Financial Risks, Twenty Six Million Unemployed or Underemployed, Stagnating Real Wages, Rules, Discretionary Authorities and Slow Productivity Growth, World Cyclical Slow Growth and Global Recession Risk: Part I

 

Financial Risks, Twenty Six Million Unemployed or Underemployed, Stagnating Real Wages, Rules, Discretionary Authorities and Slow Productivity Growth, World Cyclical Slow Growth and Global Recession Risk

Carlos M. Pelaez

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

I Twenty Six Million Unemployed or Underemployed

IA1 Summary of the Employment Situation

IA2 Number of People in Job Stress

IA3 Long-term and Cyclical Comparison of Employment

IA4 Job Creation

IB Stagnating Real Wages

II Rules, Discretionary Authorities and Slow Productivity Growth

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 Financial “Irrational Exuberance,” Increasing Interest Rate Risk, Tapering Quantitative Easing, Duration Dumping, Competitive Devaluations, Steepening Yield Curve and Global Financial and Economic Risk

ESII Twenty Six Million Unemployed or Underemployed

ESIII Job Creation

ESIV Stagnating Real Wages

ESV Rules, Discretionary Authorities and Slow Productivity Growth

ESI “Financial “Irrational Exuberance,” 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 provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/ns/cs.aspx?id=29), of the world financial system with its Global Financial Stability Report (GFSR) (http://www.imf.org/external/pubs/ft/gfsr/index.htm) and of fiscal affairs with the Fiscal Monitor (http://www.imf.org/external/ns/cs.aspx?id=262). 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. Cumulative growth of China’s GDP in IIIQ2014 relative to the same period in 2013 was 7.4 percent. Secondary industry accounts for 44.2 percent of cumulative GDP in IIIQ2014. In cumulative IIIQ2014, industry alone accounts for 37.4 percent of GDP and construction with the remaining 6.8 percent. Tertiary industry accounts for 46.7 percent of cumulative GDP in IIIQ2014 and primary industry for 9.0 percent. China’s growth strategy consisted of rapid increases in productivity in industry to absorb population from agriculture where incomes are lower (Pelaez and Pelaez, The Global Recession Risk (2007), 56-80). The strategy is changing to lower growth rates while improving living standards. 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 1.7 percent relative to IIIQ2013, which is equivalent to 7.0 percent per year. GDP grew 7.4 percent in IQ2014 relative to a year earlier and 1.5 percent in IQ2014 that is equivalent to 6.1 percent per year. GP grew 7.5 percent in IIQ2014 relative to a year earlier and 2.0 percent relative to the prior quarter, which is equivalent 8.2 percent. In IIIQ2014, GDP grew 7.3 percent relative to a year earlier and 1.9 percent relative to the prior quarter, which is 7.8 percent in annual equivalent (Section VC and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.htm http://cmpassocregulationblog.blogspot.com/2014/04/imf-view-world-inflation-waves-squeeze.html and earlier 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 26.0 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 (http://cmpassocregulationblog.blogspot.com/2014/11/squeeze-of-economic-activity-by-carry.html and earlier http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.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 mixed with reallocations of portfolios of risk financial assets

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 $2671 billion, or $2.7 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 Dec 4, 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
3/27/14	0.08	2.69	4.95
4/3/14	0.08	2.80	5.04
4/10/14	0.08	2.65	4.89
4/17/14	0.09	2.73	4.89
4/24/14	0.10	2.70	4.84
5/1/14	0.09	2.63	4.77
5/8/14	0.08	2.61	4.79
5/15/14	0.09	2.50	4.72
5/22/14	0.09	2.56	4.81
5/29/14	0.09	2.45	4.69
6/05/14	0.09	2.59	4.83
6/12/14	0.09	2.58	4.79
6/19/14	0.10	2.64	4.83
6/26/14	0.10	2.53	4.71
7/2/14	0.10	2.64	4.84
7/10/14	0.09	2.55	4.75
7/17/14	0.09	2.47	4.69
7/24/14	0.09	2.52	4.72
7/31/14	0.08	2.58	4.75
8/7/14	0.09	2.43	4.71
8/14/14	0.09	2.40	4.69
8/21/14	0.09	2.41	4.69
8/28/14	0.09	2.34	4.57
9/04/14	0.09	2.45	4.70
9/11/14	0.09	2.54	4.79
9/18/14	0.09	2.63	4.91
9/25/14	0.09	2.52	4.79
10/02/14	0.09	2.44	4.76
10/09/14	0.08	2.34	4.68
10/16/14	0.09	2.17	4.64
10/23/14	0.09	2.29	4.71
11/13/14	0.09	2.35	4.82
11/20/14	0.10	2.34	4.86
11/26/14	0.10	2.24	4.73
12/04/14	0.12	2.25	4.78

Source: Board of Governors of the Federal Reserve System

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

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 Oct 29, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20141029a.htm):

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, 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 anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, 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. However, if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated” (emphasis added).

Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):

So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly” (emphasis added).

Chart S provides the yield of the two-year Treasury constant maturity from Mar 17, 2014, two days before the guidance of Chair Yellen on Mar 19, 2014, to Dec 4, 2014. Chart SA provides the yields of the seven-, ten- and thirty-year Treasury constant maturity in the same dates. Yields increased right after the guidance of Chair Yellen. The two-year yield remain at a higher level than before while the ten-year yield fell and increased again. There could be more immediate impact on two-year yields of an increase in the fed funds rates but the effects would spread throughout the term structure of interest rates (Cox, Ingersoll and Ross 1981, 1985, Ingersoll 1987). Yields converged toward slightly lower earlier levels in the week of Apr 24, 2014 with reallocation of portfolios of risk financial assets away from equities and into bonds and commodities. There is ongoing reshuffling of portfolios to hedge against geopolitical events and world/regional economic performance.

Chart S, US, Yield of Two-Year Treasury Constant Maturity, Mar 17 to Dec 4, 2014 

Source: Board of Governors of the Federal Reserve System

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

Chart SA, US, Yield of Seven-Year, Ten-Year and Thirty-Year Treasury Constant Maturity, Mar 17 to Dec 4, 2014 

Source: Board of Governors of the Federal Reserve System

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

At a speech on Mar 31, 2014, Chair Yellen analyzed labor market conditions as follows (http://www.federalreserve.gov/newsevents/speech/yellen20140331a.htm):

“And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress. The first of those goals is maximum sustainable employment, the highest level of employment that can be sustained while maintaining a stable inflation rate. Most of my colleagues on the Federal Open Market Committee and I estimate that the unemployment rate consistent with maximum sustainable employment is now between 5.2 percent and 5.6 percent, well below the 6.7 percent rate in February.

Let me explain what I mean by that word "slack" and why it is so important.

Slack means that there are significantly more people willing and capable of filling a job than there are jobs for them to fill. During a period of little or no slack, there still may be vacant jobs and people who want to work, but a large share of those willing to work lack the skills or are otherwise not well suited for the jobs that are available. With 6.7 percent unemployment, it might seem that there must be a lot of slack in the U.S. economy, but there are reasons why that may not be true.”

Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart VI-1B for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart VI-1B cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s. The loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy.  This interpretation is consistent with the case of the 24 emerging market economies analyzed by Reinhart and Rogoff (2010GTD, 4), concluding that “higher debt levels are associated with significantly higher levels of inflation in emerging markets. Median inflation more than doubles (from less than seven percent to 16 percent) as debt rises from the low (0 to 30 percent) range to above 90 percent. Fiscal dominance is a plausible interpretation of this pattern.”

The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:

“So, inflation is caused by ‘tightness’ and deflation by ‘slack’ in the economy. This is not just a cause and forecasting variable, it is the cause, because given ‘slack’ we apparently do not have to worry about inflation from other sources, notwithstanding the weak correlation of [Phillips circuits]. These statements [by the Fed] do mention ‘stable inflation expectations. How does the Fed know expectations are ‘stable’ and would not come unglued once people look at deficit numbers? As I read Fed statements, almost all confidence in ‘stable’ or ‘anchored’ expectations comes from the fact that we have experienced a long period of low inflation (adaptive expectations). All these analyses ignore the stagflation experience in the 1970s, in which inflation was high even with ‘slack’ markets and little ‘demand, and ‘expectations’ moved quickly. They ignore the experience of hyperinflations and currency collapses, which happen in economies well below potential.”

Yellen (2014Aug22) states that “Historically, slack has accounted for only a small portion of the fluctuations in inflation. Indeed, unusual aspects of the current recovery may have shifted the lead-lag relationship between a tightening labor market and rising inflation pressures in either direction.”

Chart VI-1B provides the tortuous Phillips Circuit of Brazil from 1963 to 1987. There were no reliable consumer price index and unemployment data in Brazil for that period. Chart VI-1B used the more reliable indicator of inflation, the wholesale price index, and idle capacity of manufacturing as a proxy of unemployment in large urban centers.

ChVI1-B, Brazil, Phillips Circuit, 1963-1987

Source:

©Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.

The minutes of the meeting of the Federal Open Market Committee (FOMC) on Sep 16-17, 2014, reveal concern with global economic conditions (http://www.federalreserve.gov/monetarypolicy/fomcminutes20140917.htm):

“Most viewed the risks to the outlook for economic activity and the labor market as broadly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.”

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 from Aug 2014 to Oct 2014, CPI inflation for all items seasonally adjusted was minus 0.4 percent in annual equivalent, obtained by calculating accumulated inflation from Aug 2014 to Oct 2014 and compounding for a full year. In the 12 months ending in Oct 2014, CPI inflation of all items not seasonally adjusted was 1.7 percent. Inflation in Oct 2014 seasonally adjusted was 0.0 percent relative to Sep 2014, or 0.0 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: 1.8 percent in 12 months and 1.2 percent in annual equivalent Jul 2014-Sep 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 0.030 percent for one month, 0.030 percent for three months, 0.086 percent for six months, 0.150 percent for one year, 0.643 percent for two years, 1.073 percent for three years, 1.682 percent for five years, 2.063 percent for seven years, 2.307 percent for ten years and 2.968 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 Sep 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.

Table VIII-1, US, Consumer Price Index Percentage Change 12 Months NSA and Annual Equivalent

	∆% 12 Months Oct 2014/Oct 2013 NSA	∆% Annual Equivalent Aug 2014 to Oct 2014 SA
CPI All Items	1.7	-0.4
CPI ex Food and Energy	1.8	1.2

Source: Bureau of Labor Statistics

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

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 Dec 5, 2014, Dec 31, 2013, May 1, 2013, Dec 5, 2013 and Dec 5, 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 2.31 percent on Dec 5, 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 2.31 percent would jump instantaneously from yield of 2.31 percent on Dec 5, 2014 to 4.45 percent as occurred on Dec 5, 2006 when the economy was closer to full employment. The price of the hypothetical bond issued with coupon of 2.31 percent would drop from 100 to 82.8780 after an instantaneous increase of the yield to 4.45 percent. The price loss would be 17.1 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

	12/05/14	12/31/13	5/01/13	12/05/13	12/205/06
1 M	0.02	0.01	0.03	0.02	4.88
3 M	0.02	0.07	0.06	0.06	4.99
6 M	0.08	0.10	0.08	0.10	5.03
1 Y	0.18	0.13	0.11	0.13	4.86
2 Y	0.65	0.38	0.20	0.30	4.52
3 Y	1.09	0.78	0.30	0.61	4.43
5 Y	1.69	1.75	0.65	1.49	4.39
7 Y	2.06	2.45	1.07	2.23	4.40
10 Y	2.31	3.04	1.66	2.88	4.45
20 Y	2.69	3.72	2.44	3.65	4.67
30 Y	2.97	3.96	2.83	3.92	4.57

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 3.98 percent on Dec 4, 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. Nick Timiraos, writing on “Demand for home loans plunges,” on Apr 24, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304788404579522051733228402?mg=reno64-wsj), analyzes data in Inside Mortgage Finance that mortgage lending of $235 billion in IQ2014 is 58 percent lower than a year earlier and 23 percent below IVQ2013. Mortgage lending collapsed to the lowest level in 14 years. In testimony before the Committee on the Budget of the US Senate on May 8, 2004, Chair Yellen provides analysis of the current economic situation and outlook (http://www.federalreserve.gov/newsevents/testimony/yellen20140507a.htm): “One cautionary note, though, is that readings on housing activity--a sector that has been recovering since 2011--have remained disappointing so far this year and will bear watching.”

Chart VI-13, US, Conventional Mortgage Rate, Jan 8, 2004 to Dec 4, 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

Table VI-2 extracts four rows of Table VI-1 with the Dollar/EUR (USD/EUR) exchange rate and 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 1.2285 EUR on Dec 5, 2014 or by 4.5 percent {[(1.2285/1.192)-1]100 = 3.1%}. 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 6.1502/USD on Fri Dec 5, 2014, or by an additional 9.8 percent, for cumulative revaluation of 25.7 percent. The final row of Table VI-2 shows: devaluation of 0.1 percent in the week of Nov 14, 2014; revaluation of 0.1 percent in the week of Nov 21, 2014; devaluation of 0.3 percent in the week of Nov 218, 2014; and devaluation of 0.1 percent in the week of Dec 5, 2014. 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	12/05/14
Rate	1.1423	1.5914	1.192	1.2285
CNY/USD	01/03 2000	07/21 2005	7/15 2008	12/05/ 2014
Rate	8.2765	8.2765	6.8211	6.1502
Weekly Rates	11/14/2014	11/21/2014	11/28/2014	12/05/ 2014
CNY/USD	6.1313	6.1228	6.1431	6.1502
∆% from Earlier Week*	-0.1	0.1	-0.3	-0.1

*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 Nov 28, 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 6.1429/USD on Nov 28, 2014, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD by 25.7 percent by Dec 5, 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 and subsequent increase or devaluation. The final segment shows decline 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-Nov 28, 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 Nov 28, 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 6.1429/USD on Nov 28, 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-Nov 28, 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 finer details with the rate of Chinese Yuan (CNY) to the US Dollar (USD) from Oct 28, 2011 to Nov 21, 2014. There have been alternations of revaluation and devaluation. The initial data point is CNY 6.5370 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 1.4 percent. Another devaluation is from CNY 6.0402/USD on Jan 14, 2014 to CNY 6.1429 on Nov 28, 2014, or devaluation of 1.7 percent. The United States Treasury estimates US government debt held by private investors at $9670 billion in Jun 2014. China’s holding of US Treasury securities represent 13.1 percent of US government marketable interest-bearing debt held by private investors (http://www.fms.treas.gov/bulletin/index.html). Min Zeng, writing on “China plays a big role as US Treasury yields fall,” on Jul 16, 2004, published in the Wall Street Journal (http://online.wsj.com/articles/china-plays-a-big-role-as-u-s-treasury-yields-fall-1405545034?tesla=y&mg=reno64-wsj), finds that acceleration in purchases of US Treasury securities by China has been an important factor in the decline of Treasury yields in 2014. Japan increased its holdings from $1149.1 billion in Aug 2013 to $1230.1 billion in Aug 2014 or 7.0 percent. The combined holdings of China and Japan in Aug 2014 add to $2500 billion, which is equivalent to 25.9 percent of US government marketable interest-bearing securities held by investors of $9670 billion in Jun 2014 (http://www.fms.treas.gov/bulletin/index.html). Total foreign holdings of Treasury securities rose from $5595.8 billion in Aug 2013 to $6066.6 billion in Aug 2014, or 8.4 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.”

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

Source: Board of Governors of the Federal Reserve System

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

There are major ongoing and unresolved realignments of exchange rates in the international financial system as countries and regions seek parities that can optimize their productive structures. Seeking exchange rate parity or exchange rate optimizing internal economic activities is complex in a world of unconventional monetary policy of zero interest rates and even negative nominal interest rates of government obligations such as negative yields for the two-year government bond of Germany. Regulation, trade and devaluation conflicts should have been expected from a global recession (Pelaez and Pelaez (2007), The Global Recession Risk, Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008a)): “There are significant grounds for concern on the basis of this experience. International economic cooperation and the international financial framework can collapse during extreme events. It is unlikely that there will be a repetition of the disaster of the Great Depression. However, a milder contraction can trigger regulatory, trade and exchange wars” (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 181). Chart VI-2 of the Board of Governors of the Federal Reserve System provides the key exchange rate of US dollars (USD) per euro (EUR) from Jan 4, 1999 to Nov 28, 2014. US recession dates are in shaded areas. The rate on Jan 4, 1999 was USD 1.1812/EUR, declining to USD 0.8279/EUR on Oct 25, 2000, or appreciation of the USD by 29.9 percent. The rate depreciated 21.9 percent to USD 1.0098/EUR on Jul 22, 2002. There was sharp devaluation of the USD of 34.9 percent to USD 1.3625/EUR on Dec 27, 2004 largely because of the 1 percent interest rate between Jun 2003 and Jun 2004 together with a form of quantitative easing by suspension of auctions of the 30-year Treasury, which was equivalent to withdrawing supply from markets. Another depreciation of 17.5 percent took the rate to USD 1.6010/EUR on Apr 22, 2008, already inside the shaded area of the global recession. The flight to the USD and obligations of the US Treasury appreciated the dollar by 22.3 percent to USD 1.2446/EUR on Oct 27, 2008. In the return of the carry trade after stress tests showed sound US bank balance sheets, the rate depreciated 21.2 percent to USD 1.5085/EUR on Nov 25, 2009. The sovereign debt crisis of Europe in the spring of 2010 caused sharp appreciation of 20.7 percent to USD 1.1959/EUR on Jun 6, 2010. Renewed risk appetite depreciated the rate 24.4 percent to USD 1.4875/EUR on May 3, 2011. The rate depreciated 4.0 percent to USD 1.2438/EUR on Nov 28, 2014, which is the last point in Chart VI-2. 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-2, US Dollars (USD) per Euro (EUR), Jan 4, 1999 to Nov 28, 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-3 provides three indexes of the US Dollars (USD) from Jan 4, 1995 to Nov 28, 2014.

