Recovery without Hiring, World Inflation Waves, Euro Zone Survival Risk and World Economic Slowdown
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011
Executive Summary
I Recovery without Hiring
II World Inflation Waves
III World Financial Turbulence
IIIA Financial Risks
IIIB Fiscal Compact
IIIC European Central Bank
IIID Euro Zone Survival Risk
IIIE Appendix on Sovereign Bond Valuation
IV Global Inflation
V World Economic Slowdown
VA United States
VB Japan
VC China
VD Euro Area
VE Germany
VF France
VG Italy
VH United Kingdom
VI Valuation of Risk Financial Assets
VII Economic Indicators
VIII Interest Rates
IX Conclusion
References
Appendix I The Great Inflation
Executive Summary
An important characteristic of the current fractured labor market of the US is the closing of the avenue for exiting unemployment and underemployment normally available through dynamic hiring. Another avenue that is closed is the opportunity for advancement in moving to new jobs that pay better salaries and benefits again because of the collapse of hiring in the United States. Those who are unemployed or underemployed cannot find a new job even accepting lower wages and no benefits. The employed cannot escape declining inflation-adjusted earnings because there is no hiring.
Total nonfarm hiring (HNF), total private hiring (HP) and their respective rates are provided for the month of Oct in the years from 2001 to 2011 in Table ES-3. Hiring numbers are in thousands. There is some recovery in HNF from 3706 (or 3.7 million) in Oct 2009 to 3984 in Oct 2010 and 4091 in Oct 2011 for cumulative gain of 10.4 percent. HP rose from 3411 in Oct 2009 to 3847 in Oct 2011 for cumulative gain of 12.8 percent. HNF has fallen from 5696 in Oct 2006 to 4091 in Oct 2011 or by 28.2 percent. HP has fallen from 5374 in Oct 2005 to 3847 in Oct 2011 or by 28.4 percent. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.
Table ES-3, US, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment Not Seasonally Adjusted
| HNF | Rate RNF | HP | Rate HP | |
| 2001 Oct | 5502 | 4.2 | 5144 | 4.7 |
| 2002 Oct | 5256 | 4.0 | 4912 | 4.5 |
| 2003 Oct | 5427 | 4.1 | 5085 | 4.7 |
| 2004 Oct | 5602 | 4.2 | 5254 | 4.7 |
| 2005 Oct | 5495 | 4.1 | 5180 | 4.6 |
| 2006 Oct | 5696 | 4.1 | 5374 | 4.7 |
| 2007 Oct | 5652 | 4.1 | 5326 | 4.6 |
| 2008 Oct | 4278 | 3.1 | 4012 | 3.5 |
| 2009 Oct | 3706 | 2.8 | 3411 | 3.2 |
| 2010 Oct | 3984 | 3.0 | 3705 | 3.4 |
| 2011 Oct | 4091 | 3.1 | 3847 | 3.5 |
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Chart ES1 provides total nonfarm hiring on a monthly basis from 2001 to 2011. Hiring rebounded in early 2010 but then fell and stabilized at a lower level than the early peak in 2010. Nonfarm hiring fell again in Oct as shown in Chart ES1 with SA monthly data. The number of seasonally-adjusted hires in Sep was 4396 thousand, falling to 4091 thousand in Oct or by 6.9 percent. The number of hires not seasonally adjusted was 4150 in Sep, falling to 4040 in Oct or by 2.7 percent.
Chart ES1, US, Total Nonfarm Hiring (HNF), 2001-2011 Month SA
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
There is only milder improvement in total private hiring shown in Chart ES2. HP rose in 2010 followed by stability and renewed increase in 2011. The number of private hiring seasonally adjusted fell from 3885 thousand in Sep to 3782 in Oct or by 2.7 percent. The number of private hiring not seasonally adjusted fell from 4027 thousand in Sep to 3847 in Oct or by -4.5 percent.
Chart ES2, US, Total Private Hiring Month SA 2011-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
The analysis of world inflation in this blog reveals three waves of inflation of producer and consumer prices. In the first wave from Jan to Apr of 2011, lack of risk aversion channeled cheap money into commodity futures, causing worldwide increase in inflation. In the second wave in May and Jun, risk aversion because of the sovereign debt crisis in Europe caused unwinding of the carry trade into commodity futures with resulting decline in commodity prices and inflation. In the third wave since Aug, alternations of risk aversion revived carry trades of commodity futures with resulting higher and lower inflation.
Table ES2 provides annual equivalent rates of inflation for producer prices indexes followed in this blog. The behavior of the US producer price index in 2011 shows neatly three waves. In Jan-Apr, without risk aversion, US producer prices rose at the annual equivalent rate of 17.3 percent. After risk aversion, producer prices increased in the US at the annual equivalent rate of 0.8 percent in May-Jul. Since Jul, under alternating episodes of risk aversion, producer prices have increased at the annual equivalent rate of 2.9 percent. Resolution of the European debt crisis would result in jumps of valuations of risk financial assets. Increases in commodity prices would cause the same high producer-price inflation experienced in Jan-Apr. There are seven producer-price indexes in Table ES2 showing very similar behavior in 2011. Zero interest rates without risk aversion cause increases in commodity prices that in turn increase input and output prices. Producer price inflation rose during the first part of the year for the US, China, Germany, France, Italy and the UK when risk aversion was contained. With the increase in risk aversion in May and Jun, inflation moderated because carry trades were unwound. Producer price inflation has returned since July, with alternating bouts of risk aversion.
Table ES2, Annual Equivalent Rates of Producer Price Indexes
| INDEX 2011 | AE ∆% |
| US Producer Price Index | |
| AE ∆% Jul-Nov | 2.9 |
| AE ∆% May-Jul | 0.8 |
| AE ∆% Jan-Apr | 17.3 |
| Japan Corporate Goods Price Index | |
| AE ∆% Jul-Nov | -1.9 |
| AE ∆% Jan-Apr | 7.1 |
| China Producer Price Index | |
| AE ∆% Jul-Nov | -3.1 |
| AE ∆% Jan-Jun | 20.4 |
| Germany Producer Price Index | |
| AE ∆% Jul-Oct | 4.6 |
| AE ∆% Jun-May | 1.2 |
| Jan-Apr | 7.1 |
| France Producer Price Index for the French Market | |
| AE ∆% Jul-Oct | 3.4 |
| AE ∆% May-Jun | -3.5 |
| AE ∆% Jan-Apr | 11.4 |
| Italy Producer Price Index | |
| AE ∆% Jul-Oct | 1.2 |
| AE ∆% Jun-May | -1.2 |
| AE ∆% Jan-April | 10.7 |
| UK Output Prices | |
| AE ∆% May-Nov | 2.1 |
| AE ∆% Jan-Apr | 12.0 |
| UK Input Prices | |
| AE ∆% Jul-Nov | -0.1 |
| AE ∆% May-Jun | -8.7 |
| AE ∆% Jan-Apr | 35.6 |
Sources: http://www.bls.gov/ppi/data.htm
http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1111.pdf
http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20111209_402771437.htm
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20111130
http://www.istat.it/it/archivio/47110
http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/november-2011/index.html
Annual equivalent consumer price inflation in the US in Jan-Apr reached 7.5 percent as carry trades raised commodity futures, as shown in Table ES3. Return of risk aversion in May to Jul resulted in annual equivalent inflation of only 2.0 percent in May-Jul. Inflation then rose again in Jul-Oct to annual equivalent 3.3 percent with alternation of bouts of risk aversion and 2.7 in Jul-Nov. The three waves are neatly repeated in consumer price inflation for China, the euro zone, Germany, France, Italy and the UK. In the absence of risk aversion, zero interest rates with guidance now forever, induce carry trades that raise commodity prices, increasing prices.
Table ES3, Annual Equivalent Rates of Consumer Price Indexes
| Index 2011 | AE ∆% |
| US Consumer Price Index | |
| AE ∆% Jul-Nov | 2.7 |
| AE ∆% May-Jul | 2.0 |
| AE ∆% Jan-Apr | 7.5 |
| China Consumer Price Index | |
| AE ∆% Jul-Nov | 2.9 |
| AE ∆% Apr-Jun | 2.0 |
| AE ∆% Jan-Mar | 8.3 |
| Euro Zone Harmonized Index of Consumer Prices | |
| AE ∆% Aug-Nov | 4.3 |
| AE ∆% May-Jul | -2.4 |
| AE ∆% Jan-Apr | 5.2 |
| Germany Consumer Price Index | |
| AE ∆% Jul-Nov | 1.2 |
| AE ∆% May-Jun | 0.6 |
| AE ∆% Feb-Apr | 4.9 |
| France Consumer Price Index | |
| AE ∆% Aug-Nov | 3.0 |
| AE ∆% May-Jul | -1.2 |
| AE ∆% Jan-Apr | 4.3 |
| Italy Consumer Price Index | |
| AE ∆% Jul-Nov | 2.7 |
| AE ∆% May-Jun | 1.2 |
| AE ∆% Jan-Apr | 4.9 |
| UK Consumer Price Index | |
| AE ∆% Aug-Nov | 4.6 |
| May-Jul | 0.4 |
| Jan-Apr | 6.5 |
Sources: http://www.bls.gov/cpi/data.htm
http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20111209_402771439.htm
http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-15122011-AP/EN/2-15122011-AP-EN.PDF
http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20111213
http://www.istat.it/it/archivio/48180
http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/november-2011/index.html
I Recovery without Hiring. An important characteristic of the current fractured labor market of the US is the closing of the avenue for exiting unemployment and underemployment normally available through dynamic hiring. Another avenue that is closed is the opportunity for advancement in moving to new jobs that pay better salaries and benefits again because of the collapse of hiring in the United States. Those who are unemployed or underemployed cannot find a new job even accepting lower wages and no benefits. The employed cannot escape declining inflation-adjusted earnings because there is no hiring. The objective of this section is to analyze hiring and labor underutilization in the United States.
An appropriate measure of job stress is considered by Blanchard and Katz (1997, 53):
“The right measure of the state of the labor market is the exit rate from unemployment, defined as the number of hires divided by the number unemployed, rather than the unemployment rate itself. What matters to the unemployed is not how many of them there are, but how many of them there are in relation to the number of hires by firms.”
The natural rate of unemployment and the similar NAIRU are quite difficult to estimate in practice (Ibid; see Ball and Mankiw 2002).
The Bureau of Labor Statistics (BLS) created the Job Openings and Labor Turnover Survey (JOLTS) with the purpose that (http://www.bls.gov/jlt/jltover.htm#purpose):
“These data serve as demand-side indicators of labor shortages at the national level. Prior to JOLTS, there was no economic indicator of the unmet demand for labor with which to assess the presence or extent of labor shortages in the United States. The availability of unfilled jobs—the jobs opening rate—is an important measure of tightness of job markets, parallel to existing measures of unemployment.”
The BLS collects data from about 16,000 US business establishments in nonagricultural industries through the 50 states and DC. The data are released monthly and constitute an important complement to other data provided by the BLS.
Hiring in the nonfarm sector (HNF) has declined from 64.9 million in 2006 to 47.2 million in 2010 or by 17.7 million while hiring in the private sector (HP) has declined from 60.4 million in 2006 to 43.3 million in 2010 or by 17.1 million, as shown in Table I-1. The ratio of nonfarm hiring to unemployment (RNF) has fallen from 47.7 in 2006 to 36.4 in 2010 and in the private sector (RHP) from 52.9 in 2006 to 40.3 in 2010 (http://cmpassocregulationblog.blogspot.com/2011/03/slow-growth-inflation-unemployment-and.html).
Table I-1, US, Annual Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US and Percentage of Total Employment
| HNF | Rate RNF | HP | Rate HP | |
| 2001 | 63,766 | 48.4 | 59,374 | 53.6 |
| 2002 | 59,797 | 45.9 | 55,665 | 51.1 |
| 2003 | 57,787 | 44.5 | 54,082 | 49.9 |
| 2004 | 61,624 | 46.9 | 57,534 | 52.4 |
| 2005 | 64,498 | 48.2 | 60,444 | 54.0 |
| 2006 | 64,870 | 47.7 | 60,419 | 52.9 |
| 2007 | 63,326 | 46.0 | 58,760 | 50.9 |
| 2008 | 53,986 | 39.5 | 50,286 | 44.0 |
| 2009 | 45,372 | 34.7 | 41,966 | 38.8 |
| 2010 | 47,234 | 36.4 | 43,299 | 40.3 |
Source: http://www.bls.gov/jlt/data.htm
Chart I-1 provides the yearly levels of total nonfarm hiring (NFH) in Table I-1. The fall of hiring during the contraction of 2007 to 2009 was much stronger than in the shallow contraction of 2001 with GDP contraction of only 0.4 percent from Mar 2001 (IQ2001) to Dec 2011 (IVQ 2001) compared with 5.1 percent contraction in the much longer recession from Dec 2007 (IVQ2007) to Jun 2009 (IIQ2009) (http://www.nber.org/cycles/cyclesmain.html).
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Chart I-2 shows the ratio or rate of nonfarm hiring to unemployment (RNF) that also fell much more in the recession of 2007 to 2009 than in the shallow recession of 2001.
![clip_image006[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesE1C6CC\image32.png "clip_image006[1]")
Chart I-2, US, Rate Total Nonfarm Hiring (HNF), Yearly, 2001-2010
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Total nonfarm hiring (HNF) yearly percentage changes are provided in Table I-2. There were much milder declines in 2002 of 6.2 percent and 3.4 percent in 2003 followed by strong rebounds of 6.6 percent in 2004 and 4.7 percent in 2005. In contrast, the contractions of nonfarm hiring in the recession after 2007 were much sharper in percentage points: 2.4 in 2007, 14.7 in 2008 and 16 percent in 2009. On a yearly basis, nonfarm hiring grew 4.1 percent in 2010 relative to 2009.
Table I-2, US, Annual Total Nonfarm Hiring (HNF), Yearly Percentage Change, 2001-2010
| Year | Annual |
| 2002 | -6.2 |
| 2003 | -3.4 |
| 2004 | 6.6 |
| 2005 | 4.7 |
| 2006 | 0.6 |
| 2007 | -2.4 |
| 2008 | -14.7 |
| 2009 | -16.0 |
| 2010 | 4.1 |
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Chart I-3 plots yearly percentage changes of nonfarm hiring. Percentage declines after 2007 were quite sharp.
Chart I-3, US, Annual Total Nonfarm Hiring (HNF), Yearly Percentage Change, 2001-2010
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Total private hiring (HP) yearly data are provided in Chart I-4. There has been sharp contraction of total private hiring in the US and only mild recovery in 2010.
Source:
US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Chart I-5 plots the rate of total private hiring relative to unemployment (RHP). The rate collapsed during the global recession after 2007.
Chart I-5, US, Rate Total Private Hiring, Yearly, 2001-2010
Source:
US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Total nonfarm hiring (HNF), total private hiring (HP) and their respective rates are provided for the month of Oct in the years from 2001 to 2011 in Table I-3. Hiring numbers are in thousands. There is some recovery in HNF from 3706 (or 3.7 million) in Oct 2009 to 3984 in Oct 2010 and 4091 in Oct 2011 for cumulative gain of 10.4 percent. HP rose from 3411 in Oct 2009 to 3847 in Oct 2011 for cumulative gain of 12.8 percent. HNF has fallen from 5696 in Oct 2006 to 4091 in Oct 2011 or by 28.2 percent. HP has fallen from 5374 in Oct 2005 to 3847 in Oct 2011 or by 28.4 percent. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.
Table I-3, US, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment Not Seasonally Adjusted
| HNF | Rate RNF | HP | Rate HP | |
| 2001 Oct | 5502 | 4.2 | 5144 | 4.7 |
| 2002 Oct | 5256 | 4.0 | 4912 | 4.5 |
| 2003 Oct | 5427 | 4.1 | 5085 | 4.7 |
| 2004 Oct | 5602 | 4.2 | 5254 | 4.7 |
| 2005 Oct | 5495 | 4.1 | 5180 | 4.6 |
| 2006 Oct | 5696 | 4.1 | 5374 | 4.7 |
| 2007 Oct | 5652 | 4.1 | 5326 | 4.6 |
| 2008 Oct | 4278 | 3.1 | 4012 | 3.5 |
| 2009 Oct | 3706 | 2.8 | 3411 | 3.2 |
| 2010 Oct | 3984 | 3.0 | 3705 | 3.4 |
| 2011 Oct | 4091 | 3.1 | 3847 | 3.5 |
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Chart I-6 provides total nonfarm hiring on a monthly basis from 2001 to 2011. Hiring rebounded in early 2010 but then fell and stabilized at a lower level than the early peak in 2010. Nonfarm hiring fell again in Oct as shown in Chart I-6 with SA monthly data. The number of seasonally-adjusted hires in Sep was 4396 thousand, falling to 4091 thousand in Oct or by 6.9 percent. The number of hires not seasonally adjusted was 4150 in Sep, falling to 4040 in Oct or by 2.7 percent.
![clip_image002[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesE1C6CC\image36%5b1%5d.png "clip_image002[1]")
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Similar behavior occurs in the rate of nonfarm hiring plot in Chart I-7. Recovery in early 2010 was followed by decline and stabilization at a lower level but with decrease in monthly SA estimates for Sep 2011.
Chart I-7, US, Rate Total Nonfarm Hiring, Month SA 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
There is only milder improvement in total private hiring shown in Chart I-8. HP rose in 2010 followed by stability and renewed increase in 2011. The number of private hiring seasonally adjusted fell from 3885 thousand in Sep to 3782 in Oct or by 2.7 percent. The number of private hiring not seasonally adjusted fell from 4027 thousand in Sep to 3847 in Oct or by -4.5 percent.
