Interest Rate Risks, World Inflation Waves, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, Collapse of United States Dynamism of Income Growth and Employment Creation, Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities, United States Industrial Production, World Cyclical Slow Growth and Global Recession Risk: Part I

 

Interest Rate Risks, World Inflation Waves, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, Collapse of United States Dynamism of Income Growth and Employment Creation, Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities, United States Industrial Production, World Cyclical Slow Growth and Global Recession Risk

Carlos M. Pelaez

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014

Executive Summary

I World Inflation Waves

IA Appendix: Transmission of Unconventional Monetary Policy

IB1 Theory

IB2 Policy

IB3 Evidence

IB4 Unwinding Strategy

IB United States Inflation

IC Long-term US Inflation

ID Current US Inflation

IE Theory and Reality of Economic History, Cyclical Slow Growth Not Secular Stagnation and Monetary Policy Based on Fear of Deflation

IB Collapse of United States Dynamism of Income Growth and Employment Creation

IIA Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk

Premium on Treasury Securities

IIA1 United States Unsustainable Deficit/Debt

IIA2 Unresolved US Balance of Payments Deficits

IIB United States Industrial Production

III World Financial Turbulence

IIIA Financial Risks

IIIE Appendix Euro Zone Survival Risk

IIIF Appendix on Sovereign Bond Valuation

IV Global Inflation

V World Economic Slowdown

VA United States

VB Japan

VC China

VD Euro Area

VE Germany

VF France

VG Italy

VH United Kingdom

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

Appendixes

Appendix I The Great Inflation

IIIB Appendix on Safe Haven Currencies

IIIC Appendix on Fiscal Compact

IIID Appendix on European Central Bank Large Scale Lender of Last Resort

IIIG Appendix on Deficit Financing of Growth and the Debt Crisis

IIIGA Monetary Policy with Deficit Financing of Economic Growth

IIIGB Adjustment during the Debt Crisis of the 1980s

Executive Summary

Contents of Executive Summary

ESI Increasing Interest Rate Risk, Tapering Quantitative Easing, Duration Dumping, Steepening

Yield Curve and Global Financial and Economic Risk

ESII World Inflation Waves

ESIII Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates

ESIV Collapse of United States Dynamism of Income Growth and Employment Creation

ESV Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities

ESVI United States Industrial Production

ESI Increasing Interest Rate Risk, Tapering Quantitative Easing, Duration Dumping, Steepening Yield Curve and Global Financial and Economic Risk. The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task for both theory and measurement. The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task for both theory and measurement. The IMF (2013WEOOct) provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/pubs/ft/weo/2013/02/), of the world financial system with its Global Financial Stability Report (GFSR) (IMF 2013GFSROct) (http://www.imf.org/External/Pubs/FT/GFSR/2013/02/index.htm) and of fiscal affairs with the Fiscal Monitor (IMF 2013FMOct) (http://www.imf.org/external/pubs/ft/fm/2013/02/fmindex.htm). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider a summary of global economic and financial risks, which are analyzed in detail in the comments of this blog in Section VI Valuation of Risk Financial Assets, Table VI-4.

Economic risks include the following:

1. China’s Economic Growth. China is lowering its growth target to 7.5 percent per year. China’s GDP growth decelerated from 12.1 percent in IQ2010 and 11.2 percent in IIQ2010 to 7.7 percent in IQ2013, 7.5 percent in IIQ2013 and 7.8 percent in IIIQ2013. GDP grew 7.7 percent in IVQ2013 relative to a year earlier and 1.8 percent relative to IIIQ2013, which is equivalent to 7.4 percent per year (http://cmpassocregulationblog.blogspot.com/2014/01/capital-flows-exchange-rates-and.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/07/tapering-quantitative-easing-policy-and_7005.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/01/recovery-without-hiring-world-inflation.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/10/world-inflation-waves-stagnating-united_21.html). There is also concern about indebtedness, move to devaluation and deep policy reforms.
2. United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 29.3 million in job stress, fewer 10 million full-time jobs, high youth unemployment, historically low hiring and declining/stagnating real wages. Actual GDP is about two trillion dollars lower than trend GDP.
3. Economic Growth and Labor Markets in Advanced Economies. Advanced economies are growing slowly. There is still high unemployment in advanced economies.
4. World Inflation Waves. Inflation continues in repetitive waves globally (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/02/squeeze-of-economic-activity-by-carry.html and earlier http://cmpassocregulationblog.blogspot.com/2014/01/world-inflation-waves-interest-rate.html). There is growing concern on capital outflows and currency depreciation of emerging markets.

A list of financial uncertainties includes:

1. Euro Area Survival Risk. The resilience of the euro to fiscal and financial doubts on larger member countries is still an unknown risk.
2. Foreign Exchange Wars. Exchange rate struggles continue as zero interest rates in advanced economies induce devaluation of their currencies with alternating episodes of revaluation.
3. Valuation of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with lower volumes.
4. Duration Trap of the Zero Bound. The yield of the US 10-year Treasury rose from 2.031 percent on Mar 9, 2012, to 2.294 percent on Mar 16, 2012. Considering a 10-year Treasury with coupon of 2.625 percent and maturity in exactly 10 years, the price would fall from 105.3512 corresponding to yield of 2.031 percent to 102.9428 corresponding to yield of 2.294 percent, for loss in a week of 2.3 percent but far more in a position with leverage of 10:1. Min Zeng, writing on “Treasurys fall, ending brutal quarter,” published on Mar 30, 2012, in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303816504577313400029412564.html?mod=WSJ_hps_sections_markets), informs that Treasury bonds maturing in more than 20 years lost 5.52 percent in the first quarter of 2012.
5. Credibility and Commitment of Central Bank Policy. There is a credibility issue of the commitment of monetary policy (Sargent and Silber 2012Mar20).
6. Carry Trades. Commodity prices driven by zero interest rates have resumed their increasing path with fluctuations caused by intermittent risk aversion

What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Mar 19, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140319a.htm):

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.” (emphasis added).

How long is “considerable time”? At the press conference following the meeting on Mar 19, 2014, Chair Yellen answered a question of Jon Hilsenrath of the Wall Street Journal explaining “In particular, the Committee has endorsed the view that it anticipates that will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates. And of course on our present path, well, that's not utterly preset. We would be looking at next, next fall. So, I think that's important guidance” (file:///C:/Users/cmpelaez/Desktop/%7BYellenPressConferenceFOMCpresconf20140319.pdf03192014%7D.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”

Chart VIII-1 of the Board of Governors of the Federal Reserve System provides the rate on the overnight fed funds rate and the yields of the 10-year constant maturity Treasury and the Baa seasoned corporate bond. Table VIII-3 provides the data for selected points in Chart VIII-1. There are two important economic and financial events, illustrating the ease of inducing carry trade with extremely low interest rates and the resulting financial crash and recession of abandoning extremely low interest rates.

• The Federal Open Market Committee (FOMC) lowered the target of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85). Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment. The exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV). The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever-increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity by the penalty in the form of low interest rates and unsound credit decisions. The put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). The FOMC implemented increments of 25 basis points of the fed funds target from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006, as shown in Chart VIII-1. The gradual exit from the first round of unconventional monetary policy from 1.00 percent in Jun 2004 (http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040630/default.htm) to 5.25 percent in Jun 2006 (http://www.federalreserve.gov/newsevents/press/monetary/20060629a.htm) caused the financial crisis and global recession.
• On Dec 16, 2008, the policy determining committee of the Fed decided (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm): “The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.” Policymakers emphasize frequently that there are tools to exit unconventional monetary policy at the right time. At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states that: “The Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.” Perception of withdrawal of $2614 billion, or $2.6 trillion, of bank reserves (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1), would cause Himalayan increase in interest rates that would provoke another recession. There is no painless gradual or sudden exit from zero interest rates because reversal of exposures created on the commitment of zero interest rates forever.

In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):

“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differ from each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”

Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and r^e the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+r^e). Thus, g = [(r/r^e) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dr^e>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Friedman 1957). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (1)

Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.

Chart VIII-1, Fed Funds Rate and Yields of Ten-year Treasury Constant Maturity and Baa Seasoned Corporate Bond, Jan 2, 2001 to Mar 20, 2014 

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/

Table VIII-3, Selected Data Points in Chart VIII-1, % per Year

	Fed Funds Overnight Rate	10-Year Treasury Constant Maturity	Seasoned Baa Corporate Bond
1/2/2001	6.67	4.92	7.91
10/1/2002	1.85	3.72	7.46
7/3/2003	0.96	3.67	6.39
6/22/2004	1.00	4.72	6.77
6/28/2006	5.06	5.25	6.94
9/17/2008	2.80	3.41	7.25
10/26/2008	0.09	2.16	8.00
10/31/2008	0.22	4.01	9.54
4/6/2009	0.14	2.95	8.63
4/5/2010	0.20	4.01	6.44
2/4/2011	0.17	3.68	6.25
7/25/2012	0.15	1.43	4.73
5/1/13	0.14	1.66	4.48
9/5/13	0.08	2.98	5.53
11/21/2013	0.09	2.79	5.44
11/26/13	0.09	2.74	5.34 (11/26/13)
12/5/13	0.09	2.88	5.47
12/11/13	0.09	2.89	5.42
12/18/13	0.09	2.94	5.36
12/26/13	0.08	3.00	5.37
1/1/2014	0.08	3.00	5.34
1/8/2014	0.07	2.97	5.28
1/15/2014	0.07	2.86	5.18
1/22/2014	0.07	2.79	5.11
1/30/2014	0.07	2.72	5.08
2/6/2014	0.07	2.73	5.13
2/13/2014	0.06	2.73	5.12
2/20/14	0.07	2.76	5.15
2/27/14	0.07	2.65	5.01
3/6/14	0.08	2.74	5.11
3/13/14	0.08	2.66	5.05
3/20/14	0.08	2.79	5.13

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/

It is quite difficult to measure inflationary expectations because they tend to break abruptly from past inflation. There could still be an influence of past and current inflation in the calculation of future inflation by economic agents. Table VIII-1 provides inflation of the CPI. In the three months Dec 2013 to Feb 2014, CPI inflation for all items seasonally adjusted was 1.6 percent in annual equivalent, obtained by calculating accumulated inflation from Dec 2013 to Feb 2014 and compounding for a full year. In the 12 months ending in Feb 2014, CPI inflation of all items not seasonally adjusted was 1.1 percent. Inflation in Feb 2014 seasonally adjusted was 0.1 percent relative to Jan 2014, or 1.2 percent annual equivalent (http://www.bls.gov/cpi/). The second row provides the same measurements for the CPI of all items excluding food and energy: 1.6 percent in 12 months and 1.2 percent in annual equivalent Dec 2013-Feb 2014. The Wall Street Journal provides the yield curve of US Treasury securities (http://professional.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3000). The shortest term is 0.048 percent for one month, 0.053 percent for three months, 0.081 percent for six months, 0.129 percent for one year, 0.429 percent for two years, 0.897 percent for three years, 1.709 percent for five years, 2.288 percent for seven years, 2.747 percent for ten years and 3.611 percent for 30 years. The Irving Fisher (1930) definition of real interest rates is approximately the difference between nominal interest rates, which are those estimated by the Wall Street Journal, and the rate of inflation expected in the term of the security, which could behave as in Table VIII-1. Inflation in Jan 2014 is low in 12 months because of the unwinding of carry trades from zero interest rates to commodity futures prices but could ignite again with subdued risk aversion. Real interest rates in the US have been negative during substantial periods in the past decade while monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”

Negative real rates of interest distort calculations of risk and returns from capital budgeting by firms, through lending by financial intermediaries to decisions on savings, housing and purchases of households. Inflation on near zero interest rates misallocates resources away from their most productive uses and creates uncertainty of the future path of adjustment to higher interest rates that inhibit sound decisions.

Professionals use a variety of techniques in measuring interest rate risk (Fabozzi, Buestow and Johnson, 2006, Chapter Nine, 183-226):

• Full valuation approach in which securities and portfolios are shocked by 50, 100, 200 and 300 basis points to measure their impact on asset values
• Stress tests requiring more complex analysis and translation of possible events with high impact even if with low probability of occurrence into effects on actual positions and capital
• Value at Risk (VaR) analysis of maximum losses that are likely in a time horizon
• Duration and convexity that are short-hand convenient measurement of changes in prices resulting from changes in yield captured by duration and convexity
• Yield volatility

Analysis of these methods is in Pelaez and Pelaez (International Financial Architecture (2005), 101-162) and Pelaez and Pelaez, Globalization and the State, Vol. (I) (2008a), 78-100). Frederick R. Macaulay (1938) introduced the concept of duration in contrast with maturity for analyzing bonds. Duration is the sensitivity of bond prices to changes in yields. In economic jargon, duration is the yield elasticity of bond price to changes in yield, or the percentage change in price after a percentage change in yield, typically expressed as the change in price resulting from change of 100 basis points in yield. The mathematical formula is the negative of the yield elasticity of the bond price or –[dB/d(1+y)]((1+y)/B), where d is the derivative operator of calculus, B the bond price, y the yield and the elasticity does not have dimension (Hallerbach 2001). The duration trap of unconventional monetary policy is that duration is higher the lower the coupon and higher the lower the yield, other things being constant. Coupons and yields are historically low because of unconventional monetary policy. Duration dumping during a rate increase may trigger the same crossfire selling of high duration positions that magnified the credit crisis. Traders reduced positions because capital losses in one segment, such as mortgage-backed securities, triggered haircuts and margin increases that reduced capital available for positioning in all segments, causing fire sales in multiple segments (Brunnermeier and Pedersen 2009; see Pelaez and Pelaez, Regulation of Banks and Finance (2008b), 217-24). Financial markets are currently experiencing fear of duration and riskier asset classes resulting from the debate within and outside the Fed on tapering quantitative easing. Table VIII-2 provides the yield curve of Treasury securities on Mar 21, 2014, Dec 31, 2013, May 1, 2013, Mar 21, 2013 and Mar 21, 2006. There is oscillating steepening of the yield curve for longer maturities, which are also the ones with highest duration. The 10-year yield increased from 1.45 percent on Jul 26, 2012 to 3.04 percent on Dec 31, 2013 and 2.75 percent on Mar 21, 2014, as measured by the United States Treasury. Assume that a bond with maturity in 10 years were issued on Dec 31, 2013, at par or price of 100 with coupon of 1.45 percent. The price of that bond would be 86.3778 with instantaneous increase of the yield to 3.04 percent for loss of 13.6 percent and far more with leverage. Assume that the yield of a bond with exactly ten years to maturity and coupon of 2.75 percent as occurred on Mar 21, 2013 would jump instantaneously from yield of 2.75 percent on Mar 21, 2014 to 4.71 percent as occurred on Mar 21, 2006 when the economy was closer to full employment. The price of the hypothetical bond issued with coupon of 2.75 percent would drop from 100 to 84.5113 after an instantaneous increase of the yield to 4.71 percent. The price loss would be 15.5 percent. Losses absorb capital available for positioning, triggering crossfire sales in multiple asset classes (Brunnermeier and Pedersen 2009). What is the path of adjustment of zero interest rates on fed funds and artificially low bond yields? There is no painless exit from unconventional monetary policy. Chris Dieterich, writing on “Bond investors turn to cash,” on Jul 25, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323971204578625900935618178.html), uses data of the Investment Company Institute (http://www.ici.org/) in showing withdrawals of $43 billion in taxable mutual funds in Jun, which is the largest in history, with flows into cash investments such as $8.5 billion in the week of Jul 17 into money-market funds.

Table VIII-2, United States, Treasury Yields

	3/21/14	12/31/13	5/01/13	3/21/13	3/21/06
1 M	0.05	0.01	0.03	0.08	4.67
3 M	0.06	0.07	0.06	0.07	4.69
6 M	0.08	0.10	0.08	0.11	4.82
1 Y	0.14	0.13	0.11	0.14	4.79
2 Y	0.45	0.38	0.20	0.27	4.72
3 Y	0.91	0.78	0.30	0.38	4.71
5 Y	1.73	1.75	0.65	0.81	4.68
7 Y	2.30	2.45	1.07	1.30	4.69
10 Y	2.75	3.04	1.66	1.95	4.71
20 Y	3.34	3.72	2.44	2.77	4.91
30 Y	3.61	3.96	2.83	3.15	4.74

M: Months; Y: Years

Source: United States Treasury

http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

Interest rate risk is increasing in the US with amplifying fluctuations. Chart VI-13 of the Board of Governors provides the conventional mortgage rate for a fixed-rate 30-year mortgage. The rate stood at 5.87 percent on Jan 8, 2004, increasing to 6.79 percent on Jul 6, 2006. The rate bottomed at 3.35 percent on May 2, 2013. Fear of duration risk in longer maturities such as mortgage-backed securities caused continuing increases in the conventional mortgage rate that rose to 4.51 percent on Jul 11, 2013, 4.58 percent on Aug 22, 2013 and 4.32 percent on Mar 20, 2014, which is the last data point in Chart VI-13. Shayndi Raice and Nick Timiraos, writing on “Banks cut as mortgage boom ends,” on Jan 9, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303754404579310940019239208), analyze the drop in mortgage applications to a 13-year low, as measured by the Mortgage Bankers Association.

Chart VI-13, US, Conventional Mortgage Rate, Jan 8, 2004 to Mar 20, 2014

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/update/

There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table VI-7G when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table VI-7G shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.

Table VI-7G, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994

1994	FF	30Y	30P	10Y	10P	MOR	CPI
Jan	3.00	6.29	100	5.75	100	7.06	2.52
Feb	3.25	6.49	97.37	5.97	98.36	7.15	2.51
Mar	3.50	6.91	92.19	6.48	94.69	7.68	2.51
Apr	3.75	7.27	88.10	6.97	91.32	8.32	2.36
May	4.25	7.41	86.59	7.18	88.93	8.60	2.29
Jun	4.25	7.40	86.69	7.10	90.45	8.40	2.49
Jul	4.25	7.58	84.81	7.30	89.14	8.61	2.77
Aug	4.75	7.49	85.74	7.24	89.53	8.51	2.69
Sep	4.75	7.71	83.49	7.46	88.10	8.64	2.96
Oct	4.75	7.94	81.23	7.74	86.33	8.93	2.61
Nov	5.50	8.08	79.90	7.96	84.96	9.17	2.67
Dec	6.00	7.87	81.91	7.81	85.89	9.20	2.67

Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months

Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t

Chart VI-14 provides the overnight fed funds rate, the yield of the 10-year Treasury constant maturity bond, the yield of the 30-year constant maturity bond and the conventional mortgage rate from Jan 1991 to Dec 1996. In Jan 1991, the fed funds rate was 6.91 percent, the 10-year Treasury yield 8.09 percent, the 30-year Treasury yield 8.27 percent and the conventional mortgage rate 9.64 percent. Before monetary policy tightening in Oct 1993, the rates and yields were 2.99 percent for the fed funds, 5.33 percent for the 10-year Treasury, 5.94 for the 30-year Treasury and 6.83 percent for the conventional mortgage rate. After tightening in Nov 1994, the rates and yields were 5.29 percent for the fed funds rate, 7.96 percent for the 10-year Treasury, 8.08 percent for the 30-year Treasury and 9.17 percent for the conventional mortgage rate.

