6.1 | 1.3 | 5.5 |
| 1963 | 4.4 | 1.6 | 5.5 |
| 1964 | 5.8 | 1.0 | 5.0 |
| 1965 | 6.4 | 1.9 | 4.0 |
| 1966 | 6.5 | 3.5 | 3.8 |
| 1967 | 2.5 | 3.0 | 3.8 |
| 1968 | 4.8 | 4.7 | 3.4 |
| 1969 | 3.1 | 6.2 | 3.5 |
| 1970 | 0.2 | 5.6 | 6.1 |
| 1971 | 3.4 | 3.3 | 6.0 |
| 1972 | 5.3 | 3.4 | 5.2 |
| 1973 | 5.8 | 8.7 | 4.9 |
| 1974 | -0.6 | 12.3 | 7.2 |
| 1975 | -0.2 | 6.9 | 8.2 |
| 1976 | 5.4 | 4.9 | 7.8 |
| 1977 | 4.6 | 6.7 | 6.4 |
| 1978 | 5.6 | 9.0 | 6.0 |
| 1979 | 3.1 | 13.3 | 6.0 |
| 1980 | -0.3 | 12.5 | 7.2 |
| 1981 | 2.5 | 8.9 | 8.5 |
| 1982 | -1.9 | 3.8 | 10.8 |
| 1983 | 4.5 | 3.8 | 8.3 |
| 1984 | 7.2 | 3.9 | 7.3 |
| 1985 | 4.1 | 3.8 | 7.0 |
| 1986 | 3.5 | 1.1 | 6.6 |
| 1987 | 3.2 | 4.4 | 5.7 |
| 1988 | 4.1 | 4.4 | 5,3 |
| 1989 | 3.6 | 4.6 | 5.4 |
| 1990 | 1.9 | 6.1 | 6.3 |
Note: GDP: Gross Domestic Product; CPI: consumer price index; UNE: rate of unemployment; CPI and UNE are at year end instead of average to obtain a complete series
Source: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
http://www.bls.gov/web/empsit/cpseea01.htm
http://data.bls.gov/pdq/SurveyOutputServlet
There is a false impression that there is a monetary policy “science,” measurements and forecasting to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table 13 when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table 13 shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without Fed tightening because of the long lag in effect of monetary policy on inflation. The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability. A glance at Table 13 shows CPI inflation of 0.7 percent in 1961, creating a counterfactual of what would have been the Great Inflation if the Fed had set the policy rate at zero and purchased a third of the outstanding Treasury debt. The symmetric inflation target of “a little less than 2 percent,” or an infinitesimal neighborhood of 2, is an inadequate analogy with the Great Depression that may bring the economy closer to the relevant historical event of the Great Inflation of the 1970s that ended with the rate hike that reached 22.36 percent for fed funds on Jul 22, 1981 and the erroneous pursuit of nonexistent inflation that caused the Great Bond Crash of 1994.
Table 13, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994
| 1994 | FF | 30Y | 30P | 10Y | 10P | MOR | CPI |
| Jan | 3.00 | 6.29 | 100 | 5.75 | 100 | 7.06 | 2.52 |
| Feb | 3.25 | 6.49 | 97.37 | 5.97 | 98.36 | 7.15 | 2.51 |
| Mar | 3.50 | 6.91 | 92.19 | 6.48 | 94.69 | 7.68 | 2.51 |
| Apr | 3.75 | 7.27 | 88.10 | 6.97 | 91.32 | 8.32 | 2.36 |
| May | 4.25 | 7.41 | 86.59 | 7.18 | 88.93 | 8.60 | 2.29 |
| Jun | 4.25 | 7.40 | 86.69 | 7.10 | 90.45 | 8.40 | 2.49 |
| Jul | 4.25 | 7.58 | 84.81 | 7.30 | 89.14 | 8.61 | 2.77 |
| Aug | 4.75 | 7.49 | 85.74 | 7.24 | 89.53 | 8.51 | 2.69 |
| Sep | 4.75 | 7.71 | 83.49 | 7.46 | 88.10 | 8.64 | 2.96 |
| Oct | 4.75 | 7.94 | 81.23 | 7.74 | 86.33 | 8.93 | 2.61 |
| Nov | 5.50 | 8.08 | 79.90 | 7.96 | 84.96 | 9.17 | 2.67 |
| Dec | 6.00 | 7.87 | 81.91 | 7.81 | 85.89 | 9.20 | 2.67 |
Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months
Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t
Table 14, updated with every blog comment, provides in the second column the yield at the close of market of the 10-year Treasury note 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 14. 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 and subsequently by the tragic earthquake and tsunami in Japan. The yield of 3.173 percent at the close of market on May 13, 2011, would be equivalent to price of 95.3387 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price loss of 5.8 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, continuing purchases of Treasury securities by the Fed, the tragic earthquake and tsunami affecting Japan and recurring fears on European sovereign credit issues. Important causes of the rise in yields shown in Table 14 are expectations of rising inflation and US government debt estimated to exceed 70 percent of GDP in 2012 (http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html), rising from 40.8 percent of GDP in 2008 and 53.2 percent in 2009 (Table 2 in http://cmpassocregulationblog.blogspot.com/2011/04/budget-quagmire-fed-commodities_10.html). On May 11, 2001, the line “Reserve Bank credit” in the Fed balance sheet stood at $2728 billion, or $2.7 trillion, with portfolio of long-term securities of $2492 billion, or $2.5 trillion, consisting of $1381 Treasury nominal notes and bonds, $59 billion of notes and bonds inflation-indexed, $125 billion Federal agency debt securities and $927 billion mortgage-backed securities; reserve balances deposited with Federal Reserve Banks reached $1544 billion or $1.5 trillion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). There is no simple exit of this trap created by the highest monetary policy accommodation in US history together with the highest deficits and debt in percent of GDP since World War II. The yield of the 10-year Treasury note fluctuated during the week from 3.15 percent on Mon May 9 to 3.173 percent on Fri May13 while the yield of the 10-year German government bond fell from 3.10 percent on Mon May 9 to 3.08 percent on Fri May 13 (http://noir.bloomberg.com/markets/rates/germany.html). Risk aversion from various sources, discussed in the following section III, has been affecting financial markets for several weeks. The risk is that in a reversal of risk aversion that has been typical in this cyclical expansion of the economy yields of Treasury securities may back up sharply.
Table 14, 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 |
| 03/11/11 | 3.401 | 93.4727 | -7.7 |
| 03/18/11 | 3.273 | 94.5115 | -6.7 |
| 03/25/11 | 3.435 | 93.1935 | -7.9 |
| 04/01/11 | 3.445 | 93.1129 | -8.0 |
| 04/08/11 | 3.576 | 92.0635 | -9.1 |
| 04/15/11 | 3.411 | 93.3874 | -7.8 |
| 04/22/11 | 3.402 | 93.4646 | -7.7 |
| 04/29/11 | 3.290 | 94.3759 | -6.8 |
| 05/06/11 | 3.147 | 95.5542 | -5.6 |
| 05/13/11 | 3.173 | 95.3387 | -5.8 |
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
II Seigniorage. The financing of the government by printing money, known as seigniorage, is considered in three subsections. Section (IA) New Economics and the Great Inflation builds the background of an episode similar to current policy and conditions of the period in the 1960s and 1970s when the US experienced the highest peacetime inflation in history together with high rates of unemployment. Section (IB) Seigniorage provides a sample of the analysis of how issue of base money by the central bank can finance the government. Section (IC) Government Finance and Base money provides analysis of the current relation between financing the government and issuing money in a new, complex seigniorage.
