Twenty Nine Million Unemployed or Underemployed, Stagnating Real Wages and Real Disposable Income, Peaking Valuations of Risk Financial Assets, World Economic Slowdown and Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2010, 2011, 2012, 2013
Executive Summary
I Twenty Nine 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
II Stagnating Real Wages
IIA Stagnating Real Disposable Income and Consumption Expenditures
IIA1 Stagnating Real Disposable Income and Consumption Expenditures
IIA2 Financial Repression
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
Chart IIA-3 provides personal income in the US between 1980 and 1989. These data are not adjusted for inflation that was still high in the 1980s in the exit from the Great Inflation of the 1960s and 1970s. Personal income grew steadily during the 1980s after recovery from two recessions from Jan IQ1980 to Jul IIIQ1980 and from Jul IIIQ1981 to Nov IVQ1982 (http://www.nber.org/cycles.html) with combined drop of GDP by 4.8 percent.
Chart IIA-3, US, Personal Income, Billion Dollars, Quarterly Seasonally Adjusted at Annual Rates, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
A different evolution of personal income is shown in Chart IB-4. Personal income also fell during the recession from Dec IVQ2007 to Jun IIQ2009 (http://www.nber.org/cycles.html). Growth of personal income during the expansion has been tepid even with the new revisions. In IVQ2012, nominal disposable personal income grew at the SAAR of 8.1 percent and real disposable personal income at 6.2 percent (http://www.bea.gov/iTable/index_nipa.cfm), which the BEA explains as: “Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf pages 1-2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0113.pdf). The Bureau of Economic Analysis explains as (http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf 2-3): “The January estimate of employee contributions for government social insurance reflected the expiration of the “payroll tax holiday,” that increased the social security contribution rate for employees and self-employed workers by 2.0 percentage points, or $114.1 billion at an annual rate. For additional information, see FAQ on “How did the expiration of the payroll tax holiday affect personal income for January 2013?” at www.bea.gov. The January estimate of employee contributions for government social insurance also reflected an increase in the monthly premiums paid by participants in the supplementary medical insurance program, in the hospital insurance provisions of the Patient Protection and Affordable Care Act, and in the social security taxable wage base.”
The increase was provided in the “fiscal cliff” law H.R. 8 American Taxpayer Relief Act of 2012 (http://www.gpo.gov/fdsys/pkg/BILLS-112hr8eas/pdf/BILLS-112hr8eas.pdf).
In IQ2013, personal income fell at the SAAR of minus 3.2 percent; real personal income excluding current transfer receipts at minus 5.8 percent; and real disposable personal income at minus 5.3 percent (Table 5 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf). The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):
“The February and January changes in disposable personal income (DPI) mainly reflected the effect of special factors in January, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to November and to December in anticipation of changes in individual tax rates.”
Chart IIA-4, US, Personal Income, Current Billions of Dollars, Quarterly Seasonally Adjusted at Annual Rates, 2007-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Real or inflation-adjusted disposable personal income is provided in Chart IIA-5 from 1980 to 1989. Real disposable income after allowing for taxes and inflation grew steadily at high rates during the entire decade.
Chart IIA-5, US, Real Disposable Income, Billions of Chained 2005 Dollars, Quarterly Seasonally Adjusted at Annual Rates 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In IQ2013, personal income fell at the SAAR of minus 3.2 percent; real personal income excluding current transfer receipts at minus 5.8 percent; and real disposable personal income at minus 5.3 percent (Table 5 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf). The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):
“The February and January changes in disposable personal income (DPI) mainly reflected the effect of special factors in January, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to November and to December in anticipation of changes in individual tax rates.”
Chart IIA-6, US, Real Disposable Income, Billions of Chained 2005 Dollars, Seasonally Adjusted at Annual Rates, 2007-2013
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-7 provides percentage quarterly changes in real disposable income from the preceding period at seasonally adjusted annual rates from 1980 to 1989. Rates of changes were high during the decade with few negative changes.
Chart IIA-7, US, Real Disposable Income Percentage Change from Preceding Period at Quarterly Seasonally-Adjusted Annual Rates, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-8 provides percentage quarterly changes in real disposable income from the preceding period at seasonally-adjusted annual rates from 2007 to 2012. There has been a period of positive rates followed by decline of rates and then negative and low rates in 2011. Recovery in 2012 has not reproduced the dynamism of the brief early phase of expansion. In IVQ2012, nominal disposable personal income grew at the SAAR of 7.9 percent and real disposable personal income at 6.2 percent, which the BEA explains as: Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf). In IQ2013, personal income fell at the SAAR of minus 3.2 percent; real personal income excluding current transfer receipts at minus 5.8 percent; and real disposable personal income at minus 5.3 percent (Table 5 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf). The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):
“The February and January changes in disposable personal income (DPI) mainly reflected the effect of special factors in January, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to November and to December in anticipation of changes in individual tax rates.”
Chart, IIA-8, US, Real Disposable Income, Percentage Change from Preceding Period at Seasonally-Adjusted Annual Rates, 2007-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
In the latest available report, the Bureau of Economic Analysis (BEA) estimates US personal income in Mar 2013 at the seasonally adjusted annual rate of $13,630.4 billion, as shown in Table IIA-3 above (see Table 1 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf). The major portion of personal income is compensation of employees of $8,763.9 billion, or 64.3 percent of the total. Wage and salary disbursements are $7,039.2 billion, of which $5,831.7 billion by private industries and supplements to wages and salaries of $1,724.7 billion (employer contributions to pension and insurance funds are $1,195.3 billion and contributions to social insurance are $529.4 billion). In Dec 1985, US personal income was $3,596.4 billion at SAAR (http://www.bea.gov/iTable/index_nipa.cfm). Compensation of employees was $2,498.5 billion, or 69.5 percent of the total. Wage and salary disbursement were $2.056.3 billion of which $1671.0 billion by private industries. Supplements to wages and salaries were $442.2 billion with employer contributions to pension and insurance funds of $289.4 billion and $152.9 billion to government social insurance. Chart IIA-9 provides US wage and salary disbursement by private industries in the 1980s. Growth was robust after the interruption of the recessions.
Chart IIA-9, US, Wage and Salary Disbursement, Private Industries, Quarterly, Seasonally Adjusted at Annual Rates Billions of Dollars, 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-10 shows US wage and salary disbursement of private industries from 2007 to 2012. There is a drop during the contraction followed by initial recovery in 2010 and then the current much weaker relative performance in 2011, 2012 and 2013.
Chart IIA-10, US, Wage and Salary Disbursement, Private Industries, Quarterly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-11 provides finer detail with monthly wage and salary disbursement of private industries from 2007 to 2013. There is decline during the contraction and a period of mild recovery followed by stagnation and recent recovery that is weaker than in earlier expansion periods of the business cycle. There is decline of 0.6 percent in Jan 2013 because of the higher contributions to government social insurance followed by recovery of 0.7 percent in Feb 2013 and 0.2 percent in Mar 2013.
Chart IIA-11, US, Wage and Salary Disbursement, Private Industries, Monthly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-12 provides monthly real disposable personal income per capita from 1980 to 1989. This is the ultimate measure of wellbeing in receiving income by obtaining the value per inhabitant. The measure cannot adjust for the distribution of income. Real disposable personal income per capita grew rapidly during the expansion after 1983 and continued growing during the rest of the decade.
Chart IIA-12, US, Real Disposable Per Capita Income, Monthly, Seasonally Adjusted at Annual Rates, Billions of Dollars 1980-1989
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-13 provides monthly real disposable personal per capita income from 2007 to 2013. There was initial recovery from the drop during the global recession followed by stagnation. Real per capita disposable income increased 1.1 percent from $32,602 in chained dollars of 2005 in Oct 2012 to $32,967 in Nov 2012 and 2.7 percent to $33,846 in Dec 2012 for cumulative increase of 3.8 percent from Oct 2012 to Dec 2012. Real per capita disposable income fell 4.1 percent from $33,846 in Dec 2012 to $32,467 in Jan 2013, increasing marginally 0.7 percent to $32,686 in Feb 2013 for cumulative change of 0.3 percent from Oct 2012 (data at http://www.bea.gov/iTable/index_nipa.cfm). This increase is shown in a jump in the final segment in Chart IIA-13 with Nov-Dec 2012, decline in Jan 2013 and recovery in Feb 2013. Real per capita disposable income increased 0.2 percent from $32,686 in Feb 2013 in chained dollars of 2005 to $32,767 in Mar 2013 for cumulative gain of 0.5 percent relative to Oct 2012. BEA explains as: “Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf pages 1-2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0113.pdf). The Bureau of Economic Analysis explains as (http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf 2-3): “The January estimate of employee contributions for government social insurance reflected the expiration of the “payroll tax holiday,” that increased the social security contribution rate for employees and self-employed workers by 2.0 percentage points, or $114.1 billion at an annual rate. For additional information, see FAQ on “How did the expiration of the payroll tax holiday affect personal income for January 2013?” at www.bea.gov. The January estimate of employee contributions for government social insurance also reflected an increase in the monthly premiums paid by participants in the supplementary medical insurance program, in the hospital insurance provisions of the Patient Protection and Affordable Care Act, and in the social security taxable wage base.”
The increase was provided in the “fiscal cliff” law H.R. 8 American Taxpayer Relief Act of 2012 (http://www.gpo.gov/fdsys/pkg/BILLS-112hr8eas/pdf/BILLS-112hr8eas.pdf).
The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):
“The February and January changes in disposable personal income (DPI) mainly reflected the effect of special factors in January, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to November and to December in anticipation of changes in individual tax rates.”
Chart IIA-13, US, Real Disposable Per Capita Income, Monthly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
IIA2 Financial Repression. McKinnon (1973) and Shaw (1974) argue that legal restrictions on financial institutions can be detrimental to economic development. “Financial repression” is the term used in the economic literature for these restrictions (see Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 81-6). Interest rate ceilings on deposits and loans have been commonly used. Prohibition of payment of interest on demand deposits and ceilings on interest rates on time deposits were imposed by the Banking Act of 1933. These measures were justified by arguments that the banking panic of the 1930s was caused by competitive rates on bank deposits that led banks to engage in high-risk loans (Friedman, 1970, 18; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 74-5). The objective of policy was to prevent unsound loans in banks. Savings and loan institutions complained of unfair competition from commercial banks that led to continuing controls with the objective of directing savings toward residential construction. Friedman (1970, 15) argues that controls were passive during periods when rates implied on demand deposit were zero or lower and when Regulation Q ceilings on time deposits were above market rates on time deposits. The Great Inflation or stagflation of the 1960s and 1970s changed the relevance of Regulation Q.
Most regulatory actions trigger compensatory measures by the private sector that result in outcomes that are different from those intended by regulation (Kydland and Prescott 1977). Banks offered services to their customers and loans at rates lower than market rates to compensate for the prohibition to pay interest on demand deposits (Friedman 1970, 24). The prohibition of interest on demand deposits was eventually lifted in recent times. In the second half of the 1960s, already in the beginning of the Great Inflation (DeLong 1997), market rates rose above the ceilings of Regulation Q because of higher inflation. Nobody desires savings allocated to time or savings deposits that pay less than expected inflation. This is a fact currently with zero interest rates and consumer price inflation of 2.0 percent in the 12 months ending in Feb 2013 (http://www.bls.gov/cpi/) but rising during waves of carry trades from zero interest rates to commodity futures exposures (http://cmpassocregulationblog.blogspot.com/2013/03/recovery-without-hiring-ten-million.html). Funding problems motivated compensatory measures by banks. Money-center banks developed the large certificate of deposit (CD) to accommodate increasing volumes of loan demand by customers. As Friedman (1970, 25) finds:
“Large negotiable CD’s were particularly hard hit by the interest rate ceiling because they are deposits of financially sophisticated individuals and institutions who have many alternatives. As already noted, they declined from a peak of $24 billion in mid-December, 1968, to less than $12 billion in early October, 1969.”
Banks created different liabilities to compensate for the decline in CDs. As Friedman (1970, 25; 1969) explains:
“The most important single replacement was almost surely ‘liabilities of US banks to foreign branches.’ Prevented from paying a market interest rate on liabilities of home offices in the United States (except to foreign official institutions that are exempt from Regulation Q), the major US banks discovered that they could do so by using the Euro-dollar market. Their European branches could accept time deposits, either on book account or as negotiable CD’s at whatever rate was required to attract them and match them on the asset side of their balance sheet with ‘due from head office.’ The head office could substitute the liability ‘due to foreign branches’ for the liability ‘due on CDs.”
Friedman (1970, 26-7) predicted the future:
“The banks have been forced into costly structural readjustments, the European banking system has been given an unnecessary competitive advantage, and London has been artificially strengthened as a financial center at the expense of New York.”
In short, Depression regulation exported the US financial system to London and offshore centers. What is vividly relevant currently from this experience is the argument by Friedman (1970, 27) that the controls affected the most people with lower incomes and wealth who were forced into accepting controlled-rates on their savings that were lower than those that would be obtained under freer markets. As Friedman (1970, 27) argues:
“These are the people who have the fewest alternative ways to invest their limited assets and are least sophisticated about the alternatives.”
Chart IIA-14 of the Bureau of Economic Analysis (BEA) provides quarterly savings as percent of disposable income or the US savings rate from 1980 to 2012. There was a long-term downward sloping trend from 12 percent in the early 1980s to less than 2 percent in 2005-2006. The savings rate then rose during the contraction and also in the expansion. In 2011 and into 2012 the savings rate declined as consumption is financed with savings in part because of the disincentive or frustration of receiving a few pennies for every $10,000 of deposits in a bank. The savings rate increased in the final segment of Chart IIA-14 in 2012 followed by another decline because of the pain of the opportunity cost of zero remuneration for hard-earned savings. Swelling realization of income in Oct-Dec 2012 in anticipation of tax increases in Jan 2012 caused the jump of the savings rate to 6.5 percent in Dec 2012. The BEA explains as: Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf). The savings rate then collapsed to 2.3 percent in Jan 2013 in part because of the decline of 4.0 percent in real disposable personal income and to 2.7 percent with increase of real disposable income by 0.7 percent in Feb 2013. The savings rate remained at 2.7 percent in Mar 2013 with increase of real disposable income by 0.3 percent. The decline of personal income was caused by increasing contributions to government social insurance (page 1 http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0113.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf). The objective of monetary policy is to reduce borrowing rates to induce consumption but it has collateral disincentive of reducing savings and misallocating resources away from their best uses. The zero interest rate of monetary policy is a tax on saving. This tax is highly regressive, meaning that it affects the most people with lower income or wealth and retirees. The long-term decline of savings rates in the US has created a dependence on foreign savings to finance the deficits in the federal budget and the balance of payments.
Chart IIA-14, US, Personal Savings as a Percentage of Disposable Personal Income, Quarterly, 1980-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-15 of the US Bureau of Economic Analysis provides personal savings as percent of personal disposable income, or savings ratio, from Jan 2007 to Mar 2013. The uncertainties caused by the global recession resulted in sharp increase in the savings ratio that peaked at 8.3 percent in May 2008 (http://www.bea.gov/iTable/index_nipa.cfm). The second highest ratio occurred at 6.7 percent in May 2009. There was another rising trend until 5.8 percent in Jun 2010 and then steady downward trend until trough of 3.2 percent in Nov 2011, which was followed by an upward trend with 4.1 percent in Jun 2012 but decline to 3.7 percent in Aug 2012, 3.3 percent in Sep 2012, 3.4 percent in Oct and increase to 4.1 percent in Nov 2012 followed by jump to 6.5 percent in Dec 2012. Swelling realization of income in Oct-Dec 2012 in anticipation of tax increases in Jan 2012 caused the jump of the savings rate to 6.5 percent in Dec 2012. The BEA explains as: Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf). There was a reverse effect in Jan 2013 with decline of the savings rate to 2.3 percent. Real disposable personal income fell 4.0 percent and real disposable per capita income fell from $33,846 in Dec 2012 to $32,467 in Jan 2013 or by 4.1 percent, which is explained by the Bureau of Economic Analysis as follows (page 3 http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf):
“Contributions for government social insurance -- a subtraction in calculating personal income --increased $6.4 billion in February, compared with an increase of $126.8 billion in January. The
January estimate reflected increases in both employer and employee contributions forgovernment social insurance. The January estimate of employee contributions for government social insurance reflected the expiration of the “payroll tax holiday,” that increased the social security contribution rate for employees and self-employed workers by 2.0 percentage points, or $114.1 billion at an annual rate. For additional information, see FAQ on “How did the expiration of the payroll tax holiday affect personal income for January 2013?” at www.bea.gov. The January estimate of employee contributions for government social insurance also reflected an increase in the monthly premiums paid by participants in the supplementary medical insurance program, in the hospital insurance provisions of the Patient Protection and Affordable Care Act, and in the social security taxable wage base; together, these changes added $12.9 billion to January. Employer contributions were boosted $5.9 billion in January, which reflected increases in the social security taxable wage base (from $110,100 to $113,700), in the tax rates paid by employers to state unemployment insurance, and in employer contributions for the federal unemployment tax and for pension guaranty. The total contribution of special factors to the January change in contributions for government social insurance was $132.9billion.”
