World Inflation Waves, Squeeze of Economic Activity by Carry Trades Induced by Zero Interest Rates, United States Industrial Production, Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities, World Cyclical Slow Growth and Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014
I World Inflation Waves
IA Appendix: Transmission of Unconventional Monetary Policy
IB1 Theory
IB2 Policy
IB3 Evidence
IB4 Unwinding Strategy
IC United States Inflation
IC Long-term US Inflation
ID Current US Inflation
IE Theory and Reality of Economic History, Cyclical Slow Growth Not Secular Stagnation and Monetary Policy Based on Fear of Deflation
IIA Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities
IIB United States Industrial Production
III World Financial Turbulence
IIIA Financial Risks
IIIE Appendix Euro Zone Survival Risk
IIIF Appendix on Sovereign Bond Valuation
IV Global Inflation
V World Economic Slowdown
VA United States
VB Japan
VC China
VD Euro Area
VE Germany
VF France
VG Italy
VH United Kingdom
VI Valuation of Risk Financial Assets
VII Economic Indicators
VIII Interest Rates
IX Conclusion
References
Appendixes
Appendix I The Great Inflation
IIIB Appendix on Safe Haven Currencies
IIIC Appendix on Fiscal Compact
IIID Appendix on European Central Bank Large Scale Lender of Last Resort
IIIG Appendix on Deficit Financing of Growth and the Debt Crisis
IIIGA Monetary Policy with Deficit Financing of Economic Growth
IIIGB Adjustment during the Debt Crisis of the 1980s
III World Financial Turbulence. Financial markets are being shocked by multiple factors including:
(1) World economic slowdown
(2) Slowing growth in China with political development and slowing growth in Japan and world trade
(3) Slow growth propelled by savings/investment reduction in the US with high unemployment/underemployment, falling wages, hiring collapse, contraction of real private fixed investment, increase of wealth of households over the business cycle by total 7.3 percent adjusted for inflation from IVQ2007 to IVQ2013 while growing at 3.1 percent per year adjusted for inflation from IVQ1945 to IVQ2013 and unsustainable fiscal deficit/debt threatening prosperity that can cause risk premium on Treasury debt with Himalayan interest rate hikes
(4) Outcome of the sovereign debt crisis in Europe.
This section provides current data and analysis. Subsection IIIA Financial Risks provides analysis of the evolution of valuations of risk financial assets during the week. There are various appendixes for convenience of reference of material related to the debt crisis of the euro area. Some of this material is updated in Subsection IIIA when new data are available and then maintained in the appendixes for future reference until updated again in Subsection IIIA. Subsection IIIB Appendix on Safe Haven Currencies discusses arguments and measures of currency intervention and is available in the Appendixes section at the end of the blog comment. Subsection IIIC Appendix on Fiscal Compact provides analysis of the restructuring of the fiscal affairs of the European Union in the agreement of European leaders reached on Dec 9, 2011 and is available in the Appendixes section at the end of the blog comment. Subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort considers the policies of the European Central Bank and is available in the Appendixes section at the end of the blog comment. Appendix IIIE Euro Zone Survival Risk analyzes the threats to survival of the European Monetary Union and is available following Subsection IIIA. Subsection IIIF Appendix on Sovereign Bond Valuation provides more technical analysis and is available following Subsection IIIA. Subsection IIIG Appendix on Deficit Financing of Growth and the Debt Crisis provides analysis of proposals to finance growth with budget deficits together with experience of the economic history of Brazil and is available in the Appendixes section at the end of the blog comment.
IIIA Financial Risks. Financial turbulence, attaining unusual magnitude in recent months, characterized the expansion from the global recession since IIIQ2009. Table III-1, updated with every comment in this blog, provides beginning values on Sep 5 and daily values throughout the week ending on Sep 12, 2014 of various financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at 5 PM. The first column provides the value on Fri Sep 12 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Sep 12, 2014”, first row “USD/EUR 1.2965 -0.1% -0.3%,” provides the information that the US dollar (USD) depreciated 0.1 percent to USD 1.2965/EUR in the week ending on Fri Sep 12 relative to the exchange rate on Fri Sep 5 and depreciated 0.3 percent relative to Thu Sep 11. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing waves of inflation. An important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9 (European Council 2911Dec9), which is analyzed in IIIC Appendix on Fiscal Compact. European leaders reached a new agreement on Jan 30 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/127631.pdf) and another agreement on Jun 29, 2012 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf). The most important source of financial turbulence is shifting toward fluctuating interest rates. The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.2940/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Sep 12, appreciating to USD 1.2940/EUR on Mon Sep 15, 2014, or by 0.2 percent. The dollar appreciated because fewer dollars, 1.2940, were required on Mon Sep 15 to buy one euro than $1.2965 on Fri Sep 12. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.2965/EUR on Feb 12. The second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Sep 12, to the last business day of the current week, in this case Fri Sep 19, such as appreciation of 1.0 percent to USD 1.2829/EUR by Sep 19. The third row provides the percentage change from the prior business day to the current business day. For example, the USD appreciated (denoted by positive sign) by 1.0 percent from the rate of USD 1.2965/EUR on Fri Sep 12 to the rate of USD 1.2829/EUR on Fri Sep 19 {[(1.2829/1.2965) – 1]100 = -1.0%}. The dollar appreciated (denoted by positive sign) by 0.7 percent from the rate of USD 1.2922 on Thu Sep 18 to USD 1.2829/EUR on Fri Sep 19 {[(1.2829/1.2922) -1]100 = -0.7 %}. Other factors constant, appreciation of the dollar relative to the euro is caused by increasing risk aversion, with rising uncertainty on European and global sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from higher yielding risk assets to the safety of dollar-denominated assets during risk aversion and return to higher yielding risk assets during risk appetite.
Table III-I, Weekly Financial Risk Assets Sep 15 to Sep 19, 2014
| Fri Sep 12, 2014 | Mon 15 | Tue 16 | Wed 17 | Thu 18 | Fri 19 |
| USD/ EUR 1.2965 -0.1% -0.3% | 1.2940 0.2% 0.2% | 1.2960 0.0% -0.2% | 1.2865 0.8% 0.7% | 1.2922 0.3% -0.4% | 1.2829 1.0% 0.7% |
| JPY/ USD 107.36 -2.2% -0.2% | 107.19 0.2% 0.2% | 107.13 0.2% 0.1% | 108.37 -0.9% -1.2% | 108.69 -1.2% -0.3% | 109.05 -1.6% -0.3% |
| CHF/ USD 0.9334 -0.2% 0.3% | 0.9352 -0.2% -0.2% | 0.9326 0.1% 0.3% | 0.9412 -0.8% -0.9% | 0.9338 0.0% 0.8% | 0.9409 -0.8% -0.8% |
| CHF/ EUR 1.2101 -0.3% 0.0% | 1.2102 0.0% 0.0% | 1.2086 0.1% 0.1% | 1.2109 -0.1% -0.2% | 1.2066 0.3% 0.4% | 1.2071 0.2% 0.0% |
| USD/ AUD 0.9037 1.1066 -3.8% -0.7% | 0.9029 1.1075 -0.1% -0.1% | 0.9093 1.0997 0.6% 0.7% | 0.8962 1.1158 -0.8% -1.5% | 0.8991 1.1122 -0.5% 0.3% | 0.8926 1.1203 -1.2% -0.7% |
| 10Y Note 2.606 | 2.589 | 2.592 | 2.618 | 2.62 | 2.576 |
| 2Y Note 0.562 | 0.542 | 0.534 | 0.567 | 0.56 | 0.567 |
| German Bond 2Y -0.06 10Y 1.08 | 2Y -0.08 10Y 1.07 | 2Y -0.06 10Y 1.06 | 2Y -0.07 10Y 1.05 | 2Y -0.06 10Y 1.08 | 2Y -0.07 10Y 1.04 |
| DJIA 16987.51 -0.9% -0.4% | 17031.14 0.3% 0.3% | 17131.97 0.9% 0.6% | 17156.85 1.0% 0.1% | 17265.99 1.6% 0.6% | 17279.74 1.7% 0.1% |
| Dow Global 2592.71 -1.5% -0.4% | 2587.71 -0.2% -0.2% | 2593.88 0.0% 0.2% | 2601.99 0.4% 0.3% | 2610.54 0.7% 0.3% | 2604.59 0.5% -0.2% |
| DJ Asia Pacific 1509.77 -1.7% -0.3% | 1501.83 -0.5% -0.5% | 1494.70 -1.0% -0.5% | 1495.41 -1.0% 0.0% | 1492.00 -1.2% -0.2% | 1497.12 -0.8% 0.3% |
| Nikkei 15948.29 1.8% 0.2% | 15948.29 0.0% 0.0% | 15911.53 -0.2% -0.2% | 15888.67 -0.4% -0.1% | 16067.57 0.7% 1.1% | 16321.17 2.3% 1.6% |
| Shanghai 2331.95 0.2% 0.9% | 2339.14 0.3% 0.3% | 2296.56 -1.5% -1.8% | 2307.89 -1.0% 0.5% | 2315.93 -0.7% 0.3% | 2329.45 -0.1% 0.6% |
| DAX 9651.13 -1.0% -0.4% | 9659.63 0.1% 0.1% | 9632.93 -0.2% -0.3% | 9661.50 0.1% 0.3% | 9798.13 1.5% 1.4% | 9799.26 1.5% 0.0% |
| DJ UBS Comm. NA | NA | NA | NA | NA | NA |
| WTI $/B 92.27 -1.1% -0.6% | 92.92 0.7% 0.7% | 94.88 2.8% 2.1% | 94.42 2.3% -0.5% | 93.07 0.8% -1.4% | 92.41 0.2% -0.7% |
| Brent $/B 97.11 -3.7% -1.0% | 96.65 -0.5% -0.5% | 99.05 2.0% 2.5% | 98.97 -1.9% -0.1% | 97.70 0.6% -1.3% | 98.39 1.3% 0.7% |
| Gold $/OZ 1229.9 -2.8% -0.6% | 1233.6 0.3% 0.3% | 1235.2 0.4% 0.1% | 1234.4 0.4% -0.1% | 1225.7 -0.3% -0.7% | 1215.3 -1.2% -0.8% |
Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss
Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce
Sources: http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
There is initial discussion of current and recent risk-determining events followed below by analysis of risk-measuring yields of the US and Germany and the USD/EUR rate.
1 First, risk determining events. Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). If there were an infallible science of central banking, models and forecasts would provide accurate information to policymakers on the future course of the economy in advance. Such forewarning is essential to central bank science because of the long lag between the actual impulse of monetary policy and the actual full effects on income and prices many months and even years ahead (Romer and Romer 2004, Friedman 1961, 1953, Culbertson 1960, 1961, Batini and Nelson 2002). The transcripts of the Fed meetings in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm) analyzed by Jon Hilsenrath demonstrate that Fed policymakers frequently did not understand the current state of the US economy in 2008 and much less the direction of income and prices. The conclusion of Friedman (1953) is that monetary impulses increase financial and economic instability because of lags in anticipating needs of policy, taking policy decisions and effects of decisions. This is a fortiori true when untested unconventional monetary policy in gargantuan doses shocks the economy and financial markets.
In testimony on the Semiannual Monetary Policy Report to the Congress before the Committee on Financial Services, US House of Representatives, on Feb 11, 2014, Chair Janet Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20140211a.htm):
“Turning to monetary policy, let me emphasize that I expect a great deal of continuity in the FOMC's approach to monetary policy. I served on the Committee as we formulated our current policy strategy and I strongly support that strategy, which is designed to fulfill the Federal Reserve's statutory mandate of maximum employment and price stability. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. That said, purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. In December of last year and again this January, the Committee said that its current expectation--based on its assessment of a broad range of measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments--is that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the 2 percent goal. I am committed to achieving both parts of our dual mandate: helping the economy return to full employment and returning inflation to 2 percent while ensuring that it does not run persistently above or below that level (emphasis added).”
Prior risk determining events are in an appendix below following Table III-1A. Current focus is on “tapering” quantitative easing by the Federal Open Market Committee (FOMC). At the meeting on Sep 17, 2014, the FOMC decided additional tapering monthly bond purchases. Earlier programs are continued with an additional lower open-ended $15 billion of bond purchases per month, increasing the stock of $4,187,075 million “securities held outright” and bank reserves deposited at the Fed of $2,751,908 million (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1) (http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm):
“The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.“
At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states needs and intentions of policy:
“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time.
For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”
There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Market are overreacting to the so-called “tapering” of outright purchases of $85 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Sep 17, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm):
“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.” (emphasis added).
Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):
So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly” (emphasis added).
