Duration Dumping and Peaking Valuations of Risk Financial Assets, World Inflation Waves, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, Unresolved US Balance of Payments Deficits and Fiscal Imbalance, Household Income at 1995 Levels, Forty-six Million in Poverty and Forty-eight Million without Health Insurance, United States Industrial Production, World Economic Slowdown and Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013
Executive Summary
I World Inflation Waves
IA Appendix: Transmission of Unconventional Monetary Policy
IA1 Theory
IA2 Policy
IA3 Evidence
IA4 Unwinding Strategy
IB United States Inflation
IC Long-term US Inflation
ID Current US Inflation
IE Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation
II United States Industrial Production
IIA Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities
IIA1 United States Unsustainable Deficit/Debt
IIA2 Unresolved US Balance of Payments Deficits
IIB Household Income at 1995 Levels, 46 Million in Poverty and 48 Million without Health Insurance
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
I World Inflation Waves. This section provides analysis and data on world inflation waves. IA Appendix: Transmission of Unconventional Monetary Policy provides more technical analysis. Section IB United States Inflation analyzes inflation in the United States in two subsections: IC Long-term US Inflation and ID Current US Inflation. There is similar lack of reality in economic history as in monetary policy based on fear of deflation as analyzed in Subsection IE Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation
The critical fact of current world financial markets is the combination of “unconventional” monetary policy with intermittent shocks of financial risk aversion. There are two interrelated unconventional monetary policies. First, unconventional monetary policy consists primarily of reducing short-term policy interest rates toward the “zero bound” such as fixing the fed funds rate at 0 to ¼ percent by decision of the Federal Open Market Committee (FOMC) since Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). Fixing policy rates at zero is the strongest measure of monetary policy with collateral effects of inducing carry trades from zero interest rates to exposures in risk financial assets such as commodities, exchange rates, stocks and higher yielding fixed income. Second, unconventional monetary policy also includes a battery of measures in also reducing long-term interest rates of government securities and asset-backed securities such as mortgage-backed securities.
When inflation is low, the central bank lowers interest rates to stimulate aggregate demand in the economy, which consists of consumption and investment. When inflation is subdued and unemployment high, monetary policy would lower interest rates to stimulate aggregate demand, reducing unemployment. When interest rates decline to zero, unconventional monetary policy would consist of policies such as large-scale purchases of long-term securities to lower their yields. Long-term asset-backed securities finance a major portion of credit in the economy. Loans for purchasing houses, automobiles and other consumer products are bundled in securities that in turn are sold to investors. Corporations borrow funds for investment by issuing corporate bonds. Loans to small businesses are also financed by bundling them in long-term bonds. Securities markets bridge the needs of higher returns by savers obtaining funds from investors that are channeled to consumers and business for consumption and investment. Lowering the yields of these long-term bonds could lower costs of financing purchases of consumer durables and investment by business. The essential mechanism of transmission from lower interest rates to increases in aggregate demand is portfolio rebalancing. Withdrawal of bonds in a specific maturity segment or directly in a bond category such as currently mortgage-backed securities causes reductions in yields that are equivalent to increases in the prices of the bonds. There can be secondary increases in purchases of those bonds in private portfolios in pursuit of their increasing prices. Lower yields translate into lower costs of buying homes and consumer durables such as automobiles and also lower costs of investment for business. There are two additional intended routes of transmission.
1. Unconventional monetary policy or its expectation can increase stock market valuations (Bernanke 2010WP). Increases in equities traded in stock markets can augment perceptions of the wealth of consumers, inducing increases in consumption.
2. Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can cause increases in net exports of the US that increase aggregate economic activity (Yellen 2011AS).
Monetary policy can lower short-term interest rates quite effectively. Lowering long-term yields is somewhat more difficult. The critical issue is that monetary policy cannot ensure that increasing credit at low interest cost increases consumption and investment. There is a large variety of possible allocation of funds at low interest rates from consumption and investment to multiple risk financial assets. Monetary policy does not control how investors will allocate asset categories. A critical financial practice is to borrow at low short-term interest rates to invest in high-risk, leveraged financial assets. Investors may increase in their portfolios asset categories such as equities, emerging market equities, high-yield bonds, currencies, commodity futures and options and multiple other risk financial assets including structured products. If there is risk appetite, the carry trade from zero interest rates to risk financial assets will consist of short positions at short-term interest rates (or borrowing) and short dollar assets with simultaneous long positions in high-risk, leveraged financial assets such as equities, commodities and high-yield bonds. Low interest rates may induce increases in valuations of risk financial assets that may fluctuate in accordance with perceptions of risk aversion by investors and the public. During periods of muted risk aversion, carry trades from zero interest rates to exposures in risk financial assets cause temporary waves of inflation that may intensify instead of preventing financial instability. During periods of risk aversion such as fears of disruption of world financial markets and the global economy resulting from events such as collapse of the European Monetary Union, carry trades are unwound with sharp deterioration of valuations of risk financial assets. More technical discussion is in IA Appendix: Transmission of Unconventional Monetary Policy.
Symmetric inflation targets are temporarily of secondary priority in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output. Monetary easing by unconventional measures, including zero interest rates and outright purchases of securities for the portfolio of the central bank, is now open ended in perpetuity, or QE→∞, as provided in the statement of the meeting of the Federal Open Market Committee (FOMC) on Sep 13, 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm):
“To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):
“I think the best way to provide forward guidance is by tying our policy actions to explicit measures of economic performance. There are many ways of doing this, including setting a target for the level of nominal GDP. But recognizing the difficult nature of that policy approach, I have a more modest proposal: I think the Fed should make it clear that the federal funds rate will not be increased until the unemployment rate falls below 7 percent. Knowing that rates would stay low until significant progress is made in reducing unemployment would reassure markets and the public that the Fed would not prematurely reduce its accommodation.
Based on the work I have seen, I do not expect that such policy would lead to a major problem with inflation. But I recognize that there is a chance that the models and other analysis supporting this approach could be wrong. Accordingly, I believe that the commitment to low rates should be dropped if the outlook for inflation over the medium term rises above 3 percent.
The economic conditionality in this 7/3 threshold policy would clarify our forward policy intentions greatly and provide a more meaningful guide on how long the federal funds rate will remain low. In addition, I would indicate that clear and steady progress toward stronger growth is essential.”
Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:
“I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Price Index) inflation over the next two to three years, would be appropriate.”
The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):
“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
Unconventional monetary policy will remain in perpetuity, or QE→∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE→∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at around 1.8 percent, which is well below 3.0 percent estimated by Lucas (2011May) from 1870 to 2010. Unconventional monetary policy interprets the dual mandate of low inflation and maximum employment as mainly a “growth mandate” of forcing economic growth in the US at a rate that generates full employment. A hurdle to this “growth mandate” is that US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 16 quarters from IIIQ2009 to IIQ2013. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,738.0 billion in IIQ2010 by GDP of $14,356.9 billion in IIQ2009 {[$14,738.0/$14,356.9 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). Because of mediocre GDP growth, there are 28.3 million unemployed or underemployed in the United States for an effective unemployment rate of 17.4 percent (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). Zero interest rates and quantitative easing did not provide the impulse for growth and were not required in past successful cyclical expansions.
First, total nonfarm payroll employment seasonally adjusted (SA) increased 169,000 in Aug 2013 and private payroll employment rose 152,000. The average number of nonfarm jobs created in Jan-Aug 2012 was 178,625 while the average number of private jobs created in Jan-Aug 2013 was 180,250, or increase by 0.9 percent. The average number of private jobs created in the US in Jan-Aug 2012 was 181,750 while the average in Jan-Aug 2013 was 185,625, or increase by 2.1 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 eight months from Jan to Aug 2013 was 178,625, which is a rate of job creation inadequate to reduce significantly unemployment and underemployment in the United States because of 113,167 new entrants in the labor force per month with 28.3 million unemployed or underemployed. The difference between the average increase of 178,625 new private nonfarm jobs per month in the US from Jan to Aug 2013 and the 113,167 average monthly increase in the labor force from 2011 to 2012 is 65,458 monthly new jobs net of absorption of new entrants in the labor force. There are 28.3 million in job stress in the US currently. Creation of 65,458 new jobs per month net of absorption of new entrants in the labor force would require 433 months to provide jobs for the unemployed and underemployed (28.348 million divided by 65,458) or 36 years (433 divided by 12). The civilian labor force of the US in Aug 2013 not seasonally adjusted stood at 155.971 million with 11.462 million unemployed or effectively 18.316 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 162.825 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 1.3 years (1 million divided by product of 65,458 by 12, which is 785,496). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.799 million (0.05 times labor force of 155.971 million) for new net job creation of 3.663 million (11.462 million unemployed minus 7.799 million unemployed at rate of 5 percent) that at the current rate would take 4.7 years (3.663 million divided by 0.785496). Under the calculation in this blog, there are 18.316 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 162.825 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.586 million jobs net of labor force growth that at the current rate would take 12.9 years (18.316 million minus 0.05(162.825 million) = 10.175 million divided by 0.785596, 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 144.509 million in Aug 2013, by 2.806 million, or decline of 1.9 percent, while the civilian noninstitutional or economically active population increased from 231.958 million in Jul 2007 to 245.959 million in Aug 2013, by 14.001 million or increase of 6.0 percent, using not seasonally adjusted data. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs. The United States economy has grown at the average yearly rate of 3 percent per year and 2 percent per year in per capita terms from 1870 to 2010, as measured by Lucas (2011May). An important characteristic of the economic cycle in the US has been rapid growth in the initial phase of expansion after recessions. Inferior performance of the US economy and labor markets is the critical current issue of analysis and policy design.
Second, revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) provide important information on long-term growth and cyclical behavior. Table Summary provides relevant data.
- Long-term. US GDP grew at the average yearly rate of 3.3 percent from 1929 to 2012 and at 3.2 percent from 1947 to 2012. There were periodic contractions or recessions in this period but the economy grew at faster rates in the subsequent expansions, maintaining long-term economic growth at trend.
- Cycles. The combined contraction of GDP in the two almost consecutive recessions in the early 1980s is 4.7 percent. The contraction of US GDP from IVQ2007 to IIQ2009 during the global recession was 4.3 percent. The critical difference in the expansion is growth at average 7.8 percent in annual equivalent in the first four quarters of recovery from IQ1983 to IVQ1983. The average rate of growth of GDP in four cyclical expansions in the postwar period is 7.7 percent. In contrast, the rate of growth in the first four quarters from IIIQ2009 to IIQ2010 was only 2.7 percent. Average annual equivalent growth in the expansion from IQ1983 to IQ1986 was 5.7 percent. In contrast, average annual equivalent growth in the expansion from IIIQ2009 to IIQ2013 was only 2.7 percent. The US appears to have lost its dynamism of income growth and employment creation.
Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita
| GDP | ||
| Long-Term | ||
| 1929-2012 | 3.3 | |
| 1947-2012 | 3.2 | |
| Cyclical Contractions ∆% | ||
| IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982 | -4.7 | |
| IVQ2007 to IIQ2009 | -4.3 | |
| Cyclical Expansions Average Annual Equivalent ∆% | ||
| IQ1983 to IQ1986 | 5.7 | |
| First Four Quarters IQ1983 to IVQ1983 | 7.8 | |
| IIIQ2009 to IIQ2013 | 2.2 | |
| First Four Quarters IIIQ2009 to IIQ2010 | 2.7 | |
| Real Disposable Income | Real Disposable Income per Capita | |
| Long-Term | ||
| 1929-2012 | 3.2 | 2.0 |
| 1947-1999 | 3.7 | 2.3 |
| Whole Cycles | ||
| 1980-1989 | 3.5 | 2.6 |
| 2006-2012 | 1.4 | 0.6 |
Source: Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf
The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm http://bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_adv.pdf http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://bea.gov/newsreleases/national/pi/2013/pdf/pi0613.pdf) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace from 1.8 to 1.9 percent per year. Table Summary GDP provides the data.
1. Average Annual Growth in the Past Six Quarters. GDP growth in the four quarters of 2012 and the first two quarters of 2013 accumulated to 2.9 percent. This growth is equivalent to 1.9 percent per year, obtained by dividing GDP in IIQ2013 of $15,681.0 by GDP in IVQ2011 of $15,242.1 and compounding by 4/6: {[($15,681.0/$15,242.1)4/6 -1]100 = 1.9.
2. Average Annual Growth in the First Two Quarters of 2013. GDP growth in the first two quarters of 2013 accumulated to 0.9 percent that is equivalent to 1.8 percent in a year. This is obtained by dividing GDP in IIQ2013 of $15,681.0 by GDP in IVQ2012 of $15,539.6 and compounding by 4/2: {[($15,681.0/$15,539.6)4/2 -1]100 =1.8%}. The US economy grew 1.6 percent in IIQ2013 relative to the same quarter a year earlier in IIQ2012. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is just at the borderline of contraction.
Table Summary GDP, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%
| Real GDP, Billions Chained 2005 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| IVQ2007 | 14,996.1 | NA | NA | 1.9 |
| IVQ2011 | 15,242.1 | 1.6 | 1.2 | 2.0 |
| IQ2012 | 15,381.6 | 2.6 | 0.9 | 3.3 |
| IIQ2012 | 15,427.7 | 2.9 | 0.3 | 2.8 |
| IIIQ2012 | 15,534.0 | 3.6 | 0.7 | 3.1 |
| IVQ2012 | 15,539.6 | 3.6 | 0.0 | 2.0 |
| IQ2013 | 15,583.9 | 3.9 | 0.3 | 1.3 |
| IIQ2013 | 15,681.0 | 4.6 | 0.6 | 1.6 |
| Cumulative ∆% IQ2012 to IIQ2013 | 2.9 | 2.8 | ||
| Annual Equivalent ∆% | 1.9 | 1.9 |
Source: US Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_2nd.pdf
In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is concern of the production and employment costs of controlling future inflation. Even if there is no inflation, QE→∞ cannot be abandoned because of the fear of rising interest rates. The economy would operate in an inferior allocation of resources and suboptimal growth path, or interior point of the production possibilities frontier where the optimum of productive efficiency and wellbeing is attained, because of the distortion of risk/return decisions caused by perpetual financial repression. Not even a second-best allocation is feasible with the shocks to efficiency of financial repression in perpetuity.
The major reason and channel of transmission of unconventional monetary policy is through expectations of inflation. Fisher (1930) provided theoretical and historical relation of interest rates and inflation. Let in be the nominal interest rate, ir the real or inflation-adjusted interest rate and πe the expectation of inflation in the time term of the interest rate, which are all expressed as proportions. The following expression provides the relation of real and nominal interest rates and the expectation of inflation:
(1 + ir) = (1 + in)/(1 + πe) (1)
That is, the nominal interest rate equals the real interest rate discounted by the expectation of inflation in time term of the interest rate. Fisher (1933) analyzed the devastating effect of deflation on debts. Nominal debt contracts remained at original principal interest but net worth and income of debtors contracted during deflation. Real interest rates increase during declining inflation. For example, if the interest rate is 3 percent and prices decline 0.2 percent, equation (1) calculates the real interest rate as:
(1 +0.03)/(1 – 0.02) = 1.03/(0.998) = 1.032
That is, the real rate of interest is (1.032 – 1) 100 or 3.2 percent. If inflation were 2 percent, the real rate of interest would be 0.98 percent, or about 1.0 percent {[(1.03/1.02) -1]100 = 0.98%}.
The yield of the one-year Treasury security was quoted in the Wall Street Journal at 0.114 percent on Fri May 17, 2013 (http://online.wsj.com/mdc/page/marketsdata.html?mod=WSJ_topnav_marketdata_main). The expected rate of inflation πe in the next twelve months is not observed. Assume that it would be equal to the rate of inflation in the past twelve months estimated by the Bureau of Economic Analysis (BLS) at 1.1 percent (http://www.bls.gov/cpi/). The real rate of interest would be obtained as follows:
(1 + 0.00114)/(1 + 0.011) = (1 + rr) = 0.9902
That is, ir is equal to 1 – 0.9902 or minus 0.98 percent. Investing in a one-year Treasury security results in a loss of 0.98 percent relative to inflation. The objective of unconventional monetary policy of zero interest rates is to induce consumption and investment because of the loss to inflation of riskless financial assets. Policy would be truly irresponsible if it intended to increase inflationary expectations or πe. The result could be the same rate of unemployment with higher inflation (Kydland and Prescott 1977).
Friedman (1953) analyzed the effects of full-employment economic policy on economic stability. There are two critical issues. First, there are lags in effect of monetary policy on aggregate income and prices (Friedman 1961, Culbertson 1960, 1961, Batini and Nelson 2002, Romer and Romer 2004). Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Second, concrete knowledge on the functioning of the economy is inadequate. The result of shocking the economy with policies at the wrong time could be an increase in instability. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities).
Carry trades from zero interest rates to highly leveraged exposures in risk financial assets characterize the current environment. Some analytical aspects of the carry trade are instructive (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 101-5, Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 202-4), Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 70-4). Consider the following symbols: Rt is the exchange rate of a country receiving carry trade denoted in units of domestic currency per dollars at time t of initiation of the carry trade; Rt+τ is the exchange of the country receiving carry trade denoted in units of domestic currency per dollars at time t+τ when the carry trade is unwound; if is the domestic interest rate of the high-yielding country where investment will be made; iusd is the interest rate on short-term dollar debt assumed to be 0.5 percent per year; if >iusd, which expresses the fact that the interest rate on the foreign country is much higher than that in short-term USD (US dollars); St is the dollar value of the investment principal; and π is the dollar profit from the carry trade. The investment of the principal St in the local currency debt of the foreign country provides a profit of:
π = (1 + if)(RtSt)(1/Rt+τ) – (1 + iusd)St (2)
The profit from the carry trade, π, is nonnegative when:
(1 + if)/ (1 + iusd) ≥ Rt+τ/Rt (3)
In words, the difference in interest rate differentials, left-hand side of inequality (3), must exceed the percentage devaluation of the currency of the host country of the carry trade, right hand side of inequality (3). The carry trade must earn enough in the host-country interest rate to compensate for depreciation of the host-country at the time of return to USD. A simple example explains the vulnerability of the carry trade in fixed-income. Let if be 0.10 (10 percent), iusd 0.005 (0.5 percent), St USD100 and Rt CUR 1.00/USD. Adopt the fixed-income rule of months of 30 days and years of 360 days. Consider a strategy of investing USD 100 at 10 percent for 30 days with borrowing of USD 100 at 0.5 percent for 30 days. At time t, the USD 100 are converted into CUR 100 and invested at [(30/360)10] equal to 0.833 percent for thirty days. At the end of the 30 days, assume that the rate Rt+30 is still CUR 1/USD such that the return amount from the carry trade is USD 0.833. There is still a loan to be paid [(0.005)(30/360)USD100] equal to USD 0.042. The investor receives the net amount of USD 0.833 minus USD 0.042 or US 0.791. The rate of return on the investment of the USD 100 is 0.791 percent, which is equivalent to the annual rate of return of 9.49 percent {(0.791)(360/30)}. This is incomparably better than earning 0.5 percent. There are alternatives of hedging by buying forward the exchange for conversion back into USD.
What really matters in the statement of the Federal Open Market Committee (FOMC) on Sep 18, 2013, is interest rates of fed funds at 0 to ¼ percent for the foreseeable future, even with paring of purchases of longer term bonds for the portfolio of the Fed (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):
“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy 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” (emphasis added).
Another critical concern in the statement of the FOMC on Sep 18, 2013, is on the effects of tapering expectations on interest rates (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):
“Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth” (emphasis added).
Carry trades induced by zero interest rates increase the volatility of inflation σp and real income σy. World inflation waves originating in carry trades from zero interest rates to commodity futures and options deteriorate the sales prices of producing and investing companies net of costs of inputs and real income of consumers. The main objective of monetary policy is providing for financial stability. Unconventional monetary policy creates economic instability with higher volatilities of prices and real income as well as financial instability with major oscillations of risk financial assets. Carry trades induced by zero interest rates cause alternating improvements and deteriorations of net margins of sales prices less costs of raw materials and real income of consumers, disrupting decisions on production, investment and consumption.
Table IA-1 provides annual equivalent rates of inflation for producer price indexes followed in this blog of countries and regions that account for close to three quarters of world output. The behavior of the US producer price index in 2011 and into 2012-2013 shows neatly multiple waves. (1) In Jan-Apr 2011, without risk aversion, US producer prices rose at the annual equivalent rate of 10.0 percent. (2) After risk aversion, producer prices increased in the US at the annual equivalent rate of 1.8 percent in May-Jun 2011. (3) From Jul to Sep 2011, under alternating episodes of risk aversion, producer prices increased at the annual equivalent rate of 4.9 percent. (4) Under the pressure of risk aversion because of the European debt crisis, US producer prices increased at the annual equivalent rate of 0.6 percent in Oct-Nov 2011. (5) From Dec 2011 to Jan 2012, US producer were flat at the annual equivalent rate of 0.0 percent. (6) Inflation of producer prices returned with 2.4 percent annual equivalent in Feb-Mar 2012. (7) With return of risk aversion from the European debt crisis, producer prices fell at the annual equivalent rate of 4.7 percent in Apr-May 2012. (8) New positions in commodity futures even with continuing risk aversion caused annual equivalent inflation of 3.0 percent in Jun-Jul 2012. (9) Relaxed risk aversion because of announcement of sovereign bond buying by the European Central Bank induced carry trades that resulted in annual equivalent producer price inflation in the US of 12.7 percent in Aug-Sep 2012. (10) Renewed risk aversion caused unwinding of carry trades of zero interest rates to commodity futures exposures with annual equivalent inflation of minus 3.2 percent in Oct-Dec 2012. (10) In Jan-Feb 2013, producer prices rose at the annual equivalent rate of 5.5 percent with more relaxed risk aversion at the margin. (11) Return of risk aversion resulted in annual equivalent inflation of minus 7.5 percent in Mar-Apr 2013 with worldwide portfolio reallocation toward equities and high-yield bonds and away from commodity exposures. (12) Inflation of producer prices returned at 4.9 percent in annual equivalent in May-Aug 2013. Resolution of the European debt crisis if there is not an unfavorable growth event with political development in China would result in jumps of valuations of risk financial assets. Increases in commodity prices would cause the same high producer price inflation experienced in Jan-Apr 2011 and Aug-Sep 2012. An episode of exploding commodity prices could ignite inflationary expectations that would result in an inflation phenomenon of costly resolution. There are nine producer-price indexes in Table IA-1 for seven countries (two for the UK) and one region (euro area) showing very similar behavior. Zero interest rates without risk aversion cause increases in commodity prices that in turn increase input prices at a faster pace than output prices. Producer price inflation rose at very high rates during the first part of 2011 for the US, Japan, China, Euro Area, Germany, France, Italy and the UK when risk aversion was contained. With the increase in risk aversion in May and Jun 2011, inflation moderated because carry trades were unwound. Producer price inflation returned after Jul 2011, with alternating bouts of risk aversion. In the final months of the year producer price inflation collapsed because of the disincentive to exposures in commodity futures resulting from fears of resolution of the European debt crisis. There is renewed worldwide inflation in the early part of 2012 with subsequent collapse because of another round of sharp risk aversion and relative portfolio reallocation away from commodities and into equities and high-yield bonds. Sharp worldwide jump in producer prices occurred recently because of the combination of zero interest rates forever or QE→∞ with temporarily relaxed risk aversion. Producer prices were moderating or falling in the final months of 2012 because of renewed risk aversion that causes unwinding of carry trades from zero interest rates to commodity futures exposures. In the first months of 2013, new carry trades caused higher worldwide inflation. Unconventional monetary policy fails in stimulating the overall real economy, merely introducing undesirable instability because monetary authorities cannot control allocation of floods of money at zero interest rates to carry trades into risk financial assets. The economy is constrained in a suboptimal allocation of resources that is perpetuated along a continuum of short-term periods. The result is long-term or dynamic inefficiency in the form of a trajectory of economic activity that is lower than what would be attained with rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html).
Table IA-1, Annual Equivalent Rates of Producer Price Indexes
| INDEX 2011-2013 | AE ∆% |
| US Producer Price Index | |
| AE ∆% May-Aug 2013 | 4.9 |
| AE ∆% Mar-Apr 2013 | -7.5 |
| AE ∆% Jan-Feb 2013 | 5.5 |
| AE ∆% Oct-Dec 2012 | -3.2 |
| AE ∆% Aug-Sep 2012 | 12.7 |
| AE ∆% Jun-Jul 2012 | 3.0 |
| AE ∆% Apr-May 2012 | -4.7 |
| AE ∆% Feb-Mar 2012 | 2.4 |
| AE ∆% Dec 2011-Jan-2012 | 0.0 |
| AE ∆% Oct-Nov 2011 | 0.6 |
| AE ∆% Jul-Sep 2011 | 4.9 |
| AE ∆% May-Jun 2011 | 1.8 |
| AE ∆% Jan-Apr 2011 | 10.0 |
| Japan Corporate Goods Price Index | |
| AE ∆% Dec 2012-Aug 2013 | 3.5 |
| AE ∆% Oct-Nov 2012 | -3.0 |
| AE ∆% Aug-Sep 2012 | 3.0 |
| AE ∆% May-Jul 2012 | -5.8 |
| AE ∆% Feb-Apr 2012 | 2.0 |
| AE ∆% Dec 2011-Jan 2012 | -0.6 |
| AE ∆% Jul-Nov 2011 | -2.2 |
| AE ∆% May-Jun 2011 | -1.2 |
| AE ∆% Jan-Apr 2011 | 5.9 |
| China Producer Price Index | |
| AE ∆% Aug 2013 | 1.2 |
| AE ∆% Mar-Jul 2013 | -4.9 |
| AE ∆% Jan-Feb 2013 | 2.4 |
| AE ∆% Nov-Dec 2012 | -1.2 |
| AE ∆% Oct 2012 | 2.4 |
| AE ∆% May-Sep 2012 | -5.8 |
| AE ∆% Feb-Apr 2012 | 2.4 |
| AE ∆% Dec 2011-Jan 2012 | -2.4 |
| AE ∆% Jul-Nov 2011 | -3.1 |
| AE ∆% Jan-Jun 2011 | 6.4 |
| Euro Zone Industrial Producer Prices | |
| AE ∆% Jul 2013 | 3.7 |
| AE ∆% Mar-Jun 2013 | -3.3 |
| AE ∆% Jan-Feb 2013 | 3.7 |
| AE ∆% Nov-Dec 2012 | -2.4 |
| AE ∆% Sep-Oct 2012 | 0.6 |
| AE ∆% Jul-Aug 2012 | 7.4 |
| AE ∆% Apr-Jun 2012 | -2.0 |
| AE ∆% Jan-Mar 2012 | 8.3 |
| AE ∆% Oct-Dec 2011 | 0.4 |
| AE ∆% Jul-Sep 2011 | 2.8 |
| AE ∆% May-Jun 2011 | -0.6 |
| AE ∆% Jan-Apr 2011 | 11.4 |
| Germany Producer Price Index | |
| AE ∆% May-Jul 2013 | -1.6 NSA 1.2 SA |
| AE ∆% Feb-Apr 2013 | -2.0 NSA –2.8 SA |
| AE ∆% Jan 2013 | 10.0 NSA 2.4 SA |
| AE ∆% Oct-Dec 2012 | -1.6 NSA 1.2 SA |
| AE ∆% Aug-Sep 2012 | 4.9 NSA 4.3 SA |
| AE ∆% May-Jul 2012 | -2.8 NSA –1.2 SA |
| AE ∆% Feb-Apr 2012 | 4.9 NSA 2.4 SA |
| AE ∆% Dec 2011-Jan 2012 | 1.2 NSA –0.6 SA |
| AE ∆% Oct-Nov 2011 | 1.8 NSA 2.4 SA |
| AE ∆% Jul-Sep 2011 | 2.8 NSA 2.8 SA |
| AE ∆% May-Jun 2011 | 0.6 NSA 4.3 SA |
| AE ∆% Jan-Apr 2011 | 10.4 NSA 6.5 SA |
| France Producer Price Index for the French Market | |
| AE ∆% Jul 2013 | 8.7 |
| AE ∆% Apr-Jun 2013 | -10.3 |
| AE ∆% Jan-Mar 2013 | 4.9 |
| AE ∆% Nov-Dec 2012 | -4.1 |
| AE ∆% Jul-Oct 2012 | 7.4 |
| AE ∆% Apr-Jun 2012 | -4.3 |
| AE ∆% Jan-Mar 2012 | 6.2 |
| AE ∆% Oct-Dec 2011 | 2.8 |
| AE ∆% Jul-Sep 2011 | 3.7 |
| AE ∆% May-Jun 2011 | -1.8 |
| AE ∆% Jan-Apr 2011 | 10.4 |
| Italy Producer Price Index | |
| AE ∆% Jun-Jul 2013 | 3.0 |
| AE ∆% Apr-May 2013 | -3.5 |
| AE ∆% Feb-Mar 2013 | 1.2 |
| AE ∆% Sep 2012-Jan 2013 | -5.2 |
| AE ∆% Jul-Aug 2012 | 9.4 |
| AE ∆% May-Jun 2012 | -0.6 |
| AE ∆% Mar-Apr 2012 | 6.8 |
| AE ∆% Jan-Feb 2012 | 8.1 |
| AE ∆% Oct-Dec 2011 | 2.0 |
| AE ∆% Jul-Sep 2011 | 4.9 |
| AE ∆% May-Jun 2011 | 1.8 |
| AE ∆% Jan-April 2011 | 10.7 |
| UK Output Prices | |
| AE ∆% Jun-Aug 2013 | 1.2 |
| AE ∆% Apr-May 2013 | -1.8 |
| AE ∆% Jan-Mar 2013 | 5.3 |
| AE ∆% Nov-Dec 2012 | -3.0 |
| AE ∆% Jul-Oct 2012 | 4.0 |
| AE ∆% May-Jun 2012 | -5.3 |
| AE ∆% Feb-Apr 2012 | 7.9 |
| AE ∆% Nov 2011-Jan-2012 | 1.6 |
| AE ∆% May-Oct 2011 | 2.0 |
| AE ∆% Jan-Apr 2011 | 12.0 |
| UK Input Prices | |
| AE ∆% Aug 2013 | -2.4 |
| AE ∆% Jun-Jul 2013 | 8.7 |
| AE ∆% Mar-May 2013 | -11.4 |
| AE ∆% Jan-Feb 2013 | 28.3 |
| AE ∆% Sep-Dec 2012 | 1.5 |
| AE ∆% Jul-Aug 2012 | 14.0 |
| AE ∆% Apr-Jun 2012 | -21.9 |
| AE ∆% Jan-Mar 2012 | 18.1 |
| AE ∆% Nov-Dec 2011 | -1.2 |
| AE ∆% May-Oct 2011 | -3.1 |
| AE ∆% Jan-Apr 2011 | 35.6 |
AE: Annual Equivalent
Sources: http://www.bls.gov/cpi/ http://www.boj.or.jp/en/
http://www.stats.gov.cn/enGliSH/
http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database
https://www.destatis.de/EN/Homepage.html
http://www.insee.fr/en/default.asp
http://www.ons.gov.uk/ons/index.html
Similar world inflation waves are in the behavior of consumer price indexes of six countries and the euro zone in Table IA-2. US consumer price inflation shows similar waves. (1) Under risk appetite in Jan-Apr 2011, consumer prices increased at the annual equivalent rate of 4.6 percent. (2) Risk aversion caused the collapse of inflation to annual equivalent 3.0 percent in May-Jun 2011. (3) Risk appetite drove the rate of consumer price inflation in the US to 3.3 percent in Jul-Sep 2011. (4) Gloomier views of carry trades caused the collapse of inflation in Oct-Nov 2011 to annual equivalent 0.6 percent. (5) Consumer price inflation resuscitated with increased risk appetite at annual equivalent of 1.2 percent in Dec 2011 to Jan 2012. (6) Consumer price inflation returned at 2.4 percent annual equivalent in Feb-Apr 2012. (7) Under renewed risk aversion, annual equivalent consumer price inflation in the US was 0.0 percent in May-Jul 2012. (8) Inflation jumped to annual equivalent 4.9 percent in Aug-Oct 2012. (9) Unwinding of carry trades caused negative annual equivalent inflation of 0.8 percent in Nov 2012-Jan 2013 but some countries experienced higher inflation in Dec 2012 and Jan 2013. (10) Inflation jumped again with annual equivalent inflation of 8.7 percent in Feb 2013 in a mood of relaxed risk aversion. (11) Inflation fell at 3.5 percent annual equivalent in Mar-Apr 2013. (12) Inflation rose at 2.7 percent in annual equivalent in May-Jul 2013. Inflationary expectations can be triggered in one of these episodes of accelerating inflation because of commodity carry trades induced by unconventional monetary policy of zero interest rates in perpetuity or QE→∞ in almost continuous time. Alternating episodes of increase and decrease of inflation introduce uncertainty in household planning that frustrates consumption and home buying. Announcement of purchases of impaired sovereign bonds by the European Central Bank relaxed risk aversion that induced carry trades into commodity exposures, increasing prices of food, raw materials and energy. There is similar behavior in all the other consumer price indexes in Table IA-2. China’s CPI increased at annual equivalent 8.3 percent in Jan-Mar 2011, 2.0 percent in Apr-Jun, 2.9 percent in Jul-Nov and resuscitated at 5.8 percent annual equivalent in Dec 2011 to Mar 2012, declining to minus 3.9 percent in Apr-Jun 2012 but resuscitating at 4.1 percent in Jul-Sep 2012, declining to minus 1.2 percent in Oct 2012 and 0.0 percent in Oct-Nov 2012. High inflation in China at annual equivalent 5.5 percent in Nov-Dec 2012 is attributed to inclement winter weather that caused increases in food prices. Continuing pressure of food prices caused annual equivalent inflation of 12.2 percent in China in Dec 2012 to Feb 2013. Inflation in China fell at annual equivalent 10.3 percent in Mar 2013 and increased at annual equivalent 2.4 percent in Apr 2013. Adjustment to lower food prices caused annual equivalent inflation of minus 7.0 percent in May 2013 and minus 3.5 percent in annual equivalent in May-Jun 2013. Inflation in China returned at annual equivalent 3.8 percent in Jul-Aug 2013. The euro zone harmonized index of consumer prices (HICP) increased at annual equivalent 5.2 percent in Jan-Apr 2011, minus 2.4 percent in May-Jul 2011, 4.3 percent in Aug-Dec 2011, minus 3.0 percent in Dec 2011-Jan 2012 and then 9.6 percent in Feb-Apr 2012, falling to minus 2.8 percent annual equivalent in May-Jul 2012 but resuscitating at 5.3 percent in Aug-Oct 2012. The recent shock of risk aversion forced minus 2.4 percent annual equivalent in Nov 2012. As in several European countries, annual equivalent inflation jumped to 4.9 percent in the euro area in Dec 2012. The HICP price index fell at annual equivalent 11.4 percent in Jan 2013 and increased at 10.0 percent in Feb-Mar 2013. As in most countries and regions, euro zone inflation fell at the annual equivalent rate of 1.2 percent in Apr 2013. Prices in the euro zone rose at 1.2 percent in May-Jun 2013. Inflation in the euro zone fell at annual equivalent 5.8 percent in Jul 2013. Inflation returned in the euro zone at annual equivalent 1.2 percent in Aug 2013. The price indexes of the largest members of the euro zone, Germany, France and Italy, and the euro zone as a whole, exhibit the same inflation waves. The United Kingdom CPI increased at annual equivalent 6.5 percent in Jan-Apr 2011, falling to only 0.4 percent in May-Jul 2011 and then increasing at 4.6 percent in Aug-Nov 2011. UK consumer prices fell at 0.6 percent annual equivalent in Dec 2011 to Jan 2012 but increased at 6.2 percent annual equivalent from Feb to Apr 2012. In May-Jun 2012, with renewed risk aversion, UK consumer prices fell at the annual equivalent rate of minus 3.0 percent. Inflation returned in the UK at average annual equivalent of 4.5 percent in Jul-Dec 2012 with inflation in Oct 2012 caused mostly by increases of university tuition fees. Inflation returned at 4.5 percent annual equivalent in Jul-Dec 2012 and was higher in annual equivalent inflation of producer prices in the UK in Jul-Oct 2012 at 4.0 percent for output prices and 14.0 percent for input prices in Jul-Aug 2012 (see Table IA-1). Consumer prices in the UK fell at annual equivalent 5.8 percent in Jan 2013. Inflation returned in the UK with annual equivalent 4.3 percent in Feb-May 2013 and fell at 1.2 percent in Jun-Jul 2013. UK annual equivalent inflation returned at 4.9 percent in Aug 2013.