![clip_image004[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesE1C6CC\image8.png "clip_image004[1]")
Chart I-8, US, Total Private Hiring Month SA 2011-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Chart I-9 shows similar behavior in the rate of private hiring. The rate in 2011 in monthly SA data has not risen significantly above the peak in 2010. The rate also fell from Sep to Oct.
Chart I-9, US, Rate Total Private Hiring Month SA 2011-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
The JOLTS report of the Bureau of Labor Statistics also provides total nonfarm job openings (TNF JOB), TNF JOB rate and TNF LD (layoffs and discharges) shown in Table I-4 for the month of Oct from 2001 to 2011. The final column provides TNF LD for the years from 2001 to 2010. Nonfarm job openings fell from a peak of 4845 in Oct 2006 to 3370 in Oct 2011 or by 30.4 percent while the rate dropped from 3.4 to 2.5. Nonfarm layoffs and discharges (TNF LD) rose from 1730 in Oct 2005 to 1999 in Oct 2008 or by 15.5 percent. The yearly data show layoffs and discharges rising from 21.5 million in 2006 to 26.3 million in 2009 or by 22.3 percent.
Table I-4, US, Job Openings and Total Separations, Thousands NSA
| TNF JOB | TNF JOB | TNF LD SA | TNF LD | |
| Oct 2001 | 3989 | 2.9 | 2181 | 24351 |
| Oct 2002 | 3976 | 2.9 | 1865 | 23325 |
| Oct 2003 | 3559 | 2.6 | 1989 | 23959 |
| Oct 2004 | 4232 | 3.1 | 1818 | 23389 |
| Oct 2005 | 4531 | 3.2 | 1730 | 22774 |
| Oct 2006 | 4845 | 3.4 | 1861 | 21468 |
| Oct 2007 | 4544 | 3.2 | 1938 | 22577 |
| Oct 2008 | 3128 | 2.2 | 1999 | 23737 |
| Oct 2009 | 2357 | 1.8 | 1871 | 26318 |
| Oct 2010 | 2979 | 2.2 | 1635 | 21243 |
| Oct 2011 | 3370 | 2.5 | 1601 |
Notes: TNF JOB: Total Nonfarm Job Openings; LD: Layoffs and Discharges
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Chart I-10 shows monthly job openings rising from the trough in 2009 to a high in the beginning of 2010. Job openings then stabilized into 2011 but have surpassed the peak of 2010.
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
The rate of job openings in Chart I-11 shows similar behavior. The rate rises from 2009 into the initial part of 2010 and then stabilizes into 2011 but is now around the peak in 2010.
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Total separations are shown in Chart I-12. Separations are much lower in 2010 than before the global recession
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Yearly total separations are shown in Chart I-13. Separations are much lower in 2010 than before the global recession.
Chart I-13, US, Total Separations, Yearly 2001-2010
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Table I-5 provides total nonfarm total separations from 2001 to 2010. Separations fell from 62.7 million in 2006 to 46.3 million in 2010 or by 16.4 million.
Table I-5, US, Total Nonfarm Total Separations, Thousands, 2001-2010
| Year | Annual |
| 2001 | 65610 |
| 2002 | 60412 |
| 2003 | 57847 |
| 2004 | 59666 |
| 2005 | 62107 |
| 2006 | 62699 |
| 2007 | 62173 |
| 2008 | 57525 |
| 2009 | 50544 |
| 2010 | 46347 |
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Monthly data of layoffs and discharges reach a peak in early 2009, as shown in Chart I-14. Layoffs and discharges dropped sharply with the recovery of the economy in 2010 and 2011 once employers reduced their job count to what was required for cost reductions and loss of business.
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Layoffs and discharges in Chart I-15 rose sharply to a peak in 2009. There was pronounced drop into 2010.
Chart I-15, US, Layoffs and Discharges, Yearly 2001-2010
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
Table I-6 provides annual nonfarm layoffs and discharges from 2001 to 2010. Layoffs and discharges peaked at 26.3 million in 2009 and then fell to 21.2 million in 2010, by 5.1 million, or 19.4 percent.
Table I-6, US, Total Nonfarm Layoffs and Discharges, 2001-2010
| Year | Annual |
| 2001 | 24351 |
| 2002 | 23325 |
| 2003 | 23959 |
| 2004 | 23389 |
| 2005 | 22774 |
| 2006 | 21468 |
| 2007 | 22577 |
| 2008 | 23737 |
| 2009 | 26318 |
| 2010 | 21243 |
Source: US Bureau of Labor Statistics
http://www.bls.gov/jlt/data.htm
The Bureau of Labor Statistics also provides alternative measures of labor underutilization shown in Table I-7. The most comprehensive measure is U6 that consists of total unemployed plus total employed part time for economic reasons plus all marginally attached workers as percent of the labor force. U6 not seasonally annualized has risen from 5.6 percent in 2006 to 15.0 in Oct 2011.
Table I-7, US, Alternative Measures of Labor Underutilization %
| U1 | U2 | U3 | U4 | U5 | U6 | |
| Nov 2011 NSA | 4.9 | 4.7 | 8.2 | 8.9 | 9.7 | 15.0 |
| Oct 2011 NSA | 5.0 | 4,8 | 8.5 | 9.1 | 10.0 | 15.3 |
| Sep 2011 | 5.2 | 5.0 | 8.8 | 9.4 | 10.2 | 15.7 |
| Nov 2010 NSA | 5.5 | 5.8 | 9.3 | 10.0 | 10.8 | 16.3 |
| 2010 | 5.7 | 6.0 | 9.6 | 10.3 | 11.1 | 16.7 |
| 2009 | 4.7 | 5.9 | 9.3 | 9.7 | 10.5 | 16.2 |
| 2008 | 2.1 | 3.1 | 5.8 | 6.1 | 6.8 | 10.5 |
| 2007 | 1.5 | 2.3 | 4.6 | 4.9 | 5.5 | 8.3 |
| 2006 | 1.5 | 2.2 | 4.6 | 4.9 | 5.5 | 5.6 |
Note: LF: labor force; U1, persons unemployed 15 weeks % LF; U2, job losers and persons who completed temporary jobs %LF; U3, total unemployed % LF; U4, total unemployed plus discouraged workers, plus all other marginally attached workers; % LF plus discouraged workers; U5, total unemployed, plus discouraged workers, plus all other marginally attached workers % LF plus all marginally attached workers; U6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons % LF plus all marginally attached workers
Source: http://www.bls.gov/news.release/pdf/empsit.pdf
Monthly seasonally adjusted measures of labor underutilization are provided in Table I-8. U6 has been climbed from 15.9 percent in Apr 2011 to 16.2 percent in Oct 2011 and then fell to 15.6 in Nov 2011. Unemployment is an inaccurate measure of the stress in US job markets. A different calculation in this blog is provided by using the participation rate in the labor force before the global recession. This calculation shows 28.9 million in job stress of unemployment/underemployment in Nov 2011, not seasonally adjusted, corresponding to 18.2 percent of the labor force (http://cmpassocregulationblog.blogspot.com/2011/12/twenty-nine-million-in-job-stress.html Table 3).
Table I-8, US, Alternative Measures of Labor Underutilization SA %
| Nov | Oct 2011 | Sep 2011 | Aug 2011 | Jul 2011 | Jun 2011 | May 2011 | Apr 2011 | |
| U1 | 5.1 | 5.1 | 5.4 | 5.4 | 5.3 | 5.3 | 5.3 | 5.1 |
| U2 | 4.9 | 5.2 | 5.3 | 5.3 | 5.4 | 5.4 | 5.4 | 5.3 |
| U3 | 8.6 | 9.0 | 9.1 | 9.1 | 9.1 | 9.2 | 9.1 | 9.0 |
| U4 | 9.3 | 9.6 | 9.7 | 9.7 | 9.8 | 9.8 | 9.5 | 9.5 |
| U5 | 10.2 | 10.5 | 10.5 | 10.6 | 10.7 | 10.7 | 10.3 | 10.4 |
| U6 | 15.6 | 16.2 | 16.5 | 16.2 | 16.1 | 16.2 | 15.8 | 15.9 |
Note: LF: labor force; U1, persons unemployed 15 weeks % LF; U2, job losers and persons who completed temporary jobs %LF; U3, total unemployed % LF; U4, total unemployed plus discouraged workers, plus all other marginally attached workers; % LF plus discouraged workers; U5, total unemployed, plus discouraged workers, plus all other marginally attached workers % LF plus all marginally attached workers; U6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons % LF plus all marginally attached workers
Source: http://www.bls.gov/news.release/pdf/empsit.pdf
Chart I-16 provides U6 on a monthly basis from 2001 to 2011. There was a steep climb from 2007 into 2009 and then this measure of unemployment and underemployment stabilized at that high level. There is seasonal and sampling doubts on the employment report for Nov. The number employed part-time for economic reasons because they could not find full-time employment fell from 8.896 million in Oct to 8.518 million in Oct, seasonally adjusted, or decline of 378.000 in just one month. Without seasonal adjustment, the number of employed part-time for economic reasons actually increased without seasonal adjustment from 8.258 million in Oct to 8.271 million in Nov or by 13,000 (see Table A-8, page 20 in (http://www.bls.gov/news.release/pdf/empsit.pdf).
Source: US Bureau of Labor Statistics
http://www.bls.gov/cps/data.htm
One of the dramas of the current job market of the US consists of millions of people working part-time for economic reasons, or the failure to find full-time employment. Chart I-17 shows the jump of numbers of people working part-time for economic reasons from 2007 and subsequent stabilization at a very high level. The sample for Nov shows decline of 378.000 in just one month.
Chart I-17, US, Working Part-time for Economic Reasons
Thousands, Month SA 2001-2011
Sources: US Bureau of Labor Statistics
http://www.bls.gov/cps/data.htm
People lose their marketable job skills after prolonged unemployment and find increasing difficulty in finding another job. Chart I-18 shows the sharp rise in unemployed over 27 weeks and stabilization at an extremely high level.
Sources: http://www.bls.gov/cps/data.htm
Another segment of U6 consists of people marginally attached to the labor force who continue to seek employment but less frequently on the frustration there may not be a job for them. Chart I-19 shows the sharp rise in people marginally attached to the labor force after 2007 and subsequent stabilization.
Sources: US Bureau of Labor Statistics
http://www.bls.gov/cps/data.htm
IB World Inflation Waves. This section provides data on inflation in the US and relates it to world carry trades from zero interest rates to commodity futures. The carry trade fluctuates now in three waves in 2011 that are repeated in worldwide inflation. Unconventional monetary policy of zero interest rates and large-scale purchase of securities for the balance sheet of the central bank intends to lower long-term costs of borrowing to stimulate investment and consumption that can increase economic growth and employment. In practice, the central bank cannot direct the use of huge volumes of cash that can be borrowed at nearly zero interest rates to investment and consumption. Cheap cash has many alternative uses in allocations to a wide range of real and financial risk assets. Risk financial assets that can attract cheap cash include equities, emerging-market equities and fixed income, currencies, commodity futures and so on. The carry trade consists of short dollar and immediate-term fixed income jointly with long, highly-leveraged positions in risk financial assets. The carry trade is unwound during episodes of risk aversion such as the fears of repercussions in financial markets of disruption of European sovereign debt. Inflation in 2011 has been dominated by carry trades into commodity futures during periods of risk appetite that are unwound during periods of risk aversion.
The analysis of world inflation in this blog reveals three waves of inflation of producer and consumer prices. In the first wave from Jan to Apr of 2011, lack of risk aversion channeled cheap money into commodity futures, causing worldwide increase in inflation. In the second wave in May and Jun, risk aversion because of the sovereign debt crisis in Europe caused unwinding of the carry trade into commodity futures with resulting decline in commodity prices and inflation. In the third wave since Aug, alternations of risk aversion revived carry trades of commodity futures with resulting higher and lower inflation.
Table II-1 provides annual equivalent rates of inflation for producer prices indexes followed in this blog. The behavior of the US producer price index in 2011 shows neatly three waves. In Jan-Apr, without risk aversion, US producer prices rose at the annual equivalent rate of 17.3 percent. After risk aversion, producer prices increased in the US at the annual equivalent rate of 0.8 percent in May-Jul. Since Jul, under alternating episodes of risk aversion, producer prices have increased at the annual equivalent rate of 2.9 percent. Resolution of the European debt crisis would result in jumps of valuations of risk financial assets. Increases in commodity prices would cause the same high producer-price inflation experienced in Jan-Apr. There are seven producer-price indexes in Table II-1 showing very similar behavior in 2011. Zero interest rates without risk aversion cause increases in commodity prices that in turn increase input and output prices. Producer price inflation rose during the first part of the year for the US, China, Germany, France, Italy and the UK when risk aversion was contained. With the increase in risk aversion in May and Jun, inflation moderated as carry trades were unwound. Producer price inflation has returned since July, with alternating bouts of risk aversion.
Table II-1, Annual Equivalent Rates of Producer Price Indexes
| INDEX 2011 | AE ∆% |
| US Producer Price Index | |
| AE ∆% Jul-Nov | 2.9 |
| AE ∆% May-Jul | 0.8 |
| AE ∆% Jan-Apr | 17.3 |
| Japan Corporate Goods Price Index | |
| AE ∆% Jul-Nov | -1.9 |
| AE ∆% Jan-Apr | 7.1 |
| China Producer Price Index | |
| AE ∆% Jul-Nov | -3.1 |
| AE ∆% Jan-Jun | 20.4 |
| Germany Producer Price Index | |
| AE ∆% Jul-Oct | 4.6 |
| AE ∆% Jun-May | 1.2 |
| Jan-Apr | 7.1 |
| France Producer Price Index for the French Market | |
| AE ∆% Jul-Oct | 3.4 |
| AE ∆% May-Jun | -3.5 |
| AE ∆% Jan-Apr | 11.4 |
| Italy Producer Price Index | |
| AE ∆% Jul-Oct | 1.2 |
| AE ∆% Jun-May | -1.2 |
| AE ∆% Jan-April | 10.7 |
| UK Output Prices | |
| AE ∆% May-Nov | 2.1 |
| AE ∆% Jan-Apr | 12.0 |
| UK Input Prices | |
| AE ∆% Jul-Nov | -0.1 |
| AE ∆% May-Jun | -8.7 |
| AE ∆% Jan-Apr | 35.6 |
Sources: http://www.bls.gov/ppi/data.htm
http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1111.pdf
http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20111209_402771437.htm
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20111130
http://www.istat.it/it/archivio/47110
http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/november-2011/index.html
Annual equivalent consumer price inflation in the US in Jan-Apr reached 7.5 percent as carry trades raised commodity futures, as shown in Table II-2. Return of risk aversion in May to Jul resulted in annual equivalent inflation of only 2.0 percent in May-Jul. Inflation then rose again in Jul-Oct to annual equivalent 3.3 percent with alternation of bouts of risk aversion. The three waves are neatly repeated in consumer price inflation for China, the euro zone, Germany, France, Italy and the UK. In the absence of risk aversion, zero interest rates with guidance now forever, induce carry trades that raise commodity prices.
Table II-2, Annual Equivalent Rates of Consumer Price Indexes
| Index 2011 | AE ∆% |
| US Consumer Price Index | |
| AE ∆% Jul-Nov | 2.7 |
| AE ∆% May-Jul | 2.0 |
| AE ∆% Jan-Apr | 7.5 |
| China Consumer Price Index | |
| AE ∆% Jul-Nov | 2.9 |
| AE ∆% Apr-Jun | 2.0 |
| AE ∆% Jan-Mar | 8.3 |
| Euro Zone Harmonized Index of Consumer Prices | |
| AE ∆% Aug-Nov | 4.3 |
| AE ∆% May-Jul | -2.4 |
| AE ∆% Jan-Apr | 5.2 |
| Germany Consumer Price Index | |
| AE ∆% Jul-Nov | 1.2 |
| AE ∆% May-Jun | 0.6 |
| AE ∆% Feb-Apr | 4.9 |
| France Consumer Price Index | |
| AE ∆% Aug-Nov | 3.0 |
| AE ∆% May-Jul | -1.2 |
| AE ∆% Jan-Apr | 4.3 |
| Italy Consumer Price Index | |
| AE ∆% Jul-Nov | 2.7 |
| AE ∆% May-Jun | 1.2 |
| AE ∆% Jan-Apr | 4.9 |
| UK Consumer Price Index | |
| AE ∆% Aug-Nov | 4.6 |
| May-Jul | 0.4 |
| Jan-Apr | 6.5 |
Sources: http://www.bls.gov/cpi/data.htm
http://www.stats.gov.cn/enGliSH/newsandcomingevents/t20111209_402771439.htm
http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-15122011-AP/EN/2-15122011-AP-EN.PDF
http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20111213
http://www.istat.it/it/archivio/48180
http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/november-2011/index.html
Key percentage average yearly rates of the US economy on growth and inflation are provided in Table II-3 updated with release of new data. The choice of dates prevents the measurement of long-term potential economic growth because of two recessions from IQ2001 (Mar) to IVQ2001 (Nov) with decline of GDP of 0.4 percent and the drop in GDP of 5.1 percent in IVQ2007 (Dec) to IIQ2009 (June) (http://www.nber.org/cycles.html) followed with unusually low economic growth for an expansion phase after recession with the economy growing at the annual equivalent rate of 0.8 percent in the first half of 2011 (http://cmpassocregulationblog.blogspot.com/2011/11/us-growth-standstill-falling-real.html). Between 2000 and 2010, real GDP grew at the average rate of 1.6 percent per year, nominal GDP at 3.9 percent and the implicit deflator at 2.5 percent. The average rate of CPI inflation was 2.4 percent per year and 2.0 percent excluding food and energy. PPI inflation increased at 2.7 percent per year on average and at 1.6 percent excluding food and energy. There is also inflation in international trade. Import prices grew at 2.7 percent per year between 2000 and 2010 and 3.1 percent between 2000 and 2011. The commodity price shock is revealed by inflation of import prices of petroleum at 12.2 percent per year between 2000 and 2010 and at 12.4 percent between 2000 and 2011. The average growth rates of import prices excluding fuels are much lower at 1.9 percent for 2002 to 2010 and 2.1 percent for 2000 to 2011. Export prices rose at the average rate of 2.4 percent between 2000 and 2010 and at 2.6 percent from 2000 to 2011. What spared the US of sharper decade-long deterioration of the terms of trade, (export prices)/(import prices), was its diversification and competitiveness in agriculture. Agricultural export prices grew at the average yearly rate of 6.9 percent from 2000 to 2010 and at 6.7 percent from 2000 to 2011. US nonagricultural export prices rose at 2.1 percent per year in 2000 to 2010 and at 2.2 percent in 2000 to 2011. These dynamic growth rates are not similar to those for the economy of Japan where inflation was negative in seven of the 10 years in the 2000s.