IIA The New Economics and the Great Inflation. The “new economics,” or in the words of James Tobin (1980, 27), the “neoclassical synthesis,” dominated policy thought in the 1960s and 1970s, as vigorously exposed by Heller (1966), Okun (1970) and Tobin (1972), all of whom served in the Council of Economic Advisers (CEA). According to Heller (1975, 16), the major event breaking with the past was the 1964 tax cut. The target of policy shifted to attaining the economy’s “full employment potential,” following canonical Keynesian economics, while rejecting analysis of structural unemployment. Heller (1975, 17) reflected on the policy approach of Heller (1966):
“On one hand, the high employment, limited-recession economy forged with our macroeconomic policy tools is indeed an inflation-prone economy—the formula for successful management of high-pressure prosperity is far more elusive than the formula for getting there. Yet on the other hand, success bred great expectations on the part of the public that economics could deliver prosperity without inflation and with ever-growing material gains in the bargain. The message got through that we had ‘harnessed the existing economics…to the purposes of prosperity, stability and growth,’ and that as to the role of the tax cut in breaking old molds of thinking, ‘nothing succeeds like success’(Heller [1966])”.
There is an even more detailed account of the gap management by fiscal/monetary policies away from cyclical adjustment to growth promotion (Burns 1969QFE, 279):
“The central doctrine of this school is that the stage of the business cycle has little relevance to sound economic policy; that policy should be growth-oriented instead of cycle-oriented; that the vital matter is whether a gap exists between actual and potential output; that fiscal deficits and monetary tools need to be used to promote expansion when a gap exists; and that the stimuli should be sufficient to close the gap—provided significant inflationary pressures are not whipped up in the process.”
The “consensus macroeconomic framework, vintage 1970” used by “managers of aggregate demand” in stabilization policies is interpreted by Tobin (1980, 23-5) in terms of five broad components. (1) The key role in determining the rate of inflation is played by the nonagricultural business sector in which prices consist of marked-up labor costs. The standard model is the “augmented Phillips curve.” (2) The only way in which aggregate monetary demand, or nominal income, affects prices, output, wages and employment is through tightness in labor and product markets. Combinations of fiscal and monetary policies that result in the same change in aggregate demand have the same impact on inflation and real economic activity. (3) Okun’s law or empirical finding is that (Okun 1962):
“In the postwar period, on the average, each extra percentage point in the unemployment rate above four percent has been associated with about a three percent decrement in real GNP”
The statement is careful in expressing the empirical result on the basis of the structure estimated with data with 55 quarters from IIQ1947 to IVQ1960, resulting in the estimated relation (Okun 1962):
Y = 0.30 – 0.30X (1)
Where Y is the quarterly change in the unemployment rate expressed in percentage points and X is the quarterly percentage change of real GNP. If GNP is unchanged from one quarter to the next, X =0, trend increases in productivity and growth of the labor force result in an increase of the rate of unemployment by 0.3 percentage points. Unemployment is 0.3 point lower for each increment of one percent of GNP (0.30 x X = 0.3 x 1). An increase of one percentage point in unemployment is equivalent to decrease of GNP by 3.3 percent (1/0.3). (4) Tighter markets of products and labor at high employment rates result in acceleration of inflation above those incorporated in inflation expectations and historical trends. Slack in product and labor market causes deceleration of inflation but at a slower rate. The utilization of resources and market tightness at the natural rate of unemployment of Friedman (1968) and Phelps (1968) does not cause upward or downward pressure of wages and prices relative to expected paths. The consensus accepted a nonaccelerating inflation rate of unemployment (NAIRU) but with divergence on whether it coincided with equilibrium or optimum employment. (5) There was no widespread consensus on the instruments of demand management.
Tobin (1980, 19) explained more accurately (see also Tobin 1980AA and Lucas 1981):
“Higher inflation, higher unemployment-the relentless combination frustrated policymakers, forecasters, and theorists throughout the decade. The disarray in diagnosing stagflation and prescribing a cure makes any appraisal of the theory and practice of macroeconomic stabilization as of 1980 a foolhardy venture.”
There are three interpretations of the role of monetary policy in causing the Great Inflation and Unemployment: (1) inflation surprise, (2) inadvertent policy mistake; and (3) imperfect information (for ample discussion see http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). (1) The analysis by Kydland and Prescott (1977, 447-80, equation 5) uses the “expectation augmented” Phillips curve with the natural rate of unemployment of Friedman (1968) and Phelps (1968), which in the notation of Barro and Gordon (1983, 592, equation 1) is:
Ut = Unt – α(πt – πe) α > 0 (2)
Where Ut is the rate of unemployment at current time t, Unt is the natural rate of unemployment, πt is the current rate of inflation and πe is the expected rate of inflation by economic agents based on current information. Equation (2) expresses unemployment net of the natural rate of unemployment as a decreasing function of the gap between actual and expected rates of inflation. Equation (2) is used by Barro and Gordon (1983) in showing the temptation of the policymaker to create “inflation surprises” by pursuing an inflation rate that is higher than that expected by economic agents that lowers the difference between the actual and natural unemployment rate by the term – α(πt – πe). (2) The baseline monetary policy rule considered by Clarida, Galí and Gertler (CGG) is a simple linear equation:
r*t = r* + β(inflation gap) + γ(output gap) (3)
Where r*t is the Fed’s target rate for the fed funds rate in period t, r* is the desired nominal rate corresponding to both inflation and output being at their target levels (CGG 2000, 150), (inflation gap) is the deviation of actual inflation from target inflation and (output gap) is the percentage difference between actual GDP and its target. The rule is forward looking because the two gaps are relative to future desired levels. A second monetary rule is on the implied relation for the real rate of interest target:
rr*t = rr* + (β -1)(inflation gap) + γ(output gap) (4)
Where rr*t is the ex ante real rate target and rr* = r* - π* is the long-run equilibrium real rate. Equation (4) shows that the response of policy to the inflation gap depends on whether β is greater or less than one and the response to the output gap on whether γ is positive or negative. The data reveal that the Fed reacted weakly to expectations of inflation by allowing declines in real rates of interest or raising nominal interest but not by enough to increase real interest rates. That is, policy neglected control of the inflation gap and focused instead on the output gap. (3) Orphanides (2003, 2004) emphasizes the erroneous measurement of potential output, and a consequence of the output gap in equation (4), which misled the regulators in pursuing an “activist” policy of trying to prevent the output gap from increasing when it was decreasing. The policy to prevent the erroneously measured output gap from increasing was lowering interest rates but the actual gap was actually tightening and inflation control required higher interest rates.
IIB Seigniorage. The historical definition of seigniorage is the “difference between the face value of a coin and its costs of production and mintage” (Buiter 2007, 2). In an economy of fiat money, seigniorage is virtually the face value of the currency note because of zero marginal costs of printing. The state has monopolized the printing of fiat money because of its highly profitable financing of government expenditures. Flandreau (2006) with analysis by Bordo (2006) provide revealing historical perspectives on the debate on seigniorage or central bank targets, including that between David Ricardo and Henry Thornton (1802), on one side proposing bullionist rules, and the directors of the Bank of England, on the other side proposing a pure fiduciary standard with the Bank of England enjoying both monopoly of issue and commercial banking functions. Bordo (2006, 12) provides a vivid dimension of seigniorage by the Bank of England (BOE): “the Bank’s contribution to the war effort was significant: seigniorage was 17 percent of the fiscal deficit in 1810.” Thus, the historical opposition was that the BOE could become an inflationary agent of the government (Flandreau 2006, 18):
“The stock of the Bank of England rose sharply at the same time as its monetary issues expanded. There were, as a result, concerns that the suspension of convertibility had put a private concern in the position to collect revenue from paper issues and thus induced an inflationary bias in the system.”