How long is “considerable time”? At the press conference following the meeting on Mar 19, 2014, Chair Yellen answered a question of Jon Hilsenrath of the Wall Street Journal explaining “In particular, the Committee has endorsed the view that it anticipates that will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates. And of course on our present path, well, that's not utterly preset. We would be looking at next, next fall. So, I think that's important guidance” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140319.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”
At a speech on Mar 31, 2014, Chair Yellen analyzed labor market conditions as follows (http://www.federalreserve.gov/newsevents/speech/yellen20140331a.htm):
“And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress. The first of those goals is maximum sustainable employment, the highest level of employment that can be sustained while maintaining a stable inflation rate. Most of my colleagues on the Federal Open Market Committee and I estimate that the unemployment rate consistent with maximum sustainable employment is now between 5.2 percent and 5.6 percent, well below the 6.7 percent rate in February.
Let me explain what I mean by that word "slack" and why it is so important.
Slack means that there are significantly more people willing and capable of filling a job than there are jobs for them to fill. During a period of little or no slack, there still may be vacant jobs and people who want to work, but a large share of those willing to work lack the skills or are otherwise not well suited for the jobs that are available. With 6.7 percent unemployment, it might seem that there must be a lot of slack in the U.S. economy, but there are reasons why that may not be true.”
Yellen (2014Aug22) provides comprehensive review of the theory and measurement of labor markets. Monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):
“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”
Yellen (2014Aug22) finds that the unemployment rate is not sufficient in determining slack:
“One convenient way to summarize the information contained in a large number of indicators is through the use of so-called factor models. Following this methodology, Federal Reserve Board staff developed a labor market conditions index from 19 labor market indicators, including four I just discussed. This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.”
Yellen (2014Aug22) restates that the FOMC determines monetary policy on newly available information and interpretation of labor markets and inflation and does not follow a preset path:
“But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter. Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate. As I have noted many times, monetary policy is not on a preset path. The Committee will be closely monitoring incoming information on the labor market and inflation in determining the appropriate stance of monetary policy.”
Yellen (2014Aug22) states that “Historically, slack has accounted for only a small portion of the fluctuations in inflation. Indeed, unusual aspects of the current recovery may have shifted the lead-lag relationship between a tightening labor market and rising inflation pressures in either direction.”
Another critical concern in the statement of the FOMC on Sep 18, 2013, is on the effects of tapering expectations on interest rates (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):
“Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth” (emphasis added).
Will the FOMC increase purchases of mortgage-backed securities if mortgage rates increase?
Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):
So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly” (emphasis added).
In a speech at the IMF on Jul 2, 2014, Chair Yellen analyzed the link between monetary policy and financial risks (http://www.federalreserve.gov/newsevents/speech/yellen20140702a.htm):
“Monetary policy has powerful effects on risk taking. Indeed, the accommodative policy stance of recent years has supported the recovery, in part, by providing increased incentives for households and businesses to take on the risk of potentially productive investments. But such risk-taking can go too far, thereby contributing to fragility in the financial system. This possibility does not obviate the need for monetary policy to focus primarily on price stability and full employment--the costs to society in terms of deviations from price stability and full employment that would arise would likely be significant. In the private sector, key vulnerabilities included high levels of leverage, excessive dependence on unstable short-term funding, weak underwriting of loans, deficiencies in risk measurement and risk management, and the use of exotic financial instruments that redistributed risk in nontransparent ways.”
Yellen (2014Jul14) warned again at the Committee on Banking, Housing and Urban Affairs on Jul 15, 2014:
“The Committee recognizes that low interest rates may provide incentives for some investors to “reach for yield,” and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance. More broadly, the financial sector has continued to become more resilient, as banks have continued to boost their capital and liquidity positions, and growth in wholesale short-term funding in financial markets has been modest” (emphasis added).
Greenspan (1996) made similar warnings:
“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy” (emphasis added).
Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. What is the success in evaluating deviations of valuations of risk financial assets from “historical norms”? What are the consequences on economic activity and employment of deviations of valuations of risk financial assets from those “historical norms”? What are the policy tools and their effectiveness in returning valuations of risk financial assets to their “historical norms”?
The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.
Professor Raguram G Rajan, governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation. Rajan (2005) anticipated the risks of the world financial crisis. Professor John B. Taylor (2014Jul15, 2014Jun26) building on advanced research (Taylor (1993, 1998LB, 1999, 1998LB, 1999, 2007JH, 2008Nov, 2009, 2012JMCB, 2014Jan3) finds that a monetary policy rule would function best in promoting an environment of low inflation and strong economic growth with stability of financial markets. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html).
In testimony before the Committee on the Budget of the US Senate on May 8, 2014, Chair Yellen provides analysis of the current economic situation and outlook (http://www.federalreserve.gov/newsevents/testimony/yellen20140507a.htm):
“The economy has continued to recover from the steep recession of 2008 and 2009. Real gross domestic product (GDP) growth stepped up to an average annual rate of about 3-1/4 percent over the second half of last year, a faster pace than in the first half and during the preceding two years. Although real GDP growth is currently estimated to have paused in the first quarter of this year, I see that pause as mostly reflecting transitory factors, including the effects of the unusually cold and snowy winter weather. With the harsh winter behind us, many recent indicators suggest that a rebound in spending and production is already under way, putting the overall economy on track for solid growth in the current quarter. One cautionary note, though, is that readings on housing activity--a sector that has been recovering since 2011--have remained disappointing so far this year and will bear watching.
Conditions in the labor market have continued to improve. The unemployment rate was 6.3 percent in April, about 1-1/4 percentage points below where it was a year ago. Moreover, gains in payroll employment averaged nearly 200,000 jobs per month over the past year. During the economic recovery so far, payroll employment has increased by about 8-1/2 million jobs since its low point, and the unemployment rate has declined about 3-3/4 percentage points since its peak.
While conditions in the labor market have improved appreciably, they are still far from satisfactory. Even with recent declines in the unemployment rate, it continues to be elevated. Moreover, both the share of the labor force that has been unemployed for more than six months and the number of individuals who work part time but would prefer a full-time job are at historically high levels. In addition, most measures of labor compensation have been rising slowly--another signal that a substantial amount of slack remains in the labor market.
Inflation has been quite low even as the economy has continued to expand. Some of the factors contributing to the softness in inflation over the past year, such as the declines seen in non-oil import prices, will probably be transitory. Importantly, measures of longer-run inflation expectations have remained stable. That said, the Federal Open Market Committee (FOMC) recognizes that inflation persistently below 2 percent--the rate that the Committee judges to be most consistent with its dual mandate--could pose risks to economic performance, and we are monitoring inflation developments closely.
Looking ahead, I expect that economic activity will expand at a somewhat faster pace this year than it did last year, that the unemployment rate will continue to decline gradually, and that inflation will begin to move up toward 2 percent. A faster rate of economic growth this year should be supported by reduced restraint from changes in fiscal policy, gains in household net worth from increases in home prices and equity values, a firming in foreign economic growth, and further improvements in household and business confidence as the economy continues to strengthen. Moreover, U.S. financial conditions remain supportive of growth in economic activity and employment.”
In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):
“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differ from each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”
Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and re the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+re). Thus, g = [(r/re) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dre>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:
W = Y/r (10
Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.
In delivering the biannual report on monetary policy (Board of Governors 2013Jul17), Chairman Bernanke (2013Jul17) advised Congress that:
“Instead, we are providing additional policy accommodation through two distinct yet complementary policy tools. The first tool is expanding the Federal Reserve's portfolio of longer-term Treasury securities and agency mortgage-backed securities (MBS); we are currently purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. We are using asset purchases and the resulting expansion of the Federal Reserve's balance sheet primarily to increase the near-term momentum of the economy, with the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. We have made some progress toward this goal, and, with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low--our second tool--to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability.
The Committee's decisions regarding the asset purchase program (and the overall stance of monetary policy) depend on our assessment of the economic outlook and of the cumulative progress toward our objectives. Of course, economic forecasts must be revised when new information arrives and are thus necessarily provisional.”
Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html).
There is concern of declining inflation and appreciation of the euro. In the “Introductory statement to the press conference,” on May 8, 2014, the President of the European Central Bank Mario Draghi states (http://www.ecb.europa.eu/press/pressconf/2014/html/is140508.en.html):
“We will maintain a high degree of monetary accommodation and act swiftly, if required, with further monetary policy easing. We firmly reiterate that we continue to expect the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on an overall subdued outlook for inflation extending into the medium term, given the broad-based weakness of the economy, the high degree of unutilised capacity, and subdued money and credit creation. The Governing Council is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation. Further information and analysis concerning the outlook for inflation and the availability of bank loans to the private sector will be available in early June.”
The President of the ECB Mario Draghi analyzed unemployment in the euro area and the policy response policy in a speech at the Jackson Hole meeting of central bankers on Aug 22, 2014 (http://www.ecb.europa.eu/press/key/date/2014/html/sp140822.en.html):
“We have already seen exchange rate movements that should support both aggregate demand and inflation, which we expect to be sustained by the diverging expected paths of policy in the US and the euro area (Figure 7). We will launch our first Targeted Long-Term Refinancing Operation in September, which has so far garnered significant interest from banks. And our preparation for outright purchases in asset-backed security (ABS) markets is fast moving forward and we expect that it should contribute to further credit easing. Indeed, such outright purchases would meaningfully contribute to diversifying the channels for us to generate liquidity.”
On Sep 4, 2014, the European Central Bank lowered policy rates (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140904.en.html):
“4 September 2014 - Monetary policy decisions
At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
- The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.05%, starting from the operation to be settled on 10 September 2014.
- The interest rate on the marginal lending facility will be decreased by 10 basis points to 0.30%, with effect from 10 September 2014.
- The interest rate on the deposit facility will be decreased by 10 basis points to -0.20%, with effect from 10 September 2014.”
The President of the European Central Bank announced on Sep 4, 2014, the decision to expand the balance sheet by purchases of asset-backed securities (ABS) in a new ABS Purchase Program (ABSPP) and covered bonds (http://www.ecb.europa.eu/press/pressconf/2014/html/is140904.en.html):
“Based on our regular economic and monetary analyses, the Governing Council decided today to lower the interest rate on the main refinancing operations of the Eurosystem by 10 basis points to 0.05% and the rate on the marginal lending facility by 10 basis points to 0.30%. The rate on the deposit facility was lowered by 10 basis points to -0.20%. In addition, the Governing Council decided to start purchasing non-financial private sector assets. The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP). This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter, as decided by the Governing Council in June. In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs domiciled in the euro area under a new covered bond purchase programme (CBPP3). Interventions under these programmes will start in October 2014. The detailed modalities of these programmes will be announced after the Governing Council meeting of 2 October 2014. The newly decided measures, together with the targeted longer-term refinancing operations which will be conducted in two weeks, will have a sizeable impact on our balance sheet.”
On Jun 5, 2014, the European Central Bank introduced cuts in interest rates and a negative rate paid on deposits of banks (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605.en.html):
“5 June 2014 - Monetary policy decisions
At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
- The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.15%, starting from the operation to be settled on 11 June 2014.
- The interest rate on the marginal lending facility will be decreased by 35 basis points to 0.40%, with effect from 11 June 2014.
- The interest rate on the deposit facility will be decreased by 10 basis points to -0.10%, with effect from 11 June 2014. A separate press release to be published at 3.30 p.m. CET today will provide details on the implementation of the negative deposit facility rate.”
The ECB also introduced new measures of monetary policy on Jun 5, 2014 (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605_2.en.html):
“5 June 2014 - ECB announces monetary policy measures to enhance the functioning of the monetary policy transmission mechanism
In pursuing its price stability mandate, the Governing Council of the ECB has today announced measures to enhance the functioning of the monetary policy transmission mechanism by supporting lending to the real economy. In particular, the Governing Council has decided:
- To conduct a series of targeted longer-term refinancing operations (TLTROs) aimed at improving bank lending to the euro area non-financial private sector [1], excluding loans to households for house purchase, over a window of two years.
- To intensify preparatory work related to outright purchases of asset-backed securities (ABS).”
The President of the European Central Bank (ECB) Mario Draghi analyzed the measures at a press conference (http://www.ecb.europa.eu/press/pressconf/2014/html/is140605.en.html).
The President of the European Central Bank (ECB) Mario Draghi reaffirmed the policy stance at the press conference following the meeting on Feb 6, 2014 (http://www.ecb.europa.eu/press/pressconf/2014/html/is140206.en.html): “As I have said several times we are willing to act and we stand ready to act. We confirmed our forward guidance, so interest rates will stay at the present or lower levels for an extended period of time.”
