CMP Associates Regulation Blog

Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €56 million with the 17 countries of the euro zone (EMU 17) in May 2014 and cumulative surplus of €570 million in Jan-May 2014. Depreciation to parity could permit greater competitiveness in improving the trade surplus of €1546 million in Jan-May 2014 with Europe non-European Union, the trade surplus of €6455 million with the US and the trade surplus with non-European Union of €7279 million in Jan-Apr 2014. There is significant rigidity in the trade deficits in Jan-May 2014 of €5554 million with China and €87 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 May 2014 Millions of Euro	Trade Balance Cumulative Jan-May 2014 Millions of Euro
EU	1,223	6,791
EMU 17	-56	570
France	1,070	5,212
Germany	-313	-1,469
Spain	-16	423
UK	871	4,141
Non EU	2,453	7,279
Europe non EU	146	1,546
USA	1,995	6,455
China	-1,065	-5,554
OPEC	68	-87
Total	3,676	14,070

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-May 2014 relative to Jan-May 2013. Growth rates of cumulative imports relative to a year earlier are negative for energy with minus 16.7 percent. Exports of durable goods grew 3.8 percent and exports of capital goods increased 4.8 percent. The higher rate of growth of exports of 1.3 percent in Jan-May 2014/Jan-May 2013 relative to that of imports of minus 2.5 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 0.1 percent in IQ2014.

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

	Exports Share %	Exports ∆% Jan-May 2014/ Jan-May 2013	Imports Share %	Imports ∆% Jan-May 2014/ Jan-May 2013
Consumer Goods	31.0	3.3	27.3	1.8
Durable	6.0	3.8	2.9	7.6
Non-Durable	25.1	3.2	24.4	1.1
Capital Goods	32.3	4.8	20.3	2.8
Inter- mediate Goods	32.3	-1.5	32.5	-0.6
Energy	4.4	-15.8	19.9	-16.7
Total ex Energy	95.6	2.1	80.1	1.0
Total	100.0	1.3	100.0	-2.5

Note: % Share for 2012 total trade.

Source: Istituto Nazionale di Statistica

Table III-6 provides Italy’s trade balance by product categories in May 2014 and cumulative Jan-May 2014. Italy’s trade balance excluding energy, generated surplus of €7912 million in May 2014 and €33,161 million cumulative in Jan-May 2014 but the energy trade balance created deficit of €4237 million in May 2014 and cumulative €19,091 million in Jan-May 2014. The overall surplus in May 2014 was €3676 million with cumulative surplus of €14,070 million in Jan-May 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

	May 2014	Cumulative Jan-May 2014
Consumer Goods	1,811	9,006
Durable	1,135	5,190
Nondurable	676	3,816
Capital Goods	5,365	21,720
Intermediate Goods	736	2,435
Energy	-4,237	-19,091
Total ex Energy	7,912	33,161
Total	3,676	14,070

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	2.5	2.0	2.9 FD 1.7	6.1
Japan	-0.1	3.4	3.9	3.8
China	7.5	2.0	-1.2
UK	3.2	1.6* CPIH 1.5	-0.1 output 0.9** input -7.3	6.4
Euro Zone	0.7	0.4	-1.1	11.5
Germany	1.2	0.8	-0.7	4.9
France	0.1	0.6	-0.6	10.3
Nether-lands	0.9	0.3	-2.5	6.7
Finland	-0.1	1.0	-0.4	8.7
Belgium	1.0	0.6	-5.7	8.5
Portugal	0.8	-0.7	-0.8	14.0
Ireland	NA	0.5	0.1	11.5
Italy	-0.2	0.0	-1.7	12.6
Greece	-0.3	-0.8	1.6	27.2
Spain	1.2	-0.4	-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/july-2014/index.html**Core

PPI http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/july-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

Table IV-1 shows the simultaneous occurrence of low growth, inflation and unemployment in advanced economies. The US grew at 2.5 percent in IIQ2014 relative to IIQ2013 (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.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 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 122.8881 in Jul 2014. The actual index NSA in Jul 2014 is 98.4978, which is 19.8 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 115.2650 in Jul 2014. The output of manufacturing at 98.4978 in Jul 2014 is 14.5 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 (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 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 122.8881 in Jul 2014. The actual index NSA in Jul 2014 is 98.4978, which is 19.8 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 115.2650 in Jul 2014. The output of manufacturing at 98.4978 in Jul 2014 is 14.5 percent below trend under this alternative calculation.

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	1.4	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 5.3 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IIQ2014 of $15,994.3 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/10: {[($15,994.3/$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 2.5 percent that is equivalent to 2.5 percent in a year. This is obtained by dividing GDP in IIQ2014 of $15,994.3 billion by GDP in IIQ2013 of $15,606.6 billion and compounding by 4/4: {[($15,994.3/$15,606.6)^4/4 -1]100 = 2.5%}. The US economy grew 2.4 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	15,994.3	6.7	1.0	2.5
Cumulative ∆% IQ2012 to IQ2014	5.3		5.3
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 Jul 30, 2014 with symbolic reduction of purchases of securities for the Fed’s balance sheet (http://www.federalreserve.gov/newsevents/press/monetary/20140730a.htm):

“Press Release

Release Date: July 30, 2014

For immediate release

Information received since the Federal Open Market Committee met in June indicates that growth in economic activity rebounded in the second quarter. Labor market conditions improved, with the unemployment rate declining further. However, 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 moved somewhat closer to 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.

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 August, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month rather than $15 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month rather than $20 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 likely reduce the pace of asset purchases in further measured steps at future meetings. 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; Richard W. Fisher; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo. Voting against was Charles I. Plosser who 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 Symbolic Tapering. Earlier programs are continued with an additional lower open-ended $25 billion of bond purchases per month, increasing the stock of $4,136,776 million securities held outright and bank reserves deposited at the Fed of $2,785,792 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 August, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month rather than $15 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month rather than $20 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.”
New Advance Guidance.” Policy will be accommodative even after the economy recovers satisfactorily: “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy 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.”

Current focus is on tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Market are overreacting to the so-called “paring” of outright purchases to $25 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 Jul 30, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140730a.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:

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 Jun 18, 2014. The Fed releases the data with careful explanations (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20131218.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 IQ2014 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 Jun 18, 2014 and the second row “PR” the projection of the Mar 19, 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 2.8 to 3.0 percent at the meeting in Mar 2014 to 2.1 to 2.3 percent at the meeting in Jun 2014.

2. Rate of Unemployment “UNEM%.” The FOMC reduced the forecast of the rate of unemployment for 2014 from 6.1 to 6.3 percent at the meeting on Mar 19, 2014 to 6.0 to 6.1 percent at the meeting on Jun 18, 2014. The projection for 2015 decreased to the range of 5.4 to 5.7 in Jun 2014 from 5.6 to 5.9 in Mar 2014. Projections of the rate of unemployment are moving closer to the desire 6.5 percent or lower with 5.1 to 5.5 percent in 2016 after the meeting on Jun 18, 2014.