Chart VI-3A provides the overnight fed funds rate and yields of the three-month constant maturity Treasury bill, the ten-year constant maturity Treasury note and Moody’s Baa bond from Jan 4, 1995 to Dec 4, 2014. The first phase from 1995 to 2001 shows sharp trend of appreciation of the USD while interest rates remained at relatively high levels. The dollar revalued partly because of the emerging market crises that provoked inflows of financial investment into the US and partly because of a deliberate strong dollar policy. DeLong and Eichengreen (2001, 4-5) argue:

“That context was an economic and political strategy that emphasized private investment as the engine for U.S. economic growth. Both components of this term, "private" and "investment," had implications for the administration’s international economic strategy. From the point of view of investment, it was important that international events not pressure on the Federal Reserve to raise interest rates, since this would have curtailed capital formation and vitiated the effects of the administration’s signature achievement: deficit reduction. A strong dollar -- or rather a dollar that was not expected to weaken -- was a key component of a policy which aimed at keeping the Fed comfortable with low interest rates. In addition, it was important to create a demand for the goods and services generated by this additional productive capacity. To the extent that this demand resided abroad, administration officials saw it as important that the process of increasing international integration, of both trade and finance, move forward for the interest of economic development in emerging markets and therefore in support of U.S. economic growth.”

The process of integration consisted of restructuring “international financial architecture” (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Debtors and Creditors (2005)). Policy concerns subsequently shifted to the external imbalances, or current account deficits, and internal imbalances, or government deficits (Pelaez and Pelaez, The Global Recession Risk: Dollar Devaluation and the World Economy (2007)). Fed policy consisted of lowering the policy rate or fed funds rate, which is close to the marginal cost of funding of banks, toward zero during the past decade. Near zero interest rates induce carry trades of selling dollar debt (borrowing), shorting the USD and investing in risk financial assets. Without risk aversion, near zero interest rates cause devaluation of the dollar. Chart VI-3 shows the weakening USD between the recession of 2001 and the contraction after IVQ2007. There was a flight to dollar assets and especially obligations of the US government after Sep 2008. Cochrane and Zingales (2009) show that flight was coincident with proposals of TARP (Troubled Asset Relief Program) to withdraw “toxic assets” in US banks (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a) and Regulation of Banks and Finance (2009b)). There are shocks to globalization in the form of regulation, trade and devaluation wars and breakdown of international cooperation (Pelaez and Pelaez, Globalization and the State: Vol. I (2008a), Globalization and the State: Vol. II (2008b) and Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c)). As evident in Chart VI-3A, there is no exit from near zero interest rates without a financial crisis and economic contraction, verified by the increase of interest rates from 1 percent in Jun 2004 to 5.25 percent in Jun 2006. 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). 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 VI-3A. 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. There are conflicts on exchange rate movements among central banks. There is concern of declining inflation in the euro area and appreciation of the euro. On Jun 5, 2014, the European Central Bank introduced cuts in interest rates and a negative rate paid on deposits of banks (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605.en.html):

“5 June 2014 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.15%, starting from the operation to be settled on 11 June 2014.
2. The interest rate on the marginal lending facility will be decreased by 35 basis points to 0.40%, with effect from 11 June 2014.
3. The interest rate on the deposit facility will be decreased by 10 basis points to -0.10%, with effect from 11 June 2014. A separate press release to be published at 3.30 p.m. CET today will provide details on the implementation of the negative deposit facility rate.”

The ECB also introduced new measures of monetary policy on Jun 5, 2014 (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605_2.en.html):

“5 June 2014 - ECB announces monetary policy measures to enhance the functioning of the monetary policy transmission mechanism

In pursuing its price stability mandate, the Governing Council of the ECB has today announced measures to enhance the functioning of the monetary policy transmission mechanism by supporting lending to the real economy. In particular, the Governing Council has decided:

1. To conduct a series of targeted longer-term refinancing operations (TLTROs) aimed at improving bank lending to the euro area non-financial private sector ^[1], excluding loans to households for house purchase, over a window of two years.
2. To intensify preparatory work related to outright purchases of asset-backed securities (ABS).”

The President of the European Central Bank (ECB) Mario Draghi analyzed the measures at a press conference (http://www.ecb.europa.eu/press/pressconf/2014/html/is140605.en.html). At the press conference following the meeting of the ECB on Jul 3, 2014, Mario Draghi stated (http://www.ecb.europa.eu/press/pressconf/2014/html/is140703.en.html): “In fact, as I said, interest rates will stay low for an extended period of time, and the Governing Council is unanimous in its commitment to use also nonstandard, unconventional measures to cope with the risk of a too-prolonged period of time of low inflation.”

The President of the ECB Mario Draghi analyzed unemployment in the euro area and the policy response policy in a speech at the Jackson Hole meeting of central bankers on Aug 22, 2014 (http://www.ecb.europa.eu/press/key/date/2014/html/sp140822.en.html):

“We have already seen exchange rate movements that should support both aggregate demand and inflation, which we expect to be sustained by the diverging expected paths of policy in the US and the euro area (Figure 7). We will launch our first Targeted Long-Term Refinancing Operation in September, which has so far garnered significant interest from banks. And our preparation for outright purchases in asset-backed security (ABS) markets is fast moving forward and we expect that it should contribute to further credit easing. Indeed, such outright purchases would meaningfully contribute to diversifying the channels for us to generate liquidity.”

On Sep 4, 2014, the European Central Bank lowered policy rates (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140904.en.html):

“4 September 2014 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.05%, starting from the operation to be settled on 10 September 2014.
2. The interest rate on the marginal lending facility will be decreased by 10 basis points to 0.30%, with effect from 10 September 2014.
3. The interest rate on the deposit facility will be decreased by 10 basis points to -0.20%, with effect from 10 September 2014.”

The President of the European Central Bank announced on Sep 4, 2014, the decision to expand the balance sheet by purchases of asset-backed securities (ABS) in a new ABS Purchase Program (ABSPP) and covered bonds (http://www.ecb.europa.eu/press/pressconf/2014/html/is140904.en.html):

“Based on our regular economic and monetary analyses, the Governing Council decided today to lower the interest rate on the main refinancing operations of the Eurosystem by 10 basis points to 0.05% and the rate on the marginal lending facility by 10 basis points to 0.30%. The rate on the deposit facility was lowered by 10 basis points to -0.20%. In addition, the Governing Council decided to start purchasing non-financial private sector assets. The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP). This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter, as decided by the Governing Council in June. In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs domiciled in the euro area under a new covered bond purchase programme (CBPP3). Interventions under these programmes will start in October 2014. The detailed modalities of these programmes will be announced after the Governing Council meeting of 2 October 2014. The newly decided measures, together with the targeted longer-term refinancing operations which will be conducted in two weeks, will have a sizeable impact on our balance sheet.”

At the Thirtieth Meeting of the International Monetary and Financial Committee of the IMF (IMFC), the President of the European Central Bank (ECB), Mario Draghi stated (http://www.ecb.europa.eu/press/key/date/2014/html/sp141010.en.html):

“Our monetary policy continues to aim at firmly anchoring medium to long-term inflation expectations, in line with our objective of maintaining inflation rates below, but close to, 2% over the medium term. In this context, we have taken both conventional and unconventional measures that will contribute to a return of inflation rates to levels closer to our aim. Our unconventional measures, more specifically our TLTROs (Targeted Longer-Term Refinancing Operations) and our new purchase programmes for ABSs and covered bonds, will further enhance the functioning of our monetary policy transmission mechanism and facilitate credit provision to the real economy. Should it become necessary to further address risks of too prolonged a period of low inflation, the ECB’s Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate.”

In a speech on “Monetary Policy in the Euro Area,” on Nov 21, 2014, the President of the European Central Bank, Mario Draghi, advised of the determination to bring inflation back to normal levels by aggressive holding of securities in the balance sheet (http://www.ecb.europa.eu/press/key/date/2014/html/sp141121.en.html):

“In short, there is a combination of policies that will work to bring growth and inflation back on a sound path, and we all have to meet our responsibilities in achieving that. For our part, we will continue to meet our responsibility – we will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us.

If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialise, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases.”

In the Introductory Statement to the press conference on Dec 4,2014, the President of the European Central Bank Mario Draghi advised that (http://www.ecb.europa.eu/press/pressconf/2014/html/is141204.en.html):

“In this context, early next year the Governing Council will reassess the monetary stimulus achieved, the expansion of the balance sheet and the outlook for price developments. We will also evaluate the broader impact of recent oil price developments on medium-term inflation trends in the euro area. Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council remains unanimous in its commitment to using additional unconventional instruments within its mandate. This would imply altering early next year the size, pace and composition of our measures.”

Chart VI-3, US Dollar Currency Indexes, Jan 4, 1995-Nov 28, 2014

Source: Board of Governors of the Federal Reserve System

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

Chart VI-3A, US, Overnight Fed Funds Rate, Yield of Three-Month Treasury Constant Maturity, Yield of Ten-Year Treasury Constant Maturity and Yield of Moody’s Baa Bond, Jan 4, 1995 to Dec 4, 2014

Source: Board of Governors of the Federal Reserve System

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

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 Nov 28, 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 13.9210/USD on Nov 28, 2014.

Chart VI-4A, Mexican Peso (MXN) per US Dollar (USD), Nov 8, 1993 to Nov 28, 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. In a speech at the Brookings Institution on Apr 10, 2014, Raghuram G. Rajan (2014Apr10, 1, 10) argues:

“As the world seems to be struggling back to its feet after the great financial crisis, I want to draw attention to an area we need to be concerned about: the conduct of monetary policy in this integrated world. A good way to describe the current environment is one of extreme monetary easing through unconventional policies. In a world where debt overhangs and the need for structural change constrain domestic demand, a sizeable portion of the effects of such policies spillover across borders, sometimes through a weaker exchange rate. More worryingly, it prompts a reaction. Such competitive easing occurs both simultaneously and sequentially, as I will argue, and both advanced economies and emerging economies engage in it. Aggregate world demand may be weaker and more distorted than it should be, and financial risks higher. To ensure stable and sustainable growth, the international rules of the game need to be revisited. Both advanced economies and emerging economies need to adapt, else I fear we are about to embark on the next leg of a wearisome cycle. A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have.”

Professor Raguram G Rajan, governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation.

Chart VI-4B provides the rate of the Indian rupee (INR) per US dollar (USD) from Jan 2, 1973 to Nov 28, 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 is INR 62.0000/USD on Nov 28, 2014.

Chart VI-4B, Indian Rupee (INR) per US Dollar (USD), Jan 2, 1973 to Nov 28, 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-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 118.7000/USD on Nov 28, 2014 for appreciation of 4.3 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. Gerard Baker and Jacob M. Shlesinger, writing on “Bank of Japan’s Kuroda signals impatience with Abe government,” on May 23, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303480304579579311491068756?KEYWORDS=bank+of+japan+kuroda&mg=reno64-wsj), analyze concerns of the Governor of the Bank of Japan Haruhiko Kuroda that the JPY has strengthened relative to the USD, partly eroding earlier depreciation. 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-Nov 28, 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 2.5720/USD on Nov 28, 2014. 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 2.5720/USD on Nov 28, 2014 for depreciation of 67.3 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 Nov 28, 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 Nov 28, 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).

Focus is shifting from 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. Markets overreacted to the so-called “paring” of outright purchases to $15 billion of securities per month for the balance sheet of the Fed. 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 Oct 29, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20141029a.htm):

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, 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 anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, 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. However, if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated” (emphasis added).

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 Oct 29, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20141029a.htm):

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, 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 anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, 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. However, if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated” (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” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140319.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”

At a speech on Mar 31, 2014, Chair Yellen analyzed labor market conditions as follows (http://www.federalreserve.gov/newsevents/speech/yellen20140331a.htm):

“And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress. The first of those goals is maximum sustainable employment, the highest level of employment that can be sustained while maintaining a stable inflation rate. Most of my colleagues on the Federal Open Market Committee and I estimate that the unemployment rate consistent with maximum sustainable employment is now between 5.2 percent and 5.6 percent, well below the 6.7 percent rate in February.

Let me explain what I mean by that word "slack" and why it is so important.

Slack means that there are significantly more people willing and capable of filling a job than there are jobs for them to fill. During a period of little or no slack, there still may be vacant jobs and people who want to work, but a large share of those willing to work lack the skills or are otherwise not well suited for the jobs that are available. With 6.7 percent unemployment, it might seem that there must be a lot of slack in the U.S. economy, but there are reasons why that may not be true.”

Yellen (2014Aug22) provides comprehensive review of the theory and measurement of labor markets. 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”

Yellen (2014Aug22) finds that the unemployment rate is not sufficient in determining slack:

“One convenient way to summarize the information contained in a large number of indicators is through the use of so-called factor models. Following this methodology, Federal Reserve Board staff developed a labor market conditions index from 19 labor market indicators, including four I just discussed. This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.”

Yellen (2014Aug22) restates that the FOMC determines monetary policy on newly available information and interpretation of labor markets and inflation and does not follow a preset path:

“But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter. Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate. As I have noted many times, monetary policy is not on a preset path. The Committee will be closely monitoring incoming information on the labor market and inflation in determining the appropriate stance of monetary policy.”

Yellen (2014Aug22) states that “Historically, slack has accounted for only a small portion of the fluctuations in inflation. Indeed, unusual aspects of the current recovery may have shifted the lead-lag relationship between a tightening labor market and rising inflation pressures in either direction.”

The minutes of the meeting of the Federal Open Market Committee (FOMC) on Sep 16-17, 2014, reveal concern with global economic conditions (http://www.federalreserve.gov/monetarypolicy/fomcminutes20140917.htm):

“Most viewed the risks to the outlook for economic activity and the labor market as broadly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.”

Chair Yellen analyzes the view of inflation (http://www.federalreserve.gov/newsevents/speech/yellen20140416a.htm):

“Inflation, as measured by the price index for personal consumption expenditures, has slowed from an annual rate of about 2-1/2 percent in early 2012 to less than 1 percent in February of this year. This rate is well below the Committee's 2 percent longer-run objective. Many advanced economies are observing a similar softness in inflation.

To some extent, the low rate of inflation seems due to influences that are likely to be temporary, including a deceleration in consumer energy prices and outright declines in core import prices in recent quarters. Longer-run inflation expectations have remained remarkably steady, however. We anticipate that, as the effects of transitory factors subside and as labor market gains continue, inflation will gradually move back toward 2 percent.”

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 testimony before the Committee on the Budget of the US Senate on May 8, 2004, Chair Yellen provides analysis of the current economic situation and outlook (http://www.federalreserve.gov/newsevents/testimony/yellen20140507a.htm):

“The economy has continued to recover from the steep recession of 2008 and 2009. Real gross domestic product (GDP) growth stepped up to an average annual rate of about 3-1/4 percent over the second half of last year, a faster pace than in the first half and during the preceding two years. Although real GDP growth is currently estimated to have paused in the first quarter of this year, I see that pause as mostly reflecting transitory factors, including the effects of the unusually cold and snowy winter weather. With the harsh winter behind us, many recent indicators suggest that a rebound in spending and production is already under way, putting the overall economy on track for solid growth in the current quarter. One cautionary note, though, is that readings on housing activity--a sector that has been recovering since 2011--have remained disappointing so far this year and will bear watching.

Conditions in the labor market have continued to improve. The unemployment rate was 6.3 percent in April, about 1-1/4 percentage points below where it was a year ago. Moreover, gains in payroll employment averaged nearly 200,000 jobs per month over the past year. During the economic recovery so far, payroll employment has increased by about 8-1/2 million jobs since its low point, and the unemployment rate has declined about 3-3/4 percentage points since its peak.

While conditions in the labor market have improved appreciably, they are still far from satisfactory. Even with recent declines in the unemployment rate, it continues to be elevated. Moreover, both the share of the labor force that has been unemployed for more than six months and the number of individuals who work part time but would prefer a full-time job are at historically high levels. In addition, most measures of labor compensation have been rising slowly--another signal that a substantial amount of slack remains in the labor market.

Inflation has been quite low even as the economy has continued to expand. Some of the factors contributing to the softness in inflation over the past year, such as the declines seen in non-oil import prices, will probably be transitory. Importantly, measures of longer-run inflation expectations have remained stable. That said, the Federal Open Market Committee (FOMC) recognizes that inflation persistently below 2 percent--the rate that the Committee judges to be most consistent with its dual mandate--could pose risks to economic performance, and we are monitoring inflation developments closely.

Looking ahead, I expect that economic activity will expand at a somewhat faster pace this year than it did last year, that the unemployment rate will continue to decline gradually, and that inflation will begin to move up toward 2 percent. A faster rate of economic growth this year should be supported by reduced restraint from changes in fiscal policy, gains in household net worth from increases in home prices and equity values, a firming in foreign economic growth, and further improvements in household and business confidence as the economy continues to strengthen. Moreover, U.S. financial conditions remain supportive of growth in economic activity and employment.”

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 (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/2014/11/fluctuating-financial-variables.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/weakening-world-economic-growth.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 http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html). 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.

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 17,958.79 on Fri Dec 5, 2014, which is higher by 26.8 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 26.5 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs. Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):

So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly” (emphasis added).

In a speech at the IMF on Jul 2, 2014, Chair Yellen analyzed the link between monetary policy and financial risks (http://www.federalreserve.gov/newsevents/speech/yellen20140702a.htm):

“Monetary policy has powerful effects on risk taking. Indeed, the accommodative policy stance of recent years has supported the recovery, in part, by providing increased incentives for households and businesses to take on the risk of potentially productive investments. But such risk-taking can go too far, thereby contributing to fragility in the financial system. This possibility does not obviate the need for monetary policy to focus primarily on price stability and full employment--the costs to society in terms of deviations from price stability and full employment that would arise would likely be significant. In the private sector, key vulnerabilities included high levels of leverage, excessive dependence on unstable short-term funding, weak underwriting of loans, deficiencies in risk measurement and risk management, and the use of exotic financial instruments that redistributed risk in nontransparent ways.”

