CMP Associates Regulation Blog

Chart ESI-2 shows the ratio or rate of nonfarm hiring to employment (RNF) that also fell much more in the recession of 2007 to 2009 than in the shallow recession of 2001. Recovery is weak.

Chart ESI-2, US, Rate Total Nonfarm Hiring (HNF), Annual, 2001-2011

Source: US Bureau of Labor Statistics

Yearly percentage changes of total nonfarm hiring (HNF) are provided in Table ESI-2. There were much milder declines in 2002 of 6.9 percent and 3.6 percent in 2003 followed by strong rebounds of 6.9 percent in 2004 and 4.6 percent in 2005. In contrast, the contractions of nonfarm hiring in the recession after 2007 were much sharper in percentage points: 2.1 in 2007, 11.6 in 2008 and 15.9 percent in 2009. On a yearly basis, nonfarm hiring grew 4.8 percent in 2010 relative to 2009 and 3.0 percent in 2011.

Table ESI-2, US, Annual Total Nonfarm Hiring (HNF), Annual Percentage Change, 2001-2011

Year	Annual
2002	-6.9
2003	-3.6
2004	6.9
2005	4.6
2006	1.0
2007	-2.1
2008	-11.6
2009	-15.9
2010	4.8
2011	3.0

Source: US Bureau of Labor Statistics

Chart ESI-3 plots yearly percentage changes of nonfarm hiring. Percentage declines after 2007 were quite sharp.

Chart ESI-3, US, Annual Total Nonfarm Hiring (HNF), Annual Percentage Change, 2001-2011

Source: US Bureau of Labor Statistics

Total private hiring (HP) yearly data are provided in Chart ESI-4. There has been sharp contraction of total private hiring in the US and only milder recovery in 2011 than in 2010.

Chart ESI-4, US, Total Private Hiring Level, Annual, 2001-2011

Source: US Bureau of Labor Statistics

Chart ESI-5 plots the rate of total private hiring relative to employment (RHP). The rate collapsed during the global recession after 2007 with insufficient recovery.

Chart ESI-5, US, Rate Total Private Hiring, Annual, 2001-2011

Source: US Bureau of Labor Statistics

Total nonfarm hiring (HNF), total private hiring (HP) and their respective rates are provided for the month of Nov in the years from 2001 to 2012 in Table ESI-3. Hiring numbers are in thousands. There is some recovery in HNF from 3503 thousand (or 3.5 million) in Nov 2009 to 3844 thousand in Nov 2011 and 3904 thousand in Nov 2012 for cumulative gain of 11.4 percent. HP rose from 3305 thousand in Nov 2009 to 3640 thousand in Nov 2011 and 3683 thousand in Nov 2012 for cumulative gain of 11.4 percent. HNF has fallen from 4901 in Nov 2006 to 3904 in Nov 2012 or by 20.3 percent. HP has fallen from 4642 in Nov 2006 to 3683 in Nov 2012 or by 20.7 percent. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.

Table ESI-3, US, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment Not Seasonally Adjusted

	HNF	Rate RNF	HP	Rate HP
2001 Nov	4283	3.2	4020	3.6
2002 Nov	4247	3.2	3969	3.6
2003 Nov	4067	3.1	3853	3.5
2004 Nov	4591	3.4	4329	3.9
2005 Nov	4597	3.4	4344	3.8
2006 Nov	4901	3.6	4642	4.0
2007 Nov	4595	3.3	4345	3.7
2008 Nov	3842	2.6	3291	2.9
2009 Nov	3503	2.7	3305	3.1
2010 Nov	3667	2.8	3453	3.2
2011 Nov	3844	2.9	3640	3.3
2012 Nov	3904	2.9	3683	3.3

Source: Bureau of Labor Statistics http://www.bls.gov/jlt/

Chart ESI-6 provides total nonfarm hiring on a monthly basis from 2001 to 2012. Nonfarm hiring rebounded in early 2010 but then fell and stabilized at a lower level than the early peak not-seasonally adjusted (NSA) of 4786 in May 2010 until it surpassed it with 4869 in Jun 2011 but declined to 3904 in Oct 2012. Nonfarm hiring fell again in Dec 2011 to 3038 from 3844 in Nov and to revised 3633 in Feb 2012, increasing to 4127 in Mar 2012, 4490 in Apr 2012, 4926 in May 2012, 4988 in Jun 2012, 4732 in Jul 2012, 4962 in Aug 2012, 4380 in Sep 2012, 4589 in Oct 2012 and 3904 in Nov 2012. Chart ESI-6 provides seasonally-adjusted (SA) monthly data. The number of seasonally-adjusted hires in Aug 2011 was 4221 thousand, increasing to revised 4444 thousand in Feb 2012, or 5.3 percent, but falling to revised 4335 thousand in Mar 2012 and 4213 in Apr 2012, or cumulative decline of 0.2 percent relative to Aug 2011, moving to 4319 in Nov 2012 for cumulative increase of 1.2 percent from 4268 in Nov 2011 and increase of 0.1 percent relative to 4316 in Oct 2012. The number of hires not seasonally adjusted was 4655 in Aug 2011, falling to 3038 in Dec 2011 but increasing to 4072 in Jan 2012 and 3904 in Nov 2012. The number of nonfarm hiring not seasonally adjusted fell by 34.7 percent from 4655 in Aug 2011 to 3038 in Dec 2011 in a yearly-repeated seasonal pattern.

Chart ESI-6, US, Total Nonfarm Hiring (HNF), 2001-2012 Month SA

Source: US Bureau of Labor Statistics

Similar behavior occurs in the rate of nonfarm hiring plot in Chart ESI-7. Recovery in early 2010 was followed by decline and stabilization at a lower level but with stability in monthly SA estimates of 3.2 in Sep 2011 to 3.2 in Jan 2012, increasing to 3.4 in May 2012 and falling to 3.2 in both Jun and Jul 2012, increasing to 3.3 in Aug 2012 but falling to 3.1 in Sep 2012 and then 3.2 in both Oct and Nov 2012. The rate not seasonally adjusted fell from 3.7 in Jun 2011 to 2.3 in Dec, climbing to 3.1 in Jan 2012, 3.7 in both May and Jun 2012 and falling to 3,6 in Jul, increasing to 3.7 in Aug and falling to 3.3 in Sep 2012, 3.4 in Oct 2012 and 2.9 in Nov 2012. Rates of nonfarm hiring NSA were in the range of 2.8 (Dec) to 4.5 (Jun) in 2006.

Chart ESI-7, US, Rate Total Nonfarm Hiring, Month SA 2001-2012

Source: US Bureau of Labor Statistics

There is only milder improvement in total private hiring shown in Chart ESI-8. Hiring private (HP) rose in 2010 with stability and renewed increase in 2011 followed by stationary series in 2012. The number of private hiring seasonally adjusted fell from 4002 thousand in Sep 2011 to 3889 in Dec 2011 or by 2.8 percent, increasing to 3945 in Jan 2012 or decline by 1.4 relative to the level in Sep 2011 but decreasing to 3922 in Sep 2012 or lower by 2.0 percent relative to Sep 2011 and increasing to 4021 in Nov 2012 for increase of 1.9 percent relative to 3945 in Jan 2012. The number of private hiring not seasonally adjusted fell from 4130 in Sep 2011 to 2856 in Dec or by 30.8 percent, reaching 3782 in Jan 2012 or decline of 8.4 percent relative to Sep 2011 and moving to 3683 in Nov 2012 or 10.8 percent lower relative to Sep 2011. Companies do not hire in the latter part of the year that explains the high seasonality in year-end employment data. For example, NSA private hiring fell from 4934 in Sep 2006 to 3635 in Dec 2006 or by 26.3 percent. Private hiring NSA data are useful in showing the huge declines from the period before the global recession. In Jul 2006 private hiring NSA was 5555, declining to 4293 in Jul 2011 or by 22.7 percent and to 4403 in Jul 2012 or lower by 20.7 percent relative to Jul 2006. Private hiring NSA fell from 5215 in Sep 2005 to 3999 in Sep 2012 or 23.3 percent and fell from 4642 in Nov 2006 to 3683 in Nov 2012 or 20.7 percent. The conclusion is that private hiring in the US is around 20 percent below the hiring before the global recession. The main problem in recovery of the US labor market has been the low rate of growth of 2.2 percent in the thirteen quarters of expansion of the economy from IIIQ2009 to IIIQ2012 compared with average 6.2 percent in prior expansions from contractions (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). The US missed the opportunity to recover employment as in past cyclical expansions from contractions.

Chart I-8, US, Total Private Hiring Month SA 2001-2012

Source: US Bureau of Labor Statistics

Chart ESI-9 shows similar behavior in the rate of private hiring. The rate in 2011 in monthly SA data did not rise significantly above the peak in 2010. The rate seasonally adjusted fell from 3.6 in Sep 2011 to 3.5 in Dec 2011 and reached 3.6 in Nov 2012. The rate not seasonally adjusted (NSA) fell from 3.8 in Sep 2011 to 2.6 in Dec 2011, increasing to 3.9 in Oct 2012 but falling to 3.3 in Nov 2012. The NSA rate of private hiring fell from 4.8 in Jul 2006 to 3.4 in Aug 2009 but recovery was insufficient to only 3.3 in Nov 2012.

Chart ESI-9, US, Rate Total Private Hiring Month SA 2011-2011

Source: US Bureau of Labor Statistics

ESII Youth and Middle-Aged Unemployment. Chart ESII-1 provides longer perspective with the rate of youth unemployment in ages 16 to 24 years from 1948 to 2012. The rate of youth unemployment rose to 20 percent during the contractions of the early 1980s and also during the contraction of the global recession in 2008 and 2009. The data illustrate again the claim in this blog that the contractions of the early 1980s are the valid framework for comparison with the global recession of 2008 and 2009 instead of misleading comparisons with the 1930s. During the initial phase of recovery, the rate of youth unemployment 16 to 24 years NSA fell from 18.9 percent in Jun 1983 to 14.5 percent in Jun 1984 while the rate of youth unemployment 16 to 24 years was nearly the same during the expansion after IIIQ2009: 17.5 percent in Dec 2009, 16.7 percent in Dec 2010, 15.5 percent in Dec 2011 and 15.2 percent in Dec 2012. In Jul 2007, the rate of youth unemployment was 10.8 percent, increasing to 17.1 percent in Jul 2012. The difference originates in the vigorous seasonally-adjusted annual equivalent average rate of GDP growth of 5.7 percent during the recovery from IQ1983 to IVQ1985 compared with 2.2 percent on average during the first thirteen quarters of expansion from IIIQ2009 to IIIQ2012 (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). The fractured US labor market denies an early start for young people.

Chart ESII-1, US, Unemployment Rate 16-24 Years, Percent NSA, 1948-2012

Sources: US Bureau of Labor Statistics

It is more difficult to move to other jobs after a certain age because of fewer available opportunities for matured individuals than for new entrants into the labor force. Middle-aged unemployed are less likely to find another job. Table ESII-1 provides the unemployment level ages 45 years and over. The number unemployed ages 45 years and over rose from 1.985 million in Jul 2006 to 4.821 million in July 2010 or by 142.9 percent. The number of unemployed ages 45 years and over declined to 4.405 million in Jul 2012 that is still higher by 121.9 percent than in Jul 2006. The number unemployed age 45 and over jumped from 1.794 million in Dec 2006 to 4.762 million in Dec 2010 or 165.4 percent and at 3.927 million in Dec 2012 is higher by 2.133 million or 118.9 percent higher than 1.794 million in Nov 2006.

Table ESII-1, US, Unemployment Level 45 Years and Over, Thousands NSA

Year	Jul	Aug	Sep	Oct	Nov	Dec	Annual
2000	1253	1339	1254	1202	1242	1217	1249
2001	1539	1640	1586	1722	1786	1901	1576
2002	2173	2114	1966	1945	2013	2210	2114
2003	2281	2301	2157	2032	2132	2130	2253
2004	2116	2082	1951	1931	2053	2086	2149
2005	2119	1895	1992	1875	1920	1963	2009
2006	1985	1869	1710	1607	1704	1794	1848
2007	2053	1956	1854	1885	1925	2120	1966
2008	2492	2695	2595	2728	3078	3485	2540
2009	4757	4683	4560	4492	4655	4960	4500
2010	4821	5128	4640	4576	4909	4762	4879
2011	4772	4592	4426	4375	4195	4182	4537
2012	4405	4179	3899	3800	3861	3927	4133

Sources: US Bureau of Labor Statistics

Chart ESII-2 provides the level unemployed ages 45 years and over. There was sharp increase during the global recession and inadequate decline. There was an increase during the 2001 recession and then stability. The US is facing a major challenge of reemploying middle-aged workers.

Chart ESII-2, US, Unemployment Level Ages 45 Years and Over, Thousands, NSA, 1976-2012

Sources: US Bureau of Labor Statistics

ESIII World Inflation Waves. This section provides analysis and data on world inflation waves. There is more elaborate analysis in the text. IIA Appendix: Transmission of Unconventional Monetary Policy provides more technical analysis. Section IIB United States Inflation analyzes inflation in the United States in two subsections: IIC Long-term US Inflation and IID Current US Inflation. There is similar lack of reality in economic history as in monetary policy based on fear of deflation as analyzed in Subsection IIE Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation

The critical fact of current world financial markets is the combination of “unconventional” monetary policy with intermittent shocks of financial risk aversion. There are two interrelated unconventional monetary policies. First, unconventional monetary policy consists of (1) reducing short-term policy interest rates toward the “zero bound” such as fixing the fed funds rate at 0 to ¼ percent by decision of the Federal Open Market Committee (FOMC) since Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). Second, unconventional monetary policy also includes a battery of measures to also reduce long-term interest rates of government securities and asset-backed securities such as mortgage-backed securities.

When inflation is low, the central bank lowers interest rates to stimulate aggregate demand in the economy, which consists of consumption and investment. When inflation is subdued and unemployment high, monetary policy would lower interest rates to stimulate aggregate demand, reducing unemployment. When interest rates decline to zero, unconventional monetary policy would consist of policies such as large-scale purchases of long-term securities to lower their yields. A major portion of credit in the economy is financed with long-term asset-backed securities. Loans for purchasing houses, automobiles and other consumer products are bundled in securities that in turn are sold to investors. Corporations borrow funds for investment by issuing corporate bonds. Loans to small businesses are also financed by bundling them in long-term bonds. Securities markets bridge the needs of higher returns by savers obtaining funds from investors that are channeled to consumers and business for consumption and investment. Lowering the yields of these long-term bonds could lower costs of financing purchases of consumer durables and investment by business. The essential mechanism of transmission from lower interest rates to increases in aggregate demand is portfolio rebalancing. Withdrawal of bonds in a specific maturity segment or directly in a bond category such as currently mortgage-backed securities causes reductions in yield that are equivalent to increases in the prices of the bonds. There can be secondary increases in purchases of those bonds in private portfolios in pursuit of their increasing prices. Lower yields translate into lower costs of buying homes and consumer durables such as automobiles and also lower costs of investment for business. There are two additional intended routes of transmission.

1. Unconventional monetary policy or its expectation can increase stock market valuations (Bernanke 2010WP). Increases in equities traded in stock markets can augment perceptions of the wealth of consumers inducing increases in consumption.

2. Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can cause increases in net exports of the US that increase aggregate economic activity (Yellen 2011AS).

Monetary policy can lower short-term interest rates quite effectively. Lowering long-term yields is somewhat more difficult. The critical issue is that monetary policy cannot ensure that increasing credit at low interest cost increases consumption and investment. There is a large variety of possible allocation of funds at low interest rates from consumption and investment to multiple risk financial assets. Monetary policy does not control how investors will allocate asset categories. A critical financial practice is to borrow at low short-term interest rates to invest in high-risk, leveraged financial assets. Investors may increase in their portfolios asset categories such as equities, emerging market equities, high-yield bonds, currencies, commodity futures and options and multiple other risk financial assets including structured products. If there is risk appetite, the carry trade from zero interest rates to risk financial assets will consist of short positions at short-term interest rates (or borrowing) and short dollar assets with simultaneous long positions in high-risk, leveraged financial assets such as equities, commodities and high-yield bonds. Low interest rates may induce increases in valuations of risk financial assets that may fluctuate in accordance with perceptions of risk aversion by investors and the public. During periods of muted risk aversion, carry trades from zero interest rates to exposures in risk financial assets cause temporary waves of inflation that may foster instead of preventing financial instability. During periods of risk aversion such as fears of disruption of world financial markets and the global economy resulting from collapse of the European Monetary Union, carry trades are unwound with sharp deterioration of valuations of risk financial assets. More technical discussion is in the text in

Symmetric inflation targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output. Monetary easing by unconventional measures is now open ended in perpetuity, or QE∞, as provided in the statement of the meeting of the Federal Open Market Committee (FOMC) on Sep 13, 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm):

“To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”

Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):

“I think the best way to provide forward guidance is by tying our policy actions to explicit measures of economic performance. There are many ways of doing this, including setting a target for the level of nominal GDP. But recognizing the difficult nature of that policy approach, I have a more modest proposal: I think the Fed should make it clear that the federal funds rate will not be increased until the unemployment rate falls below 7 percent. Knowing that rates would stay low until significant progress is made in reducing unemployment would reassure markets and the public that the Fed would not prematurely reduce its accommodation.

Based on the work I have seen, I do not expect that such policy would lead to a major problem with inflation. But I recognize that there is a chance that the models and other analysis supporting this approach could be wrong. Accordingly, I believe that the commitment to low rates should be dropped if the outlook for inflation over the medium term rises above 3 percent.

The economic conditionality in this 7/3 threshold policy would clarify our forward policy intentions greatly and provide a more meaningful guide on how long the federal funds rate will remain low. In addition, I would indicate that clear and steady progress toward stronger growth is essential.”

Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:

“I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Price Index) inflation over the next two to three years, would be appropriate.”

The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):

“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

The actual objective is attempting to bring the unemployment rate to 5.2 percent but because of the lag in effect of monetary policy impulses on income and prices policy uses “projections” such that the target of monetary policy is a forecast of unemployment and inflation. Unconventional monetary policy will remain in perpetuity, or QE∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at 1.7 percent, which is well below 3.0 percent estimated by Lucas (2011May) from 1870 to 2010. Unconventional monetary policy interprets the dual mandate of low inflation and maximum employment as mainly a “growth mandate” of forcing economic growth in the US at a rate that generates full employment. A hurdle to this “growth mandate” is that the US economy grew at 6.2 percent on average during cyclical expansions in the postwar period while growth has been at only 2.2 percent on average in the cyclical expansion in the 13 quarters from IIIQ2009 to IIIQ2012. Zero interest rates and quantitative easing have not provided the impulse for growth and were not required in past successful cyclical expansions.

First, reduction of the unemployment rate to normal would take between 35 and 256 years depending on the definition (http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html). The US labor force stood at 153.373 million in Dec 2011 and 154.904 million in Dec 2012, not seasonally adjusted, for increase of 1.531 million or 127,583 per month. The average increase of 130,100 new nonfarm jobs per month in the US from Mar to Dec 2012 is insufficient even to absorb 127,583 new entrants per month into the labor force. The difference between the average increase of 137,200 new private nonfarm jobs per month in the US from Mar to Dec 2012 and the 127,583 average monthly increase in the labor force from Nov 2011 to Nov 2012 is 9,617 monthly new jobs net of absorption of new entrants in the labor force. There are 29.6 million in job stress in the US currently. The provision of 9,617 new jobs per month net of absorption of new entrants in the labor force would require 3078 months to provide jobs for the unemployed and underemployed (29.6 million divided by 9,617) or 256 years (3078 divided by 12). Net job creation of 9,617 jobs per month only adds 115,404 jobs in a year. The civilian labor force of the US in Dec 2012 not seasonally adjusted stood at 154.904 million with 11.844 million unemployed or effectively 18.700 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 8.7 years (1 million divided by product of 9,617 by 12, which is 115,404). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.745 million (0.05 times labor force of 154.904 million) for new net job creation of 4.099 million (11.844 million unemployed minus 7.745 million unemployed at rate of 5 percent) that at the current rate would take 35.5 years (4.099 million divided by 115,404). Under the calculation in this blog there are 18.700 million unemployed by including those who ceased searching because they believe there is no job for them. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 10.612 million jobs net of labor force growth that at the current rate would take 91.9 years (18.700 million minus 0.05 (161.760 million) divided by 115,404, using LF PART 66.2% and Total UEM in Table I-4 at http://cmpassocregulationblog.blogspot.com/2013/01/thirty-million-unemployed-or.html. These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. Second, calculations show that actual US GDP growth is around 1.7 percent per year that will perpetuate unemployment/underemployment (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html). This rate of 1.7 percent is well below trend growth of 3 percent per year from 1870 to 2010, which has been always recovered after events such as wars and recessions (Lucas 2011May). Weakness of growth is shown by the exceptional one-time contributions to growth from items that are not aggregate demand, 2.53 percentage points contributed by inventory change to growth of 4.1 percent in IVQ2011 and 0.64 percentage points contributed by exceptional expenditures in national defense together with 0.73 percentage points of inventory accumulation to growth of 3.1 percent in IIIQ2012. Deducting inventory accumulation and one-time national defense expenditures adjusts IIIQ2012 growth to annual 1.73 percent. Cumulative growth of 2.0 percent in IQ2012, 1.3 percent in IIQ2012 and adjusted 1.73 percent in IIIQ2012 annualizes to 1.7 percent in the first three quarters of 2012 {([(1.02)^1/4(1.013)^1/4(1.0173^1/4]^4/3 -1)100 = 1.7%}. The actual rate required to reduce unemployment/underemployment to normal is even much higher than 3 percent in historical trend.

In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is concern of the production and employment costs of controlling future inflation. Even if there is no inflation QE∞ cannot be abandoned because of the fear of rising interest rates that would cause losses in bond portfolios with high duration and make government fiscal affairs even more unsustainable. The economy would operate in an inferior allocation of resources and suboptimal growth path, or interior point of the production possibilities frontier where the optimum of productive efficiency and wellbeing is attained, because of the distortion of risk/return decisions caused by perpetual financial repression. Not even a second-best allocation is feasible with the shocks to efficiency of financial repression in perpetuity.

Table ESIII-1 provides annual equivalent rates of inflation for producer price indexes followed in this blog of countries and regions that account for close to three quarters of world output. The behavior of the US producer price index in 2011 and into 2012 shows neatly multiple waves. (1) In Jan-Apr 2011, without risk aversion, US producer prices rose at the annual equivalent rate of 9.7 percent. (2) After risk aversion, producer prices increased in the US at the annual equivalent rate of 1.2 percent in May-Jun 2011. (3) From Jul to Sep 2011, under alternating episodes of risk aversion, producer prices increased at the annual equivalent rate of 6.6 percent. (4) Under the pressure of risk aversion because of the European debt crisis US producer prices fell at the annual equivalent rate of minus 1.2 percent in Oct-Nov 2011. (5) From Dec 2011 to Jan 2012, US producer prices rose at the annual equivalent rate of 1.2 percent with relaxed risk aversion and commodity-price increases at the margin. (6) Inflation of producer prices returned with 1.2 percent annual equivalent in Feb-Mar 2012. (7) With return of risk aversion from the European debt crisis, producer prices fell at the annual equivalent rate of 7.5 percent in Apr-Jun 2012. (8) New positions in commodity futures even with continuing risk aversion caused annual equivalent inflation of 3.0 percent in Jun-Jul 2012. (9) Relaxed risk aversion because of announcement of sovereign bond-buying by the European Central Bank caused restrained induced carry trades that resulted in annual equivalent producer price inflation in the US of 18.2 percent in Aug-Sep 2012. (10) Renewed risk aversion caused unwinding of carry trades of zero interest rates to commodity futures exposures with annual equivalent inflation of minus 5.8 percent in Oct-Dec 2012. Resolution of the European debt crisis if there is not an unfavorable growth event with political development in China would result in jumps of valuations of risk financial assets. Increases in commodity prices would cause the same high producer price inflation experienced in Jan-Apr 2011 and Aug-Sep 2012. An episode of exploding commodity prices could ignite inflationary expectations that would result in an inflation phenomenon of costly resolution. There are nine producer-price indexes in Table ESIII-1 for seven countries (two for the UK) and one region (euro area) showing very similar behavior. Zero interest rates without risk aversion cause increases in commodity prices that in turn increase input and output prices. Producer price inflation rose at very high rates during the first part of 2011 for the US, Japan, China, Euro Area, Germany, France, Italy and the UK when risk aversion was contained. With the increase in risk aversion in May and Jun 2011, inflation moderated because carry trades were unwound. Producer price inflation returned after July 2011, with alternating bouts of risk aversion. In the final months of the year producer price inflation collapsed because of the disincentive to exposures in commodity futures resulting from fears of resolution of the European debt crisis. There is renewed worldwide inflation in the early part of 2012 with subsequent collapse because of another round of sharp risk aversion. Sharp worldwide jump in producer prices occurred recently as a result of the combination of zero interest rates forever or QE∞ with temporarily relaxed risk aversion. Producer prices are moderating or falling currently because of renewed risk aversion that causes unwinding of carry trades from zero interest rates to commodity futures exposures. Unconventional monetary policy fails in stimulating the overall real economy, merely introducing undesirable instability as monetary authorities cannot control allocation of floods of money at zero interest rates to carry trades into risk financial assets. The economy is constrained in a suboptimal allocation of resources that is perpetuated along a continuum of short-term periods results in long-term or dynamic inefficiency in the form of a trajectory of economic activity that is lower than what would be attained with rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html).