Consumption was maintained by burning savings because of the drain of decline of real disposable personal income by 4.0 percent and 4.1 percent in per capita terms. The savings rate rose to 2.7 percent in Feb 2013 with increase of real per capita income by 0.7 percent and remained at 2.7 percent in Mar 2013 with further increase of real per capita disposable income by 0.2 percent. Permanent manipulation of the entire spectrum of interest rates with monetary policy measures distorts the compass of resource allocation with inferior outcomes of future growth, employment and prosperity and dubious redistribution of income and wealth worsening the most the personal welfare of people without vast capital and financial relations to manage their savings.
Chart IIA-15, US, Personal Savings as a Percentage of Disposable Income, Monthly 2007-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
III World Financial Turbulence. Financial markets are being shocked by multiple factors including:
(1) world economic slowdown; (2) slowing growth in China with political development and slowing growth in Japan and world trade; (3) slow growth propelled by savings/investment reduction in the US with high unemployment/underemployment, falling wages, hiring collapse, contraction of real private fixed investment, decline of wealth of households over the business cycle by 8.4 percent adjusted for inflation while growing 617.2 percent adjusted for inflation from IVQ1945 to IVQ2012 and unsustainable fiscal deficit/debt threatening prosperity that can cause risk premium on Treasury debt with Himalayan interest rate hikes; and (4) the outcome of the sovereign debt crisis in Europe.
This section provides current data and analysis. Subsection IIIA Financial Risks provides analysis of the evolution of valuations of risk financial assets during the week. There are various appendixes for convenience of reference of material related to the euro area debt crisis. Some of this material is updated in Subsection IIIA when new data are available and then maintained in the appendixes for future reference until updated again in Subsection IIIA. Subsection IIIB Appendix on Safe Haven Currencies discusses arguments and measures of currency intervention and is available in the Appendixes section at the end of the blog comment. Subsection IIIC Appendix on Fiscal Compact provides analysis of the restructuring of the fiscal affairs of the European Union in the agreement of European leaders reached on Dec 9, 2011 and is available in the Appendixes section at the end of the blog comment. Subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort considers the policies of the European Central Bank and is available in the Appendixes section at the end of the blog comment. Appendix IIIE Euro Zone Survival Risk analyzes the threats to survival of the European Monetary Union and is available following Subsection IIIA. Subsection IIIF Appendix on Sovereign Bond Valuation provides more technical analysis and is available following Subsection IIIA. Subsection IIIG Appendix on Deficit Financing of Growth and the Debt Crisis provides analysis of proposals to finance growth with budget deficits together with experience of the economic history of Brazil and is available in the Appendixes section at the end of the blog comment.
IIIA Financial Risks. The past half year has been characterized by financial turbulence, attaining unusual magnitude in recent months. Table III-1, updated with every comment in this blog, provides beginning values on Fri Apr 26 and daily values throughout the week ending on May 3, 2013 of various financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Apr 26 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Apr 26, 2013”, first row “USD/EUR 1.3028 0.2%,” provides the information that the US dollar (USD) appreciated 0.2 percent to USD 1.3028/EUR in the week ending on Fri Apr 26 relative to the exchange rate on Fri Apr 19. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing waves of inflation. The most important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9 (European Council 2911Dec9), which is analyzed in IIIC Appendix on Fiscal Compact. European leaders reached a new agreement on Jan 30 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/127631.pdf) and another agreement on Jun 29, 2012 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf).
The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.3028/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Apr 26, depreciating to USD 1.3099/EUR on Mon Apr 29, 2013, or by 0.5 percent. The dollar depreciated because more dollars, $1.3099, were required on Mon Apr 29 to buy one euro than $1.3028 on Apr 26. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.3028/EUR on Apr 26; the second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Apr 26, to the last business day of the current week, in this case Fri May 3, such as depreciation to USD 1.3115/EUR by May 3; and the third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (denoted by negative sign) by 0.7 percent from the rate of USD 1.3028/EUR on Fri Apr 26 to the rate of USD 1.3115/EUR on Fri May 3 {[(1.3115/1.3028) – 1]100 = 0.7%} and depreciated (denoted by negative sign) by 0.4 percent from the rate of USD 1.3065 on Thu May 2 to USD 1.3115/EUR on Fri May 3 {[(1.3115/1.3065) -1]100 = 0.4%}. Other factors constant, appreciation of the dollar relative to the euro is caused by increasing risk aversion, with rising uncertainty on European sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from higher yielding risk assets to the safety of dollar-denominated assets during risk aversion and return to higher yielding risk assets during risk appetite.
III-I, Weekly Financial Risk Assets Dec 26 to Dec 30, 2012
| Fri Apr 26, 2011 | M 29 | Tue 30 | W 1 | Thu 2 | Fri 3 |
| USD/EUR 1.3028 0.2% | 1.3099 -0.5% -0.5% | 1.3168 -1.1% -0.5% | 1.3181 -1.2% -0.1% | 1.3065 -0.3% -0.9% | 1.3115 -0.7% -0.4% |
| JPY/ USD 98.06 1.5% | 97.76 0.3% 0.3% | 97.44 0.6% 0.3% | 97.39 0.7% 0.1% | 97.95 0.1% -0.6% | 99.01 -1.0% -1.1% |
| CHF/ USD 0.9428 -1.0% | 0.9366 0.0% 0.0% | 0.9295 1.4% 0.8% | 0.9273 1.6% 0.2% | 0.9349 0.8% -0.8% | 0.9354 0.8% -0.1% |
| CHF/ EUR 1.2276 -0.7% | 1.2270 0.0% 0.0% | 1.2239 0.3% 0.3% | 1.2223 0.4% 0.1% | 1.2216 0.5% 0.1% | 1.2266 0.1% -0.4% |
| USD/ AUD 1.0279 0.9729 0.0% | 1.0351 0.9661 0.7% 0.7% | 1.0371 0.9642 0.9% 0.2% | 1.0279 0.9729 0.0% -0.9% | 1.0248 0.9758 -0.3% -0.3% | 1.0317 0.9693 0.4% 0.7% |
| 10 Year T Note 1.663 | 1.666 | 1.662 | 1.627 | 1.623 | 1.742 |
| 2 Year T Note 0.209 | 0.209 | 0.206 | 0.201 | 0.198 | 0.222 |
| German Bond 2Y 0.00 10Y 1.21 | 2Y 0.00 10Y 1.20 | 2Y 0.01 10Y 1.22 | 2Y 0.02 10Y 1.21 | 2Y -0.02 10Y 1.18 | 2Y 0.00 10Y 1.24 |
| DJIA 14712.55 1.1% | 14818.75 0.7% 0.7% | 14839.80 0.9% 0.1% | 14700.95 -0.1% -0.9% | 14831.58 0.8% 0.9% | 14973.96 1.8% 1.0% |
| DJ Global 2151.66 2.5% | 2169.28 0.8% 0.8% | 2179.19 1.3% 0.5% | 2166.81 0.7% -0.6% | 2168.89 0.8% 0.1% | 2189.60 1.8% 1.0% |
| DJ Asia Pacific 1432.96 3.0% | 1434.35 0.1% 0.1% | 1450.14 1.2% 1.1% | 1444.02 0.8% -0.4% | 1434.37 0.1% -0.7% | 1430.70 -0.2% -0.3% |
| Nikkei 13884.13 4.3% | 13884.13 0.0% 0.0% | 13860.86 -0.2% -0.2% | 13799.35 -0.6% -0.4% | 13694.04 -1.4% -0.8% | 13694.04 -1.4% 0.0% |
| Shanghai 2177.91 -3.0% | 2177.91 0.0% 0.0% | 2177.91 0.0% 0.0% | 2177.91 0.0% 0.0% | 2174.12 -0.2% -0.2% | 2205.50 1.3% 1.4% |
| DAX 7814.76 4.8% | 7873.50 0.8% 0.8% | 7913.71 1.3% 0.5% | 7913.71 1.3% 0.0% | 7961.71 1.9% 0.6% | 8122.29 3.9% 2.0% |
| DJ UBS Comm. 131.92 0.3% | 134.38 1.9% 1.9% | 133.63 1.3% -0.6% | 131.33 -0.4% -1.7% | 131.60 -0.2% 0.2% | 133.12 0.9% 1.2% |
| WTI $ B 93.00 5.7% | 94.36 1.5% 1.5% | 94.41 1.5% 0.1% | 90.97 -2.2% -3.6% | 94.06 1.1% 3.4% | 95.50 2.7% 1.5% |
| Brent $/B 102.85 3.4% | 103.72 0.8% 0.8% | 103.65 0.8% -0.1% | 99.82 -2.9% -3.7% | 102.81 0.0% 3.0% | 104.05 1.2% 1.2% |
| Gold $/OZ 1453.60 3.6% | 1473.6 1.4% 1.4% | 1469.41 1.1% -0.3% | 1456.20 0.2% -0.9% | 1461.50 0.5% 0.4% | 1470.00 1.1% 0.6% |
Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss
Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce
Sources: http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
Discussion of current and recent risk-determining events is followed below by analysis of risk-measuring yields of the US and Germany and the USD/EUR rate. Financial markets worldwide were affected by the reduction of policy rates of the European Central Bank (ECB) on May 2, 2013 (http://www.ecb.int/press/pr/date/2013/html/pr130502.en.html):
“2 May 2013 - Monetary policy decisions
At today’s meeting, which was held in Bratislava, the Governing Council of the ECB took the following monetary policy decisions:
- The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.50%, starting from the operation to be settled on 8 May 2013.
- The interest rate on the marginal lending facility will be decreased by 50 basis points to 1.00%, with effect from 8 May 2013.
- The interest rate on the deposit facility will remain unchanged at 0.00%.”
Financial markets in Japan and worldwide were shocked by new bold measures of “quantitative and qualitative monetary easing” by the Bank of Japan (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The objective of policy is to “achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The main elements of the new policy are as follows:
- Monetary Base Control. Most central banks in the world pursue interest rates instead of monetary aggregates, injecting bank reserves to lower interest rates to desired levels. The Bank of Japan (BOJ) has shifted back to monetary aggregates, conducting money market operations with the objective of increasing base money, or monetary liabilities of the government, at the annual rate of 60 to 70 trillion yen. The BOJ estimates base money outstanding at “138 trillion yen at end-2012) and plans to increase it to “200 trillion yen at end-2012 and 270 trillion yen at end 2014” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
- Maturity Extension of Purchases of Japanese Government Bonds. Purchases of bonds will be extended even up to bonds with maturity of 40 years with the guideline of extending the average maturity of BOJ bond purchases from three to seven years. The BOJ estimates the current average maturity of Japanese government bonds (JGB) at around seven years. The BOJ plans to purchase about 7.5 trillion yen per month (http://www.boj.or.jp/en/announcements/release_2013/rel130404d.pdf). Takashi Nakamichi, Tatsuo Ito and Phred Dvorak, wiring on “Bank of Japan mounts bid for revival,” on Apr 4, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323646604578401633067110420.html ), find that the limit of maturities of three years on purchases of JGBs was designed to avoid views that the BOJ would finance uncontrolled government deficits.
- Seigniorage. The BOJ is pursuing coordination with the government that will take measures to establish “sustainable fiscal structure with a view to ensuring the credibility of fiscal management” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
- Diversification of Asset Purchases. The BOJ will engage in transactions of exchange traded funds (ETF) and real estate investment trusts (REITS) and not solely on purchases of JGBs. Purchases of ETFs will be at an annual rate of increase of one trillion yen and purchases of REITS at 30 billion yen.
The European sovereign debt crisis continues to shake financial markets and the world economy. Debt resolution within the international financial architecture requires that a country be capable of borrowing on its own from the private sector. Mechanisms of debt resolution have included participation of the private sector (PSI), or “bail in,” that has been voluntary, almost coercive, agreed and outright coercive (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Creditors and Debtors (2005), Chapter 4, 187-202). Private sector involvement requires losses by the private sector in bailouts of highly indebted countries. The essence of successful private sector involvement is to recover private-sector credit of the highly indebted country. Mary Watkins, writing on “Bank bailouts reshuffle risk hierarchy,” published on Mar 19, 2013, in the Financial Times (http://www.ft.com/intl/cms/s/0/7666546a-9095-11e2-a456-00144feabdc0.html#axzz2OSpbvCn8) analyzes the impact of the bailout or resolution of Cyprus banks on the hierarchy of risks of bank liabilities. Cyprus banks depend mostly on deposits with less reliance on debt, raising concerns in creditors of fixed-income debt and equity holders in banks in the euro area. Uncertainty remains as to the dimensions and structure of losses in private sector involvement or “bail in” in other rescue programs in the euro area. Alkman Granitsas, writing on “Central bank details losses at Bank of Cyprus,” on Mar 30, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324000704578392502889560768.html), analyzes the impact of the agreement with the €10 billion agreement with IMF and the European Union on the banks of Cyprus. The recapitalization plan provides for immediate conversion of 37.5 percent of all deposits in excess of €100,000 to shares of special class of the bank. An additional 22.5 percent will be frozen without interest until the plan is completed. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.
Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans.
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 14164.53 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 14973.96
on Fri May 3, 2013, which is higher by 5.7 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 5.5 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs. Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
An important risk event is the reduction of growth prospects in the euro zone discussed by European Central Bank President Mario Draghi in “Introductory statement to the press conference,” on Dec 6, 2012 (http://www.ecb.int/press/pressconf/2012/html/is121206.en.html):
“This assessment is reflected in the December 2012 Eurosystem staff macroeconomic projections for the euro area, which foresee annual real GDP growth in a range between -0.6% and -0.4% for 2012, between -0.9% and 0.3% for 2013 and between 0.2% and 2.2% for 2014. Compared with the September 2012 ECB staff macroeconomic projections, the ranges for 2012 and 2013 have been revised downwards.
The Governing Council continues to see downside risks to the economic outlook for the euro area. These are mainly related to uncertainties about the resolution of sovereign debt and governance issues in the euro area, geopolitical issues and fiscal policy decisions in the United States possibly dampening sentiment for longer than currently assumed and delaying further the recovery of private investment, employment and consumption.”
Reuters, writing on “Bundesbank cuts German growth forecast,” on Dec 7, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/8e845114-4045-11e2-8f90-00144feabdc0.html#axzz2EMQxzs3u), informs that the central bank of Germany, Deutsche Bundesbank reduced its forecast of growth for the economy of Germany to 0.7 percent in 2012 from an earlier forecast of 1.0 percent in Jun and to 0.4 percent in 2012 from an earlier forecast of 1.6 percent while the forecast for 2014 is at 1.9 percent.
The major risk event during earlier weeks was sharp decline of sovereign yields with the yield on the ten-year bond of Spain falling to 5.309 percent and that of the ten-year bond of Italy falling to 4.473 percent on Fri Nov 30, 2012 and 5.366 percent for the ten-year of Spain and 4.527 percent for the ten-year of Italy on Fri Nov 14, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Vanessa Mock and Frances Robinson, writing on “EU approves Spanish bank’s restructuring plans,” on Nov 28, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578146520774638316.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the European Union regulators approved restructuring of four Spanish banks (Bankia, NCG Banco, Catalunya Banc and Banco de Valencia), which helped to calm sovereign debt markets. Harriet Torry and James Angelo, writing on “Germany approves Greek aid,” on Nov 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578150532603095790.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the German parliament approved the plan to provide Greece a tranche of €44 billion in promised financial support, which is subject to sustainability analysis of the bond repurchase program later in Dec 2012. A hurdle for sustainability of repurchasing debt is that Greece’s sovereign bonds have appreciated significantly from around 24 percent for the bond maturing in 21 years and 20 percent for the bond maturing in 31 years in Aug 2012 to around 17 percent for the 21-year maturity and 15 percent for the 31-year maturing in Nov 2012. Declining years are equivalent to increasing prices, making the repurchase more expensive. Debt repurchase is intended to reduce bonds in circulation, turning Greek debt more manageable. Ben McLannahan, writing on “Japan unveils $11bn stimulus package,” on Nov 30, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/adc0569a-3aa5-11e2-baac-00144feabdc0.html#axzz2DibFFquN
), informs that the cabinet in Japan approved another stimulus program of $11 billion, which is twice larger than another stimulus plan in late Oct and close to elections in Dec. Henry Sender, writing on “Tokyo faces weak yen and high bond yields,” published on Nov 29, 2012 in the Financial Times (http://www.ft.com/intl/cms/s/0/9a7178d0-393d-11e2-afa8-00144feabdc0.html#axzz2DibFFquN), analyzes concerns of regulators on duration of bond holdings in an environment of likelihood of increasing yields and yen depreciation.
