CMP Associates Regulation Blog

Chart IV-7A provides the export corporate goods price index on the basis of the contract currency. The export corporate goods price index on the basis of the contract currency increased from 97.9 in Jun 2009 to 103.1 in Apr 2012 or 5.3 percent but dropped to 100.2 in Apr 2013 or minus 2.8 percent relative to Apr 2012 and gained 1.2 percent to 99.1 in Jun 2013 relative to Jun 2009.

Chart IV-7A, Japan, Export Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2013

Source: Bank of Japan

Japan imports primary commodities and raw materials. As a result, the import corporate goods price index on the yen basis in Chart IV-8 shows an upward trend after declining from the increase during the global recession in 2008 driven by carry trades from fed funds rates collapsing to zero into commodity futures and decline during risk aversion from late 2008 into beginning of 2008 originating in doubts about soundness of US bank balance sheets. More careful measurement should show that the terms of trade of Japan, export prices relative to import prices, declined during the commodity shocks originating in unconventional monetary policy. The decline of the terms of trade restricted potential growth of income in Japan. The import corporate goods price index on the yen basis increased from 93.5 in Jun 2009 to 113.1 in Apr 2012 or 21.0 percent and to 122.8 in Jul 2013 or gain of 8.6 percent relative to Apr 2012 and 31.3 percent relative to Jun 2009.

Chart IV-8, Japan, Import Corporate Goods Price Index, Monthly, Yen Basis, 2008-2013

Source: Bank of Japan

Chart IV-8A provides the import corporate goods price index on the contract currency basis. The import corporate goods price index on the basis of the contract currency increased from 86.2 in Jun 2009 to 119.5 in Apr 2012 or 38.6 percent and to 111.6 in Jul 2013 or minus 6.6 percent relative to Apr 2012 and gain of 29.5 percent relative to Jun 2009. There is evident deterioration of the terms of trade of Japan: the export corporate goods price index on the basis of the contract currency increased 5.3 percent from Jun 2009 to Apr 2012 while the import corporate goods price index increased 38.6 percent. Prices of Japan’s exports of corporate goods, mostly industrial products, increased only 5.3 percent from Jun 2009 to Apr 2012, while imports of corporate goods, mostly commodities and raw materials increased 38.6 percent. Unconventional monetary policy induces carry trades from zero interest rates to exposures in commodities that squeeze economic activity of industrial countries by increases in prices of imported commodities and raw materials during periods without risk aversion. Reversals of carry trades during periods of risk aversion decrease prices of exported commodities and raw materials that squeeze economic activity in economies exporting commodities and raw materials. Devaluation of the dollar by unconventional monetary policy could increase US competitiveness in world markets but economic activity is squeezed by increases in prices of imported commodities and raw materials. Unconventional monetary policy causes instability worldwide instead of the mission of central banks of promoting financial and economic stability.

Chart IV-8A, Japan, Import Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2013

Source: Bank of Japan

http://philadelphiafed.org/index.cfm

Table IV-8 provides the Bank of Japan’s Corporate Goods Price indexes of exports and imports on the yen and contract bases from Jan 2008 to Jun 2013. There are oscillations of the indexes that are shown vividly in the four charts above. For the entire period from Jan 2008 to Jul 2013, the export index on the contract currency basis decreased 0.1 percent and decreased 7.0 percent on the yen basis. For the entire period from Jan 2008 to Jul 2013, the import index increased 10.8 percent on the contract currency basis and increased 3.2 percent on the yen basis. The charts show sharp deteriorations in relative prices of exports to prices of imports during multiple periods. Price margins of Japan’s producers are subject to periodic squeezes resulting from carry trades from zero interest rates of monetary policy to exposures in commodities.

Table IV-8, Japan, Exports and Imports Corporate Goods Price Index, Contract Currency Basis and Yen Basis

Month	Exports Contract Currency	Exports Yen	Imports Contract Currency	Imports Yen
2008/01	99.2	115.5	100.7	119.0
2008/02	99.8	116.1	102.4	120.6
2008/03	100.5	112.6	104.5	117.4
2008/04	101.6	115.3	110.1	125.2
2008/05	102.4	117.4	113.4	130.4
2008/06	103.5	120.7	119.5	140.3
2008/07	104.7	122.1	122.6	143.9
2008/08	103.7	122.1	123.1	147.0
2008/09	102.7	118.3	117.1	137.1
2008/10	100.2	109.6	109.1	121.5
2008/11	98.6	104.5	97.8	105.8
2008/12	97.9	100.6	89.3	93.0
2009/01	98.0	99.5	85.6	88.4
2009/02	97.5	100.1	85.7	89.7
2009/03	97.3	104.2	85.2	93.0
2009/04	97.6	105.6	84.4	93.0
2009/05	97.5	103.8	84.0	90.8
2009/06	97.9	104.9	86.2	93.5
2009/07	97.5	103.1	89.2	95.0
2009/08	98.3	104.4	89.6	95.8
2009/09	98.3	102.1	91.0	94.7
2009/10	98.0	101.2	91.0	94.0
2009/11	98.4	100.8	92.8	94.8
2009/12	98.3	100.7	95.4	97.5
2010/01	99.4	102.2	97.0	100.0
2010/02	99.7	101.6	97.6	99.8
2010/03	99.7	101.8	97.0	99.2
2010/04	100.5	104.6	99.9	104.6
2010/05	100.7	102.9	101.7	104.9
2010/06	100.1	101.6	100.0	102.3
2010/07	99.4	99.0	99.9	99.8
2010/08	99.1	97.3	99.5	97.5
2010/09	99.4	97.0	100.0	97.2
2010/10	100.1	96.4	100.5	95.8
2010/11	100.7	97.4	102.6	98.2
2010/12	101.2	98.3	104.4	100.6
2011/01	102.1	98.6	107.2	102.6
2011/02	102.9	99.5	109.0	104.3
2011/03	103.5	99.6	111.8	106.3
2011/04	104.1	101.7	115.9	111.9
2011/05	103.9	99.9	118.8	112.4
2011/06	103.8	99.3	117.5	110.5
2011/07	103.6	98.3	118.3	110.2
2011/08	103.6	96.6	118.6	108.1
2011/09	103.7	96.1	117.0	106.2
2011/10	103.0	95.2	116.6	105.6
2011/11	101.9	94.8	115.4	105.4
2011/12	101.5	94.5	116.1	106.2
2012/01	101.8	94.0	115.0	104.2
2012/02	102.4	95.8	115.8	106.4
2012/03	102.9	99.2	118.3	112.9
2012/04	103.1	98.7	119.5	113.1
2012/05	102.2	96.3	118.1	109.9
2012/06	101.4	95.0	115.2	106.7
2012/07	100.6	94.0	112.0	103.6
2012/08	100.8	94.1	112.4	103.6
2012/09	100.9	94.0	114.7	105.2
2012/10	101.0	94.7	113.8	105.2
2012/11	100.9	95.9	113.3	106.6
2012/12	100.7	98.0	113.6	109.7
2013/01	101.0	102.5	114.0	115.5
2013/02	101.5	105.9	114.9	120.4
2013/03	101.3	106.7	115.2	122.2
2013/04	100.2	107.5	114.3	124.0
2013/05	99.6	109.1	112.7	125.4
2013/06	99.2	106.1	112.2	121.4
2013/7	99.1	107.4	111.6	122.8

Source: Bank of Japan http://www.boj.or.jp/en/statistics/pi/cgpi_2010/index.htm/

Further insight into inflation of the corporate goods price index (CGPI) of Japan is provided in Table IV-9. Petroleum and coal with weight of 5.7 percent increased 2.1 percent in Jul 2013 and increased 16.8 percent in 12 months. Japan exports manufactured products and imports raw materials and commodities such that the country’s terms of trade, or export prices relative to import prices, deteriorate during commodity price increases. In contrast, prices of production machinery, with weight of 3.1 percent, increased 0.2 percent in Jul 2013 and increased 1.2 percent in 12 months. In general, most manufactured products have been experiencing negative or low increases in prices while inflation rates have been high in 12 months for products originating in raw materials and commodities. Ironically, unconventional monetary policy of zero interest rates and quantitative easing that intended to increase aggregate demand and GDP growth deteriorated the terms of trade of advanced economies with adverse effects on real income.

Table IV-9, Japan, Corporate Goods Prices and Selected Components, % Weights, Month and 12 Months ∆%

Jul 2013	Weight	Month ∆%	12 Month ∆%
Total	1000.0	0.5	2.2
Food, Beverages, Tobacco, Feedstuffs	137.5	0.2	1.1
Petroleum & Coal	57.4	2.1	16.8
Production Machinery	30.8	0.2	1.2
Electronic Components	31.0	0.6	-0.8
Electric Power, Gas & Water	52.7	5.1	9.5
Iron & Steel	56.6	0.3	-1.7
Chemicals	92.1	0.1	5.0
Transport Equipment	136.4	0.0	-1.5

Source: Bank of Japan http://www.boj.or.jp/en/ http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1307.pdf

Percentage point contributions to change of the corporate goods price index (CGPI) in Jul 2013 are provided in Table IV-10 divided into domestic, export and import segments. In the domestic CGPI, increasing 0.5 percent in Jul 2013, the energy shock is evident in the contribution of 0.33 percentage points by electric power, gas and water in new carry trades of exposures in commodity futures. The exports CGPI decreased 0.1 percent on the basis of the contract currency with deduction of 0.09 percentage points by metals and related products. The imports CGPI decreased 0.5 percent on the contract currency basis. Metals & related products deducted 0.37 percentage points. Shocks of risk aversion cause unwinding carry trades that result in declining commodity prices with resulting downward pressure on price indexes. The volatility of inflation adversely affects financial and economic decisions worldwide.

Table IV-10, Japan, Percentage Point Contributions to Change of Corporate Goods Price Index

Groups Jul 2013	Contribution to Change Percentage Points
A. Domestic Corporate Goods Price Index	Monthly Change: 0.5%
Electric Power, Gas & Water	0.33
Petroleum & Coal Products	0.15
Food, Beverages, Tobacco & Feedstuff	0.04
Lumber & Wood Products	0.02
Agriculture, Forestry & Fishery Products	0.02
Iron & Steel	0.02
Nonferrous Metals	-0.02
B. Export Price Index	Monthly Change: -0.1% contract currency
Metals & Related Products	-0.09
Transportation Equipment	-0.08
General Purpose, Production & Business Oriented Machinery	-0.05
Electric & Electronic Products	0.12
Chemicals & Related Products	0.03
C. Import Price Index	Monthly Change: -0.5 % contract currency basis
Metals & Related Products	-0.37
Petroleum, Coal & Natural Gas	-0.11
Foodstuffs & Feedstuffs	-0.05
Chemicals & Related Products	-0.03
Electric & Electronic Products	0.02

Source: Bank of Japan http://www.boj.or.jp/en/ http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1307.pdf

The harmonized index of consumer prices of the euro area in Table IV-11 has similar inflation waves as in most countries (http://cmpassocregulationblog.blogspot.com/2013/07/tapering-quantitative-easing-policy-and.html and earlier

There are two categories of responses in the Empire State Manufacturing Survey of the Federal Reserve Bank of New York (http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html): current conditions and expectations for the next six months. There are responses in the survey for two types of prices: prices received or inputs of production and prices paid or sales prices of products. Table IV-5 provides indexes for the two categories and within them for the two types of prices from Jan 2011 to Aug 2013. The index of current prices paid or costs of inputs increased from 16.13 in Dec 2012 to 20.48 in Jul 2013 while the index of current prices received or sales prices increased from 1.08 in Dec 2012 to 3.61 in Jul 2013. The index of future prices paid or expectations of costs of inputs in the next six months fell from 51.61 in Dec 2012 to 40.96 in Aug 2013 while the index of future prices received or expectation of sales prices in the next six months fell from 25.81 in Dec 2012 to 19.28 in Aug 2013. Prices of sales of finished products are less dynamic than prices of costs of inputs during waves of increases. Prices of costs of costs of inputs fall less rapidly than prices of sales of finished products during waves of price decreases. As a result, margins of prices of sales less costs of inputs oscillate with typical deterioration against producers, forcing companies to manage tightly costs and labor inputs.