3. Inflation “∆% PCE Inflation.” The FOMC changed the forecast of personal consumption expenditures (PCE) inflation for 2014 from 1.5 to 1.6 percent at the meeting on Mar 19, 2014 to 1.5 to 1.7 percent at the meeting on Jun 18, 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 significantly from 1.4 to 1.6 percent at the meeting on Mar 19, 20134 to 1.5 to 1.6 percent at the meeting Jun 18, 2014. In 2015, there is minor change in the projection from 1.7 to 2.0 percent at the meeting on Mar 19, 2014 to 1.6 to 2.0 percent on Jun 18, 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
Mar PR

2.1 to 2.3
2.8 to 3.0

6.0 to 6.1
6.1 to 6.3

1.5 to 1.7
1.5 to 1.6

1.5 to 1.6
1.4 to 1.6

2015

Mar PR

3.0 to 3.2

5.4 to 5.7

5.6 to 5.9

1.5 to 2.0

1.6 to 2.0

1.7 to 2.0

2016

Mar PR

2.5 to 3.0

5.1 to 5.5

5.2 to 5.6

1.6 to 2.0

1.7 to 2.0

1.8 to 2.0

Longer Run

Mar PR

2.1 to 2.3

2.2 to 2.3

5.2 to 5.5

5.2 to 5.6

2.0

Range

2014
Mar PR

1.9 to 2.4
2.1 to 3.0

5.8 to 6.2
6.0 to 6.5

1.4 to 2.0
1.3 to 1.8

1.4 to 1.8
1.3 to 1.8

2015

Mar PR

2.2 to 3.6

2.2 to 3.5

5.2 to 5.9

5.4 to 5.9

1.4 to 2.4

1.5 to 2.4

2016

Mar PR

2.2 to 3.2

2.2 to 3.4

5.0 to 5.6

5.1 to 5.8

1.5 to 2.0

1.6 to 2.0

1.6 to 2.2

Longer Run

Mar PR

1.8 to 2.5

1.8 to 2.4

5.0 to 6.0

5.2 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/fomcprojtabl20140618.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/fomcprojtabl20140618.pdf). The rate would still remain at 0 to ¼ percent in 2014 for 15 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, 8 participants expect the rate to remain between 0.5 and 1.0 percent, 6 to be between 1.0 and 1.5 percent, 9 between 1 and 2 percent and 3 between 2 and 3 percent. For 2016, 2 participant expects the rate between 0.5 and 1 percent, 2 between 1 and 2 percent, 9 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/fomcprojtabl20140618.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	12
2016	3

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/fomcprojtabl20140618.pdf

Inflation in advanced economies has been fluctuating in waves at the production level with alternating surges and moderation of commodity price shocks. Table IV-5 provides month and 12-month percentage rates of inflation of Japan’s corporate goods price index (CGPI). Inflation measured by the CGPI decreased 0.2 percent in Aug 2014 and increased 3.9 percent in 12 months, partly because of the increase in the tax on value added of consumption in Apr 2014. Measured by 12-month rates, CGPI inflation increased from minus 0.2 percent in Jul 2010 to a high of 2.2 percent in Jul-Aug 2011, 2.3 percent in Aug 2013 and 2.6 percent in Nov 2013. Calendar-year inflation is 1.3 percent for 2013. Calendar-year inflation for 2012 is minus 0.9 percent and 1.5 percent for 2011, which is the highest after declines in 2009 and 2010 but lower than 4.6 percent in the commodity shock driven by zero interest rates during the global recession in 2008. Inflation of the corporate goods prices follows waves similar to those in other indices around the world (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). In the first wave, annual equivalent inflation reached 5.8 percent in Jan-Apr 2011, driven by commodity price shocks of the carry trade from zero interest rates to commodity futures. In the second wave, carry trades were unwound because of risk aversion caused by the European debt crisis, resulting in average annual equivalent inflation of minus 1.2 percent in May-Jun 2011. In the third wave, renewed risk aversion caused annual equivalent decline of the CGPI of minus 2.1 percent in Jul-Nov 2011. In the fourth wave, continuing risk aversion resulted in annual equivalent inflation of minus 0.6 percent in Dec 2011 to Jan 2012. In the fifth wave, renewed risk appetite resulted in annual equivalent inflation of 2.0 percent in Feb-Apr 2012. In the sixth wave, annual equivalent inflation dropped to minus 5.5 percent in May-Jul 2012. In the seventh wave, annual equivalent inflation jumped to 2.4 percent in Aug-Sep 2012. In the eighth wave, annual equivalent inflation was minus 3.0 percent in Oct-Nov 2012 in a new round of risk aversion. In the ninth wave, annual equivalent inflation returned at 3.3 percent in Dec 2012-Sep 2013. In the eleventh wave, annual equivalent inflation was minus 0.6 percent in Oct-Nov 2013. In the twelfth wave, annual equivalent inflation was 2.4 percent from Dec 2013 to Jan 2014. In the thirteenth wave, annual equivalent inflation was minus 0.6 percent in Feb-Mar 2014. In the fourteenth wave, annual equivalent inflation was 11.6 percent in Apr-Jul 2014 almost entirely because of the increase in the tax on value added of consumption. In the fifteenth wave, annual equivalent inflation was minus 2.4 percent in Aug 2014.

Table IV-5, Japan, Corporate Goods Price Index (CGPI) ∆%

	Month	Year
Aug 2014	-0.2	3.9
AE ∆% Aug	-2.4
Jul	0.4	4.3
Jun	0.1	4.5
May	0.3	4.4
Apr	2.9	4.2
AE ∆% Apr-Jul	11.6
Mar	0.0	1.7
Feb	-0.1	1.8
AE ∆% Feb-Mar	-0.6
Jan	0.1	2.4
Dec 2013	0.3	2.5
AE ∆% Dec-Jan	2.4
Nov	0.0	2.6
Oct	-0.1	2.5
AE ∆% Oct-Nov	-0.6
Sep	0.2	2.2
Aug	0.2	2.3
Jul	0.6	2.2
Jun	0.0	1.2
May	0.1	0.6
Apr	0.4	0.1
Mar	0.1	-0.5
Feb	0.5	-0.1
Jan	0.2	-0.4
Dec 2012	0.4	-0.7
AE ∆% Dec-Sep	3.3
Nov	-0.1	-1.1
Oct	-0.4	-1.1
AE ∆% Oct-Nov	-3.0
Sep	0.3	-1.5
Aug	0.1	-2.0
AE ∆% Aug-Sep	2.4
Jul	-0.4	-2.2
Jun	-0.6	-1.5
May	-0.4	-0.9
AE ∆% May-Jul	-5.5
Apr	-0.2	-0.7
Mar	0.5	0.3
Feb	0.2	0.4
AE ∆% Feb-Apr	2.0
Jan	-0.1	0.3
Dec 2011	0.0	0.8
AE ∆% Dec-Jan	-0.6
Nov	-0.1	1.3
Oct	-0.8	1.3
Sep	-0.2	2.0
Aug	-0.1	2.2
Jul	0.3	2.2
AE ∆% Jul-Nov	-2.1
Jun	0.0	1.9
May	-0.2	1.6
AE ∆% May-Jun	-1.2
Apr	0.8	1.8
Mar	0.6	1.3
Feb	0.1	0.7
Jan	0.4	0.6
AE ∆% Jan-Apr	5.8
Dec 2010	0.5	1.2
Nov	-0.1	0.9
Oct	-0.1	0.9
Sep	0.0	-0.1
Aug	-0.1	0.0
Jul	0.0	-0.2
Calendar Year
2013		1.3
2012		-0.9
2011		1.5
2010		-0.1
2009		-5.3
2008		4.6