Table ESIII-1, Annual Equivalent Rates of Producer Price Indexes

INDEX 2011-2012	AE ∆%
US Producer Price Index
AE ∆% Oct-Dec 2012	-5.8
AE ∆% Aug-Sep 2012	18.2
AE ∆% Jun-Jul 2012	3.0
AE ∆% Apr-May 2012	-7.5
AE ∆% Feb-Mar 2012	1.2
AE ∆% Dec 2011-Jan-2012	1.2
AE ∆% Oct-Nov 2011	-1.2
AE ∆% Jul-Sep 2011	6.6
AE ∆% May-Jun 2011	1.2
AE ∆% Jan-Apr 2011	9.7
Japan Corporate Goods Price Index
AE ∆% Dec 2012	3.7
AE ∆% Oct-Nov 2012	-1.8
AE ∆% Aug-Sep 2012	2.4
AE ∆% May-Jul 2012	-5.8
AE ∆% Feb-Apr 2012	2.4
AE ∆% Dec 2011-Jan 2012	-0.6
AE ∆% Jul-Nov 2011	-2.2
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-Apr 2011	5.9
China Producer Price Index
AE ∆% Nov-Dec 2012	-1.2
AE ∆% Oct 2012	2.4
AE ∆% May-Sep 2012	-5.8
AE ∆% Feb-Apr 2012	2.4
AE ∆% Dec 2011-Jan 2012	-2.4
AE ∆% Jul-Nov 2011	-3.1
AE ∆% Jan-Jun 2011	6.4
Euro Zone Industrial Producer Prices
AE ∆% Nov 2012	-2.4
AE ∆% Sep-Oct 2012	1.8
AE ∆% Jul-Aug 2012	7.4
AE ∆% Apr-Jun 2012	-3.9
AE ∆% Jan-Mar 2012	8.3
AE ∆% Oct-Dec 2011	0.8
AE ∆% Jul-Sep 2011	2.0
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-Apr 2011	12.0
Germany Producer Price Index
AE ∆% Oct-Nov 2012	-0.6 NSA 1.2 SA
AE ∆% Aug-Sep 2012	4.9 NSA 6.2 SA
AE ∆% May-Jul 2012	-2.8 NSA –0.8 SA
AE ∆% Feb-Apr 2012	4.9 NSA 1.2 SA
AE ∆% Dec 2011-Jan 2012	1.2 NSA –0.6 SA
AE ∆% Oct-Nov 2011	1.8 NSA 3.7 SA
AE ∆% Jul-Sep 2011	2.8 NSA 3.7 SA
AE ∆% May-Jun 2011	0.6 NSA 3.7 SA
AE ∆% Jan-Apr 2011	10.4 NSA 6.5 SA
France Producer Price Index for the French Market
AE ∆% Nov 2012	-5.8
AE ∆% Jul-Oct 2012	8.1
AE ∆% Apr-Jun 2012	-7.7
AE ∆% Jan-Mar 2012	8.3
AE ∆% Oct-Dec 2011	2.4
AE ∆% Jul-Sep 2011	2.8
AE ∆% May-Jun 2011	-3.5
AE ∆% Jan-Apr 2011	11.7
Italy Producer Price Index
AE ∆% Sep-Nov 2012	-2.0
AE ∆% Jul-Aug 2012	6.8
AE ∆% May-Jun 2012	-2.4
AE ∆% Mar-Apr 2012	4.3
AE ∆% Jan-Feb 2012	7.4
AE ∆% Oct-Dec 2011	0.4
AE ∆% Jul-Sep 2011	2.4
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-April 2011	10.7
UK Output Prices
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Jul-Oct 2012	4.0
AE ∆% May-Jun 2012	-5.3
AE ∆% Feb-Apr 2012	7.9
AE ∆% Nov 2011-Jan-2012	1.6
AE ∆% May-Oct 2011	2.0
AE ∆% Jan-Apr 2011	12.0
UK Input Prices
AE ∆% Dec 2012	-2.4
AE ∆% Sep-Nov 2012	1.6
AE ∆% Jul-Aug 2012	14.0
AE ∆% Apr-Jun 2012	-21.9
AE ∆% Jan-Mar 2012	18.1
AE ∆% Nov-Dec 2011	-1.2
AE ∆% May-Oct 2011	-3.1
AE ∆% Jan-Apr 2011	35.6

AE: Annual Equivalent

Sources:

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

Similar world inflation waves are in the behavior of consumer price indexes of six countries and the euro zone in Table ESIII-2. US consumer price inflation shows similar waves. (1) Under risk appetite in Jan-Apr 2011 consumer prices increased at the annual equivalent rate of 4.9 percent. (2) Risk aversion caused the collapse of inflation to annual equivalent 2.8 percent in May-Jul 2011. (3) Risk appetite drove the rate of consumer price inflation in the US to 3.7 percent in Jul-Sep 2011. (4) Gloomier views of carry trades caused the collapse of inflation in Oct-Nov 2011 to annual equivalent 0.6 percent. (5) Consumer price inflation resuscitated with increased risk appetite at annual equivalent of 1.2 percent in Dec 2011 to Jan 2012. (6) Consumer price inflation returned at 2.8 percent annual equivalent in Feb-Apr 2012. (7) Under renewed risk aversion, annual equivalent consumer price inflation in the US is minus 1.2 percent in May-Jul 2012. (8) Inflation jumped to annual equivalent 7.4 percent in Aug-Sep 2012 and 5.3 percent in Aug-Oct 2012. (9) Unwinding of carry trades caused negative annual equivalent inflation of 1.8 percent in Nov-Dec 2012 but some countries experienced higher inflation in Dec 2012. Inflationary expectations can be triggered in one of these episodes of accelerating inflation because of commodity carry trades induced by unconventional monetary policy of zero interest rates in perpetuity or QE∞. Alternating episodes of increase and decrease of inflation introduce uncertainty in household planning that frustrates consumption and home buying. Announcement of purchases of impaired sovereign bonds by the European Central Bank relaxed risk aversion that induced carry trades into commodity exposures, increasing prices of food, raw materials and energy. There is similar behavior in all the other consumer price indexes in Table ESIII-2. China’s CPI increased at annual equivalent 8.3 percent in Jan-Mar 2011, 2.0 percent in Apr-Jun, 2.9 percent in Jul-Dec and resuscitated at 5.8 percent annual equivalent in Dec 2011 to Mar 2012, declining to minus 3.9 percent in Apr-Jun 2012 but resuscitating at 4.1 percent in Jul-Sep 2012, declining to minus 1.2 percent in Oct 2012 and 0.0 percent in Oct-Nov 2012. High inflation in China at annual equivalent 5.5 percent in Nov-Dec 2012 is attributed to inclement winter weather that caused increases in food prices. The euro zone harmonized index of consumer prices (HICP) increased at annual equivalent 5.2 percent in Jan-Apr 2011, minus 2.4 percent in May-Jul 2011, 4.3 percent in Aug-Dec 2011, minus 3.0 percent in Dec 2011-Jan 2012 and then 9.6 percent in Feb-Apr 2012, falling to minus 2.8 percent annual equivalent in May-Jul 2012 but resuscitating at 5.3 percent in Aug-Oct 2012. The recent shock of risk aversion forced minus 2.4 percent annual equivalent in Nov 2012. As in several European countries, annual equivalent inflation jumped to 4.9 percent in the euro area in Dec 2012. The price indexes of the largest members of the euro zone, Germany, France and Italy, and the euro zone as a whole, exhibit the same inflation waves. The United Kingdom CPI increased at annual equivalent 6.5 percent in Jan-Apr 2011, falling to only 0.4 percent in May-Jul 2011 and then increasing at 4.6 percent in Aug-Nov 2011. UK consumer prices fell at 0.6 percent annual equivalent in Dec 2011 to Jan 2012 but increased at 6.2 percent annual equivalent from Feb to Apr 2012. In May-Jun 2012, with renewed risk aversion, UK consumer prices fell at the annual equivalent rate of minus 3.0 percent. Inflation returned in the UK at average annual equivalent of 4.5 percent in Jul-Dec 2012 with inflation in Oct 2012 caused mostly by increases of university tuition fees. Inflation returned at 4.1 percent annual equivalent in Jul-Sep 2012 and was higher in annual equivalent producer price inflation in the UK in Jul-Oct 2012 at 5.0 percent for output prices and 14.0 percent for input prices in Jul-Aug 2012 (see Table ESIII-1).

Table ESIII-2, Annual Equivalent Rates of Consumer Price Indexes

Index 2011-2012	AE ∆%
US Consumer Price Index
AE ∆% Nov-Dec 2012	-1.8
AE ∆% Aug-Oct 2012	5.3
AE ∆% May-Jul 2012	-1.2
AE ∆% Feb-Apr 2012	2.8
AE ∆% Dec 2011-Jan 2012	1.2
AE ∆% Oct-Nov 2011	0.6
AE ∆% Jul-Sep 2011	3.7
AE ∆% May-Jul 2011	2.8
AE ∆% Jan-Apr 2011	4.9
China Consumer Price Index
AE ∆% Nov-Dec 2012	5.5
AE ∆% Oct 2012	0.0
AE ∆% Jul-Sep 2012	4.1
AE ∆% Apr-Jun 2012	-3.9
AE ∆% Dec 2011-Mar 2012	5.8
AE ∆% Jul-Nov 2011	2.9
AE ∆% Apr-Jun 2011	2.0
AE ∆% Jan-Mar 2011	8.3
Euro Zone Harmonized Index of Consumer Prices
AE ∆% Dec 2012	4.9
AE ∆% Nov 2012	-2.4
AE ∆% Aug-Oct 2012	5.3
AE ∆% May-Jul 2012	-2.8
AE ∆% Feb-Apr 2012	9.6
AE ∆% Dec 2011-Jan 2012	-3.0
AE ∆% Aug-Nov 2011	4.3
AE ∆% May-Jul 2011	-2.4
AE ∆% Jan-Apr 2011	5.2
Germany Consumer Price Index
AE ∆% Dec 2012	11.4 NSA 3.7 SA
AE ∆% Sep-Nov 2012	-0.4 NSA 1.6 SA
AE ∆% Jul-Aug 2012	4.9 NSA 3.7 SA
AE ∆% May-Jun 2012	-1.8 NSA 1.2 SA
AE ∆% Feb-Apr 2012	4.9 NSA 2.4 SA
AE ∆% Dec 2011-Jan 2012	1.8 NSA 1.8 SA
AE ∆% Jul-Nov 2011	1.2 NSA 1.9 SA
AE ∆% May-Jun 2011	0.6 NSA 2.4 SA
AE ∆% Feb-Apr 2011	4.9 NSA 2.4 SA
France Consumer Price Index
AE ∆% Dec 2012	3.7
AE ∆% Nov 2012	-2.4
AE ∆% Aug-Oct 2012	2.4
AE ∆% May-Jul 2012	-2.0
AE ∆% Feb-Apr 2012	5.3
AE ∆% Dec 2011-Jan 2012	0.0
AE ∆% Aug-Nov 2011	2.7
AE ∆% May-Jul 2011	-0.8
AE ∆% Jan-Apr 2011	4.3
Italy Consumer Price Index
AE ∆% Dec 2012	2.4
AE ∆% Sep-Nov 2012	-0.8
AE ∆% Jul-Aug 2012	3.0
AE ∆% May-Jun 2012	1.2
AE ∆% Feb-Apr 2012	5.7
AE ∆% Dec 2011-Jan 2012	4.3
AE ∆% Oct-Nov 2011	3.0
AE ∆% Jul-Sep 2011	2.4
AE ∆% May-Jun 2011	1.2
AE ∆% Jan-Apr 2011	4.9
UK Consumer Price Index
AE ∆% Jul-Dec 2012	4.5
AE ∆% May-Jun 2012	-3.0
AE ∆% Feb-Apr 2012	6.2
AE ∆% Dec 2011-Jan 2012	-0.6
AE ∆% Aug-Nov 2011	4.6
AE ∆% May-Jul 2011	0.4
AE ∆% Jan-Apr 2011	6.5

AE: Annual Equivalent

Sources:

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

ESIV Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation. Unconventional monetary policy could be defined by continuous symmetric objectives of inflation and the rate of unemployment with policy impulses of highest magnitude. The central bank would operate policy such as to constantly maintain inflation around 2 percent and the rate of unemployment close to the natural rate (Friedman 1968, Phelps 1968) around 5 percent. There are lags in effect of monetary policy impulses, meaning that a policy impulse today may not have all the effects on income and prices until many months in the future (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). Unconventional monetary policy has evolved into a forecast growth mandate.

Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):

Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:

The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):

Unconventional monetary policy will remain in perpetuity, or QE∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at around 1.7 percent, which is well below 3.0 percent estimated by Lucas (2011May) from 1870 to 2010. Unconventional monetary policy interprets the dual mandate of low inflation and maximum employment as mainly a “growth mandate” of forcing economic growth in the US at a rate that generates full employment. A hurdle to this “growth mandate” is that the US economy grew at 6.2 percent on average during cyclical expansions in the postwar period while growth has been at only 2.2 percent on average in the cyclical expansion in the 13 quarters from IIIQ2009 to IIIQ2012 (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). Zero interest rates and quantitative easing have not provided the impulse for growth and were not required in past successful cyclical expansions.

First, reduction of the unemployment rate to normal would take between 35 and 256 years depending on the definition (http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html). The US labor force stood at 153.373 million in Dec 2011 and 154.904 million in Dec 2012, not seasonally adjusted, for increase of 1.531 million or 127,583 per month. The average increase of 130,100 new nonfarm jobs per month in the US from Mar to Dec 2012 is insufficient even to absorb 127,583 new entrants per month into the labor force. The difference between the average increase of 137,200 new private nonfarm jobs per month in the US from Mar to Dec 2012 and the 127,583 average monthly increase in the labor force from Nov 2011 to Nov 2012 is 9,617 monthly new jobs net of absorption of new entrants in the labor force. There are 29.6 million in job stress in the US currently. The provision of 9,617 new jobs per month net of absorption of new entrants in the labor force would require 3078 months to provide jobs for the unemployed and underemployed (29.6 million divided by 9,617) or 256 years (3078 divided by 12). Net job creation of 9,617 jobs per month only adds 115,404 jobs in a year. The civilian labor force of the US in Dec 2012 not seasonally adjusted stood at 154.904 million with 11.844 million unemployed or effectively 18.700 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 8.7 years (1 million divided by product of 9,617 by 12, which is 115,404). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.745 million (0.05 times labor force of 154.904 million) for new net job creation of 4.099 million (11.844 million unemployed minus 7.745 million unemployed at rate of 5 percent) that at the current rate would take 35.5 years (4.099 million divided by 115,404). Under the calculation in this blog there are 18.700 million unemployed by including those who ceased searching because they believe there is no job for them. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 10.612 million jobs net of labor force growth that at the current rate would take 91.9 years (18.700 million minus 0.05(161.760 million) divided by 115,404, using LF PART 66.2% and Total UEM in Table ESI-1). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. Second, calculations show that actual US GDP growth is around 1.7 percent per year that will perpetuate unemployment/underemployment (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html). This rate of 1.7 percent is well below trend growth of 3 percent per year from 1870 to 2010, which has been always recovered after events such as wars and recessions (Lucas 2011May). Weakness of growth is shown by the exceptional one-time contributions to growth from items that are not aggregate demand, 2.53 percentage points contributed by inventory change to growth of 4.1 percent in IVQ2011 and 0.64 percentage points contributed by exceptional expenditures in national defense together with 0.73 percentage points of inventory accumulation to growth of 3.1 percent in IIIQ2012. Deducting inventory accumulation and one-time national defense expenditures adjusts IIIQ2012 growth to annual 1.73 percent. Cumulative growth of 2.0 percent in IQ2012, 1.3 percent in IIQ2012 and adjusted 1.73 percent in IIIQ2012 annualizes to 1.7 percent in the first three quarters of 2012 {([(1.02)^1/4(1.013)^1/4(1.0173^1/4]^4/3 -1)100 = 1.7%}. The actual rate required to reduce unemployment/underemployment to normal is even much higher than 3 percent in historical trend.

In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is concern of the production and employment costs of controlling future inflation. Even if there is no inflation QE∞ cannot be abandoned because of the fear of rising interest rates. The economy would operate in an inferior allocation of resources and suboptimal growth path, or interior point of the production possibilities frontier where the optimum of productive efficiency and wellbeing is attained, because of the distortion of risk/return decisions caused by perpetual financial repression. Not even a second-best allocation is feasible with the shocks to efficiency of financial repression in perpetuity.

It may be quite painful to exit QE∞ or use of the balance sheet of the central bank together with zero interest rates forever. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:

Where R_τ is expected revenue in the time horizon from τ =1 to T; C_τ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that discount rates increase without bound, then V → 0, or

declines.

The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Friedman 1957, 10). According to a subsequent restatement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption decisions is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (1)

Equation (1) shows that as r goes to zero, r →0, W grows without bound, W→∞. Equally, as r→∞, W→0. Monetary policy is constrained in a QE∞ trap with all adverse effects of financial repression and resource misallocation because an increase in interest rates causes contraction of wealth, which in the United States is concentrated in home ownership and stocks in own investment portfolios and pension funds that decline during interest rate increases.

Fear of deflation as had occurred during the Great Depression and in Japan was used as an argument for the first round of unconventional monetary policy with 1 percent interest rates from Jun 2003 to Jun 2004 and quantitative easing in the form of withdrawal of supply of 30-year securities by suspension of the auction of 30-year Treasury bonds with the intention of reducing mortgage rates (for fear of deflation see Pelaez and Pelaez, International Financial Architecture (2005), 18-28, and Pelaez and Pelaez, The Global Recession Risk (2007), 83-95). The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

If the forecast of the central bank is of recession and low inflation with controlled inflationary expectations, monetary policy should consist of lowering the short-term policy rate of the central bank, which in the US is the fed funds rate. The intended effect is to lower the real rate of interest (Svensson 2003LT, 146-7). The real rate of interest, r, is defined as the nominal rate, i, adjusted by expectations of inflation, π*, with all variables defined as proportions: (1+r) = (1+i)/(1+π*) (Fisher 1930). If i, the fed funds rate, is lowered by the Fed, the numerator of the right-hand side is lower such that if inflationary expectations, π*, remain unchanged, the left-hand (1+r) decreases, that is, the real rate of interest, r, declines. Expectations of lowering short-term real rates of interest by policy of the Federal Open Market Committee (FOMC) fixing a lower fed funds rate would lower long-term real rates of interest, inducing with a lag investment and consumption, or aggregate demand, that can lift the economy out of recession. Inflation also increases with a lag by higher aggregate demand and inflation expectations (Fisher 1933). This reasoning explains why the FOMC lowered the fed funds rate in Dec 2008 to 0 to 0.25 percent and left it unchanged.

The fear of the Fed is expected deflation or negative π*. In that case, (1+ π*) < 1, and (1+r) would increase because the right-hand side of the equation would be divided by a fraction. A simple numerical example explains the effect of deflation on the real rate of interest. Suppose that the nominal rate of interest or fed funds rate, i, is 0.25 percent, or in proportion 0.25/100 = 0.0025, such that (1+i) = 1.0025. Assume now that economic agents believe that inflation will remain at 1 percent for a long period, which means that π* = 1 percent, or in proportion 1/100 =0.01. The real rate of interest, using the equation, is (1+0.0025)/(1+0.01) = (1+r) = 0.99257, such that r = 0.99257 - 1 = -0.00743, which is a proportion equivalent to –(0.00743)100 = -0.743 percent. That is, Fed policy has created a negative real rate of interest of 0.743 percent with the objective of inducing aggregate demand by higher investment and consumption. This is true if expected inflation, π*, remains at 1 percent. Suppose now that expectations of deflation become generalized such that π* becomes -1 percent, that is, the public believes prices will fall at the rate of 1 percent in the foreseeable future. Then the real rate of interest becomes (1+0.0025) divided by (1-0.01) equal to (1.0025)/(0.99) = (1+r) = 1.01263, or r = (1.01263-1) = 0.01263, which results in positive real rate of interest of (0.01263)100 = 1.263 percent.

Irving Fisher also identified the impact of deflation on debts as an important cause of deepening contraction of income and employment during the Great Depression illustrated by an actual example (Fisher 1933, 346):

“By March, 1933, liquidation had reduced the debts about 20 percent, but had increased the dollar about 75 percent, so that the real debt, that is the debt measured in terms of commodities, was increased about 40 percent [100%-20%)X(100%+75%) =140%]. Unless some counteracting cause comes along to prevent the fall in the price level, such a depression as that of 1929-1933 (namely when the more the debtors pay the more they owe) tends to continue, going deeper, in a vicious spiral, for many years. There is then no tendency of the boat to stop tipping until it has capsized”

The nominal rate of interest must always be nonnegative, that is, i ≥ 0 (Hick 1937, 154-5):

“If the costs of holding money can be neglected, it will always be profitable to hold money rather than lend it out, if the rate of interest is not greater than zero. Consequently the rate of interest must always be positive. In an extreme case, the shortest short-term rate may perhaps be nearly zero. But if so, the long-term rate must lie above it, for the long rate has to allow for the risk that the short rate may rise during the currency of the loan, and it should be observed that the short rate can only rise, it cannot fall”

The interpretation by Hicks of the General Theory of Keynes is the special case in which at interest rates close to zero liquidity preference is infinitely or perfectly elastic, that is, the public holds infinitely large cash balances at that near zero interest rate because there is no opportunity cost of foregone interest. Increases in the money supply by the central bank would not decrease interest rates below their near zero level, which is called the liquidity trap. The only alternative public policy would consist of fiscal policy that would act similarly to an increase in investment, increasing employment without raising the interest rate.

An influential view on the policy required to steer the economy away from the liquidity trap is provided by Paul Krugman (1998). Suppose the central bank faces an increase in inflation. An important ingredient of the control of inflation is the central bank communicating to the public that it will maintain a sustained effort by all available policy measures and required doses until inflation is subdued and price stability is attained. If the public believes that the central bank will control inflation only until it declines to a more benign level but not sufficiently low level, current expectations will develop that inflation will be higher once the central bank abandons harsh measures. During deflation and recession the central bank has to convince the public that it will maintain zero interest rates and other required measures until the rate of inflation returns convincingly to a level consistent with expansion of the economy and stable prices. Krugman (1998, 161) summarizes the argument as:

“The ineffectuality of monetary policy in a liquidity trap is really the result of a looking-glass version of the standard credibility problem: monetary policy does not work because the public expects that whatever the central bank may do now, given the chance, it will revert to type and stabilize prices near their current level. If the central bank can credibly promise to be irresponsible—that is, convince the market that it will in fact allow prices to rise sufficiently—it can bootstrap the economy out of the trap”

This view is consistent with results of research by Christina Romer that “the rapid rates of growth of real output in the mid- and late 1930s were largely due to conventional aggregate demand stimulus, primarily in the form of monetary expansion. My calculations suggest that in the absence of these stimuli the economy would have remained depressed far longer and far more deeply than it actually did” (Romer 1992, 757-8, cited in Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 210-2). The average growth rate of the money supply in 1933-1937 was 10 percent per year and increased in the early 1940s. Romer calculates that GDP would have been much lower without this monetary expansion. The growth of “the money supply was primarily due to a gold inflow, which was in turn due to the devaluation in 1933 and to capital flight from Europe because of political instability after 1934” (Romer 1992, 759). Gold inflow coincided with the decline in real interest rates in 1933 that remained negative through the latter part of the 1930s, suggesting that they could have caused increases in spending that was sensitive to declines in interest rates. Bernanke finds dollar devaluation against gold to have been important in preventing further deflation in the 1930s (Bernanke 2002):

“There have been times when exchange rate policy has been an effective weapon against deflation. A striking example from US history is Franklin Roosevelt’s 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the US deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market”

Fed policy is seeking what Irving Fisher proposed “that great depressions are curable and preventable through reflation and stabilization” (Fisher 1933, 350).

The President of the Federal Reserve Bank of Chicago argues that (Charles Evans 2010):

“I believe the US economy is best described as being in a bona fide liquidity trap. Highly plausible projections are 1 percent for core Personal Consumption Expenditures (PCE) inflation at the end of 2012 and 8 percent for the unemployment rate. For me, the Fed’s dual mandate misses are too large to shrug off, and there is currently no policy conflict between improving employment and inflation outcomes”

There are two types of monetary policies that could be used in this situation. First, the Fed could announce a price-level target to be attained within a reasonable time frame (Evans 2010):

“For example, if the slope of the price path is 2 percent and inflation has been underunning the path for some time, monetary policy would strive to catch up to the path. Inflation would be higher than 2 percent for a time until the path was reattained”

Optimum monetary policy with interest rates near zero could consist of “bringing the price level back up to a level even higher than would have prevailed had the disturbance never occurred” (Gauti Eggertsson and Michael Woodford 2003, 207). Bernanke (2003JPY) explains as follows:

“Failure by the central bank to meet its target in a given period leads to expectations of (and public demands for) increased effort in subsequent periods—greater quantities of assets purchased on the open market for example. So even if the central bank is reluctant to provide a time frame for meetings its objective, the structure of the price-level objective provides a means for the bank to commit to increasing its anti-deflationary efforts when its earlier efforts prove unsuccessful. As Eggertsson and Woodford show, the expectations that an increasing price level gap will give rise to intensified effort by the central bank should lead the public to believe that ultimately inflation will replace deflation, a belief that supports the central bank’s own objectives by lowering the current real rate of interest”

Second, the Fed could use its balance sheet to increase purchases of long-term securities together with credible commitment to maintain the policy until the dual mandates of maximum employment and price stability are attained.

The central bank could also be pursuing competitive devaluation of the national currency in the belief that it could increase inflation to a higher level and promote domestic growth and employment at the expense of growth and unemployment in the rest of the world. An essay by Chairman Bernanke in 1999 on Japanese monetary policy received attention in the press, stating that (Bernanke 2000, 165):

“Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and experiment—in short, to do whatever it took to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done”

Quantitative easing has never been proposed by Chairman Bernanke or other economists as certain science without adverse effects. What has not been mentioned in the press is another suggestion to the Bank of Japan (BOJ) by Chairman Bernanke in the same essay that is very relevant to current events and the contentious issue of ongoing devaluation wars (Bernanke 2000, 161):

“Because the BOJ has a legal mandate to pursue price stability, it certainly could make a good argument that, with interest rates at zero, depreciation of the yen is the best available tool for achieving its mandated objective. The economic validity of the beggar-thy-neighbor thesis is doubtful, as depreciation creates trade—by raising home country income—as well as diverting it. Perhaps not all those who cite the beggar-thy-neighbor thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery. A yen trading at 100 to the dollar is in no one’s interest”

Chairman Bernanke is referring to the argument by Joan Robinson based on the experience of the Great Depression that: “in times of general unemployment a game of beggar-my-neighbour is played between the nations, each one endeavouring to throw a larger share of the burden upon the others” (Robinson 1947, 156). Devaluation is one of the tools used in these policies (Robinson 1947, 157). Banking crises dominated the experience of the United States, but countries that recovered were those devaluing early such that competitive devaluations rescued many countries from a recession as strong as that in the US (see references to Ehsan Choudhri, Levis Kochin and Barry Eichengreen in Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 205-9; for the case of Brazil that devalued early in the Great Depression recovering with an increasing trade balance see Pelaez, 1968, 1968b, 1972; Brazil devalued and abandoned the gold standard during crises in the historical period as shown by Pelaez 1976, Pelaez and Suzigan 1981). Beggar-my-neighbor policies did work for individual countries but the criticism of Joan Robinson was that it was not optimal for the world as a whole.

Friedman (1969) finds that the optimal rule for the quantity of money is deflation at a rate that results in a zero nominal interest rate (see Ireland 2003 and Cole and Kocherlakota 1998). Atkeson and Kehoe (2004) argue that central bankers are not inclined to implement policies that could result in deflation because of the interpretation of the Great Depression as closely related to deflation. They use panel data on inflation and growth of real output for 17 countries over more than 100 years. The time-series data for each individual country are broken into five-year events with deflation measured as average negative inflation and depression as average negative growth rate of real output. Atkeson and Kehoe (2004) find that the Great Depression from 1929 to 1934 is the only case of association between deflation and depression without any evidence whatsoever of such relation in any other period. Their conclusion is (Atkeson and Kehoe 2004, 99): “Our finding thus suggests that policymakers’ fear of anticipated policy-induced deflation that would result from following, say, the Friedman rule is greatly overblown.” Their conclusion on the experience of Japan is (Atkeson and Kehoe 2004, 99):

“Since 1960, Japan’s average growth rates have basically fallen monotonically, and since 1970, its average inflation rates have too. Attributing this 40-year slowdown to monetary forces is a stretch. More reasonable, we think, is that much of the slowdown is the natural pattern for a country that was far behind the world leaders and had begun to catch up.”

In the sample of Atkeson and Kehoe (2004), there are only eight five-year periods besides the Great Depression with both inflation and depression. Deflation and depression is shown in 65 cases with 21 of depression without deflation. There is no depression in 65 of 73 five-year periods and there is no deflation in 29 episodes of depression. There is a remarkable result of no depression in 90 percent of deflation episodes. Excluding the Great Depression, there is virtually no relation of deflation and depression. Atkeson and Kehoe (2004, 102) find that the average growth rate of Japan of 1.41 percent in the 1990s is “dismal” when compared with 3.20 percent in the United States but is not “dismal” when compared with 1.61 percent for Italy and 1.84 percent for France, which are also catch-up countries in modern economic growth (see Atkeson and Kehoe 1998). The conclusion of Atkeson and Kehoe (2004), without use of controls, is that there is no association of deflation and depression in their dataset.