Table IA-2, Annual Equivalent Rates of Consumer Price Indexes
| Index 2011-2013 | AE ∆% |
| US Consumer Price Index | |
| AE ∆% May-Aug 2013 | 2.7 |
| AE ∆% Mar-Apr 2013 | -3.5 |
| AE ∆% Feb 2013 | 8.7 |
| AE ∆% Nov 2012-Jan 2013 | -0.8 |
| AE ∆% Aug-Oct 2012 | 4.9 |
| AE ∆% May-Jul 2012 | 0.0 |
| AE ∆% Feb-Apr 2012 | 2.4 |
| AE ∆% Dec 2011-Jan 2012 | 1.2 |
| AE ∆% Oct-Nov 2011 | 0.6 |
| AE ∆% Jul-Sep 2011 | 3.3 |
| AE ∆% May-Jun 2011 | 3.0 |
| AE ∆% Jan-Apr 2011 | 4.6 |
| China Consumer Price Index | |
| AE ∆% Jul-Aug 2013 | 3.8 |
| AE ∆% May-Jun 2013 | -3.5 |
| AE ∆% Apr 2013 | 2.4 |
| AE ∆% Mar 2013 | -10.3 |
| AE ∆% Dec 2012-Feb 2013 | 12.2 |
| AE ∆% Oct-Nov 2012 | 0.0 |
| AE ∆% Jul-Sep 2012 | 4.1 |
| AE ∆% Apr-Jun 2012 | -3.9 |
| AE ∆% Dec 2011-Mar 2012 | 5.8 |
| AE ∆% Jul-Nov 2011 | 2.9 |
| AE ∆% Apr-Jun 2011 | 2.0 |
| AE ∆% Jan-Mar 2011 | 8.3 |
| Euro Zone Harmonized Index of Consumer Prices | |
| AE ∆% Aug 2013 | 1.2 |
| AE ∆% Jul 2013 | -5.8 |
| AE ∆% May-Jun 2013 | 1.2 |
| AE ∆% Apr 2013 | -1.2 |
| AE ∆% Feb-Mar 2013 | 10.0 |
| AE ∆% Jan 2013 | -11.4 |
| AE ∆% Dec 2012 | 4.9 |
| AE ∆% Nov 2012 | -2.4 |
| AE ∆% Aug-Oct 2012 | 5.3 |
| AE ∆% May-Jul 2012 | -2.8 |
| AE ∆% Feb-Apr 2012 | 9.6 |
| AE ∆% Dec 2011-Jan 2012 | -3.0 |
| AE ∆% Aug-Nov 2011 | 4.3 |
| AE ∆% May-Jul 2011 | -2.4 |
| AE ∆% Jan-Apr 2011 | 5.2 |
| Germany Consumer Price Index | |
| AE ∆% May-Aug 2013 | 3.0 NSA 2.7 SA |
| AE ∆% Apr 2013 | -5.8 NSA 0.0 SA |
| AE ∆% Feb-Mar 2013 | 6.8 NSA 1.2 SA |
| AE ∆% Jan 2013 | -5.8 NSA –1.2 SA |
| AE ∆% Sep-Dec 2012 | 1.5 NSA 1.5 SA |
| AE ∆% Jul-Aug 2012 | 4.9 NSA 3.0 SA |
| AE ∆% May-Jun 2012 | -1.2 NSA 0.6 SA |
| AE ∆% Feb-Apr 2012 | 4.5 NSA 2.4 SA |
| AE ∆% Dec 2011-Jan 2012 | 0.6 NSA 1.8 SA |
| AE ∆% Jul-Nov 2011 | 1.7 NSA 1.9 SA |
| AE ∆% May-Jun 2011 | 0.6 NSA 3.0 SA |
| AE ∆% Feb-Apr 2011 | 3.0 NSA 2.4 SA |
| France Consumer Price Index | |
| AE ∆% Aug 2013 | 6.2 |
| AE ∆% Jul 2013 | -3.5 |
| AE ∆% May-Jun 2013 | 1.8 |
| AE ∆% Apr 2013 | -1.2 |
| AE ∆% Feb-Mar 2013 | 6.8 |
| AE ∆% Nov 2012-Jan 2013 | -1.6 |
| AE ∆% Aug-Oct 2012 | 2.8 |
| AE ∆% May-Jul 2012 | -2.4 |
| AE ∆% Feb-Apr 2012 | 5.3 |
| AE ∆% Dec 2011-Jan 2012 | 0.0 |
| AE ∆% Aug-Nov 2011 | 3.0 |
| AE ∆% May-Jul 2011 | -1.2 |
| AE ∆% Jan-Apr 2011 | 4.3 |
| Italy Consumer Price Index | |
| AE ∆% Dec 2012-Aug 2013 | 2.1 |
| AE ∆% Sep-Nov 2012 | -0.8 |
| AE ∆% Jul-Aug 2012 | 3.0 |
| AE ∆% May-Jun 2012 | 1.2 |
| AE ∆% Feb-Apr 2012 | 5.7 |
| AE ∆% Dec 2011-Jan 2012 | 4.3 |
| AE ∆% Oct-Nov 2011 | 3.0 |
| AE ∆% Jul-Sep 2011 | 2.4 |
| AE ∆% May-Jun 2011 | 1.2 |
| AE ∆% Jan-Apr 2011 | 4.9 |
| UK Consumer Price Index | |
| AE ∆% Aug 2013 | 4.9 |
| AE ∆% Jun-Jul 2013 | -1.2 |
| AE ∆% Feb-May 2013 | 4.3 |
| AE ∆% Jan 2013 | -5.8 |
| AE ∆% Jul-Dec 2012 | 4.5 |
| AE ∆% May-Jun 2012 | -3.0 |
| AE ∆% Feb-Apr 2012 | 6.2 |
| AE ∆% Dec 2011-Jan 2012 | -0.6 |
| AE ∆% Aug-Nov 2011 | 4.6 |
| AE ∆% May-Jul 2011 | 0.4 |
| AE ∆% Jan-Apr 2011 | 6.5 |
AE: Annual Equivalent
Sources: http://www.bls.gov/cpi/
http://www.stats.gov.cn/enGliSH/
http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database
https://www.destatis.de/EN/Homepage.html
http://www.insee.fr/en/default.asp
IIA Appendix: Transmission of Unconventional Monetary Policy. Janet L. Yellen, Vice Chair of the Board of Governors of the Federal Reserve System, provides analysis of the policy of purchasing large amounts of long-term securities for the Fed’s balance sheet. The new analysis provides three channels of transmission of quantitative easing to the ultimate objectives of increasing growth and employment and increasing inflation to “levels of 2 percent or a bit less that most Committee participants judge to be consistent, over the long run, with the FOMC’s dual mandate” (Yellen 2011AS, 4, 7):
“There are several distinct channels through which these purchases tend to influence aggregate demand, including a reduced cost of credit to consumers and businesses, a rise in asset prices that boost household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.”
The new analysis by Yellen (2011AS) is considered below in four separate subsections: IIA1 Theory; IIA2 Policy; IIA3 Evidence; and IIA4 Unwinding Strategy.
IIA1 Theory. The transmission mechanism of quantitative easing can be analyzed in three different forms. (1) Portfolio choice theory. General equilibrium value theory was proposed by Hicks (1935) in analyzing the balance sheets of individuals and institutions with assets in the capital segment consisting of money, debts, stocks and productive equipment. Net worth or wealth would be comparable to income in value theory. Expected yield and risk would be the constraint comparable to income in value theory. Markowitz (1952) considers a portfolio of individual securities with mean μp and variance σp. The Markowitz (1952, 82) rule states that “investors would (or should” want to choose a portfolio of combinations of (μp, σp) that are efficient, which are those with minimum variance or risk for given expected return μp or more and maximum expected μp for given variance or risk or less. The more complete model of Tobin (1958) consists of portfolio choice of monetary assets by maximizing a utility function subject to a budget constraint. Tobin (1961, 28) proposes general equilibrium analysis of the capital account to derive choices of capital assets in balance sheets of economic units with the determination of yields in markets for capital assets with the constraint of net worth. A general equilibrium model of choice of portfolios was developed simultaneously by various authors (Hicks 1962; Treynor 1962; Sharpe 1964; Lintner 1965; Mossin 1966). If shocks such as by quantitative easing displace investors from the efficient frontier, there would be reallocations of portfolios among assets until another efficient point is reached. Investors would bid up the prices or lower the returns (interest plus capital gains) of long-term assets targeted by quantitative easing, causing the desired effect of lowering long-term costs of investment and consumption.
(2) General Equilibrium Theory. Bernanke and Reinhart (2004, 88) argue that “the possibility monetary policy works through portfolio substitution effects, even in normal times, has a long intellectual history, having been espoused by both Keynesians (James Tobin 1969) and monetarists (Karl Brunner and Allan Meltzer 1973).” Andres et al. (2004) explain the Tobin (1969) contribution by optimizing agents in a general-equilibrium model. Both Tobin (1969) and Brunner and Meltzer (1973) consider capital assets to be gross instead of perfect substitutes with positive partial derivatives of own rates of return and negative partial derivatives of cross rates in the vector of asset returns (interest plus principal gain or loss) as argument in portfolio balancing equations (see Pelaez and Suzigan 1978, 113-23). Tobin (1969, 26) explains portfolio substitution after monetary policy:
“When the supply of any asset is increased, the structure of rates of return, on this and other assets, must change in a way that induces the public to hold the new supply. When the asset’s own rate can rise, a large part of the necessary adjustment can occur in this way. But if the rate is fixed, the whole adjustment must take place through reductions in other rates or increases in prices of other assets. This is the secret of the special role of money; it is a secret that would be shared by any other asset with a fixed interest rate.”
Andrés et al. (2004, 682) find that in their multiple-channels model “base money expansion now matters for the deviations of long rates from the expected path of short rates. Monetary policy operates by both the expectations channel (the path of current and expected future short rates) and this additional channel. As in Tobin’s framework, interest rates spreads (specifically, the deviations from the pure expectations theory of the term structure) are an endogenous function of the relative quantities of assets supplied.”
The interrelation among yields of default-free securities is measured by the term structure of interest rates. This schedule of interest rates along time incorporates expectations of investors. (Cox, Ingersoll and Ross 1985). The expectations hypothesis postulates that the expectations of investors about the level of future spot rates influence the level of current long-term rates. The normal channel of transmission of monetary policy in a recession is to lower the target of the fed funds rate that will lower future spot rates through the term structure and also the yields of long-term securities. The expectations hypothesis is consistent with term premiums (Cox, Ingersoll and Ross 1981, 774-7) such as liquidity to compensate for risk or uncertainty about future events that can cause changes in prices or yields of long-term securities (Hicks 1935; see Cox, Ingersoll and Ross 1981, 784; Chung et al. 2011, 22).
(3) Preferred Habitat. Another approach is by the preferred-habitat models proposed by Culbertson (1957, 1963) and Modigliani and Sutch (1966). This approach is formalized by Vayanos and Vila (2009). The model considers investors or “clientele” who do not abandon their segment of operations unless there are extremely high potential returns and arbitrageurs who take positions to profit from discrepancies. Pension funds matching benefit liabilities would operate in segments above 15 years; life insurance companies operate around 15 years or more; and asset managers and bank treasury managers are active in maturities of less than 10 years (Ibid, 1). Hedge funds, proprietary trading desks and bank maturity transformation activities are examples of potential arbitrageurs. The role of arbitrageurs is to incorporate “information about current and future short rates into bond prices” (Ibid, 12). Suppose monetary policy raises the short-term rate above a certain level. Clientele would not trade on this information, but arbitrageurs would engage in carry trade, shorting bonds and investing at the short-term rate, in a “roll-up” trade, resulting in decline of bond prices or equivalently increases in yields. This is a situation of an upward-sloping yield curve. If the short-term rate were lowered, arbitrageurs would engage in carry trade borrowing at the short-term rate and going long bonds, resulting in an increase in bond prices or equivalently decline in yields, or “roll-down” trade. The carry trade is the mechanism by which bond yields adjust to changes in current and expected short-term interest rates. The risk premiums of bonds are positively associated with the slope of the term structure (Ibid, 13). Fama and Bliss (1987, 689) find with data for 1964-85 that “1-year expected returns for US Treasury maturities to 5 years, measured net of the interest rate on a 1-year bond, vary through time. Expected term premiums are mostly positive during good times but mostly negative during recessions.” Vayanos and Vila (2009) develop a model with two-factors, the short-term rate and demand or quantity. The term structure moves because of shocks of short-term rates and demand. An important finding is that demand or quantity shocks are largest for intermediate and long maturities while short-rate shocks are largest for short-term maturities.
IIA2 Policy. A simplified analysis could consider the portfolio balance equations Aij = f(r, x) where Aij is the demand for i = 1,2,∙∙∙n assets from j = 1,2, ∙∙∙m sectors, r the 1xn vector of rates of return, ri, of n assets and x a vector of other relevant variables. Tobin (1969) and Brunner and Meltzer (1973) assume imperfect substitution among capital assets such that the own first derivatives of Aij are positive, demand for an asset increases if its rate of return (interest plus capital gains) is higher; and cross first derivatives are negative, demand for an asset decreases if the rate of return of alternative assets increases. Theoretical purity would require the estimation of the complete model with all rates of return. In practice, it may be impossible to observe all rates of return such as in the critique of Roll (1976). Policy proposals by the Fed have been focused on the likely impact of withdrawals of stocks of securities in specific segments, that is, of effects of one or several specific rates of return among the n possible rates. There have been at least seven approaches on the role of monetary policy in purchasing long-term securities that have increased the classes of rates of return targeted by the Fed:
(1) Suspension of Auctions of 30-year Treasury Bonds. Auctions of 30-year Treasury bonds were suspended between 2001 and 2005. This was Treasury policy not Fed policy. The effects were similar to those of quantitative easing: withdrawal of supply from the segment of 30-year bonds would result in higher prices or lower yields for close-substitute mortgage-backed securities with resulting lower mortgage rates. The objective was to encourage refinancing of house loans that would increase family income and consumption by freeing income from reducing monthly mortgage payments.
(2) Purchase of Long-term Securities by the Fed. Between Nov 2008 and Mar 2009 the Fed announced the intention of purchasing $1750 billion of long-term securities: $600 billion of agency mortgage-backed securities and agency debt announced on Nov 25 and $850 billion of agency mortgaged-backed securities and agency debt plus $300 billion of Treasury securities announced on Mar 18, 2009 (Yellen 2011AS, 5-6). The objective of buying mortgage-backed securities was to lower mortgage rates that would “support the housing sector” (Bernanke 2009SL). The FOMC statement on Dec 16, 2008 informs that: “over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and its stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant” (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). The Mar 18, 2009, statement of the FOMC explained that: “to provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities up to $1.25 trillion this year, and to increase its purchase of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months” (http://www.federalreserve.gov/newsevents/press/monetary/20090318a.htm). Policy changed to increase prices or reduce yields of mortgage-backed securities and Treasury securities with the objective of supporting housing markets and private credit markets by lowering costs of housing and long-term private credit.
(3) Portfolio Reinvestment. On Aug 10, 2010, the FOMC statement explains the reinvestment policy: “to help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in long-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature” (http://www.federalreserve.gov/newsevents/press/monetary/20100810a.htm). The objective of policy appears to be supporting conditions in housing and mortgage markets with slow transfer of the portfolio to Treasury securities that would support private-sector markets.
(4) Increasing Portfolio. As widely anticipated, the FOMC decided on Dec 3, 2010: “to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month” (http://www.federalreserve.gov/newsevents/press/monetary/20101103a.htm). The emphasis appears to shift from housing markets and private-sector credit markets to the general economy, employment and preventing deflation.
(5) Increasing Stock Market Valuations. Chairman Bernanke (2010WP) explained on Nov 4 the objectives of purchasing an additional $600 billion of long-term Treasury securities and reinvesting maturing principal and interest in the Fed portfolio. Long-term interest rates fell and stock prices rose when investors anticipated the new round of quantitative easing. Growth would be promoted by easier lending such as for refinancing of home mortgages and more investment by lower corporate bond yields. Consumers would experience higher confidence as their wealth in stocks rose, increasing outlays. Income and profits would rise and, in a “virtuous circle,” support higher economic growth. Bernanke (2000) analyzes the role of stock markets in central bank policy (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-100). Fed policy in 1929 increased interest rates to avert a gold outflow and failed to prevent the deepening of the banking crisis without which the Great Depression may not have occurred. In the crisis of Oct 19, 1987, Fed policy supported stock and futures markets by persuading banks to extend credit to brokerages. Collapse of stock markets would slow consumer spending.
(6) Devaluing the Dollar. Yellen (2011AS, 6) broadens the effects of quantitative easing by adding dollar devaluation: “there are several distinct channels through which these purchases tend to influence aggregate demand, including a reduced cost of credit to consumers and businesses, a rise in asset prices that boosts household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.”
(7) Let’s Twist Again Monetary Policy. The term “operation twist” grew out of the dance “twist” popularized by successful musical performer Chubby Chekker (http://www.youtube.com/watch?v=aWaJ0s0-E1o). Meulendyke (1998, 39) describes the coordination of policy by Treasury and the FOMC in the beginning of the Kennedy administration in 1961 (see Modigliani and Sutch 1966, 1967; http://cmpassocregulationblog.blogspot.com/2011/09/imf-view-of-world-economy-and-finance.html http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html):
“In 1961, several developments led the FOMC to abandon its “bills only” restrictions. The new Kennedy administration was concerned about gold outflows and balance of payments deficits and, at the same time, it wanted to encourage a rapid recovery from the recent recession. Higher rates seemed desirable to limit the gold outflows and help the balance of payments, while lower rates were wanted to speed up economic growth.
To deal with these problems simultaneously, the Treasury and the FOMC attempted to encourage lower long-term rates without pushing down short-term rates. The policy was referred to in internal Federal Reserve documents as “operation nudge” and elsewhere as “operation twist.” For a few months, the Treasury engaged in maturity exchanges with trust accounts and concentrated its cash offerings in shorter maturities.
The Federal Reserve participated with some reluctance and skepticism, but it did not see any great danger in experimenting with the new procedure.
It attempted to flatten the yield curve by purchasing Treasury notes and bonds while selling short-term Treasury securities. The domestic portfolio grew by $1.7 billion over the course of 1961. Note and bond holdings increased by a substantial $8.8 billion, while certificate of indebtedness holdings fell by almost $7.4 billion (Table 2). The extent to which these actions changed the yield curve or modified investment decisions is a source of dispute, although the predominant view is that the impact on yields was minimal. The Federal Reserve continued to buy coupon issues thereafter, but its efforts were not very aggressive. Reference to the efforts disappeared once short-term rates rose in 1963. The Treasury did not press for continued Fed purchases of long-term debt. Indeed, in the second half of the decade, the Treasury faced an unwanted shortening of its portfolio. Bonds could not carry a coupon with a rate above 4 1/4 percent, and market rates persistently exceeded that level. Notes—which were not subject to interest rate restrictions—had a maximum maturity of five years; it was extended to seven years in 1967.”
As widely anticipated by markets, perhaps intentionally, the Federal Open Market Committee (FOMC) decided at its meeting on Sep 21 that it was again “twisting time” (http://www.federalreserve.gov/newsevents/press/monetary/20110921a.htm):
“Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.
The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate.”
The FOMC decided at its meeting on Jun 20, 2012, to continue “Let’s Twist Again” monetary policy until the end of 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120620a.htm http://www.newyorkfed.org/markets/opolicy/operating_policy_120620.html):
“The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
IIA3 Evidence. There are multiple empirical studies on the effectiveness of quantitative easing that have been covered in past posts such as (Andrés et al. 2004, D’Amico and King 2010, Doh 2010, Gagnon et al. 2010, Hamilton and Wu 2010). On the basis of simulations of quantitative easing with the FRB/US econometric model, Chung et al (2011, 28-9) find that:
”Lower long-term interest rates, coupled with higher stock market valuations and a lower foreign exchange value of the dollar, provide a considerable stimulus to real activity over time. Phase 1 of the program by itself is estimated to boost the level of real GDP almost 2 percent above baseline by early 2012, while the full program raises the level of real GDP almost 3 percent by the second half of 2012. This boost to real output in turn helps to keep labor market conditions noticeably better than they would have been without large scale asset purchases. In particular, the model simulations suggest that private payroll employment is currently 1.8 million higher, and the unemployment rate ¾ percentage point lower, that would otherwise be the case. These benefits are predicted to grow further over time; by 2012, the incremental contribution of the full program is estimated to be 3 million jobs, with an additional 700,000 jobs provided by the most recent phase of the program alone.”
An additional conclusion of these simulations is that quantitative easing may have prevented actual deflation. Empirical research is continuing.
IIA4 Unwinding Strategy. Fed Vice-Chair Yellen (2011AS) considers four concerns on quantitative easing discussed below in turn. First, Excessive Inflation. Yellen (2011AS, 9-12) considers concerns that quantitative easing could result in excessive inflation because fast increases in aggregate demand from quantitative easing could raise the rate of inflation, posing another problem of adjustment with tighter monetary policy or higher interest rates. The Fed estimates significant slack of resources in the economy as measured by the difference of four percentage points between the high current rate of unemployment above 9 percent and the NAIRU (non-accelerating rate of unemployment) of 5.75 percent (Ibid, 2). Thus, faster economic growth resulting from quantitative easing would not likely result in upward trend of costs as resources are bid up competitively. The Fed monitors frequently slack indicators and is committed to maintaining inflation at a “level of 2 percent or a bit less than that” (Ibid, 13), say, in the narrow open interval (1.9, 2.1).
Second, Inflation and Bank Reserves. On Jan 12, 2012, the line “Reserve Bank credit” in the Fed balance sheet stood at $2450.6 billion, or $2.5 trillion, with the portfolio of long-term securities of $2175.7 billion, or $2.2 trillion, composed of $987.6 billion of notes and bonds, $49.7 billion of inflation-adjusted notes and bonds, $146.3 billion of Federal agency debt securities, and $992.1 billion of mortgage-backed securities; reserves balances with Federal Reserve Banks stood at $1095.5 billion, or $1.1 trillion (http://federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The concern addressed by Yellen (2011AS, 12-4) is that this high level of reserves could eventually result in demand growth that could accelerate inflation. Reserves would be excessively high relative to the levels before the recession. Reserves of depository institutions at the Federal Reserve Banks rose from $45.6 billion in Aug 2008 to $1084.8 billion in Aug 2010, not seasonally adjusted, multiplying by 23.8 times, or to $1038.2 billion in Nov 2010, multiplying by 22.8 times. The monetary base consists of the monetary liabilities of the government, composed largely of currency held by the public plus reserves of depository institutions at the Federal Reserve Banks. The monetary base not seasonally adjusted, or issue of money by the government, rose from $841.1 billion in Aug 2008 to $1991.1 billion or by 136.7 percent and to $1968.1 billion in Nov 2010 or by 133.9 percent (http://federalreserve.gov/releases/h3/hist/h3hist1.pdf). Policy can be viewed as creating government monetary liabilities that ended mostly in reserves of banks deposited at the Fed to purchase $2.1 trillion of long-term securities or assets, which in nontechnical language would be “printing money” (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html). The marketable debt of the US government in Treasury securities held by the public stood at $8.7 trillion on Nov 30, 2010 (http://www.treasurydirect.gov/govt/reports/pd/mspd/2010/opds112010.pdf). The current holdings of long-term securities by the Fed of $2.1 trillion, in the process of converting fully into Treasury securities, are equivalent to 24 percent of US government debt held by the public, and would represent 29.9 percent with the new round of quantitative easing if all the portfolio of the Fed, as intended, were in Treasury securities. Debt in Treasury securities held by the public on Dec 31, 2009, stood at $7.2 trillion (http://www.treasurydirect.gov/govt/reports/pd/mspd/2009/opds122009.pdf), growing on Nov 30, 2010, to $1.5 trillion or by 20.8 percent. In spite of this growth of bank reserves, “the 12-month change in core PCE [personal consumption expenditures] prices dropped from about 2 ½ percent in mid-2008 to around 1 ½ percent in 2009 and declined further to less than 1 percent by late 2010” (Yellen 2011AS, 3). The PCE price index, excluding food and energy, is around 0.8 percent in the past 12 months, which could be, in the Fed’s view, too close for comfort to negative inflation or deflation. Yellen (2011AS, 12) agrees “that an accommodative monetary policy left in place too long can cause inflation to rise to undesirable levels” that would be true whether policy was constrained or not by “the zero bound on interest rates.” The FOMC is monitoring and reviewing the “asset purchase program regularly in light of incoming information” and will “adjust the program as needed to meet its objectives” (Ibid, 12). That is, the FOMC would withdraw the stimulus once the economy is closer to full capacity to maintain inflation around 2 percent. In testimony at the Senate Committee on the Budget, Chairman Bernanke stated that “the Federal Reserve has all the tools its needs to ensure that it will be able to smoothly and effectively exit from this program at the appropriate time” (http://federalreserve.gov/newsevents/testimony/bernanke20110107a.htm). The large quantity of reserves would not be an obstacle in attaining the 2 percent inflation level. Yellen (2011A, 13-4) enumerates Fed tools that would be deployed to withdraw reserves as desired: (1) increasing the interest rate paid on reserves deposited at the Fed currently at 0.25 percent per year; (2) withdrawing reserves with reverse sale and repurchase agreement in addition to those with primary dealers by using mortgage-backed securities; (3) offering a Term Deposit Facility similar to term certificates of deposit for member institutions; and (4) sale or redemption of all or parts of the portfolio of long-term securities. The Fed would be able to increase interest rates and withdraw reserves as required to attain its mandates of maximum employment and price stability.