Source: Bank of Japan

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

Chart IV-1 of the Bank of Japan provides year-on-year percentage changes of the domestic and services Corporate Goods Price Index (CGPI) of Japan from 1970 to 2014. Percentage changes of inflation of services are not as sharp as for goods. Japan had the same sharp waves of inflation during the 1970s as in the US (see Chart IV-26 and associated table at http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks_71.html http://cmpassocregulationblog.blogspot.com/2014/03/financial-uncertainty-mediocre-cyclical_8145.html http://cmpassocregulationblog.blogspot.com/2014/03/financial-risks-slow-cyclical-united.html http://cmpassocregulationblog.blogspot.com/2014/02/mediocre-cyclical-united-states.html http://cmpassocregulationblog.blogspot.com/2013/12/collapse-of-united-states-dynamism-of.html http://cmpassocregulationblog.blogspot.com/2013/12/exit-risks-of-zero-interest-rates-world_1.html and earlier http://cmpassocregulationblog.blogspot.com/2013/10/twenty-eight-million-unemployed-or_561.html and at http://cmpassocregulationblog.blogspot.com/2013/09/increasing-interest-rate-risk_1.html http://cmpassocregulationblog.blogspot.com/2012/07/recovery-without-jobs-stagnating-real_09.html).). Behavior of the CGPI of Japan in the 1970s mirrors the Great Inflation episode in the United States with waves of inflation rising to two digits. Both political pressures and errors abounded in the unhappy stagflation of the 1970s also known as the US Great Inflation (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) http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html). Inflation also collapsed in the beginning of the 1980s because of tight monetary policy in the US with focus on inflation instead of on the gap of actual relative to potential output. The areas in shade correspond to the dates of cyclical recessions. The salient event is the sharp rise of inflation of the domestic goods CGPI in 2008 during the global recession that was mostly the result of carry trades from fed funds rates collapsing to zero to long positions in commodity futures in an environment of relaxed financial risk appetite. The panic of toxic assets in banks to be withdrawn by the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009) drove unusual risk aversion with unwinding of carry trades of exposures in commodities and other risk financial assets. Carry trades returned once TARP was clarified as providing capital to financial institutions and stress tests verified the soundness of US banks. The return of carry trades explains the rise of CGPI inflation after mid-2009. Inflation of the CGPI fluctuated with zero interest rates in alternating episodes of risk aversion and risk appetite.

Chart IV-1, Japan, Domestic Corporate Goods Price and Services Index, Year-on-Year Percentage Change, 1970-2014

Notes: Blue: Domestic Corporate Goods Price Index All Commodities; Red: Corporate Price Services Index

Source: Bank of Japan

There is similar behavior of year-on-year percentage changes of the US producer price index from 1970 to 2014 in Chart IV-2 of the US Bureau of Labor Statistics as in Chart IV-1 with the domestic goods CGPI. The behavior of the CGPI of Japan in the 1970s is quite similar to that of the US PPI. The US producer price index increased together with the CGPI driven by the period of one percent fed funds rates from 2003 to 2004 inducing carry trades into commodity futures and other risk financial assets and the slow adjustment in increments of 25 basis points at every FOMC meeting from Jun 2004 to Jun 2006. There is also the same increase in inflation in 2008 during the global recession followed by collapse because of unwinding positions during risk aversion and new rise of inflation during risk appetite.

Chart IV-2, US, Producer Price Index Finished Goods, Year-on-Year Percentage Change, 1970-2014

Source: US Bureau of Labor Statistics

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

Finer detail is provided by Chart IV-3 of the domestic CGPI from 2008 to 2014. The CGPI rose almost vertically in 2008 as the collapse of fed funds rates toward zero drove exposures in commodities and other risk financial assets because of risk appetite originating in the belief that the financial crisis was restricted to structured financial products and not to contracts negotiated in commodities and other exchanges. The panic with toxic assets in banks to be removed by TARP (Cochrane and Zingales 2009) caused unwinding carry trades in flight to US government obligations that drove down commodity prices and price indexes worldwide. Apparent resolution of the European debt crisis of 2010 drove risk appetite in 2011 with new carry trades from zero fed funds rates into commodity futures and other risk financial assets. Domestic CGPI inflation returned in waves with upward slopes during risk appetite and downward slopes during risk aversion. Yen devaluation promoted by monetary and fiscal policy translates imported inputs in higher domestic prices. The increase in the tax on value added of consumption caused the sharp increase in Apr-Jun 2014.

Chart IV-3, Japan, Domestic Corporate Goods Price Index, Monthly, 2008-2014

Source: Bank of Japan

There is similar behavior of the US producer price index from 2008 to 2014 in Chart IV-4 as in the domestic CGPI in Chart IV-3. A major difference is the strong long-term trend in the US producer price index with oscillations originating mostly in bouts of risk aversion such as the downward slope in the final segment in Chart IV-4 followed by increasing slope during periods of risk appetite. Carry trades from zero interest rates to commodity futures and other risk financial assets drive the upward trend of the US producer price index while oscillations originate in alternating episodes of risk aversion and risk appetite.

Chart IV-4, US, Producer Price Index Finished Goods, Monthly, 2008-2014

Source: US Bureau of Labor Statistics

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

There was milder increase in Japan’s export corporate goods price index during the global recession in 2008 but similar sharp decline during the bank balance sheets effect in late 2008, as shown in Chart IV-5 of the Bank of Japan. Japan exports industrial goods whose prices have been less dynamic than those of commodities and raw materials. As a result, the export CGPI on the yen basis in Chart IV-5 trends down with oscillations after a brief rise in the final part of the recession in 2009. The export corporate goods price index on the yen basis fell from 104.9 in Jun 2009 to 94.0 in Jan 2012 or minus 10.4 percent and increased to 109.0 in Aug 2014 for a gain of 16.0 percent relative to Jan 2012 and 3.9 percent relative to Jun 2009. The choice of Jun 2009 is designed to capture the reversal of risk aversion beginning in Sep 2008 with the announcement of toxic assets in banks that would be withdrawn with the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009). Reversal of risk aversion in the form of flight to the USD and obligations of the US government opened the way to renewed carry trades from zero interest rates to exposures in risk financial assets such as commodities. Japan exports industrial products and imports commodities and raw materials.

Chart IV-5, Japan, Export Corporate Goods Price Index, Monthly, Yen Basis, 2008-2014

Source: Bank of Japan

Chart IV-5A provides the export corporate goods price index on the basis of the contract currency. The export corporate goods price index on the basis of the contract currency increased from 97.9 in Jun 2009 to 103.1 in Apr 2012 or 5.3 percent but dropped to 98.3 in Aug 2014 or minus 4.7 percent relative to Apr 2012 and gained 0.4 percent to 98.3 in Aug 2014 relative to Jun 2009.