Table IV-5, US, FRBNY Empire State Manufacturing Survey, Diffusion Indexes, Prices Paid and Prices Received, SA

	Current Prices Paid	Current Prices Received	Six Months Prices Paid	Six Months Prices Received
Aug 2013	20.48	3.61	40.96	19.28
Jul	17.39	1.09	28.26	11.96
Jun	20.97	11.29	45.16	17.74
May	20.45	4.55	29.55	14.77
Apr	28.41	5.68	44.32	14.77
Mar	25.81	2.15	50.54	23.66
Feb	26.26	8.08	44.44	13.13
Jan	22.58	10.75	38.71	21.51
Dec 2012	16.13	1.08	51.61	25.81
Nov	14.61	5.62	39.33	15.73
Oct	17.20	4.30	44.09	24.73
Sep	19.15	5.32	40.43	23.40
Aug	16.47	2.35	31.76	14.12
Jul	7.41	3.70	35.80	16.05
Jun	19.59	1.03	34.02	17.53
May	37.35	12.05	57.83	22.89
Apr	45.78	19.28	50.60	22.89
Mar	50.62	13.58	66.67	32.10
Feb	25.88	15.29	62.35	34.12
Jan	26.37	23.08	53.85	30.77
Dec 2011	24.42	3.49	56.98	36.05
Nov	18.29	6.10	36.59	25.61
Oct	22.47	4.49	40.45	17.98
Sep	32.61	8.70	53.26	22.83
Aug	28.26	2.17	42.39	15.22
Jul	43.33	5.56	51.11	30.00
Jun	56.12	11.22	55.10	19.39
May	69.89	27.96	68.82	35.48
Apr	57.69	26.92	56.41	38.46
Mar	53.25	20.78	71.43	36.36
Feb	45.78	16.87	55.42	27.71
Jan	35.79	15.79	60.00	42.11

Source: http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html

Price indexes of the Federal Reserve Bank of Philadelphia Outlook Survey are provided in Table IV-6. As inflation waves throughout the world (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/06/paring-quantitative-easing-policy-and.html), indexes of both current and expectations of future prices paid and received were quite high until May 2011. Prices paid, or inputs, were more dynamic, reflecting carry trades from zero interest rates to commodity futures. All indexes softened after May 2011 with even decline of prices received in Aug 2011 during the first round of risk aversion. Current and future price indexes have increased again but not back to the levels in the beginning of 2011 because of risk aversion frustrating carry trades even under zero interest rates. The index of prices paid or prices of inputs fell from 23.5 in Dec 2012 to 17.3 in Aug 2013. The index of current prices received was minus 3.3 in May 2013, indicating decrease of prices received. The index of current prices received decreased from 12.4 in Dec 2012 to 9.90 in Aug 2013. The index of future prices paid fell to 38.7 in Aug 2013 from 45.8 in Dec 2012, indicating expectation of lower pressure of increases of input prices, while the index of future prices received fell from 25.6 in Dec 2012 to 23.0 in Aug 2013. Expectations are incorporating faster increases in prices of inputs or costs of production than of sales of produced goods, forcing companies to manage tightly costs and labor inputs.

Table IV-6, US, Federal Reserve Bank of Philadelphia Business Outlook Survey, Current and Future Prices Paid and Prices Received, SA

	Current Prices Paid	Current Prices Received	Future Prices Paid	Future Prices Received
10-Dec	44.3	6.6	59.6	25.3
11-Jan	48.9	11.9	58.3	34.4
11-Feb	58.9	13.1	62.1	33.3
11-Mar	57.5	16.8	60.2	31.8
11-Apr	49.4	19.8	54.2	32.4
11-May	47.7	18.5	52.7	27.6
11-Jun	38.9	8.1	38.3	6.8
11-Jul	35.6	6	49.6	16.7
11-Aug	23.3	-4.7	44.3	22.7
11-Sep	31.6	7.6	41.8	21.8
11-Oct	25.4	4.1	44.5	28.4
11-Nov	26.3	7.6	39	29.1
11-Dec	27.5	8.2	46.7	23.5
12-Jan	27.1	7.9	47.2	21.9
12-Feb	30.2	9.7	43.5	28.6
12-Mar	14.3	5.4	35.9	22
12-Apr	16	5.3	33.3	18.6
12-May	5.4	-2.2	37.2	8.3
12-Jun	5.4	-3.4	29.6	16.6
12-Jul	10.3	4.2	29.3	19.6
12-Aug	15.7	4.7	38	23.9
12-Sep	15.4	4	42.8	27.4
12-Oct	20.6	8.4	48.1	16.1
12-Nov	27.9	7.5	50.7	14
12-Dec	23.5	12.4	45.8	25.6
13-Jan	14.7	-1.1	34.3	21.7
13-Feb	8.9	-0.5	26.4	25.4
13-Mar	8.5	-0.8	30.9	16.6
13-Apr	3.1	-7.5	26.6	8.3
13-May	6.9	-3.3	30.7	18.2
13-Jun	22.5	14.6	26.4	23.5
13-Jul	21.5	7.00	42.1	23.9
13-Aug	17.3	9.90	38.7	23.00

Source: Federal Reserve Bank of Philadelphia

Chart IV-1 of the Business Outlook Survey of the Federal Reserve Bank of Philadelphia Outlook Survey provides the diffusion index of current prices paid or prices of inputs from 2006 to 2013. Recession dates are in shaded areas. In the middle of deep global contraction after IVQ2007, input prices continued to increase in speculative carry trades from central bank policy rates falling toward zero into commodities futures. The index peaked above 70 in the second half of 2008. Inflation of inputs moderated significantly during the shock of risk aversion in late 2008, even falling briefly into contraction territory below zero during several months in 2009 in the flight away from risk financial assets into US government securities (Cochrane and Zingales 2009) that unwound carry trades. Return of risk appetite induced carry trade with significant increase until return of risk aversion in the first round of the European sovereign debt crisis in Apr 2010. Carry trades returned during risk appetite in expectation that the European sovereign debt crisis was resolved. The various inflation waves originating in carry trades induced by zero interest rates with alternating episodes of risk aversion are mirrored in the prices of inputs after 2011, in particular after Aug 2012 with the announcement of the Outright Monetary Transactions Program of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). Subsequent risk aversion and flows of capital away from commodities into stocks and high-yield bonds caused sharp decline in the index of prices paid followed by another recent rebound.

Chart IV-1, Federal Reserve Bank of Philadelphia Business Outlook Survey Current Prices Paid Diffusion Index SA

Source: Federal Reserve Bank of Philadelphia

http://www.philadelphiafed.org/index.cfm

Chart IV-2 of the Federal Reserve Bank of Philadelphia Outlook Survey provides the diffusion index of current prices received from 2006 to 2013. The significant difference between the index of current prices paid in Chart IV-1 and the index of current prices received in Chart IV-2 is that increases in prices paid are significantly sharper than increases in prices received. There were several periods of negative readings of prices received from 2010 to 2013 but none of prices paid. Prices paid relative to prices received deteriorate most of the time largely because of the carry trades from zero interest rates to commodity futures. Profit margins of business are compressed intermittently by fluctuations of commodity prices induced by unconventional monetary policy of zero interest rates, frustrating production, investment and hiring decisions of business, which is precisely the opposite outcome desired by unconventional monetary policy.

Chart IV-2, Federal Reserve Bank of Philadelphia Business Outlook Survey Current Prices Received Diffusion Index SA

Source: Federal Reserve Bank of Philadelphia

http://www.philadelphiafed.org/index.cfm

ESIII World Inflation Waves. This section provides analysis and data on world inflation waves. IA Appendix: Transmission of Unconventional Monetary Policy provides more technical analysis. Section IB United States Inflation analyzes inflation in the United States in two subsections: IC Long-term US Inflation and ID 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 IE 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 primarily of 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). Fixing policy rates at zero is the strongest measure of monetary policy with collateral effects of inducing carry trades from zero interest rates to exposures in risk financial assets such as commodities, exchange rates, stocks and higher yielding fixed income. Second, unconventional monetary policy also includes a battery of measures in also reducing 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. Long-term asset-backed securities finance a major portion of credit in the economy. 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 yields 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 intensify 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 events such as collapse of the European Monetary Union, carry trades are unwound with sharp deterioration of valuations of risk financial assets. More technical discussion is in IA Appendix: Transmission of Unconventional Monetary Policy.

Symmetric inflation targets are temporarily of secondary priority 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, including zero interest rates and outright purchases of securities for the portfolio of the central bank, 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.”

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 1.8 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 US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 15 quarters from IIIQ2009 to IIQ2013. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,738.0 billion in IIQ2010 by GDP of $14,356.9 billion in IIQ2009 {[$14,738.0/$14,356.9 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). Zero interest rates and quantitative easing have not provided the impulse for growth and were not required in past successful cyclical expansions.

First, the average number of nonfarm jobs created in Jan-Jul 2012 was 185,571 while the average number of nonfarm jobs created in Jan-Jul 2013 was 192,429, or increase by 3.7 percent. The average number of private jobs created in the US in Jan-Jul 2012 was 189,000 while the average in Jan-Jul 2013 was 195,571, or increase by 3.5 percent. The US labor force increased from 153.617 million in 2011 to 154.975 million in 2012 by 1.358 million or 113,167 per month. The average increase of nonfarm jobs in the five months from Jan to Jul 2013 was 192,429, which is a rate of job creation inadequate to reduce significantly unemployment and underemployment in the United States because of 113,167 new entrants in the labor force per month with 28.3 million unemployed or underemployed. The difference between the average increase of 192,429 new private nonfarm jobs per month in the US from Jan to Jul 2013 and the 113,167 average monthly increase in the labor force from 2011 to 2012 is 79,262 monthly new jobs net of absorption of new entrants in the labor force. There are 28.3 million in job stress in the US currently. Creation of 79,622 new jobs per month net of absorption of new entrants in the labor force would require 357 months to provide jobs for the unemployed and underemployed (28.315 million divided by 79,262) or 30 years (357 divided by 12). The civilian labor force of the US in Jul 2013 not seasonally adjusted stood at 157.196 million with 12.083 million unemployed or effectively 17.577 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 162.690 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 1.1 years (1 million divided by product of 79,262 by 12, which is 951,144). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.860 million (0.05 times labor force of 157.196 million) for new net job creation of 4.223 million (12.083 million unemployed minus 7.860 million unemployed at rate of 5 percent) that at the current rate would take 4.4 years (4.223 million divided by 0.951144). Under the calculation in this blog, there are 17.577 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 162.690 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.586 million jobs net of labor force growth that at the current rate would take 9.9 years (17.577 million minus 0.05(162.690 million) = 9.443 million divided by 0.951144, using LF PART 66.2% and Total UEM in Table I-4). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. The number employed in the US fell from 147.315 million in Jul 2007 to 145.113 million in Jul 2013, by 2.202 million, or decline of 1.5 percent, while the civilian noninstitutional or economically active population increased from 231.958 million in Jul 2007 to 245.756 million in Jul 2013, by 13.798 million or increase of 5.9 percent, using not seasonally adjusted data. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs. The United States economy has grown at the average yearly rate of 3 percent per year and 2 percent per year in per capita terms from 1870 to 2010, as measured by Lucas (2011May). An important characteristic of the economic cycle in the US has been rapid growth in the initial phase of expansion after recessions.

Second, revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html

http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) provide important information on long-term growth and cyclical behavior. Table Summary provides relevant data.

Long-term. US GDP grew at the average yearly rate of 3.3 percent from 1929 to 2012 and at 3.2 percent from 1947 to 2012.
Cycles. The combined contraction of GDP in the two almost consecutive recessions in the early 1980s is 4.6 percent. The contraction of US GDP from IVQ2007 to IIQ2009 during the global recession was 4.3 percent. The critical difference in the expansion is growth at average 7.8 percent in annual equivalent in the first four quarters of recovery from IQ1983 to IVQ1983. The average rate of growth of GDP in four cyclical expansions in the postwar period is 7.7 percent. In contrast, the rate of growth in the first four quarters from IIIQ2009 to IIQ2010 was only 2.7 percent. Average annual equivalent growth in the expansion from IQ1983 to IQ1986 was 5.7 percent. In contrast, average annual equivalent growth in the expansion from IIIQ2009 to IIQ2013 was only 2.7 percent. The US appears to have lost its dynamism of income growth and employment creation.

Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita

	GDP
Long-Term
1929-2012	3.3
1947-2012	3.2
Cyclical Contractions ∆%
IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982	-4.6
IVQ2007 to IIQ2009	-4.3
Cyclical Expansions Average Annual Equivalent ∆%
IQ1983 to IQ1986	5.7
First Four Quarters IQ1983 to IVQ1983	7.8
IIIQ2009 to IIQ2013	2.2
First Four Quarters IIIQ2009 to IIQ2010	2.7
	Real Disposable Income	Real Disposable Income per Capita
Long-Term
1929-2012	3.2	2.0
1947-1999	3.7	2.3
Whole Cycles
1980-1989	3.5	2.6
2006-2012	1.4	0.6

Source: Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf

The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html

http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace from 1.4 to 1.8 percent per year. Table Summary GDP provides the data.