Third, Financial Imbalances. Fed policy intends to lower costs to business and households with the objective of stimulating investment and consumption generating higher growth and employment. Yellen (2011A, 14-7) considers a possible consequence of excessively reducing interest rates: “a reasonable fear is that this process could go too far, encouraging potential borrowers to employ excessive leverage to take advantage of low financing costs and leading investors to accept less compensation for bearing risks as they seek to enhance their rates of return in an environment of very low yields. This concern deserves to be taken seriously, and the Federal Reserve is carefully monitoring financial indicators for signs of potential threats to financial stability.” Regulation and supervision would be the “first line of defense” against imbalances threatening financial stability but the Fed would also use monetary policy to check imbalances (Yellen 2011AS, 17).
Fourth, Adverse Effects on Foreign Economies. The issue is whether the now recognized dollar devaluation would promote higher growth and employment in the US at the expense of lower growth and employment in other countries.
IC Long-term US Inflation. Key percentage average yearly rates of the US economy on growth and inflation are provided in Table I-1 updated with release of new data. The choice of dates prevents the measurement of long-term potential economic growth because of two recessions from IQ2001 (Mar) to IVQ2001 (Nov) with decline of GDP of 0.3 percent and the drop in GDP of 4.3 percent in the recession from IVQ2007 (Dec) to IIQ2009 (June) (http://www.nber.org/cycles.html) followed with unusually low economic growth for an expansion phase after recession (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 16 quarters from IIIQ2009 to IIQ2013 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/interest-rate-risks-duration-dumping.html). 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). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,738.0 billion in IIQ2010 by GDP of $14,356.9 billion in IIQ2009 {[$14,738.0/$14,356.9 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). As a result, there are 28.3 million unemployed or underemployed in the United States for an effective unemployment rate of 17.4 percent (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/risks-of-steepening-yield-curve-and.html). Zero interest rates and quantitative easing have not provided the impulse for growth and were not required in past successful cyclical expansions.
In the period from 1929 to 2012 the average growth rate of GDP was 3.3 percent and 3.2 percent between 1947 to 2012, which is almost the same as 3.0 percent from 1870 to 2010 measured by Lucas (2011May), as shown in Table I-1. From 1929 to 2012, nominal GDP grew at the average rate of 6.3 percent and 6.6 percent from 1947 to 2012. The implicit deflator increased at the average rate of 2.9 percent from 1929 to 2012 and at 3.3 percent from 1947 to 2012. Between 2000 and 2012, real GDP grew at the average rate of 1.7 percent per year, nominal GDP at 3.9 percent and the implicit deflator at 2.1 percent. The annual average rate of CPI increase was 3.2 percent from 1913 to 2012 and 3.7 percent from 1947 to 2012. Between 2000 and 2012, the average rate of CPI inflation was 2.4 percent per year and 2.0 percent excluding food and energy. From 2000 to 2013, the average rate of CPI inflation was 2.4 percent and 2.0 percent excluding food and energy. The average annual rate of PPI inflation was 3.1 percent from 1947 to 2012. PPI inflation increased at 2.9 percent per year on average from 2000 to 2012, 2.8 percent on average from 2000 to 2013 and at 1.8 percent excluding food and energy from 2000 to 2012 and 1.7 percent from 2000 to 2013. Producer price inflation of finished energy goods increased at average 6.1 percent between 2000 and 2012 and 5.7 percent between 2000 and 2013. There is also inflation in international trade. Import prices increased at 2.8 percent per year between 2000 and 2012 and 2.5 percent between 2000 and 2013. The commodity price shock is revealed by inflation of import prices of petroleum increasing at 11.4 percent per year between 2000 and 2012 and at 10.7 percent between 2000 and 2013. The average percentage rates of increase of import prices excluding fuels are much lower at 1.8 percent for 2002 to 2012 and 1.6 percent for 2002 to 2013. Export prices rose at the average rate of 2.4 percent between 2000 and 2012 and at 2.2 percent from 2000 to 2013. What spared the US of sharper decade-long deterioration of the terms of trade, (export prices)/(import prices), was its diversification and competitiveness in agriculture. Agricultural export prices grew at the average yearly rate of 7.4 percent from 2000 to 2012 and at 6.3 percent from 2000 to 2013. US nonagricultural export prices rose at 2.0 percent per year from 2000 to 2012 and at 1.8 percent from 2000 to 2013. The share of petroleum imports in US trade far exceeds that of agricultural exports. Unconventional monetary policy inducing carry trades in commodities has deteriorated US terms of trade, prices of exports relative to prices of imports, tending to restrict growth of US aggregate real income. These dynamic inflation rates are not similar to those for the economy of Japan where inflation was negative in seven of the 10 years in the 2000s. There is no reality of the proposition of need of unconventional monetary policy in the US because of deflation panic.
Table I-1, US, Average Growth Rates of Real and Nominal GDP, Consumer Price Index, Producer Price Index and Import and Export Prices, Percent per Year
| Real GDP | 2000-2012: 1.7% 1929-2012: 3.3% 1947-2012: 3.2% |
| Nominal GDP | 2000-2012: 3.9% 1929-2012: 6.3% 1947-2012: 6.6% |
| Implicit Price Deflator | 2000-2012: 2.1% 1929-2012: 2.9% 1947-2012: 3.3% |
| CPI | 2000-2012: 2.4% Annual 1913-2012: 3.2% 1947-2012: 3.7% |
| CPI ex Food and Energy | 2000-2012: 2.0% |
| PPI | 2000-2012: 2.9% Annual 1947-2012: 3.1% |
| PPI ex Food and Energy | 2000-2012: 1.8% |
| PPI Finished Energy Goods | 2000-2012: 6.1% 2000-2013: 5.7% |
| Import Prices | 2000-2012: 2.8% |
| Import Prices of Petroleum and Petroleum Products | 2000-2012: 11.4% |
| Import Prices Excluding Petroleum | 2000-2012: 1.2% |
| Import Prices Excluding Fuels | 2002-2012: 1.8% |
| Export Prices | 2000-2012: 2.4% |
| Agricultural Export Prices | 2000-2012: 7.4% |
| Nonagricultural Export Prices | 2000-2012: 2.0% |
Note: rates for price indexes in the row beginning with “CPI” and ending in the row “Nonagricultural Export Prices” are for Aug 2000 to Aug 2012 and for Aug 2000 to Aug 2013 using not seasonally adjusted indexes. Import prices excluding fuels are not available before Dec 2001.
Sources: http://www.bea.gov/iTable/index_nipa.cfm http://www.bls.gov/ppi/ http://www.bls.gov/cpi/ http://www.bls.gov/mxp/home.htm
Unconventional monetary policy of zero interest rates and large-scale purchases of long-term securities for the balance sheet of the central bank is proposed to prevent deflation. The data of CPI inflation of all goods and CPI inflation excluding food and energy for the past six decades show only one negative change by 0.4 percent in the CPI all goods annual index in 2009 but not one year of negative annual yearly change in the CPI excluding food and energy measuring annual inflation (http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html). Zero interest rates and quantitative easing are designed to lower costs of borrowing for investment and consumption, increase stock market valuations and devalue the dollar. In practice, the carry trade is from zero interest rates to a large variety of risk financial assets including commodities. Resulting commodity price inflation squeezes family budgets and deteriorates the terms of trade with negative effects on aggregate demand and employment. Excessive valuations of risk financial assets eventually result in crashes of financial markets with possible adverse effects on economic activity and employment.
The history of producer price inflation in the past five decades does not provide evidence of deflation. The finished core PPI does not register even one single year of decline. The headline PPI experienced only six isolated cases of decline since the 1960s (http://cmpassocregulationblog.blogspot.com/2011/08/world-financial-turbulence-global.html):
-0.3 percent in 1963,
-1.4 percent in 1986,
-0.8 percent in 1998,
-1.3 percent in 2002
-2.6 percent in 2009.
Deflation should show persistent cases of decline of prices and not isolated events. Fear of deflation in the US has caused a distraction of monetary policy. Symmetric inflation targets around 2 percent in the presence of multiple lags in effect of monetary policy and imperfect knowledge and forecasting are mostly unfeasible and likely to cause price and financial instability instead of desired price and financial stability.
Chart I-1 provides US nominal GDP from 1929 to 2012. The chart disguises the decline of nominal GDP during the 1930s from $104.6 billion in 1929 to $57.2 billion in 1933 or by 45.3 percent (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). The level of nominal GDP reached $102.9 billion in 1940 and exceeded the $104.6 billion of 1929 only with $129.4 billion in 1941. The only major visible bump in the chart occurred in the recession of IVQ2007 to IIQ2009 with revised cumulative decline of real GDP of 4.3 percent. US nominal GDP fell from $14,720.3 billion in 2008 to $14,417.9 billion in 2009 or by 2.1percent but rose to $14,958.3 billion in 2010 or by 3.7 percent, to $15,533.8 billion in 2011 for an additional 3.8 percent for cumulative increase of 7.7 percent relative to 2009 and to $16,244.6 billion in 2012 for an additional 4.6 percent and cumulative increase of 12.7 percent relative to 2009. US nominal GDP increased from $14,480.3 in 2007 to $16,244.6 billion in 2012 or by 12.2 percent (http://www.bea.gov/iTable/index_nipa.cfm). Tendency for deflation would be reflected in persistent bumps. In contrast, during the Great Depression in the four years of 1929 to 1933, GDP in constant dollars fell 26.3 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). The comparison of the global recession after 2007 with the Great Depression is entirely misleading (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html).
Chart I-1, US, Nominal GDP 1929-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-2 provides US real GDP from 1929 to 2012. The chart also disguises the Great Depression of the 1930s. In the four years of 1929 to 1933, GDP in constant dollars fell 26.3 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7; data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). Persistent deflation threatening real economic activity would also be reflected in the series of long-term growth of real GDP. There is no such behavior in Chart I-2 except for periodic recessions in the US economy that have occurred throughout history.
Chart I-2, US, Real GDP 1929-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Deflation would also be in evidence in long-term series of prices in the form of bumps. The GDP implicit deflator series in Chart I-3 from 1929 to 2012 shows sharp dynamic behavior over time. There is decline of the implicit price deflator of GDP by 25.8 percent from 1929 to 1933 (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). In contrast, the implicit price deflator of GDP of the US increased from 97.335 (2009 =100) in 2007 to 100.00 in 2009 or by 2.7 percent and increased to 105.002 in 2012 or by 5.0 percent relative to 2009 and 7.9 percent relative to 2007. The implicit price deflator of US GDP increased in every quarter from IVQ2007 to IVQ2012 with only one decline from 100.064 in IQ2009 to 99.897 in IIQ2009 or by 0.2 percent (http://www.bea.gov/iTable/index_nipa.cfm). Wars are characterized by rapidly rising prices followed by declines when peace is restored. The US economy is not plagued by deflation but by long-run inflation.
Chart I-3, US, GDP Implicit Price Deflator 1929-2012
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-4 provides percent change from preceding quarter in prices of GDP at seasonally adjusted annual rates (SAAR) from 1980 to 2012. There is one case of negative change by 0.6 percent in IIQ2009 that was adjustment from 2.8 percent in IIIQ2008 following 2.3 percent in IQ2008 and 1.8 percent IIQ2008 caused by carry trades from policy interest rates being moved to zero into commodity futures. These positions were reversed because of the fear of toxic assets in banks in the proposal of TARP in late 2008 (Cochrane and Zingales 2009). There has not been actual deflation or risk of deflation threatening depression in the US that would justify unconventional monetary policy.
Chart I-4, Percent Change from Preceding Period in Prices for GDP Seasonally Adjusted at Annual Rates 1980-2013
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-5 provides percent change from preceding year in prices of GDP from 1929 to 2012. There are four consecutive years of declines of prices of GDP during the Great Depression: 3.8 percent in 1930, 9.9 percent in 1931, 11.4 percent in 1932 and 2.7 percent in 1933. There were two consecutive declines of 1.8 percent in 1938 and 1.2 percent in 1939. Prices of GDP fell 0.1 percent in 1949 after increasing 12.6 percent in 1946, 11.2 percent in 1947 and 5.6 percent in 1948, which is similar to experience with wars in other countries. There are no other negative changes of annual prices of GDP in 72 years from 1939 to 2012.
Chart I-5, Percent Change from Preceding Year in Prices for Gross Domestic Product 1930-2012
http://www.bea.gov/iTable/index_nipa.cfm
The producer price index of the US from 1947 to 2013 in Chart I-6 shows various periods of more rapid or less rapid inflation but no bumps. The major event is the decline in 2008 when risk aversion because of the global recession caused the collapse of oil prices from $148/barrel to less than $80/barrel with most other commodity prices also collapsing. The event had nothing in common with explanations of deflation but rather with the concentration of risk exposures in commodities after the decline of stock market indexes. Eventually, there was a flight to government securities because of the fears of insolvency of banks caused by statements supporting proposals for withdrawal of toxic assets from bank balance sheets in the Troubled Asset Relief Program (TARP), as explained by Cochrane and Zingales (2009). The bump in 2008 with decline in 2009 is consistent with the view that zero interest rates with subdued risk aversion induce carry trades into commodity futures.
Chart I-6, US, Producer Price Index, Finished Goods, NSA, 1947-2013
Source: US Bureau of Labor Statistics
Chart I-7 provides 12-month percentage changes of the producer price index from 1948 to 2013. The distinguishing event in Chart I-7 is the Great Inflation of the 1970s. The shape of the two-hump Bactrian camel of the 1970s resembles the double hump from 2007 to 2013.
Chart I-7, US, Producer Price Index, Finished Goods, 12-Month Percentage Change, NSA, 1948-2013
Source: US Bureau of Labor Statistics
Annual percentage changes of the producer price index from 1948 to 2012 are shown in Table I-1A. The producer price index fell 2.8 percent in 1949 following the adjustment to World War II and fell 0.6 percent in 1952 and 1.0 percent in 1953 around the Korean War. There are two other mild decline of 0.3 percent in 1959 and 0.3 percent in 1963. There are only few subsequent and isolated declines of the producer price index of 1.4 percent in 1986, 0.8 percent in 1998, 1.3 percent in 2002 and 2.6 percent in 2009. The decline of 2009 was caused by unwinding of carry trades in 2008 that had lifted oil prices to $140/barrel during deep global recession because of the panic of probable toxic assets in banks that would be removed with the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009). There is no evidence in this history of 65 years of the US producer price index suggesting that there is frequent and persistent deflation shock requiring aggressive unconventional monetary policy. The design of such anti-deflation policy could provoke price and financial instability because of lags in effect of monetary policy, model errors, inaccurate forecasts and misleading analysis of current economic conditions.
Table I-1A, US, Annual PPI Inflation ∆% 1948-2012
| Year | Annual |
| 1948 | 8.0 |
| 1949 | -2.8 |
| 1950 | 1.8 |
| 1951 | 9.2 |
| 1952 | -0.6 |
| 1953 | -1.0 |
| 1954 | 0.3 |
| 1955 | 0.3 |
| 1956 | 2.6 |
| 1957 | 3.8 |
| 1958 | 2.2 |
| 1959 | -0.3 |
| 1960 | 0.9 |
| 1961 | 0.0 |
| 1962 | 0.3 |
| 1963 | -0.3 |
| 1964 | 0.3 |
| 1965 | 1.8 |
| 1966 | 3.2 |
| 1967 | 1.1 |
| 1968 | 2.8 |
| 1969 | 3.8 |
| 1970 | 3.4 |
| 1971 | 3.1 |
| 1972 | 3.2 |
| 1973 | 9.1 |
| 1974 | 15.4 |
| 1975 | 10.6 |
| 1976 | 4.5 |
| 1977 | 6.4 |
| 1978 | 7.9 |
| 1979 | 11.2 |
| 1980 | 13.4 |
| 1981 | 9.2 |
| 1982 | 4.1 |
| 1983 | 1.6 |
| 1984 | 2.1 |
| 1985 | 1.0 |
| 1986 | -1.4 |
| 1987 | 2.1 |
| 1988 | 2.5 |
| 1989 | 5.2 |
| 1990 | 4.9 |
| 1991 | 2.1 |
| 1992 | 1.2 |
| 1993 | 1.2 |
| 1994 | 0.6 |
| 1995 | 1.9 |
| 1996 | 2.7 |
| 1997 | 0.4 |
| 1998 | -0.8 |
| 1999 | 1.8 |
| 2000 | 3.8 |
| 2001 | 2.0 |
| 2002 | -1.3 |
| 2003 | 3.2 |
| 2004 | 3.6 |
| 2005 | 4.8 |
| 2006 | 3.0 |
| 2007 | 3.9 |
| 2008 | 6.3 |
| 2009 | -2.6 |
| 2010 | 4.2 |
| 2011 | 6.0 |
| 2012 | 1.9 |
Source: US Bureau of Labor Statistics
The producer price index excluding food and energy from 1973 to 2013, the first historical date of availability in the dataset of the Bureau of Labor Statistics (BLS), shows similarly dynamic behavior as the overall index, as shown in Chart I-8. There is no evidence of persistent deflation in the US PPI.
Chart I-8, US Producer Price Index, Finished Goods Excluding Food and Energy, NSA, 1973-2013
Source: US Bureau of Labor Statistics
Chart I-9 provides 12-month percentage rates of change of the finished goods index excluding food and energy. The dominating characteristic is the Great Inflation of the 1970s. The double hump illustrates how inflation may appear to be subdued and then returns with strength.
Chart I-9, US Producer Price Index, Finished Goods Excluding Food and Energy, 12-Month Percentage Change, NSA, 1974-2013
Source: US Bureau of Labor Statistics
The producer price index of energy goods from 1974 to 2013 is provided in Chart I-10. The first jump occurred during the Great Inflation of the 1970s analyzed in various comments of this blog (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html) and in Appendix I. There is relative stability of producer prices after 1986 with another jump and decline in the late 1990s into the early 2000s. The episode of commodity price increases during a global recession in 2008 could only have occurred with interest rates dropping toward zero, which stimulated the carry trade from zero interest rates to leveraged positions in commodity futures. Commodity futures exposures were dropped in the flight to government securities after Sep 2008. Commodity future exposures were created again when risk aversion diminished around Mar 2010 after the finding that US bank balance sheets did not have the toxic assets that were mentioned in proposing TARP in Congress (see Cochrane and Zingales 2009). Fluctuations in commodity prices and other risk financial assets originate in carry trade when risk aversion ameliorates.
Chart I-10, US, Producer Price Index, Finished Energy Goods, NSA, 1974-2013
Source: US Bureau of Labor Statistics
Chart I-11 shows 12-month percentage changes of the producer price index of finished energy goods from 1975 to 2013. This index is only available after 1974 and captures only one of the humps of energy prices during the Great Inflation. Fluctuations in energy prices have occurred throughout history in the US but without provoking deflation. Two cases are the decline of oil prices in 2001 to 2002 that has been analyzed by Barsky and Kilian (2004) and the collapse of oil prices from over $140/barrel with shock of risk aversion to the carry trade in Sep 2008.
Chart I-11, US, Producer Price Index, Finished Energy Goods, 12-Month Percentage Change, NSA, 1974-2013
Source: US Bureau of Labor Statistics
Chart I-12 provides the consumer price index NSA from 1914 to 2013. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.
Chart I-12, US, Consumer Price Index, NSA, 1914-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-13 provides 12-month percentage changes of the consumer price index from 1914 to 2013. The only episode of deflation after 1950 is in 2009, which is explained by the reversal of speculative commodity futures carry trades that were induced by interest rates driven to zero in a shock of monetary policy in 2008. The only persistent case of deflation is from 1930 to 1933, which has little if any relevance to the contemporary United States economy. There are actually three waves of inflation in the second half of the 1960s, in the mid-1970s and again in the late 1970s. Inflation rates then stabilized in a range with only two episodes above 5 percent.
Chart I-13, US, Consumer Price Index, All Items, 12- Month Percentage Change 1914-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Table I-2 provides annual percentage changes of United States consumer price inflation from 1914 to 2013. There have been only cases of annual declines of the CPI after wars: (1) World War I minus 10.5 percent in 1921 and minus 6.1 percent in 1922 following cumulative increases of 83.5 percent in four years from 1917 to 1920 at the average of 16.4 percent per year; (2) World War II: minus 1.2 percent in 1949 following cumulative 33.9 percent in three years from 1946 to 1948 at average 10.2 percent per year (3) minus 0.4 percent in 1955 two years after the end of the Korean War; and (4) minus 0.4 percent in 2009. The decline of 0.4 percent in 2009 followed increase of 3.8 percent in 2008 and is explained by the reversal of speculative carry trades into commodity futures that were created in 2008 as monetary policy rates were driven to zero. The reversal occurred after misleading statement on toxic assets in banks in the proposal for TARP (Cochrane and Zingales 2009). There were declines of 1.7 percent in both 1927 and 1928 during the episode of revival of rules of the gold standard. The only persistent deflationary period since 1914 was during the Great Depression in the years from 1930 to 1933 and again in 1938-1939. Fear of deflation on the basis of that experience does not justify unconventional monetary policy of zero interest rates that has failed to stop deflation in Japan. Financial repression causes far more adverse effects on allocation of resources by distorting the calculus of risk/returns than alleged employment-creating effects or there would not be current recovery without jobs and hiring after zero interest rates since Dec 2008 and intended now forever in a self-imposed forecast growth and employment mandate of monetary policy.
Table I-2, US, Annual CPI Inflation ∆% 1914-2012
| Year | Annual ∆% |
| 1914 | 1.0 |
| 1915 | 1.0 |
| 1916 | 7.9 |
| 1917 | 17.4 |
| 1918 | 18.0 |
| 1919 | 14.6 |
| 1920 | 15.6 |
| 1921 | -10.5 |
| 1922 | -6.1 |
| 1923 | 1.8 |
| 1924 | 0.0 |
| 1925 | 2.3 |
| 1926 | 1.1 |
| 1927 | -1.7 |
| 1928 | -1.7 |
| 1929 | 0.0 |
| 1930 | -2.3 |
| 1931 | -9.0 |
| 1932 | -9.9 |
| 1933 | -5.1 |
| 1934 | 3.1 |
| 1935 | 2.2 |
| 1936 | 1.5 |
| 1937 | 3.6 |
| 1938 | -2.1 |
| 1939 | -1.4 |
| 1940 | 0.7 |
| 1941 | 5.0 |
| 1942 | 10.9 |
| 1943 | 6.1 |
| 1944 | 1.7 |
| 1945 | 2.3 |
| 1946 | 8.3 |
| 1947 | 14.4 |
| 1948 | 8.1 |
| 1949 | -1.2 |
| 1950 | 1.3 |
| 1951 | 7.9 |
| 1952 | 1.9 |
| 1953 | 0.8 |
| 1954 | 0.7 |
| 1955 | -0.4 |
| 1956 | 1.5 |
| 1957 | 3.3 |
| 1958 | 2.8 |
| 1959 | 0.7 |
| 1960 | 1.7 |
| 1961 | 1.0 |
| 1962 | 1.0 |
| 1963 | 1.3 |
| 1964 | 1.3 |
| 1965 | 1.6 |
| 1966 | 2.9 |
| 1967 | 3.1 |
| 1968 | 4.2 |
| 1969 | 5.5 |
| 1970 | 5.7 |
| 1971 | 4.4 |
| 1972 | 3.2 |
| 1973 | 6.2 |
| 1974 | 11.0 |
| 1975 | 9.1 |
| 1976 | 5.8 |
| 1977 | 6.5 |
| 1978 | 7.6 |
| 1979 | 11.3 |
| 1980 | 13.5 |
| 1981 | 10.3 |
| 1982 | 6.2 |
| 1983 | 3.2 |
| 1984 | 4.3 |
| 1985 | 3.6 |
| 1986 | 1.9 |
| 1987 | 3.6 |
| 1988 | 4.1 |
| 1989 | 4.8 |
| 1990 | 5.4 |
| 1991 | 4.2 |
| 1992 | 3.0 |
| 1993 | 3.0 |
| 1994 | 2.6 |
| 1995 | 2.8 |
| 1996 | 3.0 |
| 1997 | 2.3 |
| 1998 | 1.6 |
| 1999 | 2.2 |
| 2000 | 3.4 |
| 2001 | 2.8 |
| 2002 | 1.6 |
| 2003 | 2.3 |
| 2004 | 2.7 |
| 2005 | 3.4 |
| 2006 | 3.2 |
| 2007 | 2.8 |
| 2008 | 3.8 |
| 2009 | -0.4 |
| 2010 | 1.6 |
| 2011 | 3.2 |
| 2012 | 2.1 |
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-14 provides the consumer price index excluding food and energy from 1957 to 2013. There is long-term inflation in the US without episodes of persistent deflation.
Chart I-14, US, Consumer Price Index Excluding Food and Energy, NSA, 1957-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-15 provides 12-month percentage changes of the consumer price index excluding food and energy from 1958 to 2013. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.
Chart I-15, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 1958-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
The consumer price index of housing is provided in Chart I-16. There was also acceleration during the Great Inflation of the 1970s. The index flattens after the global recession in IVQ2007 to IIQ2009. Housing prices collapsed under the weight of construction of several times more housing than needed. Surplus housing originated in subsidies and artificially low interest rates in the shock of unconventional monetary policy in 2003 to 2004 in fear of deflation.
Chart I-16, US, Consumer Price Index Housing, NSA, 1967-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-17 provides 12-month percentage changes of the housing CPI. The Great Inflation also had extremely high rates of housing inflation. Housing is considered as potential hedge of inflation.
Chart I-17, US, Consumer Price Index, Housing, 12- Month Percentage Change, NSA, 1968-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
ID Current US Inflation. Consumer price inflation has fluctuated in recent months. Table I-3 provides 12-month consumer price inflation in Aug 2013 and annual equivalent percentage changes for the months of Jun-Aug 2013 of the CPI and major segments. The final column provides inflation from Jul 2013 to Aug 2013. CPI inflation in the 12 months ending in Aug 2013 reached 1.5 percent, the annual equivalent rate Jun to Aug 2013 was 3.2 percent in the new episode of creating carry trades from zero interest rates to commodities exposures and the monthly inflation rate of 0.1 percent annualizes at 1.2 percent with oscillating carry trades at the margin. These inflation rates fluctuate in accordance with inducement of risk appetite or frustration by risk aversion of carry trades from zero interest rates to commodity futures. At the margin, the decline in commodity prices in sharp recent risk aversion in commodities markets caused lower inflation worldwide (with return in some countries in Dec 2012 and Jan-Feb 2013) that followed a jump in Aug-Sep 2012 because of the relaxed risk aversion resulting from the bond-buying program of the European Central Bank or Outright Monetary Transactions (OMT) (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). Carry trades moved away from commodities into stocks with resulting weaker commodity prices and stronger equity valuations. There is return of exposures in commodities but with preferences of equities by investors. With zero interest rates, commodity prices would increase again in an environment of risk appetite. Excluding food and energy, CPI inflation was 1.8 percent in the 12 months ending in Aug 2013 and 2.0 percent in annual equivalent in Jun to Aug 2013. There is no deflation in the US economy that could justify further quantitative easing, which is now open-ended or forever with zero interest rates and tapering bond-buying by the central bank, or QE→∞, even if the economy grows back to potential. Financial repression of zero interest rates is now intended as a permanent distortion of resource allocation by clouding risk/return decisions, preventing the economy from expanding along its optimal growth path. Consumer food prices in the US have risen 1.4 percent in 12 months ending in Aug 2013 and at 1.6 percent in annual equivalent in un to Aug 2013. Monetary policies stimulating carry trades of commodities futures that increase prices of food constitute a highly regressive tax on lower income families for whom food is a major portion of the consumption basket especially with wage increases below inflation in a recovery without hiring (http://cmpassocregulationblog.blogspot.com/2013/09/recovery-without-hiring-ten-million.html) and without jobs (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). Energy consumer prices decreased 0.1 percent in 12 months, increased 13.9 percent in annual equivalent in Jun to Aug 2013 and decreased 0.3 percent in Aug 2013 or at 3.5 percent in annual equivalent. Waves of inflation are induced by carry trades from zero interest rates to commodity futures, which are unwound and repositioned during alternating risk aversion and risk appetite originating in the European debt crisis and increasingly in growth and politics in China. For lower income families, food and energy are a major part of the family budget. Inflation is not persistently low or threatening deflation in annual equivalent in Jun to Aug 2013 in any of the categories in Table I-2 but simply reflecting waves of inflation originating in carry trades. Carry trades from zero interest rates induce commodity futures positions with episodes of risk aversion causing fluctuations determine an upward trend of prices.
Table I-3, US, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%
| % RI | ∆% 12 Months Aug 2013/Aug | ∆% Annual Equivalent Jun 2013 to Aug 2013 SA | ∆% Aug 2013/Jul 2013 SA | |
| CPI All Items | 100.000 | 1.5 | 3.2 | 0.1 |
| CPI ex Food and Energy | 75.719 | 1.8 | 2.0 | 0.1 |
| Food | 14.163 | 1.4 | 1.6 | 0.1 |
| Food at Home | 8.476 | 1.0 | 1.6 | 0.1 |
| Food Away from Home | 5.687 | 2.0 | 2.4 | 0.2 |
| Energy | 10.118 | -0.1 | 13.9 | -0.3 |
| Gasoline | 5.642 | -2.4 | 32.3 | -0.1 |
| Electricity | 3.059 | 2.8 | -0.8 | -0.1 |
| Commodities less Food and Energy | 19.303 | 0.0 | 0.8 | 0.0 |
| New Vehicles | 3.146 | 1.1 | 1.6 | 0.0 |
| Used Cars and Trucks | 1.903 | -1.0 | -3.5 | -0.1 |
| Medical Care Commodities | 1.695 | 0.0 | 5.3 | 0.4 |
| Apparel | 3.462 | 1.8 | 6.6 | 0.1 |
| Services Less Energy Services | 56.416 | 2.4 | 2.4 | 0.2 |
| Shelter | 31.638 | 2.4 | 2.4 | 0.2 |
| Rent of Primary Residence | 6.515 | 3.0 | 3.2 | 0.4 |
| Owner’s Equivalent Rent of Residences | 23.900 | 2.2 | 2.0 | 0.2 |
| Transportation Services | 5.833 | 2.5 | -0.8 | -0.5 |
| Medical Care Services | 5.449 | 3.1 | 4.9 | 0.7 |
% RI: Percent Relative Importance
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
The weights of the CPI, US city average for all urban consumers representing about 87 percent of the US population (http://www.bls.gov/cpi/cpiovrvw.htm#item1), are shown in Table I-4 with the BLS update for Dec 2012 (http://www.bls.gov/cpi/cpiri2012.pdf). Housing has a weight of 41.021 percent. The combined weight of housing and transportation is 57.867 percent or more than one-half of consumer expenditures of all urban consumers. The combined weight of housing, transportation and food and beverages is 73.128 percent of the US CPI. Table I-3 provides relative importance of key items in Aug 2013.