These are analyses of the BOE in its historical period without implications for its current organization and conduct of monetary policy (for current BOE practice see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a): 85-87, Pelaez and Pelaez, Regulation of Banks and Finance (2009b): 99-112, Globalization and the State, Vol. I (2009a): 41-3, Government Intervention in Globalization (2009c): 36-7).
There are three concepts related to seigniorage considered by Buiter (2006). First, the term seigniorage is used by Flandreau (2006) and Bordo (2006) as the first difference of base money:
S1,t = ∆Bt = Bt – Bt-1 (5)
Where S1,t is seigniorage, the index 1 is for the first Buiter (2007) concept or seigniorage, ∆ the operator of first difference, B is base money or the monetary liabilities of the government (currency in circulation plus reserves of depository institutions at the central bank), and t time. Buiter (2007, 5) also defines seigniorage relative to as share of GDP:
s1,t = ∆Bt/PtYt (6)
Where s1,t is seigniorage as share of GDP, Pt is price level in period t and Yt is real income in period t.
Second, central bank revenue (Flandreau 2006, 22, equation 9; Buiter 2007, 5) consists of obtaining revenue by investing in interest-yielding assets the resources derived from past issue of base money:
S2,t = itrfBt-1 (7)
Where S2,t is central bank seigniorage revenue, so to speak, itrf is the risk-free interest rate of investing from t-1 to t, and Bt-1 is the issue of base money in t-1. Buiter (2007, 5) also defined central bank revenue as share of GDP:
s2,t = itrfBt-1/ PtYt (7’)
Third, Buiter (2007, 5) also considers the inflation tax of issuing base money. Let πt be inflation between t and t-1 defined by:
πt = [(Pt/Pt-1) -1] (8)
The inflation tax is defined by (Buiter 2007, 5; Bailey 102, equation 2; Friedman 1971; Flandreau 2006, 21-4):
S3,t = πtMt-1 (9)
The corresponding definition of the inflation tax as share of GDP is:
s3,t = πtMt-1/ PtYt (9’)
There are two types of traditional costs of inflation: (1) redistribution of income from those receiving fixed-interest payments, such as fixed-dollar pension annuities, and other multiple fixed income assets or flows; and (2) distortion of economic activity by masking changes in relative prices and preventing adequate capital budgeting. Bailey (1956, 93-4) finds “a welfare cost of open inflation, which, in effect, is a tax on the holding of cash balances, a cost which is fully analogous to the welfare cost (or ‘excess burden’) of an excise tax on a commodity or productive service.” Hotelling (1938) analyzes this tax in terms of a welfare loss of consumer and producer surpluses in the movement along an upward sloping demand curve, which is part of the approach of applied welfare economics (see Pelaez and Pelaez, Globalization and the State, Vol. I (2008a): 119-25). Bailey (1956, 94-5) assumes perfect foresight or expectations, unanimous adjustment to the same expectation and only cash as means of payments such that there are no redistributive and resource misallocation effects. Liquidity preference or money demand is assumed in the form of a function of real cash balances depending on a rate of interest. In the initial equilibrium at full employment, there is a rate of interest that is consistent with a level of real cash balances that is associated with stable prices. If there is inflation, the rate of interest increases from i0 to i1 and real cash balances decline from (M/P)0 to (M/P)1 along the downward sloping liquidity preference curve. The welfare loss of consumer surplus is the Hotelling-Harberger curvilinear triangle under the demand curve between i1 – i0 and (M/P)1 - (M/P)0 (i1 > i0 and (M/P)0 > (M/P)1), or “the aggregate loss of productivity (utility) resulting from the destruction of real cash balances” caused by inflation.
The yield of a tax is equal to the tax rate times the base of the tax. Inflation resulting from issuing fiat money is considered as a tax imposed on cash balances. Assume the government has monopoly of money issuance and that money does not yield interest (Friedman 1971, 846; see Friedman 1942, Bailey 1956, Cagan 1956):
“In this case, the real yield from the tax in equilibrium, when holders of cash are fully adjusted to the inflation, is typically taken to be equal to the rate of price rise times the real stock of money, which product in turn is taken as equal to the real value of the new money issued. The rate of price rise is the rate on the tax. The real stock of money is the base of the tax. By strict analogy with an excise tax on a commodity, the yield is the product of the two.”
A monopolist produces on an inelastic segment of the demand curve and would maximize profits by stopping at the point of exactly unitary elasticity because further increases in price would be proportionately lower than decreases in quantity demanded. For the government issuing cash balances, increases in inflation would be proportionately lower than decreases in cash balances or the increase in the inflation tax rate would be lower than the reduction in the base or real cash balances held by the public. Friedman (1971) qualifies the argument of unit elasticity of demand at the point of optimum inflation tax as applying only in a steady state where income and prices are not growing. Assume that g stands for the proportionate rate of growth of the subscript variable, such as gP = d(ln P)/dt = (1/P)(dP/dt) = percentage rate of change of the price level, and gm the percentage rate of growth of the real quantity of money per capita, gy the percentage rate of growth of real per capita income, Md = NP∙f(y, gP) the aggregate money demand function assuming homogeneity of first degree in population and prices, Friedman (1971, 849, equation 5) obtains the revenue from the inflation tax, R, in the stationary state of gN = gP = 0, as:
R(gN = gy = 0) = (M/P)∙gP (10)
This is equivalent to equation (9). The maximization of (10) with respect to gP in the stationary state of gN = gP = 0 results in the first order condition of unit inflation elasticity of demand for real cash balances per capita. The results are altered by the introduction of growth because government revenue increases by two sources: (1) tax on existing cash balances by the rate of inflation; and (2) increase in demand for additional real cash balances because of income growth. Revenue maximization would be obtained by a lower gP. An interesting case is obtained by using the money demand function of Cagan (1956), mD = l(y)exp(-bgP), where b is a slope parameter of the money demand function, and gM for maximum R is 1/b (Friedman 1971, 850).
Neumann (1992) defines seigniorage in three similar forms. First, there is the real opportunity cost of seniorage, S0, of the foregone risk-free interest rate, irf:
S0 = irfBt-1/Pt (11)
Second, monetary seigniorage, SM, is defined by Neumann (1992) as the change in base money adjusted by the price level:
SM = ∆Bt/Pt-1 (12)
Third, extended monetary seigniorage, SME, provides for the additional seniorage from the interest, iD, on the stock of internal debt, Dt, the interest, if, on the stock of foreign debt, Ft, and unrealized capital gains or losses, Gt (Neumann 1992):
SME = (∆Bt + iD Dt + if Ft + Gt)/ Pt (13)
The approach of Buiter (2007) is to analyze seigniorage in the steady state and in real time, deriving the relation between the present discounted value of seigniorage and the present discounted value of central bank revenue. The government period and intertemporal budget constraints are considered for the general government (central, state and local) and the central bank, which is important in cases of central bank operational autonomy. A number of issues are elucidated and the analysis is extended to the case of monetary policy in the face of a liquidity trap.
There may be a conflict between the optimum quantity of money (or ideal path of expansion of the money over the long run) and the optimum accumulation of capital, as argued by Tobin (1986). If the return of holding real money balances equals the returns of alternative stores of value, the costs of resources or utility of individuals in economizing holdings of real money balances can be eliminated. Tobin (1986, 10) argues that negative growth of nominal money to saturate economic agents with holdings of real money balances as in Friedman (1969) may conflict with optimal capital accumulation. Accumulating wealth in holdings of money would crowd out accumulating wealth in the form of capital, or the contrary, suggesting conflicts between the two optimum wealth and money accumulation rules. Tobin (1965) argues that long-term inflation can make money relatively less attractive than capital investment, thus diverting savings toward investment in capital and wealth to building the capital stock. Tobin (1986) intends to explain the real costs of maintaining money scarce. Tobin (1986, 11) finds:
“Public expenditures must be financed. Explicit taxation is one way. Printing money is another way. Selling promises to pay money in the future, whether raised by taxation, printing money, or still further borrowing, is a third way. Printing money exacts an implicit tax, the reduction in the purchasing power of money and promises to pay future money. The ability of the government to finance expenditures by issuing money is the ‘seignoriage’ associated with its sovereign monetary policy.”