The President of the European Central Bank (ECB) Mario Draghi explained the indefinite period of low policy rates during the press conference following the meeting on Jul 4, 2013 (http://www.ecb.int/press/pressconf/2013/html/is130704.en.html):
“Yes, that is why I said you haven’t listened carefully. The Governing Council has taken the unprecedented step of giving forward guidance in a rather more specific way than it ever has done in the past. In my statement, I said “The Governing Council expects the key…” – i.e. all interest rates – “…ECB interest rates to remain at present or lower levels for an extended period of time.” It is the first time that the Governing Council has said something like this. And, by the way, what Mark Carney [Governor of the Bank of England] said in London is just a coincidence.”
The European Central Bank (ECB) lowered the policy rates on Nov 7, 2013 (http://www.ecb.europa.eu/press/pr/date/2013/html/pr131107.en.html):
“PRESS RELEASE
7 November 2013 - Monetary policy decisions
At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
- The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.25%, starting from the operation to be settled on 13 November 2013.
- The interest rate on the marginal lending facility will be decreased by 25 basis points to 0.75%, with effect from 13 November 2013.
- The interest rate on the deposit facility will remain unchanged at 0.00%.
The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.”
Mario Draghi, President of the ECB, explained as follows (http://www.ecb.europa.eu/press/pressconf/2013/html/is131107.en.html):
“Based on our regular economic and monetary analyses, we decided to lower the interest rate on the main refinancing operations of the Eurosystem by 25 basis points to 0.25% and the rate on the marginal lending facility by 25 basis points to 0.75%. The rate on the deposit facility will remain unchanged at 0.00%. These decisions are in line with our forward guidance of July 2013, given the latest indications of further diminishing underlying price pressures in the euro area over the medium term, starting from currently low annual inflation rates of below 1%. In keeping with this picture, monetary and, in particular, credit dynamics remain subdued. At the same time, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%. Such a constellation suggests that we may experience a prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on. Accordingly, our monetary policy stance will remain accommodative for as long as necessary. It will thereby also continue to assist the gradual economic recovery as reflected in confidence indicators up to October.”
The ECB decision together with the employment situation report on Fri Nov 8, 2013, influenced revaluation of the dollar. Market expectations were of relatively easier monetary policy in the euro area.
The statement of the meeting of the Monetary Policy Committee of the Bank of England on Jul 4, 2013, may be leading toward the same forward guidance (http://www.bankofengland.co.uk/publications/Pages/news/2013/007.aspx):
“At its meeting today, the Committee noted that the incoming data over the past couple of months had been broadly consistent with the central outlook for output growth and inflation contained in the May Report. The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.”
A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2013/01/peaking-valuation-of-risk-financial.html).
Matt Jarzemsky, writing on “Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 17,279.24 on Fr Sep 19, 2014, which is higher by 22.0 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 21.7 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs. Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):
So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly” (emphasis added).
In a speech at the IMF on Jul 2, 2014, Chair Yellen analyzed the link between monetary policy and financial risks (http://www.federalreserve.gov/newsevents/speech/yellen20140702a.htm):
“Monetary policy has powerful effects on risk taking. Indeed, the accommodative policy stance of recent years has supported the recovery, in part, by providing increased incentives for households and businesses to take on the risk of potentially productive investments. But such risk-taking can go too far, thereby contributing to fragility in the financial system. This possibility does not obviate the need for monetary policy to focus primarily on price stability and full employment--the costs to society in terms of deviations from price stability and full employment that would arise would likely be significant. In the private sector, key vulnerabilities included high levels of leverage, excessive dependence on unstable short-term funding, weak underwriting of loans, deficiencies in risk measurement and risk management, and the use of exotic financial instruments that redistributed risk in nontransparent ways.”
Yellen (2014Jul14) warned again at the Committee on Banking, Housing and Urban Affairs on Jul 15, 2014:
“The Committee recognizes that low interest rates may provide incentives for some investors to “reach for yield,” and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance. More broadly, the financial sector has continued to become more resilient, as banks have continued to boost their capital and liquidity positions, and growth in wholesale short-term funding in financial markets has been modest” (emphasis added).
Greenspan (1996) made similar warnings:
“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy” (emphasis added).
Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. What is the success in evaluating deviations of valuations of risk financial assets from “historical norms”? What are the consequences on economic activity and employment of deviations of valuations of risk financial assets from those “historical norms”? What are the policy tools and their effectiveness in returning valuations of risk financial assets to their “historical norms”?
The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.
Professor Raguram G Rajan, governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation. Rajan (2005) anticipated the risks of the world financial crisis. Professor John B. Taylor (2014Jul15, 2014Jun26) building on advanced research (Taylor (1993, 1998LB, 1999, 1998LB, 1999, 2007JH, 2008Nov, 2009, 2012JMCB, 2014Jan3) finds that a monetary policy rule would function best in promoting an environment of low inflation and strong economic growth with stability of financial markets. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html).
In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Professor Rajan, in an interview with Kartik Goyal of Bloomberg (http://www.bloomberg.com/news/2014-01-30/rajan-warns-of-global-policy-breakdown-as-emerging-markets-slide.html), warns of breakdown of global policy coordination. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows.
Professor Ronald I. McKinnon (2013Oct27), writing on “Tapering without tears—how to end QE3,” on Oct 27, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304799404579153693500945608?KEYWORDS=Ronald+I+McKinnon), finds that the major central banks of the world have fallen into a “near-zero-interest-rate trap.” World economic conditions are weak such that exit from the zero interest rate trap could have adverse effects on production, investment and employment. The maintenance of interest rates near zero creates long-term near stagnation. The proposal of Professor McKinnon is credible, coordinated increase of policy interest rates toward 2 percent. Professor John B. Taylor at Stanford University, writing on “Economic failures cause political polarization,” on Oct 28, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303442004579121010753999086?KEYWORDS=John+B+Taylor), analyzes that excessive risks induced by near zero interest rates in 2003-2004 caused the financial crash. Monetary policy continued in similar paths during and after the global recession with resulting political polarization worldwide.
Second, Risk-Measuring Yields and Exchange Rate. The ten-year government bond of Spain was quoted at 6.868 percent on Aug 10, 2012, declining to 6.447 percent on Aug 17 and 6.403 percent on Aug 24, 2012, and the ten-year government bond of Italy fell from 5.894 percent on Aug 10, 2012 to 5.709 percent on Aug 17 and 5.618 percent on Aug 24, 2012. The yield of the ten-year sovereign bond of Spain traded at 2.203 percent on Sep 19, 2014, and that of the ten-year sovereign bond of Italy at 2.368 percent (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Risk aversion is captured by flight of investors from risk financial assets to the government securities of the US and Germany. Diminishing aversion is captured by increase of the yield of the two- and ten-year Treasury notes and the two- and ten-year government bonds of Germany. Table III-1A provides yields of US and German governments bonds and the rate of USD/EUR. Yields of US and German government bonds decline during shocks of risk aversion and the dollar strengthens in the form of fewer dollars required to buy one euro. The yield of the US ten-year Treasury note fell from 2.202 percent on Aug 26, 2011 to 1.459 percent on Jul 20, 2012, reminiscent of experience during the Treasury-Fed accord of the 1940s that placed a ceiling on long-term Treasury debt (Hetzel and Leach 2001), while the yield of the ten-year government bond of Germany fell from 2.16 percent to 1.17 percent. In the week of Sep 19, 2014, the yield of the two-year Treasury increased to 0.567 percent and that of the ten-year Treasury decreased to 2.576 percent while the yield of the two-year bond of Germany decreased to minus 0.07 percent and the ten-year yield decreased to 1.04 percent; and the dollar appreciated at USD 1.2829/EUR. The zero interest rates for the monetary policy rate of the US, or fed funds rate, induce carry trades that ensure devaluation of the dollar if there is no risk aversion but the dollar appreciates in flight to safe haven during episodes of risk aversion. Unconventional monetary policy induces significant global financial instability, excessive risks and low liquidity. The ten-year Treasury yield of 2.576 percent is higher than consumer price inflation of 1.7 percent in the 12 months ending in Aug 2014 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2014/06/valuation-risks-world-inflation-waves.html and earlier http://cmpassocregulationblog.blogspot.com/2014/05/world-inflation-waves-squeeze-of.html) and the expectation of higher inflation if risk aversion diminishes. The one-year Treasury yield of 0.11.7 percent (http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3002) is well below the 12-month consumer price inflation of 1.7 percent. Treasury securities continue to be safe haven for investors fearing risk but with concentration in shorter maturities such as the two-year Treasury. The lower part of Table III-1A provides the same flight to government securities of the US and Germany and the USD during the financial crisis and global recession and the beginning of the European debt crisis in the spring of 2010 with the USD trading at USD 1.192/EUR on Jun 7, 2010.