Table I-4, US, Relative Importance, 2009-2010 Weights, of Components in the Consumer Price Index, US City Average, Dec 2012
| All Items | 100.000 |
| Food and Beverages | 15.261 |
| Food | 14.312 |
| Food at home | 8.898 |
| Food away from home | 5.713 |
| Housing | 41.021 |
| Shelter | 31.681 |
| Rent of primary residence | 6.545 |
| Owners’ equivalent rent | 22.622 |
| Apparel | 3.564 |
| Transportation | 16.846 |
| Private Transportation | 15.657 |
| New vehicles | 3.189 |
| Used cars and trucks | 1.844 |
| Motor fuel | 5.462 |
| Gasoline | 5.274 |
| Medical Care | 7.163 |
| Medical care commodities | 1.714 |
| Medical care services | 5.448 |
| Recreation | 5.990 |
| Education and Communication | 6.779 |
| Other Goods and Services | 3.376 |
Refers to all urban consumers, covering approximately 87 percent of the US population (see http://www.bls.gov/cpi/cpiovrvw.htm#item1). Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/cpiri2011.pdf http://www.bls.gov/cpi/cpiriar.htm http://www.bls.gov/cpi/cpiri2012.pdf
Chart I-18 provides the US consumer price index for housing from 2001 to 2013. Housing prices rose sharply during the decade until the bump of the global recession and increased again in 2011-2012 with some stabilization. The CPI excluding housing would likely show much higher inflation. The commodity carry trades resulting from unconventional monetary policy have compressed income remaining after paying for indispensable shelter.
Chart I-18, US, Consumer Price Index, Housing, NSA, 2001-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-19 provides 12-month percentage changes of the housing CPI. Percentage changes collapsed during the global recession but have been rising into positive territory in 2011 and 2012-2013 but with the rate declining and then increasing.
Chart I-19, US, Consumer Price Index, Housing, 12-Month Percentage Change, NSA, 2001-2013
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
There have been waves of consumer price inflation in the US in 2011 and into 2012 (Section IA and earlier at http://cmpassocregulationblog.blogspot.com/2013/08/duration-dumping-and-peaking-valuations.html) that are illustrated in Table I-5. The first wave occurred in Jan-Apr 2011 and was caused by the carry trade of commodity prices induced by unconventional monetary policy of zero interest rates. Cheap money at zero opportunity cost in environment of risk appetite was channeled into financial risk assets, causing increases in commodity prices. The annual equivalent rate of increase of the all-items CPI in Jan-Apr 2011 was 4.6 percent and the CPI excluding food and energy increased at annual equivalent rate of 2.1 percent. The second wave occurred during the collapse of the carry trade from zero interest rates to exposures in commodity futures because of risk aversion in financial markets created by the sovereign debt crisis in Europe. The annual equivalent rate of increase of the all-items CPI dropped to 3.0 percent in May-Jun 2011 while the annual equivalent rate of the CPI excluding food and energy increased at 3.0 percent. In the third wave in Jul-Sep 2011, annual equivalent CPI inflation rose to 3.3 percent while the core CPI increased at 2.0 percent. The fourth wave occurred in the form of increase of the CPI all-items annual equivalent rate to 0.6 percent in Oct-Nov 2011 with the annual equivalent rate of the CPI excluding food and energy remaining at 2.4 percent. The fifth wave occurred in Dec 2011 to Jan 2012 with annual equivalent headline inflation of 1.2 percent and core inflation of 2.4 percent. In the sixth wave, headline CPI inflation increased at annual equivalent 3.7 percent in Feb-Mar 2012 and core CPI inflation at 1.8 percent but including Apr 2012, the annual equivalent inflation of the headline CPI was 2.4 percent in Feb-Apr 2012 and 2.0 percent for the core CPI. The seventh wave in May-Jul occurred with annual equivalent inflation of 0.0 percent for the headline CPI in May-Jul 2012 and 2.0 percent for the core CPI. The eighth wave is with annual equivalent inflation of 6.2 percent in Aug-Sep 2012 but 4.9 percent including Oct. In the ninth wave, annual equivalent inflation in Nov 2012 was minus 2.4 percent under the new shock of risk aversion and 0.0 percent in Dec 2012 with annual equivalent of minus 0.8 percent in Nov 2012-Jan 2013 and 2.0 percent for the core CPI. In the tenth wave, annual equivalent of headline CPI was 8.7 percent in Feb 2013 and 2.4 percent for the core CPI. In the eleventh wave, annual equivalent was minus 3.5 percent in Mar-Apr 2013 and 1.2 percent for the core index. In the twelfth wave, annual equivalent inflation was 2.7 percent in May-Aug 2013 and 2.1 percent for the core CPI. The conclusion is that inflation accelerates and decelerates in unpredictable fashion because of shocks or risk aversion in carry trades from zero interest rates to commodity derivatives.
Table I-5, US, Headline and Core CPI Inflation Monthly SA and 12 Months NSA ∆%
| All Items SA Month | All Items NSA 12 month | Core SA | Core NSA | |
| Aug 2013 | 0.1 | 1.5 | 0.1 | 1.8 |
| Jul | 0.2 | 2.0 | 0.2 | 1.7 |
| Jun | 0.5 | 1.8 | 0.2 | 1.6 |
| May | 0.1 | 1.4 | 0.2 | 1.7 |
| AE ∆% May-Aug | 2.7 | 2.1 | ||
| Apr | -0.4 | 1.1 | 0.1 | 1.7 |
| Mar | -0.2 | 1.5 | 0.1 | 1.9 |
| AE ∆% Mar-Apr | -3.5 | 1.2 | ||
| Feb | 0.7 | 2.0 | 0.2 | 2.0 |
| AE ∆% Feb | 8.7 | 2.4 | ||
| Jan | 0.0 | 1.6 | 0.3 | 1.9 |
| Dec 2012 | 0.0 | 1.7 | 0.1 | 1.9 |
| Nov | -0.2 | 1.8 | 0.1 | 1.9 |
| AE ∆% Nov-Jan | -0.8 | 2.0 | ||
| Oct | 0.2 | 2.2 | 0.2 | 2.0 |
| Sep | 0.5 | 2.0 | 0.2 | 2.0 |
| Aug | 0.5 | 1.7 | 0.1 | 1.9 |
| AE ∆% Aug-Oct | 4.9 | 2.0 | ||
| Jul | 0.0 | 1.4 | 0.1 | 2.1 |
| Jun | 0.1 | 1.7 | 0.2 | 2.2 |
| May | -0.1 | 1.7 | 0.2 | 2.3 |
| AE ∆% May-Jul | 0.0 | 2.0 | ||
| Apr | 0.0 | 2.3 | 0.2 | 2.3 |
| Mar | 0.3 | 2.7 | 0.2 | 2.3 |
| Feb | 0.3 | 2.9 | 0.1 | 2.2 |
| AE ∆% Feb-Apr | 2.4 | 2.0 | ||
| Jan | 0.2 | 2.9 | 0.2 | 2.3 |
| Dec 2011 | 0.0 | 3.0 | 0.2 | 2.2 |
| AE ∆% Dec-Jan | 1.2 | 2.4 | ||
| Nov | 0.1 | 3.4 | 0.2 | 2.2 |
| Oct | 0.0 | 3.5 | 0.2 | 2.1 |
| AE ∆% Oct-Nov | 0.6 | 2.4 | ||
| Sep | 0.3 | 3.9 | 0.1 | 2.0 |
| Aug | 0.3 | 3.8 | 0.2 | 2.0 |
| Jul | 0.2 | 3.6 | 0.2 | 1.8 |
| AE ∆% Jul-Sep | 3.3 | 2.0 | ||
| Jun | 0.1 | 3.6 | 0.2 | 1.6 |
| May | 0.4 | 3.6 | 0.3 | 1.5 |
| AE ∆% May-Jun | 3.0 | 3.0 | ||
| Apr | 0.3 | 3.2 | 0.2 | 1.3 |
| Mar | 0.5 | 2.7 | 0.1 | 1.2 |
| Feb | 0.4 | 2.1 | 0.2 | 1.1 |
| Jan | 0.3 | 1.6 | 0.2 | 1.0 |
| AE ∆% Jan-Apr | 4.6 | 2.1 | ||
| Dec 2010 | 0.5 | 1.5 | 0.1 | 0.8 |
| Nov | 0.2 | 1.1 | 0.1 | 0.8 |
| Oct | 0.3 | 1.2 | 0.0 | 0.6 |
| Sep | 0.1 | 1.1 | 0.1 | 0.8 |
| Aug | 0.2 | 1.1 | 0.1 | 0.9 |
| Jul | 0.2 | 1.2 | 0.1 | 0.9 |
| Jun | 0.0 | 1.1 | 0.1 | 0.9 |
| May | 0.0 | 2.0 | 0.1 | 0.9 |
| Apr | 0.0 | 2.2 | 0.0 | 0.9 |
| Mar | 0.0 | 2.3 | 0.0 | 1.1 |
| Feb | -0.1 | 2.1 | 0.1 | 1.3 |
| Jan | 0.1 | 2.6 | -0.1 | 1.6 |
Note: Core: excluding food and energy; AE: annual equivalent
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi
The behavior of the US consumer price index NSA from 2001 to 2013 is provided in Chart I-20. Inflation in the US is very dynamic without deflation risks that would justify symmetric inflation targets. The hump in 2008 originated in the carry trade from interest rates dropping to zero into commodity futures. There is no other explanation for the increase of the Cushing OK Crude Oil Future Contract 1 from $55.64/barrel on Jan 9, 2007 to $145.29/barrel on July 3, 2008 during deep global recession, collapsing under a panic of flight into government obligations and the US dollar to $37.51/barrel on Feb 13, 2009 and then rising by carry trades to $113.93/barrel on Apr 29, 2012, collapsing again and then recovering again to $105.23/barrel, all during mediocre economic recovery with peaks and troughs influenced by bouts of risk appetite and risk aversion (data from the US Energy Information Administration EIA, http://www.eia.gov/). The unwinding of the carry trade with the TARP announcement of toxic assets in banks channeled cheap money into government obligations (see Cochrane and Zingales 2009).
Chart I-20, US, Consumer Price Index, NSA, 2001-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
Chart I-21 provides 12-month percentage changes of the consumer price index from 2001 to 2013. There was no deflation or threat of deflation from 2008 into 2009. Commodity prices collapsed during the panic of toxic assets in banks. When stress tests in 2009 revealed US bank balance sheets in much stronger position, cheap money at zero opportunity cost exited government obligations and flowed into carry trades of risk financial assets. Increases in commodity prices drove again the all items CPI with interruptions during risk aversion originating in multiple fears but especially from the sovereign debt crisis of Europe.
Chart I-21, US, Consumer Price Index, 12-Month Percentage Change, NSA, 2001-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
The trend of increase of the consumer price index excluding food and industry in Chart I-22 does not reveal any threat of deflation that would justify symmetric inflation targets. There are mild oscillations in a neat upward trend.
Chart I-22, US, Consumer Price Index Excluding Food and Energy, NSA, 2001-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
Chart I-23 provides 12-month percentage change of the consumer price index excluding food and energy. Past-year rates of inflation fell toward 1 percent from 2001 into 2003 because of the recession and the decline of commodity prices beginning before the recession with declines of real oil prices. Near zero interest rates with fed funds at 1 percent between Jun 2003 and Jun 2004 stimulated carry trades of all types, including in buying homes with subprime mortgages in expectation that low interest rates forever would increase home prices permanently, creating the equity that would permit the conversion of subprime mortgages into creditworthy mortgages (Gorton 2009EFM; see http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Inflation rose and then collapsed during the unwinding of carry trades and the housing debacle of the global recession. Carry trades into 2011 and 2012 gave a new impulse to CPI inflation, all items and core. Symmetric inflation targets destabilize the economy by encouraging hunts for yields that inflate and deflate financial assets, obscuring risk/return decisions on production, investment, consumption and hiring.
Chart I-23, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2001-2013
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
Headline and core producer price indexes are in Table I-6. The headline PPI SA increased 0.3 percent in Aug 2013 and increased 1.4 percent NSA in the 12 months ending in Aug 2013. The core PPI SA changed 0.0 percent in Aug 2013 and rose 1.1 percent in 12 months. Analysis of annual equivalent rates of change shows inflation waves similar to those worldwide. In the first wave, the absence of risk aversion from the sovereign risk crisis in Europe motivated the carry trade from zero interest rates into commodity futures that caused the average equivalent rate of 10.0 percent in the headline PPI in Jan-Apr 2011 and 4.0 percent in the core PPI. In the second wave, commodity futures prices collapsed in Jun 2011 with the return of risk aversion originating in the sovereign risk crisis of Europe. The annual equivalent rate of headline PPI inflation collapsed to 1.8 percent in May-Jun 2011 but the core annual equivalent inflation rate was higher at 2.4 percent. In the third wave, headline PPI inflation resuscitated with annual equivalent at 4.9 percent in Jul-Sep 2011 and core PPI inflation at 3.7 percent. Core PPI inflation was persistent throughout 2011, jumping from annual equivalent at 1.5 percent in the first four months of 2010 to 3.0 percent in 12 months ending in Dec 2011. Unconventional monetary policy is based on the proposition that core rates reflect more fundamental inflation and are thus better predictors of the future. In practice, the relation of core and headline inflation is as difficult to predict as future inflation (see IIID Supply Shocks in http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html). In the fourth wave, risk aversion originating in the lack of resolution of the European debt crisis caused unwinding of carry trades with annual equivalent headline PPI inflation of 0.6 percent in Oct-Nov 2011 and 1.8 percent in the core annual equivalent. In the fifth wave from Dec 2011 to Jan 2012, annual equivalent inflation was 0.0 percent for the headline index but 4.3 percent for the core index excluding food and energy. In the sixth wave, annual equivalent inflation in Feb-Mar 2012 was 2.4 percent for the headline PPI and 2.4 percent for the core. In the seventh wave, renewed risk aversion caused reversal of carry trades into commodity exposures with annual equivalent headline inflation of minus 4.7 percent in Apr-May 2012 while core PPI inflation was at annual equivalent 1.2 percent. In the eighth wave, annual equivalent inflation returned at 3.0 percent in Jun-Jul 2012 and 4.3 percent for the core index. In the ninth wave, relaxed risk aversion because of the announcement of the impaired bond buying program or Outright Monetary Transactions (OMT) of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html) induced carry trades that drove annual equivalent inflation of producer prices of the United States at 12.7 percent in Aug-Sep 2012 and 0.6 percent in the core index. In the tenth wave, renewed risk aversion caused annual equivalent inflation of minus 3.2 percent in Oct 2011-Dec 2012 in the headline index and 1.2 percent in the core index. In the eleventh wave, annual equivalent inflation was 5.5 percent in the headline index in Jan-Feb 2013 and 1.8 percent in the core index. In the twelfth wave, annual equivalent was minus 7.5 percent in Mar-Apr 2012 and 1.8 percent for the core index. In the thirteenth wave, annual equivalent inflation returned at 4.9 percent in May-Aug 2013 and 1.2 percent in the core index. It is almost impossible to forecast PPI inflation and its relation to CPI inflation. “Inflation surprise” by monetary policy could be proposed to climb along a downward sloping Phillips curve, resulting in higher inflation but lower unemployment (see Kydland and Prescott 1977, Barro and Gordon 1983 and past comments of this blog http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). The architects of monetary policy would require superior inflation forecasting ability compared to forecasting naivety by everybody else. In practice, we are all naïve in forecasting inflation and other economic variables and events.
Table I-6, US, Headline and Core PPI Inflation Monthly SA and 12-Month NSA ∆%
| Finished | Finished | Finished Core SA | Finished Core NSA | |
| Aug 2013 | 0.3 | 1.4 | 0.0 | 1.1 |
| Jul | 0.0 | 2.1 | 0.1 | 1.2 |
| Jun | 0.8 | 2.5 | 0.2 | 1.7 |
| May | 0.5 | 1.7 | 0.1 | 1.7 |
| AE ∆% May-Aug | 4.9 | 1.2 | ||
| Apr | -0.7 | 0.5 | 0.1 | 1.7 |
| Mar | -0.6 | 1.1 | 0.2 | 1.7 |
| AE ∆% Mar-Apr | -7.5 | 1.8 | ||
| Feb | 0.7 | 1.8 | 0.1 | 1.8 |
| Jan | 0.2 | 1.5 | 0.2 | 1.8 |
| AE ∆% Jan-Feb | 5.5 | 1.8 | ||
| Dec 2012 | -0.1 | 1.4 | 0.2 | 2.1 |
| Nov | -0.5 | 1.5 | 0.1 | 2.2 |
| Oct | -0.2 | 2.3 | 0.0 | 2.2 |
| AE ∆% Oct-Dec | -3.2 | 1.2 | ||
| Sep | 1.0 | 2.1 | 0.1 | 2.4 |
| Aug | 1.0 | 1.9 | 0.0 | 2.6 |
| AE ∆% Aug-Sep | 12.7 | 0.6 | ||
| Jul | 0.4 | 0.5 | 0.5 | 2.6 |
| Jun | 0.1 | 0.7 | 0.2 | 2.6 |
| AE ∆% Jun-Jul | 3.0 | 4.3 | ||
| May | -0.6 | 0.6 | 0.1 | 2.7 |
| Apr | -0.2 | 1.8 | 0.1 | 2.7 |
| AE ∆% Apr-May | -4.7 | 1.2 | ||
| Mar | 0.1 | 2.8 | 0.2 | 2.9 |
| Feb | 0.3 | 3.4 | 0.2 | 3.1 |
| AE ∆% Feb-Mar | 2.4 | 2.4 | ||
| Jan | 0.1 | 4.1 | 0.4 | 3.1 |
| Dec 2011 | -0.1 | 4.7 | 0.3 | 3.0 |
| AE ∆% Dec-Jan | 0.0 | 4.3 | ||
| Nov | 0.4 | 5.6 | 0.1 | 3.0 |
| Oct | -0.3 | 5.8 | 0.2 | 2.9 |
| AE ∆% Oct-Nov | 0.6 | 1.8 | ||
| Sep | 0.9 | 7.0 | 0.3 | 2.8 |
| Aug | -0.3 | 6.6 | 0.1 | 2.7 |
| Jul | 0.6 | 7.1 | 0.5 | 2.7 |
| AE ∆% Jul-Sep | 4.9 | 3.7 | ||
| Jun | -0.1 | 6.9 | 0.3 | 2.3 |
| May | 0.4 | 7.1 | 0.1 | 2.1 |
| AE ∆% May-Jun | 1.8 | 2.4 | ||
| Apr | 0.7 | 6.6 | 0.3 | 2.3 |
| Mar | 0.7 | 5.6 | 0.3 | 2.0 |
| Feb | 1.1 | 5.4 | 0.3 | 1.8 |
| Jan | 0.7 | 3.6 | 0.4 | 1.6 |
| AE ∆% Jan-Apr | 10.0 | 4.0 | ||
| Dec 2010 | 0.9 | 3.8 | 0.2 | 1.4 |
| Nov | 0.6 | 3.4 | 0.0 | 1.2 |
| Oct | 0.7 | 4.3 | -0.1 | 1.6 |
| Sep | 0.4 | 3.9 | 0.2 | 1.6 |
| Aug | 0.4 | 3.3 | 0.1 | 1.3 |
| Jul | 0.3 | 4.1 | 0.1 | 1.5 |
| Jun | -0.3 | 2.7 | 0.1 | 1.1 |
| May | 0.0 | 5.1 | 0.3 | 1.3 |
| Apr | -0.2 | 5.4 | 0.0 | 0.9 |
| Mar | 0.7 | 5.9 | 0.2 | 0.9 |
| Feb | -0.7 | 4.2 | 0.0 | 1.0 |
| Jan | 1.0 | 4.5 | 0.3 | 1.0 |
Note: Core: excluding food and energy; AE: annual equivalent
Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/
The US producer price index NSA from 2000 to 2013 is shown in Chart I-24. There are two episodes of decline of the PPI during recessions in 2001 and in 2008. Barsky and Kilian (2004) consider the 2001 episode as one in which real oil prices were declining when recession began. Recession and the fall of commodity prices instead of generalized deflation explain the behavior of US inflation in 2008.
Chart I-24, US, Producer Price Index, NSA, 2000-2013
Source: US Bureau of Labor Statistics
Twelve-month percentage changes of the PPI NSA from 2000 to 2013 are shown in Chart I-25. It may be possible to forecast trends a few months in the future under adaptive expectations but turning points are almost impossible to anticipate especially when related to fluctuations of commodity prices in response to risk aversion. In a sense, monetary policy has been tied to behavior of the PPI in the negative 12-month rates in 2001 to 2003 and then again in 2009 to 2010. Monetary policy following deflation fears caused by commodity price fluctuations would introduce significant volatility and risks in financial markets and eventually in consumption and investment.
Chart I-25, US, Producer Price Index, 12-Month Percentage Change NSA, 2000-2013
Source: US Bureau of Labor Statistics
The US PPI excluding food and energy from 2000 to 2013 is shown in Chart I-26. There is here again a smooth trend of inflation instead of prolonged deflation as in Japan.
Chart I-26, US, Producer Price Index Excluding Food and Energy, NSA, 2000-2013
Source: US Bureau of Labor Statistics
Twelve-month percentage changes of the producer price index excluding food and energy are shown in Chart I-27. Fluctuations replicate those in the headline PPI. There is an evident trend of increase of 12 months rates of core PPI inflation in 2011 but lower rates in 2012-2013.
Chart I-27, US, Producer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2000-2013
Source: US Bureau of Labor Statistics
The US producer price index of energy goods from 2000 to 2013 is in Chart I-28. There is a clear upward trend with fluctuations that would not occur under persistent deflation.
Chart I-28, US, Producer Price Index Finished Energy Goods, NSA, 2000-2013
Source: US Bureau of Labor Statistics
Chart I-29 provides 12-month percentage changes of the producer price index of energy goods from 2000 to 2013. Barsky and Kilian (2004) relate the episode of declining prices of energy goods in 2001 to 2002 to the analysis of decline of real oil prices. Interest rates dropping to zero during the global recession in 2008 induced carry trades that explain the rise of the PPI of energy goods toward 30 percent. Bouts of risk aversion with policy interest rates held close to zero explain the fluctuations in the 12-month rates of the PPI of energy goods in the expansion phase of the economy. Symmetric inflation targets induce significant instability in inflation and interest rates with adverse effects on financial markets and the overall economy.
Chart I-29, US, Producer Price Index Energy Goods, 12-Month Percentage Change, NSA, 2000-2013
Source: US Bureau of Labor Statistics
Table I-7 provides 12-month percentage changes of the CPI all items, CPI core and CPI housing from 2001 to 2013. There is no evidence in these data supporting symmetric inflation targets that would only induce greater instability in inflation, interest rates and financial markets. 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 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):
“Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view 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” (emphasis added).
Table I-7, CPI All Items, CPI Core and CPI Housing, 12-Month Percentage Change, NSA 2001-2013
| Jul | CPI All Items | CPI Core ex Food and Energy | CPI Housing |
| 2013 | 1.5 | 1.8 | 2.2 |
| 2012 | 1.7 | 1.9 | 1.4 |
| 2011 | 3.8 | 2.0 | 1.6 |
| 2010 | 1.1 | 0.9 | -0.4 |
| 2009 | -1.5 | 1.4 | -0.6 |
| 2008 | 5.4 | 2.5 | 3.8 |
| 2007 | 2.0 | 2.1 | 2.9 |
| 2006 | 3.8 | 2.8 | 4.2 |
| 2005 | 3.6 | 2.1 | 3.0 |
| 2004 | 2.7 | 1.7 | 2.7 |
| 2003 | 2.2 | 1.3 | 2.4 |
| 2002 | 1.8 | 2.4 | 2.1 |
| 2001 | 2.7 | 2.7 | 4.2 |
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi
IA4 Theory and Reality of Economic History and Monetary Policy Based on Fear of Deflation. Fear of deflation as had occurred during the Great Depression and in Japan was used as an argument for the first round of unconventional monetary policy with 1 percent interest rates from Jun 2003 to Jun 2004 and quantitative easing in the form of withdrawal of supply of 30-year securities by suspension of the auction of 30-year Treasury bonds with the intention of reducing mortgage rates (for fear of deflation see Pelaez and Pelaez, International Financial Architecture (2005), 18-28, and Pelaez and Pelaez, The Global Recession Risk (2007), 83-95). The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html
If the forecast of the central bank is of recession and low inflation with controlled inflationary expectations, monetary policy should consist of lowering the short-term policy rate of the central bank, which in the US is the fed funds rate. The intended effect is to lower the real rate of interest (Svensson 2003LT, 146-7). The real rate of interest, r, is defined as the nominal rate, i, adjusted by expectations of inflation, π*, with all variables defined as proportions: (1+r) = (1+i)/(1+π*) (Fisher 1930). If i, the fed funds rate, is lowered by the Fed, the numerator of the right-hand side is lower such that if inflationary expectations, π*, remain unchanged, the left-hand (1+r) decreases, that is, the real rate of interest, r, declines. Expectations of lowering short-term real rates of interest by policy of the Federal Open Market Committee (FOMC) fixing a lower fed funds rate would lower long-term real rates of interest, inducing with a lag investment and consumption, or aggregate demand, that can lift the economy out of recession. Inflation also increases with a lag by higher aggregate demand and inflation expectations (Fisher 1933). This reasoning explains why the FOMC lowered the fed funds rate in Dec 2008 to 0 to 0.25 percent and left it unchanged.
The fear of the Fed is expected deflation or negative π*. In that case, (1+ π*) < 1, and (1+r) would increase because the right-hand side of the equation would be divided by a fraction. A simple numerical example explains the effect of deflation on the real rate of interest. Suppose that the nominal rate of interest or fed funds rate, i, is 0.25 percent, or in proportion 0.25/100 = 0.0025, such that (1+i) = 1.0025. Assume now that economic agents believe that inflation will remain at 1 percent for a long period, which means that π* = 1 percent, or in proportion 1/100 =0.01. The real rate of interest, using the equation, is (1+0.0025)/(1+0.01) = (1+r) = 0.99257, such that r = 0.99257 - 1 = -0.00743, which is a proportion equivalent to –(0.00743)100 = -0.743 percent. That is, Fed policy has created a negative real rate of interest of 0.743 percent with the objective of inducing aggregate demand by higher investment and consumption. This is true if expected inflation, π*, remains at 1 percent. Suppose now that expectations of deflation become generalized such that π* becomes -1 percent, that is, the public believes prices will fall at the rate of 1 percent in the foreseeable future. Then the real rate of interest becomes (1+0.0025) divided by (1-0.01) equal to (1.0025)/(0.99) = (1+r) = 1.01263, or r = (1.01263-1) = 0.01263, which results in positive real rate of interest of (0.01263)100 = 1.263 percent.
Irving Fisher also identified the impact of deflation on debts as an important cause of deepening contraction of income and employment during the Great Depression illustrated by an actual example (Fisher 1933, 346):
“By March, 1933, liquidation had reduced the debts about 20 percent, but had increased the dollar about 75 percent, so that the real debt, that is the debt measured in terms of commodities, was increased about 40 percent [100%-20%)X(100%+75%) =140%]. Unless some counteracting cause comes along to prevent the fall in the price level, such a depression as that of 1929-1933 (namely when the more the debtors pay the more they owe) tends to continue, going deeper, in a vicious spiral, for many years. There is then no tendency of the boat to stop tipping until it has capsized”
The nominal rate of interest must always be nonnegative, that is, i ≥ 0 (Hick 1937, 154-5):
“If the costs of holding money can be neglected, it will always be profitable to hold money rather than lend it out, if the rate of interest is not greater than zero. Consequently the rate of interest must always be positive. In an extreme case, the shortest short-term rate may perhaps be nearly zero. But if so, the long-term rate must lie above it, for the long rate has to allow for the risk that the short rate may rise during the currency of the loan, and it should be observed that the short rate can only rise, it cannot fall”
The interpretation by Hicks of the General Theory of Keynes is the special case in which at interest rates close to zero liquidity preference is infinitely or perfectly elastic, that is, the public holds infinitely large cash balances at that near zero interest rate because there is no opportunity cost of foregone interest. Increases in the money supply by the central bank would not decrease interest rates below their near zero level, which is called the liquidity trap. The only alternative public policy would consist of fiscal policy that would act similarly to an increase in investment, increasing employment without raising the interest rate.
An influential view on the policy required to steer the economy away from the liquidity trap is provided by Paul Krugman (1998). Suppose the central bank faces an increase in inflation. An important ingredient of the control of inflation is the central bank communicating to the public that it will maintain a sustained effort by all available policy measures and required doses until inflation is subdued and price stability is attained. If the public believes that the central bank will control inflation only until it declines to a more benign level but not sufficiently low level, current expectations will develop that inflation will be higher once the central bank abandons harsh measures. During deflation and recession the central bank has to convince the public that it will maintain zero interest rates and other required measures until the rate of inflation returns convincingly to a level consistent with expansion of the economy and stable prices. Krugman (1998, 161) summarizes the argument as:
“The ineffectuality of monetary policy in a liquidity trap is really the result of a looking-glass version of the standard credibility problem: monetary policy does not work because the public expects that whatever the central bank may do now, given the chance, it will revert to type and stabilize prices near their current level. If the central bank can credibly promise to be irresponsible—that is, convince the market that it will in fact allow prices to rise sufficiently—it can bootstrap the economy out of the trap”
This view is consistent with results of research by Christina Romer that “the rapid rates of growth of real output in the mid- and late 1930s were largely due to conventional aggregate demand stimulus, primarily in the form of monetary expansion. My calculations suggest that in the absence of these stimuli the economy would have remained depressed far longer and far more deeply than it actually did” (Romer 1992, 757-8, cited in Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 210-2). The average growth rate of the money supply in 1933-1937 was 10 percent per year and increased in the early 1940s. Romer calculates that GDP would have been much lower without this monetary expansion. The growth of “the money supply was primarily due to a gold inflow, which was in turn due to the devaluation in 1933 and to capital flight from Europe because of political instability after 1934” (Romer 1992, 759). Gold inflow coincided with the decline in real interest rates in 1933 that remained negative through the latter part of the 1930s, suggesting that they could have caused increases in spending that was sensitive to declines in interest rates. Bernanke finds dollar devaluation against gold to have been important in preventing further deflation in the 1930s (Bernanke 2002):
“There have been times when exchange rate policy has been an effective weapon against deflation. A striking example from US history is Franklin Roosevelt’s 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the US deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market”
Fed policy is seeking what Irving Fisher proposed “that great depressions are curable and preventable through reflation and stabilization” (Fisher 1933, 350).