Tobin (1986, 11) argues that the problem is the search for a second-best optimum in the choice of taxes to meet the “necessity of government expenditure” such that “this formulation connects the money-supply process to the government budget.”
The theory of optimal seigniorage of Mankiw (1987) consists of analysis of optimum monetary and fiscal policy of a government satisfying a present value budget constraint. Government finance consists of (1) a tax on output and (2) seigniorage from printing money, both of which cause deadweight losses. The government minimizes the present value of welfare losses from the taxes by choices of the two instruments. There are three marginal conditions: (1) equality of marginal social cost of taxation currently and in the future; (2) equality of marginal social cost of inflation today and in the future; and (3) equality currently of marginal social cost of deriving revenue from direct taxes and the marginal social cost of using seigniorage. The theory of optimal seigniorage of Mankiw (1987, 340) finds two sets of policy depending on the orientation of government: (1) “smaller government, lower taxes and less inflation” and (2) “larger government, higher taxes and more inflationist monetary policy.” Time series data for the US from 1952 to 1985 find these two combinations.
IIC Government Finance and Base Money.
Table 15 provides data on the fiscal situation of the euro area, European Union, various member countries of the euro area, UK and US both the Federal government and the general government, which is the typical convention internationally and used by Standard & Poor’s (2011Apr18 for US rating analysis) and in seigniorage analysis such as by Buiter (2007). Most countries need consolidation to reduce their budget deficits and growing debts. The adjustment is harder for countries growing more slowly or even negatively because of the difficulty in increasing revenues that depend on income growth. Government outlays are tied to mandatory programs, creating difficult choices in consolidation strategies. Sovereign risk issues may return to plague financial markets. Higher world inflation can raise borrowing costs at a time of budget and debt pressures.
Table 15, Government Outlays, Revenue, Deficit and Debt As Percent of GDP 2010 %
| Gvt Outlays | Gvt Revenue | Govt Balance | Govt Debt | |
| Euro Area | 50.4 | 44.4 | -6.0 | 85.1 |
| European Union | 50.3 | 44.0 | -6.4 | 80.0 |
| Germany | 46.6 | 43.3 | -3.3 | 83.2 |
| France | 56.2 | 49.2 | -7.0 | 81.7 |
| Nether- lands | 51.2 | 45.9 | -5.4 | 62.7 |
| Finland | 55.1 | 52.3 | -2.5 | 48.4 |
| Belgium | 53.1 | 48.9 | -4.1 | 96.8 |
| Portugal | 50.7 | 41.5 | -9.1 | 93.0 |
| Ireland | 67.0 | 34.6 | -32.4 | 96.2 |
| Italy | 50.5 | 46.0 | -4.6 | 119.0 |
| Greece | 49.5 | 39.1 | -10.5 | 142.8 |
| Spain | 45.0 | 35.7 | -9.2 | 60.1 |
| UK | 50.9 | 40.6 | -10.4 | 80.0 |
| US Federal Govt 2010 | 23.8 | 14.9 | -8.9 | 62.1 |
| US Federal Govt 2012 | 23.3 | 16.3 | -7.0 | 73.9 |
| US 2010 General Govt (IMF) | 43.5 | 30.8 | -10.6 | 64.8 |
| US 2011 General Govt 2011 (IMF) | 41.2 | 30.5 | -10.8 | 72.4 |
Note: Govt: government
Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-26042011-AP/EN/2-26042011-AP-EN.PDF
http://www.cbo.gov/ftpdocs/120xx/doc12085/03-10-ReducingTheDeficit.pdf
http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx
The textbook definition of the stock of money is M1 = currency held by the public plus demand deposits, or M1 = C + D, where C is currency held by the public and D demand deposits. Table 16 provides the estimates of the money stock of the US by the Fed. Currency in circulation or held by the public, C, increased in 2007-2010 by a cumulative 20.4 percent, which is higher than 14.6 percent in 2003-2007. Demand deposits, D, increased at a faster pace of 51.4 percent in 2007-2010 than the decline of 5.3 percent in 2003-2007. The M1 money stock has increased by 34.1 percent in 2007-2010, which is significantly higher than 4.6 percent in 2003-2007. The higher rate of growth of money is not of concern to monetary authorities because of necessarily loser monetary policy during a global recession.
Table 16, Currency Held by the Public (C), Demand and Checkable Deposits (D) and M1 Money Stock (Dollar Billions Not Seasonally Adjusted)
| C | ∆% | D | ∆% | M1 | ∆% | |
| 12-2003 | 666.7 | 657.7 | 1332 | |||
| 12-2004 | 702.4 | 5.4 | 691.2 | 5.1 | 1401 | 5.2 |
| 12-2005 | 728.9 | 3.8 | 660.3 | -4.5 | 1396 | -0.4 |
| 12-2006 | 754.6 | 3.5 | 625.2 | -5.3 | 1387 | -0.6 |
| 12-2007 | 763.8 | 1.2 | 623.1 | -0.3 | 1393 | 0.4 |
| 12-2008 | 818.7 | 7.2 | 806.5 | 29.4 | 1631 | 17.1 |
| 12-2009 | 865.4 | 5.7 | 853.3 | 5.8 | 1724 | 5.7 |
| 12-2010 | 920.3 | 6.3 | 943.1 | 10.5 | 1868 | 8.4 |
| 04-2011 | 951.9 | 3.4 | 961.9 | 1.9 | 1918 | 2.7 |
Note: M1 also contains other minor items such as traveler’s checks and other checkable deposits, which is the reason why M1 is not exactly equal to C + D in this table.
Source:
http://www.federalreserve.gov/releases/h6/hist/h6hist4.pdf
http://www.federalreserve.gov/releases/h6/hist/h6hist1.pdf
The process of money creation by the central bank is by increasing base money, B, which can have a multiplier effect on the money stock, M1. In the complete model of Tobin (1969, 27), monetary policy occurs by central bank changes in “high-powered money,” or base money, B, which is considered exogenous, or determined by the central bank, while M1 is endogenous, or determined by actions of the public. Tobin (1980, 26) finds agreement and disagreement with the two phases of monetarism (see Tobin 1980AA, 1981, Lucas 1981, DeLong 2000):
“Keynesians and proponents of Monetarism-1 could disagree about the determinants of money demand but agree, at least qualitatively, on the structure that in the short run converts demand into output and prices. In fact Milton Friedman’s candidate for what he called the ‘missing equation’ of short-run macroeconomics served the same function as the short-run Phillips curve of the Keynesians. Monetarism-2, the new classical economics, denies that systematic management of demand can alter the paths of real economic variables.”
The textbook definition of base money is that B consists of currency held by the public, C, plus reserves of banks deposited at the Fed, R, or B = C + R. In the framework of Friedman and Schwartz (1963, 1970) and Cagan (1965), the change over time of the money stock is given by equation (14):
dlnM/dt = (dlnB/dt) + [M/B(1-(R/D)](d-C/M/dt)
+[M/B(1-(C/M)](d-R/D/dt) (14)
Where M is M1, R/D is the reserve/deposit ratio, C/M the currency ratio, t time and ln the natural logarithm. The formula in (14) can be used in approximations as:
m = b + c + r + e (15)
Where the lower-case letters are the contributions to the growth of M1, m, by: growth of base money, b, the currency ratio, c, the reserve/deposit ratio, r, and an approximation error, e. The formula permits decomposition of the rate of growth of M1 in contributions by the central bank, b, and by the public, c and r. The issue of money by the central bank is not “printing money,” or printing more $100 bills but rather injection of bank reserves in commercial banks by open market operations to set a target for the fed funds rate, which is the rate of overnight lending among banks of reserves deposited at the Fed. The model of Brunner and Meltzer (1976), for example, has credit and money multipliers that are dependent on various variables but the simpler model is all that is required for current purposes.