Yellen (2014Jul14) warned again at the Committee on Banking, Housing and Urban Affairs on Jul 15, 2014:

“The Committee recognizes that low interest rates may provide incentives for some investors to “reach for yield,” and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance. More broadly, the financial sector has continued to become more resilient, as banks have continued to boost their capital and liquidity positions, and growth in wholesale short-term funding in financial markets has been modest” (emphasis added).

Greenspan (1996) made similar warnings:

“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy” (emphasis added).

Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. What is the success in evaluating deviations of valuations of risk financial assets from “historical norms”? What are the consequences on economic activity and employment of deviations of valuations of risk financial assets from those “historical norms”? What are the policy tools and their effectiveness in returning valuations of risk financial assets to their “historical norms”?

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. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.

Professor Raguram G Rajan, governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation. Rajan (2005) anticipated the risks of the world financial crisis. Professor John B. Taylor (2014Jul15, 2014Jun26) building on advanced research (Taylor (1993, 1998LB, 1999, 1998LB, 1999, 2007JH, 2008Nov, 2009, 2012JMCB, 2014Jan3) finds that a monetary policy rule would function best in promoting an environment of low inflation and strong economic growth with stability of financial markets. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html).

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 85.4 percent since the trough of the sovereign debt crisis in Europe on Jul 2, 2010 to Dec 5, 2014; S&P 500 has gained 103.0 percent and DAX 77.9 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 12/5/14” 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 23.3 percent above the trough. Japan’s Nikkei Average is 103.1 percent above the trough. DJ Asia Pacific TSM is 26.2 percent above the trough. Dow Global is 50.7 percent above the trough. STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 34.8 percent above the trough. NYSE Financial Index is 60.0 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 77.9 percent above the trough. Japan’s Nikkei Average is 103.1 percent above the trough on Aug 31, 2010 and 57.3 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 17,958.79 on Fri Dec 5, 2014 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 75.1 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 3.1 percent relative to the euro and even higher before the new bout of sovereign risk issues in Europe. The column “∆% week to 12/5/14” in Table VI-4 shows increase of 9.5 percent in the week for China’s Shanghai Composite. DJ Asia Pacific decreased 0.5 percent. NYSE Financial increased 0.7 percent in the week. Dow Global decreased 0.2 percent in the week of Dec 5, 2014. The DJIA increased 0.7 percent and S&P 500 increased 0.4 percent. DAX of Germany increased 1.1 percent. STOXX 50 increased 0.7 percent. The USD appreciated 1.3 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 12/5/14” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Dec 5, 2014. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 12/5/14” but also relative to the peak in column “∆% Peak to 12/5/14.” There are now several equity indexes above the peak in Table VI-4: DJIA 60.3 percent, S&P 500 70.5 percent, DAX 59.3 percent, Dow Global 23.0 percent, DJ Asia Pacific 10.5 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 27.5 percent, Nikkei Average 57.3 percent and STOXX 50 14.2 percent. There is only one equity index below the peak: Shanghai Composite by 7.2 percent. The US dollar strengthened 14.2 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. Inyoung Hwang, writing on “Fed optimism spurs record bets against stock volatility,” on Aug 21, 2014, published in Bloomberg.com (http://www.bloomberg.com/news/2014-08-21/fed-optimism-spurs-record-bets-against-stock-voalitlity.html), informs that the S&P 500 is trading at 16.6 times estimated earnings, which is higher than the five-year average of 14.3 Tom Lauricella, writing on Mar 31, 2014, on “Stock investors see hints of a stronger quarter,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304157204579473513864900656?mod=WSJ_smq0314_LeadStory&mg=reno64-wsj), finds views of stronger earnings among many money managers with positive factors for equity markets in continuing low interest rates and US economic growth. There is important information in the Quarterly Markets review of the Wall Street Journal (http://online.wsj.com/public/page/quarterly-markets-review-03312014.html) for IQ2014. 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, real gross private domestic investment in the US was $951.6 billion of chained 2009 dollars, growing to $1,194.4 billion in IQ1988 or 25.5 percent. Real gross private domestic investment in the US increased 5.1 percent from $2,605.2 billion of chained 2009 dollars in IVQ2007 to $2,737.8 billion in IIQ2014, which is stagnation in comparison with growth of 47.9 percent in the comparable twenty-first quarters of expansion from $807.5 billion in IQ1983 to $1194.4 billion IQ1988. Real private fixed investment increased 1.8 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,633.8 billion in IIIQ2014. Private fixed investment fell relative to IVQ2007 in all quarters preceding IIQ2014. Growth of real private investment is mediocre for all but four quarters from IIQ2011 to IQ2012. 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 rebounded with $3.1 billion in IVQ2013. Corporate profits with IVA and CCA fell $201.7 billion in IQ2014 and increased $164.1 billion in IIQ2014. Corporate profits with IVA and CCA increased $43.8 billion in IIIQ2014. In IVQ2013, profits after tax with IVA and CCA decreased $24.7 billion. In IQ2014, profits after tax with IVA and CCA decreased $268.6 billion. Profits after tax with IVA and CCA increased at $118.4 billion in IIQ2014 and at $48.6 billion in IIIQ2014. Net dividends fell at $187.0 billion in IIIQ2013 and increased at $80.6 billion in IVQ2013. Net dividends fell at $89.5 billion in IQ2014 and fell at $0.5 billion in IIQ2014. Net dividends fell at $3.9 billion in IIIQ2014. Undistributed profits with IVA and CCA fell at $105.5 billion in IVQ2013. Undistributed profits with IVA and CCA fell $178.9 percent in IQ2014 and increased at $118.8 billion in IIQ2014 and at $52.5 billion in IIIQ2014. Undistributed corporate profits swelled 304.3 percent from $107.7 billion in IQ2007 to $435.4 billion in IIIQ2014 and changed signs from minus $55.9 billion in current dollars in IVQ2007. 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 12/5/ /14	∆% Week 12/5/14	∆% Trough to 12/5/ 14
DJIA	4/26/ 10	7/2/10	-13.6	60.3	0.7	85.4
S&P 500	4/23/ 10	7/20/ 10	-16.0	70.5	0.4	103.0
NYSE Finance	4/15/ 10	7/2/10	-20.3	27.5	0.7	60.0
Dow Global	4/15/ 10	7/2/10	-18.4	23.0	-0.2	50.7
Asia Pacific	4/15/ 10	7/2/10	-12.5	10.5	-0.5	26.2
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	57.3	2.6	103.1
China Shang.	4/15/ 10	7/02 /10	-24.7	-7.2	9.5	23.3
STOXX 50	4/15/10	7/2/10	-15.3	14.2	0.7	34.8
DAX	4/26/ 10	5/25/ 10	-10.5	59.3	1.1	77.9
Dollar Euro	11/25 2009	6/7 2010	21.2	18.8	1.3	-3.1
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	NA	NA	NA
10-Year T Note	4/5/ 10	4/6/10	3.986	2.784	2.306

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 Twenty Six Million Unemployed or Underemployed. The foundation of the second approach derives from Chart II-3 of the Bureau of Labor Statistics providing the level of the civilian labor force in the US. The civilian labor force consists of people who are available and willing to work and who have searched for employment recently. The labor force of the US grew 9.4 percent from 142.828 million in Jan 2001 to 156.255 million in Jul 2009 but is only 0.03 percent higher at 156.297 million in Nov 2014, all numbers not seasonally adjusted. Chart I-3 shows the flattening of the curve of expansion of the labor force and its decline in 2010 and 2011. 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 156.297 million in Nov 2014 to the noninstitutional population of 248.844 million in Nov 2014 was 62.8 percent. The labor force of the US in Nov 2014 corresponding to 66.8 percent of participation in the population would be 166.228 million (0.668 x 248.844. The difference between the measured labor force in Nov 2014 of 156.297 million and the labor force in Nov 2014 with participation rate of 66.8 percent (as in Jul 2007) of 166.228 million is 9.931 million. The level of the labor force in the US has stagnated and is 9.931 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.

Chart I-3, US, Civilian Labor Force, Thousands, SA, 2001-2014

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

Chart I-4 of the Bureau of Labor Statistics provides 12-month percentage changes of the level of the labor force in the US. The rate of growth fell almost instantaneously with the global recession and became negative from 2009 to 2011. The labor force of the US collapsed and did not recover. Growth in the beginning of the summer originates in younger people looking for jobs in the summer after graduation or during school recess.

Chart I-4, US, Civilian Labor Force, Thousands, NSA, 12-month Percentage Change, 2001-2014

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

Chart I-5 of the Bureau of Labor Statistics provides the labor force participation rate in the US or labor force as percent of the population. The labor force participation rate of the US fell from 66.8 percent in Jan 2001 to 62.8 percent NSA in Nov 2014, all numbers not seasonally adjusted. The annual labor force participation rate for 1979 was 63.7 percent and also 63.7 percent in Nov 1980 during sharp economic contraction. This comparison is further elaborated below. Chart I-5 shows an evident downward trend beginning with the global recession that has continued throughout the recovery beginning in IIIQ2009. The critical issue is whether people left the workforce of the US because they believe there is no longer a job for them.

Chart I-5, Civilian Labor Force Participation Rate, Percent of Population in Labor Force SA, 2001-2014

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

Chart I-6 of the Bureau of Labor Statistics provides the level of unemployed in the US. The number unemployed rose from the trough of 6.272 million NSA in Oct 2006 to the peak of 16.147 million in Jan 2010, declining to 13.400 million in Jul 2012, 12.696 million in Aug 2012 and 11.741 million in Sep 2012. The level unemployed fell to 11.741 million in Oct 2012, 11.404 million in Nov 2012, 11.844 million in Dec 2012, 13.181 million in Jan 2013, 12.500 million in Feb 2013 and 9.984 million in Dec 2013. The level of unemployment reached 8.630 million in Nov 2014, all numbers not seasonally adjusted.

Chart I-6, US, Unemployed, Thousands, SA, 2001-2014

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

Chart I-7 of the Bureau of Labor Statistics provides the rate of unemployment in the US or unemployed as percent of the labor force. The rate of unemployment of the US rose from 4.7 percent in Jan 2001 to 6.5 percent in Jun 2003, declining to 4.1 percent in Oct 2006. The rate of unemployment jumped to 10.6 percent in Jan 2010 and declined to 7.6 percent in Dec 2012 but increased to 8.5 percent in Jan 2013 and 8.1 percent in Feb 2013, falling back to 7.3 percent in May 2013 and 7.8 percent in Jun 2013, all numbers not seasonally adjusted. The rate of unemployment not seasonally adjusted stabilized at 7.7 percent in Jul 2013 and fell to 6.5 percent in Dec 2013 and 5.5 percent in Nov 2014.

Chart I-7, US, Unemployment Rate, SA, 2001-2014

Source: Bureau of Labor Statistics

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

Chart I-8 of the Bureau of Labor Statistics provides 12-month percentage changes of the level of unemployed. There was a jump of 81.8 percent in Apr 2009 with subsequent decline and negative rates since 2010. On an annual basis, the level of unemployed rose 59.8 percent in 2009 and 26.1 percent in 2008 with increase of 3.9 percent in 2010, decline of 7.3 percent in 2011 and decrease of 9.0 percent in 2012. The annual level of unemployment decreased 8.4 percent in 2013 and fell 16.0 percent in Nov 2014 relative to Nov 2013.

Chart I-8, US, Unemployed, 12-month Percentage Change, NSA, 2001-2014

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

Chart I-9 of the Bureau of Labor Statistics provides the number of people in part-time occupations because of economic reasons, that is, because they cannot find full-time employment. The number underemployed in part-time occupations not seasonally adjusted rose from 3.732 million in Jan 2001 to 5.270 million in Jan 2004, falling to 3.787 million in Apr 2006. The number underemployed seasonally adjusted jumped to 9.114 million in Nov 2009, falling to 8.177 million in Dec 2011 but increasing to 8.228 million in Jan 2012 and 8.133 million in Feb 2012 but then falling to 7.929 million in Dec 2012 and increasing to 8.180 million in Jul 2013. The number employed part-time for economic reasons seasonally adjusted reached 7.771 million in Dec 2013 and 6.850 million in Nov 2014. Without seasonal adjustment, the number employed part-time for economic reasons reached 9.354 million in Dec 2009, declining to 8.918 million in Jan 2012 and 8.166 million in Dec 2012 but increasing to 8.324 million in Jul 2013. The number employed part-time for economic reasons NSA stood at 7.990 million in Dec 2013 and 6.713 million in Nov 2014. The longer the period in part-time jobs the lower are the chances of finding another full-time job.

Chart I-9, US, Part-Time for Economic Reasons, Thousands, SA, 2001-2014

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

Chart I-10 of the Bureau of Labor Statistics repeats the behavior of unemployment. The 12-month percentage change of the level of people at work part-time for economic reasons jumped 84.7 percent in Mar 2009 and declined subsequently. The declines have been insufficient to reduce significantly the number of people who cannot shift from part-time to full-time employment. On an annual basis, the number of part-time for economic reasons increased 33.5 percent in 2008 and 51.7 percent in 2009, declining 0.4 percent in 2010, 3.5 percent in 2011 and 5.1 percent in 2012. The annual number of part-time for economic reasons decreased 2.3 percent in 2013. The number of part-time for economic reasons fell 11.2 percent in Nov 2014 relative to a year earlier.

Chart I-10, US, Part-Time for Economic Reasons NSA 12-Month Percentage Change, 2001-2014

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

Chart I-11 of the Bureau of Labor Statistics provides the same pattern of the number marginally attached to the labor force jumping to significantly higher levels during the global recession and remaining at historically high levels. The number marginally attached to the labor force not seasonally adjusted increased from 1.295 million in Jan 2001 to 1.691 million in Feb 2004. The number of marginally attached to the labor force fell to 1.299 million in Sep 2006 and increased to 2.609 million in Dec 2010 and 2.800 million in Jan 2011. The number marginally attached to the labor force was 2.540 million in Dec 2011, increasing to 2.809 million in Jan 2012, falling to 2.608 million in Feb 2012. The number marginally attached to the labor force fell to 2.352 million in Mar 2012, 2.363 million in Apr 2012, 2.423 million in May 2012, 2.483 million in Jun 2012, 2.529 million in Jul 2012 and 2.561 million in Aug 2012. The number marginally attached to the labor force fell to 2.517 million in Sep 2012, 2.433 million in Oct 2012, 2.505 million in Nov 2012 and 2.427 million in in Dec 2013. The number marginally attached to the labor force reached 2.109 million in Nov 2014.

Chart I-11, US, Marginally Attached to the Labor Force, Thousands, NSA, 2001-2014

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

Chart I-12 provides 12-month percentage changes of the marginally attached to the labor force from 2001 to 2014. There was a jump of 56.1 percent in May 2009 during the global recession followed by declines in percentage changes but insufficient negative changes. On an annual basis, the number of marginally attached to the labor force increased in four consecutive years: 15.7 percent in 2008, 37.9 percent in 2009, 11.7 percent in 2010 and 3.5 percent in 2011. The number marginally attached to the labor force fell 2.2 percent on annual basis in 2012 but increased 2.9 percent in the 12 months ending in Dec 2012, fell 13.0 percent in the 12 months ending in Jan 2013, falling 10.7 percent in the 12 months ending in May 2013. The number marginally attached to the labor force increased 4.0 percent in the 12 months ending in Jun 2013 and fell 4.5 percent in the 12 months ending in Jul 2013 and 8.6 percent in the 12 months ending in Aug 2013. The annual number of marginally attached to the labor force fell 6.2 percent in 2013. The number marginally attached to the labor force fell 7.2 percent in the 12 months ending in Dec 2013 and 0.6 percent in the 12 months ending in Nov 2014.

Chart I-12, US, Marginally Attached to the Labor Force 12-Month Percentage Change, NSA, 2001-2014

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

Table I-4 consists of data and additional calculations using the BLS household survey, illustrating the possibility that the actual rate of unemployment could be 10.4 percent and the number of people in job stress could be around 26.0 million, which is 15.8 percent of the effective labor force. The first column provides for 2006 the yearly average population (POP), labor force (LF), participation rate or labor force as percent of population (PART %), employment (EMP), employment population ratio (EMP/POP %), unemployment (UEM), the unemployment rate as percent of labor force (UEM/LF Rate %) and the number of people not in the labor force (NLF). All data are unadjusted or not-seasonally-adjusted (NSA). The numbers in column 2006 are averages in millions while the monthly numbers for Nov 2013, Oct 2014 and Nov 2014 are in thousands, not seasonally adjusted. The average yearly participation rate of the population in the labor force was in the range of 66.0 percent minimum to 67.1 percent maximum between 2000 and 2006 with the average of 66.4 percent (ftp://ftp.bls.gov/pub/special.requests/lf/aa2006/pdf/cpsaat1.pdf). Table I-4b provides the yearly labor force participation rate from 1979 to 2014. The objective of Table I-4 is to assess how many people could have left the labor force because they do not think they can find another job. Row “LF PART 66.2 %” applies the participation rate of 2006, almost equal to the rates for 2000 to 2006, to the noninstitutional civilian population in Nov 2013, Oct 2014 and Nov 2014 to obtain what would be the labor force of the US if the participation rate had not changed. In fact, the participation rate fell to 62.9 percent by Nov 2013 and was 63.0 percent in Oct 2014 and 62.8 percent in Nov 2014, suggesting that many people simply gave up on finding another job. Row “∆ NLF UEM” calculates the number of people not counted in the labor force because they could have given up on finding another job by subtracting from the labor force with participation rate of 66.2 percent (row “LF PART 66.2%”) the labor force estimated in the household survey (row “LF”). Total unemployed (row “Total UEM”) is obtained by adding unemployed in row “∆NLF UEM” to the unemployed of the household survey in row “UEM.” The row “Total UEM%” is the effective total unemployed “Total UEM” as percent of the effective labor force in row “LF PART 66.2%.” The results are that:

• there are an estimated 8.438 million unemployed in Nov 2014 who are not counted because they left the labor force on their belief they could not find another job (∆NLF UEM), that is, they dropped out of their job searches
• the total number of unemployed is effectively 17.068 million (Total UEM) and not 8.630 million (UEM) of whom many have been unemployed long term
• the rate of unemployment is 10.4 percent (Total UEM%) and not 5.5 percent, not seasonally adjusted, or 5.8 percent seasonally adjusted
• the number of people in job stress is close to 26.0 million by adding the 8.438 million leaving the labor force because they believe they could not find another job.