First, Risk-Determining Events. The European Council statement on Nov 23, 2012 asked the President of the European Commission “to continue the work and pursue consultations in the coming weeks to find a consensus among the 27 over the Union’s Multiannual Financial Framework for the period 2014-2020” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf) Discussions will continue in the effort to reach agreement on a budget: “A European budget is important for the cohesion of the Union and for jobs and growth in all our countries” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf). There is disagreement between the group of countries requiring financial assistance and those providing bailout funds. Gabrielle Steinhauser and Costas Paris, writing on “Greek bond rally puts buyback in doubt,” on Nov 23, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324352004578136362599130992.html?mg=reno64-wsj) find a new hurdle in rising prices of Greek sovereign debt that may make more difficult buybacks of debt held by investors. European finance ministers continue their efforts to reach an agreement for Greece that meets with approval of the European Central Bank and the IMF. The European Council (2012Oct19 http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/133004.pdf ) reached conclusions on strengthening the euro area and providing unified financial supervision:
“The European Council called for work to proceed on the proposals on the Single Supervisory Mechanism as a matter of priority with the objective of agreeing on the legislative framework by 1st January 2013 and agreed on a number of orientations to that end. It also took note of issues relating to the integrated budgetary and economic policy frameworks and democratic legitimacy and accountability which should be further explored. It agreed that the process towards deeper economic and monetary union should build on the EU's institutional and legal framework and be characterised by openness and transparency towards non-euro area Member States and respect for the integrity of the Single Market. It looked forward to a specific and time-bound roadmap to be presented at its December 2012 meeting, so that it can move ahead on all essential building blocks on which a genuine EMU should be based.”
Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. The Bank of Spain released new data on doubtful debtors in Spain’s credit institutions (http://www.bde.es/bde/en/secciones/prensa/Agenda/Datos_de_credit_a6cd708c59cf931.html). In 2006, the value of doubtful credits reached €10,859 million or 0.7 percent of total credit of €1,508,626 million. In Aug 2012, doubtful credit reached €178,579 million or 10.5 percent of total credit of €1,698,714 million.
There are three critical factors influencing world financial markets. (1) Spain could request formal bailout from the European Stability Mechanism (ESM) that may also affect Italy’s international borrowing. David Roman and Jonathan House, writing on “Spain risks backlash with budget plan,” on Sep 27, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443916104578021692765950384.html?mod=WSJ_hp_LEFTWhatsNewsCollection) analyze Spain’s proposal of reducing government expenditures by €13 billion, or around $16.7 billion, increasing taxes in 2013, establishing limits on early retirement and cutting the deficit by €65 billion through 2014. Banco de España, Bank of Spain, contracted consulting company Oliver Wyman to conduct rigorous stress tests of the resilience of its banking system. (Stress tests and their use are analyzed by Pelaez and Pelaez Globalization and the State Vol. I (2008b), 95-100, International Financial Architecture (2005) 112-6, 123-4, 130-3).) The results are available from Banco de España (http://www.bde.es/bde/en/secciones/prensa/infointeres/reestructuracion/ http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). The assumptions of the adverse scenario used by Oliver Wyman are quite tough for the three-year period from 2012 to 2014: “6.5 percent cumulative decline of GDP, unemployment rising to 27.2 percent and further declines of 25 percent of house prices and 60 percent of land prices (http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). Fourteen banks were stress tested with capital needs estimates of seven banks totaling €59.3 billion. The three largest banks of Spain, Banco Santander (http://www.santander.com/csgs/Satellite/CFWCSancomQP01/es_ES/Corporativo.html), BBVA (http://www.bbva.com/TLBB/tlbb/jsp/ing/home/index.jsp) and Caixabank (http://www.caixabank.com/index_en.html), with 43 percent of exposure under analysis, have excess capital of €37 billion in the adverse scenario in contradiction with theories that large, international banks are necessarily riskier. Jonathan House, writing on “Spain expects wider deficit on bank aid,” on Sep 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444138104578028484168511130.html?mod=WSJPRO_hpp_LEFTTopStories), analyzes the 2013 budget plan of Spain that will increase the deficit of 7.4 percent of GDP in 2012, which is above the target of 6.3 percent under commitment with the European Union. The ratio of debt to GDP will increase to 85.3 percent in 2012 and 90.5 percent in 2013 while the 27 members of the European Union have an average debt/GDP ratio of 83 percent at the end of IIQ2012. (2) Symmetric inflation targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even after the economy grows again at or close to potential output. Monetary easing by unconventional measures is now apparently open ended in perpetuity as provided in the statement of the meeting of the Federal Open Market Committee (FOMC) on Sep 13, 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm):
“To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is the concern of the production and employment costs of controlling future inflation.
(2) The European Central Bank (ECB) approved a new program of bond purchases under the name “Outright Monetary Transactions” (OMT). The ECB will purchase sovereign bonds of euro zone member countries that have a program of conditionality under the European Financial Stability Facility (EFSF) that is converting into the European Stability Mechanism (ESM). These programs provide enhancing the solvency of member countries in a transition period of structural reforms and fiscal adjustment. The purchase of bonds by the ECB would maintain debt costs of sovereigns at sufficiently low levels to permit adjustment under the EFSF/ESM programs. Purchases of bonds are not limited quantitatively with discretion by the ECB as to how much is necessary to support countries with adjustment programs. Another feature of the OMT of the ECB is sterilization of bond purchases: funds injected to pay for the bonds would be withdrawn or sterilized by ECB transactions. The statement by the European Central Bank on the program of OTM is as follows (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html):
“6 September 2012 - Technical features of Outright Monetary Transactions
As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) has today taken decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets that aim at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy. These will be known as Outright Monetary Transactions (OMTs) and will be conducted within the following framework:
Conditionality
A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.
The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.
Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.
Coverage
Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above. They may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access.
Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.
No ex ante quantitative limits are set on the size of Outright Monetary Transactions.
Creditor treatment
The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.
Sterilisation
The liquidity created through Outright Monetary Transactions will be fully sterilised.
Transparency
Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis. Publication of the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis.
Securities Markets Programme
Following today’s decision on Outright Monetary Transactions, the Securities Markets Programme (SMP) is herewith terminated. The liquidity injected through the SMP will continue to be absorbed as in the past, and the existing securities in the SMP portfolio will be held to maturity.”
Jon Hilsenrath, writing on “Fed sets stage for stimulus,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443864204577623220212805132.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the essay presented by Chairman Bernanke at the Jackson Hole meeting of central bankers, as defending past stimulus with unconventional measures of monetary policy that could be used to reduce extremely high unemployment. Chairman Bernanke (2012JHAug31, 18-9) does support further unconventional monetary policy impulses if required by economic conditions (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm):
“Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
Professor John H Cochrane (2012Aug31), at the University of Chicago Booth School of Business, writing on “The Federal Reserve: from central bank to central planner,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444812704577609384030304936.html?mod=WSJ_hps_sections_opinion), analyzes that the departure of central banks from open market operations into purchase of assets with risks to taxpayers and direct allocation of credit subject to political influence has caused them to abandon their political independence and accountability. Cochrane (2012Aug31) finds a return to the proposition of Milton Friedman in the 1960s that central banks can cause inflation and macroeconomic instability.
Mario Draghi (2012Aug29), President of the European Central Bank, also reiterated the need of exceptional and unconventional central bank policies (http://www.ecb.int/press/key/date/2012/html/sp120829.en.html):
“Yet it should be understood that fulfilling our mandate sometimes requires us to go beyond standard monetary policy tools. When markets are fragmented or influenced by irrational fears, our monetary policy signals do not reach citizens evenly across the euro area. We have to fix such blockages to ensure a single monetary policy and therefore price stability for all euro area citizens. This may at times require exceptional measures. But this is our responsibility as the central bank of the euro area as a whole.
The ECB is not a political institution. But it is committed to its responsibilities as an institution of the European Union. As such, we never lose sight of our mission to guarantee a strong and stable currency. The banknotes that we issue bear the European flag and are a powerful symbol of European identity.”
Buiter (2011Oct31) analyzes that the European Financial Stability Fund (EFSF) would need a “bigger bazooka” to bail out euro members in difficulties that could possibly be provided by the ECB. Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. Table III-7 in IIIE Appendix Euro Zone Survival Risk below provides the combined GDP in 2012 of the highly indebted euro zone members estimated in the latest World Economic Outlook of the IMF at $4167 billion or 33.1 percent of total euro zone GDP of $12,586 billion. Using the WEO of the IMF, Table III-8 in IIIE Appendix Euro Zone Survival Risk below provides debt of the highly indebted euro zone members at $3927.8 billion in 2012 that increases to $5809.9 billion when adding Germany’s debt, corresponding to 167.0 percent of Germany’s GDP. There are additional sources of debt in bailing out banks. The dimensions of the problem may require more firepower than a bazooka perhaps that of the largest conventional bomb of all times of 44,000 pounds experimentally detonated only once by the US in 1948 (http://www.airpower.au.af.mil/airchronicles/aureview/1967/mar-apr/coker.html).
Second, Risk-Measuring Yields and Exchange Rate. The ten-year government bond of Spain was quoted at 6.868 percent on Aug 10, 2012, declining to 6.447 percent on Aug 17 and 6.403 percent on Aug 24, 2012, and the ten-year government bond of Italy fell from 5.894 percent on Aug 10, 2012 to 5.709 percent on Aug 17 and 5.618 percent on Aug 24, 2012. The yield of the ten-year sovereign bond of Spain traded at 4.046 percent on May 6, 2013, and that of the ten-year sovereign bond of Italy at 4.793 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Diminishing aversion is captured by increase of the yield of the two- and ten-year Treasury notes and the two- and ten-year government bonds of Germany. Table III-1A provides yields of US and German governments bonds and the rate of USD/EUR. Yields of US and German government bonds decline during shocks of risk aversion and the dollar strengthens in the form of fewer dollars required to buy one euro. The yield of the US ten-year Treasury note fell from 2.202 percent on Aug 26, 2011 to 1.459 percent on Jul 20, 2012, reminiscent of experience during the Treasury-Fed accord of the 1940s that placed a ceiling on long-term Treasury debt (Hetzel and Leach 2001), while the yield of the ten-year government bond of Germany fell from 2.16 percent to 1.17 percent. In the week of May 3, 2013, the yield of the two-year Treasury rose to 0.22 percent and that of the ten-year Treasury increased to 1.742 percent while the two-year bond of Germany stabilized at 0.00 percent and the ten-year increased to 1.24 percent; and the dollar depreciated to USD 1.3115/EUR. The zero interest rates for the monetary policy rate of the US, or fed funds rate, carry trades ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield is about equal to consumer price inflation of 1.5 percent in the 12 months ending in Mar 2013 (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html) and the expectation of higher inflation if risk aversion diminishes. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table III-1A provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.
Table III-1A, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate
| US 2Y | US 10Y | DE 2Y | DE 10Y | USD/ EUR | |
| 5/3/13 | 0.22 | 1.742 | 0.00 | 1.24 | 1.3115 |
| 4/26/13 | 0.209 | 1.663 | 0.00 | 1.21 | 1.3028 |
| 4/19/13 | 0.232 | 1.702 | 0.02 | 1.25 | 1.3052 |
| 4/12/13 | 0.228 | 1.719 | 0.02 | 1.26 | 1.3111 |
| 4/5/13 | 0.228 | 1.706 | 0.01 | 1.21 | 1.2995 |
| 3/29/13 | 0.244 | 1.847 | -0.02 | 1.29 | 1.2818 |
| 3/22/13 | 0.242 | 1.931 | 0.03 | 1.38 | 1.2988 |
| 3/15/13 | 0.246 | 1.992 | 0.05 | 1.46 | 1.3076 |
| 3/8/13 | 0.256 | 2.056 | 0.09 | 1.53 | 1.3003 |
| 3/1/13 | 0.236 | 1.842 | 0.03 | 1.41 | 1.3020 |
| 2/22/13 | 0.252 | 1.967 | 0.13 | 1.57 | 1.3190 |
| 2/15/13 | 0.268 | 2.007 | 0.19 | 1.65 | 1.3362 |
| 2/8/13 | 0.252 | 1.949 | 0.18 | 1.61 | 1.3365 |
| 2/1/13 | 0.26 | 2.024 | 0.25 | 1.67 | 1.3642 |
| 1/25/13 | 0.278 | 1.947 | 0.26 | 1.64 | 1.3459 |
| 1/18/13 | 0.252 | 1.84 | 0.18 | 1.56 | 1.3321 |
| 1/11/13 | 0.247 | 1.862 | 0.13 | 1.58 | 1.3343 |
| 1/4/13 | 0.262 | 1.898 | 0.08 | 1.54 | 1.3069 |
| 12/28/12 | 0.252 | 1.699 | -0.01 | 1.31 | 1.3218 |
| 12/21/12 | 0.272 | 1.77 | -0.01 | 1.38 | 1.3189 |
| 12/14/12 | 0.232 | 1.704 | -0.04 | 1.35 | 1.3162 |
| 12/7/12 | 0.256 | 1.625 | -0.08 | 1.30 | 1.2926 |
| 11/30/12 | 0.248 | 1.612 | 0.01 | 1.39 | 1.2987 |
| 11/23/12 | 0.273 | 1.691 | 0.00 | 1.44 | 1.2975 |
| 11/16/12 | 0.24 | 1.584 | -0.03 | 1.33 | 1.2743 |
| 11/9/12 | 0.256 | 1.614 | -0.03 | 1.35 | 1.2711 |
| 11/2/12 | 0.274 | 1.715 | 0.01 | 1.45 | 1.2838 |
| 10/26/12 | 0.299 | 1.748 | 0.05 | 1.54 | 1.2942 |
| 10/19/12 | 0.296 | 1.766 | 0.11 | 1.59 | 1.3023 |
| 10/12/12 | 0.264 | 1.663 | 0.04 | 1.45 | 1.2953 |
| 10/5/12 | 0.26 | 1.737 | 0.06 | 1.52 | 1.3036 |
| 9/28/12 | 0.236 | 1.631 | 0.02 | 1.44 | 1.2859 |
| 9/21/12 | 0.26 | 1.753 | 0.04 | 1.60 | 1.2981 |
| 9/14/12 | 0.252 | 1.863 | 0.10 | 1.71 | 1.3130 |
| 9/7/12 | 0.252 | 1.668 | 0.03 | 1.52 | 1.2816 |
| 8/31/12 | 0.225 | 1.543 | -0.03 | 1.33 | 1.2575 |
| 8/24/12 | 0.266 | 1.684 | -0.01 | 1.35 | 1.2512 |
| 8/17/12 | 0.288 | 1.814 | -0.04 | 1.50 | 1.2335 |
| 8/10/12 | 0.267 | 1.658 | -0.07 | 1.38 | 1.2290 |
| 8/3/12 | 0.242 | 1.569 | -0.02 | 1.42 | 1.2387 |
| 7/27/12 | 0.244 | 1.544 | -0.03 | 1.40 | 1.2320 |
| 7/20/12 | 0.207 | 1.459 | -0.07 | 1.17 | 1.2158 |
| 7/13/12 | 0.24 | 1.49 | -0.04 | 1.26 | 1.2248 |
| 7/6/12 | 0.272 | 1.548 | -0.01 | 1.33 | 1.2288 |
| 6/29/12 | 0.305 | 1.648 | 0.12 | 1.58 | 1.2661 |
| 6/22/12 | 0.309 | 1.676 | 0.14 | 1.58 | 1.2570 |
| 6/15/12 | 0.272 | 1.584 | 0.07 | 1.44 | 1.2640 |
| 6/8/12 | 0.268 | 1.635 | 0.04 | 1.33 | 1.2517 |
| 6/1/12 | 0.248 | 1.454 | 0.01 | 1.17 | 1.2435 |
| 5/25/12 | 0.291 | 1.738 | 0.05 | 1.37 | 1.2518 |
| 5/18/12 | 0.292 | 1.714 | 0.05 | 1.43 | 1.2780 |
| 5/11/12 | 0.248 | 1.845 | 0.09 | 1.52 | 1.2917 |
| 5/4/12 | 0.256 | 1.876 | 0.08 | 1.58 | 1.3084 |
| 4/6/12 | 0.31 | 2.058 | 0.14 | 1.74 | 1.3096 |
| 3/30/12 | 0.335 | 2.214 | 0.21 | 1.79 | 1.3340 |
| 3/2/12 | 0.29 | 1.977 | 0.16 | 1.80 | 1.3190 |
| 2/24/12 | 0.307 | 1.977 | 0.24 | 1.88 | 1.3449 |
| 1/6/12 | 0.256 | 1.957 | 0.17 | 1.85 | 1.2720 |
| 12/30/11 | 0.239 | 1.871 | 0.14 | 1.83 | 1.2944 |
| 8/26/11 | 0.20 | 2.202 | 0.65 | 2.16 | 1.450 |
| 8/19/11 | 0.192 | 2.066 | 0.65 | 2.11 | 1.4390 |
| 6/7/10 | 0.74 | 3.17 | 0.49 | 2.56 | 1.192 |
| 3/5/09 | 0.89 | 2.83 | 1.19 | 3.01 | 1.254 |
| 12/17/08 | 0.73 | 2.20 | 1.94 | 3.00 | 1.442 |
| 10/27/08 | 1.57 | 3.79 | 2.61 | 3.76 | 1.246 |
| 7/14/08 | 2.47 | 3.88 | 4.38 | 4.40 | 1.5914 |
| 6/26/03 | 1.41 | 3.55 | NA | 3.62 | 1.1423 |
Note: DE: Germany
Source:
http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
http://www.federalreserve.gov/releases/h15/data.htm
Chart III-1A of the Board of Governors of the Federal Reserve System provides the ten-year, two-year and one-month Treasury constant maturity yields together with the overnight fed funds rate and the yield of the corporate bond with Moody’s rating of Baa. The riskier yield of the Baa corporate bond exceeds the relatively riskless yields of the Treasury securities. The beginning yields in Chart III-1A for July 31, 2001, are 3.67 percent for one month, 3.79 percent for two years, 5.07 percent for ten years, 3.82 percent for the fed funds rate and 7.85 percent for the Baa corporate bond. On July 30, 2007, yields inverted with the one month at 4.95 percent, the two-year at 4.59 percent and the ten year at 5.82 percent with the yield of the Baa corporate bond at 6.70 percent. Another interesting point is for Oct 31, 2008, with the yield of the Baa jumping to 9.54 percent and the Treasury yields declining: one month 0.12 percent, two years 1.56 percent and ten years 4.01 percent during a flight to the dollar and government securities analyzed by Cochrane and Zingales (2009). Another spike in the series is for Apr 4, 2006 with the yield of the corporate Baa bond at 8.63 and the Treasury yields of 0.12 percent for one month, 0.94 for two years and 2.95 percent for ten years. During the beginning of the flight from risk financial assets to US government securities (see Cochrane and Zingales 2009), the one-month yield was 0.07 percent, the two-year yield 1.64 percent and the ten-year yield 3.41. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe. The final point of Chart III1-A is for May 3, 2013, with the one-month yield at 0.02 percent, the two-year at 0.20 percent, the ten-year at 1.66 percent, the fed funds rate at 0.15 percent and the corporate Baa bond at 4.47 percent.