Chart IV-5A, Japan, Export Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2014

Source: Bank of Japan

Japan imports primary commodities and raw materials. As a result, the import corporate goods price index on the yen basis in Chart IV-6 shows an upward trend after declining from the increase during the global recession in 2008 driven by carry trades from fed funds rates. The index increases with carry trades from zero interest rates into commodity futures and declines during risk aversion from late 2008 into beginning of 2008 originating in doubts about soundness of US bank balance sheets. More careful measurement should show that the terms of trade of Japan, export prices relative to import prices, declined during the commodity shocks originating in unconventional monetary policy. The decline of the terms of trade restricted potential growth of income in Japan (for the relation of terms of trade and growth see Pelaez 1979, 1976a). The import corporate goods price index on the yen basis increased from 93.5 in Jun 2009 to 113.1 in Apr 2012 or 21.0 percent and to 126.7 in Aug 2014 or gain of 12.0 percent relative to Apr 2012 and 35.5 percent relative to Jun 2009.

Chart IV-6, Japan, Import Corporate Goods Price Index, Monthly, Yen Basis, 2008-2014

Source: Bank of Japan

Chart IV-6A provides the import corporate goods price index on the contract currency basis. The import corporate goods price index on the basis of the contract currency increased from 86.2 in Jun 2009 to 119.5 in Apr 2012 or 38.6 percent and to 112.3 in Aug 2014 or minus 6.0 percent relative to Apr 2012 and gain of 30.3 percent relative to Jun 2009. There is evident deterioration of the terms of trade of Japan: the export corporate goods price index on the basis of the contract currency increased 0.4 percent from Jun 2009 to Aug 2014 while the import corporate goods price index increased 30.3 percent. Prices of Japan’s exports of corporate goods, mostly industrial products, increased only 5.3 percent from Jun 2009 to Apr 2012, while imports of corporate goods, mostly commodities and raw materials increased 38.6 percent. Unconventional monetary policy induces carry trades from zero interest rates to exposures in commodities that squeeze economic activity of industrial countries by increases in prices of imported commodities and raw materials during periods without risk aversion. Reversals of carry trades during periods of risk aversion decrease prices of exported commodities and raw materials that squeeze economic activity in economies exporting commodities and raw materials. Devaluation of the dollar by unconventional monetary policy could increase US competitiveness in world markets but economic activity is squeezed by increases in prices of imported commodities and raw materials. Unconventional monetary policy causes instability worldwide instead of the mission of central banks of promoting financial and economic stability.

Chart IV-6A, Japan, Import Corporate Goods Price Index, Monthly, Contract Currency Basis, 2008-2014

Source: Bank of Japan

Table IV-6 provides the Bank of Japan’s Corporate Goods Price indexes of exports and imports on the yen and contract bases from Jan 2008 to Jul 2014. There are oscillations of the indexes that are shown vividly in the four charts above. For the entire period from Jan 2008 to Aug 2014, the export index on the contract currency basis decreased 0.9 percent and decreased 5.6 percent on the yen basis. For the entire period from Jan 2008 to Aug 2014, the import price index increased 11.5 percent on the contract currency basis and increased 6.5 percent on the yen basis. The charts show sharp deteriorations in relative prices of exports to prices of imports during multiple periods. Price margins of Japan’s producers are subject to periodic squeezes resulting from carry trades from zero interest rates of monetary policy to exposures in commodities.

Table IV-6, Japan, Exports and Imports Corporate Goods Price Index, Contract Currency Basis and Yen Basis

2008/01	99.2	115.5	100.7	119.0
2008/02	99.8	116.1	102.4	120.6
2008/03	100.5	112.6	104.5	117.4
2008/04	101.6	115.3	110.1	125.2
2008/05	102.4	117.4	113.4	130.4
2008/06	103.5	120.7	119.5	140.3
2008/07	104.7	122.1	122.6	143.9
2008/08	103.7	122.1	123.1	147.0
2008/09	102.7	118.3	117.1	137.1
2008/10	100.2	109.6	109.1	121.5
2008/11	98.6	104.5	97.8	105.8
2008/12	97.9	100.6	89.3	93.0
2009/01	98.0	99.5	85.6	88.4
2009/02	97.5	100.1	85.7	89.7
2009/03	97.3	104.2	85.2	93.0
2009/04	97.6	105.6	84.4	93.0
2009/05	97.5	103.8	84.0	90.8
2009/06	97.9	104.9	86.2	93.5
2009/07	97.5	103.1	89.2	95.0
2009/08	98.3	104.4	89.6	95.8
2009/09	98.3	102.1	91.0	94.7
2009/10	98.0	101.2	91.0	94.0
2009/11	98.4	100.8	92.8	94.8
2009/12	98.3	100.7	95.4	97.5
2010/01	99.4	102.2	97.0	100.0
2010/02	99.7	101.6	97.6	99.8
2010/03	99.7	101.8	97.0	99.2
2010/04	100.5	104.6	99.9	104.6
2010/05	100.7	102.9	101.7	104.9
2010/06	100.1	101.6	100.0	102.3
2010/07	99.4	99.0	99.9	99.8
2010/08	99.1	97.3	99.5	97.5
2010/09	99.4	97.0	100.0	97.2
2010/10	100.1	96.4	100.5	95.8
2010/11	100.7	97.4	102.6	98.2
2010/12	101.2	98.3	104.4	100.6
2011/01	102.1	98.6	107.2	102.6
2011/02	102.9	99.5	109.0	104.3
2011/03	103.5	99.6	111.8	106.3
2011/04	104.1	101.7	115.9	111.9
2011/05	103.9	99.9	118.8	112.4
2011/06	103.8	99.3	117.5	110.5
2011/07	103.6	98.3	118.3	110.2
2011/08	103.6	96.6	118.6	108.1
2011/09	103.7	96.1	117.0	106.2
2011/10	103.0	95.2	116.6	105.6
2011/11	101.9	94.8	115.4	105.4
2011/12	101.5	94.5	116.1	106.2
2012/01	101.8	94.0	115.0	104.2
2012/02	102.4	95.8	115.8	106.4
2012/03	102.9	99.2	118.3	112.9
2012/04	103.1	98.7	119.5	113.1
2012/05	102.3	96.3	118.1	109.8
2012/06	101.4	95.0	115.2	106.7
2012/07	100.6	94.0	112.0	103.5
2012/08	100.9	94.1	112.4	103.6
2012/09	101.0	94.1	114.7	105.2
2012/10	101.1	94.7	113.8	105.2
2012/11	100.9	95.9	113.2	106.5
2012/12	100.7	98.0	113.4	109.5
2013/01	101.0	102.4	113.8	115.4
2013/02	101.5	105.9	114.8	120.2
2013/03	101.3	106.6	115.1	122.0
2013/04	100.2	107.5	114.1	123.8
2013/05	99.6	109.1	112.6	125.3
2013/06	99.2	106.1	112.0	121.2
2013/07	99.1	107.5	111.6	122.8
2013/08	99.0	106.1	111.7	121.2
2013/09	99.0	107.2	112.9	123.9
2013/10	99.2	106.7	113.0	122.8
2013/11	99.1	108.0	113.1	124.9
2013-12	99.1	110.4	113.8	129.0
2014-01	99.2	110.7	114.4	130.1
2014-02	98.9	109.3	113.8	127.7
2014-03	98.6	109.0	113.4	127.4
2014-04	98.5	109.2	112.7	126.9
2014-05	98.3	108.4	112.5	126.0
2014-06	98.1	108.3	112.6	126.3
2014-07	98.2	108.2	112.6	126.0
2014-08	98.3	109.0	112.3	126.7