Benhabib and Spiegel (2009) use a dataset similar to that of Atkeson and Kehoe (2004) but allowing for nonlinearity and inflation volatility. They conclude that in cases of low and negative inflation an increase of average inflation of 1 percent is associated with an increase of 0.31 percent of average annual growth. The analysis of Benhabib and Spiegel (2009) leads to the significantly different conclusion that inflation and economic performance are strongly associated for low and negative inflation. There is no claim of causality by Atkeson and Kehoe (2004) and Benhabib and Spiegel (2009).

Delfim Netto (1959) partly reprinted in Pelaez (1973) conducted two classical nonparametric tests (Mann 1945, Wallis and Moore 1941; see Kendall and Stuart 1968) with coffee-price data in the period of free markets from 1857 to 1906 with the following conclusions (Pelaez, 1976a, 280):

“First, the null hypothesis of no trend was accepted with high confidence; secondly, the null hypothesis of no oscillation was rejected also with high confidence. Consequently, in the nineteenth century international prices of coffee fluctuated but without long-run trend. This statistical fact refutes the extreme argument of structural weakness of the coffee trade.”

The conventional theory that the terms of trade of Brazil deteriorated over the long term is without reality (Pelaez 1976a, 280-281):

“Moreover, physical exports of coffee by Brazil increased at the high average rate of 3.5 per cent per year. Brazil's exchange receipts from coffee-exporting in sterling increased at the average rate of 3.5 per cent per year and receipts in domestic currency at 4.5 per cent per year. Great Britain supplied nearly all the imports of the coffee economy. In the period of the free coffee market, British export prices declined at the rate of 0.5 per cent per year. Thus, the income terms of trade of the coffee economy improved at the relatively satisfactory average rate of 4.0 per cent per year. This is only a lower bound of the rate of improvement of the terms of trade. While the quality of coffee remained relatively constant, the quality of manufactured products improved significantly during the fifty-year period considered. The trade data and the non-parametric tests refute conclusively the long-run hypothesis. The valid historical fact is that the tropical export economy of Brazil experienced an opportunity of absorbing rapidly increasing quantities of manufactures from the "workshop" countries. Therefore, the coffee trade constituted a golden opportunity for modernization in nineteenth-century Brazil.”

Imlah (1958) provides decline of British export prices at 0.5 percent in the nineteenth century and there were no lost decades, depressions or unconventional monetary policies in the highly dynamic economy of England that drove the world’s growth impulse. Inflation in the United Kingdom between 1857 and 1906 is measured by the composite price index of O’Donoghue and Goulding (2004) at minus 7.0 percent or average rate of decline of 0.2 percent per year.

Simon Kuznets (1971) analyzes modern economic growth in his Lecture in Memory of Alfred Nobel:

“The major breakthroughs in the advance of human knowledge, those that constituted dominant sources of sustained growth over long periods and spread to a substantial part of the world, may be termed epochal innovations. And the changing course of economic history can perhaps be subdivided into economic epochs, each identified by the epochal innovation with the distinctive characteristics of growth that it generated.Without considering the feasibility of identifying and dating such economic epochs, we may proceed on the working assumption that modern economic growth represents such a distinct epoch - growth dating back to the late eighteenth century and limited (except in significant partial effects) to economically developed countries. These countries, so classified because they have managed to take adequate advantage of the potential of modern technology, include most of Europe, the overseas offshoots of Western Europe, and Japan—barely one quarter of world population.”

Cameron (1961) analyzes the mechanism by which the Industrial Revolution in Great Britain spread throughout Europe and Cameron (1967) analyzes the financing by banks of the Industrial Revolution in Great Britain. O’Donoghue and Goulding (2004) provide consumer price inflation in England since 1750 and MacFarlane and Mortimer-Lee (1994) analyze inflation in England over 300 years. Lucas (2004) estimates world population and production since the year 1000 with sustained growth of per capita incomes beginning to accelerate for the first time in English-speaking countries and in particular in the Industrial Revolution in Great Britain. The conventional theory is unequal distribution of the gains from trade and technical progress between the industrialized countries and developing economies (Singer 1950, 478):

“Dismissing, then, changes in productivity as a governing factor in changing terms of trade, the following explanation presents itself: the fruits of technical progress may be distributed either to producers (in the form of rising incomes) or to consumers (in the form of lower prices). In the case of manufactured commodities produced in more developed countries, the former method, i.e., distribution to producers through higher incomes, was much more important relatively to the second method, while the second method prevailed more in the case of food and raw material production in the underdeveloped countries. Generalizing, we may say -that technical progress in manufacturing industries showed in a rise in incomes while technical progress in the production of food and raw materials in underdeveloped countries showed in a fall in prices”

Temin (1997, 79) uses a Ricardian trade model to discriminate between two views on the Industrial Revolution with an older view arguing broad-based increases in productivity and a new view concentration of productivity gains in cotton manufactures and iron:

“Productivity advances in British manufacturing should have lowered their prices relative to imports. They did. Albert Imlah [1958] correctly recognized this ‘severe deterioration’ in the net barter terms of trade as a signal of British success, not distress. It is no surprise that the price of cotton manufactures fell rapidly in response to productivity growth. But even the price of woolen manufactures, which were declining as a share of British exports, fell almost as rapidly as the price of exports as a whole. It follows, therefore, that the traditional ‘old-hat’ view of the Industrial Revolution is more accurate than the new, restricted image. Other British manufactures were not inefficient and stagnant, or at least, they were not all so backward. The spirit that motivated cotton manufactures extended also to activities as varied as hardware and haberdashery, arms, and apparel.”

Phyllis Deane (1968, 96) estimates growth of United Kingdom gross national product (GNP) at around 2 percent per year for several decades in the nineteenth century. The facts that the terms of trade of Great Britain deteriorated during the period of epochal innovation and high rates of economic growth while the income terms of trade of the coffee economy of nineteenth-century Brazil improved at the average yearly rate of 4.0 percent from 1857 to 1906 disprove the hypothesis of weakness of trade as an explanation of relatively lower income and wealth. As Temin (1997) concludes, Britain did pass on lower prices and higher quality the benefits of technical innovation. Explanation of late modernization must focus on laborious historical research on institutions and economic regimes together with economic theory, data gathering and measurement instead of grand generalizations of weakness of trade and alleged neocolonial dependence (Stein and Stein 1970, 134-5):

“Great Britain, technologically and industrially advanced, became as important to the Latin American economy as to the cotton-exporting southern United States. [After Independence in the nineteenth century] Latin America fell back upon traditional export activities, utilizing the cheapest available factor of production, the land, and the dependent labor force.”

The experience of the United Kingdom with deflation and economic growth is relevant and rich. Table ESIV-1 uses yearly percentage changes of the composite index of prices of the United Kingdom of O’Donoghue and Goulding (2004). There are 73 declines of inflation in the 145 years from 1751 to 1896. Prices declined in 50.3 percent of 145 years. Some price declines were quite sharp and many occurred over several years. Table ESIV-1 also provides yearly percentage changes of the UK composite price index of O’Donoghue and Goulding (2004) from 1929 to 1934. Deflation was much sharper in continuous years in earlier periods than during the Great Depression. The United Kingdom could not have led the world in modern economic growth if there were meaningful causality from deflation to depression.

Table ESIV-1, United Kingdom, Negative Percentage Changes of Composite Price Index, 1751-1896, 1929-1934, Yearly ∆%

Year	∆%	Year	∆%	Year	∆%	Year	∆%
1751	-2.7	1797	-10.0	1834	-7.8	1877	-0.7
1753	-2.7	1798	-2.2	1841	-2.3	1878	-2.2
1755	-6.0	1802	-23.0	1842	-7.6	1879	-4.4
1758	-0.3	1803	-5.9	1843	-11.3	1881	-1.1
1759	-7.9	1806	-4.4	1844	-0.1	1883	-0.5
1760	-4.5	1807	-1.9	1848	-12.1	1884	-2.7
1761	-4.5	1811	-2.9	1849	-6.3	1885	-3.0
1768	-1.1	1814	-12.7	1850	-6.4	1886	-1.6
1769	-8.2	1815	-10.7	1851	-3.0	1887	-0.5
1770	-0.4	1816	-8.4	1857	-5.6	1893	-0.7
1773	-0.3	1819	-2.5	1858	-8.4	1894	-2.0
1775	-5.6	1820	-9.3	1859	-1.8	1895	-1.0
1776	-2.2	1821	-12.0	1862	-2.6	1896	-0.3
1777	-0.4	1822	-13.5	1863	-3.6	1929	-0.9
1779	-8.5	1826	-5.5	1864	-0.9	1930	-2.8
1780	-3.4	1827	-6.5	1868	-1.7	1931	-4.3
1785	-4.0	1828	-2.9	1869	-5.0	1932	-2.6
1787	-0.6	1830	-6.1	1874	-3.3	1933	-2.1
1789	-1.3	1832	-7.4	1875	-1.9	1934	0.0
1791	-0.1	1833	-6.1	1876	-0.3

Source:

O’Donoghue, Jim and Louise Goulding, 2004. Consumer Price Inflation since 1750. UK Office for National Statistics Economic Trends 604, Mar 2004, 38-46.

Lucas (2011May) estimates US economic growth in the long-term at 3 percent per year and about 2 percent per year in per capita terms. There are displacements from this trend caused by events such as wars and recessions but the economy then returns to trend. Historical US GDP data exhibit remarkable growth: Lucas (2011May) estimates an increase of US real income per person by a factor of 12 in the period from 1870 to 2010. The explanation by Lucas (2011May) of this remarkable growth experience is that government provided stability and education while elements of “free-market capitalism” were an important driver of long-term growth and prosperity. The analysis is sharpened by comparison with the long-term growth experience of G7 countries (US, UK, France, Germany, Canada, Italy and Japan) and Spain from 1870 to 2010. Countries benefitted from “common civilization” and “technology” to “catch up” with the early growth leaders of the US and UK, eventually growing at a faster rate. Significant part of this catch up occurred after World War II. If deflation causes depressions as embedded in the theory of unconventional monetary policy, the United Kingdom would not have been a growth leader in the nineteenth century while staying almost half of the time in deflation.

Chart ESIV-1 provides the consumer price index NSA from 1913 to 2012. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.

Chart ESIV-1, US, Consumer Price Index, NSA, 1913-2012

Source: US Bureau of Labor Statistics

Chart ESIV-2 provides 12-month percentage changes of the consumer price index from 1914 to 2012. The only episode of deflation after 1950 is in 2009, which is explained by the reversal of speculative commodity futures carry trades that were induced by interest rates driven to zero in a shock of monetary policy in 2008. The only persistent case of deflation is from 1930 to 1933, which has little if any relevance to the contemporary United States economy. There are actually three waves of inflation in the second half of the 1960s, in the mid 1970s and again in the late 1970s. Inflation rates then stabilized in a range with only two episodes above 5 percent.

Chart ESIV-2, US, Consumer Price Index, All Items, 12- Month Percentage Change 1914-2012

Source: US Bureau of Labor Statistics

Table ESIV-2 provides annual percentage changes of United States consumer price inflation from 1914 to 2012. There have been only cases of annual declines of the CPI after wars: (1) World War I minus 10.5 percent in 1921 and minus 6.1 percent in 1922 following cumulative increases of 83.5 percent in four years from 1917 to 1920 at the average of 16.4 percent per year; (2) World War II: minus 1.2 percent in 1949 following cumulative 33.9 percent in three years from 1946 to 1948 at average 10.2 percent per year (3) minus 0.4 percent in 1955 two years after the end of the Korean War; and (4) minus 0.4 percent in 2009. The decline of 0.4 percent in 2009 followed increase of 3.8 percent in 2008 and is explained by the reversal of speculative carry trades into commodity futures that were created in 2008 as monetary policy rates were driven to zero. The reversal occurred after misleading statement on toxic assets in banks in the proposal for TARP (Cochrane and Zingales 2009). There were declines of 1.7 percent in both 1927 and 1928 during the episode of revival of rules of the gold standard. The only persistent deflationary period since 1914 was during the Great Depression in the years from 1930 to 1933 and again in 1938-1939. Fear of deflation on the basis of that experience does not justify unconventional monetary policy of zero interest rates that has failed to stop deflation in Japan. Financial repression causes far more adverse effects on allocation of resources by distorting the calculus of risk/returns than alleged employment-creating effects or there would not be current recovery without jobs and hiring after zero interest rates since Dec 2008 and intended now forever in a self-imposed forecast growth and employment mandate of monetary policy.

Table ESIV-2, US, Annual CPI Inflation ∆% 1914-2012

Year	Annual
1914	1.0
1915	1.0
1916	7.9
1917	17.4
1918	18.0
1919	14.6
1920	15.6
1921	-10.5
1922	-6.1
1923	1.8
1924	0.0
1925	2.3
1926	1.1
1927	-1.7
1928	-1.7
1929	0.0
1930	-2.3
1931	-9.0
1932	-9.9
1933	-5.1
1934	3.1
1935	2.2
1936	1.5
1937	3.6
1938	-2.1
1939	-1.4
1940	0.7
1941	5.0
1942	10.9
1943	6.1
1944	1.7
1945	2.3
1946	8.3
1947	14.4
1948	8.1
1949	-1.2
1950	1.3
1951	7.9
1952	1.9
1953	0.8
1954	0.7
1955	-0.4
1956	1.5
1957	3.3
1958	2.8
1959	0.7
1960	1.7
1961	1.0
1962	1.0
1963	1.3
1964	1.3
1965	1.6
1966	2.9
1967	3.1
1968	4.2
1969	5.5
1970	5.7
1971	4.4
1972	3.2
1973	6.2
1974	11.0
1975	9.1
1976	5.8
1977	6.5
1978	7.6
1979	11.3
1980	13.5
1981	10.3
1982	6.2
1983	3.2
1984	4.3
1985	3.6
1986	1.9
1987	3.6
1988	4.1
1989	4.8
1990	5.4
1991	4.2
1992	3.0
1993	3.0
1994	2.6
1995	2.8
1996	3.0
1997	2.3
1998	1.6
1999	2.2
2000	3.4
2001	2.8
2002	1.6
2003	2.3
2004	2.7
2005	3.4
2006	3.2
2007	2.8
2008	3.8
2009	-0.4
2010	1.6
2011	3.2
2012	2.1

Source: US Bureau of Labor Statistics

Deflation should show persistent cases of decline of prices and not isolated events. Fear of deflation in the US has caused a distraction of monetary policy. Symmetric inflation targets around 2 percent in the presence of multiple lags in effect of monetary policy and imperfect knowledge and forecasting are mostly unfeasible and likely to cause price and financial instability instead of desired price and financial stability.

Chart ESIV-3 provides US nominal GDP from 1929 to 2011. The chart disguises the decline of nominal GDP during the 1930s from $103.6 billion in 1929 to $56.4 billion in 1933 or by 45.6 percent (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). The level of nominal GDP reached $101.4 billion in 1940 and exceeded the $103.6 billion only with $126.7 billion in 1941. The only major visible bump in the chart occurred in the recession of IVQ2007 to IIQ2009 with revised cumulative decline of real GDP of 4.7 percent. US nominal GDP fell from $14,291.5 billion in 2008 to $13,973.7 billion in 2009 or by 2.2 percent but rose to $14,498.9 billion in 2010 or by 3.8 percent and to $15,075.7 billion in 2011 for an additional 4.0 percent for cumulative increase of 7.9 percent relative to 2009. The comparison of the current business cycle with the Great Depression is misleading (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). Tendency for deflation would be reflected in persistent bumps. In contrast, during the Great Depression in the four years of 1929 to 1933, GDP in constant dollars fell 26.6 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 (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html).

Chart ESIV-3, US, Nominal GDP 1929-2011

Source: US Bureau of Economic Analysis

Chart ESIV-4 provides US real GDP from 1929 to 2011. The chart also disguises the Great Depression of the 1930s. In the four years of 1929 to 1933, GDP in constant dollars fell 26.6 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 from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). Persistent deflation threatening real economic activity would also be reflected in the series of long-term growth of real GDP. There is no such behavior in Chart ESIV-4 except for periodic recessions in the US economy that have occurred throughout history.

Chart ESIV-4, US, Real GDP 1929-2011

Source: US Bureau of Economic Analysis

Deflation would also be in evidence in long-term series of prices in the form of bumps. The GDP implicit deflator series in Chart ESIV-5 from 1929 to 2011 shows sharp dynamic behavior over time. There is decline of the implicit price deflator of GDP by 25.8 percent from 1929 to 1933 (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). Wars are characterized by rapidly rising prices followed by declines when peace is restored. The US economy is not plagued by deflation but by long-run inflation.

Chart ESIV-5, US, GDP Implicit Price Deflator 1929-2011

Source: US Bureau of Economic Analysis

Chart ESIV-6 provides percent change from preceding quarter in prices of GDP at seasonally-adjusted annual rates (SAAR) from 1980 to 2012. There is one case of negative change by 0.8 percent in IIQ2009 that was adjustment from 3.1 percent in IIIQ2008 and 2.5 percent in both IQ2008 and IIQ2008 caused by carry trades from policy interest rates being moved to zero into commodity futures reversed by the fear of toxic assets in banks in the proposal of TARP in late 2008 (Cochrane and Zingales 2009). There has not been actual deflation or risk of deflation threatening depression in the US that would justify unconventional monetary policy.

Chart ESIV-6, Percent Change from Preceding Period in Prices for GDP Seasonally Adjusted at Annual Rates 1980-2012

Source: US Bureau of Economic Analysis

Sources: http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata

Chart ESIV-7 provides percent change from preceding year in prices of GDP from 1929 to 2011. There are four consecutive years of declines of prices of GDP during the Great Depression: 3.9 percent in 1930, 9.9 percent in 1931, 11.4 percent in 1932 and 2.6 percent in 1933. There were two consecutive declines of 1.9 percent in 1938 and 1.3 percent in 1939. Prices of GDP were unchanged in 1949 after increasing 11.5 percent in 1946, 11.1 percent in 1947 and 5.7 percent in 1948, which is similar to experience with wars in other countries. There are no other negative changes of annual prices of GDP in 72 years from 1939 to 2011.

Chart ESIV-7, Percent Change from Preceding Year in Prices for Gross Domestic Product 1930-2011

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

Nicholas Georgescu-Rogen (1960, 1) reprinted in Pelaez (1973) argues that “the agrarian economy has to this day remained a reality without theory.” The economic history of Latin America shares with the relation of deflation and unconventional monetary policy a more frustrating intellectual misfortune: theory without reality. MacFarlane and Mortimer-Lee (1994, 159) quote in a different context a phrase by Thomas Henry Huxley in the President’s Address to the British Association for the Advancement of Science on Sep 14, 1870 that is appropriate to these issues: “The great tragedy of science—the slaying of a beautiful hypothesis by an ugly fact.”

ESV Peaking Valuation of Risk Financial Assets since 2006. Percentage changes of risk financial assets from the last day of the year relative to the last day of the earlier year are provided in Table ESV-1 from 2007 to 2012. Calendar year 2012 was excellent for most equity indexes. DAX outperformed all equity indexes in Table ESV-1 with increase of 29.1 percent followed by 25.9 percent for NYSE Financials. Nikkei Average gained 22.9 percent for the first increase in three years. Dow Asia Pacific gained 13.1 percent while DJIA increased 7.3 percent and S&P 500 increased 13.4 percent. The USD depreciated 2.0 percent relative to the EUR and the DJ UBS Commodities Index fell 1.1 percent. The only gain for a major equity market in Table ESV-1 for 2011 is 5.5 percent for the DJIA. S&P 500 is better than other equity markets by remaining flat for 2011. With the exception of a drop of 8.4 percent of the European equity index STOXX 50, all declines of equity markets in 2011 are in excess of 10 percent. China’s Shanghai Composite lost 21.7 percent. The equity index of Germany Dax fell 14.7 percent. The DJ UBS Commodities Index dropped 13.4 percent. Robin Wigglesworth, writing on Dec 30, 2011, on “$6.3tn wiped off markets in 2011,” published in the Financial Times (http://www.ft.com/intl/cms/s/0/483069d8-32f3-11e1-8e0d-00144feabdc0.html#axzz1i2BE7OPa), provides an estimate of $6.3 trillion erased from equity markets globally in 2011. The Bureau of Economic Analysis (BEA) estimates US nominal GDP in 2011 at $15,075.7 billion (http://www.bea.gov/iTable/index_nipa.cfm). The loss in equity markets worldwide in 2011 of $6.3 trillion is equivalent to about 41 percent of US GDP or economic activity in 2011. Table ESV-1 also provides the exchange rate of number of US dollars (USD) required in buying a unit of euro (EUR), USD/EUR. The dollar appreciated 3.2 percent on the last day of trading in 2011 relative to the last day of trading in 2010, suggesting risk aversion.

Table ESV-1, Percentage Change of Year-end Values of Financial Assets Relative to Earlier Year-end Values 2007-2012

	2012	2011	2010	2009	2008	2007
DJIA	7.3	5.5	11.0	18.8	-33.8	6.1
S&P 500	13.4	0.0	12.8	23.5	-38.5	3.1
NYSE Fin	25.9	-18.1	5.0	22.7	-53.6	-13.5
Dow Global	10.8	-13.7	4.6	30.8	-45.5	30.9
Dow Asia-Pacific	13.1	-17.6	15.9	36.4	-44.2	14.2
Nikkei Av	22.9	-17.3	-3.0	20.6	-42.9	-10.8
Shanghai	3.2	-21.7	-11.9	73.9	-65.2	104.9
STOXX 50	8.8	-8.4	-0.1	28.5	-44.6	-2.2
DAX	29.1	-14.7	16.1	23.8	-40.4	22.0
USD/EUR*	-2.0	3.2	6.7	-2.9	4.7	-10.7
DJ UBS Com	-1.1	-13.4	16.7	18.7	-36.6	11.2

*Negative sign is dollar devaluation; positive sign is dollar appreciation

The other yearly percentage changes in Table ESV-1 are also revealing wide fluctuations in valuations of risk financial assets. To be sure, economic conditions and perceptions of the future do influence valuations of risk financial assets. It is also valid to contend that unconventional monetary policy magnifies fluctuations in these valuations by inducing carry trades from zero interest rates to exposures with high leverage in risk financial assets such as equities, emerging equities, currencies, high-yield structured products and commodities futures and options. In fact, one of the alleged channels of transmission of unconventional monetary policy is through higher consumption induced by increases in wealth resulting from higher valuations of stock markets. Unconventional monetary policy could also result in magnification of values of risk financial assets beyond actual discounted future cash flows, creating financial instability. Separating all these effects in practice may be quite difficult because they are observed simultaneously while conclusive evidence would require contrasting what actually happened with the counterfactual of what would have happened in the absence of unconventional monetary policy and other effects (on counterfactuals see Pelaez and Pelaez, Globalization and the State Vol I (2008a), 125, 136, Harberger (1971, 1997), Fishlow 1965, Fogel 1964, Fogel and Engerman 1974, North and Weingast 1989, Pelaez 1979, 26-7). There is no certainty or evidence that unconventional policies attain their intended effects without risks of costly side effects. Yearly fluctuations of financial assets in Table ESV-1 are quite wide. In 2007, for example, the equity index Dow Global increased 30.9 percent while Dax gained 22.0 percent and the Shanghai Composite jumped 104.9 percent. The DJIA gained only 6.1 percent as recession began in IVQ2007. The flight to government obligations in 2008 (Cochrane and Zingales 2009, Cochrane 2011Jan) was equivalent to the astronomical declines of world equity markets and commodities. The flight from risk is also in evidence in the appreciation of the dollar by 4.7 percent in 2008 with unwinding carry trades and with renewed carry trades in the depreciation of the dollar by 2.9 percent in 2009. Recovery still continued in 2010 with shocks of the European debt crisis in the spring and in Nov 2010. The flight from risk exposures dominated declines of valuations of risk financial assets in 2011.

Table ESV-2 is designed to provide a comparison of valuations of risk financial assets at the end of 2012 relative to valuations at the end of every year from 2006 to 2011. For example, the DJIA index is 7.3 percent higher at the end of 2012 relative to the valuation at the end of 2011 but is 1.2 percent below the valuation at the end of 2007 and 4.8 percent higher relative to the valuation at the end of 2006. It is higher by 49.3 percent at the end of 2012 relative to the depressed valuation at the end of 2008. Pre-recession valuations of 2006 and 2007 have not been recovered for all financial assets in Table ESV-2. All equity indexes are still lower at the end of 2012 relative to the values at the end of 2007. Some equity indexes are higher at the end of 2012 relative to the end of 2006: DJIA by 4.8 percent, S&P by 0.1 percent and DAX by 15.1 percent. Although the Nikkei Average increased 22.9 percent in 2012 relative to 2011, it is still 32.1 percent lower than in 2007 and 39.5 percent lower than in 2006. At the end of 2012, Dow Global is 28.8 percent lower than at the end of 2007 and 6.8 percent lower than at the end of 2006. The Shanghai Composite increased 3.2 percent at the end of 2012 relative to 2011 but is 56.9 percent lower than at the end of 2007 and 11.7 percent lower than at the end of 2006. DJ UBS Commodities is 24.8 percent lower at the end of 2012 relative to 2007 and 16.4 percent lower relative to 2006. The USD is 9.6 stronger at the end of 2012 relative to 2007 and flat relative to 2006. Low valuations of risk financial assets are intimately related to risk aversion in international financial markets because of the European debt crisis, weakness and unemployment in advanced economies, fiscal imbalances and slowing growth worldwide. Valuations of stock indexes for the US and Germany are peaking at the turn of 2012 into 2013 relative to 2007 and 2006.

Table ESV-2, Percentage Change of Year-end 2012 Values of Financial Assets Relative to Year-end Values 2006-2011

	∆% 2012/ 2011	∆% 2012/ 2010	∆% 2012/2009	∆% 2012/ 2008	∆% 2012/2007	∆% 2012/ 2006
DJIA	7.3	13.2	25.7	49.3	-1.2	4.8
S&P 500	13.4	13.4	27.9	57.9	-2.9	0.1
NYSE Fin	25.9	3.1	8.3	32.9	-38.4	-46.7
Dow Global	10.8	-4.4	0.0	30.8	-28.8	-6.8
Dow Asia-Pacific	13.1	-6.8	8.0	47.4	-17.7	-6.0
Nikkei Av	22.9	1.6	-1.4	18.8	-32.1	-39.5
Shanghai	3.2	-19.2	-28.8	23.8	-56.9	-11.7
STOXX 50	8.8	-0.3	-0.5	27.9	-29.1	-30.6
DAX	29.1	10.1	27.8	58.3	-5.6	15.1
USD/EUR*	-2.0	1.3	7.9	5.2	9.6	0.0
DJ UBS Com	-1.1	-14.4	-0.1	18.6	-24.8	-16.4

*Negative sign is dollar devaluation; positive sign is dollar appreciation

Sources: http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata

The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task both for theory and measurement. The IMF (2012WEOOct) provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2012/02/index.htm), of the world financial system with its Global Financial Stability Report (GFSR) (IMF 2012GFSROct) (http://www.imf.org/external/pubs/ft/gfsr/2012/02/index.htm) and of fiscal affairs with the Fiscal Monitor (IMF 2012FMOct) (http://www.imf.org/external/pubs/ft/fm/2012/02/fmindex.htm). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider global economic and financial risks, which are analyzed in the comments of this blog.