Chart VI-14, US, Overnight Fed Funds Rate, 10-Year Treasury Constant Maturity, 30-Year Treasury Constant Maturity and Conventional Mortgage Rate, Monthly, Jan 1991 to Dec 1996

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/update/

Chart VI-15 of the Bureau of Labor Statistics provides the all items consumer price index from Jan 1991 to Dec 1996. There does not appear acceleration of consumer prices requiring aggressive tightening.

Chart VI-15, US, Consumer Price Index All Items, Jan 1991 to Dec 1996

Source: Bureau of Labor Statistics

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

Chart IV-16 of the Bureau of Labor Statistics provides 12-month percentage changes of the all items consumer price index from Jan 1991 to Dec 1996. Inflation collapsed during the recession from Jul 1990 (III) and Mar 1991 (I) and the end of the Kuwait War on Feb 25, 1991 that stabilized world oil markets. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). Policy tightening had adverse collateral effects in the form of emerging market crises in Mexico and Argentina and fixed income markets worldwide.

Chart VI-16, US, Consumer Price Index All Items, Twelve-Month Percentage Change, Jan 1991 to Dec 1996

Source: Bureau of Labor Statistics

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

Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 25.1 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul, 2010, shown in Table VI-4 below, the dollar has devalued again to USD 1.3793/EUR on Mar 21, 2014 or by 15.7 percent {[(1.3793/1.192)-1]100 = 15.7 %}. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. Risk aversion erodes devaluation of the dollar. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD subsequently revaluing to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent. After fixing again the CNY to the dollar, China revalued to CNY 6.2247/USD on Fri Mar 21, 2014, or by an additional 8.7 percent, for cumulative revaluation of 24.8 percent. The final row of Table VI-2 shows: devaluation of 0.9 percent in the week of Feb 28, 2014; revaluation of 0.4 percent in the week of Mar 7, 2014; devaluation of 0.4 percent the week of Mar 14, 2013; and devaluation of 1.2 percent in the week of Mar 21, 2013. There could be reversal of revaluation to devalue the Yuan.

Table VI-2, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate

USD/EUR	12/26/03	7/14/08	6/07/10	3/21/14
Rate	1.1423	1.5914	1.192	1.3793
CNY/USD	01/03 2000	07/21 2005	7/15 2008	3/21/ 2014
Rate	8.2798	8.2765	6.8211	6.2247
Weekly Rates	2/28/2014	3/7/2014	3/14/2014	3/21/ 2014
CNY/USD	6.1481	6.1260	6.1496	6.2247
∆% from Earlier Week*	-0.9	0.4	-0.4	-1.2

*Negative sign is depreciation; positive sign is appreciation

Source: http://professional.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000

Professor Edward P Lazear (2013Jan7), writing on “Chinese ‘currency manipulation’ is not the problem,” on Jan 7, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323320404578213203581231448.html), provides clear thought on the role of the yuan in trade between China and the United States and trade between China and Europe. There is conventional wisdom that Chinese exchange rate policy causes the loss of manufacturing jobs in the United States, which is shown by Lazear (2013Jan7) to be erroneous. The fact is that manipulation of the CNY/USD rate by China has only minor effects on US employment. Lazear (2013Jan7) shows that the movement of monthly exports of China to its major trading partners, United States and Europe, since 1995 cannot be explained by the fixing of the CNY/USD rate by China. The period is quite useful because it includes rapid growth before 2007, contraction until 2009 and weak subsequent expansion. Chart VI-1 of the Board of Governors of the Federal Reserve System provides the CNY/USD exchange rate from Jan 3, 1995 to Mar 14, 2014 together with US recession dates in shaded areas. China fixed the CNY/USD rate for a long period as shown in the horizontal segment from 1995 to 2005. There was systematic revaluation of 17.6 percent from CNY 8.2765 on Jul 21, 2005 to CNY 6.8211 on Jul 15, 2008. China fixed the CNY/USD rate until Jun 7, 2010, to avoid adverse effects on its economy from the global recession, which is shown as a horizontal segment from 2009 until mid 2010. China then continued the policy of appreciation of the CNY relative to the USD with oscillations until the beginning of 2012 when the rate began to move sideways followed by a final upward slope of devaluation that is measured in Table VI-2A but virtually disappeared in the rate of CNY 6.3589/USD on Aug 17, 2012 and was nearly unchanged at CNY 6.3558/USD on Aug 24, 2012. China then appreciated 0.2 percent in the week of Dec 21, 2012, to CNY 6.2352/USD for cumulative 1.9 percent revaluation from Oct 28, 2011 and left the rate virtually unchanged at CNY 6.2316/USD on Jan 11, 2013, appreciating to CNY 6.1500/USD on Mar 14, 2014, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD by 24.8 percent by Mar 14, 2014 has not reduced the trade surplus of China but reversal of the policy of revaluation could result in international confrontation. The interruption with upward slope in the final segment on the right of Chart VI-I is measured as virtually stability in Table VI-2A followed with decrease or revaluation. Linglin Wei, writing on “China intervenes to lower yuan,” on Feb 26, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304071004579406810684766716?KEYWORDS=china+yuan&mg=reno64-wsj), finds from informed sources that the central bank of China conducted the ongoing devaluation of the yuan with the objective of driving out arbitrageurs to widen the band of fluctuation. There is concern if the policy of revaluation is changing to devaluation.

Chart VI-1, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 3, 1995-Mar 14, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

Chart VI-1A provides the daily CNY/USD rate from Jan 5, 1981 to Mar 14, 2014. The exchange rate was CNY 1.5418/USD on Jan 5, 1981. There is sharp cumulative depreciation of 107.8 percent to CNY 3.2031 by Jul 2, 1986, continuing to CNY 5.8145/USD on Dec 29, 1993 for cumulative 277.1 percent since Jan 5, 1981. China then devalued sharply to CNY 8.7117/USD on Jan 7, 1994 for 49.8 percent relative to Dec 29, 1993 and cumulative 465.0 percent relative to Jan 5, 1981. China then fixed the rate at CNY 8.2765/USD until Jul 21, 2005 and revalued as analyzed in Chart VI-1. The final data point in Chart VI-1A is CNY 6.1500/USD on Mar 14, 2014. To be sure, China fixed the exchange rate after substantial prior devaluation. It is unlikely that the devaluation could have been effective after many years of fixing the exchange rate with high inflation and multiple changes in the world economy. The argument of Lazear (2013Jan7) is still valid in view of the lack of association between monthly exports of China to the US and Europe since 1995 and the exchange rate of China.

Chart VI-1A, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 5, 1981-Mar 14, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

Chart VI-1B provides fine details with the rate of Chinese Yuan (CNY) to the US Dollar (USD) from Oct 28, 2011 to Mar 14, 2014. There have been alternations of revaluation and devaluation. The initial data point is CNY 6.3570 on Oct 28, 2011. There is an episode of devaluation from CNY 6.2790 on Apr 30, 2012 to CNY 6.3879 on Jul 25, 2012, or devaluation of 1.7 percent. Another devaluation is from CNY 6.042/USD on Jan 4, 2014 to CNY 6.1500 on Mar 14, 2014, or devaluation of 1.8 percent.

Chart VI-1B, Chinese Yuan (CNY) per US Dollar (US), Business Days, Oct 28, 2011-Mar 14, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

Carry trades induced by zero interest rates increase capital flows into emerging markets that appreciate exchange rates. Portfolio reallocations away from emerging markets depreciate their exchange rates in reversals of capital flows. Chart VI-4A provides the exchange rate of the Mexican peso (MXN) per US dollar from Nov 8, 1993 to Mar 14, 2014. The first data point in Chart VI-4A is MXN 3.1520 on Nov 8, 1993. The rate devalued to 11.9760 on Nov 14, 1995 during emerging market crises in the 1990s and the increase of interest rates in the US in 1994 that stressed world financial markets (Pelaez and Pelaez, International Financial Architecture 2005, The Global Recession Risk 2007, 147-77). The MXN depreciated sharply to MXN 15.4060/USD on Mar 2, 2009, during the global recession. The rate moved to MXN 11.5050/USD on May 2, 2011, during the sovereign debt crisis in the euro area. The rate depreciated to 11.9760 on May 9, 2013. The final data point in the current flight from emerging markets is MXN 13.2275/USD on Mar 14, 2014.

Chart VI-4A, Mexican Peso (MXN) per US Dollar (USD), Nov 8, 1993 to Mar 14, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

There are collateral effects worldwide from unconventional monetary policy. In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Professor Rajan, in an interview with Kartik Goyal of Bloomberg (http://www.bloomberg.com/news/2014-01-30/rajan-warns-of-global-policy-breakdown-as-emerging-markets-slide.html), warns of breakdown of global policy coordination. Professor Willem Buiter (2014Feb4), a distinguished economist currently Global Chief Economist at Citigroup (http://www.willembuiter.com/resume.pdf), writing on “The Fed’s bad manners risk offending foreigners,” on Feb 4, 2014, published in the Financial Times (http://www.ft.com/intl/cms/s/0/fbb09572-8d8d-11e3-9dbb-00144feab7de.html#axzz2suwrwkFs), concurs with Raghuram Rajan. Buiter (2014Feb4) argues that international policy cooperation in monetary policy is both in the interest of the world and the United States. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows. Chart VI-4B provides the rate of the Indian rupee (INR) per US dollar (USD) from Jan 2, 1973 to Mar 14, 2014. The first data point is INR 8.0200 on Jan 2, 1973. The rate depreciated sharply to INR 51.9600 on Mar 3, 2009, during the global recession. The rate appreciated to INR 44.0300/USD on Jul 28, 2011 in the midst of the sovereign debt event in the euro area. The rate overshot to INR 68.8000 on Aug 28, 2013. The final data point if INR 61.1900/USD on Mar 14, 2014.

Chart VI-4B, Indian Rupee (INR) per US Dollar (USD), Jan 2, 1973 to Mar 14, 2014

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

ChVI-5 provides the exchange rate of JPY (Japan yen) per USD (US dollars). The first data point on the extreme left is JPY 357.7300/USD for Jan 4, 1971. The JPY has appreciated over the long term relative to the USD with fluctuations along an evident long-term appreciation. Before the global recession, the JPY stood at JPY 124.0900/USD on Jun 22, 2007. The use of the JPY as safe haven is evident by sharp appreciation during the global recession to JPY 110.48/USD on Aug 15, 2008, and to JPY 87.8000/USD on Jan 21, 2009. The final data point in Chart VI-5 is JPY 101.4600/USD on Mar 14, 2013 for appreciation of 18.2 percent relative to JPY 124.0900/USD on Jun 22, 2007 before the global recession and expansion characterized by recurring bouts of risk aversion. Takashi Nakamichi and Eleanor Warnock, writing on “Japan lashes out over dollar, euro,” on Dec 29, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323530404578207440474874604.html?mod=WSJ_markets_liveupdate&mg=reno64-wsj), analyze the “war of words” launched by Japan’s new Prime Minister Shinzo Abe and his finance minister Taro Aso, arguing of deliberate devaluations of the USD and EUR relative to the JPY, which are hurting Japan’s economic activity. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-5, Japanese Yen JPY per US Dollars USD, Monthly, Jan 4, 1971-Mar 14, 2014

Note: US Recessions in Shaded Areas 

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html 

Zero interest rates in the United States forever tend to depreciate the dollar against every other currency if there is no risk aversion preventing portfolio rebalancing toward risk financial assets, which include the capital markets and exchange rates of emerging-market economies. The objective of unconventional monetary policy as argued by Yellen 2011AS) is to devalue the dollar to increase net exports that increase US economic growth. Increasing net exports and internal economic activity in the US is equivalent to decreasing net exports and internal economic activity in other countries.

Continental territory, rich endowment of natural resources, investment in human capital, teaching and research universities, motivated labor force and entrepreneurial initiative provide Brazil with comparative advantages in multiple economic opportunities. Exchange rate parity is critical in achieving Brazil’s potential but is difficult in a world of zero interest rates. Chart IV-6 of the Board of Governors of the Federal Reserve System provides the rate of Brazilian real (BRL) per US dollar (USD) from BRL 1.2074/USD on Jan 4, 1999 to BRL 2.3584/USD on Mar 14, 2013. The rate reached BRL 3.9450/USD on Oct 10, 2002 appreciating 60.5 percent to BRL 1.5580/USD on Aug 1, 2008. The rate depreciated 68.1 percent to BRL 2.6187/USD on Dec 5, 2008 during worldwide flight from risk. The rate appreciated again by 41.3 percent to BRL 1.5375/USD on Jul 26, 2011. The final data point in Chart VI-6 is BRL 2.3584/USD on Mar 14, 2014 for depreciation of 53.4 percent. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-6, Brazilian Real (BRL) per US Dollar (USD) Jan 4, 1999 to Mar 14, 2014

Note: US Recessions in Shaded Areas 

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

Chart VI-7 of the Board of Governors of the Federal Reserve System provides the history of the BRL beginning with the first data point of BRL 0.8440/USD on Jan 2, 1995. The rate jumped to BRL 2.0700/USD on Jan 29, 1999 after changes in exchange rate policy and then to BRL 2.2000/USD on Mar 3, 1999. The rate depreciated 26.7 percent to BRL 2.7880/USD on Sep 21, 2001 relative to Mar 3, 1999.

Chart VI-7, Brazilian Real (BRL) per US Dollar (USD), Jan 2, 1995 to Mar 14, 2014

Note: US Recessions in Shaded Areas 

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H10/default.htm

The major reason and channel of transmission of unconventional monetary policy is through expectations of inflation. Fisher (1930) provided theoretical and historical relation of interest rates and inflation. Let i_n be the nominal interest rate, i_r the real or inflation-adjusted interest rate and π^e the expectation of inflation in the time term of the interest rate, which are all expressed as proportions. The following expression provides the relation of real and nominal interest rates and the expectation of inflation:

(1 + i_r) = (1 + i_n)/(1 + π^e) (1)

That is, the real interest rate equals the nominal 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

That is, the real rate of interest is (1.032 – 1) 100 or 3.2 percent. If inflation were 2 percent, the real rate of interest would be 0.98 percent, or about 1.0 percent {[(1.03/1.02) -1]100 = 0.98%}.

The yield of the one-year Treasury security was quoted in the Wall Street Journal at 0.114 percent on Fri May 17, 2013 (http://online.wsj.com/mdc/page/marketsdata.html?mod=WSJ_topnav_marketdata_main). The expected rate of inflation π^e in the next twelve months is not observed. Assume that it would be equal to the rate of inflation in the past twelve months estimated by the Bureau of Economic Analysis (BLS) at 1.1 percent (http://www.bls.gov/cpi/). The real rate of interest would be obtained as follows:

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

That is, i_r is equal to 1 – 0.9902 or minus 0.98 percent. Investing in a one-year Treasury security results in a loss of 0.98 percent relative to inflation. The objective of unconventional monetary policy of zero interest rates is to induce consumption and investment because of the loss to inflation of riskless financial assets. Policy would be truly irresponsible if it intended to increase inflationary expectations or π^e. The result could be the same rate of unemployment with higher inflation (Kydland and Prescott 1977).

Current focus is on tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Market are overreacting to the so-called “paring” of outright purchases of $55 billion of securities per month for the balance sheet of the Fed

(http://www.federalreserve.gov/newsevents/press/monetary/20140319a.htm):

“The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month. 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 and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.”

What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Mar 19, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140319a.htm):

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.” (emphasis added).

How long is “considerable time”? At the press conference following the meeting on Mar 19, 2014, Chair Yellen answered a question of Jon Hilsenrath of the Wall Street Journal explaining “In particular, the Committee has endorsed the view that it anticipates that will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates. And of course on our present path, well, that's not utterly preset. We would be looking at next, next fall. So, I think that's important guidance” (file:///C:/Users/cmpelaez/Desktop/%7BYellenPressConferenceFOMCpresconf20140319.pdf03192014%7D.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”

There is a critical phrase in the statement of Sep 19, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm): “but mortgage rates have risen further.” Did the increase of mortgage rates influence the decision of the FOMC not to taper? Is FOMC “communication” and “guidance” successful? Will the FOMC increase purchases of mortgage-backed securities if mortgage rates increase?

At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states needs and intentions of policy:

“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time.

For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”

In testimony on the Semiannual Monetary Policy Report to the Congress before the Committee on Financial Services, US House of Representatives, on Feb 11, 2014, Chair Janet Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20140211a.htm):

“Turning to monetary policy, let me emphasize that I expect a great deal of continuity in the FOMC's approach to monetary policy. I served on the Committee as we formulated our current policy strategy and I strongly support that strategy, which is designed to fulfill the Federal Reserve's statutory mandate of maximum employment and price stability.  If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. That said, purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.  In December of last year and again this January, the Committee said that its current expectation--based on its assessment of a broad range of measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments--is that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the 2 percent goal. I am committed to achieving both parts of our dual mandate: helping the economy return to full employment and returning inflation to 2 percent while ensuring that it does not run persistently above or below that level (emphasis added).”

In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):

“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differfrom each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”

Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and r^e the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+r^e). Thus, g = [(r/r^e) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dr^e>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (10

Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.

The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). There is currently population growth in the ages of 16 to 24 years but not enough job creation and discouragement of job searches for all ages (http://cmpassocregulationblog.blogspot.com/2014/01/capital-flows-exchange-rates-and.htm and earlier http://cmpassocregulationblog.blogspot.com/2013/12/theory-and-reality-of-secular.html). This is merely another case of theory without reality with dubious policy proposals. The current reality is cyclical slow growth.

