World Inflation Waves, Regional Economic Surveys, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, Increasing Interest Rates Risk, Tapering Quantitative Easing, Duration Dumping, Steepening Yield Curve and Global Financial and Economic Risk, World Economic Slowdown and Global Recession Risk: Part II

 

World Inflation Waves, Regional Economic Surveys, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, Increasing Interest Rates Risk, Tapering Quantitative Easing, Duration Dumping, Steepening Yield Curve and Global Financial and Economic Risk, 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

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

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

II Regional Economic Surveys of Federal Reserve Banks of New York and Philadelphia

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

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

II. Regional Economic Surveys of Federal Reserve Banks of New York and Philadelphia. The Empire State Manufacturing Survey Index in Table II-1 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 1.52 in Oct 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 7.75 in Oct 2013. Number of workers and hours worked have registered negative or declining readings since Sep 2012 with moderate expansion at 3.61 for number of workers in Oct 2013 and recovery from contraction in the average workweek to 3.61 in Oct 2013. There is marginal expansion in the general index for the next six months at 2.41 in Sep 2013 and strengthening new orders at 37.04 in Oct 2013.

Table II-1, US, New York Federal Reserve Bank Empire State Manufacturing Survey Index SA

	General Index	New Orders	Shipments	# Workers	Average Work-week
Current
Oct 2013	1.52	7.75	13.12	3.61	3.61
Sep	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
Oct 2013	2.41	37.04	32.18	7.23	2.41
Sep	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-2 also shows improvement after prior deterioration. The general index moved out contraction of 5.2 in May 2013 to 19.8 in Sep 2013 together with renewed expansion at 20.4 for new orders. Employment segments show improvement in Oct 2013 with 15.4 for number of workers and deterioration to 8.5 for hours worked. Expectations for the next six months are brighter with the general index at 63.7 in Oct 2013 and the index of new orders at 53.8.

Table II-2, FRB of Philadelphia Business Outlook Survey Diffusion Index

	General Index	New Orders	Shipments	# Workers	Hours Worked
11-Jan	15.0	19.1	11.1	13.9	8.0
11-Feb	25.6	15.7	24.0	19.6	6.9
11-Mar	36.1	33.2	28.1	16.1	7.3
11-Apr	13.7	12.6	23	9.9	15.1
11-May	4	6.8	5.4	22.2	2.8
11-Jun	-1.1	-1.2	5.7	3.4	3.7
11-Jul	9.4	4.7	9	12.6	-0.8
11-Aug	-19	-18.6	-4.7	-0.5	-7.6
11-Sep	-10	-4.5	-7.4	9.4	-2.8
11-Oct	9.7	8.8	11.2	7.8	5.2
11-Nov	5	3.6	6.9	10.9	6.8
11-Dec	4.2	5.9	6.2	8	-0.3
12-Jan	4.7	9	4.4	9.6	3.9
12-Feb	5	5.3	8.6	0.9	5.7
12-Mar	8.6	-0.7	0.2	5.9	-0.6
12-Apr	6.5	-0.8	0.5	13.4	-3.4
12-May	-4.9	-0.6	2.7	-0.2	-6.4
12-Jun	-12.8	-13.1	-13.8	2.3	-16.9
12-Jul	-9.1	-2.1	-7.5	-4.7	-13.9
12-Aug	-1.7	-0.8	-5.9	-7.6	-9.9
12-Sep	1.4	2.5	-10.4	-4.9	-2.9
12-Oct	4.2	-0.5	-3.5	-7.6	-6.5
12-Nov	-8.9	-4.7	-6.3	-6.9	-7.4
12-Dec	4.6	4.9	14.7	-0.2	0.4
13-Jan	-5.8	-4.3	0.4	-5.2	-8.3
13-Feb	-12.5	-7.8	2.4	0.9	-1.6
13-Mar	2	0.5	3.5	2.7	-12.9
13-Apr	1.3	-1	9.1	-6.8	-2.1
13-May	-5.2	-7.9	-8.5	-8.7	-12.4
13-Jun	12.5	16.6	4.1	-5.4	0.8
13-Jul	19.8	10.2	14.3	7.7	6.6
13-Aug	9.3	5.3	-0.9	3.5	-2.6
13-Sep	22.3	21.2	21.2	10.3	12.2
13-Oct	19.8	27.5	20.4	15.4	8.5

Future	General Index	New Orders	Shipments	# Workers	Hours Worked
10-Dec	42.1	41.9	14.5	28	22.0
11-Jan	35.9	39.8	10.3	29.1	19.6
11-Feb	38.6	42.7	14.2	22.6	11.8
11-Mar	53.6	52.3	12.6	25.2	13
11-Apr	26.6	33.5	8.8	32.3	15.9
11-May	22.4	26.1	3.8	20.9	12.5
11-Jun	9.6	7.7	-4.7	7.2	4.2
11-Jul	35	31	8	16.2	6.6
11-Aug	26.4	22.8	3.5	13.9	2.4
11-Sep	26.6	27	6	13.4	5.7
11-Oct	29.8	31	5.3	17.5	8.2
11-Nov	36.2	34	8.9	27.9	4.5
11-Dec	37.7	31.6	4.4	7.9	2
12-Jan	43.9	46.1	13	17.8	6.8
12-Feb	32.2	26.3	5.7	20.2	8.7
12-Mar	34.4	28.6	6	19.2	8
12-Apr	34.8	29.6	5.6	23.6	6.9
12-May	30.2	26	10.1	11.8	1.2
12-Jun	35.5	35.6	6	19.1	5
12-Jul	30.8	24.7	6.5	15.3	14.6
12-Aug	25.3	17.3	4.8	14.5	8.8
12-Sep	52	42.8	12.6	21.2	13.8
12-Oct	22.6	22.7	8.6	9.8	10.5
12-Nov	23.2	24.9	2.7	7	8.2
12-Dec	28.3	28	2.7	11.2	14.4
13-Jan	32.5	38.9	2.9	10.7	8.9
13-Feb	38	30.3	4.3	14.9	6.5
13-Mar	34.5	31.2	6.6	8.1	3.4
13-Apr	24.3	26.5	-2.1	8.2	6.6
13-May	34.5	31.7	16.9	10	14.1
13-Jun	41.5	37.6	17.8	27.3	7.5
13-Jul	58.8	51.2	25.8	36.2	14.6
13-Aug	39.5	40.1	12.3	22.3	15
13-Sep	62.2	58.3	18.5	31	16.2
13-Oct	63.7	53.8	17.8	27.2	9.3

Source: Federal Reserve Bank of Philadelphia

http://philadelphiafed.org/index.cfm

Chart II-1 of the Federal Reserve Bank of Philadelphia is very useful, providing current and future general activity indexes from Jan 1995 to Oct 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-Oct 2013.

Chart II-1, 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

The index of current new orders of the Business Outlook Survey of the Federal Reserve Bank of Philadelphia in Chart II-2 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-Oct 2013.

Chart II-2, Federal Reserve Bank of Philadelphia Current New Orders Diffusion Index

Source: Federal Reserve Bank of Philadelphia

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

IIB Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates. Long-term economic growth in Japan significantly improved by increasing competitiveness in world markets. Net trade of exports and imports is an important component of the GDP accounts of Japan. Table IIB-1 provides quarterly data for net trade, exports and imports of Japan. Net trade had strong positive contributions to GDP growth in Japan in all quarters from IQ2007 to IIQ2009 with exception of IVQ2008, IIIQ2008 and IQ2009. The US recession is dated by the National Bureau of Economic Research (NBER) as beginning in IVQ2007 (Dec) and ending in IIQ2009 (Jun) (http://www.nber.org/cycles/cyclesmain.html). Net trade contributions helped to cushion the economy of Japan from the global recession. Net trade deducted from GDP growth in seven of the nine quarters from IVQ2010 IQ2012. The only strong contribution of net trade was 3.4 percent in IIIQ2011. Net trade added 1.6 percentage points to GDP growth in IQ2013 and 0.7 percentage points in IIQ2013. Private consumption assumed the role of driver of Japan’s economic growth but should moderate as in most mature economies.

Table IIB-1, Japan, Contributions to Changes in Real GDP, Seasonally Adjusted Annual Rates (SAAR), %

	Net Trade	Exports	Imports
2013
I	1.6	2.2	-0.7
II	0.7	1.7	-1.0
2012
I	0.3	1.6	-1.3
II	-1.0	-0.1	-0.9
III	-2.7	-2.7	0.0
IV	-0.2	-1.6	1.3
2011
I	-1.2	-0.5	-0.7
II	-4.1	-4.5	0.4
III	3.4	5.4	-2.0
IV	-2.8	-1.7	-1.1
2010
I	2.1	3.5	-1.3
II	0.2	2.7	-2.5
III	0.3	1.2	-0.9
IV	-0.3	0.2	-0.5
2009
I	-4.4	-16.4	12.0
II	7.5	4.7	2.7
III	2.1	5.2	-3.1
IV	2.8	4.2	-1.4
2008
I	1.2	2.2	-1.0
II	0.5	-1.6	2.1
III	-0.1	0.1	-0.1
IV	-11.4	-10.2	-1.2
2007
I	1.2	1.7	-0.5
II	0.8	1.6	-0.8
III	2.0	1.4	0.6
IV	1.4	2.1	-0.7

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

There was milder increase in Japan’s export corporate goods price index during the global recession in 2008 but similar sharp decline during the bank balance sheets effect in late 2008, as shown in Chart IIB-1 of the Bank of Japan. Japan exports industrial goods whose prices have been less dynamic than those of commodities and raw materials. As a result, the export CGPI on the yen basis in Chart IIB-1 trends down with oscillations after a brief rise in the final part of the recession in 2009. The export corporate goods price index on the yen basis fell from 104.9 in Jun 2009 to 94.0 in Jan 2012 or minus 10.4 percent and increased to 107.1 in Sep 2013 for a gain of 13.9 percent relative to Jan 2012 and 2.1 percent relative to Jun 2009. The choice of Jun 2009 is designed to capture the reversal of risk aversion beginning in Sep 2008 with the announcement of toxic assets in banks that would be withdrawn with the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009). Reversal of risk aversion in the form of flight to the USD and obligations of the US government opened the way to renewed carry trades from zero interest rates to exposures in risk financial assets such as commodities. Japan exports industrial products and imports commodities and raw materials.

Chart IIB-1, Japan, Export Corporate Goods Price Index, Monthly, Yen Basis, 2008-2013

Source: Bank of Japan

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

Chart IIB-1A provides the export corporate goods price index on the basis of the contract currency. The export corporate goods price index on the basis of the contract currency increased from 97.9 in Jun 2009 to 103.1 in Apr 2012 or 5.3 percent but dropped to 100.2 in Apr 2013 or minus 2.8 percent relative to Apr 2012 and gained 1.0 percent to 98.9 in Sep 2013 relative to Jun 2009.

Chart IIB-1A, Japan, Export Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2013

Source: Bank of Japan

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

Japan imports primary commodities and raw materials. As a result, the import corporate goods price index on the yen basis in Chart IIB-2 shows an upward trend after declining from the increase during the global recession in 2008 driven by carry trades from fed funds rates. The index increases with carry trades from zero interest rates into commodity futures and declines during risk aversion from late 2008 into beginning of 2008 originating in doubts about soundness of US bank balance sheets. More careful measurement should show that the terms of trade of Japan, export prices relative to import prices, declined during the commodity shocks originating in unconventional monetary policy. The decline of the terms of trade restricted potential growth of income in Japan. The import corporate goods price index on the yen basis increased from 93.5 in Jun 2009 to 113.1 in Apr 2012 or 21.0 percent and to 124.0 in Sep 2013 or gain of 9.6 percent relative to Apr 2012 and 32.6 percent relative to Jun 2009.

Chart IIB-2, Japan, Import Corporate Goods Price Index, Monthly, Yen Basis, 2008-2013

Source: Bank of Japan

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

Chart IIB-2A provides the import corporate goods price index on the contract currency basis. The import corporate goods price index on the basis of the contract currency increased from 86.2 in Jun 2009 to 119.5 in Apr 2012 or 38.6 percent and to 113.0 in Sep 2013 or minus 5,4 percent relative to Apr 2012 and gain of 31.1 percent relative to Jun 2009. There is evident deterioration of the terms of trade of Japan: the export corporate goods price index on the basis of the contract currency increased 1.0 percent from Jun 2009 to Sep 2013 while the import corporate goods price index increased 31.1 percent. Prices of Japan’s exports of corporate goods, mostly industrial products, increased only 5.3 percent from Jun 2009 to Apr 2012, while imports of corporate goods, mostly commodities and raw materials increased 38.6 percent. Unconventional monetary policy induces carry trades from zero interest rates to exposures in commodities that squeeze economic activity of industrial countries by increases in prices of imported commodities and raw materials during periods without risk aversion. Reversals of carry trades during periods of risk aversion decrease prices of exported commodities and raw materials that squeeze economic activity in economies exporting commodities and raw materials. Devaluation of the dollar by unconventional monetary policy could increase US competitiveness in world markets but economic activity is squeezed by increases in prices of imported commodities and raw materials. Unconventional monetary policy causes instability worldwide instead of the mission of central banks of promoting financial and economic stability

Chart IIB-2A, Japan, Import Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2013

Source: Bank of Japan

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

Table IIB-2 provides the Bank of Japan’s Corporate Goods Price indexes of exports and imports on the yen and contract bases from Jan 2008 to Sep 2013. There are oscillations of the indexes that are shown vividly in the four charts above. For the entire period from Jan 2008 to Sep 2013, the export index on the contract currency basis decreased 0.3 percent and decreased 7.3 percent on the yen basis. For the entire period from Jan 2008 to Sep 2013, the import index increased 12.2 percent on the contract currency basis and increased 4.2 percent on the yen basis. The charts show sharp deteriorations in relative prices of exports to prices of imports during multiple periods. Price margins of Japan’s producers are subject to periodic squeezes resulting from carry trades from zero interest rates of monetary policy to exposures in commodities.

Table IIB-2, Japan, Exports and Imports Corporate Goods Price Index, Contract Currency Basis and Yen Basis

Month	Exports Contract Currency	Exports Yen	Imports Contract Currency	Imports Yen
2008/01	99.2	115.5	100.7	119.0
2008/02	99.8	116.1	102.4	120.6
2008/03	100.5	112.6	104.5	117.4
2008/04	101.6	115.3	110.1	125.2
2008/05	102.4	117.4	113.4	130.4
2008/06	103.5	120.7	119.5	140.3
2008/07	104.7	122.1	122.6	143.9
2008/08	103.7	122.1	123.1	147.0
2008/09	102.7	118.3	117.1	137.1
2008/10	100.2	109.6	109.1	121.5
2008/11	98.6	104.5	97.8	105.8
2008/12	97.9	100.6	89.3	93.0
2009/01	98.0	99.5	85.6	88.4
2009/02	97.5	100.1	85.7	89.7
2009/03	97.3	104.2	85.2	93.0
2009/04	97.6	105.6	84.4	93.0
2009/05	97.5	103.8	84.0	90.8
2009/06	97.9	104.9	86.2	93.5
2009/07	97.5	103.1	89.2	95.0
2009/08	98.3	104.4	89.6	95.8
2009/09	98.3	102.1	91.0	94.7
2009/10	98.0	101.2	91.0	94.0
2009/11	98.4	100.8	92.8	94.8
2009/12	98.3	100.7	95.4	97.5
2010/01	99.4	102.2	97.0	100.0
2010/02	99.7	101.6	97.6	99.8
2010/03	99.7	101.8	97.0	99.2
2010/04	100.5	104.6	99.9	104.6
2010/05	100.7	102.9	101.7	104.9
2010/06	100.1	101.6	100.0	102.3
2010/07	99.4	99.0	99.9	99.8
2010/08	99.1	97.3	99.5	97.5
2010/09	99.4	97.0	100.0	97.2
2010/10	100.1	96.4	100.5	95.8
2010/11	100.7	97.4	102.6	98.2
2010/12	101.2	98.3	104.4	100.6
2011/01	102.1	98.6	107.2	102.6
2011/02	102.9	99.5	109.0	104.3
2011/03	103.5	99.6	111.8	106.3
2011/04	104.1	101.7	115.9	111.9
2011/05	103.9	99.9	118.8	112.4
2011/06	103.8	99.3	117.5	110.5
2011/07	103.6	98.3	118.3	110.2
2011/08	103.6	96.6	118.6	108.1
2011/09	103.7	96.1	117.0	106.2
2011/10	103.0	95.2	116.6	105.6
2011/11	101.9	94.8	115.4	105.4
2011/12	101.5	94.5	116.1	106.2
2012/01	101.8	94.0	115.0	104.2
2012/02	102.4	95.8	115.8	106.4
2012/03	102.9	99.2	118.3	112.9
2012/04	103.1	98.7	119.5	113.1
2012/05	102.3	96.3	118.1	109.8
2012/06	101.4	95.0	115.2	106.7
2012/07	100.6	94.0	112.0	103.5
2012/08	100.9	94.1	112.4	103.6
2012/09	101.0	94.1	114.7	105.2
2012/10	101.1	94.8	113.8	105.2
2012/11	100.9	95.9	113.2	106.5
2012/12	100.7	98.0	113.4	109.5
2013/01	101.0	102.4	113.8	115.4
2013/02	101.5	105.9	114.8	120.2
2013/03	101.3	106.6	115.1	122.0
2013/04	100.2	107.5	114.1	123.8
2013/05	99.6	109.1	112.6	125.3
2013/06	99.2	106.1	112.0	121.2
2013/07	99.0	107.4	111.6	122.9
2013/08	98.9	106.0	111.7	121.3
2013/09	98.9	107.1	113.0	124.0

Source: Bank of Japan

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

Chart IIB-3 provides the monthly corporate goods price index (CGPI) of Japan from 1970 to 2013. Japan also experienced sharp increase in inflation during the 1970s as in the episode of the Great Inflation in the US. Monetary policy focused on accommodating higher inflation, with emphasis solely on the mandate of promoting employment, has been blamed as deliberate or because of model error or imperfect measurement for creating the Great Inflation (http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). A remarkable similarity with US experience is the sharp rise of the CGPI of Japan in 2008 driven by carry trades from policy interest rates rapidly falling to zero to exposures in commodity futures during a global recession. Japan had the same sharp waves of consumer price inflation during the 1970s as in the US (see Table IV-7 at http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states_2133.html and at http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk_1.html http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real_09.html).

Chart IIB-3, Japan, Domestic Corporate Goods Price Index, Monthly, 1970-2013

Source: Bank of Japan

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

The producer price index of the US from 1970 to 2013 in Chart IIB-4 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 IIB-4, US, Producer Price Index Finished Goods, Monthly, 1970-2013

Source: US Bureau of Labor Statistics

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

Further insight into inflation of the corporate goods price index (CGPI) of Japan is provided in Table IIB-3. Petroleum and coal with weight of 5.7 percent increased 0.2 percent in Sep 2013 and increased 11.9 percent in 12 months. Japan exports manufactured products and imports raw materials and commodities such that the country’s terms of trade, or export prices relative to import prices, deteriorate during commodity price increases. In contrast, prices of production machinery, with weight of 3.1 percent, changed 0.0 percent in Sep 2013 and increased 0.1 percent in 12 months. In general, most manufactured products have been experiencing negative or low increases in prices while inflation rates have been high in 12 months for products originating in raw materials and commodities. Ironically, unconventional monetary policy of zero interest rates and quantitative easing that intended to increase aggregate demand and GDP growth deteriorated the terms of trade of advanced economies with adverse effects on real income. There are now inflation effects of the intentional policy of devaluing the yen.

Table IIB-3, Japan, Corporate Goods Prices and Selected Components, % Weights, Month and 12 Months ∆%

Aug 2013	Weight	Month ∆%	12 Month ∆%
Total	1000.0	0.3	2.3
Food, Beverages, Tobacco, Feedstuffs	137.5	-0.1	1.4
Petroleum & Coal	57.4	0.2	11.9
Production Machinery	30.8	0.0	0.1
Electronic Components	31.0	-0.2	-1.6
Electric Power, Gas & Water	52.7	1.2	9.9
Iron & Steel	56.6	0.3	0.1
Chemicals	92.1	0.2	4.9
Transport Equipment	136.4	0.0	-1.2

Source: Bank of Japan http://www.boj.or.jp/en/

Percentage point contributions to change of the corporate goods price index (CGPI) in Sep 2013 are provided in Table IIB-4 divided into domestic, export and import segments. In the domestic CGPI, increasing 0.3 percent in Sep 2013, the energy shock is evident in the contribution of 0.08 percentage points by electric power, gas and water in new carry trades of exposures in commodity futures. The exports CGPI changed 0.0 percent on the basis of the contract currency with deduction of 0.06 percentage points by electric and electronic products. The imports CGPI increased 1.2 percent on the contract currency basis. Petroleum, coal and natural gas contributed 1.06 percentage points. Shocks of risk aversion cause unwinding carry trades that result in declining commodity prices with resulting downward pressure on price indexes. The volatility of inflation adversely affects financial and economic decisions worldwide.