The President of the Federal Reserve Bank of Chicago argues that (Charles Evans 2010):
“I believe the US economy is best described as being in a bona fide liquidity trap. Highly plausible projections are 1 percent for core Personal Consumption Expenditures (PCE) inflation at the end of 2012 and 8 percent for the unemployment rate. For me, the Fed’s dual mandate misses are too large to shrug off, and there is currently no policy conflict between improving employment and inflation outcomes”
There are two types of monetary policies that could be used in this situation. First, the Fed could announce a price-level target to be attained within a reasonable time frame (Evans 2010):
“For example, if the slope of the price path is 2 percent and inflation has been underunning the path for some time, monetary policy would strive to catch up to the path. Inflation would be higher than 2 percent for a time until the path was reattained”
Optimum monetary policy with interest rates near zero could consist of “bringing the price level back up to a level even higher than would have prevailed had the disturbance never occurred” (Gauti Eggertsson and Michael Woodford 2003, 207). Bernanke (2003JPY) explains as follows:
“Failure by the central bank to meet its target in a given period leads to expectations of (and public demands for) increased effort in subsequent periods—greater quantities of assets purchased on the open market for example. So even if the central bank is reluctant to provide a time frame for meetings its objective, the structure of the price-level objective provides a means for the bank to commit to increasing its anti-deflationary efforts when its earlier efforts prove unsuccessful. As Eggertsson and Woodford show, the expectations that an increasing price level gap will give rise to intensified effort by the central bank should lead the public to believe that ultimately inflation will replace deflation, a belief that supports the central bank’s own objectives by lowering the current real rate of interest”
Second, the Fed could use its balance sheet to increase purchases of long-term securities together with credible commitment to maintain the policy until the dual mandates of maximum employment and price stability are attained.
In the restatement of the liquidity trap and large-scale policies of monetary/fiscal stimulus, Krugman (1998, 162) finds:
“In the traditional open economy IS-LM model developed by Robert Mundell [1963] and Marcus Fleming [1962], and also in large-scale econometric models, monetary expansion unambiguously leads to currency depreciation. But there are two offsetting effects on the current account balance. On one side, the currency depreciation tends to increase net exports; on the other side, the expansion of the domestic economy tends to increase imports. For what it is worth, policy experiments on such models seem to suggest that these effects very nearly cancel each other out.
Krugman (1998) uses a different dynamic model with expectations that leads to similar conclusions.
The central bank could also be pursuing competitive devaluation of the national currency in the belief that it could increase inflation to a higher level and promote domestic growth and employment at the expense of growth and unemployment in the rest of the world. An essay by Chairman Bernanke in 1999 on Japanese monetary policy received attention in the press, stating that (Bernanke 2000, 165):
“Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and experiment—in short, to do whatever it took to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done”
Quantitative easing has never been proposed by Chairman Bernanke or other economists as certain science without adverse effects. What has not been mentioned in the press is another suggestion to the Bank of Japan (BOJ) by Chairman Bernanke in the same essay that is very relevant to current events and the contentious issue of ongoing devaluation wars (Bernanke 2000, 161):
“Because the BOJ has a legal mandate to pursue price stability, it certainly could make a good argument that, with interest rates at zero, depreciation of the yen is the best available tool for achieving its mandated objective. The economic validity of the beggar-thy-neighbor thesis is doubtful, as depreciation creates trade—by raising home country income—as well as diverting it. Perhaps not all those who cite the beggar-thy-neighbor thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery. A yen trading at 100 to the dollar is in no one’s interest”
Chairman Bernanke is referring to the argument by Joan Robinson based on the experience of the Great Depression that: “in times of general unemployment a game of beggar-my-neighbour is played between the nations, each one endeavouring to throw a larger share of the burden upon the others” (Robinson 1947, 156). Devaluation is one of the tools used in these policies (Robinson 1947, 157). Banking crises dominated the experience of the United States, but countries that recovered were those devaluing early such that competitive devaluations rescued many countries from a recession as strong as that in the US (see references to Ehsan Choudhri, Levis Kochin and Barry Eichengreen in Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 205-9; for the case of Brazil that devalued early in the Great Depression recovering with an increasing trade balance see Pelaez, 1968, 1968b, 1972; Brazil devalued and abandoned the gold standard during crises in the historical period as shown by Pelaez 1976, Pelaez and Suzigan 1981). Beggar-my-neighbor policies did work for individual countries but the criticism of Joan Robinson was that it was not optimal for the world as a whole.
Chairman Bernanke (2013Mar 25) reinterprets devaluation and recovery from the Great Depression:
“The uncoordinated abandonment of the gold standard in the early 1930s gave rise to the idea of "beggar-thy-neighbor" policies. According to this analysis, as put forth by important contemporary economists like Joan Robinson, exchange rate depreciations helped the economy whose currency had weakened by making the country more competitive internationally. Indeed, the decline in the value of the pound after 1931 was associated with a relatively early recovery from the Depression by the United Kingdom, in part because of some rebound in exports. However, according to this view, the gains to the depreciating country were equaled or exceeded by the losses to its trading partners, which became less internationally competitive--hence, ‘beggar thy neighbor.’ Economists still agree that Smoot-Hawley and the ensuing tariff wars were highly counterproductive and contributed to the depth and length of the global Depression. However, modern research on the Depression, beginning with the seminal 1985 paper by Barry Eichengreen and Jeffrey Sachs, has changed our view of the effects of the abandonment of the gold standard. Although it is true that leaving the gold standard and the resulting currency depreciation conferred a temporary competitive advantage in some cases, modern research shows that the primary benefit of leaving gold was that it freed countries to use appropriately expansionary monetary policies. By 1935 or 1936, when essentially all major countries had left the gold standard and exchange rates were market-determined, the net trade effects of the changes in currency values were certainly small. Yet the global economy as a whole was much stronger than it had been in 1931. The reason was that, in shedding the strait jacket of the gold standard, each country became free to use monetary policy in a way that was more commensurate with achieving full employment at home.”
Nurkse (1944) raised concern on the contraction of trade by competitive devaluations during the 1930s. Haberler (1937) dwelled on the issue of flexible exchange rates. Bordo and James (2001) provide perceptive exegesis of the views of Haberler (1937) and Nurkse (1944) together with the evolution of thought by Haberler. Policy coordination among sovereigns may be quite difficult in practice even if there were sufficient knowledge and sound forecasts. Friedman (1953) provided strong case in favor of a system of flexible exchange rates.
Eichengreen and Sachs (1985) argue theoretically with measurements using a two-sector model that it is possible for series of devaluations to improve the welfare of all countries. There were adverse effects of depreciation on other countries but depreciation by many countries could be beneficial for all. The important counterfactual is if depreciations by many countries would have promoted faster recovery from the Great Depression. Depreciation in the model of Eichengreen and Sachs (1985) affected domestic and foreign economies through real wages, profitability, international competitiveness and world interest rates. Depreciation causes increase in the money supply that lowers world interest rates, promoting growth of world output. Lower world interest rates could compensate contraction of output from the shift of demand away from home goods originating in neighbor’s exchange depreciation. Eichengreen and Sachs (1985, 946) conclude:
“This much, however, is clear. We do not present a blanket endorsement of the competitive devaluations of the 1930s. Though it is indisputable that currency depreciation conferred macroeconomic benefits on the initiating country, because of accompanying policies the depreciations of the 1930s had beggar-thy-neighbor effects. Though it is likely that currency depreciation (had it been even more widely adopted) would have worked to the benefit of the world as a whole, the sporadic and uncoordinated approach taken to exchange-rate policy in the 1930s tended, other things being equal, to reduce the magnitude of the benefits.”
There could major difference in the current world economy. The initiating impulse for depreciation originates in zero interest rates on the fed funds rate. The dollar is the world’s reserve currency. Risk aversion intermittently channels capital flight to the safe haven of the dollar and US Treasury securities. In the absence of risk aversion, zero interest rates induce carry trades of short positions in dollars and US debt (borrowing) together with long leveraged exposures in risk financial assets such as stocks, emerging stocks, commodities and high-yield bonds. Without risk aversion, the dollar depreciates against every currency in the world. The dollar depreciated against the euro by 39.3 percent from USD 1.1423/EUR con Jun 26, 2003 to USD 1.5914/EUR on Jun 14, 2008 during unconventional monetary policy before the global recession (Table VI-1). Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can increases net exports of the US that increase aggregate economic activity (Yellen 2011AS). The country issuing the world’s reserve currency appropriates the advantage from initiating devaluation that in policy intends to generate net exports that increase domestic output.
Pelaez and Pelaez (Regulation of Banks and Finance (2009b), 208-209) summarize the experience of Brazil as follows:
“During 1927–9, Brazil accumulated ￡30 million of foreign exchange of which ￡20 million were deposited at its stabilization fund (Pelaez 1968, 43–4). After the decline in coffee prices and the first impact of the Great Depression in Brazil a hot money movement wiped out foreign exchange reserves. In addition, capital inflows stopped entirely. The deterioration of the terms of trade further complicated matters, as the value of exports in foreign currency declined abruptly. Because of this exchange crisis, the service of the foreign debt of Brazil became impossible. In August 1931, the federal government was forced to cancel the payment of principal on certain foreign loans. The balance of trade in 1931 was expected to yield ￡20 million whereas the service of the foreign debt alone amounted to ￡22.6 million. Part of the solution given to these problems was typical of the 1930s. In September 1931, the government of Brazil required that all foreign transactions were to be conducted through the Bank of Brazil. This monopoly of foreign exchange was exercised by the Bank of Brazil for the following three years. Export permits were granted only after the exchange derived from sales abroad was officially sold to the Bank, which in turn allocated it in accordance with the needs of the economy. An active black market in foreign exchange developed. Brazil was in the first group of countries that abandoned early the gold standard, in 1931, and suffered comparatively less from the Great Depression. The Brazilian federal government, advised by the BOE, increased taxes and reduced expenditures in 1931 to compensate a decline in custom receipts (Pelaez 1968, 40). Expenditures caused by a revolution in 1932 in the state of Sao Paulo and a drought in the northeast explain the deficit. During 1932–6, the federal government engaged in strong efforts to stabilize the budget. Apart from the deliberate efforts to balance the budget during the 1930s, the recovery in economic activity itself may have induced a large part of the reduction of the deficit (Ibid, 41). Brazil’s experience is similar to that of the United States in that fiscal policy did not promote recovery from the Great Depression.”
Is depreciation of the dollar the best available tool currently for achieving the dual mandate of higher inflation and lower unemployment? Bernanke (2002) finds dollar devaluation against gold to have been important in preventing further deflation in the 1930s (http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm):
“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”
Should the US devalue following Roosevelt? Alternatively, has monetary policy intended devaluation? Fed policy is seeking, deliberately or as a side effect, what Irving Fisher proposed “that great depressions are curable and preventable through reflation and stabilization” (Fisher, 1933, 350). The Fed has created not only high volatility of assets but also what many countries are regarding as a competitive devaluation similar to those criticized by Nurkse (1944). Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment.
Friedman (1969) finds that the optimal rule for the quantity of money is deflation at a rate that results in a zero nominal interest rate (see Ireland 2003 and Cole and Kocherlakota 1998). Atkeson and Kehoe (2004) argue that central bankers are not inclined to implement policies that could result in deflation because of the interpretation of the Great Depression as closely related to deflation. They use panel data on inflation and growth of real output for 17 countries over more than 100 years. The time-series data for each individual country are broken into five-year events with deflation measured as average negative inflation and depression as average negative growth rate of real output. Atkeson and Kehoe (2004) find that the Great Depression from 1929 to 1934 is the only case of association between deflation and depression without any evidence whatsoever of such relation in any other period. Their conclusion is (Atkeson and Kehoe 2004, 99): “Our finding thus suggests that policymakers’ fear of anticipated policy-induced deflation that would result from following, say, the Friedman rule is greatly overblown.” Their conclusion on the experience of Japan is (Atkeson and Kehoe 2004, 99):
“Since 1960, Japan’s average growth rates have basically fallen monotonically, and since 1970, its average inflation rates have too. Attributing this 40-year slowdown to monetary forces is a stretch. More reasonable, we think, is that much of the slowdown is the natural pattern for a country that was far behind the world leaders and had begun to catch up.”
In the sample of Atkeson and Kehoe (2004), there are only eight five-year periods besides the Great Depression with both inflation and depression. Deflation and depression is shown in 65 cases with 21 of depression without deflation. There is no depression in 65 of 73 five-year periods and there is no deflation in 29 episodes of depression. There is a remarkable result of no depression in 90 percent of deflation episodes. Excluding the Great Depression, there is virtually no relation of deflation and depression. Atkeson and Kehoe (2004, 102) find that the average growth rate of Japan of 1.41 percent in the 1990s is “dismal” when compared with 3.20 percent in the United States but is not “dismal” when compared with 1.61 percent for Italy and 1.84 percent for France, which are also catch-up countries in modern economic growth (see Atkeson and Kehoe 1998). The conclusion of Atkeson and Kehoe (2004), without use of controls, is that there is no association of deflation and depression in their dataset.
Benhabib and Spiegel (2009) use a dataset similar to that of Atkeson and Kehoe (2004) but allowing for nonlinearity and inflation volatility. They conclude that in cases of low and negative inflation an increase of average inflation of 1 percent is associated with an increase of 0.31 percent of average annual growth. The analysis of Benhabib and Spiegel (2009) leads to the significantly different conclusion that inflation and economic performance are strongly associated for low and negative inflation. There is no claim of causality by Atkeson and Kehoe (2004) and Benhabib and Spiegel (2009).
Delfim Netto (1959) partly reprinted in Pelaez (1973) conducted two classical nonparametric tests (Mann 1945, Wallis and Moore 1941; see Kendall and Stuart 1968) with coffee-price data in the period of free markets from 1857 to 1906 with the following conclusions (Pelaez, 1976a, 280):
“First, the null hypothesis of no trend was accepted with high confidence; secondly, the null hypothesis of no oscillation was rejected also with high confidence. Consequently, in the nineteenth century international prices of coffee fluctuated but without long-run trend. This statistical fact refutes the extreme argument of structural weakness of the coffee trade.”
In his classic work on the theory of international trade, Jacob Viner (1937, 563) analyzed the “index of total gains from trade,” or “amount of gain per unit of trade,” denoted as T:
T= (∆Pe/∆Pi)∆Q
Where ∆Pe is the change in export prices, ∆Pi is the change in import prices and ∆Q is the change in export volume. Dorrance (1948, 52) restates “Viner’s index of total gain from trade” as:
“What should be done is to calculate an index of the value (quantity multiplied by price) of exports and the price of imports for any country whose foreign accounts are to be analysed. Then the export value index should be divided by the import price index. The result would be an index which would reflect, for the country concerned, changes in the volume of imports obtainable from its export income (i.e. changes in its "real" export income, measured in import terms). The present writer would suggest that this index be referred to as the ‘income terms of trade’ index to differentiate it from the other indexes at present used by economists.”
What really matters for an export activity especially during modernization is the purchasing value of goods that it exports in terms of prices of imports. For a primary producing country, the purchasing power of exports in acquiring new technology from the country providing imports is the critical measurement. The barter terms of trade of Brazil improved from 1857 to 1906 because international coffee prices oscillated without trend (Delfim Netto 1959) while import prices from the United Kingdom declined at the rate of 0.5 percent per year (Imlah 1958). The accurate measurement of the opportunity afforded by the coffee exporting economy was incomparably greater when considering the purchasing power in British prices of the value of coffee exports, or Dorrance’s (1948) income terms of trade.
The conventional theory that the terms of trade of Brazil deteriorated over the long term is without reality (Pelaez 1976a, 280-281):
“Moreover, physical exports of coffee by Brazil increased at the high average rate of 3.5 per cent per year. Brazil's exchange receipts from coffee-exporting in sterling increased at the average rate of 3.5 per cent per year and receipts in domestic currency at 4.5 per cent per year. Great Britain supplied nearly all the imports of the coffee economy. In the period of the free coffee market, British export prices declined at the rate of 0.5 per cent per year. Thus, the income terms of trade of the coffee economy improved at the relatively satisfactory average rate of 4.0 per cent per year. This is only a lower bound of the rate of improvement of the terms of trade. While the quality of coffee remained relatively constant, the quality of manufactured products improved significantly during the fifty-year period considered. The trade data and the non-parametric tests refute conclusively the long-run hypothesis. The valid historical fact is that the tropical export economy of Brazil experienced an opportunity of absorbing rapidly increasing quantities of manufactures from the "workshop" countries. Therefore, the coffee trade constituted a golden opportunity for modernization in nineteenth-century Brazil.”
Imlah (1958) provides decline of British export prices at 0.5 percent in the nineteenth century and there were no lost decades, depressions or unconventional monetary policies in the highly dynamic economy of England that drove the world’s growth impulse. Inflation in the United Kingdom between 1857 and 1906 is measured by the composite price index of O’Donoghue and Goulding (2004) at minus 7.0 percent or average rate of decline of 0.2 percent per year.
Simon Kuznets (1971) analyzes modern economic growth in his Lecture in Memory of Alfred Nobel:
“The major breakthroughs in the advance of human knowledge, those that constituted dominant sources of sustained growth over long periods and spread to a substantial part of the world, may be termed epochal innovations. And the changing course of economic history can perhaps be subdivided into economic epochs, each identified by the epochal innovation with the distinctive characteristics of growth that it generated. Without considering the feasibility of identifying and dating such economic epochs, we may proceed on the working assumption that modern economic growth represents such a distinct epoch - growth dating back to the late eighteenth century and limited (except in significant partial effects) to economically developed countries. These countries, so classified because they have managed to take adequate advantage of the potential of modern technology, include most of Europe, the overseas offshoots of Western Europe, and Japan—barely one quarter of world population.”
Cameron (1961) analyzes the mechanism by which the Industrial Revolution in Great Britain spread throughout Europe and Cameron (1967) analyzes the financing by banks of the Industrial Revolution in Great Britain. O’Donoghue and Goulding (2004) provide consumer price inflation in England since 1750 and MacFarlane and Mortimer-Lee (1994) analyze inflation in England over 300 years. Lucas (2004) estimates world population and production since the year 1000 with sustained growth of per capita incomes beginning to accelerate for the first time in English-speaking countries and in particular in the Industrial Revolution in Great Britain. The conventional theory is unequal distribution of the gains from trade and technical progress between the industrialized countries and developing economies (Singer 1950, 478):
“Dismissing, then, changes in productivity as a governing factor in changing terms of trade, the following explanation presents itself: the fruits of technical progress may be distributed either to producers (in the form of rising incomes) or to consumers (in the form of lower prices). In the case of manufactured commodities produced in more developed countries, the former method, i.e., distribution to producers through higher incomes, was much more important relatively to the second method, while the second method prevailed more in the case of food and raw material production in the underdeveloped countries. Generalizing, we may say -that technical progress in manufacturing industries showed in a rise in incomes while technical progress in the production of food and raw materials in underdeveloped countries showed in a fall in prices”
Temin (1997, 79) uses a Ricardian trade model to discriminate between two views on the Industrial Revolution with an older view arguing broad-based increases in productivity and a new view concentration of productivity gains in cotton manufactures and iron:
“Productivity advances in British manufacturing should have lowered their prices relative to imports. They did. Albert Imlah [1958] correctly recognized this ‘severe deterioration’ in the net barter terms of trade as a signal of British success, not distress. It is no surprise that the price of cotton manufactures fell rapidly in response to productivity growth. But even the price of woolen manufactures, which were declining as a share of British exports, fell almost as rapidly as the price of exports as a whole. It follows, therefore, that the traditional ‘old-hat’ view of the Industrial Revolution is more accurate than the new, restricted image. Other British manufactures were not inefficient and stagnant, or at least, they were not all so backward. The spirit that motivated cotton manufactures extended also to activities as varied as hardware and haberdashery, arms, and apparel.”
Phyllis Deane (1968, 96) estimates growth of United Kingdom gross national product (GNP) at around 2 percent per year for several decades in the nineteenth century. The facts that the terms of trade of Great Britain deteriorated during the period of epochal innovation and high rates of economic growth while the income terms of trade of the coffee economy of nineteenth-century Brazil improved at the average yearly rate of 4.0 percent from 1857 to 1906 disprove the hypothesis of weakness of trade as an explanation of relatively lower income and wealth. As Temin (1997) concludes, Britain did pass on lower prices and higher quality the benefits of technical innovation. Explanation of late modernization must focus on laborious historical research on institutions and economic regimes together with economic theory, data gathering and measurement instead of grand generalizations of weakness of trade and alleged neocolonial dependence (Stein and Stein 1970, 134-5):
“Great Britain, technologically and industrially advanced, became as important to the Latin American economy as to the cotton-exporting southern United States. [After Independence in the nineteenth century] Latin America fell back upon traditional export activities, utilizing the cheapest available factor of production, the land, and the dependent labor force.”
The experience of the United Kingdom with deflation and economic growth is relevant and rich. Table IE-1 uses yearly percentage changes of the composite index of prices of the United Kingdom of O’Donoghue and Goulding (2004). There are 73 declines of inflation in the 145 years from 1751 to 1896. Prices declined in 50.3 percent of 145 years. Some price declines were quite sharp and many occurred over several years. Table IE-1 also provides yearly percentage changes of the UK composite price index of O’Donoghue and Goulding (2004) from 1929 to 1934. Deflation was much sharper in continuous years in earlier periods than during the Great Depression. The United Kingdom could not have led the world in modern economic growth if there were meaningful causality from deflation to depression.
Table IE-1, United Kingdom, Negative Percentage Changes of Composite Price Index, 1751-1896, 1929-1934, Yearly ∆%
| Year | ∆% | Year | ∆% | Year | ∆% | Year | ∆% |
| 1751 | -2.7 | 1797 | -10.0 | 1834 | -7.8 | 1877 | -0.7 |
| 1753 | -2.7 | 1798 | -2.2 | 1841 | -2.3 | 1878 | -2.2 |
| 1755 | -6.0 | 1802 | -23.0 | 1842 | -7.6 | 1879 | -4.4 |
| 1758 | -0.3 | 1803 | -5.9 | 1843 | -11.3 | 1881 | -1.1 |
| 1759 | -7.9 | 1806 | -4.4 | 1844 | -0.1 | 1883 | -0.5 |
| 1760 | -4.5 | 1807 | -1.9 | 1848 | -12.1 | 1884 | -2.7 |
| 1761 | -4.5 | 1811 | -2.9 | 1849 | -6.3 | 1885 | -3.0 |
| 1768 | -1.1 | 1814 | -12.7 | 1850 | -6.4 | 1886 | -1.6 |
| 1769 | -8.2 | 1815 | -10.7 | 1851 | -3.0 | 1887 | -0.5 |
| 1770 | -0.4 | 1816 | -8.4 | 1857 | -5.6 | 1893 | -0.7 |
| 1773 | -0.3 | 1819 | -2.5 | 1858 | -8.4 | 1894 | -2.0 |
| 1775 | -5.6 | 1820 | -9.3 | 1859 | -1.8 | 1895 | -1.0 |
| 1776 | -2.2 | 1821 | -12.0 | 1862 | -2.6 | 1896 | -0.3 |
| 1777 | -0.4 | 1822 | -13.5 | 1863 | -3.6 | 1929 | -0.9 |
| 1779 | -8.5 | 1826 | -5.5 | 1864 | -0.9 | 1930 | -2.8 |
| 1780 | -3.4 | 1827 | -6.5 | 1868 | -1.7 | 1931 | -4.3 |
| 1785 | -4.0 | 1828 | -2.9 | 1869 | -5.0 | 1932 | -2.6 |
| 1787 | -0.6 | 1830 | -6.1 | 1874 | -3.3 | 1933 | -2.1 |
| 1789 | -1.3 | 1832 | -7.4 | 1875 | -1.9 | 1934 | 0.0 |
| 1791 | -0.1 | 1833 | -6.1 | 1876 | -0.3 |
Source:
O’Donoghue, Jim and Louise Goulding, 2004. Consumer Price Inflation since 1750. UK Office for National Statistics Economic Trends 604, Mar 2004, 38-46.
Lucas (2011May) estimates US economic growth in the long-term at 3 percent per year and about 2 percent per year in per capita terms. There are displacements from this trend caused by events such as wars and recessions but the economy then returns to trend. Historical US GDP data exhibit remarkable growth: Lucas (2011May) estimates an increase of US real income per person by a factor of 12 in the period from 1870 to 2010. The explanation by Lucas (2011May) of this remarkable growth experience is that government provided stability and education while elements of “free-market capitalism” were an important driver of long-term growth and prosperity. The analysis is sharpened by comparison with the long-term growth experience of G7 countries (US, UK, France, Germany, Canada, Italy and Japan) and Spain from 1870 to 2010. Countries benefitted from “common civilization” and “technology” to “catch up” with the early growth leaders of the US and UK, eventually growing at a faster rate. Significant part of this catch up occurred after World War II. If deflation causes depressions as embedded in the theory of unconventional monetary policy, the United Kingdom would not have been a growth leader in the nineteenth century while staying almost half of the time in deflation.
Nicholas Georgescu-Rogen (1960, 1) reprinted in Pelaez (1973) argues that “the agrarian economy has to this day remained a reality without theory.” The economic history of Latin America shares with the relation of deflation and unconventional monetary policy a more frustrating intellectual misfortune: theory without reality. MacFarlane and Mortimer-Lee (1994, 159) quote in a different context a phrase by Thomas Henry Huxley in the President’s Address to the British Association for the Advancement of Science on Sep 14, 1870 that is appropriate to these issues: “The great tragedy of science—the slaying of a beautiful hypothesis by an ugly fact.”
II United States Industrial Production. Industrial production increased 0.4 percent in Aug 2013 after changing 0.0 percent in Jul 2013 and increasing 0.1 percent in Jun 2013, as shown in Table II-1, with all data seasonally adjusted. The report of the Board of Governors of the Federal Reserve System states (http://www.federalreserve.gov/releases/g17/Current/default.htm):
“Industrial production advanced 0.4 percent in August after having been unchanged in July; the gains in August were broadly based. Following a decrease in July of 0.4 percent, which was steeper than previously reported, manufacturing production rose 0.7 percent in August. The output of mines moved up 0.3 percent, its fifth consecutive monthly increase, and the production of utilities fell 1.5 percent, its fifth consecutive monthly decrease. At 99.4 percent of its 2007 average, total industrial production in August was 2.7 percent above its year-earlier level. “
In the six months ending in Aug 2013, United States national industrial production accumulated increase of 0.6 percent at the annual equivalent rate of 1.2 percent, which is much lower than growth of 2.7 percent in the 12 months ending in Aug 2013. Excluding growth of 0.4 percent in Aug 2013, growth in the remaining five months from Mar 2012 to Jul 2013 accumulated to 0.2 percent or 0.5 percent annual equivalent. Industrial production stagnated in three of the past six months and fell in one. Business equipment accumulated growth of 0.4 percent in the six months from Mar to Aug 2013 at the annual equivalent rate of 0.8 percent, which is much lower than growth of 2.5 percent in the 12 months ending in Aug 2013. Growth of business equipment accumulated minus 0.5 percent from Mar to July 2013 at the annual equivalent rate of minus 1.2 percent. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for the industrial sector increased 0.2 percentage point in August to 77.8 percent, a rate 0.6 percentage point above its level of a year earlier and 2.4 percentage points below its long-run (1972-2012) average.” United States industry is apparently decelerating.
Table II-1, US, Industrial Production and Capacity Utilization, SA, ∆%
| 2012-2013 | Aug 13 | Jul 13 | Jun 13 | May 13 | Apr 13 | Mar 13 | Jun 13/ Jun 12 |
| Total | 0.4 | 0.0 | 0.1 | 0.1 | -0.3 | 0.3 | 2.7 |
| Market | |||||||
| Final Products | 0.5 | -0.5 | 0.4 | -0.2 | -0.5 | 0.6 | 2.1 |
| Consumer Goods | 0.3 | -0.5 | 0.3 | -0.2 | -0.7 | 0.8 | 2.3 |
| Business Equipment | 0.9 | -0.9 | 0.7 | -0.3 | -0.1 | 0.1 | 2.5 |
| Non | 0.1 | -0.5 | 0.1 | 0.0 | -0.5 | 0.0 | 1.7 |
| Construction | 0.3 | 0.5 | 0.7 | -0.5 | -1.1 | -1.1 | 5.3 |
| Materials | 0.4 | 0.5 | -0.1 | 0.4 | -0.2 | 0.1 | 3.4 |
| Industry Groups | |||||||
| Manufacturing | 0.7 | -0.4 | 0.3 | 0.2 | -0.4 | -0.2 | 2.6 |
| Mining | 0.3 | 2.4 | 0.5 | 0.8 | 0.8 | -0.2 | 7.5 |
| Utilities | -1.5 | -1.3 | -2.0 | -1.8 | -1.6 | 5.0 | -3.9 |
| Capacity | 77.8 | 77.6 | 77.8 | 77.8 | 77.8 | 78.2 | 1.8 |
Sources: Board of Governors of the Federal Reserve System http://www.federalreserve.gov/releases/g17/Current/default.htm
Manufacturing increased 0.7 percent in Aug 2013 after decreasing 0.4 percent in Jul 2013 and increasing 0.3 percent in Jul 2013 seasonally adjusted, increasing 2.5 percent not seasonally adjusted in 12 months ending in Aug 2013, as shown in Table II-2. Manufacturing grew cumulatively 0.2 percent in the six months ending in Jul 2013 or at the annual equivalent rate of 0.4 percent. Excluding the increase of 0.7 percent in Aug 2013, manufacturing accumulated growth of minus 0.5 percent from Mar 2013 to Jul 2013 or at the annual equivalent rate of minus 1.2 percent. Table II-2 provides a longer perspective of manufacturing in the US. There has been evident deceleration of manufacturing growth in the US from 2010 and the first three months of 2011 into more recent months as shown by 12 months rates of growth. Growth rates appeared to be increasing again closer to 5 percent in Apr-Jun 2012 but deteriorated. The rates of decline of manufacturing in 2009 are quite high with a drop of 18.2 percent in the 12 months ending in Apr 2009. Manufacturing recovered from this decline and led the recovery from the recession. Rates of growth appeared to be returning to the levels at 3 percent or higher in the annual rates before the recession but the pace of manufacturing fell steadily in the past six months with some weakness at the margin. The Board of Governors of the Federal Reserve System conducted the annual revision of industrial production released on Mar 22, 2013 (http://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm):
“The Federal Reserve has revised its index of industrial production (IP) and the related measures of capacity and capacity utilization. Measured from fourth quarter to fourth quarter, total IP is now reported to have increased 0.7 percentage point less in 2011 than was previously published. The revisions to IP for other years were smaller: Compared to the previous estimates, industrial production fell slightly less in 2008 and 2009 and increased slightly less in 2010 and 2012. At 97.7 percent of its 2007 average, the index in the fourth quarter of 2012 now stands 0.4 percent below its previous estimate. With these revisions, IP is still estimated to have advanced about 6 percent in 2010, the first full year following the trough in June 2009 of the most recent recession, but it is now estimated to have risen about 3 percent both in 2011 and in 2012. Since the trough of the recession, total IP has reversed about 90 percent of its peak-to-trough decline.”