In delivering the biannual report on monetary policy (Board of Governors 2013Jul17), Chairman Bernanke (2013Jul17) advised Congress that:

“Instead, we are providing additional policy accommodation through two distinct yet complementary policy tools. The first tool is expanding the Federal Reserve's portfolio of longer-term Treasury securities and agency mortgage-backed securities (MBS); we are currently purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. We are using asset purchases and the resulting expansion of the Federal Reserve's balance sheet primarily to increase the near-term momentum of the economy, with the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. We have made some progress toward this goal, and, with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low--our second tool--to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability.

The Committee's decisions regarding the asset purchase program (and the overall stance of monetary policy) depend on our assessment of the economic outlook and of the cumulative progress toward our objectives. Of course, economic forecasts must be revised when new information arrives and are thus necessarily provisional.”

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. 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). Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). If there were an infallible science of central banking, models and forecasts would provide accurate information to policymakers on the future course of the economy in advance. Such forewarning is essential to central bank science because of the long lag between the actual impulse of monetary policy and the actual full effects on income and prices many months and even years ahead (Romer and Romer 2004, Friedman 1961, 1953, Culbertson 1960, 1961, Batini and Nelson 2002). The transcripts of the Fed meetings in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm) analyzed by Jon Hilsenrath demonstrate that Fed policymakers frequently did not understand the current state of the US economy in 2008 and much less the direction of income and prices. The conclusion of Friedman (1953) is that monetary impulses increase financial and economic instability because of lags in anticipating needs of policy, taking policy decisions and effects of decisions. This is a fortiori true when untested unconventional monetary policy in gargantuan doses shocks the economy and financial markets.

The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. Indefinite financial repression induces carry trades with high leverage, risks and illiquidity. A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html). Matt Jarzemsky, writing on “Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 16302.7 on Fri Mar 21, 2014, which is higher by 15.1 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 14.8 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs.

Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.

The carry trade from zero interest rates to leveraged positions in risk financial assets had proved strongest for commodity exposures but US equities have regained leadership. The DJIA has increased 68.3 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to Mar 21, 2014; S&P 500 has gained 82.5 percent and DAX 64.8 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 3/21/14” had double digit gains relative to the trough around Jul 2, 2010 followed by negative performance but now some valuations of equity indexes show varying behavior. China’s Shanghai Composite is 14.1 percent below the trough. Japan’s Nikkei Average is 61.2 percent above the trough. DJ Asia Pacific TSM is 20.1 percent above the trough. Dow Global is 43.9 percent above the trough. STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 24.5 percent above the trough. NYSE Financial Index is 49.1 percent above the trough. DJ UBS Commodities is 7.2 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 64.8 percent above the trough. Japan’s Nikkei Average is 61.2 percent above the trough on Aug 31, 2010 and 24.8 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 14,224.23 on Fri Mar 21, 2014 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 38.7 percent higher than 10,254.43 on Mar 11, 2011, on the date of the Tōhoku or Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar depreciated by 15.7 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 3/21/14” in Table VI-4 shows increase of 2.2 percent in the week for China’s Shanghai Composite. DJ Asia Pacific decreased 1.1 percent. NYSE Financial increased 1.7 percent in the week. DJ UBS Commodities decreased 1.5 percent. Dow Global increased 0.9 percent in the week of Mar 21, 2014. The DJIA increased 1.5 percent and S&P 500 increased 1.4 percent. DAX of Germany increased 3.2 percent. STOXX 50 increased 1.9 percent. The USD appreciated 0.9 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table VI-4 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 3/21/14” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Mar 21, 2014. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 3/21/14” but also relative to the peak in column “∆% Peak to 3/21/14.” There are now several equity indexes above the peak in Table VI-4: DJIA 45.5 percent, S&P 500 53.3 percent, DAX 47.5 percent, Dow Global 17.4 percent, DJ Asia Pacific 5.2 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 18.8 percent, Nikkei Average 24.8 percent and STOXX 50 5.4 percent. There is only one equity index below the peak: Shanghai Composite by 35.3 percent. DJ UBS Commodities Index is now 8.3 percent below the peak. The US dollar strengthened 8.8 percent relative to the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul 2010 because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. In IQ1980, gross private domestic investment in the US was $951.6 billion of 2009 dollars, growing to $1,173.8 billion in IQ1987 or 23.4 percent. Real gross private domestic investment in the US increased 2.0 percent from $2,605.2 billion of 2009 dollars in IVQ2007 to $2,656.2 billion in IVQ2013. As shown in Table IAI-2, real private fixed investment fell 2.7 percent from $2,586.3 billion of 2009 dollars in IVQ2007 to $2,517.5 billion in IVQ2013. Growth of real private investment in Table IA1-2 is mediocre for all but four quarters from IIQ2011 to IQ2012 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/02/mediocre-cyclical-united-states.html). The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Corporate profits with IVA and CCA fell $26.6 billion in IQ2013 after increasing $34.9 billion in IVQ2012 and $13.9 billion in IIIQ2012. Corporate profits with IVA and CCA rebounded with $66.8 billion in IIQ2013 and $39.2 billion in IIIQ2013. Profits after tax with IVA and CCA fell $1.7 billion in IQ2013 after increasing $40.8 billion in IVQ2012 and $4.5 billion in IIIQ2012. In IIQ2013, profits after tax with IVA and CCA increased $56.9 billion and $39.5 billion in IIIQ2013. Anticipation of higher taxes in the “fiscal cliff” episode caused increase of $120.9 billion in net dividends in IVQ2012 followed with adjustment in the form of decrease of net dividends by $103.8 billion in IQ2013, rebounding with $273.5 billion in IIQ2013. Net dividends fell at $179.0 billion in IIIQ2013. There is similar decrease of $80.1 billion in undistributed profits with IVA and CCA in IVQ2012 followed by increase of $102.1 billion in IQ2013 and decline of $216.6 billion in IIQ2013. Undistributed profits with IVA and CCA rose at $218.6 billion in IIIQ2013. Undistributed profits of US corporations swelled 382.4 percent from $107.7 billion IQ2007 to $519.5 billion in IIIQ2013 and changed signs from minus $55.9 billion in billion in IVQ2007 (Section IA2). In IQ2013, corporate profits with inventory valuation and capital consumption adjustment fell $26.6 billion relative to IVQ2012, from $2047.2 billion to $2020.6 billion at the quarterly rate of minus 1.3 percent. In IIQ2013, corporate profits with IVA and CCA increased $66.8 billion from $2020.6 billion in IQ2013 to $2087.4 billion at the quarterly rate of 3.3 percent. Corporate profits with IVA and CCA increased $39.2 billion from $2087.4 billion in IIQ2013 to $2126.6 billion in IIIQ2013 at the annual rate of 1.9 percent (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp3q13_3rd.pdf). Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment. Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment. The investment decision of US business is fractured. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:

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

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

Table VI-4, Stock Indexes, Commodities, Dollar and 10-Year Treasury  

	Peak	Trough	∆% to Trough	∆% Peak to 3/21/ /14	∆% Week 3/21/14	∆% Trough to 3/21/ 14
DJIA	4/26/ 10	7/2/10	-13.6	45.5	1.5	68.3
S&P 500	4/23/ 10	7/20/ 10	-16.0	53.3	1.4	82.5
NYSE Finance	4/15/ 10	7/2/10	-20.3	18.8	1.7	49.1
Dow Global	4/15/ 10	7/2/10	-18.4	17.4	0.9	43.9
Asia Pacific	4/15/ 10	7/2/10	-12.5	5.2	-1.1	20.1
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	24.8	-0.7	61.2
China Shang.	4/15/ 10	7/02 /10	-24.7	-35.3	2.2	-14.1
STOXX 50	4/15/10	7/2/10	-15.3	5.4	1.9	24.5
DAX	4/26/ 10	5/25/ 10	-10.5	47.5	3.2	64.8
Dollar Euro	11/25 2009	6/7 2010	21.2	8.8	0.9	-15.7
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	-8.3	-1.5	7.2
10-Year T Note	4/5/ 10	4/6/10	3.986	2.784	2.743

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

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

ESII World Inflation Waves. 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 2012-2014 shows neatly multiple waves. (1) In Jan-Apr 2011, without risk aversion, US producer prices rose at the annual equivalent rate of 10.4 percent. (2) After risk aversion, producer prices increased in the US at the annual equivalent rate of 1.2 percent in May-Jun 2011. (3) From Jul to Sep 2011, under alternating episodes of risk aversion, producer prices increased at the annual equivalent rate of 4.1 percent. (4) Under the pressure of risk aversion because of the European debt crisis, US producer prices increased at the annual equivalent rate of minus 0.4 percent in Oct-Dec 2011. (5) Inflation of producer prices returned with 2.8 percent annual equivalent in Jan-Mar 2012. (6) With return of risk aversion from the European debt crisis, producer prices fell at the annual equivalent rate of 4.1 percent in Apr-May 2012. (7) New positions in commodity futures even with continuing risk aversion caused annual equivalent inflation of 0.6 percent in Jun-Jul 2012. (8) 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. (9) Renewed risk aversion caused unwinding of carry trades of zero interest rates to commodity futures exposures with annual equivalent inflation of minus 2.8 percent in Oct-Dec 2012. (10) In Jan-Feb 2013, producer prices rose at the annual equivalent rate of 6.2 percent with more relaxed risk aversion at the margin. (11) Return of risk aversion resulted in annual equivalent inflation of minus 6.4 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 4.0 percent in annual equivalent in May-Aug 2013. (13) Continuing reallocation of investment portfolios away from commodities into equities is causing downward pressure on prices. In Sep-Nov 2013, the US producer price index fell at the annual equivalent rate of 0.4 percent. (14) Renewed carry trades caused annual equivalent inflation of 5.7 percent in US producer prices in Dec 2013-Feb 2014. 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 ten producer-price indexes in Table IA-1 for seven countries (two for the US and 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 reallocation away from commodities and into equities and high-yield bonds. Sharp worldwide jump in producer prices occurred recently because 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. Inflation of producer prices returned in the US and Japan in Dec 2013-Jan 2014. Lower inflation recently originates in portfolio reallocations away from commodity exposures into equities. 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 monetary policy perpetuates along a continuum of short-term periods. The result is 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). Inflation of producer prices returned in the US and Japan in Dec 2013-Jan 2014.

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

INDEX 2011-2014	AE ∆%
US Producer Finished Goods Price Index
AE  ∆% Dec 2013-Feb 2014	5.7
AE  ∆% Sep-Nov 2013	-0.4
AE  ∆% May-Aug 2013	4.0
AE  ∆% Mar-Apr 2013	-6.4
AE  ∆% Jan-Feb 2013	6.2
AE  ∆% Oct-Dec 2012	-2.8
AE  ∆% Aug-Sep 2012	12.7
AE  ∆% Jun-Jul 2012	0.6
AE  ∆% Apr-May 2012	-4.1
AE  ∆% Jan-Mar 2012	2.8
AE  ∆% Oct-Dec 2011	-0.4
AE ∆% Jul-Sep 2011	4.1
AE ∆% May-Jun 2011	1.2
AE ∆% Jan-Apr 2011	10.4
US Final Demand Producer Price Index
AE  ∆% Dec 2013-Feb 2014	0.8
AE  ∆% Sep-Nov 2013	1.2
AE  ∆% May-Aug 2013	1.8
AE  ∆% Mar-Apr 2013	-0.6
AE  ∆% Jan-Feb 2013	1.8
AE  ∆% Oct-Dec 2012	1.2
AE  ∆% Aug-Sep 2012	5.5
AE  ∆% Jun-Jul 2012	-1.2
AE  ∆% Apr-May 2012	0.6
AE  ∆% Jan-Mar 2012	3.7
AE  ∆% Oct-Dec 2011	-0.8
AE ∆% Jul-Sep 2011	3.2
AE ∆% May-Jun 2011	2.4
AE ∆% Jan-Apr 2011	7.1
Japan Corporate Goods Price Index
AE ∆% Feb 2014	-2.4
AE ∆% Dec 2013-Jan 2014	3.0
AE ∆% Oct-Nov 2013	-0.6
AE ∆% Dec 2012-Sep 2013	3.3
AE ∆% Oct-Nov 2012	-3.0
AE ∆% Aug-Sep 2012	2.4
AE ∆%  May-Jul 2012	-5.5
AE ∆%  Feb-Apr 2012	2.0
AE ∆% Dec 2011-Jan 2012	-0.6
AE ∆% Jul-Nov 2011	-2.1
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-Apr 2011	5.8
China Producer Price Index
AE ∆% Oct 2013-Feb 2014	-0.7
AE ∆% Aug-Sep 2013	1.8
AE ∆% Mar-Jul 2013	-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 ∆% Jan	-3.5
AE ∆% Dec 2013	2.4
AE ∆% Oct-Nov 2013	-3.0
AE ∆% Jul-Sep 2013	1.6
AE ∆% Mar-Jun 2013	-3.5
AE ∆% Jan-Feb 2013	2.4
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Sep-Oct 2012	0.6
AE ∆% Jul-Aug 2012	6.8
AE ∆% Apr-Jun 2012	-2.4
AE ∆% Jan-Mar 2012	7.9
AE ∆% Oct-Dec 2011	0.4
AE ∆% Jul-Sep 2011	2.4
AE ∆% May-Jun 2011	0.0
AE ∆% Jan-Apr 2011	11.3
Germany Producer Price Index
AE ∆% Jan-Feb 2014	-0.6 NSA -2.4 SA
AE ∆% Dec 2013	1.2 NSA 2.4 SA
AE ∆% Oct-Nov 2013	-1.8 NSA –1.8 SA
AE ∆% Sep 2013	3.7 NSA 0.0 SA
AE ∆% May-Aug 2013	-1.8 NSA –0.3 SA
AE ∆% Feb-Apr 2013	-2.4 NSA –2.8 SA
AE ∆% Jan 2013	7.4 NSA 2.4 SA
AE ∆% Oct-Dec 2012	-0.8 NSA 0.8 SA
AE ∆% Aug-Sep 2012	4.3 NSA 3.0 SA
AE ∆% May-Jul 2012	-2.8 NSA –0.4 SA
AE ∆% Feb-Apr 2012	4.9 NSA 2.4 SA
AE ∆% Dec 2011-Jan 2012	0.0 NSA –0.6 SA
AE ∆% Oct-Nov 2011	0.6 NSA 1.8 SA
AE ∆% Jul-Sep 2011	2.4 NSA 3.2 SA
AE ∆% May-Jun 2011	0.6 NSA 3.7 SA
AE ∆% Jan-Apr 2011	10.4 NSA 6.2 SA
France Producer Price Index for the French Market
AE ∆% Jan	-7.0
AE ∆% Nov-Dec 2013	3.7
AE ∆% Oct 2013	-2.4
AE ∆% Jul-Sep 2013	4.9
AE ∆% Apr-Jun 2013	-10.7
AE ∆% Jan-Mar 2013	4.9
AE ∆% Nov-Dec 2012	-4.1
AE ∆% Jul-Oct 2012	7.4
AE ∆% Apr-Jun 2012	-4.3
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 ∆% Oct 2013-Jan 2014	-4.1
AE ∆% Jun-Sep 2013	0.3
AE ∆% Apr-May 2013	-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 ∆% Jan 2014	3.7
AE ∆% Sep-Dec 2013	-1.5
AE ∆% Jun-Aug 2013	2.0
AE ∆% Apr-May 2013	-0.6
AE ∆% Jan-Mar 2013	4.9
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Jul-Oct 2012	3.0
AE ∆% May-Jun 2012	-3.5
AE ∆% Feb-Apr 2012	5.3
AE ∆% Nov 2011-Jan-2012	1.2
AE ∆% May-Oct 2011	1.6
AE ∆% Jan-Apr 2011	10.0
UK Input Prices
AE ∆% Jan 2014	-10.3
AE ∆% Dec 2013	2.4
AE ∆% Aug-Nov 2013	-8.4
AE ∆% Jul 2013	18.2
AE ∆% Mar-Jun 2013	-9.5
AE ∆% Jan-Feb 2013	24.6
AE ∆% Sep-Dec 2012	3.0
AE ∆% Aug 2012	23.9
AE ∆% Apr-Jul 2012	-16.1
AE ∆% Jan-Mar 2012	14.9
AE ∆% Nov-Dec 2011	0.0
AE ∆% May-Oct 2011	-1.3
AE ∆% Jan-Apr 2011	30.6
AE ∆% Oct-Dec 2010	31.8

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 4.9 percent. (2) Risk aversion caused the collapse of inflation to annual equivalent 2.4 percent in May-Jun 2011. (3) Risk appetite drove the rate of consumer price inflation in the US to 3.2 percent in Jul-Sep 2011. (4) Gloomier views of carry trades caused the collapse of inflation in Oct-Nov 2011 to annual equivalent 1.2 percent. (5) Consumer price inflation resuscitated with increased risk appetite at annual equivalent of 1.8 percent in Dec 2011 to Jan 2012. (6) Consumer price inflation returned at 2.8 percent annual equivalent in Feb-Apr 2012. (7) Under renewed risk aversion, annual equivalent consumer price inflation in the US was minus 0.4 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 minus 0.4 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 7.4 percent in Feb 2013 in a mood of relaxed risk aversion. (11) Inflation fell at 2.4 percent annual equivalent in Mar-Apr 2013. (12) Inflation rose at 2.2 percent in annual equivalent in May-Sep 2013. (13) Inflation moderated at the annual equivalent rate of 0.6 percent in Oct-Nov 2013. (14) Inflation returned at annual equivalent 1.6 percent in Dec 2013-Feb 2014. 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→∞ in 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 3.5 percent in annual equivalent in May-Jun 2013. Inflation in China returned at annual equivalent 4.6 percent in Jul-Oct 2013, falling at 1.2 percent in annual equivalent in Nov 2013. As in many countries, inflation in China surged at 7.4 percent annual equivalent in Dec 201-Feb 2014 with significant effects of local increases in food prices. The euro zone harmonized index of consumer prices (HICP) increased at annual equivalent 5.2 percent in Jan-Apr 2011, minus 2.4 percent in May-Jul 2011, 4.3 percent in Aug-Dec 2011, minus 3.0 percent in Dec 2011-Jan 2012 and then 9.6 percent in Feb-Apr 2012, falling to minus 2.8 percent annual equivalent in May-Jul 2012 but resuscitating at 5.3 percent in Aug-Oct 2012. The 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. Inflation returned in the euro zone at annual equivalent 3.7 percent in Aug-Sep 2013. Euro zone inflation fell at the annual equivalent rate of 2.4 percent in Oct-Nov 2013. Euro zone inflation jumped at 4.9 percent annual equivalent in Dec 2013 as in many countries worldwide. Inflation in the euro zone fell at annual equivalent 12.4 percent in Dec 2013 and increased at annual equivalent 3.7 percent in Feb 2014. 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 3.0 percent for output prices and 23.9 percent for input prices in Aug 2012 (see Table IA-1). Consumer prices in the UK fell at annual equivalent 5.8 percent in Jan 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. UK annual equivalent inflation returned at 3.4 percent in Aug-Dec 2013. CPI inflation fell at annual equivalent 7.0 percent in Jan 2014.