Table IIB-4, Japan, Percentage Point Contributions to Change of Corporate Goods Price Index

Groups Sep 2013	Contribution to Change Percentage Points
A. Domestic Corporate Goods Price Index	Monthly Change:  0.3%
Electric Power, Gas & Water	0.08
Agriculture, Forestry & Fishery Products	0.04
Scrap & Waste	0.03
Nonferrous Metals	0.02
Chemicals & Related Products	0.02
Iron & Steel	0.02
Food, Beverages, Tobacco & Feedstuffs	-0.01
Electronic Components & Devices	-0.01
B. Export Price Index	Monthly Change:  0.0 % contract currency
Metals & Related Products	0.14
Chemicals & Related Products	0.05
Transportation Equipment	-0.06
Electric & Electronic Products	-0.06
C. Import Price Index	Monthly Change: 1.2 % contract currency basis
Petroleum, Coal & Natural Gas	1.06
Metals & Related Products	0.10
Chemicals & Related Products	0.06
Textiles	0.03
Foodstuffs & Feedstuffs	-0.10

Source: Bank of Japan

http://www.boj.or.jp/en/statistics/pi/cgpi_release/cgpi1309.pdf

http://www.boj.or.jp/en/

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

There are two categories of responses in the Empire State Manufacturing Survey of the Federal Reserve Bank of New York (http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html): current conditions and expectations for the next six months. There are responses in the survey for two types of prices: prices received or inputs of production and prices paid or sales prices of products. Table IIB-5 provides indexes for the two categories and within them for the two types of prices from Jan 2011 to Oct 2013. The index of current prices paid or costs of inputs increased from 16.13 in Dec 2012 to 21.69 in Oct 2013 while the index of current prices received or sales prices increased from 1.08 in Dec 2012 to 2.41 in Oct 2013. The index of future prices paid or expectations of costs of inputs in the next six months fell from 51.61 in Dec 2012 to 45.78 in Oct 2013 while the index of future prices received or expectation of sales prices in the next six months fell from 25.81 in Dec 2012 to 25.30 in Oct 2013. Prices of sales of finished products are less dynamic than prices of costs of inputs during waves of increases. Prices of costs of costs of inputs fall less rapidly than prices of sales of finished products during waves of price decreases. As a result, margins of prices of sales less costs of inputs oscillate with typical deterioration against producers, forcing companies to manage tightly costs and labor inputs.

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

	Current Prices Paid	Current Prices Received	Six Months Prices Paid	Six Months Prices Received
Oct 2013	21.69	2.41	45.78	25.30
Sep	21.51	8.6	39.78	24.73
Aug	20.48	3.61	40.96	19.28
Jul	17.39	1.09	28.26	11.96
Jun	20.97	11.29	45.16	17.74
May	20.45	4.55	29.55	14.77
Apr	28.41	5.68	44.32	14.77
Mar	25.81	2.15	50.54	23.66
Feb	26.26	8.08	44.44	13.13
Jan	22.58	10.75	38.71	21.51
Dec 2012	16.13	1.08	51.61	25.81
Nov	14.61	5.62	39.33	15.73
Oct	17.20	4.30	44.09	24.73
Sep	19.15	5.32	40.43	23.40
Aug	16.47	2.35	31.76	14.12
Jul	7.41	3.70	35.80	16.05
Jun	19.59	1.03	34.02	17.53
May	37.35	12.05	57.83	22.89
Apr	45.78	19.28	50.60	22.89
Mar	50.62	13.58	66.67	32.10
Feb	25.88	15.29	62.35	34.12
Jan	26.37	23.08	53.85	30.77
Dec 2011	24.42	3.49	56.98	36.05
Nov	18.29	6.10	36.59	25.61
Oct	22.47	4.49	40.45	17.98
Sep	32.61	8.70	53.26	22.83
Aug	28.26	2.17	42.39	15.22
Jul	43.33	5.56	51.11	30.00
Jun	56.12	11.22	55.10	19.39
May	69.89	27.96	68.82	35.48
Apr	57.69	26.92	56.41	38.46
Mar	53.25	20.78	71.43	36.36
Feb	45.78	16.87	55.42	27.71
Jan	35.79	15.79	60.00	42.11

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

Price indexes of the Federal Reserve Bank of Philadelphia Outlook Survey are provided in Table IIB-6. As inflation waves throughout the world (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html), indexes of both current and expectations of future prices paid and received were quite high until May 2011. Prices paid, or inputs, were more dynamic, reflecting carry trades from zero interest rates to commodity futures. All indexes softened after May 2011 with even decline of prices received in Aug 2011 during the first round of risk aversion. Current and future price indexes have increased again but not back to the levels in the beginning of 2011 because of risk aversion frustrating carry trades even under zero interest rates. The index of prices paid or prices of inputs decreased from 23.5 in Dec 2012 to 21.7 in Oct 2013. The index of current prices received was minus 3.3 in May 2013, indicating decrease of prices received. The index of current prices received increased from 12.4 in Dec 2012 to 14.2 in Oct 2013. The index of future prices paid fell to 46.1 in Oct 2013 from 45.8 in Dec 2012, indicating expectation of lower pressure of increases of input prices, while the index of future prices received increased from 25.6 in Dec 2012 to 35.6 in Oct 2013. Expectations are incorporating faster increases in prices of inputs or costs of production than of sales of produced goods, forcing companies to manage tightly costs and labor inputs.

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

	Current Prices Paid	Current Prices Received	Future Prices Paid	Future Prices Received
10-Dec	44.3	6.6	59.6	25.3
11-Jan	48.9	11.9	58.3	34.4
11-Feb	58.9	13.1	62.1	33.3
11-Mar	57.5	16.8	60.2	31.8
11-Apr	49.4	19.8	54.2	32.4
11-May	47.7	18.5	52.7	27.6
11-Jun	38.9	8.1	38.3	6.8
11-Jul	35.6	6	49.6	16.7
11-Aug	23.3	-4.7	44.3	22.7
11-Sep	31.6	7.6	41.8	21.8
11-Oct	25.4	4.1	44.5	28.4
11-Nov	26.3	7.6	39	29.1
11-Dec	27.5	8.2	46.7	23.5
12-Jan	27.1	7.9	47.2	21.9
12-Feb	30.2	9.7	43.5	28.6
12-Mar	14.3	5.4	35.9	22
12-Apr	16	5.3	33.3	18.6
12-May	5.4	-2.2	37.2	8.3
12-Jun	5.4	-3.4	29.6	16.6
12-Jul	10.3	4.2	29.3	19.6
12-Aug	15.7	4.7	38	23.9
12-Sep	15.4	4	42.8	27.4
12-Oct	20.6	8.4	48.1	16.1
12-Nov	27.9	7.5	50.7	14
12-Dec	23.5	12.4	45.8	25.6
13-Jan	14.7	-1.1	34.3	21.7
13-Feb	8.9	-0.5	26.4	25.4
13-Mar	8.5	-0.8	30.9	16.6
13-Apr	3.1	-7.5	26.6	8.3
13-May	6.9	-3.3	30.7	18.2
13-Jun	22.5	14.6	26.4	23.5
13-Jul	21.5	7	42.1	23.9
13-Aug	17.3	9.9	38.7	23
13-Sep	25.3	12.7	43.1	31.7
13-Oct	21.7	14.2	46.1	35.6

Source: Federal Reserve Bank of Philadelphia

http://philadelphiafed.org/index.cfm

Chart IIB-5 of the Business Outlook Survey of the Federal Reserve Bank of Philadelphia Outlook Survey provides the diffusion index of current prices paid or prices of inputs from 2006 to 2013. Recession dates are in shaded areas. In the middle of deep global contraction after IVQ2007, input prices continued to increase in speculative carry trades from central bank policy rates falling toward zero into commodities futures. The index peaked above 70 in the second half of 2008. Inflation of inputs moderated significantly during the shock of risk aversion in late 2008, even falling briefly into contraction territory below zero during several months in 2009 in the flight away from risk financial assets into US government securities (Cochrane and Zingales 2009) that unwound carry trades. Return of risk appetite induced carry trade with significant increase until return of risk aversion in the first round of the European sovereign debt crisis in Apr 2010. Carry trades returned during risk appetite in expectation that the European sovereign debt crisis was resolved. The various inflation waves originating in carry trades induced by zero interest rates with alternating episodes of risk aversion are mirrored in the prices of inputs after 2011, in particular after Aug 2012 with the announcement of the Outright Monetary Transactions Program of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). Subsequent risk aversion and flows of capital away from commodities into stocks and high-yield bonds caused sharp decline in the index of prices paid followed by another recent rebound with marginal decline.

Chart IIB-5, Federal Reserve Bank of Philadelphia Business Outlook Survey Current Prices Paid Diffusion Index SA

Source: Federal Reserve Bank of Philadelphia

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

Chart IIB-6 of the Federal Reserve Bank of Philadelphia Outlook Survey provides the diffusion index of current prices received from 2006 to 2013. The significant difference between the index of current prices paid in Chart IIB-5 and the index of current prices received in Chart IIB-6 is that increases in prices paid are significantly sharper than increases in prices received. There were several periods of negative readings of prices received from 2010 to 2013 but none of prices paid. Prices paid relative to prices received deteriorate most of the time largely because of the carry trades from zero interest rates to commodity futures. Profit margins of business are compressed intermittently by fluctuations of commodity prices induced by unconventional monetary policy of zero interest rates, frustrating production, investment and hiring decisions of business, which is precisely the opposite outcome desired by unconventional monetary policy.

Chart IIB-6, Federal Reserve Bank of Philadelphia Business Outlook Survey Current Prices Received Diffusion Index SA

Source: Federal Reserve Bank of Philadelphia

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

III World Financial Turbulence. Financial markets are being shocked by multiple factors including:

(1) World economic slowdown

(2) Slowing growth in China with political development and slowing growth in Japan and world trade

(3) Slow growth propelled by savings/investment reduction in the US with high unemployment/underemployment, falling wages, hiring collapse, contraction of real private fixed investment, decline of wealth of households over the business cycle by 0.9 percent adjusted for inflation while growing 651.8 percent adjusted for inflation from IVQ1945 to IVQ2012 and unsustainable fiscal deficit/debt threatening prosperity that can cause risk premium on Treasury debt with Himalayan interest rate hikes

(4) Outcome of the sovereign debt crisis in Europe.

This section provides current data and analysis. Subsection IIIA Financial Risks provides analysis of the evolution of valuations of risk financial assets during the week. There are various appendixes for convenience of reference of material related to the debt crisis of the euro area. Some of this material is updated in Subsection IIIA when new data are available and then maintained in the appendixes for future reference until updated again in Subsection IIIA. Subsection IIIB Appendix on Safe Haven Currencies discusses arguments and measures of currency intervention and is available in the Appendixes section at the end of the blog comment. Subsection IIIC Appendix on Fiscal Compact provides analysis of the restructuring of the fiscal affairs of the European Union in the agreement of European leaders reached on Dec 9, 2011 and is available in the Appendixes section at the end of the blog comment. Subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort considers the policies of the European Central Bank and is available in the Appendixes section at the end of the blog comment. Appendix IIIE Euro Zone Survival Risk analyzes the threats to survival of the European Monetary Union and is available following Subsection IIIA. Subsection IIIF Appendix on Sovereign Bond Valuation provides more technical analysis and is available following Subsection IIIA. Subsection IIIG Appendix on Deficit Financing of Growth and the Debt Crisis provides analysis of proposals to finance growth with budget deficits together with experience of the economic history of Brazil and is available in the Appendixes section at the end of the blog comment.

IIIA Financial Risks. Financial turbulence, attaining unusual magnitude in recent months, characterized the expansion from the global recession since IIIQ2009. Table III-1, updated with every comment in this blog, provides beginning values on Fri Oct 11 and daily values throughout the week ending on Oct 18, 2013 of various financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Oct 11 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Oct 11, 2013”, first row “USD/EUR 1.3543 0.1% -0.2 %,” provides the information that the US dollar (USD) appreciated 0.1 percent to USD 1.3543/EUR in the week ending on Fri Oct 11 relative to the exchange rate on Fri Oct 4 and depreciated 0.2 percent relative to Thu Oct 10. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing waves of inflation. An important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9 (European Council 2911Dec9), which is analyzed in IIIC Appendix on Fiscal Compact. European leaders reached a new agreement on Jan 30 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/127631.pdf) and another agreement on Jun 29, 2012 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf). The most important source of financial turbulence is shifting toward increasing interest rates. The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.3543/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Oct 11, depreciating to USD 1.3561/EUR on Mon Oct 14, 2013, or by 0.1 percent. The dollar depreciated because more dollars, $1.3561, were required on Mon Oct 14 to buy one euro than $1.3543 on Fri Oct 11. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.3543/EUR on Oct 11. The second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Oct 11, to the last business day of the current week, in this case Fri Oct 18, such as depreciation of 1.1 percent to USD 1.3686/EUR by Oct 18. The third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (denoted by negative sign) by 1.1 percent from the rate of USD 1.3543/EUR on Fri Oct 11 to the rate of USD 1.3686/EUR on Fri Oct 18 {[(1.3686/1.3543) – 1]100 = 1.1%}. The dollar depreciated (denoted by negative sign) by 0.1 percent from the rate of USD 1.3676 on Thu Oct 17 to USD 1.3686/EUR on Fri Oct 18 {[(1.3686/1.3676) -1]100 = 0.1%}. Other factors constant, appreciation of the dollar relative to the euro is caused by increasing risk aversion, with rising uncertainty on European sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from higher yielding risk assets to the safety of dollar-denominated assets during risk aversion and return to higher yielding risk assets during risk appetite.

Table III-I, Weekly Financial Risk Assets Oct 14 to Oct 18, 2013

Fri Oct 11	Mon 14	Tue 15	Wed 16	Thu 17	Fri 18
USD/ EUR 1.3543 0.1% -0.2%	1.3561 -0.1% -0.1%	1.3524 0.1% 0.3%	1.3533 0.1% -0.1%	1.3676 -1.0% -1.1%	1.3686 -1.1% -0.1%
JPY/ USD 98.58 -1.1% -0.4%	98.58 0.0% 0.0%	98.17 0.4% 0.4%	98.76 -0.2% -0.6%	97.91 0.7% 0.9%	97.77 0.8% 0.1%
CHF/ USD 0.9118 -0.5% 0.0%	0.9104 0.2% 0.2%	0.9125 -0.1% -0.2%	0.9134 -0.2% -0.1%	0.9024 1.0% 1.2%	0.9019 1.1% 0.1%
CHF/ EUR 1.2350 -0.4% -0.2%	1.2346 0.0% 0.0%	1.2344 0.0% 0.0%	1.2359 -0.1% -0.1%	1.2340 0.1% 0.2%	1.2343 0.1% 0.0%
USD/ AUD 0.9469 1.0561 0.4% 0.2%	0.9489 1.0538 0.2% 0.2%	0.9526 1.0498 0.6% 0.4%	0.9552 1.0469 0.9% 0.3%	0.9636 1.0378 1.7% 0.9%	0.9677 1.0334 2.1% 0.4%
10Y Note 2.688	2.684	2.725	2.669	2.595	2.588
2Y Note 0.344	0.346	0.348	0.328	0.316	0.321
German Bond 2Y 0.18 10Y 1.86	2Y 0.17 10Y 1.86	2Y 0.20 10Y 1.91	2Y 0.21 10Y 1.93	2Y 0.18 10Y 1.87	2Y 0.17 10Y 1.83
DJIA 15237.11 1.1% 0.7%	15301.26 0.4% 0.4%	15168.01 -0.5% -0.9%	15373.83 0.9% 1.4%	15371.65 0.9% 0.0%	15399.65 1.1% 0.2%
DJ Global 2350.14 0.9% 0.7%	2360.08 0.4% 0.4%	2359.66 0.4% 0.0%	2375.85 1.1% 0.7%	2396.40 2.0% 0.9%	2408.38 2.5% 0.5%
DJ Asia Pacific 1442.43 1.2% 1.2%	1441.40 -0.1% -0.1%	1445.67 0.2% 0.3%	1442.02 0.0% -0.3%	1458.95 1.1% 1.2%	1467.85 1.8% 0.6%
Nikkei 14404.74 2.7% 1.5%	14404.74 0.0% 0.0%	14441.54 0.3% 0.3%	14467.14 0.4% 0.2%	14586.51 1.3% 0.8%	14561.54 1.1% -0.2%
Shanghai 2228.15 2.5% 1.7%	2237.77 0.4% 0.4%	2233.41 0.2% -0.2%	2193.07 -1.6% -1.8%	2188.54 -1.8% -0.2%	2193.78 -1.5% 0.2%
DAX 8724.83 1.2% 0.5%	8723.81 0.0% 0.0%	8804.44 0.9% 0.9%	8846.00 1.4% 0.5%	8811.98 1.0% -0.4%	8865.10 1.6% 0.6%
DJ UBS Comm. 127.78 0.4% -0.3%	128.32 0.4% 0.4%	127.76 0.0% -0.4%	128.25 0.4% 0.4%	128.19 0.3% 0.0%	128.69 0.7% 0.4%
WTI $/B 101.78 -1.8% -1.1%	102.21 0.4% 0.4%	101.10 -0.7% -1.1%	102.25 0.5% 1.1%	100.67 -1.1% -1.5%	100.81 -0.9% 0.1%
Brent $/B 111.02 1.6% -0.8%	110.89 -0.1% -0.1%	109.70 -1.2% -1.1%	110.86 -0.1% 1.1%	108.98 -1.8% -1.7%	109.97 -0.9% 0.9%
Gold $/OZ 1272.2 -2.9% -1.1%	1272.0 0.0% 0.0%	1280.7 0.7% 0.7%	1280.0 0.6% -0.1%	1319.2 3.7% 3.1%	1314.6 3.3% -0.3%

Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss

Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce

Sources: http://www.bloomberg.com/markets/

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

There is initial discussion of current and recent risk-determining events followed below by analysis of risk-measuring yields of the US and Germany and the USD/EUR rate.

First, risk determining events. Prior risk determining events are in an appendix below following Table III-1A. Current focus is on “tapering” quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Market are overreacting to the so-called “tapering” of outright purchases of $85 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight. 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).

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

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

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

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

The President of the European Central Bank (ECB) Mario Draghi explained the indefinite period of low policy rates during the press conference following the meeting on Jul 4, 2013 (http://www.ecb.int/press/pressconf/2013/html/is130704.en.html):

“Yes, that is why I said you haven’t listened carefully. The Governing Council has taken the unprecedented step of giving forward guidance in a rather more specific way than it ever has done in the past. In my statement, I said “The Governing Council expects the key…” – i.e. all interest rates – “…ECB interest rates to remain at present or lower levels for an extended period of time.” It is the first time that the Governing Council has said something like this. And, by the way, what Mark Carney [Governor of the Bank of England] said in London is just a coincidence.”

The statement of the meeting of the Monetary Policy Committee of the Bank of England on Jul 4, 2013, may be leading toward the same forward guidance (http://www.bankofengland.co.uk/publications/Pages/news/2013/007.aspx):

“At its meeting today, the Committee noted that the incoming data over the past couple of months had been broadly consistent with the central outlook for output growth and inflation contained in the May Report.  The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.”

A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html). Matt Jarzemsky, writing on Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 15,399.65 on Fri Oct 18, 2013, which is higher by 8.7 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 8.5 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs.

The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.

In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows.

Second, Risk-Measuring Yields and Exchange Rate. The ten-year government bond of Spain was quoted at 6.868 percent on Aug 10, 2012, declining to 6.447 percent on Aug 17 and 6.403 percent on Aug 24, 2012, and the ten-year government bond of Italy fell from 5.894 percent on Aug 10, 2012 to 5.709 percent on Aug 17 and 5.618 percent on Aug 24, 2012. The yield of the ten-year sovereign bond of Spain traded at 4.271 percent on Oct 18, 2013, and that of the ten-year sovereign bond of Italy at 4.166 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Diminishing aversion is captured by increase of the yield of the two- and ten-year Treasury notes and the two- and ten-year government bonds of Germany. Table III-1A provides yields of US and German governments bonds and the rate of USD/EUR. Yields of US and German government bonds decline during shocks of risk aversion and the dollar strengthens in the form of fewer dollars required to buy one euro. The yield of the US ten-year Treasury note fell from 2.202 percent on Aug 26, 2011 to 1.459 percent on Jul 20, 2012, reminiscent of experience during the Treasury-Fed accord of the 1940s that placed a ceiling on long-term Treasury debt (Hetzel and Leach 2001), while the yield of the ten-year government bond of Germany fell from 2.16 percent to 1.17 percent. In the week of Oct 18, 2013, the yield of the two-year Treasury decreased to 0.321 percent and that of the ten-year Treasury decreased to 2.588 percent while the two-year bond of Germany decreased to 0.17 percent and the ten-year decreased to 1.83 percent; and the dollar depreciated to USD 1.3686/EUR. The zero interest rates for the monetary policy rate of the US, or fed funds rate, induce carry trades that ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield of 2.743 is higher than consumer price inflation of 1.5 percent in the 12 months ending in Aug 2013 (http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/duration-dumping-and-peaking-valuations_18.html) and the expectation of higher inflation if risk aversion diminishes. The one-year Treasury yield of 0.102 percent is well below the 12-month consumer price inflation of 1.5 percent. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table III-1A provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.