Table III-1A, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate
| US 2Y | US 10Y | DE 2Y | DE 10Y | USD/ EUR | |
| 09/19/14 | 0.567 | 2.576 | -0.07 | 1.04 | 1.2829 |
| 09/12/14 | 0.562 | 2.606 | -0.06 | 1.08 | 1.2965 |
| 09/05/14 | 0.510 | 2.457 | -0.08 | 0.93 | 1.2952 |
| 08/29/14 | 0.490 | 2.342 | -0.04 | 0.89 | 1.3133 |
| 08/22/14 | 0.490 | 2.399 | 0.00 | 0.98 | 1.3242 |
| 08/15/14 | 0.405 | 2.341 | -0.02 | 0.95 | 1.3400 |
| 08/08/14 | 0.446 | 2.420 | 0.00 | 1.05 | 1.3411 |
| 08/01/14 | 0.470 | 2.497 | 0.02 | 1.13 | 1.3430 |
| 07/25/14 | 0.494 | 2.464 | 0.02 | 1.15 | 1.3431 |
| 07/18/14 | 0.478 | 2.484 | 0.02 | 1.15 | 1.3525 |
| 07/11/14 | 0.446 | 2.516 | 0.01 | 1.20 | 1.3608 |
| 07/04/14 | 0.502 | 2.641 | 0.02 | 1.26 | 1.3595 |
| 06/27/14 | 0.463 | 2.536 | 0.03 | 1.26 | 1.3649 |
| 06/20/14 | 0.458 | 2.609 | 0.03 | 1.34 | 1.3600 |
| 06/13/14 | 0.451 | 2.605 | 0.02 | 1.36 | 1.3540 |
| 06/06/14 | 0.405 | 2.598 | 0.05 | 1.35 | 1.3643 |
| 05/30/14 | 0.373 | 2.473 | 0.06 | 1.36 | 1.3632 |
| 05/23/14 | 0.345 | 2.532 | 0.06 | 1.41 | 1.3630 |
| 05/16/14 | 0.357 | 2.520 | 0.09 | 1.33 | 1.3694 |
| 05/09/14 | 0.385 | 2.624 | 0.13 | 1.45 | 1.3760 |
| 05/02/14 | 0.421 | 2.583 | 0.12 | 1.45 | 1.3873 |
| 04/25/14 | 0.432 | 2.668 | 0.17 | 1.48 | 1.3833 |
| 04/18/14 | 0.401 | 2.724 | 0.17 | 1.51 | 1.3813 |
| 04/11/14 | 0.357 | 2.628 | 0.16 | 1.50 | 1.3885 |
| 04/04/14 | 0.413 | 2.724 | 0.16 | 1.55 | 1.3704 |
| 03/28/14 | 0.448 | 2.721 | 0.14 | 1.55 | 1.3752 |
| 03/21/14 | 0.431 | 2.743 | 0.20 | 1.63 | 1.3793 |
| 03/14/14 | 0.340 | 2.654 | 0.15 | 1.54 | 1.3912 |
| 03/07/14 | 0.367 | 2.792 | 0.17 | 1.65 | 1.3877 |
| 02/28/14 | 0.323 | 2.655 | 0.13 | 1.62 | 1.3801 |
| 02/21/14 | 0.316 | 2.730 | 0.12 | 1.66 | 1.3739 |
| 02/14/14 | 0.313 | 2.743 | 0.11 | 1.68 | 1.3693 |
| 02/07/14 | 0.305 | 2.681 | 0.09 | 1.66 | 1.3635 |
| 1/31/14 | 0.330 | 2.645 | 0.07 | 1.66 | 1.3488 |
| 1/24/14 | 0.342 | 2.720 | 0.12 | 1.66 | 1.3677 |
| 1/17/14 | 0.373 | 2.818 | 0.17 | 1.75 | 1.3541 |
| 1/10/14 | 0.372 | 2.858 | 0.18 | 1.84 | 1.3670 |
| 1/3/14 | 0.398 | 2.999 | 0.20 | 1.94 | 1.3588 |
| 12/27/13 | 0.393 | 3.004 | 0.24 | 1.95 | 1.3746 |
| 12/20/13 | 0.377 | 2.891 | 0.22 | 1.87 | 1.3673 |
| 12/13/13 | 0.328 | 2.865 | 0.24 | 1.83 | 1.3742 |
| 12/6/13 | 0.304 | 2.858 | 0.21 | 1.84 | 1.3705 |
| 11/29/13 | 0.283 | 2.743 | 0.11 | 1.69 | 1.3592 |
| 11/22/13 | 0.280 | 2.746 | 0.13 | 1.74 | 1.3557 |
| 11/15/13 | 0.292 | 2.704 | 0.10 | 1.70 | 1.3497 |
| 11/8/13 | 0.316 | 2.750 | 0.10 | 1.76 | 1.3369 |
| 11/1/13 | 0.311 | 2.622 | 0.11 | 1.69 | 1.3488 |
| 10/25/13 | 0.305 | 2.507 | 0.18 | 1.75 | 1.3804 |
| 10/18/13 | 0.321 | 2.588 | 0.17 | 1.83 | 1.3686 |
| 10/11/13 | 0.344 | 2.688 | 0.18 | 1.86 | 1.3543 |
| 10/4/13 | 0.335 | 2.645 | 0.17 | 1.84 | 1.3557 |
| 9/27/13 | 0.335 | 2.626 | 0.16 | 1.78 | 1.3523 |
| 9/20/13 | 0.333 | 2.734 | 0.21 | 1.94 | 1.3526 |
| 9/13/13 | 0.433 | 2.890 | 0.22 | 1.97 | 1.3297 |
| 9/6/13 | 0.461 | 2.941 | 0.26 | 1.95 | 1.3179 |
| 8/23/13 | 0.401 | 2.784 | 0.23 | 1.85 | 1.3221 |
| 8/23/13 | 0.374 | 2.818 | 0.28 | 1.93 | 1.3380 |
| 8/16/13 | 0.341 | 2.829 | 0.22 | 1.88 | 1.3328 |
| 8/9/13 | 0.30 | 2.579 | 0.16 | 1.68 | 1.3342 |
| 8/2/13 | 0.299 | 2.597 | 0.15 | 1.65 | 1.3281 |
| 7/26/13 | 0.315 | 2.565 | 0.15 | 1.66 | 1.3279 |
| 7/19/13 | 0.300 | 2.480 | 0.08 | 1.52 | 1.3141 |
| 7/12/13 | 0.345 | 2.585 | 0.10 | 1.56 | 1.3068 |
| 7/5/13 | 0.397 | 2.734 | 0.11 | 1.72 | 1.2832 |
| 6/28/13 | 0.357 | 2.486 | 0.19 | 1.73 | 1.3010 |
| 6/21/13 | 0.366 | 2.542 | 0.26 | 1.72 | 1.3122 |
| 6/14/13 | 0.276 | 2.125 | 0.12 | 1.51 | 1.3345 |
| 6/7/13 | 0.304 | 2.174 | 0.18 | 1.54 | 1.3219 |
| 5/31/13 | 0.299 | 2.132 | 0.06 | 1.50 | 1.2996 |
| 5/24/13 | 0.249 | 2.009 | 0.00 | 1.43 | 1.2932 |
| 5/17/13 | 0.248 | 1.952 | -0.03 | 1.32 | 1.2837 |
| 5/10/13 | 0.239 | 1.896 | 0.05 | 1.38 | 1.2992 |
| 5/3/13 | 0.22 | 1.742 | 0.00 | 1.24 | 1.3115 |
| 4/26/13 | 0.209 | 1.663 | 0.00 | 1.21 | 1.3028 |
| 4/19/13 | 0.232 | 1.702 | 0.02 | 1.25 | 1.3052 |
| 4/12/13 | 0.228 | 1.719 | 0.02 | 1.26 | 1.3111 |
| 4/5/13 | 0.228 | 1.706 | 0.01 | 1.21 | 1.2995 |
| 3/29/13 | 0.244 | 1.847 | -0.02 | 1.29 | 1.2818 |
| 3/22/13 | 0.242 | 1.931 | 0.03 | 1.38 | 1.2988 |
| 3/15/13 | 0.246 | 1.992 | 0.05 | 1.46 | 1.3076 |
| 3/8/13 | 0.256 | 2.056 | 0.09 | 1.53 | 1.3003 |
| 3/1/13 | 0.236 | 1.842 | 0.03 | 1.41 | 1.3020 |
| 2/22/13 | 0.252 | 1.967 | 0.13 | 1.57 | 1.3190 |
| 2/15/13 | 0.268 | 2.007 | 0.19 | 1.65 | 1.3362 |
| 2/8/13 | 0.252 | 1.949 | 0.18 | 1.61 | 1.3365 |
| 2/1/13 | 0.26 | 2.024 | 0.25 | 1.67 | 1.3642 |
| 1/25/13 | 0.278 | 1.947 | 0.26 | 1.64 | 1.3459 |
| 1/18/13 | 0.252 | 1.84 | 0.18 | 1.56 | 1.3321 |
| 1/11/13 | 0.247 | 1.862 | 0.13 | 1.58 | 1.3343 |
| 1/4/13 | 0.262 | 1.898 | 0.08 | 1.54 | 1.3069 |
| 12/28/12 | 0.252 | 1.699 | -0.01 | 1.31 | 1.3218 |
| 12/21/12 | 0.272 | 1.77 | -0.01 | 1.38 | 1.3189 |
| 12/14/12 | 0.232 | 1.704 | -0.04 | 1.35 | 1.3162 |
| 12/7/12 | 0.256 | 1.625 | -0.08 | 1.30 | 1.2926 |
| 11/30/12 | 0.248 | 1.612 | 0.01 | 1.39 | 1.2987 |
| 11/23/12 | 0.273 | 1.691 | 0.00 | 1.44 | 1.2975 |
| 11/16/12 | 0.24 | 1.584 | -0.03 | 1.33 | 1.2743 |
| 11/9/12 | 0.256 | 1.614 | -0.03 | 1.35 | 1.2711 |
| 11/2/12 | 0.274 | 1.715 | 0.01 | 1.45 | 1.2838 |
| 10/26/12 | 0.299 | 1.748 | 0.05 | 1.54 | 1.2942 |
| 10/19/12 | 0.296 | 1.766 | 0.11 | 1.59 | 1.3023 |
| 10/12/12 | 0.264 | 1.663 | 0.04 | 1.45 | 1.2953 |
| 10/5/12 | 0.26 | 1.737 | 0.06 | 1.52 | 1.3036 |
| 9/28/12 | 0.236 | 1.631 | 0.02 | 1.44 | 1.2859 |
| 9/21/12 | 0.26 | 1.753 | 0.04 | 1.60 | 1.2981 |
| 9/14/12 | 0.252 | 1.863 | 0.10 | 1.71 | 1.3130 |
| 9/7/12 | 0.252 | 1.668 | 0.03 | 1.52 | 1.2816 |
| 8/31/12 | 0.225 | 1.543 | -0.03 | 1.33 | 1.2575 |
| 8/24/12 | 0.266 | 1.684 | -0.01 | 1.35 | 1.2512 |
| 8/17/12 | 0.288 | 1.814 | -0.04 | 1.50 | 1.2335 |
| 8/10/12 | 0.267 | 1.658 | -0.07 | 1.38 | 1.2290 |
| 8/3/12 | 0.242 | 1.569 | -0.02 | 1.42 | 1.2387 |
| 7/27/12 | 0.244 | 1.544 | -0.03 | 1.40 | 1.2320 |
| 7/20/12 | 0.207 | 1.459 | -0.07 | 1.17 | 1.2158 |
| 7/13/12 | 0.24 | 1.49 | -0.04 | 1.26 | 1.2248 |
| 7/6/12 | 0.272 | 1.548 | -0.01 | 1.33 | 1.2288 |
| 6/29/12 | 0.305 | 1.648 | 0.12 | 1.58 | 1.2661 |
| 6/22/12 | 0.309 | 1.676 | 0.14 | 1.58 | 1.2570 |
| 6/15/12 | 0.272 | 1.584 | 0.07 | 1.44 | 1.2640 |
| 6/8/12 | 0.268 | 1.635 | 0.04 | 1.33 | 1.2517 |
| 6/1/12 | 0.248 | 1.454 | 0.01 | 1.17 | 1.2435 |
| 5/25/12 | 0.291 | 1.738 | 0.05 | 1.37 | 1.2518 |
| 5/18/12 | 0.292 | 1.714 | 0.05 | 1.43 | 1.2780 |
| 5/11/12 | 0.248 | 1.845 | 0.09 | 1.52 | 1.2917 |
| 5/4/12 | 0.256 | 1.876 | 0.08 | 1.58 | 1.3084 |
| 4/6/12 | 0.31 | 2.058 | 0.14 | 1.74 | 1.3096 |
| 3/30/12 | 0.335 | 2.214 | 0.21 | 1.79 | 1.3340 |
| 3/2/12 | 0.29 | 1.977 | 0.16 | 1.80 | 1.3190 |
| 2/24/12 | 0.307 | 1.977 | 0.24 | 1.88 | 1.3449 |
| 1/6/12 | 0.256 | 1.957 | 0.17 | 1.85 | 1.2720 |
| 12/30/11 | 0.239 | 1.871 | 0.14 | 1.83 | 1.2944 |
| 8/26/11 | 0.20 | 2.202 | 0.65 | 2.16 | 1.450 |
| 8/19/11 | 0.192 | 2.066 | 0.65 | 2.11 | 1.4390 |
| 6/7/10 | 0.74 | 3.17 | 0.49 | 2.56 | 1.192 |
| 3/5/09 | 0.89 | 2.83 | 1.19 | 3.01 | 1.254 |
| 12/17/08 | 0.73 | 2.20 | 1.94 | 3.00 | 1.442 |
| 10/27/08 | 1.57 | 3.79 | 2.61 | 3.76 | 1.246 |
| 7/14/08 | 2.47 | 3.88 | 4.38 | 4.40 | 1.5914 |
| 6/26/03 | 1.41 | 3.55 | NA | 3.62 | 1.1423 |
Note: DE: Germany
Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
http://www.bloomberg.com/markets/
http://www.federalreserve.gov/releases/h15/
Appendix: Prior Risk Determining Events. Current risk analysis concentrates on deciphering what the Federal Open Market Committee (FOMC) may decide on quantitative easing. The week of May 24 was dominated by the testimony of Chairman Bernanke to the Joint Economic Committee of the US Congress on May 22, 2013 (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm), followed by questions and answers and the release on May 22, 2013 of the minutes of the meeting of the Federal Open Market Committee (FOMC) from Apr 30 to May 1, 2013 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm). Monetary policy emphasizes communication of policy intentions to avoid that expectations reverse outcomes in reality (Kydland and Prescott 1977). Jon Hilsenrath, writing on “In bid for clarity, Fed delivers opacity,” on May 23, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath), analyzes discrepancies in communication by the Fed. The annotated chart of values of the Dow Jones Industrial Average (DJIA) during trading on May 23, 2013 provided by Hinselrath, links the prepared testimony of Chairman Bernanke at 10:AM, following questions and answers and the release of the minutes of the FOMC at 2PM. Financial markets strengthened between 10 and 10:30AM on May 23, 2013, perhaps because of the statement by Chairman Bernanke in prepared testimony (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm):
“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.”
In that testimony, Chairman Bernanke (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm) also analyzes current weakness of labor markets:
“Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down. Moreover, nearly 8 million people are working part time even though they would prefer full-time work. High rates of unemployment and underemployment are extraordinarily costly: Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers' skills and--particularly relevant during this commencement season--by preventing many young people from gaining workplace skills and experience in the first place. The loss of output and earnings associated with high unemployment also reduces government revenues and increases spending on income-support programs, thereby leading to larger budget deficits and higher levels of public debt than would otherwise occur.”
Hilsenrath (op. cit. http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath) analyzes the subsequent decline of the market from 10:30AM to 10:40AM as Chairman Bernanke responded questions with the statement that withdrawal of stimulus would be determined by data but that it could begin in one of the “next few meetings.” The DJIA recovered part of the losses between 10:40AM and 2PM. The minutes of the FOMC released at 2PM on May 23, 2013, contained a phrase that troubled market participants (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm): “A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.” The DJIA closed at 15,387.58 on May 21, 2013 and fell to 15,307.17 at the close on May 22, 2013, with the loss of 0.5 percent occurring after release of the minutes of the FOMC at 2PM when the DJIA stood at around 15,400. The concern about exist of the Fed from stimulus affected markets worldwide as shown in declines of equity indexes in Table III-1 with delays because of differences in trading hours. This behavior shows the trap of unconventional monetary policy with no exit from zero interest rates without risking financial crash and likely adverse repercussions on economic activity.