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

Index 2011-2014	AE ∆%
US Consumer Price Index
AE ∆% Dec 2013-Feb 2014	1.6
AE ∆% Oct-Nov 2013	0.6
AE ∆% May-Sep 2013	2.2
AE ∆% Mar-Apr 2013	-2.4
AE ∆% Feb 2013	7.4
AE ∆% Nov 2012-Jan 2013	-0.4
AE ∆% Aug-Oct 2012	4.9
AE ∆% May-Jul 2012	-0.4
AE ∆% Feb-Apr 2012	2.8
AE ∆% Dec 2011-Jan  2012	1.8
AE ∆% Oct-Nov 2011	1.2
AE ∆% Jul-Sep 2011	3.2
AE ∆% May-Jun 2011	2.4
AE ∆% Jan-Apr 2011	4.9
China Consumer Price Index
AE ∆% Dec 2013-Feb 2014	7.4
AE ∆% Nov 2013	-1.2
AE ∆% Jul-Oct 2013	4.6
AE ∆% May-Jun 2013	-3.5
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 ∆% Feb	3.7
AE ∆% Jan	-12.4
AE ∆% Dec 2013	4.9
AE ∆% Oct-Nov 2013	-2.4
AE ∆% Aug-Sep 2013	3.7
AE ∆% Jul 2013	-5.8
AE ∆% May-Jun 2013	1.2
AE ∆% Apr 2013	-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 ∆% Feb 2014	6.2 NSA 1.2 SA
AE ∆% Jan 2014	-7.0 NSA 0.0 SA
AE ∆% Nov-Dec 2013	3.7 NSA 2.4 SA
AE ∆% Oct 2013	-2.4 NSA 0.0 SA
AE ∆% Aug-Sep 2013	0.0 NSA 0.0 SA
AE ∆% May-Jul 2013	4.1 NSA 3.2 SA
AE ∆% Apr 2013	-5.8 NSA 0.0 SA
AE ∆% Feb-Mar 2013	6.8 NSA 1.2 SA
AE ∆% Jan 2013	-5.8 NSA 0.0 SA
AE ∆% Sep-Dec 2012	1.5 NSA 1.5 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 ∆% Feb 2014	7.4
AE ∆% Jan 2014	-7.0
AE ∆% Dec 2013	3.7
AE ∆% Sep-Nov 2013	-1.6
AE ∆% Aug 2013	6.2
AE ∆% Jul 2013	-3.5
AE ∆% May-Jun 2013	1.8
AE ∆% Apr 2013	-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 ∆% Feb 2014	-1.2
AE ∆% Dec 2013-Jan 2014	2.4
AE ∆% Sep-Nov 2013	-3.2
AE ∆% Dec 2012-Aug 2013	2.0
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 ∆% Jan 2014	-7.0
AE ∆% Aug-Dec 2013	3.4
AE ∆% Jun-Jul 2013	-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.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

ESIII Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates. Long-term economic growth in Japan significantly improved by increasing competitiveness in world markets. Net trade of exports and imports is an important component of the GDP accounts of Japan. Table VB-3 provides quarterly data for net trade, exports and imports of Japan. Net trade had strong positive contributions to GDP growth in Japan in all quarters from IQ2007 to IIQ2009 with exception of IVQ2008 and IQ2009. The US recession is dated by the National Bureau of Economic Research (NBER) as beginning in IVQ2007 (Dec) and ending in IIQ2009 (Jun) (http://www.nber.org/cycles/cyclesmain.html). Net trade contributions helped to cushion the economy of Japan from the global recession. Net trade deducted from GDP growth in seven of the nine quarters from IVQ2010 IQ2012. The only strong contribution of net trade was 3.8 percent in IIIQ2011. Net trade added 1.7 percentage points to GDP growth in IQ2013 and 0.6 percentage points in IIQ2013 but deducted 2.0 percentage points in IIIQ2013 and deducted 2.1 percentage points in IVQ2013. Private consumption assumed the role of driver of Japan’s economic growth but should moderate as in most mature economies.

Table VB-3, Japan, Contributions to Changes in Real GDP, Seasonally Adjusted Annual Rates (SAAR), %

	Net Trade	Exports	Imports
2013
I	1.7	2.4	-0.7
II	0.6	1.7	-1.2
III	-2.0	-0.4	-1.6
IV	-2.1	0.2	-2.4
2012
I	0.4	1.7	-1.3
II	-1.3	-0.3	-0.9
III	-2.2	-2.5	0.2
IV	-0.5	-1.7	1.3
2011
I	-1.1	-0.4	-0.7
II	-4.4	-4.7	0.3
III	3.8	5.7	-1.9
IV	-3.0	-1.9	-1.1
2010
I	2.1	3.5	-1.3
II	0.1	2.6	-2.6
III	0.5	1.4	-0.9
IV	-0.4	0.1	-0.5
2009
I	-4.4	-16.4	12.0
II	7.4	4.7	2.7
III	2.2	5.3	-3.0
IV	2.7	4.1	-1.4
2008
I	1.1	2.1	-1.0
II	0.5	-1.6	2.1
III	0.1	0.2	-0.1
IV	-11.5	-10.2	-1.2
2007
I	1.1	1.7	-0.5
II	0.7	1.6	-0.8
III	2.1	1.5	0.6
IV	1.4	2.0	-0.7

Source: Japan Economic and Social Research Institute, Cabinet Office

http://www.esri.cao.go.jp/index-e.html

http://www.esri.cao.go.jp/en/sna/sokuhou/sokuhou_top.html

There was milder increase in Japan’s export corporate goods price index during the global recession in 2008 but similar sharp decline during the bank balance sheets effect in late 2008, as shown in Chart IV-3 of the Bank of Japan. Japan exports industrial goods whose prices have been less dynamic than those of commodities and raw materials. As a result, the export CGPI on the yen basis in Chart IV-5 trends down with oscillations after a brief rise in the final part of the recession in 2009. The export corporate goods price index on the yen basis fell from 104.9 in Jun 2009 to 94.0 in Jan 2012 or minus 10.4 percent and increased to 109.2 in Feb 2014 for a gain of 16.2 percent relative to Jan 2012 and 4.1 percent relative to Jun 2009. The choice of Jun 2009 is designed to capture the reversal of risk aversion beginning in Sep 2008 with the announcement of toxic assets in banks that would be withdrawn with the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009). Reversal of risk aversion in the form of flight to the USD and obligations of the US government opened the way to renewed carry trades from zero interest rates to exposures in risk financial assets such as commodities. Japan exports industrial products and imports commodities and raw materials.

Chart IV-5, Japan, Export Corporate Goods Price Index, Monthly, Yen Basis, 2008-2014

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html

Chart IV-5A 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 1.0 percent to 98.9 in Feb 2014 relative to Jun 2009.

Chart IV-5A, Japan, Export Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2014

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html

Japan imports primary commodities and raw materials. As a result, the import corporate goods price index on the yen basis in Chart IV-6 shows an upward trend after declining from the increase during the global recession in 2008 driven by carry trades from fed funds rates. The index increases with carry trades from zero interest rates into commodity futures and declines 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 (for the relation of terms of trade and growth see Pelaez (1979, 1976a)). 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 127.8 in Feb 2014 or gain of 13.0 percent relative to Apr 2012 and 36.7 percent relative to Jun 2009.

Chart IV-6, Japan, Import Corporate Goods Price Index, Monthly, Yen Basis, 2008-2014

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html

Chart IV-6A 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 113.9 in Feb 2014 or minus 4.7 percent relative to Apr 2012 and gain of 32.1 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 1.0 percent from Jun 2009 to Feb 2014 while the import corporate goods price index increased 32.1 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-6A, Japan, Import Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2014

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html

Table IV-6 provides the Bank of Japan’s Corporate Goods Price indexes of exports and imports on the yen and contract bases from Jan 2008 to Feb 2014. There are oscillations of the indexes that are shown vividly in the four charts above. For the entire period from Jan 2008 to Feb 2014, the export index on the contract currency basis decreased 0.2 percent and decreased 4.3 percent on the yen basis. For the entire period from Jan 2008 to Feb 2014, the import price index increased 13.5 percent on the contract currency basis and increased 9.2 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-6, 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	102.3	96.3	118.1	109.8
2012/06	101.4	95.0	115.2	106.7
2012/07	100.6	94.0	112.0	103.5
2012/08	100.9	94.1	112.4	103.6
2012/09	101.0	94.1	114.7	105.2
2012/10	101.1	94.8	113.8	105.2
2012/11	100.9	95.9	113.2	106.5
2012/12	100.7	98.0	113.4	109.5
2013/01	101.0	102.4	113.8	115.4
2013/02	101.5	105.9	114.8	120.2
2013/03	101.3	106.6	115.1	122.0
2013/04	100.2	107.5	114.1	123.8
2013/05	99.6	109.1	112.6	125.3
2013/06	99.2	106.1	112.0	121.2
2013/07	99.0	107.4	111.6	122.9
2013/08	98.9	106.0	111.7	121.3
2013/09	98.9	107.1	112.9	123.9
2013/10	99.1	106.6	113.0	122.8
2013/11	99.0	107.9	113.1	124.8
2013-12	98.9	110.2	113.8	129.0
2014-01	99.1	110.6	114.4	130.1
2014-02	98.9	109.2	113.9	127.8

Source: Bank of Japan

http://www.boj.or.jp/en/statistics/index.htm/

Chart IV-7 provides the monthly corporate goods price index (CGPI) of Japan from 1970 to 2014. Japan also experienced sharp increase in inflation during the 1970s as in the episode of the Great Inflation in the US. Monetary policy focused on accommodating higher inflation, with emphasis solely on the mandate of promoting employment, has been blamed as deliberate or because of model error or imperfect measurement for creating the Great Inflation (http://cmpassocregulationblog.blogspot.com/2011/05/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 Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). A remarkable similarity with US experience is the sharp rise of the CGPI of Japan in 2008 driven by carry trades from policy interest rates rapidly falling to zero to exposures in commodity futures during a global recession. Japan had the same sharp waves of consumer price inflation during the 1970s as in the US (see Chart IV-B and associated table at http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html http://cmpassocregulationblog.blogspot.com/2014/02/mediocre-cyclical-united-states.html http://cmpassocregulationblog.blogspot.com/2013/12/collapse-of-united-states-dynamism-of.html http://cmpassocregulationblog.blogspot.com/2013/12/exit-risks-of-zero-interest-rates-world_1.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or_561.html and at http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk_1.html http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real_09.html)).

Chart IV-7, Japan, Domestic Corporate Goods Price Index, Monthly, 1970-2014

Source: Bank of Japan

http://www.stat-search.boj.or.jp/index_en.html

The producer price index of the US from 1970 to 2013 in Chart IV-8 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 IV-8, US, Producer Price Index Finished Goods, Monthly, 1970-2013

Source: US Bureau of Labor Statistics

http://www.bls.gov/ppi/

Further insight into inflation of the corporate goods price index (CGPI) of Japan is provided in Table IV-7. Petroleum and coal with weight of 5.7 percent decreased 1.4 percent in Feb 2014 and increased 5.8 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, decreased 0.4 percent in Feb 2014 and increased 0.3 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 (for analysis of terms of trade and growth see Pelaez (1979, 1976a). There are now inflation effects of the intentional policy of devaluing the yen.

Table IV-7, Japan, Corporate Goods Prices and Selected Components, % Weights, Month and 12 Months ∆%

Feb 2014	Weight	Month ∆%	12 Month ∆%
Total	1000.0	-0.2	1.8
Food, Beverages, Tobacco, Feedstuffs	137.5	0.0	0.6
Petroleum & Coal	57.4	-1.4	5.8
Production Machinery	30.8	-0.4	0.3
Electronic Components	31.0	-0.5	-2.9
Electric Power, Gas & Water	52.7	0.4	11.9
Iron & Steel	56.6	0.1	5.8
Chemicals	92.1	-0.1	2.1
Transport Equipment	136.4	0.0	-0.3

Source: Bank of Japan

http://www.boj.or.jp/en/statistics/index.htm/

http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1402.pdf

Percentage point contributions to change of the corporate goods price index (CGPI) in Feb 2014 are provided in Table IV-8 divided into domestic, export and import segments. In the domestic CGPI, decreasing 0.2 percent in Feb 2014, the energy shock is evident in the deduction of 0.19 percentage points by petroleum and coal products in reversal of carry trades of exposures in commodity futures. The exports CGPI decreased 0.2 percent on the basis of the contract currency with deduction of 0.08 percentage points by electric and electronic products. The imports CGPI decreased 0.4 percent on the contract currency basis. Petroleum, coal and natural gas products deducted 0.46 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-8, Japan, Percentage Point Contributions to Change of Corporate Goods Price Index

Groups Feb 2014	Contribution to Change Percentage Points
A. Domestic Corporate Goods Price Index	Monthly Change:  -0.2%
Petroleum & Coal Products	-0.11
Scrap & Waste	-0.03
Nonferrous Metals	-0.02
Electronic Components & Devices	-0.01
Electric Power, Gas & Water	0.03
Agriculture, Forestry & Fishery Products	0.02
B. Export Price Index	Monthly Change:    -0.2 % contract currency
Other Primary Products & Manufactured Goods	-0.08
Electric & Electronic Products	-0.08%
Chemicals & Related Products	-0.03
General Purpose, Production & Business Oriented Machinery	0.02
C. Import Price Index	Monthly Change: -0.4% contract currency basis
Petroleum, Coal & Natural Gas	-0.46
Chemicals & Related Products	-0.02
Other Primary Products & Manufactured Goods	-0.02
Foodstuffs & Feedstuffs	0.05

Source: Bank of Japan

http://www.boj.or.jp/en/statistics/index.htm/

http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1402.pdf

There are two categories of responses in the Empire State Manufacturing Survey of the Federal Reserve Bank of New York (http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html): current conditions and expectations for the next six months. There are responses in the survey for two types of prices: prices received or inputs of production and prices paid or sales prices of products. Table IV-5 provides indexes for the two categories and within them for the two types of prices from Jan 2011 to Mar 2014. The index of current prices paid or costs of inputs increased from 16.13 in Dec 2012 to 21.18 in Mar 2014 while the index of current prices received or sales prices increased from 1.08 in Dec 2012 to 2.35 in Mar 2014. The farther the index is from the area of no change at zero, the faster the rate of change. Prices paid or of inputs at 21.18 in Mar 2014 are expanding at faster pace than prices received or of sales of products at 2.35. 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 43.54 in Mar 2014 while the index of future prices received or expectation of sales prices in the next six months decreased from 25.81 in Dec 2012 to 25.88 in Mar 2014. Priced paid or of inputs are expected to increase at a faster pace in the next six months than prices received or prices of sales products. 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. Instability of sales/costs margins discourages investment and hiring.

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
Mar 2014	21.18	2.35	43.53	25.88
Feb	25.00	15.00	40.00	23.75
Jan	36.59	13.41	45.12	23.17
Dec 2013	15.66	3.61	48.19	27.71
Nov	17.11	-3.95	42.11	17.11
Oct	21.69	2.41	45.78	25.30
Sep	21.51	8.60	39.78	24.73
Aug	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 2011	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 in Table IV-6. As inflation waves throughout the world (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/02/squeeze-of-economic-activity-by-carry.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 intensity 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 decreased from 20.6 in Dec 2012 to 13.9 in Mar 2014. The index of current prices received was minus 7.2 in Apr 2013, indicating decrease of prices received. The index of current prices received decreased from 10.9 in Dec 2012 to 4.3 in Mar 2014. The farther the index is from the area of no change at zero, the faster the rate of change. The index of current prices paid or costs of inputs at 13.9 in Mar 2014 indicates faster increase than the index of current prices received or sales prices of production at 4.3. The index of future prices paid decreased to 29.4 in Mar 2014 from 41.9 in Dec 2012 while the index of future prices received decreased from 27.3 in Dec 2012 to 15.9 in Mar 2014. Expectations are incorporating faster increases in prices of inputs or costs of production, 29.4 in Mar 2014, than of sales prices of produced goods, 15.9 in Mar 2014, forcing companies to manage tightly costs and labor inputs. Volatility of margins of sales/costs discourages investment and hiring.

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	42.6	6.0	56.8	25.7
11-Jan	47.9	12.1	58.7	34.1
11-Feb	1.1	13.2	62.6	30.7
11-Mar	57.6	17	62.1	32.4
11-Apr	50.9	20.8	55.3	33.7
11-May	49.3	20.5	54.6	28.5
11-Jun	38.9	7.7	41.6	6.8
11-Jul	35.6	6.3	48.3	16.7
11-Aug	24.6	-4	45.2	23.4
11-Sep	32	7.1	40.9	22.2
11-Oct	24.3	2.8	42.9	27.8
11-Nov	22.8	6.3	35.4	28.3
11-Dec	25	7	43.1	24.7
12-Jan	25.3	8	47.5	20.8
12-Feb	31.9	9.4	43.4	24.8
12-Mar	14.1	5.3	37.8	22.6
12-Apr	18.1	6.2	35.2	20.2
12-May	7.7	0.7	39.5	9.7
12-Jun	5.5	-3.7	34.8	16.9
12-Jul	10.8	4.9	27.9	20.3
12-Aug	18	5.6	39.5	25
12-Sep	15.8	3.5	42.2	27.5
12-Oct	19.9	7.1	45.8	15.3
12-Nov	23.6	6.5	47.6	12.8
12-Dec	20.6	10.9	41.9	27.3
13-Jan	11.8	-1.6	33.9	20
13-Feb	10.6	-1.3	25.4	20.6
13-Mar	7.6	-1.3	32.4	16.8
13-Apr	5	-7.2	28.9	9.9
13-May	9.7	0.2	33.5	19.9
13-Jun	23.7	14.6	33.3	24.3
13-Jul	22.7	8	41	25.6
13-Aug	20.4	11.1	40.7	24.5
13-Sep	25.9	12.5	43	31.6
13-Oct	21	12.8	43.1	34.6
13-Nov	25.4	9	43.5	38.1
13-Dec	16.4	10.8	39.1	34.8
14-Jan	18.7	5.1	35.3	11.8
14-Feb	14.2	7.6	18.2	16.3
14-Mar	13.9	4.3	29.4	15.9

Source: Federal Reserve Bank of Philadelphia

http://www.phil.frb.org/index.cfm

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 2014. 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 with marginal decline and new increase. The index falls in the final segment but there are no episodes of contraction after 2009.