Table II-3, US, Average Growth Rates of Real and Nominal GDP, Consumer Price Index, Producer Price Index and Import and Export Prices, Percent per Year
| Real GDP | 2000-2010: 1.6% |
| Nominal GDP | 2000-2010: 3.9% |
| Implicit Price Deflator | 2000-2010: 2.5% |
| CPI | 2000-2010: 2.4% |
| CPI ex Food and Energy | 2000-2010: 2.0% |
| PPI | 2000-2010: 2.7% |
| PPI ex Food and Energy | 2000-2010: 1.6% |
| Import Prices | 2000-2010: 2.7% |
| Import Prices of Petroleum and Petroleum Products | 2000-2010: 12.2% |
| Import Prices Excluding Fuels | 2002-2010: 1.9% |
| Export Prices | 2000-2010: 2.4% |
| Agricultural Export Prices | 2000-2010: 6.9% |
| Nonagricultural Export Prices | 2000-2010: 2.1% |
Note: rates for price indexes in the row beginning with “CPI” and ending in the row “Nonagricultural Export Prices” are for Oct 2000 to Oct 2010 and for Oct 2001 to Oct 2011. Import prices excluding fuels are not available before 2002.
Sources:
http://www.bea.gov/iTable/index_nipa.cfm http://www.bls.gov/ppi/data.htm
http://www.bls.gov/mxp/data.htm http://www.bls.gov/cpi/data.htm
Unconventional monetary policy of zero interest rates and large-scale purchases of long-term securities for the balance sheet of the central bank is proposed to prevent deflation. The data of CPI inflation of all goods and CPI inflation excluding food and energy for the past six decades show only one negative change by 0.4 percent in the CPI all goods annual index in 2009 but not one year of negative annual yearly change in the CPI excluding food and energy measuring annual inflation (http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html). Zero interest rates and quantitative easing are designed to lower costs of borrowing for investment and consumption, increase stock market valuations and devalue the dollar. In practice, the carry trade is from zero interest rates to a large variety of risk financial assets including commodities. Resulting commodity price inflation squeezes family budgets and deteriorates the terms of trade with negative effects on aggregate demand and employment. Excessive valuations of risk financial assets eventually result in crashes of financial markets with possible adverse effects on economic activity and employment.
Producer price inflation history in the past five decades does not provide evidence of deflation. The finished core PPI does not register even one single year of decline. The headline PPI experienced only six isolated cases of decline (http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html):
-0.3 percent in 1963,
-1.4 percent in 1986,
-0.8 percent in 1986,
-0.8 percent in 1998,
-1.3 percent in 2001
-2.6 percent in 2009.
Deflation should show persistent cases of decline of prices and not isolated events. Fear of deflation in the US has caused a distraction of monetary policy. Symmetric inflation targets around 2 percent in the presence of multiple lags in effect of monetary policy and imperfect knowledge and forecasting are mostly unfeasible and likely to cause price and financial instability instead of desired price and financial stability.
Chart II-1 provides US nominal GDP from 1980 to 2010. The only major bump in the chart occurred in the recession of IVQ2007 to IIQ2009. Tendency for deflation would be reflected in persistent bumps. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.5 percent cumulatively and fell 45.6 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). The comparison of the global recession after 2007 with the Great Depression is entirely misleading.
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart II-2 provides US real GDP from 1980 to 2010. Persistent deflation threatening real economic activity would also be reflected in the series of long-term growth of GDP. There is no such behavior in Chart II-2 except for periodic recessions in the US economy that have occurred throughout history.
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Deflation would also be in evidence in long-term series of prices in the form of bumps. The GDP implicit deflator series in Chart II-3 from 1980 to 2010 shows rather dynamic behavior over time. The US economy is not plagued by deflation but by long-run inflation.
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart II-4 provides percent change from preceding quarter in prices of GDP at seasonally-adjusted annual rates (SAAR) from 1980 to 2010. There is one case of negative change in IIQ2009. There has not been actual deflation or risk of deflation in the US that would justify unconventional monetary policy.
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart II-5 provides percent change from preceding year in prices of GDP from 1980 to 2010. There was not one single year of deflation or risk of deflation in the past three decades.
Source: http://www.bea.gov/iTable/index_nipa.cfm
The producer price index of the US from 1960 to 2011 in Chart II-6 shows various periods of more rapid or less rapid inflation but no bumps. The major event is the decline in 2008 when risk aversion because of the global recession caused the collapse of oil prices from $148/barrel to less than $80/barrel with most other commodity prices also collapsing. The event had nothing in common with explanations of deflation but rather with the concentration of risk exposures in commodities after the decline of stock market indexes. Eventually, there was a flight to government securities because of the fears of insolvency of banks caused by statements supporting proposals for withdrawal of toxic assets from bank balance sheets in the Troubled Asset Relief Program (TARP), as explained by Cochrane and Zingales (2009). The bump in 2008 with decline in 2009 is consistent with the view that zero interest rates with subdued risk aversion induce carry trades into commodity futures.
Chart II-6, US, Producer Price Index, Finished Goods, NSA, 1960-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
Chart II-7 provides 12 month percentage changes of the producer price index from 1960 to 2011. The distinguishing event in Chart II-7 is the Great Inflation of the 1970s. The shape of the two-hump Bactrian camel of the 1970s resembles the double hump from 2007 to 2011.
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
The producer price index excluding food and energy from 1974, the first historical data of availability in the dataset of the Bureau of Labor Statistics (BLS), to 2011, shows similarly dynamic behavior as the overall index, as shown in Chart II-8. There is no evidence of persistent deflation in the US PPI.
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
Chart II-9 provides 12 months percentage rates of change of the finished goods index excluding food and energy. The dominating characteristic is the Great Inflation of the 1970s. The double hump illustrates how inflation may appear to be subdued and then returns with strength.
Chart II-9, US Producer Price Index, Finished Goods Excluding Food and Energy, 12 Month Percentage Change, NSA, 1974-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
The producer price index of energy goods from 1974 to 2011 is provided in Chart II-10. The first jump occurred during the Great Inflation of the 1970s analyzed in various comments of this blog (http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html) and in Appendix I. There is relative stability of producer prices after 1986 with another jump and decline in the late 1990s into the early 2000s. The episode of commodity price increases during a global recession in 2008 could only have happened with interest rates dropping toward zero, which stimulated the carry trade from zero interest rates to leveraged positions in commodity futures. Commodity futures exposures were dropped in the flight to government securities after Sep 2008. Commodity future exposures were created again when risk aversion diminished around Mar 2011 after the finding that US bank balance sheets did not have the toxic assets that were mentioned in proposing TARP in Congress (see Cochrane and Zingales 2009). Fluctuations in commodity prices and other risk financial assets originate in carry trade when risk aversion ameliorates.
Chart II-10, US, Producer Price Index, Finished Energy Goods, NSA, 1974-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
Chart 1I-11 shows the 12 month percentage change of the producer price index of finished energy goods from 1975 to 2011. This index is only available after 1974 and captures only one of the humps of energy prices during the Great Inflation. Fluctuations in energy prices have occurred throughout history in the US but without provoking deflation. Two cases are the decline of oil prices in 2001 to 2002 that has been analyzed by Barsky and Kilian (2004) and the collapse of oil prices from over $140/barrel with shock of risk aversion to the carry trade in Sep 2008.
Chart II-11, US, Producer Price Index, Finished Energy Goods, 12 Month Percentage Change, NSA, 1974-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
Chart II-12 provides the consumer price index NSA from 1960 to 2011. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart II-13 provides 12 month percentage changes of the consumer price index from 1960 to 2011. There are actually three waves of inflation in the second half of the 1960s, in the mid 1970s and again in the late 1970s. Inflation rates then stabilized in a range with only two episodes above 5 percent.
Chart II-13, US, Consumer Price Index, All Items, 12 Month Percentage Change 1960-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart II-14 provides the consumer price index excluding food and energy from 1960 to 2011. There is long-term inflation in the US without episodes of deflation.
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart II-15 provides 12 months percentage changes of the consumer price index excluding food and energy from 1960 to 2011. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.
Chart II-15, US, Consumer Price Index Excluding Food and Energy, 12 Month Percentage Change, NSA, 1960-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
The consumer price index of housing is provided in Chart II-16. There was also acceleration during the Great Inflation of the 1970s. The index flattens after the global recession in IVQ2007 to IIQ2009. Housing prices collapsed under the weight of construction of several times more housing than needed. Surplus housing originated in subsidies and artificially low interest rates in the shock of unconventional monetary policy in 2003 to 2004 in fear of deflation.
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart II-17 provides 12 months percentage changes of the housing CPI. The Great Inflation also had extremely high rates of housing inflation. Housing is considered as potential hedge of inflation.
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Consumer price inflation has accelerated in recent months. Table II-4 provides the 12 months and annual equivalent rate for the months of Jul to Nov of the CPI and major segments. CPI inflation in the 12 months ending in Nov reached 3.4 percent and the annual equivalent rate Jul-Nov was 2.7 percent. These inflation rates fluctuate in accordance with inducement risk appetite or frustration by risk aversion of carry trades from zero interest rates to commodity futures. Excluding food and energy, CPI inflation was 2.2 percent in the 12 months ending in Nov and 1.9 percent in annual equivalent in Jul-Nov. There is no deflation in the US economy that could justify further quantitative easing. Consumer food prices in the US have risen 4.6 percent in 12 months and 3.7 percent in annual equivalent in Jul-Nov. Monetary policies stimulating carry trades of commodities that increase prices of food constitute a highly regressive tax on lower income families for whom food is a major portion of the consumption basket. Energy prices returned with increase of 12.4 percent in 12 months and 5.7 percent in annual equivalent in Jul-Nov. For the lower income families, food and energy are a major part of the family budget. Inflation is not low or threatening deflation in annual equivalent in Jul-Nov in any of the categories in Table II-4. An upward trend is determined by carry trades from zero interest rates to commodity futures positions with episodes of risk aversion causing fluctuations.
Table II-4, US, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%
| ∆% 12 Months Nov 2011/Nov | ∆% Annual Equivalent Jul-Nov 2011 SA | |
| CPI All Items | 3.4 | 2.7 |
| CPI ex Food and Energy | 2.2 | 1.9 |
| Food | 4.6 | 3.7 |
| Food at Home | 5.9 | 4.4 |
| Food Away from Home | 2.9 | 3.2 |
| Energy | 12.4 | 5.7 |
| Gasoline | 19.7 | 9.4 |
| Fuel Oil | 25.0 | -1.6 |
| New Vehicles | 3.3 | -1.4 |
| Used Cars and Trucks | 4.8 | 0.7 |
| Medical Care Commodities | 3.1 | 1.9 |
| Apparel | 4.8 | 5.4 |
| Services Less Energy Services | 2.1 | 2.4 |
| Shelter | 1.8 | 2.4 |
| Transportation Services | 2.6 | 1.9 |
| Medical Care Services | 3.5 | 4.4 |
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
The weights of the CPI, US city average, are shown in Table II-5. Housing has a weight of 41.460 percent. The combined weight of housing and transportation is 58.768 percent or more than one half. The combined weight of housing, transportation and food and beverages is 73.56 percent of the US CPI.
Table II-5, US, 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:
US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart II-18 provides the US consumer price index for housing from 2001 to 2011. Housing prices rose sharply during the decade until the bump of the global recession and are increasing again in 2011 with some stabilization currently. The CPI excluding housing would likely show much higher inflation. Income remaining after paying for indispensable shelter has been compressed by the commodity carry trades resulting from unconventional monetary policy.
Chart II-18, US, Consumer Price Index, Housing, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart II-19 provides 12-month percentage changes of the housing CPI. Percentage changes collapsed during the global recession but have been rising into positive territory in 2011.
Chart II-19, US, Consumer Price Index, Housing, 12 Month Percentage Change, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
There have been three waves of consumer price inflation in the US in 2011 that are illustrated in Table II-6. The first wave occurred in Jan-Apr and was caused by the carry trade of commodity prices induced by unconventional monetary policy of zero interest rates. Cheap money at zero opportunity cost was channeled into financial risk assets, causing increases in commodity prices. The annual equivalent rate of increase of the all-items CPI in Jan-Apr was 7.5 percent and the CPI excluding food and energy increased at annual equivalent rate of 2.8 percent. The second wave occurred during the collapse of the carry trade from zero interest rates to exposures in commodity futures as a result of risk aversion in financial markets created by the sovereign debt crisis in Europe. The annual equivalent rate of increase of the all items CPI dropped to 2.0 percent in May-Jul but the annual equivalent rate of the CPI excluding food and energy increased to 3.2 percent. The third wave occurred in the form of increase of the all items annual equivalent rate to 2.7 percent in Jul-Nov with the annual equivalent rate of the CPI excluding food and energy dropping to 1.9 percent. The conclusion is that inflation accelerates and decelerates in unpredictable fashion that turns symmetric inflation targets in a source of destabilizing shocks to the financial system and eventually the overall economy.
Table II-6, US, Headline and Core CPI Inflation Monthly SA and 12 Months NSA ∆%
| All Items SA Month | All Items NSA 12 month | Core SA | Core NSA | |
| Nov 2011 | 0.0 | 3.4 | 0.2 | 2.2 |
| Oct | -0.1 | 3.5 | 0.1 | 2.1 |
| Sep | 0.3 | 3.9 | 0.1 | 2.0 |
| Aug | 0.4 | 3.8 | 0.2 | 2.0 |
| Jul | 0.5 | 3.6 | 0.2 | 1.8 |
| AE ∆% Jul-Nov | 2.7 | 1.9 | ||
| Jun | -0.2 | 3.6 | 0.3 | 1.6 |
| May | 0.2 | 3.6 | 0.3 | 1.5 |
| AE ∆% May-Jul | 2.0 | 3.2 | ||
| Apr | 0.4 | 3.2 | 0.2 | 1.3 |
| Mar | 0.5 | 2.7 | 0.1 | 1.2 |
| Feb | 0.5 | 2.1 | 0.2 | 1.1 |
| Jan | 0.4 | 1.6 | 0.2 | 1.0 |
| AE ∆% Jan-Apr | 7.5 | 2.8 | ||
| Dec 2010 | 0.4 | 1.5 | 0.1 | 0.8 |
| Nov | 0.1 | 1.1 | 0.1 | 0.8 |
| Oct | 0.2 | 1.2 | 0.0 | 0.6 |
| Sep | 0.2 | 1.1 | 0.0 | 0.8 |
| Aug | 0.2 | 1.1 | 0.1 | 0.9 |
| Jul | 0.3 | 1.2 | 0.1 | 0.9 |
| Jun | -0.2 | 1.1 | 0.1 | 0.9 |
| May | -0.1 | 2.0 | 0.1 | 0.9 |
| Apr | 0.0 | 2.2 | 0.0 | 0.9 |
| Mar | 0.0 | 2.3 | 0.0 | 1.1 |
| Feb | 0.0 | 2.1 | 0.1 | 1.3 |
| Jan | 0.1 | 2.6 | -0.1 | 1.6 |
Note: Core: excluding food and energy; AE: annual equivalent
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
The behavior of the US consumer price index NSA from 2001 to 2011 is provided in Chart II-20. Inflation in the US is very dynamic without deflation risks that would justify symmetric inflation targets. The hump in 2008 originated in the carry trade from interest rates dropping to zero into commodity futures. There is no other explanation for the increase of oil prices toward $140/barrel during the global recession. The unwinding of the carry trade with the TARP announcement of toxic assets in banks channeled cheap money into government obligations (see Cochrane and Zingales 2009). /
Chart II-20, US, Consumer Price Index, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart II-21 provides 12 month percentage changes of the consumer price index from 2001 to 2011. There was no deflation or threat of deflation from 2008 into 2009. Commodity prices collapsed during the panic of toxic assets in banks. When stress tests revealed US bank balance sheets in much stronger position, cheap money at zero opportunity cost exited government obligations and flowed into carry trades of risk financial assets. Increases in commodity prices drove again the all items CPI with interruptions during risk aversion originating in the sovereign debt crisis of Europe.
Chart II-21, US, Consumer Price Index, 12 Month Percentage Change, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
The trend of increase of the consumer price index excluding food and industry in Chart II-22 does not reveal any threat of deflation that would justify symmetric inflation targets. There are mild oscillations in a neat upward trend.
Chart II-22, US, Consumer Price Index Excluding Food and Energy, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart II-23 provides 12 month percentage change of the consumer price index excluding food and energy. Past-year rates of inflation fell toward 1 percent from 2001 into 2003 as a result of the recession and the decline of commodity prices beginning before the recession with declines of real oil prices. Near zero interest rates with fed funds at 1 percent between Jun 2003 and Jun 2004 stimulated carry trades of all types, including in buying homes with subprime mortgages in expectation that low interest rates forever would increase home prices permanently, creating the equity that would permit the conversion of subprime mortgages into creditworthy mortgages (Gorton 2009EFM; see http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Inflation rose and then collapsed during the unwinding of carry trades and the housing debacle of the global recession. Carry trade into 2011 gave a new impulse to CPI inflation, all items and core. Symmetric inflation targets destabilize the economy by encouraging hunts for yields that inflate and deflate financial assets.