The row “In Job Stress” in Table I-4 provides the number of people in job stress not seasonally adjusted at 26.554 million in Oct 2014, adding the total number of unemployed (“Total UEM”), plus those involuntarily in part-time jobs because they cannot find anything else (“Part Time Economic Reasons”) and the marginally attached to the labor force (“Marginally attached to LF”). The final row of Table I-4 shows that the number of people in job stress is equivalent to 15.8 percent of the labor force in Nov 2014. The employment population ratio “EMP/POP %” dropped from 62.9 percent on average in 2006 to 58.7 percent in Nov 2013, 59.5 percent in Oct 2014 and 59.3 percent in Nov 2014. The number employed in Nov 2014 was 147.666 million (NSA) or 0.351 million more people with jobs relative to the peak of 147.315 million in Jul 2007 while the civilian noninstitutional population of ages 16 years and over increased from 231.958 million in Jul 2007 to 248.844 million in Nov 2014 or by 16.886 million. The number employed increased 0.2 percent from Jul 2007 to Nov 2014 while the noninstitutional civilian population of ages of 16 years and over, or those available for work, increased 7.3 percent. The ratio of employment to population in Jul 2007 was 63.5 percent (147.315 million employment as percent of population of 231.958 million). The same ratio in Nov 2014 would result in 158.016 million jobs (0.635 multiplied by noninstitutional civilian population of 248.844 million). There are effectively 10.350 million fewer jobs in Nov 2014 than in Jul 2007, or 158.016 million minus 147.666 million. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs.

The 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/2014/11/fluctuating-financial-variables.html). This is merely another case of theory without reality with dubious policy proposals. The number of hiring relative to the number unemployed measures the chances of becoming employed. The number of hiring in the US economy has declined by 10 million and does not show signs of increasing in an unusual recovery without hiring (http://cmpassocregulationblog.blogspot.com/2014/11/fluctuating-financial-variables.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIIQ2014 would have accumulated to 23.0 percent. GDP in IIIQ2014 would be $18,438.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,273.9 billion than actual $16,164.1 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.0 million unemployed or underemployed equivalent to actual unemployment of 15.8 percent of the effective labor force (Section I and earlier (http://cmpassocregulationblog.blogspot.com/2014/11/rules-discretionary-authorities-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/10/world-financial-turbulence-twenty-seven.html). US GDP in IIIQ2014 is 12.3 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,164.1 billion in IIIQ2014 or 7.8 percent at the average annual equivalent rate of 1.1 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth 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. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Oct 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.8884 in Oct 2014. The actual index NSA in Oct 2014 is 101.5613, which is 18.0 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 115.9214 in Oct 2014. The output of manufacturing at 101.5613 in Oct 2014 is 12.4 percent below trend under this alternative calculation.

Table I-4, US, Population, Labor Force and Unemployment, NSA

	2006	Nov 2013	Oct 2014	Nov 2014
POP	229	246,567	248,657	248,844
LF	151	155,046	156,616	156,297
PART%	66.2	62.9	63.0	62.8
EMP	144	144,775	147,936	147,666
EMP/POP%	62.9	58.7	59.5	59.3
UEM	7	10,271	8,680	8,630
UEM/LF Rate%	4.6	6.6	5.5	5.5
NLF	77	91,521	92,041	92,547
LF PART 66.2%		163,227	164,611	164,735
∆NLF UEM		8,181	7,995	8,438
Total UEM		18,452	16,675	17,068
Total UEM%		11.3	10.1	10.4
Part Time Economic Reasons		7,563	6,787	6,713
Marginally Attached to LF		2,096	2,192	2,226
In Job Stress		28,111	25,654	26,007
People in Job Stress as % Labor Force		17.2	15.6	15.8

Pop: population; LF: labor force; PART: participation; EMP: employed; UEM: unemployed; NLF: not in labor force; ∆NLF UEM: additional unemployed; Total UEM is UEM + ∆NLF UEM; Total UEM% is Total UEM as percent of LF PART 66.2%; In Job Stress = Total UEM + Part Time Economic Reasons + Marginally Attached to LF

Note: the first column for 2006 is in average millions; the remaining columns are in thousands; NSA: not seasonally adjusted

The labor force participation rate of 66.2% in 2006 is applied to current population to obtain LF PART 66.2%; ∆NLF UEM is obtained by subtracting the labor force with participation of 66.2 percent from the household survey labor force LF; Total UEM is household data unemployment plus ∆NLF UEM; and total UEM% is total UEM divided by LF PART 66.2%

Source: US Bureau of Labor Statistics

http://www.bls.gov/cps/

In the analysis of Hansen (1939, 3) of secular stagnation, economic progress consists of growth of real income per person driven by growth of productivity. The “constituent elements” of economic progress are “(a) inventions, (b) the discovery and development of new territory and new resources, and (c) the growth of population” (Hansen 1939, 3). Secular stagnation originates in decline of population growth and discouragement of inventions. According to Hansen (1939, 2), US population grew by 16 million in the 1920s but grew by one half or about 8 million in the 1930s with forecasts at the time of Hansen’s writing in 1938 of growth of around 5.3 million in the 1940s. Hansen (1939, 2) characterized demography in the US as “a drastic decline in the rate of population growth. Hansen’s plea was to adapt economic policy to stagnation of population in ensuring full employment. In the analysis of Hansen (1939, 8), population caused half of the growth of US GDP per year. Growth of output per person in the US and Europe was caused by “changes in techniques and to the exploitation of new natural resources.” In this analysis, population caused 60 percent of the growth of capital formation in the US. Declining population growth would reduce growth of capital formation. Residential construction provided an important share of growth of capital formation. Hansen (1939, 12) argues that market power of imperfect competition discourages innovation with prolonged use of obsolete capital equipment. Trade unions would oppose labor-savings innovations. The combination of stagnating and aging population with reduced innovation caused secular stagnation. Hansen (1939, 12) concludes that there is role for public investments to compensate for lack of dynamism of private investment but with tough tax/debt issues.

The current application of Hansen’s (1938, 1939, 1941) proposition argues that secular stagnation occurs because full employment equilibrium can be attained only with negative real interest rates between minus 2 and minus 3 percent. Professor Lawrence H. Summers (2013Nov8) finds that “a set of older ideas that went under the phrase secular stagnation are not profoundly important in understanding Japan’s experience in the 1990s and may not be without relevance to America’s experience today” (emphasis added). Summers (2013Nov8) argues there could be an explanation in “that the short-term real interest rate that was consistent with full employment had fallen to -2% or -3% sometime in the middle of the last decade. Then, even with artificial stimulus to demand coming from all this financial imprudence, you wouldn’t see any excess demand. And even with a relative resumption of normal credit conditions, you’d have a lot of difficulty getting back to full employment.” The US economy could be in a situation where negative real rates of interest with fed funds rates close to zero as determined by the Federal Open Market Committee (FOMC) do not move the economy to full employment or full utilization of productive resources. Summers (2013Oct8) finds need of new thinking on “how we manage an economy in which the zero nominal interest rates is a chronic and systemic inhibitor of economy activity holding our economies back to their potential.”

Former US Treasury Secretary Robert Rubin (2014Jan8) finds three major risks in prolonged unconventional monetary policy of zero interest rates and quantitative easing: (1) incentive of delaying action by political leaders; (2) “financial moral hazard” in inducing excessive exposures pursuing higher yields of risker credit classes; and (3) major risks in exiting unconventional policy. Rubin (2014Jan8) proposes reduction of deficits by structural reforms that could promote recovery by improving confidence of business attained with sound fiscal discipline.

Professor John B. Taylor (2014Jan01, 2014Jan3) provides clear thought on the lack of relevance of Hansen’s contention of secular stagnation to current economic conditions. The application of secular stagnation argues that the economy of the US has attained full-employment equilibrium since around 2000 only with negative real rates of interest of minus 2 to minus 3 percent. At low levels of inflation, the so-called full-employment equilibrium of negative interest rates of minus 2 to minus 3 percent cannot be attained and the economy stagnates. Taylor (2014Jan01) analyzes multiple contradictions with current reality in this application of the theory of secular stagnation:

• Secular stagnation would predict idle capacity, in particular in residential investment when fed fund rates were fixed at 1 percent from Jun 2003 to Jun 2004. Taylor (2014Jan01) finds unemployment at 4.4 percent with house prices jumping 7 percent from 2002 to 2003 and 14 percent from 2004 to 2005 before dropping from 2006 to 2007. GDP prices doubled from 1.7 percent to 3.4 percent when interest rates were low from 2003 to 2005.
• Taylor (2014Jan01, 2014Jan3) finds another contradiction in the application of secular stagnation based on low interest rates because of savings glut and lack of investment opportunities. Taylor (2009) shows that there was no savings glut. The savings rate of the US in the past decade is significantly lower than in the 1980s.
• Taylor (2014Jan01, 2014Jan3) finds another contradiction in the low ratio of investment to GDP currently and reduced investment and hiring by US business firms.
• Taylor (2014Jan01, 2014Jan3) argues that the financial crisis and global recession were caused by weak implementation of existing regulation and departure from rules-based policies.
• Taylor (2014Jan01, 2014Jan3) argues that the recovery from the global recession was constrained by a change in the regime of regulation and fiscal/monetary policies.

In revealing research, Edward P. Lazear and James R. Spletzer (2012JHJul22) use the wealth of data in the valuable database and resources of the Bureau of Labor Statistics (http://www.bls.gov/data/) in providing clear thought on the nature of the current labor market of the United States. The critical issue of analysis and policy currently is whether unemployment is structural or cyclical. Structural unemployment could occur because of (1) industrial and demographic shifts and (2) mismatches of skills and job vacancies in industries and locations. Consider the aggregate unemployment rate, Y, expressed in terms of share s_i of a demographic group in an industry i and unemployment rate y_i of that demographic group (Lazear and Spletzer 2012JHJul22, 5-6):

Y = ∑_is_iy_i (1)

This equation can be decomposed for analysis as (Lazear and Spletzer 2012JHJul22, 6):

∆Y = ∑_i∆s_iy*_i + ∑_i∆y_is*_i (2)

The first term in (2) captures changes in the demographic and industrial composition of the economy ∆s_i multiplied by the average rate of unemployment y*_i , or structural factors. The second term in (2) captures changes in the unemployment rate specific to a group, or ∆y_i, multiplied by the average share of the group s*_i, or cyclical factors. There are also mismatches in skills and locations relative to available job vacancies. A simple observation by Lazear and Spletzer (2012JHJul22) casts intuitive doubt on structural factors: the rate of unemployment jumped from 4.4 percent in the spring of 2007 to 10 percent in October 2009. By nature, structural factors should be permanent or occur over relative long periods. The revealing result of the exhaustive research of Lazear and Spletzer (2012JHJul22) is:

“The analysis in this paper and in others that we review do not provide any compelling evidence that there have been changes in the structure of the labor market that are capable of explaining the pattern of persistently high unemployment rates. The evidence points to primarily cyclic factors.”

Table I-4b and Chart I-12-b provide the US labor force participation rate or percentage of the labor force in population. It is not likely that simple demographic trends caused the sharp decline during the global recession and failure to recover earlier levels. The civilian labor force participation rate dropped from the peak of 66.9 percent in Jul 2006 to 62.6 percent in Dec 2013 and 62.8 percent in Nov 2014. The civilian labor force participation rate was 63.7 percent on an annual basis in 1979 and 63.4 percent in Dec 1980 and Dec 1981, reaching even 62.9 percent in both Apr and May 1979. The civilian labor force participation rate jumped with the recovery to 64.8 percent on an annual basis in 1985 and 65.9 percent in Jul 1985. Structural factors cannot explain these sudden changes vividly shown visually in the final segment of Chart I-12b. Seniors would like to delay their retiring especially because of the adversities of financial repression on their savings. Labor force statistics are capturing the disillusion of potential workers with their chances in finding a job in what Lazear and Spletzer (2012JHJul22) characterize as accentuated cyclical factors. 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/2014/11/fluctuating-financial-variables.html). “Secular stagnation” would be a process over many years and not from one year to another. This is merely another case of theory without reality with dubious policy proposals.

Table I-4b, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1979-2014

Year	Jan	Feb	Jun	Jul	Aug	Sep	Oct	Nov	Dec	Annual
1979	62.9	63.0	64.5	64.9	64.5	63.8	64.0	63.8	63.8	63.7
1980	63.3	63.2	64.6	65.1	64.5	63.6	63.9	63.7	63.4	63.8
1981	63.2	63.2	64.6	65.0	64.6	63.5	64.0	63.8	63.4	63.9
1982	63.0	63.2	64.8	65.3	64.9	64.0	64.1	64.1	63.8	64.0
1983	63.3	63.2	65.1	65.4	65.1	64.3	64.1	64.1	63.8	64.0
1984	63.3	63.4	65.5	65.9	65.2	64.4	64.6	64.4	64.3	64.4
1985	64.0	64.0	65.5	65.9	65.4	64.9	65.1	64.9	64.6	64.8
1986	64.2	64.4	66.3	66.6	66.1	65.3	65.5	65.4	65.0	65.3
1987	64.7	64.8	66.3	66.8	66.5	65.5	65.9	65.7	65.5	65.6
1988	65.1	65.2	66.7	67.1	66.8	65.9	66.1	66.2	65.9	65.9
1989	65.8	65.6	67.4	67.7	67.2	66.3	66.6	66.7	66.3	66.5
1990	66.0	66.0	67.4	67.7	67.1	66.4	66.5	66.3	66.1	66.5
1991	65.5	65.7	67.2	67.3	66.6	66.1	66.1	66.0	65.8	66.2
1992	65.7	65.8	67.6	67.9	67.2	66.3	66.2	66.2	66.1	66.4
1993	65.6	65.8	67.3	67.5	67.0	66.1	66.4	66.3	66.2	66.3
1994	66.0	66.2	67.2	67.5	67.2	66.5	66.8	66.7	66.5	66.6
1995	66.1	66.2	67.2	67.7	67.1	66.5	66.7	66.5	66.2	66.6
1996	65.8	66.1	67.4	67.9	67.2	66.8	67.1	67.0	66.7	66.8
1997	66.4	66.5	67.8	68.1	67.6	67.0	67.1	67.1	67.0	67.1
1998	66.6	66.7	67.7	67.9	67.3	67.0	67.1	67.1	67.0	67.1
1999	66.7	66.8	67.7	67.9	67.3	66.8	67.0	67.0	67.0	67.1
2000	66.8	67.0	67.7	67.6	67.2	66.7	66.9	66.9	67.0	67.1
2001	66.8	66.8	67.2	67.4	66.8	66.6	66.7	66.6	66.6	66.8
2002	66.2	66.6	67.1	67.2	66.8	66.6	66.6	66.3	66.2	66.6
2003	66.1	66.2	67.0	66.8	66.3	65.9	66.1	66.1	65.8	66.2
2004	65.7	65.7	66.5	66.8	66.2	65.7	66.0	66.1	65.8	66.0
2005	65.4	65.6	66.5	66.8	66.5	66.1	66.2	66.1	65.9	66.0
2006	65.5	65.7	66.7	66.9	66.5	66.1	66.4	66.4	66.3	66.2
2007	65.9	65.8	66.6	66.8	66.1	66.0	66.0	66.1	65.9	66.0
2008	65.7	65.5	66.6	66.8	66.4	65.9	66.1	65.8	65.7	66.0
2009	65.4	65.5	66.2	66.2	65.6	65.0	64.9	64.9	64.4	65.4
2010	64.6	64.6	65.1	65.3	65.0	64.6	64.4	64.4	64.1	64.7
2011	63.9	63.9	64.5	64.6	64.3	64.2	64.1	63.9	63.8	64.1
2012	63.4	63.6	64.3	64.3	63.7	63.6	63.8	63.5	63.4	63.7
2013	63.3	63.2	64.0	64.0	63.4	63.2	62.9	62.9	62.6	63.2
2014	62.5	62.7	63.4	63.5	63.0	62.8	63.0	62.8

Source: US Bureau of Labor Statistics

http://www.bls.gov/cps/

Chart I-12b, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1979-2014

Source: Bureau of Labor Statistics

http://www.bls.gov/cps/

Broader perspective is provided by Chart I-12c of the US Bureau of Labor Statistics. The United States civilian noninstitutional population has increased along a consistent trend since 1948 that continued through earlier recessions and the global recession from IVQ2007 to IIQ2009 and the cyclical expansion after IIIQ2009.

Chart I-12c, US, Civilian Noninstitutional Population, Thousands, NSA, 1948-2014

Sources: US Bureau of Labor Statistics

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

The labor force of the United States in Chart I-12d has increased along a trend similar to that of the civilian noninstitutional population in Chart I-12c. There is an evident stagnation of the civilian labor force in the final segment of Chart I-12d during the current economic cycle. This stagnation is explained by cyclical factors similar to those analyzed by Lazear and Spletzer (2012JHJul22) that motivated an increasing population to drop out of the labor force instead of structural factors. Large segments of the potential labor force are not observed, constituting unobserved unemployment and of more permanent nature because those afflicted have been seriously discouraged from working by the lack of opportunities.

Chart I-12d, US, Labor Force, Thousands, NSA, 1948-2014

Sources: US Bureau of Labor Statistics

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

The rate of labor force participation of the US is in Chart I-12E from 1948 to 2014. There is sudden decline during the global recession after 2007 without recovery explained by cyclic factors (Lazear and Spletzer 2012JHJul22) as many potential workers stopped their job searches disillusioned that there could be an opportunity for them in sharply contracted labor markets.