Economic risks include the following:

1. China’s Economic Growth. China is lowering its growth target to 7.5 percent per year. The growth rate of GDP of China in the fourth quarter of 2012 of 2.0 percent is equivalent to 8.2 percent per year and GDP increased 7.9 percent relative to the third quarter of 2011.

2. United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 29.5 million in job stress or 18.2 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2013/01/thirty-million-unemployed-or.html), fewer 10 million full-time jobs, high youth unemployment, historically-low hiring and declining real wages.

3. Economic Growth and Labor Markets in Advanced Economies. Advanced economies are growing slowly. There is still high unemployment in advanced economies.

4. World Inflation Waves. Inflation continues in repetitive waves globally (Section II and earlier http://cmpassocregulationblog.blogspot.com/2012/12/recovery-without-hiring-forecast-growth.html).

A list of financial uncertainties includes:

1. Euro Area Survival Risk. The resilience of the euro to fiscal and financial doubts on larger member countries is still an unknown risk.

2. Foreign Exchange Wars. Exchange rate struggles continue as zero interest rates in advanced economies induce devaluation of their currencies.

3. Valuation of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with lower volumes.

4. Duration Trap of the Zero Bound. The yield of the US 10-year Treasury rose from 2.031 percent on Mar 9, 2012, to 2.294 percent on Mar 16, 2012. Considering a 10-year Treasury with coupon of 2.625 percent and maturity in exactly 10 years, the price would fall from 105.3512 corresponding to yield of 2.031 percent to 102.9428 corresponding to yield of 2.294 percent, for loss in a week of 2.3 percent but far more in a position with leverage of 10:1. Min Zeng, writing on “Treasurys fall, ending brutal quarter,” published on Mar 30, 2012, in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303816504577313400029412564.html?mod=WSJ_hps_sections_markets), informs that Treasury bonds maturing in more than 20 years lost 5.52 percent in the first quarter of 2012.

5. Credibility and Commitment of Central Bank Policy. There is a credibility issue of the commitment of monetary policy (Sargent and Silber 2012Mar20).

6. Carry Trades. Commodity prices driven by zero interest rates have resumed their increasing path with fluctuations caused by intermittent risk aversion.

It is in this context of economic and financial uncertainties that decisions on portfolio choices of risk financial assets must be made. There is a new carry trade that learned from the losses after the crisis of 2007 or learned from the crisis how to avoid losses. The sharp rise in valuations of risk financial assets shown in Table VI-1 in the text after the first policy round of near zero fed funds and quantitative easing by the equivalent of withdrawing supply with the suspension of the 30-year Treasury auction was on a smooth trend with relatively subdued fluctuations. The credit crisis and global recession have been followed by significant fluctuations originating in sovereign risk issues in Europe, doubts of continuing high growth and accelerating inflation in China now complicated by political developments, events such as in the Middle East and Japan and legislative restructuring, regulation, insufficient growth, falling real wages, depressed hiring and high job stress of unemployment and underemployment in the US now with realization of growth standstill. The “trend is your friend” motto of traders has been replaced with a “hit and realize profit” approach of managing positions to realize profits without sitting on positions. There is a trend of valuation of risk financial assets driven by the carry trade from zero interest rates with fluctuations provoked by events of risk aversion or the “sharp shifts in risk appetite” of Blanchard (2012WEOApr, XIII).

Market rallied in the week of Jan 18, 2012, on the expectation of a deal to circumvent the debt limit of the United States, which hides the unresolved unsustainable Federal deficit/debt. The highest valuations in column “∆% Trough to 1/18/13” of Table ESV-3 are by US equities indexes: DJIA 40.9 percent and S&P 500 45.3 percent, driven by stronger earnings and economy in the US than in other advanced economies but with doubts on the relation of business revenue to the weakening economy and fractured job market. DAX of Germany is now 35.8 percent above the trough. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States. A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html). Rita Nazareth and Sarah Pringle, writing on “Dow Average rises to 5-year high amid debt-ceiling talks,” on Jan 18, 2012, published in Bloomberg (http://www.bloomberg.com/news/2013-01-18/u-s-stock-futures-little-changed-before-earnings-data.html), find that the DJIA reached on Jan 18, 2012, the highest level in five years at 13,649.70 with volume of 6.6 billion shares in US exchanges, which is higher by 6.9 percent than the average in three months. Vito J. Bacanelli, writing on “GOP proposal lifts Dow to five-year high,” on Jan 19, 2013, published by Barron’s (http://online.barrons.com/article/SB50001424052748703596604578235762819811322.html?mod=BOL_hpp_mag#articleTabs_article%3D1), finds that the closing level of 13,649.70 on Jan 18, 2013, is the highest close since Dec 10, 2007, only 4 percent lower than the all-time high and the best start for a year since 1997. The DJIA reached 13,661.87 on Oct 5, 2012, which is the highest level in 52 weeks (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata) and closed at 13649.70 on Jan 11, 2013, which is only 0.089 percent below the recent 52-week high. The carry trade from zero interest rates to leveraged positions in risk financial assets had proved strongest for commodity exposures but US equities have regained leadership. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 1/18/13” had double digit gains relative to the trough around Jul 2, 2010 followed by negative performance but now some valuations of equity indexes show varying behavior: China’s Shanghai Composite is 2.8 percent below the trough; Japan’s Nikkei Average is 23.7 percent above the trough; DJ Asia Pacific TSM is 18.0 percent above the trough; Dow Global is 22.6 percent above the trough; STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 14.7 percent above the trough; and NYSE Financial Index is 25.7 percent above the trough. DJ UBS Commodities is 14.1 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 35.8 percent above the trough. Japan’s Nikkei Average is 23.7 percent above the trough on Aug 31, 2010 and 4.2 percent below the peak on Apr 5, 2010. The Nikkei Average closed at 10913.30 on Fri Jan 18, 2013 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 6.4 percent higher than 10,254.43 on Mar 11, 2011, on the date of the Tōhoku or Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 11.8 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 1/18/13” in Table ESV-3 shows that there were increases of valuations of risk financial assets in the week of Jan 18, 2013 such as 0.6 percent for DJ Asia Pacific TSM. Nikkei Average increased 1.0 percent in the week. DJ UBS Commodities increased 2.1 percent. China’s Shanghai Composite increased 3.3 percent in the week of Jan 18, 2013. The DJIA increased 1.2 percent and S&P 500 increased 0.9 percent. There were increases in several indexes: 0.3 percent for NYSE Financial Index and 0.6 percent for Dow Global. STOXX 50 fell 0.5 percent and DAX of Germany fell 0.2 percent. The USD appreciated 0.2 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table ESV-3 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 1/18/13” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Jan 18, 2013. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 1/18/13” but also relative to the peak in column “∆% Peak to 1/18/13.” There are now several equity indexes above the peak in Table ESV-3: DJIA 21.8 percent, S&P 500 22.1 percent, DAX 21.6 percent, DJ Asia Pacific 3.3 percent and NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 0.1 percent with Dow Global unchanged. There are several indexes below the peak: Nikkei Average by 4.2 percent, Shanghai Composite by 26.8 percent and STOXX 50 by 2.9 percent. DJ UBS Commodities Index is now 2.4 percent below the peak. The US dollar strengthened 11.9 percent relative to the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul 2010 because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. It may be quite painful to exit QE∞ or use of the balance sheet of the central together with zero interest rates forever. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:

Where R_τ is expected revenue in the time horizon from τ =1 to T; C_τ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that interest rates increase without bound, then V → 0, or

declines. Equally, decline in expected revenue from the stock or project, R_τ, causes decline in valuation. An intriguing issue is the difference in performance of valuations of risk financial assets and economic growth and employment. Paul A. Samuelson (http://www.nobelprize.org/nobel_prizes/economics/laureates/1970/samuelson-bio.html) popularized the view of the elusive relation between stock markets and economic activity in an often-quoted phrase “the stock market has predicted nine of the last five recessions.” In the presence of zero interest rates forever, valuations of risk financial assets are likely to differ from the performance of the overall economy. The interrelations of financial and economic variables prove difficult to analyze and measure.

Table ESV-3, Stock Indexes, Commodities, Dollar and 10-Year Treasury

	Peak	Trough	∆% to Trough	∆% Peak to 1/18/ /13	∆% Week 1/18/13	∆% Trough to 1/18/ 13
DJIA	4/26/ 10	7/2/10	-13.6	21.8	1.2	40.9
S&P 500	4/23/ 10	7/20/ 10	-16.0	22.1	0.9	45.3
NYSE Finance	4/15/ 10	7/2/10	-20.3	0.1	0.3	25.7
Dow Global	4/15/ 10	7/2/10	-18.4	0.0	0.6	22.6
Asia Pacific	4/15/ 10	7/2/10	-12.5	3.3	0.6	18.0
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	-4.2	1.0	23.7
China Shang.	4/15/ 10	7/02 /10	-24.7	-26.8	3.3	-2.8
STOXX 50	4/15/10	7/2/10	-15.3	-2.9	-0.5	14.7
DAX	4/26/ 10	5/25/ 10	-10.5	21.6	-0.2	35.8
Dollar Euro	11/25 2009	6/7 2010	21.2	11.9	0.2	-11.8
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-2.4	2.1	14.1
10-Year T Note	4/5/ 10	4/6/10	3.986	1.840

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

Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

I Recovery without Hiring. Professor Edward P. Lazear (2012Jan19) at Stanford University finds that recovery of hiring in the US to peaks attained in 2007 requires an increase of hiring by 30 percent while hiring levels have increased by only 4 percent since Jan 2009. The high level of unemployment with low level of hiring reduces the statistical probability that the unemployed will find a job. According to Lazear (2012Jan19), the probability of finding a new job currently is about one third of the probability of finding a job in 2007. Improvements in labor markets have not increased the probability of finding a new job. Lazear (2012Jan19) quotes an essay coauthored with James R. Spletzer forthcoming in the American Economic Review on the concept of churn. A dynamic labor market occurs when a similar amount of workers is hired as those who are separated. This replacement of separated workers is called churn, which explains about two-thirds of total hiring. Typically, wage increases received in a new job are higher by 8 percent. Lazear (2012Jan19) argues that churn has declined 35 percent from the level before the recession in IVQ2007. Because of the collapse of churn there are no opportunities in escaping falling real wages by moving to another job. As this blog argues, there are meager chances of escaping unemployment because of the collapse of hiring and those employed cannot escape falling real wages by moving to another job (http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html). Lazear and Spletzer (2012Mar, 1) argue that reductions of churn reduce the operational effectiveness of labor markets. Churn is part of the allocation of resources or in this case labor to occupations of higher marginal returns. The decline in churn can harm static and dynamic economic efficiency. Losses from decline of churn during recessions can affect an economy over the long-term by preventing optimal growth trajectories because resources are not used in the occupations where they provide highest marginal returns. Lazear and Spletzer (2012Mar 7-8) conclude that: “under a number of assumptions, we estimate that the loss in output during the recession [of 2007 to 2009] and its aftermath resulting from reduced churn equaled $208 billion. On an annual basis, this amounts to about .4% of GDP for a period of 3½ years.”

There are two additional facts discussed below: (1) there are about ten million fewer full-time jobs currently than before the recession of 2008 and 2009; and (2) the extremely high and rigid rate of youth unemployment is denying an early start to young people ages 16 to 24 years while unemployment of ages 45 years or over has swelled. There are four subsections. IA1 Hiring Collapse provides the data and analysis on the weakness of hiring in the United States economy. IA2 Labor Underutilization provides the measures of labor underutilization of the Bureau of Labor Statistics (BLS). Statistics on the decline of full-time employment are in IA3 Ten Million Fewer Full-time Jobs. IA4 Youth and Middle-Age Unemployment provides the data on high unemployment of ages 16 to 24 years and of ages 45 years or over.

IA1 Hiring Collapse. An important characteristic of the current fractured labor market of the US is the closing of the avenue for exiting unemployment and underemployment normally available through dynamic hiring. Another avenue that is closed is the opportunity for advancement in moving to new jobs that pay better salaries and benefits again because of the collapse of hiring in the United States. Those who are unemployed or underemployed cannot find a new job even accepting lower wages and no benefits. The employed cannot escape declining inflation-adjusted earnings because there is no hiring. The objective of this section is to analyze hiring and labor underutilization in the United States.

An appropriate measure of job stress is considered by Blanchard and Katz (1997, 53):

The natural rate of unemployment and the similar NAIRU are quite difficult to estimate in practice (Ibid; see Ball and Mankiw 2002).

The Bureau of Labor Statistics (BLS) created the Job Openings and Labor Turnover Survey (JOLTS) with the purpose that (http://www.bls.gov/jlt/jltover.htm#purpose):

Hiring in the nonfarm sector (HNF) has declined from 63.8 million in 2006 to 50.1 million in 2011 or by 13.7 million while hiring in the private sector (HP) has declined from 59.5 million in 2006 to 46.9 million in 2011 or by 12.6 million, as shown in Table I-1. The ratio of nonfarm hiring to employment (RNF) has fallen from 47.2 in 2005 to 38.1 in 2011 and in the private sector (RHP) from 52.1 in 2006 to 42.9 in 2011. The collapse of hiring in the US has not been followed by dynamic labor markets because of the low rate of economic growth of 2.2 percent in the first thirteen quarters of expansion from IIIQ2009 to IIIQ2012 compared with 6.2 percent in prior cyclical expansions (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html).

Table I-1, US, Annual Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US and Percentage of Total Employment

	HNF	Rate RNF	HP	Rate HP
2001	62,948	47.8	58,825	53.1
2002	58,583	44.9	54,759	50.3
2003	56,451	43.4	53,056	48.9
2004	60,367	45.9	56,617	51.6
2005	63,150	47.2	59,372	53.1
2006	63,773	46.9	59,494	52.1
2007	62,421	45.4	58,035	50.3
2008	55,166	40.3	51,606	45.2
2009	46,398	35.5	43,052	39.8
2010	48,647	37.5	44,826	41.7
2011	50,083	38.1	46,869	42.9

Source: Bureau of Labor Statistics http://www.bls.gov/jlt/

Chart I-1 shows the annual level of total nonfarm hiring (HNF) that collapsed during the global recession after 2007 in contrast with milder decline in the shallow recession of 2001. Nonfarm hiring has not been recovered, remaining at a depressed level

Chart I-1, US, Level Total Nonfarm Hiring (HNF), Annual, 2001-2011

Source: US Bureau of Labor Statistics

Chart I-2 shows the ratio or rate of nonfarm hiring to employment (RNF) that also fell much more in the recession of 2007 to 2009 than in the shallow recession of 2001. Recovery is weak.

Chart I-2, US, Rate Total Nonfarm Hiring (HNF), Annual, 2001-2011

Source: US Bureau of Labor Statistics

Yearly percentage changes of total nonfarm hiring (HNF) are provided in Table I-2. There were much milder declines in 2002 of 6.9 percent and 3.6 percent in 2003 followed by strong rebounds of 6.9 percent in 2004 and 4.6 percent in 2005. In contrast, the contractions of nonfarm hiring in the recession after 2007 were much sharper in percentage points: 2.1 in 2007, 11.6 in 2008 and 15.9 percent in 2009. On a yearly basis, nonfarm hiring grew 4.8 percent in 2010 relative to 2009 and 3.0 percent in 2011.

Table I-2, US, Annual Total Nonfarm Hiring (HNF), Annual Percentage Change, 2001-2011

Year	Annual
2002	-6.9
2003	-3.6
2004	6.9
2005	4.6
2006	1.0
2007	-2.1
2008	-11.6
2009	-15.9
2010	4.8
2011	3.0

Source: US Bureau of Labor Statistics

Chart I-3 plots yearly percentage changes of nonfarm hiring. Percentage declines after 2007 were quite sharp.

Chart I-3, US, Annual Total Nonfarm Hiring (HNF), Annual Percentage Change, 2001-2011

Source: US Bureau of Labor Statistics

Total private hiring (HP) yearly data are provided in Chart I-4. There has been sharp contraction of total private hiring in the US and only milder recovery in 2011 than in 2010.

Chart I-4, US, Total Private Hiring Level, Annual, 2001-2011

Source: US Bureau of Labor Statistics

Chart I-5 plots the rate of total private hiring relative to employment (RHP). The rate collapsed during the global recession after 2007 with insufficient recovery.

Chart I-5, US, Rate Total Private Hiring, Annual, 2001-2011

Source: US Bureau of Labor Statistics

Total nonfarm hiring (HNF), total private hiring (HP) and their respective rates are provided for the month of Nov in the years from 2001 to 2012 in Table I-3. Hiring numbers are in thousands. There is some recovery in HNF from 3503 thousand (or 3.5 million) in Nov 2009 to 3844 thousand in Nov 2011 and 3904 thousand in Nov 2012 for cumulative gain of 11.4 percent. HP rose from 3305 thousand in Nov 2009 to 3640 thousand in Nov 2011 and 3683 thousand in Nov 2012 for cumulative gain of 11.4 percent. HNF has fallen from 4901 in Nov 2006 to 3904 in Nov 2012 or by 20.3 percent. HP has fallen from 4642 in Nov 2006 to 3683 in Nov 2012 or by 20.7 percent. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.

Table I-3, US, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in Thousands and in Percentage of Total Employment Not Seasonally Adjusted

	HNF	Rate RNF	HP	Rate HP
2001 Nov	4283	3.2	4020	3.6
2002 Nov	4247	3.2	3969	3.6
2003 Nov	4067	3.1	3853	3.5
2004 Nov	4591	3.4	4329	3.9
2005 Nov	4597	3.4	4344	3.8
2006 Nov	4901	3.6	4642	4.0
2007 Nov	4595	3.3	4345	3.7
2008 Nov	3842	2.6	3291	2.9
2009 Nov	3503	2.7	3305	3.1
2010 Nov	3667	2.8	3453	3.2
2011 Nov	3844	2.9	3640	3.3
2012 Nov	3904	2.9	3683	3.3

Source: Bureau of Labor Statistics http://www.bls.gov/jlt/

Chart I-6 provides total nonfarm hiring on a monthly basis from 2001 to 2012. Nonfarm hiring rebounded in early 2010 but then fell and stabilized at a lower level than the early peak not-seasonally adjusted (NSA) of 4786 in May 2010 until it surpassed it with 4869 in Jun 2011 but declined to 3904 in Oct 2012. Nonfarm hiring fell again in Dec 2011 to 3038 from 3844 in Nov and to revised 3633 in Feb 2012, increasing to 4127 in Mar 2012, 4490 in Apr 2012, 4926 in May 2012, 4988 in Jun 2012, 4732 in Jul 2012, 4962 in Aug 2012, 4380 in Sep 2012, 4589 in Oct 2012 and 3904 in Nov 2012. Chart I-6 provides seasonally-adjusted (SA) monthly data. The number of seasonally-adjusted hires in Aug 2011 was 4221 thousand, increasing to revised 4444 thousand in Feb 2012, or 5.3 percent, but falling to revised 4335 thousand in Mar 2012 and 4213 in Apr 2012, or cumulative decline of 0.2 percent relative to Aug 2011, moving to 4319 in Nov 2012 for cumulative increase of 1.2 percent from 4268 in Nov 2011 and increase of 0.1 percent relative to 4316 in Oct 2012. The number of hires not seasonally adjusted was 4655 in Aug 2011, falling to 3038 in Dec 2011 but increasing to 4072 in Jan 2012 and 3904 in Nov 2012. The number of nonfarm hiring not seasonally adjusted fell by 34.7 percent from 4655 in Aug 2011 to 3038 in Dec 2011 in a yearly-repeated seasonal pattern.

Chart I-6, US, Total Nonfarm Hiring (HNF), 2001-2012 Month SA

Source: US Bureau of Labor Statistics

Similar behavior occurs in the rate of nonfarm hiring plot in Chart I-7. Recovery in early 2010 was followed by decline and stabilization at a lower level but with stability in monthly SA estimates of 3.2 in Sep 2011 to 3.2 in Jan 2012, increasing to 3.4 in May 2012 and falling to 3.2 in both Jun and Jul 2012, increasing to 3.3 in Aug 2012 but falling to 3.1 in Sep 2012 and then 3.2 in both Oct and Nov 2012. The rate not seasonally adjusted fell from 3.7 in Jun 2011 to 2.3 in Dec, climbing to 3.1 in Jan 2012, 3.7 in both May and Jun 2012 and falling to 3,6 in Jul, increasing to 3.7 in Aug and falling to 3.3 in Sep 2012, 3.4 in Oct 2012 and 2.9 in Nov 2012. Rates of nonfarm hiring NSA were in the range of 2.8 (Dec) to 4.5 (Jun) in 2006.

Chart I-7, US, Rate Total Nonfarm Hiring, Month SA 2001-2012

Source: US Bureau of Labor Statistics

There is only milder improvement in total private hiring shown in Chart I-8. Hiring private (HP) rose in 2010 with stability and renewed increase in 2011 followed by stationary series in 2012. The number of private hiring seasonally adjusted fell from 4002 thousand in Sep 2011 to 3889 in Dec 2011 or by 2.8 percent, increasing to 3945 in Jan 2012 or decline by 1.4 relative to the level in Sep 2011 but decreasing to 3922 in Sep 2012 or lower by 2.0 percent relative to Sep 2011 and increasing to 4021 in Nov 2012 for increase of 1.9 percent relative to 3945 in Jan 2012. The number of private hiring not seasonally adjusted fell from 4130 in Sep 2011 to 2856 in Dec or by 30.8 percent, reaching 3782 in Jan 2012 or decline of 8.4 percent relative to Sep 2011 and moving to 3683 in Nov 2012 or 10.8 percent lower relative to Sep 2011. Companies do not hire in the latter part of the year that explains the high seasonality in year-end employment data. For example, NSA private hiring fell from 4934 in Sep 2006 to 3635 in Dec 2006 or by 26.3 percent. Private hiring NSA data are useful in showing the huge declines from the period before the global recession. In Jul 2006 private hiring NSA was 5555, declining to 4293 in Jul 2011 or by 22.7 percent and to 4403 in Jul 2012 or lower by 20.7 percent relative to Jul 2006. Private hiring NSA fell from 5215 in Sep 2005 to 3999 in Sep 2012 or 23.3 percent and fell from 4642 in Nov 2006 to 3683 in Nov 2012 or 20.7 percent. The conclusion is that private hiring in the US is around 20 percent below the hiring before the global recession. The main problem in recovery of the US labor market has been the low rate of growth of 2.2 percent in the thirteen quarters of expansion of the economy from IIIQ2009 to IIIQ2012 compared with average 6.2 percent in prior expansions from contractions (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). The US missed the opportunity to recover employment as in past cyclical expansions from contractions.

Chart I-8, US, Total Private Hiring Month SA 2001-2012

Source: US Bureau of Labor Statistics

Chart I-9 shows similar behavior in the rate of private hiring. The rate in 2011 in monthly SA data did not rise significantly above the peak in 2010. The rate seasonally adjusted fell from 3.6 in Sep 2011 to 3.5 in Dec 2011 and reached 3.6 in Nov 2012. The rate not seasonally adjusted (NSA) fell from 3.8 in Sep 2011 to 2.6 in Dec 2011, increasing to 3.9 in Oct 2012 but falling to 3.3 in Nov 2012. The NSA rate of private hiring fell from 4.8 in Jul 2006 to 3.4 in Aug 2009 but recovery was insufficient to only 3.3 in Nov 2012.

Chart I-9, US, Rate Total Private Hiring Month SA 2011-2011

Source: US Bureau of Labor Statistics

The JOLTS report of the Bureau of Labor Statistics also provides total nonfarm job openings (TNF JOB), TNF JOB rate and TNF LD (layoffs and discharges) shown in Table I-4 for the month of Nov from 2001 to 2012. The final column provides annual TNF LD for the years from 2001 to 2011. Nonfarm job openings fell from a peak of 4162 in Nov 2006 to 3248 in Nov 2012 or by 21.9 percent while the rate dropped from 2.9 to 2.3. Nonfarm layoffs and discharges (TNF LD) rose from 1621 in Nov 2005 to 2237 in Nov 2008 or by 38.0 percent. The annual data show layoffs and discharges rising from 21.2 million in 2006 to 26.8 million in 2009 or by 26.4 percent. Business pruned payroll jobs to survive the global recession but there has not been hiring because of the weak recovery in the form of growth of 2.2 percent on average in the thirteen quarters of expansion from IIIQ2009 to IIIQ2012 in contrast with 6.2 percent on average in cyclical expansions in the United States (see Table I-5 at http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html).

Table I-4, US, Job Openings and Total Separations, Thousands NSA

	TNF JOB	TNF JOB Rate	TNF LD	TNF LD Annual
Nov 2001	3124	2.3	2132	24499
Nov 2002	3103	2.3	1881	22922
Nov 2003	2894	2.2	1813	23294
Nov 2004	2973	2.2	1864	22802
Nov 2005	3903	2.8	1621	22185
Nov 2006	4162	2.9	1864	21157
Nov 2007	3879	2.7	1940	22142
Nov 2008	2813	2.0	2237	24166
Nov 2009	2134	1.6	1900	26783
Nov 2010	2730	2.0	1783	21784
Nov 2011	2912	2.1	1807	20718
Nov 2012	3248	2.3	1701

Notes: TNF JOB: Total Nonfarm Job Openings; LD: Layoffs and Discharges

Source: Bureau of Labor Statistics http://www.bls.gov/jlt/

Chart I-10 shows monthly job openings rising from the trough in 2009 to a high in the beginning of 2010. Job openings then stabilized into 2011 but have surpassed the peak of 3057 seasonally adjusted in Nov 2010 with 3676 seasonally adjusted in Nov 2012, which is higher by 20.2 percent and higher by 0.3 percent than 3665 in Oct 2012 and lower than 3741 in Mar 2012 by 1.7 percent. The high of job openings not seasonally adjusted in 2010 was 3221 in Oct 2010 that was surpassed by 3659 in Oct 2011, increasing to 3934 in Oct 2012 but declining to 3248 in Nov 2012. The level of job openings not seasonally adjusted fell to 2912 in Nov 2011 or by 17.9 percent relative to 3546 in Sep 2011. There is here again the strong seasonality of year-end labor data. Job openings NSA fell from 4678 in Oct 2006 to 2547 in Oct 2009 or by 45.6 percent, recovering to 3221 in Oct 2010 or by 26.5 percent, which is still 21.8 percent lower at 3659 in Oct 2011 relative to Oct 2006. The level of job openings of 3248 in Nov 2012 NSA is lower by 21.9 percent relative to 4162 in Nov 2006. Again, the main problem in recovery of the US labor market has been the low rate of growth of 2.2 percent in the thirteen quarters of expansion of the economy since IIIQ2009 compared with average 6.2 percent in prior expansions from contractions (see table I-5 at http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). The US missed the opportunity to recover employment as in past cyclical expansions from contractions.

Chart I-10, US Job Openings, Thousands NSA, 2001-2012

Source: US Bureau of Labor Statistics

The rate of job openings in Chart I-11 shows similar behavior. The rate seasonally adjusted rose from 2.1 percent in Jan 2011 to 2.6 percent in Dec 2011 and 2.7 in Nov 2012. The rate not seasonally adjusted rose from the high of 2.6 in Apr 2010 to 2.7 in Jul 2011 and 2.7 in all months from Jan to Jun 2012 with exception of 2.5 in Feb 2012 and then to 2.9 in Jul 2012 but back to 2.7 in Aug 2012, 2.6 in Sep 2012, 2.8 in Oct 2012 and 2.3 in Nov 2012. The rate of job openings NSA fell from 3.0 in Sep 2005 to 1.9 in Sep 2009, recovering insufficiently to 2.3 in Nov 2012.