Table III-1A, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate

	US 2Y	US 10Y	DE 2Y	DE 10Y	USD/ EUR
10/20/13	0.321	2.588	0.17	1.83	1.3686
10/11/13	0.344	2.688	0.18	1.86	1.3543
10/4/13	0.335	2.645	0.17	1.84	1.3557
9/27/13	0.335	2.626	0.16	1.78	1.3523
9/20/13	0.333	2.734	0.21	1.94	1.3526
9/13/13	0.433	2.890	0.22	1.97	1.3297
9/6/13	0.461	2.941	0.26	1.95	1.3179
8/23/13	0.401	2.784	0.23	1.85	1.3221
8/23/13	0.374	2.818	0.28	1.93	1.3380
8/16/13	0.341	2.829	0.22	1.88	1.3328
8/9/13	0.30	2.579	0.16	1.68	1.3342
8/2/13	0.299	2.597	0.15	1.65	1.3281
7/26/13	0.315	2.565	0.15	1.66	1.3279
7/19/13	0.300	2.480	0.08	1.52	1.3141
7/12/13	0.345	2.585	0.10	1.56	1.3068
7/5/13	0.397	2.734	0.11	1.72	1.2832
6/28/13	0.357	2.486	0.19	1.73	1.3010
6/21/13	0.366	2.542	0.26	1.72	1.3122
6/14/13	0.276	2.125	0.12	1.51	1.3345
6/7/13	0.304	2.174	0.18	1.54	1.3219
5/31/13	0.299	2.132	0.06	1.50	1.2996
5/24/13	0.249	2.009	0.00	1.43	1.2932
5/17/13	0.248	1.952	-0.03	1.32	1.2837
5/10/13	0.239	1.896	0.05	1.38	1.2992
5/3/13	0.22	1.742	0.00	1.24	1.3115
4/26/13	0.209	1.663	0.00	1.21	1.3028
4/19/13	0.232	1.702	0.02	1.25	1.3052
4/12/13	0.228	1.719	0.02	1.26	1.3111
4/5/13	0.228	1.706	0.01	1.21	1.2995
3/29/13	0.244	1.847	-0.02	1.29	1.2818
3/22/13	0.242	1.931	0.03	1.38	1.2988
3/15/13	0.246	1.992	0.05	1.46	1.3076
3/8/13	0.256	2.056	0.09	1.53	1.3003
3/1/13	0.236	1.842	0.03	1.41	1.3020
2/22/13	0.252	1.967	0.13	1.57	1.3190
2/15/13	0.268	2.007	0.19	1.65	1.3362
2/8/13	0.252	1.949	0.18	1.61	1.3365
2/1/13	0.26	2.024	0.25	1.67	1.3642
1/25/13	0.278	1.947	0.26	1.64	1.3459
1/18/13	0.252	1.84	0.18	1.56	1.3321
1/11/13	0.247	1.862	0.13	1.58	1.3343
1/4/13	0.262	1.898	0.08	1.54	1.3069
12/28/12	0.252	1.699	-0.01	1.31	1.3218
12/21/12	0.272	1.77	-0.01	1.38	1.3189
12/14/12	0.232	1.704	-0.04	1.35	1.3162
12/7/12	0.256	1.625	-0.08	1.30	1.2926
11/30/12	0.248	1.612	0.01	1.39	1.2987
11/23/12	0.273	1.691	0.00	1.44	1.2975
11/16/12	0.24	1.584	-0.03	1.33	1.2743
11/9/12	0.256	1.614	-0.03	1.35	1.2711
11/2/12	0.274	1.715	0.01	1.45	1.2838
10/26/12	0.299	1.748	0.05	1.54	1.2942
10/19/12	0.296	1.766	0.11	1.59	1.3023
10/12/12	0.264	1.663	0.04	1.45	1.2953
10/5/12	0.26	1.737	0.06	1.52	1.3036
9/28/12	0.236	1.631	0.02	1.44	1.2859
9/21/12	0.26	1.753	0.04	1.60	1.2981
9/14/12	0.252	1.863	0.10	1.71	1.3130
9/7/12	0.252	1.668	0.03	1.52	1.2816
8/31/12	0.225	1.543	-0.03	1.33	1.2575
8/24/12	0.266	1.684	-0.01	1.35	1.2512
8/17/12	0.288	1.814	-0.04	1.50	1.2335
8/10/12	0.267	1.658	-0.07	1.38	1.2290
8/3/12	0.242	1.569	-0.02	1.42	1.2387
7/27/12	0.244	1.544	-0.03	1.40	1.2320
7/20/12	0.207	1.459	-0.07	1.17	1.2158
7/13/12	0.24	1.49	-0.04	1.26	1.2248
7/6/12	0.272	1.548	-0.01	1.33	1.2288
6/29/12	0.305	1.648	0.12	1.58	1.2661
6/22/12	0.309	1.676	0.14	1.58	1.2570
6/15/12	0.272	1.584	0.07	1.44	1.2640
6/8/12	0.268	1.635	0.04	1.33	1.2517
6/1/12	0.248	1.454	0.01	1.17	1.2435
5/25/12	0.291	1.738	0.05	1.37	1.2518
5/18/12	0.292	1.714	0.05	1.43	1.2780
5/11/12	0.248	1.845	0.09	1.52	1.2917
5/4/12	0.256	1.876	0.08	1.58	1.3084
4/6/12	0.31	2.058	0.14	1.74	1.3096
3/30/12	0.335	2.214	0.21	1.79	1.3340
3/2/12	0.29	1.977	0.16	1.80	1.3190
2/24/12	0.307	1.977	0.24	1.88	1.3449
1/6/12	0.256	1.957	0.17	1.85	1.2720
12/30/11	0.239	1.871	0.14	1.83	1.2944
8/26/11	0.20	2.202	0.65	2.16	1.450
8/19/11	0.192	2.066	0.65	2.11	1.4390
6/7/10	0.74	3.17	0.49	2.56	1.192
3/5/09	0.89	2.83	1.19	3.01	1.254
12/17/08	0.73	2.20	1.94	3.00	1.442
10/27/08	1.57	3.79	2.61	3.76	1.246
7/14/08	2.47	3.88	4.38	4.40	1.5914
6/26/03	1.41	3.55	NA	3.62	1.1423

Note: DE: Germany

Source:

http://www.bloomberg.com/markets/

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

Appendix: Prior Risk Determining Events. Current risk analysis concentrates on deciphering what the Federal Open Market Committee (FOMC) may decide on quantitative easing. The week of May 24 was dominated by the testimony of Chairman Bernanke to the Joint Economic Committee of the US Congress on May 22, 2013 (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm), followed by questions and answers and the release on May 22, 2013 of the minutes of the meeting of the Federal Open Market Committee (FOMC) from Apr 30 to May 1, 2013 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm). Monetary policy emphasizes communication of policy intentions to avoid that expectations reverse outcomes in reality (Kydland and Prescott 1977). Jon Hilsenrath, writing on “In bid for clarity, Fed delivers opacity,” on May 23, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath), analyzes discrepancies in communication by the Fed. The annotated chart of values of the Dow Jones Industrial Average (DJIA) during trading on May 23, 2013 provided by Hinselrath, links the prepared testimony of Chairman Bernanke at 10:AM, following questions and answers and the release of the minutes of the FOMC at 2PM. Financial markets strengthened between 10 and 10:30AM on May 23, 2013, perhaps because of the statement by Chairman Bernanke in prepared testimony (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm):

“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.”

In that testimony, Chairman Bernanke (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm) also analyzes current weakness of labor markets:

“Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down. Moreover, nearly 8 million people are working part time even though they would prefer full-time work. High rates of unemployment and underemployment are extraordinarily costly: Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers' skills and--particularly relevant during this commencement season--by preventing many young people from gaining workplace skills and experience in the first place. The loss of output and earnings associated with high unemployment also reduces government revenues and increases spending on income-support programs, thereby leading to larger budget deficits and higher levels of public debt than would otherwise occur.”

Hilsenrath (op. cit. http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath) analyzes the subsequent decline of the market from 10:30AM to 10:40AM as Chairman Bernanke responded questions with the statement that withdrawal of stimulus would be determined by data but that it could begin in one of the “next few meetings.” The DJIA recovered part of the losses between 10:40AM and 2PM. The minutes of the FOMC released at 2PM on May 23, 2013, contained a phrase that troubled market participants (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm): “A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.” The DJIA closed at 15,387.58 on May 21, 2013 and fell to 15,307.17 at the close on May 22, 2013, with the loss of 0.5 percent occurring after release of the minutes of the FOMC at 2PM when the DJIA stood at around 15,400. The concern about exist of the Fed from stimulus affected markets worldwide as shown in declines of equity indexes in Table III-1 with delays because of differences in trading hours. This behavior shows the trap of unconventional monetary policy with no exit from zero interest rates without risking financial crash and likely adverse repercussions on economic activity.

Financial markets worldwide were affected by the reduction of policy rates of the European Central Bank (ECB) on May 2, 2013. (http://www.ecb.int/press/pr/date/2013/html/pr130502.en.html):

“2 May 2013 - Monetary policy decisions

At today’s meeting, which was held in Bratislava, the Governing Council of the ECB took the following monetary policy decisions:

1. The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.50%, starting from the operation to be settled on 8 May 2013.
2. The interest rate on the marginal lending facility will be decreased by 50 basis points to 1.00%, with effect from 8 May 2013.
3. The interest rate on the deposit facility will remain unchanged at 0.00%.”

Financial markets in Japan and worldwide were shocked by new bold measures of “quantitative and qualitative monetary easing” by the Bank of Japan (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The objective of policy is to “achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The main elements of the new policy are as follows:

1. Monetary Base Control. Most central banks in the world pursue interest rates instead of monetary aggregates, injecting bank reserves to lower interest rates to desired levels. The Bank of Japan (BOJ) has shifted back to monetary aggregates, conducting money market operations with the objective of increasing base money, or monetary liabilities of the government, at the annual rate of 60 to 70 trillion yen. The BOJ estimates base money outstanding at “138 trillion yen at end-2012) and plans to increase it to “200 trillion yen at end-2012 and 270 trillion yen at end 2014” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
2. Maturity Extension of Purchases of Japanese Government Bonds. Purchases of bonds will be extended even up to bonds with maturity of 40 years with the guideline of extending the average maturity of BOJ bond purchases from three to seven years. The BOJ estimates the current average maturity of Japanese government bonds (JGB) at around seven years. The BOJ plans to purchase about 7.5 trillion yen per month (http://www.boj.or.jp/en/announcements/release_2013/rel130404d.pdf). Takashi Nakamichi, Tatsuo Ito and Phred Dvorak, wiring on “Bank of Japan mounts bid for revival,” on Apr 4, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323646604578401633067110420.html ), find that the limit of maturities of three years on purchases of JGBs was designed to avoid views that the BOJ would finance uncontrolled government deficits.
3. Seigniorage. The BOJ is pursuing coordination with the government that will take measures to establish “sustainable fiscal structure with a view to ensuring the credibility of fiscal management” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
4. Diversification of Asset Purchases. The BOJ will engage in transactions of exchange traded funds (ETF) and real estate investment trusts (REITS) and not solely on purchases of JGBs. Purchases of ETFs will be at an annual rate of increase of one trillion yen and purchases of REITS at 30 billion yen.

The European sovereign debt crisis continues to shake financial markets and the world economy. Debt resolution within the international financial architecture requires that a country be capable of borrowing on its own from the private sector. Mechanisms of debt resolution have included participation of the private sector (PSI), or “bail in,” that has been voluntary, almost coercive, agreed and outright coercive (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Creditors and Debtors (2005), Chapter 4, 187-202). Private sector involvement requires losses by the private sector in bailouts of highly indebted countries. The essence of successful private sector involvement is to recover private-sector credit of the highly indebted country. Mary Watkins, writing on “Bank bailouts reshuffle risk hierarchy,” published on Mar 19, 2013, in the Financial Times (http://www.ft.com/intl/cms/s/0/7666546a-9095-11e2-a456-00144feabdc0.html#axzz2OSpbvCn8) analyzes the impact of the bailout or resolution of Cyprus banks on the hierarchy of risks of bank liabilities. Cyprus banks depend mostly on deposits with less reliance on debt, raising concerns in creditors of fixed-income debt and equity holders in banks in the euro area. Uncertainty remains as to the dimensions and structure of losses in private sector involvement or “bail in” in other rescue programs in the euro area. Alkman Granitsas, writing on “Central bank details losses at Bank of Cyprus,” on Mar 30, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324000704578392502889560768.html), analyzes the impact of the agreement with the €10 billion agreement with IMF and the European Union on the banks of Cyprus. The recapitalization plan provides for immediate conversion of 37.5 percent of all deposits in excess of €100,000 to shares of special class of the bank. An additional 22.5 percent will be frozen without interest until the plan is completed. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):

“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.

Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans.

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

An important risk event is the reduction of growth prospects in the euro zone discussed by European Central Bank President Mario Draghi in “Introductory statement to the press conference,” on Dec 6, 2012 (http://www.ecb.int/press/pressconf/2012/html/is121206.en.html):

“This assessment is reflected in the December 2012 Eurosystem staff macroeconomic projections for the euro area, which foresee annual real GDP growth in a range between -0.6% and -0.4% for 2012, between -0.9% and 0.3% for 2013 and between 0.2% and 2.2% for 2014. Compared with the September 2012 ECB staff macroeconomic projections, the ranges for 2012 and 2013 have been revised downwards.

The Governing Council continues to see downside risks to the economic outlook for the euro area. These are mainly related to uncertainties about the resolution of sovereign debt and governance issues in the euro area, geopolitical issues and fiscal policy decisions in the United States possibly dampening sentiment for longer than currently assumed and delaying further the recovery of private investment, employment and consumption.”

Reuters, writing on “Bundesbank cuts German growth forecast,” on Dec 7, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/8e845114-4045-11e2-8f90-00144feabdc0.html#axzz2EMQxzs3u), informs that the central bank of Germany, Deutsche Bundesbank reduced its forecast of growth for the economy of Germany to 0.7 percent in 2012 from an earlier forecast of 1.0 percent in Jun and to 0.4 percent in 2012 from an earlier forecast of 1.6 percent while the forecast for 2014 is at 1.9 percent.

The major risk event during earlier weeks was sharp decline of sovereign yields with the yield on the ten-year bond of Spain falling to 5.309 percent and that of the ten-year bond of Italy falling to 4.473 percent on Fri Nov 30, 2012 and 5.366 percent for the ten-year of Spain and 4.527 percent for the ten-year of Italy on Fri Nov 14, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Vanessa Mock and Frances Robinson, writing on “EU approves Spanish bank’s restructuring plans,” on Nov 28, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578146520774638316.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the European Union regulators approved restructuring of four Spanish banks (Bankia, NCG Banco, Catalunya Banc and Banco de Valencia), which helped to calm sovereign debt markets. Harriet Torry and James Angelo, writing on “Germany approves Greek aid,” on Nov 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578150532603095790.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the German parliament approved the plan to provide Greece a tranche of €44 billion in promised financial support, which is subject to sustainability analysis of the bond repurchase program later in Dec 2012. A hurdle for sustainability of repurchasing debt is that Greece’s sovereign bonds have appreciated significantly from around 24 percent for the bond maturing in 21 years and 20 percent for the bond maturing in 31 years in Aug 2012 to around 17 percent for the 21-year maturity and 15 percent for the 31-year maturing in Nov 2012. Declining years are equivalent to increasing prices, making the repurchase more expensive. Debt repurchase is intended to reduce bonds in circulation, turning Greek debt more manageable. Ben McLannahan, writing on “Japan unveils $11bn stimulus package,” on Nov 30, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/adc0569a-3aa5-11e2-baac-00144feabdc0.html#axzz2DibFFquN), informs that the cabinet in Japan approved another stimulus program of $11 billion, which is twice larger than another stimulus plan in late Oct and close to elections in Dec. Henry Sender, writing on “Tokyo faces weak yen and high bond yields,” published on Nov 29, 2012 in the Financial Times (http://www.ft.com/intl/cms/s/0/9a7178d0-393d-11e2-afa8-00144feabdc0.html#axzz2DibFFquN), analyzes concerns of regulators on duration of bond holdings in an environment of likelihood of increasing yields and yen depreciation.

First, Risk-Determining Events. The European Council statement on Nov 23, 2012 asked the President of the European Commission “to continue the work and pursue consultations in the coming weeks to find a consensus among the 27 over the Union’s Multiannual Financial Framework for the period 2014-2020” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf) Discussions will continue in the effort to reach agreement on a budget: “A European budget is important for the cohesion of the Union and for jobs and growth in all our countries” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf). There is disagreement between the group of countries requiring financial assistance and those providing bailout funds. Gabrielle Steinhauser and Costas Paris, writing on “Greek bond rally puts buyback in doubt,” on Nov 23, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324352004578136362599130992.html?mg=reno64-wsj) find a new hurdle in rising prices of Greek sovereign debt that may make more difficult buybacks of debt held by investors. European finance ministers continue their efforts to reach an agreement for Greece that meets with approval of the European Central Bank and the IMF. The European Council (2012Oct19 http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/133004.pdf ) reached conclusions on strengthening the euro area and providing unified financial supervision:

“The European Council called for work to proceed on the proposals on the Single Supervisory Mechanism as a matter of priority with the objective of agreeing on the legislative framework by 1st January 2013 and agreed on a number of orientations to that end. It also took note of issues relating to the integrated budgetary and economic policy frameworks and democratic legitimacy and accountability which should be further explored. It agreed that the process towards deeper economic and monetary union should build on the EU's institutional and legal framework and be characterised by openness and transparency towards non-euro area Member States and respect for the integrity of the Single Market. It looked forward to a specific and time-bound roadmap to be presented at its December 2012 meeting, so that it can move ahead on all essential building blocks on which a genuine EMU should be based.”

Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. The Bank of Spain released new data on doubtful debtors in Spain’s credit institutions (http://www.bde.es/bde/en/secciones/prensa/Agenda/Datos_de_credit_a6cd708c59cf931.html). In 2006, the value of doubtful credits reached €10,859 million or 0.7 percent of total credit of €1,508,626 million. In Aug 2012, doubtful credit reached €178,579 million or 10.5 percent of total credit of €1,698,714 million.

There are three critical factors influencing world financial markets. (1) Spain could request formal bailout from the European Stability Mechanism (ESM) that may also affect Italy’s international borrowing. David Roman and Jonathan House, writing on “Spain risks backlash with budget plan,” on Sep 27, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443916104578021692765950384.html?mod=WSJ_hp_LEFTWhatsNewsCollection) analyze Spain’s proposal of reducing government expenditures by €13 billion, or around $16.7 billion, increasing taxes in 2013, establishing limits on early retirement and cutting the deficit by €65 billion through 2014. Banco de España, Bank of Spain, contracted consulting company Oliver Wyman to conduct rigorous stress tests of the resilience of its banking system. (Stress tests and their use are analyzed by Pelaez and Pelaez Globalization and the State Vol. I (2008b), 95-100, International Financial Architecture (2005) 112-6, 123-4, 130-3).) The results are available from Banco de España (http://www.bde.es/bde/en/secciones/prensa/infointeres/reestructuracion/ http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). The assumptions of the adverse scenario used by Oliver Wyman are quite tough for the three-year period from 2012 to 2014: “6.5 percent cumulative decline of GDP, unemployment rising to 27.2 percent and further declines of 25 percent of house prices and 60 percent of land prices (http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). Fourteen banks were stress tested with capital needs estimates of seven banks totaling €59.3 billion. The three largest banks of Spain, Banco Santander (http://www.santander.com/csgs/Satellite/CFWCSancomQP01/es_ES/Corporativo.html), BBVA (http://www.bbva.com/TLBB/tlbb/jsp/ing/home/index.jsp) and Caixabank (http://www.caixabank.com/index_en.html), with 43 percent of exposure under analysis, have excess capital of €37 billion in the adverse scenario in contradiction with theories that large, international banks are necessarily riskier. Jonathan House, writing on “Spain expects wider deficit on bank aid,” on Sep 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444138104578028484168511130.html?mod=WSJPRO_hpp_LEFTTopStories), analyzes the 2013 budget plan of Spain that will increase the deficit of 7.4 percent of GDP in 2012, which is above the target of 6.3 percent under commitment with the European Union. The ratio of debt to GDP will increase to 85.3 percent in 2012 and 90.5 percent in 2013 while the 27 members of the European Union have an average debt/GDP ratio of 83 percent at the end of IIQ2012. (2) Symmetric inflation targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even after the economy grows again at or close to potential output. Monetary easing by unconventional measures is now apparently open ended in perpetuity as provided in the statement of the meeting of the Federal Open Market Committee (FOMC) on Sep 13, 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm):

“To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”

In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is the concern of the production and employment costs of controlling future inflation.