1. Average Annual Growth in the Past Six Quarters. GDP growth in the four quarters of 2012 to IIQ2013 accumulated to 2.7 percent. This growth is equivalent to 1.8 percent per year, obtained by dividing GDP in IIQ2013 of $16,648.7 by GDP in IVQ2011 of $15,242.1 and compounding by 4/6: {[($15,648.7/$15,242.1)^4/6 -1]100 = 1.8.

2. Average Annual Growth in the First Two Quarters of 2013. GDP growth in the first two quarters of 2013 accumulated to 0.7 percent that is equivalent to 1.4 percent in a year. This is obtained by dividing GDP in IIQ2013 of $15648.7 by GDP in IVQ2012 to $15,583.9 and compounding by 4/2: {[($15,648.7/$15,539.6)^4/2 -1]100 =1.4%}. The US economy grew 1.4 percent in IIQ2013 relative to the same quarter a year earlier in IIQ2012. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012.

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

	Real GDP, Billions Chained 2005 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	14,996.1	NA	NA	1.9
IVQ2011	15,242.1	1.6	1.2	2.0
IQ2012	15,381.6	2.6	0.9	3.3
IIQ2012	15,427.7	2.9	0.3	2.8
IIIQ2012	15,534.0	3.6	0.7	3.1
IVQ2012	15,539.6	3.6	0.0	2.0
IQ2013	15,583.9	3.9	0.3	1.3
IIQ2013	15,648.7	4.4	0.4	1.4
Cumulative ∆% IQ2012 to IIQ2013	2.7		2.6
Annual Equivalent ∆%	1.8		1.7

Source: US Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf

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.

(1 + i_r) = (1 + i_n)/(1 + π^e) (1)

That is, the nominal interest rate equals the real interest rate discounted by the expectation of inflation in time term of the interest rate. Fisher (1933) analyzed the devastating effect of deflation on debts. Nominal debt contracts remained at original principal interest but net worth and income of debtors contracted during deflation. Real interest rates increase during declining inflation. For example, if the interest rate is 3 percent and prices decline 0.2 percent, equation (1) calculates the real interest rate as:

(1 +0.03)/(1 – 0.02) = 1.03/(0.998) = 1.032

(1 + 0.00114)/(1 + 0.011) = (1 + r_r) = 0.9902

Friedman (1953) analyzed the effects of full-employment economic policy on economic stability. There are two critical issues. First, there are lags in effect of monetary policy on aggregate income and prices (Friedman 1961, Culbertson 1960, 1961, Batini and Nelson 2002, Romer and Romer 2004). Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Second, concrete knowledge on the functioning of the economy is inadequate. The result of shocking the economy with policies at the wrong time could be an increase in instability. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σ_y and prices σ_p. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities).

Carry trades from zero interest rates to highly leveraged exposures in risk financial assets characterize the current environment. Some analytical aspects of the carry trade are instructive (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 101-5, Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 202-4), Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 70-4). Consider the following symbols: R_t is the exchange rate of a country receiving carry trade denoted in units of domestic currency per dollars at time t of initiation of the carry trade; R_t₊_τ is the exchange of the country receiving carry trade denoted in units of domestic currency per dollars at time t+τ when the carry trade is unwound; i_f is the domestic interest rate of the high-yielding country where investment will be made; i_usd is the interest rate on short-term dollar debt assumed to be 0.5 percent per year; i_f >i_usd, which expresses the fact that the interest rate on the foreign country is much higher than that in short-term USD (US dollars); S_t is the dollar value of the investment principal; and π is the dollar profit from the carry trade. The investment of the principal S_t in the local currency debt of the foreign country provides a profit of:

π = (1 + i_f)(R_tS_t)(1/R_t₊_τ) – (1 + i_usd)S_t (2)

The profit from the carry trade, π, is nonnegative when:

(1 + i_f)/ (1 + i_usd) ≥ R_t₊_τ/R_t (3)

In words, the difference in interest rate differentials, left-hand side of inequality (3), must exceed the percentage devaluation of the currency of the host country of the carry trade, right hand side of inequality (3). The carry trade must earn enough in the host-country interest rate to compensate for depreciation of the host-country at the time of return to USD. A simple example explains the vulnerability of the carry trade in fixed-income. Let i_f be 0.10 (10 percent), i_usd 0.005 (0.5 percent), S_t USD100 and R_t CUR 1.00/USD. Adopt the fixed-income rule of months of 30 days and years of 360 days. Consider a strategy of investing USD 100 at 10 percent for 30 days with borrowing of USD 100 at 0.5 percent for 30 days. At time t, the USD 100 are converted into CUR 100 and invested at [(30/360)10] equal to 0.833 percent for thirty days. At the end of the 30 days, assume that the rate R_t₊₃₀ is still CUR 1/USD such that the return amount from the carry trade is USD 0.833. There is still a loan to be paid [(0.005)(30/360)USD100] equal to USD 0.042. The investor receives the net amount of USD 0.833 minus USD 0.042 or US 0.791. The rate of return on the investment of the USD 100 is 0.791 percent, which is equivalent to the annual rate of return of 9.49 percent {(0.791)(360/30)}. This is incomparably better than earning 0.5 percent. There are alternatives of hedging by buying forward the exchange for conversion back into USD.

What really matters in the statement of the Federal Open Market Committee (FOMC) on Jul 31, 2013, is interest rates of fed funds at 0 to ¼ percent for the foreseeable future, even with paring of purchases of longer term bonds for the portfolio of the Fed (http://www.federalreserve.gov/newsevents/press/monetary/20130731a.htm):

Carry trades induced by zero interest rates increase the volatility of inflation σ_p and real income σ_y. World inflation waves originating in carry trades from zero interest rates to commodity futures and options deteriorate the sales prices of producing and investing companies net of costs of inputs and real income of consumers. The main objective of monetary policy is providing for financial stability. Unconventional monetary policy creates economic instability with higher volatilities of prices and real income as well as financial instability with major oscillations of risk financial assets. Carry trades induced by zero interest rates cause alternating improvements and deteriorations of net margins of sales prices less costs of raw materials and real income of consumers, disrupting decisions on production, investment and consumption.

Table IA-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 2012-2013 shows neatly multiple waves. (1) In Jan-Apr 2011, without risk aversion, US producer prices rose at the annual equivalent rate of 10.0 percent. (2) After risk aversion, producer prices increased in the US at the annual equivalent rate of 1.8 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 4.9 percent. (4) Under the pressure of risk aversion because of the European debt crisis, US producer prices increased at the annual equivalent rate of 0.6 percent in Oct-Nov 2011. (5) From Dec 2011 to Jan 2012, US producer were flat at the annual equivalent rate of 0.0 percent. (6) Inflation of producer prices returned with 2.4 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 4.7 percent in Apr-May 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 induced carry trades that resulted in annual equivalent producer price inflation in the US of 12.7 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 3.2 percent in Oct-Dec 2012. (10) In Jan-Feb 2013, producer prices rose at the annual equivalent rate of 5.5 percent with more relaxed risk aversion at the margin. (11) Return of risk aversion resulted in annual equivalent inflation of minus 7.5 percent in Mar-Apr 2013 with worldwide portfolio reallocation toward equities and high-yield bonds and away from commodity exposures. (12) Inflation of producer prices returned at 5.3 percent in annual equivalent in May-Jul 2013. 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 IA-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 prices at a faster pace than 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 Jul 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 and relative portfolio allocation away from commodities and into equities and high-yield bonds. Sharp worldwide jump in producer prices occurred recently because of the combination of zero interest rates forever or QE→∞ with temporarily relaxed risk aversion. Producer prices were moderating or falling in the final months of 2012 because of renewed risk aversion that causes unwinding of carry trades from zero interest rates to commodity futures exposures. In the first months of 2013, new carry trades caused higher worldwide inflation. Unconventional monetary policy fails in stimulating the overall real economy, merely introducing undesirable instability because 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 IA-1, Annual Equivalent Rates of Producer Price Indexes

INDEX 2011-2013	AE ∆%
US Producer Price Index
AE ∆% May-Jul	5.3
AE ∆% Mar-Apr	-7.5
AE ∆% Jan-Feb 2013	5.5
AE ∆% Oct-Dec 2012	-3.2
AE ∆% Aug-Sep 2012	12.7
AE ∆% Jun-Jul 2012	3.0
AE ∆% Apr-May 2012	-4.7
AE ∆% Feb-Mar 2012	2.4
AE ∆% Dec 2011-Jan-2012	0.0
AE ∆% Oct-Nov 2011	0.6
AE ∆% Jul-Sep 2011	4.9
AE ∆% May-Jun 2011	1.8
AE ∆% Jan-Apr 2011	10.0
Japan Corporate Goods Price Index
AE ∆% Dec 2012-Jul 2013	3.3
AE ∆% Oct-Nov 2012	-3.0
AE ∆% Aug-Sep 2012	3.0
AE ∆% May-Jul 2012	-5.8
AE ∆% Feb-Apr 2012	2.0
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 ∆% Mar-Jul	-4.9
AE ∆% Jan-Feb 2013	2.4
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 ∆% Mar-Jun	-3.3
AE ∆% Jan-Feb 2013	3.7
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Sep-Oct 2012	0.6
AE ∆% Jul-Aug 2012	7.4
AE ∆% Apr-Jun 2012	-2.0
AE ∆% Jan-Mar 2012	8.3
AE ∆% Oct-Dec 2011	0.4
AE ∆% Jul-Sep 2011	2.8
AE ∆% May-Jun 2011	-0.6
AE ∆% Jan-Apr 2011	11.4
Germany Producer Price Index
AE ∆% May-Jun	-1.8 NSA 2.4 SA
AE ∆% Feb-Apr 2013	-2.0 NSA –2.8 SA
AE ∆% Jan 2013	10.0 NSA 2.4 SA
AE ∆% Oct-Dec 2012	-1.6 NSA 0.8 SA
AE ∆% Aug-Sep 2012	4.9 NSA 4.3 SA
AE ∆% May-Jul 2012	-2.8 NSA –0.8 SA
AE ∆% Feb-Apr 2012	4.9 NSA 2.4 SA
AE ∆% Dec 2011-Jan 2012	1.2 NSA –0.6 SA
AE ∆% Oct-Nov 2011	1.8 NSA 3.0 SA
AE ∆% Jul-Sep 2011	2.8 NSA 2.8 SA
AE ∆% May-Jun 2011	0.6 NSA 4.3 SA
AE ∆% Jan-Apr 2011	10.4 NSA 6.5 SA
France Producer Price Index for the French Market
AE ∆% Apr-Jun	-10.3
AE ∆% Jan-Mar 2013	3.7
AE ∆% Nov-Dec 2012	-4.1
AE ∆% Jul-Oct 2012	8.7
AE ∆% Apr-Jun 2012	-5.1
AE ∆% Jan-Mar 2012	6.2
AE ∆% Oct-Dec 2011	2.8
AE ∆% Jul-Sep 2011	3.7
AE ∆% May-Jun 2011	-1.8
AE ∆% Jan-Apr 2011	10.4
Italy Producer Price Index
AE ∆% Jun	4.9
AE ∆% Apr-May	-3.5
AE ∆% Feb-Mar 2013	1.2
AE ∆% Sep 2012-Jan 2013	-5.2
AE ∆% Jul-Aug 2012	9.4
AE ∆% May-Jun 2012	-0.6
AE ∆% Mar-Apr 2012	6.8
AE ∆% Jan-Feb 2012	8.1
AE ∆% Oct-Dec 2011	2.0
AE ∆% Jul-Sep 2011	4.9
AE ∆% May-Jun 2011	1.8
AE ∆% Jan-April 2011	10.7
UK Output Prices
AE ∆% Jun-Jul	1.8
AE ∆% Apr-May	-1.8
AE ∆% Jan-Mar 2013	5.3
AE ∆% Nov-Dec 2012	-3.0
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 ∆% Jun-Jul	8.1
AE ∆% Mar-May 2013	-11.4
AE ∆% Jan-Feb 2013	28.3
AE ∆% Sep-Dec 2012	1.5
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://www.bls.gov/cpi/ http://www.boj.or.jp/en/

http://www.stats.gov.cn/enGliSH/

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

https://www.destatis.de/EN/Homepage.html

http://www.insee.fr/en/default.asp

http://www.istat.it/en/

http://www.ons.gov.uk/ons/index.html

ESIV Stagnating Real Hourly Remuneration. Chart VA-6 provides percentage changes in a quarter relative to the same quarter a year earlier for nonfarm business real hourly compensation. Labor compensation eroded sharply during the recession with brief recovery in 2010 and another fall until recently.

Chart VA-6, US, Nonfarm Business Real Hourly Compensation, Percent Change from Same Quarter a Year Earlier 1999-2013

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

Real hourly compensation increased at relatively high rates after 1947 to the early 1970s but reached a plateau that lasted until the early 1990s, as shown in Chart VA-9. There were rapid increases until the global recession.