Chart I-11, US, Rate of Job Openings, NSA, 2001-2012

Source: US Bureau of Labor Statistics

Total separations are shown in Chart I-12. Separations are much lower in 2012 than before the global recession but hiring has not recovered.

Chart I-12, US, Total Nonfarm Separations, Month SA, 2001-2012

Source: US Bureau of Labor Statistics

Annual total separations are shown in Chart I-13. Separations are much lower in 2011 than before the global recession but without recovery in hiring.

Chart I-13, US, Total Separations, Annual, 2001-2011

Source: US Bureau of Labor Statistics

Table I-5 provides total nonfarm total separations from 2001 to 2011. Separations fell from 61.6 million in 2006 to 47.6 million in 2010 or by 14.0 million and 48.2 million in 2011 or by 13.4 million.

Table I-5, US, Total Nonfarm Total Separations, Thousands, 2001-2011

Year	Annual
2001	64765
2002	59190
2003	56487
2004	58340
2005	60733
2006	61565
2007	61162
2008	58601
2009	51527
2010	47641
2011	48242

Source: US Bureau of Labor Statistics

Monthly data of layoffs and discharges reach a peak in early 2009, as shown in Chart I-14. Layoffs and discharges dropped sharply with the recovery of the economy in 2010 and 2011 once employers reduced their job count to what was required for cost reductions and loss of business. Weak rates of growth of 2.2 percent of GDP on average from IIIQ2009 to IIIQ2012 compared with 6.2 percent on average in cyclical expansions (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html) frustrated employment recovery.

Chart I-14, US, Total Nonfarm Layoffs and Discharges, Monthly SA, 2011-2012

Source: US Bureau of Labor Statistics

Layoffs and discharges in Chart I-15 rose sharply to a peak in 2009. There was pronounced drop into 2010 and 2011.

Chart I-15, US, Total Nonfarm Layoffs and Discharges, Annual, 2001-2011

Source: US Bureau of Labor Statistics

Table I-6 provides annual nonfarm layoffs and discharges from 2001 to 2011. Layoffs and discharges peaked at 26.8 million in 2009 and then fell to 20.7 million in 2011, by 6.1 million, or 22.8 percent.

Table I-6, US, Total Nonfarm Layoffs and Discharges, 2001-2011

Year	Annual
2001	24499
2002	22922
2003	23294
2004	22802
2005	22185
2006	21157
2007	22142
2008	24166
2009	26783
2010	21784
2011	20718

Source: US Bureau of Labor Statistics

IA2 Labor Underutilization. The Bureau of Labor Statistics also provides alternative measures of labor underutilization shown in Table I-7. The most comprehensive measure is U6 that consists of total unemployed plus total employed part time for economic reasons plus all marginally attached workers as percent of the labor force. U6 not seasonally annualized has risen from 8.2 percent in 2006 to 14.4 percent in Nov 2012.

Table I-7, US, Alternative Measures of Labor Underutilization NSA %

	U1	U2	U3	U4	U5	U6
2012
Dec	4.2	4.3	7.6	8.3	9.2	14.4
Nov	4.2	3.9	7.4	7.9	8.8	13.9
Oct	4.3	3.9	7.5	8.0	9.0	13.9
Sep	4.2	4.0	7.6	8.0	9.0	14.2
Aug	4.3	4.4	8.2	8.7	9.7	14.6
Jul	4.3	4.6	8.6	9.1	10.0	15.2
Jun	4.5	4.4	8.4	8.9	9.9	15.1
May	4.7	4.3	7.9	8.4	9.3	14.3
Apr	4.8	4.3	7.7	8.3	9.1	14.1
Mar	4.9	4.8	8.4	8.9	9.7	14.8
Feb	4.9	5.1	8.7	9.3	10.2	15.6
Jan	4.9	5.4	8.8	9.4	10.5	16.2
2011
Dec	4.8	5.0	8.3	8.8	9.8	15.2
Nov	4.9	4.7	8.2	8.9	9.7	15.0
Oct	5.0	4.8	8.5	9.1	10.0	15.3
Sep	5.2	5.0	8.8	9.4	10.2	15.7
Aug	5.2	5.1	9.1	9.6	10.6	16.1
Jul	5.2	5.2	9.3	10.0	10.9	16.3
Jun	5.1	5.1	9.3	9.9	10.9	16.4
May	5.5	5.1	8.7	9.2	10.0	15.4
Apr	5.5	5.2	8.7	9.2	10.1	15.5
Mar	5.7	5.8	9.2	9.7	10.6	16.2
Feb	5.6	6.0	9.5	10.1	11.1	16.7
Jan	5.6	6.2	9.8	10.4	11.4	17.3
Dec 2010	5.4	5.9	9.1	9.9	10.7	16.6
Annual
2012	4.5	4.4	8.1	8.6	9.5	14.7
2011	5.3	5.3	8.9	9.5	10.4	15.9
2010	5.7	6.0	9.6	10.3	11.1	16.7
2009	4.7	5.9	9.3	9.7	10.5	16.2
2008	2.1	3.1	5.8	6.1	6.8	10.5
2007	1.5	2.3	4.6	4.9	5.5	8.3
2006	1.5	2.2	4.6	4.9	5.5	8.2
2005	1.8	2.5	5.1	5.4	6.1	8.9
2004	2.1	2.8	5.5	5.8	6.5	9.6
2003	2.3	3.3	6.0	6.3	7.0	10.1
2002	2.0	3.2	5.8	6.0	6.7	9.6
2001	1.2	2.4	4.7	4.9	5.6	8.1
2000	0.9	1.8	4.0	4.2	4.8	7.0

Note: LF: labor force; U1, persons unemployed 15 weeks % LF; U2, job losers and persons who completed temporary jobs %LF; U3, total unemployed % LF; U4, total unemployed plus discouraged workers, plus all other marginally attached workers; % LF plus discouraged workers; U5, total unemployed, plus discouraged workers, plus all other marginally attached workers % LF plus all marginally attached workers; U6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons % LF plus all marginally attached workers

Source: US Bureau of Labor Statistics

Monthly seasonally adjusted measures of labor underutilization are provided in Table I-8. U6 climbed from 16.1 percent in Aug 2011 to 16.3 percent in Sep 2011 and then fell to 14.5 percent in Apr 2012, increasing to 14.9 percent in Jul 2012, 14.7 percent in both Aug and Sep 2012, 14.5 percent in Oct 2012, 14.4 percent in Nov 2012 and 14.4 percent in Dec 2012. Unemployment is an incomplete measure of the stress in US job markets. A different calculation in this blog is provided by using the participation rate in the labor force before the global recession. This calculation shows 29.5 million in job stress of unemployment/underemployment in Dec 2012, not seasonally adjusted, corresponding to 18.2 percent of the labor force (Table I-4 http://cmpassocregulationblog.blogspot.com/2013/01/thirty-million-unemployed-or.html).

Table I-8, US, Alternative Measures of Labor Underutilization SA %

	U1	U2	U3	U4	U5	U6
Nov 2012		4.1	7.8	8.5	9.4	14.4
Nov	4.3	4.1	7.8	8.3	9.2	14.4
Oct	4.4	4.2	7.9	8.4	9.3	14.5
Sep	4.3	4.2	7.8	8.3	9.3	14.7
Aug	4.4	4.5	8.1	8.6	9.6	14.7
Jul	4.5	4.6	8.2	8.7	9.7	14.9
Jun	4.6	4.6	8.2	8.7	9.6	14.8
May	4.6	4.5	8.2	8.7	9.6	14.8
Apr	4.5	4.4	8.1	8.7	9.5	14.5
Mar	4.6	4.5	8.2	8.7	9.6	14.5
Feb	4.8	4.7	8.3	8.9	9.8	15.0
Jan	4.9	4.7	8.3	8.9	9.9	15.1
Dec 2011	5.0	4.9	8.5	9.0	10.0	15.2
Nov	5.0	4.9	8.6	9.3	10.2	15.5
Oct	5.1	5.1	8.9	9.5	10.4	16.0
Sep	5.3	5.2	9.0	9.6	10.5	16.3
Aug	5.3	5.3	9.0	9.6	10.5	16.1
Jul	5.3	5.3	9.0	9.7	10.6	16.0
Jun	5.3	5.4	9.1	9.7	10.7	16.1
May	5.3	5.4	9.0	9.5	10.3	15.8
Apr	5.2	5.3	9.0	9.6	10.5	16.0
Mar	5.3	5.4	8.9	9.5	10.4	15.8
Feb	5.4	5.4	9.0	9.6	10.6	16.0
Jan	5.5	5.5	9.1	9.7	10.8	16.2

Source: US Bureau of Labor Statistics http://www.bls.gov/data/

Chart I-16 provides U6 on a monthly basis from 2001 to 2012. There was a steep climb from 2007 into 2009 and then this measure of unemployment and underemployment stabilized at that high level but declined into 2012. The low of U16 SA was 7.9 percent in Dec 2006 and the peak was 17.1 percent in Oct 2009. The low NSA was 7.6 percent in Oct 2006 and the peak was 18.0 percent in Jan 2010.

Chart I-16, US, U6, total unemployed, plus all marginally attached workers, plus total employed part Month, SA, 2001-2012

Source: US Bureau of Labor Statistics

Chart I-17 provides the number employed part-time for economic reasons or who cannot find full-time employment. There are sharp declines at the end of 2009, 2010 and 2011 but an increase in 2012.

Chart I-17, US, Working Part-time for Economic Reasons

Thousands, Month SA 2001-2012

Sources: US Bureau of Labor Statistics

There is strong seasonality in US labor markets around the end of the year. The number employed part-time for economic reasons because they could not find full-time employment fell from 9.101 million in Sep 2011 to 8.043 million in Aug 2012, seasonally adjusted, or decline of 1.058 million in nine months, as shown in Table I-9, but then rebounded to 8.607 million in Sep 2012 for increase of 564,000 in one month from Aug to Sep 2012, declining to 8.286 million in Oct 2012 or by 321,000 again in one month, further declining to 8.138 million in Nov 2012 for another major one-month decline of 148,000 and 7.918 million in Dec 2012 or fewer 220,000 in just one month. There is an increase of 243,000 in part-time for economic reasons from Aug 2012 to Oct 2012 and of 95,000 from Aug 2012 to Nov 2012. The number employed full-time increased from 112.871 million in Oct 2011 to 115.145 million in Mar 2012 or 2.274 million but then fell to 114.441 million in May 2012 or 0.845 million fewer full-time employed than in Mar 2012. The number employed full-time increased from 114.492 million in Aug 2012 to 115.469 million in Oct 2012 or increase of 0.977 million full-time jobs in two months and further to 115.868 million in Dec 2012 or increase of 1.376 million more full-time jobs in four months from Aug 2012 to Dec 2012. The number of employed part-time for economic reasons actually increased without seasonal adjustment from 8.271 million in Nov 2011 to 8.428 million in Dec 2011 or by 157,000 and then to 8.918 million in Jan 2012 or by an additional 490,000 for cumulative increase from Nov 2011 to Jan 2012 of 647,000. The level of employed part-time for economic reasons then fell from 8.918 million in Jan 2012 to 7.867 million in Mar 2012 or by 1.0151 million and to 7.694 million in Apr 2012 or 1.224 million fewer relative to Jan 2012. In Aug 2012, the number employed part-time for economic reasons reached 7.842 million NSA or 148,000 more than in Apr 2012. The number employed part-time for economic reasons increased from 7.842 million in Aug 2012 to 8.110 million in Sep 2012 or by 3.4 percent. The number part-time for economic reasons fell from 8.110 million in Sep 2012 to 7.870 million in Oct 2012 or by 240.000 in one month and fell to 7.794 million in Nov 2012 for an additional decline of 76.000 and cumulative from Sep 2012 of 316,000. The number employed part-time for economic reasons NSA increased to 8.116 million in Dec 2012 or 322,000 more than in Nov 2012. The number employed full time without seasonal adjustment fell from 113.138 million in Nov 2011 to 113.050 million in Dec 2011 or by 88,000 and fell further to 111.879 in Jan 2012 for cumulative decrease of 1.259 million. The number employed full-time not seasonally adjusted fell from 113.138 million in Nov 2011 to 112.587 million in Feb 2012 or by 551.000 but increased to 116.214 million in Aug 2012 or 3.076 million more full-time jobs than in Nov 2011. The number employed full-time not seasonally adjusted decreased from 116.214 million in Aug 2012 to 115.678 million in Sep 2012 for loss of 536,000 full-time jobs and rose to 116.045 million in Oct 2012 or by 367,000 full-time jobs in one month relative to Sep 2012. The number employed full-time NSA fell from 116.045 million in Oct 2012 to 115.515 million in Nov 2012 or decline of 530.000 in one month. The number employed full-time fell from 115.515 in Nov 2012 to 115.079 million in Dec 2012 or decline by 436,000 in one month. Comparisons over long periods require use of NSA data. The number with full-time jobs fell from a high of 123.219 million in Jul 2007 to 108.777 million in Jan 2010 or by 14.442 million. The number with full-time jobs in Dec 2012 is 115.079 million, which is lower by 8.140 million relative to the peak of 123.219 million in Jul 2007. There appear to be around 10 million fewer full-time jobs in the US than before the global recession. Growth at 2.2 percent on average in the thirteen quarters of expansion from IIIQ2009 to IIIQ2012 compared with 6.2 percent on average in expansions from postwar cyclical contractions is the main culprit of the fractured US labor market (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html).

Table I-9, US, Employed Part-time for Economic Reasons, Thousands, and Full-time, Millions

	Part-time Thousands	Full-time Millions
Seasonally Adjusted
Dec 2012	7,918	115.868
Nov 2012	8,138	115.665
Oct 2012	8,286	115.469
Sep 2012	8,607	115.259
Aug 2012	8,043	114.492
Jul 2012	8,245	114.478
Jun 2012	8,210	114.606
May 2012	8,116	114.300
Apr 2012	7,896	114.441
Mar 2012	7,664	115.145
Feb 2012	8,127	114.263
Jan 2012	8,220	113.833
Dec 2011	8,168	113.820
Nov 2011	8,436	113.217
Oct 2011	8,726	112.871
Sep 2011	9,101	112.541
Aug 2011	8,816	112.255
Jul 2011	8,416	112.141
Not Seasonally Adjusted
Dec 2012	8,116	115.079
Nov 2012	7,794	115.515
Oct 2012	7,870	116.045
Sep 2012	8,110	115.678
Aug 2012	7,842	116.214
Jul 2012	8,316	116.131
Jun 2012	8,394	116.024
May 2012	7,837	114.634
Apr 2012	7,694	113.999
Mar 2012	7,867	113.916
Feb 2012	8,455	112.587
Jan 2012	8,918	111.879
Dec 2011	8,428	113.050
Nov 2011	8,271	113.138
Oct 2011	8,258	113.456
Sep 2011	8,541	112.980
Aug 2011	8,604	114.286
Jul 2011	8,514	113.759
Jun 2011	8,738	113.255
May 2011	8,270	112.618
Apr 2011	8,425	111.844
Mar 2011	8,737	111.186
Feb 2011	8,749	110.731
Jan 2011	9,187	110.373
Dec 2010	9,205	111.207
Nov 2010	8,670	111.348
Oct 2010	8,408	112.342
Sep 2010	8,628	112.385
Aug 2010	8,628	113.508
Jul 2010	8,737	113.974
Jun 2010	8,867	113.856
May 2010	8,513	112.809
Apr 2010	8,921	111.391
Mar 2010	9,343	109.877
Feb 2010	9,282	109.100
Jan 2010	9,290	108.777 (low)
Dec 2009	9,354 (high)	109.875
Nov 2009	8,894	111.274
Oct 2009	8,474	111.599
Sep 2009	8,255	111.991
Aug 2009	8,835	113.863
Jul 2009	9,103	114.184
Jun 2009	9,301	114.014
May 2009	8,785	113.083
Apr 2009	8,648	112.746
Mar 2009	9,305	112.215
Feb 2009	9,170	112.947
Jan 2009	8,829	113.815
Dec 2008	8,250	116.422
Nov 2008	7,135	118.432
Oct 2008	6,267	120.020
Sep 2008	5,701	120.213
Aug 2008	5,736	121.556
Jul 2008	6,054	122.378
Jun 2008	5,697	121.845
May 2008	5,096	120.809
Apr 2008	5,071	120.027
Mar 2008	5,038	119.875
Feb 2008	5,114	119.452
Jan 2008	5,340	119.332
Dec 2007	4,750	121.042
Nov 2007	4,374	121.846
Oct 2007	4,028	122.006
Sep 2007	4,137	121.728
Aug 2007	4,494	122.870
Jul 2007	4,516	123.219 (high)
Jun 2007	4,469	122.150
May 2007	4,315	120.846
Apr 2007	4,205	119.609
Mar 2007	4,384	119.640
Feb 2007	4,417	119.041
Jan 2007	4,726	119.094
Dec 2006	4,281	120.371
Nov 2006	4,054	120.507
Oct 2006	4,010	121.199
Sep 2006	3,735 (low)	120.780
Aug 2006	4,104	121.979
Jul 2006	4,450	121.951
Jun 2006	4,456	121.070
May 2006	3,968	118.925
Apr 2006	3,787	118.559
Mar 2006	4,097	117.693
Feb 2006	4,403	116.823
Jan 2006	4,597	116.395

Source: US Bureau of Labor Statistics http://www.bls.gov/data/

People lose their marketable job skills after prolonged unemployment and find increasing difficulty in finding another job. Chart I-18 shows the sharp rise in unemployed over 27 weeks and stabilization at an extremely high level.

Chart I-18, US, Number Unemployed for 27 Weeks or Over, Thousands SA Month 2001-2011

Sources: US Bureau of Labor Statistics

Another segment of U6 consists of people marginally attached to the labor force who continue to seek employment but less frequently on the frustration there may not be a job for them. Chart I-19 shows the sharp rise in people marginally attached to the labor force after 2007 and subsequent stabilization.

Chart I-19, US, Marginally Attached to the Labor Force, NSA Month 2001-2012

Sources: US Bureau of Labor Statistics

IA3 Ten Million Fewer Full-time Jobs. Chart I-20 reveals the fracture in the US labor market. The number of workers with full-time jobs not-seasonally-adjusted rose with fluctuations from 2002 to a peak in 2007, collapsing during the global recession. The terrible state of the job market is shown in the segment from 2009 to 2012 with fluctuations around the typical behavior of a stationary series: there is no improvement in the United States in creating full-time jobs.

Chart I-20, US, Full-time Employed, Thousands, NSA, 2001-2012

Sources: US Bureau of Labor Statistics

IA4 Youth Unemployment and Middle-Aged Unemployment. The United States is experiencing high youth unemployment as in European economies. Table I-10 provides the employment level for ages 16 to 24 years of age estimated by the Bureau of Labor Statistics. On an annual basis, youth employment fell from 20.041 million in 2006 to 17.362 million in 2011 or 2.679 million fewer youth jobs and to 17.834 million in 2012 or 2.207 million fewer jobs. During the seasonal peak months of youth employment in the summer from Jun to Aug, youth employment has fallen by more than two million jobs relative to 21.914 million in Jul 2006 with 19.461 million in Jul 2012 for 2.453 fewer youth jobs. There are two hardships behind these data. First, young people cannot find employment after finishing high-school and college, reducing prospects for achievement in older age. Second, students with more modest means cannot find employment to keep them in college.

Table I-10, US, Employment Level 16-24 Years, Thousands, NSA

Year	Aug	Sep	Oct	Nov	Dec	Annual
2001	20529	19706	19694	19675	19547	20088
2002	20653	19466	19542	19397	19394	19683
2003	20181	18909	19139	19163	19136	19351
2004	20660	19158	19609	19615	19619	19630
2005	20814	19503	19794	19750	19733	19770
2006	21167	19604	19853	19903	20129	20041
2007	20413	19498	19564	19660	19361	19875
2008	20096	18818	18757	18454	18378	19202
2009	18270	16972	16671	16689	16615	17601
2010	18061	16874	16867	16946	16727	17077
2011	18067	17238	17532	17402	17234	17362
2012	18171	17687	17842	17877	17604	17834

Sources: US Bureau of Labor Statistics

Chart I-21 provides US employment level ages 16 to 24 years from 2002 to 2012. Employment level is sharply lower in Jun 2012 relative to the peak in 2007.

Chart I-21, US, Employment Level 16-24 Years, Thousands SA, 2001-2012

Sources: US Bureau of Labor Statistics

Table I-11 provides US unemployment level ages 16 to 24 years. The number unemployed ages 16 to 24 years increased from 2342 thousand in 2007 to 3634 thousand in 2011 or by 1.292 million and 3451 thousand in 2012 or by 1.109 million. This situation may persist for many years.

Table I-11, US, Unemployment Level 16-24 Years, Thousands NSA

Year	Jul	Aug	Sep	Oct	Nov	Dec	Annual
2001	2585	2461	2301	2424	2470	2412	2371
2002	3034	2688	2506	2468	2570	2374	2683
2003	3200	2724	2698	2522	2522	2248	2746
2004	3018	2585	2493	2572	2448	2294	2638
2005	2688	2519	2339	2285	2369	2055	2521
2006	2750	2467	2297	2252	2242	2007	2353
2007	2622	2388	2419	2258	2250	2323	2342
2008	3408	2990	2904	2842	2833	2928	2830
2009	4387	4004	3774	3789	3699	3532	3760
2010	4374	3903	3604	3731	3561	3352	3857
2011	4110	3820	3541	3386	3287	3161	3634
2012	4011	3672	3174	3285	3102	3153	3451

Sources: US Bureau of Labor Statistics

Chart I-22 provides the unemployment level ages 16 to 24 from 2002 to 2012. The level rose sharply from 2007 to 2010 with tepid improvement into 2012.

Chart I-22, US, Unemployment Level 16-24 Years, Thousands SA, 2001-2012

Sources: US Bureau of Labor Statistics

Table I-12 provides the rate of unemployment of young peoples in ages 16 to 24 years. The annual rate jumped from 10.5 percent in 2007 to 18.4 percent in 2010, 17.3 percent in 2011 and 16.2 percent in 2012. During the seasonal peak in Jul 2011 the rate of youth unemployed was 18.1 percent in Jul 2011 and 17.1 percent in Jul 2012 compared with 10.8 percent in Jul 2007.

Table I-12, US, Unemployment Rate 16-24 Years, Thousands, NSA

Year	Jun	Jul	Aug	Sep	Oct	Nov	Dec	Annual
2001	11.6	10.5	10.7	10.5	11.0	11.2	11.0	10.6
2002	13.2	12.4	11.5	11.4	11.2	11.7	10.9	12.0
2003	14.8	13.3	11.9	12.5	11.6	11.6	10.5	12.4
2004	13.4	12.3	11.1	11.5	11.6	11.1	10.5	11.8
2005	12.6	11.0	10.8	10.7	10.3	10.7	9.4	11.3
2006	11.9	11.2	10.4	10.5	10.2	10.1	9.1	10.5
2007	12.0	10.8	10.5	11.0	10.3	10.3	10.7	10.5
2008	14.4	14.0	13.0	13.4	13.2	13.3	13.7	12.8
2009	19.9	18.5	18.0	18.2	18.5	18.1	17.5	17.6
2010	20.0	19.1	17.8	17.6	18.1	17.4	16.7	18.4
2011	18.9	18.1	17.5	17.0	16.2	15.9	15.5	17.3
2012	18.1	17.1	16.8	15.2	15.5	14.8	15.2	16.2

Sources: US Bureau of Labor Statistics

Chart I-23 provides the BLS estimate of the not-seasonally-adjusted rate of youth unemployment for ages 16 to 24 years from 2002 to 2012. The rate of youth unemployment increased sharply during the global recession of 2008 and 2009 but has failed to drop to earlier lower levels during the thirteen consecutive quarters of expansion of the economy since IIIQ2009 because of much lower growth at 2.2 percent annual equivalent on average compared with 6.2 percent on average in cyclical expansions since World War II (Table I -5 http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html).

Chart I-23, US, Unemployment Rate 16-24 Years, Percent, NSA, 2001-2012

Sources: US Bureau of Labor Statistics

Chart I-24 provides longer perspective with the rate of youth unemployment in ages 16 to 24 years from 1948 to 2012. The rate of youth unemployment rose to 20 percent during the contractions of the early 1980s and also during the contraction of the global recession in 2008 and 2009. The data illustrate again the claim in this blog that the contractions of the early 1980s are the valid framework for comparison with the global recession of 2008 and 2009 instead of misleading comparisons with the 1930s. During the initial phase of recovery, the rate of youth unemployment 16 to 24 years NSA fell from 18.9 percent in Jun 1983 to 14.5 percent in Jun 1984 while the rate of youth unemployment 16 to 24 years was nearly the same during the expansion after IIIQ2009: 17.5 percent in Dec 2009, 16.7 percent in Dec 2010, 15.5 percent in Dec 2011 and 15.2 percent in Dec 2012. In Jul 2007, the rate of youth unemployment was 10.8 percent, increasing to 17.1 percent in Jul 2012. The difference originates in the vigorous seasonally-adjusted annual equivalent average rate of GDP growth of 5.7 percent during the recovery from IQ1983 to IVQ1985 compared with 2.2 percent on average during the first thirteen quarters of expansion from IIIQ2009 to IIIQ2012 (see table I-5 in http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). The fractured US labor market denies an early start for young people.

Chart I-24, US, Unemployment Rate 16-24 Years, Percent NSA, 1948-2012

Sources: US Bureau of Labor Statistics

It is more difficult to move to other jobs after a certain age because of fewer available opportunities for matured individuals than for new entrants into the labor force. Middle-aged unemployed are less likely to find another job. Table I-13 provides the unemployment level ages 45 years and over. The number unemployed ages 45 years and over rose from 1.985 million in Jul 2006 to 4.821 million in July 2010 or by 142.9 percent. The number of unemployed ages 45 years and over declined to 4.405 million in Jul 2012 that is still higher by 121.9 percent than in Jul 2006. The number unemployed age 45 and over jumped from 1.794 million in Dec 2006 to 4.762 million in Dec 2010 or 165.4 percent and at 3.927 million in Dec 2012 is higher by 2.133 million or 118.9 percent higher than 1.794 million in Nov 2006.

Table I-13, US, Unemployment Level 45 Years and Over, Thousands NSA

Year	Jul	Aug	Sep	Oct	Nov	Dec	Annual
2000	1253	1339	1254	1202	1242	1217	1249
2001	1539	1640	1586	1722	1786	1901	1576
2002	2173	2114	1966	1945	2013	2210	2114
2003	2281	2301	2157	2032	2132	2130	2253
2004	2116	2082	1951	1931	2053	2086	2149
2005	2119	1895	1992	1875	1920	1963	2009
2006	1985	1869	1710	1607	1704	1794	1848
2007	2053	1956	1854	1885	1925	2120	1966
2008	2492	2695	2595	2728	3078	3485	2540
2009	4757	4683	4560	4492	4655	4960	4500
2010	4821	5128	4640	4576	4909	4762	4879
2011	4772	4592	4426	4375	4195	4182	4537
2012	4405	4179	3899	3800	3861	3927	4133

Sources: US Bureau of Labor Statistics

Chart I-25 provides the level unemployed ages 45 years and over. There was sharp increase during the global recession and inadequate decline. There was an increase during the 2001 recession and then stability. The US is facing a major challenge of reemploying middle-aged workers.