Chart III-1A, US, Ten-Year, Two-Year and One-Month Treasury Constant Maturity Yields, Overnight Fed Funds Rate and Yield of Moody’s Baa Corporate Bond, Jul 31, 2001-May 2, 2013
Note: US Recessions in shaded areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
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. 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:
![clip_image006[1]](http://lh4.ggpht.com/-mSv2BfhxpS8/UX4cx3s6woI/AAAAAAAAUIY/YRJRbd9xSU0/clip_image006%25255B1%25255D_thumb.gif?imgmax=800)
Where Rτ is expected revenue in the time horizon from τ =1 to T; Cτ 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.
There was mostly strong performance in equity indexes with many indexes increasing in Table III-1 in the week ending on May 3, 2013. Stagnating revenues are causing reevaluation of discounted net earnings with deteriorating views on the world economy and United States fiscal sustainability but investors have been driving indexes higher. DJIA increased 1.0 percent on May 3, increasing 1.8 percent in the week. Germany’s Dax increased 2.0 percent on Fri May 3 and increased 3.9 percent in the week. Dow Global increased 1.0 percent on May 3 and increased 1.8 percent in the week. Japan’s Nikkei Average changed 0.0 percent on Fri May 3 and decreased 1.4 percent in the week as the yen continues to be oscillating but relatively weaker and the stock market gains in expectations of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Dow Asia Pacific TSM decreased 0.3 percent on May 3 and decreased 0.2 percent in the week. Shanghai Composite that decreased 0.2 percent on Mar 8 and decreased 1.7 percent in the week of Mar 8, falling below 2000 to close at 1980.13 on Fri Nov 30 but closing at 2205.50 on Fri May 3 for increase of 1.4 percent and increase of 1.3 percent in the week of May 3. There is evident trend of deceleration of the world economy that could affect corporate revenue and equity valuations, causing oscillation in equity markets with increases during favorable risk appetite.
Commodities were mostly stronger in the week of May 3, 2013. The DJ UBS Commodities Index increased 1.2 percent on Fri May 3 and increased 0.9 percent in the week, as shown in Table III-1. WTI increased 2.7 percent in the week of May 3 while Brent increased 1.2 percent in the week. Gold increased 0.6 percent on Fri May 3 and increased 1.1 percent in the week.
Table III-2 provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the long-term refinancing operations (LTROs). Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increased from €546,747 million on Dec 31, 2010, to €879,130 million on Dec 28, 2011 and €852,233 million on Apr 26, 2013 with some repayment of loans already occurring. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has reached €1,463,808 million in the statement of Apr 26, 2013, with marginal reduction. There is high credit risk in these transactions with capital of only €88,917 million as analyzed by Cochrane (2012Aug31).
Table III-2, Consolidated Financial Statement of the Eurosystem, Million EUR
| Dec 31, 2010 | Dec 28, 2011 | Apr 26, 2013 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 435,316 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 253,124 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 35,630 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 21,650 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 852,233 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 107,304 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 611,575 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 29,894 |
| 9 Other Assets | 278,719 | 336,574 | 264,894 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 2,611,252 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,463,808 |
| Capital and Reserves | 78,143 | 85,748 | 88,917 |
Source: European Central Bank
http://www.ecb.int/press/pr/wfs/2011/html/fs110105.en.html
http://www.ecb.int/press/pr/wfs/2011/html/fs111228.en.html
http://www.ecb.int/press/pr/wfs/2013/html/fs130430.en.html
IIIE Appendix Euro Zone survival risk. Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. That success would be assured with growth of the Italian economy. A critical problem is that the common euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Newly available data in Table III-3 providing Italy’s trade with regions and countries supports the argument of Caballero and Giavazzi (2012Jan15). Italy’s exports to the European Monetary Union (EMU), or euro area, are only 40.5 percent of the total. Exports to the non-European Union area with share of 46.3 percent in Italy’s total exports are growing at 9.1 percent in Jan-Feb 2013 relative to Jan-Feb 2012 while those to EMU are growing at minus 3.1 percent.
Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%
| Feb 2013 | Exports | ∆% Jan-Feb 2013/ Jan-Feb 2012 | Imports | Imports |
| EU | 53.7 | -2.3 | 52.9 | -2.7 |
| EMU 17 | 40.5 | -3.1 | 42.7 | -2.6 |
| France | 11.1 | -1.2 | 8.3 | -5.3 |
| Germany | 12.5 | -4.9 | 14.6 | -7.8 |
| Spain | 4.7 | -8.4 | 4.4 | -2.4 |
| UK | 4.9 | 0.9 | 2.5 | 2.9 |
| Non EU | 46.3 | 9.1 | 47.1 | -8.9 |
| Europe non EU | 13.9 | 5.2 | 11.3 | 11.9 |
| USA | 6.8 | 9.7 | 3.3 | -19.3 |
| China | 2.3 | 4.8 | 6.5 | -7.1 |
| OPEC | 5.7 | 20.0 | 10.8 | -16.9 |
| Total | 100.0 | 2.5 | 100.0 | -5.8 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/87669
Table III-4 provides Italy’s trade balance by product categories in Feb 2013 and cumulative Jan-Feb 2013. Italy’s trade balance excluding energy generated surplus of €5648 million in Feb 2013 and €9498 million cumulative in Jan-Feb 2013 but the energy trade balance created deficit of €4562 million in Feb 2013 and cumulative €10,025 million in Jan-Feb 2013. The overall surplus in Feb 2013 was €1086 million with cumulative deficit of €527 million in Jan-Feb 2013. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.
Table III-4, Italy, Trade Balance by Regions and Countries, Millions of Euro
| Regions and Countries | Trade Balance Jan 2013 Millions of Euro | Trade Balance Cumulative Jan-Feb 2013 Millions of Euro |
| EU | 380 | 1,048 |
| EMU 17 | -395 | -692 |
| France | 1,034 | 2,036 |
| Germany | -411 | -657 |
| Spain | 94 | 251 |
| UK | 561 | 1,270 |
| Non EU | 706 | -1,575 |
| Europe non EU | 533 | 341 |
| USA | 1,218 | 1,890 |
| China | -1,226 | -2,845 |
| OPEC | -1,235 | -2,670 |
| Total | 1,086 | -527 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/87669
Growth rates of Italy’s trade and major products are provided in Table III-5 for the period Jan-Feb 2013 relative to Jan-Feb 2012. Growth rates of cumulative imports relative to a year earlier are negative for energy with minus 16.3 percent, minus 14.5 percent for durable goods. The higher rate of growth of exports of 2.5 percent in Jan-Feb 2013/Jan-Feb 2012 relative to imports of minus 5.8 percent may reflect weak demand in Italy with GDP declining during six consecutive quarters from IIIQ2011 through IVQ2012 together with softening commodity prices.
Table III-5, Italy, Exports and Imports % Share of Products in Total and ∆%
| Exports | Exports | Imports | Imports | |
| Consumer | 29.3 | 7.7 | 25.6 | 0.6 |
| Durable | 5.8 | 3.3 | 2.9 | -14.5 |
| Non | 23.5 | 8.8 | 22.7 | 2.6 |
| Capital Goods | 31.6 | 4.2 | 19.5 | -8.6 |
| Inter- | 33.6 | -0.7 | 32.6 | -1.1 |
| Energy | 5.5 | -13.3 | 22.3 | -16.3 |
| Total ex Energy | 94.5 | 3.5 | 77.7 | -2.5 |
| Total | 100.0 | 2.5 | 100.0 | -5.8 |
Note: % Share for Jan-Nov 2012.
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/87669
Table III-6 provides Italy’s trade balance by product categories in Feb 2013 and cumulative Jan-Feb 2013. Italy’s trade balance excluding energy generated surplus of €5648 million in Feb 2013 and €9498 million cumulative in Jan-Feb 2013 but the energy trade balance created deficit of €4562 million in Feb 2013 and cumulative €10,025 million in Jan-Feb 2013. The overall surplus in Feb 2013 was €1086 million with cumulative deficit of €527 million in Jan-Feb 2013. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.
Table III-6, Italy, Trade Balance by Product Categories, € Millions
| Jan 2013 | Cumulative Jan 2013 | |
| Consumer Goods | 1,669 | 2,665 |
| Durable | 991 | 1,793 |
| Nondurable | 678 | 872 |
| Capital Goods | 3,637 | 6,708 |
| Intermediate Goods | 343 | 125 |
| Energy | -4,562 | -10,025 |
| Total ex Energy | 5,648 | 9,498 |
| Total | 1,086 | -527 |
Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/87669
Brazil faced in the debt crisis of 1982 a more complex policy mix. Between 1977 and 1983, Brazil’s terms of trade, export prices relative to import prices, deteriorated 47 percent and 36 percent excluding oil (Pelaez 1987, 176-79; Pelaez 1986, 37-66; see Pelaez and Pelaez, The Global Recession Risk (2007), 178-87). Brazil had accumulated unsustainable foreign debt by borrowing to finance balance of payments deficits during the 1970s. Foreign lending virtually stopped. The German mark devalued strongly relative to the dollar such that Brazil’s products lost competitiveness in Germany and in multiple markets in competition with Germany. The resolution of the crisis was devaluation of the Brazilian currency by 30 percent relative to the dollar and subsequent maintenance of parity by monthly devaluation equal to inflation and indexing that resulted in financial stability by parity in external and internal interest rates avoiding capital flight. With a combination of declining imports, domestic import substitution and export growth, Brazil followed rapid growth in the US and grew out of the crisis with surprising GDP growth of 4.5 percent in 1984.
The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the Subsection IIIF Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 30, 2011, the yield of the 2-year bond of the government of Greece was quoted around 100 percent. In contrast, the 2-year US Treasury note traded at 0.239 percent and the 10-year at 2.871 percent while the comparable 2-year government bond of Germany traded at 0.14 percent and the 10-year government bond of Germany traded at 1.83 percent. There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt exceeding 100 percent of GDP, which is the third largest in the world after the US and Japan. Appendix IIIE links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).
Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.
Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:
“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”
If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.
The prospects of survival of the euro zone are dire. Table III-7 is constructed with IMF World Economic Outlook database (http://www.imf.org/external/pubs/ft/weo/2013/01/weodata/index.aspx) for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2013.
Table III-7, World and Selected Regional and Country GDP and Fiscal Situation
| GDP 2013 | Primary Net Lending Borrowing | General Government Net Debt | |
| World | 74,172 | ||
| Euro Zone | 12,752 | -0.04 | 73.9 |
| Portugal | 218 | -1.4 | 115.0 |
| Ireland | 222 | -3.2 | 106.2 |
| Greece | 244 | -- | 155.4 |
| Spain | 1,388 | -3.5 | 79.1 |
| Major Advanced Economies G7 | 34,068 | -3.8 | 91.5 |
| United States | 16,238 | -4.6 | 89.0 |
| UK | 2,423 | -5.0 | 86.1 |
| Germany | 3,598 | 1.8 | 54.1 |
| France | 2,739 | -1.4 | 86.5 |
| Japan | 5,150 | -9.0 | 143.4 |
| Canada | 1,844 | -2.4 | 35.9 |
| Italy | 2,076 | 2.7 | 102.3 |
| China | 9,020 | -2.1* | 21.3** |
*Net Lending/borrowing**Gross Debt
Source: IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2013/01/weodata/index.aspx
The data in Table III-7 are used for some very simple calculations in Table III-8. The column “Net Debt USD Billions” in Table III-8 is generated by applying the percentage in Table III-7 column “General Government Net Debt % GDP 2013” to the column “GDP USD Billions.” The total debt of France and Germany in 2013 is $4315.7 billion, as shown in row “B+C” in column “Net Debt USD Billions” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $4087.3 billion, adding rows D+E+F+G+H in column “Net Debt USD billions.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table III-8. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $8403.0 billion, which would be equivalent to 132.6 percent of their combined GDP in 2013. Under this arrangement, the entire debt of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 233.5 percent if including debt of France and 167.7 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks.
Table III-8, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %
| Net Debt USD Billions | Debt as % of Germany Plus France GDP | Debt as % of Germany GDP | |
| A Euro Area | 9,423.7 | ||
| B Germany | 1,946.5 | $8403.0 as % of $3598 =233.5% $6033.8 as % of $3598 =167.7% | |
| C France | 2,369.2 | ||
| B+C | 4,315.7 | GDP $6,337.0 Total Debt $8403.0 Debt/GDP: 132.6% | |
| D Italy | 2,123.7 | ||
| E Spain | 1,097.9 | ||
| F Portugal | 250.7 | ||
| G Greece | 379.2 | ||
| H Ireland | 235.8 | ||
| Subtotal D+E+F+G+H | 4,087.3 |
Source: calculation with IMF data IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2013/01/weodata/index.aspx
There is extremely important information in Table III-9 for the current sovereign risk crisis in the euro zone. Table III-9 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Feb 2013. German exports to other European Union (EU) members are 58.1 percent of total exports in Feb 2013 and 58.4 percent in cumulative Jan-Feb 2013. Exports to the euro area are 38.1 percent in Feb and 38.4 percent cumulative in Jan-Feb. Exports to third countries are 41.9 percent of the total in Jan-Feb and 41.6 percent cumulative in Jan-Feb. There is similar distribution for imports. Exports to non-euro countries are decreasing 1.9 percent in Feb 2013 and increasing 1.2 percent cumulative in Jan-Feb 2013 while exports to the euro area are decreasing 4.1 percent in Feb 2013 and decreasing 2.0 percent cumulative in Jan-Feb 2013. Exports to third countries, accounting for 41.9 percent of the total in Jan 2013, are decreasing 1.9 percent in Jan 2013 and increasing 1.2 percent cumulative in Jan-Feb 2013, accounting for 41.6 percent of the cumulative total in Jan-Feb 2013. Price competitiveness through devaluation could improve export performance and growth. Economic performance in Germany is closely related to its high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of high share in its exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.