Source: Bank of Japan

Chart IV-7, Japan, Domestic Corporate Goods Price Index, Monthly, 1970-2014

Source: Bank of Japan

The producer price index of the US from 1970 to 2014 in Chart IV-8 shows various periods of more rapid or less rapid inflation but no bumps. The major event is the decline in 2008 when risk aversion because of the global recession caused the collapse of oil prices from $148/barrel to less than $80/barrel with most other commodity prices also collapsing. The event had nothing in common with explanations of deflation but rather with the concentration of risk exposures in commodities after the decline of stock market indexes. Eventually, there was a flight to government securities because of the fears of insolvency of banks caused by statements supporting proposals for withdrawal of toxic assets from bank balance sheets in the Troubled Asset Relief Program (TARP), as explained by Cochrane and Zingales (2009). The bump in 2008 with decline in 2009 is consistent with the view that zero interest rates with subdued risk aversion induce carry trades into commodity futures.

Chart IV-8, US, Producer Price Index Finished Goods, Monthly, 1970-2014

Source: US Bureau of Labor Statistics

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

Further insight into inflation of the corporate goods price index (CGPI) of Japan is provided in Table IV-7. The increase in the tax on value added of consumption caused sharp increases in prices across all segments. Petroleum and coal with weight of 5.7 percent decreased 1.1 percent in Aug 2014 and increased 8.4 percent in 12 months. Japan exports manufactured products and imports raw materials and commodities such that the country’s terms of trade, or export prices relative to import prices, deteriorate during commodity price increases. In contrast, prices of production machinery, with weight of 3.1 percent, decreased 0.1 percent in Aug 2014 and increased 3.5 percent in 12 months. In general, most manufactured products have been experiencing negative or low increases in prices while inflation rates have been high in 12 months for products originating in raw materials and commodities. Ironically, unconventional monetary policy of zero interest rates and quantitative easing that intended to increase aggregate demand and GDP growth deteriorated the terms of trade of advanced economies with adverse effects on real income (for analysis of terms of trade and growth see Pelaez (1979, 1976a). There are now inflation effects of the intentional policy of devaluing the yen.

Table IV-7, Japan, Corporate Goods Prices and Selected Components, % Weights, Month and 12 Months ∆%

Aug 2014	Weight	Month ∆%	12 Month ∆%
Total	1000.0	-0.2	3.9
Food, Beverages, Tobacco, Feedstuffs	137.5	0.0	3.1
Petroleum & Coal	57.4	-1.1	8.4
Production Machinery	30.8	-0.1	3.5
Electronic Components	31.0	0.1	-1.3
Electric Power, Gas & Water	52.7	-0.3	8.4
Iron & Steel	56.6	0.0	5.0
Chemicals	92.1	-0.2	3.3
Transport Equipment	136.4	0.0	2.8

Source: Bank of Japan

Percentage point contributions to change of the corporate goods price index (CGPI) in Jul 2014 are provided in Table IV-8 divided into domestic, export and import segments. The final block provides change in the corporate goods price without the effects of the increase in the tax on value added of consumption. In the domestic CGPI, decreasing 0.2 percent in Aug 2014, the energy shock is evident in the deduction of 0.02 percentage points by electric power, gas and water and 0.09 percentage points in petroleum and coal products in reversal of carry trades of exposures in commodity futures. The exports CGPI increased 0.1 percent on the basis of the contract currency with contribution of 0.08 percentage points by electric and electronic proucts and 0.05 percentage points by metals and related products. The imports CGPI decreased 0.3 percent on the contract currency basis. Petroleum, coal and natural gas products deducted 0.40 percentage points. Shocks of risk aversion cause unwinding carry trades that result in declining commodity prices with resulting downward pressure on price indexes. The volatility of inflation adversely affects financial and economic decisions worldwide. The final block D shows that the increase in the domestic corporate goods price index without the effects of the consumption tax is minus 0.1 percent.

Table IV-8, Japan, Percentage Point Contributions to Change of Corporate Goods Price Index

Groups Aug 2014	Contribution to Change Percentage Points
A. Domestic Corporate Goods Price Index	Monthly Change: -0.2%
Petroleum & Coal Products	-0.09
Agriculture, Forestry & Fishery Products	-0.03
Electric Power, Gas & Water	-0.02
B. Export Price Index	Monthly Change: 0.1% contract currency
Electric & Electronic Products	0.08
Metals & Related Products	0.05
General Purpose, Production & Business Oriented Machinery	0.03
Chemicals & Related Products	0.03
Other Primary Products & Manufactured Goods	-0.05
C. Import Price Index	Monthly Change: -0.3% contract currency basis
Petroleum, Coal & Natural Gas	-0.40
Transportation Equipment	-0.02
Other Primary Products & Manufactured Goods	-0.02
Metals & Related Products	0.09
Textiles	0.05
Electric & Electronic Products	0.02
D. Domestic Corporate Goods Price Index Excluding Consumption Tax	Monthly Change: -0.1%
Petroleum & Coal Products	-0.09
Agriculture, Forestry & Fishery Products	-0.03
Electric Power, Gas & Water	-0.02

Source: Bank of Japan

China is experiencing similar inflation behavior as the advanced economies in several prior months in the form of declining commodity prices but differs in decreasing inflation of producer prices relative to a year earlier. As shown in Table IV-9, inflation of the price indexes for industry in Aug 2014 is minus 0.2 percent; 12-month inflation is minus 1.2 percent in Aug; and cumulative inflation in Jan-Aug 2014 relative to Jan-Aug 2013 is minus 1.6 percent. Inflation of segments in Aug 2013 in China is provided in Table IV-9 in column “Month Aug 2014 ∆%.” There were decreases of prices of mining & quarrying of 0.7 percent in Aug and decrease of 4.4 percent in 12 months. Prices of consumer goods changed 0.0 percent in Aug and increased 0.2 percent in 12 months. Prices of inputs in the purchaser price index decreased 0.1 percent in Aug and declined 1.4 percent in 12 months. Fuel and power decreased 0.6 percent in Aug and declined 1.6 percent in 12 months. An important category of inputs for exports is textile raw materials, decreasing 0.1 percent in Aug and decreasing 1.2 percent in 12 months.