Chart VA-9, US, Nonfarm Business, Real Hourly Compensation, 1947-2013, Index 2005=100

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

ESV United States Industrial Production. Industrial production changed 0.0 percent in Jul 2013 after increasing 0.2 percent in Jun 2013 and changing 0.0 percent in May 2013, as shown in Table II-1, with all data seasonally adjusted. The report of the Board of Governors of the Federal Reserve System states (http://www.federalreserve.gov/releases/g17/Current/default.htm):

“Industrial production was unchanged in July after having gained 0.2 percent in June. In July, manufacturing production declined 0.1 percent. The output of mines advanced 2.1 percent, its fourth consecutive monthly increase, and the production of utilities fell 2.1 percent, its fourth consecutive monthly decrease. At 98.9 percent of its 2007 average, total industrial production in July was 1.4 percent above its year-earlier level.”

In the six months ending in Jul 2013, United States national industrial production accumulated increase of 0.7 percent at the annual equivalent rate of 1.4 percent, which is equal to growth of 1.4 percent in 12 months. Excluding growth of 0.7 in Feb 2013, growth in the remaining five months from Mar 2012 to Jul 2013 accumulated to 0.0 percent or 0.0 percent annual equivalent. Industrial production stagnated in two of the past six months and fell in one. Business equipment accumulated growth of 2.0 percent in the six months from Feb to Jul 2013 at the annual equivalent rate of 1.8 percent, which is much higher than growth of 2.1 percent in 12 months. Growth of business equipment accumulated 0.1 percent from Mar to July 2013 at the annual equivalent rate of 0.2 percent. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for total industry edged down 0.1 percentage point to 77.6 percent in July, a rate 0.3 percentage point below its level of a year earlier and 2.6 percentage points below its long-run (1972-2012) average.” United States industry is apparently decelerating.

Table II-1, US, Industrial Production and Capacity Utilization, SA, ∆%

2012-2013	Jul 13	Jun 13	May 13	Apr 13	Mar 13	Feb 13	Jun 13/ Jun 12
Total	0.0	0.2	0.0	-0.4	0.2	0.7	1.4
Market Groups
Final Products	-0.3	0.5	-0.2	-0.5	0.5	1.0	1.3
Consumer Goods	-0.5	0.6	-0.2	-0.6	0.8	0.8	1.3
Business Equipment	0.0	0.4	-0.1	-0.2	0.0	1.9	2.1
Non Industrial Supplies	-0.3	0.0	-0.1	-0.7	0.0	0.8	0.9
Construction	0.5	0.5	-0.6	-1.3	-1.2	2.3	4.4
Materials	0.4	0.0	0.3	-0.2	0.0	0.3	1.7
Industry Groups
Manufacturing	-0.1	0.2	0.3	-0.4	-0.3	0.6	1.3
Mining	2.1	1.0	0.1	0.8	-0.3	0.9	5.7
Utilities	-2.1	-0.8	-1.8	-1.6	5.0	0.9	-3.7
Capacity	77.6	77.7	77.7	77.8	78.2	78.1	1.8

Sources: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/g17/Current/default.htm

Manufacturing decreased 0.1 percent in Jul 2013 after increasing 0.2 percent in Jun 2013 and 0.3 percent in May 2013 seasonally adjusted, increasing 1.4 percent not seasonally adjusted in 12 months ending in Jul 2013, as shown in Table II-2. Manufacturing grew cumulatively 0.3 percent in the six months ending in Jul 2013 or at the annual equivalent rate of 0.6 percent. Excluding the increase of 0.6 percent in Feb 2012, manufacturing accumulated growth of minus 0.3 percent from Mar 2013 to Jul 2013 or at the annual equivalent rate of minus 0.7 percent. Table II-2 provides a longer perspective of manufacturing in the US. There has been evident deceleration of manufacturing growth in the US from 2010 and the first three months of 2011 into more recent months as shown by 12 months rates of growth. Growth rates appeared to be increasing again closer to 5 percent in Apr-Jun 2012 but deteriorated. The rates of decline of manufacturing in 2009 are quite high with a drop of 18.2 percent in the 12 months ending in Apr 2009. Manufacturing recovered from this decline and led the recovery from the recession. Rates of growth appeared to be returning to the levels at 3 percent or higher in the annual rates before the recession but the pace of manufacturing fell steadily in the past six months with some weakness at the margin. The Board of Governors of the Federal Reserve System conducted the annual revision of industrial production released on Mar 22, 2013 (http://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm):

“The Federal Reserve has revised its index of industrial production (IP) and the related measures of capacity and capacity utilization. Measured from fourth quarter to fourth quarter, total IP is now reported to have increased 0.7 percentage point less in 2011 than was previously published. The revisions to IP for other years were smaller: Compared to the previous estimates, industrial production fell slightly less in 2008 and 2009 and increased slightly less in 2010 and 2012. At 97.7 percent of its 2007 average, the index in the fourth quarter of 2012 now stands 0.4 percent below its previous estimate. With these revisions, IP is still estimated to have advanced about 6 percent in 2010, the first full year following the trough in June 2009 of the most recent recession, but it is now estimated to have risen about 3 percent both in 2011 and in 2012. Since the trough of the recession, total IP has reversed about 90 percent of its peak-to-trough decline.”

The bottom part of Table II-2 shows decline of manufacturing by 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increased by 16.8 percent from the trough in Apr 2009 to Dec 2012. Manufacturing grew 21.8 percent from the trough in Apr 2009 to Jun 2013. Manufacturing output in Jul 2013 is 8.7 percent below the peak in Jun 2007.

Table II-2, US, Monthly and 12-Month Rates of Growth of Manufacturing ∆%

	Month SA ∆%	12-Month NSA ∆%
Jul 2013	-0.1	1.4
Jun	0.2	1.4
May	0.3	1.7
Apr	-0.4	2.0
Mar	-0.3	1.7
Feb	0.6	1.9
Jan	-0.1	2.4
Dec 2012	0.9	3.0
Nov	1.4	3.3
Oct	-0.4	2.1
Sep	0.1	3.1
Aug	-0.7	3.5
Jul	0.2	4.0
Jun	0.3	5.0
May	-0.3	4.8
Apr	0.6	5.1
Mar	-0.5	3.9
Feb	0.6	5.3
Jan	1.0	4.2
Dec 2011	1.0	3.8
Nov	0.0	3.2
Oct	0.6	3.1
Sep	0.4	3.0
Aug	0.4	2.4
Jul	0.7	2.5
Jun	0.1	2.1
May	0.3	1.9
Apr	-0.7	3.1
Mar	0.7	4.9
Feb	0.0	5.4
Jan	0.2	5.6
Dec 2010	0.6	6.2
Nov	0.2	5.3
Oct	0.1	6.6
Sep	0.1	7.0
Aug	0.1	7.4
Jul	0.7	7.8
Jun	0.0	9.3
May	1.4	8.9
Apr	0.9	7.1
Mar	1.3	4.9
Feb	0.0	1.3
Jan	1.0	1.2
Dec 2009	0.0	-3.1
Nov	1.1	-6.1
Oct	0.1	-9.1
Sep	0.8	-10.6
Aug	1.1	-13.6
Jul	1.2	-15.2
Jun	-0.3	-17.6
May	-1.1	-17.6
Apr	-0.8	-18.2
Mar	-1.9	-17.3
Feb	-0.2	-16.1
Jan	-2.9	-16.4
Dec 2008	-3.4	-14.0
Nov	-2.2	-11.3
Oct	-0.6	-9.0
Sep	-3.4	-8.6
Aug	-1.3	-5.1
Jul	-1.1	-3.5
Jun	-0.5	-3.1
May	-0.5	-2.4
Apr	-1.1	-1.1
Mar	-0.3	-0.5
Feb	-0.6	0.9
Jan	-0.4	2.3
Dec 2007	0.2	2.0
Nov	0.5	3.4
Oct	-0.4	2.8
Sep	0.5	3.0
Aug	-0.4	2.6
Jul	0.1	3.4
Jun	0.3	2.9
May	-0.1	3.1
Apr	0.7	3.6
Mar	0.7	2.4
Feb	0.4	1.6
Jan	-0.5	1.3
Dec 2006		2.7
Dec 2005		3.4
Dec 2004		4.0
Dec 2003		1.7
Dec 2002		2.4
Dec 2001		-5.5
Dec 2000		0.4
Dec 1999		5.4
Average ∆% Dec 1986-Dec 2012		2.3
Average ∆% Dec 1986-Dec 1999		4.3
Average ∆% Dec 1999-Dec 2006		1.3
Average ∆% Dec 1999-Dec 2012		0.4
∆% Peak 103.0005 in 06/2007 to 93.9456 in 12/2012		-8.8
∆% Peak 103.0005 on 06/2007 to Trough 80.4617 in 4/2009		-21.9
∆% Trough 80.4617 in 04/2009 to 93.9456 in 12/2012		16.8
∆% Trough 80.4617 in 04/2009 to 94.0248 in 7/2013		16.9
∆% Peak 103.0005 on 06/2007 to Trough 94.0248 in 7/2013		-8.7

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/g17/Current/default.htm

United States manufacturing output from 1919 to 2012 on a monthly basis is in Chart II-4 of the Board of Governors of the Federal Reserve System. The second industrial revolution of Jensen (1993) is quite evident in the acceleration of the rate of growth of output given by the sharper slope in the 1980s and 1990s. Growth was robust after the shallow recession of 2001 but dropped sharply during the global recession after IVQ2007. Manufacturing output recovered sharply but has not reached earlier levels and is losing momentum at the margin.

Chart II-4, US, Manufacturing Output, 1919-2013

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/g17/Current/default.htm

Manufacturing jobs increased 6,000 in Jul 2013 relative to Jun 2013, seasonally adjusted (http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html and earlier http://cmpassocregulationblog.blogspot.com/2013/07/twenty-nine-million-unemployed-or.html). Manufacturing jobs not seasonally adjusted increased 16,000 from Jul 2012 to Jul 2013 or at the average monthly rate of 1,333. There are effects of the weaker economy and international trade together with the yearly adjustment of labor statistics. In the six months ending in Jun 2013, United States national industrial production accumulated increase of 0.9 percent at the annual equivalent rate of 1.8 percent, which is lower than growth of 2.0 percent in 12 months. Excluding growth of 0.7 in Feb 2013, growth in the remaining five months from Jan 2012 to Jun 2013 accumulated to 0.2 percent or 0.5 percent annual equivalent. Industrial production stagnated in two of the past six months and fell in one. Business equipment accumulated growth of 0.9 percent in the six months from Dec 2012 to May 2013 at the annual equivalent rate of 1.8 percent, which is much lower than growth of 2.2 percent in 12 months. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “The rate of capacity utilization for total industry edged up 0.1 percentage point to 77.8 percent, a rate that was 0.1 percentage point above its level of a year earlier but 2.4 percentage points below its long-run (1972–2012) average.” United States industry is apparently decelerating.

Manufacturing increased 0.3 percent in Jun 2013 after increasing 0.2 percent in May 2013 and decreasing 0.3 percent in Apr 2013 seasonally adjusted, increasing 1.7 percent not seasonally adjusted in 12 months ending in Jun 2013, as shown in Table II-2. Manufacturing grew cumulatively 0.5 percent in the six months ending in Jun 2013 or at the annual equivalent rate of 1.0 percent. Excluding the increase of 0.7 percent in Feb 2012, manufacturing accumulated growth of minus 0.2 percent from Jan 2013 to Jun 2013 or at the annual equivalent rate of minus 0.5 percent. Manufacturing output fell by 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increased by 16.8 percent from the trough in Apr 2009 to Dec 2012. Manufacturing grew 21.8 percent from the trough in Apr 2009 to Jun 2013. Manufacturing output in Jun 2013 is 4.8 percent below the peak in Jun 2007. Data do suggest that world trade slowdown is accompanying world economic slowdown.

Table I-3 provides national income by industry without capital consumption adjustment (WCCA). “Private industries” or economic activities have share of 86.3 percent in US national income in IVQ2012 and 86.6 percent in IQ2013. Most of US national income is in the form of services. In Jul 2013, there were 135.664 million nonfarm jobs NSA in the US, according to estimates of the establishment survey of the Bureau of Labor Statistics (BLS) (http://www.bls.gov/news.release/empsit.nr0.htm Table B-1). Total private jobs of 115.081 million NSA in Jul 2013 accounted for 84.8 percent of total nonfarm jobs of 135.664 million, of which 12.045 million, or 10.5 percent of total private jobs and 8.9 percent of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 96.093 million NSA in Jul 2013, or 70.8 percent of total nonfarm jobs and 83.5 percent of total private-sector jobs. Manufacturing has share of 11.0 percent in US national income in IQ2013, as shown in Table I-3. Most income in the US originates in services. Subsidies and similar measures designed to increase manufacturing jobs will not increase economic growth and employment and may actually reduce growth by diverting resources away from currently employment-creating activities because of the drain of taxation.

