Slow Growth, Falling Real Disposable Income, Repression of Savings, “Large-scale Lender of Last Resort,” Euro Zone Survival Risk and World Economic Slowdown: Part I

 

Slow Growth, Falling Real Disposable Income, Repression of Savings, “Large-scale Lender of Last Resort,” Euro Zone Survival Risk and World Economic Slowdown

Carlos M. Pelaez

© Carlos M. Pelaez, 2010, 2011

Executive Summary

I Slow Growth

II Falling Real Disposable Income and Repression of Savings

IIA Falling Real Disposable Income

IIB Repression of Savings

III World Financial Turbulence

IIIA Financial Risks

IIIB Fiscal Compact

IIIC European Central Bank Large Scale Lender of Last Resort

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

ESI Large Scale Lender of Last Resort

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.”

Draghi (2011Dec19) explains measures by the European Central Bank (ECB) to ensure “access to funding markets” by euro zone banks:

§ “We have decided on three-year refinancing operations to support the supply of credit to the euro area economy. These measures address the risk that persistent financial markets tensions could affect the capacity of euro area banks to obtain refinancing over longer horizons.

§ Earlier, in October, the Governing Council had already decided to have two more refinancing operations with a maturity of around one year.

§ Also, it was announced then that in all refinancing operations until at least the first half of 2012 all liquidity demand by banks would be fully allotted at fixed rate.

§ Funding via the covered bonds market was also facilitated by the ECB deciding in October to introduce a new Covered Bond Purchase Programme of €40 billion.

§ Funding in US dollar is facilitated by lowering the pricing on the temporary US dollar liquidity swap arrangements.”

Lionel Barber and Ralph Atkins interviewed Mario Draghi on Dec 14 with the transcript published in the Financial Times on Dec 18 (http://www.ft.com/intl/cms/s/0/25d553ec-2972-11e1-a066-00144feabdc0.html#axzz1gzoHXOj6) as “FT interview transcript: Mario Draghi.” A critical question in the interview is if the new measures are a European version of quantitative easing. Draghi analyzes the difference between the measures of the European Central Bank (ECB) and quantitative easing such as in Japan, US and UK:

1. The measures are termed “non-standard” instead of “unconventional.” While quantitative easing attempts to lower the yield of targeted maturities, the three-year facility operates through the “bank channel.” Quantitative easing would not be feasible because the ECB is statutorily prohibited of funding central governments. The ECB would comply with its mandate of medium-term price stability.

2. There is a critical difference in the two programs. Quantitative easing has been used as a form of financial repression known as “directed lending.” For example, the purchase of mortgage-backed securities more recently or the suspension of the auctions of 30-year bonds in response to the contraction early in the 2000s has the clear objective of directing spending to housing. The ECB gives the banks entire discretion on how to use the funding within their risk/return decisions, which could include purchase of government bonds.

The question on the similarity of the ECB three-year lending facility and quantitative easing is quite valid. Tracy Alloway, writing on Oct 10, 2011, on “Investors worry over cheap ECB money side effects,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/d2f87d16-f339-11e0-8383-00144feab49a.html#axzz1hAqMH1vn), analyzes the use of earlier long-term refinancing operations (LTRO) of the ECB. LTROs by the ECB in Jun, Sep and Dec 2009 lent €614 billion at 1 percent. Alloway quotes estimates of Deutsche Bank that banks used €442billion to acquire assets with higher yields. Carry trades developed from LTRO funds at 1 percent into liquid investments at a higher yield to earn highly profitable spreads. Alloway quotes estimates of Morgan Stanley that European debt of GIIPS (Greece, Ireland, Italy, Portugal and Spain) in European bank balance sheets is €700 billion. Tracy Alloway, writing on Dec 21, 2011, on “Demand for ECB loans rises to €489bn,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/d6ddd0ae-2bbd-11e1-98bc-00144feabdc0.html#axzz1hAqMH1vn), informs that European banks borrowed the largest value of €489 billion in all LTROs of the ECB. Tom Fairless and David Cottle, writing on Dec 21, 2011, on “ECB sees record refinancing demand,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204464404577111983838592746.html?mod=WSJPRO_hpp_LEFTTopStories), inform that the first of three operations of the ECB lent €489.19 billion, or $639.96 billion, to 523 banks. Three such LTROs could add to $1.9 trillion, which is not far from the value of quantitative easing in the US of $2.5 trillion. Fairless and Cottle find that there could be renewed hopes that banks could use the LTROs to support euro zone bond markets. It is possible that there could be official moral suasion by governments on banks to increase their holdings of government bonds or at least not to sell existing holdings. Banks are not free to choose assets in evaluation of risk and returns. Floods of cheap money at 1 percent per year induce carry trades to high-risk assets and not necessarily financing of growth with borrowing and lending decisions constrained by shocks of confidence.

ESII US Growth Standstill. In the first three quarters of 2011, US real GDP grew at the seasonally-adjusted annual equivalent rates of 0.4 percent in the first quarter of 2011 (IQ2011), 1.3 percent in IIQ2011 and revised 1.8 percent in IIIQ2011. The annual equivalent rate of growth of GDP for 2011 is 1.2 percent, obtained as follows. Discounting 0.4 percent to one quarter is 0.1 percent; discounting 1.3 percent to one quarter is 0.32 percent; and discounting 1.8 percent to one quarter is 0.45 percent. Real GDP growth in the first three quarters of 2011 accumulated to 0.87 percent {[(1.001 x 1.0032 x 1.0045)-1]100}, which is equal to 1.12 percent for an entire year of four quarters {(compounding 0.87 by 4/3) = (1.0087)^4/3}. The US economy is still close to a standstill especially considering the GDP report in detail.

Characteristics of the four cyclical contractions are provided in Table ES1 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction in annual equivalent rate. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.8 percent, which is almost equal to the decline of 5.1 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 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.

Table ES1, US, Number of Quarters, Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions 

	Number of Quarters	Cumulative Percentage Contraction	Average Percentage Annual Equivalent Rate
IIQ1953 to IIQ1954	4	-2.5	-0.63
IIIQ1957 to IIQ1958	3	-3.1	-9.0
IQ1980 to IIIQ1980	2	-2.2	-1.1
IIIQ1981 to IVQ1982	4	-2.7	-0.67
IVQ2007 to IIQ2009	6	-5.1	-0.87

Source: Business Cycle Reference Dates: http://www.nber.org/cycles/cyclesmain.html

Data: http://www.bea.gov/iTable/index_nipa.cfm

Table ES2 shows the extraordinary contrast between the mediocre average annual equivalent growth rate of 2.4 percent of the US economy in the nine quarters of the current cyclical expansion and the average of 6.2 percent in the four earlier cyclical expansions. The BEA data for the three quarters of 2011 show the economy in standstill with annual equivalent growth of 1.1 percent. The expansion of IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent.

Table ES2, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions

	Number of Quarters	Cumulative Growth ∆%	Average Annual Equivalent Growth Rate
IIIQ 1954 to IQ1957	11	12.6	4.4
IIQ1958 to IIQ1959	5	10.2	8.1
IIQ1975 to IVQ1976	8	9.5	4.6
IQ1983 to IV1985	13	19.6	5.7
Average Four Above Expansions			6.2
IIIQ2009 to IIIQ2011	9	5.5	2.4

Source: http://www.bea.gov/iTable/index_nipa.cfm

Chart ES1 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.

Chart ES1, US, Real GDP, 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart ES2 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2011. The economy has underperformed during the first nine quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.

Chart ES2, US, Real GDP, 2007-2011

Source: http://www.bea.gov/iTable/index_nipa.cfm

ESIII Falling Real Disposable Income. Data in Table ES3 reveal the weakness of the economy. The column RDPI (real disposable income) shows that after eleven months in 2011 in Jan-Nov growth of RDPI has accumulated to minus 0.4 percent, which for a full year is equivalent to minus 0.4 percent. Growth of real personal consumption expenditures (RPCE) accumulated to 1.6 percent in Jan-Nov, which is equivalent to yearly growth of 1.8 percent. Inflation creates the illusion that there has been growth of income, when in fact RDPI stagnated, and growth of consumption, which in fact has grown at the mediocre annual equivalent rate of 1.8 percent. Growth is the result of drawing down savings instead of growth of income and opportunities. The growth engine of the US economy has stalled with resulting adverse effects on job creation and opportunities for advancement.

Table ES3, US, Percentage Change from Prior Month Seasonally Adjusted of Personal Income, Disposable Income and Personal Consumption Expenditures %

	NPI	NDPI	RDPI	NPCE	RPCE
2011
Nov	0.1	0.0	0.0	0.1	0.2
Oct	0.4	0.2	0.3	0.1	0.2
Sep	0.2	0.1	-0.1	0.7	0.5
Aug	-0.1	-0.1	-0.4	0.1	-0.1
Jul	0.1	0.1	-0.3	0.8	0.4
Jun	0.1	0.1	0.2	-0.2	-0.1
May	0.1	0.1	-0.1	0.2	0.0
Apr	0.2	0.2	-0.2	0.3	-0.1
Mar	0.5	0.4	0.0	0.6	0.2
Feb	0.6	0.5	0.1	0.8	0.4
Jan	1.2	1.6	0.1	0.4	0.0
Jan-Nov 2011	3.4	3.2	–0.4	3.9	1.6
Jan-Nov 2011 AE	3.8	3.5	–0.4	4.3	1.8
2010
Dec	0.5	0.5	0.2	0.4	0.1
Nov	0.1	0.1	0.0	0.4	0.3
Oct	0.5	0.5	0.3	0.6	0.4
IVQ10	1.1	1.1	0.5	1.4	0.8
IVQ2010 AE	4.5	4.5	2.0	5.7	3.2

Notes: NPI: current dollars personal income; NDPI: current dollars disposable personal income; RDPI: chained (2005) dollars DPI; NPCE: current dollars personal consumption expenditures; RPCE: chained (2005) dollars PCE; AE: annual equivalent; IVQ2010: fourth quarter 2010; A: annual equivalent

Percentage change month to month seasonally adjusted

Source: http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi1111.pdf

ESIV Financial Repression. McKinnon (1973) and Shaw (1974) argue that legal restrictions on financial institutions can be detrimental to economic development. “Financial repression” is the term used in the economic literature for these restrictions (see Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 81-6). Interest rate ceilings on deposits and loans have been commonly used. Chart ES3 provides savings as percent of disposable income or the US savings rate. There was a long-term downward sloping trend from 12 percent in the early 1980s to less than 2 percent in 2005-2006. The savings rate then rose during the contraction and also in the expansion. In 2011 the savings rate has been declining as consumption is financed with savings in part because of the disincentive or frustration of receiving a few pennies for every $10,000 of deposits in a bank. The objective of monetary policy is to reduce borrowing rates to induce consumption but it has collateral disincentive of reducing savings. The zero interest rate of monetary policy is a tax on saving. This tax is highly regressive, meaning that it affects the most people with lower income or wealth and retirees. The long-term decline of savings rates in the US has created a dependence on foreign savings to finance the deficits in the federal budget and the balance of payments. Ceilings on interest rates imposed by Regulation Q exported the US financial system to London and offshore centers. What is vividly relevant currently from this experience is the argument by Friedman (1970, 27) that the controls affected the most people with lower incomes and wealth who were forced into accepting controlled-rates on their savings that were lower than those that would be obtained under freer markets. As Friedman (1970, 27) argues:

“These are the people who have the fewest alternative ways to invest their limited assets and are least sophisticated about the alternatives.”

Chart ES3, US, Personal Savings as a Percentage of Disposable Personal Income, Quarterly, 1980-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

I US Growth Standstill. In the first three quarters of 2011, US real GDP grew at the seasonally-adjusted annual equivalent rates of 0.4 percent in the first quarter of 2011 (IQ2011), 1.3 percent in IIQ2011 and revised 1.8 percent in IIIQ2011. The annual equivalent rate of growth of GDP for 2011 is 1.2 percent, obtained as follows. Discounting 0.4 percent to one quarter is 0.1 percent; discounting 1.3 percent to one quarter is 0.32 percent; and discounting 1.8 percent to one quarter is 0.45 percent. Real GDP growth in the first three quarters of 2011 accumulated to 0.87 percent {[(1.001 x 1.0032 x 1.0045)-1]100}, which is equal to 1.12 percent for an entire year of four quarters {(compounding 0.87 by 4/3) = (1.0087)^4/3}. The US economy is still close to a standstill especially considering the GDP report in detail. The Bureau of Economic Analysis (BEA) of the US Department of Commerce released on Thu Dec 22 the second estimate of GDP for IIIQ2011 at 1.8 percent seasonally-adjusted annual rate (SAAR) (http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp3q11_3rd.pdf). The objective of this section is analyzing US economic growth. There is initial brief discussion of the concept of “slow-growth recession” followed by comparison of the current growth experience of the US with earlier expansions after past deep contractions and consideration of the quarterly performance in the first half of 2011.