Table III-9, Germany, Structure of Exports and Imports by Region, € Billions and ∆%
| Feb 2013 | Feb 12-Month | Cumulative Jan-Feb 2012 € Billions | Cumulative Jan-Feb 2013/ | |
| Total | 88.7 | -2.8 | 177.2 | 0.0 |
| A. EU | 51.5 % 58.1 | -3.4 | 103.5 % 58.4 | -0.8 |
| Euro Area | 33.8 % 38.1 | -4.1 | 68.1 % 38.4 | -2.0 |
| Non-euro Area | 17.7 % 19.9 | -1.9 | 35.4 % 20.0 | 1.6 |
| B. Third Countries | 37.2 % 41.9 | -1.9 | 73.7 % 41.6 | 1.2 |
| Total Imports | 71.9 | -5.9 | 146.8 | -1.6 |
| C. EU Members | 46.4 % 62.6 | -4.5 | 93.3 % 63.6 | -0.1 |
| Euro Area | 32.1 % 43.1 | -5.7 | 64.4 % 43.9 | -1.6 |
| Non-euro Area | 14.3 % 19.5 | -1.5 | 28.9 % 19.7 | 3.3 |
| D. Third Countries | 25.5 % 37.4 | -8.3 | 53.5 % 36.4 | -4.0 |
Notes: Total Exports = A+B; Total Imports = C+D
IIIF Appendix on Sovereign Bond Valuation. There are two approaches to government finance and their implications: (1) simple unpleasant monetarist arithmetic; and (2) simple unpleasant fiscal arithmetic. Both approaches illustrate how sovereign debt can be perceived riskier under profligacy.
First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:
D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)
Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,
{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:
N(t+1) = (1+n)N(t), n>-1 (2)
The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:
B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)
On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.
Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (4)
Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+τ. The second equation of Cochrane (2011Jan, 5) is:
MtV(it, ·) = PtYt (5)
Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):
“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”
An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.
There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:
(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress
(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality
(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.
IV Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table IV-1, updated with every blog comment, provides the latest annual data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly-indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of sovereign risk issues (Peter Spiegel and Quentin Peel, “Europe: Northern Exposures,” Financial Times, Mar 9, 2011 http://www.ft.com/intl/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1gAlaswcW). Newly available data on inflation is considered below in this section. Data in Table IV-1 for the euro zone and its members are updated from information provided by Eurostat but individual country information is provided in this section as soon as available, following Table IV-1. Data for other countries in Table IV-1 are also updated with reports from their statistical agencies. Economic data for major regions and countries is considered in Section V World Economic Slowdown following with individual country and regional data tables.
Table IV-1, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 1.8 | 1.5 | 1.1 | 7.5 |
| Japan | 0.5 | -0.9 | -0.5 | 4.1 |
| China | 7.7 | 2.1 | -1.9 | |
| UK | 0.6 | 2.8* CPIH 2.6 | 2.0 output | 7.9 |
| Euro Zone | -0.9 | 1.7 | 0.7 | 12.1 |
| Germany | 0.4 | 1.8 | 0.4 | 5.4 |
| France | -0.3 | 1.1 | 1.9 | 11.0 |
| Nether-lands | -0.9 | 3.2 | -0.4 | 6.4 |
| Finland | -1.4 | 2.5 | 1.3 | 8.2 |
| Belgium | -0.4 | 1.3 | 3.7 | 8.2 |
| Portugal | -3.8 | 0.7 | 1.5 | 17.5 |
| Ireland | 0.8 | 0.6 | 2.6 | 14.1 |
| Italy | -2.7 | 1.8 | 0.0 | 11.5 |
| Greece | -6.0 | -0.2 | -1.3 | NA |
| Spain | -1.9 | 2.6 | 0.5 | 26.7 |
Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier
*Office for National Statistics http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/march-2013/index.html**Core
PPI http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/march-2013/index.html
Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/; country statistical sources http://www.census.gov/aboutus/stat_int.html
Table IV-1 shows the simultaneous occurrence of low growth, inflation and unemployment in advanced economies. The US grew at 1.8 percent in IQ2013 relative to IQ2012 (Table 8 in http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp1q13_adv.pdf http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.html and earlier http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states.html). Japan’s GDP grew 0.3 percent in IVQ2011 relative to IVQ2010 and contracted 1.6 percent in IIQ2011 relative to IIQ2010 because of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 but grew at the seasonally-adjusted annual rate (SAAR) of 10.6 percent in IIIQ2011, increasing at the SAAR of 0.4 percent in IVQ 2011, increasing at the SAAR of 6.1 percent in IQ2012 and decreasing at 0.9 percent in IIQ2012 but contracting at the SAAR of 3.7 percent in IIIQ2012 and increasing at the SAAR of 0.2 percent in IVQ2012 (see Section VB http://cmpassocregulationblog.blogspot.com/2013/03/thirty-one-million-unemployed-or.htm and earlier at
http://cmpassocregulationblog.blogspot.com/2013/02/recovery-without-hiring-united-states.html); the UK grew at 0.3 percent in IQ2013 relative to IVQ2012 and GDP increased 0.6 percent in IQ2013 relative to IQ2012 (http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.html and earlier http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states.html); and the Euro Zone grew at minus 0.6 percent in IVQ2012 and minus 0.9 percent in IVQ2012 relative to IVQ2011 (http://cmpassocregulationblog.blogspot.com/2013/04/thirty-million-unemployed-or_8.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/03/thirty-one-million-unemployed-or.htm). These are stagnating or “growth recession” rates, which are positive or about nil growth rates with some contractions that are insufficient to recover employment. The rates of unemployment are quite high: 7.5 percent in the US but 17.6 percent for unemployment/underemployment or job stress of 29.6 million (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/04/thirty-million-unemployed-or.html), 4.1 percent for Japan (Section VB and earlier at http://cmpassocregulationblog.blogspot.com/2013/04/thirty-million-unemployed-or.html), 7.9 percent for the UK with high rates of unemployment for young people (see the labor statistics of the UK in Subsection VH at http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html
and earlier at http://cmpassocregulationblog.blogspot.com/2013/03/united-states-commercial-banks-assets.html). Twelve-month rates of inflation have been quite high, even when some are moderating at the margin: 1.5 percent in the US, -0.9 percent for Japan, 2.1 percent for China, 1.7 percent for the Euro Zone and 2.8 percent for the UK. Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. There are six key interrelated vulnerabilities in the world economy that have been causing global financial turbulence: (1) sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings (see Section III and earlier http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html); (2) the tradeoff of growth and inflation in China now with change in growth strategy to domestic consumption instead of investment and political developments in a decennial transition; (3) slow growth by repression of savings with de facto interest rate controls (http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.html and earlier http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states.html), weak hiring with the loss of 10 million full-time jobs (http://cmpassocregulationblog.blogspot.com/2013/04/recovery-without-hiring-ten-million.html and earlier http://cmpassocregulationblog.blogspot.com/2013/03/recovery-without-hiring-ten-million.html) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/04/thirty-million-unemployed-or.html); (4) the timing, dose, impact and instruments of normalizing monetary and fiscal policies (see http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies; (5) the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 that had repercussions throughout the world economy because of Japan’s share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) geopolitical events in the Middle East.
In the effort to increase transparency, the Federal Open Market Committee (FOMC) provides both economic projections of its participants and views on future paths of the policy rate that in the US is the federal funds rate or interest on interbank lending of reserves deposited at Federal Reserve Banks. These projections and views are discussed initially followed with appropriate analysis.
Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):
“I think the best way to provide forward guidance is by tying our policy actions to explicit measures of economic performance. There are many ways of doing this, including setting a target for the level of nominal GDP. But recognizing the difficult nature of that policy approach, I have a more modest proposal: I think the Fed should make it clear that the federal funds rate will not be increased until the unemployment rate falls below 7 percent. Knowing that rates would stay low until significant progress is made in reducing unemployment would reassure markets and the public that the Fed would not prematurely reduce its accommodation.
Based on the work I have seen, I do not expect that such policy would lead to a major problem with inflation. But I recognize that there is a chance that the models and other analysis supporting this approach could be wrong. Accordingly, I believe that the commitment to low rates should be dropped if the outlook for inflation over the medium term rises above 3 percent.
The economic conditionality in this 7/3 threshold policy would clarify our forward policy intentions greatly and provide a more meaningful guide on how long the federal funds rate will remain low. In addition, I would indicate that clear and steady progress toward stronger growth is essential.”
Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:
“I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Price Index) inflation over the next two to three years, would be appropriate.”
The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):
“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.
Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans. 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.
Unconventional monetary policy will remain in perpetuity, or QE→∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE→∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at 1.6 to 2.1 percent, which is well below 3.0 percent estimated by Lucas (2011May) from 1870 to 2010. Unconventional monetary policy interprets the dual mandate of low inflation and maximum employment as mainly a “growth mandate” of forcing economic growth in the US at a rate that generates full employment. A hurdle to this “growth mandate” is that US economic growth has been at only 2.1 percent on average in the cyclical expansion in the 14 quarters from IIIQ2009 to IVQ2012. 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).Zero interest rates and quantitative easing have not provided the impulse for growth and were not required in past successful cyclical expansions.
First, total nonfarm payroll employment seasonally adjusted (SA) increased 165,000 in Apr 2013 and private payroll employment rose 176,000. The average number of nonfarm jobs created in Jan-Apr 2012 was 224,750 while the average number of nonfarm jobs created in Jan-Apr 2013 was 195,750, or decline by 12.9 percent. The average number of private jobs created in the US in Jan-Apr 2012 was 229,000 while the average in Jan-Apr 2013 was 203,250, or decline by 11.2 percent. The US labor force increased from 153.617 million in 2011 to 154.975 million in 2012 by 1.358 million or 113,167 per month. The average increase of nonfarm jobs in the four months from Jan to Mar 2013 was 195,750, which is a rate of job creation inadequate to reduce significantly unemployment and underemployment in the United States because of 113,167 new entrants in the labor force per month with 28.6 million unemployed or underemployed. The difference between the average increase of 203,250 new private nonfarm jobs per month in the US from Jan to Mar 2013 and the 113,167 average monthly increase in the labor force from 2011 to 2012 is 90,083 monthly new jobs net of absorption of new entrants in the labor force. There are 28.6 million in job stress in the US currently. The provision of 90,083 new jobs per month net of absorption of new entrants in the labor force would require 318 months to provide jobs for the unemployed and underemployed (28.637 million divided by 90,083) or 26.5 years (318 divided by 12). The civilian labor force of the US in Apr 2013 not seasonally adjusted stood at 154.739 million with 11.014 million unemployed or effectively 18.581 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 162.306 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 90,083 by 12, which is 1,080,996). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.737 million (0.05 times labor force of 154.739 million) for new net job creation of 3.277 million (11.014 million unemployed minus 7.737 million unemployed at rate of 5 percent) that at the current rate would take 3.0 years (3.277 million divided by 1.080996). Under the calculation in this blog there are 18.581 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 162.306 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 11.381 million jobs net of labor force growth that at the current rate would take 9.7 years (18.581 million minus 0.05(162.306 million) or 10.466 million divided by 1.080996, using LF PART 66.2% and Total UEM in Table I-4). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. The number employed in the US fell from 147.315 million in Jul 2007 to 143.724 million in Apr 2013, by 3.591 million, or decline of 2.4 percent, while the noninstitutional population increased from 231.958 million in Jul 2007 to 245.175 million in Apr 2013, by 13.217 million or increase of 5.7 percent, using not seasonally adjusted data. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs.
Second, the economy of the US can be summarized in growth of economic activity or GDP as decelerating from mediocre growth of 2.4 percent on an annual basis in 2010 and 1.8 percent in 2011 to 2.2 percent in 2012. Calculations below show that actual growth is around 1.9 percent per year. This rate is well below 3 percent per year in trend from 1870 to 2010, which has been always recovered after events such as wars and recessions (Lucas 2011May). United States real GDP grew at the rate of 3.2 percent between 1929 and 2012 and at 3.2 percent between 1947 and 2012 (http://www.bea.gov/iTable/index_nipa.cfm see http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html). Growth is not only mediocre but also sharply decelerating to a rhythm that is not consistent with reduction of unemployment and underemployment of 29.6 million people corresponding to 18.2 percent of the effective labor force of the United States (http://cmpassocregulationblog.blogspot.com/2013/04/thirty-million-unemployed-or.html). In the four quarters of 2011, the four quarters of 2012 and the first quarter of 2013, US real GDP grew at the seasonally-adjusted annual equivalent rates of 0.1 percent in the first quarter of 2011 (IQ2011), 2.5 percent in IIQ2011, 1.3 percent in IIIQ2011, 4.1 percent in IVQ2011, 2.0 percent in IQ2012, 1.3 percent in IIQ2012, revised 3.1 percent in IIIQ2012, 0.4 percent in IVQ2012 and 2.5 percent in IQ2013. The annual equivalent rate of growth of GDP for the four quarters of 2011, the four quarters of 2012 and the first quarter of 2013 is 1.9 percent, obtained as follows. Discounting 0.1 percent to one quarter is 0.025 percent {[(1.001)1/4 -1]100 = 0.025}; discounting 2.5 percent to one quarter is 0.62 percent {[(1.025)1/4 – 1]100}; discounting 1.3 percent to one quarter is 0.32 percent {[(1.013)1/4 – 1]100}; discounting 4.1 percent to one quarter is 1.0 {[(1.04)1/4 -1]100; discounting 2.0 percent to one quarter is 0.50 percent {[(1.020)1/4 -1]100); discounting 1.3 percent to one quarter is 0.32 percent {[(1.013)1/4 -1]100}; discounting 3.1 percent to one quarter is 0.77 {[(1.031)1/4 -1]100); discounting 0.4 percent to one quarter is 0.1 percent {[(1.004)1/4 – 1]100}; and discounting 2.5 percent to one quarter is 0.62 percent {[(1.025)1/4 -1}100}. Real GDP growth in the four quarters of 2011, the four quarters of 2012 and the first quarter of 2013 accumulated to 4.3 percent {[(1.00025 x 1.0062 x 1.0032 x 1.010 x 1.005 x 1.0032 x 1.0077 x 1.001 x 1.0062) - 1]100 = 4.3%}. This is equivalent to growth from IQ2011 to IVQ2012 obtained by dividing the seasonally-adjusted annual rate (SAAR) of IQ2013 of $13,750.1 billion by the SAAR of IVQ2010 of $13,181.2 (http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1 and Table I-6 below) and expressing as percentage {[($13,750.1/$13,181.2) - 1]100 = 4.3%}. The growth rate in annual equivalent for the four quarters of 2011, the four quarters of 2012 and the first quarter of 2013 is 1.9 percent {[(1.00025 x 1.0062 x 1.0032 x 1.010 x 1.005 x 1.0032 x 1.0077 x 1.001 x 1.0062)4/9 -1]100 = 1.9%], or {[($13,750.1/$13,181.2)]4/9-1]100 = 1.9%} dividing the SAAR of IVQ2012 by the SAAR of IVQ2010 in Table I-6 below, obtaining the average for nine quarters and the annual average for one year of four quarters. Growth in the four quarters of 2012 accumulates to 1.7 percent {[(1.02)1/4(1.013)1/4(1.031)1/4(1.004)1/4 -1]100 = 1.7%}. This is equivalent to dividing the SAAR of $13,665.4 billion for IVQ2012 in Table I-6 by the SAAR of $13,441.0 billion in IVQ2011 except for a rounding discrepancy to obtain 1.7 percent {[($13,665.4/$13,441.0) – 1]100 = 1.7%}. The US economy is still close to a standstill especially considering the GDP report in detail.
In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is concern of the production and employment costs of controlling future inflation. Even if there is no inflation, QE→∞ cannot be abandoned because of the fear of rising interest rates. The economy would operate in an inferior allocation of resources and suboptimal growth path, or interior point of the production possibilities frontier where the optimum of productive efficiency and wellbeing is attained, because of the distortion of risk/return decisions caused by perpetual financial repression. Not even a second-best allocation is feasible with the shocks to efficiency of financial repression in perpetuity.
The statement of the FOMC at the conclusion of its meeting on Dec 12, 2012, revealed policy intentions (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm) practically unchanged in the statement at the conclusion of its meeting on Jan 30, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130130a.htm) and at its meeting on May 1, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130501a.htm):
“Release Date: May 1, 2013
For immediate release
Information received since the Federal Open Market Committee met in March suggests that economic activity has been expanding at a moderate pace. Labor market conditions have shown some improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Inflation has been running somewhat below the Committee's longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee continues to see downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.“
There are several important issues in this statement.
- Mandate. The FOMC 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”
- Open-ended Quantitative Easing or QE∞. Earlier programs are continued with an additional open-ended $85 billion of bond purchases per month: “To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.”