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 2014. 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 2014 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 pursued 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

ESIV Collapse of United States Dynamism of Income Growth and Employment Creation. Lucas (2011May) estimates US economic growth in the long-term at 3 percent per year and about 2 percent per year in per capita terms. There are displacements from this trend caused by events such as wars and recessions but the economy grows much faster during the expansion, compensating for the contraction and maintaining trend growth over the entire cycle. Historical US GDP data exhibit remarkable growth: Lucas (2011May) estimates an increase of US real income per person by a factor of 12 in the period from 1870 to 2010. The explanation by Lucas (2011May) of this remarkable growth experience is that government provided stability and education while elements of “free-market capitalism” were an important driver of long-term growth and prosperity. Lucas sharpens this analysis by comparison with the long-term growth experience of G7 countries (US, UK, France, Germany, Canada, Italy and Japan) and Spain from 1870 to 2010. Countries benefitted from “common civilization” and “technology” to “catch up” with the early growth leaders of the US and UK, eventually growing at a faster rate. Significant part of this catch up occurred after World War II. Lucas (2011May) finds that the catch up stalled in the 1970s. The analysis of Lucas (2011May) is that the 20-40 percent gap that developed originated in differences in relative taxation and regulation that discouraged savings and work incentives in comparison with the US. A larger welfare and regulatory state, according to Lucas (2011May), could be the cause of the 20-40 percent gap. Cobet and Wilson (2002) provide estimates of output per hour and unit labor costs in national currency and US dollars for the US, Japan and Germany from 1950 to 2000 (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). The average yearly rate of productivity change from 1950 to 2000 was 2.9 percent in the US, 6.3 percent for Japan and 4.7 percent for Germany while unit labor costs in USD increased at 2.6 percent in the US, 4.7 percent in Japan and 4.3 percent in Germany. From 1995 to 2000, output per hour increased at the average yearly rate of 4.6 percent in the US, 3.9 percent in Japan and 2.6 percent in Germany while unit labor costs in USD fell at minus 0.7 percent in the US, 4.3 percent in Japan and 7.5 percent in Germany. There was increase in productivity growth in Japan and France within the G7 in the second half of the 1990s but significantly lower than the acceleration of 1.3 percentage points per year in the US. The key indicator of growth of real income per capita, which is what a person earns after inflation, measures long-term economic growth and prosperity. A refined concept would include real disposable income per capita, which is what a person earns after inflation and taxes.

Table IB-1 provides the data required for broader comparison of long-term and cyclical performance of the United States economy. Revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) provide important information on long-term growth and cyclical behavior. First, Long-term performance. Using annual data, US GDP grew at the average rate of 3.3 percent per year from 1929 to 2013 and at 3.2 percent per year from 1947 to 2013. Real disposable income grew at the average yearly rate of 3.2 percent from 1929 to 2013 and at 3.7 percent from 1947 to 1999. Real disposable income per capita grew at the average yearly rate of 2.0 percent from 1929 to 2013 and at 2.3 percent from 1947 to 1999. US economic growth was much faster during expansions, compensating contractions in maintaining trend growth for whole cycles. Using annual data, US real disposable income grew at the average yearly rate of 3.5 percent from 1980 to 1989 and real disposable income per capita at 2.6 percent. The US economy has lost its dynamism in the current cycle: real disposable income grew at the yearly average rate of 1.3 percent from 2006 to 2013 and real disposable income per capita at 0.5 percent. Real disposable income grew at the average rate of 1.2 percent from 2007 to 2013 and real disposable income per capita at 0.4 percent. Table IB-1 illustrates the contradiction of long-term growth with the proposition of secular stagnation (Hansen 1938, 1938, 1941 with early critique by Simons (1942). Secular stagnation would occur over long periods. Table IB-1 also provides the corresponding rates of population growth that is only marginally lower at 0.8 to 0.9 percent recently from 1.1 percent over the long-term. GDP growth fell abruptly from 2.6 percent on average from 2000 to 2006 to 1.1 percent from 2006 to 2013 and 1.0 percent from 2007 to 2013 and real disposable income growth fell from 2.9 percent on average from 2000 to 2006 to 1.3 percent from 2006 to 2013. The decline of real per capita disposable income is even sharper from average 2.0 percent from 2000 to 2006 to 0.5 percent from 2006 to 2013 and 0.4 percent from 2007 to 2013 while population growth was 0.8 percent on average. Lazear and Spletzer (2012JHJul122) provide theory and measurements showing that cyclic factors explain currently depressed labor markets. This is also the case of the overall economy. Second, first four quarters of expansion. Growth in the first four quarters of expansion is critical in recovering loss of output and employment occurring during the contraction. In the first four quarters of expansion from IQ1983 to IVQ1983: GDP increased 7.8 percent, real disposable personal income 5.3 percent and real disposable income per capita 4.4 percent. In the first four quarters of expansion from IIIQ2009 to IIQ2010: GDP increased 2.7 percent, real disposable personal income 0.3 percent and real disposable income per capita decreased 0.5 percent. Third, first 18 quarters of expansion. In the expansion from IQ1983 to IIQ1987: GDP grew 24.5 percent at the annual equivalent rate of 5.0 percent; real disposable income grew 18.3 percent at the annual equivalent rate of 3.8 percent; and real disposable income per capita grew 13.7 percent at the annual equivalent rate of 2.9 percent. In the expansion from IIIQ2009 to IVQ2013: GDP grew 11.0 percent at the annual equivalent rate of 2.3 percent; real disposable income grew 6.4 percent at the annual equivalent rate of 1.4 percent; and real disposable personal income per capita grew 2.9 percent at the annual equivalent rate of 0.6 percent. Fourth, entire quarterly cycle. In the entire cycle combining contraction and expansion from IQ1980 to IIQ1987: GDP grew 24.3 percent at the annual equivalent rate of 2.8 percent; real disposable personal income 25.2 percent at the annual equivalent rate of 2.9 percent; and real disposable personal income per capita 16.7 percent at the annual equivalent rate of 2.0 percent. In the entire cycle combining contraction and expansion from IVQ2007 to IVQ2013: GDP grew 6.2 percent at the annual equivalent rate of 1.0 percent; real disposable personal income 8.1 percent at the annual equivalent rate of 1.3 percent; and real disposable personal income per capita 3.1 percent at the annual equivalent rate of 0.5 percent. The United States grew during its history at high rates of per capita income that made its economy the largest in the world. That dynamism is disappearing. Bordo (2012 Sep27) and Bordo and Haubrich (2012DR) provide strong evidence that recoveries have been faster after deeper recessions and recessions with financial crises, casting serious doubts on the conventional explanation of weak growth during the current expansion allegedly because of the depth of the contraction of 4.3 percent from IVQ2007 to IIQ2009 and the financial crisis. The proposition of secular stagnation should explain a long-term process of decay and not the actual abrupt collapse of the economy and labor markets currently.

Table IB-1, US, GDP, Real Disposable Personal Income, Real Disposable Income per Capita and Population in 1983-85 and 2007-2013, %

Long-term Average ∆% per Year	GDP	Population
1929-2013	3.3	1.1
1947-2013	3.2	1.2
1947-1999	3.6	1.3
2000-2013	1.8	0.9
2000-2006	2.6	0.9
2006-2013	1.1	0.8
2007-2013	1.0	0.8
Long-term Average ∆% per Year	Real Disposable Income	Real Disposable Income per Capita	Population
1929-2013	3.2	2.0	1.1
1947-1999	3.7	2.3	1.3
2000-2013	2.1	1.2	0.9
2000-2006	2.9	2.0	0.9
2006-2013	1.3	0.5	0.8
2007-2013	1.2	0.4	0.8
Whole Cycles Average ∆% per Year
1980-1989	3.5	2.6	0.9
2006-2013	1.3	0.5	0.8
2007-2013	1.2	0.4	0.8
Comparison of Cycles	# Quarters	∆%	∆% Annual Equivalent
GDP
I83 to IV83 IQ83 to IQ87 IQ83 to IIQ87	4 17 18
I83 to IV83 I83 to IQ87 I83 to II87	4 17 18	7.8 23.1 24.5	7.8 5.0 5.0
RDPI
I83 to IV83 I83 to I87 I83 to II87	4 17 18	5.3 19.5 18.3	5.3 4.3 3.8
RDPI Per Capita
I83 to IV83 I83 to I87 I83 to II87	4 17 18	4.4 15.1 13.7	4.4 3.4 2.9
Whole Cycle IQ1980 to IIQ1987
GDP	31	24.3	2.8
RDPI	31	25.2	2.9
RDPI per Capita	31	16.7	2.0
Population	31	7.3	0.9
GDP
III09 to II10 III09 to IV13	4 18	2.7 11.0	2.7 2.3
RDPI
III09 to II10 III09 to IV13	4 18	0.3 6.4	0.3 1.4
RDPI per Capita
III09 to II10 II09 to IVQ13	4 18	-0.5 2.9	-0.5 0.6
Population
II09 to II010 II09 to IV13	4 18	0.8 3.4	0.8 0.8
IVQ2007 to IVQ2013	25
GDP	25	6.2	1.0
RDPI	25	8.1	1.3
RDPI per Capita	25	3.1	0.5
Population	25	4.8	0.8

RDPI: Real Disposable Personal Income

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

There are seven basic facts illustrating the current economic disaster of the United States:

• GDP maintained trend growth in the entire business cycle from IQ1980 to IIQ1987, including contractions and expansions. GDP is well below trend in the entire business cycle from IVQ2007 to IVQ2013, including contractions and expansions
• Per capita real disposable income exceeded trend growth in the 1980s but is substantially below trend in IVQ2013
• Level of employed persons increased in the 1980s but declined into IVQ2013
• Level of full-time employed persons increased in the 1980s but declined into IVQ2013
• Level unemployed, unemployment rate and employed part-time for economic reasons fell in the recovery from the recessions in the 1980s but not substantially in the recovery since IIIQ2009
• Wealth of households and nonprofit organizations soared in the 1980s but stagnated in real terms into IVQ2013
• Gross private domestic investment increased sharply from IQ1980 to IIQ1987 but gross private domestic investment stagnated and private fixed investment fell from IVQ2007 into IVQ2013

There is a critical issue of the United States economy will be able in the future to attain again the level of activity and prosperity of projected trend growth. Growth at trend during the entire business cycles built the largest economy in the world but there may be an adverse, permanent weakness in United States economic performance and prosperity. Table IB-2 provides data for analysis of these seven basic facts. The seven blocks of Table IB-2 are separated initially after individual discussion of each one followed by the full Table IB-2.

1. Trend Growth.

i. As shown in Table IB-2, actual GDP grew cumulatively 23.9 percent from IQ1980 to IIQ1987, which is relatively close to what trend growth would have been at 25.7 percent. Real GDP grew 24.3 percent from IVQ1979 to IIQ1987. Rapid growth at the average annual rate of 5.0 percent per quarter during the expansion from IQ1983 to IIQ1987 erased the loss of GDP of 4.6 percent during the contraction and maintained trend growth at 2.8 percent for GDP and 2.9 percent for real disposable personal income over the entire cycle.

ii. In contrast, cumulative growth from IVQ2007 to IVQ2013 was 6.2 percent while trend growth would have been 20.3 percent. GDP in IVQ2013 at seasonally adjusted annual rate is $15,932.9 billion as estimated by the Bureau of Economic Analysis (BEA) (http://www.bea.gov/iTable/index_nipa.cfm) and would have been $18,040.3 billion, or $2107.4 billion higher, had the economy grown at trend over the entire business cycle as it happened during the 1980s and throughout most of US history. There is $2.1 trillion of foregone GDP that the economy would have created as it occurred during past cyclical expansions, which explains why employment net of population growth has not rebounded to even higher than before. There would not be recovery of full employment even with growth of 3 percent per year beginning immediately because the opportunity was lost to grow faster during the expansion from IIIQ2009 to IVQ2013 after the recession from IVQ2007 to IIQ2009. The United States has acquired a heavy social burden of unemployment and underemployment of 29.1 million people or 17.8 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/03/rules-discretionary-authorities-and.html) that will not diminish significantly even with return to growth of GDP of 3 percent per year because of growth of the labor force by new entrants. The ratio of the labor force of 154.871 million in Jul 2007 to the noninstitutional population of 231.958 million in Jul 2007 was 66.8 percent while the ratio of the labor force of 155.027 million in Feb 2014 to the noninstitutional population of 247.085 million in Feb 2014 was 62.7 percent. The labor force of the US in Feb 2014 corresponding to 66.8 percent of participation in the population would be 165.053 million (0.668 x 247.085). The difference between the measured labor force in Feb 2014 of 155.027 million and the labor force in Feb 2014 with participation rate of 66.8 percent (as in Jul 2007) of 165.053 million is 10.026 million. The level of the labor force in the US has stagnated and is 10.026 million lower than what it would have been had the same participation rate been maintained. Millions of people have abandoned their search for employment because they believe there are no jobs available for them. The key issue is whether the decline in participation of the population in the labor force is the result of people giving up on finding another job. Millions of people have abandoned their search for employment because they believe there are no jobs available for them (http://cmpassocregulationblog.blogspot.com/2014/03/rules-discretionary-authorities-and.html). Structural change in demography occurs over relatively long periods and not suddenly as shown by Edward P. Lazear and James R. Spletzer (2012JHJul22). There is an abrupt cyclical event and no evidence for secular stagnation and similar propositions.

Period IQ1980 to IIQ1987
GDP SAAR USD Billions
IQ1980	6,517.9
IIQ1987	8,076.1
∆% IQ1980 to IIQ1987 (24.3 percent from IVQ1979 $6496.8 billion)	23.9
∆% Trend Growth IQ1980 to IIQ1987	25.7

Period IVQ2007 to IVQ2013
GDP SAAR USD Billions
IVQ2007	14,996.1
IVQ2013	15,932.9
∆% IVQ2007 to IVQ2013 Actual	6.2
∆% IVQ2007 to IVQ2013 Trend	20.3

2. Stagnating Per Capita Real Disposable Income

i. In the entire business cycle from IQ1980 to IIQ1987, as shown in Table IB-2, growth of per capita real disposable income, or what is left per person after inflation and taxes, grew cumulatively 16.6 percent, which is close to what would have been trend growth of 16.6 percent.

ii. In contrast, in the entire business cycle from IVQ2007 to IVQ2013, per capita real disposable income increased 3.1 percent while trend growth would have been 13.2 percent. Income available after inflation and taxes is about the same or lower as before the contraction after 18 consecutive quarters of GDP growth at mediocre rates relative to those prevailing during historical cyclical expansions. In IVQ2012, nominal disposable personal income grew at the SAAR of 10.7 percent and real disposable personal income at 9.0 percent http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0114.pdf Table 6), which the BEA explains as: “Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf pages 1-2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0113.pdf). The Bureau of Economic Analysis explains as (http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf 2-3): “The January estimate of employee contributions for government social insurance reflected the expiration of the “payroll tax holiday,” that increased the social security contribution rate for employees and self-employed workers by 2.0 percentage points, or $114.1 billion at an annual rate. For additional information, see FAQ on “How did the expiration of the payroll tax holiday affect personal income for January 2013?” at www.bea.gov. The January estimate of employee contributions for government social insurance also reflected an increase in the monthly premiums paid by participants in the supplementary medical insurance program, in the hospital insurance provisions of the Patient Protection and Affordable Care Act, and in the social security taxable wage base.”

The increase was provided in the “fiscal cliff” law H.R. 8 American Taxpayer Relief Act of 2012 (http://www.gpo.gov/fdsys/pkg/BILLS-112hr8eas/pdf/BILLS-112hr8eas.pdf).

In IQ2013, personal income fell at the SAAR of minus 4.1 percent; real personal income excluding current transfer receipts at minus 7.2 percent; and real disposable personal income at minus 7.9 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0114.pdf). The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):

“The February and January changes in disposable personal income (DPI) mainly reflected the effect of special factors in January, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to November and to December in anticipation of changes in individual tax rates.”

In IIQ2013, personal income grew at 4.7 percent, real personal income excluding current transfer receipts at 5.6 percent and real disposable income at 4.1 percent (http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0114.pdf). In IIIQ2013, personal income grew at 4.0 percent, real personal income excluding current transfers at 1.9 percent and real disposable income at 3.0 percent (Table 6 athttp://www.bea.gov/newsreleases/national/pi/2014/pdf/pi0114.pdf). In IVQ2013, personal income grew at 2.2 percent and real disposable income at 0.7 percent.

Period IQ1980 to IIQ1987

Real Disposable Personal Income per Capita IQ1980 Chained 2009 USD	20,242
Real Disposable Personal Income per Capita IIQ1987 Chained 2009 USD	23,609
∆% IQ1980 to IIQ1987 (16.7 percent from IVQ1982 $20,230)	16.6
∆% Trend Growth	16.6

Period IVQ2007 to IVQ2013

Real Disposable Personal Income per Capita IVQ2007 Chained 2009 USD	35,823
Real Disposable Personal Income per Capita IVQ2013 Chained 2009 USD	36,941
∆% IVQ2007 to IVQ2013	3.1
∆% Trend Growth	13.2

3. Number of Employed Persons

i. As shown in Table IB-2, the number of employed persons increased over the entire business cycle from 98.527 million not seasonally adjusted (NSA) in IQ1980 to 113.498 million NSA in IIQ1987 or by 15.2 percent.

ii. In contrast, during the entire business cycle the number employed fell from 146.334 million in IVQ2007 to 144,423 million in IVQ2013 or by 1.3 percent. There are 29.1 million persons unemployed or underemployed, which is 17.8 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/03/rules-discretionary-authorities-and.html).

