CMP Associates Regulation Blog

There is additional information of the report of new house sales in Table IIB-2. The stock of unsold houses fell from rates of 6 to 7 percent of sales in 2011 to 4 to 5 percent in 2013 and 4.8 percent in Aug 2014. Robbie Whelan and Conor Dougherty, writing on “Builders fuel home sale rise,” on Feb 26, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324338604578327982067761860.html), find that inventories of houses have declined as investors acquire distressed houses of higher quality. Median and average house prices oscillate. In Aug 2014, median prices of new houses sold not seasonally adjusted (NSA) decreased 1.6 percent after decreasing 1.1 percent in Jul 2014. Average prices increased 0.8 percent in Aug 2014 and increased 3.3 percent in Jul 2014. Between Dec 2010 and Aug 2014, median prices increased 14.3 percent, partly concentrated in increases of 4.4 percent in May 2014 and 5.2 percent in Mar 2014. Average prices increased 19.3 percent between Dec 2010 and Aug 2014, with increase of 0.8 percent in Aug 2014. Between Dec 2010 and Dec 2012, median prices increased 7.1 percent and average prices increased 2.6 percent. Price increases concentrated in 2012 with increase of median prices of 18.2 percent from Dec 2011 to Dec 2012 and of average prices of 13.8 percent. Median prices increased 6.7 percent from Dec 2012 to Aug 2014, with decrease of 1.6 percent in Aug 2014, while average prices increased 16.3 percent, with increase of 0.8 percent in Aug 2014. Robbie Whelan, writing on “New homes hit record as builders cap supply,” on May 24, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323475304578500973445311276.html?mod=WSJ_economy_LeftTopHighlights), finds that homebuilders are continuing to restrict the number of new homes for sale. Restriction of available new homes for sale increases prices paid by buyers.

Table IIB-2, US, New House Stocks and Median and Average New Homes Sales Price

	Unsold* Stocks in Equiv. Months of Sales SA %	Median New House Sales Price USD NSA	Month ∆%	Average New House Sales Price USD NSA	Month ∆%
Aug 2014	4.8	275,600	-1.6	347,900	0.8
Jul	5.6	280,100	-1.1	345,100	3.3
Jun	5.6	283,100	-1.2	334,100	3.3
May	5.0	286,600	4.4	323,500	-0.5
Apr	5.5	274,500	-2.8	325,100	-1.9
Mar	5.7	282,300	5.2	331,500	1.7
Feb	5.2	268,400	-0.5	325,900	-3.4
Jan	5.0	269,800	-2.1	337,300	5.0
Dec 2013	5.1	275,500	-0.6	321,200	-4.3
Nov	5.0	277,100	4.8	335,600	0.0
Oct	4.9	264,300	-2.0	335,700	4.4
Sep	5.5	269,800	5.7	321,400	3.4
Aug	5.5	255,300	-2.6	310,800	-5.8
Jul	5.6	262,200	0.9	329,900	7.8
Jun	4.2	259,800	-1.5	306,100	-2.5
May	4.5	263,700	-5.6	314,000	-6.8
Apr	4.3	279,300	8.5	337,000	12.3
Mar	4.2	257,500	-2.9	300,200	-3.9
Feb	4.1	265,100	5.4	312,500	1.8
Jan	3.9	251,500	-2.6	306,900	2.6
Dec 2012	4.5	258,300	5.4	299,200	2.9
Nov	4.6	245,000	-0.9	290,700	1.9
Oct	4.9	247,200	-2.9	285,400	-4.1
Sep	4.5	254,600	0.6	297,700	-2.6
Aug	4.6	253,200	6.7	305,500	8.2
Jul	4.6	237,400	2.1	282,300	3.9
Jun	4.8	232,600	-2.8	271,800	-3.2
May	4.7	239,200	1.2	280,900	-2.4
Apr	4.9	236,400	-1.4	287,900	1.5
Mar	4.9	239,800	0.0	283,600	3.5
Feb	4.8	239,900	8.2	274,000	3.1
Jan	5.3	221,700	1.4	265,700	1.1
Dec 2011	5.3	218,600	2.0	262,900	5.2
Nov	5.7	214,300	-4.7	250,000	-3.2
Oct	6.0	224,800	3.6	258,300	1.1
Sep	6.3	217,000	-1.2	255,400	-1.5
Aug	6.5	219,600	-4.5	259,300	-4.1
Jul	6.7	229,900	-4.3	270,300	-1.0
Jun	6.6	240,200	8.2	273,100	4.0
May	6.6	222,000	-1.2	262,700	-2.3
Apr	6.7	224,700	1.9	268,900	3.1
Mar	7.2	220,500	0.2	260,800	-0.8
Feb	8.1	220,100	-8.3	262,800	-4.7
Jan	7.3	240,100	-0.5	275,700	-5.5
Dec 2010	7.0	241,200	9.8	291,700	3.5

*Percent of new houses for sale relative to houses sold

Source: US Census Bureau

The depressed level of residential construction and new house sales in the US is evident in Table IIB-3 providing new house sales not seasonally adjusted in Jan-Aug of various years. Sales of new houses are virtually the same in Jan-Aug 2014 relative to Jan-Aug 2013 with increase of 2.7 percent. Sales of new houses in Jan-Aug 2014 are substantially lower than in any year between 1963 and 2014 with the exception of the years from 2009 to 2012. There are only four increases of 20.9 percent relative to Jan-Aug 2012, 46.9 percent relative to Jan-Aug 2011, 32.9 percent relative to Jan-Aug 2010 and 17.6 percent relative to Jan-Aug 2009. Sales of new houses in Jan-Aug 2014 are lower by 15.9 percent relative to Jan-Aug 2008, 46.8 percent relative to 2007, 59.4 percent relative to 2006 and 66.1 percent relative to 2005. The housing boom peaked in 2005 and 2006 when increases in fed funds rates to 5.25 percent in Jun 2006 from 1.0 percent in Jun 2004 affected subprime mortgages that were programmed for refinancing in two or three years on the expectation that price increases forever would raise home equity. Higher home equity would permit refinancing under feasible mortgages incorporating full payment of principal and interest (Gorton 2009EFM; see other references in http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Sales of new houses in Jan-Aug 2014 relative to the same period in 2004 fell 63.5 percent and 59.6 percent relative to the same period in 2003. Similar percentage declines are also observed for 2014 relative to years from 2000 to 2004. Sales of new houses in Jan-Aug 2014 fell 34.1 per cent relative to the same period in 1995. The population of the US was 179.3 million in 1960 and 281.4 million in 2000 (Hobbs and Stoops 2002, 16). Detailed historical census reports are available from the US Census Bureau at (http://www.census.gov/population/www/censusdata/hiscendata.html). The US population reached 308.7 million in 2010 (http://2010.census.gov/2010census/data/). The US population increased by 129.4 million from 1960 to 2010 or 72.2 percent. The final row of Table IIB-3 reveals catastrophic data: sales of new houses in Jan-Aug 2014 of 307 thousand units are lower by 22.7 percent relative to 341 thousand units of houses sold in Jan-Aug 1963, the first year when data become available. The civilian noninstitutional population increased from 123.360 million in Dec 1963 to 246.745 million in Dec 2013, or 100.0 percent (http://www.bls.gov/data/). The Bureau of Labor Statistics (BLS) defines the civilian noninstitutional population (http://www.bls.gov/lau/rdscnp16.htm#cnp): “The civilian noninstitutional population consists of persons 16 years of age and older residing in the 50 States and the District of Columbia who are not inmates of institutions (for example, penal and mental facilities and homes for the aged) and who are not on active duty in the Armed Forces.”

Table IIB-3, US, Sales of New Houses Not Seasonally Adjusted, Thousands and %

	Not Seasonally Adjusted Thousands
Jan-Aug 2014	307
Jan-Aug 2013	299
∆% Jan-Aug 2014/Jan-Aug 2013	2.7
Jan-Aug 2012	254
∆% Jan-Aug 2014/Jan-Aug 2012	20.9
Jan-Aug 2011	209
∆% Jan-Aug 2014/Jan-Aug 2011	46.9
Jan-Aug 2010	231
∆% Jan-Aug 2014/ Jan-Aug 2010	32.9
Jan-Aug 2009	261
∆% Jan-Aug 2014/ Jan-Aug 2009	17.6
Jan-Aug 2008	365
∆% Jan-Aug 2014/ Jan-Aug 2008	-15.9
Jan-Aug 2007	577
∆% Jan-Aug 2014/ Jan-Aug 2007	-46.8
Jan-Aug 2006	756
∆% Jan-Aug 2014/Jan-Aug 2006	-59.4
Jan-Aug 2005	906
∆% Jan-Aug 2014/Jan-Aug 2005	-66.1
Jan-Aug 2004	841
∆% Jan-Aug 2014/Jan-Aug 2004	-63.5
Jan-Aug 2003	759
∆% Jan-Aug 2014/ Jan-Aug 2003	-59.6
Jan-Aug 2002	670
∆% Jan-Aug 2014/ Jan-Aug 2002	-54.2
Jan-Aug2001	644
∆% Jan-Aug 2014/ Jan-Aug 2001	-52.3
Jan-Aug 2000	608
∆% Jan-Aug 2014/ Jan-Aug 2000	-49.5
Jan-Aug 1995	466
∆% Jan-Aug 2014/ Jan-Aug 1995	-34.1
Jan-Aug 1963	397
∆% Jan-Aug 2014/ Jan-Aug 1963	-22.7

*Computed using unrounded data

Source: US Census Bureau

Table IIB-4 provides the entire available annual series of new house sales from 1963 to 2013. The revised level of 306 thousand new houses sold in 2011 is the lowest since 560 thousand in 1963 in the 48 years of available data while the level of 368 thousand in 2012 is only higher than 323 thousand in 2010. The level of sales of new houses of 429 thousand in 2013 is the lowest from 1963 to 2009 with exception of 412 thousand in 1982. The population of the US increased 129.4 million from 179.3 million in 1960 to 308.7 million in 2010, or 72.2 percent. The civilian noninstitutional population of the US increased from 122.416 million in 1963 to 245.679 million in 2013 or 100.7 percent (http://www.bls.gov/data/). The Bureau of Labor Statistics (BLS) defines the civilian noninstitutional population (http://www.bls.gov/lau/rdscnp16.htm#cnp): “The civilian noninstitutional population consists of persons 16 years of age and older residing in the 50 States and the District of Columbia who are not inmates of institutions (for example, penal and mental facilities and homes for the aged) and who are not on active duty in the Armed Forces.”

The civilian noninstitutional population is the universe of the labor force. In fact, there is no year from 1963 to 2013 in Table IIA-4 with sales of new houses below 400 thousand with the exception of the immediately preceding years of 2009, 2010, 2011 and 2012.

Table IIB-4, US, New Houses Sold, NSA Thousands

Year	New Houses Sold Thousands
1963	560
1964	565
1965	575
1966	461
1967	487
1968	490
1969	448
1970	485
1971	656
1972	718
1973	634
1974	519
1975	549
1976	646
1977	819
1978	817
1979	709
1980	545
1981	436
1982	412
1983	623
1984	639
1985	688
1986	750
1987	671
1988	676
1989	650
1990	534
1991	509
1992	610
1993	666
1994	670
1995	667
1996	757
1997	804
1998	886
1999	880
2000	877
2001	908
2002	973
2003	1,086
2004	1,203
2005	1,283
2006	1,051
2007	776
2008	485
2009	375
2010	323
2011	306
2012	368
2013	429

Source: US Census Bureau

http://www.census.gov/briefrm/esbr/www/esbr051.html

Chart IIB-1 of the US Bureau of the Census shows the sharp decline of sales of new houses in the US. Sales rose temporarily until about mid 2010 but then declined to a lower plateau followed by increase and stability.

Chart IIB-1, US, New One-Family Houses Sold in the US, SAAR (Seasonally Adjusted Annual Rate)

Source: US Census Bureau

Percentage changes and average rates of growth of new house sales for selected periods are shown in Table IIB-5. The percentage change of new house sales from 1963 to 2013 is minus 23.4 percent. Between 1991 and 2001, sales of new houses rose 78.4 percent at the average yearly rate of 6.0 percent. Between 1995 and 2005 sales of new houses increased 92.4 percent at the yearly rate of 6.8 percent. There are similar rates in all years from 2000 to 2005. The boom in housing construction and sales began in the 1980s and 1990s. The collapse of real estate culminated several decades of housing subsidies and policies to lower mortgage rates and borrowing terms (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009b), 42-8). Sales of new houses sold in 2013 fell 35.7 percent relative to the same period in 1995 and 66.6 percent relative to 2005.

Table IIB-5, US, Percentage Change and Average Yearly Rate of Growth of Sales of New One-Family Houses

	∆%	Average Yearly % Rate
1963-2013	-23.4	NA
1991-2001	78.4	6.0
1995-2005	92.4	6.8
2000-2005	46.3	7.9
1995-2013	-35.7	NA
2000-2013	-51.1	NA
2005-2013	-66.6	NA

NA: Not Applicable

Source: US Census Bureau

Chart IIB-2 of the US Bureau of the Census provides the entire monthly sample of new houses sold in the US between Jan 1963 and Aug 2014 without seasonal adjustment. The series is almost stationary until the 1990s. There is sharp upward trend from the early 1990s to 2005-2006 after which new single-family houses sold collapse to levels below those in the beginning of the series in the 1960s.