Financial markets worldwide were affected by the reduction of policy rates of the European Central Bank (ECB) on May 2, 2013. (http://www.ecb.int/press/pr/date/2013/html/pr130502.en.html):
“2 May 2013 - Monetary policy decisions
At today’s meeting, which was held in Bratislava, the Governing Council of the ECB took the following monetary policy decisions:
- The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.50%, starting from the operation to be settled on 8 May 2013.
- The interest rate on the marginal lending facility will be decreased by 50 basis points to 1.00%, with effect from 8 May 2013.
- The interest rate on the deposit facility will remain unchanged at 0.00%.”
Financial markets in Japan and worldwide were shocked by new bold measures of “quantitative and qualitative monetary easing” by the Bank of Japan (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The objective of policy is to “achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The main elements of the new policy are as follows:
- Monetary Base Control. Most central banks in the world pursue interest rates instead of monetary aggregates, injecting bank reserves to lower interest rates to desired levels. The Bank of Japan (BOJ) has shifted back to monetary aggregates, conducting money market operations with the objective of increasing base money, or monetary liabilities of the government, at the annual rate of 60 to 70 trillion yen. The BOJ estimates base money outstanding at “138 trillion yen at end-2012) and plans to increase it to “200 trillion yen at end-2012 and 270 trillion yen at end 2014” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
- Maturity Extension of Purchases of Japanese Government Bonds. Purchases of bonds will be extended even up to bonds with maturity of 40 years with the guideline of extending the average maturity of BOJ bond purchases from three to seven years. The BOJ estimates the current average maturity of Japanese government bonds (JGB) at around seven years. The BOJ plans to purchase about 7.5 trillion yen per month (http://www.boj.or.jp/en/announcements/release_2013/rel130404d.pdf). Takashi Nakamichi, Tatsuo Ito and Phred Dvorak, wiring on “Bank of Japan mounts bid for revival,” on Apr 4, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323646604578401633067110420.html), find that the limit of maturities of three years on purchases of JGBs was designed to avoid views that the BOJ would finance uncontrolled government deficits.
- Seigniorage. The BOJ is pursuing coordination with the government that will take measures to establish “sustainable fiscal structure with a view to ensuring the credibility of fiscal management” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
- Diversification of Asset Purchases. The BOJ will engage in transactions of exchange traded funds (ETF) and real estate investment trusts (REITS) and not solely on purchases of JGBs. Purchases of ETFs will be at an annual rate of increase of one trillion yen and purchases of REITS at 30 billion yen.
The European sovereign debt crisis continues to shake financial markets and the world economy. Debt resolution within the international financial architecture requires that a country be capable of borrowing on its own from the private sector. Mechanisms of debt resolution have included participation of the private sector (PSI), or “bail in,” that has been voluntary, almost coercive, agreed and outright coercive (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Creditors and Debtors (2005), Chapter 4, 187-202). Private sector involvement requires losses by the private sector in bailouts of highly indebted countries. The essence of successful private sector involvement is to recover private-sector credit of the highly indebted country. Mary Watkins, writing on “Bank bailouts reshuffle risk hierarchy,” published on Mar 19, 2013, in the Financial Times (http://www.ft.com/intl/cms/s/0/7666546a-9095-11e2-a456-00144feabdc0.html#axzz2OSpbvCn8) analyzes the impact of the bailout or resolution of Cyprus banks on the hierarchy of risks of bank liabilities. Cyprus banks depend mostly on deposits with less reliance on debt, raising concerns in creditors of fixed-income debt and equity holders in banks in the euro area. Uncertainty remains as to the dimensions and structure of losses in private sector involvement or “bail in” in other rescue programs in the euro area. Alkman Granitsas, writing on “Central bank details losses at Bank of Cyprus,” on Mar 30, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324000704578392502889560768.html), analyzes the impact of the agreement with the €10 billion agreement with IMF and the European Union on the banks of Cyprus. The recapitalization plan provides for immediate conversion of 37.5 percent of all deposits in excess of €100,000 to shares of special class of the bank. An additional 22.5 percent will be frozen without interest until the plan is completed. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.
Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans.
Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
An important risk event is the reduction of growth prospects in the euro zone discussed by European Central Bank President Mario Draghi in “Introductory statement to the press conference,” on Dec 6, 2012 (http://www.ecb.int/press/pressconf/2012/html/is121206.en.html):
“This assessment is reflected in the December 2012 Eurosystem staff macroeconomic projections for the euro area, which foresee annual real GDP growth in a range between -0.6% and -0.4% for 2012, between -0.9% and 0.3% for 2013 and between 0.2% and 2.2% for 2014. Compared with the September 2012 ECB staff macroeconomic projections, the ranges for 2012 and 2013 have been revised downwards.
The Governing Council continues to see downside risks to the economic outlook for the euro area. These are mainly related to uncertainties about the resolution of sovereign debt and governance issues in the euro area, geopolitical issues and fiscal policy decisions in the United States possibly dampening sentiment for longer than currently assumed and delaying further the recovery of private investment, employment and consumption.”
Reuters, writing on “Bundesbank cuts German growth forecast,” on Dec 7, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/8e845114-4045-11e2-8f90-00144feabdc0.html#axzz2EMQxzs3u), informs that the central bank of Germany, Deutsche Bundesbank reduced its forecast of growth for the economy of Germany to 0.7 percent in 2012 from an earlier forecast of 1.0 percent in Jun and to 0.4 percent in 2012 from an earlier forecast of 1.6 percent while the forecast for 2014 is at 1.9 percent.
The major risk event during earlier weeks was sharp decline of sovereign yields with the yield on the ten-year bond of Spain falling to 5.309 percent and that of the ten-year bond of Italy falling to 4.473 percent on Fri Nov 30, 2012 and 5.366 percent for the ten-year of Spain and 4.527 percent for the ten-year of Italy on Fri Nov 14, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Vanessa Mock and Frances Robinson, writing on “EU approves Spanish bank’s restructuring plans,” on Nov 28, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578146520774638316.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the European Union regulators approved restructuring of four Spanish banks (Bankia, NCG Banco, Catalunya Banc and Banco de Valencia), which helped to calm sovereign debt markets. Harriet Torry and James Angelo, writing on “Germany approves Greek aid,” on Nov 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578150532603095790.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the German parliament approved the plan to provide Greece a tranche of €44 billion in promised financial support, which is subject to sustainability analysis of the bond repurchase program later in Dec 2012. A hurdle for sustainability of repurchasing debt is that Greece’s sovereign bonds have appreciated significantly from around 24 percent for the bond maturing in 21 years and 20 percent for the bond maturing in 31 years in Aug 2012 to around 17 percent for the 21-year maturity and 15 percent for the 31-year maturing in Nov 2012. Declining years are equivalent to increasing prices, making the repurchase more expensive. Debt repurchase is intended to reduce bonds in circulation, turning Greek debt more manageable. Ben McLannahan, writing on “Japan unveils $11bn stimulus package,” on Nov 30, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/adc0569a-3aa5-11e2-baac-00144feabdc0.html#axzz2DibFFquN), informs that the cabinet in Japan approved another stimulus program of $11 billion, which is twice larger than another stimulus plan in late Oct and close to elections in Dec. Henry Sender, writing on “Tokyo faces weak yen and high bond yields,” published on Nov 29, 2012 in the Financial Times (http://www.ft.com/intl/cms/s/0/9a7178d0-393d-11e2-afa8-00144feabdc0.html#axzz2DibFFquN), analyzes concerns of regulators on duration of bond holdings in an environment of likelihood of increasing yields and yen depreciation.
First, Risk-Determining Events. The European Council statement on Nov 23, 2012 asked the President of the European Commission “to continue the work and pursue consultations in the coming weeks to find a consensus among the 27 over the Union’s Multiannual Financial Framework for the period 2014-2020” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf) Discussions will continue in the effort to reach agreement on a budget: “A European budget is important for the cohesion of the Union and for jobs and growth in all our countries” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf). There is disagreement between the group of countries requiring financial assistance and those providing bailout funds. Gabrielle Steinhauser and Costas Paris, writing on “Greek bond rally puts buyback in doubt,” on Nov 23, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324352004578136362599130992.html?mg=reno64-wsj) find a new hurdle in rising prices of Greek sovereign debt that may make more difficult buybacks of debt held by investors. European finance ministers continue their efforts to reach an agreement for Greece that meets with approval of the European Central Bank and the IMF. The European Council (2012Oct19 http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/133004.pdf ) reached conclusions on strengthening the euro area and providing unified financial supervision:
“The European Council called for work to proceed on the proposals on the Single Supervisory Mechanism as a matter of priority with the objective of agreeing on the legislative framework by 1st January 2013 and agreed on a number of orientations to that end. It also took note of issues relating to the integrated budgetary and economic policy frameworks and democratic legitimacy and accountability which should be further explored. It agreed that the process towards deeper economic and monetary union should build on the EU's institutional and legal framework and be characterised by openness and transparency towards non-euro area Member States and respect for the integrity of the Single Market. It looked forward to a specific and time-bound roadmap to be presented at its December 2012 meeting, so that it can move ahead on all essential building blocks on which a genuine EMU should be based.”
Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. The Bank of Spain released new data on doubtful debtors in Spain’s credit institutions (http://www.bde.es/bde/en/secciones/prensa/Agenda/Datos_de_credit_a6cd708c59cf931.html). In 2006, the value of doubtful credits reached €10,859 million or 0.7 percent of total credit of €1,508,626 million. In Aug 2012, doubtful credit reached €178,579 million or 10.5 percent of total credit of €1,698,714 million.
There are three critical factors influencing world financial markets. (1) Spain could request formal bailout from the European Stability Mechanism (ESM) that may also affect Italy’s international borrowing. David Roman and Jonathan House, writing on “Spain risks backlash with budget plan,” on Sep 27, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443916104578021692765950384.html?mod=WSJ_hp_LEFTWhatsNewsCollection) analyze Spain’s proposal of reducing government expenditures by €13 billion, or around $16.7 billion, increasing taxes in 2013, establishing limits on early retirement and cutting the deficit by €65 billion through 2014. Banco de España, Bank of Spain, contracted consulting company Oliver Wyman to conduct rigorous stress tests of the resilience of its banking system. (Stress tests and their use are analyzed by Pelaez and Pelaez Globalization and the State Vol. I (2008b), 95-100, International Financial Architecture (2005) 112-6, 123-4, 130-3).) The results are available from Banco de España (http://www.bde.es/bde/en/secciones/prensa/infointeres/reestructuracion/ http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). The assumptions of the adverse scenario used by Oliver Wyman are quite tough for the three-year period from 2012 to 2014: “6.5 percent cumulative decline of GDP, unemployment rising to 27.2 percent and further declines of 25 percent of house prices and 60 percent of land prices (http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). Fourteen banks were stress tested with capital needs estimates of seven banks totaling €59.3 billion. The three largest banks of Spain, Banco Santander (http://www.santander.com/csgs/Satellite/CFWCSancomQP01/es_ES/Corporativo.html), BBVA (http://www.bbva.com/TLBB/tlbb/jsp/ing/home/index.jsp) and Caixabank (http://www.caixabank.com/index_en.html), with 43 percent of exposure under analysis, have excess capital of €37 billion in the adverse scenario in contradiction with theories that large, international banks are necessarily riskier. Jonathan House, writing on “Spain expects wider deficit on bank aid,” on Sep 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444138104578028484168511130.html?mod=WSJPRO_hpp_LEFTTopStories), analyzes the 2013 budget plan of Spain that will increase the deficit of 7.4 percent of GDP in 2012, which is above the target of 6.3 percent under commitment with the European Union. The ratio of debt to GDP will increase to 85.3 percent in 2012 and 90.5 percent in 2013 while the 27 members of the European Union have an average debt/GDP ratio of 83 percent at the end of IIQ2012. (2) Symmetric inflation targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even after the economy grows again at or close to potential output. Monetary easing by unconventional measures is now apparently open ended in perpetuity as provided in the statement of the meeting of the Federal Open Market Committee (FOMC) on Sep 13, 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm):
“To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is the concern of the production and employment costs of controlling future inflation.
(2) The European Central Bank (ECB) approved a new program of bond purchases under the name “Outright Monetary Transactions” (OMT). The ECB will purchase sovereign bonds of euro zone member countries that have a program of conditionality under the European Financial Stability Facility (EFSF) that is converting into the European Stability Mechanism (ESM). These programs provide enhancing the solvency of member countries in a transition period of structural reforms and fiscal adjustment. The purchase of bonds by the ECB would maintain debt costs of sovereigns at sufficiently low levels to permit adjustment under the EFSF/ESM programs. Purchases of bonds are not limited quantitatively with discretion by the ECB as to how much is necessary to support countries with adjustment programs. Another feature of the OMT of the ECB is sterilization of bond purchases: funds injected to pay for the bonds would be withdrawn or sterilized by ECB transactions. The statement by the European Central Bank on the program of OTM is as follows (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html):
“6 September 2012 - Technical features of Outright Monetary Transactions
As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) has today taken decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets that aim at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy. These will be known as Outright Monetary Transactions (OMTs) and will be conducted within the following framework:
Conditionality
A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.