Period IQ1980 to IIQ1987

Employed Millions IQ1980 NSA End of Quarter	98.527
Employed Millions IIQ1987 NSA End of Quarter	113.498
∆% Employed IQ1980 to IIQ1987	15.2

Period IVQ2007 to IVQ2013

Employed Millions IVQ2007 NSA End of Quarter	146.334
Employed Millions IVQ2013 NSA End of Quarter	144.423
∆% Employed IVQ2007 to IVQ2013	-1.3

4. Number of Full-Time Employed Persons

i. As shown in Table IB-2, during the entire business cycle in the 1980s, including contractions and expansion, the number of employed full-time rose from 81.280 million NSA in IQ1980 to 95.548 million NSA in IIQ1987 or 17.6 percent.

ii. In contrast, during the entire current business cycle, including contraction and expansion, the number of persons employed full-time fell from 121.042 million in IVQ2007 to 116.661 million in IVQ2013 or by minus 3.6 percent.

4. Number of Full-time Employed Persons

Period IQ1980 to IIQ1987

Employed Full-time Millions IQ1980 NSA End of Quarter	81.280
Employed Full-time Millions IIQ1987 NSA End of Quarter	95.548
∆% Full-time Employed IQ1980 to IIQ1987	17.6

Period IVQ2007 to IVQ2013

Employed Full-time Millions IVQ2007 NSA End of Quarter	121.042
Employed Full-time Millions IVQ2013 NSA End of Quarter	116.661
∆% Full-time Employed IVQ2007 to IVQ2013	-3.6

5. Unemployed, Unemployment Rate and Employed Part-time for Economic Reasons.

i. As shown in Table IB-2 and in the following block, in the cycle from IQ1980 to IQ1987: (a) The rate of unemployment was slightly lower at 6.3 percent in IIQ1987 relative to 6.6 percent in IQ1980. (b) The number unemployed increased from 6.983 million in IQ1980 to 7.655 million in IIQ1987 or 9.6 percent. (c) The number employed part-time for economic reasons increased 57.9 percent from 3.624 million in IQ1980 to 5.723 million in IIQ1987.

ii. In contrast, in the economic cycle from IVQ2007 to IIIQ2013: (a) The rate of unemployment increased from 4.8 percent in IVQ2007 to 6.5 percent in IVQ2013. (b) The number unemployed increased 35.4 percent from 7.371 million in IVQ2007 to 9.984 million in IVQ2013. (c) The number employed part-time for economic reasons because they could not find any other job increased 68.2 percent from 4.750 million in IVQ2007 to 7.990 million in IVQ2013. (d) U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA increased from 8.7 percent in IVQ2007 to 13.0 percent in IVQ2013.

Period IQ1980 to IIQ1987

Unemployment Rate IQ1980 NSA End of Quarter	6.6
Unemployment Rate  IIQ1987 NSA End of Quarter	6.3
Unemployed IQ1980 Millions End of Quarter	6.983
Unemployed IIQ1987 Millions End of Quarter	7.655
∆%	9.6
Employed Part-time Economic Reasons Millions IQ1980 End of Quarter	3.624
Employed Part-time Economic Reasons Millions IIQ1987 End of Quarter	5.723
∆%	57.9

Period IVQ2007 to IVQ2013

Unemployment Rate IVQ2007 NSA End of Quarter	4.8
Unemployment Rate IVQ2013 NSA End of Quarter	6.5
Unemployed IVQ2007 Millions End of Quarter	7.371
Unemployed IVQ2013 Millions End of Quarter	9.984
∆%	35.4
Employed Part-time Economic Reasons IVQ2007 Millions End of Quarter	4.750
Employed Part-time Economic Reasons Millions IVQ2013 End of Quarter	7.990
∆%	68.2
U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA
IVQ2007	8.7
IVQ2013	13.0

6. Wealth of Households and Nonprofit Organizations.

The comparison of net worth of households and nonprofit organizations in the entire economic cycle from IQ1980 (and from IVQ1979) to IQ1987 and from IVQ2007 to IIIQ2012 is provided in Table IIA-5. The data reveal the following facts for the cycles in the 1980s:

• IVQ1979 to IIQ1987. Net worth increased 96.8 percent from IVQ1979 to IIQ1987, the all items CPI index increased 47.9 percent from 76.7 in Dec 1979 to 113.5 in Jun 1987 and real net worth increased 33.1 percent.
• IQ1980 to IVQ1985. Net worth increased 65.4 percent, the all items CPI index increased 36.5 percent from 80.1 in Mar 1980 to 109.3 in Dec 1985 and real net worth increased 21.2 percent.
• IVQ1979 to IVQ1985. Net worth increased 69.1 percent, the all items CPI index increased 42.5 percent from 76.7 in Dec 1979 to 109.3 in Dec 1985 and real net worth increased 18.7 percent.
• IQ1980 to IIQ1987. Net worth increased 92.6 percent, the all items CPI index increased 41.7 percent from 80.1 in Mar 1980 to 113.5 in Jun 1987 and real net worth increased 35.9 percent.

There is disastrous performance in the current economic cycle:

• IVQ2007 to IVQ2013. Net worth increased 19.1 percent, the all items CPI increased 11.0 percent from 210.036 in Dec 2007 to 233.049 in Dec 2013 and real or inflation adjusted net worth increased 7.3 percent.

The explanation is partly in the sharp decline of wealth of households and nonprofit organizations and partly in the mediocre growth rates of the cyclical expansion beginning in IIIQ2009. 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). US economic growth has been at only 2.3 percent on average in the cyclical expansion in the 18 quarters from IVQ2009 to IVQ2013. 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) and the second estimate of GDP for IVQ2013 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp4q13_2nd.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/2014/03/financial-risks-slow-cyclical-united.html and earlier http://cmpassocregulationblog.blogspot.com/2014/02/mediocre-cyclical-united-states.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html and earlier http://cmpassocregulationblog.blogspot.com/2014/02/mediocre-cyclical-united-states.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth on trend in the entire cycle from IVQ2007 to IV2013 would have accumulated to 20.3 percent. GDP in IVQ2013 would be $18,040.3 billion if the US had grown at trend, which is higher by $2,107.4 billion than actual $15,932.9 billion. There are about two trillion dollars of GDP less than on trend, explaining the 29.1 million unemployed or underemployed equivalent to actual unemployment of 17.8 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/03/rules-discretionary-authorities-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/02/financial-instability-rules.html). US GDP grew from $14,996.1 billion in IVQ2007 in constant dollars to $15,932.9 billion in IVQ2013 or 6.2 percent at the average annual equivalent rate of 1.0 percent. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation.

Period IQ1980 to IVQ1985
Net Worth of Households and Nonprofit Organizations USD Millions
IVQ1979 IQ1980	9,041.9 9,240.6
IVQ1985 IIIQ1986 IVQ1986 IQ1987 IIQ1987	15,285.4 16,295.1 16,846.5 17,509.9 17,795.9
∆ USD Billions IVQ1985 IIQ1987 IQ1980-IVQ1985 IQ1980-IIIQ1986 IQ1980-IVQ1986 IQ1980-IQ1987 IQ1980-IIQ1987	+6,243.5  ∆%69.1 R∆%18.7 +8,754.0  ∆%96.8 R∆%33.1 +6,044.8 ∆%65.4 R∆%21.2 +7,054.5 ∆%76.3 R∆%28.2 +7,605.9 ∆%82.3 R∆%32.2 +8,269.3 ∆%89.5 R∆%35.4 +8,555.3 ∆%92.6 R∆%35.9
Period IVQ2007 to IQ2013
Net Worth of Households and Nonprofit Organizations USD Millions
IVQ2007	67,752.8
IVQ2013	80,663.7
∆ USD Billions	+12,910.9 ∆%19.1 R∆%7.3

Net Worth = Assets – Liabilities. R∆% real percentage change or adjusted for CPI percentage change.

Source: Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: fourth quarter 2013. Washington, DC, Federal Reserve System, Mar 6. http://www.federalreserve.gov/releases/z1/Current/

7. Gross Private Domestic Investment.

i. The comparison of gross private domestic investment in the entire economic cycles from IQ1980 to IIQ1987 and from IVQ2007 to IVQ2013 is in the following block and in Table IB-2. Gross private domestic investment increased from $951.6 billion in IQ1980 to $1,174.4 billion in IIQ1987 or by 23.4 percent.

ii In the current cycle, gross private domestic investment increased from $2,605.2 billion in IVQ2007 to $2,656.2 billion in IVQ2013, or 2.0 percent. Private fixed investment fell from $2,586.3 billion in IVQ2007 to $2,517.5 billion in IVQ2013, or decline by 2.7 percent.

Period IQ1980 to IIQ1987
Gross Private Domestic Investment USD 2009 Billions
IQ1980	951.6
IIQ1987	1,174.4
∆%	23.4
Period IVQ2007 to IVQ2013
Gross Private Domestic Investment USD Billions
IVQ2007	2,605.2
IVQ2013	2,656.4
∆%	2.0
Private Fixed Investment USD 2009 Billions
IVQ2007	2,586.3
IVQ2013	2,517.5
∆%	-2.7

Table IB-2, US, GDP and Real Disposable Personal Income per Capita Actual and Trend Growth and Employment, 1980-1985 and 2007-2012, SAAR USD Billions, Millions of Persons and ∆%

Period IQ1980 to IQ1987
GDP SAAR USD Billions
IQ1980	6,517.9
IIQ1987	8,076.1
∆% IQ1980 to IIQ1987 (24.3 percent from IVQ1979 $6496.8 billion)	23.9
∆% Trend Growth IQ1980 to IIQ1987	25.7
Real Disposable Personal Income per Capita IQ1980 Chained 2009 USD	20,242
Real Disposable Personal Income per Capita IIQ1987 Chained 2009 USD	23,609
∆% IQ1980 to IIQ1987 (16.7 percent from IVQ1979 $20,230 billion)	16.6
∆% Trend Growth	16.6
Employed Millions IQ1980 NSA End of Quarter	98.527
Employed Millions IIQ1987 NSA End of Quarter	113.498
∆% Employed IQ1980 to IIQ1987	15.2
Employed Full-time Millions IQ1980 NSA End of Quarter	81.280
Employed Full-time Millions IIQ1987 NSA End of Quarter	95.548
∆% Full-time Employed IQ1980 to IQ1987	17.6
Unemployment Rate IQ1980 NSA End of Quarter	6.6
Unemployment Rate  IIQ1987 NSA End of Quarter	6.3
Unemployed IQ1980 Millions NSA End of Quarter	6.983
Unemployed IIQ1987 Millions NSA End of Quarter	7.655
∆%	9.6
Employed Part-time Economic Reasons IQ1980 Millions NSA End of Quarter	3.624
Employed Part-time Economic Reasons Millions IIQ1987 NSA End of Quarter	5.723
∆%	57.9
Net Worth of Households and Nonprofit Organizations USD Billions
IVQ1979	9,041.9
IIQ1987	17,795.9
∆ USD Billions	+8,754.0
∆% CPI Adjusted	33.1
Gross Private Domestic Investment USD 2009 Billions
IQ1980	951.6
IIQ1987	1174.4
∆%	23.4
Period IVQ2007 to IVQ2013
GDP SAAR USD Billions
IVQ2007	14,996.1
IVQ2013	15,932.9
∆% IVQ2007 to IVQ2013	6.2
∆% IVQ2007 to IVQ2013 Trend Growth	20.3
Real Disposable Personal Income per Capita IVQ2007 Chained 2009 USD	35,823
Real Disposable Personal Income per Capita IVQ2013 Chained 2009 USD	36,941
∆% IVQ2007 to IVQ2013	3.1
∆% Trend Growth	13.2
Employed Millions IVQ2007 NSA End of Quarter	146.334
Employed Millions IVQ2013 NSA End of Quarter	144.423
∆% Employed IVQ2007 to IVQ2013	-1.3
Employed Full-time Millions IVQ2007 NSA End of Quarter	121.042
Employed Full-time Millions IVQ2013 NSA End of Quarter	116.661
∆% Full-time Employed IVQ2007 to IVQ2013	-3.6
Unemployment Rate IVQ2007 NSA End of Quarter	4.8
Unemployment Rate IVQ2013 NSA End of Quarter	6.5
Unemployed IVQ2007 Millions NSA End of Quarter	7.371
Unemployed IVQ2013 Millions NSA End of Quarter	9.984
∆%	35.4
Employed Part-time Economic Reasons IVQ2007 Millions NSA End of Quarter	4.750
Employed Part-time Economic Reasons Millions IVQ2013 NSA End of Quarter	7.990
∆%	68.2
U6 Total Unemployed plus all marginally attached workers plus total employed part time for economic reasons as percent of all civilian labor force plus all marginally attached workers NSA
IVQ2007	8.7
IIIQ2013	13.0
Net Worth of Households and Nonprofit Organizations USD Billions
IVQ2007	67,752.8
IBQ2013	80.663.7
∆ USD Billions	12,910.9 ∆%19.1 R∆%7.3
Gross Private Domestic Investment USD Billions
IVQ2007	2,605.2
IVQ2013	2,656.2
∆%	2.0
Private Fixed Investment USD 2005 Billions
IVQ2007	2,586.3
IVQ2013	2,517.5
∆%	-2.7

Note: GDP trend growth used is 3.0 percent per year and GDP per capita is 2.0 percent per year as estimated by Lucas (2011May) on data from 1870 to 2010.

Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm US Bureau of Labor Statistics http://www.bls.gov/data/. Board of Governors of the Federal Reserve System. 2014. Flow of funds, balance sheets and integrated macroeconomic accounts: fourth quarter 2013. Washington, DC, Federal Reserve System, Mar 6. http://www.federalreserve.gov/releases/z1/Current/

The Congressional Budget Office (CBO 2014BEOFeb4) estimates potential GDP, potential labor force and potential labor productivity provided in Table IB-3. The CBO estimates average rate of growth of potential GDP from 1950 to 2012 at 3.3 percent per year. The projected path is significantly lower at 2.1 percent per year from 2013 to 2024. The legacy of the economic cycle expansion from IIIQ2009 to IVQ2013 at 2.3 percent on average is in contrast with 5.0 percent on average in the expansion from IQ1983 to IIQ1987 (http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html). Subpar economic growth may perpetuate unemployment and underemployment estimated at 29.1 million or 17.8 percent of the effective labor force in Feb 2014 (http://cmpassocregulationblog.blogspot.com/2014/03/rules-discretionary-authorities-and.html) with much lower hiring than in the period before the current cycle (http://cmpassocregulationblog.blogspot.com/2014/03/global-financial-risks-recovery-without.html).

Table IB-3, US, Congressional Budget Office History and Projections of Potential GDP of US Overall Economy, ∆%

	Potential GDP	Potential Labor Force	Potential Labor Productivity*
Average Annual ∆%
1950-1973	3.9	1.6	2.3
1974-1981	3.2	2.5	0.8
1982-1990	3.2	1.6	1.6
1991-2001	3.2	1.3	1.9
2002-2012	2.2	0.8	1.4
2007-2012	1.7	0.6	1.1
Total 1950-2012	3.3	1.5	1.8
Projected Average Annual ∆%
2013-2018	2.1	0.6	1.5
2019-2024	2.1	0.5	1.6
2013-2024	2.1	0.5	1.6

*Ratio of potential GDP to potential labor force

Source: CBO (2014BEOFeb4), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014.

Chart IB-1 of the Congressional Budget Office (CBO 2013BEOFeb5) provides actual and potential GDP of the United States from 2000 to 2011 and projected to 2024. Lucas (2011May) estimates trend of United States real GDP of 3.0 percent from 1870 to 2010 and 2.2 percent for per capita GDP. The United States successfully returned to trend growth of GDP by higher rates of growth during cyclical expansion as analyzed by Bordo (2012Sep27, 2012Oct21) and Bordo and Haubrich (2012DR). Growth in expansions following deeper contractions and financial crises was much higher in agreement with the plucking model of Friedman (1964, 1988). The unusual weakness of growth at 2.3 percent on average from IIIQ2009 to IVQ2013 during the current economic expansion in contrast with 5.0 percent on average in the cyclical expansion from IQ1983 to IQ1987 (http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html) cannot be explained by the contraction of 4.3 percent of GDP from IVQ2007 to IIQ2009 and the financial crisis. Weakness of growth in the expansion is perpetuating unemployment and underemployment of 29.1 million or 17.8 percent of the labor force as estimated for Feb 2014 (http://cmpassocregulationblog.blogspot.com/2014/03/rules-discretionary-authorities-and.html). There is no exit from unemployment/underemployment and stagnating real wages because of the collapse of hiring (http://cmpassocregulationblog.blogspot.com/2014/03/global-financial-risks-recovery-without.html). The US economy and labor markets collapsed without recovery. Abrupt collapse of economic conditions can be explained only with cyclic factors (Lazear and Spletzer 2012Jul22) and not by secular stagnation (Hansen 1938, 1939, 1941 with early dissent by Simons 1942).

Chart IB-1, US, Congressional Budget Office, Actual and Projections of Potential GDP, 2000-2024, Trillions of Dollars

Source: Congressional Budget Office, CBO (2013BEOFeb5). The last year in common in both projections is 2017. The revision lowers potential output in 2017 by 7.3 percent relative to the projection in 2007.

Chart IB-2 provides differences in the projections of potential output by the CBO in 2007 and more recently on Feb 4, 2014, which the CBO explains in CBO (2014Feb28).

Chart IB-2, Congressional Budget Office, Revisions of Potential GDP

Source: Congressional Budget Office, 2014Feb 28. Revisions to CBO’s Projection of Potential Output since 2007. Washington, DC, CBO, Feb 28, 2014.

Chart IB-3 provides actual and projected potential GDP from 2000 to 2024. The gap between actual and potential GDP disappears at the end of 2017 (CBO2014Feb4). GDP increases in the projection at 2.5 percent per year.

Chart IB-3, Congressional Budget Office, GDP and Potential GDP

Source: CBO (2013BEOFeb5), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014.

ESV Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities. The current account of the US balance of payments is provided in Table IIA2-1 for IVQ2012 and IFQ2013. The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US not seasonally adjusted decreased from $99.2 billion in IVQ2012 to $83.7 billion in IVQ2013. The current account deficit seasonally adjusted at annual rate fell from 2.5 percent of GDP in IVQ2012 to 2.3 percent of GDP in IIIQ2013 and 1.9 percent of GDP in IVQ2013. The ratio of the current account deficit to GDP has stabilized below 3 percent of GDP compared with much higher percentages before the recession but is combined now with much higher imbalance in the Treasury budget (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71).