Chart II-23, US, Consumer Price Index Excluding Food and Energy, 12 Month Percentage Change, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
The headline and core producer price index are in Table II-7. The headline PPI increased 0.3 percent SA in Nov but the 12-month rate NSA fell to 5.7 percent. The core PPI SA increased 0.1 in Nov and rose 2.9 percent in 12 months. Analysis of annual equivalent rates of change shows three different waves. In the first wave, the absence of risk aversion from the sovereign risk crisis in Europe motivated the carry trade from zero interest rates into commodity futures that caused the average equivalent rate of 17.3 percent in the headline PPI in Jan-Apr and 5.3 percent in the core PPI. In the second wave, commodity futures prices collapsed in May with the return of risk aversion originating in the sovereign risk crisis of Europe. The annual equivalent rate of headline PPI inflation collapsed to 0.8 percent in May-Jul but the core annual equivalent inflation rate was much higher at 3.2 percent. In the third wave, headline PPI inflation resuscitated with annual equivalent 2.9 percent in Jul-Nov and core PPI inflation was 1.9 percent. Core PPI inflation has been persistent throughout 2011 and has jumped from around 1 percent in the first four months of 2010 to 2.9 percent in 12 months in Nov and 1.9 percent in annual equivalent rate in Jul-Nov. It is impossible to forecast PPI inflation and its relation to CPI inflation. “Inflation surprise” by monetary policy could be proposed to climb along a downward sloping Phillips curve, resulting in higher inflation but lower unemployment (see Kydland and Prescott 1977, Barro and Gordon 1983 and past comments of this blog http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html). The architects of monetary policy would require superior inflation forecasting ability compared to forecasting naivety by everybody else. In practice, we are all naïve in forecasting inflation and other economic variables and events.
Table II-7, US, Headline and Core PPI Inflation Monthly SA and 12 Months NSA ∆%
| Finished | Finished | Finished Core SA | Finished Core NSA | |
| Nov 2011 | 0.3 | 5.7 | 0.1 | 2.9 |
| Oct | -0.3 | 5.9 | 0.0 | 2.8 |
| Sep | 0.8 | 6.9 | 0.2 | 2.5 |
| Aug | 0.1 | 6.5 | -0.1 | 2.5 |
| Jul | 0.3 | 7.1 | 0.6 | 2.7 |
| AE ∆% Jul-Oct | 2.9 | 1.9 | ||
| Jun | -0.3 | 6.9 | 0.3 | 2.3 |
| May | 0.1 | 7.1 | 0.1 | 2.1 |
| AE ∆% May-Jul | 0.8 | 3.2 | ||
| Apr | 0.8 | 6.6 | 0.3 | 2.3 |
| Mar | 0.7 | 5.6 | 0.3 | 2.0 |
| Feb | 1.5 | 5.4 | 0.2 | 1.8 |
| Jan | 1.0 | 3.6 | 0.5 | 1.6 |
| AE ∆% Jan-Apr | 17.3 | 5.3 | ||
| Dec 2010 | 0.9 | 3.8 | 0.2 | 1.4 |
| Nov | 0.5 | 3.4 | 0.0 | 1.2 |
| Oct | 0.6 | 4.3 | -0.3 | 1.6 |
| Sep | 0.3 | 3.9 | 0.2 | 1.6 |
| Aug | 0.6 | 3.3 | 0.1 | 1.3 |
| Jul | 0.1 | 4.1 | 0.2 | 1.5 |
| Jun | -0.3 | 2.7 | 0.1 | 1.1 |
| May | -0.2 | 5.1 | 0.2 | 1.3 |
| Apr | -0.1 | 5.4 | 0.1 | 0.9 |
| Mar | 0.7 | 5.9 | 0.2 | 0.9 |
| Feb | -0.4 | 4.2 | 0.0 | 1.0 |
| Jan | 1.1 | 4.5 | 0.3 | 1.0 |
Note: Core: excluding food and energy; AE: annual equivalent
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
The US producer price index NSA from 2001 to 2011 is shown in Chart II-24. There are two episodes of decline of the PPI during recessions in 2001 and in 2008. Barsky and Kilian (2004) consider the 2001 episode as one in which real oil prices were declining when recession began. Recession and the fall of commodity prices instead of generalized deflation explain the behavior of US inflation in 2008.
Chart II-24, US, Producer Price Index, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
Twelve months percentage changes of the PPI NSA from 2001 to 2011 are shown in Chart II-25. It may be possible to forecast trends a few months in the future under adaptive expectations but turning points are almost impossible to anticipate especially when related to fluctuations of commodity prices in response to risk aversion. In a sense, monetary policy has been tied to behavior of the PPI in the negative 12 months rates in 2001 to 2003 and then again in 2009 to 2010. Monetary policy following deflation fears caused by commodity price fluctuations would introduce significant volatility and risks in financial markets and eventually in consumption and investment.
![clip_image058[1]](file:///C:\Users\cmpelaez\AppData\Local\Temp\WindowsLiveWriter1264636800\supfilesE1C6CC\image120.png "clip_image058[1]")
Chart II-25, US, Producer Price Index, 12 Month Percentage Change NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
The US PPI excluding food and energy from 2001 to 2011 is shown in Chart II-26. There is here again a smooth trend of inflation instead of prolonged deflation as in Japan.
Chart II-26, US, Producer Price Index Excluding Food and Energy, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
Twelve months percentage changes of the producer price index excluding food and energy are shown in Chart II-27. Fluctuations replicate those in the headline PPI. There is an evident trend of increase of 12 months rates of core PPI inflation in 2011.
Chart II-27, US, Producer Price Index Excluding Food and Energy, 12 Month Percentage Chance, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
The US producer price index of energy goods from 2001 to 2011 is in Chart II-28. There is a clear upward trend with fluctuations that would not occur under persistent deflation.
Chart II-28, US, Producer Price Index Energy Goods, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
Chart II-29 provides 12 months rates of change of the producer price index of energy goods from 2001 to 2011. The episode of declining prices of energy goods in 2001 to 2002 is related to the analysis of decline of real oil prices by Barsky and Kilian (2004). Interest rates dropping to zero during the global recession explain the rise of the PPI of energy goods toward 30 percent. Bouts of risk aversion with policy interest rates held close to zero explain the fluctuations in the 12 months rates of the PPI of energy goods in the expansion phase of the economy. Symmetric inflation targets induce significant instability in inflation and interest rates with adverse effects on financial markets and the overall economy.
Chart II-29, US, Producer Price Index Energy Goods, 12 Month Percentage Change, NSA, 2001-2011
Source: US Bureau of Labor Statistics
http://www.bls.gov/ppi/data.htm
Table II-8 provides 12 month percentage changes of the CPI all items, CPI core and CPI housing from 2001 to 2011. There is no evidence in these data supporting symmetric inflation targets that would only induce greater instability in inflation, interest rates and financial markets. Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval of (1.99, 2.0). The impact on the overall economy and the financial system of errors of policy are magnified by large-scale policy doses of trillions of dollars of quantitative easing and zero interest rates. The US economy has been experiencing financial repression as a result of negative real rates of interest in the past few years and programmed in monetary policy statements until 2013 or, for practical purposes, forever. The essential calculus of risk/return in capital budgeting and financial allocations has been distorted.
Table II-8, CPI All Items, CPI Core and CPI Housing, 12 Months Rates of Change, NSA 2001-2011
| Nov | CPI All Items | CPI Core | CPI Housing |
| 2011 | 3.4 | 2.2 | 1.9 |
| 2010 | 1.1 | 0.8 | 0.0 |
| 2009 | 1.8 | 1.7 | -0.3 |
| 2008 | 1.1 | 2.0 | 2.7 |
| 2007 | 4.3 | 2.3 | 3.1 |
| 2006 | 2.0 | 2.6 | 3.0 |
| 2005 | 3.5 | 2.1 | 4.0 |
| 2004 | 3.5 | 2.2 | 3.1 |
| 2003 | 1.8 | 1.1 | 2.2 |
| 2002 | 2.2 | 2.0 | 2.4 |
| 2001 | 1.9 | 2.8 | 3.1 |
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
III International Financial Turbulence. Financial markets are being shocked by multiple factors including (1) world economic slowdown; (2) growth in China, Japan and world trade; (3) slow growth propelled by savings reduction in the US with high unemployment/underemployment; and (3) the outcome of the sovereign debt crisis in Europe. This section analyzes the events of the week culminating in the meeting of European leaders. Subsection IIIA Financial Risks provides analysis of the evolution of valuations of risk assets during the week. Subsection IIIB Fiscal Compact analysis the restructuring of the fiscal affairs of the European Union in the agreement of European leaders on Dec 9. Subsection IIIC European Central Bank considers the policies of the European Central Bank. Subsection IIID Euro Zone Survival Risk analyzes the threats to survival of the European Monetary Union. Subsection IIIE Appendix on Sovereign Bond Valuation provides more technical appendix.
IIIA Financial Risks. The past four months have been characterized by financial turbulence, attaining unusual magnitude in the past few weeks. Table III-1, updated with every comment in this blog, provides beginning values on Fr Dec 9 and daily values throughout the week ending on Fri Dec 16 of several financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Dec 9 and the percentage change in that prior week below the label of the financial risk asset. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing inflation. The most important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9, which is analyzed in the following subsection IIIB Fiscal Compact. The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.3378/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Dec 9, appreciating to USD 1.3191/EUR on Mon Dec 12, or by 1.4 percent. The dollar appreciated because fewer dollars, $1.3191, were required on Dec 12 to buy one euro than $1.3378 on Dec 9. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.3191/EUR on Dec 12; the second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Dec 9, to the last business day of the current week, in this case Fri Dec 16, such as appreciation to USD 1.3036/EUR by Dec 16; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD appreciated (positive sign) by 2.5 percent from the rate of USD 1.3378/EUR on Fri Dec 9 to the rate of USD 1.3036/EUR on Fr Dec 16 {[(1.3036/1.3378) – 1]100 = -2.5%} and depreciated by 0.2 percent from the rate of USD 1.3016 on Thu Dec 15 to USD 1.3036/EUR on Fri Dec 16 {[(1.3036/1.3016) -1]100 = 0.2%}. Other factors constant, appreciation of the dollar relative to the euro is caused by increasing risk aversion, with rising uncertainty on European sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from the safety of dollar investments to higher yield risk financial assets. When risk aversion declines, funds have been moving away from safe assets in dollars to risk financial assets.
Table III-1, Weekly Financial Risk Assets Dec 12 to Dec 16, 2011
| Dec 9, 2011 | M 12 | Tu 13 | W 14 | Th 15 | Fr 16 |
| USD/ 1.3378 0.0% | 1.3191 1.4% 1.4% | 1.3034 2.6% 0.6% | 1.2984 2.9% 0.4% | 1.3016 2.7% -0.2% | 1.3036 2.5% -0.2% |
| JPY/ 77.62 0.4% | 77.9155 -0.4% -0.4% | 77.9865 -0.5% -0.1% | 78.0345 -0.5% -0.1% | 77.9070 -0.4% 0.2% | 77.72 -0.1% 0.2% |
| CHF/ 0.9240 -0.5% | 0.9369 -1.4% -1.4% | 0.9458 -2.4% -0.9% | 0.9533 -3.2% -0.8% | 0.9402 -1.8% 1.4% | 0.9364 -1.3% 0.4% |
| CHF/ EUR 1.2362 -0.1% | 1.2359 0.0% 0.0% | 1.2327 0.3% 0.3% | 1.2378 -0.1% -0.4% | 1.2237 1.0% 1.1% | 1.2207 1.2% 0.2% |
| USD/ 1.021 0.9794 0.0% | 1.0075 0.9926 -1.3% -1.3% | 1.0020 0.998 -1.9% -0.5% | 0.9908 1.0093 -3.1% -1.1% | 0.9924 1.0077 -2.9% 0.2% | 0.996 1.004 -2.5% 0.4% |
| 10 Year 2.065 | 2.01 | 1.97 | 1.90 | 1.91 | 1.847 |
| 2 Year T Note 0.226 | 0.22 | 0.23 | 0.24 | 0.24 | 0.226 |
| German Bond 2Y 0.32 10Y 2.15 | 2Y 0.25 10Y 2.02 | 2Y 0.28 10Y 2.03 | 2Y 0.28 10Y 1.92 | 2Y 0.26 10Y 1.95 | 2Y 0.22 10Y 1.85 |
| DJIA 12184.26 1.4% | 12021.39 -1.3% -1.3% | 11954.94 -1.9% -0.6% | 11823.48 -3.0% -1.1% | 11868.81 -2.6% 0.4% | 11866.39 -2.6% 0.0% |
| DJ Global 1830.78 -0.3% | 1796.26 -1.9% -1.9% | 1776.60 -2.9% -1.1% | 1748.36 -4.5% -1.6% | 1751.90 -4.3% 0.3% | 1751.60 -4.3% 0.0% |
| DJ Asia Pacific 1176.56 -2.0 | 1180.45 0.3% 0.3% | 1168.34 -0.7% -1.0% | 1157.63 -1.6% -0.9% | 1140.21 -3.1% -1.5% | 1148.37 -2.4% 0.7% |
| Nikkei 8536.46 -1.3% | 8653.82 1.4% 1.4% | 8552.81 0.2% -1.2% | 8519.13 -0.2% -0.4% | 8377.37 -1.9% -1.7% | 8401.72 -1.6% 0.3% |
| Shanghai 2315.27 -1.9% | 2291.54 -1.0% -1.0% | 2248.59 -2.9% -1.9% | 2228.53 -3.7% -0.9% | 2180.90 -5.8% -2.1% | 2224.84 -3.9% 2.0% |
| DAX 5986.71 -1.5% | 5785.43 -3.4% -3.4% | 5774.26 -3.5% -0.2% | 5675.14 -5.2% -1.7% | 5730.62 -4.3% 1.0% | 5701.78 -4.8% -0.5% |
| DJ UBS Comm. 142.98 -2.3% | 140.77 -1.5% -1.6% | 141.64 -0.9% 0.6% | 136.53 -4.5% -3.6% | 136.26 -4.7% -0.2% | 137.01 -4.2% 0.5% |
| WTI $ B 99.73 -1.2% | 98.02 -1.7% -1.7% | 99.98 0.3% 2.0% | 94.910 -4.8% -5.1% | 93.870 -5.9% -1.1% | 94.02 -5.7% 0.2% |
| Brent $ B 108.8 -1.2% | 107.36 -1.3% -1.3% | 109.39 0.5% 1.9% | 104.80 -3.7% -4.2% | 103.20 -5.1% -1.5% | 103.72 -4.7% 0.5% |
| Gold $/OZ 1715.2 -1.9% | 1669.8 -2.6% -2.6% | 1634.1 -4.7% -2.1% | 1579.0 -7.9% -3.4% | 1572.8 -8.3% -0.4% | 1599.9 -6.7% 1.7% |
Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss
Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce
Sources: http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
The flow of cash from safe havens to risk financial assets is processed by carry trades from zero interest rates that are frustrated by episodes of risk aversion or encouraged with return of risk appetite. Factors of risk appetite and risk aversion during the week of Dec 2 are important in understanding the financial environment before the meeting of European leaders on Dec 9. The frustration with the lack of evident resolution of the European sovereign debt crisis caused renewed risk aversion in the week of Dec 16.
· Bank Fears. European sovereign risk crises are closely linked to the exposures of regional banks to government debt. An important form of financial repression consists of changing the proportions of debt held by financial institutions toward higher shares in government debt. The financial history of Latin America, for example, is rich in such policies. Bailouts in the euro zone have sanctioned “bailing in” the private sector, which means that creditors such as banks will participate by “voluntary” reduction of the principal in government debt (see Pelaez and Pelaez, International Financial Architecture (2005), 163-202). David Enrich, Sara Schaeffer Muñoz and Patricia Knowsmann, writing on “European nations pressure own banks for loans,” on Nov 29, 2011, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204753404577066431341281676.html?mod=WSJPRO_hpp_MIDDLETopStories), provide important data and analysis on the role of banks in the European sovereign risk crisis. They assemble data from various sources showing that domestic banks hold 16.2 percent of Italy’s total government securities outstanding of €1,617.4 billion, 22.9 percent of Portugal’s total government securities of €103.9 billion and 12.3 percent of Spain’s total government securities of €535.3 billion. Capital requirements force banks to hold government securities to reduce overall risk exposure in balance sheets. Enrich, Schaeffer Muñoz and Knowsmann find information that governments are setting pressures on banks to acquire more government debt or at least to stop selling their holdings of government debt.