The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.
Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.
Coverage
Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above. They may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access.
Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.
No ex ante quantitative limits are set on the size of Outright Monetary Transactions.
Creditor treatment
The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.
Sterilisation
The liquidity created through Outright Monetary Transactions will be fully sterilised.
Transparency
Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis. Publication of the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis.
Securities Markets Programme
Following today’s decision on Outright Monetary Transactions, the Securities Markets Programme (SMP) is herewith terminated. The liquidity injected through the SMP will continue to be absorbed as in the past, and the existing securities in the SMP portfolio will be held to maturity.”
Jon Hilsenrath, writing on “Fed sets stage for stimulus,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443864204577623220212805132.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the essay presented by Chairman Bernanke at the Jackson Hole meeting of central bankers, as defending past stimulus with unconventional measures of monetary policy that could be used to reduce extremely high unemployment. Chairman Bernanke (2012JHAug31, 18-9) does support further unconventional monetary policy impulses if required by economic conditions (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm):
“Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
Professor John H Cochrane (2012Aug31), at the University of Chicago Booth School of Business, writing on “The Federal Reserve: from central bank to central planner,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444812704577609384030304936.html?mod=WSJ_hps_sections_opinion), analyzes that the departure of central banks from open market operations into purchase of assets with risks to taxpayers and direct allocation of credit subject to political influence has caused them to abandon their political independence and accountability. Cochrane (2012Aug31) finds a return to the proposition of Milton Friedman in the 1960s that central banks can cause inflation and macroeconomic instability.
Mario Draghi (2012Aug29), President of the European Central Bank, also reiterated the need of exceptional and unconventional central bank policies (http://www.ecb.int/press/key/date/2012/html/sp120829.en.html):
“Yet it should be understood that fulfilling our mandate sometimes requires us to go beyond standard monetary policy tools. When markets are fragmented or influenced by irrational fears, our monetary policy signals do not reach citizens evenly across the euro area. We have to fix such blockages to ensure a single monetary policy and therefore price stability for all euro area citizens. This may at times require exceptional measures. But this is our responsibility as the central bank of the euro area as a whole.
The ECB is not a political institution. But it is committed to its responsibilities as an institution of the European Union. As such, we never lose sight of our mission to guarantee a strong and stable currency. The banknotes that we issue bear the European flag and are a powerful symbol of European identity.”
Buiter (2011Oct31) analyzes that the European Financial Stability Fund (EFSF) would need a “bigger bazooka” to bail out euro members in difficulties that could possibly be provided by the ECB. Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. Table III-7 in IIIE Appendix Euro Zone Survival Risk below provides the combined GDP in 2012 of the highly indebted euro zone members estimated in the latest World Economic Outlook of the IMF at $4167 billion or 33.1 percent of total euro zone GDP of $12,586 billion. Using the WEO of the IMF, Table III-8 in IIIE Appendix Euro Zone Survival Risk below provides debt of the highly indebted euro zone members at $3927.8 billion in 2012 that increases to $5809.9 billion when adding Germany’s debt, corresponding to 167.0 percent of Germany’s GDP. There are additional sources of debt in bailing out banks. The dimensions of the problem may require more firepower than a bazooka perhaps that of the largest conventional bomb of all times of 44,000 pounds experimentally detonated only once by the US in 1948 (http://www.airpower.au.af.mil/airchronicles/aureview/1967/mar-apr/coker.html).
Chart III-1A of the Board of Governors of the Federal Reserve System provides the ten-year, two-year and one-month Treasury constant maturity yields together with the overnight fed funds rate, and the yield of the corporate bond with Moody’s rating of Baa. The riskier yield of the Baa corporate bond exceeds the relatively riskless yields of the Treasury securities. The beginning yields in Chart III-1A for Jan 2, 1962, are 2.75 percent for the fed fund rates and 4.06 percent for the ten-year Treasury constant maturity. On July 31, 2001, the yields in Chart III-1A are 3.67 percent for one month, 3.79 percent for two years, 5.07 percent for ten years, 3.82 percent for the fed funds rate and 7.85 percent for the Baa corporate bond. On July 30, 2007, yields inverted with the one-month at 4.95 percent, the two-year at 4.59 percent and the ten-year at 5.82 percent with the yield of the Baa corporate bond at 6.70 percent. Another interesting point is for Oct 31, 2008, with the yield of the Baa jumping to 9.54 percent and the Treasury yields declining: one month 0.12 percent, two years 1.56 percent and ten years 4.01 percent during a flight to the dollar and government securities analyzed by Cochrane and Zingales (2009). Another spike in the series is for Apr 4, 2006 with the yield of the corporate Baa bond at 8.63 and the Treasury yields of 0.12 percent for one month, 0.94 for two years and 2.95 percent for ten years. During the beginning of the flight from risk financial assets to US government securities (see Cochrane and Zingales 2009), the one-month yield was 0.07 percent, the two-year yield 1.64 percent and the ten-year yield 3.41. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe. The final point of Chart III1-A is for Sep 18, 2014, with the one-month yield at 0.01 percent, the two-year at 0.59 percent, the ten-year at 2.63 percent, the fed funds rate at 0.09 percent and the corporate Baa bond at 4.91 percent. There is an evident increase in the yields of the 10-year Treasury constant maturity and the Moody’s Baa corporate bond with subsequent decline in wide swings of portfolio reallocations.
Chart III-1A, US, Ten-Year, Two-Year and One-Month Treasury Constant Maturity Yields, Overnight Fed Funds Rate and Yield of Moody’s Baa Corporate Bond, Jan 2, 1962-Sep 18, 2014
Note: US Recessions in shaded areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15
Inyoung Hwang, writing on “Fed optimism spurs record bets against stock volatility,” on Aug 21, 2014, published in Bloomberg.com (http://www.bloomberg.com/news/2014-08-21/fed-optimism-spurs-record-bets-against-stock-voalitlity.html), informs that the S&P 500 is trading at 16.6 times estimated earnings, which is higher than the five-year average of 14.3 Tom Lauricella, writing on Mar 31, 2014, on “Stock investors see hints of a stronger quarter,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304157204579473513864900656?mod=WSJ_smq0314_LeadStory&mg=reno64-wsj), finds views of stronger earnings among many money managers with positive factors for equity markets in continuing low interest rates and US economic growth. There is important information in the Quarterly Markets review of the Wall Street Journal (http://online.wsj.com/public/page/quarterly-markets-review-03312014.html) for IQ2014. Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. In IQ1980, real gross private domestic investment in the US was $951.6 billion of chained 2009 dollars, growing to $1,254.6 billion in IVQ1987 or 31.8 percent. Real gross private domestic investment in the US increased 3.4 percent from $2,605.2 billion of chained 2009 dollars in IVQ2007 to $2,694.7 billion in IIQ2014, which is stagnation in comparison with growth of 31.8 percent in the comparable first twenty quarters of expansion from IQ1983 to IVQ1987. As shown in Table IAI-2, real private fixed investment changed 0.0 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,586.3 billion in IIQ2014. There is a statistical coincidence that the value of private fixed investment in the US is exactly equal in chained 2009 dollars at $2586.3 billion in IVQ2007 and in IIQ2014. Growth of real private investment is mediocre for all but four quarters from IIQ2011 to IQ2012.
The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Undistributed corporate profits swelled 250.8 percent from $107.7 billion in IQ2007 to $377.8 billion in IIQ2014 and changed signs from minus $55.9 billion in current dollars in IVQ2007. Corporate profits with IVA and CCA rebounded with $37.1 billion in IIIQ2013 and $3.1 billion in IVQ2013. Corporate profits with IVA and CCA increased $154.9 billion in IIQ2014. In IIIQ2013, profits after tax with IVA and CCA increased $28.7 billion and decreased $24.7 billion in IVQ2013. In IQ2014, profits after tax with IVA and CCA decreased $268.6 billion. Profits after tax with IVA and CCA increased at $115.2 billion in IIQ2014. Net dividends fell at $187.0 billion in IIIQ2013 and increased at $80.6 billion in IVQ2013. Net dividends fell at $89.5 billion in IIQ2014 and fell at $1.3 billion in IIQ2014. Undistributed profits with IVA and CCA rose at $215.8 billion in IIIQ2013 and fell at $105.5 billion in IVQ2013. Undistributed corporate profits swelled 250.8 percent from $107.7 billion in IQ2007 to $377.8 billion in IIQ2014 and changed signs from minus $55.9 billion in current dollars in IVQ2007. Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment. The investment decision of US business is fractured. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:
Where Rτ is expected revenue in the time horizon from τ =1 to T; Cτ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that interest rates increase without bound, then V → 0, or
declines. Equally, decline in expected revenue from the stock or project, Rτ, causes decline in valuation.
There is mixed performance in equity indexes with several indexes in Table III-1 increasing in the week ending on Sep 19, 2014, after wide swings caused by reallocations of investment portfolios worldwide. Stagnating revenues, corporate cash hoarding and declining investment are causing reevaluation of discounted net earnings with deteriorating views on the world economy and United States fiscal sustainability but investors have been driving indexes higher. DJIA increased 0.1 percent on Sep 19, increasing 1.7 percent in the week. Germany’s DAX changed 0.0 percent on Sep 19 and increased 1.5 percent in the week. Dow Global decreased 0.2 percent on Sep 19 and increased 0.5 percent in the week. Japan’s Nikkei Average increased 1.6 percent on Sep 19 and increased 2.3 percent in the week as the yen continues oscillating but relatively weaker and the stock market gains in expectations of success of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Dow Asia Pacific TSM increased 0.3 percent on Sep 19 and decreased 0.8 percent in the week. Shanghai Composite that decreased 0.2 percent on Mar 8 and decreased 1.7 percent in the week of Mar 8, falling below 2000 to close at 1980.13 on Fri Nov 30 but closing at 2329.45 on Sep 19 for increase of 0.6 percent and decreasing 0.1 percent in the week. There is deceleration with oscillations of the world economy that could affect corporate revenue and equity valuations, causing fluctuations in equity markets with increases during favorable risk appetite.
Commodities were mixed in the week of Sep 19, 2014. Table III-1 shows that WTI increased 0.2 percent in the week of Sep 19 while Brent increased 1.3 percent in the week with turmoil in oil producing regions. Gold decreased 0.8 percent on Sep 19 and decreased 1.2 percent in the week.
Table III-2 provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the long-term refinancing operations (LTROs). Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increased from €546,747 million on Dec 31, 2010, to €879,130 million on Dec 28, 2011 and €483,131 million on Sep 12, 2014, with some repayment of loans already occurring. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has reached €1,044,753 million in the statement of Sep 12, 2014, with marginal reduction. There is high credit risk in these transactions with capital of only €95,312 million as analyzed by Cochrane (2012Aug31).
Table III-2, Consolidated Financial Statement of the Eurosystem, Million EUR
| Dec 31, 2010 | Dec 28, 2011 | Sep 12, 2014 | |
| 1 Gold and other Receivables | 367,402 | 419,822 | 334,434 |
| 2 Claims on Non Euro Area Residents Denominated in Foreign Currency | 223,995 | 236,826 | 250,065 |
| 3 Claims on Euro Area Residents Denominated in Foreign Currency | 26,941 | 95,355 | 25,689 |
| 4 Claims on Non-Euro Area Residents Denominated in Euro | 22,592 | 25,982 | 21,139 |
| 5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro | 546,747 | 879,130 | 483,131 |
| 6 Other Claims on Euro Area Credit Institutions Denominated in Euro | 45,654 | 94,989 | 63,535 |
| 7 Securities of Euro Area Residents Denominated in Euro | 457,427 | 610,629 | 561,622 |
| 8 General Government Debt Denominated in Euro | 34,954 | 33,928 | 26,709 |
| 9 Other Assets | 278,719 | 336,574 | 237,479 |
| TOTAL ASSETS | 2,004, 432 | 2,733,235 | 2,003,802 |
| Memo Items | |||
| Sum of 5 and 7 | 1,004,174 | 1,489,759 | 1,044,753 |
| Capital and Reserves | 78,143 | 81,481 | 95,312 |
Source: European Central Bank
http://www.ecb.int/press/pr/wfs/2011/html/fs110105.en.html
http://www.ecb.int/press/pr/wfs/2011/html/fs111228.en.html
http://www.ecb.europa.eu/press/pr/wfs/2014/html/fs140916.en.html
IIIE Appendix Euro Zone Survival Risk. Resolution of the European sovereign debt crisis with survival of the euro area would require success in the restructuring of Italy. Growth of the Italian economy would assure that success. A critical problem is that the common euro currency prevents Italy from devaluing the exchange to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness.
Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. Growth of the Italian economy would ensure that success. A critical problem is that the common euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. Growth of the Italian economy would ensure that success. A critical problem is that the common euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Newly available data in Table III-3 providing Italy’s trade with regions and countries supports the argument of Caballero and Giavazzi (2012Jan15). Italy’s exports to the European Monetary Union (EMU), or euro area, are only 39.8 percent of the total in Jul 2014. Exports to the non-European Union area with share of 46.3 percent in Italy’s total exports are growing at minus 1.9 percent in Jan-Jul 2014 relative to Jan-Jul 2013 while those to EMU are growing at 2.8 percent.
Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%
| Jul 2014 | Exports | ∆% Jan-Jul 2014/ Jan-Jul 2013 | Imports | ∆% Jan-Jul 2014/ Jan-Jul 2013 |
| EU | 53.7 | 3.9 | 55.3 | 0.9 |
| EMU 18 | 39.8 | 2.8 | 44.3 | -0.1 |
| France | 10.8 | -0.9 | 8.4 | 0.5 |
| Germany | 12.4 | 4.5 | 14.7 | 2.7 |
| Spain | 4.4 | 4.7 | 4.5 | 3.2 |
| UK | 5.0 | 5.5 | 2.7 | 2.4 |
| Non EU | 46.3 | -1.9 | 44.7 | -4.7 |
| Europe non EU | 13.0 | -9.0 | 12.1 | -4.6 |
| USA | 6.9 | 9.5 | 3.2 | 7.6 |
| China | 2.5 | 7.9 | 6.4 | 5.0 |
| OPEC | 6.0 | -7.9 | 8.1 | -33.3 |
| Total | 100.0 | 1.3 | 100.0 | -1.7 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: Istituto Nazionale di Statistica
http://www.istat.it/it/archivio/131450
Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade surplus of €1312 million with the 17 countries of the euro zone (EMU 17) in Jul 2014 and cumulative surplus of €1657 million in Jan-Jul 2014. Depreciation to parity could permit greater competitiveness in improving the trade surplus of €3087 million in Jan-Jul 2014 with Europe non-European Union, the trade surplus of €9891 million with the US and the trade surplus with non-European Union of €7279 million in Jan-Jul 2014. There is significant rigidity in the trade deficit in Jan-Jul 2014 of €8253 million with China. There is a trade surplus of €626 million with members of the Organization of Petroleum Exporting Countries (OPEC). Higher exports could drive economic growth in the economy of Italy that would permit less onerous adjustment of the country’s fiscal imbalances, raising the country’s credit rating.
Table III-4, Italy, Trade Balance by Regions and Countries, Millions of Euro
| Regions and Countries | Trade Balance Jul 2014 Millions of Euro | Trade Balance Cumulative Jan-Jul 2014 Millions of Euro |
| EU | 3,312 | 11,209 |
| EMU 18 | 1,312 | 1,657 |
| France | 1,245 | 7,473 |
| Germany | 100 | -1,850 |
| Spain | 266 | 767 |
| UK | 1,208 | 6,234 |
| Non EU | 3,545 | 12,995 |
| Europe non EU | 1,317 | 3,087 |
| USA | 1,885 | 9,891 |
| China | -1,510 | -8,253 |
| OPEC | 163 | 626 |
| Total | 6,857 | 24,205 |
Notes: EU: European Union; EMU: European Monetary Union (euro zone)
Source: Istituto Nazionale di Statistica
http://www.istat.it/it/archivio/131450
Growth rates of Italy’s trade and major products are in Table III-5 for the period Jan-Jul 2014 relative to Jan-Jul 2013. Growth rates of cumulative imports relative to a year earlier are negative for energy with minus 17.6 percent. Exports of durable goods grew 2.5 percent and exports of capital goods increased 3.3 percent. The higher rate of growth of exports of 1.3 percent in Jan-Jul 2014/Jan-Jul 2013 relative to that of imports of minus 1.7 percent may reflect weak demand in Italy with GDP declining during nine consecutive quarters from IIIQ2011 through IIIQ2013 together with softening commodity prices. GDP increased marginally 0.1 percent in IVQ2013 and fell 0.2 percent in IIQ2014.
Table III-5, Italy, Exports and Imports % Share of Products in Total and ∆%
| Exports | Exports | Imports | Imports | |
| Consumer | 31.0 | 3.3 | 27.3 | 2.2 |
| Durable | 6.0 | 2.5 | 2.9 | 7.6 |
| Non-Durable | 25.1 | 3.5 | 24.4 | 1.5 |
| Capital Goods | 32.3 | 3.3 | 20.3 | 4.7 |
| Inter- | 32.3 | -0.5 | 32.5 | 0.9 |
| Energy | 4.4 | -15.6 | 19.9 | -17.6 |
| Total ex Energy | 95.6 | 2.0 | 80.1 | 2.3 |
| Total | 100.0 | 1.3 | 100.0 | -1.7 |
Note: % Share for 2012 total trade.
Source: Istituto Nazionale di Statistica
http://www.istat.it/it/archivio/131450
Table III-6 provides Italy’s trade balance by product categories in Jul 2014 and cumulative Jan-Jul 2014. Italy’s trade balance excluding energy, generated surplus of 10,845 million in Jul 2014 and €50,883 million cumulative in Jan-Jul 2014 but the energy trade balance created deficit of €3988 million in Jul 2014 and cumulative €26,679 million in Jan-Jul 2014. The overall surplus in Jul 2014 was €6857 million with cumulative surplus of €24,205 million in Jan-Jul 2014. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.
Table III-6, Italy, Trade Balance by Product Categories, € Millions
| Jul 2014 | Cumulative Jan-Jul 2014 | |
| Consumer Goods | 3,271 | 14,126 |
| Durable | 1,346 | 7,560 |
| Nondurable | 1,925 | 6,566 |
| Capital Goods | 5,946 | 32,193 |
| Intermediate Goods | 1,628 | 4,564 |
| Energy | -3,988 | -26,679 |
| Total ex Energy | 10,845 | 50,883 |
| Total | 6,857 | 24,205 |
Source: Istituto Nazionale di Statistica
http://www.istat.it/it/archivio/131450
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 | Primary Net Lending Borrowing | General Government Net Debt | |
| 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
http://www.imf.org/external/ns/cs.aspx?id=28
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 | Jul 12-Month | Cumulative Jan-Jul 2014 € Billions | Cumulative Jan-Jul 2014/ | |
| Total | 101.0 | 8.5 | 659.4 | 3.3 |
| A. EU | 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:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (4)
Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+τ. The second equation of Cochrane (2011Jan, 5) is:
MtV(it, ·) = PtYt (5)
Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):
“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”
An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.
There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:
(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress
(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality
(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.
IV Global Inflation. There is inflation everywhere in the world economy, with slow growth and persistently high unemployment in advanced economies. Table IV-1, updated with every blog comment, provides the latest annual data for GDP, consumer price index (CPI) inflation, producer price index (PPI) inflation and unemployment (UNE) for the advanced economies, China and the highly indebted European countries with sovereign risk issues. The table now includes the Netherlands and Finland that with Germany make up the set of northern countries in the euro zone that hold key votes in the enhancement of the mechanism for solution of sovereign risk issues (Peter Spiegel and Quentin Peel, “Europe: Northern Exposures,” Financial Times, Mar 9, 2011 http://www.ft.com/intl/cms/s/0/55eaf350-4a8b-11e0-82ab-00144feab49a.html#axzz1gAlaswcW). Newly available data on inflation is considered below in this section. Data in Table IV-1 for the euro zone and its members are updated from information provided by Eurostat but individual country information is provided in this section as soon as available, following Table IV-1. Data for other countries in Table IV-1 are also updated with reports from their statistical agencies. Economic data for major regions and countries is considered in Section V World Economic Slowdown following with individual country and regional data tables.
Table IV-1, GDP Growth, Inflation and Unemployment in Selected Countries, Percentage Annual Rates
| GDP | CPI | PPI | UNE | |
| US | 2.5 | 1.7 | 2.2 FD 1.8 | 6.1 |
| Japan | -0.1 | 3.4 | 3.9 | 3.8 |
| China | 7.5 | 2.0 | -1.2 | |
| UK | 3.2 | 1.5* CPIH 1.5 | -0.3 output | 6.2 |
| Euro Zone | 0.7 | 0.4 | -1.1 | 11.5 |
| Germany | 1.2 | 0.8 | -0.7 | 4.9 |
| France | 0.1 | 0.5 | -0.6 | 10.3 |
| Nether-lands | 0.9 | 0.4 | -2.5 | 6.7 |
| Finland | -0.1 | 1.2 | -0.4 | 8.7 |
| Belgium | 1.0 | 0.4 | -5.7 | 8.5 |
| Portugal | 0.8 | -0.1 | -0.8 | 14.0 |
| Ireland | NA | 0.6 | 0.1 | 11.5 |
| Italy | -0.2 | -0.2 | -1.7 | 12.6 |
| Greece | -0.3 | -0.2 | 1.6 | 27.2 |
| Spain | 1.2 | -0.5 | -0.4 | 24.5 |
Notes: GDP: rate of growth of GDP; CPI: change in consumer price inflation; PPI: producer price inflation; UNE: rate of unemployment; all rates relative to year earlier
*Office for National Statistics http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/august-2014/index.html
**Core
PPI http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/august-2014/index.html Source: EUROSTAT http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/; country statistical sources http://www.census.gov/aboutus/stat_int.html
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
and earlier http://cmpassocregulationblog.blogspot.com/2014/06/financial-indecision-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/06/financial-instability-mediocre-cyclical.html, Table 8 in http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_2nd.pdf). Japan’s GDP fell 1.8 percent in IIQ2014 relative to IQ2014 and fell 0.1 percent relative to a year earlier. Japan’s GDP grew at the seasonally adjusted annual rate (SAAR) of minus 7.1 percent in IIQ2014 (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/weakening-world-economic-growth.html and earlier http://cmpassocregulationblog.blogspot.com/2014/06/financialgeopolitical-risks-recovery.html and earlier http://cmpassocregulationblog.blogspot.com/2014/05/world-inflation-waves-squeeze-of.html). The UK grew at 0.8 percent in IIQ2014 relative to IVQ2013 and GDP increased 3.2 percent in IIQ2014 relative to IIQ2013 (http://cmpassocregulationblog.blogspot.com/2014/08/weakening-world-economic-growth.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2014/06/financial-indecision-mediocre-cyclical.html). The Euro Zone grew at 0.0 percent in IIQ2014 and 0.7 percent in IIQ2014 relative to IIQ2013 (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/weakening-world-economic-growth.html). These are stagnating or “growth recession” rates, which are positive or about nil growth rates with some contractions that are insufficient to recover employment. The rates of unemployment are quite high: 6.1 percent in the US but 16.4 percent for unemployment/underemployment or job stress of 27.9 million (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-twentyseven.html), 3.8 percent for Japan (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), 6.2 percent for the UK with high rates of unemployment for young people (Section VH and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html and earlier http://cmpassocregulationblog.blogspot.com/2014/06/financialgeopolitical-risks-recovery.html). Twelve-month rates of inflation have been quite high, even when some are moderating at the margin: 1.7 percent in the US, 3.4 percent for Japan, 2.0 percent for China, 0.4 percent for the Euro Zone and 1.5 percent for the UK. Stagflation is still an unknown event but the risk is sufficiently high to be worthy of consideration (see http://cmpassocregulationblog.blogspot.com/2011/06/risk-aversion-and-stagflation.html). The analysis of stagflation also permits the identification of important policy issues in solving vulnerabilities that have high impact on global financial risks. Six key interrelated vulnerabilities in the world economy have been causing global financial turbulence. (1) Sovereign risk issues in Europe resulting from countries in need of fiscal consolidation and enhancement of their sovereign risk ratings (see Section III and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.html). (2) The tradeoff of growth and inflation in China now with change in growth strategy to domestic consumption instead of investment, high debt and political developments in a decennial transition. (3) Slow growth by repression of savings with de facto interest rate controls (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html), weak hiring with the loss of 10 million full-time jobs (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.html 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) and continuing job stress of 24 to 30 million people in the US and stagnant wages in a fractured job market (http://cmpassocregulationblog.blogspot.com/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) (4) The timing, dose, impact and instruments of normalizing monetary and fiscal policies (Section II and earlier http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.html http://cmpassocregulationblog.blogspot.com/2014/08/weakening-world-economic-growth.html and earlier http://cmpassocregulationblog.blogspot.com/2014/02/theory-and-reality-of-cyclical-slow.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html http://cmpassocregulationblog.blogspot.com/2012/02/thirty-one-million-unemployed-or.html http://cmpassocregulationblog.blogspot.com/2011/08/united-states-gdp-growth-standstill.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2011/03/global-financial-risks-and-fed.html http://cmpassocregulationblog.blogspot.com/2011/02/policy-inflation-growth-unemployment.html) in advanced and emerging economies. (5) The Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 had repercussions throughout the world economy. Japan has share of about 9 percent in world output, role as entry point for business in Asia, key supplier of advanced components and other inputs as well as major role in finance and multiple economic activities (http://professional.wsj.com/article/SB10001424052748704461304576216950927404360.html?mod=WSJ_business_AsiaNewsBucket&mg=reno-wsj); and (6) geopolitical events in the Middle East.