Table IIA2-1, US, Balance of Payments, Millions of Dollars NSA

	IVQ2012	IVQ2013	Difference
Goods Balance	-178,547	-170,150	-8,397
X Goods	398,156	412,235	3.5 ∆%
M Goods	-576,703	-582,384	1.0 ∆%
Services Balance	56,151	58,171	2,020
X Services	165,425	172,451	4.2 ∆%
M Services	-109,274	-114,280	4.6 ∆%
Balance Goods and Services	-122,396	-111,979	10,417
Balance Income	54,839	59,918	5,079
Unilateral Transfers	-31,621	-31,679	-58
Current Account Balance	-99,178	-83,739	15,439
% GDP	IVQ2012	IVQ2013	IIIQ2013
	2.5	1.9	2.3

X: exports; M: imports

Balance on Current Account = Balance on Goods and Services + Balance on Income + Unilateral Transfers

Source: Bureau of Economic Analysis

http://www.bea.gov/international/index.htm#bop

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.”

The alternative fiscal scenario of the CBO (2012NovCDR, 2013Sep17) resembles an economic world in which eventually the placement of debt reaches a limit of what is proportionately desired of US debt in investment portfolios. This unpleasant environment is occurring in various European countries.

The current real value of government debt plus monetary liabilities depends on the expected discounted values of future primary surpluses or difference between tax revenue and government expenditure excluding interest payments (Cochrane 2011Jan, 27, equation (16)). There is a point when adverse expectations about the capacity of the government to generate primary surpluses to honor its obligations can result in increases in interest rates on government debt.

This analysis suggests that there may be a point of saturation of demand for United States financial liabilities without an increase in interest rates on Treasury securities. A risk premium may develop on US debt. Such premium is not apparent currently because of distressed conditions in the world economy and international financial system. Risk premiums are observed in the spread of bonds of highly indebted countries in Europe relative to bonds of the government of Germany.

The issue of global imbalances centered on the possibility of a disorderly correction (Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State Vol. II (2008b) 183-94, Government Intervention in Globalization (2008c), 167-71). Such a correction has not occurred historically but there is no argument proving that it could not occur. The need for a correction would originate in unsustainable large and growing United States current account deficits (CAD) and net international investment position (NIIP) or excess of financial liabilities of the US held by foreigners net relative to financial liabilities of foreigners held by US residents. The IMF estimated that the US could maintain a CAD of two to three percent of GDP without major problems (Rajan 2004). The threat of disorderly correction is summarized by Pelaez and Pelaez, The Global Recession Risk (2007), 15):

“It is possible that foreigners may be unwilling to increase their positions in US financial assets at prevailing interest rates. An exit out of the dollar could cause major devaluation of the dollar. The depreciation of the dollar would cause inflation in the US, leading to increases in American interest rates. There would be an increase in mortgage rates followed by deterioration of real estate values. The IMF has simulated that such an adjustment would cause a decline in the rate of growth of US GDP to 0.5 percent over several years. The decline of demand in the US by four percentage points over several years would result in a world recession because the weakness in Europe and Japan could not compensate for the collapse of American demand. The probability of occurrence of an abrupt adjustment is unknown. However, the adverse effects are quite high, at least hypothetically, to warrant concern.”

The United States could be moving toward a situation typical of heavily indebted countries, requiring fiscal adjustment and increases in productivity to become more competitive internationally. The CAD and NIIP of the United States are not observed in full deterioration because the economy is well below trend. There are two complications in the current environment relative to the concern with disorderly correction in the first half of the past decade. In the release of Jun 14, 2013, the Bureau of Economic Analysis (http://www.bea.gov/newsreleases/international/transactions/2013/pdf/trans113.pdf) informs of revisions of US data on US international transactions since 1999:

“The statistics of the U.S. international transactions accounts released today have been revised for the first quarter of 1999 to the fourth quarter of 2012 to incorporate newly available and revised source data, updated seasonal adjustments, changes in definitions and classifications, and improved estimating methodologies.”

Table IIA2-2 provides data on the US fiscal and balance of payments imbalances. In 2007, the federal deficit of the US was $161 billion corresponding to 1.1 percent of GDP while the Congressional Budget Office (CBO 2013Sep11) estimates the federal deficit in 2012 at $1087 billion or 6.8 percent of GDP. The combined record federal deficits of the US from 2009 to 2012 are $5090 billion or 31.6 percent of the estimate of GDP for fiscal year 2012 implicit in the CBO (CBO 2013Sep11) estimate of debt/GDP. The deficits from 2009 to 2012 exceed one trillion dollars per year, adding to $5.090 trillion in four years, using the fiscal year deficit of $1087 billion for fiscal year 2012, which is the worst fiscal performance since World War II. Federal debt in 2007 was $5035 billion, less than the combined deficits from 2009 to 2012 of $5090 billion. Federal debt in 2012 was 70.1 percent of GDP (CBO 2013Sep11). This situation may worsen in the future (CBO 2013Sep17):

“Between 2009 and 2012, the federal government recorded the largest budget deficits relative to the size of the economy since 1946, causing federal debt to soar. Federal debt held by the public is now about 73 percent of the economy’s annual output, or gross domestic product (GDP). That percentage is higher than at any point in U.S. history except a brief period around World War II, and it is twice the percentage at the end of 2007. If current laws generally remained in place, federal debt held by the public would decline slightly relative to GDP over the next several years, CBO projects. After that, however, growing deficits would ultimately push debt back above its current high level. CBO projects that federal debt held by the public would reach 100 percent of GDP in 2038, 25 years from now, even without accounting for the harmful effects that growing debt would have on the economy. Moreover, debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely.

The gap between federal spending and revenues would widen steadily after 2015 under the assumptions of the extended baseline, CBO projects. By 2038, the deficit would be 6½ percent of GDP, larger than in any year between 1947 and 2008, and federal debt held by the public would reach 100 percent of GDP, more than in any year except 1945 and 1946. With such large deficits, federal debt would be growing faster than GDP, a path that would ultimately be unsustainable.

Incorporating the economic effects of the federal policies that underlie the extended baseline worsens the long-term budget outlook. The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues and higher interest payments. With those effects included, debt under the extended baseline would rise to 108 percent of GDP in 2038.”

Table IIA2-2, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and %

	2007	2008	2009	2010	2011	2012
Goods & Services	-699	-702	-384	-499	-557	-535
Income	101	146	124	178	233	224
UT	-115	-125	-122	-128	-134	-130
Current Account	-713	-681	-382	-449	-458	-440
NGDP	14480	14720	14418	14958	15534	16245
Current Account % GDP	-4.9	-4.6	-2.6	-3.0	-2.9	-2.7
NIIP	-1796	-3260	-2275	-2250	-3730	-3863
US Owned Assets Abroad	18400	19464	18558	20555	21636	21638
Foreign Owned Assets in US	20196	22724	20833	22805	25366	25501
NIIP % GDP	-12.4	-22.1	-15.8	-15.0	-24.0	-23.8
Exports Goods Services Income	2487	2654	2185	2523	2874	2987
NIIP % Exports Goods Services Income	-72	-123	-104	-89	-130	-129
DIA MV	5274	3102	4322	4809	4514	5249
DIUS MV	3551	2486	2995	3422	3510	3924
Fiscal Balance	-161	-459	-1413	-1294	-1296	-1087
Fiscal Balance % GDP	-1.1	-3.1	-9.8	-8.8	-8.4	-6.8
Federal   Debt	5035	5803	7545	9019	10128	11281
Federal Debt % GDP	35.1	39.3	52.3	61.0	65.8	70.1
Federal Outlays	2729	2983	3518	3457	3603	3537
∆%	2.8	9.3	17.9	-1.7	4.2	-1.8
% GDP	19.0	20.2	24.4	23.4	23.4	22.0
Federal Revenue	2568	2524	2105	2163	2304	2450
∆%	6.7	-1.7	-16.6	2.7	6.5	6.4
% GDP	17.9	17.1	14.6	14.6	15.0	15.2

Sources: 

Notes: UT: unilateral transfers; NGDP: nominal GDP or in current dollars; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. There are minor discrepancies in the decimal point of percentages of GDP between the balance of payments data and federal debt, outlays, revenue and deficits in which the original number of the CBO source is maintained. These discrepancies do not alter conclusions. Budget http://www.cbo.gov/ Balance of Payments and NIIP http://www.bea.gov/international/index.htm#bop Gross Domestic Product, Bureau of Economic Analysis (BEA) http://www.bea.gov/iTable/index_nipa.cfm

Table IIA2-3 provides quarterly estimates NSA of the external imbalance of the United States. The current account deficit seasonally adjusted falls from 2.6 percent of GDP in IIIQ2012 to 2.5 percent in IQ2013 and 2.3 percent of GDP in IIIQ2013. The net international investment position increases from $3.9 trillion in IVQ2012 to $4.2 trillion in IQ2013 and $4.6 trillion in IIQ2013, decreasing to $4.2 trillion in IIIQ2013.

Table IIA2-3, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and % NSA

	IIIQ2012	IVQ2012	IQ2013	IIQ2013	IIIQ2013
Goods & Services	-145	-122	-100	-126	-137
Income	55	55	52	57	60
UT	-33	-32	-34	-33	-35
Current Account	-123	-99	-82	-102	-111
Current Account % GDP	-2.6	-2.5	-2.5	-2.3	-2.3
NIIP	-4109	-3863	-4236	-4555	-4166
US Owned Assets Abroad	21551	21638	21590	20969	21591
Foreign Owned Assets in US	-25660	-25501	-25826	-25424	-25756
DIA MV	5059	5249	5501	5435	5980
DIUS MV	3962	3924	4251	4333	4524

Notes: UT: unilateral transfers; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value..

Sources: US Bureau of Economic Analysis

Notes: UT: unilateral transfers; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value.

Sources: US Bureau of Economic Analysis http://www.bea.gov/international/index.htm#bop

Chart IIA2-1 of the Board of Governors of the Federal Reserve System provides the overnight Fed funds rate on business days from Jul 1, 1954 at 1.13 percent through Jan 10, 1979, at 9.91 percent per year, to Mar 20, 2014, at 0.08 percent per year. US recessions are in shaded areas according to the reference dates of the NBER (http://www.nber.org/cycles.html). In the Fed effort to control the “Great Inflation” of the 1930s (see 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 Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html), the fed funds rate increased from 8.34 percent on Jan 3, 1979 to a high in Chart VI-10 of 22.36 percent per year on Jul 22, 1981 with collateral adverse effects in the form of impaired savings and loans associations in the United States, emerging market debt and money-center banks (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7; Pelaez 1986, 1987). Another episode in Chart IIA2-1 is the increase in the fed funds rate from 3.15 percent on Jan 3, 1994, to 6.56 percent on Dec 21, 1994, which also had collateral effects in impairing emerging market debt in Mexico and Argentina and bank balance sheets in a world bust of fixed income markets during pursuit by central banks of non-existing inflation (Pelaez and Pelaez, International Financial Architecture (2005), 113-5). Another interesting policy impulse is the reduction of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of equally non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85), followed by increments of 25 basis points from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006 in Chart IIA2-1. Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).

The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever-increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). A final episode in Chart IIA2-1 is the reduction of the fed funds rate from 5.41 percent on Aug 9, 2007, to 2.97 percent on October 7, 2008, to 0.12 percent on Dec 5, 2008 and close to zero throughout a long period with the final point at 0.08 percent on Mar 20, 2014. Evidently, this behavior of policy would not have occurred had there been theory, measurements and forecasts to avoid these violent oscillations that are clearly detrimental to economic growth and prosperity without inflation. Current policy consists of forecast mandate of maintaining policy accommodation until the forecast of the rate of unemployment reaches 6.5 percent and the rate of personal consumption expenditures excluding food and energy reaches 2.5 percent (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm). It is a forecast mandate because of the lags in effect of monetary policy impulses on income and prices (Romer and Romer 2004). The intention is to reduce unemployment close to the “natural rate” (Friedman 1968, Phelps 1968) of around 5 percent and inflation at or below 2.0 percent. If forecasts were reasonably accurate, there would not be policy errors. A commonly analyzed risk of zero interest rates is the occurrence of unintended inflation that could precipitate an increase in interest rates similar to the Himalayan rise of the fed funds rate from 9.91 percent on Jan 10, 1979, at the beginning in Chart IIA2-1, to 22.36 percent on Jul 22, 1981. There is a less commonly analyzed risk of the development of a risk premium on Treasury securities because of the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). There is not a fiscal cliff or debt limit issue ahead but rather free fall into a fiscal abyss. The combination of the fiscal abyss with zero interest rates could trigger the risk premium on Treasury debt or Himalayan hike in interest rates.

Chart IIA2-1, US, Fed Funds Rate, Business Days, Jul 1, 1954 to Mar 20, 2014, Percent per Year

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/update/

There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table VI-7G when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table VI-7G shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.

Table VI-7G, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994

1994	FF	30Y	30P	10Y	10P	MOR	CPI
Jan	3.00	6.29	100	5.75	100	7.06	2.52
Feb	3.25	6.49	97.37	5.97	98.36	7.15	2.51
Mar	3.50	6.91	92.19	6.48	94.69	7.68	2.51
Apr	3.75	7.27	88.10	6.97	91.32	8.32	2.36
May	4.25	7.41	86.59	7.18	88.93	8.60	2.29
Jun	4.25	7.40	86.69	7.10	90.45	8.40	2.49
Jul	4.25	7.58	84.81	7.30	89.14	8.61	2.77
Aug	4.75	7.49	85.74	7.24	89.53	8.51	2.69
Sep	4.75	7.71	83.49	7.46	88.10	8.64	2.96
Oct	4.75	7.94	81.23	7.74	86.33	8.93	2.61
Nov	5.50	8.08	79.90	7.96	84.96	9.17	2.67
Dec	6.00	7.87	81.91	7.81	85.89	9.20	2.67

Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months

Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t

Chart VI-14 provides the overnight fed funds rate, the yield of the 10-year Treasury constant maturity bond, the yield of the 30-year constant maturity bond and the conventional mortgage rate from Jan 1991 to Dec 1996. In Jan 1991, the fed funds rate was 6.91 percent, the 10-year Treasury yield 8.09 percent, the 30-year Treasury yield 8.27 percent and the conventional mortgage rate 9.64 percent. Before monetary policy tightening in Oct 1993, the rates and yields were 2.99 percent for the fed funds, 5.33 percent for the 10-year Treasury, 5.94 for the 30-year Treasury and 6.83 percent for the conventional mortgage rate. After tightening in Nov 1994, the rates and yields were 5.29 percent for the fed funds rate, 7.96 percent for the 10-year Treasury, 8.08 percent for the 30-year Treasury and 9.17 percent for the conventional mortgage rate.

Chart VI-14, US, Overnight Fed Funds Rate, 10-Year Treasury Constant Maturity, 30-Year Treasury Constant Maturity and Conventional Mortgage Rate, Monthly, Jan 1991 to Dec 1996

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/h15/update/

Chart VI-15 of the Bureau of Labor Statistics provides the all items consumer price index from Jan 1991 to Dec 1996. There does not appear acceleration of consumer prices requiring aggressive tightening.

Chart VI-15, US, Consumer Price Index All Items, Jan 1991 to Dec 1996

Source: Bureau of Labor Statistics

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

Chart IV-16 of the Bureau of Labor Statistics provides 12-month percentage changes of the all items consumer price index from Jan 1991 to Dec 1996. Inflation collapsed during the recession from Jul 1990 (III) and Mar 1991 (I) and the end of the Kuwait War on Feb 25, 1991 that stabilized world oil markets. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). Policy tightening had adverse collateral effects in the form of emerging market crises in Mexico and Argentina and fixed income markets worldwide.

Chart VI-16, US, Consumer Price Index All Items, Twelve-Month Percentage Change, Jan 1991 to Dec 1996

Source: Bureau of Labor Statistics

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

The Congressional Budget Office (CBO 2014BEOFeb4) estimates potential GDP, potential labor force and potential labor productivity provided in Table IB-3. The CBO estimates average rate of growth of potential GDP from 1950 to 2012 at 3.3 percent per year. The projected path is significantly lower at 2.1 percent per year from 2013 to 2024. The legacy of the economic cycle expansion from IIIQ2009 to IVQ2013 at 2.3 percent on average is in contrast with 5.0 percent on average in the expansion from IQ1983 to IIQ1987 (http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html). Subpar economic growth may perpetuate unemployment and underemployment estimated at 29.1 million or 17.8 percent of the effective labor force in Feb 2014 (http://cmpassocregulationblog.blogspot.com/2014/03/rules-discretionary-authorities-and.html) with much lower hiring than in the period before the current cycle (http://cmpassocregulationblog.blogspot.com/2014/03/global-financial-risks-recovery-without.html).

Table IB-3, US, Congressional Budget Office History and Projections of Potential GDP of US Overall Economy, ∆%

	Potential GDP	Potential Labor Force	Potential Labor Productivity*
Average Annual ∆%
1950-1973	3.9	1.6	2.3
1974-1981	3.2	2.5	0.8
1982-1990	3.2	1.6	1.6
1991-2001	3.2	1.3	1.9
2002-2012	2.2	0.8	1.4
2007-2012	1.7	0.6	1.1
Total 1950-2012	3.3	1.5	1.8
Projected Average Annual ∆%
2013-2018	2.1	0.6	1.5
2019-2024	2.1	0.5	1.6
2013-2024	2.1	0.5	1.6

*Ratio of potential GDP to potential labor force

Source: CBO (2014BEOFeb4), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014.

Chart IB-1 of the Congressional Budget Office (CBO 2013BEOFeb5) provides actual and potential GDP of the United States from 2000 to 2011 and projected to 2024. Lucas (2011May) estimates trend of United States real GDP of 3.0 percent from 1870 to 2010 and 2.2 percent for per capita GDP. The United States successfully returned to trend growth of GDP by higher rates of growth during cyclical expansion as analyzed by Bordo (2012Sep27, 2012Oct21) and Bordo and Haubrich (2012DR). Growth in expansions following deeper contractions and financial crises was much higher in agreement with the plucking model of Friedman (1964, 1988). The unusual weakness of growth at 2.3 percent on average from IIIQ2009 to IVQ2013 during the current economic expansion in contrast with 5.0 percent on average in the cyclical expansion from IQ1983 to IQ1987 (http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html) cannot be explained by the contraction of 4.3 percent of GDP from IVQ2007 to IIQ2009 and the financial crisis. Weakness of growth in the expansion is perpetuating unemployment and underemployment of 29.1 million or 17.8 percent of the labor force as estimated for Feb 2014 (http://cmpassocregulationblog.blogspot.com/2014/03/rules-discretionary-authorities-and.html). There is no exit from unemployment/underemployment and stagnating real wages because of the collapse of hiring (http://cmpassocregulationblog.blogspot.com/2014/03/global-financial-risks-recovery-without.html). The US economy and labor markets collapsed without recovery. Abrupt collapse of economic conditions can be explained only with cyclic factors (Lazear and Spletzer 2012Jul22) and not by secular stagnation (Hansen 1938, 1939, 1941 with early dissent by Simons 1942).