Total reserves of depository institutions at the Fed, R, and base money, B, are provided in Table 17. Total reserves of banks fell by 4.4 percent between 2003 and 2007, but grew from $43 billion in Dec 2007 to $820 billion in Dec 2008, by a multiple of 19 times or almost one trillion dollars. Reserves grew by an additional 38.9 percent in 2009, fell 5.3 percent in 2010 and increased an additional 41.7 percent through Apr 2011 in the second round of quantitative easing beginning in Nov 2010. Reserves in Apr 2011 are higher by 35.5 times relative to Dec 2007. Base money, B, grew by 10.2 percent in 2003-2007, but 142.9 percent in 2007-2010 and by an additional 23.8 percent in the first four months of 2011. Schwartz (2009) complains that the Fed appears to work only with two amounts, zero, as in the interest rate of the fed funds set at 0 to ¼ percent, and trillions of dollars, as the increase of the Fed balance sheet, at $2.7 trillion on May 11 (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1), from much lower levels, such as $902 billion on Jul 25, 2007 (http://www.federalreserve.gov/releases/h41/hist/h41hist1.pdf).
Table 17, Total Reserves of Depository Institutions (R) and Base Money (B) (Dollar Billions Not Seasonally Adjusted)
| R | ∆% | B | ∆% | |
| D-2003 | 42 | 752 | ||
| D-2004 | 46 | 9.5 | 765 | 1.7 |
| D-2005 | 45 | -2.2 | 793 | 3.7 |
| D-2006 | 43 | -4.4 | 818 | 3.2 |
| D-2007 | 43 | 0 | 829 | 1.3 |
| D-2008 | 820 | 1806.9 | 1659 | 100.1 |
| D-2009 | 1139 | 38.9 | 2022 | 21.9 |
| D-2010 | 1078 | -5.3 | 2014 | -0.4 |
| Apr 2011 | 1528 | 41.7 | 2494 | 23.8 |
Source: http://www.federalreserve.gov/releases/h3/hist/h3hist1.pdf
Table 18 provides average yearly rates of growth of two definitions of the money stock, M1, and M2 that adds also interest-paying deposits. The data were part of a research project on the monetary history of Brazil using the NBER framework of Friedman and Schwartz (1963, 1970) and Cagan (1965) as well as the institutional framework of Rondo E. Cameron (1967, 1972) who inspired the research (Pelaez 1974, 1975, 1976a,b, 1977, 1979, Pelaez and Suzigan 1978, 1981). The data were also used to test the correct specification of money and income following Sims (1972; see also Williams et al. 1976) as well as another test of orthogonality of money demand and supply using covariance analysis. The average yearly rates of inflation are high for almost any period in 1861-1970, even when prices were declining at 1 percent in 19th century England, and accelerated to 27.1 percent in 1945-1970. There may be concern of an uncontrolled fiscal deficit monetized by sharp increases in base money. The Fed may have desired to control inflation at 2 percent after lowering the fed funds rate to 1 percent in 2003 but inflation rose to 4.1 percent in 2007. There is not “one hundred percent” confidence in controlling inflation because of the lags in effects of monetary policy impulses and the equally important lags in realization of the need for action and taking of action and also the inability to forecast any economic variable (Friedman 1953). Romer and Romer (2004) find that a one percentage point tightening of monetary policy is associated with a 4.3 percent decline in industrial production. There is no change in inflation in the first 22 months after monetary policy tightening when it begins to decline steadily, with decrease by 6 percent after 48 months (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 102). Even if there were one hundred percent confidence in reducing inflation by monetary policy, it could take a prolonged period with adverse effects on economic activity. Certainty does not occur in economic policy, which is characterized by costs that cannot be anticipated.
Table 18, Brazil, Yearly Growth Rates of M1, M2, Nominal Income (Y), Real Income (y), Real Income per Capita (y/n) and Prices (P)
| M1 | M2 | Y | y | y/N | P | |
| 1861-1970 | 9.3 | 6.2 | 10.2 | 4.6 | 2.4 | 5.8 |
| 1861-1900 | 5.4 | 5.9 | 5.9 | 4.4 | 2.6 | 1.6 |
| 1861-1913 | 4.7 | 4.7 | 5.3 | 4.4 | 2.4 | 0.1 |
| 1861-1929 | 5.5 | 5.6 | 6.4 | 4.3 | 2.3 | 2.1 |
| 1900-1970 | 13.9 | 13.9 | 15.2 | 4.9 | 2.6 | 10.3 |
| 1900-1929 | 8.9 | 8.9 | 10.8 | 4.2 | 2.1 | 6.6 |
| 1900-1945 | 8.6 | 9.1 | 9.2 | 4.3 | 2.2 | 4.9 |
| 1920-1970 | 17.8 | 17.3 | 19.4 | 5.3 | 2.8 | 14.1 |
| 1920-1945 | 8.3 | 8.7 | 7.5 | 4.3 | 2.2 | 3.2 |
| 1920-1929 | 5.4 | 6.9 | 11.1 | 5.3 | 3.3 | 5.8 |
| 1929-1939 | 8.9 | 8.1 | 11.7 | 6.3 | 4.1 | 5.4 |
| 1945-1970 | 30.3 | 29.2 | 33.2 | 6.1 | 3.1 | 27.1 |
Note: growth rates are obtained by regressions of the natural logarithms on time.
Source: See Pelaez and Suzigan (1978), 143; M1 and M2 from Pelaez and Suzigan (1981); money income and real income from Contador and Haddad (1975) and Haddad (1974); prices by the exchange rate adjusted by British wholesale prices until 1906 and then from Villela and Suzigan (1973); national accounts after 1947 from Fundação Getúlio Vargas.
The seigniorage literature is highly relevant to current fiscal and monetary policy. The government has to be financed and monetary policy has always been an important option. Seigniorage is typically coordinated, willingly or as currently de facto, with fiscal profligacy. Meltzer (2005, 145) analyzes the Great Inflation as follows:
“The Great Inflation of 1965 to the mid 1980s was the central monetary event of the latter half of the 20th century. Its economic cost was large. It destroyed the Bretton Woods system of fixed exchange rate, bankrupted much of the thrift industry, heavily taxed the US capital stock and arbitrarily redistributed income and wealth. It was also a political event, as are all major policy issues. This paper argues that the Great Inflation cannot be understood fully without its political dimensions. Political pressure to coordinate policy reinforced widespread beliefs that coordination of fiscal and monetary policies was desirable.”
The argument for zero interest rates and quantitative easing can be used to explain current inflation. Bernanke and Reinhart (2004, 88) argue that “the possibility monetary policy works through portfolio substitution effects, even in normal times, has a long intellectual history, having been espoused by both Keynesians (James Tobin 1969) and monetarists (Karl Brunner and Allan Meltzer 1973).” Andres et al. (2004) formalize the Tobin (1969) contribution by optimizing agents in a general-equilibrium model. Both Tobin (1969) and Brunner and Meltzer (1973) consider capital assets to be gross instead of perfect substitutes with positive partial derivatives of own rates of return and negative partial derivatives of cross rates in the vector of asset returns (interest plus principal gain or loss) as argument in portfolio balancing equations (see Pelaez and Suzigan 1978, 113-23). Tobin (1969, 26) explains portfolio substitution after monetary policy:
“When the supply of any asset is increased, the structure of rates of return, on this and other assets, must change in a way that induces the public to hold the new supply. When the asset’s own rate can rise, a large part of the necessary adjustment can occur in this way. But if the rate is fixed, the whole adjustment must take place through reductions in other rates or increases in prices of other assets. This is the secret of the special role of money; it is a secret that would be shared by any other asset with a fixed interest rate.”