The concept of growth recession was popular during the stagflation from the late 1960s to the early 1980s. The economy of the US underperformed with several recession episodes in “stop and go” fashion of economic activity while the rate of inflation rose to the highest in a peacetime period (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/05/global-inflation-seigniorage-monetary.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html). A growth recession could be defined as a period in which economic growth is insufficient to move the economy toward full employment of humans, equipment and other productive resources. The US is experiencing a dramatic slow growth recession with 29.9 million people in job stress, consisting of an effective number of unemployed of 18.1 million, 8.3 million employed part-time because they cannot find full employment and 2.6 million marginally attached to the labor force (see Table 3 in http://cmpassocregulationblog.blogspot.com/2011/12/twenty-nine-million-in-job-stress.html )The discussion of the growth recession issue in the 1970s by two recognized economists of the twentieth century, James Tobin and Paul A. Samuelson, is worth recalling.

In analysis of the design of monetary policy in 1974, Tobin (1974, 219) finds that the forecast of the President’s Council of Economic Advisers (CEA) was also the target such that monetary policy would have to be designed and implemented to attain that target. The concern was with maintaining full employment as provided in the Employment Law of 1946 (http://www.law.cornell.edu/uscode/15/1021.html http://uscode.house.gov/download/pls/15C21.txt http://www.eric.ed.gov/PDFS/ED164974.pdf) see http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html), which also created the CEA. Tobin (1974, 219) describes the forecast/target of the CEA for 1974:

“The expected and approved path appears to be quarter-to-quarter rates of growth of real gross national product in 1974 of roughly -0.5, 0.1, and 1 percent, with unemployment rising to about 5.6 percent in the second quarter and remaining there the rest of the year. The rate of price inflation would fall shortly in the second quarter, but rise slightly toward the end of the year.”

Referring to monetary policy design, Tobin (1974, 221) states: “if interest rates remain stable or rise during the current (growth) recession and recovery, this will be a unique episode in business cycle annals.” Subpar economic growth is often called a “growth recession.” The critically important concept is that economic growth is not sufficient to move the economy toward full employment, creating the social and economic adverse outcome of idle capacity and unemployed and underemployed workers, much the same as currently.

The unexpected incidence of inflation surprises during growth recessions is considered by Samuelson (1974, 76):

“Indeed, if there were in Las Vegas or New York a continuous casino on the money GNP of 1974’s fourth quarter, it would be absurd to think that the best economic forecasters could improve upon the guess posted there. Whatever knowledge and analytical skill they possess would already have been fed into the bidding. It is a manifest contradiction to think that most economists can be expected to do better than their own best performance. I am saying that the best forecasters have been poor in predicting the general price level’s movements and level even a year ahead. By Valentine’s Day 1973 the best forecasters were beginning to talk of the growth recession that we now know did set in at the end of the first quarter. Aside from their end-of-1972 forecasts, the fashionable crowd has little to blame itself for when it comes to their 1973 real GNP projections. But, of course, they did not foresee the upward surge of food and decontrolled industrial prices. This has been a recurring pattern: surprise during the event at the virulence of inflation, wisdom after the event in demonstrating that it did, after all, fit with past patterns of experience.”

Economists are known for their forecasts being second only to those of astrologers. Accurate forecasts are typically realized for the wrong reasons. In contrast with meteorologists, economists do not even agree on what happened. There is not even agreement on what caused the global recession and why the economy has reached a perilous standstill.

Historical parallels are instructive but have all the limitations of empirical research in economics. The more instructive comparisons are not with the Great Depression of the 1930s but rather with the recessions in the 1950s, 1970s and 1980s. The growth rates and job creation in the expansion of the economy away from recession are subpar in the current expansion compared to others in the past. Four recessions are initially considered, following the reference dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles/cyclesmain.html ): IIQ1953-IIQ1954, IIIQ1957-IIQ1958, IIIQ1973-IQ1975 and IQ1980-IIIQ1980. The data for the earlier contractions illustrate that the growth rate and job creation in the current expansion are inferior. The sharp contractions of the 1950s and 1970s are considered in Table I-1, showing the Bureau of Economic Analysis (BEA) quarter-to-quarter, seasonally adjusted (SA), yearly-equivalent growth rates of GDP. The recovery from the recession of 1953 consisted of four consecutive quarters of high percentage growth rates from IIIQ1954 to IIIQ1955: 4.6, 8.3, 12.0, 6.8 and 5.4. The recession of 1957 was followed by four consecutive high percentage growth rates from IIIQ1958 to IIQ1959: 9.7, 9.7, 8.3 and 10.5. The recession of 1973-1975 was followed by high percentage growth rates from IIQ1975 to IIQ1976: 6.9, 5.3, 9.4 and 3.0. The disaster of the Great Inflation and Unemployment of the 1970, which made stagflation notorious, is even better in growth rates during the expansion phase from contractions in comparison than the current slow-growth recession.  

Table I-1, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA

	IQ	IIQ	IIIQ	IVQ
1953	7.7	3.1	-2.4	-6.2
1954	-1.9	0.5	4.6	8.3
1955	12.0	6.8	5.4	2.3
1957	2.5	-1.0	3.9	-4.1
1958	-10.4	2.5	9.7	9.7
1959	8.3	10.5	-0.5	1.4
1973	10.6	4.7	-2.1/	3.9
1974	3.5	1.0	-3.9	6.9
1975	-4.8	3.1	6.9	5.3
1976	9.4	3.0	2.0	2.9
1979	0.7	0.4	2.9	1.1
1980	1.3	-7.9	-0.7	7.6

Source: http://www.bea.gov/iTable/index_nipa.cfm

The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ1982 are combined, the impact of lost GDP of 4.8 percent is more comparable to the latest revised 5.1 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. 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). Table I-2 provides the Bureau of Economic Analysis (BEA) quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981-1982 and 2007 to 2009, using the latest major revision published on Jul 29, 2011 (http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf) and the third estimate of IIIQ2011 released on Dec 22, 2011 (http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp3q11_3rd.pdf). There were four quarters of contraction in 1981-1982 ranging in rate from -1.5 percent to -6.4 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.7 percent to -8.9 percent. The striking difference is that in the first nine quarters of expansion from IQ1983 to IIIQ1984, shown in Table 2 in relief, GDP grew at the high quarterly percentage growth rates of 5.1, 9.3, 8.1, 8.5, 7.1, 3.9, 3.3 and 5.4 while the percentage growth rates in the first eight nine quarters of expansion from IIIQ2009 to IIIQ2011, shown in relief in Table I-2, were mediocre: 1.7, 3.8, 3.9, 3.8, 2.5, 2.3, 0.4, 1.3 and 1.8. Asterisks denote the estimates that have been revised by the BEA. During three quarters of a year GDP has been growing at annual equivalent rates of 0.4 percent in IQ2011, 1.3 percent in IIQ2011 and 1.8 percent in IIIQ2011 in what can be considered as a slow growth recession because of the 28.9 million in job stress (http://cmpassocregulationblog.blogspot.com/2011/12/twenty-nine-million-in-job-stress.html). Inventory change contributed to initial growth but was rapidly replaced by growth in investment and demand in 1983.

Table I-2, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA

Q	1981	1982	1983	1984	2008	2009	2010
I	8.6	-6.4	5.1	7.1	-1.8*	-6.7*	3.9*
II	-3.2	2.2	9.3	3.9	1.3*	-0.7	3.8*
III	4.9	-1.5	8.1	3.3	-3.7*	1.7	2.5*
IV	-4.9	0.3	8.5	5.4	-8.9*	3.8*	2.3*
				1985			2011
I				3.8			0.4
II				3.4			1.3
III				6.4			1.8
IV				3.1

Source: http://www.bea.gov/iTable/index_nipa.cfm

Chart I-1 provides the strong growth of real quarterly GDP in the US between 1947 and 1999. There is an evident acceleration of the rate of GDP growth in the 1990s as shown by a much sharper slope of the growth curve. Cobet and Wilson (2002) define labor productivity as the value of manufacturing output produced per unit of labor input used (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). Between 1950 and 2000, labor productivity in the US grew less rapidly than in Germany and Japan. The major part of the increase in productivity in Germany and Japan occurred between 1950 and 1973 while the rate of productivity growth in the US was relatively subdued in several periods. While Germany and Japan reached their highest growth rates of productivity before 1973, the US accelerated its rate of productivity growth in the second half of the 1990s. Between 1950 and 2000, the rate of productivity growth in the US of 2.9 percent per year was much lower than 6.3 percent in Japan and 4.7 percent in Germany. Between 1995 and 2000, the rate of productivity growth of the US of 4.6 percent exceeded that of Japan of 3.9 percent and the rate of Germany of 2.6 percent.

Chart I-1, US, Real GDP 1947-1999

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-2 provides the growth of real quarterly GDP in the US between 1979 an 2010. The drop of output in the recession from IVQ2007 to IIQ2009 has been followed by anemic recovery and a standstill that can lead to growth recession, or low rates of economic growth, but perhaps even another contraction or conventional recession.

Chart I-2, US, Real GDP 1970-2010

Source:

US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-3 provides real GDP percentage change on the quarter a year earlier for 1983-1984. The objective is simply to compare expansion in two recoveries from sharp contractions as shown in Table 2. Growth rates in the early phase of the recovery in 1983 and 1984 were very high, which is the opportunity to reduce unemployment that has characterized cyclical expansion in the postwar US economy.

Chart I-3, Real GDP Percentage Change on Quarter a Year Earlier 1983-1984

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

In contrast, growth rates in the comparable first nine months of expansion in 2009 and 2011 in Chart I-4 have been mediocre. As a result, growth has not provided the exit from unemployment and underemployment as in other cyclical expansions in the postwar period. Growth rates did not rise in V shape as in earlier expansions and then declined close to the standstill of growth recessions.

Chart I-4, US, Real GDP Percentage Change on Quarter a Year Earlier 2009-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Table I-3 provides the change in real GDP in the United States in the 1930s, 1980s and 2000s. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 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). Data are available for the 1930s only on a yearly basis. US GDP fell 4.8 percent in the two recessions from IQ1980 to IIIQ1980 and from III1981 to IVQ1981 to IVQ1982 and 5.1 percent cumulatively in the recession from IVQ2007 to IIQ2009.

Table I-3, US, Percentage Change of GDP in the 1930s, 1980s and 2000s, ∆%

Year	GDP ∆%	Year	GDP ∆%	Year	GDP ∆%
1930	-8.6	1980	-0.3	2000	4.1
1931	-6.5	1981	2.5	2001	1.1
1932	-13.1	1982	-1.9	2002	1.8
1933	-1.3	1983	4.5	2003	2.5
1934	10.9	1984	7.2	2004	3.5
1935	8.9	1985	4.1	2005	3.1
1936	13.1	1986	3.5	2006	2.7
1937	5.1	1987	3.2	2007	1.9
1938	-3.4	1988	4.1	2008	-0.3
1930	8.1	1989	3.6	2009	-3.5
1940	8.8	1990	1.9	2010	3.0

Source: http://www.bea.gov/iTable/index_nipa.cfm

Chart I-5 provides percentage change of GDP in the US during the 1930s. There is vast literature analyzing the Great Depression (Pelaez and Pelaez, Regulation of Banks and Finance (2009) 198-217). Cole and Ohanian (1999) find that US real per capita output in 1939 remained 11 percent lower than in 1929 while the typical expansion of real per capita output in the US is 31 percent. Private hours worked in the US were 25 percent lower in 1939 than in 1929.

Chart I-5, US, Percentage Change of GDP in the 1930s

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

In contrast, Chart I-6 shows rapid recovery from the recessions in the 1980s. High growth rates in the initial quarters of expansion eliminated the unemployment and underemployment created during the contraction. The economy then returned to grow at the trend of expansion.

Chart I-6, US, Percentage Change of GDP in the 1980s

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-7 provides the rates of growth during the 2000s. Growth rates in the initial eleven quarters of expansion have been relatively lower than during recessions after World War II. As a result, unemployment and underemployment continue at the rate of 18.2 percent of the US labor force.

Chart I-7, US, Percentage Change of GDP in the 2000s

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Characteristics of the four cyclical contractions are provided in Table I-4 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction in annual equivalent rate. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.8 percent, which is almost equal to the decline of 5.1 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.7 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.

Table I-4, US, Number of Quarters, Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions 

	Number of Quarters	Cumulative Percentage Contraction	Average Percentage Annual Equivalent Rate
IIQ1953 to IIQ1954	4	-2.5	-0.63
IIIQ1957 to IIQ1958	3	-3.1	-9.0
IQ1980 to IIIQ1980	2	-2.2	-1.1
IIIQ1981 to IVQ1982	4	-2.7	-0.67
IVQ2007 to IIQ2009	6	-5.1	-0.87

Source: Business Cycle Reference Dates: http://www.nber.org/cycles/cyclesmain.html

Data: http://www.bea.gov/iTable/index_nipa.cfm

Table I-5 shows the extraordinary contrast between the mediocre average annual equivalent growth rate of 2.4 percent of the US economy in the nine quarters of the current cyclical expansion and the average of 6.2 percent in the four earlier cyclical expansions. The BEA data for the three quarters of 2011 show the economy in standstill with annual equivalent growth of 1.1 percent. The expansion of IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent.