Chart I-12E, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1948-2014

Sources: US Bureau of Labor Statistics

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

ESIII Job Creation. What is striking about the data in Table I-8 is that the numbers of monthly increases in jobs in 1983 and 1984 are several times higher than in 2010 to 2013. The civilian noninstitutional population grew by 41.0 percent from 174.215 million in 1983 to 245.679 million in 2013 and labor force higher by 39.3 percent, growing from 111.550 million in 1983 to 155.389 million in 2013. Total nonfarm payroll employment seasonally adjusted (SA) increased 214,000 in Oct 2014 and private payroll employment increased 209,000. The average monthly number of nonfarm jobs created from Oct 2012 to Oct 2013 was 199,167 using seasonally adjusted data, while the average number of nonfarm jobs created from Oct 2013 to Oct 2014 was 220,250, or increase by 10.6 percent. The average number of private jobs created in the US from Oct 2012 to Oct 2013 was 202,750, using seasonally adjusted data, while the average from Oct 2013 to Oct 2014 was 215,250, or increase by 6.2 percent. This blog calculates the effective labor force of the US at 163.104 million in Oct 2013 and 164.611 million in Oct 2014 (Table I-4), for growth of 1.507 million at average 125,583 per month. The difference between the average increase of 215,250 new private nonfarm jobs per month in the US from Oct 2013 to Oct 2014 and the 125,583 average monthly increase in the labor force from Oct 2013 to Oct 2014 is 89,667 monthly new jobs net of absorption of new entrants in the labor force. There are 26.554 million in job stress in the US currently. Creation of 89,667 new jobs per month net of absorption of new entrants in the labor force would require 296 months to provide jobs for the unemployed and underemployed (26.554 million divided by 89,667) or 25 years (294 divided by 12). The civilian labor force of the US in Oct 2014 not seasonally adjusted stood at 156.616 million with 8.680 million unemployed or effectively 16.675 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 164.611 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 0.9 years (1 million divided by product of 89,667 by 12, which is 1,076,000). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.831 million (0.05 times labor force of 156.616 million). New net job creation would be 0.849 million (8.680 million unemployed minus 7.831 million unemployed at rate of 5 percent) that at the current rate would take 0.8 years (0.849 million divided by 1.076). Under the calculation in this blog, there are 16.675 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 164.611 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.464 million jobs net of labor force growth that at the current rate would take 7.8 years (16.675 million minus 0.05(164.611 million) = 8.444 million divided by 1.076, using LF PART 66.2% and Total UEM in Table I-4). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. The number employed in Oct 2014 was 147.936 million (NSA) or 0.621 million more people with jobs relative to the peak of 147.315 million in Jul 2007 while the civilian noninstitutional population of ages 16 years and over increased from 231.958 million in Jul 2007 to 248.657 million in Oct 2014 or by 16.699 million. The number employed increased 0.4 percent from Jul 2007 to Oct 2014 while the noninstitutional civilian population of ages of 16 years and over, or those available for work, increased 7.2 percent. The ratio of employment to population in Jul 2007 was 63.5 percent (147.315 million employment as percent of population of 231.958 million). The same ratio in Oct 2014 would result in 157.897 million jobs (0.635 multiplied by noninstitutional civilian population of 248.657 million). There are effectively 9.961 million fewer jobs in Oct 2014 than in Jul 2007, or 157.897 million minus 147.936 million. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs.

There is current interest in past theories of “secular stagnation.” Alvin H. Hansen (1939, 4, 7; see Hansen 1938, 1941; for an early critique see Simons 1942) argues:

“Not until the problem of full employment of our productive resources from the long-run, secular standpoint was upon us, were we compelled to give serious consideration to those factors and forces in our economy which tend to make business recoveries weak and anaemic (sic) and which tend to prolong and deepen the course of depressions. This is the essence of secular stagnation-sick recoveries which die in their infancy and depressions which feed on them-selves and leave a hard and seemingly immovable core of unemployment. Now the rate of population growth must necessarily play an important role in determining the character of the output; in other words, the com-position of the flow of final goods. Thus a rapidly growing population will demand a much larger per capita volume of new residential building construction than will a stationary population. A stationary population with its larger proportion of old people may perhaps demand more personal services; and the composition of consumer demand will have an important influence on the quantity of capital required. The demand for housing calls for large capital outlays, while the demand for personal services can be met without making large investment expenditures. It is therefore not unlikely that a shift from a rapidly growing population to a stationary or declining one may so alter the composition of the final flow of consumption goods that the ratio of capital to output as a whole will tend to decline.”

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/2014/11/fluctuating-financial-variables.html). The proper explanation is not in secular stagnation but in cyclically slow growth. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIIQ2014 would have accumulated to 23.0 percent. GDP in IIIQ2014 would be $18,438.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,273.9 billion than actual $16,164.1 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.0 million unemployed or underemployed equivalent to actual unemployment of 15.8 percent of the effective labor force (Section I and earlier (http://cmpassocregulationblog.blogspot.com/2014/11/rules-discretionary-authorities-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/10/world-financial-turbulence-twenty-seven.html). US GDP in IIIQ2014 is 12.3 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,164.1 billion in IIIQ2014 or 7.8 percent at the average annual equivalent rate of 1.1 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth 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. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Oct 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.8884 in Oct 2014. The actual index NSA in Oct 2014 is 101.5613, which is 18.0 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 115.9214 in Oct 2014. The output of manufacturing at 101.5613 in Oct 2014 is 12.4 percent below trend under this alternative calculation.

Table I-8, US, Monthly Change in Jobs, Number SA

Month	1981	1982	1983	2008	2009	2010	Private
Jan	94	-326	224	15	-798	18	20
Feb	68	-5	-75	-86	-701	-50	-38
Mar	105	-130	172	-80	-826	156	113
Apr	73	-280	276	-214	-684	251	192
May	10	-45	277	-182	-354	516	94
Jun	197	-243	379	-172	-467	-122	110
Jul	112	-342	418	-210	-327	-61	120
Aug	-36	-158	-308	-259	-216	-42	117
Sep	-87	-181	1115	-452	-227	-57	107
Oct	-99	-277	271	-474	-198	241	199
Nov	-209	-123	353	-765	-6	137	149
Dec	-278	-14	356	-697	-283	71	94
			1984			2011	Private
Jan			446			70	72
Feb			481			168	223
Mar			275			212	231
Apr			363			322	320
May			308			102	166
Jun			379			217	186
Jul			313			106	219
Aug			242			122	125
Sep			310			221	268
Oct			286			183	177
Nov			349			164	191
Dec			128			196	222
			1985			2012	Private
Jan			266			360	364
Feb			124			226	228
Mar			346			243	246
Apr			196			96	102
May			274			110	131
Jun			146			88	75
Jul			190			160	172
Aug			193			150	136
Sep			203			161	159
Oct			188			225	255
Nov			209			203	211
Dec			167			214	215
			1986			2013	Private
Jan			125			197	219
Feb			107			280	263
Mar			94			141	164
Apr			187			203	188
May			127			199	222
Jun			-94			201	201
Jul			318			149	170
Aug			114			202	180
Sep			347			164	153
Oct			186			237	247
Nov			186			274	272
Dec			205			84	86
			1987			2014	Private
Jan			172			144	166
Feb			232			222	201
Mar			249			203	200
Apr			338			304	278
May			226			229	228
Jun			172			267	260
Jul			347			243	239
Aug			171			203	200
Sep			228			271	249
Oct			492			243	236
Nov			232			321	314
Dec			294

Source: US Bureau of Labor Statistics

http://www.bls.gov/

Charts numbered from I-38 to I-41 from the database of the Bureau of Labor Statistics provide a comparison of payroll survey data for the contractions and expansions in the 1980s and after 2007. Chart I-38 provides total nonfarm payroll jobs from 2001 to 2013. The sharp decline in total nonfarm jobs during the contraction after 2007 has been followed by initial stagnation and then inadequate growth in 2012 and 2013-2014 while population growth continued.

Chart I-38, US, Total Nonfarm Payroll Jobs SA 2001-2014

Source: US Bureau of Labor Statistics

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

Chart I-39 provides total nonfarm jobs SA from 1979 to 1989. Recovery is strong throughout the decade with the economy growing at trend over the entire economic cycle.

Chart I-39, US, Total Nonfarm Payroll Jobs SA 1979-1989

Source: US Bureau of Labor Statistics

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

Most job creation in the US is by the private sector. Chart I-40 shows the sharp destruction of private payroll jobs during the contraction after 2007. There has been growth after 2010 but insufficient to recover higher levels of employment prevailing before the contraction. At current rates, recovery of employment may spread over several years in contrast with past expansions of the business cycle in the US.

Chart I-40, US, Total Private Payroll Jobs SA 2001-2014

Source: US Bureau of Labor Statistics

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

In contrast, growth of private payroll jobs in the US recovered vigorously during the expansion in 1983 through 1985, as shown in Chart I-41. Rapid growth of creation of private jobs continued throughout the 1980s.

Chart I-41, US, Total Private Payroll Jobs SA 1979-1989

Source: US Bureau of Labor Statistics

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

Types of jobs created, and not only the pace of job creation, may be important. Aspects of growth of payroll jobs from Nov 2013 to Nov 2014, not seasonally adjusted (NSA), are in Table I-9. Total nonfarm employment increased by 2,765,000 (row A, column Change), consisting of growth of total private employment by 2,672,000 (row B, column Change) and increase by 93,000 of government employment (row C, column Change). Monthly average growth of private payroll employment has been 222,667, which is mediocre relative to 24 to 30 million in job stress, while total nonfarm employment has grown on average by only 230,417 per month, which barely keeps with 125,667 new entrants per month in the labor force. These monthly rates of job creation net of the demands of new entrants in the labor force perpetuate unemployment and underemployment. Manufacturing employment increased by 186,000, at the monthly rate of 15,500 while private service providing employment grew by 2,207,000, at the monthly rate of 183,917. An important feature in Table I-9 is that jobs in professional and business services increased by 688,000 with temporary help services increasing by 233,000. This episode of jobless recovery is characterized by part-time jobs and creation of jobs that are inferior to those that have been lost. Monetary and fiscal stimuli fail to increase consumption in a fractured job market. The segment leisure and hospitality added 374,000 jobs in 12 months. An important characteristic is that the loss of government jobs has stabilized in federal government with loss of 13,000 jobs while states added 23,000 jobs and local government added 83,000 jobs. Local government provides the bulk of government jobs, 14.452 million, while federal government provides 2.717 million and states government 5.264 million.

Table I-9, US, Employees in Nonfarm Payrolls Not Seasonally Adjusted, in Thousands

	Nov 2013	Nov 2014	Change
A Total Nonfarm	138,536	141,301	2,765
B Total Private	116,196	118,868	2,672
B1 Goods Producing	18,928	19,393	465
B1a Manufacturing	12,051	12,237	186
B2 Private service providing	97,268	99,475	2,207
B2a Wholesale Trade	5,799	5,904	105
B2b Retail Trade	15,646	15,906	260
B2c Transportation & Warehousing	4,605	4,761	156
B2d Financial Activities	7,897	8,013	116
B2e Professional and Business Services	18,975	19,663	688
B2e1 Temporary help services	2,844	3,077	233
B2f Health Care & Social Assistance	17,936	18,308	372
B2g Leisure & Hospitality	14,148	14,522	374
C Government	22,340	22,433	93
C1 Federal	2,730	2,717	-13
C2 State	5,241	5,264	23
C3 Local	14,369	14,452	83

Note: A = B+C, B = B1 + B2, C=C1 + C2 + C3

Source: US Bureau of Labor Statistics

http://www.bls.gov/

Chart I-42 of the Board of Governors of the Federal Reserve System shows that output of durable manufacturing accelerated in the 1980s and 1990s with slower growth in the 2000s perhaps because processes matured. Growth was robust after the major drop during the global recession but appears to vacillate in the final segment.

Chart I-42, US, Output of Durable Manufacturing, 1972-2014

Source: Board of Governors of the Federal Reserve

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

Manufacturing jobs not seasonally adjusted increased 186,000 from Nov 2013 to
Nov 2014 or at the average monthly rate of 15,500. There are effects of the weaker economy and international trade together with the yearly adjustment of labor statistics. Industrial production decreased 0.1 percent in Oct 2014 and increased 0.8 percent in Sep 2014 after decreasing 0.2 percent in Aug 2014, as shown in Table I-1, with all data seasonally adjusted. The Federal Reserve completed its annual revision of industrial production and capacity utilization on Mar 28, 2014 (http://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm). The report of the Board of Governors of the Federal Reserve System states (http://www.federalreserve.gov/releases/g17/Current/default.htm):

“Industrial production edged down 0.1 percent in October after having advanced 0.8 percent in September. In October, manufacturing output increased 0.2 percent for the second consecutive month. The index for mining declined 0.9 percent and the output of utilities moved down 0.7 percent. At 104.9 percent of its 2007 average, total industrial production in October was 4.0 percent above its level of a year earlier. Capacity utilization for the industrial sector decreased 0.3 percentage point in October to 78.9 percent, a rate that is 1.2 percentage points below its long-run (1972–2013) average.”

In the six months ending in Oct 2014, United States national industrial production accumulated increase of 1.6 percent at the annual equivalent rate of 3.2 percent, which is lower than growth of 4.0 percent in the 12 months ending in Oct 2014. Excluding growth of 0.8 percent in Sep 2014, growth in the remaining five months from May to Oct 2014 accumulated to 0.8 percent or 1.9 percent annual equivalent. Industrial production declined in two of the past six months. Industrial production expanded at annual equivalent 2.0 percent in the most recent quarter from Aug to Oct 2014 and at 4.5 percent in the prior quarter May-Jul 2014. Business equipment accumulated growth of 1.6 percent in the six months from May to Oct 2014 at the annual equivalent rate of 3.2 percent, which is lower than growth of 4.6 percent in the 12 months ending in Oct 2014. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for the industrial sector decreased 0.3 percentage point in October to 78.9 percent, a rate that is 1.2 percentage points below its long-run (1972–2013) average.” United States industry apparently decelerated to a lower growth rate followed by possible acceleration and weaker growth in past months.

Manufacturing decreased by 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increase by 19.9 percent from the trough in Apr 2009 to Dec 2013. Manufacturing grew 26.2 percent from the trough in Apr 2009 to Oct 2014. Manufacturing output in Oct 2014 is 1.4 percent below the peak in Jun 2007. Growth at trend in the entire cycle from IVQ2007 to IIIQ2014 would have accumulated to 23.0 percent. GDP in IIIQ2014 would be $18,438.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,273.9 billion than actual $16,164.1 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.0 million unemployed or underemployed equivalent to actual unemployment of 15.8 percent of the effective labor force (Section I and earlier (http://cmpassocregulationblog.blogspot.com/2014/11/rules-discretionary-authorities-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/10/world-financial-turbulence-twenty-seven.html). US GDP in IIIQ2014 is 12.3 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,164.1 billion in IIIQ2014 or 7.8 percent at the average annual equivalent rate of 1.1 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth 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. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Oct 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.8884 in Oct 2014. The actual index NSA in Oct 2014 is 101.5613, which is 18.0 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 115.9214 in Oct 2014. The output of manufacturing at 101.5613 in Oct 2014 is 12.4 percent below trend under this alternative calculation.

Table I-13 provides national income by industry without capital consumption adjustment (WCCA). “Private industries” or economic activities have share of 87.3 percent in IIQ2014. Most of US national income is in the form of services. In Nov 2014, there were 141.301 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 118.868 million NSA in Nov 2014 accounted for 84.1 percent of total nonfarm jobs of 141.301 million, of which 12.237 million, or 10.3 percent of total private jobs and 8.7 percent of total nonfarm jobs, were in manufacturing. Private service-providing jobs were 99.475 million NSA in Nov 2014, or 70.4 percent of total nonfarm jobs and 83.7 percent of total private-sector jobs. Manufacturing has share of 11.3 percent in US national income in IIQ2014 and durable goods 6.4 percent, as shown in Table I-13. 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-13, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total

	SAAR IIQ2014	% Total	SAAR IIIQ2014	% Total
National Income WCCA	15,222.0	100.0	15,446.8	100.0
Domestic Industries	15,008.6	98.6	15,234.7	98.6
Private Industries	13,287.8	87.3	13,509.3	87.5
Agriculture	179.0	1.2
Mining	261.4	1.7
Utilities	215.6	1.4
Construction	670.3	4.4
Manufacturing	1712.8	11.3
Durable Goods	975.4	6.4
Nondurable Goods	737.4	4.8
Wholesale Trade	917.7	6.0
Retail Trade	1048.0	6.9
Transportation & WH	478.1	3.1
Information	580.3	3.8
Finance, Insurance, RE	2642.8	17.4
Professional & Business Services	2064.5	13.6
Education, Health Care	1484.3	9.8
Arts, Entertainment	605.0	4.0
Other Services	428.0	2.8
Government	1720.8	11.3	1725.4	11.2
Rest of the World	213.5	1.4	212.2	1.4

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

ESIV Stagnating Real Wages. Average weekly hours in Table IB-2 fell from 34.9 in Dec 2007 at the beginning of the contraction to 33.8 in Jun 2009, which was the last month of the contraction. Average weekly hours rose to 34.4 in Dec 2011 and oscillated to 34.9 in Dec 2012 and 34.7 in Dec 2013. Average weekly hours of all employees increased to 34.9 in Nov 2014.

Table IB-2, US, Average Weekly Hours of All Employees, NSA 2006-2014

Source: US Bureau of Labor Statistics

http://www.bls.gov/

Year	Jan	Feb	Mar	Apr	May	Jun	Jul	Aug	Sep	Oct	Nov	Dec
2006			34.2	34.6	34.3	34.6	34.9	34.6	34.5	34.9	34.4	34.6
2007	34.1	34.1	34.3	34.7	34.4	34.7	34.9	34.7	35.0	34.5	34.5	34.9
2008	34.1	34.2	34.7	34.4	34.4	34.9	34.5	34.6	34.4	34.4	34.6	34.1
2009	33.8	34.2	33.9	33.6	33.7	33.8	33.8	34.3	33.7	33.8	34.2	33.9
2010	33.7	33.6	33.8	34.0	34.4	34.1	34.2	34.7	34.1	34.3	34.2	34.2
2011	34.2	34.0	34.1	34.2	34.6	34.4	34.4	34.4	34.4	34.8	34.3	34.4
2012	34.5	34.2	34.2	34.6	34.2	34.4	34.8	34.5	34.9	34.3	34.3	34.9
2013	34.0	34.2	34.3	34.3	34.3	34.9	34.3	34.5	34.9	34.4	34.4	34.7
2014	34.0	34.4	34.7	34.4	34.4	34.9	34.5	34.6	34.5	34.5	34.9

Source: US Bureau of Labor Statistics

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

Chart IB-1 provides average weekly hours monthly from Mar 2006 to May 2014. Average weekly hours remained relatively stable in the period before the contraction and fell sharply during the contraction as business could not support lower production with the same labor input. Average weekly hours rose rapidly during the expansion but have stabilized at a level below that prevailing before the contraction.