The bottom part of Table II-2 shows decline of manufacturing by 21.9 from the peak in Jun 2007 to the trough in Apr 2009 and increased by 16.8 percent from the trough in Apr 2009 to Dec 2012. Manufacturing grew 21.1 percent from the trough in Apr 2009 to Aug 2013. Manufacturing output in Aug 2013 is 5.4 percent below the peak in Jun 2007.
Table II-2, US, Monthly and 12-Month Rates of Growth of Manufacturing ∆%
| Month SA ∆% | 12-Month NSA ∆% | |
| Aug 2013 | 0.7 | 2.5 |
| Jul | -0.4 | 1.4 |
| Jun | 0.3 | 1.4 |
| May | 0.2 | 1.7 |
| Apr | -0.4 | 2.1 |
| Mar | -0.2 | 1.8 |
| Feb | 0.6 | 1.9 |
| Jan | -0.1 | 2.4 |
| Dec 2012 | 0.9 | 3.0 |
| Nov | 1.4 | 3.3 |
| Oct | -0.4 | 2.1 |
| Sep | 0.1 | 3.1 |
| Aug | -0.7 | 3.5 |
| Jul | 0.2 | 4.0 |
| Jun | 0.4 | 5.0 |
| May | -0.2 | 4.8 |
| Apr | 0.6 | 5.1 |
| Mar | -0.5 | 3.9 |
| Feb | 0.6 | 5.3 |
| Jan | 1.1 | 4.2 |
| Dec 2011 | 1.0 | 3.8 |
| Nov | 0.0 | 3.2 |
| Oct | 0.6 | 3.1 |
| Sep | 0.4 | 3.0 |
| Aug | 0.3 | 2.4 |
| Jul | 0.7 | 2.5 |
| Jun | 0.1 | 2.1 |
| May | 0.3 | 1.9 |
| Apr | -0.8 | 3.1 |
| Mar | 0.7 | 4.9 |
| Feb | 0.0 | 5.4 |
| Jan | 0.2 | 5.6 |
| Dec 2010 | 0.6 | 6.2 |
| Nov | 0.2 | 5.3 |
| Oct | 0.1 | 6.6 |
| Sep | 0.1 | 7.0 |
| Aug | 0.1 | 7.4 |
| Jul | 0.7 | 7.8 |
| Jun | 0.0 | 9.3 |
| May | 1.5 | 8.9 |
| Apr | 1.0 | 7.1 |
| Mar | 1.3 | 4.9 |
| Feb | 0.1 | 1.3 |
| Jan | 1.1 | 1.2 |
| Dec 2009 | 0.0 | -3.1 |
| Nov | 1.2 | -6.1 |
| Oct | 0.1 | -9.1 |
| Sep | 0.8 | -10.6 |
| Aug | 1.2 | -13.6 |
| Jul | 1.3 | -15.2 |
| Jun | -0.3 | -17.6 |
| May | -1.1 | -17.6 |
| Apr | -0.7 | -18.2 |
| Mar | -1.8 | -17.3 |
| Feb | -0.1 | -16.1 |
| Jan | -2.9 | -16.4 |
| Dec 2008 | -3.4 | -14.0 |
| Nov | -2.3 | -11.3 |
| Oct | -0.6 | -9.0 |
| Sep | -3.5 | -8.6 |
| Aug | -1.4 | -5.1 |
| Jul | -1.1 | -3.5 |
| Jun | -0.6 | -3.1 |
| May | -0.4 | -2.4 |
| Apr | -1.1 | -1.1 |
| Mar | -0.3 | -0.5 |
| Feb | -0.6 | 0.9 |
| Jan | -0.4 | 2.3 |
| Dec 2007 | 0.2 | 2.0 |
| Nov | 0.5 | 3.4 |
| Oct | -0.3 | 2.8 |
| Sep | 0.6 | 3.0 |
| Aug | -0.4 | 2.6 |
| Jul | 0.2 | 3.4 |
| Jun | 0.3 | 2.9 |
| May | 0.0 | 3.1 |
| Apr | 0.7 | 3.6 |
| Mar | 0.8 | 2.4 |
| Feb | 0.4 | 1.6 |
| Jan | -0.5 | 1.3 |
| Dec 2006 | 2.7 | |
| Dec 2005 | 3.4 | |
| Dec 2004 | 4.0 | |
| Dec 2003 | 1.7 | |
| Dec 2002 | 2.4 | |
| Dec 2001 | -5.5 | |
| Dec 2000 | 0.4 | |
| Dec 1999 | 5.4 | |
| Average ∆% Dec 1986-Dec 2012 | 2.3 | |
| Average ∆% Dec 1986-Dec 1999 | 4.3 | |
| Average ∆% Dec 1999-Dec 2006 | 1.3 | |
| Average ∆% Dec 1999-Dec 2012 | 0.4 | |
| ∆% Peak 103.0005 in 06/2007 to 93.9456 in 12/2012 | -8.8 | |
| ∆% Peak 103.0005 on 06/2007 to Trough 80.4617 in 4/2009 | -21.9 | |
| ∆% Trough 80.4617 in 04/2009 to 93.9456 in 12/2012 | 16.8 | |
| ∆% Trough 80.4617 in 04/2009 to 97.4442 in 8/2013 | 21.1 | |
| ∆% Peak 103.0005 on 06/2007 to Trough 97.4442 in 8/2013 | -5.4 |
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/default.htm
Chart II-1 of the Board of Governors of the Federal Reserve System provides industrial production, manufacturing and capacity since the 1970s. There was acceleration of growth of industrial production, manufacturing and capacity in the 1990s because of rapid growth of productivity in the US (Cobet and Wilson (2002); see Pelaez and Pelaez, The Global Recession Risk (2007), 135-44). The slopes of the curves flatten in the 2000s. Production and capacity have not recovered to the levels before the global recession.
Chart II-1, US, Industrial Production, Capacity and Utilization
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/ipg1.gif
The modern industrial revolution of Jensen (1993) is captured in Chart II-2 of the Board of Governors of the Federal Reserve System (for the literature on M&A and corporate control see Pelaez and Pelaez, Regulation of Banks and Finance (2009a), 143-56, Globalization and the State, Vol. I (2008a), 49-59, Government Intervention in Globalization (2008c), 46-49). The slope of the curve of total industrial production accelerates in the 1990s to a much higher rate of growth than the curve excluding high-technology industries. Growth rates decelerate into the 2000s and output and capacity utilization have not recovered fully from the strong impact of the global recession. Growth in the current cyclical expansion has been more subdued than in the prior comparably deep contractions in the 1970s and 1980s. Chart II-2 shows that the past recessions after World War II are the relevant ones for comparison with the recession after 2007 instead of common comparisons with the Great Depression (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). The bottom left-hand part of Chart II-2 shows the strong growth of output of communication equipment, computers and semiconductor that continued from the 1990s into the 2000s. Output of semiconductors has already surpassed the level before the global recession.
Chart II-2, US, Industrial Production, Capacity and Utilization of High Technology Industries
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/ipg3.gif
Additional detail on industrial production and capacity utilization is provided in Chart II-3 of the Board of Governors of the Federal Reserve System. Production of consumer durable goods fell sharply during the global recession by more than 30 percent and is still around the level before the contraction. Output of nondurable consumer goods fell around 10 percent and is some 5 percent below the level before the contraction. Output of business equipment fell sharply during the contraction of 2001 but began rapid growth again after 2004. An important characteristic is rapid growth of output of business equipment in the cyclical expansion after sharp contraction in the global recession. Output of defense and space only suffered reduction in the rate of growth during the global recession and surged ahead of the level before the contraction. Output of construction supplies collapsed during the global recession and is well below the level before the contraction. Output of energy materials was stagnant before the contraction but has recovered sharply above the level before the contraction.
Chart II-3, US, Industrial Production and Capacity Utilization
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/ipg2.gif
United States manufacturing output from 1919 to 2012 on a monthly basis is in Chart II-4 of the Board of Governors of the Federal Reserve System. The second industrial revolution of Jensen (1993) is quite evident in the acceleration of the rate of growth of output given by the sharper slope in the 1980s and 1990s. Growth was robust after the shallow recession of 2001 but dropped sharply during the global recession after IVQ2007. Manufacturing output recovered sharply but has not reached earlier levels and is losing momentum at the margin.
Chart II-4, US, Manufacturing Output, 1919-2013
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/default.htm
Manufacturing jobs increased 614,000 in Aug 2013 relative to Jul 2013, seasonally adjusted (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). Manufacturing jobs not seasonally adjusted increased 15,000 from Aug 2012 to Aug 2013 or at the average monthly rate of 1,250. There are effects of the weaker economy and international trade together with the yearly adjustment of labor statistics. Industrial production increased 0.4 percent in Aug 2013 after changing 0.0 percent in Jul 2013 and increasing 0.1 percent in Jun 2013, as shown in Table II-1, with all data seasonally adjusted. The report of the Board of Governors of the Federal Reserve System states (http://www.federalreserve.gov/releases/g17/Current/default.htm):
“Industrial production advanced 0.4 percent in August after having been unchanged in July; the gains in August were broadly based. Following a decrease in July of 0.4 percent, which was steeper than previously reported, manufacturing production rose 0.7 percent in August. The output of mines moved up 0.3 percent, its fifth consecutive monthly increase, and the production of utilities fell 1.5 percent, its fifth consecutive monthly decrease. At 99.4 percent of its 2007 average, total industrial production in August was 2.7 percent above its year-earlier level. “
In the six months ending in Aug 2013, United States national industrial production accumulated increase of 0.6 percent at the annual equivalent rate of 1.2 percent, which is much lower than growth of 2.7 percent in the 12 months ending in Aug 2013. Excluding growth of 0.4 percent in Aug 2013, growth in the remaining five months from Mar 2012 to Jul 2013 accumulated to 0.2 percent or 0.5 percent annual equivalent. Industrial production stagnated in three of the past six months and fell in one. Business equipment accumulated growth of 0.4 percent in the six months from Mar to Aug 2013 at the annual equivalent rate of 0.8 percent, which is much lower than growth of 2.5 percent in the 12 months ending in Aug 2013. Growth of business equipment accumulated minus 0.5 percent from Mar to July 2013 at the annual equivalent rate of minus 1.2 percent. The Fed analyzes capacity utilization of total industry in its report (http://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for the industrial sector increased 0.2 percentage point in August to 77.8 percent, a rate 0.6 percentage point above its level of a year earlier and 2.4 percentage points below its long-run (1972-2012) average.” United States industry is apparently decelerating.
Manufacturing increased 0.7 percent in Aug 2013 after decreasing 0.4 percent in Jul 2013 and increasing 0.3 percent in Jul 2013 seasonally adjusted, increasing 2.5 percent not seasonally adjusted in 12 months ending in Aug 2013, as shown in Table II-2. Manufacturing grew cumulatively 0.2 percent in the six months ending in Jul 2013 or at the annual equivalent rate of 0.4 percent. Excluding the increase of 0.7 percent in Aug 2013, manufacturing accumulated growth of minus 0.5 percent from Mar 2013 to Jul 2013 or at the annual equivalent rate of minus 1.2 percent.
Table II-3 provides national income by industry without capital consumption adjustment (WCCA). “Private industries” or economic activities have share of 86.6 percent in IQ2013. Most of US national income is in the form of services. In Aug 2013, there were 135.961 million nonfarm jobs NSA in the US, according to estimates of the establishment survey of the Bureau of Labor Statistics (BLS) (http://www.bls.gov/news.release/empsit.nr0.htm Table B-1). Total private jobs of 115.218 million NSA in Aug 2013 accounted for 84.7 percent of total nonfarm jobs of 135.961 million, of which 12.063 million, or 10.5 percent of total private jobs and 8.9 percent of total nonfarm jobs, were in manufacturing. Private service-producing jobs were 96.174 million NSA in Aug 2013, or 70.7 percent of total nonfarm jobs and 83.5 percent of total private-sector jobs. Manufacturing has share of 10.9 percent in US national income in IQ2013, as shown in Table II-3. Most income in the US originates in services. Subsidies and similar measures designed to increase manufacturing jobs will not increase economic growth and employment and may actually reduce growth by diverting resources away from currently employment-creating activities because of the drain of taxation.
Table II-3, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total
| SAAR IQ2013 | % Total | SAAR | % Total | |
| National Income WCCA | 14,354.5 | 100.0 | 14,480.5 | 100.0 |
| Domestic Industries | 14,117.1 | 98.3 | 14,223.1 | 98.2 |
| Private Industries | 12,432.9 | 86.6 | 12,542.6 | 86.6 |
| Agriculture | 226.4 | 1.6 | ||
| Mining | 247.6 | 1.7 | ||
| Utilities | 209.1 | 1.5 | ||
| Construction | 618.2 | 4.3 | ||
| Manufacturing | 1568.1 | 10.9 | ||
| Durable Goods | 878.8 | 6.1 | ||
| Nondurable Goods | 689.2 | 4.8 | ||
| Wholesale Trade | 870.0 | 6.1 | ||
| Retail Trade | 971.4 | 6.8 | ||
| Transportation & WH | 434.0 | 3.0 | ||
| Information | 496.0 | 3.5 | ||
| Finance, Insurance, RE | 2418.9 | 16.8 | ||
| Professional, BS | 1973.6 | 13.7 | ||
| Education, Health Care | 1423.7 | 9.9 | ||
| Arts, Entertainment | 569.7 | 4.0 | ||
| Other Services | 406.1 | 2.8 | ||
| Government | 1684.3 | 11.7 | 1680.5 | 11.6 |
| Rest of the World | 237.4 | 1.7 | 257.4 | 1.8 |
Notes: SSAR: Seasonally-Adjusted Annual Rate; WCCA: Without Capital Consumption Adjustment by Industry; WH: Warehousing; RE, includes rental and leasing: Real Estate; Art, Entertainment includes recreation, accommodation and food services; BS: business services
Source: US Bureau of Economic Analysis http://bea.gov/iTable/index_nipa.cfm
Motor vehicle sales and production in the US have been in long-term structural change. Table VA-8 provides the data on new motor vehicle sales and domestic car production in the US from 1990 to 2010. New motor vehicle sales grew from 14,137 thousand in 1990 to the peak of 17,806 thousand in 2000 or 29.5 percent. In that same period, domestic car production fell from 6,231 thousand in 1990 to 5,542 thousand in 2000 or -11.1 percent. New motor vehicle sales fell from 17,445 thousand in 2005 to 11,772 in 2010 or 32.5 percent while domestic car production fell from 4,321 thousand in 2005 to 2,840 thousand in 2010 or 34.3 percent. In Jan-Aug 2013, light vehicle sales accumulated to 10,647,486, which is higher by 9.6 percent relative to 9,711,044 a year earlier (http://motorintelligence.com/m_frameset.html). The seasonally adjusted annual rate of light vehicle sales in the US reached 16.09 million in Aug 2013, slightly higher than 15.80 million in Jul 2013 and higher than 14.49 million in Aug 2012 (http://motorintelligence.com/m_frameset.html).
Table II-4, US, New Motor Vehicle Sales and Car Production, Thousand Units
| New Motor Vehicle Sales | New Car Sales and Leases | New Truck Sales and Leases | Domestic Car Production | |
| 1990 | 14,137 | 9,300 | 4,837 | 6,231 |
| 1991 | 12,725 | 8,589 | 4,136 | 5,454 |
| 1992 | 13,093 | 8,215 | 4,878 | 5,979 |
| 1993 | 14,172 | 8,518 | 5,654 | 5,979 |
| 1994 | 15,397 | 8,990 | 6,407 | 6,614 |
| 1995 | 15,106 | 8,536 | 6,470 | 6,340 |
| 1996 | 15,449 | 8,527 | 6,922 | 6,081 |
| 1997 | 15,490 | 8,273 | 7,218 | 5,934 |
| 1998 | 15,958 | 8,142 | 7,816 | 5,554 |
| 1999 | 17,401 | 8,697 | 8,704 | 5,638 |
| 2000 | 17,806 | 8,852 | 8,954 | 5,542 |
| 2001 | 17,468 | 8,422 | 9,046 | 4,878 |
| 2002 | 17,144 | 8,109 | 9,036 | 5,019 |
| 2003 | 16,968 | 7,611 | 9,357 | 4,510 |
| 2004 | 17,298 | 7,545 | 9,753 | 4,230 |
| 2005 | 17,445 | 7,720 | 9,725 | 4,321 |
| 2006 | 17,049 | 7,821 | 9,228 | 4,367 |
| 2007 | 16,460 | 7,618 | 8,683 | 3,924 |
| 2008 | 13,494 | 6,814 | 6.680 | 3,777 |
| 2009 | 10,601 | 5,456 | 5,154 | 2,247 |
| 2010 | 11,772 | 5,729 | 6,044 | 2,840 |
Source: US Census Bureau http://www.census.gov/compendia/statab/cats/wholesale_retail_trade/motor_vehicle_sales.html
Chart II-5 of the Board of Governors of the Federal Reserve provides output of motor vehicles and parts in the United States from 1972 to 2013. Output has stagnated since the late 1990s.
Chart II-5, US, Motor Vehicles and Parts Output, 1972-2013
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/default.htm
Chart II-6 of the Board of Governors of the Federal Reserve System provides output of computers and electronic products in the United States from 1972 to 2013. Output accelerated sharply in the 1990s and 2000s and has surpassed the level before the global recession beginning in IVQ2007.
Chart II-6, US, Output of Computers and Electronic Products, 1972-2013
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/default.htm
Chart II-7 of the Board of Governors of the Federal Reserve System shows that output of durable manufacturing accelerated in the 1980s and 1990s with slower growth in the 2000s perhaps because processes matured. Growth was robust after the major drop during the global recession but appears to vacillate in the final segment.
Chart II-7, US, Output of Durable Manufacturing, 1972-2013
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/default.htm
Chart II-8 of the Board of Governors of the Federal Reserve System provides output of aerospace and miscellaneous transportation equipment from 1972 to 2013. There is long-term upward trend with oscillations around the trend and cycles of large amplitude.
Chart II-8, US, Output of Aerospace and Miscellaneous Transportation Equipment, 1972-2013
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/g17/Current/default.htm
The Empire State Manufacturing Survey Index in Table II-5 provides continuing deterioration that started in Jun 2012 well before Hurricane Sandy in Oct 2012. The current general index has been in negative contraction territory from minus 3.78 in Aug 2012 to minus 7.78 in Jan 2012 and minus 1.43 in May 2013. The current general index improved to 6.29 in Sep 2013, which is again in expansion territory. The index of current orders has also been in negative contraction territory from minus 4.63 in Aug 2012 to minus 7.18 in Jan 2013 and minus 6.69 in Jun 2013. The index of current new orders increased to 0.27 in Jul 2013 and 2.35 in Sep 2013. Number of workers and hours worked have registered negative or declining readings since Sep 2012 with moderate expansion at 7.53 for number of workers in Sep 2013 and recovery from contraction in the average workweek to 1.08 in Sep 2013. There is marginal expansion in the general index for the next six months at 8.60 in Sep 2013 and strengthening new orders at 38.17 in Sep 2013.
Table II-5, US, New York Federal Reserve Bank Empire State Manufacturing Survey Index SA
| General | New Orders | Shipments | # Workers | Average Work-week | |
| Current | |||||
| Sep 2013 | 6.29 | 2.35 | 16.43 | 7.53 | 1.08 |
| Aug | 8.24 | 0.27 | 1.47 | 10.84 | 4.82 |
| Jul | 9.46 | 3.77 | 8.96 | 3.26 | -7.61 |
| Jun | 7.84 | -6.69 | -11.77 | 0.00 | -11.29 |
| May | -1.43 | -1.17 | -0.02 | 5.68 | -1.14 |
| Apr | 3.05 | 2.20 | 0.75 | 6.82 | 5.68 |
| Mar | 9.24 | 8.18 | 7.76 | 3.23 | 0.00 |
| Feb | 10.04 | 13.31 | 13.08 | 8.08 | -4.04 |
| Jan | -7.78 | -7.18 | -3.08 | -4.30 | -5.38 |
| Dec 2012 | -7.30 | -3.44 | 11.93 | -9.68 | -10.75 |
| Nov | -4.31 | 2.93 | 14.18 | -14.61 | -7.87 |
| Oct | -6.75 | -7.21 | -6.48 | -1.08 | -4.30 |
| Sep | -7.54 | -10.60 | 7.30 | 4.26 | -1.06 |
| Aug | -3.78 | -4.63 | 6.37 | 16.47 | 3.53 |
| Jul | 7.08 | -2.27 | 11.52 | 18.52 | 0.00 |
| Jun | 4.15 | 2.28 | 6.34 | 12.37 | 3.09 |
| May | 14.52 | 8.99 | 23.11 | 20.48 | 12.05 |
| Apr | 6.40 | 4.81 | 4.51 | 19.28 | 6.02 |
| Mar | 18.00 | 6.55 | 15.97 | 13.58 | 18.52 |
| Feb | 18.31 | 7.93 | 19.90 | 11.76 | 7.06 |
| Jan | 12.12 | 11.21 | 18.94 | 12.09 | 6.59 |
| Dec 2011 | 9.60 | 6.35 | 23.77 | 2.33 | -2.33 |
| Nov | 1.82 | -0.97 | 11.34 | -3.66 | 2.44 |
| Oct | -7.39 | 1.51 | 2.46 | 3.37 | -4.49 |
| Sep | -4.75 | -4.31 | -4.48 | -5.43 | -2.17 |
| Six Months | |||||
| Sep 2013 | 8.60 | 38.17 | 37.84 | 4.30 | -2.15 |
| Aug | 3.61 | 30.01 | 30.02 | 8.43 | -6.02 |
| Jul | 1.09 | 31.12 | 34.44 | 1.09 | -1.09 |
| Jun | 11.29 | 19.77 | 20.21 | 1.61 | -9.68 |
| May | 4.55 | 28.84 | 25.18 | 11.36 | 1.14 |
| Apr 2013 | 5.68 | 36.23 | 39.28 | 25.00 | 7.95 |
| Mar | 2.15 | 34.94 | 41.60 | 19.35 | 2.15 |
| Feb | 8.08 | 29.11 | 26.82 | 15.15 | 11.11 |
| Jan | 10.75 | 25.11 | 23.86 | 7.53 | 3.23 |
| Dec 2012 | 1.08 | 17.19 | 22.46 | 10.75 | 5.38 |
| Nov | 5.62 | 15.96 | 25.67 | -1.12 | 0.00 |
| Oct | 4.30 | 22.79 | 17.39 | 0.00 | -11.83 |
| Sep | 5.32 | 27.85 | 23.35 | 8.51 | 2.13 |
| Aug | 2.35 | 14.34 | 21.16 | 3.53 | -8.24 |
| Jul | 3.70 | 19.85 | 21.60 | 6.17 | -4.94 |
| Jun | 1.03 | 26.02 | 22.18 | 16.49 | 2.06 |
| May | 12.05 | 31.26 | 26.00 | 12.05 | 8.43 |
| Apr | 19.28 | 38.95 | 40.75 | 27.71 | 10.84 |
| Mar | 13.58 | 39.18 | 41.64 | 32.10 | 20.99 |
| Feb | 15.29 | 39.25 | 40.92 | 29.41 | 18.82 |
| Jan | 23.08 | 45.70 | 44.12 | 28.57 | 17.58 |
| Dec 2011 | 3.49 | 42.20 | 40.36 | 24.42 | 22.09 |
| Nov | 6.10 | 30.89 | 33.01 | 14.63 | 8.54 |
| Oct | 4.49 | 19.71 | 22.65 | 6.74 | -2.25 |
| Sep | 8.70 | 23.52 | 22.89 | 0.00 | -6.52 |
Source: http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html
The Business Outlook Survey Diffusion Index of the Federal Reserve Bank of Philadelphia in Table II-6 also shows improvement after prior deterioration. The general index moved out contraction of 5.2 in May 2013 to 22.3 in Sep 2013 together with renewed expansion at 21.2 for new orders. Employment segments show improvement in Sep 2013: 10.3 for number of workers and 12.2 for hours worked. Expectations for the next six months are brighter with the general index at 62.2 in Sep 2013 and the index of new orders at 58.3.
Table II-6, FRB of Philadelphia Business Outlook Survey Diffusion Index
| General Index | New Orders | Shipments | # Workers | Hours Worked | |
| Jan-11 | 15.0 | 19.1 | 11.1 | 13.9 | 8.0 |
| Feb-11 | 25.6 | 15.7 | 24.0 | 19.6 | 6.9 |
| Mar-11 | 36.1 | 33.2 | 28.1 | 16.1 | 7.3 |
| Apr-11 | 13.7 | 12.6 | 23 | 9.9 | 15.1 |
| May-11 | 4.0 | 6.8 | 5.4 | 22.2 | 2.8 |
| Jun-11 | -1.1 | -1.2 | 5.7 | 3.4 | 3.7 |
| Jul-11 | 9.4 | 4.7 | 9 | 12.6 | -0.8 |
| Aug-11 | -19.0 | -18.6 | -4.7 | -0.5 | -7.6 |
| Sep-11 | -10.0 | -4.5 | -7.4 | 9.4 | -2.8 |
| Oct-11 | 9.7 | 8.8 | 11.2 | 7.8 | 5.2 |
| Nov-11 | 5.0 | 3.6 | 6.9 | 10.9 | 6.8 |
| Dec-11 | 4.2 | 5.9 | 6.2 | 8 | -0.3 |
| Jan-12 | 4.7 | 9.0 | 4.4 | 9.6 | 3.9 |
| Feb-12 | 5.0 | 5.3 | 8.6 | 0.9 | 5.7 |
| Mar-12 | 8.6 | -0.7 | 0.2 | 5.9 | -0.6 |
| Apr-12 | 6.5 | -0.8 | 0.5 | 13.4 | -3.4 |
| May-12 | -4.9 | -0.6 | 2.7 | -0.2 | -6.4 |
| Jun-12 | -12.8 | -13.1 | -13.8 | 2.3 | -16.9 |
| Jul-12 | -9.1 | -2.1 | -7.5 | -4.7 | -13.9 |
| Aug-12 | -1.7 | -0.8 | -5.9 | -7.6 | -9.9 |
| Sep-12 | 1.4 | 2.5 | -10.4 | -4.9 | -2.9 |
| Oct-12 | 4.2 | -0.5 | -3.5 | -7.6 | -6.5 |
| Nov-12 | -8.9 | -4.7 | -6.3 | -6.9 | -7.4 |
| Dec-12 | 4.6 | 4.9 | 14.7 | -0.2 | 0.4 |
| Jan-13 | -5.8 | -4.3 | 0.4 | -5.2 | -8.3 |
| Feb-13 | -12.5 | -7.8 | 2.4 | 0.9 | -1.6 |
| Mar-13 | 2 | 0.5 | 3.5 | 2.7 | -12.9 |
| Apr-13 | 1.3 | -1 | 9.1 | -6.8 | -2.1 |
| May-13 | -5.2 | -7.9 | -8.5 | -8.7 | -12.4 |
| Jun-13 | 12.5 | 16.6 | 4.1 | -5.4 | 0.8 |
| Jul-13 | 19.8 | 10.2 | 14.3 | 7.7 | 6.6 |
| Aug-13 | 9.3 | 5.3 | -0.9 | 3.5 | -2.6 |
| Sep-13 | 22.3 | 21.2 | 21.2 | 10.3 | 12.2 |
| Future | General Index | New Orders | Shipments | # Workers | Hours Worked |
| Dec-10 | 42.1 | 41.9 | 14.5 | 28.0 | 22.0 |
| Jan-11 | 35.9 | 39.8 | 10.3 | 29.1 | 19.6 |
| Feb-11 | 38.6 | 42.7 | 14.2 | 22.6 | 11.8 |
| Mar-11 | 53.6 | 52.3 | 12.6 | 25.2 | 13.0 |
| Apr-11 | 26.6 | 33.5 | 8.8 | 32.3 | 15.9 |
| May-11 | 22.4 | 26.1 | 3.8 | 20.9 | 12.5 |
| Jun-11 | 9.6 | 7.7 | -4.7 | 7.2 | 4.2 |
| Jul-11 | 35 | 31 | 8 | 16.2 | 6.6 |
| Aug-11 | 26.4 | 22.8 | 3.5 | 13.9 | 2.4 |
| Sep-11 | 26.6 | 27 | 6 | 13.4 | 5.7 |
| Oct-11 | 29.8 | 31 | 5.3 | 17.5 | 8.2 |
| Nov-11 | 36.2 | 34 | 8.9 | 27.9 | 4.5 |
| Dec-11 | 37.7 | 31.6 | 4.4 | 7.9 | 2 |
| Jan-12 | 43.9 | 46.1 | 13 | 17.8 | 6.8 |
| Feb-12 | 32.2 | 26.3 | 5.7 | 20.2 | 8.7 |
| Mar-12 | 34.4 | 28.6 | 6 | 19.2 | 8 |
| Apr-12 | 34.8 | 29.6 | 5.6 | 23.6 | 6.9 |
| May-12 | 30.2 | 26 | 10.1 | 11.8 | 1.2 |
| Jun-12 | 35.5 | 35.6 | 6 | 19.1 | 5 |
| Jul-12 | 30.8 | 24.7 | 6.5 | 15.3 | 14.6 |
| Aug-12 | 25.3 | 17.3 | 4.8 | 14.5 | 8.8 |
| Sep-12 | 52 | 42.8 | 12.6 | 21.2 | 13.8 |
| Oct-12 | 22.6 | 22.7 | 8.6 | 9.8 | 10.5 |
| Nov-12 | 23.2 | 24.9 | 2.7 | 7 | 8.2 |
| Dec-12 | 28.3 | 28 | 2.7 | 11.2 | 14.4 |
| Jan-13 | 32.5 | 38.9 | 2.9 | 10.7 | 8.9 |
| Feb-13 | 38 | 30.3 | 4.3 | 14.9 | 6.5 |
| Mar-13 | 34.5 | 31.2 | 6.6 | 8.1 | 3.4 |
| Apr-13 | 24.3 | 26.5 | -2.1 | 8.2 | 6.6 |
| May-13 | 34.5 | 31.7 | 16.9 | 10 | 14.1 |
| Jun-13 | 41.5 | 37.6 | 17.8 | 27.3 | 7.5 |
| Jul-13 | 58.8 | 51.2 | 25.8 | 36.2 | 14.6 |
| Aug-13 | 39.5 | 40.1 | 12.3 | 22.3 | 15 |
| Sep-13 | 62.2 | 58.3 | 18.5 | 31 | 16.2 |
Source: Federal Reserve Bank of Philadelphia
http://www.philadelphiafed.org/index.cfm
Chart II-9 of the Federal Reserve Bank of Philadelphia is very useful, providing current and future general activity indexes from Jan 1995 to Sep 2013. The shaded areas are the recession cycle dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles.html). The Philadelphia Fed index dropped during the initial period of recession and then led the recovery, as industry overall. There was a second decline of the index into 2011 followed now by what hopefully appeared as renewed strength from late 2011 into Jan 2012 with decline to negative territory of the current activity index in Nov 2012 and return to positive territory in Dec 2012 with decline of current conditions into contraction in Jan-Feb 2013 and rebound to mild expansion in Mar-Apr 2013. The index of current activity moved into expansion in Jun-Sep 2013.