(2) The European Central Bank (ECB) approved a new program of bond purchases under the name “Outright Monetary Transactions” (OMT). The ECB will purchase sovereign bonds of euro zone member countries that have a program of conditionality under the European Financial Stability Facility (EFSF) that is converting into the European Stability Mechanism (ESM). These programs provide enhancing the solvency of member countries in a transition period of structural reforms and fiscal adjustment. The purchase of bonds by the ECB would maintain debt costs of sovereigns at sufficiently low levels to permit adjustment under the EFSF/ESM programs. Purchases of bonds are not limited quantitatively with discretion by the ECB as to how much is necessary to support countries with adjustment programs. Another feature of the OMT of the ECB is sterilization of bond purchases: funds injected to pay for the bonds would be withdrawn or sterilized by ECB transactions. The statement by the European Central Bank on the program of OTM is as follows (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html):

“6 September 2012 - Technical features of Outright Monetary Transactions

As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) has today taken decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets that aim at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy. These will be known as Outright Monetary Transactions (OMTs) and will be conducted within the following framework:

Conditionality

A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.

The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.

Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.

Coverage

Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above. They may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access.

Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.

No ex ante quantitative limits are set on the size of Outright Monetary Transactions.

Creditor treatment

The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.

Sterilisation

The liquidity created through Outright Monetary Transactions will be fully sterilised.

Transparency

Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis. Publication of the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis.

Securities Markets Programme

Following today’s decision on Outright Monetary Transactions, the Securities Markets Programme (SMP) is herewith terminated. The liquidity injected through the SMP will continue to be absorbed as in the past, and the existing securities in the SMP portfolio will be held to maturity.”

Jon Hilsenrath, writing on “Fed sets stage for stimulus,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443864204577623220212805132.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the essay presented by Chairman Bernanke at the Jackson Hole meeting of central bankers, as defending past stimulus with unconventional measures of monetary policy that could be used to reduce extremely high unemployment. Chairman Bernanke (2012JHAug31, 18-9) does support further unconventional monetary policy impulses if required by economic conditions (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm):

“Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

Professor John H Cochrane (2012Aug31), at the University of Chicago Booth School of Business, writing on “The Federal Reserve: from central bank to central planner,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444812704577609384030304936.html?mod=WSJ_hps_sections_opinion), analyzes that the departure of central banks from open market operations into purchase of assets with risks to taxpayers and direct allocation of credit subject to political influence has caused them to abandon their political independence and accountability. Cochrane (2012Aug31) finds a return to the proposition of Milton Friedman in the 1960s that central banks can cause inflation and macroeconomic instability.

Mario Draghi (2012Aug29), President of the European Central Bank, also reiterated the need of exceptional and unconventional central bank policies (http://www.ecb.int/press/key/date/2012/html/sp120829.en.html):

“Yet it should be understood that fulfilling our mandate sometimes requires us to go beyond standard monetary policy tools. When markets are fragmented or influenced by irrational fears, our monetary policy signals do not reach citizens evenly across the euro area. We have to fix such blockages to ensure a single monetary policy and therefore price stability for all euro area citizens. This may at times require exceptional measures. But this is our responsibility as the central bank of the euro area as a whole.

The ECB is not a political institution. But it is committed to its responsibilities as an institution of the European Union. As such, we never lose sight of our mission to guarantee a strong and stable currency. The banknotes that we issue bear the European flag and are a powerful symbol of European identity.”

Buiter (2011Oct31) analyzes that the European Financial Stability Fund (EFSF) would need a “bigger bazooka” to bail out euro members in difficulties that could possibly be provided by the ECB. Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. Table III-7 in IIIE Appendix Euro Zone Survival Risk below provides the combined GDP in 2012 of the highly indebted euro zone members estimated in the latest World Economic Outlook of the IMF at $4167 billion or 33.1 percent of total euro zone GDP of $12,586 billion. Using the WEO of the IMF, Table III-8 in IIIE Appendix Euro Zone Survival Risk below provides debt of the highly indebted euro zone members at $3927.8 billion in 2012 that increases to $5809.9 billion when adding Germany’s debt, corresponding to 167.0 percent of Germany’s GDP. There are additional sources of debt in bailing out banks. The dimensions of the problem may require more firepower than a bazooka perhaps that of the largest conventional bomb of all times of 44,000 pounds experimentally detonated only once by the US in 1948 (http://www.airpower.au.af.mil/airchronicles/aureview/1967/mar-apr/coker.html).

Chart III-1A of the Board of Governors of the Federal Reserve System provides the ten-year, two-year and one-month Treasury constant maturity yields together with the overnight fed funds rate, and the yield of the corporate bond with Moody’s rating of Baa. The riskier yield of the Baa corporate bond exceeds the relatively riskless yields of the Treasury securities. The beginning yields in Chart III-1A for Jan 2, 1962, are 2.75 percent for the fed fund rates and 4.06 percent for the ten-year Treasury constant maturity. On July 31, 2001, the yields in Chart III-1A are 3.67 percent for one month, 3.79 percent for two years, 5.07 percent for ten years, 3.82 percent for the fed funds rate and 7.85 percent for the Baa corporate bond. On July 30, 2007, yields inverted with the one month at 4.95 percent, the two-year at 4.59 percent and the ten year at 5.82 percent with the yield of the Baa corporate bond at 6.70 percent. Another interesting point is for Oct 31, 2008, with the yield of the Baa jumping to 9.54 percent and the Treasury yields declining: one month 0.12 percent, two years 1.56 percent and ten years 4.01 percent during a flight to the dollar and government securities analyzed by Cochrane and Zingales (2009). Another spike in the series is for Apr 4, 2006 with the yield of the corporate Baa bond at 8.63 and the Treasury yields of 0.12 percent for one month, 0.94 for two years and 2.95 percent for ten years. During the beginning of the flight from risk financial assets to US government securities (see Cochrane and Zingales 2009), the one-month yield was 0.07 percent, the two-year yield 1.64 percent and the ten-year yield 3.41. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe. The final point of Chart III1-A is for Oct 17, 2013, with the one-month yield at 0.01 percent, the two-year at 0.33 percent, the ten-year at 2.61 percent, the fed funds rate at 0.10 percent and the corporate Baa bond at 5.27 percent. There is an evident increase in the yields of the 10-year Treasury constant maturity and the Moody’s Baa corporate bond with marginal reduction.

Chart III-1A, US, Ten-Year, Two-Year and One-Month Treasury Constant Maturity Yields, Overnight Fed Funds Rate and Yield of Moody’s Baa Corporate Bond, Jan 2, 1962-Oct 17, 2013

Note: US Recessions in shaded areas

Source: Board of Governors of the Federal Reserve System

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

Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. In IQ1980, gross private domestic investment in the US was $951.6 billion of 2009 dollars, growing to $1,143.0 billion in IVQ1986 or 20.1 percent. Real gross private domestic investment in the US decreased 3.1 percent from $2,605.2 billion of 2009 dollars in IVQ2007 to $2,524.9 billion in IIQ2013. Real private fixed investment fell 4.9 percent from $2,586.3 billion of 2009 dollars in IVQ2007 to $2,458.4 billion in IIQ2013. Growth of real private investment in is mediocre for all but four quarters from IIQ2011 to IQ2012 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Corporate profits with IVA and CCA fell $26.6 billion in IQ2013 after increasing $34.9 billion in IVQ2012 and $13.9 billion in IIIQ2012. Corporate profits with IVA and CCA rebounded with $66.8 billion in IIQ2013. Profits after tax with IVA and CCA fell $1.7 billion in IQ2013 after increasing $40.8 billion in IVQ2012 and $4.5 billion in IIIQ2012. In IIQ2013, profits after tax with IVA and CCA increased $56.9 billion. Anticipation of higher taxes in the “fiscal cliff” episode caused increase of $120.9 billion in net dividends in IVQ2012 followed with adjustment in the form of decrease of net dividends by $103.8 billion in IQ2013, rebounding with $273.5 billion in IIQ2013. There is similar decrease of $80.1 billion in undistributed profits with IVA and CCA in IVQ2012 followed by increase of $102.1 billion in IQ2013 and decline of $216.6 billion in IIQ2013. Undistributed profits of US corporations swelled 263.4 percent from $107.7 billion IQ2007 to $391.4 billion in IIQ2013 and changed signs from minus $55.9 billion in billion in IVQ2007 (Section IA2). In IQ2013, corporate profits with inventory valuation and capital consumption adjustment fell $26.6 billion relative to IVQ2012, from $2047.2 billion to $2020.6 billion at the quarterly rate of minus 1.3 percent. In IIQ2013, corporate profits with IVA and CCA increased $66.8 billion from $2020.6 billion in IQ2013 to $2087.4 billion at the quarterly rate of 3.3 percent (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.pdf). Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment. The investment decision of US business is fractured. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:

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

declines.

There was stronger performance in equity indexes with several indexes in Table III-1 increasing in the week ending on Oct 18, 2013, after wide swings caused by reallocations of investment portfolios worldwide. Stagnating revenues, corporate cash hoarding and declining investment are causing reevaluation of discounted net earnings with deteriorating views on the world economy and United States fiscal sustainability but investors have been driving indexes higher. DJIA increased 0.2 percent on Oct 18, increasing 1.1 percent in the week. Germany’s Dax increased 0.5 percent on Fri Oct 11 and increased 1.2 percent in the week. Dow Global increased 0.5 percent on Oct 18 and increased 2.5 percent in the week. Japan’s Nikkei Average decreased 0.2 percent on Oct 18 and increased 1.1 percent in the week as the yen continues oscillating but relatively weaker and the stock market gains in expectations of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Dow Asia Pacific TSM increased 0.6 percent on Oct 18 and increased 1.8 percent in the week. Shanghai Composite that decreased 0.2 percent on Mar 8 and decreased 1.7 percent in the week of Mar 8, falling below 2000 to close at 1980.13 on Fri Nov 30 but closing at 2193.78 on Oct 18 for increase of 0.2 percent and decrease of 1.5 percent in the week of Oct 18. There is deceleration with oscillations of the world economy that could affect corporate revenue and equity valuations, causing fluctuations in equity markets with increases during favorable risk appetite.

Commodities were mixed in the week of Oct 18, 2013. The DJ UBS Commodities Index increased 0.4 percent on Fri Oct 18 and increased 0.7 percent in the week, as shown in Table III-1. WTI decreased 0.9 percent in the week of Oct 18 while Brent decreased 0.9 percent in the week. Gold decreased 0.3 percent on Fri Oct 18 and increased 3.3 percent in the week.

Table III-2 provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the long-term refinancing operations (LTROs). Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increased from €546,747 million on Dec 31, 2010, to €879,130 million on Dec 28, 2011 and €753,023 million on Oct 11, 2013 with some repayment of loans already occurring. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has reached €1,352,734 million in the statement of Oct 4, 2013, with marginal reduction. There is high credit risk in these transactions with capital of only €90,420 million as analyzed by Cochrane (2012Aug31).

Table III-2, Consolidated Financial Statement of the Eurosystem, Million EUR

	Dec 31, 2010	Dec 28, 2011	Oct 11, 2013
1 Gold and other Receivables	367,402	419,822	343,919
2 Claims on Non Euro Area Residents Denominated in Foreign Currency	223,995	236,826	245,653
3 Claims on Euro Area Residents Denominated in Foreign Currency	26,941	95,355	20,883
4 Claims on Non-Euro Area Residents Denominated in Euro	22,592	25,982	22,760
5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro	546,747	879,130	753,023
6 Other Claims on Euro Area Credit Institutions Denominated in Euro	45,654	94,989	76,035
7 Securities of Euro Area Residents Denominated in Euro	457,427	610,629	599,711
8 General Government Debt Denominated in Euro	34,954	33,928	28,328
9 Other Assets	278,719	336,574	250,110
TOTAL ASSETS	2,004, 432	2,733,235	2,340,421
Memo Items
Sum of 5 and  7	1,004,174	1,489,759	1,352,734
Capital and Reserves	78,143	81,481	90,420

Source: European Central Bank

http://www.ecb.int/press/pr/wfs/2011/html/fs110105.en.html

http://www.ecb.int/press/pr/wfs/2011/html/fs111228.en.html

http://www.ecb.europa.eu/press/pr/wfs/2013/html/fs131015.en.html

IIIE Appendix Euro Zone Survival Risk. Resolution of the European sovereign debt crisis with survival of the euro area would require success in the restructuring of Italy. That success would be assured with growth of the Italian economy. A critical problem is that the common euro currency prevents Italy from devaluing the exchange to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness. Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. Growth of the Italian economy would ensure that success. A critical problem is that the common euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Newly available data in Table III-3 providing Italy’s trade with regions and countries supports the argument of Caballero and Giavazzi (2012Jan15). Italy’s exports to the European Monetary Union (EMU), or euro area, are only 40.5 percent of the total in Jan-Aug 2013. Exports to the non-European Union area with share of 45.8 percent in Italy’s total exports are growing at 2.3 percent in Jan-Aug 2013 relative to Jan-Aug 2012 while those to EMU are growing at minus 3.2 percent.

Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%

Aug 2013	Exports % Share	∆% Jan-Aug 2013/ Jan-Aug 2012	Imports % Share	∆% Jan-Aug 2013/ Jan-Aug 2012
EU	54.2	-2.4	53.2	-2.5
EMU 17	40.5	-3.2	42.7	-2.7
France	11.1	-2.9	8.3	-5.9
Germany	12.5	-3.2	14.6	-6.5
Spain	4.7	-7.5	4.4	-3.4
UK	4.9	1.9	2.5	-0.9
Non EU	45.8	2.3	46.8	-10.7
Europe non EU	13.4	-1.2	11.0	5.5
USA	6.8	-1.6	3.3	-14.6
China	2.3	9.8	6.5	-10.0
OPEC	5.7	8.1	10.8	-26.3
Total	100.0	-0.3	100.0	-6.4

Notes: EU: European Union; EMU: European Monetary Union (euro zone)

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/101000

Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €589 million with the 17 countries of the euro zone (EMU 17) in Aug 2013 and cumulative deficit of €1609 million in Jan-Aug 2013. Depreciation to parity could permit greater competitiveness in improving the trade surplus of €5057 million in Jan-Aug 2013 with Europe non European Union, the trade surplus of €10,003 million with the US and trade surplus with non-European Union of €11,063 million in Jan-Aug 2013. There is significant rigidity in the trade deficits in Jan-Aug 2013 of €9127 million with China and €5475 million with members of the Organization of Petroleum Exporting Countries (OPEC). Higher exports could drive economic growth in the economy of Italy that would permit less onerous adjustment of the country’s fiscal imbalances, raising the country’s credit rating.

Table III-4, Italy, Trade Balance by Regions and Countries, Millions of Euro 

Regions and Countries	Trade Balance Aug 2013 Millions of Euro	Trade Balance Cumulative Jan-Aug 2013 Millions of Euro
EU	392	8,164
EMU 17	-589	-1,609
France	493	8,330
Germany	-245	-2,520
Spain	13	594
UK	773	6,530
Non EU	566	11,063
Europe non EU	399	5,057
USA	1,074	10,003
China	-1,062	-9,127
OPEC	-1,109	-5,475
Total	958	19,227

Notes: EU: European Union; EMU: European Monetary Union (euro zone)

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/101000

Growth rates of Italy’s trade and major products are in Table III-5 for the period Jan-Aug 2013 relative to Jan-Aug 2012. Growth rates of cumulative imports relative to a year earlier are negative for energy with minus 16.7 percent and minus 10.7 percent for durable goods. The higher rate of growth of exports of minus 0.3 percent in Jan-Aug 2013/Jan-Aug 2012 relative to imports of minus 6.4 percent may reflect weak demand in Italy with GDP declining during eight consecutive quarters from IIIQ2011 through IIQ2013 together with softening commodity prices.

Table III-5, Italy, Exports and Imports % Share of Products in Total and ∆%

	Exports Share %	Exports ∆% Jan-Aug 2013/ Jan-Aug 2012	Imports Share %	Imports ∆% Jan-Aug 2013/ Jan-Aug 2012
Consumer Goods	29.3	6.1	25.6	0.4
Durable	5.8	1.8	2.9	-10.7
Non-Durable	23.5	7.1	22.7	1.8
Capital Goods	31.6	1.1	19.5	-5.4
Inter- mediate Goods	33.6	-3.8	32.6	-5.2
Energy	5.5	-20.2	22.3	-16.7
Total ex Energy	94.5	0.8	77.7	-3.4
Total	100.0	-0.3	100.0	-6.4

Note: % Share for 2012 total trade.

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/101000

Table III-6 provides Italy’s trade balance by product categories in Aug 2013 and cumulative Jan-Aug 2013. Italy’s trade balance excluding energy generated surplus of €5355 million in Aug 2013 and €55,973 million cumulative in Jan-Aug 2013 but the energy trade balance created deficit of €4397 million in Aug 2013 and cumulative €36,746 million in Jan-Aug 2013. The overall surplus in Aug 2013 was €958 million with cumulative surplus of €19,227 million in Jan-Aug 2013. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.

Table III-6, Italy, Trade Balance by Product Categories, € Millions

	Aug 2013	Cumulative Jan-Aug 2013
Consumer Goods	1,383	14,544
Durable	769	8,467
Nondurable	614	6,077
Capital Goods	3,141	35,569
Intermediate Goods	831	5,860
Energy	-4,397	-36,746
Total ex Energy	5,355	55,973
Total	958	19,227

Source: Istituto Nazionale di Statistica http://www.istat.it/it/archivio/101000

Brazil faced in the debt crisis of 1982 a more complex policy mix. Between 1977 and 1983, Brazil’s terms of trade, export prices relative to import prices, deteriorated 47 percent and 36 percent excluding oil (Pelaez 1987, 176-79; Pelaez 1986, 37-66; see Pelaez and Pelaez, The Global Recession Risk (2007), 178-87). Brazil had accumulated unsustainable foreign debt by borrowing to finance balance of payments deficits during the 1970s. Foreign lending virtually stopped. The German mark devalued strongly relative to the dollar such that Brazil’s products lost competitiveness in Germany and in multiple markets in competition with Germany. The resolution of the crisis was devaluation of the Brazilian currency by 30 percent relative to the dollar and subsequent maintenance of parity by monthly devaluation equal to inflation and indexing that resulted in financial stability by parity in external and internal interest rates avoiding capital flight. With a combination of declining imports, domestic import substitution and export growth, Brazil followed rapid growth in the US and grew out of the crisis with surprising GDP growth of 4.5 percent in 1984.

The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the Subsection IIIF Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 30, 2011, the yield of the 2-year bond of the government of Greece was quoted around 100 percent. In contrast, the 2-year US Treasury note traded at 0.239 percent and the 10-year at 2.871 percent while the comparable 2-year government bond of Germany traded at 0.14 percent and the 10-year government bond of Germany traded at 1.83 percent. There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt exceeding 100 percent of GDP, which is the third largest in the world after the US and Japan. Appendix IIIE links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).

Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.

Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:

“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”

If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.

The prospects of survival of the euro zone are dire. Table III-7 is constructed with IMF World Economic Outlook database (http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/index.aspx) for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2013.