· Bond Auctions. An important inflexion occurred on Nov 29. Jack Farchy, writing on “Italian bond sale boosts stock rally,” on Nov 29, 2011, published in the Financial Times (http://www.ft.com/intl/cms/s/0/2168664e-196b-11e1-92d8-00144feabdc0.html#axzz1f5gvxb00), informs on the boost to stock markets from the placement by Italy of the auction of €7.5 billion of bonds. Although the yields of 7.89 percent for three-year bonds and 7.56 percent for ten-year bonds were above the fear level of 7.0 percent, the euro gained 0.7 percent and stock markets rose. Success in the auction of bonds by Spain was an important turning point in the week of Dec 16. Emese Bartha , writing on Dec 15, on “Spain bonds sale goes smoothly,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204026804577099920841452332.html?mod=WSJPRO_hpp_LEFTTopStories), analyzes the strong demand for Spanish sovereign bonds. The target for the auction was to place between €2.5 and €3.5 billion of bonds maturing in Jan 2016 with coupon of 3.15 percent, bonds maturing in Apr 2020 with coupon of 4 percent and bonds maturing in Apr 2021 with coupon of 5.5 percent. Bartha informs that Spain placed bonds in value of €6.028 billion, around USD 7.83 billion. The bids reached €11.214 billion, or ratio of bids to actual sales of 1.86. Borrowing costs remained high with yield of 4.023 percent for the Jan 16 bonds versus 5.276 percent on Dec 1. Bloomberg finds yield of 0.56 percent for the four-year government bond of Germany and 0.81 percent for the five-year bond on Fri Dec 16 (http://www.bloomberg.com/markets/rates-bonds/government-bonds/germany/). An important objective of the creation of the European Monetary Union (EMU) or euro zone was to lower borrowing costs throughout the members toward the yields of German bonds. Risk spreads of countries under sovereign risk pressure relative to yields of German government bonds have swelled to records in the history of the EMU.
· China Lowers Reserve Requirements. Yajun Zhang and Prudence Ho, writing on “China cuts reserve requirement ratio,” on Nov 30, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204012004577069804232647954.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the People’s Bank of China (PBOC), or Chinese central bank, announced the reduction of the reserve requirement of banks by 0.50 percentage points effective Dec 5. This is the first such reduction since Dec 2008. The PBOC increased the reserve requirement six times in 2011 and increased deposit rates five times since Oct 2010. Market participants are more hopeful that China will attain the elusive soft landing to lower inflation but with economic growth.
· Central Bank Dollar Swaps. The biggest boost to financial markets was provided by the return of central bank dollar swaps that were used during the financial crisis. The objective of the measure is to prevent deterioration of financial markets that could worsen the European sovereign debt crisis. The statement by the Federal Reserve is as follows (http://www.federalreserve.gov/newsevents/press/monetary/20111130a.htm):
“The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing coordinated actions to enhance their capacity to provide liquidity support to the global financial system. The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.
These central banks have agreed to lower the pricing on the existing temporary U.S. dollar liquidity swap arrangements by 50 basis points so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 50 basis points. This pricing will be applied to all operations conducted from December 5, 2011. The authorization of these swap arrangements has been extended to February 1, 2013. In addition, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank will continue to offer three-month tenders until further notice.
As a contingency measure, these central banks have also agreed to establish temporary bilateral liquidity swap arrangements so that liquidity can be provided in each jurisdiction in any of their currencies should market conditions so warrant. At present, there is no need to offer liquidity in non-domestic currencies other than the U.S. dollar, but the central banks judge it prudent to make the necessary arrangements so that liquidity support operations could be put into place quickly should the need arise. These swap lines are authorized through February 1, 2013.
Federal Reserve Actions
The Federal Open Market Committee has authorized an extension of the existing temporary U.S. dollar liquidity swap arrangements with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank through February 1, 2013. The rate on these swap arrangements has been reduced from the U.S. dollar OIS rate plus 100 basis points to the OIS rate plus 50 basis points. In addition, as a contingency measure, the Federal Open Market Committee has agreed to establish similar temporary swap arrangements with these five central banks to provide liquidity in any of their currencies if necessary. Further details on the revised arrangements will be available shortly.
U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets. However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses.“
· European Central Bank. The European Central Bank (ECB) has been pressured to assist in the bailouts by acquiring sovereign debts. The ECB has been providing liquidity lines to banks under pressure and has acquired sovereign debts but not in the scale desired by authorities. In an important statement to the European Parliament, the President of the ECB Mario Draghi (2011Dec1) opened the possibility of further ECB actions but after a decisive “fiscal compact:”
“What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.
Just as we effectively have a compact that describes the essence of monetary policy – an independent central bank with a single objective of maintaining price stability – so a fiscal compact would enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively.
We might be asked whether a new fiscal compact would be enough to stabilise markets and how a credible longer-term vision can be helpful in the short term. Our answer is that it is definitely the most important element to start restoring credibility.
Other elements might follow, but the sequencing matters. And it is first and foremost important to get a commonly shared fiscal compact right. Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term. After all, investors are themselves often taking decisions with a long time horizon, especially with regard to government bonds.
A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations.”
· French and Spanish Bond Auctions. Jack Farchy, writing on “French and Spanish auctions calm nerves,” on Dec 1, 2011, published in the Financial Times (http://www.ft.com/intl/cms/s/0/2168664e-196b-11e1-92d8-00144feabdc0.html#axzz1fIVz4kv1), analyzes the significant improvement in bond markets. Yields of government bonds of “peripheral countries” fell significantly and the yields of Italian government bonds fell below 7 percent. Spain placed the auction of €3.75 billion of government bonds and France placed €4.35 billion of government bonds.
· Brazilian Interest Rate Cut. The Banco Central do Brasil, Brazil’s central bank, lowered its policy rate SELIC for the third consecutive meeting of its monetary policy committee, COPOM (http://www.bcb.gov.br/textonoticia.asp?codigo=3268&IDPAI=NEWS):
“Copom reduces the Selic rate to 11.00 percent · 30/11/2011 7:47:00 PM
Brasília - Continuing the process of adjustment of monetary conditions, the Copom unanimously decided to reduce the Selic rate to 11.00 percent, without bias.
The Copom understands that, by promptly mitigating the effects stemming from a more restrictive global environment, a moderate adjustment in the basic rate level is consistent with the scenario of inflation convergence to the target in 2012.”
A worldwide easing movement by central banks contributed to the boom in valuation of risk financial assets. Much depends on the insistence of strong fiscal measures that were announced in the meeting of European leaders on Dec 9 but with doubts on implementation and effectiveness in the week of Dec 16.
The combination of these policies explains the surge of valuations of risk financial assets in the weeks of Dec 2 and Dec 9. Table III-1 shows mixed valuations of risk financial assets in the week of Dec 16. Risk aversion returned in the earlier three weeks because of the uncertainties on rapidly moving political development in Greece, Italy, Spain and perhaps even in France and Germany. Most currency movements in Table III-1 reflect increasing risk aversion because of doubts on the success of the new agreement on Europe reached in the week of Dec 9. The dollar appreciated in the week of Dec 16 after virtually no change in the prior week. Safe-haven currencies, such as the Swiss franc (CHF) and the Japanese yen (JPY) have been under threat of appreciation. A characteristic of the global recession would be struggle for maintaining competitiveness by policies of regulation, trade and devaluation (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation War (2008c)). Appreciation of the exchange rate causes two major effects on Japan.
1. Trade. Consider an example with actual data (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 70-72). The yen traded at JPY 117.69/USD on Apr 2, 2007 and at JPY 102.77/USD on Apr 2, 2008, or appreciation of 12.7 percent. This meant that an export of JPY 10,000 to the US sold at USD 84.97 on Apr 2, 2007 [(JPY 10,000)/(USD 117.69/USD)], rising to USD 97.30 on Apr 2, 2008 [(JPY 10,000)/(JPY 102.77)]. If the goods sold by Japan were invoiced worldwide in dollars, Japanese’s companies would suffer a reduction in profit margins of 12.7 percent required to maintain the same dollar price. An export at cost of JPY 10,000 would only bring JPY 8,732 when converted at JPY 102.77 to maintain the price of USD 84.97 (USD 84.97 x JPY 102.77/USD). If profit margins were already tight, Japan would be uncompetitive and lose revenue and market share. The pain of Japan from dollar devaluation is illustrated by Table 58 in the Nov 6 comment of this blog (http://cmpassocregulationblog.blogspot.com/2011/10/slow-growth-driven-by-reducing-savings.html): The yen traded at JPY 110.19/USD on Aug 18, 2008 and at JPY 75.812/USD on Oct 28, 2011, for cumulative appreciation of 31.2 percent. Cumulative appreciation from Sep 15, 2010 (JPY 83.07/USD) to Oct 28, 2011 (JPY 75.812) was 8.7 percent.
2. Foreign Earnings and Investment. Consider the case of a Japanese company receiving earnings from investment overseas. Accounting the earnings and investment in the books in Japan would also result in a loss of 12.7 percent. Accounting would show fewer yen for investment and earnings overseas.
There is a point of explosion of patience with dollar devaluation and domestic currency appreciation. Andrew Monahan, writing on “Japan intervenes on yen to cap sharp rise,” on Oct 31, 2011, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204528204577009152325076454.html?mod=WSJPRO_hpp_MIDDLETopStories), analyzes the intervention of the Bank of Japan, at request of the Ministry of Finance, on Oct 31, 2011. Traders consulted by Monahan estimate that the Bank of Japan sold JPY 7 trillion, about $92.31 billion, against the dollar, exceeding the JPY 4.5 trillion on Aug 4, 2011. The intervention caused an increase of the yen rate to JPY 79.55/USD relative to earlier trading at a low of JPY 75.31/USD. The JPY appreciated to JPY76.88/USD by Fri Nov 18 for cumulative appreciation of 3.4 percent from JPY 79.55 just after the intervention. The JPY appreciated another 0.3 percent in the week of Nov 18 but depreciated 1.1 percent in the week of Nov 25. There was mild depreciation of 0.3 percent in the week of Dec 2 that was followed by appreciation of 0.4 percent in the week of Dec 9. The JPY was virtually unchanged in the week of Dec 16 with depreciation of 0.1 percent. Historically, interventions in yen currency markets have been unsuccessful (Pelaez and Pelaez, The Global Recession Risk (2007), 107-109). Interventions are even more difficult currently with daily trading of some $4 trillion in world currency markets. Risk aversion with zero interest rates in the US diverts hot capital movements toward safe-haven currencies such as Japan, causing appreciation of the yen. Mitsuru Obe, writing on Nov 25, on “Japanese government bonds tumble,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204452104577060231493070676.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the increase in yields of the Japanese government bond with 10 year maturity to a high for one month of 1.025 percent at the close of market on Nov 25. Thin markets in after-hours trading may have played an important role in this increase in yield but there may have been an effect of a dreaded reduction in positions of bonds by banks under pressure of reducing assets. The report on Japan sustainability by the IMF (2011JSRNov23, 2), analyzes how rising yields could threaten Japan:
· “As evident from recent developments, market sentiment toward sovereigns with unsustainably large fiscal imbalances can shift abruptly, with adverse effects on debt dynamics. Should JGB yields increase, they could initiate an adverse feedback loop from rising yields to deteriorating confidence, diminishing policy space, and a contracting real economy.
· Higher yields could result in a withdrawal of liquidity from global capital markets, disrupt external positions and, through contagion, put upward pressure on sovereign bond yields elsewhere.”
Exchange rate controls by the Swiss National Bank (SNB) fixing the rate at a minimum of CHF 1.20/EUR (http://www.snb.ch/en/mmr/reference/pre_20110906/source/pre_20110906.en.pdf) has prevented flight of capital into the Swiss franc. The Swiss franc depreciated 1.3 percent relative to the USD in the week of Dec 16 and depreciated 1.2 percent relative to the euro, as shown in Table III-1. Risk aversion is evident in the depreciation of the Australian dollar by cumulative 2.5 percent in the week of Fr Dec 16 after no change in the week of Dec 9. Risk appetite would be revealed by carry trades from zero interest rates in the US and Japan into high yielding currencies such as in Australia with appreciation of the Australian dollar (see Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 202-4, Pelaez and Pelaez, Government Intervention in Globalization (2008c), 70-4).
Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Increasing risk aversion is captured by decrease of the yield of the 10-year Treasury note from 2.326 percent on Oct 28 to 1.964 percent on Fri Nov 25 and 2.065 on Dec 9 and collapse to 1.847 percent by Fr Dec 16. The 10-year Treasury yield is still at a level well below consumer price inflation of 3.4 percent in the 12 months ending in Nov (http://www.bls.gov/cpi/). Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury with stable low yield of 0.226 percent on Dec 16. Investors are willing to sacrifice yield relative to inflation in defensive actions to avoid turbulence in valuations of risk financial assets but may be managing duration more carefully. During the financial panic of Sep 2008, funds moved away from risk exposures to government securities.
A similar risk aversion phenomenon occurred in Germany. The estimate of euro zone CPI inflation is at 3.0 percent for the 12 months ending in Nov (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-15122011-AP/EN/2-15122011-AP-EN.PDF) but the yield of the two-year German government bond fell from 0.32 percent on Dec 9 to 0.22 percent on Dec, virtually equal to the yield of the two-year Treasury note of the US. The yield of the 10-year German government bond was also collapsed from 2.15 percent on Dec 9 to 1.85 percent on Dec 16, also virtually equal to the 1.847 yield of the US 10-year Treasury note. Safety overrides inflation-adjusted yield but there could be duration aversion. Turbulence has also affected the market for German sovereign bonds. Emese Bartha, Art Patnaude and Nick Cawley, writing on “German bond auction falls flat,” on Nov 23, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204630904577055590007145230.html?mod=WSJPRO_hpp_LEFTTopStories), find decrease in risk appetite even for the highest quality financial assets in the euro zone. The auction of €6 billion of 10-year bunds on Nov 23 placed only €3.664 billion, or 60.7 percent. Although inflation of consumer prices in the UK at 5.0 percent exceeds euro zone inflation at 3.0 percent, David Oakley, Tracy Alloway, Alex Barker and Gerrit Wiesmann, writing on “UK borrowing costs drop below Germany,” on Nov 24, published in the Financial Times (http://www.ft.com/intl/cms/s/0/78994200-15c2-11e1-8db8-00144feabdc0.html#axzz1eWzvlRSp), inform that on Thu Nov 24 the UK 10-year gilt traded at 2.20 percent, which was lower than the yield of 2.23 percent of the German 10-year bond. Richard Milne, writing on “Italian bond yields rise above 8%,” on Nov 25, published in the Financial Times (http://www.ft.com/intl/cms/s/0/07079856-1754-11e1-b20e-00144feabdc0.html#axzz1eoXVrMVL), provides a quote of 8.13 percent for two-year Italian government bonds registered by Reuters’ data.
All the equity indexes in Table III-1 fell during the week of Dec 9. Germany’s Dax rose 1.0 percent on Thu Dec 15 but still ended down by 4.8 percent. Dow Global rose 0.3 percent on Thu Dec 15 but was still down 4.3 percent in the week. DJIA gained 1.4 percent in the week of Dec 9 but lost 2.6 percent in the week of Dec 16.
Financial risk assets increase during moderation of risk aversion in carry trades from zero interest rates and fall during increasing risk aversion. Commodities fell together with most equity indexes. The DJ-UBS commodities index lost 4.2 percent in the week of Dec 16, Brent fell 4.7 percent and WTI fell 5.7 percent. Gold also declined 6.7 percent in the week of Dec 16.
IB Fiscal Compact. There are three types of actions in Europe to steer the euro zone away from the threats of fiscal and banking crises: (1) fiscal compact; (2) enhancement of stabilization tools and resources; and (3) bank capital requirements. The first two consist of agreements by the Euro Area Heads of State and government while the third one consists of measurements and recommendations by the European Banking Authority.
1. Fiscal Compact. The “fiscal compact” consists of (1) conciliation of fiscal policies and budgets within a “fiscal rule”; and (2) establishment of mechanisms of governance, monitoring and enforcement of the fiscal rule.
i. Fiscal Rule. The essence of the fiscal rule is that “general government budgets shall be balanced or in surplus” by compliance of members countries that “the annual structural deficit does not exceed 0.5% of nominal GDP” (European Council 2011Dec9, 3). Individual member states will create “an automatic correction mechanism that shall be triggered in the event of deviation” (European Council 2011Dec9, 3). Member states will define their automatic correction mechanisms following principles proposed by the European Commission. Those member states falling into an “excessive deficit procedure” will provide a detailed plan of structural reforms to correct excessive deficits. The European Council and European Commission will monitor yearly budget plans for consistency with correction of excessive deficits. Member states will report in anticipation their debt issuance plans. Deficits in excess of 3 percent of GDP and/or debt in excess of 60 percent of GDP will trigger automatic consequences.
ii. Policy Coordination and Governance. The euro area is committed to following common economic policy. In accordance, “a procedure will be established to ensure that all major economic policy reforms planned by euro area member states will be discussed and coordinated at the level of the euro area, with a view to benchmarking best practices” (European Council 2011Dec9, 5). Governance of the euro area will be strengthened with regular euro summits at least twice yearly.
2. Stabilization Tools and Resources. There are several enhancements to the bailouts of member states.
i. Facilities. The European Financial Stability Facility (EFSF) will use leverage and the European Central Bank as agent of its market operations. The European Stability Mechanism (ESM) or permanent bailout facility will be operational as soon as 90 percent of the capital commitments are ratified by member states. The ESM is planned to begin in Jul 2012.
ii. Financial Resources. The overall ceiling of the EFSF/ESM of €500 billion (USD 670 billion) will be reassessed in mar 2012. Measures will be taken to maintain “the combined effective lending capacity of EUR 500 billion” (European Council 2011Dec9, 6). Member states will “consider, and confirm within 10 days, the provision of additional resources for the IMF of up to EUR 200 billion (USD 270 billion), in the form of bilateral loans, to ensure that the IMF has adequate resources to deal with the crisis. We are looking forward to parallel contributions from the international community” (European Council 2011Dec9, 6). Bailouts “will strictly adhere to the well established IMF principles and practices.” There is a specific statement on private sector involvement and its relation to recent experience: “We clearly reaffirm that the decisions taken on 21 July and 26/27 October concerning Greek debt are unique and exceptional; standardized and identical Collective Action clauses will be included, in such a way as to preserve market liquidity, in the terms and conditions of all new euro government bonds” (European Council 2011Dec9, 6). Will there be again “unique and exceptional” conditions? The ESM is authorized to take emergency decisions with “a qualified majority of 85% in case the Commission and the ECB conclude that an urgent decision related to financial assistance is needed when the financial and economic sustainability of the euro area is threatened” (European Council 2011Dec9, 6).