Chart IB-1, US, Average Weekly Hours of All Employees, SA 2006-2014

Source: US Bureau of Labor Statistics

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

Calculations of inflation-adjusted average hourly earnings using BLS data are in Table IB-3. The final column of Table IB-3 (“12-Month Real ∆%”) provides inflation-adjusted average hourly earnings of all employees in the US. Average hourly earnings rose above inflation throughout the first nine months of 2007 just before the global recession that began in the final quarter of 2007 when average hourly earnings began to lose to inflation. In contrast, average hourly earnings of all US workers have risen less than inflation in four months in 2010 and in all but the first month in 2011 and the loss accelerated at 1.8 percent in Sep 2011, declining to a real loss of 1.1 percent in Feb 2012 and 0.6 percent in Mar 2012. There was a gain of 0.5 percent in Apr 2012 in inflation-adjusted average hourly earnings but another fall of 0.6 percent in May 2012 followed by increases of 0.3 percent in Jun and 1.0 percent in Jul 2012. Real hourly earnings stagnated in the 12 months ending in Aug 2012 with increase of only 0.1 percent, and increased 0.7 percent in the 12 months ending in Sep 2012. Real hourly earnings fell 1.3 percent in Oct 2012 and gained 1.0 percent in Dec 2012 but declined 0.3 percent in Jan 2013 and stagnated at change of 0.1 percent in Feb 2013. Real hourly earnings increased 0.4 percent in the 12 months ending in Mar 2013 and 0.2 percent in Apr 2013, increasing 0.6 percent in May 2013. In Jun 2013, real hourly earnings increased 1.0 percent relative to Jun 2012. Real hourly earnings fell 0.6 percent in the 12 months ending in Jul 2013 and increased 0.7 percent in the 12 months ending in Aug 2013. Real hourly earnings increased 1.2 percent in the 12 months ending in Oct 2013 and 1.0 percent in Nov 2013. Real hourly earnings increased 0.4 percent in the 12 months ending in Dec 2013. Real hourly earnings increased 0.4 percent in the 12 months ending in Jan 2014 and 1.7 percent in the 12 months ending in Feb 2014. Real hourly earnings increased 1.2 percent in the 12 months ending in Mar 2014. Real hourly earnings fell 0.1 percent in the 12 months ending in Apr 2014. Real hourly earnings stagnated at 0.0 percent in the 12 months ending in May 2014. Real hourly earnings fell 0.1 percent in the 12 months ending in Jun 2014. Real hourly earnings changed 0.0 percent in the 12 months ending in Jul 2014 and increased 0.5 percent in the 12 months ending in Aug 2014. Real hourly earnings fell 0.4 percent in the 12 months ending in Sep 2014 and increased 0.3 percent in the 12 months ending in Oct 2014. Real hourly earnings are oscillating in part because of world inflation waves caused by carry trades from zero interest rates to commodity futures (http://cmpassocregulationblog.blogspot.com/2014/11/squeeze-of-economic-activity-by-carry.html) and in part because of the collapse of hiring (http://cmpassocregulationblog.blogspot.com/2014/11/fluctuating-financial-variables.html) originating in weak economic growth (http://cmpassocregulationblog.blogspot.com/2014/11/valuations-of-risk-financial-assets.html).

Table IB-3, US, Average Hourly Earnings Nominal and Inflation Adjusted, Dollars and % NSA

	AHE ALL	12 Month- Nominal ∆%	∆% 12 Month CPI	12-Month Real ∆%
2007
Jan*	$20.69*	4.2*	2.1	2.1*
Feb*	$20.77*	4.1*	2.4	1.7*
Mar	$20.80	3.6	2.8	0.8
Apr	$21.03	3.3	2.6	0.7
May	$20.82	3.8	2.7	1.1
Jun	$20.81	3.8	2.7	1.1
Jul	$20.97	3.4	2.4	1.0
Aug	$20.83	3.5	2.0	1.5
Sep	$21.17	4.0	2.8	1.2
Oct	$21.05	2.6	3.5	-0.9
Nov	$21.12	3.3	4.3	-1.0
Dec	$21.35	3.6	4.1	-0.5
2010
Jan	$22.53	2.0	2.6	-0.6
Feb	$22.59	1.4	2.1	-0.7
Mar	$22.49	1.1	2.3	-1.2
Apr	$22.54	1.8	2.2	-0.4
May	$22.61	2.5	2.0	0.5
Jun	$22.35	1.7	1.1	0.6
Jul	$22.42	1.8	1.2	0.6
Aug	$22.55	1.7	1.1	0.6
Sep	$22.61	1.8	1.1	0.7
Oct	$22.70	1.9	1.2	0.7
Nov	$22.70	1.1	1.1	0.0
Dec	$22.77	1.7	1.5	0.2
2011
Jan	$23.17	2.8	1.6	1.2
Feb	$23.00	1.8	2.1	-0.3
Mar	$22.91	1.9	2.7	-0.8
Apr	$22.97	1.9	3.2	-1.3
May	$23.07	2.0	3.6	-1.5
Jun	$22.82	2.1	3.6	-1.4
Jul	$22.95	2.4	3.6	-1.2
Aug	$22.86	1.4	3.8	-2.3
Sep	$23.06	2.0	3.9	-1.8
Oct	$23.31	2.7	3.5	-0.8
Nov	$23.16	2.0	3.4	-1.4
Dec	$23.22	2.0	3.0	-1.0
2012
Jan	$23.57	1.7	2.9	-1.2
Feb	$23.41	1.8	2.9	-1.1
Mar	$23.40	2.1	2.7	-0.6
Apr	$23.62	2.8	2.3	0.5
May	$23.33	1.1	1.7	-0.6
Jun	$23.28	2.0	1.7	0.3
Jul	$23.49	2.4	1.4	1.0
Aug	$23.27	1.8	1.7	0.1
Sep	$23.68	2.7	2.0	0.7
Oct	$23.52	0.9	2.2	-1.3
Nov	$23.59	1.9	1.8	0.1
Dec	$23.85	2.7	1.7	1.0
2013
Jan	$23.88	1.3	1.6	-0.3
Feb	$23.91	2.1	2.0	0.1
Mar	$23.84	1.9	1.5	0.4
Apr	$23.92	1.3	1.1	0.2
May	$23.80	2.0	1.4	0.6
Jun	$23.93	2.8	1.8	1.0
Jul	$23.81	1.4	2.0	-0.6
Aug	$23.79	2.2	1.5	0.7
Sep	$24.16	2.0	1.2	0.8
Oct	$24.04	2.2	1.0	1.2
Nov	$24.11	2.2	1.2	1.0
Dec	$24.30	1.9	1.5	0.4
2014
Jan	$24.35	2.0	1.6	0.4
Feb	$24.58	2.8	1.1	1.7
Mar	$24.48	2.7	1.5	1.2
Apr	$24.38	1.9	2.0	-0.1
May	$24.29	2.1	2.1	0.0
Jun	$24.40	2.0	2.1	-0.1
Jul	$24.29	2.0	2.0	0.0
Aug	$24.31	2.2	1.7	0.5
Sep	$24.48	1.3	1.7	-0.4
Oct	$24.51	2.0	1.7	0.3
Nov	$24.76	2.7

Note: AHE ALL: average hourly earnings of all employees; CPI: consumer price index; Real: adjusted by CPI inflation; NA: not available

*AHE of production and nonsupervisory employees because of unavailability of data for all employees for Jan-Feb 2006

Source: US Bureau of Labor Statistics

http://www.bls.gov/

Calculations of inflation-adjusted average hourly earnings using BLS data are in Table IB-3. The final column of Table IB-3 (“12-Month Real ∆%”) provides inflation-adjusted average hourly earnings of all employees in the US. Average hourly earnings rose above inflation throughout the first nine months of 2007 just before the global recession that began in the final quarter of 2007 when average hourly earnings began to lose to inflation. In contrast, average hourly earnings of all US workers have risen less than inflation in four months in 2010 and in all but the first month in 2011 and the loss accelerated at 1.8 percent in Sep 2011, declining to a real loss of 1.1 percent in Feb 2012 and 0.6 percent in Mar 2012. There was a gain of 0.6 percent in Apr 2012 in inflation-adjusted average hourly earnings but another fall of 0.6 percent in May 2012 followed by increases of 0.3 percent in Jun and 0.9 percent in Jul 2012. Real hourly earnings stagnated in the 12 months ending in Aug 2012 with increase of only 0.1 percent, and increased 0.7 percent in the 12 months ending in Sep 2012. Real hourly earnings fell 1.2 percent in Oct 2012 and gained 1.0 percent in Dec 2012 but declined 0.3 percent in Jan 2013 and stagnated at change of 0.2 percent in Feb 2013. Real hourly earnings increased 0.4 percent in the 12 months ending in Mar 2013 and 0.2 percent in Apr 2013, increasing 0.7 percent in May 2013. In Jun 2013, real hourly earnings increased 1.1 percent relative to Jun 2012. Real hourly earnings fell 0.6 percent in the 12 months ending in Jul 2013 and increased 0.7 percent in the 12 months ending in Aug 2013. Real hourly earnings increased 1.2 percent in the 12 months ending in Oct 2013 and 0.9 percent in Nov 2013. Real hourly earnings increased 0.4 percent in the 12 months ending in Dec 2013. Real hourly earnings increased 0.4 percent in the 12 months ending in Jan 2014 and 1.7 percent in the 12 months ending in Feb 2014. Real hourly earnings increased 1.2 percent in the 12 months ending in Mar 2014. Real hourly earnings fell 0.1 percent in the 12 months ending in Apr 2014. Real hourly earnings fell 0.1 percent in the 12 months ending in May 2014. Real hourly earnings fell 0.1 percent in the 12 months ending in Jun 2014. Real hourly earnings increased 0.1 percent in the 12 months ending in Jul 2014 and increased 0.5 percent in the 12 months ending in Aug 2014. Real hourly earnings fell 0.4 percent in the 12 months ending in Sep 2014 and increased 0.3 percent in the 12 months ending in Oct 2014. Real hourly earnings are oscillating in part because of world inflation waves caused by carry trades from zero interest rates to commodity futures (http://cmpassocregulationblog.blogspot.com/2014/11/squeeze-of-economic-activity-by-carry.html) and in part because of the collapse of hiring (http://cmpassocregulationblog.blogspot.com/2014/11/fluctuating-financial-variables.html) originating in weak economic growth (http://cmpassocregulationblog.blogspot.com/2014/11/valuations-of-risk-financial-assets.html).

Table IB-4, US, Average Hourly Earnings of All Employees NSA in Constant Dollars of 1982-1984

Year	Apr	May	Jun	Jul	Aug	Sep	Oct	Dec
2006	10.10	9.91	9.88	9.97	9.87	10.03	10.16	10.21
2007	10.17	10.01	9.99	10.07	10.02	10.15	10.07	10.16
2008	9.99	9.90	9.83	9.76	9.82	9.93	10.05	10.46
2009	10.38	10.31	10.19	10.23	10.28	10.29	10.31	10.37
2010	10.34	10.36	10.25	10.28	10.33	10.35	10.38	10.39
2011	10.21	10.21	10.11	10.16	10.09	10.16	10.29	10.29
2012	10.27	10.15	10.14	10.25	10.10	10.23	10.17	10.39
∆%12M	0.6	-0.6	0.3	0.9	0.1	0.7	-1.2	1.0
2013	10.29	10.22	10.25	10.19	10.17	10.32	10.29	10.43
∆%12M	0.2	0.7	1.1	-0.6	0.7	0.9	1.2	0.4
2014	10.28	10.21	10.24	10.20	10.22	10.28	10.32
∆%12M	-0.1	-0.1	-0.1	0.1	0.5	-0.4	0.3

Source: US Bureau of Labor Statistics

http://www.bls.gov/

Chart IB-2 of the US Bureau of Labor Statistics plots average hourly earnings of all US employees in constant 1982-1984 dollars with evident decline from annual earnings of $10.34 in 2009 and $10.35 in 2010 to $10.24 in 2011 and $10.24 again in 2012 or loss of 1.1 percent (data in http://www.bls.gov/data/). Annual real hourly earnings increased 0.5 percent in 2013 relative to 2012. The economic welfare or wellbeing of United States workers deteriorated in a recovery without hiring (http://cmpassocregulationblog.blogspot.com/2014/11/fluctuating-financial-variables.html), stagnating/declining real wages and 26.0 million unemployed or underemployed (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/11/rules-discretionary-authorities-and.html) because of mediocre economic growth (http://cmpassocregulationblog.blogspot.com/2014/11/valuations-of-risk-financial-assets.html).

Chart IB-2, US, Average Hourly Earnings of All Employees in Constant Dollars of 1982-1984, SA 2006-2014

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

Chart IB-3 provides 12-month percentage changes of average hourly earnings of all employees in constant dollars of 1982-1984, that is, adjusted for inflation. There was sharp contraction of inflation-adjusted average hourly earnings of US employees during parts of 2007 and 2008. Rates of change in 12 months became positive in parts of 2009 and 2010 but then became negative again in 2011 and into 2012 with temporary increase in Apr 2012 that was reversed in May with another gain in Jun and Jul 2012 followed by stagnation in Aug 2012. There was marginal gain in Sep 2012 with sharp decline in Oct 2012, stagnation in Nov 2012, increase in Dec 2012 and renewed decrease in Jan 2013 with near stagnation in Feb 2013 followed by mild increase in Mar-Apr 2013. Hourly earnings adjusted for inflation increased in Jun 2013 and fell in Jul 2013, increasing in Aug-Dec 2013 and Jan-Mar 2014. Average hourly earnings decreased in Apr-May 2014 and rebounded mildly in Jun-Jul 2014, increasing in Aug 2014 and decreasing in Sep 2014. Average hourly earnings increase in Oct 2014.

Chart IB-3, Average Hourly Earnings of All Employees NSA 12-Month Percent Change, 1982-1984 Dollars, NSA 2007-2014

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

Average weekly earnings of all US employees in the US in constant dollars of 1982-1984 from the dataset of the US Bureau of Labor Statistics (BLS) are provided in Table IB-5. Average weekly earnings fell 3.2 percent after adjusting for inflation in the 12 months ending in Aug 2011, decreased 0.9 percent in the 12 months ending in Sep 2011 and increased 0.6 percent in the 12 months ending in Oct 2011. Average weekly earnings fell 1.0 percent in the 12 months ending in Nov 2011 and 0.4 percent in the 12 months ending in Dec 2011. Average weekly earnings declined 0.3 percent in the 12 months ending in Jan 2012 and 0.5 percent in the 12 months ending in Feb 2012. Average weekly earnings in constant dollars were virtually flat in Mar 2012 relative to Mar 2011, decreasing 0.2 percent. Average weekly earnings in constant dollars increased 1.7 percent in Apr 2012 relative to Apr 2011 but fell 1.7 percent in May 2012 relative to May 2011, increasing 0.3 percent in the 12 months ending in Jun 2012 and 2.1 percent in the 12 months ending in Jul 2012. Real weekly earnings increased 0.4 percent in the 12 months ending in Aug 2012 and 2.1 percent in the 12 months ending in Sep 2012. Real weekly earnings fell 2.7 percent in the 12 months ending in Oct 2012 and increased 0.1 percent in the 12 months ending in Nov 2012 and 2.4 percent in the 12 months ending in Dec 2012. Real weekly earnings fell 1.7 percent in the 12 months ending in Jan 2013 and virtually stagnated with gain of 0.2 percent in the 12 months ending in Feb 2013, increasing 0.7 percent in the 12 months ending in Mar 2013. Real weekly earnings fell 0.7 percent in the 12 months ending in Apr 2013 and increased 0.9 percent in the 12 months ending in May 2013. Average weekly earnings increased 2.5 percent in the 12 months ending in Jun 2013 and fell 2.0 percent in the 12 months ending in Jul 2013. Real weekly earnings increased 0.7 percent in the 12 months ending in Aug 2013, 0.8 percent in the 12 months ending in Sep 2013 and 1.5 percent in the 12 months ending in Oct 2013. Average weekly earnings increased 1.2 percent in the 12 months ending in Nov 2013 and fell 0.2 percent in the 12 months ending in Dec 2013. Average weekly earnings increased 0.4 percent in the 12 months ending in Jan 2014 and 2.3 percent in the 12 months ending in Feb 2014. Average weekly earnings increased 2.3 percent in the 12 months ending in Mar 2014 and 0.3 percent in the 12 months ending in Apr 2014. Average weekly earnings in constant dollars increased 0.2 percent in the 12 months ending in May 2014 and fell 0.1 percent in the 12 months ending in Jun 2014. Real average weekly earnings increased 0.6 percent in the 12 months ending in Jul 2014 and 0.8 percent in the 12 months ending in Aug 2014.