Table III-7, World and Selected Regional and Country GDP and Fiscal Situation

	GDP 2013 USD Billions	Primary Net Lending Borrowing % GDP 2013	General Government Net Debt % GDP 2013
World	73,454
Euro Zone	12,685	-0.4	74.9
Portugal	219	0.1	119.3
Ireland	221	-3.3	105.5
Greece	243	--	172.6
Spain	1,356	-3.7	80.7
Major Advanced Economies G7	34,068	-3.8	91.5
United States	16,724	-3.6	87.4
UK	2,490	-4.7	84.8
Germany	3,593	1.7	56.3
France	2,739	-2.0	87.2
Japan	5,007	-8.8	139.9
Canada	1,825	-2.8	36.5
Italy	2,068	2.0	110.5
China	8,939	-2.5*	22.9**

*Net Lending/borrowing**Gross Debt

Source: IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/index.aspx

The data in Table III-7 are used for some very simple calculations in Table III-8. The column “Net Debt USD Billions” in Table III-8 is generated by applying the percentage in Table III-7 column “General Government Net Debt % GDP 2013” to the column “GDP USD Billions.” The total debt of France and Germany in 2013 is $4411.3 billion, as shown in row “B+C” in column “Net Debt USD Billions” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $4293.3 billion, adding rows D+E+F+G+H in column “Net Debt USD billions.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table III-8. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $8704.6 billion, which would be equivalent to 137.5 percent of their combined GDP in 2013. Under this arrangement, the entire debt of selected members of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 242.3 percent if including debt of France and 175.8 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing

Table III-8, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %

	Net Debt USD Billions	Debt as % of Germany Plus France GDP	Debt as % of Germany GDP
A Euro Area	9,501.1
B Germany	2,022.9		$8704.6 as % of $3593 =242.3% $6316.2 as % of $3593 =175.8%
C France	2,388.4
B+C	4,411.3	GDP $6,332.0 Total Debt $8704.6 Debt/GDP: 137.5%
D Italy	2,285.1
E Spain	1,094.3
F Portugal	261.3
G Greece	419.4
H Ireland	233.2
Subtotal D+E+F+G+H	4,293.3

Source: calculation with IMF data IMF World Economic Outlook databank http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/index.aspx

There is extremely important information in Table III-9 for the current sovereign risk crisis in the euro zone. Table III-9 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Aug 2013. German exports to other European Union (EU) members are 55.2 percent of total exports in Aug 2013 and 57.0 percent in cumulative Jan-Aug 2013. Exports to the euro area are 34.2 percent in Aug and 36.8 percent cumulative in Jan-Aug. Exports to third countries are 44.8 percent of the total in Aug and 43.0 percent cumulative in Jan-Aug. There is similar distribution for imports. Exports to non-euro countries are decreasing 3.5 percent in the 12 months ending in Aug 2013, increasing 1.0 percent cumulative in Jan-Aug 2013 while exports to the euro area are decreasing 4.1 percent in the 12 months ending in Aug 2013 and decreasing 3.1 percent cumulative in Jan-Aug 2013. Exports to third countries, accounting for 44.8 percent of the total in Aug 2013, are decreasing 7.2 percent in the 12 months ending in Aug 2013 and decreasing 0.3 percent cumulative in Jan-Aug 2013, accounting for 43.0 percent of the cumulative total in Jan-Aug 2013. Price competitiveness through devaluation could improve export performance and growth. Economic performance in Germany is closely related to its high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of high share in its exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.

Table III-9, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	Aug 2013  € Billions	Aug 12-Month ∆%	Cumulative Jan-Aug 2012 € Billions	Cumulative Jan-Aug 2013/ Jan-Aug 2012 ∆%
Total Exports	85.3	-5.4	726.1	-1.1
A. EU Members	47.1 % 55.2	-3.9	414.1 % 57.0	-1.7
Euro Area	29.2 % 34.2	-4.1	267.5 % 36.8	-3.1
Non-euro Area	17.9 % 21.0	-3.5	146.6 % 20.2	1.0
B. Third Countries	38.2 % 44.8	-7.2	312.0 % 43.0	-0.3
Total Imports	72.2	-2.2	598.9	-1.4
C. EU Members	44.7 % 61.9	-0.9	385.4 % 64.4	0.0
Euro Area	30.7 % 42.3	-2.8	269.2 % 44.9	-0.8
Non-euro Area	14.1 % 19.5	3.5	116.2 % 19.4	1.8
D. Third Countries	27.5 % 38.1	-4.3	213.5 % 35.6	-3.8

Notes: Total Exports = A+B; Total Imports = C+D

Source: Statistisches Bundesamt Deutschland https://www.destatis.de/EN/PressServices/Press/pr/2013/10/PE13_333_51.html

IIIF Appendix on Sovereign Bond Valuation. There are two approaches to government finance and their implications: (1) simple unpleasant monetarist arithmetic; and (2) simple unpleasant fiscal arithmetic. Both approaches illustrate how sovereign debt can be perceived riskier under profligacy.

First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:

D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)

Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,

{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:

N(t+1) = (1+n)N(t), n>-1 (2)

The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:

B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)

On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.

Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:

(M_t + B_t)/P_t = E_t∫(1/R_{t, t+τ})s_t+τdτ (4)

Equation (4) expresses the monetary, M_t, and debt, B_t, liabilities of the government, divided by the price level, P_t, in terms of the expected value discounted by the ex-post rate on government debt, R_{t, t+τ}, of the future primary surpluses s_t+τ, which are equal to T_t+τ – G_t+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post R_{t, t+τ}. The second equation of Cochrane (2011Jan, 5) is:

M_tV(i_t, ·) = P_tY_t (5)

Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):

“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”

An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.

There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:

(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress

(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality

(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.

IV Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table IV-1, updated with every blog comment, provides the latest annual data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of sovereign risk issues (Peter Spiegel and Quentin Peel, “Europe: Northern Exposures,” Financial Times, Mar 9, 2011 http://www.ft.com/intl/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1gAlaswcW). Newly available data on inflation is considered below in this section. Data in Table IV-1 for the euro zone and its members are updated from information provided by Eurostat but individual country information is provided in this section  as soon as available, following Table IV-1. Data for other countries in Table IV-1 are also updated with reports from their statistical agencies. Economic data for major regions and countries is considered in Section V World Economic Slowdown following with individual country and regional data tables.

Table IV-1, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates

	GDP	CPI	PPI	UNE
US	1.6	1.5	1.4	7.3
Japan	1.2	0.9	2.3	3.8
China	7.8	3.1	-1.3
UK	1.3	2.7* CPIH 2.5	1.2 output 0.7** input 1.1	7.7
Euro Zone	-0.6	1.1	-0.8	12.0
Germany	0.5	1.6	-0.4	5.2
France	0.4	1.0	-0.4	11.0
Nether-lands	-1.9	2.4	-2.0	7.0
Finland	-1.1	1.8	0.5	8.0
Belgium	0.0	1.0	0.2	8.7
Portugal	-2.1	0.3	-0.2	16.5
Ireland	-1.1	0.0	3.0	13.6
Italy	-2.2	0.9	-2.3	12.2
Greece	NA	-1.0	-1.8	NA
Spain	-1.6	0.5	-0.1	26.2

Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier

*Office for National Statistics http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/september-2013/index.html **Core

PPI http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/september-2013/stb-producer-price-inflation--september-2013.html

Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/; country statistical sources http://www.census.gov/aboutus/stat_int.html

Table IV-1 shows the simultaneous occurrence of low growth, inflation and unemployment in advanced economies. The US grew at 1.6 percent in IIQ2013 relative to IIQ2012 (Table 8 in http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.pdf http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). Japan’s GDP grew 0.9 percent in IIQ2013 relative to IQ2013 and 1.2 percent relative to a year earlier. Japan’s grew at the seasonally adjusted annual rate (SAAR) of 3.8 percent in IIQQ2013 (http://cmpassocregulationblog.blogspot.com/2013/09/recovery-without-hiring-ten-million.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/duration-dumping-and-peaking-valuations_3896.html). The UK grew at 0.7 percent in IIQ2013 relative to IQ2013 and GDP increased 1.3 percent in IIQ2013 relative to IIQ2012 (http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/interest-rate-risks-duration-dumping.html). The Euro Zone grew at 0.3 percent in IIQ2013 and minus 0.6 percent in IIQ2013 relative to IIQ2012 (http://cmpassocregulationblog.blogspot.com/2013/10/imf-view-collapse-of-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html). These are stagnating or “growth recession” rates, which are positive or about nil growth rates with some contractions that are insufficient to recover employment. The rates of unemployment are quite high: 7.3 percent in the US but 17.4 percent for unemployment/underemployment or job stress of 28.3 million (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), 4.1 percent for Japan (http://cmpassocregulationblog.blogspot.com/2013/10/collapse-of-united-states-dynamism-of.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/twenty-eight-million-unemployed-or.html), 7.7 percent for the UK with high rates of unemployment for young people (Section VH and earlier http://cmpassocregulationblog.blogspot.com/2013/09/recovery-without-hiring-ten-million.html). Twelve-month rates of inflation have been quite high, even when some are moderating at the margin: 1.5 percent in the US, 0.9 percent for Japan, 2.6 percent for China, 1.3 percent for the Euro Zone and 2.7 percent for the UK. Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. Six key interrelated vulnerabilities in the world economy have been causing global financial turbulence. (1) Sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings (see Section III and earlier http://cmpassocregulationblog.blogspot.com/2013/10/imf-view-collapse-of-united-states.html). (2) The tradeoff of growth and inflation in China now with change in growth strategy to domestic consumption instead of investment and political developments in a decennial transition. (3) Slow growth by repression of savings with de facto interest rate controls (http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html), weak hiring with the loss of 10 million full-time jobs (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) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (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); (4) The timing, dose, impact and instruments of normalizing monetary and fiscal policies (see http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies. (5) The Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 had repercussions throughout the world economy. Japan has share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) geopolitical events in the Middle East.

In the effort to increase transparency, the Federal Open Market Committee (FOMC) provides both economic projections of its participants and views on future paths of the policy rate that in the US is the federal funds rate or interest on interbank lending of reserves deposited at Federal Reserve Banks. These projections and views are discussed initially followed with appropriate analysis.

Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):

“I think the best way to provide forward guidance is by tying our policy actions to explicit measures of economic performance. There are many ways of doing this, including setting a target for the level of nominal GDP. But recognizing the difficult nature of that policy approach, I have a more modest proposal: I think the Fed should make it clear that the federal funds rate will not be increased until the unemployment rate falls below 7 percent. Knowing that rates would stay low until significant progress is made in reducing unemployment would reassure markets and the public that the Fed would not prematurely reduce its accommodation.

Based on the work I have seen, I do not expect that such policy would lead to a major problem with inflation. But I recognize that there is a chance that the models and other analysis supporting this approach could be wrong. Accordingly, I believe that the commitment to low rates should be dropped if the outlook for inflation over the medium term rises above 3 percent.

The economic conditionality in this 7/3 threshold policy would clarify our forward policy intentions greatly and provide a more meaningful guide on how long the federal funds rate will remain low. In addition, I would indicate that clear and steady progress toward stronger growth is essential.”

Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:

“I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Price Index) inflation over the next two to three years, would be appropriate.”

The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):

“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):

“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.

Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans. Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.

Unconventional monetary policy will remain in perpetuity, or QE→∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE→∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at 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) and the second estimate of GDP for IIQ2013 (http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.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/mediocre-and-decelerating-united-states.html and earlier 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/mediocre-and-decelerating-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.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). Zero interest rates and quantitative easing have not provided the impulse for growth and were not required in past successful cyclical expansions.

First, total nonfarm payroll employment seasonally adjusted (SA) increased 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/gdp/2013/pdf/gdp2q13_3rd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0813.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.

1. 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.
2. 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://www.bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0813.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/gdp/2013/pdf/gdp2q13_3rd.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0713.pdf http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0813.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 $15,679.7 by GDP in IVQ2011 of $15,242.1 and compounding by 4/6: {[($15,679.7/$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 $15,679.7 by GDP in IVQ2012 of $15,539.6 and compounding by 4/2: {[($15,679.7/$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	∆% over Year Earlier
IVQ2007	14,996.1	NA	NA	1.9
IVQ2011	15,242.1	1.6	1.2	2.0
IQ2012	15,381.6	2.6	0.9	3.3
IIQ2012	15,427.7	2.9	0.3	2.8
IIIQ2012	15,534.0	3.6	0.7	3.1
IVQ2012	15,539.6	3.6	0.0	2.0
IQ2013	15,583.9	3.9	0.3	1.3
IIQ2013	15,679.7	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://www.bea.gov/iTable/index_nipa.cfm http://www.bea.gov/newsreleases/national/gdp/2013/pdf/gdp2q13_3rd.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 statement of the FOMC at the conclusion of its meeting on Dec 12, 2012, revealed policy intentions (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm) practically unchanged in the statement at the conclusion of its meeting on Jan 30, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130130a.htm) and at its meeting on Sep 18, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):

“Press Release

Release Date: September 18, 2013

For immediate release

Information received since the Federal Open Market Committee met in July suggests that economic activity has been expanding at a moderate pace. Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated. 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. Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.

Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. In judging when to moderate the pace of asset purchases, the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective. Asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's economic outlook as well as its assessment of the likely efficacy and costs of such purchases.

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.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Charles L. Evans; Jerome H. Powell; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.”

There are several important issues in this statement.

1. Mandate. The FOMC pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

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

1. Open-ended Quantitative Easing or QE_∞. Earlier programs are continued with an additional open-ended $85 billion of bond purchases per month: “However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.”
2. Advance Guidance on “6 ¼ 2 ½ “Rule. Policy will be accommodative even after the economy recovers satisfactorily: “To support continued progress toward maximum employment and price stability, the Committee 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.”
3. Monitoring and Policy Focus on Jobs. The FOMC reconsiders its policy continuously in accordance with available information: “In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.”
4. No Present Course of Asset Purchases. Market participants focused on slightly different wording about asset purchases: “In judging when to moderate the pace of asset purchases, the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective. Asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's economic outlook as well as its assessment of the likely efficacy and costs of such purchases.”
5. Concern with Mortgage Rates. “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.”

Current focus is on tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Market are overreacting to the so-called “paring” of outright purchases of $85 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Sep 18, 2013 (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” (emphasis added).

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

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

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

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

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

The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. Indefinite financial repression induces carry trades with high leverage, risks and illiquidity.

Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval of (1.99, 2.0). Symmetric targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output that is actually a target of growth forecast. The impact on the overall economy and the financial system of errors of policy are magnified by large-scale policy doses of trillions of dollars of quantitative easing and zero interest rates. The US economy has been experiencing financial repression as a result of negative real rates of interest during nearly a decade and programmed in monetary policy statements until 2015 or, for practical purposes, forever. The essential calculus of risk/return in capital budgeting and financial allocations has been distorted. If economic perspectives are doomed until 2015 such as to warrant zero interest rates and open-ended bond-buying by “printing” digital bank reserves (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html; see Shultz et al 2012), rational investors and consumers will not invest and consume until just before interest rates are likely to increase. Monetary policy statements on intentions of zero interest rates for another three years or now virtually forever discourage investment and consumption or aggregate demand that can increase economic growth and generate more hiring and opportunities to increase wages and salaries. The doom scenario used to justify monetary policy accentuates adverse expectations on discounted future cash flows of potential economic projects that can revive the economy and create jobs. If it were possible to project the future with the central tendency of the monetary policy scenario and monetary policy tools do exist to reverse this adversity, why the tools have not worked before and even prevented the financial crisis? If there is such thing as “monetary policy science”, why it has such poor record and current inability to reverse production and employment adversity? There is no excuse of arguing that additional fiscal measures are needed because they were deployed simultaneously with similar ineffectiveness.

In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows.

Table IV-2 provides economic projections of governors of the Board of Governors of the Federal Reserve and regional presidents of Federal Reserve Banks released at the meeting of Sep 18, 2013. The Fed releases the data with careful explanations (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf). Columns “∆% GDP,” “∆% PCE Inflation” and “∆% Core PCE Inflation” are changes “from the fourth quarter of the previous year to the fourth quarter of the year indicated.” The GDP report for IIQ2013 is analyzed in Section I (http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html) and the PCE inflation data from the report on personal income and outlays in Section IV (http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk.html). The Bureau of Economic Analysis (BEA) provides the third estimate of IIQ2013 GDP released on Aug Sep 26 with revisions since 1929 (http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). PCE inflation is the index of personal consumption expenditures (PCE) of the report of the Bureau of Economic Analysis (BEA) on “Personal Income and Outlays” (http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm), which is analyzed in Section IV (http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). The report on “Personal Income and Outlays” the report for Aug 2013 was released on Sep 27, 2013 (http://cmpassocregulationblog.blogspot.com/2013/09/mediocre-and-decelerating-united-states.html). PCE core inflation consists of PCE inflation excluding food and energy. Column “UNEMP %” is the rate of unemployment measured as the average civilian unemployment rate in the fourth quarter of the year. The Bureau of Labor Statistics (BLS) provides the Employment Situation Report with the civilian unemployment rate in the first Friday of every month, which is analyzed in this blog. The report for Jul 2013 was released on Aug 2 and analyzed in this blog and the report for Aug 2013 was released on Sep 6, 2013 (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). “Longer term projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy” (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20121212.pdf).

It is instructive to focus on 2013 and 2014 because 2015, 2016 and longer term are too far away, and there is not much information even on what will happen in 2013-2014 and beyond. The central tendency should provide reasonable approximation of the view of the majority of members of the FOMC but the second block of numbers provides the range of projections by FOMC participants. The first row for each year shows the projection introduced after the meeting of Sep 18, 2013 and the second row “PR” the projection of the Jun 19, 2013 meeting. There are three major changes in the view.

1. Growth “∆% GDP.” The FOMC has reduced the forecast of GDP growth in 2013 from 2.3 to 2.6 percent at the meeting in Jun 2013 to 2.0 to 2.3 percent at the meeting on Sep 18, 2013. The FOMC decreased GDP growth in 2014 from 3.0 to 3.5 percent at the meeting in Jun 2013 to 2.9 to 3.1 percent at the meeting in Sep 2013.

2. Rate of Unemployment “UNEM%.” The FOMC reduced the forecast of the rate of unemployment from 7.2 to 7.3 percent at the meeting on Jun 19, 2013 to 7.1 to 7.3 percent at the meeting on Sep 18, 2013. The projection for 2014 decreased to the range of 6.4 to 6.8 in Sep 2013 from 6.5 to 6.8 in Jun 2013. Projections of the rate of unemployment are moving closer to the desire 6.5 percent or lower with 5.9 to 6.2 percent in 2015 after the meeting on Sep 18, 2013.

3. Inflation “∆% PCE Inflation.” The FOMC changed the forecast of personal consumption expenditures (PCE) inflation from 0.8 to 1.2 percent at the meeting on Jun 19, 2012 to 1.1 to 1.2 percent at the meeting on Sep 18, 2013. There are no projections exceeding 2.0 percent in the central tendency but some in the range reach 2.3 percent in 2015 and 2015. The longer run projection is at 2.0 percent.

4. Core Inflation “∆% Core PCE Inflation.” Core inflation is PCE inflation excluding food and energy. There is again not much of a difference of the projection, changing from 1.2 to 1.3 percent at the meeting on Jun 19, 2013 to 1.2 to 1.3 percent at the meeting Sep 13, 2013. In 2014, there is minor change in the projection from 1.5 to 1.8 percent in Jun 19, 2013 to 1.5 to 1.7 percent in Sep 18, 2013. The rate of change of the core PCE is below 2.0 percent in the central tendency with 2.3 percent at the top of the range in 2015 and 2016.

Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents in FOMC, Mar 2013 and Jun 19, 2013 

	∆% GDP	UNEM %	∆% PCE Inflation	∆% Core PCE Inflation
Central Tendency
2013  Jun PR	2.0 to 2.3 2.3 to 2.6	7.1 to 7.3 7.2 to 7.3	1.1 to 1.2 0.8 to 1.2	1.2 to 1.3 1.2 to 1.3
2014  Jun PR	2.9 to 3.1 3.0 to 3.5	6.4 to 6.8 6.5 to 6.8	1.3 to 1.8 1.4 to 2.0	1.5 to 1.7 1.5 to 1.8
2015 Jun PR	3.0 to 3.5 2.9 to 3.6	5.9 to 6.2 5.8 to 6.2	1.6 to 2.0 1.7 to 2.0	1.7 to 2.0 1.7 to 2.0
2016 Jun PR	2.5 to 3.3 NA	5.4 to 5.9 NA	1.7 to 2.0 NA	1.9 to 2.0 NA
Longer Run Jun PR	2.2 to 2.5 2.3 to 2.5	5.2 to 5.8 5.2 to 6.0	2.0 2.0
Range
2013 Jun PR	1.8 to 2.4 2.0 to 2.6	6.9 to 7.3 6.9 to 7.5	1.0 to 1.3 0.8 to 1.5	1.2 to 1.4 1.1 to 1.5
2014 Jun PR	2.2 to 3.3 2.2 to 3.6	6.2 to 6.9 6.2 to 6.9	1.2 to 2.0 1.4 to 2.0	1.4 to 2.0 1.5 to 2.0
2015 Jun PR	2.2 to 3.7 2.3 to 3.8	5.3 to 6.3 5.7 to 6.4	1.4 to 2.3 1.6 to 2.3	1.6 to 2.3 1.7 to 2.3
2016 Jun PR	2.2 to 3.5 NA	5.2 to 6.0 NA	1.5 to 2.3 NA	1.7 to 2.3 NA
Longer Run Jun PR	2.1 to 2.5 2.0 to 3.0	5.2 to 6.0 5.0 to 6.0	2.0 2.0

Notes: UEM: unemployment; PR: Projection

Source: Board of Governors of the Federal Reserve System, FOMC

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf

Another important decision at the FOMC meeting on Jan 25, 2012, is formal specification of the goal of inflation of 2 percent per year but without specific goal for unemployment (http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm):

“Following careful deliberations at its recent meetings, the Federal Open Market Committee (FOMC) has reached broad agreement on the following principles regarding its longer-run goals and monetary policy strategy. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.