Table I-3, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total

	SAAR IVQ2012	% Total	SAAR IQ2013	% Total
National Income WCCA	14,251.4	100.0	14,343.1	100.0
Domestic Industries	13,994.4	98.2	14,105.7	98.3
Private Industries	12,303.9	86.3	12,421.4	86.6
Agriculture	159.8	1.1	226.4	1.6
Mining	261.4	1.8	247.8	1.7
Utilities	199.6	1.4	209.1	1.5
Construction	604.4	4.2	622.9	4.3
Manufacturing	1574.8	11.1	1570.9	11.0
Durable Goods	882.8	6.2	882.2	6.2
Nondurable Goods	692.0	4.9	688.8	4.8
Wholesale Trade	874.3	6.1	870.8	6.1
Retail Trade	977.9	6.9	970.2	6.8
Transportation & WH	421.8	2.9	434.2	3.0
Information	476.2	3.3	495.5	3.5
Finance, Insurance, RE	2366.3	16.6	2416.3	16.8
Professional, BS	2006.8	14.1	1962.4	13.7
Education, Health Care	1413.1	9.9	1418.7	9.9
Arts, Entertainment	562.6	3.9	570.6	4.0
Other Services	404.8	2.8	405.7	2.8
Government	1690.5	11.9	1684.3	11.7
Rest of the World	257.0	1.8	237.4	1.7

Notes: SSAR: Seasonally-Adjusted Annual Rate; WCCA: Without Capital Consumption Adjustment by Industry; WH: Warehousing; RE, includes rental and leasing: Real Estate; Art, Entertainment includes recreation, accommodation and food services; BS: business services

Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm

ESVI Exodus of Foreign Financing of United States Fiscal and Balance of Payments Deficits. Risk aversion channels funds toward US long-term and short-term securities that finance the US balance of payments and fiscal deficits benefitting from risk flight to US dollar denominated assets. There are now temporary interruptions because of fear of rising interest rates that erode prices of US government securities because of mixed signals on monetary policy and exit from the Fed balance sheet of three trillion dollars of securities held outright. Net foreign purchases of US long-term securities (row C in Table VA-13) deteriorated sharply from minus $27.0 billion in May 2013 to minus $66.9 billion in Jun 2013. Foreign (residents) purchases minus sales of US long-term securities (row A in Table VA-13) in May 2013 of $0.0 billion decreased to minus $77.8 billion in Jun 2013. Net US (residents) purchases of long-term foreign securities (row B in Table VA-3) increased from minus $27.0 billion in May 2013 to $11.0 billion in Jun 2013. In Jun 2013,

C = A + B = -$77.8 billion + $11.0 billion = -$66.9 billion

There are minor rounding errors. There is decreasing demand in Table VA-1 in Jan in A1 private purchases by residents overseas of US long-term securities of $81.6 billion of which decreases in A11 Treasury securities of $40.1 billion, decrease in A12 of $9.1 billion in agency securities, decrease by $6.9 billion of corporate bonds and decrease of $25.5 billion in equities. Worldwide risk aversion causes flight into US Treasury obligations with significant oscillations. Official purchases of securities in row A2 increased $3.8 billion with decrease of Treasury securities of $0.7 billion in Jun 2013. Official purchases of agency securities increased $3.9 billion in Jun. Row D shows decrease in Jun 2013 of 4.4 billion in purchases of short-term dollar denominated obligations. Foreign private holdings of US Treasury bills increased $25.9 billion (row D11) with foreign official holdings decreasing $17.1 billion while the category “other” decreased $13.2 billion. Foreign private holdings of US Treasury bills increased $25.9 billion in what could be reduction of duration exposures. Risk aversion of default losses in foreign securities dominates decisions to accept zero interest rates in Treasury securities with no perception of principal losses. In the case of long-term securities, investors prefer to sacrifice inflation and possible duration risk to avoid principal losses with significant oscillations in risk perceptions

Table VA-13, Net Cross-Borders Flows of US Long-Term Securities, Billion Dollars, NSA

	Jun 2012 12 Months	Jun 2013 12 Months	May 2013	Jun 2013
A Foreign Purchases less Sales of US LT Securities	500.4	328.0	0.0	-77.8
A1 Private	321.0	137.3	-43.8	-81.6
A11 Treasury	325.6	-5.4	-29.0	-40.1
A12 Agency	104.7	69.0	-9.3	-9.1
A13 Corporate Bonds	-78.2	10.4	4.6	-6.9
A14 Equities	-31.0	63.3	-10.2	-25.5
A2 Official	179.4	190.7	43.8	3.8
A21 Treasury	177.5	109.7	40.3	-0.7
A22 Agency	-4.3	53.6	-1.1	3.9
A23 Corporate Bonds	0.8	19.7	3.0	1.9
A24 Equities	5.4	7.6	1.6	-1.4
B Net US Purchases of LT Foreign Securities	19.1	-156.2	-27.0	11.0
B1 Foreign Bonds	59.4	-48.7	-11.4	13.3
B2 Foreign Equities	-40.2	-107.5	-15.6	-2.4
C Net Foreign Purchases of US LT Securities	519.5	171.8	-27.0	-66.9
D Increase in Foreign Holdings of Dollar Denominated Short-term	-40.7	41.1	-35.8	-4.4
D1 US Treasury Bills	-11.3	44.6	-39.2	8.8
D11 Private	35.4	46.4	-19.8	25.9
D12 Official	-46.7	-1.7	-19.4	-17.1
D2 Other	-29.4	-3.5	3.4	-13.2

C = A + B;

A = A1 + A2

A1 = A11 + A12 + A13 + A14

A2 = A21 + A22 + A23 + A24

B = B1 + B2

D = D1 + D2

Sources: http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/index.aspx

Table VA-14 provides major foreign holders of US Treasury securities. China is the largest holder with $1275.8 billion in Jun 2013, increasing 11.2 percent from $1147.0 billion in Jun 2012 while decreasing $21.5 billion from May 2013 or 1.7 percent. Japan decreased its holdings from $1108.4 billion in Jun 2012 to $1083.4 billion in Jun 2013 or by 2.3 percent. Japan reduced its holdings from $1103.7 billion in May 2013 to $1083.4 billion in Jun 2013 by $20.3 billion or 1.8 percent. Total foreign holdings of Treasury securities rose from $5313.5 billion in Jun 2012 to $5600.6 billion in Jun 2013, or 5.4 percent. Foreign holdings of Treasury securities fell from $5740.4 in Mar 2013 to $5670.8 in Apr 2013 or 1.2 percent. Foreign holdings of US Treasury securities fell from $5657.1 billion in May 2013 to $5600.6 billion in Jun 2013, by $56.5 billion or by 1.0 percent. The US continues to finance its fiscal and balance of payments deficits with foreign savings (see Pelaez and Pelaez, The Global Recession Risk (2007)). A point of saturation of holdings of US Treasury debt may be reached as foreign holders evaluate the threat of reduction of principal by dollar devaluation and reduction of prices by increases in yield, including possibly risk premium. Shultz et al (2012) find that the Fed financed three-quarters of the US deficit in fiscal year 2011, with foreign governments financing significant part of the remainder of the US deficit while the Fed owns one in six dollars of US national debt. Concentrations of debt in few holders are perilous because of sudden exodus in fear of devaluation and yield increases and the limit of refinancing old debt and placing new debt. In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):

“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”

Table VA-14, US, Major Foreign Holders of Treasury Securities $ Billions at End of Period

	Jun 2013	May 2013	Jun 2012
Total	5600.6	5657.1	5313.5
China	1275.8	1297.3	1147.0
Japan	1083.4	1103.7	1108.4
Caribbean Banking Centers	290.8	280.0	244.6
Oil Exporters	256.8	264.5	270.2
Brazil	253.7	255.2	244.3
Taiwan	186.2	188.8	196.4
Switzerland	180.4	182.6	172.4
Belgium	176.1	175.2	144.5
United Kingdom	162.6	155.8	138.0
Luxembourg	150.6	143.2	137.8
Russia	138.0	143.4	163.8
Hong Kong	124.2	136.4	136.0
Foreign Official Holdings	4009.2	4072.8	3857.9
A. Treasury Bills	362.7	379.8	364.5
B. Treasury Bonds and Notes	3646.4	3693.0	3493.4

Source: http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx#ussecs

I World Inflation Waves. This section provides analysis and data on world inflation waves. IA Appendix: Transmission of Unconventional Monetary Policy provides more technical analysis. Section IB United States Inflation analyzes inflation in the United States in two subsections: IC Long-term US Inflation and ID 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 IE 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):

Long-term. US GDP grew at the average yearly rate of 3.3 percent from 1929 to 2012 and at 3.2 percent from 1947 to 2012.
Cycles. The combined contraction of GDP in the two almost consecutive recessions in the early 1980s is 4.6 percent. The contraction of US GDP from IVQ2007 to IIQ2009 during the global recession was 4.3 percent. The critical difference in the expansion is growth at average 7.8 percent in annual equivalent in the first four quarters of recovery from IQ1983 to IVQ1983. The average rate of growth of GDP in four cyclical expansions in the postwar period is 7.7 percent. In contrast, the rate of growth in the first four quarters from IIIQ2009 to IIQ2010 was only 2.7 percent. Average annual equivalent growth in the expansion from IQ1983 to IQ1986 was 5.7 percent. In contrast, average annual equivalent growth in the expansion from IIIQ2009 to IIQ2013 was only 2.7 percent. The US appears to have lost its dynamism of income growth and employment creation.

Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita

	GDP
Long-Term
1929-2012	3.3
1947-2012	3.2
Cyclical Contractions ∆%
IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982	-4.6
IVQ2007 to IIQ2009	-4.3
Cyclical Expansions Average Annual Equivalent ∆%
IQ1983 to IQ1986	5.7
First Four Quarters IQ1983 to IVQ1983	7.8
IIIQ2009 to IIQ2013	2.2
First Four Quarters IIIQ2009 to IIQ2010	2.7
	Real Disposable Income	Real Disposable Income per Capita
Long-Term
1929-2012	3.2	2.0
1947-1999	3.7	2.3
Whole Cycles
1980-1989	3.5	2.6
2006-2012	1.4	0.6

Source: Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf

http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace from 1.4 to 1.8 percent per year. Table Summary GDP provides the data.

3. Average Annual Growth in the Past Six Quarters. GDP growth in the four quarters of 2012 to IIQ2013 accumulated to 2.7 percent. This growth is equivalent to 1.8 percent per year, obtained by dividing GDP in IIQ2013 of $16,648.7 by GDP in IVQ2011 of $15,242.1 and compounding by 4/6: {[($15,648.7/$15,242.1)^4/6 -1]100 = 1.8.

4. Average Annual Growth in the First Two Quarters of 2013. GDP growth in the first two quarters of 2013 accumulated to 0.7 percent that is equivalent to 1.4 percent in a year. This is obtained by dividing GDP in IIQ2013 of $15648.7 by GDP in IVQ2012 to $15,583.9 and compounding by 4/2: {[($15,648.7/$15,539.6)^4/2 -1]100 =1.4%}. The US economy grew 1.4 percent in IIQ2013 relative to the same quarter a year earlier in IIQ2012. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012.