Chart II-9, Federal Reserve Bank of Philadelphia Business Outlook Survey, Current and Future Activity Indexes
Source: Federal Reserve Bank of Philadelphia
http://www.philadelphiafed.org/index.cfm
http://www.philadelphiafed.org/index.cfm
The index of current new orders of the Business Outlook Survey of the Federal Reserve Bank of Philadelphia in Chart II-10 illustrates the weakness of the cyclical expansion. The index weakened in 2006 and 2007 and then fell sharply into contraction during the global recession. There have been twelve readings into contraction from Jan 2012 to May 2013 and generally weak readings with some exceptions. The index of new orders moved into expansion in Jun-Sep 2013.
Chart II-10, Federal Reserve Bank of Philadelphia Current New Orders Diffusion Index
Source: Federal Reserve Bank of Philadelphia
http://www.philadelphiafed.org/index.cfm
IIA Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities. There are two subsection: IIA1 United States Unsustainable Deficit/debt and IIA2 Unresolved US Balance of Payments Deficits.
IIA1 United States Unsustainable Fiscal Deficit/Debt. Table IIA1-1 of the CBO (2012NovMBR, 2013BEOFeb5, 2013HBDFFeb5, 2013MEFFeb5, 2013Aug12) shows the significant worsening of United States fiscal affairs from 2007-2008 to 2009-2012. The deficit of $1.1 trillion in fiscal-year 2012 was the fourth consecutive federal deficit exceeding one trillion dollars. All four deficits are the highest in share of GDP since 1946 (CBO 2012MBR, 2013HBDFeb5, 2013Aug12, 2013AugHBD).
Table IAI-1, US, Budget Fiscal Year Totals, Billions of Dollars and % GDP
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |
| Receipts | 2568 | 2524 | 2105 | 2163 | 2302 | 2450 |
| Outlays | 2729 | 2983 | 3518 | 3456 | 3599 | 3538 |
| Deficit | -161 | -459 | 1413 | 1294 | 1296 | 1087 |
| % GDP | -1.1 | -3.1 | -9.8 | -8.7 | -8.4 | -6.8 |
Source: CBO (2012NovMBR), CBO (2013BEOFeb5), CBO (2013HBDFeb5), CBO (2013Aug12).
Table IIA1-2 provides additional information required for understanding the deficit/debt situation of the United States. The table is divided into three parts: federal fiscal data for the years from 2009 to 2012; federal fiscal data for the years from 2005 to 2008; and Treasury debt held by the public from 2005 to 2012. Total revenues of the US from 2009 to 2012 accumulate to $9021 billion, or $9.0 trillion, while expenditures or outlays accumulate to $14,109 billion, or $14.1 trillion, with the deficit accumulating to $5090 billion, or $5.1 trillion. Revenues decreased 6.5 percent from $9653 billion in the four years from 2005 to 2008 to $9021 billion in the years from 2009 to 2012. Decreasing revenues were caused by the global recession from IVQ2007 (Dec) to IIQ2009 (Jun) and also by growth of only 2.2 percent on average in the cyclical expansion from IIIQ2009 to IVQ2012. In contrast, the expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). Because of mediocre GDP growth, there are 28.3 million unemployed or underemployed in the United States for an effective unemployment rate of 17.4 percent (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). Weakness of growth and employment creation is analyzed in IB Collapse of United States Dynamism of Income Growth and Employment Creation (http://cmpassocregulationblog.blogspot.com/2013/08/interest-rate-risks-duration-dumping.html). In contrast with the decline of revenue, outlays or expenditures increased 30.2 percent from $10,839 billion, or $10.8 trillion, in the four years from 2005 to 2008, to $14,109 billion, or $14.1 trillion, in the four years from 2009 to 2012. Increase in expenditures by 30.2 percent while revenue declined by 6.5 percent caused the increase in the federal deficit from $1186 billion in 2005-2008 to $5090 billion in 2009-2012. Federal revenue was 14.9 percent of GDP on average in the years from 2009 to 2012, which is well below 17.4 percent of GDP on average from 1973 to 2012. Federal outlays were 23.3 percent of GDP on average from 2009 to 2012, which is well above 20.4 percent of GDP on average from 1973 to 2012. The lower part of Table I-2 shows that debt held by the public swelled from $5803 billion in 2008 to $11,281 billion in 2012, by $5478 billion or 94.4 percent. Debt held by the public as percent of GDP or economic activity jumped from 39.3 percent in 2008 to 70.1 percent in 2012, which is well above the average of 38.0 percent from 1973 to 2012. The United States faces tough adjustment because growth is unlikely to recover, creating limits on what can be obtained by increasing revenues, while continuing stress of social programs restricts what can be obtained by reducing expenditures.
Table IIA1-2, US, Treasury Budget and Debt Held by the Public, Billions of Dollars and Percent of GDP
| Receipts | Outlays | Deficit (-), Surplus (+) | |
| $ Billions | |||
| 2012 | 2,450 | 3,537 | -1,087 |
| Fiscal Year 2011 | 2,303 | 3,598 | -1,296 |
| Fiscal Year 2010 | 2,163 | 3,456 | -1,294 |
| Fiscal Year 2009 | 2,105 | 3,518 | -1,413 |
| Total 2009-2012 | 9,021 | 14,109 | -5,090 |
| Average % GDP 2009-2012 | 14.9 | 23.3 | -8.4 |
| Fiscal Year 2008 | 2,524 | 2,983 | -459 |
| Fiscal Year 2007 | 2,568 | 2,729 | -161 |
| Fiscal Year 2006 | 2,407 | 2,655 | -248 |
| Fiscal Year 2005 | 2,154 | 2,472 | -318 |
| Total 2005-2008 | 9,653 | 10,839 | -1,186 |
| Average % GDP 2005-2008 | 17.3 | 19.5 | -2.1 |
| Debt Held by the Public | Billions of Dollars | Percent of GDP | |
| 2005 | 4,592 | 35.6 | |
| 2006 | 4,829 | 35.3 | |
| 2007 | 5,035 | 35.1 | |
| 2008 | 5,803 | 39.3 | |
| 2009 | 7,545 | 52.3 | |
| 2010 | 9,019 | 61.0 | |
| 2011 | 10,128 | 65.8 | |
| 2012 | 11,281 | 70.1 |
Source: http://www.fms.treas.gov/mts/index.html CBO (2012NovMBR). CBO (2011AugBEO); Office of Management and Budget 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB; CBO. 2011JanBEO. Budget and Economic Outlook. Washington, DC, Jan. CBO. 2012AugBEO. Budget and Economic Outlook. Washington, DC, Aug 22. CBO. 2012Jan31. Historical budget data. Washington, DC, Jan 31. CBO. 2012NovCDR. Choices for deficit reduction. Washington, DC. Nov. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO (2013Aug12). 2013AugHBD. Historical budget data—August 2013. Washington, DC, Congressional Budget Office, Aug.
Unusually low economic growth of average 2.2 percent of GDP in the current expansion (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html) has had adverse impact on revenue generation. The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.7 percent and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). Because of mediocre GDP growth, there are 28.3 million unemployed or underemployed in the United States for an effective unemployment rate of 17.4 percent (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). The impact of low growth on employment creation and labor market hiring is discussed in Subsection IB Collapse of United States Dynamism of Income Growth and Employment (http://cmpassocregulationblog.blogspot.com/2013/08/interest-rate-risks-duration-dumping.html). Table IIAI-3 provides total United States federal receipts from 2010 to 2012. Individual income taxes of $1132 billion, or $1.1 trillion, increased 25.9 percent from 2010 to 2012 and account for 46.2 percent of US total receipts in 2012. Total receipts stood at 15.2 percent of GDP in 2012, which is lower than 17.4 percent in the past 40 years (CBO 2013Aug12Av).
Table IIA1-3, United States, Total Receipts, Billions of Dollars and ∆%
| Major Source | 2010 | 2011 | 2012 | ∆% 2011-2012 |
| Individual Income Taxes | 899 | 1092 | 1132 | 3.7 |
| Corporate Income Taxes | 191 | 181 | 242 | 33.7 |
| Social Insurance | 865 | 819 | 845 | 3.2 |
| Other | 208 | 210 | 231 | 10.0 |
| Total | 2163 | 2302 | 2450 | 6.4 |
| % of GDP | 14.6 | 15.0 | 15.2 | NA |
Source: CBO (2012NovMBR), CBO (2013BEOFeb5), CBO 2013HBDFeb5), CBO (2013Aug12).
Total outlays of the federal government of the United States have grown to extremely high levels. Table IIA1-4 of the CBO (2013Aug12) provides total outlays in 2006 and 2012. Total outlays of $3537.1 billion in 2012, or $3.5 trillion, are higher by $882 billion, or $0.9 trillion, relative to $2655.1 billion in 2006, or $2.7 trillion. Outlays have grown from 19.4 percent of GDP in 2007 to 22.0 percent of GDP in 2012. Outlays as percent of GDP were on average 20.4 percent from 1973 to 2012 and receipts as percent of GDP were on average 17.4 percent of GDP. It has proved extremely difficult to increase receipts above 19 percent of GDP. Mandatory outlays increased from $1411.8 billion in 2006 to $2031.3 billion in 2012, by $619.5 billion. The final row shows that the total of social security, Medicare, Medicaid, Income Security, net interest and defense absorbs 79.6 percent of US total outlays. There has been no meaningful constraint of spending, which is quite difficult because of the rigid structure of social programs.
Table IIA1-4, US, Central Government Total Revenue and Outlays, Billions of Dollars and Percent
| 2006 | % Total | 2012 | % Total | |
| I TOTAL REVENUE $B | 2406.9 | 100.0 | 2450.2 | 100.0 |
| % GDP | 17.6 | 15.2 | ||
| Individual Income Taxes $B | 1043.9 | 1132.2 | ||
| % GDP | 7.6 | 7.0 | ||
| Corporate Income Taxes $B | 353.9 | 243.2 | ||
| % GDP | 2.6 | 1.5 | ||
| Social Insurance Taxes | 837.8 | 845.3 | ||
| % GDP | 6.1 | 5.3 | ||
| II TOTAL OUTLAYS | 2655.1 | 3537.1 | ||
| % GDP | 19.4 | 22.0 | ||
| Discretionary | 1016.6 | 1285.4 | ||
| % GDP | 7.4 | 8.0 | ||
| Defense | 520.0 | 670.5 | ||
| % GDP | 3.8 | 4.2 | ||
| Nondefense | 496.7 | 614.8 | ||
| % GDP | 3.6 | 3.8 | ||
| Mandatory | 1411.8 | 2031.3 | ||
| % GDP | 10.3 | 12.6 | ||
| Social Security | 543.9 | 767.7 | ||
| % GDP | 4.0 | 4.8 | ||
| Medicare | 376.8 | 551.2 | ||
| % GDP | 2.8 | 3.4 | ||
| Medicaid | 180.6 | 250.5 | ||
| % GDP | 1.3 | 1.6 | ||
| Income Security | 200.1 | 353.7 | ||
| % GDP | 1.5 | 2.2 | ||
| Offsetting Receipts | -144.1 | -210.0 | ||
| % GDP | -1.1 | -1.3 | ||
| Net Interest | 226.6 | 220.4 | ||
| % GDP | 1.7 | 1.4 | ||
| Defense +Medicare | 2048.0 | 77.1* | 2814.0 | 79.6* |
| % GDP | 15.0 | 17.5 |
*Percent of Total Outlays
Source: CBO (2013Aug12). 2013AugHBD. Historical budget data—August 2013. Washington, DC, Congressional Budget Office, Aug.
The US is facing a major fiscal challenge. Table IIA1-5 provides federal revenues, expenditures, deficit and debt as percent of GDP and the yearly change in GDP in the eight decades from 1930 to 2011. The most recent period of debt exceeding 90 percent of GDP based on yearly observations in Table IIA1-5 is between 1944 and 1948. The data in Table IIA-15 use the earlier GDP estimates of the Bureau of Economic Analysis (BEA) until 1972 for the ratios to GDP of revenue, expenditures, deficit and debt and the revised CBO (2013Aug12) after 1973 that incorporate the new BEA GDP estimates (http://www.bea.gov/iTable/index_nipa.cfm). The percentage change of GDP is based on the new BEA estimates. The debt/GDP ratio actually rose to 106.2 percent of GDP in 1945 and to 108.7 percent of GDP in 1946. GDP fell revised 11.6 percent in 1946, which is only matched in Table I-5 by the decline of revised 12.9 percent in 1932. Part of the decline is explained by the bloated US economy during World War II, growing at revised 17.7 percent in 1941, 18.9 percent in 1942 and 17.0 percent in 1943. Expenditures as a share of GDP rose to their highest in the series: 43.6 percent in 1943, 43.6 percent in 1944 and 41.9 percent in 1945. The repetition of 43.6 percent in 1943 and 1944 is in the original source of Table IIA1-5. During the Truman administration from Apr 1945 to Jan 1953, the federal debt held by the public fell systematically from the peak of 108.7 percent of GDP in 1946 to 61.6 percent of GDP in 1952. During the Eisenhower administration from Jan 1953 to Jan 1961, the federal debt held by the public fell from 58.6 percent of GDP in 1953 to 45.6 percent of GDP in 1960. The Truman and Eisenhower debt reductions were facilitated by diverse factors such as low interest rates, lower expenditure/GDP ratios that could be attained again after lowering war outlays and less rigid structure of mandatory expenditures than currently. There is no subsequent jump of debt as the one from revised 39.3 percent of GDP in 2008 to 65.8 percent of GDP in 2011 and at 70.1 percent in 2012.
Table IIA1-5, United States Central Government Revenue, Expenditure, Deficit, Debt and GDP Growth 1930-2011
| Rev | Exp | Deficit | Debt | GDP | |
| 1930 | 4.2 | 3.4 | 0.8 | -8.5 | |
| 1931 | 3.7 | 4.3 | -0.6 | -6.4 | |
| 1932 | 2.8 | 6.9 | -4.0 | -12.9 | |
| 1933 | 3.5 | 8.0 | -4.5 | -1.3 | |
| 1934 | 4.8 | 10.7 | -5.9 | 10.8 | |
| 1935 | 5.2 | 9.2 | -4.0 | 8.9 | |
| 1936 | 5.0 | 10.5 | -5.5 | 12.9 | |
| 1937 | 6.1 | 8.6 | -2.5 | 5.1 | |
| 1938 | 7.6 | 7.7 | -0.1 | -3.3 | |
| 1939 | 7.1 | 10.3 | -3.2 | 8.0 | |
| 1940s | |||||
| 1940 | 6.8 | 9.8 | -3.0 | 44.2 | 8.8 |
| 1941 | 7.6 | 12.0 | -4.3 | 42.3 | 17.7 |
| 1942 | 10.1 | 24.3 | -14.2 | 47.0 | 18.9 |
| 1943 | 13.3 | 43.6 | -30.3 | 70.9 | 17.0 |
| 1944 | 20.9 | 43.6 | -22.7 | 88.3 | 8.0 |
| 1945 | 20.4 | 41.9 | -21.5 | 106.2 | -1.0 |
| 1946 | 17.7 | 24.8 | -7.2 | 108.7 | -11.6 |
| 1947 | 16.5 | 14.8 | 1.7 | 96.2 | -1.1 |
| 1948 | 16.2 | 11.6 | 4.6 | 84.3 | 4.1 |
| 1949 | 14.5 | 14.3 | 0.2 | 79.0 | -0.5 |
| 1950s | |||||
| 1950 | 14.4 | 15.6 | -1.1 | 80.2 | 8.7 |
| 1951 | 16.1 | 14.2 | 1.9 | 66.9 | 8.1 |
| 1952 | 19.0 | 19.4 | -0.4 | 61.6 | 4.1 |
| 1953 | 18.7 | 20.4 | -1.7 | 58.6 | 4.7 |
| 1954 | 18.5 | 18.8 | -0.3 | 59.5 | -0.6 |
| 1955 | 16.5 | 17.3 | -0.8 | 57.2 | 7.1 |
| 1956 | 17.5 | 16.5 | 0.9 | 52.0 | 2.1 |
| 1957 | 17.7 | 17.0 | 0.8 | 48.6 | 2.1 |
| 1958 | 17.3 | 17.9 | -0.6 | 49.2 | -0.7 |
| 1959 | 16.2 | 18.8 | -2.6 | 47.9 | 6.9 |
| 1960s | |||||
| 1960 | 17.8 | 17.8 | 0.1 | 45.6 | 2.6 |
| 1961 | 17.8 | 18.4 | -0.6 | 45.0 | 2.6 |
| 1962 | 17.6 | 18.8 | -1.3 | 43.7 | 6.1 |
| 1963 | 17.8 | 18.6 | -0.8 | 42.4 | 4.4 |
| 1964 | 17.6 | 18.5 | -0.9 | 40.0 | 5.8 |
| 1965 | 17.0 | 17.2 | -0.2 | 37.9 | 6.5 |
| 1966 | 17.3 | 17.8 | -0.5 | 34.9 | 6.6 |
| 1967 | 18.4 | 19.4 | -1.1 | 32.9 | 2.7 |
| 1968 | 17.6 | 20.5 | -2.9 | 33.9 | 4.9 |
| 1969 | 19.7 | 19.4 | 0.3 | 29.3 | 3.1 |
| 1970s | |||||
| 1970 | 19.0 | 19.3 | -0.3 | 28.0 | 0.2 |
| 1971 | 17.3 | 19.5 | -2.1 | 28.1 | 3.3 |
| 1972 | 17.6 | 19.6 | -2.0 | 27.4 | 5.2 |
| 1973 | 17.0 | 18.1 | -1.1 | 25.1 | 5.6 |
| 1974 | 17.7 | 18.1 | -0.4 | 23.1 | -0.5 |
| 1975 | 17.3 | 20.6 | -3.3 | 24.5 | -0.2 |
| 1976 | 16.6 | 20.8 | -4.1 | 26.7 | 5.4 |
| 1977 | 17.5 | 20.2 | -2.6 | 27.1 | 4.6 |
| 1978 | 17.5 | 20.1 | -2.6 | 26.6 | 5.6 |
| 1979 | 18.0 | 19.6 | -1.6 | 24.9 | 3.2 |
| 1980s | |||||
| 1980 | 18.5 | 21.1 | -2.6 | 25.5 | -0.2 |
| 1981 | 19.1 | 21.6 | -2.5 | 25.2 | 2.6 |
| 1982 | 18.6 | 22.5 | -3.9 | 27.9 | -1.9 |
| 1983 | 17.0 | 22.8 | -5.9 | 32.1 | 4.6 |
| 1984 | 16.9 | 21.5 | -4.7 | 33.1 | 7.3 |
| 1985 | 17.2 | 22.2 | -5.0 | 35.3 | 4.2 |
| 1986 | 17.0 | 21.8 | -4.9 | 38.4 | 3.5 |
| 1987 | 17.9 | 21.0 | -3.1 | 39.5 | 3.5 |
| 1988 | 17.6 | 20.6 | -3.0 | 39.8 | 4.2 |
| 1989 | 17.8 | 20.5 | -2.7 | 39.3 | 3.7 |
| 1990s | |||||
| 1990 | 17.4 | 21.2 | -3.7 | 40.8 | 1.9 |
| 1991 | 17.3 | 21.7 | -4.4 | 44.0 | -0.1 |
| 1992 | 17.0 | 21.5 | -4.5 | 46.6 | 3.6 |
| 1993 | 17.0 | 20.7 | -3.8 | 47.8 | 2.7 |
| 1994 | 17.5 | 20.3 | -2.8 | 47.7 | 4.0 |
| 1995 | 17.8 | 20.0 | -2.2 | 47.5 | 2.7 |
| 1996 | 18.2 | 19.6 | -1.3 | 46.8 | 3.8 |
| 1997 | 18.6 | 18.9 | -0.3 | 44.5 | 4.5 |
| 1998 | 19.2 | 18.5 | 0.8 | 41.6 | 4.4 |
| 1999 | 19.2 | 17.9 | 1.3 | 38.2 | 4.8 |
| 2000s | |||||
| 2000 | 19.9 | 17.6 | 2.3 | 33.6 | 4.1 |
| 2001 | 18.8 | 17.6 | 1.2 | 31.4 | 1.0 |
| 2002 | 17.0 | 18.5 | -1.5 | 32.5 | 1.8 |
| 2003 | 15.7 | 19.1 | -3.3 | 34.5 | 2.8 |
| 2004 | 15.6 | 19.0 | -3.4 | 35.5 | 3.8 |
| 2005 | 16.7 | 19.2 | -2.5 | 35.6 | 3.4 |
| 2006 | 17.6 | 19.4 | -1.8 | 35.3 | 2.7 |
| 2007 | 17.9 | 19.0 | -1.1 | 35.1 | 1.8 |
| 2008 | 17.1 | 20.2 | -3.1 | 39.3 | -0.3 |
| 2009 | 14.6 | 24.4 | -9.8 | 52.3 | -2.8 |
| 2010s | |||||
| 2010 | 14.6 | 23.4 | -8.7 | 61.0 | 2.5 |
| 2011 | 15.0 | 23.4 | -8.4 | 65.8 | 1.8 |
| 2012 | 15.2 | 22.0 | -6.8 | 70.1 | 2.8 |
Sources:
Office of Management and Budget. 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB. CBO (2012JanBEO). CBO (2012Jan31). CBO (2012AugBEO). CBO (2013BEOFeb5). CBO2013HBDFeb5), CBO (2013Aug12).
Table IIA1-6 provides 40-year average ratios of fiscal variables to GDP before and after the revision by the Bureau of Economic Analysis (BEA) in Aug 2013 (http://www.bea.gov/iTable/index_nipa.cfm). The ratios are equal or slightly higher because of the addition of intellectual property to GDP estimates. There are no major changes.
Table IIA1-6, US, Congressional Budget Office, 40-Year Averages of Revenues and Outlays Before and After Update of the US National Income Accounts by the Bureau of Economic Analysis, % of GDP
| Before Update | After Update | |
| Revenues | ||
| Individual Income Taxes | 8.2 | 7.9 |
| Social Insurance Taxes | 6.2 | 6.0 |
| Corporate Income Taxes | 1.9 | 1.9 |
| Other | 1.6 | 1.6 |
| Total Revenues | 17.9 | 17.4 |
| Outlays | ||
| Mandatory | 10.2 | 9.9 |
| Discretionary | 8.6 | 8.4 |
| Net Interest | 2.2 | 2.2 |
| Total Outlays | 21.0 | 20.4 |
| Deficit | -3.1 | -3.0 |
| Debt Held by the Public | 39.2 | 38.0 |
Source: CBO (2013Aug12Av). Kim Kowaleski and Amber Marcellino.
The capital budgeting decision of business requires the calculation of present value of projects. This calculation consists of a projection toward the horizon of planning of revenues net of costs, which are discounted to present value by the weighted average cost of capital. Business invests in the projects with highest net present value. The nonpartisan Congressional Budget Office (CBO) provides a similar service. Congress and the administration send budget proposals and legislation for evaluation by the CBO of their effects on federal government revenues, expenditures, deficit or surpluses and debt. The CBO does not provide its own policy proposals but analyzes alternative policies. The CBO uses state of the art knowledge but significant uncertainty remains because of the hurdle of projecting financial and economic variables to the future.
Table IIA1-7 provides the latest exercise by the CBO (2013BEOFeb5, 2012AugBEO, CBO2012NovCDR, 2013Sep11) of projecting the fiscal accounts of the US. Table IIA1-7 extends data back to 1995 with the projections of the CBO from 2013 to 2023, using the new estimates of the Bureau of Economic Analysis of US GDP (http://www.bea.gov/iTable/index_nipa.cfm). Budget analysis in the US uses a ten-year horizon. The significant event in the data before 2011 is the budget surpluses from 1998 to 2001, from 0.8 percent of GDP in 1998 to 2.3 percent of GDP in 2000. Debt held by the public fell from 46.1 percent of GDP in 1995 to 31.4 percent of GDP in 2001.
Table IIA1-7, US, CBO Baseline Budget Outlook 2013-2023
| Out | Out | Deficit | Deficit | Debt | Debt | |
| 1995 | 1,516 | 20.0 | -164 | -2.2 | 3,604 | 47.5 |
| 1996 | 1,560 | 19.6 | -107 | -1.3 | 3,734 | 46.8 |
| 1997 | 1,601 | 18.9 | -22 | -0.3 | 3,772 | 44.5 |
| 1998 | 1,652 | 18.5 | +69 | +0.8 | 3,721 | 41.6 |
| 1999 | 1,702 | 17.9 | +126 | +1.3 | 3,632 | 38.2 |
| 2000 | 1,789 | 17.6 | +236 | +2.3 | 3,410 | 33.6 |
| 2001 | 1,863 | 17.6 | +128 | +1.2 | 3,320 | 31.4 |
| 2002 | 2,011 | 18.5 | -158 | -1.5 | 3,540 | 32.5 |
| 2003 | 2,159 | 19.1 | -378 | -3.3 | 3,913 | 34.5 |
| 2004 | 2,293 | 19.0 | -413 | -3.4 | 4,295 | 35.5 |
| 2005 | 2,472 | 19.2 | -318 | -2.5 | 4,592 | 35.6 |
| 2006 | 2,655 | 19.4 | -248 | -1.8 | 4,829 | 35.3 |
| 2007 | 2,729 | 19.0 | -161 | -1.1 | 5,035 | 35.1 |
| 2008 | 2,983 | 20.2 | -459 | -3.1 | 5,803 | 39.3 |
| 2009 | 3,518 | 24.4 | -1,413 | -9.8 | 7,545 | 52.3 |
| 2010 | 3,456 | 23.4 | -1,294 | -8.7 | 9,019 | 61.0 |
| 2011 | 3,598 | 23.4 | -1,296 | -8.4 | 10,128 | 65.8 |
| 2012 | 3,537 | 22.0 | -1,087 | -6.8 | 11,281 | 70.1 |
| 2013 | 3,455 | 20.8 | -642 | -3.9 | 12,036 | 72.5 |
| 2014 | 3,602 | 20.9 | -560 | -3.3 | 12,685 | 73.6 |
| 2015 | 3,777 | 20.7 | -378 | -2.1 | 13,156 | 72.1 |
| 2016 | 4,038 | 20.8 | -432 | -2.2 | 13,666 | 70.3 |
| 2017 | 4,261 | 20.6 | -482 | -2.3 | 14,223 | 68.8 |
| 2018 | 4,485 | 20.7 | -542 | -2.5 | 14,827 | 68.4 |
| 2019 | 4,752 | 21.0 | -648 | -2.9 | 15,537 | 68.6 |
| 2020 | 5,012 | 21.2 | -733 | -3.1 | 16,330 | 69.0 |
| 2021 | 5,275 | 21.4 | -782 | -3.2 | 17,168 | 69.6 |
| 2022 | 5,620 | 21.8 | -889 | -3.5 | 18,118 | 70.4 |
| 2023 | 5,855 | 21.8 | -895 | -3.3 | 19,070 | 71.1 |
| 2014 to 2018 | 20,163 | 20.7 | -2,394 | -2.5 | NA | NA |
| 2014 | 46,677 | 21.1 | -6,340 | -2.9 | NA | NA |
Note: Out = outlays
Sources: CBO (2011AugBEO); Office of Management and Budget. 2011. Historical Tables. Budget of the US Government Fiscal Year 2011. Washington, DC: OMB; CBO. 2011JanBEO. Budget and Economic Outlook. Washington, DC, Jan. CBO. 2012AugBEO. Budget and Economic Outlook. Washington, DC, Aug 22. CBO. 2012Jan31. Historical budget data. Washington, DC, Jan 31. CBO. 2012NovCDR. Choices for deficit reduction. Washington, DC. Nov. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO. 2013HBDFeb5. Historical budget data—February 2013 baseline projections. Washington, DC, Congressional Budget Office, Feb 5. CBO (2013Sep11).
Table IIA1-8 provides baseline CBO projections of federal revenues, outlays, deficit and debt as percent of GDP. The adjustment depends on increasing revenues from 15.0 percent of GDP in 2011 to 18.5 percent of GDP in 2023, which is above the 40-year average of 17.4 percent of GDP while outlays fall from 23.4 percent of GDP in 2011 to 21.8 percent of GDP in 2023. The last row of Table IIA1-8 provides the CBO estimates of averages for 1973 to 2012 of 17.4 percent for revenues/GDP, 20.4 percent for outlays/GDP and 38.0 percent for debt/GDP. The United States faces tough adjustment of its fiscal accounts.
Table IIA1-8, US, Baseline CBO Projections of Federal Government Revenues, Outlays, Deficit and Debt as Percent of GDP
| Revenues | Outlays | Deficit | Debt | |
| 2011 | 15.0 | 23.4 | -8.4 | 65.8 |
| 2012 | 15.2 | 22.0 | -6.8 | 70.1 |
| 2013 | 17.0 | 20.8 | -3.9 | 72.5 |
| 2014 | 17.7 | 20.9 | -3.3 | 73.6 |
| 2015 | 18.6 | 20.7 | -2.1 | 72.1 |
| 2016 | 18.5 | 20.8 | -2.2 | 70.3 |
| 2017 | 18.3 | 20.6 | -2.3 | 68.8 |
| 2018 | 18.2 | 20.7 | -2.5 | 68.4 |
| 2019 | 18.1 | 21.0 | -2.9 | 68.6 |
| 2020 | 18.1 | 21.2 | -3.1 | 69.0 |
| 2021 | 18.2 | 21.4 | -3.2 | 69.6 |
| 2022 | 18.4 | 21.8 | -3.5 | 70.4 |
| 2023 | 18.5 | 21.8 | -3.3 | 71.0 |
| Total 2014-2018 | 18.3 | 20.7 | -2.5 | NA |
| Total 2014-2023 | 18.3 | 21.1 | -2.9 | NA |
| Average | 17.4 | 20.4 | -3.0 | 38.0 |
Source: CBO (2012AugBEO). CBO (2012NovCDR). CBO (2013BEOFeb5). CBO 2013HBDFeb5), CBO (2013Sep11), CBO (2013Aug12Av). Kim Kowaleski and Amber Marcellino.