Table I-5, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions

	Number of Quarters	Cumulative Growth ∆%	Average Annual Equivalent Growth Rate
IIIQ 1954 to IQ1957	11	12.6	4.4
IIQ1958 to IIQ1959	5	10.2	8.1
IIQ1975 to IVQ1976	8	9.5	4.6
IQ1983 to IV1985	13	19.6	5.7
Average Four Above Expansions			6.2
IIIQ2009 to IIIQ2011	9	5.5	2.4

Source: http://www.bea.gov/iTable/index_nipa.cfm

Chart I-8 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.

Chart I-8, US, Real GDP, 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-9 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2011. The economy has underperformed during the first nine quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.

Chart I-9, US, Real GDP, 2007-2011

Source: http://www.bea.gov/iTable/index_nipa.cfm

As shown in Tables I-4 and I-5 above the loss of real GDP in the US during the contraction was 5.1 percent but the gain in the cyclical expansion has been only 5.5 percent (last row in Table 4). As a result, the level of real GDP in IIIQ2011 with the third estimate is only higher by 0.04 percent than the level of real GDP in IVQ2007. Table I-6 provides in the second column real GDP in billions of chained 2005 dollars. The third column provides the percentage change of the quarter relative to IVQ2007; the fourth column provides the percentage change relative to the prior quarter; and the final fifth column provides the percentage change relative to the same quarter a year earlier. The contraction actually concentrated in two quarters: decline of 2.3 percent in IVQ2008 relative to the prior quarter and decline of 1.7 percent in IQ2009 relative to IVQ2008. The combined fall of GDP in IVQ2008 and IQ2009 was 4.0 percent (1.023 x 1.017). Those two quarters coincided with the worst effects of the financial crisis. GDP fell 0.2 percent in IIQ2009 but grew 0.4 percent in IIIQ2009, which is the beginning of recovery in the cyclical dates of the NBER. Most of the recovery occurred in three successive quarters from IVQ2009 to IIQ2010 of equal growth at 0.9 percent for cumulative growth in those three quarters of 2.7 percent. The economy lost momentum already in IIIQ2010 and IVQ2010 growing at 0.6 percent in each quarter, or annual equivalent 2.4 per cent combining the two quarters in annual equivalent rate {(1.006 x 1.006)²}. The economy then stalled during the first half of 2011 with growth of 0.1 percent in IQ2011 and 0.33 percent in IIQ2011 for combined annual equivalent rate of 0.86 percent {(1.001 x 1.0033)²}. The economy grew 0.045 percent in IIIQ2011 for annual equivalent growth of 1.12 percent in the first three quarters {(1.001 x 1.0033 x 1.0045)^4/3}. Growth in a quarter relative to a year earlier in Table I-6 slows from over 3 percent during three consecutive quarters from IIQ2010 to IVQ2010 to 2.2 percent in IQ2011, 1.6 percent in IIQ2011 and 1.5 percent in IIIQ2011. The revision of the seasonally adjusted annual rate in IIQ2011 from 1.0 percent to 1.3 percent merely increases growth in IIQ2011 relative to IQ2011 from 0.25 percent to 0.33 percent. There is stronger quarterly growth in IIIQ2011 of 0.45 percent even with the downward revision of the third estimate. Growth in IIQ2011 relative to IIQ2010 and in IIIQ2011 relative to IIIQ2010 remains at the mediocre rates of 1.6 percent and 1.5 percent, respectively. The critical question for which there is not yet definitive solution is whether what lies ahead is continuing growth recession with the economy crawling and unemployment/underemployment at extremely high levels or another contraction or conventional recession. Forecasts of various sources continued to maintain high growth in the second half of 2011 without taking into consideration the continuous slowing of the economy in late 2010 and the first half of 2011. The sovereign debt crisis is the common source of doubts on the rate and direction of economic growth in the US.

Table I-6, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%

	Real GDP, Billions Chained 2005 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	13,326.0	NA	NA	2.2
IQ2008	13,266.8	-0.4	-0.4	1.6
IIQ2008	13,310.5	-0.1	0.3	1.0
IIIQ2008	13,186.9	-1.0	-0.9	-0.6
IVQ2008	12,883.5	-3.3	-2.3	-3.3
IQ2009	12,663.2	-4.9	-1.7	-4.5
IIQ2009	12,641.3	-5.1	-0.2	-5.0
IIIQ2009	12,694.5	-4.7	0.4	-3.7
IV2009	12,813.5	-3.8	0.9	-0.5
IQ2010	12,937.7	-2.9	0.9	2.2
IIQ2010	13,058.5	-1.8	0.9	3.3
IIIQ2010	13,139.6	-1.4	0.6	3.5
IVQ2010	13,216.1	-0.8	0.6	3.1
IQ2011	13,227.9	-0.7	0.1	2.2
IIQ2011	13,271.8	-0.4	0.33	1.6
IIIQ2011	13,331.6	0.04	0.5	1.5

Source: http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1

Chart I-10 provides the percentage change of real GDP from the same quarter a year earlier from 1980 to 1989. There were two contractions almost in succession in 1980 and from 1981 to 1983. The expansion was marked by initial high rates of growth as in other recession in the postwar US period during which employment lost in the contraction was recovered. Growth rates continued to be high after the initial phase of expansion.

Chart I-10, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

The experience of recovery after 2009 is not as complete as during the 1980s. Chart I-11 shows the much lower rates of growth in the early phase of the current expansion and how they have sharply declined from an early peak.

Chart I-11, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 2007-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-12 provides growth rates from a quarter relative to the prior quarter during the 1980s. There is the same strong initial growth followed by a long period of sustained growth.

Chart I-12, Percentage Change of Real Gross Domestic Product from Prior Quarter 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart I-13 provides growth rates in a quarter relative to the prior quarter from 2007 to 2011. Growth in the current expansion after IIIQ2009 has not been as strong as in other postwar cyclical expansions.

Chart I-13, Percentage Change of Real Gross Domestic Product from Prior Quarter 2007-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

The revised estimates and earlier estimates from IQ2008 to IQ2011 in seasonally adjusted annual equivalent rates are shown in Table I-7. The strongest revision is for IVQ2008 for which the contraction of GDP is revised from minus 6.8 percent to minus 8.9 percent. IQ2009 is also revised from contraction of minus 4.9 percent to minus 6.7 percent. There is only minor revision in IIIQ2008 of the contraction of minus 4.0 percent to minus 3.7 percent. Growth of 5.0 percent in IV2009 is revised to 3.8 percent but growth in IIQ2010 is upwardly revised to 3.8 percent. The revisions do not alter the conclusion that the current expansion is much weaker than historical sharp contractions since the 1950s and is now changing into slow growth recession or even possibly contraction.

Table I-7, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA, Revised and Earlier Estimates

Quarters	Revised Estimate	Earlier Estimate
2008
I	-1.8	-0.7
II	1.3	0.6
III	-3.7	-4.0
IV	-8.9	-6.8
2009
I	-6.7	-4.9
II	-0.7	-0.7
III	1.7	1.6
IV	3.8	5.0
2010
I	3.9	3.7
II	3.8	1.7
III	2.5	2.6
IV	2.3	3.1
2011
I	0.4	1.9

Source: http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp2q11_adv.pdf

Contributions to the rate of growth of GDP in percentage points (PP) are provided in Table I-8. Aggregate demand, personal consumption expenditures (PCE) and gross private domestic investment (GDI) were much stronger during the expansion phase in IQ1983 to IIQ1984 than in IIIQ2009 to IIIQ2011. Growth of 1.8 percent at seasonally-adjusted annual rate (SAAR) of GDP in IIIQ2011 consisted of positive contributions of 1.24 percentage points of personal consumption expenditures (PCE) + 0.17 percent points of gross domestic investment (GDI) + 0.43 percentage points of net exports (net trade or exports less imports). Real disposable income stagnated in IIIQ2011 but families still consumed by drawing down savings as percent of personal income from 5.2 in IVQ2010 to 3.5 in IIIQ2011.

Table I-8, US, Contributions to the Rate of Growth of GDP in Percentage Points

	GDP	PCE	GDI	∆ PI	Trade	GOV
2011
I	0.4	1.47	0.47	0.32	-0.34	-1.23
II	1.3	0.49	0.79	-0.28	0.24	-0.18
III	1.8	1.24	0.17	-1.35	0.43	-0.02
2010
I	3.9	1.92	3.25	3.10	-0.97	-0.26
II	3.8	2.05	2.92	0.79	-1.94	0.77
III	2.5	1.85	1.14	0.86	-0.68	0.20
IV	2.3	2.48	-0.91	-1.79	1.37	-0.58
2009
I	-6.7	-1.02	-7.76	-2.66	2.44	-0.33
II	-0.7	-1.28	-2.84	-0.58	2.21	1.21
III	1.7	1.66	0.35	0.21	-0.59	0.28
IV	3.8	0.33	3.51	3.93	0.15	-0.18
1982
I	-6.4	1.62	-7.50	-5.47	-0.49	-0.03
II	-2.2	0.90	-0.05	2.35	0.84	0.50
III	-1.5	1.92	-0.72	1.15	-3.31	0.57
IV	0.3	4.64	-5.66	-5.48	-0.10	1.44
1983
I	5.1	2.54	2.20	0.94	-0.30	0.63
II	9.3	5.22	5.87	3.51	-2.54	0.75
III	8.1	4.66	4.30	0.60	-2.32	1.48
IV	8.5	4.20	6.84	3.09	-1.17	-1.35
1984
I	8.0	2.35	7.15	5.07	-2.37	0.86
II	7.1	3.75	2.44	-0.30	-0.89	1.79
III	3.9	2.02	-0.89	0.21	-0.36	0.62
IV	3.3	3.38	1.79	-2.50	-0.58	1.75
1985
I	3.8	4.34	-2.38	-2.94	0.91	0.95

Note: PCE: personal consumption expenditures; GDI: gross private domestic investment; ∆ PI: change in private inventories; Trade: net exports of goods and services; GOV: government consumption expenditures and gross investment; – is negative and no sign positive

GDP: percent change at annual rate; percentage points at annual rates

Source: http://www.bea.gov/iTable/index_nipa.cfm

Important aspects of the national accounts are provided in Table I-9. The top part of the table identifies sources of change in the rate of growth from one quarter to a future quarter by seasonally-adjusted annual rates (SAAR). The increase in growth in IIIQ2011 relative to the IIQ2011 originated in: (1) increase of personal consumption expenditures by 1.7 percent compared with 0.7 percent of which an increase of consumption of durable goods by 5.7 percent compared with decline by 5.3 percent in IIQ2011; (2) increase in growth of nonresidential fixed investment (NRFI) from 10.3 percent in IIQ2011 to 15.7 percent in IIIQ2011; (3) increase of exports from 3.6 percent in IIQ2011 to 4.7 percent in IIIQ2011; (4) deceleration of decline of state/local government expenditures from minus 2.8 percent in IIQ2011 to minus 1.6 percent in IIIQ2011; (5) increase in federal government expenditures from 1.9 percent in IIQ2011 to 2.1 percent in IIIQ2011; and deceleration of growth of imports from 1.4 percent to 1.2 percent. Negative contributions to acceleration of growth into IIIQ2011 originated in (1) deceleration of residential fixed (RFI) investment from 4.2 percent to 1.3 percent; and (2) reduction of private inventories by 1.35 percentage points.

Table I-9, US, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase, %

	IVQ2010	IQ2011	IIQ2011	IIIQ2011
GDP	2.3	0.4	1.3	1.8
PCE	3.6	2.1	0.7	1.7
Durable Goods	17.2	11.7	-5.3	5.7
NRFI	8.7	2.1	10.3	15.7
RFI	2.5	-2.4	4.2	1.3
Exports	7.8	7.9	3.6	4.7
Imports	-2.3	8.3	1.4	1.2
GOV	-2.8	-5.9	-0.9	-0.1
Federal GOV	-3.0	-9.4	1.9	2.1
State/Local GOV	-2.7	-3.4	-2.8	-1.6
∆ PI (PP)	-1.79	0.32	-0.28	-1.35
Final Sales of Domestic Product	4.2	0.0	1.6	3.2
Gross Domestic Purchases	0.9	0.7	1.0	1.3
Prices Gross Domestic Purchases	2.1	4.0	3.3	2.0
Prices of GDP	1.9	2.5	2.5	2.6
Prices of GDP Excluding Food and Energy	1.3	2.5	2.7	1.8
Prices of PCE	1.9	3.9	3.3	2.3
Prices of PCE Excluding Food and Energy	0.7	1.6	2.3	2.1
Prices of Market Based PCE	1.8	4.0	3.5	2.6
Prices of Market Based PCE Excluding Food and Energy	0.3	1.3	2.4	2.3
Real Disposable Personal Income*	3.5	2.6	1.1	0.1
Personal Savings As % Disposable Income	5.2	5.0	4.8	3.9

Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in

private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income

*Percent change from quarter one year ago

Source: http://www.bea.gov/newsreleases/national/gdp/2011/pdf/gdp3q11_3rd.pdf

Final sales of domestic product at seasonally-adjusted annual equivalent rate (SAAR) rose from 1.6 percent in IIQ2011 to 3.2 percent in IIIQ2011. Price indicators of GDP and gross domestic purchases accelerated into IIIQ2011. Prices of PCE excluding food and energy, which is the inflation indicator of monetary policy, fell from change of 2.3 percent in IIQ2011 to 2.0 percent in IIIQ2011. Similar behavior is observed for the other market-based price indexes. The final two rows of Table I-9 show no growth real disposable income in IIIQ2011 relative to IIIQ2010 and reduction of personal savings as percent of disposable income from 4.8 in IIQ2011 to 3.8 percent in IIIQ2011. Families interrupted saving and consumed.