Portfolio rebalancing originates in the theory of financial markets in conditions of risk. An important advance in this theory was the application of general equilibrium methods and the elimination of the assumption of perfect substitution between money and other capital assets (Tobin, 1961). Portfolio choice theory developed by Markowitz (1952), Tobin (1958), Hicks (1935, 1962), Treynor (1962), Sharpe (1964), Lintner (1965) and Mossin (1966) provided the separation theorem of Tobin, which states that the share of wealth allocated to individual risky assets is independent of the optimum share of risk assets in the total portfolio, and the theory of choice of an optimum risk-asset portfolio with borrowing or lending at the riskless or “pure” rate of interest. Equilibrium is attained by changes in the share of individual risk assets in the risk-asset portfolio that change their prices or rates of return. Tobin (1969) provided the general equilibrium model in which the Tobin q, or market value of capital relative to the reproduction cost of capital, responds positively to an injection of base money, ∂q/∂B>0, where B is base money. Andrés et al (2004) formalized further the Tobin (1969) model and its applicability to quantitative easing. Vayanos and Vila (2009) formalize for present purposes the preferred habitat model of Culbertson (1957, 1963) and Modigliani and Sutch (1966) with a rich analysis of how arbitrageurs engage in carry trade along the term structure when quantitative easing changes bond prices. Various recent contributions, such as Hamilton and Wu (2010), measure the effects of quantitative easing on Treasury yields.
The Fed does not control the effects of monetary policy on the rebalancing of the portfolio of assets. What the Fed does is create shocks altering relative rates of return of asset holdings that trigger portfolio rebalancing in a movement toward the efficient frontier in which the near zero interest rate creates the opportunity of borrowing to invest in long positions in all types of risk financial assets, including commodities, emerging market stocks and foreign exchange. Fed policy has been providing analysis originally with lowering yields of securities around the term of financing of asset-backed securities with which almost every loan is financed such as car loans, credit card receivables and mortgages; subsequently with wealth effects of increasing stock market prices (Bernanke 2010WP); and more recently by explicitly recognizing the effects on dollar devaluation (Yellen 2011AS). The entire spectrum of valuation of risk financial assets is affected by Fed policy and not just the arbitrary choice of yields of asset-backed securities, the US stock market and dollar devaluation. The critical issue on the Great Inflation is whether the concentration of the Fed solely on the output gap as in the 1960s and 1970s creates the risk of stagflation. In the first round of near zero interest rates and quantitative easing by suspending the auctions of 30 year Treasury bonds CPI inflation rose from 1.9 percent in 2003 to 4.1 percent in 2007, as shown in the last line of Table 20 while the yield of the 10-year Treasury note rose from 3.112 percent on Jun 10, 2003 to 5.297 percent on Jun 12, 2007.
Seigniorage from current monetary policy is quite complex such that it is convenient to reproduce here the Neumann (1992) formula in equation (13):
SME = (∆Bt + iD Dt + if Ft + Gt)/Pt (13)
The numerator has the conventional seigniorage of issuing base money, ∆Bt/Pt, and effects on the internal debt, iD Dt/ Pt, foreign debt, if Ft/Pt, and unrealized capital gains, Gt/Pt. Policy consist of lowering interest rates to zero and flattening the yield curve with resulting devaluation and increases in commodity prices that affect a third of consumer prices. Lower short-term interest rates and long-term yields of government securities permit financing of the government at lower costs than would prevail without the issue of a trillion dollars of base money. Artificially low interest rates and yields cause major redistributions of income and wealth and also distort the calculus of risk and returns that is essential for sound economic and financial decisions. Cheap financing of the government with the highest monetary accommodation in history is an important transfer of command of resources from the private to the government sector. The policy is justified by the need to divert savings toward capital investment and wealth to building the capital stock. The result is evidently not even a second best because of the distortion of capital budgeting and risk/return economic and financial calculations on the basis of artificial interest rates.
III Financial Turbulence. The past two weeks have been characterized by unusual financial turbulence. Table 19 provides beginning values on May 12, high and low values and values on May 12. All data are for New York time at 5 PM. The high and low values exclude observations on May 2 and May 13.
Table 19, Risk Financial Assets
| May 2 | High | Low | May 13 | |
| USD/EUR | 1.483 | 1.483 | 1.411 | 1.411 |
| JPY/USD | 81.17 | 81.045 | 80.06 | 80.77 |
| CHF/USD | 0.863 | 0.8842 | 0.861 | 0.887 |
| DJIA | 100 | 100 | 98.62 | 98.35 |
| DJ Global | 100 | 99.56 | 98.72 | 96.25 |
| DAX | 100 | 99.66 | 97.95 | 98.35 |
| DJ UBS | 100 | 98.85 | 91.18 | 91.76 |
| WTI $/barrel | 113.52 | 111.05 | 98.790 | 99.56 |
| Brent $/barrel | 125.89 | 122.45 | 110.80 | 114.070 |
| Gold $/ounce | 1535.50 | 1541.00 | 1511.00 | 1493.30 |
| 10 Y US T % | 3.282 | 3.249 | 3.15 | 3.173 |
| 10 Y Ger % | 3.252 | 3.30 | 3.10 | 3.08 |
Note: USD: US dollars; EUR: euro; JPY: Japanese Yen;
Source: http://noir.bloomberg.com/intro_markets.html
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
Exchange rates provide important indicators of risk aversion. The first three rows of Table 19 provide key exchange rates. The dollar devalues on a trend as a result of zero interest rates but the trend is reversed during periods of risk aversion. Investors short the overnight or low-maturity segment of the yield curve, which is equivalent to borrowing, short the dollar and invest in risk financial assets by taking long, highly-leveraged positions. This strategy is known as the “carry trade,” in which low short-term US interest rates are the “carry cost” of positions in risk financial assets such as commodities, stocks, emerging stocks and so on. The dollar (USD) revalued relative to the euro (EUR) from USD 1.483/EUR on May 2 to USD 1.411/EUR on May 13, or by 4.9 percent. The high occurred on May 3 and the low on May 11. The Japanese yen (JPY) has been on its own carry trade for a longer period because zero interest rates go back more than a decade. The Swiss franc (CHF) is an important indicator of flight to safety of a strong banking deposit and investment center. The CHF/USD rate strengthened before the current episode because risk aversion signs preceded the turmoil of the past two weeks. The last two rows of Table 19 show the decline in the yield of the 10-year Treasury note from 3.282 percent on May 2 to 3.173 percent on May 13 and even as low as 3.15 percent. Similar behavior is exhibited by the 10-year government bond of Germany with decline in yield from 3.282 percent on May 2 to 3.08 percent on May 13. Investors hold government securities of the US and Germany during episodes of risk aversion, with demand raising their prices, which is equivalent to lowering yields.
Table 19 also provides indexes of three stock market indices, Dow Jones Industrial Average (DJIA), Dow Jones Global (DJ Global) and DAX of Germany with value of 100 on May 2. All four indexes fell as investors abandoned risk positions and sought safety havens.
The sharpest decline was in commodity prices. Table 19 provides the value of the DJ UBS Commodity Index and the futures prices of WTI and Brent oil and gold. The DJ UBS Commodity Index fell 8.1 percent from May 2 to May 13.