Chart I-25, US, Unemployment Level Ages 45 Years and Over, Thousands, NSA, 1976-2012

Sources: US Bureau of Labor Statistics

II World Inflation Waves. This section provides analysis and data on world inflation waves. IIA Appendix: Transmission of Unconventional Monetary Policy provides more technical analysis. Section IIB United States Inflation analyzes inflation in the United States in two subsections: IIC Long-term US Inflation and IID Current US Inflation. There is similar lack of reality in economic history as in monetary policy based on fear of deflation as analyzed in Subsection IIE Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation

3. Unconventional monetary policy or its expectation can increase stock market valuations (Bernanke 2010WP). Increases in equities traded in stock markets can augment perceptions of the wealth of consumers inducing increases in consumption.

4. Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can cause increases in net exports of the US that increase aggregate economic activity (Yellen 2011AS).

Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):

Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:

The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):

First, reduction of the unemployment rate to normal would take between 35 and 256 years depending on the definition (http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html). The US labor force stood at 153.373 million in Dec 2011 and 154.904 million in Dec 2012, not seasonally adjusted, for increase of 1.531 million or 127,583 per month. The average increase of 130,100 new nonfarm jobs per month in the US from Mar to Dec 2012 is insufficient even to absorb 127,583 new entrants per month into the labor force. The difference between the average increase of 137,200 new private nonfarm jobs per month in the US from Mar to Dec 2012 and the 127,583 average monthly increase in the labor force from Nov 2011 to Nov 2012 is 9,617 monthly new jobs net of absorption of new entrants in the labor force. There are 29.6 million in job stress in the US currently. The provision of 9,617 new jobs per month net of absorption of new entrants in the labor force would require 3078 months to provide jobs for the unemployed and underemployed (29.6 million divided by 9,617) or 256 years (3078 divided by 12). Net job creation of 9,617 jobs per month only adds 115,404 jobs in a year. The civilian labor force of the US in Dec 2012 not seasonally adjusted stood at 154.904 million with 11.844 million unemployed or effectively 18.700 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 8.7 years (1 million divided by product of 9,617 by 12, which is 115,404). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.745 million (0.05 times labor force of 154.904 million) for new net job creation of 4.099 million (11.844 million unemployed minus 7.745 million unemployed at rate of 5 percent) that at the current rate would take 35.5 years (4.099 million divided by 115,404). Under the calculation in this blog there are 18.700 million unemployed by including those who ceased searching because they believe there is no job for them. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 10.612 million jobs net of labor force growth that at the current rate would take 91.9 years (18.700 million minus 0.05(161.760 million) divided by 115,404, using LF PART 66.2% and Total UEM in Table I-4 at http://cmpassocregulationblog.blogspot.com/2013/01/thirty-million-unemployed-or.html. These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. Second, calculations show that actual US GDP growth is around 1.7 percent per year that will perpetuate unemployment/underemployment (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html). This rate of 1.7 percent is well below trend growth of 3 percent per year from 1870 to 2010, which has been always recovered after events such as wars and recessions (Lucas 2011May). Weakness of growth is shown by the exceptional one-time contributions to growth from items that are not aggregate demand, 2.53 percentage points contributed by inventory change to growth of 4.1 percent in IVQ2011 and 0.64 percentage points contributed by exceptional expenditures in national defense together with 0.73 percentage points of inventory accumulation to growth of 3.1 percent in IIIQ2012. Deducting inventory accumulation and one-time national defense expenditures adjusts IIIQ2012 growth to annual 1.73 percent. Cumulative growth of 2.0 percent in IQ2012, 1.3 percent in IIQ2012 and adjusted 1.73 percent in IIIQ2012 annualizes to 1.7 percent in the first three quarters of 2012 {([(1.02)^1/4(1.013)^1/4(1.0173^1/4]^4/3 -1)100 = 1.7%}. The actual rate required to reduce unemployment/underemployment to normal is even much higher than 3 percent in historical trend.

Table IIA-1 provides annual equivalent rates of inflation for producer price indexes followed in this blog of countries and regions that account for close to three quarters of world output. The behavior of the US producer price index in 2011 and into 2012 shows neatly multiple waves. (1) In Jan-Apr 2011, without risk aversion, US producer prices rose at the annual equivalent rate of 9.7 percent. (2) After risk aversion, producer prices increased in the US at the annual equivalent rate of 1.2 percent in May-Jun 2011. (3) From Jul to Sep 2011, under alternating episodes of risk aversion, producer prices increased at the annual equivalent rate of 6.6 percent. (4) Under the pressure of risk aversion because of the European debt crisis US producer prices fell at the annual equivalent rate of minus 1.2 percent in Oct-Nov 2011. (5) From Dec 2011 to Jan 2012, US producer prices rose at the annual equivalent rate of 1.2 percent with relaxed risk aversion and commodity-price increases at the margin. (6) Inflation of producer prices returned with 1.2 percent annual equivalent in Feb-Mar 2012. (7) With return of risk aversion from the European debt crisis, producer prices fell at the annual equivalent rate of 7.5 percent in Apr-Jun 2012. (8) New positions in commodity futures even with continuing risk aversion caused annual equivalent inflation of 3.0 percent in Jun-Jul 2012. (9) Relaxed risk aversion because of announcement of sovereign bond-buying by the European Central Bank caused restrained induced carry trades that resulted in annual equivalent producer price inflation in the US of 18.2 percent in Aug-Sep 2012. (10) Renewed risk aversion caused unwinding of carry trades of zero interest rates to commodity futures exposures with annual equivalent inflation of minus 5.8 percent in Oct-Dec 2012. Resolution of the European debt crisis if there is not an unfavorable growth event with political development in China would result in jumps of valuations of risk financial assets. Increases in commodity prices would cause the same high producer price inflation experienced in Jan-Apr 2011 and Aug-Sep 2012. An episode of exploding commodity prices could ignite inflationary expectations that would result in an inflation phenomenon of costly resolution. There are nine producer-price indexes in Table IIA-1 for seven countries (two for the UK) and one region (euro area) showing very similar behavior. Zero interest rates without risk aversion cause increases in commodity prices that in turn increase input and output prices. Producer price inflation rose at very high rates during the first part of 2011 for the US, Japan, China, Euro Area, Germany, France, Italy and the UK when risk aversion was contained. With the increase in risk aversion in May and Jun 2011, inflation moderated because carry trades were unwound. Producer price inflation returned after July 2011, with alternating bouts of risk aversion. In the final months of the year producer price inflation collapsed because of the disincentive to exposures in commodity futures resulting from fears of resolution of the European debt crisis. There is renewed worldwide inflation in the early part of 2012 with subsequent collapse because of another round of sharp risk aversion. Sharp worldwide jump in producer prices occurred recently as a result of the combination of zero interest rates forever or QE∞ with temporarily relaxed risk aversion. Producer prices are moderating or falling currently because of renewed risk aversion that causes unwinding of carry trades from zero interest rates to commodity futures exposures. Unconventional monetary policy fails in stimulating the overall real economy, merely introducing undesirable instability as monetary authorities cannot control allocation of floods of money at zero interest rates to carry trades into risk financial assets. The economy is constrained in a suboptimal allocation of resources that is perpetuated along a continuum of short-term periods results in long-term or dynamic inefficiency in the form of a trajectory of economic activity that is lower than what would be attained with rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html).

Table IIA-1, Annual Equivalent Rates of Producer Price Indexes

INDEX 2011-2012	AE ∆%
US Producer Price Index
AE ∆% Oct-Dec 2012	-5.8
AE ∆% Aug-Sep 2012	18.2
AE ∆% Jun-Jul 2012	3.0
AE ∆% Apr-May 2012	-7.5
AE ∆% Feb-Mar 2012	1.2
AE ∆% Dec 2011-Jan-2012	1.2
AE ∆% Oct-Nov 2011	-1.2
AE ∆% Jul-Sep 2011	6.6
AE ∆% May-Jun 2011	1.2
AE ∆% Jan-Apr 2011	9.7
Japan Corporate Goods Price Index
AE ∆% Dec 2012	3.7
AE ∆% Oct-Nov 2012	-1.8
AE ∆% Aug-Sep 2012	2.4
AE ∆% May-Jul 2012	-5.8
AE ∆% Feb-Apr 2012	2.4
AE ∆% Dec 2011-Jan 2012	-0.6
AE ∆% Jul-Nov 2011	-2.2
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-Apr 2011	5.9
China Producer Price Index
AE ∆% Nov-Dec 2012	-1.2
AE ∆% Oct 2012	2.4
AE ∆% May-Sep 2012	-5.8
AE ∆% Feb-Apr 2012	2.4
AE ∆% Dec 2011-Jan 2012	-2.4
AE ∆% Jul-Nov 2011	-3.1
AE ∆% Jan-Jun 2011	6.4
Euro Zone Industrial Producer Prices
AE ∆% Nov 2012	-2.4
AE ∆% Sep-Oct 2012	1.8
AE ∆% Jul-Aug 2012	7.4
AE ∆% Apr-Jun 2012	-3.9
AE ∆% Jan-Mar 2012	8.3
AE ∆% Oct-Dec 2011	0.8
AE ∆% Jul-Sep 2011	2.0
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-Apr 2011	12.0
Germany Producer Price Index
AE ∆% Oct-Nov 2012	-0.6 NSA 1.2 SA
AE ∆% Aug-Sep 2012	4.9 NSA 6.2 SA
AE ∆% May-Jul 2012	-2.8 NSA –0.8 SA
AE ∆% Feb-Apr 2012	4.9 NSA 1.2 SA
AE ∆% Dec 2011-Jan 2012	1.2 NSA –0.6 SA
AE ∆% Oct-Nov 2011	1.8 NSA 3.7 SA
AE ∆% Jul-Sep 2011	2.8 NSA 3.7 SA
AE ∆% May-Jun 2011	0.6 NSA 3.7 SA
AE ∆% Jan-Apr 2011	10.4 NSA 6.5 SA
France Producer Price Index for the French Market
AE ∆% Nov 2012	-5.8
AE ∆% Jul-Oct 2012	8.1
AE ∆% Apr-Jun 2012	-7.7
AE ∆% Jan-Mar 2012	8.3
AE ∆% Oct-Dec 2011	2.4
AE ∆% Jul-Sep 2011	2.8
AE ∆% May-Jun 2011	-3.5
AE ∆% Jan-Apr 2011	11.7
Italy Producer Price Index
AE ∆% Sep-Nov 2012	-2.0
AE ∆% Jul-Aug 2012	6.8
AE ∆% May-Jun 2012	-2.4
AE ∆% Mar-Apr 2012	4.3
AE ∆% Jan-Feb 2012	7.4
AE ∆% Oct-Dec 2011	0.4
AE ∆% Jul-Sep 2011	2.4
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-April 2011	10.7
UK Output Prices
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Jul-Oct 2012	4.0
AE ∆% May-Jun 2012	-5.3
AE ∆% Feb-Apr 2012	7.9
AE ∆% Nov 2011-Jan-2012	1.6
AE ∆% May-Oct 2011	2.0
AE ∆% Jan-Apr 2011	12.0
UK Input Prices
AE ∆% Dec 2012	-2.4
AE ∆% Sep-Nov 2012	1.6
AE ∆% Jul-Aug 2012	14.0
AE ∆% Apr-Jun 2012	-21.9
AE ∆% Jan-Mar 2012	18.1
AE ∆% Nov-Dec 2011	-1.2
AE ∆% May-Oct 2011	-3.1
AE ∆% Jan-Apr 2011	35.6

AE: Annual Equivalent

Sources:

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

Similar world inflation waves are in the behavior of consumer price indexes of six countries and the euro zone in Table IIA-2. US consumer price inflation shows similar waves. (1) Under risk appetite in Jan-Apr 2011 consumer prices increased at the annual equivalent rate of 4.9 percent. (2) Risk aversion caused the collapse of inflation to annual equivalent 2.8 percent in May-Jul 2011. (3) Risk appetite drove the rate of consumer price inflation in the US to 3.7 percent in Jul-Sep 2011. (4) Gloomier views of carry trades caused the collapse of inflation in Oct-Nov 2011 to annual equivalent 0.6 percent. (5) Consumer price inflation resuscitated with increased risk appetite at annual equivalent of 1.2 percent in Dec 2011 to Jan 2012. (6) Consumer price inflation returned at 2.8 percent annual equivalent in Feb-Apr 2012. (7) Under renewed risk aversion, annual equivalent consumer price inflation in the US is minus 1.2 percent in May-Jul 2012. (8) Inflation jumped to annual equivalent 7.4 percent in Aug-Sep 2012 and 5.3 percent in Aug-Oct 2012. (9) Unwinding of carry trades caused negative annual equivalent inflation of 1.8 percent in Nov-Dec 2012 but some countries experienced higher inflation in Dec 2012. Inflationary expectations can be triggered in one of these episodes of accelerating inflation because of commodity carry trades induced by unconventional monetary policy of zero interest rates in perpetuity or QE∞. Alternating episodes of increase and decrease of inflation introduce uncertainty in household planning that frustrates consumption and home buying. Announcement of purchases of impaired sovereign bonds by the European Central Bank relaxed risk aversion that induced carry trades into commodity exposures, increasing prices of food, raw materials and energy. There is similar behavior in all the other consumer price indexes in Table II-2. China’s CPI increased at annual equivalent 8.3 percent in Jan-Mar 2011, 2.0 percent in Apr-Jun, 2.9 percent in Jul-Dec and resuscitated at 5.8 percent annual equivalent in Dec 2011 to Mar 2012, declining to minus 3.9 percent in Apr-Jun 2012 but resuscitating at 4.1 percent in Jul-Sep 2012, declining to minus 1.2 percent in Oct 2012 and 0.0 percent in Oct-Nov 2012. High inflation in China at annual equivalent 5.5 percent in Nov-Dec 2012 is attributed to inclement winter weather that caused increases in food prices. The euro zone harmonized index of consumer prices (HICP) increased at annual equivalent 5.2 percent in Jan-Apr 2011, minus 2.4 percent in May-Jul 2011, 4.3 percent in Aug-Dec 2011, minus 3.0 percent in Dec 2011-Jan 2012 and then 9.6 percent in Feb-Apr 2012, falling to minus 2.8 percent annual equivalent in May-Jul 2012 but resuscitating at 5.3 percent in Aug-Oct 2012. The recent shock of risk aversion forced minus 2.4 percent annual equivalent in Nov 2012. As in several European countries, annual equivalent inflation jumped to 4.9 percent in the euro area in Dec 2012. The price indexes of the largest members of the euro zone, Germany, France and Italy, and the euro zone as a whole, exhibit the same inflation waves. The United Kingdom CPI increased at annual equivalent 6.5 percent in Jan-Apr 2011, falling to only 0.4 percent in May-Jul 2011 and then increasing at 4.6 percent in Aug-Nov 2011. UK consumer prices fell at 0.6 percent annual equivalent in Dec 2011 to Jan 2012 but increased at 6.2 percent annual equivalent from Feb to Apr 2012. In May-Jun 2012, with renewed risk aversion, UK consumer prices fell at the annual equivalent rate of minus 3.0 percent. Inflation returned in the UK at average annual equivalent of 4.5 percent in Jul-Dec 2012 with inflation in Oct 2012 caused mostly by increases of university tuition fees. Inflation returned at 4.1 percent annual equivalent in Jul-Sep 2012 and was higher in annual equivalent producer price inflation in the UK in Jul-Oct 2012 at 5.0 percent for output prices and 14.0 percent for input prices in Jul-Aug 2012 (see Table IIA-1).

Table IIA-2, Annual Equivalent Rates of Consumer Price Indexes

Index 2011-2012	AE ∆%
US Consumer Price Index
AE ∆% Nov-Dec 2012	-1.8
AE ∆% Aug-Oct 2012	5.3
AE ∆% May-Jul 2012	-1.2
AE ∆% Feb-Apr 2012	2.8
AE ∆% Dec 2011-Jan 2012	1.2
AE ∆% Oct-Nov 2011	0.6
AE ∆% Jul-Sep 2011	3.7
AE ∆% May-Jul 2011	2.8
AE ∆% Jan-Apr 2011	4.9
China Consumer Price Index
AE ∆% Nov-Dec 2012	5.5
AE ∆% Oct 2012	0.0
AE ∆% Jul-Sep 2012	4.1
AE ∆% Apr-Jun 2012	-3.9
AE ∆% Dec 2011-Mar 2012	5.8
AE ∆% Jul-Nov 2011	2.9
AE ∆% Apr-Jun 2011	2.0
AE ∆% Jan-Mar 2011	8.3
Euro Zone Harmonized Index of Consumer Prices
AE ∆% Dec 2012	4.9
AE ∆% Nov 2012	-2.4
AE ∆% Aug-Oct 2012	5.3
AE ∆% May-Jul 2012	-2.8
AE ∆% Feb-Apr 2012	9.6
AE ∆% Dec 2011-Jan 2012	-3.0
AE ∆% Aug-Nov 2011	4.3
AE ∆% May-Jul 2011	-2.4
AE ∆% Jan-Apr 2011	5.2
Germany Consumer Price Index
AE ∆% Dec 2012	11.4 NSA 3.7 SA
AE ∆% Sep-Nov 2012	-0.4 NSA 1.6 SA
AE ∆% Jul-Aug 2012	4.9 NSA 3.7 SA
AE ∆% May-Jun 2012	-1.8 NSA 1.2 SA
AE ∆% Feb-Apr 2012	4.9 NSA 2.4 SA
AE ∆% Dec 2011-Jan 2012	1.8 NSA 1.8 SA
AE ∆% Jul-Nov 2011	1.2 NSA 1.9 SA
AE ∆% May-Jun 2011	0.6 NSA 2.4 SA
AE ∆% Feb-Apr 2011	4.9 NSA 2.4 SA
France Consumer Price Index
AE ∆% Dec 2012	3.7
AE ∆% Nov 2012	-2.4
AE ∆% Aug-Oct 2012	2.4
AE ∆% May-Jul 2012	-2.0
AE ∆% Feb-Apr 2012	5.3
AE ∆% Dec 2011-Jan 2012	0.0
AE ∆% Aug-Nov 2011	2.7
AE ∆% May-Jul 2011	-0.8
AE ∆% Jan-Apr 2011	4.3
Italy Consumer Price Index
AE ∆% Dec 2012	2.4
AE ∆% Sep-Nov 2012	-0.8
AE ∆% Jul-Aug 2012	3.0
AE ∆% May-Jun 2012	1.2
AE ∆% Feb-Apr 2012	5.7
AE ∆% Dec 2011-Jan 2012	4.3
AE ∆% Oct-Nov 2011	3.0
AE ∆% Jul-Sep 2011	2.4
AE ∆% May-Jun 2011	1.2
AE ∆% Jan-Apr 2011	4.9
UK Consumer Price Index
AE ∆% Jul-Dec 2012	4.5
AE ∆% May-Jun 2012	-3.0
AE ∆% Feb-Apr 2012	6.2
AE ∆% Dec 2011-Jan 2012	-0.6
AE ∆% Aug-Nov 2011	4.6
AE ∆% May-Jul 2011	0.4
AE ∆% Jan-Apr 2011	6.5

AE: Annual Equivalent

Sources:

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

IIA Appendix: Transmission of Unconventional Monetary Policy. Janet L. Yellen, Vice Chair of the Board of Governors of the Federal Reserve System, provides analysis of the policy of purchasing large amounts of long-term securities for the Fed’s balance sheet. The new analysis provides three channels of transmission of quantitative easing to the ultimate objectives of increasing growth and employment and increasing inflation to “levels of 2 percent or a bit less that most Committee participants judge to be consistent, over the long run, with the FOMC’s dual mandate” (Yellen 2011AS, 4, 7):

“There are several distinct channels through which these purchases tend to influence aggregate demand, including a reduced cost of credit to consumers and businesses, a rise in asset prices that boost household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.”

The new analysis by Yellen (2011AS) is considered below in four separate subsections: IIA1 Theory; IIA2 Policy; IIA3 Evidence; and IIA4 Unwinding Strategy.

IIA1 Theory. The transmission mechanism of quantitative easing can be analyzed in three different forms. (1) Portfolio choice theory. General equilibrium value theory was proposed by Hicks (1935) in analyzing the balance sheets of individuals and institutions with assets in the capital segment consisting of money, debts, stocks and productive equipment. Net worth or wealth would be comparable to income in value theory. Expected yield and risk would be the constraint comparable to income in value theory. Markowitz (1952) considers a portfolio of individual securities with mean μ_p and variance σ_p. The Markowitz (1952, 82) rule states that “investors would (or should” want to choose a portfolio of combinations of (μ_p, σ_p) that are efficient, which are those with minimum variance or risk for given expected return μ_p or more and maximum expected μ_p for given variance or risk or less. The more complete model of Tobin (1958) consists of portfolio choice of monetary assets by maximizing a utility function subject to a budget constraint. Tobin (1961, 28) proposes general equilibrium analysis of the capital account to derive choices of capital assets in balance sheets of economic units with the determination of yields in markets for capital assets with the constraint of net worth. A general equilibrium model of choice of portfolios was developed simultaneously by various authors (Hicks 1962; Treynor 1962; Sharpe 1964; Lintner 1965; Mossin 1966). If shocks such as by quantitative easing displace investors from the efficient frontier, there would be reallocations of portfolios among assets until another efficient point is reached. Investors would bid up the prices or lower the returns (interest plus capital gains) of long-term assets targeted by quantitative easing, causing the desired effect of lowering long-term costs of investment and consumption.

(2) General Equilibrium Theory. Bernanke and Reinhart (2004, 88) argue that “the possibility monetary policy works through portfolio substitution effects, even in normal times, has a long intellectual history, having been espoused by both Keynesians (James Tobin 1969) and monetarists (Karl Brunner and Allan Meltzer 1973).” Andres et al. (2004) explain the Tobin (1969) contribution by optimizing agents in a general-equilibrium model. Both Tobin (1969) and Brunner and Meltzer (1973) consider capital assets to be gross instead of perfect substitutes with positive partial derivatives of own rates of return and negative partial derivatives of cross rates in the vector of asset returns (interest plus principal gain or loss) as argument in portfolio balancing equations (see Pelaez and Suzigan 1978, 113-23). Tobin (1969, 26) explains portfolio substitution after monetary policy:

“When the supply of any asset is increased, the structure of rates of return, on this and other assets, must change in a way that induces the public to hold the new supply. When the asset’s own rate can rise, a large part of the necessary adjustment can occur in this way. But if the rate is fixed, the whole adjustment must take place through reductions in other rates or increases in prices of other assets. This is the secret of the special role of money; it is a secret that would be shared by any other asset with a fixed interest rate.”

Andrés et al. (2004, 682) find that in their multiple-channels model “base money expansion now matters for the deviations of long rates from the expected path of short rates. Monetary policy operates by both the expectations channel (the path of current and expected future short rates) and this additional channel. As in Tobin’s framework, interest rates spreads (specifically, the deviations from the pure expectations theory of the term structure) are an endogenous function of the relative quantities of assets supplied.”

The interrelation among yields of default-free securities is measured by the term structure of interest rates. This schedule of interest rates along time incorporates expectations of investors. (Cox, Ingersoll and Ross 1985). The expectations hypothesis postulates that the expectations of investors about the level of future spot rates influence the level of current long-term rates. The normal channel of transmission of monetary policy in a recession is to lower the target of the fed funds rate that will lower future spot rates through the term structure and also the yields of long-term securities. The expectations hypothesis is consistent with term premiums (Cox, Ingersoll and Ross 1981, 774-7) such as liquidity to compensate for risk or uncertainty about future events that can cause changes in prices or yields of long-term securities (Hicks 1935; see Cox, Ingersoll and Ross 1981, 784; Chung et al. 2011, 22).

(3) Preferred Habitat. Another approach is by the preferred-habitat models proposed by Culbertson (1957, 1963) and Modigliani and Sutch (1966). This approach is formalized by Vayanos and Vila (2009). The model considers investors or “clientele” who do not abandon their segment of operations unless there are extremely high potential returns and arbitrageurs who take positions to profit from discrepancies. Pension funds matching benefit liabilities would operate in segments above 15 years; life insurance companies operate around 15 years or more; and asset managers and bank treasury managers are active in maturities of less than 10 years (Ibid, 1). Hedge funds, proprietary trading desks and bank maturity transformation activities are examples of potential arbitrageurs. The role of arbitrageurs is to incorporate “information about current and future short rates into bond prices” (Ibid, 12). Suppose monetary policy raises the short-term rate above a certain level. Clientele would not trade on this information, but arbitrageurs would engage in carry trade, shorting bonds and investing at the short-term rate, in a “roll-up” trade, resulting in decline of bond prices or equivalently increases in yields. This is a situation of an upward-sloping yield curve. If the short-term rate were lowered, arbitrageurs would engage in carry trade borrowing at the short-term rate and going long bonds, resulting in an increase in bond prices or equivalently decline in yields, or “roll-down” trade. The carry trade is the mechanism by which bond yields adjust to changes in current and expected short-term interest rates. The risk premiums of bonds are positively associated with the slope of the term structure (Ibid, 13). Fama and Bliss (1987, 689) find with data for 1964-85 that “1-year expected returns for US Treasury maturities to 5 years, measured net of the interest rate on a 1-year bond, vary through time. Expected term premiums are mostly positive during good times but mostly negative during recessions.” Vayanos and Vila (2009) develop a model with two-factors, the short-term rate and demand or quantity. The term structure moves because of shocks of short-term rates and demand. An important finding is that demand or quantity shocks are largest for intermediate and long maturities while short-rate shocks are largest for short-term maturities.

IIA2 Policy. A simplified analysis could consider the portfolio balance equations A_ij = f(r, x) where A_ij is the demand for i = 1,2,∙∙∙n assets from j = 1,2, ∙∙∙m sectors, r the 1xn vector of rates of return, r_i, of n assets and x a vector of other relevant variables. Tobin (1969) and Brunner and Meltzer (1973) assume imperfect substitution among capital assets such that the own first derivatives of A_ij are positive, demand for an asset increases if its rate of return (interest plus capital gains) is higher; and cross first derivatives are negative, demand for an asset decreases if the rate of return of alternative assets increases. Theoretical purity would require the estimation of the complete model with all rates of return. In practice, it may be impossible to observe all rates of return such as in the critique of Roll (1976). Policy proposals by the Fed have been focused on the likely impact of withdrawals of stocks of securities in specific segments, that is, of effects of one or several specific rates of return among the n possible rates. There have been at least seven approaches on the role of monetary policy in purchasing long-term securities that have increased the classes of rates of return targeted by the Fed:

(1) Suspension of Auctions of 30-year Treasury Bonds. Auctions of 30-year Treasury bonds were suspended between 2001 and 2005. This was Treasury policy not Fed policy. The effects were similar to those of quantitative easing: withdrawal of supply from the segment of 30-year bonds would result in higher prices or lower yields for close-substitute mortgage-backed securities with resulting lower mortgage rates. The objective was to encourage refinancing of house loans that would increase family income and consumption by freeing income from reducing monthly mortgage payments.

(2) Purchase of Long-term Securities by the Fed. Between Nov 2008 and Mar 2009 the Fed announced the intention of purchasing $1750 billion of long-term securities: $600 billion of agency mortgage-backed securities and agency debt announced on Nov 25 and $850 billion of agency mortgaged-backed securities and agency debt plus $300 billion of Treasury securities announced on Mar 18, 2009 (Yellen 2011AS, 5-6). The objective of buying mortgage-backed securities was to lower mortgage rates that would “support the housing sector” (Bernanke 2009SL). The FOMC statement on Dec 16, 2008 informs that: “over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and its stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant” (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). The Mar 18, 2009, statement of the FOMC explained that: “to provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities up to $1.25 trillion this year, and to increase its purchase of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months” (http://www.federalreserve.gov/newsevents/press/monetary/20090318a.htm). Policy changed to increase prices or reduce yields of mortgage-backed securities and Treasury securities with the objective of supporting housing markets and private credit markets by lowering costs of housing and long-term private credit.