Percentage shares of GDP are shown in Table I-10. PCE is equivalent to 70.6 percent of GDP and is growing at very low levels with stagnation of real disposable income, high levels of unemployment and underemployment and higher savings rates. Gross private domestic investment is also growing slowly even with about two trillions of dollars in cash holdings by companies. In a slowing world economy, it may prove more difficult to grow exports faster than imports to generate higher growth.

Table I-10, US, Percentage Shares of GDP, %

	IVQ2010
GDP	100.0
PCE	70.6
Goods	23.6
Services	47.0
Gross Private Domestic Investment	12.3
Fixed Investment	12.1
NRFI	9.8
RFI	2.2
Change in Private       Inventories	0.3
Net Exports of Goods and Services	-3.4
Exports	13.1
Imports	16.5
Government	20.5
Federal	8.4
State and Local	12.1

PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment

Source: http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1

Table I-11 shows the percentage point (PP) contributions to the annual levels of GDP growth in the earlier recessions 1958-1959, 1975-1976, 1982-1983 and 2009 and 2010. The data incorporate the new revisions released by the BEA on Jul 29, 2011. The most striking contrast is in the rates of growth of annual GDP in the expansion phases of 7.2 percent in 1959, 4.5 percent in 1983 followed by 7.2 percent in 1984 and 4.1 percent in 1985 but only 3.0 percent in 2010 after six consecutive quarters of growth. The annual levels also show much stronger growth of PCEs in the expansions after the earlier contractions. PCEs contributed 1.44 PPs to GDP growth in 2010 of which 0.99 PP in goods and 0.46 PP in services. GDI deducted 3.61 PPs of GDP growth in 2009 of which -2.77 PPs by fixed investment and -0.84 PP of ∆PI and added 1.96 PPs to GDI in 2010 of which 0.48 PPs of fixed investment and 1.64 PPs of ∆PI. Trade, or exports of goods and services net of imports, contributed 1.11 PPs in 2009 of which exports deducted 1.18 PPs and imports added 2.29 PPs. In 2010, trade deducted 0.51 PP with exports contributing 1.31 PPs and imports deducting 1.82 PPs. In 2009, Government added 0.34 PP of which 0.45 PP by the federal government and -0.11 PP by state and local government; in 2010, government added 0.14 PP of which 0.37 PP by the federal government with state and local government deducting 0.23 PP.

Table I-11, US, Percentage Point Contributions to the Annual Growth Rate of GDP

	GDP	PCE	GDI	∆ PI	Trade	GOV
1958	-0.9	0.54	-1.25	-0.18	-0.89	0.70
1959	7.2	3.61	2.80	0.86	0.00	0.76
1975	-0.2	1.40	-2.98	-1.27	0.89	0.48
1976	5.4	3.51	2.84	1.41	-1.08	0.10
1982	-1.9	0.86	-2.55	-1.34	-0.60	0.35
1983	4.5	3.65	-1.45	0.29	-1.35	0.76
1984	7.2	3.43	4.63	1.95	-1.58	0.70
1985	4.1	3.32	-0.17	-1.06	-0.42	1.41
2009	-3.5	-1.32	-3.61	-0.84	1.11	0.34
2010	3.0	1.44	1.96	1.64	-0.51	0.14

Source: http://www.bea.gov/iTable/index_nipa.cfm

II Falling Real Disposable Income and Repression of Savings. Subsection IIA Falling Real Disposable Income provides analysis of the personal income and consumption outlays of the Bureau of Economic Analysis for Nov. Subsection IIB Repression of Savings analyzes financial repression and how it is affecting savings in the US.

Subsection IIA Falling Real Disposable Income. The data on personal income and consumption have been revised back to 2003 as it the case of the national accounts (GDP revisions are covered in http://cmpassocregulationblog.blogspot.com/2011/07/growth-recession-debt-financial-risk.html). All revisions are incorporated in this subsection. There are two types of very valuable information on income, consumption and prices in Table II-1, showing monthly, and annual equivalent percentage changes, seasonally adjusted, of current dollars or nominal personal income (NPI), current dollars or nominal disposable personal income (NDPI), real or constant chained (2005) dollars DPI (RDPI), current dollars nominal personal consumption expenditures (NPCE) and constant or chained (2005) dollars PCE.

Table II-1, US, Percentage Change from Prior Month Seasonally Adjusted of Personal Income, Disposable Income and Personal Consumption Expenditures %

	NPI	NDPI	RDPI	NPCE	RPCE
2011
Nov	0.1	0.0	0.0	0.1	0.2
Oct	0.4	0.2	0.3	0.1	0.2
Sep	0.2	0.1	-0.1	0.7	0.5
Aug	-0.1	-0.1	-0.4	0.1	-0.1
Jul	0.1	0.1	-0.3	0.8	0.4
Jun	0.1	0.1	0.2	-0.2	-0.1
May	0.1	0.1	-0.1	0.2	0.0
Apr	0.2	0.2	-0.2	0.3	-0.1
Mar	0.5	0.4	0.0	0.6	0.2
Feb	0.6	0.5	0.1	0.8	0.4
Jan	1.2	1.6	0.1	0.4	0.0
Jan-Nov 2011	3.4	3.2	–0.4	3.9	1.6
Jan-Nov 2011 AE	3.8	3.5	–0.4	4.3	1.8
2010
Dec	0.5	0.5	0.2	0.4	0.1
Nov	0.1	0.1	0.0	0.4	0.3
Oct	0.5	0.5	0.3	0.6	0.4
IVQ10	1.1	1.1	0.5	1.4	0.8
IVQ2010 AE	4.5	4.5	2.0	5.7	3.2

Notes: NPI: current dollars personal income; NDPI: current dollars disposable personal income; RDPI: chained (2005) dollars DPI; NPCE: current dollars personal consumption expenditures; RPCE: chained (2005) dollars PCE; AE: annual equivalent; IVQ2010: fourth quarter 2010; A: annual equivalent

Percentage change month to month seasonally adjusted

Source: http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi1111.pdf

First, the data in Table 11 reveal the weakness of the economy. The column RDPI (real disposable income) shows that after eleven months in 2011 in Jan-Nov growth of RDPI has accumulated to minus 0.4 percent, which for a full year is equivalent to minus 0.4 percent. Growth of real personal consumption expenditures (RPCE) accumulated to 1.6 percent in Jan-Nov, which is equivalent to yearly growth of 1.8 percent. Inflation creates the illusion that there has been growth of income, when in fact RDPI stagnated, and growth of consumption, which in fact has grown at the mediocre annual equivalent rate of 1.8 percent. Growth is the result of drawing down savings instead of growth of income and opportunities. The growth engine of the US economy has stalled with resulting adverse effects on job creation and opportunities for advancement.

Second, the difference between NDPI and RDPI (NDPI/RDPI) and NPCE and RPCE (NPCE/RPCE) indicates inflation. Let the rate of inflation be π, the percentage change in nominal value NV and the change in real value rv. Then:

(1+π)(1+rv) = (1+NV) (1)

Thus, if we know (1+NV) and (1+rv), simple rearrangement provides (1+π):

(1+π) = (1+NV)/(1+rv) (2)

The growing gap between NDPI/RDPI and NPCE/RPCE is inflation and accelerating from the final quarter of 2010 to the first eleven months of 2011 but at slower rate since the drop in commodity prices beginning in May. The gap becomes more evident in the cumulative percentages Jan-Nov 2011 and IVQ2010 and their annual equivalents Jan-Nov 2011 AE and IVQ2010 AE. The annual equivalent gap of NDPI/RDPI in Jan-Nov 2011 in Table II-1 is 3.9 percent (1.035/0.996), which is much higher than in IVQ2010 of 2.5 percent (1.045/1.02). The gap NPCE/RPCE in Jan-Nov 2011 in Table II-1 is 2.5 percent (1.043/1.018), which is slightly higher than 2.4 percent (1.057/1.032) in IVQ2010. There is a radical change in the pattern of US growth. RDPI was growing at the annual equivalent rate of 2.0 percent with real PCE growing at 3.2 percent in annual equivalent in IVQ2010. In the first eleven months of 2011, RDPI has contracted at the annual equivalent rate of 0.4 percent and real PCE continues to grow at 1.8 percent at the expense of reduction of the savings rate. Inflation in the deflator of personal income and outlays is moving toward 3 percent per year. That is, the government is benefitting from a tax known as the inflation tax. By issuing money through its central bank the government buys goods and services. In a situation of sizeable deficits and inflation, the government gains by purchasing before effects of issuing money that causes increases in prices (see http://cmpassocregulationblog.blogspot.com/2011/05/global-inflation-seigniorage-monetary.html http://cmpassocregulationblog.blogspot.com/2011/05/global-inflation-seigniorage-financial.html Pelaez and Pelaez, International Financial Architecture (2005), 201-12). This is a hidden but actually felt contribution of monetary accommodation to financing bloated government expenditures. The new inflation tax argument is not by increases in inflation resulting from increasing monetary aggregates but by the rise in valuations of assets such as commodities induced through the carry trade of near zero interest rates.

Further information on income and consumption is provided by Table II-2. The 12-month rates of increase of RDPI and RPCE in the first eleven months of 2011 show a sharp trend of deterioration of RDPI from over 3 percent in the final four months of 2010 to less than 3 percent in IQ2011 and then collapsing to a range of 0.9 to 0.5 percent in May-Jul. In Aug 2011, RDPI fell 0.2 percent relative to Aug 2010 and fell 0.1 percent in every month from Sep to Nov. RPCE growth decelerated less sharply from close to 3 percent in IVQ 2010 to 2.3 percent in Jul, 1.7 percent in Aug, 2.1 percent in Sep, 1.9 percent in Oct and 1.7 percent in Nov. Market participants have been concerned with data in Tables II-1 and II-2 showing more subdued growth of RPCE. Growth rates of personal income and consumption have weakened. Goods and especially durable goods have been driving growth of PCE as shown by the much higher 12-months rates of growth of real goods PCE (RPCEG) and durable goods real PCE (RPCEGD) than services real PCE (RPCES). The faster expansion of industry in the economy is derived from growth of consumption of goods and in particular of consumer durable goods while growth of consumption of services is much more moderate. The 12 months rates of growth of RPCEGD have fallen from more than 10 percent in Sep 2010 to Feb 2011 to the range of 6.3 to 7.8 percent in the quarter May-Jul and then 6.1 percent in Aug, rebounding to 7.8 percent in Sep but falling to 6.8 percent in Oct and increasing to 7.5 percent in Nov. RPCEG growth rates have fallen from over 5 percent late in 2010 and early Jan-Feb 2011 to the range of 3.4 to 4.0 percent in the quarter May-Jul and then only 2.4 percent in Aug, 3.2 percent in Sep, 2.7 percent in Oct and 2.6 percent in Nov.

Table II-2, Real Disposable Personal Income and Real Personal Consumption Expenditures Percentage Change from the Same Month a Year Earlier %

	RDPI	RPCE	RPCEG	RPCEGD	RPCES
2011
Nov	-0.1	1.7	2.6	7.5	1.3
Oct	-0.1	1.9	2.7	6.6	1.4
Sep	-0.1	2.1	3.2	7.8	1.5
Aug	-0.2	1.7	2.4	6.1	1.4
Jul	0.5	2.3	3.9	7.1	1.5
Jun	0.8	2.0	3.4	6.3	1.4
May	0.9	2.2	4.0	7.8	1.4
Apr	1.6	2.5	4.7	9.2	1.4
Mar	2.4	2.6	4.5	9.3	1.7
Feb	2.7	2.9	5.9	12.8	1.4
Jan	2.8	2.9	5.8	12.0	1.5
2010
Dec	3.2	2.8	5.4	10.2	1.6
Nov	3.6	3.2	5.9	10.2	1.9
Oct	3.8	2.9	6.1	12.2	1.3
Sep	3.1	2.7	5.6	10.5	1.4

Notes: RDPI: real disposable personal income; RPCE: real personal consumption expenditures (PCE); RPCEG: real PCE goods; RPCEGD: RPCEG durable goods; RPCES: RPCE services

Numbers are percentage changes from the same month a year earlier

Source: http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi1111.pdf

Chart II-1 shows US real personal consumption expenditures (RPCE) between 1995 and 2011. There is an evident drop in RPCE during the global recession in 2007 to 2009 but the slope is flatter during the current recovery than in the period before 2007.