Chart IIB-2, US, New Single-family Houses Sold, NSA, 1963-2014

Source: US Census Bureau

The available historical annual data of median and average prices of new houses sold in the US between 1963 and 2013 is provided in Table IIB-6. On a yearly basis, median and average prices reached a peak in 2007 and then fell substantially. There is recovery in 2012-2013.

Table IIB-6, US, Median and Average Prices of New Houses Sold, Annual Data

Period	Median	Average
1963	$18,000	$19,300
1964	$18,900	$20,500
1965	$20,000	$21,500
1966	$21,400	$23,300
1967	$22,700	$24,600
1968	$24,700	$26,600
1969	$25,600	$27,900
1970	$23,400	$26,600
1971	$25,200	$28,300
1972	$27,600	$30,500
1973	$32,500	$35,500
1974	$35,900	$38,900
1975	$39,300	$42,600
1976	$44,200	$48,000
1977	$48,800	$54,200
1978	$55,700	$62,500
1979	$62,900	$71,800
1980	$64,600	$76,400
1981	$68,900	$83,000
1982	$69,300	$83,900
1983	$75,300	$89,800
1984	$79,900	$97,600
1985	$84,300	$100,800
1986	$92,000	$111,900
1987	$104,500	$127,200
1988	$112,500	$138,300
1989	$120,000	$148,800
1990	$122,900	$149,800
1991	$120,000	$147,200
1992	$121,500	$144,100
1993	$126,500	$147,700
1994	$130,000	$154,500
1995	$133,900	$158,700
1996	$140,000	$166,400
1997	$146,000	$176,200
1998	$152,500	$181,900
1999	$161,000	$195,600
2000	$169,000	$207,000
2001	$175,200	$213,200
2002	$187,600	$228,700
2003	$195,000	$246,300
2004	$221,000	$274,500
2005	$240,900	$297,000
2006	$246,500	$305,900
2007	$247,900	$313,600
2008	$232,100	$292,600
2009	$216,700	$270,900
2010	$221,800	$272,900
2011	$227,200	$267,900
2012	$245,200	$292,200
2013	$268,900	$324,500

Source: US Census Bureau

Percentage changes of median and average prices of new houses sold in selected years are shown in Table IIB-7. Prices rose sharply between 2000 and 2005. In fact, prices in 2013 are higher than in 2000. Between 2006 and 2013, median prices of new houses sold increased 9.1 percent and average prices increased 6.1 percent. Between 2012 and 2013, median prices increased 9.7 percent and average prices increased 11.1 percent.

Table IIB-7, US, Percentage Change of New Houses Median and Average Prices, NSA, ∆%

	Median New Home Sales Prices ∆%	Average New Home Sales Prices ∆%
∆% 2000 to 2003	15.4	18.9
∆% 2000 to 2005	42.5	43.5
∆% 2000 to 2013	59.1	56.8
∆% 2005 to 2013	11.6	9.3
∆% 2000 to 2006	45.9	47.8
∆% 2006 to 2013	9.1	6.1
∆% 2009 to 2013	24.1	19.8
∆% 2010 to 2013	21.2	18.9
∆% 2011 to 2013	18.4	21.1
∆% 2012 to 2013	9.7	11.1

Source: US Census Bureau

Chart IIB-3 of the US Census Bureau provides the entire series of new single-family sales median prices from Jan 1963 to Jul 2014. There is long-term sharp upward trend with few declines until the current collapse. Median prices increased sharply during the Great Inflation of the 1960s and 1970s and paused during the savings and loans crisis of the late 1980s and the recession of 1991. Housing subsidies throughout the 1990s caused sharp upward trend of median new house prices that accelerated after the fed funds rate of 1 percent from 2003 to 2004. There was sharp reduction of prices after 2006 with recovery recently toward earlier prices.

Chart IIB-3, US, Median Sales Price of New Single-family Houses Sold, US Dollars, NSA, 1963-2014

Source: US Census Bureau

Chart IIB-4 of the US Census Bureau provides average prices of new houses sold from the mid-1970s to Jul 2014. There is similar behavior as with median prices of new houses sold in Chart IIB-3. The only stress occurred in price pauses during the savings and loans crisis of the late 1980s and the collapse after 2006 with recent recovery.

Chart IIB-4, US, Average Sales Price of New Single-family Houses Sold, US Dollars, NSA, 1975-2013

Source: US Census Bureau

http://www.federalreserve.gov/releases/H15/default.htm

Chart IIB-5 of the Board of Governors of the Federal Reserve System provides the rate for the 30-year conventional mortgage, the yield of the 30-year Treasury bond and the rate of the overnight federal funds rate, monthly, from 1954 to 2014. All rates decline throughout the period from the Great Inflation of the 1970s through the following Great Moderation and until currently. In Apr 1971, the fed funds rate was 4.15 percent and the conventional mortgage rate 7.31 percent. In November 2012, the fed funds rate was 0.16 percent, the yield of the 30-year Treasury 2.80 percent and the conventional mortgage rate 3.35. The final segment shows an increase in the yield of the 30-year Treasury to 3.61 percent in July 2013 with the fed funds rate at 0.09 percent and the conventional mortgage at 4.37 percent. The final data point shows marginal decrease of the conventional mortgage rate to 4.12 percent in Aug 2014 with the yield of the 30-year Treasury bond at 3.20 percent and overnight rate on fed funds at 0.09 percent. The recent increase in interest rates if sustained could affect the US real estate market. Shayndi Raice and Nick Timiraos, writing on “Banks cut as mortgage boom ends,” on Jan 9, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303754404579310940019239208), analyze the drop in mortgage applications to a 13-year low, as measured by the Mortgage Bankers Association. Nick Timiraos, writing on “Demand for home loans plunges,” on Apr 24, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304788404579522051733228402?mg=reno64-wsj), analyzes data in Inside Mortgage Finance that mortgage lending of $235 billion in IQ2014 is 58 percent lower than a year earlier and 23 percent below IVQ2013. Mortgage lending collapsed to the lowest level in 14 years. In testimony before the Committee on the Budget of the US Senate on May 8, 2004, Chair Yellen provides analysis of the current economic situation and outlook (http://www.federalreserve.gov/newsevents/testimony/yellen20140507a.htm): “One cautionary note, though, is that readings on housing activity--a sector that has been recovering since 2011--have remained disappointing so far this year and will bear watching.”

Chart IIB-5, US, Thirty-year Conventional Mortgage, Thirty-year Treasury Bond and Overnight Federal Funds Rate, Monthly, 1954-2014

Source: Board of Governors of the Federal Reserve System

Table IIB-8 provides the monthly data in Chart IIB-5 from Dec 2012 to Jun 2014. While the fed funds rate fell from 0.16 percent in Dec 2012 to 0.07 percent in Jan 2014, the yield of the constant maturity 30-year Treasury bond rose from 2.88 percent in Dec 2012 to 3.77 percent in Jan 2014 and the conventional mortgage rate increased from 3.35 percent in Dec 2012 to 4.43 percent in Jan 2014. In Aug 2014, the fed funds rate stabilized at 0.09 percent with decline to 3.20 percent of the 30-year yield and decline at 4.12 percent of the conventional mortgage rate.

Table IIB-8, US, Fed Funds Rate, Thirty Year Treasury Bond and Conventional Mortgage Rate, Monthly, Percent Per Year, Dec 2012 to Aug 2014

	Fed Funds Rate	Yield of Thirty Year Constant Maturity Bond	Conventional Mortgage Rate
2012-12	0.16	2.88	3.35
2013-01	0.14	3.08	3.41
2013-02	0.15	3.17	3.53
2013-03	0.14	3.16	3.57
2013-04	0.15	2.93	3.45
2013-05	0.11	3.11	3.54
2013-06	0.09	3.4	4.07
2013-07	0.09	3.61	4.37
2013-08	0.08	3.76	4.46
2013-09	0.08	3.79	4.49
2013-10	0.09	3.68	4.19
2013-11	0.08	3.8	4.26
2013-12	0.09	3.89	4.46
2014-01	0.07	3.77	4.43
2014-02	0.07	3.66	4.30
2014-03	0.08	3.62	4.34
2014-04	0.09	3.52	4.34
2014-05	0.09	3.39	4.19
2014-06	0.10	3.42	4.16
2014-07	0.09	3.33	4.13
2014-08	0.09	3.20	4.12

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/releases/H15/default.htm

IIB4 United States House Prices. The Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac, provides the FHFA House Price Index (HPI) that “is calculated using home sales price information from Fannie Mae and Freddie Mac-acquired mortgages” (http://fhfa.gov/webfiles/24216/q22012hpi.pdf 1). Table IIA2-1 provides the FHFA HPI for purchases only, which shows behavior similar to that of the Case-Shiller index but with lower magnitudes. House prices catapulted from 2000 to 2003, 2005 and 2006. From IIQ2000 to IIQ2006, the index for the US as a whole rose 59.5 percent, with 74.9 percent for New England, 79.0 percent for Middle Atlantic, 73.9 percent for South Atlantic but only by 31.6 percent for East South Central. Prices fell relative to 2014 for the US and all regions from 2006 with exception of increase of 3.0 percent for East South Central. Prices for the US increased 5.3 percent in IIQ2014 relative to IIQ2013 and 13.2 percent from IIQ2012 to IIQ2014. From IIQ2000 to IIQ2014, prices rose for the US and the four regions in Table IIA2-1.

Table IIA2-1, US, FHFA House Price Index Purchases Only NSA ∆%

	United States	New England	Middle Atlantic	South Atlantic	East South Central
IIQ2000 to IIQ2003	22.9	40.7	34.0	24.3	9.9
IIQ2000 to IIQ2005	48.7	71.8	66.3	57.5	21.9
IIQ2000 to IIQ2006	59.5	74.9	79.0	73.9	31.6
IIQ2005 to IIQ2014	1.5	-7.5	2.9	-2.7	11.2
IIQ2006 to IIQ2014	-5.4	-9.1	-4.4	-11.8	3.0
IIQ2007 to IIQ2014	-6.6	-7.6	-5.9	-13.6	-1.6
IIQ2011 to IIQ2014	17.0	6.4	5.1	19.0	10.3
IIQ2012 to IIQ2014	13.2	7.2	5.4	14.0	6.7
IIQ2013 to IIQ2014	5.3	3.0	2.5	5.7	2.6
IIQ2000 to IIQ2014	50.9	59.0	71.1	53.4	35.5

Source: Federal Housing Finance Agency

http://fhfa.gov/Default.aspx?Page=14

Data of the FHFA HPI for the remaining US regions are in Table IIA2-2. Behavior is not very different from that in Table IIA2-1 with the exception of East North Central. House prices in the Pacific region doubled between 2000 and 2006. Although prices of houses declined sharply from 2005 and 2006 to 2014 with exception of West South Central and West North Central, there was still appreciation relative to 2000.

Table IIA2-2, US, FHFA House Price Index Purchases Only NSA ∆%

	West South Central	West North Central	East North Central	Mountain	Pacific
IIQ2000 to IIQ2003	12.0	18.1	14.6	17.4	40.8
IIQ2000 to IIQ2005	22.4	31.7	25.1	50.7	104.8
IIQ2000 to IIQ2006	31.2	37.0	27.8	69.9	125.1
IIQ2005 to IIQ2014	28.4	5.7	-5.4	2.8	-11.0
IIQ2006 to IIQ2014	19.8	1.7	-7.4	-8.8	-19.0
IIQ2007 to IIQ2014	13.7	0.0	-10.0	-6.6	-16.8
IIQ2011 to IIQ2014	15.6	12.9	13.0	30.4	33.2
IIQ2012 to IIQ2014	11.4	9.3	9.8	21.2	27.9
IIQ2013 to IIQ2014	4.8	4.0	4.4	7.4	9.8
IIQ2000 to IIQ2014	57.2	39.3	18.4	55.0	82.2

Source: Federal Housing Finance Agency

http://fhfa.gov/Default.aspx?Page=14

Monthly and 12-month percentage changes of the FHFA House Price Index are in Table IIA2-3. Percentage monthly increases of the FHFA index were positive from Apr to Jul 2011 with exception of declines in May and Aug 2011 while 12 months percentage changes improved steadily from around minus 6 percent in Mar to May 2011 to minus 4.4 percent in Jun 2011. The FHFA house price index fell 0.5 percent in Oct 2011 and fell 3.0 percent in the 12 months ending in Oct 2011. There was significant recovery in Nov 2012 with increase in the house price index of 0.5 percent and reduction of the 12-month rate of decline to 2.2 percent. The house price index rose 0.4 percent in Dec 2011 and the 12-month percentage change improved to minus 1.3 percent. There was further improvement with revised decline of 0.2 percent in Jan 2012 and decline of the 12-month percentage change to minus 1.0 percent. The index improved to positive change of 0.3 percent in Feb 2012 and increase of 0.3 percent in the 12 months ending in Feb 2012. There was strong improvement in Mar 2012 with gain in prices of 0.9 percent and 2.3 percent in 12 months. The house price index of FHFA increased 0.6 percent in Apr 2012 and 2.9 percent in 12 months and improvement continued with increase of 0.6 percent in May 2012 and 3.8 percent in the 12 months ending in May 2012. Improvement consolidated with increase of 0.3 percent in Jun 2012 and 3.7 percent in 12 months. In Jul 2012, the house price index increased 0.1 percent and 3.7 percent in 12 months. Strong increase of 0.6 percent in Aug 2012 pulled the 12-month change to 4.3 percent. There was another increase of 0.7 percent in Oct and 5.5 percent in 12 months followed by increase of 0.5 percent in Nov 2012 and 5.5 percent in 12 months. The FHFA house price index increased 0.7 percent in Jan 2013 and 6.5 percent in 12 months. Improvement continued with increase of 0.4 percent in Apr 2013 and 7.3 percent in 12 months. In May 2013, the house price indexed increased 0.9 percent and 7.6 percent in 12 months. The FHFA house price index increased 0.6 percent in Jun 2013 and 7.9 percent in 12 months. In Jul 2013, the FHFA house price index increased 0.7 percent and 8.6 percent in 12 months. Improvement continued with increase of 0.5 percent in Aug 2013 and 8.4 percent in 12 months. In Sep 2013, the house price index increased 0.3 percent and 8.3 percent in 12 months. The house price index increased 0.5 percent in Oct 2013 and 8.1 percent in 12 months. In Nov 2013, the house price index decreased 0.1 percent and increased 7.4 percent in 12 months. The house price index rose 0.8 percent in Dec 2013 and 7.8 percent in 12 months. Improvement continued with increase of 0.34 percent in Jan 2014 and 7.4 percent in 12 months. In Feb 2014, the house price index increased 0.6 percent and 7.1 percent in 12 months. The house price index increased 0.7 percent in Mar 2014 and 6.5 percent in 12 months. In Apr 2014, the house price index increased 0.1 percent and increased 6.1 percent in 12 months. The house price index increased 0.2 percent in May 2014 and 5.4 percent in 12 months. In Jun 2014, the house price index increased 0.3 percent and 5.2 percent in 12 months. The house price index increased 0.1 percent in Jul 2014 and 4.5 percent in 12 months.