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

	Real GDP, Billions Chained 2005 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	14,996.1	NA	NA	1.9
IVQ2011	15,242.1	1.6	1.2	2.0
IQ2012	15,381.6	2.6	0.9	3.3
IIQ2012	15,427.7	2.9	0.3	2.8
IIIQ2012	15,534.0	3.6	0.7	3.1
IVQ2012	15,539.6	3.6	0.0	2.0
IQ2013	15,583.9	3.9	0.3	1.3
IIQ2013	15,648.7	4.4	0.4	1.4
Cumulative ∆% IQ2012 to IIQ2013	2.7		2.6
Annual Equivalent ∆%	1.8		1.7

Source: US Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf

(1 + i_r) = (1 + i_n)/(1 + π^e) (1)

(1 +0.03)/(1 – 0.02) = 1.03/(0.998) = 1.032

(1 + 0.00114)/(1 + 0.011) = (1 + r_r) = 0.9902

π = (1 + i_f)(R_tS_t)(1/R_t₊_τ) – (1 + i_usd)S_t (2)

The profit from the carry trade, π, is nonnegative when:

(1 + i_f)/ (1 + i_usd) ≥ R_t₊_τ/R_t (3)

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

INDEX 2011-2013	AE ∆%
US Producer Price Index
AE ∆% May-Jul	5.3
AE ∆% Mar-Apr	-7.5
AE ∆% Jan-Feb 2013	5.5
AE ∆% Oct-Dec 2012	-3.2
AE ∆% Aug-Sep 2012	12.7
AE ∆% Jun-Jul 2012	3.0
AE ∆% Apr-May 2012	-4.7
AE ∆% Feb-Mar 2012	2.4
AE ∆% Dec 2011-Jan-2012	0.0
AE ∆% Oct-Nov 2011	0.6
AE ∆% Jul-Sep 2011	4.9
AE ∆% May-Jun 2011	1.8
AE ∆% Jan-Apr 2011	10.0
Japan Corporate Goods Price Index
AE ∆% Dec 2012-Jul 2013	3.3
AE ∆% Oct-Nov 2012	-3.0
AE ∆% Aug-Sep 2012	3.0
AE ∆% May-Jul 2012	-5.8
AE ∆% Feb-Apr 2012	2.0
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 ∆% Mar-Jul	-4.9
AE ∆% Jan-Feb 2013	2.4
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 ∆% Mar-Jun	-3.3
AE ∆% Jan-Feb 2013	3.7
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Sep-Oct 2012	0.6
AE ∆% Jul-Aug 2012	7.4
AE ∆% Apr-Jun 2012	-2.0
AE ∆% Jan-Mar 2012	8.3
AE ∆% Oct-Dec 2011	0.4
AE ∆% Jul-Sep 2011	2.8
AE ∆% May-Jun 2011	-0.6
AE ∆% Jan-Apr 2011	11.4
Germany Producer Price Index
AE ∆% May-Jun	-1.8 NSA 2.4 SA
AE ∆% Feb-Apr 2013	-2.0 NSA –2.8 SA
AE ∆% Jan 2013	10.0 NSA 2.4 SA
AE ∆% Oct-Dec 2012	-1.6 NSA 0.8 SA
AE ∆% Aug-Sep 2012	4.9 NSA 4.3 SA
AE ∆% May-Jul 2012	-2.8 NSA –0.8 SA
AE ∆% Feb-Apr 2012	4.9 NSA 2.4 SA
AE ∆% Dec 2011-Jan 2012	1.2 NSA –0.6 SA
AE ∆% Oct-Nov 2011	1.8 NSA 3.0 SA
AE ∆% Jul-Sep 2011	2.8 NSA 2.8 SA
AE ∆% May-Jun 2011	0.6 NSA 4.3 SA
AE ∆% Jan-Apr 2011	10.4 NSA 6.5 SA
France Producer Price Index for the French Market
AE ∆% Apr-Jun	-10.3
AE ∆% Jan-Mar 2013	3.7
AE ∆% Nov-Dec 2012	-4.1
AE ∆% Jul-Oct 2012	8.7
AE ∆% Apr-Jun 2012	-5.1
AE ∆% Jan-Mar 2012	6.2
AE ∆% Oct-Dec 2011	2.8
AE ∆% Jul-Sep 2011	3.7
AE ∆% May-Jun 2011	-1.8
AE ∆% Jan-Apr 2011	10.4
Italy Producer Price Index
AE ∆% Jun	4.9
AE ∆% Apr-May	-3.5
AE ∆% Feb-Mar 2013	1.2
AE ∆% Sep 2012-Jan 2013	-5.2
AE ∆% Jul-Aug 2012	9.4
AE ∆% May-Jun 2012	-0.6
AE ∆% Mar-Apr 2012	6.8
AE ∆% Jan-Feb 2012	8.1
AE ∆% Oct-Dec 2011	2.0
AE ∆% Jul-Sep 2011	4.9
AE ∆% May-Jun 2011	1.8
AE ∆% Jan-April 2011	10.7
UK Output Prices
AE ∆% Jun-Jul	1.8
AE ∆% Apr-May	-1.8
AE ∆% Jan-Mar 2013	5.3
AE ∆% Nov-Dec 2012	-3.0
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 ∆% Jun-Jul	8.1
AE ∆% Mar-May 2013	-11.4
AE ∆% Jan-Feb 2013	28.3
AE ∆% Sep-Dec 2012	1.5
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://www.bls.gov/cpi/ http://www.boj.or.jp/en/

http://www.stats.gov.cn/enGliSH/

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

https://www.destatis.de/EN/Homepage.html

http://www.insee.fr/en/default.asp

http://www.istat.it/en/

http://www.ons.gov.uk/ons/index.html

Similar world inflation waves are in the behavior of consumer price indexes of six countries and the euro zone in Table IA-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 4.6 percent. (2) Risk aversion caused the collapse of inflation to annual equivalent 3.0 percent in May-Jun 2011. (3) Risk appetite drove the rate of consumer price inflation in the US to 3.3 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 2.4 percent annual equivalent in Feb-Apr 2012. (7) Under renewed risk aversion, annual equivalent consumer price inflation in the US was 0.0 percent in May-Jul 2012. (8) Inflation jumped to annual equivalent 4.9 percent in Aug-Oct 2012. (9) Unwinding of carry trades caused negative annual equivalent inflation of 0.8 percent in Nov 2012-Jan 2013 but some countries experienced higher inflation in Dec 2012 and Jan 2013. (10) Inflation jumped again with annual equivalent inflation of 8.7 percent in Feb 2013 in a mood of relaxed risk aversion. (11) Inflation fell at 3.5 percent annual equivalent in Mar-Apr 2013. (12) Inflation rose at 3.2 percent in annual equivalent in May-Jul 2013. 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→∞ or almost continuous time. 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 IA-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-Nov 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. Continuing pressure of food prices caused annual equivalent inflation of 12.2 percent in China in Dec 2012 to Feb 2013. Inflation in China fell at annual equivalent 10.3 percent in Mar 2013 and increased at annual equivalent 2.4 percent in Apr 2013. Adjustment to lower food prices caused annual equivalent inflation of minus 7.0 percent in May 2013 and minus 3.6 percent in annual equivalent in May-Jun 2013. Inflation in China returned at annual equivalent 1.2 percent in Jul 2013. 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 HICP price index fell at annual equivalent 11.4 percent in Jan 2013 and increased at 10.0 percent in Feb-Mar 2013. As in most countries and regions, euro zone inflation fell at the annual equivalent rate of 1.2 percent in Apr 2013. Prices in the euro zone rose at 1.2 percent in May-Jun 2013. Inflation in the euro zone fell at annual equivalent 5.8 percent in Jul 2013. 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 4.5 percent annual equivalent in Jul-Dec 2012 and was higher in annual equivalent inflation of producer prices in the UK in Jul-Oct 2012 at 4.0 percent for output prices and 14.0 percent for input prices in Jul-Aug 2012 (see Table IA-1). Consumer prices in the UK fell at annual equivalent 5.8 percent in Jan 2013, rebounding at 6.2 percent in Feb-Mar 2013. Inflation returned in the UK with annual equivalent 4.3 percent in Feb-May 2013 and fell at 1.2 percent in Jun-Jul 2013.

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

Index 2011-2013	AE ∆%
US Consumer Price Index
AE ∆% May-Jul 2013	3.2
AE ∆% Mar-Apr 2013	-3.5
AE ∆% Feb 2013	8.7
AE ∆% Nov 2012-Jan 2013	-0.8
AE ∆% Aug-Oct 2012	4.9
AE ∆% May-Jul 2012	0.0
AE ∆% Feb-Apr 2012	2.4
AE ∆% Dec 2011-Jan 2012	1.2
AE ∆% Oct-Nov 2011	0.6
AE ∆% Jul-Sep 2011	3.3
AE ∆% May-Jun 2011	3.0
AE ∆% Jan-Apr 2011	4.6
China Consumer Price Index
AE ∆% Jul	1.2
AE ∆% May-Jun 2013	-3.6
AE ∆% Apr 2013	2.4
AE ∆% Mar 2013	-10.3
AE ∆% Dec 2012-Feb 2013	12.2
AE ∆% Oct-Nov 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 ∆% Jul	-5.8
AE ∆% May-Jun 2013	1.2
AE ∆% Apr	-1.2
AE ∆% Feb-Mar 2013	10.0
AE ∆% Jan 2013	-11.4
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 ∆% May-Jul	4.1 NSA 3.7 SA
AE ∆% Apr	-5.8 NSA 0.0 SA
AE ∆% Feb-Mar 2013	6.8 NSA 1.2 SA
AE ∆% Jan 2013	-5.8 NSA –1.2 SA
AE ∆% Sep-Dec 2012	1.5 NSA 1.8 SA
AE ∆% Jul-Aug 2012	4.9 NSA 3.0 SA
AE ∆% May-Jun 2012	-1.2 NSA 0.6 SA
AE ∆% Feb-Apr 2012	4.5 NSA 2.4 SA
AE ∆% Dec 2011-Jan 2012	0.6 NSA 1.8 SA
AE ∆% Jul-Nov 2011	1.7 NSA 1.9 SA
AE ∆% May-Jun 2011	0.6 NSA 3.0 SA
AE ∆% Feb-Apr 2011	3.0 NSA 2.4 SA
France Consumer Price Index
AE ∆% Jul	-3.5
AE ∆% May-Jun	1.8
AE ∆% Apr	-1.2
AE ∆% Feb-Mar 2013	6.8
AE ∆% Nov 2012-Jan 2013	-1.6
AE ∆% Aug-Oct 2012	2.8
AE ∆% May-Jul 2012	-2.4
AE ∆% Feb-Apr 2012	5.3
AE ∆% Dec 2011-Jan 2012	0.0
AE ∆% Aug-Nov 2011	3.0
AE ∆% May-Jul 2011	-1.2
AE ∆% Jan-Apr 2011	4.3
Italy Consumer Price Index
AE ∆% Dec 2012-Jul 2013	1.7
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 ∆% Jun-Jul	-1.2
AE ∆% Feb-May 2013	4.3
AE ∆% Jan 2013	-5.8
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://www.bls.gov/cpi/

http://www.stats.gov.cn/enGliSH/

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

https://www.destatis.de/EN/Homepage.html

http://www.insee.fr/en/default.asp

http://www.istat.it/en/

http://www.ons.gov.uk/ons/index.html

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.

IC Long-term US Inflation. Key percentage average yearly rates of the US economy on growth and inflation are provided in Table I-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 0.3 percent and the drop in GDP of 4.3 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/2013/08/risks-of-steepening-yield-curve-and.html). US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 16 quarters from IIIQ2009 to IIQ2013. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,738.0 billion in IIQ2010 by GDP of $14,356.9 billion in IIQ2009 {[$14,738.0/$14,356.9 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). Zero interest rates and quantitative easing have not provided the impulse for growth and were not required in past successful cyclical expansions.

In the period from 1929 to 2012 the average growth rate of GDP was 3.3 percent and 3.2 percent between 1947 to 2012, which is almost the same as 3.0 percent from 1870 to 2010 measured by Lucas (2011May), as shown in Table I-1. From 1929 to 2012, nominal GDP grew at the average rate of 6.3 percent and 6.6 percent from 1947 to 2012. The implicit deflator increased at the average rate of 2.9 percent from 1929 to 2012 and at 3.3 percent from 1947 to 2012. Between 2000 and 2012, real GDP grew at the average rate of 1.7 percent per year, nominal GDP at 3.9 percent and the implicit deflator at 2.1 percent. The annual average rate of CPI increase was 3.2 percent from 1913 to 2012 and 3.7 percent from 1947 to 2012. Between 2000 and 2012, the average rate of CPI inflation was 2.4 percent per year and 2.0 percent excluding food and energy. From 2000 to 2013, the average rate of CPI inflation was 2.4 percent and 2.0 percent excluding food and energy. The average annual rate of PPI inflation was 3.1 percent from 1947 to 2012. PPI inflation increased at 2.8 percent per year on average from 2000 to 2012, 2.8 percent on average from 2000 to 2013 and at 1.8 percent excluding food and energy from 2000 to 2012 and 1.7 percent from 2000 to 2013. Producer price inflation of finished energy goods increased at average 5.7 percent between 2000 and 2012 and 5.5 percent between 2000 and 2013. There is also inflation in international trade. Import prices increased at 2.7 percent per year between 2000 and 2012 and 2.6 percent between 2000 and 2013. The commodity price shock is revealed by inflation of import prices of petroleum increasing at 10.9 percent per year between 2000 and 2012 and at 10.7 percent between 2000 and 2013. The average percentage rates of increase of import prices excluding fuels are much lower at 1.9 percent for 2002 to 2012 and 1.6 percent for 2002 to 2013. Export prices rose at the average rate of 2.4 percent between 2000 and 2012 and at 2.2 percent from 2000 to 2013. 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 6.8 percent from 2000 to 2012 and at 6.5 percent from 2000 to 2013. US nonagricultural export prices rose at 2.0 percent per year from 2000 to 2012 and at 1.8 percent from 2000 to 2013. 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. There is no reality of the proposition of need of unconventional monetary policy in the US because of deflation panic.