Chart II-1, US, Real Personal Consumption Expenditures 1995-2011

Source: US Bureau of Economic Analysis http://www.bea.gov/national/index.htm#personal

Percent changes from the prior period in seasonally-adjusted annual equivalent quarterly rates (SAAR) of real personal consumption expenditures (RPCE) are provided in Chart II-2 from 1995 to 2011. The average rate could be visualized as a horizontal line. Although there are not yet sufficient observations, it appears from Chart II-2 that the average rate of growth of RPCE was higher before the recession than during the past nine quarters of expansion that began in IIIQ2009.

Chart II-2, Percent Change from Prior Period in Real Personal Consumption Expenditure, Quarterly Seasonally Adjusted at Annual Rates 1995-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/national/index.htm#personal

Personal income and its disposition are shown in Table II-3. An important adversity is shown in Table II-3 in the form of sharp deceleration in growth of personal income from $155.3 billion in Jan 2011 relative to Dec 2010 to the contraction by $9.7 billion in Aug relative to Jul. In the same period, growth of wages and salaries fell from $55.4 billion in Jan/Dec to contraction by $7.1 billion in Aug/Jul and a second contraction by $6.9 billion in Nov/Oct. In Nov/Oct income recovered 0.1 percent but wages and salaries lost 0.2 percent. The final column of Table II-3 shows the decline of the savings rate from 5.2 percent in Dec 2010 to 3.5 percent in Nov 2011. The mediocre recovery of the economy is significantly driven by consuming out of savings with negative growth of real disposable personal income.

Table II-3, US, Personal Income and its Disposition, Seasonally Adjusted at Annual Rates $ Billions

	Personal Income	Wages & Salaries	Personal Taxes	DPI	Savings Rate %
Nov	13,045.9	6.688.4	1,447.3	11,598.6	3.5
Oct	13,037.4	6,695.3	1433.7	11,603.6	3.6
Change Nov/Oct	8.5 ∆% 0.1	-6.9   ∆% –0.2	13.6 ∆% 0.9	-5.0 ∆% 0.0
Sep	12,990.2	6,658.1	1,413.8	11,576.4	3.5
Change Oct/Sep	47.2 ∆% 0.4	37.2  ∆% 0.6	19.9 ∆% 1.4	27.2  ∆% 0.2
Aug	12,969.4	6,630.3	1,405.9	11,563.5	4.1
Change Sep/Aug	20.8 ∆% 0.2	27.8 ∆% 0.4	7.9 ∆% 0.6	12.9 ∆% 0.1
Jul	12,979.1	6,637.4	1,405.9	11,573.2	4.3
Change Aug/Jul	-9.7 ∆% –0.1	-7.1 ∆% –0.1	0.0 ∆% 0.0	-9.7 ∆% -0.1
Jun	12,970.1	6,615.1	1,403.2	11,566.9	5.0
Change Jul/Jun	9.0 ∆% 0.1	22.3 ∆% 0.3	2.7 ∆% 0.2	6.3 ∆% 0.1
May	12,957.2	6,619.6	1,397.4	11,559.7	4.7
Change Jun/ May	12.9 ∆% 0.1	-4.5 ∆% -0.1	5.8 ∆% 0.4	7.2 ∆% 0.1
Apr	12,938.7	6,616.5	1,387.9	11,550.8	4.8
Change May/ Apr	18.5 ∆% 0.1	3.1 ∆% 0.0	9.5 ∆% 0.7	8.9 ∆% 0.1
Mar	12,909.7	6,614.8	1,377.7	11,532.1	4.9
Change Apr/ Mar	29.0 ∆% 0.2	1.7 ∆% 0.0	10.2 ∆% 0.7	18.7 ∆% 0.2
Feb	12,850.6	6,582.9	1,367.1	11,483.5	5.0
Change Mar/ Feb	59.1 ∆% 0.5	31.9 ∆% 0.5	10.6 0.8	48.6 ∆% 0.4
Jan	12,780.3	6,536.8	1,352.8	11,427.5	5.2
Change Feb/Jan	70.3 ∆% 0.6	46.1 ∆% 0.7	14.3 ∆% 1.1	56.0 ∆% 0.5
Dec 2010	12,625.0	6,481.4	1,247.6	11,377.3	5.2
Change Jan/ Dec	155.3 ∆% 1.2	55.4 ∆% 0.9	105.2 ∆% 8.4	50.2 ∆% 0.4

Source: http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi1111.pdf

http://www.bea.gov/iTable/index_nipa.cfm

Chart II-3 provides personal income in the US between 1980 and 1989. These data are not adjusted for inflation that was still high in the 1980s in the exit from the Great Inflation of the 1960s and 1970s. Personal income grew steadily during the 1980s after recovery from two recessions from Jan IQ1980 to Jul IIIQ1980 and from Jul IIIQ1981 to Nov IVQ1982 (http://www.nber.org/cycles.html) with combined drop of GDP by 4.8 percent.

Chart II-3, US, Personal Income, Billion Dollars, Seasonally Adjusted at Annual Rates, 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

A different evolution of personal income is shown in Chart II-4. Personal income also fell during the recession from Dec IVQ2007 to Jun IIQ2009 (http://www.nber.org/cycles.html). Growth of personal income has been anemic and has stalled in 2011.

Chart II-4, US, Personal Income, Current Billions of Dollars, Seasonally Adjusted at Annual Rates, 2007-2011

Source:

http://www.bea.gov/iTable/index_nipa.cfm

Real or inflation-adjusted disposable personal income is provided in Chart II-5 from 1980 to 1989. Real disposable income after allowing for taxes and inflation grew steadily at high rates during the entire decade.

Chart II-5, US, Real Disposable Income, Billions of Chained 2005 Dollars, Seasonally Adjusted at Annual Rates 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

The stagnation of real disposable income is evident in Chart II-6. There was initial recovery in 2010 and then income after inflation and taxes stagnated into 2011. The 12 months rates of growth real disposable income in Aug 2011 of 0.1 percent and Sep 2011 of 0.2 percent are barely positive. In fact, as Table 11 shows, real disposable income in the US contracted by 0.3 percent cumulatively in Jan-Sep 2011 at the annual equivalent rate of minus 0.4 percent.

Chart II-6, US, Real Disposable Income, Billions of Chained 2005 Dollars, Seasonally Adjusted at Annual Rates, 2007-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart II-7 provides percentage quarterly changes in real disposable income from the preceding period at seasonally-adjusted annual rates from 1980 to 1989. Rates of change were high during the decade with few negative changes.

Chart II-7, US, Real Disposable Income Percentage Change from Preceding Period at Seasonally-Adjusted Annual Rates, 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart II-8 provides percentage quarterly changes in real disposable income from the preceding period at seasonally-adjusted annual rates from 2007 to 2011. There has been a period of positive rates followed by decline of rates and then negative rates.

Chart, II-8, US, Real Disposable Income, Percentage from Preceding Period at Seasonally-Adjusted Annual Rates, 2007-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

In the latest available report, the Bureau of Economic Analysis (BEA) estimates US personal income in Nov 2011 at the seasonally adjusted annual rate of $13,045.9 billion, as shown in Table II-3 above (http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi1111.pdf Table 1, page 6). The major portion of personal income is compensation of employees of $8,304.9 billion, or 63.7 percent of the total. Wage and salary disbursements are $6,688.4 billion, of which $5,499.1 billion by private industries, and supplements to wages and salaries of employer contributions to pension and insurance funds and Social Security are $1118.2 billion. Chart II-9 provides US wage and salary disbursement by private industries in the 1980s. Growth was robust after the interruption of the recessions.

Chart II-9, US, Wage and Salary Disbursement, Private Industries, Quarterly, Seasonally Adjusted at Annual Rates Billions of Dollars, 1980-1989

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart II-10 shows US wage and salary disbursement of private industries from 2007 to 2011. There is a drop during the contraction followed by initial recovery in 2010 and then the current stagnation in 2011.

Chart II-10, US, Wage and Salary Disbursement, Private Industries, Quarterly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Chart II-11 provides finer detail with monthly wage and salary disbursement of private industries from 2007 to 2011. There is decline during the contraction and a period of mild recovery with current stagnation.

Chart II-11, US, Wage and Salary Disbursement, Private Industries, Monthly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

IIB Repression of Savings. McKinnon (1973) and Shaw (1974) argue that legal restrictions on financial institutions can be detrimental to economic development. “Financial repression” is the term used in the economic literature for these restrictions (see Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 81-6). Interest rate ceilings on deposits and loans have been commonly used. Prohibition of payment of interest on demand deposits and ceilings on interest rates on time deposits were imposed by the Banking Act of 1933. These measures were justified by arguments that the banking panic of the 1930s was caused by competitive rates on bank deposits that led banks to engage in high-risk loans (Friedman, 1970, 18; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 74-5). The objective of policy was to prevent unsound loans in banks. Savings and loan institutions complained of unfair competition from commercial banks that led to continuing controls with the objective of directing savings toward residential construction. Friedman (1970, 15) argues that controls were passive during periods when rates implied on demand deposit were zero or lower and when Regulation Q ceilings on time deposits were above market rates on time deposits. The Great Inflation or stagflation of the 1960s and 1970s changed the relevance of Regulation Q.

Most regulatory actions trigger compensatory measures by the private sector that result in outcomes that are different from those intended by regulation (Kydland and Prescott 1977). Banks offered services to their customers and loans at rates lower than market rates to compensate for the prohibition to pay interest on demand deposits (Friedman 1970, 24). The prohibition of interest on demand deposits was eventually lifted in recent times. In the second half of the 1960s, already in the beginning of the Great Inflation (DeLong 1997), market rates rose above the ceilings of Regulation Q because of higher inflation. Nobody desires savings allocated to time or savings deposits that pay less than expected inflation. This is a fact currently with zero interest rates and consumer price inflation of 3.4 percent in the 12 months ending in Nov. Funding problems motivated compensatory measures by banks. Money-center banks invented the large certificate of deposit (CD) to accommodate increasing volumes of loan demand by customers. As Friedman (1970, 25) finds:

“Large negotiable CD’s were particularly hard hit by the interest rate ceiling because they are deposits of financially sophisticated individuals and institutions who have many alternatives. As already noted, they declined from a peak of $24 billion in mid-December, 1968, to less than $12 billion in early October, 1969.”

Banks created different liabilities to compensate for the decline in CDs. As Friedman (1970, 25; 1969) explains:

“The most important single replacement was almost surely ‘liabilities of US banks to foreign branches.’ Prevented from paying a market interest rate on liabilities of home offices in the United States (except to foreign official institutions that are exempt from Regulation Q), the major US banks discovered that they could do so by using the Euro-dollar market. Their European branches could accept time deposits, either on book account or as negotiable CD’s at whatever rate was required to attract them and match them on the asset side of their balance sheet with ‘due from head office.’ The head office could substitute the liability ‘due to foreign branches’ for the liability ‘due on CDs.”

Friedman (1970, 26-7) predicted the future:

“The banks have been forced into costly structural readjustments, the European banking system has been given an unnecessary competitive advantage, and London has been artificially strengthened as a financial center at the expense of New York.”

In short, Depression regulation exported the US financial system to London and offshore centers. What is vividly relevant currently from this experience is the argument by Friedman (1970, 27) that the controls affected the most people with lower incomes and wealth who were forced into accepting controlled-rates on their savings that were lower than those that would be obtained under freer markets. As Friedman (1970, 27) argues:

“These are the people who have the fewest alternative ways to invest their limited assets and are least sophisticated about the alternatives.”

Chart II-12 provides savings as percent of disposable income or the US savings rate. There was a long-term downward sloping trend from 12 percent in the early 1980s to less than 2 percent in 2005-2006. The savings rate then rose during the contraction and also in the expansion. In 2011 the savings rate has been declining as consumption is financed with savings in part because of the disincentive or frustration of receiving a few pennies for every $10,000 of deposits in a bank. The objective of monetary policy is to reduce borrowing rates to induce consumption but it has collateral disincentive of reducing savings. The zero interest rate of monetary policy is a tax on saving. This tax is highly regressive, meaning that it affects the most people with lower income or wealth and retirees. The long-term decline of savings rates in the US has created a dependence on foreign savings to finance the deficits in the federal budget and the balance of payments.

Chart II-12, US, Personal Savings as a Percentage of Disposable Personal Income, Quarterly, 1980-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

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 Large Scale Lender of Last Resort 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 analysis.