3. Bank Capital. The European Banking Authority (EBA) finds that European banks have a capital shortfall of €114.7 billion (http://stress-test.eba.europa.eu/capitalexercise/Press%20release%20FINAL.pdf). To avoid credit difficulties, the EBA recommends “that the credit institutions build a temporary capital buffer to reach a 9% Core Tier 1 ratio by 30 June 2012” (http://stress-test.eba.europa.eu/capitalexercise/EBA%20BS%202011%20173%20Recommendation%20FINAL.pdf 6). Patrick Jenkins, Martin Stabe and Stanley Pignal, writing on Dec 9, 2011, on “EU banks slash sovereign holdings,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/a6d2fd4e-228f-11e1-acdc-00144feabdc0.html#axzz1gAlaswcW), analyze the balance sheets of European banks released by the European Banking Authority. They conclude that European banks have reduced their holdings of riskier sovereign debt of countries in Europe by €65 billion from the end of 2010 to Sep 2011. Bankers informed that the European Central Bank and hedge funds acquired those exposures that represent 13 percent of their holdings of debt to Greece, Ireland, Italy, Portugal and Spain, which are down to €513 billion by the end of IIIQ2011.
IIIC European Central Bank. In the introductory statement to the press conference following the regularly-scheduled meeting of the European Central Bank (ECB), Draghi (2011Dec8) explains the decision to lower the policy rate (see also Draghi 2011Dec15):
“Based on its regular economic and monetary analyses, the Governing Council decided to lower the key ECB interest rates by 25 basis points, following the 25 basis point decrease on 3 November 2011. Inflation is likely to stay above 2% for several months to come, before declining to below 2%. The intensified financial market tensions are continuing to dampen economic activity in the euro area and the outlook remains subject to high uncertainty and substantial downside risks. In such an environment, cost, wage and price pressures in the euro area should remain modest over the policy-relevant horizon. At the same time, the underlying pace of monetary expansion remains moderate. Overall, it is essential for monetary policy to maintain price stability over the medium term, thereby ensuring a firm anchoring of inflation expectations in the euro area in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. Such anchoring is a prerequisite for monetary policy to make its contribution towards supporting economic growth and job creation in the euro area.”
What markets awaited came in the weaker form of temporary liquidity measures instead of the expectation of more aggressive bond buying by the ECB (Draghi 2011Dec8). These measures are termed as “non-standard:” (1) longer-term refinancing transactions with maturity of 36 months with the option of repayment after a year; (2) extension of collateral to new asset-backed securities; (3) reduction of the reserve ratio from 2 to 1 percent; and (4) discontinuance of fine-tuning in the final day of the maintenance period. Draghi (2011Dec8) reaffirmed the need for strong fiscal measures or compact in the euro zone (see also Draghi 2011Dec15):
“Turning to fiscal policies, all euro area governments urgently need to do their utmost to support fiscal sustainability in the euro area as a whole. A new fiscal compact, comprising a fundamental restatement of the fiscal rules together with the fiscal commitments that euro area governments have made, is the most important precondition for restoring the normal functioning of financial markets. Policy-makers need to correct excessive deficits and move to balanced budgets in the coming years by specifying and implementing the necessary adjustment measures. This will support public confidence in the soundness of policy actions and thus strengthen overall economic sentiment.
To accompany fiscal consolidation, the Governing Council has repeatedly called for bold and ambitious structural reforms. Going hand in hand, fiscal consolidation and structural reforms would strengthen confidence, growth prospects and job creation. Key reforms should be immediately carried out to help the euro area countries to improve competitiveness, increase the flexibility of their economies and enhance their longer-term growth potential. Labour market reforms should focus on removing rigidities and enhancing wage flexibility. Product market reforms should focus on fully opening up markets to increased competition.”
Draghi (2011Dec15) analyzed clearly the use of conventional lender of last resort monetary policy as decided by the Governing Council of the European Central Bank (see also ECB 2011MB, 5-9):
“Therefore, the Governing Council last week decided on three other measures, each of which provides additional support in order to bring the necessary monetary policy impulse to the real economy.
The current package should be felt tangibly in the financial sector and the real economy over the coming weeks and months. Of course, it comes against strong headwinds generated by deleveraging.
We established very long-term refinancing operations with a maturity of three years. This duration is a novelty in ECB monetary policy operations.
The extension of central bank credit provision to very long maturities is meant to give banks a longer horizon in their liquidity planning. It helps them to avoid rebalancing the maturities of their assets and liabilities through a downscaling of longer-term lending. Incidentally, we want to make it absolutely clear that in the present conditions where systemic risk is seriously hampering the functioning of the economy, we see no stigma attached to the use of central banking credit provisions: our facilities are there to be used.
Banks will be able to refinance term lending with the Eurosystem and thus preserve their long-term exposures to the real economy. After the first year, banks will have the option to terminate the operation. So they can flexibly adapt to changing liquidity conditions and a normalising market environment.
Our second measure will allow banks to use loans as collateral with the Eurosystem, thereby unfreezing a large portion of bank assets. It should also provide banks with an incentive to abstain from curtailing credit to the economy and to avoid fire-sales of other assets on their balance sheets.
The goal of these measures is to ensure that households and firms – and especially small and medium-sized enterprises – will receive credit as effectively as possible under the current circumstances. Of course, we have to screen the collateral carefully so as to protect our balance sheet.
The third measure we announced last week is to reduce the required reserves ratio from 2% to 1%. This measure frees up liquidity of the banking sector by about 100 billion euro. Along with other measures, this reduction in the reserve requirements should, too, help revive money market activity and lending.
You will notice that I referred repeatedly to small and medium-sized enterprises. The reason for drawing your attention to these businesses is that they are a significant part of our economy, accounting for about 70% of employment in the euro area and 60% of the turnover of all firms. We believe that the measures introduced last Thursday will provide support for this sector and indirectly also support much-needed investment, growth and employment.“
Draghi (2011Dec15) analyzes the fiscal compact as follows:
“We have now begun the process of re-designing Europe’s fiscal framework on three fronts.
The first lies with the countries concerned: they have to put their policies back on a sound footing. I believe that they are now on the right track and they are right in implementing budgetary consolidation resolutely. The unavoidable short-term contraction may be mitigated by the return of confidence. But in the medium term, sustainable growth can be achieved only by undertaking deep structural reforms that have been procrastinated for too long.
The second pillar of a response to the crisis consists of a re-design of the fiscal governance in the euro area, what I called the fiscal compact. The fiscal compact is a fundamental restatement of the rules to which national budgetary policies ought to be subject so as to gain credibility beyond doubt.
Last week’s summit committed to enshrine these rules in the primary legislation. They will foresee that the annual structural deficit should not exceed 0.5% of nominal GDP. Euro area Member States will implement such a rule in their national legal frameworks at a constitutional level, so that it is possible to avoid excessive deficits before they arise, rather than trying to control them after they have emerged. Prevention is better than cure.
Rules will also foresee an automatic correction mechanism in case of deviation. Moreover, the leaders agreed on a numerical benchmark for annual debt reduction to bring down debt levels. They also agreed to sanctions that will apply automatically to euro area Member States in breach of the 3% reference value for deficits.
The European Court of Justice may be asked to verify the implementation of these rules at national level.
Taken together, I believe that these decisions are capable of making public finances in the euro area credibly robust.
But restoring financial markets’ confidence also requires that investors be reassured that government debt will always be repaid and timely serviced. Greece will remain a unique case, and a credible stabilisation mechanism, a firewall, will be in place and can be activated when needed subject to proper conditionality. The leaders unambiguously agreed to assess the adequacy of the firewall by next March. Its objective is to address the threats to financial stability, and especially the risk of contagion between different sovereign debt markets.
The leaders decided to deploy the leveraging of the European Financial Stability Facility (EFSF) at the earliest opportunity. At the same time they agreed that the EFSF’s successor, the European Stability Mechanism, should come into force by July 2012.
It is crucial that the EFSF be fully equipped and be made operational as soon as possible. With this goal in mind, last Thursday, the Governing Council decided that the ECB would stand ready to act with its technical infrastructure and know-how as an agent for the EFSF in carrying out its market operations.”
An important statement of Draghi (2011Dec15) focuses on the role of central banking: “You all know that the statutes of the ECB inherited this important principle and that central bank independence and the credible pursuit of price stability go hand in hand.”
IIID Euro Zone Survival Risk. Charles Forelle and Stephen Fidler, writing on Dec 10, 2011, on “Questions place EU pact,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203413304577087562993283958.html?mod=WSJPRO_hpp_LEFTTopStories#project%3DEUSUMMIT121011%26articleTabs%3Darticle), provide data, information and analysis of the agreement of Dec 9. There are multiple issues centering on whether investors will be reassured that the measures have reduced the risks of European sovereign obligations. While the European Central Bank has welcomed the measures, it is not yet clear of its future role in preventing erosion of sovereign debt values.
Another complicating factor is whether there will be further actions on sovereign debt ratings. On Dec 5, 2011, four days before the conclusion of the meeting of European leaders, Standard & Poor’s (2011Dec5) placed the sovereign ratings of 15 members of the euro zone on “CreditWatch with negative implications.” S&P finds five conditions that trigger the action: (1) worsening credit conditions in the euro area; (2) differences among member states on how to manage the debt crisis in the short run and on measures to move toward enhanced fiscal convergence; (3) household and government debt at high levels throughout large parts of the euro area; (4) increasing risk spreads on euro area sovereigns, including those with AAA ratings; and (5) increasing risks of recession in the euro zone. S&P also placed the European Financial Stability Facility (EFSF) in CreditWatch with negative implications (http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245325307963). On Dec 9, 2011, Moody’s Investors Service downgraded the ratings of the three largest French banks (http://www.moodys.com/research/Moodys-downgrades-BNP-Paribass-long-term-ratings-to-Aa3-concluding--PR_232989 http://www.moodys.com/research/Moodys-downgrades-Credit-Agricole-SAs-long-term-ratings-to-Aa3--PR_233004 http://www.moodys.com/research/Moodys-downgrades-Socit-Gnrales-long-term-ratings-to-A1--PR_232986 ).
The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the following Subsection IIID Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 16 the yield of the 2-year bond of the government of Greece was quoted above 108 percent. In contrast, the 2-year US Treasury note traded at 0.226 percent and the 10-year at 1.847 percent while the comparable 2-year government bond of Germany traded at 0.22 percent and the 10-year government bond of Germany traded at 2.1.85 percent (see Table III-1). There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt of 120 percent of GDP, which is the third largest in the world after the US and Japan. Appendix ID links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).
Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.
Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:
“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”
If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.
The prospects of survival of the euro zone are dire. Table III-2 is constructed with current IMF World Economic Outlook database for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2010.
Table III-2, World and Selected Regional and Country GDP and Fiscal Situation
| GDP 2010 | Primary Net Lending Borrowing | General Government Net Debt | |
| World | 62,911.2 | ||
| Euro Zone | 12,167.8 | -3.6 | 65.9 |
| Portugal | 229.2 | -6.3 | 88.7 |
| Ireland | 206.9 | -28.9 | 78.0 |
| Greece | 305.4 | -4.9 | 142.8 |
| Spain | 1,409.9 | -7.8 | 48.8 |
| Major Advanced Economies G7 | 31,716.9 | -6.5 | 76.5 |
| United States | 14,526.6 | -8.4 | 68.3 |
| UK | 2,250.2 | -7.7 | 67.7 |
| Germany | 3,286.5 | -1.2 | 57.6 |
| France | 2,562.7 | -4.9 | 76.5 |
| Japan | 5,458.8 | -8.1 | 117.2 |
| Canada | 1,577.0 | -4.9 | 32.2 |
| Italy | 2,055.1 | -0.3 | 99.4 |
| China | 5,878.3 | -2.3 | 33.8* |
| Cyprus | 23.2 | -5.3 | 61.6 |
*Gross Debt
Source: http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx
The data in Table III-2 are used for some very simple calculations in Table III-3. The column “Net Debt USD Billions” in Table III-3 is generated by applying the percentage in Table 2 column “General Government Net Debt % GDP 2010” to the column “GDP USD Billions.” The total debt of France and Germany in 2010 is $3853.5 billion, as shown in row “B+C” in column “Net Debt USD Billions” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $3531.6 billion. There is some simple “unpleasant bond arithmetic” in the two final columns of Table III-3. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $7385.1 billion, which would be equivalent to 126.3 percent of their combined GDP in 2010. Under this arrangement the entire debt of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 224 percent if including debt of France and 165 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks.
Table III-3, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %
| Net Debt USD Billions | Debt as % of Germany Plus France GDP | Debt as % of Germany GDP | |
| A Euro Area | 8,018.6 | ||
| B Germany | 1,893.0 | $7385.1 as % of $3286.5 =224.7% $5424.6 as % of $3286.5 =165.1% | |
| C France | 1,960.5 | ||
| B+C | 3,853.5 | GDP $5849.2 Total Debt $7385.1 Debt/GDP: 126.3% | |
| D Italy | 2,042.8 | ||
| E Spain | 688.0 | ||
| F Portugal | 203.3 | ||
| G Greece | 436.1 | ||
| H Ireland | 161.4 | ||
| Subtotal D+E+F+G+H | 3,531.6 |
Source: calculation with IMF data http://www.imf.org/external/pubs/ft/weo/2011/01/weodata/index.aspx
There is extremely important information in Table 4 for the current sovereign risk crisis in the euro zone. Table III-4 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Oct. German exports to other European Union members are 58.7 percent of total exports in Oct and 59.6 percent in Jan-Oct. Exports to the euro area are 39.0 percent in Oct and 40.0 percent in Jan-Oct. Exports to third countries are only 41.3 percent of the total in Oct and 40.4 percent in Jan-Oct. There is similar distribution for imports. Economic performance in Germany is closely related to its high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone.
Table III-4, Germany, Structure of Exports and Imports by Region, € Billions and ∆%
| Oct 2011 | 12 Months | Jan-Oct | Jan-Oct 2011/ | |
| Total | 89.2 | 3.8 | 881.1 | 12.5 |
| A. EU | 52.4 % 58.7 | 0.8 | 524.9 % 59.6 | 11.4 |
| Euro Area | 34.8 % 39.0 | -0.4 | 352.1 % 40.0 | 10.2 |
| Non-euro Area | 17.7 % 19.8 | 3.1 | 172.7 % 19.6 | 14.0 |
| B. Third Countries | 36.8 % 41.3 | 8.3 | 356.2 % 40.4 | 14.1 |
| Total Imports | 77.6 | 8.6 | 750.7 | 14.6 |
| C. EU Members | 49.2 % 63.4 | 7.3 | 475.9 % 63.4 | 15.1 |
| Euro Area | 33.8 % 43.6 | 6.1 | 334.2 % 44.5 | 14.3 |
| Non-euro Area | 15.4 % 19.9 | 10.2 | 141.6 % 18.9 | 17.1 |
| D. Third Countries | 28.5 % 36.7 | 10.9 | 274.9 % 36.6 | 13.8 |
Notes: Total Exports = A+B; Total Imports = C+D
IIIE Appendix on Sovereign Bond Valuation. There are two approaches to government finance and their implications: (1) simple unpleasant monetarist arithmetic; and (2) simple unpleasant fiscal arithmetic. Both approaches illustrate how sovereign debt can be perceived riskier under profligacy.
First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:
D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)
Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,
{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:
N(t+1) = (1+n)N(t), n>-1 (2)
The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:
B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)
On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.
Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (4)
Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+τ. The second equation of Cochrane (2011Jan, 5) is:
MtV(it, ·) = PtYt (5)
Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):
“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”
An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.
There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:
(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress
(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality
(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.
IV Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table IV-1 updated with every post, provides the latest annual 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 (Peter Spiegel and Quentin Peel, “Europe: Northern Exposures,” Financial Times, Mar 9, 2011 http://www.ft.com/intl/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1gAlaswcW). Newly available data on inflation is considered below in this section. The data in Table IV-1 for the euro zone and its members is updated from information provided by Eurostat but individual country information is provided in this section as soon as available, following Table IV-1. Data for other countries in Table IV-1 are also updated with reports from their statistical agencies. Economic data for major regions and countries is considered in Section VI World Economic Slowdown following with individual country and regional data tables.