- Advance Guidance on “6 ¼ 2 ½ “Rule. Policy will be accommodative even after the economy recovers satisfactorily: “To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
- Monitoring and Policy Focus on Jobs. The FOMC reconsiders its policy continuously in accordance with available information: “In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.”
- Increase or Reduction of Asset Purchases. Market participants focused on slightly different wording about increasing asset purchases: “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.” Will there be an increase in asset purchases?
Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval of (1.99, 2.0). Symmetric targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output that is actually a target of growth forecast. The impact on the overall economy and the financial system of errors of policy are magnified by large-scale policy doses of trillions of dollars of quantitative easing and zero interest rates. The US economy has been experiencing financial repression as a result of negative real rates of interest during nearly a decade and programmed in monetary policy statements until 2015 or, for practical purposes, forever. The essential calculus of risk/return in capital budgeting and financial allocations has been distorted. If economic perspectives are doomed until 2015 such as to warrant zero interest rates and open-ended bond-buying by “printing” digital bank reserves (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html; see Shultz et al 2012), rational investors and consumers will not invest and consume until just before interest rates are likely to increase. Monetary policy statements on intentions of zero interest rates for another three years or now virtually forever discourage investment and consumption or aggregate demand that can increase economic growth and generate more hiring and opportunities to increase wages and salaries. The doom scenario used to justify monetary policy accentuates adverse expectations on discounted future cash flows of potential economic projects that can revive the economy and create jobs. If it were possible to project the future with the central tendency of the monetary policy scenario and monetary policy tools do exist to reverse this adversity, why the tools have not worked before and even prevented the financial crisis? If there is such thing as “monetary policy science”, why it has such poor record and current inability to reverse production and employment adversity? There is no excuse of arguing that additional fiscal measures are needed because they were deployed simultaneously with similar ineffectiveness.
Table IV-2 provides economic projections of governors of the Board of Governors of the Federal Reserve and regional presidents of Federal Reserve Banks released at the meeting of Mar 20, 2013. The Fed releases the data with careful explanations (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf). Columns “∆% GDP,” “∆% PCE Inflation” and “∆% Core PCE Inflation” are changes “from the fourth quarter of the previous year to the fourth quarter of the year indicated.” The GDP report for IQ2 013 is analyzed in Section I (http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.htm and earlier at http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/03/mediocre-gdp-growth-at-16-to-20-percent.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/02/thirty-one-million-unemployed-or.html http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html) and the PCE inflation data from the report on personal income and outlays in Section IV (http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/03/mediocre-gdp-growth-at-16-to-20-percent.html and earlier at (http://cmpassocregulationblog.blogspot.com/2013/02/thirty-one-million-unemployed-or.html). The Bureau of Economic Analysis (BEA) provides the first estimate of IQ2013 GDP with the second estimate for IQ2013 to be released on May 30 (http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm See Section I (http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states_28.htm and earlier at http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states.html). PCE inflation is the index of personal consumption expenditures (PCE) of the report of the Bureau of Economic Analysis (BEA) on “Personal Income and Outlays” (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm), which is analyzed in Section IV and earlier at http://cmpassocregulationblog.blogspot.com/2013/04/mediocre-and-decelerating-united-states.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/03/mediocre-gdp-growth-at-16-to-20-percent.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/02/thirty-one-million-unemployed-or.html and the report for Nov 2012 at http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states_24.html and earlier at http://cmpassocregulationblog.blogspot.com/2012/12/mediocre-and-decelerating-united-states.html. The next report on “Personal Income and Outlays” for Apr will be released at 8:30 AM on May 31, 2013 (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm). PCE core inflation consists of PCE inflation excluding food and energy. Column “UNEMP %” is the rate of unemployment measured as the average civilian unemployment rate in the fourth quarter of the year. The Bureau of Labor Statistics (BLS) provides the Employment Situation Report with the civilian unemployment rate in the first Friday of every month, which is analyzed in this blog. The report for Jan 2013 was released on Feb 1, 2013 and analyzed in this blog (http://cmpassocregulationblog.blogspot.com/2013/02/thirty-one-million-unemployed-or.html). The report for Feb 2013 was released on Mar 8, 2013 (http://www.bls.gov/ces/) and analyzed in this blog on Mar 10, 2013 (http://cmpassocregulationblog.blogspot.com/2013/03/thirty-one-million-unemployed-or.htm). The report for Mar 2013 was released on Apr 5, 2013 (http://www.bls.gov/ces/) and analyzed in this blog in the comment on Apr 7 (http://cmpassocregulationblog.blogspot.com/2013/04/thirty-million-unemployed-or.html). The report for Apr 13 was released on May 3 and analyzed in Section I. “Longer term projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy” (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20121212.pdf).
It is instructive to focus on 2013 as 2014, 2015 and longer term are too far away, and there is not much information even on what will happen in 2013 and beyond. The central tendency should provide reasonable approximation of the view of the majority of members of the FOMC but the second block of numbers provides the range of projections by FOMC participants. The first row for each year shows the projection introduced after the meeting of Mar 20, 2012 and the second row “PR” the projection of the Dec 12, 2012 meeting. There are three major changes in the view.
1. Growth “∆% GDP.” The FOMC has reduced the forecast of GDP growth in 2013 from 2.3 to 3.0 percent at the meeting in Dec 2012 to 2.3 to 2.8 percent at the meeting on Mar 20, 2013.
2. Rate of Unemployment “UNEM%.” The FOMC reduced the forecast of the rate of unemployment from 7.4 to 7.7 percent at the meeting on Dec 12, 2012 to 7.3 to 7.5 percent at the meeting on Mar 20, 2013.
3. Inflation “∆% PCE Inflation.” The FOMC changed the forecast of personal consumption expenditures (PCE) inflation from 1.3 to 2.0 percent at the meeting on Dec 12, 2012 to 1.3 to 1.7 percent at the meeting on Mar 20, 2013.
4. Core Inflation “∆% Core PCE Inflation.” Core inflation is PCE inflation excluding food and energy. There is again not much of a difference of the projection that changed from 1.6 to 1.9 percent at the meeting on Dec 12, 2012 to 1.5 to 1.6 percent at the meeting on Mar 20, 2013.
Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents in FOMC, Dec 2012 and Mar 2012
| ∆% GDP | UNEM % | ∆% PCE Inflation | ∆% Core PCE Inflation | |
| Central | ||||
| 2013 | 2.3 to 2.8 | 7.3 to 7.5 | 1.3 to 1.7 | 1.5 to 1.6 1.6 to 1.9 |
| 2014 | 2.9 to 3.4 | 6.7 to 7.0 | 1.5 to 2.0 | 1.7 to 2.0 |
| 2015 | 2.9 to 3.7 3.0 to 3.7 | 6.0 to 6.5 6.0 to 6.6 | 1.7 to 2.0 1.7 to 2.0 | 1.8 to 2.1 1.8 to 2.0 |
| Longer Run Sep PR | 2.3 to 2.5 2.3 to 2.5 | 5.2 to 6.0 5.2 to 6.0 | 2.0 2.0 | |
| Range | ||||
| 2013 | 2.0 to 3.0 | 6.9 to 7.6 | 1.3 to 2.0 | 1.5 to 2.0 |
| 2014 | 2.6 to 3.8 | 6.1 to 7.1 | 1.4 to 2.1 | 1.5 to 2.1 |
| 2015 Dec PR | 2.5 to 3.8 2.5 to 4.2 | 5.7 to 6.5 5.7 to 6.8 | 1.6 to 2.6 1.5 to 2.2 | 1.7 to 2.6 1.7 to 2.2 |
| Longer Run Dec PR | 2.0 to 3.0 2.2 to 3.0 | 5.0 to 6.0 5.0 to 6.0 | 2.0 2.0 |
Notes: UEM: unemployment; PR: Projection
Source: Board of Governors of the Federal Reserve System, FOMC http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf
Another important decision at the FOMC meeting on Jan 25, 2012, is formal specification of the goal of inflation of 2 percent per year but without specific goal for unemployment (http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm):
“Following careful deliberations at its recent meetings, the Federal Open Market Committee (FOMC) has reached broad agreement on the following principles regarding its longer-run goals and monetary policy strategy. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.
The FOMC is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decision making by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.
Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals.
The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances.
The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants' estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC's Summary of Economic Projections. For example, in the most recent projections, FOMC participants' estimates of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent, roughly unchanged from last January but substantially higher than the corresponding interval several years earlier.
In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate. ”
The probable intention of this specific inflation goal is to “anchor” inflationary expectations. Massive doses of monetary policy of promoting growth to reduce unemployment could conflict with inflation control. Economic agents could incorporate inflationary expectations in their decisions. As a result, the rate of unemployment could remain the same but with much higher rate of inflation (see Kydland and Prescott 1977 and Barro and Gordon 1983; http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html See Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-116). Strong commitment to maintaining inflation at 2 percent could control expectations of inflation.
The FOMC continues its efforts of increasing transparency that can improve the credibility of its firmness in implementing its dual mandate. Table IV-3 provides the views by participants of the FOMC of the levels at which they expect the fed funds rate in 2012, 2013, 2014 and the in the longer term. Table IV-3 is inferred from a chart provided by the FOMC with the number of participants expecting the target of fed funds rate (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf). There are 18 participants expecting the rate to remain at 0 to ¼ percent in 2013 and one to be higher in the interval below 1.0 percent. The rate would still remain at 0 to ¼ percent in 2014 for 14 participants with three expecting the rate to be in the range of 1.0 to 2.0 percent, one participant expecting rates at 0.5 to 1.0 percent and one participant expecting rates from 2.0 to 3.0. This table is consistent with the guidance statement of the FOMC that rates will remain at low levels until late in 2014. For 2015, nine participants expect rates to be below 1.0 percent while nine expect rates from 1.0 to 4.5 percent. In the long run, all 19 participants expect the fed funds rate in the range of 3.0 to 4.5 percent.
Table IV-3, US, Views of Target Federal Funds Rate at Year-End of Federal Reserve Board
Members and Federal Reserve Bank Presidents Participating in FOMC, June 20, 2012
| 0 to 0.25 | 0.5 to 1.0 | 1.0 to 1.5 | 1.0 to 2.0 | 2.0 to 3.0 | 3.0 to 4.5 | |
| 2013 | 18 | 1 | ||||
| 2014 | 14 | 1 | 3 | 1 | ||
| 2015 | 1 | 8 | 6 | 1 | 2 | 1 |
| Longer Run | 19 |
Source: Board of Governors of the Federal Reserve System, FOMC http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf
Additional information is provided in Table IV-4 with the number of participants expecting increasing interest rates in the years from 2013 to 2015. It is evident from Table IV-4 that the prevailing view of the FOMC is for interest rates to continue at low levels in future years. This view is consistent with the economic projections of low economic growth, relatively high unemployment and subdued inflation provided in Table IV-2.
Table IV-4, US, Views of Appropriate Year of Increasing Target Federal Funds Rate of Federal
Reserve Board Members and Federal Reserve Bank Presidents Participating in FOMC, June 20, 2012
| Appropriate Year of Increasing Target Fed Funds Rate | Number of Participants |
| 2013 | 1 |
| 2014 | 4 |
| 2015 | 13 |
| 2016 | 1 |
Source: Board of Governors of the Federal Reserve System, FOMC http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf
The Bureau of Economic Analysis (BEA) provides the annual revision of the national income and product accounts since Jan 2009 through May 2009 in the report on personal income and outlays for Jun 2012 released on Jul 31, 2012 (http://www.bea.gov/newsreleases/national/pi/2012/pdf/pi0612.pdf), including prices of personal consumption expenditures (PCE) and for Jul 2012 released on Aug 30 (http://www.bea.gov/newsreleases/national/pi/2012/pdf/pi0712.pdf) and the release for Mar 2013 (http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf). There are waves of inflation similar to those worldwide (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html) in inflation of personal consumption expenditures (PCE) in Table IV-5. These waves are in part determined by commodity price shocks originating in the carry trade from zero interest rates to positions in risk financial assets, in particular in commodity futures, which increase the prices of food and energy when there is relaxed risk aversion. Return of risk aversion causes collapse in prices. The first wave is in Jan-Apr 2011 when headline PCE inflation grew at the average annual equivalent rate of 4.0 percent and PCE inflation excluding food and energy (PCEX) at 2.1 percent. The drivers of inflation were increases in food prices (PCEF) at the annual equivalent rate of 7.4 percent and of energy prices (PCEE) at 29.8 percent. This behavior will prevail under zero interest rates and relaxed risk aversion because of carry trades from zero interest rates to leveraged positions in commodity futures. The second wave occurred in May-Jun 2011 when risk aversion from the European sovereign risk crisis interrupted the carry trade. PCE prices increased 1.8 percent in annual equivalent and 2.4 percent excluding food and energy. The third wave is captured by the annual equivalent rates in Jul-Sep 2011 of headline PCE inflation of 2.4 percent with subdued PCE inflation excluding food and energy of 1.6 percent while PCE food rose at 6.2 percent and PCE energy increased at 13.6 percent. In the fourth wave in Oct-Dec 2011, increased risk aversion explains the fall of the annual equivalent rate of inflation to 0.8 for headline PCE inflation and 1.6 percent for PCEX excluding food and energy. PCEF of prices of food rose at the annual equivalent rate of 1.6 percent in Oct-Dec 2011 while PCEE of prices of energy fell at the annual equivalent rate of 13.5 percent. In the fifth wave in Jan-Mar 2012, headline PCE in annual equivalent was 3.3 percent and 2.4 percent excluding food and energy (PCEX). Energy prices of personal consumption (PCEE) increased at the annual equivalent rate of 21.3 percent because of the jump of 3.6 percent in Feb 2012 followed by 1.0 percent in Mar 2012. In the sixth wave, renewed risk aversion caused reversal of carry trades with headline PCE inflation falling at the annual equivalent rate of 1.2 percent in Apr-May 2012 while PCE inflation excluding food and energy increased at the annual equivalent rate of 1.2 percent. In the seventh wave, further shocks of risk aversion resulted in headline PCE annual equivalent inflation at 1.2 percent in Jun-Jul 2012 with core PCE excluding food and energy at 1.8 percent. In the eighth wave, temporarily relaxed risk aversion with zero interest rates resulted in central PCE inflation at 4.3 percent annual equivalent in Aug-Sep 2012 with PCEX excluding food and energy at 0.0 percent while PCEE energy jumped at 85.8 percent annual equivalent. Relaxed risk aversion was induced by the program of outright monetary transactions (OTM) of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). In the ninth wave, prices collapsed with reversal of carry trade positions in a new episode of risk aversion with central PCE at annual equivalent 0.6 percent in Oct 2012 to Jan 2013 and PCEX at 1.5 percent while energy prices fell at minus 17.5 percent. In the tenth wave, central PCE increased at annual equivalent 4.9 percent in Feb 2013, PCEX at 1.2 percent and PCEE at 96.7 percent. In the eleventh wave, renewed risk aversion resulted in decline in annual equivalent of general PCE prices at 1.2 percent in Mar 2013 while PCEX was unchanged and energy prices fell at 28.0 percent.