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 16 and daily values throughout the week ending on Fri Dec 23 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 16 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 (European Council 2911Dec9), 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 1.3036/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Dec 16, appreciating to USD 1.2999/EUR on Mon Dec 19, or by 0.3 percent. The dollar appreciated because fewer dollars, $1.2999, were required on Dec 19 to buy one euro than $1.3036 on Dec 16. 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 1.2999/EUR on Dec 19; 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 16, to the last business day of the current week, in this case Fri Dec 23, such as virtually no change to USD 1.3044/EUR by Dec 23; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (positive sign) by 0.1 percent from the rate of USD 1.3036/EUR on Fri Dec 16 to the rate of USD 1.3051/EUR on Thu Dec 22 {[(1.3051/1.3036) – 1]100 = 0.1%} and appreciated by 0.1 percent from the rate of USD 1.3051 on Thu Dec 22 to USD 1.3044/EUR on Fri Dec 23 {[(1.3044/1.3051) -1]100 = 0.1%}. 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 higher yield risk financial assets to the safety of dollar investments. When risk aversion declines, funds have been moving away from safe assets in dollars to risk financial assets.

III-I, Weekly Financial Risk Assets July 18 to July 22, 2011

Fri Nov 16, 2011	M 19	Tu 20	W 21	Th 22	Fr 23
USD/ EUR 1.3036 2.5%	1.2999 0.3% 0.3%	1.3080 -0.3% 0.6%	1.3045 -0.1% 0.3%	1.3051 -0.1% 0.0%	1.3044 0.0% 0.1%
JPY/  USD 77.72 -0.1%	78.0440 -0.4% -0.4%	77.8595 -0.2% 0.2%	78.0957 -0.5% -0.2%	78.1635 -0.6% -0.1%	78.0875 -0.5% 0.1%
CHF/   USD 0.9364 -1.3%	0.9373 -0.1% -0.1%	0.9316 0.5% 0.6%	0.9359 0.1% -0.5%	0.9360 0.1% 0.0%	0.9366 0.0% -0.1%
CHF/  EUR 1.2207 1.2%	1.2184 0.2% 0.2%	1.2185 0.2% 0.0%	1.2208 0.0% -0.2%	1.2216 -0.1% -0.1%	1.2217 -0.1% 0.0%
USD/  AUD 0.996 1.004 -2.5%	0.9893 1.0108 -0.7% -0.7%	1.0080 0.9921 1.2% 1.9%	1.0094 0.9907 1.3% 0.1%	1.0127 0.9875 1.6% 0.3%	1.0151 0.9851 1.9% 0.2%
10 Year   T Note 1.847	1.81	1.92	1.97	1.95	2.027
2 Year     T Note 0.226	0.23	0.25	0.27	0.27	0.28
German Bond 2Y 0.22 10Y 1.85	2Y 0.21 10Y 1.88	2Y 0.21 10Y 1.95	2Y 0.23 10Y 1.93	2Y 0.23 10Y 1.94	2Y 0.23 10Y 1.96
DJIA 11866.39 -2.6%	11766.26 -0.8% -0.8%	12103.58 2.0% 2.9%	12107.74 2.0% 0.0%	12169.65 2.6% 0.5%	12294.00 3.6% 1.0%
DJ Global 1751.60 -4.3%	1731.53 -1.1% -1.1%	1771.88 1.2% 2.3%	1776.41 1.4% 0.2%	1790.37 2.2% 0.8%	1803.20 2.9% 0.7%
DJ Asia Pacific 1148.37 -2.4%	1127.36 -1.8% -1.8%	1133.45 -1.3% 0.5%	1154.78 0.6% 1.9%	1150.92 0.2% -0.3%	1158.82 0.9% 0.7%
Nikkei 8401.72 -1.6%	8296.12 -1.3% -1.3%	8336.48 -0.8% 0.5%	8459.98 0.7% 1.5%	8395.16 -0.1% -0.8%	8395.16 -0.1% -0.8%
Shanghai 2224.84 -3.9%	2218.24 -0.3% -0.3%	2215.93 -0.4% -0.1%	2191.15 -1.5% -1.1%	2186.30 -1.7% -0.2%	2204.78 -0.9% 0.9%
DAX 5701.78 -4.8%	5670.71 -0.5% -0.5%	5847.03 2.5% 3.1%	5791.53 1.6% -0.9%	5852.18 2.6% 1.1%	5878.93 3.1% 0.5%
DJ UBS Comm. 137.01 -4.2%	137.26 0.2% 0.2%	139.57 1.9% 1.7%	140.38 2.5% 0.6%	141.09 3.0% 0.5%	141.20 3.1% 0.1%
WTI $ B 94.02 -5.7%	93.80 -0.2% -0.2%	97.350 3.5% 3.8%	98.960 5.3% 1.7%	99.38 5.7% 0.4%	99.68 6.0% 0.3%
Brent    $/B 103.72 -4.7%	103.58 -0.1% -0.1%	106.910 3.1% 3.2%	107.90 4.0% 0.9%	107.60 3.7% -0.3%	107.96 4.1% 0.3%
Gold  $/OZ 1599.9 -6.7%	1595.4 -0.3% -0.3%	1617.2 1.1% 1.4%	1617.0 1.1% 0.0%	1606.0 0.4% -0.7%	1606.0 0.4% 0.0%

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. An impasse of risk aversion was experienced in the week of Dec 23 with some uncertainties on the implementation of the new agreement of European leaders.

· 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 0.61 percent for the four-year government bond of Germany and 0.89 percent for the five-year bond on Fri Dec 23 (http://www.bloomberg.com/markets/rates-bonds/government-bonds/germany/). Spain continues to make progress in placing its debt. Miles Johnson, writing on Dec 20, on “Spain’s short term debt yields tumble,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/1f57a9ba-2af9-11e1-8a38-00144feabdc0.html#axzz1gzoHXOj6), informs on the sharp reduction of short-term yields of Spanish debt. Spain placed €5.64 billion of short-term debt on Dec 20. The yield of the three-month security was 1.735 percent, compared with 5.11 percent of a similar auction in Nov, and the yield of the six-month security was 2.435 percent, compared with 5.227 per cent in the prior month. The newly-elected government in Spain intends to maintain the debt/GDP ratio below 60 percent; restrict the structural government deficit below 0.4 percent per year; and enhance bank balance sheets with recognition of losses in real estate loans. The yield of Italy’s ten-year government bond fell below 7 percent during the week of Dec 23 but still remains just below 7 percent. 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 risk impasse continued through the week of Dec 23.

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 strength in valuations of risk financial assets in the week of Dec 23. 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 muted risk aversion because of continuing doubts on the success of the new agreement on Europe reached in the week of Dec 9. Risk aversion is probably best observed in foreign exchange markets with daily trading of $4 trillion instead of in relatively thin equity markets during year-end holidays. The dollar has remained virtually unchanged during two consecutive weeks. Safe-haven currencies, such as the Swiss franc (CHF) and the Japanese yen (JPY) have been under threat of appreciation but also remained relatively unchanged. 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. The pain of Japan from dollar devaluation continues as illustrated by Table VI-6 in Section VI Valuation of Risk Financial Assets: The yen traded at JPY 110.19/USD on Aug 18, 2008 and at JPY 78.08/USD on Dec 23, 2011, for cumulative appreciation of 29.1 percent. Cumulative appreciation from Sep 15, 2010 (JPY 83.07/USD) to Dec 23, 2011 (JPY 78.08) was 6.0 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 but depreciated by 0.5 percent in the week of Dec 23 as shown in Table III-1. 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 remained unchanged relative to the USD in the week of Dec 23 and depreciated 0.1 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. In the week of Dec 23, the Australian dollar appreciated 1.9 percent as shown in Table III-1. 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, 2.065 on Dec 9 and collapse to 1.847 percent by Fr Dec 16. The yield of the 10-year Treasury rose from 1.81 percent on Mon Dec 19 to 2.027 percent on Fri Dec 23, as shown in Table III-1, in a more relaxed mood of risk aversion. 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 but rising to 0.28 percent on Dec 23 as shown in Table III-1. 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 16, virtually equal to the yield of the two-year Treasury note of the US and settled at 0.23 percent on Fri Dec 23, as shown in Table III-1. The yield of the 10-year German government bond has also collapsed from 2.15 percent on Dec 9 to 1.85 percent on Dec 16 but rising to 1.96 percent on Dec 23, also virtually equal to the yield of 2.027 percent 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.

Most equity indexes in Table III-1 rose during the week of Dec 23. Germany’s Dax rose 2.6 percent on Thu Dec 22, gaining 3.1 percent in the week. DJIA rose 2.6 percent on Thu Dec 22 and another 1.0 percent on Dec 23 for a week’s gain of 3.6 percent. Dow Global gained 1.4 percent in the week of Dec 9, lost 2.6 percent in the week of Dec 16 and gained 2.9 percent in the week of Dec 23.

Financial risk assets increase during moderation of risk aversion in carry trades from zero interest rates and fall during increasing risk aversion. Commodities rose 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, but as shown in Table III-1 the DJ UBS gained 3.1 percent in the week of Dec 23. Gold also declined 6.7 percent in the week of Dec 16 but gained only 0.4 percent in the week of Dec 23.

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 adjustment 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). Matthew Dalton and Matina Stevis, writing on Dec 20, 2011, on “Euro Zone Agrees to New IMF Loans,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204791104577107974167166272.html?mod=WSJPRO_hps_MIDDLESecondNews), inform that at a meeting on Dec 20, finance ministers of the euro-zone developed plans to contribute €150 billion in bilateral loans to the IMF as provided in the agreement of Dec 9. 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.”

Draghi (2011Dec19) explains measures to ensure “access to funding markets” by euro zone banks:

§ “We have decided on three-year refinancing operations to support the supply of credit to the euro area economy. These measures address the risk that persistent financial markets tensions could affect the capacity of euro area banks to obtain refinancing over longer horizons.

§ Earlier, in October, the Governing Council had already decided to have two more refinancing operations with a maturity of around one year.

§ Also, it was announced then that in all refinancing operations until at least the first half of 2012 all liquidity demand by banks would be fully allotted at fixed rate.

§ Funding via the covered bonds market was also facilitated by the ECB deciding in October to introduce a new Covered Bond Purchase Programme of €40 billion.

§ Funding in US dollar is facilitated by lowering the pricing on the temporary US dollar liquidity swap arrangements.”

Lionel Barber and Ralph Atkins interviewed Mario Draghi on Dec 14 with the transcript published in the Financial Times on Dec 18 (http://www.ft.com/intl/cms/s/0/25d553ec-2972-11e1-a066-00144feabdc0.html#axzz1gzoHXOj6) as “FT interview transcript: Mario Draghi.” A critical question in the interview is if the new measures are a European version of quantitative easing. Draghi analyzes the difference between the measures of the European Central Bank (ECB) and quantitative easing such as in Japan, US and UK:

3. The measures are termed “non-standard” instead of “unconventional.” While quantitative easing attempts to lower the yield of targeted maturities, the three-year facility operates through the “bank channel.” Quantitative easing would not be feasible because the ECB is statutorily prohibited of funding central governments. The ECB would comply with its mandate of medium-term price stability.

4. There is a critical difference in the two programs. Quantitative easing has been used as a form of financial repression known as “directed lending.” For example, the purchase of mortgage-backed securities more recently or the suspension of the auctions of 30-year bonds in response to the contraction early in the 2000s has the clear objective of directing spending to housing. The ECB gives the banks entire discretion on how to use the funding within their risk/return decisions, which could include purchase of government bonds.

The question on the similarity of the ECB three-year lending facility and quantitative easing is quite valid. Tracy Alloway, writing on Oct 10, 2011, on “Investors worry over cheap ECB money side effects,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/d2f87d16-f339-11e0-8383-00144feab49a.html#axzz1hAqMH1vn), analyzes the use of earlier long-term refinancing operations (LTRO) of the ECB. LTROs by the ECB in Jun, Sep and Dec 2009 lent €614 billion at 1 percent. Alloway quotes estimates of Deutsche Bank that banks used €442billion to acquire assets with higher yields. Carry trades developed from LTRO funds at 1 percent into liquid investments at a higher yield to earn highly profitable spreads. Alloway quotes estimates of Morgan Stanley that European debt of GIIPS (Greece, Ireland, Italy, Portugal and Spain) in European bank balance sheets is €700 billion. Tracy Alloway, writing on Dec 21, 2011, on “Demand for ECB loans rises to €489bn,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/d6ddd0ae-2bbd-11e1-98bc-00144feabdc0.html#axzz1hAqMH1vn), informs that European banks borrowed the largest value of €489 billion in all LTROs of the ECB. Tom Fairless and David Cottle, writing on Dec 21, 2011, on “ECB sees record refinancing demand,” published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970204464404577111983838592746.html?mod=WSJPRO_hpp_LEFTTopStories), inform that the first of three operations of the ECB lent €489.19 billion, or $639.96 billion, to 523 banks. Three such LTROs could add to $1.9 trillion, which is not far from the value of quantitative easing in the US of $2.5 trillion. Fairless and Cottle find that there could be renewed hopes that banks could use the LTROs to support euro zone bond markets. It is possible that there could be official moral suasion by governments on banks to increase their holdings of government bonds or at least not to sell existing holdings. Banks are not free to choose assets in evaluation of risk and returns. Floods of cheap money at 1 percent per year induce carry trades to high-risk assets and not necessarily financing of growth with borrowing and lending decisions constrained by shocks of confidence.