Table IIA2-3, US, FHFA House Price Index Purchases Only SA. Month and NSA 12-Month ∆%

	Month ∆% SA	12 Month ∆% NSA
Jul 2014	0.1	4.5
Jun	0.3	5.2
May	0.2	5.4
Apr	0.1	6.1
Mar	0.7	6.5
Feb	0.6	7.1
Jan	0.4	7.4
Dec 2013	0.8	7.8
Nov	-0.1	7.4
Oct	0.5	8.1
Sep	0.3	8.3
Aug	0.5	8.4
Jul	0.7	8.6
Jun	0.6	7.9
May	0.9	7.6
Apr	0.4	7.3
Mar	1.2	7.5
Feb	0.9	7.0
Jan	0.7	6.5
Dec 2012	0.5	5.6
Nov	0.5	5.5
Oct	0.7	5.5
Sep	0.4	4.2
Aug	0.6	4.3
Jul	0.1	3.7
Jun	0.3	3.7
May	0.6	3.8
Apr	0.6	2.9
Mar	0.9	2.3
Feb	0.3	0.3
Jan	-0.2	-1.0
Dec 2011	0.4	-1.3
Nov	0.5	-2.2
Oct	-0.5	-3.0
Sep	0.4	-2.4
Aug	-0.1	-3.7
Jul	0.2	-3.5
Jun	0.4	-4.4
May	-0.1	-6.0
Apr	0.1	-5.8
Mar	-1.0	-5.9
Feb	-1.0	-5.0
Jan	-0.5	-4.6
Dec 2010		-3.8
Dec 2009		-2.0
Dec 2008		-10.1
Dec 2007		-3.2
Dec 2006		2.5
Dec 2005		9.8
Dec 2004		10.2
Dec 2003		8.0
Dec 2002		7.8
Dec 2001		6.7
Dec 2000		7.2
Dec 1999		6.2
Dec 1998		5.9
Dec 1997		3.4
Dec 1996		2.8
Dec 1995		2.9
Dec 1994		2.6
Dec 1993		3.1
Dec 1992		2.4

Source: Federal Housing Finance Agency

http://www.fhfa.gov/?Page=14

The bottom part of Table IIA2-3 provides 12-month percentage changes of the FHFA house price index since 1992 when data become available for 1991. Table IIA2-4 provides percentage changes and average rates of percent change per year for various periods. Between 1992 and 2013, the FHFA house price index increased 98.1 percent at the yearly average rate of 3.3 percent. In the period 1992-2000, the FHFA house price index increased 39.4 percent at the average yearly rate of 4.2 percent. The average yearly rate of price increase accelerated to 7.5 percent in the period 2000-2003, 8.5 percent in 2000-2005 and 7.5 percent in 2000-2006. At the margin, the average rate jumped to 10.0 percent in 2003-2005 and 7.5 percent in 2003-2006. House prices measured by the FHFA house price index declined 7.8 percent between 2006 and 2013 and 5.5 percent between 2005 and 2013.

Table IIA2-4, US, FHFA House Price Index, Percentage Change and Average Rate of Percentage Change per Year, Selected Dates 1992-2013

Dec	∆%	Average ∆% per Year
1992-2013	98.1	3.3
1992-2000	39.4	4.2
2000-2003	24.2	7.5
2000-2005	50.4	8.5
2003-2005	21.1	10.0
2005-2013	-5.5	NA
2000-2006	54.2	7.5
2003-2006	24.1	7.5
2006-2013	-7.8	NA

Source: Source: Federal Housing Finance Agency

http://www.fhfa.gov/?Page=14

IIC Household Income at 1995 Levels, 45 Million in Poverty and 41 Million without Health Insurance. The objective of this section is to analyze newly released data by the US Census Bureau on income, poverty and health insurance (DeNavas-Walt, Proctor and Smith 2013, DeNavas and Proctor (2014) and Smith and Medalia 2014). This report depicts 2013 household income of the US in constant 2013 dollars regressing to the level of 1995. The number of people in poverty in the US in 2013 is 46.318 million, equivalent to 14.5 percent of the population, which is almost the same as 15.0 percent in 1982 and higher than any percentage since 17.3 percent in 1965 with exception of isolated years in the range of 15.1 to 15.2 percent. The number of people without health insurance in 2013 is 41.953 million, which is equivalent to 13.4 percent of the population. Although the economy recovered throughout 2011, 2012 and 2013, income deteriorated while poverty and lack health insurance remained stress levels. Increasing poverty and lack of health insurance challenge the social and health safety net because of a sudden jump of needs for social and health services on capacity that provide those needs that is fixed in the short run while growth of the economy requires absorbing labor input and maintaining health of the stock of human capital. Part of the explanation of the dramatically poor socio-economic indicators of the US could be explained by the sharp economic contraction from IV2007 to IIQ2009 but part originates in the worst recovery in a cyclical expansion during the postwar period (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html).

The report of the US Bureau of the Census on Income, poverty and health insurance coverage in the United States: 2013 provides highly valuable socio-economic information and analysis (DeNavas-Walt and Proctor 2014). Table IIB-1 provides years of high percentage of people below poverty in the US. Data for 2006 to 2009 are included to provide a framework of reference for the current deterioration. The series has two high points of 15.1 percent of the population in poverty in 2010 and 1993 exceeded only by 15.2 percent in 1983. The prior high numbers of poverty are found in 1960 to 1965 with 17.3 percent in 1965 and higher numbers going to 22.4 percent in 1959. The number of people in poverty in the US in 2013 was 45.318 million, which has increased by 8.858 million from 36.460 million in 2006. The fractured job market with 26.9 million unemployed or underemployed because they cannot find full-time jobs (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html) and decline of hiring by 9.1 million (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.html) prevents exit from poverty. Inflation-adjusted average weekly wages stagnated.

Table IIB-1, US, Historical High Percentage of People below Poverty, Thousands and Percent

	Total Population	Number Below Poverty	Percent Below Poverty
2013	312,965	45,318	14.5
2012	310,648	46,496	15.0
2011	308,456	46,247	15.0
2010	306,130	46,343	15.1
2009	303,820	43,569	14.3
1993	259,278	39,265	15.1
1983	231,700	35,303	15.2
1982	229,412	34,398	15.0
1965	191,413	33,185	17.3
1964	189,710	36,055	19.0
1963	187,258	36,436	19.5
1962	184,276	38,625	21.0
1961	181,277	39,628	21.9
1960	179,503	39,851	22.2
1959	176,557	39,490	22.4
Memo
2009	303,820	43,569	14.3
2008	301,041	39,829	13.2
2007	298,699	37,276	12.5
2006	296,450	36,460	12.3

Source: DeNavas-Walt, Proctor and Smith (2013), DeNavas and Proctor (2014).

Millions in poverty in the calendar year in which the recession ended and in the first calendar year after the recession are provided in Table IIB-2. There have been increases in the number of people in poverty in the first calendar years after the recessions since 1980. The brief recession of Jan to Jul 1980 experienced the highest increase in the first calendar year of 1.0 percent and 2.550 million more in poverty. In the three recessions before 1980 shown in Table IIB-2, the number of people in poverty fell in the first calendar year after the end of the recession.

Table IIB-2, US, Millions in Poverty in the Calendar Year in which Recession Ended and in the First Calendar Year after Recession, Millions and ∆%

	Millions	%	Millions	%	Change Millions	% Points
Dec 2007 to Jun 2009
2009	43.569	14.3
2010			46.343	15.1	2.774	0.8
Mar 2001 to Nov 2001
2001	32.907	11.7
2002			34.570	12.1	1.663	0.4
Jul 1990 to Mar 1991
1991	35.708	14.2
1992			38.014	14.8	2.306	0.6
Jul 1981 to Nov 1982
1982	34.398	15.0
1983			35.303	15.2	0.905	0.2
Jan 1980 to July 1980
1980	29.272	13.0
1981			31.822	14.0	2.550	1.0
Nov 1973 to Mar 1975
1975	25.877	12.3
1976			24.975	11.8	-0.902	-0.5
Dec 1960 to Nov 1970
1970	25.420	12.6
1971			25.559	12.5	-0.139	-0.1
Apr 1960 to Feb 1961
1961	39.628	21.9
1962			38.625	21.0	-1.003	-0.9

Source: DeNavas-Walt, Proctor and Smith (2013), DeNavas and Proctor (2014).

Another dramatic fact revealed by DeNavas-Walt, Proctor and Smith (2013) is the increase in the number people without health insurance shown in Table IIB-3 at 49.951 million for 2010. Approximately 16.3 percent of the US population did not have health insurance in 2010. There was marginal improvement with 47.951 million without health insurance in 2012, corresponding to 15.4 percent of the population.

Table IIB-3, US, People without Health Insurance in the Final Year of Recession and in the First Calendar Year after Recession Ended, Millions and Percent

	Millions Without Health Insurance	Percent of Population
Recession Dec 2007 to Jun 2009
2009	49.985	16.4
2010	49.951	16.3
Change/2009	0.919	-0.1 % Points
2012	47.951	15.7
Change/2009	-2.034	-0.7 % Points
Recession Mar 2001 to Nov 2001
2001	38.023	13.5
2002	39.776	13.9
Change	1.753	0.4
Recession Jul 1990 to Mar 1991
1991	35.445	14.1
1992	38.641	15.0
Change	3.196	0.9

Source: DeNavas-Walt, Proctor and Smith (2013).

The population of the US increased by 16.571 million from 296.824 million in 2006 to 311.395 million in 2013, as shown in Table IIB-4. The number uncovered by health insurance decreased by 3.261 million between 2006 and 2013. The loss of private health insurance coverage by 2.878 million from 2006 to 2013 was partially compensated by an increase in government coverage by 27.238 million.

Table IIB-4, US, Population, Private and Government Health Insurance and Uncovered by Health Insurance, Thousands and Percent, 2006-2011

	Population	Private Health Insurance	Govern- ment Health Insurance	Uncovered
2013	313,395	201,064	107,581	41,953
2012	311,116	198,812	101,493	47,951
2011	308,827	197,323	99,497	48,614
2010	306,553	196,147	95,525	49,951
2009	304,280	196,245	93,245	48,985
2008	301,483	202,626	87,586	44,780
2007	299,106	203,903	83,147	44,088
2006	296,824	203,942	80,343	45,214

Source: DeNavas-Walt, Proctor and Smith (2013), DeNavas and Proctor (2014), Smith and Medalia (2014).

Median household income in the US fell 8.0 percent from $56,436 in 2007 to $51,939 in 2013, as shown in Table IIB-5. Median income fell in all years with exception of 2013 relative to 2012. Median income fell 3.9 percent in 2012 relative to 2009 even after four years of recovery of the economy.

Table IIB-5, US, Median Household Income, 2012 Dollars and

	2013	2012	2011	2010	2009	2007
NH	122,952	122,459	121,084	119,927	117,538	116,783
MINC	51,939	51,759	51,842	52,646	54,059	56,436
∆% 2013/2007			-8.0
∆% 2013/2012			0.3
∆% 2013/2011			0.2
∆% 2013/2010			-1.3
∆% 2013/2009			-3.9

Notes: NH: Total Number of Households, Thousands; MINC: Median Income, Dollars

Source: DeNavas-Walt, Proctor and Smith (2013), DeNavas and Proctor (2014).

Numbers of households in the US, median income in constant 2013 dollars and mean income also in 2013 dollars are provided in Table IIB-6. There is a dramatic fact in Table IIB-6: inflation-adjusted median household income in the US is higher in all years from 1996 to 2012 than the $51,939 of 2013. The contraction and low rate of growth in the expansion have resulted in the destruction of the progress in household income accomplished in 18 years of technological advance and use of humans, machines and natural resources in economic activity. The median measures the center of the middle class of the US that is no better off after 18 years of efforts. There is sharp contrast with the 1980s. Rapid economic growth after the contraction from Jul 1981 to Nov 1982 (http://www.nber.org/cycles.html) resulted in an increase of household median income from $46,425 in 1983 to $52,432 in 1989, or by 12.9 percent. Another fact of Table IA-6 is that household income in 2013 of $51,939 is virtually the same as $52,432 in 1989. The typical household in the US is not better off than in 1989, which is separated from the present by 24 years of efforts.