(3) Portfolio Reinvestment. On Aug 10, 2010, the FOMC statement explains the reinvestment policy: “to help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in long-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature” (http://www.federalreserve.gov/newsevents/press/monetary/20100810a.htm). The objective of policy appears to be supporting conditions in housing and mortgage markets with slow transfer of the portfolio to Treasury securities that would support private-sector markets.

(4) Increasing Portfolio. As widely anticipated, the FOMC decided on Dec 3, 2010: “to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month” (http://www.federalreserve.gov/newsevents/press/monetary/20101103a.htm). The emphasis appears to shift from housing markets and private-sector credit markets to the general economy, employment and preventing deflation.

(5) Increasing Stock Market Valuations. Chairman Bernanke (2010WP) explained on Nov 4 the objectives of purchasing an additional $600 billion of long-term Treasury securities and reinvesting maturing principal and interest in the Fed portfolio. Long-term interest rates fell and stock prices rose when investors anticipated the new round of quantitative easing. Growth would be promoted by easier lending such as for refinancing of home mortgages and more investment by lower corporate bond yields. Consumers would experience higher confidence as their wealth in stocks rose, increasing outlays. Income and profits would rise and, in a “virtuous circle,” support higher economic growth. Bernanke (2000) analyzes the role of stock markets in central bank policy (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-100). Fed policy in 1929 increased interest rates to avert a gold outflow and failed to prevent the deepening of the banking crisis without which the Great Depression may not have occurred. In the crisis of Oct 19, 1987, Fed policy supported stock and futures markets by persuading banks to extend credit to brokerages. Collapse of stock markets would slow consumer spending.

(6) Devaluing the Dollar. Yellen (2011AS, 6) broadens the effects of quantitative easing by adding dollar devaluation: “there are several distinct channels through which these purchases tend to influence aggregate demand, including a reduced cost of credit to consumers and businesses, a rise in asset prices that boosts household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.”

(7) Let’s Twist Again Monetary Policy. The term “operation twist” grew out of the dance “twist” popularized by successful musical performer Chubby Chekker (http://www.youtube.com/watch?v=aWaJ0s0-E1o). Meulendyke (1998, 39) describes the coordination of policy by Treasury and the FOMC in the beginning of the Kennedy administration in 1961 (see Modigliani and Sutch 1966, 1967; http://cmpassocregulationblog.blogspot.com/2011/09/imf-view-of-world-economy-and-finance.html http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html):

“In 1961, several developments led the FOMC to abandon its “bills only” restrictions. The new Kennedy administration was concerned about gold outflows and balance of payments deficits and, at the same time, it wanted to encourage a rapid recovery from the recent recession. Higher rates seemed desirable to limit the gold outflows and help the balance of payments, while lower rates were wanted to speed up economic growth.

To deal with these problems simultaneously, the Treasury and the FOMC attempted to encourage lower long-term rates without pushing down short-term rates. The policy was referred to in internal Federal Reserve documents as “operation nudge” and elsewhere as “operation twist.” For a few months, the Treasury engaged in maturity exchanges with trust accounts and concentrated its cash offerings in shorter maturities.

The Federal Reserve participated with some reluctance and skepticism, but it did not see any great danger in experimenting with the new procedure.

It attempted to flatten the yield curve by purchasing Treasury notes and bonds while selling short-term Treasury securities. The domestic portfolio grew by $1.7 billion over the course of 1961. Note and bond holdings increased by a substantial $8.8 billion, while certificate of indebtedness holdings fell by almost $7.4 billion (Table 2). The extent to which these actions changed the yield curve or modified investment decisions is a source of dispute, although the predominant view is that the impact on yields was minimal. The Federal Reserve continued to buy coupon issues thereafter, but its efforts were not very aggressive. Reference to the efforts disappeared once short-term rates rose in 1963. The Treasury did not press for continued Fed purchases of long-term debt. Indeed, in the second half of the decade, the Treasury faced an unwanted shortening of its portfolio. Bonds could not carry a coupon with a rate above 4 1/4 percent, and market rates persistently exceeded that level. Notes—which were not subject to interest rate restrictions—had a maximum maturity of five years; it was extended to seven years in 1967.”

As widely anticipated by markets, perhaps intentionally, the Federal Open Market Committee (FOMC) decided at its meeting on Sep 21 that it was again “twisting time” (http://www.federalreserve.gov/newsevents/press/monetary/20110921a.htm):

“Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. 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 some pickup in the pace of recovery over coming quarters but 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 extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.

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 discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate.”

The FOMC decided at its meeting on Jun 20, 2012, to continue “Let’s Twist Again” monetary policy until the end of 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120620a.htm http://www.newyorkfed.org/markets/opolicy/operating_policy_120620.html):

“The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

IIA3 Evidence. There are multiple empirical studies on the effectiveness of quantitative easing that have been covered in past posts such as (Andrés et al. 2004, D’Amico and King 2010, Doh 2010, Gagnon et al. 2010, Hamilton and Wu 2010). On the basis of simulations of quantitative easing with the FRB/US econometric model, Chung et al (2011, 28-9) find that:

”Lower long-term interest rates, coupled with higher stock market valuations and a lower foreign exchange value of the dollar, provide a considerable stimulus to real activity over time. Phase 1 of the program by itself is estimated to boost the level of real GDP almost 2 percent above baseline by early 2012, while the full program raises the level of real GDP almost 3 percent by the second half of 2012. This boost to real output in turn helps to keep labor market conditions noticeably better than they would have been without large scale asset purchases. In particular, the model simulations suggest that private payroll employment is currently 1.8 million higher, and the unemployment rate ¾ percentage point lower, that would otherwise be the case. These benefits are predicted to grow further over time; by 2012, the incremental contribution of the full program is estimated to be 3 million jobs, with an additional 700,000 jobs provided by the most recent phase of the program alone.”

An additional conclusion of these simulations is that quantitative easing may have prevented actual deflation. Empirical research is continuing.

IIA4 Unwinding Strategy. Fed Vice-Chair Yellen (2011AS) considers four concerns on quantitative easing discussed below in turn. First, Excessive Inflation. Yellen (2011AS, 9-12) considers concerns that quantitative easing could result in excessive inflation because fast increases in aggregate demand from quantitative easing could raise the rate of inflation, posing another problem of adjustment with tighter monetary policy or higher interest rates. The Fed estimates significant slack of resources in the economy as measured by the difference of four percentage points between the high current rate of unemployment above 9 percent and the NAIRU (non-accelerating rate of unemployment) of 5.75 percent (Ibid, 2). Thus, faster economic growth resulting from quantitative easing would not likely result in upward trend of costs as resources are bid up competitively. The Fed monitors frequently slack indicators and is committed to maintaining inflation at a “level of 2 percent or a bit less than that” (Ibid, 13), say, in the narrow open interval (1.9, 2.1).

Second, Inflation and Bank Reserves. On Jan 12, 2012, the line “Reserve Bank credit” in the Fed balance sheet stood at $2450.6 billion, or $2.5 trillion, with the portfolio of long-term securities of $2175.7 billion, or $2.2 trillion, composed of $987.6 billion of notes and bonds, $49.7 billion of inflation-adjusted notes and bonds, $146.3 billion of Federal agency debt securities, and $992.1 billion of mortgage-backed securities; reserves balances with Federal Reserve Banks stood at $1095.5 billion, or $1.1 trillion (http://federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The concern addressed by Yellen (2011AS, 12-4) is that this high level of reserves could eventually result in demand growth that could accelerate inflation. Reserves would be excessively high relative to the levels before the recession. Reserves of depository institutions at the Federal Reserve Banks rose from $45.6 billion in Aug 2008 to $1084.8 billion in Aug 2010, not seasonally adjusted, multiplying by 23.8 times, or to $1038.2 billion in Nov 2010, multiplying by 22.8 times. The monetary base consists of the monetary liabilities of the government, composed largely of currency held by the public plus reserves of depository institutions at the Federal Reserve Banks. The monetary base not seasonally adjusted, or issue of money by the government, rose from $841.1 billion in Aug 2008 to $1991.1 billion or by 136.7 percent and to $1968.1 billion in Nov 2010 or by 133.9 percent (http://federalreserve.gov/releases/h3/hist/h3hist1.pdf). Policy can be viewed as creating government monetary liabilities that ended mostly in reserves of banks deposited at the Fed to purchase $2.1 trillion of long-term securities or assets, which in nontechnical language would be “printing money” (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html). The marketable debt of the US government in Treasury securities held by the public stood at $8.7 trillion on Nov 30, 2010 (http://www.treasurydirect.gov/govt/reports/pd/mspd/2010/opds112010.pdf). The current holdings of long-term securities by the Fed of $2.1 trillion, in the process of converting fully into Treasury securities, are equivalent to 24 percent of US government debt held by the public, and would represent 29.9 percent with the new round of quantitative easing if all the portfolio of the Fed, as intended, were in Treasury securities. Debt in Treasury securities held by the public on Dec 31, 2009, stood at $7.2 trillion (http://www.treasurydirect.gov/govt/reports/pd/mspd/2009/opds122009.pdf), growing on Nov 30, 2010, to $1.5 trillion or by 20.8 percent. In spite of this growth of bank reserves, “the 12-month change in core PCE [personal consumption expenditures] prices dropped from about 2 ½ percent in mid-2008 to around 1 ½ percent in 2009 and declined further to less than 1 percent by late 2010” (Yellen 2011AS, 3). The PCE price index, excluding food and energy, is around 0.8 percent in the past 12 months, which could be, in the Fed’s view, too close for comfort to negative inflation or deflation. Yellen (2011AS, 12) agrees “that an accommodative monetary policy left in place too long can cause inflation to rise to undesirable levels” that would be true whether policy was constrained or not by “the zero bound on interest rates.” The FOMC is monitoring and reviewing the “asset purchase program regularly in light of incoming information” and will “adjust the program as needed to meet its objectives” (Ibid, 12). That is, the FOMC would withdraw the stimulus once the economy is closer to full capacity to maintain inflation around 2 percent. In testimony at the Senate Committee on the Budget, Chairman Bernanke stated that “the Federal Reserve has all the tools its needs to ensure that it will be able to smoothly and effectively exit from this program at the appropriate time” (http://federalreserve.gov/newsevents/testimony/bernanke20110107a.htm). The large quantity of reserves would not be an obstacle in attaining the 2 percent inflation level. Yellen (2011A, 13-4) enumerates Fed tools that would be deployed to withdraw reserves as desired: (1) increasing the interest rate paid on reserves deposited at the Fed currently at 0.25 percent per year; (2) withdrawing reserves with reverse sale and repurchase agreement in addition to those with primary dealers by using mortgage-backed securities; (3) offering a Term Deposit Facility similar to term certificates of deposit for member institutions; and (4) sale or redemption of all or parts of the portfolio of long-term securities. The Fed would be able to increase interest rates and withdraw reserves as required to attain its mandates of maximum employment and price stability.

Third, Financial Imbalances. Fed policy intends to lower costs to business and households with the objective of stimulating investment and consumption generating higher growth and employment. Yellen (2011A, 14-7) considers a possible consequence of excessively reducing interest rates: “a reasonable fear is that this process could go too far, encouraging potential borrowers to employ excessive leverage to take advantage of low financing costs and leading investors to accept less compensation for bearing risks as they seek to enhance their rates of return in an environment of very low yields. This concern deserves to be taken seriously, and the Federal Reserve is carefully monitoring financial indicators for signs of potential threats to financial stability.” Regulation and supervision would be the “first line of defense” against imbalances threatening financial stability but the Fed would also use monetary policy to check imbalances (Yellen 2011AS, 17).

Fourth, Adverse Effects on Foreign Economies. The issue is whether the now recognized dollar devaluation would promote higher growth and employment in the US at the expense of lower growth and employment in other countries.

IIB United States Inflation. Monetary policy pursues symmetric inflation targets of maintaining core inflation of the index of personal consumption expenditures (core PCE) in an open interval of 2.00 percent. If inflation increases above 2.00 percent, the central bank could use restrictive monetary policy such as increases in interest rates to contain inflation in a tight range or interval around 2.00 percent. If inflation falls below 2 percent, the central bank could use restrictive monetary policy such as lowering interest rates to prevent inflation from falling too much below 2.00 percent. Currently, with about thirty million unemployed and underemployed (http://cmpassocregulationblog.blogspot.com/2012/11/twenty-eight-million-unemployed-or.html ) and depressed hiring (http://cmpassocregulationblog.blogspot.com/2012/11/recovery-without-hiring-united-states.html), there may even be a policy bias to raise or at least ignore inflation, even with falling real wages, maintaining accommodation as a form of promoting full employment. There are two arguments in favor of symmetric inflation targets preventing inflation from falling to very low levels.

1. Room for interest rate policy. Nominal interest rates hardly ever fall below zero. In economic jargon, the floor of zero nominal interest rates is referred to as “the zero bound.” Symmetric targets are proposed to maintain a sufficiently high inflation rate such that interest rates can be lowered to promote economic activity when recession threatens. With inflation close to zero there is no room for lowering interest rates with policy tools.

2. Fear of Deflation. Inflation is a process of sustained increases in prices. Deflation is a process of sustained decreases in prices. The probability of deflation increases as inflation approximates zero. The influence of fear of deflation in monetary policy is discussed in Pelaez and Pelaez (International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-95).

IIB United States Inflation. Subsection IIC Long-term US Inflation evaluates long-term inflation in the US, concluding that there has not been deflation risk since World War II. Subsection IID Current US Inflation finds no evidence in current inflation justifying fear of deflation.

IIC Long-term US Inflation. Key percentage average yearly rates of the US economy on growth and inflation are provided in Table II-1 updated with release of new data. The choice of dates prevents the measurement of long-term potential economic growth because of two recessions from IQ2001 (Mar) to IVQ2001 (Nov) with decline of GDP of 0.4 percent and the drop in GDP of 4.7 percent in the recession from IVQ2007 (Dec) to IIQ2009 (June) (http://www.nber.org/cycles.html) followed with unusually low economic growth for an expansion phase after recession (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). Calculations show that actual US GDP growth is around 1.7 percent per year that will perpetuate unemployment/underemployment (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). This rate of 1.7 percent is well below trend growth of 3 percent per year from 1870 to 2010, which has been always recovered after events such as wars and recessions (Lucas 2011May). Weakness of growth is shown by the exceptional one-time contributions to growth from items that are not aggregate demand, 2.53 percentage points contributed by inventory change to growth of 4.1 percent in IVQ2011 and 0.64 percentage points contributed by expenditures in national defense together with 0.73 points of inventory accumulation to growth of 3.1 percent in IIIQ2012. Deducting inventory accumulation and one-time national defense expenditures adjusts IIIQ2012 growth to annual 1.73 percent. Cumulative growth of 2.0 percent in IQ2012, 1.3 percent in IIQ2012 and adjusted 1.73 percent in IIIQ2012 annualizes to 1.5 percent in the first three quarters of 2012 {([(1.02)^1/4(1.013)^1/4(1.0173^1/4]^4/3 -1)100 = 1.7%}. Between 2000 and 2011, real GDP grew at the average rate of 1.6 percent per year, nominal GDP at 3.9 percent and the implicit deflator at 2.3 percent. Between 2000 and 2012, the average rate of CPI inflation was 2.3 percent per year and 2.0 percent excluding food and energy. PPI inflation increased at 2.8 percent per year on average from 2000 to 2012 and at 1.7 percent excluding food and energy. Producer price inflation of finished energy goods increased at average 5.4 percent between 2000 and 2012. There is also inflation in international trade. Import prices increased at 2.8 percent per year between 2000 and 2012. The commodity price shock is revealed by inflation of import prices of petroleum increasing at 13.5 percent per year between 2000 and 2011 and at 11.6 percent between 2000 and 2012. The average percentage rates of increase of import prices excluding fuels are much lower at 1.9 percent for 2001 to 2011 and 1.7 percent for 2001 to 2012. Export prices rose at the average rate of 2.6 percent between 2000 and 2011 and at 2.4 percent from 2000 to 2012. What spared the US of sharper decade-long deterioration of the terms of trade, (export prices)/(import prices), was its diversification and competitiveness in agriculture. Agricultural export prices grew at the average yearly rate of 6.3 percent from 2000 to 2011 and at 6.9 percent from 2000 to 2012. US nonagricultural export prices rose at 2.2 percent per year from 2000 to 2011 and at 2.0 percent from 2000 to 2012. The share of petroleum imports in US trade far exceeds that of agricultural exports. Unconventional monetary policy inducing carry trades in commodities has deteriorated US terms of trade, prices of exports relative to prices of imports, tending to restrict growth of US aggregate real income. These dynamic inflation rates are not similar to those for the economy of Japan where inflation was negative in seven of the 10 years in the 2000s.

II-1, US, Average Growth Rates of Real and Nominal GDP, Consumer Price Index, Producer Price Index and Import and Export Prices, Percent per Year

Real GDP	2000-2011: 1.6%
Nominal GDP	2000-2011: 3.9%
Implicit Price Deflator	2000-2011: 2.3%
CPI	2000-2011: 2.4% 2000-2012: 2.3%
CPI ex Food and Energy	2000-2011: 2.0% 2000-2012: 2.0%
PPI	2000-2011: 2.9% 2000-2012: 2.8%
PPI ex Food and Energy	2000-2011: 1.7% 2000-2012: 1.7%
PPI Finished Energy Goods	2000-2011: 6.1% 2000-2012: 5.4%
Import Prices	2000-2011: 3.2% 2000-2012: 2.8%
Import Prices of Petroleum and Petroleum Products	2000-2011: 13.5% 2000-2012: 11.6%
Import Prices Excluding Petroleum	2000-2011: 1.3% 2000-2012: 1.2%
Import Prices Excluding Fuels	2001-2011: 1.9% 2001-2012: 1.7%
Export Prices	2000-2011: 2.6% 2000-2012: 2.4%
Agricultural Export Prices	2000-2011: 6.3% 2000-2012: 6.9%
Nonagricultural Export Prices	2000-2011: 2.2% 2000-2012: 2.0%

Note: rates for price indexes in the row beginning with “CPI” and ending in the row “Nonagricultural Export Prices” are for Dec 2000 to Dec 2011 and for Dec 2000 to Dec 2012 using not seasonally adjusted indexes. Import prices excluding fuels are not available before Dec 2001.

Sources:

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

Unconventional monetary policy of zero interest rates and large-scale purchases of long-term securities for the balance sheet of the central bank is proposed to prevent deflation. The data of CPI inflation of all goods and CPI inflation excluding food and energy for the past six decades show only one negative change by 0.4 percent in the CPI all goods annual index in 2009 but not one year of negative annual yearly change in the CPI excluding food and energy measuring annual inflation (http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html). Zero interest rates and quantitative easing are designed to lower costs of borrowing for investment and consumption, increase stock market valuations and devalue the dollar. In practice, the carry trade is from zero interest rates to a large variety of risk financial assets including commodities. Resulting commodity price inflation squeezes family budgets and deteriorates the terms of trade with negative effects on aggregate demand and employment. Excessive valuations of risk financial assets eventually result in crashes of financial markets with possible adverse effects on economic activity and employment.

Producer price inflation history in the past five decades does not provide evidence of deflation. The finished core PPI does not register even one single year of decline. The headline PPI experienced only six isolated cases of decline (http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html):

-0.3 percent in 1963,

-1.4 percent in 1986,

-0.8 percent in 1986,

-0.8 percent in 1998,

-1.3 percent in 2001

-2.6 percent in 2009.

Chart II-1 provides US nominal GDP from 1929 to 2011. The chart disguises the decline of nominal GDP during the 1930s from $103.6 billion in 1929 to $56.4 billion in 1933 or by 45.6 percent (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). The level of nominal GDP reached $101.4 billion in 1940 and exceeded the $103.6 billion only with $126.7 billion in 1941. The only major visible bump in the chart occurred in the recession of IVQ2007 to IIQ2009 with revised cumulative decline of real GDP of 4.7 percent. US nominal GDP fell from $14,291.5 billion in 2008 to $13,973.7 billion in 2009 or by 2.2 percent but rose to $14,498.9 billion in 2010 or by 3.8 percent and to $15,075.7 billion in 2011 for an additional 4.0 percent for cumulative increase of 7.9 percent relative to 2009. The comparison of the current business cycle with the Great Depression is misleading (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html). Tendency for deflation would be reflected in persistent bumps. In contrast, during the Great Depression in the four years of 1929 to 1933, GDP in constant dollars fell 26.6 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 (http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html).

Chart II-1, US, Nominal GDP 1929-2011

Source: US Bureau of Economic Analysis

Chart II-2 provides US real GDP from 1929 to 2011. The chart also disguises the Great Depression of the 1930s. In the four years of 1929 to 1933, GDP in constant dollars fell 26.6 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 from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). Persistent deflation threatening real economic activity would also be reflected in the series of long-term growth of real GDP. There is no such behavior in Chart II-2 except for periodic recessions in the US economy that have occurred throughout history.

Chart II-2, US, Real GDP 1929-2011

Source: US Bureau of Economic Analysis

Deflation would also be in evidence in long-term series of prices in the form of bumps. The GDP implicit deflator series in Chart II-3 from 1929 to 2011 shows sharp dynamic behavior over time. There is decline of the implicit price deflator of GDP by 25.8 percent from 1929 to 1933 (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). Wars are characterized by rapidly rising prices followed by declines when peace is restored. The US economy is not plagued by deflation but by long-run inflation.

Chart II-3, US, GDP Implicit Price Deflator 1929-2011

Source: US Bureau of Economic Analysis

Chart II-4 provides percent change from preceding quarter in prices of GDP at seasonally-adjusted annual rates (SAAR) from 1980 to 2012. There is one case of negative change by 0.8 percent in IIQ2009 that was adjustment from 3.1 percent in IIIQ2008 and 2.5 percent in both IQ2008 and IIQ2008 caused by carry trades from policy interest rates being moved to zero into commodity futures reversed by the fear of toxic assets in banks in the proposal of TARP in late 2008 (Cochrane and Zingales 2009). There has not been actual deflation or risk of deflation threatening depression in the US that would justify unconventional monetary policy.

Chart II-4, Percent Change from Preceding Period in Prices for GDP Seasonally Adjusted at Annual Rates 1980-2012

Source: US Bureau of Economic Analysis

Chart II-5 provides percent change from preceding year in prices of GDP from 1929 to 2011. There are four consecutive years of declines of prices of GDP during the Great Depression: 3.9 percent in 1930, 9.9 percent in 1931, 11.4 percent in 1932 and 2.6 percent in 1933. There were two consecutive declines of 1.9 percent in 1938 and 1.3 percent in 1939. Prices of GDP were unchanged in 1949 after increasing 11.5 percent in 1946, 11.1 percent in 1947 and 5.7 percent in 1948, which is similar to experience with wars in other countries. There are no other negative changes of annual prices of GDP in 72 years from 1939 to 2011.

Chart II-5, Percent Change from Preceding Year in Prices for Gross Domestic Product 1930-2011

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

The producer price index of the US from 1947 to 2012 in Chart II-6 shows various periods of more rapid or less rapid inflation but no bumps. The major event is the decline in 2008 when risk aversion because of the global recession caused the collapse of oil prices from $148/barrel to less than $80/barrel with most other commodity prices also collapsing. The event had nothing in common with explanations of deflation but rather with the concentration of risk exposures in commodities after the decline of stock market indexes. Eventually, there was a flight to government securities because of the fears of insolvency of banks caused by statements supporting proposals for withdrawal of toxic assets from bank balance sheets in the Troubled Asset Relief Program (TARP), as explained by Cochrane and Zingales (2009). The bump in 2008 with decline in 2009 is consistent with the view that zero interest rates with subdued risk aversion induce carry trades into commodity futures.

Chart II-6, US, Producer Price Index, Finished Goods, NSA, 1947-2012

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/

Chart II-7 provides 12-month percentage changes of the producer price index from 1948 to 2012. The distinguishing event in Chart II-7 is the Great Inflation of the 1970s. The shape of the two-hump Bactrian camel of the 1970s resembles the double hump from 2007 to 2012.

Chart II-7, US, Producer Price Index, Finished Goods, 12-Month Percentage Change, NSA, 1948-2012

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/

The producer price index excluding food and energy from 1973 to 2012, the first historical date of availability in the dataset of the Bureau of Labor Statistics (BLS), shows similarly dynamic behavior as the overall index, as shown in Chart II-8. There is no evidence of persistent deflation in the US PPI.

Chart II-8, US Producer Price Index, Finished Goods Excluding Food and Energy, NSA, 1973-2012

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/

Chart II-9 provides 12-month percentage rates of change of the finished goods index excluding food and energy. The dominating characteristic is the Great Inflation of the 1970s. The double hump illustrates how inflation may appear to be subdued and then returns with strength.

Chart II-9, US Producer Price Index, Finished Goods Excluding Food and Energy, 12-Month Percentage Change, NSA, 1974-2012

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/

The producer price index of energy goods from 1974 to 2012 is provided in Chart II-10. The first jump occurred during the Great Inflation of the 1970s analyzed in various comments of this blog (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html) and in Appendix I. There is relative stability of producer prices after 1986 with another jump and decline in the late 1990s into the early 2000s. The episode of commodity price increases during a global recession in 2008 could only have occurred with interest rates dropping toward zero, which stimulated the carry trade from zero interest rates to leveraged positions in commodity futures. Commodity futures exposures were dropped in the flight to government securities after Sep 2008. Commodity future exposures were created again when risk aversion diminished around Mar 2011 after the finding that US bank balance sheets did not have the toxic assets that were mentioned in proposing TARP in Congress (see Cochrane and Zingales 2009). Fluctuations in commodity prices and other risk financial assets originate in carry trade when risk aversion ameliorates.

Chart II-10, US, Producer Price Index, Finished Energy Goods, NSA, 1974-2012

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/

Chart II-11 shows 12-month percentage changes of the producer price index of finished energy goods from 1975 to 2012. This index is only available after 1974 and captures only one of the humps of energy prices during the Great Inflation. Fluctuations in energy prices have occurred throughout history in the US but without provoking deflation. Two cases are the decline of oil prices in 2001 to 2002 that has been analyzed by Barsky and Kilian (2004) and the collapse of oil prices from over $140/barrel with shock of risk aversion to the carry trade in Sep 2008.

Chart II-11, US, Producer Price Index, Finished Energy Goods, 12-Month Percentage Change, NSA, 1974-2012

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/

Chart II-12 provides the consumer price index NSA from 1913 to 2012. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.

Chart II-12, US, Consumer Price Index, NSA, 1913-2012

Source: US Bureau of Labor Statistics

Chart II-13 provides 12-month percentage changes of the consumer price index from 1914 to 2012. The only episode of deflation after 1950 is in 2009, which is explained by the reversal of speculative commodity futures carry trades that were induced by interest rates driven to zero in a shock of monetary policy in 2008. The only persistent case of deflation is from 1930 to 1933, which has little if any relevance to the contemporary United States economy. There are actually three waves of inflation in the second half of the 1960s, in the mid 1970s and again in the late 1970s. Inflation rates then stabilized in a range with only two episodes above 5 percent.