Table IV-1, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 1.5 | 3.4 | 5.7 | 8.6 |
| Japan | -0.7 | -0.2 | 1.7 | 4.5 |
| China | 9.1 | 4.2 | 2.7 | |
| UK | 0.5 | 4.8* | 5.4* output | 8.3 |
| Euro Zone | 1.4 | 3.0 | 5.5 | 10.3 |
| Germany | 2.6 | 2.8 | 5.3 | 5.5 |
| France | 1.6 | 2.7 | 5.8 | 9.8 |
| Nether-lands | 1.1 | 2.7 | 6.8 | 4.8 |
| Finland | 2.7 | 3.2 | 5.8 | 7.8 |
| Belgium | 1.8 | 3.7 | 6.2 | 6.6 |
| Portugal | -1.7 | 3.8 | 5.5 | 12.9 |
| Ireland | NA | 1.7 | 4.4 | 14.3 |
| Italy | NA | 3.7 | 4.7 | 8.5 |
| Greece | -5.2 | 2.8 | 7.9 | 18.3 |
| Spain | 0.8 | 2.9 | 6.5 | 22.8 |
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.ons.gov.uk/ons/rel/ppi2/producer-price-index/november-2011/index.html
CPI http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/november-2011/index.html
**Excluding food, beverage, tobacco and petroleum
Source: EUROSTAT; country statistical sources http://www.census.gov/aboutus/stat_int.html
Table IV-1 shows the simultaneous occurrence of low growth, inflation and unemployment in advanced economies. The US grew at 1.5 percent in IIIQ2011 relative to IIIQ2010 (Table 8, p 11 in http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp3q11_2nd.pdf); Japan’s GDP fell 0.7 percent in IIIQ2011 relative to IIIQ2010 and contracted 1.7 percent in IIQ2011 relative to IIQ2010 because of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 but grew at the seasonally-adjusted annual rate (SAAR) of 5.6 percent in IIIQ2011 (http://www.esri.cao.go.jp/jp/sna/sokuhou/kekka/gaiyou/main_1.pdf and see historical data in IIIB at http://cmpassocregulationblog.blogspot.com/2011/12/euro-zone-survival-risk-world-financial_11.html); the UK grew at 0.5 percent in IIIQ2011 relative to IIIQ2010 (http://www.ons.gov.uk/ons/rel/naa2/second-estimate-of-gdp/q3-2011/stb---second-estimate-of-gdp-q3-2011.html); and the Euro Zone grew at 1.4 percent in IIIQ2011 relative to IIIQ2010 (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-06122011-AP/EN/2-06122011-AP-EN.PDF). These are stagnating or “growth recession” rates, which are positive growth rates instead of contractions but insufficient to recover employment. The rates of unemployment are quite high: 8.6 percent in the US but 18.2 percent for unemployment/underemployment (see Table 3 in http://cmpassocregulationblog.blogspot.com/2011/12/twenty-nine-million-in-job-stress.html), 4.5 percent for Japan, 8.3 percent for the UK with high rates of unemployment for young people (see the labor statistics of the UK in VH) and 10.3 percent in the Euro Zone. Twelve months rates of inflation have been quite high, even when some are moderating at the margin: 3.4 percent in the US, minus 0.2 percent for Japan, 3.0 percent for the Euro Zone and 4.8 percent for the UK. Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). 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 III in this post and the earlier post http://cmpassocregulationblog.blogspot.com/2011/12/euro-zone-survival-risk-world-financial.html) (2) the tradeoff of growth and inflation in China; (3) slow growth by repression of savings with de facto interest rate controls (http://cmpassocregulationblog.blogspot.com/2011/11/us-growth-standstill-falling-real.html), weak hiring (see Section I Recovery without Hiring, Section I Recovery without Hiring and http://cmpassocregulationblog.blogspot.com/2011/11/recovery-without-hiring-world-financial.html) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (see Section I Twenty Nine Million in Job Stress at http://cmpassocregulationblog.blogspot.com/2011/12/twenty-nine-million-in-job-stress.html); (4) the timing, dose, impact and instruments of normalizing monetary and fiscal policies (see II Budget/Debt Quagmire in http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html 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 Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 that had 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.
The Federal Open Market Committee (FOMC) did not change the course of monetary policy at its meeting on Dec 13 with the following statement (http://www.federalreserve.gov/newsevents/press/monetary/20111213a.htm):
“Information received since the Federal Open Market Committee met in November suggests that the economy has been expanding moderately, notwithstanding some apparent slowing in global growth. While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed. Inflation has moderated since earlier in the year, and longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.”
There were no changes of direction in the meeting of the Federal Open Market Committee (FOMC) from Nov 1 to Nov 2, 2011. The FOMC released the statement as follows (http://www.federalreserve.gov/newsevents/press/monetary/20111102a.htm):
“For immediate release
Information received since the Federal Open Market Committee met in September indicates that economic growth strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that had weighed on growth earlier in the year. Nonetheless, recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has increased at a somewhat faster pace in recent months. Business investment in equipment and software has continued to expand, but investment in nonresidential structures is still weak, and the housing sector remains depressed. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.”
The FOMC also released the economic projections of governors of the Board of Governors of the Federal Reserve and Federal Reserve Banks presidents shown in Table IV-2. It is instructive to focus on 2012, as 2011 is almost gone, and there is not much information on what will happen in 2013 and beyond. The central tendency should provide reasonable approximation of the view of the majority of members of the FOMC. The first row for each year shows the projection introduced after the meeting of Nov 2 and the second row “Jun PR” the projection of the Jun meeting. There are three major changes in the view.
1. Growth “GDP ∆.” The FOMC has reduced the forecast of GDP growth in 2012 from 3.3 to 3.7 percent in Jun to 2.5 to 2.9 percent in Nov.
2. Rate of Unemployment “UNEM%.” The FOMC increased the rate of unemployment from 7.8 to 8.2 percent in Jun to 8.5 to 8.7 percent in Nov.
3. Inflation “∆% PCE Inflation.” The FOMC changed the forecast of personal consumption expenditures (PCE) inflation from 1.5 to 2.0 percent in Jun to virtually the same of 1.4 to 2.0 percent in Nov.
Core Inflation “∆% Core PCE Inflation.” Core inflation is PCE inflation excluding food and energy. There is again not much of a difference of the projection for 2012 in Jun of 1.4 to 2.0 percent and the Nov projection of 1.5 to 2.0 percent.
Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, November 2011
| ∆% GDP | UNEM % | ∆% PCE Inflation | ∆% Core PCE Inflation | |
| Central | ||||
| 2011 | 1.6 – 1.7 | 9.0 – 9.1 | 2.7 – 2.9 | 1.8 – 1.9 |
| 2012 | 2.5 – 2.9 | 8.5 – 8.7 | 1.4 – 2.0 | 1.5 – 2.0 |
| 2013 | 3.0 – 3.5 3.5 – 4.2 | 7.8 – 8.2 | 1.5 – 2.0 | 1.4 – 1.9 |
| 2014 | 3.0 – 3.9 | 6.8 – 7.7 | 1.5 – 2.0 | 1.5 – 2.0 |
| Longer Run | 2.4 – 2.7 | 5.2 – 6.0 | 1.7 – 2.0 | |
| Range | ||||
| 2011 | 1.6 – 1.8 | 8.9 – 9.1 | 2.5 – 3.3 | 1.7 – 2.0 |
| 2012 | 2.3 – 3.5 | 8.1 – 8.9 | 1.4 – 2.8 | 1.3 – 2.1 |
| 2013 | 2.7 – 4.0 | 7.5 – 8.4 | 1.4 – 2.5 | 1.4 – 2.1 |
| 2014 | 2.7 – 4.5 | 6.5 – 8.0 | 1.5 – 2.4 | 1.4 – 2.2 |
| Longer Run | 2.2 – 3.0 | 5.0 – 6.0 | 1.5 – 2.0 |
Notes: UEM: unemployment; PR: Projection
Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20111102.pdf
There are two categories of responses in the Empire State Manufacturing Survey of the Federal Reserve Bank of New York (http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html): current conditions and expectations for the next six months. There are responses in the survey for two types of prices: prices received or inputs of production and prices paid or sales prices of products. Table IV-3 provides the responses and indexes for the two categories and within them for the two types of prices for May to Dec of 2011. Current prices paid were rising at an accelerating rate in May but the rate of increase has dropped significantly as shown by the decline in the index from 68.89 in May to 22.47 in Oct and 18.29 in Nov but with an increase to 24.42 in Dec. The index fell in every month from May to Aug and then again in Nov and Oct. The index of current prices received also fell sharply from 27.96 in May to 4.49 in Oct but rose to 6.10 in Nov to decline again in Dec to 3.49, meaning that prices are increasing at a moderate rate relative to May. Responses of no change in prices received dominate with 79.78 percent in Oct and 69.51 in Nov. In the expectations for the next six months, the index of prices paid also declined from 68.82 in May to 36.59 in Nov but rose to 56.98 in Dec with an increasing percentage of 59.30 percent of responses expecting rising prices. The index of expectations for the next six months of prices received has also fallen from 35.48 in May to 25.61 in Nov with 54.88 percent expecting no change in prices paid. In Dec, the index of prices paid rose again to 36.05 with 44.19 percent of respondents expecting price increases.
Table IV-3, US, FRBNY Empire State Manufacturing Survey, Prices Paid and Prices Received, SA
| Higher | Same | Lower | Index | |
| Current | ||||
| Prices Paid | ||||
| May | 69.89 | 30.11 | 0.00 | 69.89 |
| Jun | 58.16 | 39.80 | 2.04 | 56.12 |
| Jul | 47.78 | 47.78 | 4.44 | 43.33 |
| Aug | 34.78 | 58.70 | 6.52 | 28.26 |
| Sep | 34.78 | 63.04 | 2.17 | 32.61 |
| Oct | 29.21 | 64.04 | 6.74 | 22.47 |
| Nov | 26.83 | 64.63 | 8.54 | 18.29 |
| Dec | 29.07 | 66.28 | 4.65 | 24.42 |
| Prices Received | ||||
| May | 33.33 | 61.29 | 5.38 | 27.96 |
| Jun | 17.35 | 76.53 | 6.12 | 11.22 |
| Jul | 14.44 | 76.67 | 8.89 | 5.56 |
| Aug | 15.22 | 71.74 | 13.04 | 2.17 |
| Sep | 17.39 | 73.91 | 8.70 | 8.70 |
| Oct | 12.36 | 79.78 | 7.87 | 4.49 |
| Nov | 18.29 | 69.51 | 12.20 | 6.10 |
| Dec | 10.47 | 85.26 | 6.98 | 3.49 |
| Six Months | ||||
| Prices Paid | ||||
| May | 70.97 | 26.88 | 2.15 | 68.82 |
| Jun | 58.16 | 38.78 | 3.06 | 55.10 |
| Jul | 56.67 | 37.78 | 5.56 | 51.11 |
| Aug | 46.74 | 48.91 | 4.35 | 42.39 |
| Sep | 54.35 | 44.57 | 1.09 | 53.26 |
| Oct | 47.19 | 46.07 | 6.74 | 40.45 |
| Nov | 42.68 | 51.22 | 6.10 | 36.59 |
| Dec | 59.30 | 38.37 | 2.33 | 56.98 |
| Prices Received | ||||
| May | 40.86 | 53.76 | 5.38 | 35.48 |
| Jun | 30.61 | 58.16 | 11.22 | 19.39 |
| Jul | 38.89 | 52.22 | 8.89 | 30.00 |
| Aug | 23.91 | 67.39 | 8.70 | 15.22 |
| Sep | 33.70 | 55.43 | 10.87 | 22.83 |
| Oct | 28.09 | 61.80 | 10.11 | 17.98 |
| Nov | 35.37 | 54.88 | 9.76 | 25.61 |
| Dec | 44.19 | 47.67 | 8.14 | 36.05 |
Source: http://www.newyorkfed.org/survey/empire/dec2011.pdf
http://www.newyorkfed.org/survey/empire/nov2011.pdf
http://www.newyorkfed.org/survey/empire/sep2011.pdf
http://www.newyorkfed.org/survey/empire/july2011.pdf
http://www.newyorkfed.org/survey/empire/aug2011.pdf
Current prices for the Dec survey the Business Outlook index of the Federal Reserve Bank of Philadelphia in Table IV-4 are showing increases. Prices paid increased from 20.0 in Oct to 22.8 in Nov and 33.7 in Dec while prices received moved from contraction territory of minus 2.5 in Oct to 2.6 in Nov and 12.0 in Dec. The expectation for the next six months shows decline of prices paid from 44.7 in Oct to 40.9 in Nov but then an increase to 51.2 in Dec. The expectation for the next six months shows prices received increasing from 25.4 in Oct to 29.7 in Nov but then falling to 26.0 in Dec.
Table IV-4, US, FRB of Philadelphia Business Outlook Survey, Prices Paid and Prices Received, SA
| Increase | No Change | Decrease | Index | |
| Current | ||||
| Prices Paid | ||||
| Dec | 40.8 | 52.1 | 7.1 | 33.7 |
| Nov | 31.4 | 56.3 | 8.5 | 22.8 |
| Oct | 30.6 | 58.1 | 10.6 | 20.0 |
| Sep | 28.9 | 58.1 | 5.7 | 23.2 |
| Aug | 26.1 | 59.4 | 13.3 | 12.8 |
| Jul | 32.6 | 59.9 | 7.5 | 25.1 |
| Jun | 36.6 | 49.6 | 9.8 | 26.8 |
| May | 56.3 | 35.6 | 8.0 | 48.3 |
| Prices Received | ||||
| Dec | 21.7 | 68.7 | 9.6 | 12.0 |
| Nov | 15.4 | 69.0 | 12.8 | 2.6 |
| Oct | 12.2 | 69.3 | 14.7 | -2.5 |
| Sep | 17.5 | 61.6 | 16.7 | 0.9 |
| Aug | 10.1 | 69.9 | 19.1 | -9.0 |
| Jul | 17.7 | 65.1 | 16.6 | 1.1 |
| Jun | 16.8 | 66.5 | 12.4 | 4.4 |
| May | 19.7 | 76.2 | 2.9 | 16.8 |
| Six Months | ||||
| Prices Paid | ||||
| Dec | 51.2 | 38.4 | 0.0 | 51.2 |
| Nov | 47.8 | 40.9 | 6.9 | 40.9 |
| Oct | 51.4 | 35.4 | 6.7 | 44.7 |
| Sep | 44.2 | 44.8 | 7.9 | 36.3 |
| Aug | 42.6 | 48.7 | 8.0 | 34.6 |
| Jul | 44.6 | 43.4 | 5.9 | 38.7 |
| Jun | 40.4 | 40.0 | 12.9 | 27.5 |
| May | 59.1 | 33.1 | 6.7 | 52.4 |
| Prices Received | ||||
| Dec | 32.9 | 55.1 | 6.9 | 26.0 |
| Nov | 37.5 | 52.5 | 7.7 | 29.7 |
| Oct | 34.3 | 48.9 | 8.9 | 25.4 |
| Sep | 27.6 | 56.5 | 9.4 | 18.2 |
| Aug | 30.1 | 54.6 | 13.6 | 16.5 |
| Jul | 22.5 | 61.4 | 14.2 | 8.3 |
| Jun | 19.3 | 56.0 | 16.7 | 2.5 |
| May | 34.9 | 53.2 | 7.6 | 27.3 |
http://www.phil.frb.org/research-and-data/regional-economy/business-outlook-survey/2011/bos1111.pdf
http://www.phil.frb.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdf
Inflation in advanced economies has been moderating at the producer price level with moderation of the commodity price shock. Table IV-5 provides the month and 12 months rates of inflation of Japan’s corporate goods price index (CGPI). Inflation measured by the CGPI increased 0.1 percent in Nov and increased 1.7 percent in 12 months. Measured by 12 months rates, CGPI inflation has increased from minus 0.2 percent in Jul 2010 to a high of 2.8 percent in Jul 2011 and now to much lower 1.7 percent in Nov. At the margin, annual equivalent inflation in the quarter Jul to Nov 2011 is minus 1.9 percent compared with annual equivalent inflation in Jan-Apr 2011 of 7.2 percent. Annual equivalent inflation in May-Jun 2011 was minus 1.2 percent. Moderation of commodity price increases after May 2011 has caused collapse of monthly inflation toward zero or less with 0.1 percent in Nov. The CGPI of Japan follows the same pattern of inflation waves. Inflation was relatively high in the first four months of 2011 driven by the carry trade from zero interest rates to commodity futures and other risk financial assets. Risk aversion influenced by the European sovereign debt crisis after May caused reversal of long positions in commodity futures and other risk financial assets.
Table IV-5, Japan Corporate Goods Price Index (CGPI) ∆%
| Month | Year | |
| Nov 2011 | 0.1 | 1.7 |
| Oct | -0.8 | 1.6 |
| Sep | -0.1 | 2.5 |
| Aug | -0.2 | 2.6 |
| Jul | 0.2 | 2.8 |
| AE ∆% Jul-Nov | -1.9 | |
| Jun | 0.0 | 2.5 |
| May | -0.2 | 2.2 |
| AE ∆% May-Jun | -1.2 | |
| Apr | 1.0 | 2.6 |
| Mar | 0.6 | 2.0 |
| Feb | 0.1 | 1.7 |
| Jan | 0.6 | 1.6 |
| AE ∆% Jan-Apr | 7.1 | |
| Dec 2010 | 0.4 | 1.2 |
| Nov | 0.0 | 0.9 |
| Oct | 0.2 | 0.9 |
| Sep | 0.0 | -0.1 |
| Aug | 0.0 | 0.0 |
| Jul | -0.1 | -0.2 |
| Fiscal Year | ||
| 2010 | -0.1 | |
| 2009 | -5.2 | |
| 2008 | 4.5 |
AE: annual equivalent
Source: http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1111.pdf
Further insight into inflation of the corporate goods price index (CGPI) of Japan is provided in Table IV-6. Manufactured products accounting for 91.9 percent of the products in the index were flat in Nov and increased 1.7 percent in 12 months. Petroleum and coal with weight of 5.4 percent rose 1.9 percent in Nov and increased 14.2 percent in 12 months. Japan exports manufactured products and imports raw materials and commodities such that the country’s terms of trade, or export prices relative to import prices, deteriorate during commodity price increases. In contrast, machinery and equipment, with weight of 10.8 percent, fell 0.3 percent in Nov and fell 0.7 percent in 12 months. In general, most manufactured products experienced negative increases in prices while inflation rates were high in 12 months for products originating in raw materials and commodities. Ironically, unconventional monetary policy of zero interest rates and quantitative easing deteriorated the terms of trade of advanced economies.