Real weekly earnings decreased 1.5 percent in the 12 months ending in Sep 2014 and increased 0.6 percent in the 12 months ending in Oct 2014. Table I-5 confirms the trend of deterioration of purchasing power of average weekly earnings in 2011 and into 2013 with oscillations according to carry trades causing world inflation waves (http://cmpassocregulationblog.blogspot.com/2014/11/squeeze-of-economic-activity-by-carry.html). On an annual basis, average weekly earnings in constant 1982-1984 dollars increased from $349.34 in 2007 to $354.16 in 2013, by 1.4 percent or at the average rate of 0.2 percent per year (data in http://www.bls.gov/data/). Annual average weekly earnings in constant dollars of $353.11 in 2010 were virtually unchanged at $353.00 in 2012. Those who still work bring back home a paycheck that buys fewer high-quality goods than a year earlier. The fractured US job market does not provide an opportunity for advancement as in past booms following recessions because of poor job creation with 26.0 million unemployed or underemployed (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/11/rules-discretionary-authorities-and.html) in a recovery without hiring (http://cmpassocregulationblog.blogspot.com/2014/11/fluctuating-financial-variables.html) because of mediocre economic growth (http://cmpassocregulationblog.blogspot.com/2014/11/valuations-of-risk-financial-assets.html).

Table IB-5, US, Average Weekly Earnings of All Employees in Constant Dollars of 1982-1984, NSA 2007-2014

Year	May	Jun	Jul	Aug	Sep	Oct
2006	339.78	341.73	347.80	341.42	346.02	354.71
2007	344.42	346.58	351.35	347.64	355.39	347.58
2008	340.46	343.08	336.75	339.86	341.51	345.63
2009	347.47	344.28	345.61	352.48	346.72	348.35
2010	356.49	349.66	351.71	358.43	352.96	356.00
2011	353.25	347.78	349.45	347.12	349.62	358.27
2012	347.19	348.98	356.80	348.48	357.13	348.76
∆%12M	-1.7	0.3	2.1	0.4	2.1	-2.7
2013	350.44	357.66	349.61	350.94	360.10	354.10
∆%12M	0.9	2.5	-2.0	0.7	0.8	1.5
2014	351.23	357.28	351.74	353.64	354.81	356.14
∆%12M	0.2	-0.1	0.6	0.8	-1.5	0.6

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

Chart IB-4 provides average weekly earnings of all employees in constant dollars of 1982-1984. The same pattern emerges of sharp decline during the contraction, followed by recovery in the expansion and continuing fall with oscillations caused by carry trades from zero interest rates into commodity futures from 2010 to 2011 and into 2012-2014.

Chart IB-4, US, Average Weekly Earnings of All Employees in Constant Dollars of 1982-1984, SA 2006-2014

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

Chart IB-5 provides 12-month percentage changes of average weekly earnings of all employees in the US in constant dollars of 1982-1984. There is the same pattern of contraction during the global recession in 2008 and then again trend of deterioration in the recovery without hiring and inflation waves (http://cmpassocregulationblog.blogspot.com/2014/11/squeeze-of-economic-activity-by-carry.html).

Chart IB-5, US, Average Weekly Earnings of All Employees NSA in Constant Dollars of 1982-1984 12-Month Percent Change, NSA 2007-2014

Source: US Bureau of Labor Statistics

ESV Rules, Discretionary Authorities and Slow Productivity Growth. The Bureau of Labor Statistics (BLS) of the Department of Labor provides the quarterly report on productivity and costs. The operational definition of productivity used by the BLS is (http://www.bls.gov/news.release/pdf/prod2.pdf 1): “Labor productivity, or output per hour, is calculated by dividing an index of real output by an index of hours worked of all persons, including employees, proprietors, and unpaid family workers.” The BLS has revised the estimates for productivity and unit costs. Table II-1 provides the new estimate for IIIQ2014 and revised data for nonfarm business sector productivity and unit labor costs for IIQ2014 and IQ2014 in seasonally adjusted annual equivalent (SAAE) rate and the percentage change from the same quarter a year earlier. Reflecting increases in output of 4.9 percent and increase of 2.5 percent in hours worked, nonfarm business sector labor productivity increased at the SAAE rate of 2.3 percent in IIIQ2014, as shown in column 2 “IIIQ2014 SAEE.” The increase of labor productivity from IIIQ2013 to IIIQ2014 was 1.0 percent, reflecting increases in output of 3.1 percent and of hours worked of 2.1 percent, as shown in column 3 “IIIQ2014 YoY.” Hours worked increased from 2.1 percent in IQ2014 in SAAE to 2.5 percent in IIQ2014 and increased to 2.5 percent in IIIQ2014 while output growth increased from minus 2.4 percent in IQ2014 to 5.5 percent in IIQ2014, easing to 4.9 percent in IIIQ2014. The BLS defines unit labor costs as (http://www.bls.gov/news.release/pdf/prod2.pdf 1): “BLS defines unit labor costs as the ratio of hourly compensation to labor productivity; increases in hourly compensation tend to increase unit labor costs and increases in output per hour tend to reduce them.” Unit labor costs increased at the SAAE rate of minus 1.0 percent in IIIQ2014 and increased 1.2 percent in IIIQ2014 relative to IIIQ2013. Hourly compensation increased at the SAAE rate of 1.3 percent in IIIQ2014, which deflating by the estimated consumer price increase SAAE rate in IIIQ2014 results in increase of real hourly compensation at 0.2 percent. Real hourly compensation increased 0.4 percent in IIIQ2014 relative to IIIQ2013.

Table II-1, US, Nonfarm Business Sector Productivity and Costs %

	III 2014 SAAE	IIIQ 2014 YoY	IIQ 2014 SSAE	IIQ 2014 YOY	IQ 2014 SAAE	IQ 2014 YoY
Productivity	2.3	1.0	2.9	1.3	-4.5	0.7
Output	4.9	3.1	5.5	3.3	-2.4	2.4
Hours	2.5	2.1	2.5	2.0	2.1	1.7
Hourly Comp.	1.3	2.2	-0.9	2.0	6.6	3.2
Real Hourly Comp.	0.2	0.4	-3.8	0.0	4.6	1.8
Unit Labor Costs	-1.0	1.2	-3.7	0.7	11.6	2.5
Unit Nonlabor Payments	5.4	1.8	10.1	2.6	-11.7	0.0
Implicit Price Deflator	1.8	1.5	2.0	1.5	0.8	1.4

Notes: SAAE: seasonally adjusted annual equivalent; Comp.: compensation; YoY: Quarter on Same Quarter Year Earlier

http://www.bls.gov/lpc/

The analysis by Kydland (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2004/kydland-bio.html) and Prescott (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2004/prescott-bio.html) (1977, 447-80, equation 5) uses the “expectation augmented” Phillips curve with the natural rate of unemployment of Friedman (1968) and Phelps (1968), which in the notation of Barro and Gordon (1983, 592, equation 1) is:

U_t = Uⁿ_t – α(π_t – π^e) α > 0 (1)

Where U_t is the rate of unemployment at current time t, Uⁿ_t is the natural rate of unemployment, π_t is the current rate of inflation and π^e is the expected rate of inflation by economic agents based on current information. Equation (1) expresses unemployment net of the natural rate of unemployment as a decreasing function of the gap between actual and expected rates of inflation. The system is completed by a social objective function, W, depending on inflation, π, and unemployment, U:

W = W(π_t, U_t) (2)

The policymaker maximizes the preferences of the public, (2), subject to the constraint of the tradeoff of inflation and unemployment, (1). The total differential of W set equal to zero provides an indifference map in the Cartesian plane with ordered pairs (π_t, U_t - Uⁿ) such that the consistent equilibrium is found at the tangency of an indifference curve and the Phillips curve in (1). The indifference curves are concave to the origin. The consistent policy is not optimal. Policymakers without discretionary powers following a rule of price stability would attain equilibrium with unemployment not higher than with the consistent policy. The optimal outcome is obtained by the rule of price stability, or zero inflation, and no more unemployment than under the consistent policy with nonzero inflation and the same unemployment. Taylor (1998LB) attributes the sustained boom of the US economy after the stagflation of the 1970s to following a monetary policy rule instead of discretion (see Taylor 1993, 1999). It is not uncommon for effects of regulation differing from those intended by policy. Professors Edward C. Prescott and Lee E. Ohanian (2014Feb), writing on “US productivity growth has taken a dive,” on Feb 3, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303942404579362462611843696?KEYWORDS=Prescott), argue that impressive productivity growth over the long-term constructed US prosperity and wellbeing. Prescott and Ohanian (2014Feb) measure US productivity growth at 2.5 percent per year since 1948. Average US productivity growth has been only 1.1 percent on average since 2011. Prescott and Ohanian (2014Feb) argue that living standards in the US increased at 28 percent in a decade but with current slow growth of productivity will only increase 12 percent by 2024. There may be collateral effects on productivity growth from policy design similar to those in Kydland and Prescott (1977). The Bureau of Labor Statistics important report on productivity and costs released on Dec 3, 2014 (http://www.bls.gov/lpc/) supports the argument of decline of productivity growth in the US analyzed by Prescott and Ohanian (2014Feb). Table II-2 provides the annual percentage changes of productivity, real hourly compensation and unit labor costs for the entire economic cycle from 2007 to 2013. The data confirm the argument of Prescott and Ohanian (2014Feb): productivity increased cumulatively 2.0 percent from 2011 to 2013 at the average annual rate of 0.7 percent. The situation is direr by excluding growth of 1.0 percent in 2012, which leaves an average of 0.5 percent for 2011 and 2013. Average productivity growth for the entire economic cycle from 2007 to 2013 is only 1.6 percent. The argument by Prescott and Ohanian (2014Feb) is proper in choosing the tail of the business cycle because the increase in productivity in 2009 of 3.2 percent and 3.3 percent in 2013 consisted of reducing labor hours.

Table II-2, US, Revised Nonfarm Business Sector Productivity and Costs Annual Average, ∆% Annual Average 

	2013 ∆%	2012 ∆%	2011 ∆%	2010 ∆%	2009 ∆%	2008  ∆%	2007 ∆%
Productivity	0.9	1.0	0.1	3.3	3.2	0.8	1.6
Real Hourly Compensation	-0.3	0.6	-0.9	0.3	1.5	-1.1	1.4
Unit Labor Costs	0.2	1.7	2.1	-1.3	-2.0	2.0	2.7

Source: US Bureau of Labor Statistics

http://www.bls.gov/lpc/

Productivity jumped in the recovery after the recession from Mar IQ2001 to Nov IVQ2001 (http://www.nber.org/cycles.html). Table II-3 provides quarter on quarter and annual percentage changes in nonfarm business output per hour, or productivity, from 1999 to 2014. The annual average jumped from 2.7 percent in 2001 to 4.3 percent in 2002. Nonfarm business productivity increased at the SAAE rate of 9.4 percent in the first quarter after the recession in IQ2002. Productivity increases decline later in the expansion period. Productivity increases were mediocre during the recession from Dec IVQ2007 to Jun IIIQ2009 (http://www.nber.org/cycles.html) and increased during the first phase of expansion from IIQ2009 to IQ2010, trended lower and collapsed in 2011 and 2012 with sporadic jumps and declines. Productivity increased at 3.3 percent in IVQ2013 and contracted at 4.5 percent in IQ2014. Productivity increased at 2.9 percent in IIQ2014 and at 2.3 percent in IIIQ2014.

Table II-3, US, Nonfarm Business Output per Hour, Percent Change from Prior Quarter at Annual Rate, 1999-2014

Source: US Bureau of Labor Statistics

Year	Qtr1	Qtr2	Qtr3	Qtr4	Annual
1999	3.8	0.7	3.5	6.8	3.3
2000	-1.4	8.6	0.1	4.1	3.3
2001	-1.2	6.8	2.2	5.0	2.7
2002	9.4	0.3	3.1	-0.6	4.3
2003	4.0	5.6	9.0	3.9	3.7
2004	-0.1	4.0	1.3	1.3	3.1
2005	4.4	-0.4	3.0	0.2	2.1
2006	2.5	-0.3	-1.8	3.2	0.9
2007	0.4	2.6	4.6	1.8	1.6
2008	-3.9	4.0	1.0	-2.5	0.8
2009	3.2	7.9	6.0	4.8	3.2
2010	2.2	1.3	2.3	1.5	3.3
2011	-3.2	1.3	-0.9	3.1	0.1
2012	0.2	1.8	1.7	-2.0	1.0
2013	0.8	0.5	3.6	3.3	0.9
2014	-4.5	2.9	2.3

http://www.bls.gov/lpc/

Chart II-1 of the Bureau of Labor Statistics (BLS) provides SAAE rates of nonfarm business productivity from 1999 to 2014. There is a clear pattern in both episodes of economic cycles in 2001 and 2007 of rapid expansion of productivity in the transition from contraction to expansion followed by more subdued productivity expansion. Part of the explanation is the reduction in labor utilization resulting from adjustment of business to the sudden shock of collapse of revenue. Productivity rose briefly in the expansion after 2009 but then collapsed and moved to negative change with some positive changes recently at lower rates. Contractions in the cycle from 2007 to 2014 have been more frequent and sharper.

Chart II-1, US, Nonfarm Business Output per Hour, Percent Change from Prior Quarter at Annual Rate, 1999-2014

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

Percentage changes from prior quarter at SAAE rates and annual average percentage changes of nonfarm business unit labor costs are provided in Table II-4. Unit labor costs fell during the contractions with continuing negative percentage changes in the early phases of the recovery. Weak labor markets partly explain the decline in unit labor costs. As the economy moves toward full employment, labor markets tighten with increase in unit labor costs. The expansion beginning in IIIQ2009 has been characterized by high unemployment and underemployment. Table II-4 shows continuing subdued increases in unit labor costs in 2011 but with increase at 11.4 percent in IQ2012 followed by decrease at 1.2 percent in IIQ2012, decline at 1.8 percent in IIIQ2012 and increase at 12.7 percent in IVQ2012. Unit labor costs decreased at 7.0 percent in IQ2013 and increased at 3.2 percent in IIQ2013. Unit labor costs decreased at 2.9 percent in IIIQ2013 and at 1.3 percent in IVQ2013. Unit labor costs increased at 11.6 percent in IQ2014 and at minus 3.7 percent in IIQ2014. Unit labor costs decreased at 1.0 percent in IIIQ2014.

Table II-4, US, Nonfarm Business Unit Labor Costs, Percent Change from Prior Quarter at Annual Rate 1999-2014

Year	Qtr1	Qtr2	Qtr3	Qtr4	Annual
1999	2.8	0.2	0.0	1.7	0.9
2000	17.4	-6.8	8.2	-1.7	4.0
2001	11.4	-5.4	-1.7	-1.4	1.6
2002	-6.6	3.3	-1.1	1.7	-2.0
2003	-1.5	1.6	-2.6	1.5	0.1
2004	-0.5	3.9	5.6	0.5	1.4
2005	-1.3	2.6	1.9	2.3	1.6
2006	6.1	0.5	2.3	4.0	3.0
2007	9.8	-2.7	-3.2	2.6	2.7
2008	8.2	-3.6	2.4	7.1	2.0
2009	-12.3	2.1	-3.0	-2.3	-2.0
2010	-4.8	3.2	-0.2	0.1	-1.3
2011	11.0	-3.5	3.3	-7.7	2.1
2012	11.4	-1.2	-1.8	12.7	1.7
2013	-7.0	3.2	-2.9	-1.3	0.2
2014	11.6	-3.7	-1.0

Source: US Bureau of Labor Statistics

http://www.bls.gov/lpc/

Chart II-2 provides percentage change from prior quarter at annual rate of nonfarm business real hourly compensation from 1999 to 2014. There are significant fluctuations in quarterly percentage changes oscillating between positive and negative. There is no clear pattern in the two contractions in the 2000s.

Chart II-2, US, Nonfarm Business Unit Labor Costs, Percent Change from Prior Quarter at Annual Rate 1999-2014

Source: US Bureau of Labor Statistics

http://www.bls.gov/lpc/

Table II-5 provides percentage change from prior quarter at annual rates for nonfarm business real hourly worker compensation. The expansion after the contraction of 2001 was followed by strong recovery of real hourly compensation. Real hourly compensation increased at the rate of 3.1 percent in IQ2011 but fell at annual rates of 6.9 percent in IIQ2011 and 6.2 percent in IVQ2011. Real hourly compensation increased at 9.3 percent in IQ2012, decreasing at 0.7 percent in IIQ2012, declining at 1.8 percent in IIIQ2012 and increasing at 7.8 percent in IVQ2012. Real hourly compensation fell at 0.9 percent in 2011 and increased at 0.6 percent in 2012. Real hourly compensation fell at 7.4 percent in IQ2013 and increased at 3.2 percent in IIQ2013, falling at 1.4 percent in IIIQ2013. Real hourly compensation increased at 0.7 percent in IVQ2013 and at 4.6 percent in IQ2014. Real hourly compensation decreased at 3.7 percent in IIQ2014. Real hourly compensation increased at 0.2 percent in IIIQ2014. The annual rate of increase of real hourly compensation for 2013 is minus 0.3 percent.

Table II-5, Nonfarm Business Real Hourly Compensation, Percent Change from Prior Quarter at Annual Rate 1999-2014

Year	Qtr1	Qtr2	Qtr3	Qtr4	Annual
1999	5.0	-2.0	0.3	5.5	2.0
2000	11.5	-1.8	4.4	-0.5	3.9
2001	6.0	-1.8	-0.7	4.0	1.5
2002	0.7	0.4	-0.2	-1.4	0.7
2003	-1.5	8.0	2.9	3.9	1.5
2004	-3.9	4.8	4.2	-2.5	1.8
2005	1.2	-0.6	-1.1	-1.2	0.3
2006	6.4	-3.3	-3.4	9.2	0.6
2007	6.0	-4.5	-1.2	-0.5	1.4
2008	-0.5	-4.7	-2.7	14.6	-1.1
2009	-7.1	7.9	-0.6	-0.8	1.5
2010	-3.1	4.5	0.8	-1.4	0.3
2011	3.1	-6.9	-0.3	-6.2	-0.9
2012	9.3	-0.7	-1.8	7.8	0.6
2013	-7.4	3.2	-1.4	0.7	-0.3
2014	4.6	-3.8	0.2

Source: US Bureau of Labor Statistics

http://www.bls.gov/lpc/

Chart II-3 provides percentage change from prior quarter at annual rate of nonfarm business real hourly compensation. There have been multiple negative percentage quarterly changes in the current cycle since IVQ2007.