Table IV-9, China, Price Indexes for Industry ∆%

	Month Aug 2014 ∆%	12-Month Aug 2014 ∆%	Jan-Aug 2014/Jan-Aug 2013 ∆%
I Producer Price Indexes	-0.2	-1.2	-1.6
Means of Production	-0.3	-1.7	-2.1
Mining & Quarrying	-0.7	-4.4	-4.9
Raw Materials	-0.4	-1.5	-2.3
Processing	-0.2	-1.5	-1.7
Consumer Goods	0.0	0.2	0.0
Food	0.1	0.6	0.2
Clothing	0.0	0.7	0.8
Daily Use Articles	0.0	0.4	0.0
Durable Consumer Goods	-0.1	-0.8	-0.9
II Purchaser Price Indexes	-0.1	-1.4	-1.8
Fuel and Power	-0.6	-1.6	-2.0
Ferrous Metals	-0.6	-5.0	-4.4
Nonferrous Metals	0.1	-1.5	-4.6
Chemical Raw Materials	0.3	-0.3	-1.5
Wood & Pulp	-0.2	-0.5	-0.5
Building Materials	-0.7	-0.3	0.5
Other Industrial Raw Materials	-0.1	-0.9	-1.1
Agricultural	0.8	0.2	-0.3
Textile Raw Materials	-0.1	-1.2	-0.8

Source: National Bureau of Statistics of China

China’s producer price inflation follows waves similar to those around the world but with declining trend since May 2012, as shown in Table IV-10. In the first wave, annual equivalent inflation was 6.4 percent in Jan-Jun 2011, driven by carry trades from zero interest rates to commodity futures. In the second wave, risk aversion unwound carry trades, resulting in annual equivalent inflation of minus 3.1 percent in Jul-Nov 2011. In the third wave, renewed risk aversion resulted in annual equivalent inflation of minus 2.4 percent in Dec 2011-Jan 2012. In the fourth wave, new carry trades resulted in annual equivalent inflation of 2.4 percent in Feb-Apr 2012. In the fifth wave, annual equivalent inflation is minus 5.8 percent in May-Sep 2012. There are declining producer prices in China in Aug-Sep 2012 in contrast with increases worldwide. In a sixth wave, producer prices increased 0.2 percent in Oct 2012, which is equivalent to 2.4 percent in a year. In an eighth wave, annual equivalent inflation was minus 1.2 percent in Nov-Dec 2012. In the ninth wave, annual equivalent inflation in Jan-Feb 2013 is 2.4 percent. In the tenth wave, annual equivalent inflation was minus 4.9 percent in Mar-Jul 2013. In the eleventh wave, annual equivalent inflation was 1.8 percent in Aug-Sep 2013. In the twelfth wave, annual equivalent inflation was minus 1.5 percent in Oct 2013-Aug 2014.

Table IV-10, China, Month and 12-Month Rate of Change of Producer Price Index, ∆%

	12-Month ∆%	Month ∆%
Aug 2014	-1.2	-0.2
Jul	-0.9	-0.1
Jun	-1.1	-0.2
May	-1.4	-0.1
Apr	-2.0	-0.2
Mar	-2.3	-0.3
Feb	-2.0	-0.2
Jan	-1.6	-0.1
Dec 2013	-1.4	0.0
Nov	-1.4	0.0
Oct	-1.5	0.0
AE ∆% Oct-Aug		-1.5
Sep	-1.3	0.2
Aug	-1.6	0.1
AE ∆% Aug-Sep		1.8
Jul	-2.3	-0.3
Jun	-2.7	-0.6
May	-2.9	-0.6
Apr	-2.6	-0.6
Mar	-1.9	0.0
AE ∆% Mar-Jul		-4.9
Feb	-1.6	0.2
Jan	-1.6	0.2
AE ∆% Jan-Feb		2.4
Dec 2012	-1.9	-0.1
Nov	-2.2	-0.1
AE ∆% Nov-Dec		-1.2
Oct	-2.8	0.2
AE ∆% Oct		2.4
Sep	-3.6	-0.1
Aug	-3.5	-0.5
Jul	-2.9	-0.8
Jun	-2.1	-0.7
May	-1.4	-0.4
AE ∆% May-Sep		-5.8
Apr	-0.7	0.2
Mar	-0.3	0.3
Feb	0.0	0.1
AE ∆% Feb-Apr		2.4
Jan	0.7	-0.1
Dec 2011	1.7	-0.3
AE ∆% Dec-Jan		-2.4
Nov	2.7	-0.7
Oct	5.0	-0.7
Sep	6.5	0.0
Aug	7.3	0.1
Jul	7.5	0.0
AE ∆% Jul-Nov		-3.1
Jun	7.1	0.0
May	6.8	0.3
Apr	6.8	0.5
Mar	7.3	0.6
Feb	7.2	0.8
Jan	6.6	0.9
AE ∆% Jan-Jun		6.4
Dec 2010	5.9	0.7

AE: Annual Equivalent

Source: National Bureau of Statistics of China

Chart IV-9 of the National Bureau of Statistics of China provides monthly and 12-month rates of inflation of the price indexes for the industrial sector. Negative monthly rates in Oct, Nov, Dec 2011, Jan, Mar, Apr, May, Jun, Jul, Aug, Sep, Nov and Dec 2012 pulled down the 12-month rates to 5.0 percent in Oct 2011, 2.7 percent in Nov, 1.7 percent in Dec, 0.7 percent in Jan 2012, 0.0 percent in Feb, minus 0.3 percent in Mar, minus 0.7 percent in Apr, minus 1.4 percent in May, 2.1 in Jun, minus 2.9 percent in Jul, minus 3.5 percent in Aug, minus 3.6 percent in Sep. The increase of 0.2 percent in Oct 2012 pulled up the 12-month rate to minus 2.8 percent and the rate eased to minus 2.2 percent in Nov 2012 and minus 1.9 percent in Dec 2012. Increases of 0.2 percent in Jan and Feb 2013 pulled the 12-month rate to minus 1.6 percent while no change in Mar 2013 brought down the 12-month rate to minus 1.9 percent. Declines of prices of 0.6 percent in Apr, May and Jun 2013 pushed the 12-month rate to minus 2.7 percent. Producer prices fell 2.3 percent in the 12 months ending in Jul 2013 and minus 1.6 percent in Aug 2013 with increase of 0.1 percent in the month of Aug 2013. Producer price inflation was minus 1.3 percent in the 12 months ending in Sep 2013 and minus 1.5 percent in the 12 months ending in Oct 2013. Producer price inflation was minus 1.4 percent in the 12 months ending in Nov 2013 and minus 1.4 percent in the 12 months ending in Dec 2013. Producer price inflation was minus 1.6 percent in the 12 months ending in Jan 2014 and minus 2.0 percent in the 12 months ending in Feb 2014. In Mar 2014, producer price inflation was minus 0.3 percent and minus 2.3 percent in 12 months followed by minus 0.2 percent in Apr 2014 and minus 2.0 percent in 12 months. Producer prices fell 0.1 percent in May 2014 and decreased 1.4 percent in 12 months. The producer price index fell 0.2 percent in Jun 2014 and decreased 1.1 percent in 12 months. The producer price index fell 0.1 percent in Jul 2014 and decreased 0.9 percent in 12 months. The producer price index fell 0.2 percent in Aug 2014 and declined 1.2 percent in 12 months.