Table IIB-6, Median and Mean Household Income in 2013 Adjusted Dollars

Year	# Households	Median Income 2013 Dollars	Mean Income 2013 Dollars
2013	122,952	51,939	72,641
2012	122,459	51,759	72,310
2011	121,084	51,842	72,166
2010	119,927	52,646	72,001
2009	117,538	54,059	73,824
2008	117,181	54,423	74,029
2007	116,783	56,436	75,957
2006	116,011	55,689	76,912
2005	114,384	55,278	75,584
2004	113,343	54,674	74,569
2003	112,000	54,865	74,812
2002	111,278	54,913	74,910
2001	109,297	55,562	76,588
2000	108,209	56,800	77,287
1999	106,434	56,895	76,524
1998	103,874	55,497	74,007
1997	102,528	53,551	71,910
1996	101,018	52,471	69,666
1995	99,627	51,719	68,204
1994	98,990	50,148	67,041
1993	97,107	49,594	65,766
1992	96,426	49,836	63,182
1991	95,669	50,249	63,253
1990	94,312	51,735	64,624
1989	93,347	52,432	66,243
1988	92,830	51,514	64,365
1987	91,124	51,121	63,575
1986	89,479	50,488	62,375
1985	88,458	48,761	60,009
1984	86,789	47,866	58,648
1983	85,407	46,425	56,463
1982	83,918	46,751	56,342
1981	83,527	46,877	56,002
1980	82,368	47,668	56,693

Source: DeNavas-Walt, Proctor and Smith (2013), DeNavas and Proctor (2014).

The percentage change in median household income and the change in number of workers with earnings in the first calendar years after recessions are provided in Table IIB-7. The first calendar year after the end of recession in 2010 is by far the worst of any such year in recessions since 1970. Household median income fell 2.6 percent from 2009 to 2010 and the number of workers with earnings fell by 1.334 million. The first calendar year 2010 after the end of recession in 2009 is the only in the recessions back to 1970 in which there was decline of the number of workers with earnings and the one with lowest increase in full-time year-round workers.

Table IIB-7, Percentage Change in Median Household Income and Change in Number of Workers with Earnings in First Calendar Years after Recessions, ∆% and Thousands

	Median Household Income ∆%	Change in Number of Workers with Earnings Thousands	Change in Full-time Year-round Workers Thousands
Recession Dec 2007 to June 2009
2010	-2.6	-1,334	192
Recession Mar 2001 to Nov 2001
2002	-1.2	470	286
Recession Jul 1990 to Mar 1991
1992	-0.8	1,692	1,468
Recession Jul 1981 to Nov 1982
1983	-0.7	1,696	2,887
Recession Jan 1980 to Jul 1980
1981	-1.7	995	362
Recession Nov 1973 to Mar 1975
1976	1.7	2,821	1,538
Recession Dec 1960 to Nov 1970
1971	-1.0	1,277	1,213

Source:

DeNavas-Walt, Proctor and Smith (2013).

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, increase of wealth of households over the business cycle by total 7.3 percent adjusted for inflation from IVQ2007 to IVQ2013 while growing at 3.1 percent per year adjusted for inflation from IVQ1945 to IVQ2013 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 Sep 19 and daily values throughout the week ending on Sep 26, 2014 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 Sep 19 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Sep 19, 2014”, first row “USD/EUR 1.2829 1.0% 0.7%,” provides the information that the US dollar (USD) appreciated 1.0 percent to USD 1.2829/EUR in the week ending on Fri Sep 19 relative to the exchange rate on Fri Sep 12 and appreciated 0.7 percent relative to Thu Sep 18. 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 fluctuating interest rates. The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.2829/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Sep 19, depreciating to USD 1.2849/EUR on Mon Sep 22, 2014, or by 0.2 percent. The dollar depreciated because more dollars, 1.2849, were required on Mon Sep 22 to buy one euro than $1.2829 on Fri Sep 19. 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 1.2829/EUR on Feb 19. 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 Sep 19, to the last business day of the current week, in this case Fri Sep 26, such as appreciation of 1.1 percent to USD 1.2683/EUR by Sep 26. The third row provides the percentage change from the prior business day to the current business day. For example, the USD appreciated (denoted by positive sign) by 1.1 percent from the rate of USD 1.2829/EUR on Fri Sep 19 to the rate of USD 1.2683/EUR on Fri Sep 26 {[(1.2683/1.2829) – 1]100 = -1.1%}. The dollar appreciated (denoted by positive sign) by 0.5 percent from the rate of USD 1.2751 on Thu Sep 25 to USD 1.2683/EUR on Fri Sep 26 {[(1.2683/1.2751) -1]100 = -0.5 %}. Other factors constant, appreciation of the dollar relative to the euro is caused by increasing risk aversion, with rising uncertainty on European and global 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 Sep 22 to Sep 26, 2014

Fri Sep

19, 2014

Mon 22

Tue 23

Wed 24

Thu 25

Fri 26

USD/ EUR

1.2829

1.0%

0.7%

1.2849

-0.2%

1.2848

-0.1%

0.0%

1.2780

0.4%

0.5%

1.2751

0.6%

0.2%

1.2683

1.1%

0.5%

JPY/ USD

109.05

-1.6%

-0.3%

108.83

0.2%

108.88

0.2%

0.0%

109.05

0.0%

-0.2%

108.76

0.3%

109.29

-0.2%

-0.5%

CHF/ USD

0.9409

-0.8%

0.9398

0.1%

0.9397

0.1%

0.0%

0.9455

-0.5%

-0.6%

0.9466

-0.6%

-0.1%

0.9514

-1.1%

-0.5%

CHF/ EUR

1.2071

0.2%

0.0%

1.2076

0.0%

1.2074

0.0%

1.2083

-0.1%

1.2070

0.0%

0.1%

1.2067

0.0%

USD/ AUD

0.8926

1.1203

-1.2%

-0.7%

0.8873

1.1270

-0.6%

0.8842

1.1310

-1.0%

-0.4%

0.8885

1.1255

-0.5%

0.5%

0.8788

1.1379

-1.6%

-1.1%

0.8766

1.1408

-1.8%

-0.3%

10Y Note

2.576

2.566

2.527

2.562

2.507

2.527

2Y Note

0.567

0.551

0.539

0.585

0.561

0.581

German Bond

2Y -0.07 10Y 1.04

2Y -0.07 10Y 1.01

2Y -0.05 10Y 1.01

2Y -0.06 10Y 1.00

2Y -0.07 10Y 0.97

DJIA

17279.74

1.7%

0.1%

17172.68

-0.6%

17055.87

-1.3%

-0.7%

17210.06

-0.4%

0.9%

16945.80

-1.9%

-1.5%

17113.15

-1.0%

1.0%

Dow Global

2604.59

0.5%

-0.2%

2582.07

-0.9%

2564.28

-1.5%

-0.7%

2575.72

-1.1%

0.4%

2546.56

-2.2%

-1.1%

2551.63

-2.0%

0.2%

DJ Asia Pacific

1497.12

-0.8%

0.3%

1486.72

-0.7%

1484.88

-0.8%

-0.1%

1484.21

-0.9%

0.0%

1487.23

-0.7%

0.2%

1473.70

-1.6%

-0.9%

Nikkei

16321.17

2.3%

1.6%

16205.90

-0.7%

16205.90

-0.7%

0.0%

16167.45

-0.9%

-0.2%

16374.14

0.3%

1.3%

16229.86

-0.6%

-0.9%

Shanghai

2329.45

-0.1%

0.6%

2289.87

-1.7%

2309.72

-0.8%

0.9%

2343.57

0.6%

1.5%

2345.10

0.7%

0.1%

2347.72

0.8%

0.1%

DAX

9799.26

1.5%

0.0%

9749.54

-0.5%

9595.03

-2.1%

-1.6%

9661.97

-1.4%

0.7%

9510.01

-3.0%

-1.6%

9490.55

-3.2%

-0.2%

DJ UBS Comm.

WTI $/B

92.41

0.2%

-0.7%

91.52

-1.0%

91.56

-0.9%

0.0%

92.80

0.4%

1.4%

92.53

0.1%

-0.3%

93.54

1.2%

1.1%

Brent $/B

98.39

1.3%

0.7%

97.70

-0.7%

96.85

-1.6%

-0.9%

96.95

-1.5%

0.1%

97.00

-1.4%

0.1%

97.00

-1.4%

0.0%

Gold $/OZ

1215.3

-1.2%

-0.8%

1216.8

0.1%

1221.0

0.5%

0.3%

1218.6

0.3%

-0.2%

1221.2

0.5%

0.2%

1214.10

-0.1%

-0.6%

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

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

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

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.

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

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

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

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). At the meeting on Sep 17, 2014, the FOMC decided additional tapering monthly bond purchases. Earlier programs are continued with an additional lower open-ended $15 billion of bond purchases per month, increasing the stock of $4,187,075 million “securities held outright” and bank reserves deposited at the Fed of $2,751,908 million (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1) (http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm):

“The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.“

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

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

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

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 as evident in the FOMC statement for Sep 17, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm):

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

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

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

How long is “considerable time”? At the press conference following the meeting on Mar 19, 2014, Chair Yellen answered a question of Jon Hilsenrath of the Wall Street Journal explaining “In particular, the Committee has endorsed the view that it anticipates that will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates. And of course on our present path, well, that's not utterly preset. We would be looking at next, next fall. So, I think that's important guidance” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140319.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”

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

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

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

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

Yellen (2014Aug22) provides comprehensive review of the theory and measurement of labor markets. Monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):

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

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

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

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

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

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

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).

Will the FOMC increase purchases of mortgage-backed securities if mortgage rates increase?

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

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

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

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

Greenspan (1996) made similar warnings:

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

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

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

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

In testimony before the Committee on the Budget of the US Senate on May 8, 2014, Chair Yellen provides analysis of the current economic situation and outlook (http://www.federalreserve.gov/newsevents/testimony/yellen20140507a.htm):

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

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

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

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

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

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

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

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

W = Y/r (10

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

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

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

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

Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σ_y and prices σ_p. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html).

There is concern of declining inflation and appreciation of the euro. In the “Introductory statement to the press conference,” on May 8, 2014, the President of the European Central Bank Mario Draghi states (http://www.ecb.europa.eu/press/pressconf/2014/html/is140508.en.html):

“We will maintain a high degree of monetary accommodation and act swiftly, if required, with further monetary policy easing. We firmly reiterate that we continue to expect the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on an overall subdued outlook for inflation extending into the medium term, given the broad-based weakness of the economy, the high degree of unutilised capacity, and subdued money and credit creation. The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation. Further information and analysis concerning the outlook for inflation and the availability of bank loans to the private sector will be available in early June.”

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

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

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

“4 September 2014 - Monetary policy decisions

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

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

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

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

On Jun 5, 2014, the European Central Bank introduced cuts in interest rates and a negative rate paid on deposits of banks (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605.en.html):

“5 June 2014 - Monetary policy decisions

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

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

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

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

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

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

The President of the European Central Bank (ECB) Mario Draghi analyzed the measures at a press conference (http://www.ecb.europa.eu/press/pressconf/2014/html/is140605.en.html).

The President of the European Central Bank (ECB) Mario Draghi reaffirmed the policy stance at the press conference following the meeting on Feb 6, 2014 (http://www.ecb.europa.eu/press/pressconf/2014/html/is140206.en.html): “As I have said several times we are willing to act and we stand ready to act. We confirmed our forward guidance, so interest rates will stay at the present or lower levels for an extended period of time.”

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 European Central Bank (ECB) lowered the policy rates on Nov 7, 2013 (http://www.ecb.europa.eu/press/pr/date/2013/html/pr131107.en.html):

“PRESS RELEASE

7 November 2013 - Monetary policy decisions

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

The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.25%, starting from the operation to be settled on 13 November 2013.
The interest rate on the marginal lending facility will be decreased by 25 basis points to 0.75%, with effect from 13 November 2013.
The interest rate on the deposit facility will remain unchanged at 0.00%.

The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.”

Mario Draghi, President of the ECB, explained as follows (http://www.ecb.europa.eu/press/pressconf/2013/html/is131107.en.html):

“Based on our regular economic and monetary analyses, we decided to lower the interest rate on the main refinancing operations of the Eurosystem by 25 basis points to 0.25% and the rate on the marginal lending facility by 25 basis points to 0.75%. The rate on the deposit facility will remain unchanged at 0.00%. These decisions are in line with our forward guidance of July 2013, given the latest indications of further diminishing underlying price pressures in the euro area over the medium term, starting from currently low annual inflation rates of below 1%. In keeping with this picture, monetary and, in particular, credit dynamics remain subdued. At the same time, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%. Such a constellation suggests that we may experience a prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on. Accordingly, our monetary policy stance will remain accommodative for as long as necessary. It will thereby also continue to assist the gradual economic recovery as reflected in confidence indicators up to October.”

The ECB decision together with the employment situation report on Fri Nov 8, 2013, influenced revaluation of the dollar. Market expectations were of relatively easier monetary policy in the euro area.