Table I-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	2000-2012: 1.7% 1929-2012: 3.3% 1947-2012: 3.2%
Nominal GDP	2000-2012: 3.9% 1929-2012: 6.3% 1947-2012: 6.6%
Implicit Price Deflator	2000-2012: 2.1% 1929-2012: 2.9% 1947-2012: 3.3%
CPI	2000-2012: 2.4% 2000-2013: 2.4% Annual 1913-2012: 3.2% 1947-2012: 3.7
CPI ex Food and Energy	2000-2012: 2.0% 2000-2013: 2.0%
PPI	2000-2012: 2.8% 2000-2013: 2.8% Annual 1947-2012: 3.1%
PPI ex Food and Energy	2000-2012: 1.8% 2000-2013: 1.7%
PPI Finished Energy Goods	2000-2012: 5.7% 2000-2013: 5.5%
Import Prices	2000-2012: 2.7% 2000-2013: 2.6%
Import Prices of Petroleum and Petroleum Products	2000-2012: 10.9% 2000-2013: 10.7%
Import Prices Excluding Petroleum	2000-2012: 1.2% 2000-2013: 1.1%
Import Prices Excluding Fuels	2002-2012: 1.9% 2002-2013: 1.6%
Export Prices	2000-2012: 2.4% 2000-2013: 2.2%
Agricultural Export Prices	2000-2012: 6.8% 2000-2013: 6.5%
Nonagricultural Export Prices	2000-2012: 2.0% 2000-2013: 1.8%

Note: rates for price indexes in the row beginning with “CPI” and ending in the row “Nonagricultural Export Prices” are for Jul 2000 to Jul 2012 and for Jul 2000 to Jul 2013 using not seasonally adjusted indexes. Import prices excluding fuels are not available before Dec 2001.

Sources: http://www.bea.gov/iTable/index_nipa.cfm http://www.bls.gov/ppi/ http://www.bls.gov/cpi/ http://www.bls.gov/mxp/home.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 since the 1960s (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 1998,

-1.3 percent in 2002

-2.6 percent in 2009.

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

Chart I-1 provides US nominal GDP from 1929 to 2012. The chart disguises the decline of nominal GDP during the 1930s from $104.6 billion in 1929 to $57.2 billion in 1933 or by 45.3 percent (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). The level of nominal GDP reached $102.9 billion in 1940 and exceeded the $104.6 billion of 1929 only with $129.4 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 4.3 percent. US nominal GDP fell from $14,720.3 billion in 2008 to $14,417.9 billion in 2009 or by 2.1percent but rose to $14,958.3 billion in 2010 or by 3.7 percent, to $15,533.8 billion in 2011 for an additional 3.8 percent for cumulative increase of 7.7 percent relative to 2009 and to $16,244.6 billion in 2012 for an additional 4.6 percent and cumulative increase of 12.7 percent relative to 2009. US nominal GDP increased from $14,480.3 in 2007 to $16,244.6 billion in 2012 or by 12.2 percent (http://www.bea.gov/iTable/index_nipa.cfm). 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 26.3 percent cumulatively and fell 45.3 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/2013/08/risks-of-steepening-yield-curve-and.html).

Chart I-1, US, Nominal GDP 1929-2012

Source: US Bureau of Economic Analysis

Chart I-2 provides US real GDP from 1929 to 2012. The chart also disguises the Great Depression of the 1930s. In the four years of 1929 to 1933, GDP in constant dollars fell 26.3 percent cumulatively and fell 45.3 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 I-2 except for periodic recessions in the US economy that have occurred throughout history.

Chart I-2, US, Real GDP 1929-2012

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 I-3 from 1929 to 2012 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). In contrast, the implicit price deflator of GDP of the US increased from 97.335 (2009 =100) in 2007 to 100.00 in 2009 or by 2.7 percent and increased to 105.002 in 2012 or by 5.0 percent relative to 2009 and 7.9 percent relative to 2007. The implicit price deflator of US GDP increased in every quarter from IVQ2007 to IVQ2012 with only one decline from 100.064 in IQ2009 to 99.897 in IIQ2009 or by 0.2 percent (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 I-3, US, GDP Implicit Price Deflator 1929-2012

Source: US Bureau of Economic Analysis

Chart I-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 0.6 percent in IIQ2009 that was adjustment from 2.8 percent in IIIQ2008 following 2.3 percent in IQ2008 and 1.8 percent IIQ2008 caused by carry trades from policy interest rates being moved to zero into commodity futures. These positions were reversed because of 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 I-4, Percent Change from Preceding Period in Prices for GDP Seasonally Adjusted at Annual Rates 1980-2013

Source: US Bureau of Economic Analysis

Chart I-5 provides percent change from preceding year in prices of GDP from 1929 to 2012. There are four consecutive years of declines of prices of GDP during the Great Depression: 3.8 percent in 1930, 9.9 percent in 1931, 11.4 percent in 1932 and 2.7 percent in 1933. There were two consecutive declines of 1.8 percent in 1938 and 1.2 percent in 1939. Prices of GDP were fell 0.1 percent in 1949 after increasing 12.6 percent in 1946, 11.2 percent in 1947 and 5.6 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 2012.

Chart I-5, Percent Change from Preceding Year in Prices for Gross Domestic Product 1930-2012

The producer price index of the US from 1947 to 2013 in Chart I-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 I-6, US, Producer Price Index, Finished Goods, NSA, 1947-2013

Source: US Bureau of Labor Statistics

Chart I-7 provides 12-month percentage changes of the producer price index from 1948 to 2013. The distinguishing event in Chart I-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 2013.

Chart I-7, US, Producer Price Index, Finished Goods, 12-Month Percentage Change, NSA, 1948-2013

Source: US Bureau of Labor Statistics

Annual percentage changes of the producer price index from 1948 to 2012 are shown in Table I-1A. The producer price index fell 2.8 percent in 1949 following the adjustment to World War II and fell 0.6 percent in 1952 and 1.0 percent in 1953 around the Korean War. There are two other mild decline of 0.3 percent in 1959 and 0.3 percent in 1963. There are only few subsequent and isolated declines of the producer price index of 1.4 percent in 1986, 0.8 percent in 1998, 1.3 percent in 2002 and 2.6 percent in 2009. The decline of 2009 was caused by unwinding of carry trades in 2008 that had lifted oil prices to $140/barrel during deep global recession because of the panic of probable toxic assets in banks that would be removed with the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009). There is no evidence in this history of 65 years of the US producer price index suggesting that there is frequent and persistent deflation shock requiring aggressive unconventional monetary policy. The design of such anti-deflation policy could provoke price and financial instability because of lags in effect of monetary policy, model errors, inaccurate forecasts and misleading analysis of current economic conditions.

Table I-1A, US, Annual PPI Inflation ∆% 1948-2012

Year	Annual
1948	8.0
1949	-2.8
1950	1.8
1951	9.2
1952	-0.6
1953	-1.0
1954	0.3
1955	0.3
1956	2.6
1957	3.8
1958	2.2
1959	-0.3
1960	0.9
1961	0.0
1962	0.3
1963	-0.3
1964	0.3
1965	1.8
1966	3.2
1967	1.1
1968	2.8
1969	3.8
1970	3.4
1971	3.1
1972	3.2
1973	9.1
1974	15.4
1975	10.6
1976	4.5
1977	6.4
1978	7.9
1979	11.2
1980	13.4
1981	9.2
1982	4.1
1983	1.6
1984	2.1
1985	1.0
1986	-1.4
1987	2.1
1988	2.5
1989	5.2
1990	4.9
1991	2.1
1992	1.2
1993	1.2
1994	0.6
1995	1.9
1996	2.7
1997	0.4
1998	-0.8
1999	1.8
2000	3.8
2001	2.0
2002	-1.3
2003	3.2
2004	3.6
2005	4.8
2006	3.0
2007	3.9
2008	6.3
2009	-2.6
2010	4.2
2011	6.0
2012	1.9

Source: US Bureau of Labor Statistics

The producer price index excluding food and energy from 1973 to 2013, 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 I-8. There is no evidence of persistent deflation in the US PPI.

Chart I-8, US Producer Price Index, Finished Goods Excluding Food and Energy, NSA, 1973-2013

Source: US Bureau of Labor Statistics

Chart I-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 I-9, US Producer Price Index, Finished Goods Excluding Food and Energy, 12-Month Percentage Change, NSA, 1974-2013

Source: US Bureau of Labor Statistics

The producer price index of energy goods from 1974 to 2013 is provided in Chart I-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 I-10, US, Producer Price Index, Finished Energy Goods, NSA, 1974-2013

Source: US Bureau of Labor Statistics

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

Chart I-11 shows 12-month percentage changes of the producer price index of finished energy goods from 1975 to 2013. 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 I-11, US, Producer Price Index, Finished Energy Goods, 12-Month Percentage Change, NSA, 1974-2013

Source: US Bureau of Labor Statistics

http://www.bls.gov/ppi

Chart I-12 provides the consumer price index NSA from 1914 to 2013. 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 I-12, US, Consumer Price Index, NSA, 1914-2013

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

Chart I-13 provides 12-month percentage changes of the consumer price index from 1914 to 2013. 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 I-13, US, Consumer Price Index, All Items, 12- Month Percentage Change 1914-2013

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

Table I-2 provides annual percentage changes of United States consumer price inflation from 1914 to 2013. 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 I-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 http://www.bls.gov/cpi/data.htm

Chart I-14 provides the consumer price index excluding food and energy from 1957 to 2013. There is long-term inflation in the US without episodes of persistent deflation.

Chart I-14, US, Consumer Price Index Excluding Food and Energy, NSA, 1957-2013

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

Chart I-15 provides 12-month percentage changes of the consumer price index excluding food and energy from 1958 to 2013. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.

Chart I-15, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 1958-2013

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

The consumer price index of housing is provided in Chart I-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 I-16, US, Consumer Price Index Housing, NSA, 1967-2013

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

Chart I-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 I-17, US, Consumer Price Index, Housing, 12- Month Percentage Change, NSA, 1968-2013

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

ID Current US Inflation. Consumer price inflation has fluctuated in recent months. Table I-3 provides 12-month consumer price inflation in Jul 2013 and annual equivalent percentage changes for the months of May-Jul 2013 of the CPI and major segments. The final column provides inflation from Jun 2013 to Jul 2013. CPI inflation in the 12 months ending in Jul 2013 reached 2.0 percent, the annual equivalent rate May to Jul 2013 was minus 3.2 percent in the new episode of creating carry trades from zero interest rates to commodities exposures and the monthly inflation rate of 0.2 percent annualizes at 2.4 percent with new carry trades at the margin. 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 recent risk aversion in commodities markets caused lower inflation worldwide (with return in some countries in Dec 2012 and Jan-Feb 2013) that followed 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). Carry trades moved away from commodities into stocks with resulting weaker commodity prices and stronger equity valuations. There is return of exposures in commodities. With zero interest rates, commodity prices would increase again in an environment of risk appetite. Excluding food and energy, CPI inflation was 1.7 percent in the 12 months ending in Jul 2013 and 2.4 percent in annual equivalent in May to Jul 2013. 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 tapering 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 1.4 percent in 12 months ending in Jul 2013 and at 0.8 percent in annual equivalent in May to Jul 2013. 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 (http://cmpassocregulationblog.blogspot.com/2013/08/recovery-without-hiring-loss-of-full.html) and without jobs (http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). Energy consumer prices increased 4.7 percent in 12 months, increased 17.1 percent in annual equivalent in May to Jul 2013 and increased 0.2 percent in Jul 2013 or at 2.4 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 May to Jul 2013 in any of the categories in Table I-2 but simply reflecting waves of inflation originating in carry trades. Carry trades from zero interest rates to commodity futures positions with episodes of risk aversion causing fluctuations determine an upward trend of prices.