Chart II-13, US, Consumer Price Index, All Items, 12- Month Percentage Change 1914-2012

Source: US Bureau of Labor Statistics

Table II-2 provides annual percentage changes of United States consumer price inflation from 1914 to 2012. There have been only cases of annual declines of the CPI after wars: (1) World War I minus 10.5 percent in 1921 and minus 6.1 percent in 1922 following cumulative increases of 83.5 percent in four years from 1917 to 1920 at the average of 16.4 percent per year; (2) World War II: minus 1.2 percent in 1949 following cumulative 33.9 percent in three years from 1946 to 1948 at average 10.2 percent per year (3) minus 0.4 percent in 1955 two years after the end of the Korean War; and (4) minus 0.4 percent in 2009. The decline of 0.4 percent in 2009 followed increase of 3.8 percent in 2008 and is explained by the reversal of speculative carry trades into commodity futures that were created in 2008 as monetary policy rates were driven to zero. The reversal occurred after misleading statement on toxic assets in banks in the proposal for TARP (Cochrane and Zingales 2009). There were declines of 1.7 percent in both 1927 and 1928 during the episode of revival of rules of the gold standard. The only persistent deflationary period since 1914 was during the Great Depression in the years from 1930 to 1933 and again in 1938-1939. Fear of deflation on the basis of that experience does not justify unconventional monetary policy of zero interest rates that has failed to stop deflation in Japan. Financial repression causes far more adverse effects on allocation of resources by distorting the calculus of risk/returns than alleged employment-creating effects or there would not be current recovery without jobs and hiring after zero interest rates since Dec 2008 and intended now forever in a self-imposed forecast growth and employment mandate of monetary policy.

Table II-2, US, Annual CPI Inflation ∆% 1914-2012

Year	Annual
1914	1.0
1915	1.0
1916	7.9
1917	17.4
1918	18.0
1919	14.6
1920	15.6
1921	-10.5
1922	-6.1
1923	1.8
1924	0.0
1925	2.3
1926	1.1
1927	-1.7
1928	-1.7
1929	0.0
1930	-2.3
1931	-9.0
1932	-9.9
1933	-5.1
1934	3.1
1935	2.2
1936	1.5
1937	3.6
1938	-2.1
1939	-1.4
1940	0.7
1941	5.0
1942	10.9
1943	6.1
1944	1.7
1945	2.3
1946	8.3
1947	14.4
1948	8.1
1949	-1.2
1950	1.3
1951	7.9
1952	1.9
1953	0.8
1954	0.7
1955	-0.4
1956	1.5
1957	3.3
1958	2.8
1959	0.7
1960	1.7
1961	1.0
1962	1.0
1963	1.3
1964	1.3
1965	1.6
1966	2.9
1967	3.1
1968	4.2
1969	5.5
1970	5.7
1971	4.4
1972	3.2
1973	6.2
1974	11.0
1975	9.1
1976	5.8
1977	6.5
1978	7.6
1979	11.3
1980	13.5
1981	10.3
1982	6.2
1983	3.2
1984	4.3
1985	3.6
1986	1.9
1987	3.6
1988	4.1
1989	4.8
1990	5.4
1991	4.2
1992	3.0
1993	3.0
1994	2.6
1995	2.8
1996	3.0
1997	2.3
1998	1.6
1999	2.2
2000	3.4
2001	2.8
2002	1.6
2003	2.3
2004	2.7
2005	3.4
2006	3.2
2007	2.8
2008	3.8
2009	-0.4
2010	1.6
2011	3.2
2012	2.1

Source: US Bureau of Labor Statistics

Chart II-14 provides the consumer price index excluding food and energy from 1960 to 2012. There is long-term inflation in the US without episodes of deflation.

Chart II-14, US, Consumer Price Index Excluding Food and Energy, NSA, 1957-2012

Source: US Bureau of Labor Statistics

Chart II-15 provides 12-month percentage changes of the consumer price index excluding food and energy from 1960 to 2012. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.

Chart II-15, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 1958-2012

Source: US Bureau of Labor Statistics

The consumer price index of housing is provided in Chart II-16. There was also acceleration during the Great Inflation of the 1970s. The index flattens after the global recession in IVQ2007 to IIQ2009. Housing prices collapsed under the weight of construction of several times more housing than needed. Surplus housing originated in subsidies and artificially low interest rates in the shock of unconventional monetary policy in 2003 to 2004 in fear of deflation.

Chart II-16, US, Consumer Price Index Housing, NSA, 1967-2012

Source: US Bureau of Labor Statistics

Chart II-17 provides 12-month percentage changes of the housing CPI. The Great Inflation also had extremely high rates of housing inflation. Housing is considered as potential hedge of inflation.

Chart II-17, US, Consumer Price Index, Housing, 12- Month Percentage Change, NSA, 1968-2012

Source: US Bureau of Labor Statistics

IID Current US Inflation. Consumer price inflation has fluctuated in recent months. Table II-3 provides 12-month consumer price inflation in Dec and annual equivalent percentage changes for the months of Oct-Dec 2012 of the CPI and major segments. The final column provides inflation from Nov 2012 to Dec 2012. CPI inflation in the 12 months ending in Dec reached 1.7 percent, the annual equivalent rate Aug to Oct was minus 0.8 percent in the new episode of risk aversion in commodities and the monthly inflation rate of 0.0 percent annualizes at 0.0 percent. These inflation rates fluctuate in accordance with inducement of risk appetite or frustration by risk aversion of carry trades from zero interest rates to commodity futures. At the margin, the decline in commodity prices in sharp current risk aversion in financial markets caused lower inflation worldwide (with return in some countries in Dec 2012) that is followed by a jump in Aug-Sep 2012 because of the relaxed risk aversion resulting from the bond-buying program of the European Central Bank or Outright Monetary Transactions (OMT) (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). With zero interest rates, commodity prices would increase again in an environment of risk appetite. Excluding food and energy, CPI inflation was 1.9 percent in the 12 months ending in Nov 2012 and 1.6 percent in annual equivalent in Sep-Nov 2012. There is no deflation in the US economy that could justify further quantitative easing, which is now open-ended or forever with zero interest rates and bond-buying by the central bank, or QE∞, even if the economy grows back to potential. Financial repression of zero interest rates is now intended as a permanent distortion of resource allocation by clouding risk/return decisions, preventing the economy from expanding along its optimal growth path. Consumer food prices in the US have risen 1.8 percent in 12 months ending in Dec 2012 and at 2.4 percent in annual equivalent in Oct-Dec 2012. Monetary policies stimulating carry trades of commodities futures that increase prices of food constitute a highly regressive tax on lower income families for whom food is a major portion of the consumption basket especially with wage increases below inflation in a recovery without hiring (Section I) and without jobs (http://cmpassocregulationblog.blogspot.com/2012/12/twenty-eight-million-unemployed-or.html). Energy consumer prices increased 0.5 percent in 12 months, decreased 20.1 percent in annual equivalent in Oct-Dec and decreased 1.2 percent in Dec or at minus 13.5 percent in annual equivalent as carry trades from zero interest rates to commodity futures are unwound and repositioned during alternating risk aversion and risk appetite originating in the European debt crisis and increasingly in growth and politics in China. For lower income families, food and energy are a major part of the family budget. Inflation is not persistently low or threatening deflation in annual equivalent in Oct-Dec in any of the categories in Table II-2 but simply reflecting waves of inflation originating in carry trades. An upward trend is determined by carry trades from zero interest rates to commodity futures positions with episodes of risk aversion causing fluctuations.

Table II-3, US, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%

	% RI	∆% 12 Months Dec 2012/Dec 2011 NSA	∆% Annual Equivalent Oct to Dec 2012 SA	∆% Dec 2012/Nov 2012 SA
CPI All Items	100.000	1.7	-0.8	0.0
CPI ex Food and Energy	75.998	1.9	1.6	0.1
Food	14.243	1.8	2.4	0.2
Food at Home	8.553	1.3	3.3	0.2
Food Away from Home	5.690	2.5	1.2	0.1
Energy	9.759	0.5	-20.1	-1.2
Gasoline	5.490	1.7	-34.6	-2.3
Electricity	2.842	-0.5	5.7	0.2
Commodities less Food and Energy	19.668	0.3	-1.6	-0.2
New Vehicles	3.171	1.6	0.4	0.0
Used Cars and Trucks	1.847	-2.0	-7.0	-0.4
Medical Care Commodities	1.718	1.7	-3.5	-0.5
Apparel	3.665	1.8	0.0	-0.1
Services Less Energy Services	56.330	2.5	2.8	0.2
Shelter	31.559	2.2	2.4	0.1
Rent of Primary Residence	6.509	2.7	3.3	0.2
Owner’s Equivalent Rent of Residences	23.942	2.1	2.0	0.1
Transportation Services	5.812	2.6	5.7	0.5
Medical Care Services	5.426	3.7	2.4	0.3

% RI: Percent Relative Importance Oct 2012

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/

The weights of the CPI, US city average for all urban consumers representing about 87 percent of the US population (http://www.bls.gov/cpi/cpiovrvw.htm#item1), are shown in Table II-4 with the BLS update of Mar 7, 2012 (http://www.bls.gov/cpi/cpiri2011.pdf). Housing has a weight of 41.020 percent. The combined weight of housing and transportation is 57.895 percent or more than one half of consumer expenditures of all urban consumers. The combined weight of housing, transportation and food and beverages is 73.151 percent of the US CPI. Table II-3 provides relative importance of key items in Dec 2012.

Table II-4, US, Relative Importance, 2009-2010 Weights, of Components in the Consumer Price Index, US City Average, Dec 2011

All Items	100.000
Food and Beverages	15.256
Food	14.308
Food at home	8.638
Food away from home	5.669
Housing	41.020
Shelter	31.539
Rent of primary residence	6.485
Owners’ equivalent rent	23.957
Apparel	3.562
Transportation	16.875
Private Transportation	15.694
New vehicles	3.195
Used cars and trucks	1.913
Motor fuel	5.463
Gasoline	5.273
Medical Care	7.061
Medical care commodities	1.716
Medical care services	5.345
Recreation	6.044
Education and Communication	6.797
Other Goods and Services	3.385

Note: reissued Mar 7, 2012. Refers to all urban consumers, covering approximately 87 percent of the US population (see http://www.bls.gov/cpi/cpiovrvw.htm#item1). Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/cpiri2011.pdf http://www.bls.gov/cpi/cpiriar.htm

Chart II-18 provides the US consumer price index for housing from 2001 to 2012. Housing prices rose sharply during the decade until the bump of the global recession and increased again in 2011 with some stabilization currently. The CPI excluding housing would likely show much higher inflation. Income remaining after paying for indispensable shelter has been compressed by the commodity carry trades resulting from unconventional monetary policy.

Chart II-18, US, Consumer Price Index, Housing, NSA, 2001-2012

Source: US Bureau of Labor Statistics

Chart II-19 provides 12-month percentage changes of the housing CPI. Percentage changes collapsed during the global recession but have been rising into positive territory in 2011 and 2012 but with the rate declining recently.

Chart II-19, US, Consumer Price Index, Housing, 12-Month Percentage Change, NSA, 2001-2012

Source: US Bureau of Labor Statistics

There have been waves of consumer price inflation in the US in 2011 and into 2012 (Section IIA and earlier at http://cmpassocregulationblog.blogspot.com/2012/12/recovery-without-hiring-forecast-growth.html) that are illustrated in Table II-5. The first wave occurred in Jan-Apr 2011 and was caused by the carry trade of commodity prices induced by unconventional monetary policy of zero interest rates. Cheap money at zero opportunity cost in environment of risk appetite was channeled into financial risk assets, causing increases in commodity prices. The annual equivalent rate of increase of the all-items CPI in Jan-Apr 2011 was 4.9 percent and the CPI excluding food and energy increased at annual equivalent rate of 2.4 percent. The second wave occurred during the collapse of the carry trade from zero interest rates to exposures in commodity futures as a result of risk aversion in financial markets created by the sovereign debt crisis in Europe. The annual equivalent rate of increase of the all-items CPI dropped to 2.4 percent in May-Jul 2011 while the annual equivalent rate of the CPI excluding food and energy increased at 3.0 percent. In the third wave in Jul-Sep 2011, annual equivalent CPI inflation rose to 3.7 percent while the core CPI increased at 2.0 percent. The fourth wave occurred in the form of decrease of the CPI all-items annual equivalent rate to 0.6 percent in Oct-Nov 2011 with the annual equivalent rate of the CPI excluding food and energy remaining at 2.4 percent. The fifth wave occurred in Dec 2011 to Jan 2012 with annual equivalent headline inflation of 1.2 percent and core inflation of 1.8 percent. In the sixth wave, headline CPI inflation increased at annual equivalent 4.3 percent in Feb-Mar 2012 and core CPI inflation at 1.8 percent but including Apr, the annual equivalent inflation of the headline CPI was 2.8 percent in Feb-Apr and 2.0 percent for the core CPI. The seventh wave in May-Jul occurred with annual equivalent inflation of minus 1.2 percent for the headline CPI in May-Jul 2012 and 2.0 percent for the core CPI. The eighth wave is with annual equivalent inflation of 7.4 percent in Aug-Sep 2012 but 5.3 percent including Oct. In the ninth wave, annual equivalent inflation in Nov 2012 was minus 3.5 percent under the new shock of risk aversion and 0.0 percent in Dec 2012 with annual equivalent of minus 1.8 percent in Nov-Dec 2012. The conclusion is that inflation accelerates and decelerates in unpredictable fashion that turns symmetric inflation targets in a source of destabilizing shocks to the financial system and eventually the overall economy. Unconventional monetary policy of zero interest rates and withdrawal of bonds to lower long-term interest rates distorts risk/return decisions required for efficient allocation of resources and attaining optimal growth paths and prosperity.

Table II-5, US, Headline and Core CPI Inflation Monthly SA and 12 Months NSA ∆%

	All Items SA Month	All Items NSA 12 month	Core SA Month	Core NSA 12 months
Dec 2012	0.0	1.7	0.1	2.2
Nov	-0.3	1.8	0.1	1.9
AE ∆% Nov-Dec	-1.8		1.2
Oct	0.1	2.2	0.2	2.0
Sep	0.6	2.0	0.1	2.0
Aug	0.6	1.7	0.1	1.9
AE ∆% Aug-Oct	5.3		1.6
Jul	0.0	1.4	0.1	2.1
Jun	0.0	1.7	0.2	2.2
May	-0.3	1.7	0.2	2.3
AE ∆% May-Jul	-1.2		2.0
Apr	0.0	2.3	0.2	2.3
Mar	0.3	2.7	0.2	2.3
Feb	0.4	2.9	0.1	2.2
AE ∆% Feb-Apr	2.8		2.0
Jan	0.2	2.9	0.2	2.3
Dec 2011	0.0	3.0	0.1	2.2
AE ∆% Dec-Jan	1.2		1.8
Nov	0.1	3.4	0.2	2.2
Oct	0.0	3.5	0.2	2.1
AE ∆% Oct-Nov	0.6		2.4
Sep	0.3	3.9	0.1	2.0
Aug	0.3	3.8	0.2	2.0
Jul	0.3	3.6	0.2	1.8
AE ∆% Jul-Sep	3.7		2.0
Jun	0.1	3.6	0.2	1.6
May	0.3	3.6	0.3	1.5
AE ∆% May-Jun	2.4		3.0
Apr	0.4	3.2	0.2	1.3
Mar	0.5	2.7	0.2	1.2
Feb	0.4	2.1	0.2	1.1
Jan	0.3	1.6	0.2	1.0
AE ∆% Jan-Apr	4.9		2.4
Dec 2010	0.4	1.5	0.1	0.8
Nov	0.2	1.1	0.1	0.8
Oct	0.3	1.2	0.0	0.6
Sep	0.1	1.1	0.0	0.8
Aug	0.2	1.1	0.1	0.9
Jul	0.2	1.2	0.1	0.9
Jun	0.0	1.1	0.1	0.9
May	-0.1	2.0	0.1	0.9
Apr	0.0	2.2	0.0	0.9
Mar	0.0	2.3	0.1	1.1
Feb	0.0	2.1	0.1	1.3
Jan	0.1	2.6	-0.1	1.6

Note: Core: excluding food and energy; AE: annual equivalent

Source: Bureau of Labor Satistics http://www.bls.gov/cpi/

The behavior of the US consumer price index NSA from 2001 to 2011 is provided in Chart II-20. Inflation in the US is very dynamic without deflation risks that would justify symmetric inflation targets. The hump in 2008 originated in the carry trade from interest rates dropping to zero into commodity futures. There is no other explanation for the increase of the Cushing OK Crude Oil Future Contract 1 from $55.64/barrel on Jan 9, 2007 to $145.29/barrel on July 3, 2008 during deep global recession, collapsing under a panic of flight into government obligations and the US dollar to $37.51/barrel on Feb 13, 2009 and then rising by carry trades to $113.93/barrel on Apr 29, 2012, collapsing again and then recovering again to $105.23/barrel, all during mediocre economic recovery with peaks and troughs influenced by bouts of risk appetite and risk aversion (data from the US Energy Information Administration EIA, http://www.eia.gov/). The unwinding of the carry trade with the TARP announcement of toxic assets in banks channeled cheap money into government obligations (see Cochrane and Zingales 2009).

Chart II-20, US, Consumer Price Index, NSA, 2001-2012

Source: US Bureau of Labor Statistics

Chart II-21 provides 12-month percentage changes of the consumer price index from 2001 to 2012. There was no deflation or threat of deflation from 2008 into 2009. Commodity prices collapsed during the panic of toxic assets in banks. When stress tests in 2009 revealed US bank balance sheets in much stronger position, cheap money at zero opportunity cost exited government obligations and flowed into carry trades of risk financial assets. Increases in commodity prices drove again the all items CPI with interruptions during risk aversion originating in multiple fears but especially from the sovereign debt crisis of Europe.

Chart II-21, US, Consumer Price Index, 12-Month Percentage Change, NSA, 2001-2012

Source: US Bureau of Labor Statistics

The trend of increase of the consumer price index excluding food and industry in Chart II-22 does not reveal any threat of deflation that would justify symmetric inflation targets. There are mild oscillations in a neat upward trend.

Chart II-22, US, Consumer Price Index Excluding Food and Energy, NSA, 2001-2012

Source: US Bureau of Labor Statistics

Chart II-23 provides 12-month percentage change of the consumer price index excluding food and energy. Past-year rates of inflation fell toward 1 percent from 2001 into 2003 as a result of the recession and the decline of commodity prices beginning before the recession with declines of real oil prices. Near zero interest rates with fed funds at 1 percent between Jun 2003 and Jun 2004 stimulated carry trades of all types, including in buying homes with subprime mortgages in expectation that low interest rates forever would increase home prices permanently, creating the equity that would permit the conversion of subprime mortgages into creditworthy mortgages (Gorton 2009EFM; see http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Inflation rose and then collapsed during the unwinding of carry trades and the housing debacle of the global recession. Carry trades into 2011 and 2012 gave a new impulse to CPI inflation, all items and core. Symmetric inflation targets destabilize the economy by encouraging hunts for yields that inflate and deflate financial assets, obscuring risk/return decisions on production, investment, consumption and hiring.

Chart II-23, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2001-2012

Source: US Bureau of Labor Statistics

Headline and core producer price indexes are in Table II-6. The headline PPI SA decreased 0.2 percent in Dec 2012 and increased 1.3 percent NSA in the 12 months ending in Dec 2012. The core PPI SA increased 0.1 percent in Dec 2012 and rose 2.0 percent in 12 months. Analysis of annual equivalent rates of change shows inflation waves similar to those worldwide. In the first wave, the absence of risk aversion from the sovereign risk crisis in Europe motivated the carry trade from zero interest rates into commodity futures that caused the average equivalent rate of 9.7 percent in the headline PPI in Jan-Apr 2011 and 4.0 percent in the core PPI. In the second wave, commodity futures prices collapsed in May 2011 with the return of risk aversion originating in the sovereign risk crisis of Europe. The annual equivalent rate of headline PPI inflation collapsed to 1.2 percent in May-Jun 2011 but the core annual equivalent inflation rate was much higher at 3.0 percent. In the third wave, headline PPI inflation resuscitated with annual equivalent at 6.6 percent in Jul-Sep 2011 and core PPI inflation at 4.1 percent. Core PPI inflation was persistent throughout 2011, jumping from annual equivalent at 1.8 percent in the first four months of 2010 to 3.0 percent in 12 months ending in Dec 2011. Unconventional monetary policy is based on the proposition that core rates reflect more fundamental inflation and are thus better predictors of the future. In practice, the relation of core and headline inflation is as difficult to predict as future inflation (see IIID Supply Shocks in http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html). In the fourth wave, risk aversion originating in the lack of resolution of the European debt crisis caused unwinding of carry trades with annual equivalent headline PPI inflation of minus 1.2 percent in Oct-Nov 2011 and 0.6 percent in the core annual equivalent. In the fifth wave from Dec 2011 to Jan 2012, annual equivalent inflation was 1.2 percent for the headline index but 4.9 percent for the core index excluding food and energy. In the sixth wave, annual equivalent inflation in Feb-Mar 2012 was 1.2 percent for the headline PPI and 1.8 percent for the core. In the seventh wave, renewed risk aversion caused reversal of carry trade commodity exposures with annual equivalent headline inflation of minus 7.5 percent in Apr-May 2012 while core PPI inflation was at annual equivalent 1.2 percent. In the eighth wave, annual equivalent inflation returned at 3.0 percent in Jun-Jul 2012 and 4.9 percent for the core index. In the ninth wave, relaxed risk aversion because of the announcement of the impaired bond buying program or Outright Monetary Transactions (OMT) of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html) induced carry trades that drove annual equivalent inflation of producer prices of the United States at 18.2 percent in Aug-Sep 2012 and 0.6 percent in the core index. In the tenth wave, renewed risk aversion caused annual equivalent inflation of minus 4.7 percent in Oct-Nov in the headline index and 0.0 percent in the core index. It is almost impossible to forecast PPI inflation and its relation to CPI inflation. “Inflation surprise” by monetary policy could be proposed to climb along a downward sloping Phillips curve, resulting in higher inflation but lower unemployment (see Kydland and Prescott 1977, Barro and Gordon 1983 and past comments of this blog http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). The architects of monetary policy would require superior inflation forecasting ability compared to forecasting naivety by everybody else. In practice, we are all naïve in forecasting inflation and other economic variables and events.

Table II-6, US, Headline and Core PPI Inflation Monthly SA and 12-Month NSA ∆%

	Finished Goods SA Month	Finished Goods NSA 12 months	Finished Core SA Month	Finished Core NSA 12 months
Dec 2012	-0.2	1.3	0.1	2.0
Nov	-0.8	1.5	0.1	2.2
Oct	-0.2	2.3	-0.2	2.1
AE ∆% Oct-Dec	-4.7		0.0
Sep	1.2	2.1	0.0	2.3
Aug	1.6	1.9	0.1	2.6
AE ∆% Aug-Sep	18.2		0.6
Jul	0.3	0.5	0.6	2.6
Jun	0.2	0.7	0.2	2.6
AE ∆% Jun-Jul	3.0		4.9
May	-1.0	0.6	0.1	2.7
Apr	-0.3	1.8	0.1	2.7
AE ∆% Apr-May	-7.5		1.2
Mar	-0.2	2.8	0.2	2.9
Feb	0.4	3.4	0.1	3.1
AE ∆% Feb-Mar	1.2		1.8
Jan	0.3	4.1	0.6	3.1
Dec 2011	-0.1	4.7	0.2	3.0
AE ∆% Dec-Jan	1.2		4.9
Nov	0.1	5.6	0.1	3.0
Oct	-0.3	5.8	0.0	2.9
AE ∆% Oct-Nov	-1.2		0.6
Sep	0.9	7.0	0.3	2.8
Aug	0.2	6.6	0.2	2.7
Jul	0.5	7.1	0.5	2.7
AE ∆% Jul-Sep	6.6		4.1
Jun	0.1	6.9	0.3	2.3
May	0.1	7.1	0.2	2.1
AE ∆% May-Jun	1.2		3.0
Apr	0.7	6.6	0.3	2.3
Mar	0.5	5.6	0.3	2.0
Feb	1.1	5.4	0.2	1.8
Jan	0.8	3.6	0.5	1.6
AE ∆% Jan-Apr	9.7		4.0
Dec 2010	0.9	3.8	0.2	1.4
Nov	0.4	3.4	-0.1	1.2
Oct	0.8	4.3	-0.2	1.6
Sep	0.4	3.9	0.2	1.6
Aug	0.7	3.3	0.2	1.3
Jul	0.2	4.1	0.2	1.5
Jun	-0.2	2.7	0.1	1.1
May	-0.2	5.1	0.3	1.3
Apr	-0.1	5.4	0.1	0.9
Mar	0.5	5.9	0.2	0.9
Feb	-0.6	4.2	0.0	1.0
Jan	1.0	4.5	0.3	1.0

Note: Core: excluding food and energy; AE: annual equivalent

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/

The US producer price index NSA from 2000 to 2012 is shown in Chart II-24. There are two episodes of decline of the PPI during recessions in 2001 and in 2008. Barsky and Kilian (2004) consider the 2001 episode as one in which real oil prices were declining when recession began. Recession and the fall of commodity prices instead of generalized deflation explain the behavior of US inflation in 2008.

Chart II-24, US, Producer Price Index, NSA, 2000-2012

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the PPI NSA from 2000 to 2012 are shown in Chart II-25. It may be possible to forecast trends a few months in the future under adaptive expectations but turning points are almost impossible to anticipate especially when related to fluctuations of commodity prices in response to risk aversion. In a sense, monetary policy has been tied to behavior of the PPI in the negative 12-month rates in 2001 to 2003 and then again in 2009 to 2010. Monetary policy following deflation fears caused by commodity price fluctuations would introduce significant volatility and risks in financial markets and eventually in consumption and investment.

Chart II-25, US, Producer Price Index, 12-Month Percentage Change NSA, 2000-2012

Source: US Bureau of Labor Statistics

The US PPI excluding food and energy from 2000 to 2012 is shown in Chart II-26. There is here again a smooth trend of inflation instead of prolonged deflation as in Japan.

Chart II-26, US, Producer Price Index Excluding Food and Energy, NSA, 2000-2012

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the producer price index excluding food and energy are shown in Chart II-27. Fluctuations replicate those in the headline PPI. There is an evident trend of increase of 12 months rates of core PPI inflation in 2011 but lower rates in the beginning of 2012.

Chart II-27, US, Producer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2000-2012

Source: US Bureau of Labor Statistics

The US producer price index of energy goods from 2000 to 2012 is in Chart II-28. There is a clear upward trend with fluctuations that would not occur under persistent deflation.

Chart II-28, US, Producer Price Index Finished Energy Goods, NSA, 2000-2012

Source: US Bureau of Labor Statistics

Chart II-29 provides 12-month percentage changes of the producer price index of energy goods from 2000 to 2012. The episode of declining prices of energy goods in 2001 to 2002 is related to the analysis of decline of real oil prices by Barsky and Kilian (2004). Interest rates dropping to zero during the global recession explain the rise of the PPI of energy goods toward 30 percent. Bouts of risk aversion with policy interest rates held close to zero explain the fluctuations in the 12-month rates of the PPI of energy goods in the expansion phase of the economy. Symmetric inflation targets induce significant instability in inflation and interest rates with adverse effects on financial markets and the overall economy.

Chart II-29, US, Producer Price Index Energy Goods, 12-Month Percentage Change, NSA, 2000-2012

Source: US Bureau of Labor Statistics