Chart IV-9, China, Producer Prices for the Industrial Sector Month and 12 Months ∆%

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

Chart IV-10 of the National Bureau of Statistics of China provides monthly and 12-month inflation of the purchaser product indices for the industrial sector. Decreasing monthly inflation with four successive contractions from Oct 2011 to Jan 2012 and May-Aug 2012 pulled down the 12-month rate to minus 4.1 percent in Aug and Sep. Consecutive increases of 0.1 percent in Sep and Oct 2012 raised the 12-month rate to minus 3.3 percent in Oct 2012. The rate eased to minus 2.8 in Nov 2012 with decrease of 0.2 percent in Nov 2012 and minus 2.4 percent in Dec 2012 with monthly decrease of 0.1 percent. Increase of 0.3 percent in Jan 2013 and 0.2 in Feb 2013 pulled the 12-month rate to minus 1.9 percent. Decrease of prices of 0.1 percent in Mar 2013 brought down the 12-month rate to minus 2.0 percent. Declining prices of 0.6 percent in Apr and May 2013 and 0.5 percent in Jun 2013 pushed down the 12-month rate to minus 2.6 percent. The index fell 2.2 percent in the 12 months ending in Jul 2013 and 1.6 percent in the 12 months ending in Aug 2013. The index fell 1.6 percent in the 12 months ending in Sep 2013 and 1.6 percent in the 12 months ending in Oct 2013. Purchaser price inflation was minus 1.5 percent in the 12 months ending in Nov 2013 and minus 1.4 percent in the 12 months ending in Dec 2013. Purchaser price inflation was minus 1.7 percent in the 12 months ending in Jan 2014 and minus 2.1 percent in the 12 months ending in Feb 2014. In Mar 2014, inflation of the purchaser price index was minus 0.5 percent and minus 2.5 percent in 12 months followed by minus 0.4 percent in Apr 2014 and minus 2.3 percent in 12 months. The purchaser price index fell 0.1 percent in May 2014 and decreased 1.8 percent in 12 months. In Jun 2014, the purchaser price index fell 0.1 percent and decreased 1.5 percent in 12 months. The purchaser price index changed 0.0 percent in Jul 2014 and fell 1.1 percent in 12 months. The purchaser price index fell 0.1 percent in Aug 2014 and fell 1.4 percent in 12 months.

Chart IV-10, China, Purchaser Product Indices for Industrial Sector, Month and 12 Months ∆%

Source: National Bureau of Statistics of China

China is highly conscious of food price inflation because of its high weight in the basket of consumption of the population. Consumer price inflation in China in Aug 2014 was 0.2 percent and 2.0 percent in 12 months, as shown in Table IV-11. Food prices decreased 0.1 percent in Jul 2013 and increased 3.6 percent in 12 months. Food prices increased 0.2 percent in May 2014 and 4.1 percent in 12 months. Food prices decreased 1.3 percent in Apr 2014, increasing 2.3 percent in 12 months ending in Apr 2014 and 3.2 percent in Jan-Apr 2014 relative to a year earlier. Food prices increased 2.4 percent in Jan 2014, 3.7 percent in 12 months and 3.7 percent in the cumulative Jan 2014 relative to a year earlier. Food prices fell 0.2 percent in Nov 2013, increasing 5.9 percent in 12 months and 4.7 percent in the cumulative to Nov 2013 relative to a year earlier. Food prices decreased 0.4 percent in Oct 2013, increasing 6.5 percent in 12 months in adjustment to sharp increase in Sep 2013. Adjustment from the prior shock had occurred in May with decline of food prices by 1.6 percent and increase of 3.8 percent in 12 months and 3.8 percent in Jan-May 2013 relative to a year earlier. Food prices increased 0.7 percent in Aug 2014 and increased 3.0 percent in 12 months. Another area of concern is housing inflation, which was 0.2 percent in Jan and increased 2.8 percent in 12 months. House inflation was 0.3 percent in Feb 2014 and 2.8 percent in 12 months. House inflation was 0.2 percent in Mar 2014 and 2.5 percent in 12 months. House inflation was 0.1 percent in Apr 2014 and 2.4 percent in 12 months. House inflation was 0.0 percent in May 2014 and 2.3 percent in 12 months. House inflation changed 0.0 percent in Jun 2014 and increased 2.2 percent in 12 months. Prices of services increased 0.1 percent in Jun and gained 2.6 percent in 12 months. House prices changed 0.0 percent in Jul 2014 and increased 2.0 percent in 12 months. House prices increased 0.1 percent in Aug 2014 and 1.9 percent in 12 months. House renting increased 0.2 percent in Aug 2014 and 2.6 percent in 12 months.

Table IV-11, China, Consumer Price Index

2014	Aug 2014 Month ∆%	Aug 2014 12-Month ∆%	Jan-Aug 2014 ∆%/ Jan-Aug 2013
Consumer Prices	0.2	2.0	2.2
Urban	0.1	2.0	2.3
Rural	0.3	1.9	2.0
Food	0.7	3.0	3.4
Non-food	-0.1	1.5	1.6
Consumer Goods	0.3	1.8	2.0
Services	0.0	2.4	2.8
Excluding Food and Energy	0.0	1.6	1.7
Commodity Categories:
Food	0.7	3.0	3.4
Tobacco, Liquor	-0.1	-0.6	-0.6
Clothing	-0.2	2.6	2.4
Household	0.0	1.1	1.2
Healthcare & Personal Articles	0.1	1.4	1.2
Transportation & Communication	-0.3	0.2	0.2
Recreation, Education, Culture & Services	-0.2	1.9	2.2
Residence	0.1	1.9	2.4
House Renting	0.2	2.6	3.6

Source: National Bureau of Statistics of China

Month and 12-month rates of change of consumer prices are provided in Table IV-12. There are waves of consumer price inflation in China similar to those around the world (http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html). In the first wave, consumer prices increased at the annual equivalent rate of 8.3 percent in Jan-Mar 2011, driven by commodity price increases resulting from unconventional monetary policy of zero interest rates. In the second wave, risk aversion unwound carry trades with annual equivalent inflation falling to the rate of 2.0 percent in Apr-Jun 2011. In the third wave, inflation returned at 2.9 percent with renewed interest in commodity exposures in Jul-Nov 2011. In the fourth wave, inflation returned at a high 5.8 percent annual equivalent in Dec 2011 to Mar 2012. In the fifth wave, annual equivalent inflation was minus 3.9 percent in Apr to Jun 2012. In the sixth wave, annual equivalent inflation rose to 4.1 percent in Jul-Sep 2012. In the seventh wave, inflation was minus 1.2 percent annual equivalent in Oct 2012 and 0.0 percent in Oct-Nov 2012. In the eighth wave, annual equivalent inflation was 12.2 percent in Dec 2012-Feb 2013 primarily because of winter weather that caused increases in food prices. In the ninth wave, collapse of food prices resulted in annual equivalent inflation of minus 10.3 percent in Mar 2013. In the tenth wave, annual equivalent inflation returned at 2.4 percent in Apr 2013. In the eleventh wave, annual equivalent inflation was minus 3.5 percent in May-Jun 2013. In the twelfth wave, inflation rose at annual equivalent 4.6 percent in Jul-Oct 2013 with sharp increase of food prices in Sep 2013. In the thirteenth wave, annual equivalent inflation was minus 1.2 percent in Nov 2013. In the fourteenth wave, annual equivalent inflation was 7.4 percent in Dec 2013-Feb 2014. In the fifteenth wave, annual inflation was minus 4.7 percent in Mar-Apr 2014. In the sixteenth wave, annual equivalent inflation was 1.2 percent in May 2014. In the seventeenth wave, annual equivalent inflation was minus 1.2 percent in Jun 2014. In the eighteenth wave, annual equivalent inflation was 1.8 percent in Jul-Aug 2014. Inflation volatility originating in unconventional monetary policy clouds investment and consumption decisions by business and households. There is local problem in China with food prices.