Chart IB-1, US, Congressional Budget Office, Actual and Projections of Potential GDP, 2000-2024, Trillions of Dollars

Source: Congressional Budget Office, CBO (2013BEOFeb5). The last year in common in both projections is 2017. The revision lowers potential output in 2017 by 7.3 percent relative to the projection in 2007.

Chart IB-2 provides differences in the projections of potential output by the CBO in 2007 and more recently on Feb 4, 2014, which the CBO explains in CBO (2014Feb28).

Chart IB-2, Congressional Budget Office, Revisions of Potential GDP

Source: Congressional Budget Office, 2014Feb 28. Revisions to CBO’s Projection of Potential Output since 2007. Washington, DC, CBO, Feb 28, 2014.

Chart IB-3 provides actual and projected potential GDP from 2000 to 2024. The gap between actual and potential GDP disappears at the end of 2017 (CBO2014Feb4). GDP increases in the projection at 2.5 percent per year.

Chart IB-3, Congressional Budget Office, GDP and Potential GDP

Source: CBO (2013BEOFeb5), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014.

Chart IIA2-3 of the Bureau of Economic Analysis of the Department of Commerce shows on the lower negative panel the sharp increase in the deficit in goods and the deficits in goods and services from 1960 to 2012. The upper panel shows the increase in the surplus in services that was insufficient to contain the increase of the deficit in goods and services. The adjustment during the global recession has been in the form of contraction of economic activity that reduced demand for goods.

Chart IIA2-3, US, Balance of Goods, Balance on Services and Balance on Goods and Services, 1960-2013, Millions of Dollars

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

Chart IIA2-4 of the Bureau of Economic Analysis shows exports and imports of goods and services from 1960 to 2012. Exports of goods and services in the upper positive panel have been quite dynamic but have not compensated for the sharp increase in imports of goods. The US economy apparently has become less competitive in goods than in services.

Chart IIA2-4, US, Exports and Imports of Goods and Services, 1960-2013, Millions of Dollars

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

Chart IIA2-5 of the Bureau of Economic Analysis shows the US balance on current account from 1960 to 2012. The sharp devaluation of the dollar resulting from unconventional monetary policy of zero interest rates and elimination of auctions of 30-year Treasury bonds did not adjust the US balance of payments. Adjustment only occurred after the contraction of economic activity during the global recession.

Chart IIA2-5, US, Balance on Current Account, 1960-2013, Millions of Dollars

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

Chart IIA2-6 of the Bureau of Economic Analysis provides real GDP in the US from 1960 to 2012. The contraction of economic activity during the global recession was a major factor in the reduction of the current account deficit as percent of GDP.

Chart IIA2-6, US, Real GDP, 1960-2013, Billions of Chained 2009 Dollars

Source: Bureau of Economic Analysis

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

Chart IIA-7 provides the US current account deficit on a quarterly basis from 1980 to IQ1983. The deficit is at a lower level because of growth below potential not only in the US but worldwide. The combination of high government debt and deficit with external imbalance restricts potential prosperity in the US.

Chart IIB-7, US, Balance on Current Account, Quarterly, 1980-2013

Source: Bureau of Economic Analysis

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

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-8) increased from minus $45.9 billion in Dec 2013 to $7.3 billion in Jan 2014. Foreign (residents) purchases minus sales of US long-term securities (row A in Table VA-8) in Nov 2013 of minus $9.1 billion decreased to minus $18.6 billion in Dec 2013. Net US (residents) purchases of long-term foreign securities (row B in Table VA-8) improved from minus $18.6 billion in Dec 2013 to minus $14.8 billion in Jan 2014. In Jan 2014,

C = A + B = -$14.8 billion + $22.0 billion = -$7.3 billion

There are minor rounding errors. There is improving demand in Table VA-8 in Jan in A1 private purchases by residents overseas of US long-term securities of $1.8 billion of which slowing in A11 Treasury securities of $16.1 billion, improving in A12 of minus $4.5 billion in agency securities, improving of minus $4.4 billion of corporate bonds and improvement of $5.4 billion in equities. Worldwide risk aversion causes flight into US Treasury obligations with significant oscillations. Official purchases of securities in row A2 decreased $16.5 billion with decrease of Treasury securities of $16.7 billion in Jan 2014. Official purchases of agency securities increased $0.5 billion in Jan. Row D shows increase in Jan 2013 of $1.0 billion in purchases of short-term dollar denominated obligations. Foreign private holdings of US Treasury bills decreased $10.9 billion (row D11) with foreign official holdings decreasing $4.4 billion while the category “other” increased $16.3 billion. Foreign private holdings of US Treasury bills decreased $10.9 billion in what could be arbitrage 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-8, Net Cross-Borders Flows of US Long-Term Securities, Billion Dollars, NSA

	Jan 2013 12 Months	Jan 2014 12 Months	Dec 2013	Jan 2014
A Foreign Purchases less Sales of US LT Securities	582.0	15.4	-18.6	-14.8
A1 Private	327.4	16.0	-1.6	1.8
A11 Treasury	130.8	88.8	29.7	16.1
A12 Agency	122.0	-16.7	-10.3	-4.5
A13 Corporate Bonds	-25.3	-9.8	-7.9	-4.4
A14 Equities	100.0	-46.3	-13.1	-5.4
A2 Official	254.7	-0.6	-17.0	-16.5
A21 Treasury	229.8	-78.3	-11.9	-16.7
A22 Agency	4.3	70.3	-5.1	0.5
A23 Corporate Bonds	10.1	13.2	0.5	0.0
A24 Equities	10.5	-5.8	-0.5	-0.4
B Net US Purchases of LT Foreign Securities	-53.8	-172.9	-27.3	22.0
B1 Foreign Bonds	2.7	-7.2	-8.2	33.5
B2 Foreign Equities	-56.5	-165.7	-19.2	-11.5
C Net Foreign Purchases of US LT Securities	528.2	-157.2	-45.9	7.3
D Increase in Foreign Holdings of Dollar Denominated Short-term	120.9	-37.0	3.5	1.0
D1 US Treasury Bills	70.2	-4.9	33.7	-15.3
D11 Private	43.6	-21.7	19.6	-10.9
D12 Official	26.6	16.8	14.2	-4.4
D2 Other	50.7	-32.1	-30.2	16.3

C = A + B;

A = A1 + A2

A1 = A11 + A12 + A13 + A14

A2 = A21 + A22 + A23 + A24

B = B1 + B2

D = D1 + D2

Sources: United States Treasury

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

Table VA-9 provides major foreign holders of US Treasury securities. China is the largest holder with $1273.5 billion in Jan 2014, increasing 4.9 percent from $1214.2 billion in Jan 2013 while increasing $3.5 billion from Dec 2013 or 0.3 percent. Japan increased its holdings from $1103.9 billion in Jan 2013 to $1201.4 billion in Jan 2014 or by 8.8 percent. Japan increased its holdings from $1182.5 billion in Dec 2013 to $1201.4 billion in Jan 2014 by $18.9 billion or 1.6 percent. Total foreign holdings of Treasury securities rose from $5622.1 billion in Jan 2013 to $5832.7 billion in Jan 2014, or 3.7 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-9, US, Major Foreign Holders of Treasury Securities $ Billions at End of Period

	Jan 2014	Dec 2013	Jan 2013
Total	5832.7	5802.0	5622.1
China	1273.5	1270.0	1214.2
Japan	1201.4	1182.5	1103.9
Belgium	310.3	256.8	185.6
Caribbean Banking Centers	293.3	294.3	274.5
Oil Exporters	246.4	238.3	261.7
Brazil	246.0	245.4	254.1
Taiwan	179.1	182.2	192.7
Switzerland	173.7	176.7	190.0
United Kingdom	162.9	163.7	139.4
Hong Kong	160.3	158.8	142.9
Luxembourg	135.3	134.4	147.6
Russia	131.8	138.6	164.4
Ireland	108.8	125.4	108.5
Foreign Official Holdings	4067.9	4054.5	4048.9
A. Treasury Bills	393.9	398.3	377.1
B. Treasury Bonds and Notes	3674.0	3656.2	3671.8

Source: United States Treasury

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

ESVI United States Industrial Production. Industrial production increased 0.6 percent in Feb 2014 after decreasing 0.2 percent in Jan 2013 and changing 0.0 percent in Dec 2013, as shown in Table I-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 increased 0.6 percent in February after having declined 0.2 percent in January. In February, manufacturing output rose 0.8 percent and nearly reversed its decline of 0.9 percent in January, which resulted, in part, from extreme weather. The gain in factory production in February was the largest since last August. The output of utilities edged down 0.2 percent following a jump of 3.8 percent in January, and the production at mines moved up 0.3 percent. At 101.6 percent of its 2007 average, total industrial production in February was 2.8 percent above its level of a year earlier. The capacity utilization rate for total industry increased in February to 78.8 percent, a rate that is 1.3 percentage points below its long-run (1972–2013) average.”

In the six months ending in Feb 2014, United States national industrial production accumulated increase of 2.0 percent at the annual equivalent rate of 4.1 percent, which is higher than growth of 2.9 percent in the 12 months ending in Jan 2014. Excluding growth of -0.2 percent in Jan 2014, growth in the remaining five months from Sep to Feb 2013 accumulated to 2.2 percent or 5.4 percent annual equivalent. Industrial production fell in one of the past six months. Business equipment accumulated growth of 2.3 percent in the six months from Sep 2013 to Feb 2014 at the annual equivalent rate of 4.7 percent, which is lower than growth of 2.8 percent in the 12 months ending in Feb 2014. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “The capacity utilization rate for total industry increased in February to 78.8 percent, a rate that is 1.3 percentage points below its long-run (1972–2013) average.” United States industry apparently decelerated to a lower growth rate with possible acceleration in the past few months.

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

2013-2014	Feb 14	Jan 14	Dec   13	Nov  13	Oct  13	Sep  13	Feb  14/ Feb  13
Total	0.6	-0.2	0.0	0.8	0.2	0.6	2.8
Market Groups
Final Products	0.9	-0.3	0.3	0.4	0.3	1.0	2.6
Consumer Goods	0.8	-0.5	0.6	0.6	0.4	1.0	2.6
Business Equipment	1.3	0.3	-0.4	-0.3	0.2	1.2	2.8
Non Industrial Supplies	0.5	-0.5	0.0	0.5	0.4	0.8	2.1
Construction	0.2	-0.3	-0.7	0.5	0.9	1.1	0.1
Materials	0.4	0.0	-0.3	1.3	0.1	0.2	3.2
Industry Groups
Manufacturing	0.8	-0.9	0.2	0.4	0.5	0.2	1.5
Mining	0.3	0.5	-0.5	1.9	-1.6	1.0	6.1
Utilities	-0.2	3.8	-0.9	2.9	1.0	3.2	8.3
Capacity	78.8	78.5	78.8	78.9	78.4	78.4	1.9

Sources: Board of Governors of the Federal Reserve System

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

Manufacturing increased 0.8 percent in Feb 2014 after decreasing 0.9 percent in Jan 2014 and increasing 0.2 percent in Dec 2013 seasonally adjusted, increasing 1.9 percent not seasonally adjusted in 12 months ending in Feb 2014, as shown in Table I-2. Manufacturing grew cumulatively 1.2 percent in the six months ending in Jan 2014 or at the annual equivalent rate of 2.4 percent. Excluding the decrease of 0.9 percent in Jan 2014, manufacturing accumulated growth of 2.1 percent from Sep 2013 to Feb 2013 or at the annual equivalent rate of 5.2 percent. Table I-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 strength 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 I-2 shows decline of manufacturing by 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increase by 19.1 percent from the trough in Apr 2009 to Dec 2013. Manufacturing grew 19.1 percent from the trough in Apr 2009 to Feb 2014. Manufacturing output in Feb 2014 is 6.9 percent below the peak in Jun 2007.

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

	Month SA ∆%	12-Month NSA ∆%
Feb 2014	0.8	1.9
Jan	-0.9	1.2
Dec 2013	0.2	2.0
Nov	0.4	2.8
Oct	0.5	3.8
Sep	0.2	2.6
Aug	0.8	2.6
Jul	-0.5	1.4
Jun	0.3	1.8
May	0.3	1.8
Apr	-0.3	2.2
Mar	-0.2	1.8
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 2013		2.3
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 2013		0.5
∆% Peak 103.0005 in 06/2007 to 95.8199 in 12/2013		-7.0
∆% Peak 103.0005 in 06/2007 to Trough 80.4617 in 4/2009		-21.9
∆% Trough  80.4617 in 04/2009 to 95.8087 in 12/2013		19.1
∆% Trough  80.4617 in 04/2009 to 95.8199 in 12/2013		19.1
∆% Peak 103.0005 on 06/2007 to 95.9398 in 2/2014		-6.9

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 2014 on a monthly basis is in Chart I-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 I-4, US, Manufacturing Output, 1919-2014

Source: Board of Governors of the Federal Reserve System

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

Manufacturing jobs increased 6,000 in Feb 2014 relative to Jan 2014, seasonally adjusted. Manufacturing jobs not seasonally adjusted increased 63,000 from Feb 2013 to Feb 2014 or at the average monthly rate of 5,250. There are effects of the weaker economy and international trade together with the yearly adjustment of labor statistics.

Industrial production increased 0.6 percent in Feb 2014 after decreasing 0.2 percent in Jan 2013 and changing 0.0 percent in Dec 2013, as shown in Table I-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 increased 0.6 percent in February after having declined 0.2 percent in January. In February, manufacturing output rose 0.8 percent and nearly reversed its decline of 0.9 percent in January, which resulted, in part, from extreme weather. The gain in factory production in February was the largest since last August. The output of utilities edged down 0.2 percent following a jump of 3.8 percent in January, and the production at mines moved up 0.3 percent. At 101.6 percent of its 2007 average, total industrial production in February was 2.8 percent above its level of a year earlier. The capacity utilization rate for total industry increased in February to 78.8 percent, a rate that is 1.3 percentage points below its long-run (1972–2013) average.”

In the six months ending in Feb 2014, United States national industrial production accumulated increase of 2.0 percent at the annual equivalent rate of 4.1 percent, which is higher than growth of 2.9 percent in the 12 months ending in Jan 2014. Excluding growth of -0.2 percent in Jan 2014, growth in the remaining five months from Sep to Feb 2013 accumulated to 2.2 percent or 5.4 percent annual equivalent. Industrial production fell in one of the past six months. Business equipment accumulated growth of 2.3 percent in the six months from Sep 2013 to Feb 2014 at the annual equivalent rate of 4.7 percent, which is lower than growth of 2.8 percent in the 12 months ending in Feb 2014. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “The capacity utilization rate for total industry increased in February to 78.8 percent, a rate that is 1.3 percentage points below its long-run (1972–2013) average.” United States industry apparently decelerated to a lower growth rate with possible acceleration in the past few months.

Manufacturing increased 0.8 percent in Feb 2014 after decreasing 0.9 percent in Jan 2014 and increasing 0.2 percent in Dec 2013 seasonally adjusted, increasing 1.9 percent not seasonally adjusted in 12 months ending in Feb 2014, as shown in Table I-2. Manufacturing grew cumulatively 1.2 percent in the six months ending in Jan 2014 or at the annual equivalent rate of 2.4 percent. Excluding the decrease of 0.9 percent in Jan 2014, manufacturing accumulated growth of 2.1 percent from Sep 2013 to Feb 2013 or at the annual equivalent rate of 5.2 percent. Table I-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 strength at the margin. Manufacturing fell 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increased by 19.1 percent from the trough in Apr 2009 to Dec 2013. Manufacturing grew 19.1 percent from the trough in Apr 2009 to Feb 2014. Manufacturing output in Feb 2014 is 6.9 percent below the peak in Jun 2007.

Table I-11 provides national income by industry without capital consumption adjustment (WCCA). “Private industries” or economic activities have share of 86.8 percent in IIIQ2013. Most of US national income is in the form of services. In Feb 2014, there were 136.183 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 114.021 million NSA in Feb 2014 accounted for 83.7 percent of total nonfarm jobs of 136.183 million, of which 11.964 million, or 10.5 percent of total private jobs and 8.8 percent of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 96.658 million NSA in Feb 2014, or 71.0 percent of total nonfarm jobs and 84.8 percent of total private-sector jobs. Manufacturing has share of 10.8 percent in US national income in IIIQ2013, as shown in Table I-11. 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-11, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total

	SAAR IIQ2013	% Total	SAAR IIIQ2013	% Total
National Income WCCA	14,495.5	100.0	14,642.3	100.0
Domestic Industries	14,248.7	98.3	14,379.4	98.2
Private Industries	12,568.6	86.7	12,704.3	86.8
Agriculture	220.3	1.5	224.2	1.5
Mining	254.3	1.8	253.3	1.7
Utilities	216.5	1.5	221.4	1.5
Construction	629.0	4.3	638.7	4.4
Manufacturing	1558.9	10.8	1575.6	10.8
Durable Goods	888.1	6.1	910.6	6.2
Nondurable Goods	670.1	4.6	665.0	4.5
Wholesale Trade	874.4	6.0	884.6	6.0
Retail Trade	995.8	6.9	998.0	6.8
Transportation & WH	436.3	3.0	442.3	3.0
Information	507.2	3.5	498.9	3.4
Finance, Insurance, RE	2448.1	16.9	2517.6	17.2
Professional & Business Services	2004.7	13.8	2008.0	13.7
Education, Health Care	1438.9	9.9	1445.7	9.8
Arts, Entertainment	577.1	4.0	585.6	4.0
Other Services	409.7	2.8	410.4	2.8
Government	1680.1	11.6	1675.1	11.4
Rest of the World	246.8	1.7	262.9	1.8

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

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014