Table IV-5, US, Percentage Change from Prior Month of Prices of Personal Consumption Expenditures, Seasonally Adjusted Monthly ∆%
| PCE | PCEG | PCEG | PCES | PCEX | PCEF | PCEE | |
| 2013 | |||||||
| Mar | -0.1 | -0.6 | -0.2 | 0.1 | 0.0 | 0.1 | -2.7 |
| ∆% AE Mar | -1.2 | -7.0 | -2.4 | 1.2 | 0.0 | 1.2 | -28.0 |
| Feb | 0.4 | 0.9 | -0.1 | 0.1 | 0.1 | 0.2 | 5.8 |
| ∆% AE Feb | 4.9 | 11.4 | -1.2 | 1.2 | 1.2 | 2.4 | 96.7 |
| Jan | 0.1 | -0.2 | 0.1 | 0.2 | 0.2 | 0.0 | -1.9 |
| 2012 | |||||||
| Dec | 0.0 | -0.3 | -0.2 | 0.2 | 0.0 | 0.2 | -0.9 |
| Nov | -0.1 | -0.8 | -0.1 | 0.2 | 0.1 | 0.2 | -3.7 |
| Oct | 0.2 | 0.1 | -0.2 | 0.2 | 0.2 | 0.2 | 0.2 |
| ∆% AE Oct-Jan | 0.6 | -3.5 | -1.2 | 2.4 | 1.5 | 1.8 | -17.5 |
| Sep | 0.3 | 0.7 | -0.2 | 0.1 | 0.0 | -0.1 | 4.8 |
| Aug | 0.4 | 0.8 | -0.2 | 0.1 | 0.0 | 0.1 | 5.8 |
| ∆% AE Aug-Sep | 4.3 | 9.4 | -2.4 | 1.2 | 0.0 | 0.0 | 85.8 |
| Jul | 0.1 | 0.0 | -0.3 | 0.1 | 0.1 | 0.0 | -0.2 |
| Jun | 0.1 | -0.1 | -0.1 | 0.2 | 0.2 | 0.2 | -1.5 |
| ∆% AE Jun-Jul | 1.2 | -0.6 | -2.4 | 1.8 | 1.8 | 1.2 | -9.8 |
| May | -0.2 | -0.8 | 0.0 | 0.1 | 0.1 | -0.1 | -4.7 |
| Apr | 0.0 | -0.3 | -0.2 | 0.2 | 0.1 | 0.1 | -1.8 |
| ∆% AE Apr- May | -1.2 | -6.4 | -1.2 | 1.8 | 1.2 | 0.0 | -32.8 |
| Mar | 0.2 | 0.3 | -0.1 | 0.2 | 0.2 | 0.1 | 1.0 |
| Feb | 0.3 | 0.6 | 0.0 | 0.2 | 0.1 | 0.0 | 3.6 |
| Jan | 0.3 | 0.3 | 0.1 | 0.2 | 0.3 | 0.1 | 0.3 |
| ∆% AE Jan- Mar | 3.3 | 4.9 | 0.0 | 2.4 | 2.4 | 0.8 | 21.3 |
| 2011 | |||||||
| Dec | 0.1 | -0.2 | -0.2 | 0.2 | 0.2 | 0.2 | -1.4 |
| Nov | 0.1 | -0.1 | -0.3 | 0.1 | 0.1 | 0.0 | -0.5 |
| Oct | 0.0 | -0.2 | -0.1 | 0.1 | 0.1 | 0.2 | -1.7 |
| ∆% AE Oct- Dec | 0.8 | -2.0 | -2.4 | 1.6 | 1.6 | 1.6 | -13.5 |
| Sep | 0.2 | 0.2 | -0.4 | 0.1 | 0.0 | 0.5 | 1.5 |
| Aug | 0.2 | 0.3 | -0.2 | 0.2 | 0.2 | 0.6 | 0.8 |
| Jul | 0.2 | 0.3 | -0.1 | 0.2 | 0.2 | 0.4 | 0.9 |
| ∆% AE Jul-Sep | 2.4 | 3.3 | -2.8 | 2.0 | 1.6 | 6.2 | 13.6 |
| Jun | 0.1 | 0.1 | 0.2 | 0.1 | 0.2 | 0.3 | -1.2 |
| May | 0.2 | 0.2 | 0.1 | 0.2 | 0.2 | 0.4 | 0.1 |
| ∆% AE May-Jun | 1.8 | 1.8 | 1.8 | 1.8 | 2.4 | 4.3 | -6.4 |
| Apr | 0.3 | 0.5 | 0.2 | 0.2 | 0.2 | 0.3 | 1.9 |
| Mar | 0.4 | 0.8 | 0.0 | 0.2 | 0.1 | 0.8 | 3.5 |
| Feb | 0.3 | 0.6 | 0.2 | 0.2 | 0.2 | 0.7 | 2.5 |
| Jan | 0.3 | 0.5 | 0.1 | 0.1 | 0.2 | 0.6 | 0.9 |
| ∆% AE Jan-Apr | 4.0 | 7.4 | 1.5 | 2.1 | 2.1 | 7.4 | 29.8 |
| 2010 | |||||||
| Dec | 0.2 | 0.6 | -0.4 | 0.0 | 0.0 | 0.2 | 4.2 |
| Nov | 0.1 | 0.2 | -0.2 | 0.1 | 0.1 | 0.1 | 0.8 |
| Oct | 0.2 | 0.5 | -0.2 | 0.1 | 0.1 | 0.2 | 3.1 |
| Sep | 0.1 | 0.2 | -0.1 | 0.1 | 0.1 | 0.2 | 0.8 |
| Aug | 0.2 | 0.3 | 0.1 | 0.1 | 0.1 | 0.1 | 1.5 |
| Jul | 0.2 | 0.2 | -0.3 | 0.1 | 0.1 | 0.1 | 1.8 |
| Jun | 0.0 | -0.2 | -0.3 | 0.1 | 0.1 | -0.1 | -1.0 |
| May | 0.0 | -0.4 | -0.2 | 0.2 | 0.1 | 0.0 | -2.1 |
| Apr | 0.0 | -0.3 | -0.2 | 0.1 | 0.1 | 0.2 | -0.8 |
| Mar | 0.2 | -0.1 | 0.1 | 0.3 | 0.2 | 0.2 | -0.6 |
| Feb | 0.1 | -0.2 | -0.3 | 0.2 | 0.1 | 0.1 | -1.0 |
| Jan | 0.2 | 0.3 | -0.1 | 0.2 | 0.1 | 0.1 | 1.8 |
Notes: percentage changes in price index relative to the same month a year earlier of PCE: personal consumption expenditures; PCEG: PCE goods; PCEG-D: PCE durable goods; PCES: PCE services; PCEX: PCE excluding food and energy; PCEF: PCE food; PCEE: PCE energy goods and services
Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
The charts of PCE inflation are also instructive. Chart IV-1 provides the monthly change of headline PCE price index. There is significant volatility in the monthly changes but excluding outliers fluctuations have been in a tight range between 1999 and 2013 around 0.2 percent per month.
Chart IV-1, US, Percentage Change of PCE Price Index from Prior Month, 1999-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
There is much less volatility in the PCE index excluding food and energy shown in Chart IV-2 with monthly percentage changes from 1999 to 2013. With the exception of 2001 there are no negative changes and again changes around 0.2 percent when excluding outliers.
Chart IV-2, US, Percentage Change of PCE Price Index Excluding Food and Energy from Prior Month, 1999-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Fluctuations in the PCE index of food are much wider as shown in Chart IV-3 by monthly percentage changes from 1999 to 2013. There are also multiple negative changes and positive changes even exceeding 1.0 percent in three months.
Chart IV-3, US, Percentage Change of PCE Price Index Food from Prior Month, 1999-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
The band of fluctuation of the PCE price index of energy in Chart IV-4 is much wider. An interesting feature is the abundance of negative changes and large percentages.
Chart IV-4, US, Percentage Change of PCE Price Index Energy from Prior Month, 1999-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Table IV-6 provides 12-month rates of PCE inflation since 2000. Headline 12-month PCE inflation has increased from 1.5 percent in Jan 2011 to 2.8 percent in Aug 2011 and 2.9 percent in Sep 2011, declining to 1.0 percent in Mar 2013. PCE inflation excluding food and energy (PCEX), used as indicator in monetary policy, has increased from 1.1 percent in Jan 2011 to 1.9 percent in Dec 2011 and 1.1 percent in Mar 2013, which is still below or at the tolerable maximum of 2.0-2.5 percent in monetary policy. The unintended effect of shocks of commodity prices from zero interest rates captured by PCE food prices (PCEF) and energy (PCEE) in the absence of risk aversion should be weighed in design and implementation of monetary policy. The final row of Table IV-6 provides average rates of 12-month change of PCE prices in Dec. The average for central PCE prices is 2.1 per cent per year from 2000 to 2012 and 1.8 percent for core PCE. PCE food grew at the average rate of 2.5 percent from 2000 to 2012 and energy PCE at 5.8 percent with significant oscillations.
Table IV-6, US, Percentage Change in 12 Months of Prices of Personal Consumption Expenditures ∆%
| PCE | PCEG | PCEG | PCES | PCEX | PCEF | PCEE | |
| 2013 | |||||||
| Mar | 1.0 | -0.5 | -1.7 | 1.7 | 1.1 | 1.1 | -1.6 |
| Feb | 1.3 | 0.4 | -1.7 | 1.8 | 1.3 | 1.2 | 2.2 |
| Jan | 1.3 | 0.1 | -1.6 | 1.9 | 1.4 | 1.0 | 0.1 |
| 2012 | |||||||
| Dec | 1.5 | 0.6 | -1.6 | 1.9 | 1.4 | 1.2 | 2.4 |
| Nov | 1.5 | 0.7 | -1.6 | 2.0 | 1.5 | 1.2 | 1.9 |
| Oct | 1.8 | 1.4 | -1.7 | 1.9 | 1.6 | 0.9 | 5.3 |
| Sep | 1.6 | 1.1 | -1.6 | 1.9 | 1.5 | 0.9 | 3.2 |
| Aug | 1.4 | 0.6 | -1.8 | 1.9 | 1.5 | 1.5 | 0.0 |
| Jul | 1.3 | 0.1 | -1.8 | 2.0 | 1.7 | 2.0 | -4.7 |
| Jun | 1.5 | 0.4 | -1.6 | 2.1 | 1.8 | 2.4 | -3.6 |
| May | 1.5 | 0.6 | -1.3 | 2.0 | 1.7 | 2.4 | -3.3 |
| Apr | 1.9 | 1.6 | -1.2 | 2.1 | 1.9 | 2.9 | 1.5 |
| Mar | 2.2 | 2.5 | -0.8 | 2.1 | 2.0 | 3.2 | 5.4 |
| Feb | 2.4 | 2.9 | -0.7 | 2.2 | 1.9 | 3.9 | 8.0 |
| Jan | 2.4 | 3.0 | -0.5 | 2.2 | 1.9 | 4.6 | 6.8 |
| 2011 | |||||||
| Dec | 2.4 | 3.1 | -0.5 | 2.1 | 1.9 | 5.1 | 7.4 |
| Nov | 2.6 | 4.0 | -0.6 | 1.9 | 1.7 | 5.0 | 13.5 |
| Oct | 2.6 | 4.2 | -0.5 | 1.8 | 1.6 | 5.2 | 15.1 |
| Sep | 2.9 | 4.9 | -0.7 | 1.9 | 1.6 | 5.1 | 20.7 |
| Aug | 2.8 | 4.9 | -0.4 | 1.8 | 1.6 | 4.8 | 19.8 |
| Jul | 2.8 | 4.8 | -0.2 | 1.8 | 1.5 | 4.3 | 20.6 |
| Jun | 2.7 | 4.7 | -0.4 | 1.7 | 1.4 | 4.0 | 21.6 |
| May | 2.6 | 4.5 | -0.9 | 1.7 | 1.4 | 3.6 | 22.0 |
| Apr | 2.4 | 3.8 | -1.2 | 1.6 | 1.2 | 3.2 | 19.4 |
| Mar | 2.1 | 3.0 | -1.6 | 1.6 | 1.1 | 3.0 | 16.1 |
| Feb | 1.8 | 2.1 | -1.6 | 1.7 | 1.2 | 2.4 | 11.5 |
| Jan | 1.5 | 1.3 | -2.0 | 1.7 | 1.1 | 1.8 | 7.7 |
| 2010 | |||||||
| Dec | 1.5 | 1.1 | -2.2 | 1.7 | 1.1 | 1.3 | 8.6 |
| Nov | 1.4 | 0.6 | -2.0 | 1.7 | 1.2 | 1.3 | 4.4 |
| Oct | 1.5 | 0.8 | -1.7 | 1.8 | 1.2 | 1.3 | 6.3 |
| Sep | 1.6 | 0.5 | -1.3 | 2.1 | 1.5 | 1.2 | 4.1 |
| Aug | 1.7 | 0.6 | -0.9 | 2.2 | 1.6 | 0.7 | 4.0 |
| Dec 2009 | 2.3 | 4.1 | -0.7 | 1.4 | 1.6 | -1.6 | 20.5 |
| Dec 2008 | 0.6 | -3.8 | -2.4 | 2.8 | 1.8 | 6.8 | -23.7 |
| Dec 2007 | 3.5 | 3.6 | -1.9 | 3.5 | 2.5 | 5.0 | 18.6 |
| Dec 2006 | 2.3 | 0.5 | -2.0 | 3.2 | 2.3 | 1.3 | 3.7 |
| Dec 2005 | 3.0 | 1.7 | -1.4 | 3.7 | 2.3 | 1.7 | 16.3 |
| Dec 2004 | 3.0 | 2.6 | -0.7 | 3.2 | 2.2 | 2.3 | 18.0 |
| Dec 2003 | 2.0 | -0.1 | -3.9 | 3.2 | 1.5 | 3.6 | 9.4 |
| Dec 2002 | 2.2 | 0.6 | -2.8 | 3.0 | 1.8 | 1.0 | 12.7 |
| Dec 2001 | 1.0 | -2.0 | -2.4 | 2.8 | 1.7 | 2.4 | -13.8 |
| Dec 2000 | 2.4 | 1.5 | -1.3 | 2.9 | 1.8 | 2.8 | 14.1 |
| Average | 2.1 | 1.0 | -20.3* | 2.7 | 1.8 | 2.5 | 5.8 |
*Percentage change from 2000 to 2011.
Notes: percentage changes in price index relative to the same month a year earlier of PCE: personal consumption expenditures; PCEG: PCE goods; PCEG-D: PCE durable goods; PCES: PCE services; PCEX: PCE excluding food and energy; PCEF: PCE food; PCEE: PCE energy goods and services
Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
The headline PCE index is shown in Chart IV-5 from 1999 to 2013. There is an evident upward trend with the carry-trade bump of the global recession after IVQ2008.
Chart IV-5, US, Price Index of Personal Consumption Expenditures 1999-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
The headline consumer price index is shown in Chart IV-6. There is also an upward trend but with fluctuations and the 2008 carry-trade bump.
Chart IV-6, US, Consumer Price Index, NSA, 1999-2013
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
The PCE price index excluding food and energy is shown in Chart IV-7. There is less pronounced long-term trend with fewer bumps because of excluding more volatile commodity items.
Chart IV-7, US, Price Index of Personal Consumption Expenditures Excluding Food and Energy 1999-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
The core consumer price index, excluding food and energy, is shown in Chart IV-8. There is also an upward trend but with fluctuations.
Chart IV-8, US, Consumer Price Index Excluding Food and Energy, NSA, 1999-2012
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
The PCE price index of food is shown in Chart IV-9. There is a more pronounced upward trend and sharper fluctuations.
Chart IV-9, US, Price Index of Personal Consumption Expenditures Food 1999-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
There is similar behavior in the consumer price index of food in Chart IV-10. There is an upward trend from 1999 to 2011 with a major bump in 2009 when commodity futures positions were unwound. Zero interest rates with bouts of risk aversion dominate the trend into 2011. Risk aversion softens the trend toward the end of 2011 and in 2012.
Chart IV-10, US, Consumer Price Index, Food, NSA, 1999-2013
Source: US Bureau of Labor Statistics
http://www.bea.gov/iTable/index_nipa.cfm
The most pronounced trend of PCE price indexes is that of energy in Chart IV-11. It is impossible to explain the hump in 2008 in the middle of the global recession without the carry trade from zero interest rates to leveraged positions in commodity futures. Risk aversion after Sep 2008 caused flight to the safe haven of government obligations. The return of risk appetite with zero interest rates caused a first wave of carry trades with another upward trend interrupted by the first European sovereign risk crisis in Apr-Jul 2010. Zero interest rates with risk appetite caused another sharp upward trend of commodity prices interrupted by risk aversion from the second sovereign crisis. In the absence of risk aversion, carry trades from zero interest rates to positions in risk financial assets will continue to cause distortions such as commodity price trends and fluctuations.
Chart IV-11, US, Price Index of Personal Consumption Expenditures Energy Goods and Services 1999-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IV-12 provides the consumer price index of energy commodities. Unconventional monetary policy of zero or near zero interest rates causes upward trends in commodity prices reflected in (1) increase from 2003 to 2007; (2) sharp increase during the global contraction in 2008; (3) collapse from 2008 into 2009 as positions in commodity futures were unwound in a flight to government obligations; (4) new upward trend after 2010; and (5) episodes of decline during risk aversion shocks such as the more recent segment during the worsening European debt crisis in Nov and Dec of 2011 and with new strength of commodity prices in the beginning of 2012 followed by softness in another episode of risk aversion and increases during risk appetite.
Chart IV-12, US, Consumer Price Index, Energy, NSA, 1999-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart IV-13 of the US Energy Information Administration provides prices of the crude oil futures contract. Unconventional monetary policy of very low interest rates and quantitative easing with suspension of the 30-year bond to lower mortgage rates caused a sharp upward trend of oil prices. There is no explanation for the jump of oil prices to $149/barrel in 2008 during a sharp global recession other than carry trades from zero interest rates to commodity futures. Prices collapsed in the flight to government obligations. Risk appetite with zero interest rates resulted in another upward trend of commodity prices after 2009 with fluctuations during periods of risk aversion. All price indexes are affected by unconventional monetary policy.