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

	Month ∆%	12-Month ∆%
Aug 2014	0.2	2.0
Jul	0.1	2.3
AE ∆% Jul-Aug	1.8
Jun	-0.1	2.3
AE ∆% Jun	-1.2
May	0.1	2.5
AE ∆% May	1.2
Apr	-0.3	1.8
Mar	-0.5	2.4
AE ∆% Mar-Apr	-4.7
Feb	0.5	2.0
Jan	1.0	2.5
Dec 2013	0.3	2.5
AE ∆% Dec-Feb	7.4
Nov	-0.1	3.0
AE ∆% Nov	-1.2
Oct	0.1	3.2
Sep	0.8	3.1
Aug	0.5	2.6
Jul	0.1	2.7
AE ∆% Jul-Oct	4.6
Jun	0.0	2.7
May	-0.6	2.1
AE ∆% May-Jun	-3.5
Apr	0.2	2.4
AE ∆% Apr	2.4
Mar 2013	-0.9	2.1
AE ∆% Mar	-10.3
Feb	1.1	3.2
Jan	1.0	2.0
Dec 2012	0.8	2.5
AE ∆% Dec-Feb	12.2
Nov	0.1	2.0
Oct	-0.1	1.7
AE ∆% Oct-Nov	0.0
Sep	0.3	1.9
Aug	0.6	2.0
Jul	0.1	1.8
AE ∆% Jul-Sep	4.1
Jun	-0.6	2.2
May	-0.3	3.0
Apr	-0.1	3.4
AE ∆% Apr to Jun	-3.9
Mar	0.2	3.6
Feb	-0.1	3.2
Jan	1.5	4.5
Dec 2011	0.3	4.1
AE ∆% Dec to Mar	5.8
Nov	-0.2	4.2
Oct	0.1	5.5
Sep	0.5	6.1
Aug	0.3	6.2
Jul	0.5	6.5
AE ∆% Jul to Nov	2.9
Jun	0.3	6.4
May	0.1	5.5
Apr	0.1	5.3
AE ∆% Apr to Jun	2.0
Mar	-0.2	5.4
Feb	1.2	4.9
Jan	1.0	4.9
AE ∆% Jan to Mar	8.3
Dec 2010	0.5	4.6

AE: Annual Equivalent

Source: National Bureau of Statistics of China

Chart IV-11 of the National Bureau of Statistics of China provides monthly and 12-month rates of consumer price inflation. In contrast with producer prices, consumer prices had not moderated at the monthly marginal rates. Consumer prices fell 0.2 percent in Nov 2011 after increasing only 0.1 percent in Oct but increased 0.3 percent in Dec and a high 1.5 percent in Jan 2012, declining 0.1 percent in Feb, rising 0.2 percent in Mar and declining 0.1 percent in Apr, 0.3 percent in May and 0.6 percent in Jun 2012 but increasing 0.1 percent in Jul, 0.6 percent in Aug 2012 and 0.3 percent in Sep 2012. Consumer prices fell 0.1 percent in Oct 2012. The decline of 0.1 percent in Feb 2012 pulled down the 12-month rate to 3.2 percent, which bounced back to 3.6 percent in Mar with the monthly increase of 0.2 percent and fell to 2.2 percent in Jun with increasing pace of monthly decline from Apr to Jun 2012. Even with increase of 0.1 percent in Jul 2012, consumer price inflation in 12 months fell to 1.8 percent in Jul 2012 but bounced back to 2.0 percent with increase of 0.6 percent in Aug. In Sep, increase of 0.3 percent still maintained 12-month inflation at 1.9 percent. The decline of 0.1 percent in Oct 2012 pulled down the 12-month rate to 1.7 percent, which is the lowest in Chart IV-3. Increase of 0.1 percent in Nov 2012 pulled up the 12-month rate to 2.0 percent. Abnormal increase of 0.8 percent in Dec 2012 because of winter weather pulled up the 12-month rate to 2.5 percent. Even with increase of 1.0 percent in Jan 2013 12-month inflation fell to 2.0 percent. Inflation of 1.1 percent in Feb 2013 pulled the 12-month rate to 3.2 percent. Collapse of food prices with decline of consumer prices by 0.9 percent in Mar 2013 brought down the 12-month rate to 2.1 percent. Renewed inflation of 0.2 percent in Apr 2013 raised the 12-month rate to 2.4 percent. Decline of inflation by 0.6 percent in May reduced 12-month inflation to 2.1 percent. Inflation rose to 2.7 percent in the 12 months ending in Jun 2013 with unchanged monthly inflation. Consumer prices increased 0.1 percent in Jul 2013 and 2.7 percent in 12 months. In combination of increases of food prices and other prices, inflation returned with 0.5 percent in Aug 2013 and 2.6 percent in 12 months. Consumer prices increased 0.8 percent in Sept 2013 and 3.1 percent in 12 months with increase in food prices of 1.5 in the month of Sep 2013. Consumer prices increased 0.1 percent in Oct 2013 and 3.2 percent in 12 months. Consumer prices fell 0.1 percent in Nov 2013 and increased 3.0 percent in 12 months. Consumer prices increased 0.3 percent in Dec 2013 and increased 2.5 percent in 12 months. Consumer prices increased 1.0 percent in Jan 2014 and 2.5 percent in 12 months. In Feb 2014, consumer prices increased 0.5 percent and 2.0 percent in 12 months. Consumer prices fell 0.5 percent in Mar 2014 and increased 2.4 percent in 12 months followed by 0.3 percent in Apr 2014 and 1.8 percent in 12 months. Consumer prices increased 0.1 percent in May 2014 and 2.5 percent in 12 months. In Jun 2014, consumer prices fell 0.1 percent and increased 2.3 percent in 12 months. Consumer prices increased 0.1 percent in Jul 2014 and increased 2.3 percent in 12 months. In Aug 2014, consumer prices increased 0.2 percent and rose 2.0 percent in 12 months.

Chart IV-11, China, Consumer Prices ∆% Month and 12 Months

Source: National Bureau of Statistics of China