In the current expansion phase of the business cycle after the credit/dollar crisis and global recession of 2007-2009, risk aversion has occurred in the form of: (1) sovereign risk doubts in the euro area; (2) slower growth in China because of the tough tradeoff of inflation and growth; (3) accelerating inflation in the midst of fiscal/monetary accommodation inherited from the recession; (4) geopolitical events in the Middle East and subsequently the earthquake/tsunami in Japan; (5) mediocre growth, job stress, wage stagnation and fiscal/monetary imbalance in the US; and (6) increasingly the rise of inflation everywhere in the world that injects uncertainty in financial and economic decisions, or allocation disruptive effect of Bailey (1956), and redistributions of income and wealth, or income/wealth redistributive effect of Bailey (1956). The strongest impact occurred in Apr to Jul 2010 because of the sovereign doubts in Europe, recurring less strongly in Nov 2010 and again in Mar 2011.
IV Valuations of Risk Financial Assets. Near zero interest rates encourage the carry trade of borrowing at extremely low short-term rates and taking long positions in risk financial assets such as commodities, currencies, stocks and so on. Families, investors and most everybody worldwide were encouraged to benefit from the low interest rates originating in Fed policy of 1 percent fed funds rate in 2003-2004 and housing subsidies by borrowing significantly or high leverage, ignoring potential future adverse events or taking high risks, investing fully or having little or no cash assets or low liquidity and induced easy lending or taking unsound credit decisions. The carry trade of borrowing at extremely low short-term rates and taking long positions in risk financial assets is shown in Table 20 in the form of high valuations in most risk financial assets and then eventual collapse in the form of the credit/dollar crisis and global recession after 2007. The financial crisis and global recession were caused by interest rate and housing 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).
Table 20, 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 | 0513 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.411 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 05/13/ 2011 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.507 |
| 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
Table 20A extracts four rows of Table 15 with the Dollar/Euro (USD/EUR) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 24.2 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul, 2010, shown in Table 22, the dollar has devalued again to USD 1.411/EUR or by 18.4 percent. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD until it revalued to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent and after fixing it again to the dollar, revalued to CNY 6.5070/USD on May 13, 2011, or by an additional 4.6 percent, for cumulative revaluation of 21.4 percent.
Table 20A, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate
| USD/EUR | 6/26/03 | 7/14/08 | 6/07/10 | 05/13/ 2011 |
| Rate | 1.1423 | 1.5914 | 1.192 | 1.411 |
| CNY/USD | 01/03 | 07/21 | 7/15 | 05/13/ 2011 |
| Rate | 8.2798 | 8.2765 | 6.8211 | 6.507 |
Source: Table 20.
Dollar devaluation did not eliminate the US current account deficit, which is projected by the International Monetary Fund (IMF) at 3.2 percent of GDP in 2011 and also in 2012, as shown in Table 21. Revaluation of the CNY has not reduced the current account surplus of China, which is projected by the IMF to increase from 5.7 percent of GDP in 2011 to 6.3 percent of GDP in 2012, as shown in Table 21.
Table 21, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2011 Dollar GDP
| GDP $B | FD %GDP 2011 | CAD %GDP 2011 | Debt %GDP 2011 | FD%GDP 2012 | CAD%GDP 2012 | Debt %GDP 2012 | |
| US | 15227 | -10.6 | -3.2 | 64.8 | -10.8 | -3.2 | 72.4 |
| Japan | 5821 | -9.9 | 2.3 | 127.8 | -8.4 | 2.3 | 135.1 |
| UK | 2471 | -8.6 | -2.4 | 75.1 | -6.9 | -1.9 | 78.6 |
| Euro | 12939 | -4.4 | 0.03 | 66.9 | -3.6 | 0.05 | 68.2 |
| Ger | 3519 | -2.3 | 5.1 | 54.7 | -1.5 | 4.6 | 54.7 |
| France | 2751 | -6.0 | -2.8 | 77.9 | -5.0 | -2.7 | 79.9 |
| Italy | 2181 | -4.3 | -3.4 | 100.6 | -3.5 | -2.9 | 100.4 |
| Can | 1737 | -4.6 | -2.8 | 35.1 | -2.8 | -2.6 | 36.3 |
| China | 6516 | -1.6 | 5.7 | 17.1 | -0.9 | 6.3 | 16.3 |
| Brazil | 2090 | -2.4 | -2.6 | 39.9 | -2.6 | -2.9 | 39.4 |
Note: GER = Germany; Can = Canada; FD = fiscal deficit; CAD = current account deficit
Source: http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx
There is a new carry trade that learned from the losses after the crisis of 2007 or learned from the crisis how to avoid losses. The sharp rise in valuations of risk financial assets shown in Table 20 after the first policy round of near zero fed funds and quantitative easing by withdrawing supply with the suspension of the 30-year Treasury auction was on a smooth trend with relatively subdued fluctuations. The credit crisis and global recession have been followed by significant fluctuations originating in sovereign risk issues in Europe, doubts of continuing high growth and accelerating inflation in China, events such as in the Middle East and Japan and legislative restructuring, regulation, insufficient growth, low wages, depressed hiring and high job stress of unemployment and underemployment in the US. The “trend is your friend” motto of traders has been replaced with a “hit and realize profit” approach of managing positions to realize profits without sitting on positions. There is a trend of valuation of risk financial assets with fluctuations provoked by events of risk aversion. Table 22, which is updated for every comment, shows the deep contraction of risk financial assets after the Apr 2010 sovereign risk issues in the fourth column “∆% to Trough” and the sharp recovery after around Jul 2010 in the last column “∆% Trough to 05/13/11” with all risk financial assets in the range from 14.0 percent for European stocks to 30.8 percent for S&P 500, excluding Japan that has currently weaker performance because of the earthquake/tsunami, while the dollar devalued by 18.4 percent and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 5/13/2011” shows the fall of most risk financial assets because of the risk aversion in the week of May 13. Aggressive tightening by the Fed to maintain the credibility of inflation not rising above 2 percent—in contrast with timid “measured” policy during the adjustment in Jun 2004 to Jun 2006 after the earlier round of near zero interest rates—may cause another credit/dollar crisis and stress on the overall world economy. The choices may prove tough and will magnify effects on financial variables because of the corner in which policy has been driven by aggressive impulses that have resulted in the fed funds rate of 0 to ¼ percent and holdings by the Fed that move toward 30 percent of Treasury securities in circulation.
Table 22, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 5/ | ∆% Week 5/ | ∆% Trough to 5/ | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 12.4 | -0.3 | 30.0 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 9.9 | -0.2 | 30.8 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | -5.8 | -1.8 | 18.2 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | 4.3 | -1.4 | 27.9 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | 6.5 | -1.0 | 21.7 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | -15.3 | -2.1 | 9.3 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -9.2 | 0.2 | 20.5 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | -3.4 | -0.8 | 14.0 |
| DAX | 4/26/ | 5/25/ | -10.5 | 16.9 | -1.2 | 30.6 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 6.7 | 1.4 | -18.4 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | 10.2 | 0.2 | 28.9 |
| 10-Year Tre. | 4/5/ | 4/6/10 | 3.986 | 3.173 |
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.
Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis by the Fed on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. Table 23 shows a gain by Apr 29, 2011 in the DJIA of 14.3 percent and of the S&P 500 of 12.5 percent since Apr 26, 2010, around the time when sovereign risk issues in Europe began to be acknowledged in financial risk asset valuations. There were still fluctuations. Reversals of valuations are possible during aggressive changes in interest rate policy. In the week of May 6, return of risk aversion, resulted in moderation of the valuation of the DJIA to 12.8 percent and that of the S&P 500 to 10.6 percent. There was further loss of dynamism in the week of May 13 with the DJIA reducing its gain to 12.4 percent and the S&P 500 to 10.4 percent.