Chart II-3, US, Nonfarm Business Real Hourly Compensation, Percent Change from Prior Quarter at Annual Rate 1999-2014

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

Chart II-4 provides percentage change of nonfarm business output per hour in a quarter relative to the same quarter a year earlier. As in most series of real output, productivity increased sharply in 2010 but the momentum was lost after 2011 as with the rest of the real economy.

Chart II-4, US, Nonfarm Business Output per Hour, Percent Change from Same Quarter a Year Earlier 1999-2014

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

Chart II-5 provides percentage changes of nonfarm business unit labor costs relative to the same quarter a year earlier. Softening of labor markets caused relatively high yearly percentage changes in the recession of 2001 repeated in the recession in 2009. Recovery was strong in 2010 but then weakened.

Chart II-5, US, Nonfarm Business Unit Labor Costs, Percent Change from Same Quarter a Year Earlier 1999-2014

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

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

Chart II-6, US, Nonfarm Business Real Hourly Compensation, Percent Change from Same Quarter a Year Earlier 1999-2014

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

In the analysis of Hansen (1939, 3) of secular stagnation, economic progress consists of growth of real income per person driven by growth of productivity. The “constituent elements” of economic progress are “(a) inventions, (b) the discovery and development of new territory and new resources, and (c) the growth of population” (Hansen 1939, 3). Secular stagnation originates in decline of population growth and discouragement of inventions. According to Hansen (1939, 2), US population grew by 16 million in the 1920s but grew by one half or about 8 million in the 1930s with forecasts at the time of Hansen’s writing in 1938 of growth of around 5.3 million in the 1940s. Hansen (1939, 2) characterized demography in the US as “a drastic decline in the rate of population growth.” Hansen’s plea was to adapt economic policy to stagnation of population in ensuring full employment. In the analysis of Hansen (1939, 8), population caused half of the growth of US GDP per year. Growth of output per person in the US and Europe was caused by “changes in techniques and to the exploitation of new natural resources.” In this analysis, population caused 60 percent of the growth of capital formation in the US. Declining population growth would reduce growth of capital formation. Residential construction provided an important share of growth of capital formation. Hansen (1939, 12) argues that market power of imperfect competition discourages innovation with prolonged use of obsolete capital equipment. Trade unions would oppose labor-savings innovations. The combination of stagnating and aging population with reduced innovation caused secular stagnation. Hansen (1939, 12) concludes that there is role for public investments to compensate for lack of dynamism of private investment but with tough tax/debt issues.

The current application of Hansen’s (1938, 1939, 1941) proposition argues that secular stagnation occurs because full employment equilibrium can be attained only with negative real interest rates between minus 2 and minus 3 percent. Professor Lawrence H. Summers (2013Nov8) finds that “a set of older ideas that went under the phrase secular stagnation are not profoundly important in understanding Japan’s experience in the 1990s and may not be without relevance to America’s experience today” (emphasis added). Summers (2013Nov8) argues there could be an explanation in “that the short-term real interest rate that was consistent with full employment had fallen to -2% or -3% sometime in the middle of the last decade. Then, even with artificial stimulus to demand coming from all this financial imprudence, you wouldn’t see any excess demand. And even with a relative resumption of normal credit conditions, you’d have a lot of difficulty getting back to full employment.” The US economy could be in a situation where negative real rates of interest with fed funds rates close to zero as determined by the Federal Open Market Committee (FOMC) do not move the economy to full employment or full utilization of productive resources. Summers (2013Oct8) finds need of new thinking on “how we manage an economy in which the zero nominal interest rates is a chronic and systemic inhibitor of economy activity holding our economies back to their potential.”

Former US Treasury Secretary Robert Rubin (2014Jan8) finds three major risks in prolonged unconventional monetary policy of zero interest rates and quantitative easing: (1) incentive of delaying action by political leaders; (2) “financial moral hazard” in inducing excessive exposures pursuing higher yields of risker credit classes; and (3) major risks in exiting unconventional policy. Rubin (2014Jan8) proposes reduction of deficits by structural reforms that could promote recovery by improving confidence of business attained with sound fiscal discipline.

Professor John B. Taylor (2014Jan01, 2014Jan3) provides clear thought on the lack of relevance of Hansen’s contention of secular stagnation to current economic conditions. The application of secular stagnation argues that the economy of the US has attained full-employment equilibrium since around 2000 only with negative real rates of interest of minus 2 to minus 3 percent. At low levels of inflation, the so-called full-employment equilibrium of negative interest rates of minus 2 to minus 3 percent cannot be attained and the economy stagnates. Taylor (2014Jan01) analyzes multiple contradictions with current reality in this application of the theory of secular stagnation:

• Secular stagnation would predict idle capacity, in particular in residential investment when fed fund rates were fixed at 1 percent from Jun 2003 to Jun 2004. Taylor (2014Jan01) finds unemployment at 4.4 percent with house prices jumping 7 percent from 2002 to 2003 and 14 percent from 2004 to 2005 before dropping from 2006 to 2007. GDP prices doubled from 1.7 percent to 3.4 percent when interest rates were low from 2003 to 2005.
• Taylor (2014Jan01, 2014Jan3) finds another contradiction in the application of secular stagnation based on low interest rates because of savings glut and lack of investment opportunities. Taylor (2009) shows that there was no savings glut. The savings rate of the US in the past decade is significantly lower than in the 1980s.
• Taylor (2014Jan01, 2014Jan3) finds another contradiction in the low ratio of investment to GDP currently and reduced investment and hiring by US business firms.
• Taylor (2014Jan01, 2014Jan3) argues that the financial crisis and global recession were caused by weak implementation of existing regulation and departure from rules-based policies.
• Taylor (2014Jan01, 2014Jan3) argues that the recovery from the global recession was constrained by a change in the regime of regulation and fiscal/monetary policies.

The analysis by Kydland (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2004/kydland-bio.html) and Prescott (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2004/prescott-bio.html) (1977, 447-80, equation 5) uses the “expectation augmented” Phillips curve with the natural rate of unemployment of Friedman (1968) and Phelps (1968), which in the notation of Barro and Gordon (1983, 592, equation 1) is:

U_t = Uⁿ_t – α(π_t – π^e) α > 0 (1)

Where U_t is the rate of unemployment at current time t, Uⁿ_t is the natural rate of unemployment, π_t is the current rate of inflation and π^e is the expected rate of inflation by economic agents based on current information. Equation (1) expresses unemployment net of the natural rate of unemployment as a decreasing function of the gap between actual and expected rates of inflation. The system is completed by a social objective function, W, depending on inflation, π, and unemployment, U:

W = W(π_t, U_t) (2)

The policymaker maximizes the preferences of the public, (2), subject to the constraint of the tradeoff of inflation and unemployment, (1). The total differential of W set equal to zero provides an indifference map in the Cartesian plane with ordered pairs (π_t, U_t - Uⁿ) such that the consistent equilibrium is found at the tangency of an indifference curve and the Phillips curve in (1). The indifference curves are concave to the origin. The consistent policy is not optimal. Policymakers without discretionary powers following a rule of price stability would attain equilibrium with unemployment not higher than with the consistent policy. The optimal outcome is obtained by the rule of price stability, or zero inflation, and no more unemployment than under the consistent policy with nonzero inflation and the same unemployment. Taylor (1998LB) attributes the sustained boom of the US economy after the stagflation of the 1970s to following a monetary policy rule instead of discretion (see Taylor 1993, 1999). It is not uncommon for effects of regulation differing from those intended by policy. Professors Edward C. Prescott and Lee E. Ohanian (2014Feb), writing on “US productivity growth has taken a dive,” on Feb 3, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303942404579362462611843696?KEYWORDS=Prescott), argue that impressive productivity growth over the long-term constructed US prosperity and wellbeing. Prescott and Ohanian (2014Feb) measure US productivity growth at 2.5 percent per year since 1948. Average US productivity growth has been only 1.1 since 2011. Prescott and Ohanian (2014Feb) argue that living standards in the US increased at 28 percent in a decade but with current slow growth of productivity will only increase 12 percent by 2024. There may be collateral effects on productivity growth from policy design similar to those in Kydland and Prescott (1977). The Bureau of Labor Statistics important report on productivity and costs released on Sep 4, 2014 (http://www.bls.gov/lpc/) supports the argument of decline of productivity in the US analyzed by Prescott and Ohanian (2014Feb). Table II-2 provides the annual percentage changes of productivity, real hourly compensation and unit labor costs for the entire economic cycle from 2007 to 2013. The data confirm the argument of Prescott and Ohanian (2014Feb): productivity increased cumulatively 2.0 percent from 2011 to 2013 at the average annual rate of 0.7 percent. The situation is direr by excluding growth of 1.0 percent in 2012, which leaves an average of 0.5 percent for 2011 and 2013. Average productivity growth for the entire economic cycle from 2007 to 2013 is only 1.6 percent. The argument by Prescott and Ohanian (2014Feb) is proper in choosing the tail of the business cycle because the increase in productivity in 2009 of 3.2 percent and 3.3 percent in 2013 consisted on reducing labor hours.

In revealing research, Edward P. Lazear and James R. Spletzer (2012JHJul22) use the wealth of data in the valuable database and resources of the Bureau of Labor Statistics (http://www.bls.gov/data/) in providing clear thought on the nature of the current labor market of the United States. The critical issue of analysis and policy currently is whether unemployment is structural or cyclical. Structural unemployment could occur because of (1) industrial and demographic shifts and (2) mismatches of skills and job vacancies in industries and locations. Consider the aggregate unemployment rate, Y, expressed in terms of share s_i of a demographic group in an industry i and unemployment rate y_i of that demographic group (Lazear and Spletzer 2012JHJul22, 5-6):

Y = ∑_is_iy_i (1)

This equation can be decomposed for analysis as (Lazear and Spletzer 2012JHJul22, 6):

∆Y = ∑_i∆s_iy*_i + ∑_i∆y_is*_i (2)

The first term in (2) captures changes in the demographic and industrial composition of the economy ∆s_i multiplied by the average rate of unemployment y*_i , or structural factors. The second term in (2) captures changes in the unemployment rate specific to a group, or ∆y_i, multiplied by the average share of the group s*_i, or cyclical factors. There are also mismatches in skills and locations relative to available job vacancies. A simple observation by Lazear and Spletzer (2012JHJul22) casts intuitive doubt on structural factors: the rate of unemployment jumped from 4.4 percent in the spring of 2007 to 10 percent in October 2009. By nature, structural factors should be permanent or occur over relative long periods. The revealing result of the exhaustive research of Lazear and Spletzer (2012JHJul22) is:

“The analysis in this paper and in others that we review do not provide any compelling evidence that there have been changes in the structure of the labor market that are capable of explaining the pattern of persistently high unemployment rates. The evidence points to primarily cyclic factors.”

The theory of secular stagnation cannot explain sudden collapse of the US economy and labor markets. The theory of secular stagnation departs from an aggregate production function in which output grows with the use of labor, capital and technology (see Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 11-6). Simon Kuznets (1971) analyzes modern economic growth in his Lecture in Memory of Alfred Nobel:

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

Chart II-7 provides nonfarm-business labor productivity, measured by output per hour, from 1947 to 2014. The rate of productivity increase continued in the early part of the 2000s but then softened and fell during the global recession. The interruption of productivity increases occurred exclusively in the current business cycle. Lazear and Spletzer (2012JHJul22) find “primarily cyclic” factors in explaining the frustration of currently depressed labor markets in the United States. Stagnation of productivity is another cyclic event and not secular trend. The theory and application of secular stagnation to current US economic conditions is void of reality.

Chart II-7, US, Nonfarm Business Labor Productivity, Output per Hour, 1947-2014, Index 2005=100

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

Table II-6 expands Table II-2 providing more complete measurements of the Productivity and Cost research of the Bureau of Labor Statistics. The proper emphasis of Prescott and Ohanian (2014Feb) is on the low productivity increases from 2011 to 2013. Labor productivity increased 3.3 percent in 2010 and 3.2 percent in 2009. There is much stronger yet not sustained performance in 2010 with productivity growing 3.3 percent because of growth of output of 3.2 percent with decline of hours worked of 0.1 percent. Productivity growth of 3.2 percent in 2009 consists of decline of output by 4.3 percent while hours worked collapsed 7.2 percent, which is not a desirable route to progress. The expansion phase of the economic cycle concentrated in one year, 2010, with underperformance in the remainder of the expansion from 2011 to 2013 of productivity growth at average 0.7 percent per year.

Table II-6, US, Productivity and Costs, Annual Percentage Changes 2007-2013

	2013	2012	2011	2010	2009	2008	2007
Productivity	0.9	1.0	0.1	3.3	3.2	0.8	1.6
Output	2.6	3.2	2.2	3.2	-4.3	-1.3	2.3
Hours Worked	1.7	2.2	2.1	-0.1	-7.2	-2.0	0.7
Employment	1.8	2.0	1.6	-1.2	-5.7	-1.5	0.9
Average Weekly Hours Worked	-0.2	0.2	0.5	1.1	-1.6	-0.6	-0.2
Unit Labor Costs	0.2	1.7	2.1	-1.3	-2.0	2.0	2.7
Hourly Compensation	1.1	2.7	2.2	2.0	1.1	2.7	4.3
Consumer Price Inflation	1.5	2.1	3.2	1.6	-0.4	3.8	2.8
Real Hourly Compensation	-0.3	0.6	-0.9	0.3	1.5	-1.1	1.4
Non-labor Payments	5.5	5.3	3.7	7.5	0.0	-0.4	3.4
Output per Job	0.7	1.2	0.6	4.5	1.5	0.2	1.4

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

Productivity growth can bring about prosperity while productivity regression can jeopardize progress. 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. Table II-7 provides average growth rates of indicators in the research of productivity and growth of the US Bureau of Labor Statistics. There is dramatic decline of productivity growth from 2.2 percent per year on average from 1947 to 2013 to 1.5 percent per year on average in the whole cycle from 2007 to 2013. Productivity increased at the average rate of 2.3 percent from 1947 to 2007. There is profound drop in the average rate of output growth from 3.4 percent on average from 1947 to 2013 to 0.9 percent from 2007 to 2013. Output grew at 3.7 percent per year on average from 1947 to 2007. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.3 percent on average in the cyclical expansion in the 21 quarters from IIIQ2009 to IIIQ2014. 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 IIIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp3q14_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 $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/11/growth-uncertainties-mediocre-cyclical.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, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987, 4.9 percent from IQ1983 to IQ1988 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2014/11/valuations-of-risk-financial-assets.html and earlier http://cmpassocregulationblog.blogspot.com/2014/11/growth-uncertainties-mediocre-cyclical.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIIQ2014 would have accumulated to 23.0 percent. GDP in IIIQ2014 would be $18,438.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,273.9 billion than actual $16,164.1 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.0 million unemployed or underemployed equivalent to actual unemployment of 15.8 percent of the effective labor force (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/11/rules-discretionary-authorities-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/10/world-financial-turbulence-twenty-seven.html). US GDP in IIIQ2014 is 12.3 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,164.1 billion in IIIQ2014 or 7.8 percent at the average annual equivalent rate of 1.1 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth 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. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Oct 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.8884 in Oct 2014. The actual index NSA in Oct 2014 is 101.5613, which is 18.0 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 115.9214 in Oct 2014. The output of manufacturing at 101.5613 in Oct 2014 is 12.4 percent below trend under this alternative calculation. United States policy design deserves consideration of Kydland and Prescott (1977) and Prescott and Ohanian (2014Feb, 2014Jun) to induce productivity growth for future progress. Hourly compensation increased at the average yearly rate of 5.1 percent from 1947 to 2013 and consumer price inflation at 3.6 percent with real hourly compensation increasing at the average yearly rate of 1.6 percent. Hourly compensation increased at the average yearly rate of 2.0 percent from 2007 to 2013 while consumer price inflation increased at 2.0 percent with real hourly compensation changing at the average yearly rate of 0.0 percent. Hourly compensation increased at the average rate of 5.4 percent from 1947 to 2007 and the consumer price index at 3.8 percent for real hourly compensation of 1.7 percent per year. While hours worked increased at the average yearly rate of 1.2 percent from 1947 to 2013, hours worked fell 3.7 percent from 2007 to 2013. Hours worked increased at the average rate of 1.4 percent from 1947 to 2007. While employment increased at the average yearly rate of 1.4 percent from 1947 to 2013, employment fell 3.3 percent from 2007 to 2013. Employment increased at the average rate of 1.6 percent from 1947 to 2007.

Table II-7, US, Productivity and Costs, Average Annual Percentage Changes 2007-2013 and 1947-2013

	Average Annual Percentage Rate 2007-2013	Average Annual Percentage Rate 1947-2007	Average Annual Percentage Rate  1947-2013
Productivity	1.5	2.3	2.2
Output	0.9	3.7	3.4
Hours	-3.7*	1.4	1.2
Employment	-3.3*	1.6	1.4
Average Weekly Hours	-0.5*	-14.6*	-15.0*
Hourly Compensation	2.0	5.4	5.1
Consumer Price Inflation	2.0	3.8	3.6
Real Hourly Compensation	0.0	1.7	1.6
Unit Labor Costs	0.4	3.0	2.8
Unit Non-labor Payments	2.6	3.5	3.4
Output per Job	1.5	2.0	2.0

* Percentage Change

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

Unit labor costs increased sharply during the Great Inflation from the late 1960s to 1981 as shown by sharper slope in Chart II-8. Unit labor costs continued to increase but at a lower rate because of cyclic factors and not because of imaginary secular stagnation.

Chart II-8, US, Nonfarm Business, Unit Labor Costs, 1947-2014, Index 2009=100

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

Real hourly compensation increased at relatively high rates after 1947 to the early 1970s but reached a plateau that lasted until the early 1990s, as shown in Chart II-9. There were rapid increases until the global recession. Cyclic factors and not alleged secular stagnation explain the interruption of increases in real hourly compensation.

Chart II-9, US, Nonfarm Business, Real Hourly Compensation, 1947-2014, Index 2009=100

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

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