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 17,113.15 on Fr Sep 26, 2014, which is higher by 20.8 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 20.5 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs.

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

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

Greenspan (1996) made similar warnings:

In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Professor Rajan, in an interview with Kartik Goyal of Bloomberg (http://www.bloomberg.com/news/2014-01-30/rajan-warns-of-global-policy-breakdown-as-emerging-markets-slide.html), warns of breakdown of global policy coordination. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows.

Professor Ronald I. McKinnon (2013Oct27), writing on “Tapering without tears—how to end QE3,” on Oct 27, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304799404579153693500945608?KEYWORDS=Ronald+I+McKinnon), finds that the major central banks of the world have fallen into a “near-zero-interest-rate trap.” World economic conditions are weak such that exit from the zero interest rate trap could have adverse effects on production, investment and employment. The maintenance of interest rates near zero creates long-term near stagnation. The proposal of Professor McKinnon is credible, coordinated increase of policy interest rates toward 2 percent. Professor John B. Taylor at Stanford University, writing on “Economic failures cause political polarization,” on Oct 28, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303442004579121010753999086?KEYWORDS=John+B+Taylor), analyzes that excessive risks induced by near zero interest rates in 2003-2004 caused the financial crash. Monetary policy continued in similar paths during and after the global recession with resulting political polarization worldwide.

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 2.177 percent on Sep 26, 2014, and that of the ten-year sovereign bond of Italy at 2.385 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 Sep 26, 2014, the yield of the two-year Treasury increased to 0.581 percent and that of the ten-year Treasury decreased to 2.527 percent while the yield of the two-year bond of Germany stabilized at 0.07 percent and the ten-year yield decreased to 0.97 percent; and the dollar appreciated at USD 1.2683/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 2.576 percent is higher than consumer price inflation of 1.7 percent in the 12 months ending in Aug 2014 (http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2014/06/valuation-risks-world-inflation-waves.html and earlier http://cmpassocregulationblog.blogspot.com/2014/05/world-inflation-waves-squeeze-of.html) and the expectation of higher inflation if risk aversion diminishes. The one-year Treasury yield of 0.099 percent (http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3002) is well below the 12-month consumer price inflation of 1.7 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
09/26/14	0.581	2.527	-0.07	0.97	1.2683
09/19/14	0.567	2.576	-0.07	1.04	1.2829
09/12/14	0.562	2.606	-0.06	1.08	1.2965
09/05/14	0.510	2.457	-0.08	0.93	1.2952
08/29/14	0.490	2.342	-0.04	0.89	1.3133
08/22/14	0.490	2.399	0.00	0.98	1.3242
08/15/14	0.405	2.341	-0.02	0.95	1.3400
08/08/14	0.446	2.420	0.00	1.05	1.3411
08/01/14	0.470	2.497	0.02	1.13	1.3430
07/25/14	0.494	2.464	0.02	1.15	1.3431
07/18/14	0.478	2.484	0.02	1.15	1.3525
07/11/14	0.446	2.516	0.01	1.20	1.3608
07/04/14	0.502	2.641	0.02	1.26	1.3595
06/27/14	0.463	2.536	0.03	1.26	1.3649
06/20/14	0.458	2.609	0.03	1.34	1.3600
06/13/14	0.451	2.605	0.02	1.36	1.3540
06/06/14	0.405	2.598	0.05	1.35	1.3643
05/30/14	0.373	2.473	0.06	1.36	1.3632
05/23/14	0.345	2.532	0.06	1.41	1.3630
05/16/14	0.357	2.520	0.09	1.33	1.3694
05/09/14	0.385	2.624	0.13	1.45	1.3760
05/02/14	0.421	2.583	0.12	1.45	1.3873
04/25/14	0.432	2.668	0.17	1.48	1.3833
04/18/14	0.401	2.724	0.17	1.51	1.3813
04/11/14	0.357	2.628	0.16	1.50	1.3885
04/04/14	0.413	2.724	0.16	1.55	1.3704
03/28/14	0.448	2.721	0.14	1.55	1.3752
03/21/14	0.431	2.743	0.20	1.63	1.3793
03/14/14	0.340	2.654	0.15	1.54	1.3912
03/07/14	0.367	2.792	0.17	1.65	1.3877
02/28/14	0.323	2.655	0.13	1.62	1.3801
02/21/14	0.316	2.730	0.12	1.66	1.3739
02/14/14	0.313	2.743	0.11	1.68	1.3693
02/07/14	0.305	2.681	0.09	1.66	1.3635
1/31/14	0.330	2.645	0.07	1.66	1.3488
1/24/14	0.342	2.720	0.12	1.66	1.3677
1/17/14	0.373	2.818	0.17	1.75	1.3541
1/10/14	0.372	2.858	0.18	1.84	1.3670
1/3/14	0.398	2.999	0.20	1.94	1.3588
12/27/13	0.393	3.004	0.24	1.95	1.3746
12/20/13	0.377	2.891	0.22	1.87	1.3673
12/13/13	0.328	2.865	0.24	1.83	1.3742
12/6/13	0.304	2.858	0.21	1.84	1.3705
11/29/13	0.283	2.743	0.11	1.69	1.3592
11/22/13	0.280	2.746	0.13	1.74	1.3557
11/15/13	0.292	2.704	0.10	1.70	1.3497
11/8/13	0.316	2.750	0.10	1.76	1.3369
11/1/13	0.311	2.622	0.11	1.69	1.3488
10/25/13	0.305	2.507	0.18	1.75	1.3804
10/18/13	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://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

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

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

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:

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

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

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

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

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

Jon Hilsenrath, 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 Sep 25, 2014, with the one-month yield at 0.00 percent, the two-year at 0.596 percent, the ten-year at 2.52 percent, the fed funds rate at 0.09 percent and the corporate Baa bond at 4.79 percent. There is an evident increase in the yields of the 10-year Treasury constant maturity and the Moody’s Baa corporate bond with subsequent decline in wide swings of portfolio reallocations.

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-Sep 25, 2014

Note: US Recessions in shaded areas

Source: Board of Governors of the Federal Reserve System

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

Inyoung Hwang, writing on “Fed optimism spurs record bets against stock volatility,” on Aug 21, 2014, published in Bloomberg.com (http://www.bloomberg.com/news/2014-08-21/fed-optimism-spurs-record-bets-against-stock-voalitlity.html), informs that the S&P 500 is trading at 16.6 times estimated earnings, which is higher than the five-year average of 14.3 Tom Lauricella, writing on Mar 31, 2014, on “Stock investors see hints of a stronger quarter,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304157204579473513864900656?mod=WSJ_smq0314_LeadStory&mg=reno64-wsj), finds views of stronger earnings among many money managers with positive factors for equity markets in continuing low interest rates and US economic growth. There is important information in the Quarterly Markets review of the Wall Street Journal (http://online.wsj.com/public/page/quarterly-markets-review-03312014.html) for IQ2014. Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. In IQ1980, real gross private domestic investment in the US was $951.6 billion of chained 2009 dollars, growing to $1,254.6 billion in IVQ1987 or 31.8 percent. Real gross private domestic investment in the US increased 3.8 percent from $2,605.2 billion of chained 2009 dollars in IVQ2007 to $2,703.7 billion in IIQ2014, which is stagnation in comparison with growth of 31.8 percent in the comparable first twenty quarters of expansion from IQ1983 to IVQ1987. Real private fixed investment increased 0.3 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,594.5 billion in IIQ2014. Private fixed investment fell relative to IVQ2007 in all quarters preceding IIQ2014. Growth of real private investment in is mediocre for all but four quarters from IIQ2011 to IQ2012. The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Corporate profits with IVA and CCA rebounded with $37.1 billion in IIIQ2013 and $3.1 billion in IVQ2013. Corporate profits with IVA and CCA fell $201.7 billion in IIQ2014 and increased $164.1 billion in IIQ2014. In IIIQ2013, profits after tax with IVA and CCA increased $28.7 billion and decreased $24.7 billion in IVQ2013. In IQ2014, profits after tax with IVA and CCA decreased $268.6 billion. Profits after tax with IVA and CCA increased at $118.4 billion in IIQ2014. Net dividends fell at $187.0 billion in IIIQ2013 and increased at $80.6 billion in IVQ2013. Net dividends fell at $89.5 billion in IIQ2014 and fell at $0.5 billion in IIQ2014. Undistributed profits with IVA and CCA rose at $215.8 billion in IIIQ2013 and fell at $105.5 billion in IVQ2013. Undistributed profits with IVA and CCA fell $178.9 percent in IQ2014 and increased at $118.8 billion in IIQ2014. Undistributed corporate profits swelled 262.2 percent from $107.7 billion in IQ2007 to $390.1 billion in IIQ2014 and changed signs from minus $55.9 billion in current dollars in IVQ2007. Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment.

The investment decision of US business is fractured. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:

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

declines. Equally, decline in expected revenue from the stock or project, R_τ, causes decline in valuation.

There is mixed performance in equity indexes with several indexes in Table III-1 decreasing in the week ending on Sep 26, 2014, 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 1.0 percent on Sep 26, decreasing 1.0 percent in the week. Germany’s DAX decreased 0.2 percent on Sep 26 and decreased 3.2 percent in the week. Dow Global increased 0.2 percent on Sep 26 and decreased 2.0 percent in the week. Japan’s Nikkei Average decreased 0.9 percent on Sep 26 and decreased 0.6 percent in the week as the yen continues oscillating but relatively weaker and the stock market gains in expectations of success of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Dow Asia Pacific TSM decreased 0.9 percent on Sep 26 and decreased 1.6 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 2347.72 on Sep 26 for increase of 0.1 percent and increasing 0.8 percent in the week. 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 Sep 26, 2014. Table III-1 shows that WTI increased 1.2 percent in the week of Sep 26 while Brent decreased 1.4 percent in the week with turmoil in oil producing regions. Gold decreased 0.6 percent on Sep 26 and decreased 0.1 percent in the week.

Table III-2 provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the long-term refinancing operations (LTROs). Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increased from €546,747 million on Dec 31, 2010, to €879,130 million on Dec 28, 2011 and €472,263 million on Sep 19, 2014, 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 €1,033,658 million in the statement of Sep 19, 2014, with marginal reduction. There is high credit risk in these transactions with capital of only €95,312 million as analyzed by Cochrane (2012Aug31).

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

	Dec 31, 2010	Dec 28, 2011	Sep 19, 2014
1 Gold and other Receivables	367,402	419,822	334,434
2 Claims on Non Euro Area Residents Denominated in Foreign Currency	223,995	236,826	247,268
3 Claims on Euro Area Residents Denominated in Foreign Currency	26,941	95,355	26,857
4 Claims on Non-Euro Area Residents Denominated in Euro	22,592	25,982	19,871
5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro	546,747	879,130	472,263
6 Other Claims on Euro Area Credit Institutions Denominated in Euro	45,654	94,989	63,325
7 Securities of Euro Area Residents Denominated in Euro	457,427	610,629	561,395
8 General Government Debt Denominated in Euro	34,954	33,928	26,709
9 Other Assets	278,719	336,574	236,031
TOTAL ASSETS	2,004, 432	2,733,235	1,988,153
Memo Items
Sum of 5 and 7	1,004,174	1,489,759	1,033,658
Capital and Reserves	78,143	81,481	95,312

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/2014/html/fs140923.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. Growth of the Italian economy would assure that success. 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. 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 39.8 percent of the total in Jul 2014. Exports to the non-European Union area with share of 46.3 percent in Italy’s total exports are growing at minus 1.9 percent in Jan-Jul 2014 relative to Jan-Jul 2013 while those to EMU are growing at 2.8 percent.

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

Jul 2014	Exports % Share	∆% Jan-Jul 2014/ Jan-Jul 2013	Imports % Share	∆% Jan-Jul 2014/ Jan-Jul 2013
EU	53.7	3.9	55.3	0.9
EMU 18	39.8	2.8	44.3	-0.1
France	10.8	-0.9	8.4	0.5
Germany	12.4	4.5	14.7	2.7
Spain	4.4	4.7	4.5	3.2
UK	5.0	5.5	2.7	2.4
Non EU	46.3	-1.9	44.7	-4.7
Europe non EU	13.0	-9.0	12.1	-4.6
USA	6.9	9.5	3.2	7.6
China	2.5	7.9	6.4	5.0
OPEC	6.0	-7.9	8.1	-33.3
Total	100.0	1.3	100.0	-1.7

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

Source: Istituto Nazionale di Statistica

Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade surplus of €1312 million with the 17 countries of the euro zone (EMU 17) in Jul 2014 and cumulative surplus of €1657 million in Jan-Jul 2014. Depreciation to parity could permit greater competitiveness in improving the trade surplus of €3087 million in Jan-Jul 2014 with Europe non-European Union, the trade surplus of €9891 million with the US and the trade surplus with non-European Union of €7279 million in Jan-Jul 2014. There is significant rigidity in the trade deficit in Jan-Jul 2014 of €8253 million with China. There is a trade surplus of €626 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 Jul 2014 Millions of Euro	Trade Balance Cumulative Jan-Jul 2014 Millions of Euro
EU	3,312	11,209
EMU 18	1,312	1,657
France	1,245	7,473
Germany	100	-1,850
Spain	266	767
UK	1,208	6,234
Non EU	3,545	12,995
Europe non EU	1,317	3,087
USA	1,885	9,891
China	-1,510	-8,253
OPEC	163	626
Total	6,857	24,205

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

Source: Istituto Nazionale di Statistica

Growth rates of Italy’s trade and major products are in Table III-5 for the period Jan-Jul 2014 relative to Jan-Jul 2013. Growth rates of cumulative imports relative to a year earlier are negative for energy with minus 17.6 percent. Exports of durable goods grew 2.5 percent and exports of capital goods increased 3.3 percent. The higher rate of growth of exports of 1.3 percent in Jan-Jul 2014/Jan-Jul 2013 relative to that of imports of minus 1.7 percent may reflect weak demand in Italy with GDP declining during nine consecutive quarters from IIIQ2011 through IIIQ2013 together with softening commodity prices. GDP increased marginally 0.1 percent in IVQ2013 and fell 0.2 percent in IIQ2014.