The LTROs of the ECB are not very different from the liquidity facilities of the Fed during the financial crisis. Kohn (2009Sep10) finds that the trillions of dollars in facilities provided by the Fed (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-64, Regulation of Banks and Finance (2009b), 224-7) could fall under normal principles of “lender of last resort” of central banks:

“The liquidity measures we took during the financial crisis, although unprecedented in their details, were generally consistent with Bagehot's principles and aimed at short-circuiting these feedback loops. The Federal Reserve lends only against collateral that meets specific quality requirements, and it applies haircuts where appropriate. Beyond the collateral, in many cases we also have recourse to the borrowing institution for repayment. In the case of the TALF, we are backstopped by the Treasury. In addition, the terms and conditions of most of our facilities are designed to be unattractive under normal market conditions, thus preserving borrowers' incentives to obtain funds in the market when markets are operating normally. Apart from a very small number of exceptions involving systemically important institutions, such features have limited the extent to which the Federal Reserve has taken on credit risk, and the overall credit risk involved in our lending during the crisis has been small.

In Ricardo's view, if the collateral had really been good, private institutions would have lent against it. However, as has been recognized since Bagehot, private lenders, acting to protect themselves, typically severely curtail lending during a financial crisis, irrespective of the quality of the available collateral. The central bank--because it is not liquidity constrained and has the infrastructure in place to make loans against a variety of collateral--is well positioned to make those loans in the interest of financial stability, and can make them without taking on significant credit risk, as long as its lending is secured by sound collateral. A key function of the central bank is to lend in such circumstances to contain the crisis and mitigate its effects on the economy.”

The Bagehot (1873) principle is that central banks should provide a safety net, lending to temporarily illiquid but solvent banks and not to insolvent banks (see Cline 2001, 2002; Pelaez and Pelaez, International Financial Architecture (2005), 175-8). Kohn (2009Apr18) characterizes “quantitative easing” as “large scale purchases of assets:”

“Another aspect of our efforts to affect financial conditions has been the extension of our open market operations to large-scale purchases of agency mortgage-backed securities (MBS), agency debt, and longer-term Treasury debt. We initially announced our intention to undertake large-scale asset purchases last November, when the federal funds rate began to approach its zero lower bound and we needed to begin applying stimulus through other channels as the economic contraction deepened. These purchases are intended to reduce intermediate- and longer-term interest rates on mortgages and other credit to households and businesses; those rates influence decisions about investments in long-lived assets like houses, consumer durable goods, and business capital. In ordinary circumstances, the typically quite modest volume of central bank purchases and sales of such assets has only small and temporary effects on their yields. However, the extremely large volume of purchases now underway does appear to have substantially lowered yields. The decline in yields reflects "preferred habitat" behavior, meaning that there is not perfect arbitrage between the yields on longer-term assets and current and expected short-term interest rates. These preferences are likely to be especially strong in current circumstances, so that long-term asset prices rise and yields fall as the Federal Reserve acquires a significant portion of the outstanding stock of securities held by the public.”

Non-standard ECB policy and unconventional Fed policy have a common link in the scale of implementation or policy doses. Direct lending by the central bank to banks is the function “large scale lender of last resort.” If there is moral suasion by governments to coerce banks into increasing their holdings of government bonds, the correct term would be financial repression.

The financial reform of the United States around the proposal of a national bank by Alexander Hamilton (1780) to develop the money economy with specialization away from the barter economy is credited with creating the financial system that brought prosperity over a long period (see Pelaez 2008). Continuing growth and prosperity together with sound financial management earned the US dollar the role as reserve currency and the AAA rating of its Treasury securities. McKinnon (2011Dec18) analyzes the resolution of the European debt crisis by comparison with the reform of Alexander Hamilton. Northern states of the US had financed the revolutionary war with the issue of paper notes that were at risk of default by 1890. Alexander Hamilton proposed the purchase of the states’ paper notes by the Federal government without haircuts. McKinnon (2011Dec18) describes the conflicts before passing the assumption bill in 1790 for federal absorption of the debts of states. Other elements in the Hamilton reform consisted of creation of a market for US Treasury bonds by their use as paid-in capital in the First Bank of the United States. McKinnon (2011Dec18) finds growth of intermediation in the US by the branching of the First Bank of the United States throughout several states, accepting deposits to provide commercial short-term credit. The reform consolidated the union of states, fiscal credibility for the union and financial intermediation required for growth. The reform also introduced low tariffs and an excise tax on whisky to service the interest on the federal debt. Trade relations among members of the euro zone are highly important to economic activity. There are two lessons drawn by McKinnon (2011Dec18) from the experience of Hamilton for the euro zone currently. (1) The reform of Hamilton included new taxes for the assumption of debts of states with concrete provisions for their credibility. (2) Commercial lending was consolidated with a trusted bank both for accepting private deposits and for commercial lending, creating the structure of financial intermediation required for growth.

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 23 the yield of the 2-year bond of the government of Greece was quoted above 105 percent. In contrast, the 2-year US Treasury note traded at 0.28 percent and the 10-year at 2.027 percent while the comparable 2-year government bond of Germany traded at 0.23 percent and the 10-year government bond of Germany traded at 1.96 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 IIID 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 USD Billions	Primary Net Lending Borrowing % GDP 2010	General Government Net Debt % GDP 2010
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 € Billions	12 Months ∆%	Jan-Oct 2011 € Billions	Jan-Oct 2011/ Jan-Oct 2010 ∆%
Total Exports	89.2	3.8	881.1	12.5
A. EU Members	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

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/press/pr/2011/12/PE11__455__51,templateId=renderPrint.psml

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:

(M_t + B_t)/P_t = E_t∫(1/R_{t, t+τ})s_t+τdτ (4)

Equation (4) expresses the monetary, M_t, and debt, B_t, liabilities of the government, divided by the price level, P_t, in terms of the expected value discounted by the ex-post rate on government debt, R_{t, t+τ}, of the future primary surpluses s_t+τ, which are equal to T_t+τ – G_t+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 R_{t, t+τ}. The second equation of Cochrane (2011Jan, 5) is:

M_tV(i_t, ·) = P_tY_t (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* RPI 5.2	5.4* output 13.4* input 10.0**	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_3rd.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 and 0.6 percent in IIIQ2011 relative to IIQ2011 (http://www.ons.gov.uk/ons/rel/naa2/quarterly-national-accounts/q3-2011/index.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/recovery-without-hiring-world-inflation_20.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 (http://cmpassocregulationblog.blogspot.com/2011/12/recovery-without-hiring-world-inflation_20.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 Tendency
2011 Jun PR	1.6 – 1.7 2.7 – 2.9	9.0 – 9.1 8.6 – 8.9	2.7 – 2.9 2.3 – 2.5	1.8 – 1.9 1.5 – 1.8
2012 Jun PR	2.5 – 2.9 3.3 – 3.7	8.5 – 8.7 7.8 – 8.2	1.4 – 2.0 1.5 – 2.0	1.5 – 2.0 1.4 – 2.0
2013 Jun PR	3.0 – 3.5 3.5 – 4.2	7.8 – 8.2 7.0 – 7.5	1.5 – 2.0 1.5 – 2.0	1.4 – 1.9 1.4 – 2.0
2014 Jun PR	3.0 – 3.9 NA	6.8 – 7.7 NA	1.5 – 2.0 NA	1.5 – 2.0 NA
Longer Run	2.4 – 2.7 2.5 – 2.8	5.2 – 6.0 5.2 – 5.6	1.7 – 2.0 1.7 – 2.0
Range
2011 Jun PR	1.6 – 1.8 2.5 – 3.0	8.9 – 9.1 8.4 – 9.1	2.5 – 3.3 2.1 – 3.5	1.7 – 2.0 1.5 – 2.3
2012 Jun PR	2.3 – 3.5 2.2 – 4.0	8.1 – 8.9 7.5 – 8.7	1.4 – 2.8 1.2 – 2.8	1.3 – 2.1 1.2 – 2.5
2013 Jun PR	2.7 – 4.0 3.0 – 4.5	7.5 – 8.4 6.5 – 8.3	1.4 – 2.5 1.3 – 2.5	1.4 – 2.1 1.3 – 2.5
2014 Jun PR	2.7 – 4.5 NA	6.5 – 8.0 NA	1.5 – 2.4 NA	1.4 – 2.2 NA
Longer Run	2.2 – 3.0 2.4 – 3.0	5.0 – 6.0 5.0 – 6.0	1.5 – 2.0 1.5 – 2.0

Notes: UEM: unemployment; PR: Projection

Source: http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20111102.pdf

There are three waves of inflation of personal consumption expenditures (PCE) in 2011 shown in Table IV-3. These waves are in part determined by commodity price shocks originating in the carry trade from zero interest rates to positions in risk financial assets, in particular in commodity futures, which increase the prices of food and energy when there is relaxed risk aversion. The first wave is in Jan-Apr when headline PCE inflation grew at the average annual equivalent rate of 4.6 percent and PCE inflation excluding food and energy at 2.1 percent. The drivers of inflation were increases in food prices at the annual equivalent rate of 8.7 percent and of energy prices at 41.7 percent. This behavior will prevail under zero interest rates and relaxed risk aversion. The second wave occurred in May and Jun when risk aversion from the European sovereign risk crisis interrupted the carry trade. PCE prices rose 0.6 percent in annual equivalent and 3.0 percent excluding food and energy. The third wave is captured by the annual equivalent rates in Jul-Nov of headline PCE inflation of 1.9 percent with subdued PCE inflation excluding food and energy of 1.4 percent while PCE food rose at 3.7 percent and PCE energy increased at 5.9 percent. Increased risk aversion explains negative and subdued price changes in Oct with headline PCE prices falling 0.1 percent while PCE prices excluding food and energy rose 0.1 percent. In Nov, headline PCE was flat and rose 0.1 percent excluding food and energy.

Table IV-3, US, Percentage Change from Prior Month of Prices of Personal Consumption Expenditures ∆%

	PCE	PCEG	PCEG -D	PCES	PCEX	PCEF	PCEE
2011
Nov	0.0	-0.2	-0.3	0.1	0.1	-0.1	-1.6
Oct	-0.1	-0.3	-0.1	0.1	0.1	0.1	-2.0
Sep	0.2	0.3	-0.4	0.1	0.0	0.5	2.1
Aug	0.3	0.4	-0.1	0.2	0.2	0.6	1.2
Jul	0.4	0.7	-0.1	0.2	0.2	0.4	2.8
∆% AE Jul- Nov	1.9	2.2	-2.4	1.7	1.4	3.7	5.9
Jun	-0.1	-0.5	0.2	0.1	0.2	0.1	-4.5
May	0.2	0.0	0.1	0.3	0.3	0.3	-1.2
∆% AE May-Jun	0.6	-3.0	1.8	2.4	3.0	2.4	-29.4
Apr	0.3	0.6	0.2	0.2	0.2	0.4	2.3
Mar	0.4	0.8	0.0	0.2	0.1	0.9	3.7
Feb	0.4	0.8	0.2	0.2	0.2	0.8	3.5
Jan	0.4	0.8	0.1	0.2	0.2	0.7	2.3
∆% AE Jan-Apr	4.6	9.4	1.5	2.4	2.1	8.7	41.7
2010
Dec	0.3	0.6	-0.4	0.1	0.0	0.1	4.1
Nov	0.1	0.0	-0.2	0.1	0.1	0.0	0.1
Oct	0.2	0.4	-0.2	0.1	0.1	0.1	2.8
Sep	0.1	0.2	-0.2	0.1	0.0	0.3	1.2
Aug	0.2	0.3	-0.1	0.1	0.1	0.1	1.7
Jul	0.2	0.5	-0.3	0.1	0.0	0.1	3.4
Jun	-0.2	-0.6	-0.3	0.1	0.1	-0.2	-3.6
May	-0.1	-0.6	-0.2	0.2	0.1	0.0	-2.9
Apr	0.0	-0.2	-0.2	0.2	0.1	0.2	-0.5
Mar	0.2	-0.1	0.0	0.3	0.2	0.2	-0.4
Feb	0.1	-0.1	-0.3	0.2	0.1	0.2	-0.2
Jan	0.2	0.5	0.2	0.1	0.1	0.2	2.7

Notes: percentage changes in price index relative to the same month a year earlier of PCE: personal consumption expenditures; PCEG: PCE goods; PCEG-D: PCE durable goods; PCES: PCE services; PCEX: PCE excluding food and energy; PCEF: PCE food; PCEE: PCE energy goods and services

Source: http://www.bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/pi/2011/pdf/pi1111.pdf

The charts of PCE inflation are also instructive. Chart IV-1 provides the monthly change of headline PCE price index. There is significant volatility in the monthly changes but excluding outliers fluctuations have been in a tight range between 1999 and 2011 around 0.2 percent per month.

Chart IV-1, US, Percentage Change of PCE Price Index from Prior Month, 1999-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

There is similar behavior in the monthly fluctuations of the PCE price index excluding food and energy in Chart IV-2. The exclusion of commodity components eliminates negative changes with one exception. Fluctuations have been in a tight range from 0.0 percent to 0.4 percent, excluding two outliers.