Chart IV-13, US, Crude Oil Futures Contract
Source: US Energy Information Administration
http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RCLC1&f=D
The producer price index of the euro zone decreased 0.2 percent in Dec 2012 and decreased 0.2 percent in Nov 2012 but increased 0.4 percent in Jan 2013 and 0.2 percent in Feb 2013, falling 0.2 percent in Mar 2013, as shown in Table IV-7. In Jan-Mar 2012, producer prices increased cumulatively 2.0 percent or at annual equivalent rate of 8.3 percent. Energy inflation has oscillated with the shocks of risk aversion that cause unwinding of carry trade positions from zero interest rates to commodity futures. Energy prices fell 0.6 percent in Dec 2012 and Jan 2013 but increased 0.4 percent in Feb 2013 and 0.8 percent in Jan 2013. Energy prices fell 0.6 percent in Dec 2012, 0.5 percent in Nov 2012 and fell 0.4 percent in Oct 2012 after -0.1 percent in Sep 2012, increased 2.4 percent in Aug, and 1.4 percent in Jul 2012 or at the annual equivalent rate of 16.2 percent in the quarter Jul-Sep 2012 and at 25.3 percent in Jul-Aug 2012. Energy prices increased 5.2 percent cumulatively in Jan-Mar 2012 or at the annual equivalent rate of 22.5 percent. During periods of relaxed risk aversion, carry trades from zero interest rates to commodity exposures drive high inflation waves. Prices of capital goods have barely moved. Prices of durable consumer goods accelerated at annual equivalent rate of 3.3 percent in Jan-Mar 2012 but were flat in every month from Apr to Jun 2012, increasing 0.1 percent in both Aug and Jul 2012 but then remained unchanged in Sep 2012, increasing at 0.1 percent in Oct 2012 and increasing 0.2 percent in Jan 2013 and 0.1 percent in Feb-Mar 2013. Purchasing managers’ indexes worldwide reflect increasing prices of inputs for business while sales prices are stagnant or declining, squeezing economic activity (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html). Unconventional monetary policy causes uncertainty in business decisions with shocks of declining net revenue margins during worldwide inflation waves (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html).
Table IV-7, Euro Zone, Industrial Producer Prices Month ∆%
| Mar 2013 | Feb 2013 | Jan 2013 | Dec | Nov | Oct 2012 | Sep 2012 | |
| Industry ex | -0.2 | 0.2 | 0.4 | -0.2 | -0.2 | -0.1 | 0.2 |
| Industry ex | 0.0 | 0.1 | 0.2 | 0.0 | -0.1 | 0.1 | 0.3 |
| Intermediate | -0.1 | 0.0 | 0.1 | 0.0 | -0.2 | 0.0 | 0.4 |
| Energy | -0.6 | 0.4 | 0.9 | -0.6 | -0.5 | -0.4 | -0.1 |
| Capital Goods | 0.0 | 0.2 | 0.2 | 0.0 | 0.0 | 0.1 | 0.0 |
| Durable Consumer Goods | 0.1 | 0.1 | 0.2 | -0.1 | 0.0 | 0.1 | 0.0 |
| Nondurable Consumer Goods | 0.1 | 0.1 | 0.2 | 0.1 | 0.1 | 0.2 | 0.4 |
Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/
Twelve-month percentage changes of industrial prices in the euro zone have moderated significantly, as shown in Table IV-8. The 12-month percentage change of industrial prices excluding construction fell from 4.5 percent in Dec 2011 to 2.0 percent in Jul 2012 but increased to 3.0 percent in Aug and 2.9 percent in Sep 2012, falling to 2.7 percent in Oct 2012, 2.3 percent in Nov 2012, 2.2 percent in Dec 2012, 1.8 percent in Jan 2013 and 1.4 percent in Feb 2013. The 12-month rate of increase of euro zone producer prices in Mar 2013 was 0.7 percent. Energy prices increased 9.7 percent in Dec 2011 and Jan 2011 but the rate fell to 4.5 percent in the 12 months ending in Jul 2012, increasing to 7.5 percent in Aug 2012 and 6.4 percent in Sep 2012 but falling to 5.2 percent in Oct 2012, 3.8 percent in Nov 2012, 3.8 percent in Dec 2012, 2.4 percent in Jan 2013 and 1.8 percent in Feb 2013. Energy prices were unchanged in the 12 months ending in Mar 2013. There is major vulnerability in producer price inflation that can return together with long positions in commodity futures with carry trades from zero interest during relaxation of risk aversion. Business net revenue or prices of sold goods less costs of inputs suffers wide oscillation preventing sound calculation of risk/returns and capital budgeting (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html).
Table IV-8, Euro Zone, Industrial Producer Prices 12-Month ∆%
| Mar 2013 | Feb | Jan 2013 | Dec 2012 | Nov | Oct 2012 | Sep 2012 | |
| Industry ex | 0.7 | 1.4 | 1.8 | 2.3 | 2.3 | 2.7 | 2.9 |
| Industry ex | 1.0 | 1.2 | 1.5 | 1.7 | 1.6 | 1.6 | 1.3 |
| Intermediate | 0.4 | 0.8 | 1.3 | 1.6 | 1.4 | 1.3 | 0.7 |
| Energy | 0.0 | 1.8 | 2.4 | 3.8 | 3.8 | 5.2 | 6.4 |
| Capital Goods | 0.7 | 0.8 | 0.7 | 0.9 | 0.9 | 0.8 | 0.8 |
| Durable Consumer Goods | 0.6 | 0.6 | 0.8 | 1.0 | 1.1 | 1.3 | 1.3 |
| Nondurable Consumer Goods | 2.1 | 2.3 | 2.5 | 2.6 | 2.6 | 2.7 | 2.7 |
Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/
Industrial producer prices in the euro area are following similar inflation waves as in the rest of the world (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html), as shown in Table IV-9. In the first wave in Jan-Apr 2011, annual equivalent producer price inflation was 11.4 percent driven by carry trades from zero interest rates into commodity futures. In the second wave in May-Jun 2011, annual equivalent producer price inflation declined at minus 1.2 percent. In the third wave in Jul-Sep 2011, annual equivalent inflation increased at 2.8 percent. In the third wave in Oct-Dec 2011, risk aversion originating in the European sovereign debt crisis interrupted commodity carry trades, resulting in annual equivalent inflation of only 0.4 percent. In the fifth wave in Jan-Mar 2012, annual equivalent inflation jumped to 8.3 percent with a high annual equivalent rate of 9.4 percent in Jan-Feb 2012. In the sixth wave, risk aversion from the European sovereign debt event caused reversal of commodity carry trades with equivalent annual inflation of minus 2.0 percent in Apr-Jun 2012. In the seventh wave, annual equivalent inflation jumped to 7.4 percent in Jul-Aug 2012 while energy prices driven by carry trades increased at the annual equivalent rate of 25.3 percent. In the eighth wave, annual equivalent inflation retreated to 0.6 percent in Sep-Oct 2012. In the ninth wave, annual equivalent inflation was minus 2.4 percent in Nov-Dec 2012. In the tenth wave, annual equivalent inflation was 3.7 percent in Jan-Feb 2013. In the eleventh wave, annual equivalent inflation was minus 2.4 percent in Mar 2013. The bottom part of Table IV-7 provides 12-month percentage changes from 1999 to 2010. The final row of Table IV-7 provides the average annual rate of producer-price inflation in the euro area at 2.5 percent in Dec from 1999 to 2012.
Table IV-9, Euro Area, Industrial Producer Prices Excluding Construction, Month and 12-Month ∆%
| Month ∆% | 12-Month ∆% | |
| Mar 2013 | -0.2 | 0.7 |
| AE ∆% Mar | -2.4 | |
| Feb | 0.2 | 1.4 |
| Jan | 0.4 | 1.8 |
| AE ∆% Jan-Feb | 3.7 | |
| Dec 2012 | -0.2 | 2.3 |
| Nov | -0.2 | 2.3 |
| AE ∆% Nov-Dec | -2.4 | |
| Oct | -0.1 | 2.7 |
| Sep | 0.2 | 2.9 |
| AE ∆% Sep-Oct | 0.6 | |
| Aug | 0.9 | 3.0 |
| Jul | 0.3 | 2.0 |
| AE ∆% Jul-Aug | 7.4 | |
| Jun | -0.4 | 2.3 |
| May | -0.3 | 2.8 |
| Apr | 0.2 | 3.0 |
| AE ∆% Apr-Jun | -2.0 | |
| Mar | 0.5 | 3.9 |
| Feb | 0.6 | 4.1 |
| Jan | 0.9 | 4.2 |
| AE ∆% Jan-Mar | 8.3 | |
| Dec 2011 | -0.2 | 4.5 |
| Nov | 0.2 | 5.5 |
| Oct | 0.1 | 5.7 |
| AE ∆% Oct-Dec | 0.4 | |
| Sep | 0.2 | 5.7 |
| Aug | -0.1 | 5.8 |
| Jul | 0.6 | 6.0 |
| AE ∆% Jul-Sep | 2.8 | |
| Jun | 0.0 | 5.7 |
| May | -0.1 | 6.1 |
| AE ∆% May-Jun | -1.2 | |
| Apr | 1.0 | 6.5 |
| Mar | 0.7 | 6.4 |
| Feb | 0.7 | 6.2 |
| Jan | 1.2 | 5.6 |
| AE ∆% Jan-Apr | 11.4 | |
| Dec 2012 | 2.3 | |
| Dec 2011 | 4.5 | |
| Dec 2010 | 5.1 | |
| Dec 2009 | -3.0 | |
| Dec 2008 | 1.5 | |
| Dec 2007 | 4.4 | |
| Dec 2006 | 3.8 | |
| Dec 2005 | 4.5 | |
| Dec 2004 | 3.7 | |
| Dec 2003 | 1.0 | |
| Dec 2002 | 1.5 | |
| Dec 2001 | -0.5 | |
| Dec 2000 | 4.7 | |
| Dec 1999 | 2.6 | |
| Average ∆% 1999-2012 | 2.5 |
Source: EUROSTAT
http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/ http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database
There are waves of inflation of producer prices in France as everywhere in the world economy (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html), as shown in Table IV-10. There was a first wave of sharply increasing inflation in the first four months of 2011 originating in the surge of commodity prices driven by carry trades from zero interest rates to commodity futures risk positions. Producer price inflation in the first four months of 2011 was at the annual equivalent rate of 10.4 percent. In the second wave, producer prices fell 0.2 percent in May and another 0.1 percent in Jun for annual equivalent inflation in May-Jun 2011 of minus 1.8 percent. In the third wave from Jul to Sep 2011, annual equivalent producer price inflation was 3.7 percent. In the fourth wave Oct-Dec 2011, annual equivalent producer price inflation was 2.8 percent. In the fifth wave Jan-Mar 2012, average annual inflation rose to 6.2 percent during carry trades from zero interest rates to commodity futures. In the sixth wave in Apr-Jun 2012, annual equivalent inflation fell at the rate of 5.1 percent during unwinding of carry trades because of increasing risk aversion. In the seventh wave, carry trades returned under more relaxed risk aversion with producer price inflation in France at 7.1 percent in annual equivalent in Jul-Oct 2012. In the eighth wave, return of risk aversion caused unwinding carry trade and annual equivalent inflation of minus 4.1 percent in Nov-Dec 2012. In the ninth wave, inflation returned with annual equivalent 4.5 percent in Jan-Mar 2013. The bottom part of Table IV-12 shows producer price inflation at 3.2 percent in the 12 months ending in Dec 2005 and again at 4.6 percent in the 12 months ending in Dec 2007. Producer prices fell in 2009 during the global contraction and decline of commodity prices but returned at 4.3 percent in the 12 months ending in Dec 2010.
Table IV-10, France, Producer Price Index for the French Market, ∆%
| Month | 12 Months | |
| Mar 2013 | 0.0 | 1.9 |
| Feb | 0.5 | 2.4 |
| Jan | 0.6 | 2.3 |
| AE ∆% Jan-Mar | 4.5 | |
| Dec 2012 | -0.5 | 2.2 |
| Nov | -0.2 | 2.4 |
| AE ∆% Nov-Dec | -4.1 | |
| Oct | 0.5 | 3.0 |
| Sep | 0.3 | 3.0 |
| Aug | 1.4 | 3.0 |
| Jul | 0.6 | 1.6 |
| AE ∆% Jul-Oct | 7.1 | |
| Jun | -0.6 | 1.6 |
| May | -0.8 | 2.1 |
| Apr | 0.1 | 2.8 |
| AE ∆% Apr-Jun | -5.1 | |
| Mar | 0.5 | 3.6 |
| Feb | 0.5 | 4.0 |
| Jan | 0.5 | 4.2 |
| AE ∆% Jan-Mar | 6.2 | |
| Dec 2011 | -0.2 | 4.5 |
| Nov | 0.4 | 5.2 |
| Oct | 0.5 | 5.3 |
| AE ∆% Oct-Dec | 2.8 | |
| Sep | 0.3 | 5.4 |
| Aug | 0.0 | 5.6 |
| Jul | 0.6 | 5.7 |
| AE ∆% Jul-Sep | 3.7 | |
| Jun | -0.1 | 5.4 |
| May | -0.2 | 5.7 |
| AE ∆% May-Jun | -1.8 | |
| Apr | 1.0 | 6.0 |
| Mar | 0.8 | 5.7 |
| Feb | 0.7 | 5.2 |
| Jan | 0.8 | 4.6 |
| AE ∆% Jan-Apr | 10.4 | |
| Dec 2010 | 4.3 | |
| Dec 2009 | -2.9 | |
| Dec 2008 | 0.8 | |
| Dec 2007 | 4.6 | |
| Dec 2006 | 2.6 | |
| Dec 2005 | 3.2 |
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20130430
Chart IV-14 of the Institut National de la Statistique et des Études Économiques provides the index of producer prices for the internal market of France from Jan 1999 to Mar 2013. There is the same sharp rise in commodity prices during the global recession in 2008 with carry0trade exposures in commodity futures prices. Risk aversion caused flight into United States government obligations and dollar-denominated riskless assets. Unwinding of carry trades caused sharp decline of producer prices. Return of risk appetite after 2009 caused carry-trade exposures driving upward trend in producer prices with waves of inflation driven by intermittent bouts of risk aversion (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html).
Chart IV-14, France, Producer Prices for the Internal Market, Jan 1999-Mar 2013, 2010=100
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20130430
France’s producer price index for the domestic market is shown in Table IV-11 for Mar 2013. The segment of prices of coke and refined petroleum decreased 3.9 percent in Mar 2013 and decreased 7.9 percent in 12 months. Manufacturing prices, with the highest weight in the index, decreased 0.3 percent in Mar and rose 0.1 percent in 12 months. Mining prices increased 0.9 percent in Mar and increased 7.9 percent in 12 months. Waves of inflation originating in carry trades from unconventional monetary policy of zero interest rates (http://cmpassocregulationblog.blogspot.com/2013/04/world-inflation-waves-squeeze-of.html) tend to deteriorate sales prices of productive activities relative to prices of inputs and commodities with adverse impact on operational margins and thus on production, investment and hiring.
Table IV-11, France, Producer Price Index for the Domestic Market, %
| Mar 2013 | Weight | Month ∆% | 12 Months ∆% |
| Total | 1000 | 0.0 | 1.9 |
| Mining | 234 | 0.9 | 7.9 |
| Mfg | 766 | -0.3 | 0.1 |
| Food Products, Beverages, Tobacco | 209 | 0.4 | 4.1 |
| Coke and Refined Petroleum | 52 | -3.9 | -7.9 |
| Electrical, Electronic | 51 | -0.2 | -0.2 |
| Transport | 72 | 0.1 | 0.0 |
| Other Mfg | 382 | -0.1 | -0.4 |
Source: Institut National de la Statistique et des Études Économiques http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20130430
Chart IV-20 of the Institut National de la Statistique et des Études Économiques of France provides the behavior of the producer price index of France for the various segments: import prices, foreign markets, domestic market and all markets. All the components rose to the peak in 2008 driven by carry trades from zero interest rates of unconventional monetary policy that was of such an impulse as to drive increases in commodity prices during the global recession. Prices collapsed with the flight out of financial risk assets such as commodity positions to government obligations. Commodity price increases returned with zero interest rates and subdued risk aversion. The shock of confidence of the current European sovereign risk moderated exposures to financial risk that influenced the flatter curve of France’s producer prices followed by another mild trend of increase and moderation in Dec 2011 and then renewed inflation in the first quarter of 2012 with a new pause in Apr 2012, decline in May-Jun 2012, the jump in Jul-Oct 2012 and the decline in Nov-Dec 2012 followed by increase in Jan-Feb 2013. Prices stabilized in Mar 2013.
Chart IV-20, France, Producer Price Index (PPI)
Source: Institut National de la Statistique et des Études Économiques
http://www.insee.fr/en/themes/info-rapide.asp?id=25&date=20130430
© Carlos M. Pelaez, 2010, 2011, 2012, 2013
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