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

	Exports Share %	Exports ∆% Jan-Jul 2014/ Jan-Jul 2013	Imports Share %	Imports ∆% Jan-Jul 2014/ Jan-Jul 2013
Consumer Goods	31.0	3.3	27.3	2.2
Durable	6.0	2.5	2.9	7.6
Non-Durable	25.1	3.5	24.4	1.5
Capital Goods	32.3	3.3	20.3	4.7
Inter- mediate Goods	32.3	-0.5	32.5	0.9
Energy	4.4	-15.6	19.9	-17.6
Total ex Energy	95.6	2.0	80.1	2.3
Total	100.0	1.3	100.0	-1.7

Note: % Share for 2012 total trade.

Source: Istituto Nazionale di Statistica

Table III-6 provides Italy’s trade balance by product categories in Jul 2014 and cumulative Jan-Jul 2014. Italy’s trade balance excluding energy, generated surplus of 10,845 million in Jul 2014 and €50,883 million cumulative in Jan-Jul 2014 but the energy trade balance created deficit of €3988 million in Jul 2014 and cumulative €26,679 million in Jan-Jul 2014. The overall surplus in Jul 2014 was €6857 million with cumulative surplus of €24,205 million in Jan-Jul 2014. 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

	Jul 2014	Cumulative Jan-Jul 2014
Consumer Goods	3,271	14,126
Durable	1,346	7,560
Nondurable	1,925	6,566
Capital Goods	5,946	32,193
Intermediate Goods	1,628	4,564
Energy	-3,988	-26,679
Total ex Energy	10,845	50,883
Total	6,857	24,205

Source: Istituto Nazionale di Statistica

http://www.imf.org/external/ns/cs.aspx?id=28

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/ns/cs.aspx?id=28) 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 2014.

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

	GDP 2014 USD Billions	Primary Net Lending Borrowing % GDP 2014	General Government Net Debt % GDP 2014
World	76,776
Euro Zone	13,416	-0.1	73.2
Portugal	231	0.3	119.9
Ireland	230	-0.7	103.5
Greece	249	1.5	169.3
Spain	1,415	-2.8	65.7
Major Advanced Economies G7	35,904	-2.7	87.0
United States	17,528	-3.2	82.3
UK	2,828	-3.5	84.4
Germany	3,876	1.6	52.9
France	2,886	-1.7	89.5
Japan	4,846	-6.4	137.1
Canada	1,769	-2.2	39.5
Italy	2,172	2.3	112.4
China	10,028	-2.0*	20.2**

*Net Lending/borrowing**Gross Debt

Source: IMF World Economic Outlook http://www.imf.org/external/ns/cs.aspx?id=28

The data in Table III-7 are used for some very simple calculations in Table III-8. The column “Net Debt USD Billions 2014” in Table III-8 is generated by applying the percentage in Table III-7 column “General Government Net Debt % GDP 2014” to the column “GDP 2014 USD Billions.” The total debt of France and Germany in 2014 is $4633.4 billion, as shown in row “B+C” in column “Net Debt USD Billions 2014” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $4307.7 billion, adding rows D+E+F+G+H in column “Net Debt USD billions 2014.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table I-9. 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 $8941.1 billion, which would be equivalent to 132.2 percent of their combined GDP in 2014. 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 230.7 percent if including debt of France and 164.0 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks. Analysis of fiscal stress is quite difficult without including another global recession in an economic cycle that is already mature by historical experience.

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 2014	Debt as % of Germany Plus France GDP	Debt as % of Germany GDP
A Euro Area	9,820.5
B Germany	2,050.4		$8941.1 as % of $3876 =230.7% $6358.1 as % of $3876 =164.0%
C France	2,583.0
B+C	4,633.4	GDP $6,762.0 Total Debt $8941.1 Debt/GDP: 132.2%
D Italy	2,441.3
E Spain	929.7
F Portugal	277.0
G Greece	421.6
H Ireland	238.1
Subtotal D+E+F+G+H	4,307.7

Source: calculation with IMF data IMF World Economic Outlook databank

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 Jul 2014. German exports to other European Union (EU) members are 56.3 percent of total exports in Jul 2014 and 58.3 percent in cumulative Jan-Jul 2014. Exports to the euro area are 35.1 percent of the total in Jul and 37.0 percent cumulative in Jan-Jul. Exports to third countries are 43.7 percent of the total in Jul and 41.7 percent cumulative in Jan-Jul. There is similar distribution for imports. Exports to non-euro countries are increasing 15.9 percent in the 12 months ending in Jul 2014, increasing 10.3 percent cumulative in Jan-Jul 2014 while exports to the euro area are increasing 6.2 percent in the 12 months ending in Jul 2014 and increasing 2.8 percent cumulative in Jan-Jul 2014. Exports to third countries, accounting for 43.7 percent of the total in Jul 2014, are increasing 7.2 percent in the 12 months ending in Jul 2014 and increasing 0.5 percent cumulative in Jan-Jul 2014, accounting for 41.7 percent of the cumulative total in Jan-Jul 2014. Price competitiveness through devaluation could improve export performance and growth. Economic performance in Germany is closely related to Germany’s 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 VE-9, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	Jul 2014 € Billions	Jul 12-Month ∆%	Cumulative Jan-Jul 2014 € Billions	Cumulative Jan-Jul 2014/ Jan-Jul 2013 ∆%
Total Exports	101.0	8.5	659.4	3.3
A. EU Members	56.9 % 56.3	9.6	384.2 % 58.3	5.4
Euro Area	35.5 % 35.1	6.2	244.0 % 37.0	2.8
Non-euro Area	21.4 % 21.2	15.9	140.2 % 21.3	10.3
B. Third Countries	44.1 % 43.7	7.2	275.2 % 41.7	0.5
Total Imports	77.6	1.0	536.6	2.4
C EU Members	50.4 % 64.9	2.6	351.5 % 65.5	4.0
Euro Area	34.7 % 44.7	-0.5	241.9 % 45.1	2.1
Non-euro Area	15.7 % 20.2	10.3	109.6 % 20.4	8.4
D Third Countries	27.2 % 35.1	-1.8	185.1 % 34.5	-0.5

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

Source: Statistisches Bundesamt Deutschland

https://www.destatis.de/EN/PressServices/Press/pr/2014/09/PE14_317_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	2.6	1.7	2.2 FD 1.8	6.1
Japan	-0.1	3.3	3.9	3.8
China	7.5	2.0	-1.2
UK	3.2	1.5* CPIH 1.5	-0.3 output 0.9** input -7.2	6.2
Euro Zone	0.7	0.4	-1.1	11.5
Germany	1.2	0.8	-0.7	4.9
France	0.1	0.5	-0.6	10.3
Nether-lands	0.9	0.4	-2.5	6.7
Finland	-0.1	1.2	-0.4	8.7
Belgium	1.0	0.4	-5.7	8.5
Portugal	0.8	-0.1	-0.8	14.0
Ireland	NA	0.6	0.1	11.5
Italy	-0.2	-0.2	-1.7	12.6
Greece	-0.3	-0.2	1.6	27.2
Spain	1.2	-0.5	-0.4	24.5

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/august-2014/index.html

**Core

PPI http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/august-2014/index.html Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/; country statistical sources http://www.census.gov/aboutus/stat_int.html

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 policies 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):

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 2.0 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 Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 20 quarters from IIIQ2009 to IIQ2014. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the third estimate of GDP for IIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_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 $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,294.6 billion than actual $16,010.4 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). US GDP in IIQ2014 is 12.5 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,010.4 billion in IIQ2014 or 6.8 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.

First, total nonfarm payroll employment seasonally adjusted (SA) increased 142,000 in Aug 2014 and private payroll employment increased 134,000. The average monthly number of nonfarm jobs created from Aug 2012 to Aug 2013 was 197,917 using seasonally adjusted data, while the average number of nonfarm jobs created from Aug 2013 to Aug 2014 was 206,833, or increase by 4.5 percent. The average number of private jobs created in the US from Aug 2012 to Aug 2013 was 203,917, using seasonally adjusted data, while the average from Aug 2013 to Aug 2014 was 203,167, or decrease by 0.4 percent. This blog calculates the effective labor force of the US at 162.825 million in Aug 2013 and 164.327 million in Aug 2014 (Table I-4), for growth of 1.502 million at average 125,167 per month. The difference between the average increase of 203,167 new private nonfarm jobs per month in the US from Aug 2013 to Aug 2014 and the 125,167 average monthly increase in the labor force from Aug 2013 to Aug 2014 is 78,000 monthly new jobs net of absorption of new entrants in the labor force. There are 26.904 million in job stress in the US currently. Creation of 78,000 new jobs per month net of absorption of new entrants in the labor force would require 345 months to provide jobs for the unemployed and underemployed (26.904 million divided by 78,000) or 29 years (345 divided by 12). The civilian labor force of the US in Aug 2014 not seasonally adjusted stood at 156.434 million with 9.787 million unemployed or effectively 17.680 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 164.327 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 1.1 years (1 million divided by product of 78,000 by 12, which is 936,000). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.822 million (0.05 times labor force of 156.434 million) for new net job creation of 1.965 million (9.787 million unemployed minus 7.822 million unemployed at rate of 5 percent) that at the current rate would take 2.1 years (1.965 million divided by 0.936000). Under the calculation in this blog, there are 17.680 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 164.327 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.464 million jobs net of labor force growth that at the current rate would take 10.1 years (17.680 million minus 0.05(164.327 million) = 9.464 million divided by 0.936000, 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 Aug 2014 was 146.647 million (NSA) or 0.668 million fewer people with jobs relative to the peak of 147.315 million in Jul 2007 while the civilian noninstitutional population of ages 16 years and over increased from 231.958 million in Jul 2007 to 248.229 million in Aug 2014 or by 16.271 million. The number employed fell 0.5 percent from Jul 2007 to Aug 2014 while the noninstitutional civilian population of ages of 16 years and over, or those available for work, increased 7.0 percent. The ratio of employment to population in Jul 2007 was 63.5 percent (147.315 million employment as percent of population of 231.958 million). The same ratio in Aug 2014 would result in 157.625 million jobs (0.635 multiplied by noninstitutional civilian population of 248.229 million). There are effectively 10.978 million fewer jobs in Aug 2014 than in Jul 2007, or 157.625 million minus 146.647 million. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs.

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

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

The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). There is currently population growth in the ages of 16 to 24 years but not enough job creation and discouragement of job searches for all ages (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.htmland earlier http://cmpassocregulationblog.blogspot.com/2014/08/weakening-world-economic-growth.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-risk-recovery-without-hiring.html).

Second, long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 20 quarters from IIIQ2009 to IIQ2014. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the second estimate of GDP for IIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_2nd.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,310.7 billion than actual $15,994.3 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-valuations-twenty-seven.html). US GDP in IIQ2014 is 12.6 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $15,994.3 billion in IIQ2014 or 6.7 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.

First, First, total nonfarm payroll employment seasonally adjusted (SA) increased 142,000 in Aug 2014 and private payroll employment increased 134,000. The average monthly number of nonfarm jobs created from Aug 2012 to Aug 2013 was 197,917 using seasonally adjusted data, while the average number of nonfarm jobs created from Aug 2013 to Aug 2014 was 206,833, or increase by 4.5 percent. The average number of private jobs created in the US from Aug 2012 to Aug 2013 was 203,917, using seasonally adjusted data, while the average from Aug 2013 to Aug 2014 was 203,167, or decrease by 0.4 percent. This blog calculates the effective labor force of the US at 162.825 million in Aug 2013 and 164.327 million in Aug 2014 (Table I-4), for growth of 1.502 million at average 125,167 per month. The difference between the average increase of 203,167 new private nonfarm jobs per month in the US from Aug 2013 to Aug 2014 and the 125,167 average monthly increase in the labor force from Aug 2013 to Aug 2014 is 78,000 monthly new jobs net of absorption of new entrants in the labor force. There are 26.904 million in job stress in the US currently. Creation of 78,000 new jobs per month net of absorption of new entrants in the labor force would require 345 months to provide jobs for the unemployed and underemployed (26.904 million divided by 78,000) or 29 years (345 divided by 12). The civilian labor force of the US in Aug 2014 not seasonally adjusted stood at 156.434 million with 9.787 million unemployed or effectively 17.680 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 164.327 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 1.1 years (1 million divided by product of 78,000 by 12, which is 936,000). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.822 million (0.05 times labor force of 156.434 million) for new net job creation of 1.965 million (9.787 million unemployed minus 7.822 million unemployed at rate of 5 percent) that at the current rate would take 2.1 years (1.965 million divided by 0.936000). Under the calculation in this blog, there are 17.680 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 164.327 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.464 million jobs net of labor force growth that at the current rate would take 10.1 years (17.680 million minus 0.05(164.327 million) = 9.464 million divided by 0.936000, 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 Aug 2014 was 146.647 million (NSA) or 0.668 million fewer people with jobs relative to the peak of 147.315 million in Jul 2007 while the civilian noninstitutional population of ages 16 years and over increased from 231.958 million in Jul 2007 to 248.229 million in Aug 2014 or by 16.271 million. The number employed fell 0.5 percent from Jul 2007 to Aug 2014 while the noninstitutional civilian population of ages of 16 years and over, or those available for work, increased 7.0 percent. The ratio of employment to population in Jul 2007 was 63.5 percent (147.315 million employment as percent of population of 231.958 million). The same ratio in Aug 2014 would result in 157.625 million jobs (0.635 multiplied by noninstitutional civilian population of 248.229 million). There are effectively 10.978 million fewer jobs in Aug 2014 than in Jul 2007, or 157.625 million minus 146.647 million. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs.