Chart IV-2, US, Percentage Change of PCE Price Index Excluding Food and Energy from Prior Month, 1999-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

As with all commodity prices, oscillations of the PCE price index of food in Chart IV-3 are quite wide. Monetary policy of zero interest rates has caused trends of increase such as from 2007 into the global recession and in the current expansion phase after 2010.

Chart IV-3, US, Percentage Change of PCE Price Index Food from Prior Month, 1999-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

The band of fluctuation of the PCE price index of energy in Chart IV-4 is much wider. An interesting feature is the abundance of negative changes.

Chart IV-4, US, Percentage Change of PCE Price Index Energy from Prior Month, 1999-2011

Source: US Bureau of Economic Analysis

http://www.bea.gov/iTable/index_nipa.cfm

Table IV-4 provides 12 months rates of PCE inflation. While headline PCE inflation has increased from 1.5 percent in Jan to 2.5 percent in Nov, PCE inflation excluding food and energy (PCEX), used as indicator in monetary policy, has increased from 1.0 percent in Jan to 1.7 percent in Nov, which is still below the tolerable maximum of 2.0 percent in monetary policy. The unintended effect of shocks of commodity prices from zero interest rates captured by PCE food prices (PCEF) and energy (PCEE) in the absence of risk aversion should be weighed in design and implementation of monetary policy.

Table IV-4, US, Percentage Change in 12 Months of Prices of Personal Consumption Expenditures ∆%

	PCE	PCEG	PCEG -D	PCES	PCEX	PCEF	PCEE
2011
Nov	2.5	3.9	-0.6	1.8	1.7	5.0	13.1
Oct	2.7	4.2	-0.5	1.9	1.7	5.1	15.1
Sep	2.9	4.9	-0.7	2.0	1.6	5.1	20.7
Aug	2.9	4.8	-0.5	1.9	1.7	4.8	19.6
Jul	2.8	4.7	-0.2	1.8	1.6	4.3	20.2
Jun	2.6	4.5	-0.5	1.7	1.4	3.9	20.8
May	2.6	4.4	-1.0	1.7	1.3	3.6	21.9
Apr	2.4	3.9	-1.4	1.6	1.2	3.3	19.8
Mar	2.0	3.0	-1.8	1.5	1.0	3.1	16.5
Feb	1.8	2.1	-1.8	1.6	1.1	2.4	11.9
Jan	1.5	1.2	-2.3	1.6	1.0	1.8	7.9
2010
Dec	1.4	1.0	-2.5	1.5	0.9	1.3	8.3
Nov	1.2	0.4	-2.4	1.5	1.0	1.3	4.1
Oct	1.3	0.6	-2.1	1.6	1.0	1.3	6.3
Sep	1.4	0.4	-1.7	1.9	1.2	1.3	4.1
Aug	1.5	0.4	-1.4	1.9	1.4	0.7	3.8

Notes: percentage changes in price index relative to the same month a year earlier of PCE: personal consumption expenditures; PCEG: PCE goods; PCEG-D: PCE durable goods; PCES: PCE services; PCEX: PCE excluding food and energy; PCEF: PCE food; PCEE: PCE energy goods and services

Source:

http://www.bea.gov/iTable/index_nipa.cfm

The headline PCE index is shown in Chart IV-5 from 1999 to 2011. There is an evident upward trend with the bump of the global recession after IVQ2010.

The headline consumer price index is shown in Chart IV-6. There is also an upward trend but with fluctuations.

Chart IV-5, US, Price Index of Personal Consumption Expenditures 1999-2011

Source: http://www.bea.gov/iTable/index_nipa.cfm

Chart IV-6, US, Consumer Price Index, NSA, 1999-2011

Source: US Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

The PCE price index excluding food and energy is shown in Chart IV-7. There is less pronounced long-term trend with fewer bumps because of excluding more volatile commodity items.

Chart IV-7, US, Price Index of Personal Consumption Expenditures Excluding Food and Energy 1999-2011

Source: http://www.bea.gov/iTable/index_nipa.cfm

The core consumer price index, excluding food and energy, is shown in Chart IV-8. There is also an upward trend but with fluctuations.

Chart IV-8, US, Consumer Price Index Excluding Food and Energy, NSA, 1999-2011

Source: US Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

The PCE price index of food is shown in Chart IV-9. There is a more pronounced upward trend and sharper fluctuations.

Chart IV-9, US, Price Index of Personal Consumption Expenditures Food 1999-2011

Source: http://www.bea.gov/iTable/index_nipa.cfm

There is similar behavior in the consumer price index of food in Chart IV-10. There is an upward trend from 1999 to 2011 with a major bump in 2009 when commodity futures positions were unwound. Zero interest rates with bouts of risk aversion dominate the trend into 2011.

Chart IV-10, US, Consumer Price Index, Food, NSA, 2001-2011

Source: US Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

The most pronounced trend of the PCE price indexes is that of energy in Chart IV-11. It is impossible to explain the hump in 2008 in the middle of the global recession without the carry trade from zero interest rates to leveraged positions in commodity futures. Risk aversion after Sep 2008 caused flight to the safe haven of government obligations. The return of risk appetite with zero interest rates caused a first wave of carry trades with another upward trend interrupted by the first European sovereign risk crisis in Apr-Jul 2010. Zero interest rates with risk appetite caused another sharp upward trend of commodity prices interrupted by risk aversion from the second sovereign crisis. In the absence of risk aversion, carry trades from zero interest rates to positions in risk financial assets will continue to cause distortions such as commodity price trends and fluctuations.

Chart IV-11, US, Price Index of Personal Consumption Expenditures Energy Goods and Services 1999-2011

Source: http://www.bea.gov/iTable/index_nipa.cfm

Chart IV-12 provides the consumer price index of energy commodities. Unconventional monetary policy of zero or near zero interest rates causes upward trends in commodity prices reflected in (1) increase from 2003 to 2007; (2) sharp increase during the global contraction in 2008; (3) collapse from 2008 into 2009 as positions in commodity futures were unwound in a flight to government obligations; and (4) new upward trend after 2010 with episodes of decline during risk aversion shocks.

Chart IV-12, US, Consumer Price Index, Energy Commodities, NSA, 1999-2011

Source: US Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

The producer price index of Germany rose 0.1 percent in Nov relative to Oct and 5.2 percent in the 12 months ending in Nov, as shown in Table IV-5. The producer price index of Germany has the same three waves of inflation as in many other countries. In the first wave from Jan to Apr, the annual equivalent rate of producer-price inflation was 7.1 percent, propelled by carry trades from zero interest rates to exposures in commodity futures in a mood of risk appetite. In the second wave in May and Jun, the annual equivalent rate of producer price inflation was only 1.2 percent because of the collapse of the carry trade in fear of risk from the European sovereign risk situation. In the third wave from Jul to Nov, annual-equivalent producer price inflation in Germany has been 2.7 percent with fluctuations in commodity prices resulting from perception of the sovereign risk crisis in Europe. Annual data in the bottom of Table IV-5 show that the producer price index fell 5.2 percent in the 12 months ending in Dec 2009 as a result of the fall of commodity prices originating in risk aversion after the panic of 2008.

Table IV-5, Germany, Producer Price Index ∆%

	12 Months ∆% NSA	Month ∆% Calendar and SA
Nov 2011	5.2	0.1
Oct	5.3	0.2
Sep	5.5	0.3
Aug	5.5	-0.2
Jul	5.8	0.7
AE ∆% Jul-Nov		2.7
Jun	5.6	0.1
May	6.1	0.0
AE ∆% May-Jun		1.2
Apr	6.4	1.0
Mar	6.2	0.4
Feb	6.4	0.7
Jan	5.7	1.2
AE ∆% Jan-Apr		7.1
Dec 2010	5.3	0.7
Nov	4.4	0.2
Oct	4.3	0.5
Sep	3.9	0.5
Aug	3.2	0.1
Jul	3.7	0.7
Jun	1.7	0.5
May	0.9	0.2
Apr	0.6	0.6
Mar	-1.5	0.6
Feb	-2.9	0.1
Jan	-3.4	0.4
Dec 2009	-5.2	0.2
Dec 2008	4.0	-0.2
Dec 2007	1.9	0.4
Dec 2006	4.2	0.2
Dec 2005	4.8	0.2
Dec 2004	2.9	0.2
Dec 2003	1.8	0.0

Source: http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/DE/Presse/pm/2011/12/PD11__475__61241,templateId=renderPrint.psml

Chart IV-13 of the Federal Statistical Agency of Germany Statistiche Bundesamt Deutschland provides the producer price index of Germany from 2003 to 2011. Producer price inflation peaked in 2008 with the rise of commodity prices induced by the carry trade from zero interest rates to commodity futures. Prices then declined with the flight away from risk financial assets to government obligations after the financial panic in Sep 2008. With zero interest rates and no risk aversion, the carry trade pushed commodity future prices upwardly resulting in new rising trend of the producer price index.

Chart IV-13, Germany, Index of Producer Prices for Industrial Products, 2005=100

Source: Statistiche Bundesamt Deutschland

http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/KeyIndicators/ProducerPrices/liste__erzpr,templateId=renderPrint.psml

Chart IV-14 of the Federal Statistical Agency of Germany Statistiche Bundesamt Deutschland provides the unadjusted producer price index and trend. There is a clear upward trend of prices after the end of risk aversion with zero interest rates in 2009.

Chart IV-14, Germany, Producer Price Index, Non-adjusted Value and Trend, 2005=100

Source: Statistiche Bundesamt Deutschland

http://www.destatis.de/jetspeed/portal/cms/Sites/destatis/Internet/EN/Content/Statistics/TimeSeries/EconomicIndicators/Prices/Content100/kpre550graf0.psml

There have been fluctuations in producer price inflation in France for the French market as shown in Table IV-6. There was a wave of sharply increasing inflation in the first four months of 2011 originating in the surge of commodity prices driven by carry trade from zero interest rates to commodity futures risk positions. Producer price inflation in the first four months of 2011 was at the annual equivalent rate of 11.4 percent. Producer prices fell 0.5 percent in May and another 0.1 percent in Jun for annual equivalent inflation in May-Jun of minus 3.5 percent. In the months from Jul to Nov, annual equivalent producer price inflation was 3.7 percent. The bottom part of Table IV-6 shows producer price inflation at 6.4 percent in the 12 months ending in Dec 2005 and again at 5.2 percent in the 12 months ending in Dec 2007. Producer prices fell in 2008 and 2009 during the global contraction and decline of commodity prices but returned at 5.4 percent in the 12 months ending in Dec 2010.

Table IV-6, France, Producer Price Index for the French Market, ∆%

	Month	12 Months
Nov 2011	0.4	5.6
Oct	0.5	5.8
Sep	0.2	6.1
Aug	0.0	6.2
Jul	0.4	6.3
AE ∆% Jul-Nov	3.7
Jun	-0.1	6.1
May	-0.5	6.2
AE ∆% May-Jun	-3.5
Apr	1.0	6.7
Mar	0.9	6.7
Feb	0.8	6.3
Jan	0.9	5.6
AE ∆% Jan-Apr	11.4
Dec 2010	0.8	5.4
Dec 2009	0.1	-2.9
Dec 2008	-1.5	-0.2
Dec 2007	0.6	5.2
Dec 2006	-0.2	2.9
Dec 2005	0.2	6.4

Source: Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20111223

Chart IV-15 of the Institut National de la Statistique et des Études Économiques of France provides the behavior of the producer price index of France for the various segments: import prices, foreign markets, domestic market and all markets. All the components exhibit the rise to the peak in 2008 driven by carry trades from zero interest rates of unconventional monetary policy that was of such an impulse as to drive increases in commodity prices during the global recession. Prices collapsed with the flight out of financial risk assets such as commodity positions to government obligations. Commodity price increases returned with zero interest rates and subdued risk aversion. The shock of confidence of the current European sovereign risk moderated exposures to financial risk that influenced the flatter curve of France’s producer prices followed by another mild trend of increase.

Chart IV-15, France, Producer Price Index (PPI)

Source: Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20111223

France’s producer price index for the domestic market is shown in Table IV-7 for Nov 2011. The segment of prices of coke and refined petroleum increased 3.4 percent in Nov and 27.1 percent in 12 months. Manufacturing prices, with the highest weight in the index, increased 0.4 percent in Nov and rose 5.3 percent in 12 months. Mining prices increased 0.5 percent in the month and 7.5 percent in 12 months.

Table IV-7, France, Producer Price Index for the Domestic Market, %

Nov 2011	Weight	Month ∆%	12 Months ∆%
Total	1000	0.4	5.6
Mining	130	0.5	7.5
Mfg	870	0.4	5.3
Food Products, Beverages, Tobacco	188	0.1	5.4
Coke, Refined Petroleum	70	3.4	27.1
Electrical, Electronic	92	0.0	1.9
Transport	79	0.1	2.8
Other Mfg	441	-0.1	2.4

Source:  Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20111223

 

© Carlos M. Pelaez, 2010, 2011