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

	% RI	∆% 12 Months Jul 2013/Jul 2012 NSA	∆% Annual Equivalent May 2013 to Jul 2013 SA	∆% Jul 2013/Jun 2013 SA
CPI All Items	100.000	2.0	3.2	0.2
CPI ex Food and Energy	75.699	1.7	2.4	0.2
Food	14.156	1.4	0.8	0.1
Food at Home	8.476	1.0	0.0	0.1
Food Away from Home	5.680	2.1	2.4	0.2
Energy	10.145	4.7	17.1	0.2
Gasoline	5.668	5.2	32.9	1.0
Electricity	3.049	3.1	2.8	-0.3
Commodities less Food and Energy	19.378	-0.2	0.8	0.0
New Vehicles	3.155	1.2	1.6	0.1
Used Cars and Trucks	1.894	-2.1	-3.5	-0.4
Medical Care Commodities	1.692	-0.1	1.6	0.4
Apparel	3.519	1.6	7.0	0.6
Services Less Energy Services	56.321	2.4	2.4	0.2
Shelter	31.585	2.3	2.8	0.2
Rent of Primary Residence	6.504	2.8	2.8	0.2
Owner’s Equivalent Rent of Residences	23.873	2.2	2.0	0.1
Transportation Services	5.817	3.0	2.8	0.4
Medical Care Services	5.446	2.6	1.2	0.1

% RI: Percent Relative Importance

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 I-4 with the BLS update for Dec 2012 (http://www.bls.gov/cpi/cpiri2012.pdf). Housing has a weight of 41.021 percent. The combined weight of housing and transportation is 57.867 percent or more than one-half of consumer expenditures of all urban consumers. The combined weight of housing, transportation and food and beverages is 73.128 percent of the US CPI. Table I-3 provides relative importance of key items in Jul 2013.

Table I-4, US, Relative Importance, 2009-2010 Weights, of Components in the Consumer Price Index, US City Average, Dec 2012

All Items	100.000
Food and Beverages	15.261
Food	14.312
Food at home	8.898
Food away from home	5.713
Housing	41.021
Shelter	31.681
Rent of primary residence	6.545
Owners’ equivalent rent	22.622
Apparel	3.564
Transportation	16.846
Private Transportation	15.657
New vehicles	3.189
Used cars and trucks	1.844
Motor fuel	5.462
Gasoline	5.274
Medical Care	7.163
Medical care commodities	1.714
Medical care services	5.448
Recreation	5.990
Education and Communication	6.779
Other Goods and Services	3.376

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 http://www.bls.gov/cpi/cpiri2012.pdf

Chart I-18 provides the US consumer price index for housing from 2001 to 2013. Housing prices rose sharply during the decade until the bump of the global recession and increased again in 2011-2012 with some stabilization. The CPI excluding housing would likely show much higher inflation. The commodity carry trades resulting from unconventional monetary policy have compressed income remaining after paying for indispensable shelter.

Chart I-18, US, Consumer Price Index, Housing, NSA, 2001-2013

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

Chart I-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 2012-2013 but with the rate declining and then increasing.

Chart I-19, US, Consumer Price Index, Housing, 12-Month Percentage Change, NSA, 2001-2013

Source: US Bureau of Labor Statistics

There have been waves of consumer price inflation in the US in 2011 and into 2012 (Section IA and earlier at http://cmpassocregulationblog.blogspot.com/2013/07/tapering-quantitative-easing-policy-and.html) that are illustrated in Table I-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 4.6 percent and the CPI excluding food and energy increased at annual equivalent rate of 2.1 percent. The second wave occurred during the collapse of the carry trade from zero interest rates to exposures in commodity futures because 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 3.0 percent in May-Jun 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 3.3 percent while the core CPI increased at 2.0 percent. The fourth wave occurred in the form of increase 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 2.4 percent. In the sixth wave, headline CPI inflation increased at annual equivalent 3.7 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 2.4 percent in Feb-Apr and 2.0 percent for the core CPI. The seventh wave in May-Jul occurred with annual equivalent inflation of 0.0 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 6.2 percent in Aug-Sep 2012 but 4.9 percent including Oct. In the ninth wave, annual equivalent inflation in Nov 2012 was minus 2.4 percent under the new shock of risk aversion and 0.0 percent in Dec 2012 with annual equivalent of minus 0.8 percent in Nov 2012-Jan 2013 and 2.0 percent for the core CPI. In the tenth wave, annual equivalent of headline CPI was 8.7 percent in Feb 2013 and 2.4 percent for the core CPI. In the eleventh wave, annual equivalent was minus 3.5 percent in Mar-Apr 2013 and 1.2 percent for the core index. In the twelfth wave, annual equivalent inflation was 3.2 percent in May-Jul 2013 and 2.4 percent for the core CPI. The conclusion is that inflation accelerates and decelerates in unpredictable fashion because of shocks or risk aversion in carry trades from zero interest rates to commodity derivatives.

Table I-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
Jul 2013	0.2	2.0	0.2	1.7
Jun	0.5	1.8	0.2	1.6
May	0.1	1.4	0.2	1.7
AE ∆% May-Jul	3.2		2.4
Apr	-0.4	1.1	0.1	1.7
Mar	-0.2	1.5	0.1	1.9
AE ∆% Mar-Apr	-3.5		1.2
Feb	0.7	2.0	0.2	2.0
AE ∆% Feb	8.7		2.4
Jan	0.0	1.6	0.3	1.9
Dec 2012	0.0	1.7	0.1	1.9
Nov	-0.2	1.8	0.1	1.9
AE ∆% Nov-Jan	-0.8		2.0
Oct	0.2	2.2	0.2	2.0
Sep	0.5	2.0	0.2	2.0
Aug	0.5	1.7	0.1	1.9
AE ∆% Aug-Oct	4.9		2.0
Jul	0.0	1.4	0.1	2.1
Jun	0.1	1.7	0.2	2.2
May	-0.1	1.7	0.2	2.3
AE ∆% May-Jul	0.0		2.0
Apr	0.0	2.3	0.2	2.3
Mar	0.3	2.7	0.2	2.3
Feb	0.3	2.9	0.1	2.2
AE ∆% Feb-Apr	2.4		2.0
Jan	0.2	2.9	0.2	2.3
Dec 2011	0.0	3.0	0.2	2.2
AE ∆% Dec-Jan	1.2		2.4
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	0.2	3.6	0.2	1.8
AE ∆% Jul-Sep	3.3		2.0
Jun	0.1	3.6	0.2	1.6
May	0.4	3.6	0.3	1.5
AE ∆% May-Jun	3.0		3.0
Apr	0.3	3.2	0.2	1.3
Mar	0.5	2.7	0.1	1.2
Feb	0.4	2.1	0.2	1.1
Jan	0.3	1.6	0.2	1.0
AE ∆% Jan-Apr	4.6		2.1
Dec 2010	0.5	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	0.1	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	0.0	2.0	0.1	0.9
Apr	0.0	2.2	0.0	0.9
Mar	0.0	2.3	0.0	1.1
Feb	-0.1	2.1	0.1	1.3
Jan	0.1	2.6	-0.1	1.6

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

Source: US Bureau of Labor Statistics

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

The behavior of the US consumer price index NSA from 2001 to 2013 is provided in Chart I-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 I-20, US, Consumer Price Index, NSA, 2001-2013

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

Chart I-21 provides 12-month percentage changes of the consumer price index from 2001 to 2013. 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 I-21, US, Consumer Price Index, 12-Month Percentage Change, NSA, 2001-2013

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

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

Chart I-22, US, Consumer Price Index Excluding Food and Energy, NSA, 2001-2013

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

Chart I-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 because 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 I-23, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2001-2013

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

Headline and core producer price indexes are in Table I-6. The headline PPI SA changed 0.0 percent in Jul 2013 and increased 2.1 percent NSA in the 12 months ending in Jul 2013. The core PPI SA increased 0.1 percent in Jun 2013 and rose 1.2 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 10.0 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 Jun 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 1.8 percent in May-Jun 2011 but the core annual equivalent inflation rate was higher at 2.4 percent. In the third wave, headline PPI inflation resuscitated with annual equivalent at 4.9 percent in Jul-Sep 2011 and core PPI inflation at 3.7 percent. Core PPI inflation was persistent throughout 2011, jumping from annual equivalent at 1.5 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 0.6 percent in Oct-Nov 2011 and 1.8 percent in the core annual equivalent. In the fifth wave from Dec 2011 to Jan 2012, annual equivalent inflation was 0.0 percent for the headline index but 4.3 percent for the core index excluding food and energy. In the sixth wave, annual equivalent inflation in Feb-Mar 2012 was 2.4 percent for the headline PPI and 2.4 percent for the core. In the seventh wave, renewed risk aversion caused reversal of carry trades into commodity exposures with annual equivalent headline inflation of minus 4.7 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 4.3 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 12.7 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 3.2 percent in Oct-Dec in the headline index and 1.2 percent in the core index. In the eleventh wave, annual equivalent inflation was 5.5 percent in the headline index in Jan-Feb 2013 and 1.8 percent in the core index. In the twelfth wave, annual equivalent was minus 7.5 percent in Mar-Apr 2012 and 1.8 percent for the core index. In the thirteenth wave, annual equivalent inflation returned at 5.3 percent in May-Jul 2013 and 1.6 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 I-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
Jul 2013	0.0	2.1	0.1	1.2
Jun	0.8	2.5	0.2	1.7
May	0.5	1.7	0.1	1.7
AE ∆% May-Jul	5.3		1.6
Apr	-0.7	0.6	0.1	1.7
Mar	-0.6	1.1	0.2	1.7
AE ∆% Mar-Apr	-7.5		1.8
Feb	0.7	1.8	0.1	1.8
Jan	0.2	1.5	0.2	1.8
AE ∆% Jan-Feb	5.5		1.8
Dec 2012	-0.1	1.4	0.2	2.1
Nov	-0.5	1.5	0.1	2.2
Oct	-0.2	2.3	0.0	2.2
AE ∆% Oct-Dec	-3.2		1.2
Sep	1.0	2.1	0.1	2.4
Aug	1.0	1.9	0.0	2.6
AE ∆% Aug-Sep	12.7		0.6
Jul	0.4	0.5	0.5	2.6
Jun	0.1	0.7	0.2	2.6
AE ∆% Jun-Jul	3.0		4.3
May	-0.6	0.6	0.1	2.7
Apr	-0.2	1.8	0.1	2.7
AE ∆% Apr-May	-4.7		1.2
Mar	0.1	2.8	0.2	2.9
Feb	0.3	3.4	0.2	3.1
AE ∆% Feb-Mar	2.4		2.4
Jan	0.1	4.1	0.4	3.1
Dec 2011	-0.1	4.7	0.3	3.0
AE ∆% Dec-Jan	0.0		4.3
Nov	0.4	5.6	0.1	3.0
Oct	-0.3	5.8	0.2	2.9
AE ∆% Oct-Nov	0.6		1.8
Sep	0.9	7.0	0.3	2.8
Aug	-0.3	6.6	0.1	2.7
Jul	0.6	7.1	0.5	2.7
AE ∆% Jul-Sep	4.9		3.7
Jun	-0.1	6.9	0.3	2.3
May	0.4	7.1	0.1	2.1
AE ∆% May-Jun	1.8		2.4
Apr	0.7	6.6	0.3	2.3
Mar	0.7	5.6	0.3	2.0
Feb	1.1	5.4	0.3	1.8
Jan	0.7	3.6	0.4	1.6
AE ∆% Jan-Apr	10.0		4.0
Dec 2010	0.9	3.8	0.2	1.4
Nov	0.6	3.4	0.0	1.2
Oct	0.7	4.3	-0.1	1.6
Sep	0.4	3.9	0.2	1.6
Aug	0.4	3.3	0.1	1.3
Jul	0.3	4.1	0.1	1.5
Jun	-0.3	2.7	0.1	1.1
May	0.0	5.1	0.3	1.3
Apr	-0.2	5.4	0.0	0.9
Mar	0.7	5.9	0.2	0.9
Feb	-0.7	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 2013 is shown in Chart I-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 I-24, US, Producer Price Index, NSA, 2000-2013

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the PPI NSA from 2000 to 2013 are shown in Chart I-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 I-25, US, Producer Price Index, 12-Month Percentage Change NSA, 2000-2013

Source: US Bureau of Labor Statistics

The US PPI excluding food and energy from 2000 to 2013 is shown in Chart I-26. There is here again a smooth trend of inflation instead of prolonged deflation as in Japan.

Chart I-26, US, Producer Price Index Excluding Food and Energy, NSA, 2000-2013

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the producer price index excluding food and energy are shown in Chart I-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 2012-2013.

Chart I-27, US, Producer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2000-2013

Source: US Bureau of Labor Statistics

The US producer price index of energy goods from 2000 to 2013 is in Chart I-28. There is a clear upward trend with fluctuations that would not occur under persistent deflation.

Chart I-28, US, Producer Price Index Finished Energy Goods, NSA, 2000-2013

Source: US Bureau of Labor Statistics

Chart I-29 provides 12-month percentage changes of the producer price index of energy goods from 2000 to 2013. Barsky and Kilian (2004) relate the episode of declining prices of energy goods in 2001 to 2002 to the analysis of decline of real oil prices. Interest rates dropping to zero during the global recession in 2008 induced carry trades that 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 I-29, US, Producer Price Index Energy Goods, 12-Month Percentage Change, NSA, 2000-2013

Source: US Bureau of Labor Statistics