Table 23, Percentage Changes of DJIA and S&P 500 in Selected Dates
| 2010 | ∆% DJIA from earlier date | ∆% DJIA from | ∆% S&P 500 from earlier date | ∆% S&P 500 from |
| 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 | 0.1 | 9.0 |
| Mar 11 | -1.0 | 7.5 | -1.3 | 7.6 |
| Mar 18 | -1.5 | 5.8 | -1.9 | 5.5 |
| Mar 25 | 3.1 | 9.1 | 2.7 | 8.4 |
| Apr 1 | 1.3 | 10.5 | 1.4 | 9.9 |
| Apr 8 | 0.03 | 10.5 | -0.3 | 9.6 |
| Apr 15 | -0.3 | 10.1 | -0.6 | 8.9 |
| Apr 22 | 1.3 | 11.6 | 1.3 | 10.3 |
| Apr 29 | 2.4 | 14.3 | 1.9 | 12.5 |
| May 6 | -1.3 | 12.8 | -1.7 | 10.6 |
| May 13 | -0.3 | 12.4 | -0.2 | 10.4 |
Source: http://online.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3004
Table 24, updated with every post, shows that exchange rate valuations affect a large variety of countries, in fact, almost the entire world, in magnitudes that cause major problems for domestic monetary policy and trade flows. Dollar devaluation is expected to continue because of zero fed funds rate, expectations of rising inflation and the large budget deficit of the federal government (http://professional.wsj.com/article/SB10001424052748703907004576279321350926848.html?mod=WSJ_hp_LEFTWhatsNewsCollection) but with interruptions caused by risk aversion events.
Table 24, Exchange Rates
| Peak | Trough | ∆% P/T | May 6 2011 | ∆T May 13 2011 | ∆% P May 13 | |
| EUR USD | 7/15 | 6/7 2010 | 5/13 | |||
| Rate | 1.59 | 1.192 | 1.411 | |||
| ∆% | -33.4 | 15.5 | -12.7 | |||
| JPY USD | 8/18 | 9/15 | 5/13 2011 | |||
| Rate | 110.19 | 83.07 | 80.77 | |||
| ∆% | 24.6 | 2.8 | 26.7 | |||
| CHF USD | 11/21 2008 | 12/8 2009 | 5/13 2011 | |||
| Rate | 1.225 | 1.025 | 0.887 | |||
| ∆% | 16.3 | 13.5 | 27.6 | |||
| USD GBP | 7/15 | 1/2/ 2009 | 5/13 2011 | |||
| Rate | 2.006 | 1.388 | 1.62 | |||
| ∆% | -44.5 | 14.3 | -23.8 | |||
| USD AUD | 7/15 2008 | 10/27 2008 | 5/13 | |||
| Rate | 1.0215 | 1.6639 | 1.057 | |||
| ∆% | -62.9 | 43.1 | 7.4 | |||
| ZAR USD | 10/22 2008 | 8/15 | 5/13 2011 | |||
| Rate | 11.578 | 7.238 | 7.008 | |||
| ∆% | 37.5 | 3.2 | 39.5 | |||
| SGD USD | 3/3 | 8/9 | 5/13 | |||
| Rate | 1.553 | 1.348 | 1.245 | |||
| ∆% | 13.2 | 7.6 | 19.8 | |||
| HKD USD | 8/15 2008 | 12/14 2009 | 5/13 | |||
| Rate | 7.813 | 7.752 | 7.773 | |||
| ∆% | 0.8 | -0.3 | 0.5 | |||
| BRL USD | 12/5 2008 | 4/30 2010 | 5/13 2011 | |||
| Rate | 2.43 | 1.737 | 1.637 | |||
| ∆% | 28.5 | 5.8 | 32.6 | |||
| CZK USD | 2/13 2009 | 8/6 2010 | 5/13 | |||
| Rate | 22.19 | 18.693 | 17.277 | |||
| ∆% | 15.7 | 7.6 | 22.1 | |||
| SEK USD | 3/4 2009 | 8/9 2010 | 5/13 2011 | |||
| Rate | 9.313 | 7.108 | 6.387 | |||
| ∆% | 23.7 | 10.1 | 31.4 | |||
| CNY USD | 7/20 2005 | 7/15 | 5/13 | |||
| Rate | 8.2765 | 6.8211 | 6.5070 | |||
| ∆% | 17.6 | 4.6 | 21.4 |
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
V Economic Indicators. The economy continues to expand at a moderate rate with inflation everywhere and a fractured labor market. Section (I) Global Inflation analyzes the indicators with nominal values: international trade, import/export prices, CPI, PPI, retail sales and business inventories. Table 25 shows the Treasury Monthly Statement. The deficit in the fiscal year to Apr 2011, $869.9 billion, is running 10.2 percent higher than in the same period in 2010, $789.7 billion. Receipts and outlays are growing are nearly identical rates of 9.2 percent and 9.1 percent, respectively. Individual taxes in the fiscal year to Apr in 2011 at $631 billion are higher by 26 percent than in the fiscal year to Apr in 2010 at $500 billion.
Table 25, Treasury Budget in Fiscal Year to Apr
| 2011 | 2010 | ∆% | |
| Receipts | 1,309,439 | 1,199,153 | 9.2 |
| Outlays | 2,179,337 | 1,998,831 | 9.1 |
| Deficit | 869,898 | 789,679 | 10.2 |
| Individual Taxes | 631,159 | 500,815 | 26.0 |
Source: http://www.fms.treas.gov/mts/mts0411.pdf
The Energy Information Administration (EIA) finds that US commercial crude oil inventories rose from $366.5 million barrels in the week of Apr 29 to 370.3 million barrels in the week of May 6 or by 3.8 million barrels (http://www.eia.doe.gov/pub/oil_gas/petroleum/data_publications/weekly_petroleum_status_report/current/pdf/highlights.pdf). In the week of Apr 6, US crude oil imports were on average about 9 million barrels per day, exceeding the prior week’s average by 87,000 barrels per day. In the past four weeks, average oil imports were 8.8 million barrels per day, which is 943,000 barrels per day lower than in the same four-week period in 2010. The world average crude oil price was $116.91 per barrel on May 6, which is $3.93 per barrel lower than a week earlier but $35.20 per barrel higher than a year earlier. The regular gasoline price national average was $3.965/gallon on May 9, which exceeded the prior week’s national average by $0.002/gallon and was $1.060/gallon higher than a year earlier. Initial claims for unemployment insurance, seasonally adjusted, fell 44,000 to 434,000 in the week of May 7 from 478,000 in the week of Apr 30 (http://www.dol.gov/opa/media/press/eta/ui/current.htm). Initial claims not seasonally adjusted fell 21,391 to 394,583 in the week of May 7 from 415,974 in the week of Apr 30. The four-week moving average of initial claims, seasonally adjusted, rose 4500 to 436,750 in the week of May 7 from 432,250 in the week of Apr 30.
VI Interest Rates. The 10-year Treasury note, maturing on May 15, 2021, with coupon of 3.125 percent, traded at yield of 3.17 percent or equivalent price of 99.6094 (http://noir.bloomberg.com/markets/rates/index.html), which is not comparable to the price in Table 14. The 10-year government bond of Germany with coupon of 3.25 percent, maturing in July 2021, traded at yield of 3.08 percent or equivalent price of 101.48 percent (http://noir.bloomberg.com/markets/rates/germany.html).
VII Conclusion. Monetary policy should return to normal nonzero interest rates to avoid further distortions of risk/returns calculations and decisions. Deflation is not a threat but rather the allocation disruption, income/wealth redistribution and welfare loss (Bailey 1956). The central bank does not have knowledge and instruments to manage both the trend of growth and cyclical fluctuations. (Go to http://cmpassocregulationblog.blogspot.com/ http://sites.google.com/site/economicregulation/carlos-m-pelaez)
http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10 )
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© Carlos M. Pelaez, 2010, 2011.
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