Table IIA1-9 provides the long-term budget outlook of the CBO for 2013, 2023 and 2038. Revenues increase from 17.0 percent of GDP in 2013 to 19.7 percent in 2038. The growing stock of debt raises net interest spending from 1.3 percent of GDP in 2013 to 3.1 percent in 2023 and 4.9 percent 2038. Total spending increases from 20.8 percent of GDP in 2013 to 26.2 percent in 2038. Federal debt held by the public rises to 100.0 percent of GDP in 2038. US fiscal affairs are in an unsustainable path with tough rigidities in spending and revenues.
Table IIA1-9, Congressional Budget Office, Long-term Budget Outlook, % of GDP
| 2013 | 2023 | 2038 | |
| Revenues | 17.0 | 18.5 | 19.7 |
| Total Noninterest Spending | 19.5 | 18.8 | 21.3 |
| Social Security | 4.9 | 5.3 | 6.2 |
| Medicare | 3.0 | 3.3 | 4.9 |
| Medicaid, CHIP and Exchange Subsidies | 1.7 | 2.6 | 3.2 |
| Other | 10.0 | 7.6 | 7.1 |
| Net Interest | 1.3 | 3.1 | 4.9 |
| Total Spending | 20.8 | 21.8 | 26.2 |
| Revenues Minus Total Noninterest Spending | -2.5 | -0.3 | -1.6 |
| Revenues Minus Total Spending | -3.9 | -3.3 | -6.4 |
| Federal Debt Held by the Public | 73.0 | 71.0 | 100.0 |
Source: CBO (2013Sep17). The 2013 long-term budget outlook. Washington, DC, Congressional Budget Office, Sep 17.
Chart I-1 provides actual federal debt held by the public as percent of GDP from 1790 to 2012 and projected by the CBO (2013Sep17) from 2013 to 2038. The ratio of debt to GDP climbed from 42.3 percent in 1941 to a peak of 108.7 percent in 1946 because of the Second World War. The ratio of debt to GDP declined to 80.2 percent in 1950 and 66.9 percent in 1951 because of unwinding war effort, economy growing to capacity and less rigid mandatory expenditures. The ratio of debt to GDP of 70.1 percent in 2012 is the highest in the United States since 1950. The CBO (2013BEOFeb5) projects the ratio of debt of GDP of the United States to reach 100.0 percent in 2038, which will be more than double the average ratio of 38.0 percent in 1973-2012. The misleading debate on the so-called “fiscal cliff” has disguised the unsustainable path of United States fiscal affairs.
Chart IIA1-1, Congressional Budget Office, Federal Debt Held by the Public, Extended Baseline Projection, % of GDP
Source: CBO. 2013Sep17. The 2013 long-term budget outlook. Washington, DC, Congressional Budget Office, Sep 17.
IIA2 Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities. The current account of the US balance of payments is provided in Table IIA2-1 for IIQ2012 and IIQ2013. The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US not seasonally adjusted decreased from $118.3 billion in IIQ2012 to $104.6 billion in IIQ2013. The current account deficit seasonally adjusted at annual rate fell from 2.7 percent of GDP in IIQ2012 to 2.5 percent of GDP in IQ2013 and 2.4 percent of GDP in IIQ2013. The ratio of the current account deficit to GDP has stabilized around 3 percent of GDP compared with much higher percentages before the recession but is combined now with much higher imbalance in the Treasury budget (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71).
Table IIA2-1, US, Balance of Payments, Millions of Dollars NSA
| IIQ2012 | IIQ2013 | Difference | |
| Goods Balance | -191,299 | -178,171 | 13,128 |
| X Goods | 395,151 | 400,113 | 1.3 ∆% |
| M Goods | -586,450 | -578,283 | -1.4 ∆% |
| Services Balance | 45,836 | 52,588 | 6,752 |
| X Services | 160,060 | 167,200 | 4.5 ∆% |
| M Services | -114,224 | -114,612 | 0.3 ∆% |
| Balance Goods and Services | -145,464 | -125,582 | 19,882 |
| Balance Income | 58,505 | 53,507 | -4,998 |
| Unilateral Transfers | -31,381 | -32,493 | -1,112 |
| Current Account Balance | -118,340 | -104,568 | 13,772 |
| % GDP | IIQ2012 | IIQ2013 | IQ2013 |
| 2.7 | 2.4 | 2.5 |
X: exports; M: imports
Balance on Current Account = Balance on Goods and Services + Balance on Income + Unilateral Transfers
Source: Bureau of Economic Analysis http://www.bea.gov/international/index.htm#bop
In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):
“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”
The alternative fiscal scenario of the CBO (2012NovCDR, 2013Sep17) resembles an economic world in which eventually the placement of debt reaches a limit of what is proportionately desired of US debt in investment portfolios. This unpleasant environment is occurring in various European countries.
The current real value of government debt plus monetary liabilities depends on the expected discounted values of future primary surpluses or difference between tax revenue and government expenditure excluding interest payments (Cochrane 2011Jan, 27, equation (16)). There is a point when adverse expectations about the capacity of the government to generate primary surpluses to honor its obligations can result in increases in interest rates on government debt.
This analysis suggests that there may be a point of saturation of demand for United States financial liabilities without an increase in interest rates on Treasury securities. A risk premium may develop on US debt. Such premium is not apparent currently because of distressed conditions in the world economy and international financial system. Risk premiums are observed in the spread of bonds of highly indebted countries in Europe relative to bonds of the government of Germany.
The issue of global imbalances centered on the possibility of a disorderly correction (Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State Vol. II (2008b) 183-94, Government Intervention in Globalization (2008c), 167-71). Such a correction has not occurred historically but there is no argument proving that it could not occur. The need for a correction would originate in unsustainable large and growing United States current account deficits (CAD) and net international investment position (NIIP) or excess of financial liabilities of the US held by foreigners net relative to financial liabilities of foreigners held by US residents. The IMF estimated that the US could maintain a CAD of two to three percent of GDP without major problems (Rajan 2004). The threat of disorderly correction is summarized by Pelaez and Pelaez, The Global Recession Risk (2007), 15):
“It is possible that foreigners may be unwilling to increase their positions in US financial assets at prevailing interest rates. An exit out of the dollar could cause major devaluation of the dollar. The depreciation of the dollar would cause inflation in the US, leading to increases in American interest rates. There would be an increase in mortgage rates followed by deterioration of real estate values. The IMF has simulated that such an adjustment would cause a decline in the rate of growth of US GDP to 0.5 percent over several years. The decline of demand in the US by four percentage points over several years would result in a world recession because the weakness in Europe and Japan could not compensate for the collapse of American demand. The probability of occurrence of an abrupt adjustment is unknown. However, the adverse effects are quite high, at least hypothetically, to warrant concern.”
The United States could be moving toward a situation typical of heavily indebted countries, requiring fiscal adjustment and increases in productivity to become more competitive internationally. The CAD and NIIP of the United States are not observed in full deterioration because the economy is well below potential. There are two complications in the current environment relative to the concern with disorderly correction in the first half of the past decade. In the release of Jun 14, 2013, the Bureau of Economic Analysis (http://www.bea.gov/newsreleases/international/transactions/2013/pdf/trans113.pdf) informs of revisions of US data on US international transactions since 1999:
“The statistics of the U.S. international transactions accounts released today have been revised for the first quarter of 1999 to the fourth quarter of 2012 to incorporate newly available and revised source data, updated seasonal adjustments, changes in definitions and classifications, and improved estimating methodologies.”
Table IIA2-2 provides data on the US fiscal and balance of payments imbalances. In 2007, the federal deficit of the US was $161 billion corresponding to 1.1 percent of GDP while the Congressional Budget Office (CBO 2013Sep11) estimates the federal deficit in 2012 at $1087 billion or 6.8 percent of GDP. The combined record federal deficits of the US from 2009 to 2012 are $5090 billion or 31.6 percent of the estimate of GDP for fiscal year 2012 implicit in the CBO (CBO 2013Sep11) estimate of debt/GDP. The deficits from 2009 to 2012 exceed one trillion dollars per year, adding to $5.090 trillion in four years, using the fiscal year deficit of $1087 billion for fiscal year 2012, which is the worst fiscal performance since World War II. Federal debt in 2007 was $5035 billion, less than the combined deficits from 2009 to 2012 of $5090 billion. Federal debt in 2012 was 70.1 percent of GDP (CBO 2013Sep11). This situation may worsen in the future (CBO 2013Sep17):
“Between 2009 and 2012, the federal government recorded the largest budget deficits relative to the size of the economy since 1946, causing federal debt to soar. Federal debt held by the public is now about 73 percent of the economy’s annual output, or gross domestic product (GDP). That percentage is higher than at any point in U.S. history except a brief period around World War II, and it is twice the percentage at the end of 2007. If current laws generally remained in place, federal debt held by the public would decline slightly relative to GDP over the next several years, CBO projects. After that, however, growing deficits would ultimately push debt back above its current high level. CBO projects that federal debt held by the public would reach 100 percent of GDP in 2038, 25 years from now, even without accounting for the harmful effects that growing debt would have on the economy. Moreover, debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely.
The gap between federal spending and revenues would widen steadily after 2015 under the assumptions of the extended baseline, CBO projects. By 2038, the deficit would be 6½ percent of GDP, larger than in any year between 1947 and 2008, and federal debt held by the public would reach 100 percent of GDP, more than in any year except 1945 and 1946. With such large deficits, federal debt would be growing faster than GDP, a path that would ultimately be unsustainable.
Incorporating the economic effects of the federal policies that underlie the extended baseline worsens the long-term budget outlook. The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues and higher interest payments. With those effects included, debt under the extended baseline would rise to 108 percent of GDP in 2038.”
Table IIA2-2, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and %
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |
| Goods & | -699 | -702 | -384 | -499 | -557 | -535 |
| Income | 101 | 146 | 124 | 178 | 233 | 224 |
| UT | -115 | -125 | -122 | -128 | -134 | -130 |
| Current Account | -713 | -681 | -382 | -449 | -458 | -440 |
| NGDP | 14480 | 14720 | 14418 | 14958 | 15534 | 16245 |
| Current Account % GDP | -4.9 | -4.6 | -2.6 | -3.0 | -2.9 | -2.7 |
| NIIP | -1796 | -3260 | -2275 | -2250 | -3730 | -3863 |
| US Owned Assets Abroad | 18400 | 19464 | 18558 | 20555 | 21636 | 21638 |
| Foreign Owned Assets in US | 20196 | 22724 | 20833 | 22805 | 25366 | 25501 |
| NIIP % GDP | -12.4 | -22.1 | -15.8 | -15.0 | -24.0 | -23.8 |
| Exports | 2487 | 2654 | 2185 | 2523 | 2874 | 2987 |
| NIIP % | -72 | -123 | -104 | -89 | -130 | -129 |
| DIA MV | 5274 | 3102 | 4322 | 4809 | 4514 | 5249 |
| DIUS MV | 3551 | 2486 | 2995 | 3422 | 3510 | 3924 |
| Fiscal Balance | -161 | -459 | -1413 | -1294 | -1296 | -1087 |
| Fiscal Balance % GDP | -1.1 | -3.1 | -9.8 | -8.7 | -8.4 | -6.8 |
| Federal Debt | 5035 | 5803 | 7545 | 9019 | 10128 | 11281 |
| Federal Debt % GDP | 35.1 | 39.3 | 52.3 | 61.0 | 65.8 | 70.1 |
| Federal Outlays | 2729 | 2983 | 3518 | 3456 | 3598 | 3537 |
| ∆% | 2.8 | 9.3 | 17.9 | -1.8 | 4.1 | -1.7 |
| % GDP | 19.0 | 20.2 | 24.4 | 23.4 | 23.4 | 22.0 |
| Federal Revenue | 2568 | 2524 | 2105 | 2162 | 2302 | 2450 |
| ∆% | 6.7 | -1.7 | -16.6 | 2.7 | 6.5 | 6.4 |
| % GDP | 17.9 | 17.1 | 14.6 | 14.6 | 15.0 | 15.2 |
Sources:
Notes: UT: unilateral transfers; NGDP: nominal GDP or in current dollars; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. There are minor discrepancies in the decimal point of percentages of GDP between the balance of payments data and federal debt, outlays, revenue and deficits in which the original number of the CBO source is maintained. These discrepancies do not alter conclusions. Budget http://www.cbo.gov/ Balance of Payments and NIIP http://www.bea.gov/international/index.htm#bop Gross Domestic Product, Bureau of Economic Analysis (BEA). http://www.bea.gov/iTable/index_nipa.cfm
Table IIA2-3 provides quarterly estimates NSA of the external and internal imbalances of the United States. The current account deficit seasonally adjusted falls from 3.0 percent of GDP in IQ2012 to 2.5 percent in IQ2013. The net international investment position increases from $3.9 trillion in IQ2012 to $4.3 trillion in IQ2013.
Table IIA2-3, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and % NSA
| IQ2012 | IIQ2012 | IIIQ2012 | IVQ2012 | IQ2013 | |
| Goods & | -122 | -145 | -144 | -122 | -100 |
| Income | 55 | 58 | 55 | 55 | 52 |
| UT | -33 | -31 | -33 | -32 | -34 |
| Current Account | -100 | -118 | -122 | -99 | -82 |
| Current Account % GDP | -3.0 | -2.7 | -2.6 | -2.5 | -2.5 |
| NIIP | -3886 | -4332 | -4109 | -3863 | -4277 |
| US Owned Assets Abroad | 21349 | 20948 | 21551 | 21638 | 21619 |
| Foreign Owned Assets in US | -25235 | -25280 | -25660 | -25501 | -25896 |
| DIA MV | 4976 | 4679 | 5059 | 5249 | 5518 |
| DIUS MV | 3856 | 3765 | 3962 | 3924 | 4261 |
Sources:
Notes: UT: unilateral transfers; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value..
Sources: US Bureau of Economic Analysis http://www.bea.gov/international/index.htm#bop
Chart IIA2-1 of the Board of Governors of the Federal Reserve System provides the overnight Fed funds rate on business days from Jul 1, 1954 at 1.13 percent through Jan 10, 1979, at 9.91 percent per year, to Sep 19, 2013, at 0.09 percent per year. US recessions are in shaded areas according to the reference dates of the NBER (http://www.nber.org/cycles.html). In the Fed effort to control the “Great Inflation” of the 1930s (see http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html), the fed funds rate increased from 8.34 percent on Jan 3, 1979 to a high in Chart IIA2-1 of 22.36 percent per year on Jul 22, 1981 with collateral adverse effects in the form of impaired savings and loans associations in the United States, emerging market debt and money-center banks (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7; Pelaez 1986, 1987). Another episode in Chart IIA2-1 is the increase in the fed funds rate from 3.15 percent on Jan 3, 1994, to 6.56 percent on Dec 21, 1994, which also had collateral effects in impairing emerging market debt in Mexico and Argentina and bank balance sheets in a world bust of fixed income markets during pursuit by central banks of non-existing inflation (Pelaez and Pelaez, International Financial Architecture (2005), 113-5). Another interesting policy impulse is the reduction of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of equally non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85), followed by increments of 25 basis points from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006 in Chart IIA2-1. Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).
The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever-increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). A final episode in Chart IIA2-1 is the reduction of the fed funds rate from 5.41 percent on Aug 9, 2007, to 2.97 percent on October 7, 2008, to 0.12 percent on Dec 5, 2008 and close to zero throughout a long period with the final point at 0.09 percent on Sep 19, 2013. Evidently, this behavior of policy would not have occurred had there been theory, measurements and forecasts to avoid these violent oscillations that are clearly detrimental to economic growth and prosperity without inflation. Current policy consists of forecast mandate of maintaining policy accommodation until the forecast of the rate of unemployment reaches 6.5 percent and the rate of personal consumption expenditures excluding food and energy reaches 2.5 percent (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm). It is a forecast mandate because of the lags in effect of monetary policy impulses on income and prices (Romer and Romer 2004). The intention is to reduce unemployment close to the “natural rate” (Friedman 1968, Phelps 1968) of around 5 percent and inflation at or below 2.0 percent. If forecasts were reasonably accurate, there would not be policy errors. A commonly analyzed risk of zero interest rates is the occurrence of unintended inflation that could precipitate an increase in interest rates similar to the Himalayan rise of the fed funds rate from 9.91 percent on Jan 10, 1979, at the beginning in Chart IIA2-1, to 22.36 percent on Jul 22, 1981. There is a less commonly analyzed risk of the development of a risk premium on Treasury securities because of the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). There is not a fiscal cliff or debt limit issue ahead but rather free fall into a fiscal abyss. The combination of the fiscal abyss with zero interest rates could trigger the risk premium on Treasury debt or Himalayan hike in interest rates.
Chart IIA2-1, US, Fed Funds Rate, Business Days, Jul 1, 1954 to Sep 19, 2013, Percent per Year
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table IIA2-4 when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table IIA2-4 shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.
Table IIA2-4, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994
| 1994 | FF | 30Y | 30P | 10Y | 10P | MOR | CPI |
| Jan | 3.00 | 6.29 | 100 | 5.75 | 100 | 7.06 | 2.52 |
| Feb | 3.25 | 6.49 | 97.37 | 5.97 | 98.36 | 7.15 | 2.51 |
| Mar | 3.50 | 6.91 | 92.19 | 6.48 | 94.69 | 7.68 | 2.51 |
| Apr | 3.75 | 7.27 | 88.10 | 6.97 | 91.32 | 8.32 | 2.36 |
| May | 4.25 | 7.41 | 86.59 | 7.18 | 88.93 | 8.60 | 2.29 |
| Jun | 4.25 | 7.40 | 86.69 | 7.10 | 90.45 | 8.40 | 2.49 |
| Jul | 4.25 | 7.58 | 84.81 | 7.30 | 89.14 | 8.61 | 2.77 |
| Aug | 4.75 | 7.49 | 85.74 | 7.24 | 89.53 | 8.51 | 2.69 |
| Sep | 4.75 | 7.71 | 83.49 | 7.46 | 88.10 | 8.64 | 2.96 |
| Oct | 4.75 | 7.94 | 81.23 | 7.74 | 86.33 | 8.93 | 2.61 |
| Nov | 5.50 | 8.08 | 79.90 | 7.96 | 84.96 | 9.17 | 2.67 |
| Dec | 6.00 | 7.87 | 81.91 | 7.81 | 85.89 | 9.20 | 2.67 |
Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months
Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t
The Congressional Budget Office (CBO 2013BEOFeb5) estimates potential GDP, potential labor force and potential labor productivity provided in Table IIA2-5. The CBO estimates average rate of growth of potential GDP from 1950 to 2012 at 3.3 percent per year. The projected path is significantly lower at 2.2 percent per year from 2012 to 2023. The legacy of the economic cycle expansion from IIIQ2009 to IIQ2013 at 2.2 percent on average is in contrast with 5.2 percent on average in the expansion from IQ1983 to IIIQ1986 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). Subpar economic growth may perpetuate unemployment and underemployment estimated at 28.3 million or 17.4 percent of the effective labor force in Aug 2013 (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html) with much lower hiring than in the period before the current cycle (http://cmpassocregulationblog.blogspot.com/2013/09/recovery-without-hiring-ten-million.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/recovery-without-hiring-loss-of-full.html).
Table IIA2-5, US, Congressional Budget Office History and Projections of Potential GDP of US Overall Economy, ∆%
| Potential GDP | Potential Labor Force | Potential Labor Productivity* | |
| Average Annual ∆% | |||
| 1950-1973 | 3.9 | 1.6 | 2.3 |
| 1974-1981 | 3.3 | 2.5 | 0.8 |
| 1982-1990 | 3.1 | 1.6 | 1.5 |
| 1991-2001 | 3.1 | 1.3 | 1.8 |
| 2002-2012 | 2.2 | 0.8 | 1.4 |
| Total 1950-2012 | 3.3 | 1.5 | 1.7 |
| Projected Average Annual ∆% | |||
| 2013-2018 | 2.2 | 0.6 | 1.6 |
| 2019-2023 | 2.3 | 0.5 | 1.8 |
| 2012-2023 | 2.2 | 0.5 | 1.7 |
*Ratio of potential GDP to potential labor force
Source: Congressional Budget Office, CBO (2013BEOFeb5).
Chart IIA2-2 of the Congressional Budget Office (CBO 2013BEOFeb5) provides actual and potential GDP of the United States from 2000 to 2011 and projected to 2024. Lucas (2011May) estimates trend of United States real GDP of 3.0 percent from 1870 to 2010 and 2.2 percent for per capita GDP. The United States successfully returned to trend growth of GDP by higher rates of growth during cyclical expansion as analyzed by Bordo (2012Sep27, 2012Oct21) and Bordo and Haubrich (2012DR). Growth in expansions following deeper contractions and financial crises was much higher in agreement with the plucking model of Friedman (1964, 1988). The unusual weakness of growth at 2.2 percent on average from IIIQ2009 to IIQ2013 during the current economic expansion in contrast with 5.7 percent on average in the cyclical expansion from IQ1983 to IQ1986 (http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html) cannot be explained by the contraction of 4.3 percent of GDP from IVQ2007 to IIQ2009 and the financial crisis. Weakness of growth in the expansion is perpetuating unemployment and underemployment of 28.3 million or 17.4 percent of the labor force as estimated for Jul 2013 (http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). There is no exit from unemployment/underemployment and stagnating real wages because of the collapse of hiring (http://cmpassocregulationblog.blogspot.com/2013/09/recovery-without-hiring-ten-million.htm and earlier http://cmpassocregulationblog.blogspot.com/2013/08/recovery-without-hiring-loss-of-full.html).
Chart IIA2-2, US, Congressional Budget Office, Actual and Projections of Potential GDP, 2000-2024, Trillions of Dollars
Source: Congressional Budget Office, CBO (2013BEOFeb5).
Chart IIA2-3 of the Bureau of Economic Analysis of the Department of Commerce shows on the lower negative panel the sharp increase in the deficit in goods and the deficits in goods and services from 1960 to 2012. The upper panel shows the increase in the surplus in services that was insufficient to contain the increase of the deficit in goods and services. The adjustment during the global recession has been in the form of contraction of economic activity that reduced demand for goods.
Chart IIA2-3, US, Balance of Goods, Balance on Services and Balance on Goods and Services, 1960-2012, Millions of Dollars
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_ita.cfm
Chart IIA2-4 of the Bureau of Economic Analysis shows exports and imports of goods and services from 1960 to 2012. Exports of goods and services in the upper positive panel have been quite dynamic but have not compensated for the sharp increase in imports of goods. The US economy apparently has become less competitive in goods than in services.
Chart IIA2-4, US, Exports and Imports of Goods and Services, 1960-2012, Millions of Dollars
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_ita.cfm
Chart IIA2-5 of the Bureau of Economic Analysis shows the US balance on current account from 1960 to 2012. The sharp devaluation of the dollar resulting from unconventional monetary policy of zero interest rates and elimination of auctions of 30-year Treasury bonds did not adjust the US balance of payments. Adjustment only occurred after the contraction of economic activity during the global recession.
Chart IIA2-5, US, Balance on Current Account, 1960-2012, Millions of Dollars
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_ita.cfm
Chart IIA2-6 of the Bureau of Economic Analysis provides real GDP in the US from 1960 to 2012. The contraction of economic activity during the global recession was a major factor in the reduction of the current account deficit as percent of GDP.
Chart IIA2-6, US, Real GDP, 1960-2012, Billions of Chained 2009 Dollars
Source: Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-7 provides the US current account deficit on a quarterly basis from 1980 to IQ1983. The deficit is at a lower level because of growth below potential not only in the US but worldwide. The combination of high government debt and deficit with external imbalance restricts potential prosperity in the US.
Chart IIB-7, US, Balance on Current Account, Quarterly, 1980-2013
Source: Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Risk aversion channels funds toward US long-term and short-term securities that finance the US balance of payments and fiscal deficits benefitting from risk flight to US dollar denominated assets. There are now temporary interruptions because of fear of rising interest rates that erode prices of US government securities because of mixed signals on monetary policy and exit from the Fed balance sheet of three trillion dollars of securities held outright. Net foreign purchases of US long-term securities (row C in Table IIA2-6) recovered sharply from minus $67.0 billion in Jun 2013 to $33.1 billion in Jul 2013. Foreign (residents) purchases minus sales of US long-term securities (row A in Table IIA2-6) in Jun 2013 of minus $78.6 billion increased to $46.7 billion in Jul 2013. Net US (residents) purchases of long-term foreign securities (row B in Table II2-6) decreased from $11.6 billion in Jun 2013 to minus $15.6 billion in Jul 2013. In Jul 2013,
C = A + B = $46.7 billion - $15.6 billion = $33.1 billion
There are minor rounding errors. There is increasing demand in Table IIA2-6 in Jul in A1 private purchases by residents overseas of US long-term securities of $41.7 billion of which increases in A11 Treasury securities of $49.1 billion, decrease in A12 of $2.1 billion in agency securities, decrease by $1.0 billion of corporate bonds and decrease of $9.2 billion in equities. Worldwide risk aversion causes flight into US Treasury obligations with significant oscillations. Official purchases of securities in row A2 increased $3.8 billion with decrease of Treasury securities of $0.7 billion in Jun 2013. Official purchases of agency securities increased $5.0 billion in Jul. Row D shows decrease in Jul 2013 of 14.6 billion in purchases of short-term dollar denominated obligations. Foreign private holdings of US Treasury bills decreased $21.1 billion (row D11) with foreign official holdings increasing $0.2 billion while the category “other” increased $6.7 billion. Foreign private holdings of US Treasury bills decreased $25.9 billion in what could be increase of duration exposures. Risk aversion of default losses in foreign securities dominates decisions to accept zero interest rates in Treasury securities with no perception of principal losses. In the case of long-term securities, investors prefer to sacrifice inflation and possible duration risk to avoid principal losses with significant oscillations in risk perceptions.
Table IIA2-6, Net Cross-Borders Flows of US Long-Term Securities, Billion Dollars, NSA
| Jul 2012 12 Months | Jul 2013 12 Months | Jun 2013 | Jul 2013 | |
| A Foreign Purchases less Sales of | 565.8 | 298.0 | -78.6 | 46.7 |
| A1 Private | 368.1 | 127.0 | -82.4 | 41.7 |
| A11 Treasury | 357.6 | 12.5 | -40.1 | 49.8 |
| A12 Agency | 110.5 | 51.5 | -9.4 | 2.1 |
| A13 Corporate Bonds | -77.6 | 11.6 | -7.1 | -1.0 |
| A14 Equities | -22.4 | 51.5 | -25.8 | -9.2 |
| A2 Official | 197.7 | 171.0 | 3.8 | 5.0 |
| A21 Treasury | 202.9 | 62.3 | -0.7 | -15.9 |
| A22 Agency | -14.6 | 81.7 | 3.9 | 20.1 |
| A23 Corporate Bonds | 1.2 | 18.9 | 1.9 | 0.0 |
| A24 Equities | 8.3 | 8.1 | -1.4 | 0.7 |
| B Net US Purchases of LT Foreign Securities | 55.8 | -169.2 | 11.6 | -15.6 |
| B1 Foreign Bonds | 81.4 | -43.6 | 15.1 | 0.4 |
| B2 Foreign Equities | -25.6 | -125.6 | -3.5 | -16.0 |
| C Net Foreign Purchases of US LT Securities | 621.6 | 128.8 | -67.0 | 31.1 |
| D Increase in Foreign Holdings of Dollar Denominated Short-term | -2.0 | 37.1 | -4.8 | -14.1 |
| D1 US Treasury Bills | 14.9 | 35.6 | 8.8 | -20.8 |
| D11 Private | 50.0 | 29.5 | 25.9 | -21.1 |
| D12 Official | -35.1 | 6.1 | -17.1 | 0.2 |
| D2 Other | -16.9 | 1.5 | -13.6 | 6.7 |
C = A + B;
A = A1 + A2
A1 = A11 + A12 + A13 + A14
A2 = A21 + A22 + A23 + A24
B = B1 + B2
D = D1 + D2
Sources: http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/index.aspx
Table IIA2-7 provides major foreign holders of US Treasury securities. China is the largest holder with $1277.3 billion in Jul 2013, increasing 10.1 percent from $1160.0 billion in Jul 2012 while increasing $1.5 billion from Jun 2013 or 0.1 percent. Japan increased its holdings from $1119.8 billion in Jul 2012 to $1135.4 billion in Jul 2013 or by 1.4 percent. Japan increased its holdings from $1083.4 billion in Jun 2013 to $1135.4 billion in Jul 2013 by $52.0 billion or 4.8 percent. Total foreign holdings of Treasury securities rose from $5381.6 billion in Jul 2012 to $5590.1 billion in Jul 2013, or 3.9 percent. Foreign holdings of Treasury securities fell from $5740.4 in Mar 2013 to $5670.8 in Apr 2013 or 1.2 percent. Foreign holdings of US Treasury securities fell from $5600.6 billion in Jun 2013 to $5590.1 billion in Jul 2013, by $10.5 billion or 0.2 percent. The US continues to finance its fiscal and balance of payments deficits with foreign savings (see Pelaez and Pelaez, The Global Recession Risk (2007)). A point of saturation of holdings of US Treasury debt may be reached as foreign holders evaluate the threat of reduction of principal by dollar devaluation and reduction of prices by increases in yield, including possibly risk premium. Shultz et al (2012) find that the Fed financed three-quarters of the US deficit in fiscal year 2011, with foreign governments financing significant part of the remainder of the US deficit while the Fed owns one in six dollars of US national debt. Concentrations of debt in few holders are perilous because of sudden exodus in fear of devaluation and yield increases and the limit of refinancing old debt and placing new debt. In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):
“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”
Table IIA2-7, US, Major Foreign Holders of Treasury Securities $ Billions at End of Period
| Jul 2013 | Jun 2013 | Jul 2012 | |
| Total | 5590.1 | 5600.6 | 5381.6 |
| China | 1277.3 | 1275.8 | 1160.0 |
| Japan | 1135.4 | 1083.4 | 1119.8 |
| Caribbean Banking Centers | 287.7 | 290.8 | 247.6 |
| Oil Exporters | 257.7 | 256.8 | 268.4 |
| Brazil | 256.4 | 253.7 | 256.5 |
| Taiwan | 185.8 | 186.2 | 194.4 |
| Switzerland | 178.2 | 180.4 | 184.8 |
| Belgium | 167.7 | 176.1 | 141.3 |
| United Kingdom | 156.9 | 162.7 | 135.4 |
| Luxembourg | 146.8 | 150.6 | 135.1 |
| Russia | 131.6 | 138.0 | 156.2 |
| Hong Kong | 120.2 | 124.2 | 137.1 |
| Foreign Official Holdings | 3995.5 | 4009.2 | 3917.4 |
| A. Treasury Bills | 363.0 | 362.7 | 356.9 |
| B. Treasury Bonds and Notes | 3632.5 | 3646.4 | 3560.6 |
Source: http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx#ussecs
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013
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