The FOMC is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decision making by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.

Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals.

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances.

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants' estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC's Summary of Economic Projections. For example, in the most recent projections, FOMC participants' estimates of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent, roughly unchanged from last January but substantially higher than the corresponding interval several years earlier.

In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary.  However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate. ”

The probable intention of this specific inflation goal is to “anchor” inflationary expectations. Massive doses of monetary policy of promoting growth to reduce unemployment could conflict with inflation control. Economic agents could incorporate inflationary expectations in their decisions. As a result, the rate of unemployment could remain the same but with much higher rate of inflation (see Kydland and Prescott 1977 and Barro and Gordon 1983; http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html See Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-116). Strong commitment to maintaining inflation at 2 percent could control expectations of inflation.

The FOMC continues its efforts of increasing transparency that can improve the credibility of its firmness in implementing its dual mandate. Table IV-3 provides the views by participants of the FOMC of the levels at which they expect the fed funds rate in 2013, 2014, 2015, 2016 and the in the longer term. Table IV-3 is inferred from a chart provided by the FOMC with the number of participants expecting the target of fed funds rate (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130320.pdf). There are 17 participants expecting the rate to remain at 0 to ¼ percent in 2013. The rate would still remain at 0 to ¼ percent in 2014 for 13 participants with three expecting the rate to be in the range of 0.5 to 1.0 percent and one participant expecting rates at 1.0 to 1.5 percent. This table is consistent with the guidance statement of the FOMC that rates will remain at low levels. For 2015, eight participants expect rates to be below or at 1.0 percent while six expect rates from 1.0 to 1.5 percent and three expecting rates in excess of 2.0 percent. For 2016, nine participants expect rates between 1.0 and 2.0 percent, four between 2.0 and 3.0 percent and three between 3.0 and 4.4 percent. In the long term, all 17 participants expect the fed funds rate in the range of 3.0 to 4.5 percent.

Table IV-3, US, Views of Target Federal Funds Rate at Year-End of Federal Reserve Board

Members and Federal Reserve Bank Presidents Participating in FOMC, Jun 19, 2013

	0 to 0.25	0.5 to 1.0	1.0 to 1.5	1.0 to 2.0	2.0 to 3.0	3.0 to 4.5
2013	17
2014	13	3	1
2015		8	6		3
2016		1		9	4	3
Longer Run						17

Source: Board of Governors of the Federal Reserve System, FOMC

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf

Additional information is provided in Table IV-4 with the number of participants expecting increasing interest rates in the years from 2013 to 2016. It is evident from Table IV-4 that the prevailing view of the FOMC is for interest rates to continue at low levels in future years. This view is consistent with the economic projections of low economic growth, relatively high unemployment and subdued inflation provided in Table IV-2. The FOMC states that rates will continue to be low even after return of the economy to potential growth.

Table IV-4, US, Views of Appropriate Year of Increasing Target Federal Funds Rate of Federal

Reserve Board Members and Federal Reserve Bank Presidents Participating in FOMC, June 19, 2013

Appropriate Year of Increasing Target Fed Funds Rate	Number of Participants
2014	3
2015	12
2016	2

Source: Board of Governors of the Federal Reserve System, FOMC

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf

There are two categories of responses in the Empire State Manufacturing Survey of the Federal Reserve Bank of New York (http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html): current conditions and expectations for the next six months. There are responses in the survey for two types of prices: prices received or inputs of production and prices paid or sales prices of products. Table IV-5 provides indexes for the two categories and within them for the two types of prices from Jan 2011 to Oct 2013. The index of current prices paid or costs of inputs increased from 16.13 in Dec 2012 to 21.69 in Oct 2013 while the index of current prices received or sales prices increased from 1.08 in Dec 2012 to 2.41 in Sep 2013. The index of future prices paid or expectations of costs of inputs in the next six months fell from 51.61 in Dec 2012 to 45.78 in Oct 2013 while the index of future prices received or expectation of sales prices in the next six months fell from 25.81 in Dec 2012 to 25.30 in Oct 2013. Prices of sales of finished products are less dynamic than prices of costs of inputs during waves of increases. Prices of costs of costs of inputs fall less rapidly than prices of sales of finished products during waves of price decreases. As a result, margins of prices of sales less costs of inputs oscillate with typical deterioration against producers, forcing companies to manage tightly costs and labor inputs.

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

	Current Prices Paid	Current Prices Received	Six Months Prices Paid	Six Months Prices Received
Oct 2013	21.69	2.41	45.78	25.30
Sep	21.51	8.6	39.78	24.73
Aug	20.48	3.61	40.96	19.28
Jul	17.39	1.09	28.26	11.96
Jun	20.97	11.29	45.16	17.74
May	20.45	4.55	29.55	14.77
Apr	28.41	5.68	44.32	14.77
Mar	25.81	2.15	50.54	23.66
Feb	26.26	8.08	44.44	13.13
Jan	22.58	10.75	38.71	21.51
Dec 2012	16.13	1.08	51.61	25.81
Nov	14.61	5.62	39.33	15.73
Oct	17.20	4.30	44.09	24.73
Sep	19.15	5.32	40.43	23.40
Aug	16.47	2.35	31.76	14.12
Jul	7.41	3.70	35.80	16.05
Jun	19.59	1.03	34.02	17.53
May	37.35	12.05	57.83	22.89
Apr	45.78	19.28	50.60	22.89
Mar	50.62	13.58	66.67	32.10
Feb	25.88	15.29	62.35	34.12
Jan	26.37	23.08	53.85	30.77
Dec 2011	24.42	3.49	56.98	36.05
Nov	18.29	6.10	36.59	25.61
Oct	22.47	4.49	40.45	17.98
Sep	32.61	8.70	53.26	22.83
Aug	28.26	2.17	42.39	15.22
Jul	43.33	5.56	51.11	30.00
Jun	56.12	11.22	55.10	19.39
May	69.89	27.96	68.82	35.48
Apr	57.69	26.92	56.41	38.46
Mar	53.25	20.78	71.43	36.36
Feb	45.78	16.87	55.42	27.71
Jan	35.79	15.79	60.00	42.11

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

Price indexes of the Federal Reserve Bank of Philadelphia Outlook Survey are provided in Table IV-6. As inflation waves throughout the world (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html), indexes of both current and expectations of future prices paid and received were quite high until May 2011. Prices paid, or inputs, were more dynamic, reflecting carry trades from zero interest rates to commodity futures. All indexes softened after May 2011 with even decline of prices received in Aug 2011 during the first round of risk aversion. Current and future price indexes have increased again but not back to the levels in the beginning of 2011 because of risk aversion frustrating carry trades even under zero interest rates. The index of prices paid or prices of inputs decreased from 23.5 in Dec 2012 to 21.7 in Oct 2013. The index of current prices received was minus 3.3 in May 2013, indicating decrease of prices received. The index of current prices received increased from 12.4 in Dec 2012 to 14.2 in Oct 2013. The index of future prices paid fell to 46.1 in Oct 2013 from 45.8 in Dec 2012, indicating expectation of lower pressure of increases of input prices, while the index of future prices received increased from 25.6 in Dec 2012 to 35.6 in Oct 2013. Expectations are incorporating faster increases in prices of inputs or costs of production than of sales of produced goods, forcing companies to manage tightly costs and labor inputs.

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

	Current Prices Paid	Current Prices Received	Future Prices Paid	Future Prices Received
10-Dec	44.3	6.6	59.6	25.3
11-Jan	48.9	11.9	58.3	34.4
11-Feb	58.9	13.1	62.1	33.3
11-Mar	57.5	16.8	60.2	31.8
11-Apr	49.4	19.8	54.2	32.4
11-May	47.7	18.5	52.7	27.6
11-Jun	38.9	8.1	38.3	6.8
11-Jul	35.6	6	49.6	16.7
11-Aug	23.3	-4.7	44.3	22.7
11-Sep	31.6	7.6	41.8	21.8
11-Oct	25.4	4.1	44.5	28.4
11-Nov	26.3	7.6	39	29.1
11-Dec	27.5	8.2	46.7	23.5
12-Jan	27.1	7.9	47.2	21.9
12-Feb	30.2	9.7	43.5	28.6
12-Mar	14.3	5.4	35.9	22
12-Apr	16	5.3	33.3	18.6
12-May	5.4	-2.2	37.2	8.3
12-Jun	5.4	-3.4	29.6	16.6
12-Jul	10.3	4.2	29.3	19.6
12-Aug	15.7	4.7	38	23.9
12-Sep	15.4	4	42.8	27.4
12-Oct	20.6	8.4	48.1	16.1
12-Nov	27.9	7.5	50.7	14
12-Dec	23.5	12.4	45.8	25.6
13-Jan	14.7	-1.1	34.3	21.7
13-Feb	8.9	-0.5	26.4	25.4
13-Mar	8.5	-0.8	30.9	16.6
13-Apr	3.1	-7.5	26.6	8.3
13-May	6.9	-3.3	30.7	18.2
13-Jun	22.5	14.6	26.4	23.5
13-Jul	21.5	7	42.1	23.9
13-Aug	17.3	9.9	38.7	23
13-Sep	25.3	12.7	43.1	31.7
13-Oct	21.7	14.2	46.1	35.6

Source: Federal Reserve Bank of Philadelphia

http://philadelphiafed.org/index.cfm

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

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

Source: Federal Reserve Bank of Philadelphia

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

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

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

Source: Federal Reserve Bank of Philadelphia

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

China is experiencing similar inflation behavior as the advanced economies in several prior months in the form of declining commodity prices but differs in decreasing inflation of producer prices relative to a year earlier. As shown in Table IV-7, inflation of the price indexes for industry in Sep 2013 is 0.2 percent; 12-month inflation is minus 1.3 percent in Sep; and cumulative inflation in Jan-Sep 2013 relative to Jan-Sep 2012 is minus 2.1 percent. Inflation of segments in Sep 2013 in China is provided in Table IV-9 in column “Month Sep 2013 ∆%.” There were increases of prices of mining & quarrying of 0.6 percent in Sep and decrease of 4.0 percent in 12 months. Prices of consumer goods increased 0.3 percent in Sep and decreased 1.7 percent in 12 months. Prices of inputs in the purchaser price index increased 0.2 percent in Sep and declined 1.6 percent in 12 months. Fuel and power increased 0.3 percent in Sep and declined 3.0 percent in 12 months. An important category of inputs for exports is textile raw materials, increasing 0.1 percent in Sep and increasing 0.7 percent in 12 months.

Table IV-7, China, Price Indexes for Industry ∆%

	Month     Sep 2013 ∆%	12-Month Sep 2013 ∆%	Jan-Sep 2013/Jan-Sep 2012 ∆%
I Producer Price Indexes	0.2	-1.3	-2.1
Means of Production	0.3	-1.7	-2.8
Mining & Quarrying	0.6	-4.0	-6.2
Raw Materials	0.6	-2.0	-3.3
Processing	0.1	-1.4	-2.2
Consumer Goods	0.1	-0.1	0.2
Food	0.3	0.4	0.7
Clothing	0.2	1.0	1.2
Daily Use Articles	0.0	-0.6	0.0
Durable Consumer Goods	0.0	-0.9	-0.8
II Purchaser Price Indexes	0.2	-1.6	-2.2
Fuel and Power	0.3	-3.0	-3.7
Ferrous Metals	0.2	-1.4	-5.1
Nonferrous Metals	0.0	-5.7	-4.2
Chemical Raw Materials	0.2	-2.2	-2.9
Wood & Pulp	0.1	-0.4	-0.5
Building Materials	0.1	-0.6	-1.5
Other Industrial Raw Materials	0.0	-0.9	-0.9
Agricultural	0.4	1.4	1.7
Textile Raw Materials	0.1	0.7	-0.3

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

China’s producer price inflation follows waves similar to those around the world but with declining trend since May 2012, as shown in Table IV-8. In the first wave, annual equivalent inflation was 6.4 percent in Jan-Jun 2011, driven by carry trades from zero interest rates to commodity futures. In the second wave, risk aversion unwound carry trades, resulting in annual equivalent inflation of minus 3.1 percent in Jul-Nov 2011. In the third wave, renewed risk aversion resulted in annual equivalent inflation of minus 2.4 percent in Dec 2011-Jan 2012. In the fourth wave, new carry trades resulted in annual equivalent inflation of 2.4 percent in Feb-Apr 2012. In the fifth wave, annual equivalent inflation is minus 5.8 percent in May-Sep 2012. There are declining producer prices in China in Aug-Sep 2012 in contrast with increases worldwide. In a sixth wave, producer prices increased 0.2 percent in Oct 2012, which is equivalent to 2.4 percent in a year. In an eighth wave, annual equivalent inflation was minus 1.2 percent in Nov-Dec 2012. In the ninth wave, annual equivalent inflation in Jan-Feb 2013 is 2.4 percent. In the tenth wave, annual equivalent inflation was minus 4.9 percent in Mar-Jul 2013. In the eleventh wave, annual equivalent inflation was 1.8 percent in Aug-Sep 2013.

Table IV-8, China, Month and 12-Month Rate of Change of Producer Price Index, ∆%

	12-Month ∆%	Month ∆%
Sep 2013	-1.3	0.2
Aug	-1.6	0.1
AE ∆% Aug-Sep		1.8
Jul	-2.3	-0.3
Jun	-2.7	-0.6
May	-2.9	-0.6
Apr	-2.6	-0.6
Mar	-1.9	0.0
AE ∆% Mar-Jul		-4.9
Feb	-1.6	0.2
Jan	-1.6	0.2
AE ∆% Jan-Feb		2.4
Dec 2012	-1.9	-0.1
Nov	-2.2	-0.1
AE ∆% Nov-Dec		-1.2
Oct	-2.8	0.2
AE ∆% Oct		2.4
Sep	-3.6	-0.1
Aug	-3.5	-0.5
Jul	-2.9	-0.8
Jun	-2.1	-0.7
May	-1.4	-0.4
AE ∆% May-Sep		-5.8
Apr	-0.7	0.2
Mar	-0.3	0.3
Feb	0.0	0.1
AE ∆% Feb-Apr		2.4
Jan	0.7	-0.1
Dec 2011	1.7	-0.3
AE ∆% Dec-Jan		-2.4
Nov	2.7	-0.7
Oct	5.0	-0.7
Sep	6.5	0.0
Aug	7.3	0.1
Jul	7.5	0.0
AE ∆% Jul-Nov		-3.1
Jun	7.1	0.0
May	6.8	0.3
Apr	6.8	0.5
Mar	7.3	0.6
Feb	7.2	0.8
Jan	6.6	0.9
AE ∆% Jan-Jun		6.4
Dec 2010	5.9	0.7

AE: Annual Equivalent

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Chart IV-3 of the National Bureau of Statistics of China provides monthly and 12-month rates of inflation of the price indexes for the industrial sector. Negative monthly rates in Oct, Nov, Dec 2011, Jan, Mar, Apr, May, Jun, Jul, Aug, Sep, Nov and Dec 2012 pulled down the 12-month rates to 5.0 percent in Oct 2011, 2.7 percent in Nov, 1.7 percent in Dec, 0.7 percent in Jan 2012, 0.0 percent in Feb, minus 0.3 percent in Mar, minus 0.7 percent in Apr, minus 1.4 percent in May, 2.1 in Jun, minus 2.9 percent in Jul, minus 3.5 percent in Aug, minus 3.6 percent in Sep. The increase of 0.2 percent in Oct 2012 pulled up the 12-month rate to minus 2.8 percent and the rate eased to minus 2.2 percent in Nov 2012 and minus 1.9 percent in Dec 2012. Increases of 0.2 percent in Jan and Feb 2013 pulled the 12-month rate to minus 1.6 percent while no change in Mar 2013 brought down the 12-month rate to minus 1.9 percent. Declines of prices of 0.6 percent in Apr, May and Jun 2013 pushed the 12-month rate to minus 2.7 percent. Producer prices fell 2.3 percent in the 12 months ending in Jul 2013 and minus 1.6 percent in Aug 2013 with increase of 0.1 percent in the month of Aug 2013. Producer price inflation was minus 1.3 percent in the 12 months ending in Sep 2013.

Chart IV-3, China, Producer Prices for the Industrial Sector Month and 12 months ∆%

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Chart IV-4 of the National Bureau of Statistics of China provides monthly and 12-month inflation of the purchaser product indices for the industrial sector. Decreasing monthly inflation with four successive contractions from Oct 2011 to Jan 2012 and May-Aug 2012 pulled down the 12-month rate to minus 4.1 percent in Aug and Sep. Consecutive increases of 0.1 percent in Sep and Oct 2012 raised the 12-month rate to minus 3.3 percent in Oct 2012. The rate eased to minus 2.8 in Nov 2012 with decrease of 0.2 percent in Nov 2012 and minus 2.4 percent in Dec 2012 with monthly decrease of 0.1 percent. Increase of 0.3 percent in Jan 2013 and 0.2 in Feb 2013 pulled the 12-month rate to minus 1.9 percent. Decrease of prices of 0.1 percent in Mar 2013 brought down the 12-month rate to minus 2.0 percent. Declining prices of 0.6 percent in Apr and May 2013 and 0.5 percent in Jun 2013 pushed down the 12-month rate to minus 2.6 percent. The index fell 2.2 percent in the 12 months ending in Jul 2013 and 1.6 percent in the 12 months ending in Aug 2013. The index fell 1.3 percent in the 12 months ending in Sep 2013.

Chart IV-4, China, Purchaser Product Indices for Industrial Sector, Month and 12 months ∆%

Source: National Bureau of Statistics of China

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

China is highly conscious of food price inflation because of its high weight in the basket of consumption of the population. Consumer price inflation in China in Sep 2013 was 0.8 percent and 3.1 percent in 12 months, as shown in Table IV-9. Food prices increased 1.5 percent in Sep 2013, increasing 4.4 percent in 12 months in another shock. Adjustment from the prior shock had occurred in May with decline of food prices by 1.6 percent and increase of 3.8 percent in 12 months and 3.8 percent in Jan-May 2013 relative to a year earlier. Another area of concern is housing inflation, which was 0.3 percent in Sep but increased 2.8 percent in 12 months. Prices of services increased 0.5 percent in Sep and gained 2.9 percent in 12 months.

Table IV-9, China, Consumer Price Index

2013	Sep 2013 Month   ∆%	Sep 2013 12-Month  ∆%	Jan-Sep 2013   ∆%/ Jan-Sep 2012
Consumer Prices	0.8	3.1	2.5
Urban	0.8	3.0	2.5
Rural	0.8	3.3	2.7
Food	1.5	6.1	4.4
Non-food	0.4	1.6	1.6
Consumer Goods	0.9	3.1	2.4
Services	0.5	2.9	2.8
Commodity Categories:
Food	1.5	6.1	4.4
Tobacco, Liquor	-0.2	-0.2	0.6
Clothing	1.2	2.3	2.3
Household	0.0	1.4	1.5
Healthcare & Personal Articles	0.2	1.1	1.5
Transportation & Communication	0.2	-0.2	-0.4
Recreation, Education, Culture & Services	1.0	1.9	1.4
Residence	0.3	2.6	2.8

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Month and 12-month rates of change of consumer prices are provided in Table IV-10. There are waves of consumer price inflation in China similar to those around the world (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html). In the first wave, consumer prices increased at the annual equivalent rate of 8.3 percent in Jan-Mar 2011, driven by commodity price increases resulting from unconventional monetary policy of zero interest rates. In the second wave, risk aversion unwound carry trades with annual equivalent inflation falling to the rate of 2.0 percent in Apr-Jun 2011. In the third wave, inflation returned at 2.9 percent with renewed interest in commodity exposures in Jul-Nov 2011. In the fourth wave, inflation returned at a high 5.8 percent annual equivalent in Dec 2011 to Mar 2012. In the fifth wave, annual equivalent inflation was minus 3.9 percent in Apr to Jun 2012. In the sixth wave, annual equivalent inflation rose to 4.1 percent in Jul-Sep 2012. In the seventh wave, inflation was minus 1.2 percent annual equivalent in Oct 2012 and 0.0 percent in Oct-Nov 2012. In the eighth wave, annual equivalent inflation was 12.2 percent in Dec 2012-Feb 2013 primarily because of winter weather that caused increases in food prices. In the ninth wave, collapse of food prices resulted in annual equivalent inflation of minus 10.3 percent in Mar 2013. In the tenth wave, annual equivalent inflation returned at 2.4 percent in Apr 2013. In the eleventh wave, annual equivalent inflation was minus 3.5 percent in May-Jun 2013. In the twelfth wave, inflation rose at annual equivalent 5.7 percent in Jul-Sep 2013 with sharp increase of food prices in Sep 2013. Inflation volatility originating in unconventional monetary policy clouds investment and consumption decisions by business and households. There is local problem in China with food prices.