Table IV-6, Japan, Corporate Goods Prices and Selected Components, % Weights, Month and 12 Months ∆%
| Oct 2011 | Weight | Month ∆% | 12 Month ∆% |
| Total | 1000.0 | 0.1 | 1.7 |
| Mfg Industry Products | 918.8 | 0.0 | 1.4 |
| Processed | 114.5 | -0.1 | 0.5 |
| Petroleum & Coal | 53.8 | 1.9 | 14.2 |
| Machinery & Equipment | 108.4 | -0.3 | -0.7 |
| Electric & Electronic | 129.0 | -0.5 | -3.2 |
| Electric Power, Gas & Water | 46.5 | 0.8 | 8.9 |
| Iron & Steel | 52.6 | -0.6 | 3.4 |
| Chemicals | 85.2 | -0.2 | 3.9 |
| Transport | 10.6 | -0.2 | -0.6 |
Source: http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1111.pdf
Percentage point contributions to change of the corporate goods price index (CGPI) are provided in Table IV-7 divided into the domestic, export and import segments. Petroleum and coal contributed minus 0.13 percentage points to domestic CGPI inflation of 0.1 percent while agriculture, forestry & fishery contributed 0.05 percent. Electric power, gas and water contributed 0.04 percentage points. The exports CGPI fell 0.5 percent on the basis of the contract currency and increased 0.1 percent on the basis of the yen with negative contributions of 0.29 percentage chemicals and related products and 0.18 percentage points transportation equipment. The imports CGPI fell 0.9 percent on the contract currency basis and 0.0 percent on the yen basis. The most important contributions were minus 0.54 percentage points by petroleum, coal and natural gas, minus 0.13 percentage points by metals and related products and 0.11 percentage points other primary products and manufactured products.
Table IV-7, Japan, Percentage Point Contributions to Change of Corporate Goods Price Index
| Groups Oct 2011 | Contribution to Change Percentage Points |
| A. Domestic Corporate Goods Price Index | Monthly Change: |
| Petroleum & Coal | 0.13 |
| Agriculture, Forestry & Fishery | 0.05 |
| Electric Power, Gas & Water | 0.04 |
| Information & Telecommunication Equipment | -0.05 |
| Scrap & Waste | -0.05 |
| Iron & Steel | -0.03 |
| B. Export Price Index | Monthly Change: 0.1% Yen basis |
| Chemicals & Related Products | -0.29 |
| Transportation Equipment | -0.18 |
| Electric & Electronic Products | -0.07 |
| General Machinery & Equipment | -0.04 |
| Other Primary Products & Manufactured Goods | 0.08 |
| C. Import Price Index | Monthly Change: -0.9 % contract currency basis 0.0% Yen basis |
| Petroleum, Coal & Natural Gas | -0.54 |
| Metals & Related Products | -0.13 |
| Other Primary Products & Manufactured Products | -0.11 |
| Foodstuffs & Feedstuffs | -0.10 |
Source: http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1111.pdf
Inflation in the euro zone in Table IV-8 is following three waves. In the first wave, inflation rose in Jan-Apr toward 3 percent in 12 months, with 2.8 percent in the twelve months ending in Apr. Annual equivalent inflation in Jan-Apr was 5.2 percent. In the second wave, inflation in May-Jul was equivalent to minus 2.4 percent for a full year and the 12 months rate stabilized between 2.5 percent and 2.7 percent. In the third wave, inflation in Aug-Nov rose to 4.3 percent in annual equivalent and settled at 3.0 percent in the 12 months ending in Nov.
Table IV-8, Euro Area Harmonized Index of Consumer Prices Month and 12 Months ∆%
| Month ∆% | 12 Months ∆% | |
| Nov 2011 | 0.1 | 3.0 |
| Oct | 0.3 | 3.0 |
| Sep | 0.8 | 3.0 |
| Aug | 0.2 | 2.5 |
| Aug-Nov | 4.3 | |
| Jul | -0.6 | 2.5 |
| Jun | 0.0 | 2.7 |
| May | 0.0 | 2.7 |
| AE ∆% May-Jul | -2.4 | |
| Apr | 0.6 | 2.8 |
| Mar | 1.4 | 2.7 |
| Feb | 0.4 | 2.4 |
| Jan | -0.7 | 2.3 |
| AE ∆% Jan-Apr | 5.2 | |
| Dec 2010 | 0.6 | 2.2 |
AE: annual equivalent
Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-15122011-AP/EN/2-15122011-AP-EN.PDF
Inflation in the euro zone remained subdued below 2 percent in the first five years of the euro zone from 1999 to 2004, as shown in Table IV-9. Inflation climbed above 2.0 percent after 2005, peaking at 3.7 percent in 2008 with the surge in commodity prices but falling to 1.0 percent in 2009 with the collapse of commodity prices. Inflation climbed back above 2.1 percent in 2010 and 2011.
Table IV-9, Euro Area, Yearly Percentage Change of Harmonized Index of Consumer Prices, ∆%
| Year | ∆% |
| 1999 | 1.2 |
| 2000 | 1.9 |
| 2001 | 2.2 |
| 2002 | 2.1 |
| 2003 | 2.0 |
| 2004 | 2.0 |
| 2005 | 2.2 |
| 2006 | 2.2 |
| 2007 | 2.3 |
| 2008 | 3.7 |
| 2009 | 1.0 |
| 2010 | 2.1 |
Eurostat provides the decomposition in percentage point contributions of the rate of inflation in 12 months in Nov 2011 relative to Nov 2010 shown in Table IV-10. Energy-rich components account for the 12 month rate of inflation with percentage point contributions: 0.48 by fuel for transport, 0.22 by heating oil, 0.12 by gas and 0.12 by electricity. Table 19 only lists highest magnitudes of positive and negative contributions.
Table IV-10, Euro Area, Harmonized Index of Consumer Prices Sub-Indices with Most Important Impact %
| Nov 2011/ | Weight 2011 % | Rate ∆% | Impact |
| Positive Contribution | |||
| Fuel for Transport | 46.9 | 13.1 | 0.48 |
| Heating Oil | 9.5 | 26.7 | 0.22 |
| Gas | 16.7 | 10.2 | 0.12 |
| Electricity | 24.5 | 7.5 | 0.11 |
| Tobacco | 24.8 | 6.1 | 0.08 |
| Jewelry & Watches | 5.3 | 12.4 | 0.05 |
| Negative Contribution | |||
| Cars | 39.3 | 1.2 | -0.07 |
| IT Equipment | 5.0 | -10.7 | -0.07 |
| Restaurants & Cafés | 70.1 | 2.0 | -0.08 |
| Cars | 39.3 | 0.9 | -0.09 |
| Vegetables | 15.8 | -2.9 | -0.09 |
| Rents | 59.8 | 1.3 | -0.11 |
| Telecom | 30.1 | -1.9 | -0.15 |
PP: percentage points
Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-15122011-AP/EN/2-15122011-AP-EN.PDF
Eurostat provides the decomposition in percentage point contributions of the rate of inflation of 0.1 percent in Nov 2011 relative to Oct 2011 shown in Table IV-11. The largest positive contributions originated in 0.04 percentage points from inflation of vegetables and 0.04 percentage points from heating oil. Two items contributed 0.2 percentage points: fuel for transport and gardens/plants/flowers. Several categories experienced price declines.
Table IV-11, Euro Area, Harmonized Index of Consumer Prices Sub-Indices with Most Important Impact %
| Nov 2011/ | Weight 2011 % | Rate ∆% | Impact Percentage Points |
| Positive Contribution | |||
| Vegetables | 15.8 | 3.1 | 0.04 |
| Heating Oil | 9.5 | 3.8 | 0.04 |
| Fuel for Transport | 46.9 | 0.4 | 0.02 |
| Gardens, Plants & Flowers | 6.6 | 2.8 | 0.02 |
| Garments | 49.5 | 0.4 | 0.01 |
| Health Insurance | 6.4 | 1.9 | 0.01 |
| Negative Contribution | |||
| Recreational & Sporting Services | 10.7 | -0.4 | -0.01 |
| Pharmaceuticals | 12.5 | -0.9 | -0.01 |
| Cars | 39.3 | -0.4 | -0.02 |
| Air Transport | 5.8 | -5.2 | -0.03 |
| Package Holidays | 15.1 | -3.4 | -0.05 |
| Accommodation Services | 15.7 | -4.2 | -0.07 |
Source: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-15122011-AP/EN/2-15122011-AP-EN.PDF
Table IV-12 provides monthly and 12 months consumer price inflation in France. There are the same three waves as in inflation worldwide. In the first wave, annual equivalent inflation in Jan-Apr was 4.3 percent driven by the carry trade from zero interest rates to commodity futures positions in an environment of risk appetite. In the second wave, risk aversion caused the reversal of carry trades into commodity futures, resulting in the fall of the annual equivalent inflation rate to minus 1.2 percent in May-Jul. In the third wave, annual equivalent inflation rose to 3.0 percent in Aug-Nov with alternations of risk aversion and risk appetite.
Table IV-12, France, Consumer Price Index, Month and 12 Months ∆%
| Month | 12 Months | |
| Nov 2011 | 0.3 | 2.5 |
| Oct | 0.3 | 2.4 |
| Sep | -0.1 | 2.2 |
| Aug | 0.5 | 2.2 |
| AE ∆% Aug-Nov | 3.0 | |
| Jul | -0.5 | 1.9 |
| Jun | 0.1 | 2.1 |
| May | 0.1 | 2.0 |
| AE ∆% May-Jul | -1.2 | |
| Apr | 0.3 | 2.1 |
| Mar | 0.8 | 2.0 |
| Feb | 0.5 | 1.6 |
| Jan | -0.2 | 1.8 |
| AE ∆% Jan-Apr | 4.3 | |
| Dec 2010 | 0.4 | 1.8 |
| Nov | 0.1 | 1.6 |
| Oct | 0.1 | 1.6 |
| Sep | -0.1 | 1.5 |
| Aug | 0.2 | 1.4 |
| Jul | -0.3 | 1.7 |
| Jun | 0.0 | 1.5 |
| May | 0.1 | 1.6 |
| Apr | 0.3 | 1.7 |
| Mar | 0.5 | 1.6 |
| Feb | 0.6 | 1.3 |
| Jan | -0.3 | 1.1 |
AE: Annual Equivalent
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20111213
Table IV-13 provides the estimates of inflation by the Institut National de la Statistique et des Études Économiques for the years from 1999 to 2010. Inflation has been relatively moderate in France. The rise of inflation to 2.8 percent in 2008 was caused by the commodity price shock as investment funds shifted from other risk financial assets in carry trades driven by interest rates falling toward zero.
Table IV-13, France, Consumer Price Index Year ∆%
| Year | ∆% |
| 2010 | 1.5 |
| 2009 | 0.1 |
| 2008 | 2.8 |
| 2007 | 1.5 |
| 2006 | 1.6 |
| 2005 | 1.8 |
| 2004 | 2.1 |
| 2003 | 2.1 |
| 2002 | 1.9 |
| 2001 | 1.7 |
| 2000 | 1.7 |
| 1999 | 0.5 |
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20111213
Chart IV-1 of the Institut National de la Statistique et des Études Économiques of France shows headline and core consumption price inflation of France. Inflation rose during the commodity price shock of unconventional monetary policy. Risk aversion in late 2008 and beginning of 2009 caused collapse of valuation of commodity futures with resulting decline in inflation. Unconventional monetary policy with alternations of risk aversion resulted in higher inflation in France that has stabilized in recent months until the increase of 0.3 percent in both Oct and Nov.
Chart IV-1, France, Consumer Price Index (IPC) and Core Consumer Price Index (ISJ) 12 Months Rates of Change
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20111213
The wave of commodity price increases (http://cmpassocregulationblog.blogspot.com/2011/11/world-inflation-waves-and-monetary_21.html) in the first four months of 2011 also influenced the surge of consumer price inflation in Italy shown in Table IV-14. Annual equivalent inflation in the first four months of 2011 was 4.9 percent. The crisis of confidence or risk aversion resulted in reversal of carry trades on commodity positions. Consumer price inflation in Italy was subdued in Jun and May at 0.1 percent for annual equivalent 1.2 percent. Annual equivalent inflation in the five months Jul-Nov jumped again to 2.7 percent.
Table IV-14, Italy, Consumer Price Index
| Month | 12 Months | |
| Nov 2011 | -0.1 | 3.3 |
| Oct | 0.6 | 3.4 |
| Sep | 0.0 | 3.0 |
| Aug | 0.3 | 2.8 |
| Jul | 0.3 | 2.7 |
| AE ∆% Jul-Nov | 2.7 | |
| Jun | 0.1 | 2.7 |
| May | 0.1 | 2.6 |
| AE ∆% May-Jun | 1.2 | |
| Apr | 0.5 | 2.6 |
| Mar | 0.4 | 2.5 |
| Feb | 0.3 | 2.4 |
| Jan | 0.4 | 2.1 |
| AE ∆% Jan-Apr | 4.9 | |
| Dec 2010 | 0.4 | 1.9 |
Source: http://www.istat.it/it/archivio/48180
Chart IV-2 of the Istituto Nazionale di Statistica of Italy shows 12 months percentage change of the consumer price index of Italy. The 12 month rates of consumer price inflation also show the acceleration in the beginning of 2011 followed by more moderate inflation and the resurgence after Jul.
Chart IV-2, Italy, Consumer Prices 12 Months ∆%
Source: http://www.istat.it/en/
Consumer price inflation in the UK in 2011 is shown in Table IV-15. CPI inflation in Nov rose to 0.2 percent from 0.1 percent in Oct after 0.6 percent in both Sep and Aug. The same three waves are present in UK CPI inflation. In the first wave in Jan-Apr, annual equivalent inflation was at a high 6.5 percent. In the second wave in May-Jul, annual equivalent inflation fell to only 0.4 percent. In the third wave in Jul-Nov, annual equivalent inflation has returned at 5.3 percent.
Table IV-15, UK, Consumer Price Index, Month and 12 Months ∆%
| Month ∆% | 12 Months ∆% | |
| Nov 2011 | 0.2 | 4.8 |
| Oct | 0.1 | 5.0 |
| Sep | 0.6 | 5.2 |
| Aug | 0.6 | 4.5 |
| AE ∆% Aug-Nov | 4.6 | |
| Jul | 0.0 | 4.4 |
| Jun | -0.1 | 4.2 |
| May | 0.2 | 4.5 |
| May-Jul | 0.4 | |
| Apr | 1.0 | 4.5 |
| Mar | 0.3 | 4.0 |
| Feb | 0.7 | 4.4 |
| Jan | 0.1 | 4.0 |
| AE ∆% Jan-Apr | 6.5 | |
| Dec 2010 | 1.0 | 3.7 |
| Nov | 0.4 | 3.3 |
| Oct | 0.3 | 3.2 |
| Sep | 0.0 | 3.1 |
| Aug | 0.5 | 3.1 |
| Jul | -0.2 | 3.1 |
| Jun | 0.1 | 3.2 |
| May | 0.2 | 3.4 |
| Apr | 0.6 | 3.7 |
| Mar | 0.6 | 3.4 |
| Feb | 0.4 | 3.0 |
| Jan | -0.2 | 3.5 |
Source: http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/november-2011/index.html
Inflation has been unusually high in the UK since 2006, as shown in Table IV-16. There were no rates of inflation close to 2.0 percent in the period from 1997 to 2004. Inflation has exceeded 2 percent since 2005, reaching 3.6 percent in 2008 and 3.3 percent in 2010.
Table IV-16, UK, Consumer Price Index, Annual ∆%
| 1997 | 1.8 |
| 1998 | 1.6 |
| 1999 | 1.3 |
| 2000 | 0.8 |
| 2001 | 1.2 |
| 2002 | 1.3 |
| 2003 | 1.4 |
| 2004 | 1.3 |
| 2005 | 2.1 |
| 2006 | 2.3 |
| 2007 | 2.3 |
| 2008 | 3.6 |
| 2009 | 2.2 |
| 2010 | 3.3 |
Source: http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/november-2011/index.html
Table IV-17 provides the analysis of the monthly rate of inflation in Oct by the UK Office for National Statistics. The drivers of monthly inflation of 0.2 percent were clothing and footwear with contribution of 0.08 percentage points; food and nonalcoholic beverages with contribution of 0.7 percentage points; housing and household services with contribution of 0.05 percentage points; and furniture and household goods with contribution of 0.06 percentage points. Transport fell 0.6 percent in Sep with contribution of minus 0.11 percentage points and food and nonalcoholic beverages fell 0.6 percent with negative contribution of 0.09 percentage points. Contributions of percentage points to the 12 months rate of consumer price inflation of 4.8 provided by the UK Office for National Statistics are also in Table IV-17. Housing and household services rose 9.2 percent in 12 months, contributing 1.17 percentage points. Transport rose 7.2 percent in 12 months, contributing 1.14 percentage points. There is only negative change of 0.5 percent in recreation and culture but with negligible impact on the index.
Table IV-17, UK, Consumer Price Index Month ∆% and Percentage Point Contribution by Components
| Oct 2011 | Month ∆% | Percentage Point Contribution | 12 Months ∆% | Percentage Point Contribution |
| CPI All Items | 0.2 | 4.8 | ||
| Food & Non-Alcoholic Beverages | 0.6 | 0.07 | 4.0 | 0.46 |
| Alcohol & Tobacco | 0.3 | 0.01 | 9.7 | 0.41 |
| Clothing & Footwear | 1.2 | 0.0.8 | 2.8 | 0.23 |
| Housing & Household Services | 0.4 | 0.05 | 9.2 | 1.17 |
| Furniture & Household Goods | 1.0 | 0.06 | 5.0 | 0.32 |
| Health | 0.1 | 0.00 | 3.3 | 0.08 |
| Transport | -0.6 | -0.09 | 7.2 | 1.14 |
| Communication | -0.1 | 0.00 | 4.9 | 0.13 |
| Recreation & Culture | -0.2 | -0.04 | -0.5 | -0.08 |
| Education | 0.0 | 0.00 | 5.1 | 0.09 |
| Restaurants & Hotels | 0.2 | 0.02 | 4.6 | 0.55 |
| Miscellaneous Goods & Services | 0.0 | 0.00 | 2.8 | 0.27 |
Source: http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/november-2011/index.html
© Carlos M. Pelaez, 2010, 2011
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