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

The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). There is currently population growth in the ages of 16 to 24 years but not enough job creation and discouragement of job searches for all ages (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/08/weakening-world-economic-growth.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-risk-recovery-without-hiring.html).

Second, Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 20 quarters from IIIQ2009 to IIQ2014. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the third estimate of GDP for IIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_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 $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,294.6 billion than actual $16,010.4 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). US GDP in IIQ2014 is 12.5 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,010.4 billion in IIQ2014 or 6.8 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation. The economy of the US can be summarized in growth of economic activity or GDP as fluctuating from mediocre growth of 2.5 percent on an annual basis in 2010 to 1.6 percent in 2011, 2.3 percent in 2012 and 2.2 percent in 2013. The following calculations show that actual growth is around 2.1 to 2.6 percent per year. The rate of growth of 0.9 percent in the entire cycle from 2007 to 2013 is well below 3 percent per year in trend from 1870 to 2010, which the economy of the US always attained for entire cycles in expansions after events such as wars and recessions (Lucas 2011May). Revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) provide important information on long-term growth and cyclical behavior. Table Summary provides relevant data.

Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita

	GDP
Long-Term
1929-2013	3.3
1947-2013	3.2
Whole Cycles
1980-1989	3.5
2006-2013	1.0
2007-2013	0.9
Cyclical Contractions ∆%
IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982	-4.7
IVQ2007 to IIQ2009	-4.2
Cyclical Expansions Average Annual Equivalent ∆%
IQ1983 to IVQ1985 IQ1983-IQ1986 IQ1983-IIIQ1986 IQ1983-IVQ1986 IQ1983-IQ1987 IQ1983-IIQ1987 IQ1983-IIIQ1987 IQ1983 to IVQ1987	5.9 5.7 5.4 5.2 5.0 5.0 4.9 5.0
First Four Quarters IQ1983 to IVQ1983	7.8
IIIQ2009 to IIQ2014	2.2
First Four Quarters IIIQ2009 to IIQ2010	2.7
	Real Disposable Income	Real Disposable Income per Capita
Long-Term
1929-2013	3.2	2.0
1947-1999	3.7	2.3
Whole Cycles
1980-1989	3.5	2.6
2006-2013	1.3	0.5

Source: Bureau of Economic Analysis

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

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) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace from 2.1 to 2.5 percent per year. Table Summary GDP provides the data.

1. Average Annual Growth in the Past Eight Quarters. GDP growth in the four quarters of 2012, the four quarters of 2013 and the first two quarters of 2014 accumulated to 5.4 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IIQ2014 of $16,010.4 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/10: {[($16,010.4/$15,190.3)^4/10 -1]100 = 2.1 percent.

2. Average Annual Growth in the Past Four Quarters. GDP growth in the four quarters of IIQ2013 to IIQ2014 accumulated to 2.6 percent that is equivalent to 2.6 percent in a year. This is obtained by dividing GDP in IIQ2014 of $16,010.4 billion by GDP in IIQ2013 of $15,606.6 billion and compounding by 4/4: {[($16,010.4/$15,606.6)^4/4 -1]100 = 2.6%}. The US economy grew 2.6 percent in IIQ2014 relative to the same quarter a year earlier in IIQ2013. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is in the borderline of contraction, and negative in IQ2014. US GDP fell 0.5 percent in IQ2014. The rate of growth of GDP in the revision of IIIQ2013 is 4.5 percent in seasonally adjusted annual rate (SAAR). Inventory accumulation contributed 1.49 percentage points to this rate of growth. The actual rate without this impulse of unsold inventories would have been 3.0 percent, or 0.74 percent in IIIQ2013, such that annual equivalent growth in 2013 is closer to 2.8 percent {[(1.007)(1.004)(1.0074)(1.009)^4/4-1]100 = 2.8%}, compounding the quarterly rates and converting into annual equivalent. Inventory divestment deducted 1.16 percentage points from GDP growth in IQ2014. Without this deduction of inventory divestment, GDP growth would have been minus 0.9 percent in IQ2014, such that the actual growth rates in the four quarters ending in IQ2014 is closer to 2.2 percent {[(1.004)(1.011)(1.009)(0.9977)]^4/4 -1]100 = 2.2%}.

Table Summary GDP, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2005 Dollars and ∆%

	Real GDP, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	14,991.8	NA	NA	1.9
IVQ2011	15,190.3	1.3	1.1	1.7
IQ2012	15,275.0	1.9	0.6	2.6
IIQ2012	15,336.7	2.3	0.4	2.3
IIIQ2012	15,431.3	2.9	0.6	2.7
IVQ2012	15,433.7	2.9	0.0	1.6
IQ2013	15,538.4	3.6	0.7	1.7
IIQ2013	15,606.6	4.1	0.4	1.8
IIIQ2013	15,779.9	5.3	1.1	2.3
IVQ2013	15,916.2	6.2	0.9	3.1
IQ2014	15,831.7	5.6	-0.5	1.9
IIQ2014	16,010.4	6.8	1.1	2.6
Cumulative ∆% IQ2012 to IQ2014	5.4		5.4
Annual Equivalent ∆%	2.1		2.1

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

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 its meeting on Sep 17, 2014 with symbolic reduction of purchases of securities for the Fed’s balance sheet (http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm):

“Press Release

Release Date: September 17, 2014

For immediate release

Information received since the Federal Open Market Committee met in July suggests that economic activity is expanding at a moderate pace. On balance, labor market conditions improved somewhat further; however, the unemployment rate is little changed and a range of labor market indicators suggests that there remains significant underutilization of labor resources. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee's longer-run objective. 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 activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.

The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.

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. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will end its current program of asset purchases at its next meeting. However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation 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 remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

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. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action were Richard W. Fisher and Charles I. Plosser. President Fisher believed that the continued strengthening of the real economy, improved outlook for labor utilization and for general price stability, and continued signs of financial market excess, will likely warrant an earlier reduction in monetary accommodation than is suggested by the Committee's stated forward guidance. President Plosser objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for "a considerable time after the asset purchase program ends," because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee's goals.”

There are several important issues in this statement.

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

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

Open-ended Quantitative Easing or QE_∞ with End of Bond Purchases. Earlier programs are continued with an additional lower open-ended $15 billion of bond purchases per month, increasing the stock of $4,187,075 million securities held outright and bank reserves deposited at the Fed of $2,751,908 million (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1): “The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate. 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. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will end its current program of asset purchases at its next meeting. However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.”
New Advance Guidance. “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored” (emphasis added).
Policy Commitment with Unemployment Rate. The emphasis of policy is in maintaining full employment: “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. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

Focus is shifting from tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Markets overreacted to the so-called “paring” of outright purchases to $15 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Sep 17, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm):

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

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

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

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

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

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

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

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

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

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).

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

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

Greenspan (1996) made similar warnings:

The FOMC provides guidelines on the process of normalization of monetary policy at the meeting on Sep 17, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140917c.htm):

“All FOMC participants but one agreed on the following key elements of the approach they intend to implement when it becomes appropriate to begin normalizing the stance of monetary policy:

The Committee will determine the timing and pace of policy normalization--meaning steps to raise the federal funds rate and other short-term interest rates to more normal levels and to reduce the Federal Reserve's securities holdings--so as to promote its statutory mandate of maximum employment and price stability.
- When economic conditions and the economic outlook warrant a less accommodative monetary policy, the Committee will raise its target range for the federal funds rate.
- During normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve balances.
- During normalization, the Federal Reserve intends to use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the federal funds rate. The Committee will use an overnight reverse repurchase agreement facility only to the extent necessary and will phase it out when it is no longer needed to help control the federal funds rate.
The Committee intends to reduce the Federal Reserve's securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA.
- The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.
- The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance.
The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.
The Committee is prepared to adjust the details of its approach to policy normalization in light of economic and financial developments.”

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

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

W = Y/r (10

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

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

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. Professor Rajan, in an interview with Kartik Goyal of Bloomberg (http://www.bloomberg.com/news/2014-01-30/rajan-warns-of-global-policy-breakdown-as-emerging-markets-slide.html), warns of breakdown of global policy coordination. Professor Raguram G Rajan, governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation.

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 17, 2014. The Fed releases the data with careful explanations (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.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 IIQ2014 is analyzed in Section I (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html) and the PCE inflation data from the report on personal income and outlays in Section IV (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). The Bureau of Economic Analysis provides the estimate of IIQ2014 GDP (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2014/06/financial-indecision-mediocre-cyclical.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/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). The report on “Personal Income and Outlays” was released on Aug 29, 2014 (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.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 Aug 2014 was released on Sep 5, 2014 (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-valuations-twenty-seven.html). “The longer-run projections are the rates of growth, unemployment, and inflation to which a policymaker expects the economy to converge over time—maybe in five or six years—in the absence of further shocks and under appropriate monetary policy” (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20131218.pdf).

It is instructive to focus on 2014 and 2015 because 2016 and longer term are too far away, and there is not much information even on what will happen in 2014-2015 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 17, 2014 and the second row “PR” the projection of the Jun 18, 2014 meeting. There are three changes in the view.

1. Growth “∆% GDP.” The FOMC has changed the forecast of GDP growth in 2014. The FOMC decreased GDP growth in 2014 from 2.1 to 2.3 percent at the meeting in Jun 2014 to 2.0 to 2.2 percent at the meeting in Sep 2014.

2. Rate of Unemployment “UNEM%.” The FOMC reduced the forecast of the rate of unemployment for 2014 from 6.0 to 6.1 percent at the meeting on Jun 18, 2014 to 5.9 to 6.0 percent at the meeting on Sep 17, 2014. The projection for 2015 decreased to the range of 5.4 to 5.6 in Sep 2014 from 5.4 to 5.7 in Jun 2014. Projections of the rate of unemployment are moving closer to the desire 6.5 percent or lower with 4.9 to 5.3 percent in 2017 after the meeting on Sep 17, 2014.

3. Inflation “∆% PCE Inflation.” The FOMC did not change the forecast of personal consumption expenditures (PCE) inflation for 2014 from 1.5 to 1.7 percent at the meeting on Jun 18, 2014 to 1.5 to 1.7 percent at the meeting on Sep 17, 2014. There are no projections exceeding 2.0 percent in the central tendency but some in the range reach 2.4 percent in 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 for 2014, not changing from 1.5 to 1.6 percent at the meeting on Jun 18, 20134 to 1.5 to 1.6 percent at the meeting Sep 17, 2014. In 2015, there is minor change in the projection from 1.6 to 2.0 percent at the meeting on Jun 18, 2014 to 1.5 to 1.6 percent on Sep 17, 2014. The rate of change of the core PCE is below 2.0 percent in the central tendency with 2.4 percent at the top of the range in 2015.

Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents in FOMC, Mar 19, 2013 and Jun 18, 2014

∆% GDP

UNEM %

∆% PCE Inflation

∆% Core PCE Inflation

Central
Tendency

2014
Jun PR

2.0 to 2.2
2.1 to 2.3

5.9 to 6.0
6.0 to 6.1

1.5 to 1.7
1.5 to 1.7

1.5 to 1.6
1.5 to 1.6

2015

Jun PR

2.6 to 3.0

3.0 to 3.2

5.4 to 5.6

5.4 to 5.7

1.6 to 1.9

1.5 to 2.0

1.6 to 1.9

1.6 to 2.0

2016

Jun PR

2.6 to 2.9

2.5 to 3.0

5.1 to 5.4

5.1 to 5.5

1.7 to 2.0

1.6 to 2.0

1.8 to 2.0

1.7 to 2.0

2017

Jun PR

2.3 to 2.5 NA

4.9 to 5.3

1.9 to 2.0

Longer Run

Jun PR

2.0 to 2.3

2.1 to 2.3

5.2 to 5.5

2.0

Range

2014
Jun PR

1.8 to 2.3
1.9 to 2.4

5.7 to 6.1
5.8 to 6.2

1.5 to 1.8
1.4 to 2.0

1.5 to 1.8
1.4 to 1.8

2015

Jun PR

2.1 to 3.2

2.2 to 3.6

5.2 to 5.7

5.2 to 5.9

1.5 to 2.4

1.4 to 2.4

1.6 to 2.4

1.5 to 2.4

2016

Jun PR

2.1 to 3.0

2.2 to 3.2

4.9 to 5.6

5.0 to 5.6

1.6 to 2.1

1.5 to 2.0

1.7 to 2.2

1.6 to 2.0

2017

Jun PR

2.0 to 2.6

4.7 to 5.8

1.7 to 2.2

1.8 to 2.2

Longer Run

Jun PR

1.8 to 2.6

1.8 to 2.5

5.0 to 6.0

2.0

Notes: UEM: unemployment; PR: Projection

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

http://www.federalreserve.gov/newsevents/press/monetary/20140618b.htm

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.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 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/fomcprojtabl20140917.pdf). The rate would still remain at 0 to ¼ percent in 2014 for 16 participants with one expecting the rate to be in the range of 0.5 to 1.0. This table is consistent with the guidance statement of the FOMC that rates will remain at low levels. For 2015, 3 participants expect the rate to remain between 0.5 and 1.0 percent, 5 to be between 1.0 and 1.5 percent, 10 between 1 and 2 percent and 1 between 2 and 3 percent. For 2016, 2 participant expects the rate between 1.0 and 1 percent, 2 between 1 and 2 percent, 8 between 2 and 3 percent and 6 between 3 and 4.5 percent. In the long term, all 16 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 18, 2014

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

http://www.federalreserve.gov/newsevents/press/monetary/20140618b.htm

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf

Additional information is provided in Table IV-4 with the number of participants expecting increasing interest rates in the years from 2014 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 until 2015. 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, Mar 19, 2014

Appropriate Year of Increasing Target Fed Funds Rate	Number of Participants
2014	1
2015	14
2016	2

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

http://www.federalreserve.gov/newsevents/press/monetary/20140618b.htm

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf

Unconventional monetary policy of zero interest rates and quantitative easing has been used in Japan and now also in the US. Table IV-5 provides the consumer price index of Japan, with inflation of 3.3 percent in 12 months ending in Aug 2014 and increase of 0.2 percent NSA (not-seasonally-adjusted) in Aug 2014. The increase of the tax on value added of consumption on Apr 1, 2014, was the driver of CPI inflation in Japan in Apr-May 2014. Inflation of consumer prices in the first three months of 2013 annualizes at 0.0 percent NSA. Inflation in Mar-Dec 2013 not seasonally adjusted annualizes at 1.9 percent. There are negative percentage changes in most of the 12-month rates in 2011 with the exception of Jul and Aug both with 0.2 percent and stability in Sep. All 12-month rates of inflation in the first five months of 2013 are negative. Inflation in the 12 months ending in Jun 2013 was 0.2 percent and 0.7 percent in the 12 months ending in Jul 2013. Inflation increased to 0.9 percent in the 12 months ending in Aug 2013 and 1.1 percent in the 12 months ending in Sep 2013. Inflation was 1.1 percent in the 12 months ending in Oct 2013 and 1.5 percent in the 12 months ending in Nov 2013. Inflation was 1.6 percent in the 12 months ending in Dec 2013 and 1.4 percent in the 12 months ending in Jan 2014. Inflation was 1.5 percent in the 12 months ending in Feb 2014 and 1.6 percent in the 12 months ending in Mar 2014. Inflation was 3.4 percent in the 12 months ending in Apr 2014 and 3.7 percent in the 12 months ending in May 2014, mostly because of the increase in the sales tax. Inflation in 12 months ending in Aug 2014 was 3.3 percent. There are ten years of deflation, three of zero inflation and only six of inflation in the annual rate of inflation from 1995 to 2013. This experience is entirely different from that of the US that shows long-term inflation. There is only one annual negative change of the CPI all items of the US in Table IV-5, minus 0.4 percent in 2009 but following 3.8 percent in 2008 because of carry trades from policy rates moving to zero in 2008 during a global contraction that were reversed because of risk aversion in late 2008 and early 2009, causing decreasing commodity prices. Both the US and Japan experienced high rates of inflation during the US Great Inflation of the 1970s (see http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). It is difficult to justify unconventional monetary policy because of risks of deflation similar to that experienced in Japan. Fear of deflation as had occurred during the Great Depression and in Japan was used as an argument for the first round of unconventional monetary policy with 1 percent interest rates from Jun 2003 to Jun 2004. The 1 percent interest rate combined with quantitative easing in the form of withdrawal of supply of 30-year securities by suspension of the auction of 30-year Treasury bonds with the intention of reducing mortgage rates. For fear of deflation, see Pelaez and Pelaez, International Financial Architecture (2005), 18-28, and Pelaez and Pelaez, The Global Recession Risk (2007), 83-95. The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.htm

Table IV-5, Japan, Consumer Price Index, All Items ∆%

	∆% Month NSA	∆% 12-Month NSA
Aug 2014	0.2	3.3
Jul	0.0	3.4
Jun	-0.1	3.6
May	0.4	3.7
Apr	2.1	3.4
Mar	0.3	1.6
Feb	0.0	1.5
Jan	-0.2	1.4
Dec 2013	0.1	1.6
Nov	0.0	1.5
Oct	0.1	1.1
Sep	0.3	1.1
Aug	0.3	0.9
Jul	0.2	0.7
Jun	0.0	0.2
May	0.1	-0.3
Apr	0.3	-0.7
Mar	0.2	-0.9
Feb	-0.2	-0.7
Jan	0.0	-0.3
Dec 2012	0.0	-0.1
Nov	-0.4	-0.2
Oct	0.0	-0.4
Sep	0.1	-0.3
Aug	0.1	-0.4
Jul	-0.3	-0.4
Jun	-0.5	-0.2
May	-0.3	0.2
Apr	0.1	0.4
Mar	0.5	0.5
Feb	0.2	0.3
Jan	0.2	0.1
Dec 2011	0.0	-0.2
Nov	-0.6	-0.5
Oct	0.1	-0.2
Sep	0.0	0.0
Aug	0.1	0.2
Jul	0.0	0.2
Jun	-0.2	-0.4
May	0.0	-0.4
Apr	0.1	-0.4
Mar	0.3	-0.5
Feb	0.0	-0.5
Jan	-0.1	-0.6
Dec 2010	–0.3	0.0
	CPI All Items USA	CPI All Items Japan
Annual
2013	1.5	0.4
2012	2.1	0.0
2011	3.2	-0.3
2010	1.6	-0.7
2009	-0.4	-1.4
2008	3.8	1.4
2007	2.8	0.0
2006	3.2	0.3
2005	3.4	-0.3
2004	2.7	0.0
2003	2.3	-0.3
2002	1.6	-0.9
2001	2.8	-0.7
2000	3.4	-0.7
1999	2.2	-0.3
1998	1.6	0.6
1997	2.3	1.8
1996	3.0	0.1
1995	2.8	-0.1
1994	2.6	0.7
1993	3.0	1.3
1992	3.0	1.6
1991	4.2	3.3
1990	5.4	3.1
1989	4.8	2.3
1988	4.1	0.7
1987	3.6	0.1
1986	1.9	0.6
1985	3.6	2.0
1984	4.3	2.3
1983	3.2	1.9
1982	6.2	2.8
1981	10.3	4.9
1980	13.5	7.7
1979	11.3	3.7
1978	7.6	4.2
1977	6.5	8.1
1976	5.8	9.4
1975	9.1	11.7
1974	11.0	23.2
1973	6.2	11.7
1972	3.2	4.9
1971	4.4	6.3

Source: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications

Table IV-7, Japan, Consumer Price Index, All Items ∆%

Source: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications

Chart IV-1 of Japan’s Statistics Bureau at the Ministry of Internal Affairs and Communications provides the major consumer price indexes of Japan on an annual basis. There is inflexion of the trend of decline of the index of all items and the index of all items excluding fresh food in 2012 and 2013.

Chart IV-1, Japan, Consumer Price Index All Items, Consumer Price Index All Items Less Fresh Food and Consumer Price Index All Items Less Food, Alcoholic Beverages and Energy, Annual, 2001-2013

Sources: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications

Chart IV-2 of Japan’s Statistics Bureau at the Ministry of Internal Affairs and Communications provides annual percentage changes of the consumer price index all items, excluding fresh food and excluding food, alcoholic beverages and energy. The indexes of all items and excluding fresh food increased in 2013.

Chart IV-2, Japan, Japan, Consumer Price Index, Percentage Changes Relative to Prior Year, 2001-2013

Sources: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications

Japan’s Statistics Bureau of the Ministry of Internal Affairs and Communications provides the consumer price index for all items and regions of Japan monthly from 1971 to 2013 with 2010=100, shown in Chart IV-3. There was inflation in Japan during the 1970s and 1980s similar to other countries and regions. The index shows stability after the 1990s with sporadic cases of deflation. Slower growth with sporadic inflation has been characterized as a “lost decade” in Japan (see Pelaez and Pelaez, The Global Recession Risk (2007), 82-115).

Chart IV-3, Japan, Consumer Price Index All Items, All Japan, Index 2010=100, Monthly, 1970-2013

Source: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications

Chart IV-4 of the US Bureau of Labor Statistics provides the US consumer price index NSA from 1915 to 2014. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.

Chart IV-4, US, Consumer Price Index, All Items, NSA, 1915-2014

Source: US Bureau of Labor Statistics

Chart IV-5 of the Statistics Bureau of the Ministry of Internal Affairs and Communications of Japan provides 12-month percentage changes of the consumer price index for all items and regions of Japan monthly from 1971 to 2013. Japan experienced the same inflation waves of the United States during the Great Inflation of the 1970s followed by similar low inflation after the inflation-control increase of interest rates in the early 1980s. Numerous cases of negative inflation or deflation are observed after the 1990s.

Chart IV-5, Japan, CPI All Items, All Japan, 12-Month ∆%, 1971-2013

Sources: Japan, Statistics Bureau, Ministry of Internal Affairs and Communications

Chart IV-6 of the US Bureau of Labor Statistics provides 12-month percentage changes of the US consumer price index from 1914 to 2014. There are actually three waves of inflation in the second half of the 1960s, in the mid 1970s and again in the late 1970s. Table IV-1 provides similar inflation waves in the economy of Japan with 11.7 percent in 1973, 23.1 percent in 1974 and 11.7 percent in 1975. The Great Inflation of the 1970s is analyzed in various comments of this blog (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and in Appendix I 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). Inflation rates then stabilized in the US in a range with only two episodes above 5 percent. There are isolated cases of deflation concentrated over extended periods only during the 1930s. There is no case in United States economic history for unconventional monetary policy because of fear of deflation. There are cases of long-term deflation without lost decades or depressions.

Delfim Netto (1958) partly reprinted in Pelaez (1973) conducted two classical nonparametric tests (Mann 1945, Wallis and Moore 1941; see Kendall and Stuart 1968) with coffee-price data in the period of free markets from 1857 to 1906 with the following conclusions (Pelaez, 1976a, 280):

“First, the null hypothesis of no trend was accepted with high confidence; secondly, the null hypothesis of no oscillation was rejected also with high confidence. Consequently, in the nineteenth century international prices of coffee fluctuated but without long-run trend. This statistical fact refutes the extreme argument of structural weakness of the coffee trade.”

The conventional theory that the terms of trade of Brazil deteriorated over the long term is without reality (Pelaez 1976a, 280-281):

“Moreover, physical exports of coffee by Brazil increased at the high average rate of 3.5 per cent per year. Brazil's exchange receipts from coffee-exporting in sterling increased at the average rate of 3.5 per cent per year and receipts in domestic currency at 4.5 per cent per year. Great Britain supplied nearly all the imports of the coffee economy. In the period of the free coffee market, British export prices declined at the rate of 0.5 per cent per year. Thus, the income terms of trade of the coffee economy improved at the relatively satisfactory average rate of 4.0 per cent per year. This is only a lower bound of the rate of improvement of the terms of trade. While the quality of coffee remained relatively constant, the quality of manufactured products improved significantly during the fifty-year period considered. The trade data and the non-parametric tests refute conclusively the long-run hypothesis. The valid historical fact is that the tropical export economy of Brazil experienced an opportunity of absorbing rapidly increasing quantities of manufactures from the "workshop" countries. Therefore, the coffee trade constituted a golden opportunity for modernization in nineteenth-century Brazil.”

Imlah (1958) provides decline of British export prices at 0.5 percent in the nineteenth century and there were no lost decades, depressions or unconventional monetary policies in the highly dynamic economy of England that provided the world’s growth impulse. The experience of the United Kingdom with deflation and economic growth is relevant and rich. Yearly percentage changes of the composite index of prices of the United Kingdom of O’Donoghue and Goulding (2004) provide strong evidence. There are 73 declines of inflation in the 145 years from 1751 to 1896. Prices declined in 50.3 percent of 145 years. Some price declines were quite sharp and many occurred over several years. O’Donoghue and Goulding (2004) also provide inflation data for the UK from 1929 to 1934. Deflation was much sharper in continuous years in earlier periods than during the Great Depression. The United Kingdom could not have led the world in modern economic growth if there were meaningful causality from deflation to depression.

Chart IV-6, US, Consumer Price Index, All Items, NSA, 12-Month Percentage Change 1915-2014

Source: US Bureau of Labor Statistics

Chart IV-7 provides the US consumer price index excluding food and energy from 1957 (when it first becomes available) to 2014. There is long-term inflation in the US without episodes of deflation that would justify symmetric inflation targets to increase inflation from low levels.

Chart IV-7, US, Consumer Price Index Excluding Food and Energy, NSA, 1957-2014

Source: US Bureau of Labor Statistics

Chart IV-8 provides 12-month percentage changes of the consumer price index excluding food and energy from 1958 (when it first becomes available) to 2014. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.

Chart IV-8, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 1958-2014

Source: US Bureau of Labor Statistics