Table IV-10, China, Month and 12-Month Rates of Change of Consumer Price Index ∆%

	Month ∆%	12-Month ∆%
Sep 2013	0.8	3.1
Aug	0.5	2.6
Jul	0.1	2.7
AE ∆% Jul-Sep	5.7
Jun	0.0	2.7
May	-0.6	2.1
AE ∆% May-Jun	-3.5
Apr	0.2	2.4
AE ∆% Apr	2.4
Mar 2013	-0.9	2.1
AE ∆% Mar	-10.3
Feb	1.1	3.2
Jan	1.0	2.0
Dec 2012	0.8	2.5
AE ∆% Dec-Feb	12.2
Nov	0.1	2.0
Oct	-0.1	1.7
AE ∆% Oct-Nov	0.0
Sep	0.3	1.9
Aug	0.6	2.0
Jul	0.1	1.8
AE ∆% Jul-Sep	4.1
Jun	-0.6	2.2
May	-0.3	3.0
Apr	-0.1	3.4
AE ∆% Apr to Jun	-3.9
Mar	0.2	3.6
Feb	-0.1	3.2
Jan	1.5	4.5
Dec 2011	0.3	4.1
AE ∆% Dec to Mar	5.8
Nov	-0.2	4.2
Oct	0.1	5.5
Sep	0.5	6.1
Aug	0.3	6.2
Jul	0.5	6.5
AE ∆% Jul to Nov	2.9
Jun	0.3	6.4
May	0.1	5.5
Apr	0.1	5.3
AE ∆% Apr to Jun	2.0
Mar	-0.2	5.4
Feb	1.2	4.9
Jan	1.0	4.9
AE ∆% Jan to Mar	8.3
Dec 2010	0.5	4.6

AE: Annual Equivalent

Source: National Bureau of Statistics of China http://www.stats.gov.cn/english/

Chart IV-5 of the National Bureau of Statistics of China provides monthly and 12-month rates of consumer price inflation. In contrast with producer prices, consumer prices had not moderated at the monthly marginal rates. Consumer prices fell 0.2 percent in Nov 2011 after increasing only 0.1 percent in Oct but increased 0.3 percent in Dec and a high 1.5 percent in Jan 2012, declining 0.1 percent in Feb, rising 0.2 percent in Mar and declining 0.1 percent in Apr, 0.3 percent in May and 0.6 percent in Jun 2012 but increasing 0.1 percent in Jul, 0.6 percent in Aug 2012 and 0.3 percent in Sep 2012. Consumer prices fell 0.1 percent in Oct 2012. The decline of 0.1 percent in Feb 2012 pulled down the 12-month rate to 3.2 percent, which bounced back to 3.6 percent in Mar with the monthly increase of 0.2 percent and fell to 2.2 percent in Jun with increasing pace of monthly decline from Apr to Jun 2012. Even with increase of 0.1 percent in Jul 2012, consumer price inflation in 12 months fell to 1.8 percent in Jul 2012 but bounced back to 2.0 percent with increase of 0.6 percent in Aug. In Sep, increase of 0.3 percent still maintained 12-month inflation at 1.9 percent. The decline of 0.1 percent in Oct 2012 pulled down the 12-month rate to 1.7 percent, which is the lowest in Chart IV-3. Increase of 0.1 percent in Nov 2012 pulled up the 12-month rate to 2.0 percent. Abnormal increase of 0.8 percent in Dec 2012 because of winter weather pulled up the 12-month rate to 2.5 percent. Even with increase of 1.0 percent in Jan 2013 12-month inflation fell to 2.0 percent. Inflation of 1.1 percent in Feb 2013 pulled the 12-month rate to 3.2 percent. Collapse of food prices with decline of consumer prices by 0.9 percent in Mar 2013 brought down the 12-month rate to 2.1 percent. Renewed inflation of 0.2 percent in Apr 2013 raised the 12-month rate to 2.4 percent. Decline of inflation by 0.6 percent in May reduced 12-month inflation to 2.1 percent. Inflation rose to 2.7 percent in the 12 months ending in Jun 2013 with unchanged monthly inflation. Consumer prices increased 0.1 percent in Jul 2013 and 2.7 percent in 12 months. In combination of increases of food prices and other prices, inflation returned with 0.5 percent in Aug 2013 and 2.6 percent in 12 months. Consumer prices increased 0.8 percent in Sept 2013 and 3.1 percent in 12 months with increase in food prices of 1.5 in the month of Sep 2013.

Chart IV-5, China, Consumer Prices ∆% Month and 12 Months

Source: National Bureau of Statistics of China

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

The harmonized index of consumer prices of the euro area in Table IV-11 has similar inflation waves as in most countries (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html). In the first wave, consumer prices in the euro area increased at the annual equivalent rate of 5.2 percent in Jan-Apr 2011. In the second wave, risk aversion caused unwinding of commodity carry trades with inflation decreasing at the annual equivalent rate of minus 2.4 percent in May-Jul 2011. In the third wave, improved risk appetite resulted in annual equivalent inflation in Aug-Nov 2011 at 4.3 percent. In the fourth wave, return of risk aversion caused decline of consumer prices at the annual equivalent rate of minus 3.0 percent in Dec 2011 to Jan 2012. In the fifth wave, improved attitudes toward risk aversion resulted in higher consumer price inflation at the high annual equivalent rate of 9.6 percent in Feb-Apr 2012. In the sixth wave, annual equivalent inflation fell to minus 2.8 percent in May-Jul 2012. In the seventh wave, increasing risk appetite caused new carry trade exposures that resulted in annual equivalent inflation of 6.8 percent in Aug-Sep 2012 and 5.3 percent in Aug-Oct 2012. In the eighth wave, annual-equivalent inflation was minus 2.4 percent in Nov 2012. In the ninth wave, annual equivalent inflation was 4.9 percent in Dec 2012. In the tenth wave, annual equivalent inflation was minus 11.4 percent in Jan 2013. In the eleventh wave, annual equivalent inflation was 10.0 percent in Feb-Mar 2013. In the twelfth wave, annual equivalent inflation was minus 1.2 percent in Apr 2013. In the thirteenth wave, annual equivalent inflation rose to 1.2 percent in May-Jun 2013. In the fourteenth wave, annual equivalent inflation was minus 5.8 percent in Jul 2013. In the fifteenth wave, annual equivalent inflation was 3.7 percent in Aug-Sep 2013. Inflation volatility around the world is confusing the information required in investment and consumption decisions. The bottom part of Table IV-7 provides annual inflation in the euro area from 1999 to 2012. HICP inflation was 3.3 percent in 2008 mostly because of carry trades from interest rates falling to zero into commodity futures. Exposures in commodity futures were reversed in the flight to US government obligations with resulting inflation of 0.3 percent in 2009. Reallocations of portfolios of financial investors according to risk aversion caused high volatility of inflation in 2011 and 2013.

Table IV-11, Euro Area Harmonized Index of Consumer Prices Month and 12 Months ∆%

	Month ∆%	12 Months ∆%
Sep 2013	0.5	1.1
Aug	0.1	1.3
AE ∆% Aug- Sep	3.7
Jul 2013	-0.5	1.6
AE ∆% Jul	-5.8
Jun	0.1	1.6
May	0.1	1.4
AE ∆% May-Jun	1.2
Apr	-0.1	1.2
AE ∆% Apr	-1.2
Mar	1.2	1.7
Feb	0.4	1.9
AE ∆% Feb-Mar	10.0
Jan	-1.0	2.0
AE ∆% Jan	-11.4
Dec 2012	0.4	2.2
AE ∆% Dec	4.9
Nov	-0.2	2.2
AE ∆% Nov	-2.4
Oct	0.2	2.5
Sep	0.7	2.6
Aug	0.4	2.6
AE ∆% Aug-Oct	5.3
Jul 2012	-0.5	2.4
Jun	-0.1	2.4
May	-0.1	2.4
AE ∆% May-Jul	-2.8
Apr	0.5	2.6
Mar	1.3	2.7
Feb	0.5	2.7
AE ∆%  Feb-Apr	9.6
Jan	-0.8	2.7
Dec 2011	0.3	2.7
AE ∆%  Dec-Jan	-3.0
Nov	0.1	3.0
Oct	0.4	3.0
Sep	0.7	3.0
Aug	0.2	2.6
AE ∆%  Aug-Nov	4.3
Jul	-0.6	2.6
Jun	0.0	2.7
May	0.0	2.7
AE ∆%  May-Jul	-2.4
Apr	0.6	2.8
Mar	1.4	2.7
Feb	0.4	2.4
Jan	-0.7	2.3
AE ∆% Jan-Apr	5.2
Dec 2010	0.6	2.2
Annual ∆%
2012		2.5
2011		2.7
2010		1.6
2009		0.3
2008		3.3
2007		2.1
2006		2.2
2005		2.2
2004		2.2
2003		2.1
2002		2.3
2001		2.4
2000		2.2
1999		1.2

AE: annual equivalent Source: EUROSTAT

http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/

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

Table IV-12 provides weights and inflation of selected components of the HICP of the euro area. Inflation of all items excluding energy increased 1.4 percent in Sep 2013 relative to Sep 2012 and increased 0.5 percent in Sep 2013 relative to Aug 2013. Prices of non-energy industrial goods increased 0.4 percent in Sep 2013 relative to a year earlier and increased 3.4 percent in Sep 2013. Inflation of services was 1.4 percent in Sep 2013 relative to a year earlier and decreased 0.9 percent in Sep 2013.

Table IV-12, Euro Area, HICP Inflation and Selected Components, ∆%

	Weight % 2013	Sep 2013/ Sep 2012	12-month Average Rate Sep 2013-2012/ Sep 2012-2011	∆% Sep 2013/Aug 2013
All Items	1000.0	1.1	1.7	0.5
All Items ex Energy	890.4	1.4	1.6	0.5
All Items ex Energy, Food, Alcohol & Tobacco	696.7	1.0	1.2	0.7
All Items ex Energy & Unprocessed Food	816.9	1.2	1.4	0.6
All Items ex Energy & Seasonal Food	852.7	1.3	1.5	0.6
All Items ex Tobacco	975.8	1.0	1.7	0.5
Energy	109.6	-0.9	2.4	0.5
Food, Alcohol & Tobacco	193.7	2.6	3.1	-0.4
Non-energy Industrial Goods	273.6	0.4	0.8	3.4
Services	423.0	1.4	1.5	-0.9

Source: EUROSTAT AE: annual equivalent Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/

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

Table IV-13 provides monthly and 12 months consumer price inflation in France. There are the same waves as in inflation worldwide (Section I, http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2013/08/duration-dumping-and-peaking-valuations.html). In the first wave, annual equivalent inflation in Jan-Apr 2011 was 4.3 percent driven by the carry trade from zero interest rates to commodity futures positions in an environment of risk appetite. In the second wave, risk aversion caused the reversal of carry trades into commodity futures, resulting in the fall of the annual equivalent inflation rate to minus 1.2 percent in May-Jul 2011. In the third wave, annual equivalent inflation rose to 3.0 percent in Aug-Nov 2011 with alternations of risk aversion and risk appetite. In the fourth wave, risk aversion originating in the European debt crisis caused annual equivalent inflation of 0.0 percent from Dec 2011 to Jan 2012. In the fifth wave, annual equivalent inflation increased to 5.3 percent in Feb-Apr 2012. In the sixth wave, annual equivalent inflation was minus 2.4 percent in May-Jul 2012 during another bout of risk aversion causing reversal of carry trades from zero interest rates to commodity price futures exposures. In the seventh wave, annual equivalent inflation jumped to 8.7 percent in Aug 2012, 3.0 percent in Aug-Sep 2012 and 2.8 percent in Aug-Oct 2012. In the eighth wave, annual equivalent inflation was minus 2.4 percent in Nov 2012 and minus 1.6 percent in Nov 2012 to Jan 2013. In the ninth wave, annual equivalent inflation was 6.8 percent in Feb-Mar 2013. In the tenth wave, annual equivalent inflation was minus 1.2 percent in Apr because of reversal of commodity carry trades. In the eleventh wave, annual equivalent inflation was 1.8 percent in May-Jun 2013. In the twelfth wave, annual equivalent inflation was minus 3.5 percent in Jul 2013. In the thirteenth wave, annual equivalent inflation returned at 6.2 percent in Aug 2013. In the fourteenth wave, annual equivalent inflation was minus 2.4 percent in Sep 2013.

Table IV-13, France, Consumer Price Index, Month and 12-Month ∆%

	Month ∆%	12-Month ∆%
Sep 2013	-0.2	0.9
AE ∆% Sep	-2.4
Aug	0.5	0.9
AE ∆% Aug	6.2
Jul	-0.3	1.1
AE ∆% Jul	-3.5
Jun	0.2	0.9
May	0.1	0.8
AE ∆% May-Jun	1.8
Apr	-0.1	0.7
AE ∆% Apr	-1.2
Mar	0.8	1.0
Feb	0.3	1.0
AE ∆% Feb-Mar	6.8
Jan	-0.5	1.2
Dec 2012	0.3	1.3
Nov	-0.2	1.4
AE ∆% Nov-Jan	-1.6
Oct	0.2	1.9
Sep	-0.2	1.9
Aug	0.7	2.1
AE ∆% Aug-Oct	2.8
Jul	-0.5	1.9
Jun	0.0	1.9
May	-0.1	2.0
AE ∆% May-Jul	-2.4
Apr	0.1	2.1
Mar	0.8	2.3
Feb	0.4	2.3
AE ∆% Feb-Apr	5.3
Jan	-0.4	2.4
Dec 2011	0.4	2.5
AE ∆% Dec-Jan	0.0
Nov	0.3	2.5
Oct	0.3	2.4
Sep	-0.1	2.2
Aug	0.5	2.2
AE ∆% Aug-Nov	3.0
Jul	-0.5	1.9
Jun	0.1	2.1
May	0.1	2.0
AE ∆% May-Jul	-1.2
Apr	0.3	2.1
Mar	0.8	2.0
Feb	0.5	1.6
Jan	-0.2	1.8
AE ∆% Jan-Apr	4.3
Dec 2010	0.4	1.8
Annual
2012		2.0
2011		2.1
2010		1.5
2009		0.1
2008		2.8
2007		1.5
2006		1.6
2005		1.8
2004		2.1
2003		2.1
2002		1.9
2001		1.7
2000		1.7
1999		0.5
1998		0.7
1997		1.2
1996		2.0
1995		1.8
1994		1.6
1993		2.1
1992		2.4
1991		3.2

AE: Annual Equivalent Metropolitan France

Source: Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20131015

Chart IV-6 of Institut National de la Statistique et des Études Économiques provides the consumer price index in France since Jan 1998. There is the same jump and decline of inflation during the global recession from 2008 to 2009 caused by carry trades from zero interest rates into commodity exposures. The index also captures the waves of inflation around an upward trend.

Chart IV-6, France, Consumer Price Index, Jan 1998-Sep 2013, 1998=100

Source: Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20131015

Table IV-14 provides consumer price inflation in France and of various items in Sep 2013 and in the 12 months ending in Sep 2013. Inflation of all items was minus 0.2 percent in Sep 2013 and 0.9 percent in 12 months. Energy prices increased 0.8 percent in Sep 2013 and increased 0.7 percent in 12 months. Transport and communications decreased 1.9 percent in Sep 2013 and fell 1.3 percent in 12 months. Food and rentals and dwellings show higher 12-month increases of 1.1 percent and 1.8 percent, respectively, with energy increasing 0.7 percent in 12 months. Services fell 1.2 percent in Sep 2013 and increased 1.4 percent in 12 months.

Table IV-14, France, Consumer Price Index, Month and 12-Month Percentage Changes of Index and Components, ∆%

Sep 2013	Weights	Month ∆%	12-Month ∆%
All Items	10000	-0.2	0.9
Food	1658	-0.5	1.1
Manufactured Products	2738	1.3	-0.7
Energy	822	0.8	0.7
Petroleum Products	495	1.4	-2.5
Services	4576	-1.2	1.4
Rentals, Dwellings	748	0.1	1.8
Transport and Communications	506	-1.9	-1.3

Source: Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20131015

Chart IV-7 of the Institut National de la Statistique et des Études Économiques (INSEE) of France shows headline and core consumer price inflation of France. Inflation rose during the commodity price shock of unconventional monetary policy. Risk aversion in late 2008 and beginning of 2009 caused collapse of valuation of commodity futures with resulting decline in inflation. The current downward trend of inflation originates in concentration of carry trades in equities and high-yield bonds with reversal of exposures in commodities.

Chart IV-7, France, Consumer Price Index (IPC) and Core Consumer Price Index (ISJ) 12 Months Rates of Change

Source: Institut National de la Statistique et des Études Économiques

http://www.insee.fr/en/themes/info-rapide.asp?id=29&date=20131015

Inflation in the UK is somewhat higher than in many advanced economies, deserving more detailed analysis. Table IV-15 provides 12-month percentage changes of UK output prices for all manufactured products, excluding food, beverage and petroleum and excluding duty. The 12-month rates rose significantly in 2011 in all three categories, reaching 6.3 percent for all manufactured products in Sep 2011 but declining to 5.7 percent in Oct 2011, 5.4 percent in Nov 2011 and down to 1.8 percent in Jul 2012. Inflation of all manufactured products increased marginally to 2.3 percent in Aug 2012, 2.5 percent in Sep, 2.6 in Oct, 2.1 percent in Nov-Jan 2012, 2.3 percent in Feb 2013, 1.9 percent in Mar 2013 and 1.0 percent in Apr 2013. Output prices increased 1.2 percent in the 12 months ending in May 2013, 2.0 percent in Jun 2013 and 2.1 percent in Jul 2013. Output price inflation was 1.7 percent in the 12 months ending in Aug 2013 and 1.2 percent in the 12 months ending in Sep 2013. Output price inflation is highly sensitive to commodity prices as shown by the increase by 6.7 percent in 2008 when oil prices rose over $140/barrel even in the midst of a global recession driven by the carry trade from zero interest rates to oil futures. The mirage episode of false deflation in 2001 and 2002 is also captured by output prices for the UK, which originated in decline of commodity prices (see Barsky and Killian 2004) but was used as an argument for unconventional monetary policy of zero interest rates and quantitative easing during the past decade.

Table IV-15, UK Output Prices 12 Months ∆% NSA

	All Manufactured Products	Excluding Food, Beverage, Tobacco and Petroleum	All Excluding Duty
Sep 2013	1.2	0.7	1.3
Aug	1.7	1.0	1.8
Jul	2.1	1.1	2.2
Jun	2.0	0.9	2.0
May	1.2	0.8	1.4
Apr	1.0	0.7	1.1
Mar	1.9	1.3	1.7
Feb	2.3	1.3	2.1
Jan	2.1	1.4	1.9
Dec 2012	2.1	1.5	1.8
Nov	2.1	1.4	1.8
Oct	2.6	1.4	2.3
Sep	2.5	1.2	2.2
Aug	2.3	1.2	1.9
Jul	1.8	1.2	1.5
Jun	2.0	1.7	1.7
May	2.8	2.1	2.5
Apr	3.3	2.3	3.1
Mar	3.7	2.5	3.5
Feb	4.1	3.0	4.1
Jan	4.0	2.4	4.0
Dec 2011	4.8	3.0	4.8
Nov	5.4	3.1	5.6
Oct	5.7	3.3	5.9
Sep	6.3	3.7	6.4
Aug	6.0	3.5	6.2
Jul	6.1	3.4	6.2
Jun	5.8	3.2	5.9
May	5.4	3.4	5.5
Apr	5.6	3.6	5.8
Mar	5.6	3.1	5.5
Feb	5.3	3.1	5.2
Jan	5.0	3.3	5.0
Dec 2010	4.2	2.7	4.0
Year ∆%
2012	2.8	1.8	2.5
2011	5.6	3.4	5.7
2010	4.2	3.0	3.9
2009	1.6	2.5	1.0
2008	6.7	3.7	6.7
2007	2.4	1.4	2.1
2006	2.0	1.5	2.0
2005	1.9	1.0	1.9
2004	1.0	-0.3	0.6
2003	0.6	0.1	0.5
2002	-0.1	-0.4	-0.1
2001	-0.3	-0.6	-0.3
2000	1.4	-0.5	0.8
1999	0.6	-1.0	-0.3
1998	0.0	-0.9	-0.9
1997	0.9	0.3	0.1

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/september-2013/index.html

Monthly and annual equivalent rates of change of output prices are shown in Table IV-16. There are waves of inflation similar to those in other countries (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html). In the first wave, annual equivalent inflation was 12.0 percent in Jan-Apr 2011 with relaxed risk aversion in commodity markets. In the second wave, intermittent risk aversion resulted in annual equivalent inflation of 2.0 percent in May-Oct 2011. In the third wave, alternation of risk aversion resulted in annual equivalent inflation of 1.6 percent in Nov 2011 to Jan 2012. In the fourth wave, the energy commodity shock processed through carry trades caused the jump of annual equivalent inflation to 7.9 percent in Feb-Apr 2012. A fifth wave occurred in May-Jun 2012 with decline of output inflation by 5.3 percent annual equivalent in an environment of risk aversion that caused decline of commodity prices. A sixth wave under commodity shocks induced by carry trades from zero interest rates resulted in annual equivalent inflation of 4.5 percent in Jul-Sep 2012 and 4.0 percent in Jul-Oct 2012. In the seventh wave, annual equivalent inflation in Nov-Dec 2012 fell to minus 3.0 percent. In the eighth wave, annual equivalent inflation returned at 5.3 percent in Jan-Mar 2013. In the ninth wave, risk aversion returned with annual equivalent inflation of minus 1.8 percent in Apr-May 2013. In the tenth wave, annual equivalent inflation was 2.0 percent in Jun-Aug 2013. In the eleventh wave, annual equivalent inflation was minus 1.2 percent in Sep 2013.

Table IV-16, UK Output Prices Month ∆% NSA

	All Manufactured Products	Excluding Food, Beverage and Petroleum	All Excluding Duty
Sep 2013	-0.1	-0.1	0.0
∆% AE Sep	-1.2	-1.2	0.0
Aug	0.2	0.0	0.2
Jul	0.2	0.1	0.3
Jun	0.1	-0.1	0.0
∆% AE Jun-Aug	2.0	0.0	2.0
May	-0.1	0.1	-0.1
Apr	-0.2	0.0	-0.2
∆% AE Apr-May	-1.8	0.6	-1.8
Mar	0.2	0.1	0.2
Feb	0.7	0.3	0.8
Jan	0.4	0.3	0.4
∆% AE Jan-Mar	5.3	2.8	5.7
Dec 2012	-0.2	0.0	-0.2
Nov	-0.3	-0.1	-0.2
∆% AE Nov-Dec	-3.0	-0.6	-2.4
Oct	0.2	0.1	0.2
Sep	0.5	0.3	0.5
Aug	0.5	0.1	0.6
Jul	0.1	-0.1	0.1
∆% AE Jul-Oct	4.0	1.2	4.3
Jun	-0.6	-0.2	-0.6
May	-0.3	-0.1	-0.4
∆% AE May-Jun	-5.3	-1.8	-5.8
Apr	0.7	0.6	0.5
Mar	0.6	0.1	0.5
Feb	0.6	0.5	0.6
∆% AE Feb-Apr	7.9	4.9	6.6
Jan	0.4	0.3	0.3
Dec 2011	-0.2	-0.1	-0.2
Nov	0.2	-0.1	0.2
∆% AE Nov-Jan	1.6	0.4	1.2
Oct	0.0	-0.1	0.1
Sep	0.3	0.3	0.2
Aug	0.0	0.1	0.1
Jul	0.3	0.4	0.3
Jun	0.2	0.2	0.2
May	0.2	0.2	0.2
∆% AE May-Oct	2.0	2.2	2.2
Apr	1.1	0.8	0.9
Mar	1.1	0.5	1.1
Feb	0.5	0.0	0.5
Jan	1.1	0.8	1.1
Jan-Apr ∆% AE	12.0	6.5	11.4
Dec 2010	0.5	0.0	0.6

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/september-2013/index.html

Input prices in the UK have been more dynamic than output prices until the current event of risk aversion, as shown by Table IV-17, but with sharp oscillations because of the commodity and raw material content. The 12-month rates of increase of input prices, even excluding food, tobacco, beverages and petroleum, are very high, reaching 18.1 percent in Sep 2011 for materials and fuels purchased and 13.3 percent excluding food, beverages and petroleum. Inflation in 12 months of materials and fuels purchased moderated to 5.4 percent in Mar 2012 and 4.1 percent excluding food, tobacco, beverages and petroleum with the rates falling further in Apr 2012 to 1.1 percent for materials and fuels purchased and 2.2 percent excluding food, tobacco, beverages and petroleum. Input-price inflation collapsed in the 12 months ending in Jul 2012 to minus 2.6 percent for materials and fuels purchased and minus 1.5 percent excluding food, beverages and tobacco. Inflation returned at 1.2 percent in the 12 months ending in Aug 2012 but minus 0.5 percent excluding food, tobacco, beverages and petroleum. Inflation of input prices in Sep 2012 was minus 0.8 percent and minus 0.8 percent excluding food, beverages and petroleum. In Nov 2012, inflation of input prices of all manufacturing and materials purchased was minus 0.1 percent in 12 months and minus 0.2 percent in 12 months excluding food, tobacco, beverages and petroleum. Inflation of materials and fuels purchased in 12 months was 0.6 percent in Dec 2012 and 0.1 percent excluding tobacco, beverages and petroleum. Inflation of inputs returned with 1.9 percent in the 12 months ending in Jan 2013 and 0.7 percent excluding various items, increasing to 2.2 percent in Feb 2013 and 1.8 percent excluding various items. In Mar 2013, inflation of all manufacturing materials and fuels increased 0.7 percent in 12 months and 2.0 percent excluding various items. Prices of all manufacturing materials and fuels fell 0.2 percent in the 12 months ending in Apr 2013 and increased 1.3 percent excluding food and other items. Prices of all manufacturing increased 1.6 percent in the 12 months ending in May 2013 and 1.4 percent excluding various items. In Jul 2013, prices of manufactured products increased 5.1 percent in 12 months and 3.9 percent excluding food, tobacco, beverages and petroleum. In Aug 2013, prices of manufactured products increased 2.4 percent in 12 months and 3.0 percent excluding items. Inflation of input prices in the 12 months ending in Sep 2013 was 1.1 percent and 1.7 percent excluding items. There is comparable experience with 22.2 percent inflation of materials and fuels purchased in 2008 and 16.9 percent excluding food, beverages and petroleum followed in 2009 by decline of 3.8 percent by materials and fuels purchased and increase of 1.6 percent for the index excluding items. UK input and output inflation is sensitive to commodity price increases driven by carry trades from zero interest rates. The mirage of false deflation is also observed in input prices in 1997-9 and then again from 2001 to 2003.

Table IV-17, UK, Input Prices 12-Month ∆% NSA

	All Manufacturing Materials and Fuels Purchased	Excluding Food, Tobacco, Beverages and Petroleum
Sep 2013	1.1	1.7
Aug	2.4	3.0
Jul	5.1	3.9
Jun	4.0	2.1
May	1.6	1.4
Apr	-0.2	1.3
Mar	0.7	2.0
Feb	2.2	1.8
Jan	1.9	0.7
Dec 2012	0.6	0.1
Nov	-0.1	-0.2
Oct	0.2	-0.4
Sep	-0.8	-0.8
Aug	1.2	-0.5
Jul	-2.6	-1.5
Jun	-2.2	-0.3
May	0.1	1.1
Apr	1.1	2.2
Mar	5.4	4.1
Feb	7.7	5.7
Jan	6.5	5.6
Dec 2011	8.9	7.2
Nov	13.8	10.2
Oct	14.5	11.0
Sep	18.1	13.3
Aug	16.3	13.0
Jul	18.5	13.3
Jun	16.8	12.6
May	16.3	11.4
Apr	17.9	12.2
Mar	14.8	10.3
Feb	14.9	10.7
Jan	14.2	10.5
Dec 2010	13.1	9.0
Year ∆%
2012	1.4	1.2
2011	15.4	11.3
2010	9.9	5.7
2009	-3.8	1.6
2008	22.2	16.9
2007	2.9	2.4
2006	9.8	7.2
2005	11.0	6.9
2004	3.3	1.6
2003	1.2	-0.6
2002	-4.4	-4.8
2001	-1.2	-1.2
2000	7.4	3.7
1999	-1.3	-3.6
1998	-9.1	-4.6
1997	-8.2	-6.3

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/september-2013/index.html

Table IV-18 provides monthly percentage changes of UK input prices for materials and fuels purchased and excluding food, tobacco, beverages and petroleum. There are strong waves of inflation of input prices in the UK similar to those worldwide (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html). In the first wave, input prices rose at the high annual equivalent rate of 35.6 percent in Jan-Apr 2011, driven by carry trades from unconventional monetary policy into commodity exposures. Inflation of input prices was at 32.8 percent annual equivalent in Oct-Dec 2010. In the second wave, alternating risk aversion caused annual equivalent inflation of minus 3.1 percent in May-Oct 2011. In the third wave, renewed risk aversion resulted in annual equivalent inflation of minus 1.2 percent in Nov-Dec 2011. In the fourth wave, annual equivalent inflation of input prices in the UK surged at 18.1 percent in Jan-Mar 2012 under relaxed risk aversion. In the fifth wave, annual equivalent inflation was minus 21.9 percent in Apr-Jun 2012 because of collapse of commodity prices during increasing risk aversion. In the sixth wave, annual equivalent inflation of materials and fuels purchased jumped to 14.0 percent in Jul-Aug 2012. In the seventh wave, annual equivalent inflation moderated to 1.5 percent in Sep-Dec 2012. In the eighth wave, annual equivalent inflation in Jan-Feb 2013 jumped to 28.3 percent. In the eighth wave, annual equivalent inflation of materials and fuels purchased was minus 11.4 percent in Mar-May 2013. In the ninth wave, annual equivalent inflation returned at 8.7 percent in annual equivalent in Jun-Jul 2013. In the tenth wave, annual equivalent inflation was minus 10.8 percent in Aug-Sep 2013.

Table IV-18, UK Input Prices Month ∆% 

	All Manufacturing Materials and Fuels Purchased NSA	Excluding Food, Tobacco, Beverages and Petroleum SA
Sep 2013	-1.2	-0.6
Aug	-0.7	0.2
∆% Aug-Sep	-10.8	-2.4
Jul	1.2	1.0
Jun	0.2	0.3
∆% Jun-Jul	8.7	8.1
May	-0.7	-0.4
Apr	-2.4	-0.5
Mar	0.1	-0.3
∆% Mar-May	-11.4	-4.7
Feb	2.8	1.6
Jan	1.4	0.4
∆% Jan-Feb	28.3	12.7
Dec 2012	0.1	-0.2
Nov	0.1	0.2
Oct	0.2	0.1
Sep	0.1	0.3
∆% Sep-Dec	1.5	1.2
Aug	2.0	1.1
Jul	0.2	-0.5
∆% Jul-Aug	14.0	3.6
Jun	-2.1	-0.3
May	-2.6	-0.8
Apr	-1.4	0.1
∆% Apr-Jun	-21.9	-3.9
Mar	1.6	-0.5
Feb	2.5	0.7
Jan	0.1	-0.1
∆% AE Jan-Mar	18.1	0.4
Dec 2011	-0.6	-0.7
Nov	0.4	0.1
∆% AE Nov-Dec	-1.2	-3.6
Oct	-0.8	-0.5
Sep	2.1	0.6
Aug	-1.9	0.1
Jul	0.6	0.9
Jun	0.1	1.0
May	-1.6	-0.1
∆% AE May-Oct	-3.1	4.1
Apr	2.8	2.0
Mar	3.8	1.0
Feb	1.4	1.0
Jan	2.3	1.5
∆% AE Jan-Apr	35.6	17.8
Dec 2010	3.9	1.9
Nov	0.9	0.9
Oct	2.4	1.5
∆% AE Oct-Dec	32.8	18.6

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/september-2013/index.html

The UK Office for National Statistics also provides contributions in percentage points to the monthly and 12-month rates of inflation of manufactured products, shown in Table IV-19. There are high contributions to 12-month percentage changes of 0.63 percentage points by food products, 0.27 percentage points by tobacco and alcohol, 0.08 percentage points by computer, electrical and optical and 0.20 percentage points by other manufactured products. There are diversified sources of contributions to 12 months output price inflation such as 0.08 percentage points by clothing, textile and leather and 0.11 percentage points by transport equipment. Petroleum deducted 0.17 percentage points. In general, contributions by products rich in commodities are the drivers of price changes. There were diversified contributions in percentage points to monthly inflation: 0.20 percentage points by petroleum and 0.04 percentage points by paper and printing.

Table IV-19, UK, Contributions to Month and 12-Month Change in Prices of All Manufactured Products, Percentage Points, NSA

Sep 2013	12 Months % Points	12 Months ∆%	Month  % Points	Month ∆%
Total %		1.2		-0.1
Food Products	0.63	3.9	0.00	0.0
Tobacco & Alcohol	0.27	2.4	-0.11	-0.2
Clothing, Textile & Leather	0.08	0.8	0.02	0.1
Paper and Printing	0.01	0.4	0.04	0.3
Petroleum	-0.17	-1.4	0.20	0.3
Chemicals & Pharmaceutical	-0.04	-0.4	-0.07	-0.2
Metal, Machinery & Equipment	0.02	0.6	-0.01	-0.1
Computer, Electrical & Optical	0.08	0.9	-0.17	-0.3
Transport Equipment	0.11	1.1	-0.07	-0.2
Other Manufactured Products	0.20	1.1	0.07	0.0

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/september-2013/index.html

The UK Office for National Statistics also provides contributions in percentage points to the monthly and 12-month rates of inflation of input prices in Sep 2013, shown in Table IV-20. Crude oil is a large factor with contribution of 0.00 percentage points to the 12-month rate and deduction of 0.52 percentage points to the monthly rate in Sep 2013. Price changes also transfer to the domestic economy through the prices of imported inputs: imported metals deducted 0.42 percentage points from the 12-month rate and 0.13 percentage points from the Sep rate. Domestic food materials added 0.05 percentage points to the 12-month rate and deducted 0.07 percentage points from the Sep rate. Exposures and reversals of commodity exposures in carry trades during risk aversion are a major source of financial instability.

Table IV-20, UK, Contributions to Month and 12-Month Change in Prices of Inputs, Percentage Points NSA

Sep 2013	12 Months % Points	12 Months ∆%	Month % Points	Month ∆%
Total		1.1		-1.2
Fuel	0.58	5.9	0.03	0.4
Crude Oil	0.00	0.0	-0.52	-1.9
Domestic Food Materials	0.05	0.4	-0.07	-0.7
Imported Food Materials	0.19	3.4	-0.09	-1.5
Other Domestic Produced Materials	0.01	0.2	0.01	0.3
Imported Metals	-0.42	-5.5	-0.13	-1.9
Imported Chemicals	0.14	1.3	-0.08	-0.7
Imported Parts and Equipment	0.30	1.9	-0.18	-1.2
Other Imported Materials	0.25	2.5	-0.17	-1.7

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/september-2013/index.html

Consumer price inflation in the UK is shown in Table IV-21. The CPI index increased 0.4 percent in Sep 2013 and increased 2.7 percent in 12 months. The same inflation waves (Section I and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html) are present in UK CPI inflation. In the first wave in Jan-Apr 2011, annual equivalent inflation was at a high 6.5 percent. In the second wave in May-Jul 2011, annual equivalent inflation fell to only 0.4 percent. In the third wave in Aug-Nov 2011, annual equivalent inflation returned at 4.6 percent. In the fourth wave in Dec 2011 to Jan 2012, annual equivalent inflation was minus 0.6 percent because of decline of 0.5 percent in Jan 2012. In the fifth wave, annual equivalent inflation increased to 6.2 percent in Feb-Apr 2012. In the seventh wave, annual equivalent inflation was minus 3.0 percent in May-Jun 2012. In the eighth wave, annual equivalent inflation in Jul-Dec 2012 was 4.5 percent and 6.2 percent in Oct 2012 with the rate in Oct caused mostly by increases in university tuition payments. In the ninth wave, annual equivalent inflation was minus 5.8 percent in Jan 2013. In the tenth wave, annual equivalent inflation jumped to 4.3 percent in Feb-May 2013. In the eleventh wave, annual equivalent inflation was minus 1.2 percent in Jun-Jul 2013. In the twelfth wave, annual equivalent inflation was 4.9 percent in Aug-Sep 2013.

Table IV-21, UK, Consumer Price Index All Items, Month and 12-Month ∆%

	Month ∆%	12 Months ∆%
Sep 2013	0.4	2.7
Aug	0.4	2.7
AE ∆% Aug-Sep	4.9
Jul	0.0	2.8
Jun	-0.2	2.9
AE ∆% Jun-Jul	-1.2
May	0.2	2.7
Apr	0.2	2.4
Mar	0.3	2.8
Feb	0.7	2.8
AE ∆% Feb-May	4.3
Jan 2013	-0.5	2.7
AE ∆% Jan	-5.8
Dec 2012	0.5	2.7
Nov	0.2	2.7
Oct	0.5	2.7
Sep	0.4	2.2
Aug	0.5	2.5
Jul	0.1	2.6
AE ∆% Jul-Dec	4.5
Jun	-0.4	2.4
May	-0.1	2.8
AE ∆% May-Jun	-3.0
Apr	0.6	3.0
Mar	0.3	3.5
Feb	0.6	3.4
AE ∆% Feb-Apr	6.2
Jan	-0.5	3.6
Dec 2011	0.4	4.2
AE ∆% Dec-Jan	-0.6
Nov	0.2	4.8
Oct	0.1	5.0
Sep	0.6	5.2
Aug	0.6	4.5
AE ∆% Aug-Nov	4.6
Jul	0.0	4.4
Jun	-0.1	4.2
May	0.2	4.5
May-Jul	0.4
Apr	1.0	4.5
Mar	0.3	4.0
Feb	0.7	4.4
Jan	0.1	4.0
AE ∆% Jan-Apr	6.5
Dec 2010	1.0	3.7
Nov	0.4	3.3
Oct	0.3	3.2
Sep	0.0	3.1
Aug	0.5	3.1
Jul	-0.2	3.1
Jun	0.1	3.2
May	0.2	3.4
Apr	0.6	3.7
Mar	0.6	3.4
Feb	0.4	3.0
Jan	-0.2	3.5

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/september-2013/index.html

Inflation has been unusually high in the UK since 2006, as shown in Table IV-22. There were no rates of inflation close to 2.0 percent in the period from 1997 to 2004. Inflation has exceeded 2 percent since 2005, reaching 3.6 percent in 2008, 3.3 percent in 2010, 4.5 percent in 2011 and 2.8 percent in 2012.

Table IV-22, UK, Consumer Price Index, Annual ∆%

	Annual
	change
2005=100
1997	1.8
1998	1.6
1999	1.3
2000	0.8
2001	1.2
2002	1.3
2003	1.4
2004	1.3
2005	2.1
2006	2.3
2007	2.3
2008	3.6
2009	2.2
2010	3.3
2011	4.5
2012	2.8

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/september-2013/index.html

Table IV-23 provides the analysis of inflation in Sep 2013 by the UK Office for National Statistics. In the rate of 0.4 percent for Sep, clothing and footwear added 0.29 percentage points, furniture and household goods added 0.01 percentage points and transport deducted 0.20 percentage points. Contributions of percentage points to the 12-month rate of consumer price inflation of 2.7 percent are in the second column in Table IV-17. Food and nonalcoholic beverages added 0.47 percentage points, alcohol and tobacco added 0.24 percentage points, housing and household goods added 0.59 percentage points and transport added 0.17 percentage points.

Table IV-23, UK, Consumer Price Index Month and Twelve-month Percentage Point Contributions to Change by Components

Sep 2013	Percentage Point Contribution 12 M Sep	Percentage Point Contribution Sep
CPI All Items ∆%	2.7	0.4
Food & Non-Alcoholic Beverages	0.47	0.01
Alcohol & Tobacco	0.24	0.02
Clothing & Footwear	0.10	0.29
Housing & Household Services	0.59	0.01
Furniture & Household Goods	0.05	0.01
Health	0.07	0.01
Transport	0.17	-0.20
Communication	0.08	0.00
Recreation & Culture	0.12	0.08
Education	0.40	0.04
Restaurants & Hotels	0.30	0.05
Miscellaneous Goods & Services	0.09	0.03
Rounding Effects	0.02	0.05

Note: there are rounding effects in contributions

Source: UK Office for National Statistics

http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/september-2013/index.html

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