In the effort to increase transparency, the Federal Open Market Committee (FOMC) provides both economic projections of its participants and views on future paths of the policy rate that in the US is the federal funds rate or interest on interbank lending of reserves deposited at Federal Reserve Banks. These 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):
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.”
Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans. Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
Unconventional monetary policy will remain in perpetuity, or QE→∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE→∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at around 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 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.
First, total nonfarm payroll employment seasonally adjusted (SA) increased 142,000 in Aug 2014 and private payroll employment increased 134,000. The average monthly number of nonfarm jobs created from Aug 2012 to Aug 2013 was 197,917 using seasonally adjusted data, while the average number of nonfarm jobs created from Aug 2013 to Aug 2014 was 206,833, or increase by 4.5 percent. The average number of private jobs created in the US from Aug 2012 to Aug 2013 was 203,917, using seasonally adjusted data, while the average from Aug 2013 to Aug 2014 was 203,167, or decrease by 0.4 percent. This blog calculates the effective labor force of the US at 162.825 million in Aug 2013 and 164.327 million in Aug 2014 (Table I-4), for growth of 1.502 million at average 125,167 per month. The difference between the average increase of 203,167 new private nonfarm jobs per month in the US from Aug 2013 to Aug 2014 and the 125,167 average monthly increase in the labor force from Aug 2013 to Aug 2014 is 78,000 monthly new jobs net of absorption of new entrants in the labor force. There are 26.904 million in job stress in the US currently. Creation of 78,000 new jobs per month net of absorption of new entrants in the labor force would require 345 months to provide jobs for the unemployed and underemployed (26.904 million divided by 78,000) or 29 years (345 divided by 12). The civilian labor force of the US in Aug 2014 not seasonally adjusted stood at 156.434 million with 9.787 million unemployed or effectively 17.680 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 164.327 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 1.1 years (1 million divided by product of 78,000 by 12, which is 936,000). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.822 million (0.05 times labor force of 156.434 million) for new net job creation of 1.965 million (9.787 million unemployed minus 7.822 million unemployed at rate of 5 percent) that at the current rate would take 2.1 years (1.965 million divided by 0.936000). Under the calculation in this blog, there are 17.680 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 164.327 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.464 million jobs net of labor force growth that at the current rate would take 10.1 years (17.680 million minus 0.05(164.327 million) = 9.464 million divided by 0.936000, using LF PART 66.2% and Total UEM in Table I-4). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. The number employed in Aug 2014 was 146.647 million (NSA) or 0.668 million fewer people with jobs relative to the peak of 147.315 million in Jul 2007 while the civilian noninstitutional population of ages 16 years and over increased from 231.958 million in Jul 2007 to 248.229 million in Aug 2014 or by 16.271 million. The number employed fell 0.5 percent from Jul 2007 to Aug 2014 while the noninstitutional civilian population of ages of 16 years and over, or those available for work, increased 7.0 percent. The ratio of employment to population in Jul 2007 was 63.5 percent (147.315 million employment as percent of population of 231.958 million). The same ratio in Aug 2014 would result in 157.625 million jobs (0.635 multiplied by noninstitutional civilian population of 248.229 million). There are effectively 10.978 million fewer jobs in Aug 2014 than in Jul 2007, or 157.625 million minus 146.647 million. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs.
There is current interest in past theories of “secular stagnation.” Alvin H. Hansen (1939, 4, 7; see Hansen 1938, 1941; for an early critique see Simons 1942) argues:
“Not until the problem of full employment of our productive resources from the long-run, secular standpoint was upon us, were we compelled to give serious consideration to those factors and forces in our economy which tend to make business recoveries weak and anaemic (sic) and which tend to prolong and deepen the course of depressions. This is the essence of secular stagnation-sick recoveries which die in their infancy and depressions which feed on them-selves and leave a hard and seemingly immovable core of unemployment. Now the rate of population growth must necessarily play an important role in determining the character of the output; in other words, the com-position of the flow of final goods. Thus a rapidly growing population will demand a much larger per capita volume of new residential building construction than will a stationary population. A stationary population with its larger proportion of old people may perhaps demand more personal services; and the composition of consumer demand will have an important influence on the quantity of capital required. The demand for housing calls for large capital outlays, while the demand for personal services can be met without making large investment expenditures. It is therefore not unlikely that a shift from a rapidly growing population to a stationary or declining one may so alter the composition of the final flow of consumption goods that the ratio of capital to output as a whole will tend to decline.”
The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). There is currently population growth in the ages of 16 to 24 years but not enough job creation and discouragement of job searches for all ages (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.htmland earlier http://cmpassocregulationblog.blogspot.com/2014/08/weakening-world-economic-growth.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-risk-recovery-without-hiring.html).
Second, long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 20 quarters from IIIQ2009 to IIQ2014. Boskin (2010Sep) measures that the US economy grew at 6.2 percent in the first four quarters and 4.5 percent in the first 12 quarters after the trough in the second quarter of 1975; and at 7.7 percent in the first four quarters and 5.8 percent in the first 12 quarters after the trough in the first quarter of 1983 (Professor Michael J. Boskin, Summer of Discontent, Wall Street Journal, Sep 2, 2010 http://professional.wsj.com/article/SB10001424052748703882304575465462926649950.html). There are new calculations using the revision of US GDP and personal income data since 1929 by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) and the second estimate of GDP for IIQ2014 (http://www.bea.gov/newsreleases/national/gdp/2014/pdf/gdp2q14_2nd.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). The expansion from IQ1983 to IVQ1985 was at the average annual growth rate of 5.9 percent, 5.4 percent from IQ1983 to IIIQ1986, 5.2 percent from IQ1983 to IVQ1986, 5.0 percent from IQ1983 to IQ1987, 5.0 percent from IQ1983 to IIQ1987, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html). The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Growth at trend in the entire cycle from IVQ2007 to IIQ2014 would have accumulated to 22.1 percent. GDP in IIQ2014 would be $18,305.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,310.7 billion than actual $15,994.3 billion. There are about two trillion dollars of GDP less than at trend, explaining the 26.9 million unemployed or underemployed equivalent to actual unemployment of 16.4 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2014/09/competitive-monetary-policy-and.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-valuations-twenty-seven.html). US GDP in IIQ2014 is 12.6 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $15,994.3 billion in IIQ2014 or 6.7 percent at the average annual equivalent rate of 1.0 percent. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. The US missed the opportunity to grow at higher rates during the expansion and it is difficult to catch up because growth rates in the final periods of expansions tend to decline. The US missed the opportunity for recovery of output and employment always afforded in the first four quarters of expansion from recessions. Zero interest rates and quantitative easing were not required or present in successful cyclical expansions and in secular economic growth at 3.0 percent per year and 2.0 percent per capita as measured by Lucas (2011May). There is cyclical uncommonly slow growth in the US instead of allegations of secular stagnation. There is similar behavior in manufacturing. The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jul 2014. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.
First, First, total nonfarm payroll employment seasonally adjusted (SA) increased 142,000 in Aug 2014 and private payroll employment increased 134,000. The average monthly number of nonfarm jobs created from Aug 2012 to Aug 2013 was 197,917 using seasonally adjusted data, while the average number of nonfarm jobs created from Aug 2013 to Aug 2014 was 206,833, or increase by 4.5 percent. The average number of private jobs created in the US from Aug 2012 to Aug 2013 was 203,917, using seasonally adjusted data, while the average from Aug 2013 to Aug 2014 was 203,167, or decrease by 0.4 percent. This blog calculates the effective labor force of the US at 162.825 million in Aug 2013 and 164.327 million in Aug 2014 (Table I-4), for growth of 1.502 million at average 125,167 per month. The difference between the average increase of 203,167 new private nonfarm jobs per month in the US from Aug 2013 to Aug 2014 and the 125,167 average monthly increase in the labor force from Aug 2013 to Aug 2014 is 78,000 monthly new jobs net of absorption of new entrants in the labor force. There are 26.904 million in job stress in the US currently. Creation of 78,000 new jobs per month net of absorption of new entrants in the labor force would require 345 months to provide jobs for the unemployed and underemployed (26.904 million divided by 78,000) or 29 years (345 divided by 12). The civilian labor force of the US in Aug 2014 not seasonally adjusted stood at 156.434 million with 9.787 million unemployed or effectively 17.680 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 164.327 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 1.1 years (1 million divided by product of 78,000 by 12, which is 936,000). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.822 million (0.05 times labor force of 156.434 million) for new net job creation of 1.965 million (9.787 million unemployed minus 7.822 million unemployed at rate of 5 percent) that at the current rate would take 2.1 years (1.965 million divided by 0.936000). Under the calculation in this blog, there are 17.680 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 164.327 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.464 million jobs net of labor force growth that at the current rate would take 10.1 years (17.680 million minus 0.05(164.327 million) = 9.464 million divided by 0.936000, using LF PART 66.2% and Total UEM in Table I-4). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. The number employed in Aug 2014 was 146.647 million (NSA) or 0.668 million fewer people with jobs relative to the peak of 147.315 million in Jul 2007 while the civilian noninstitutional population of ages 16 years and over increased from 231.958 million in Jul 2007 to 248.229 million in Aug 2014 or by 16.271 million. The number employed fell 0.5 percent from Jul 2007 to Aug 2014 while the noninstitutional civilian population of ages of 16 years and over, or those available for work, increased 7.0 percent. The ratio of employment to population in Jul 2007 was 63.5 percent (147.315 million employment as percent of population of 231.958 million). The same ratio in Aug 2014 would result in 157.625 million jobs (0.635 multiplied by noninstitutional civilian population of 248.229 million). There are effectively 10.978 million fewer jobs in Aug 2014 than in Jul 2007, or 157.625 million minus 146.647 million. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs.
There is current interest in past theories of “secular stagnation.” Alvin H. Hansen (1939, 4, 7; see Hansen 1938, 1941; for an early critique see Simons 1942) argues:
“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 123.2212 in Aug 2014. The actual index NSA in Aug 2014 is 101.5145, which is 17.6 percent below trend. Manufacturing output grew at average 2.3 percent between Dec 1986 and Dec 2013, raising the index at trend to 117.7603 in Aug 2014. The output of manufacturing at 101.5145 in Aug 2014 is 13.8 percent below trend under this alternative calculation.
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 | ∆% | |
| 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 Sep 17, 2014 with symbolic reduction of purchases of securities for the Fed’s balance sheet (http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm):
“Press Release
Release Date: September 17, 2014
For immediate release
Information received since the Federal Open Market Committee met in July suggests that economic activity is expanding at a moderate pace. On balance, labor market conditions improved somewhat further; however, the unemployment rate is little changed and a range of labor market indicators suggests that there remains significant underutilization of labor resources. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee's longer-run objective. Longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will end its current program of asset purchases at its next meeting. However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action were Richard W. Fisher and Charles I. Plosser. President Fisher believed that the continued strengthening of the real economy, improved outlook for labor utilization and for general price stability, and continued signs of financial market excess, will likely warrant an earlier reduction in monetary accommodation than is suggested by the Committee's stated forward guidance. President Plosser objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for "a considerable time after the asset purchase program ends," because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee's goals.”
There are several important issues in this statement.
- Mandate. The FOMC pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):
“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”
- Open-ended Quantitative Easing or QE∞ with End of Bond Purchases. Earlier programs are continued with an additional lower open-ended $15 billion of bond purchases per month, increasing the stock of $4,187,075 million securities held outright and bank reserves deposited at the Fed of $2,751,908 million (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1): “The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will end its current program of asset purchases at its next meeting. However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.”
- New Advance Guidance. “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored” (emphasis added).
- Policy Commitment with Unemployment Rate. The emphasis of policy is in maintaining full employment: “When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”
Focus is shifting from tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Markets overreacted to the so-called “paring” of outright purchases to $15 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Sep 17, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140917a.htm):
“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).
How long is “considerable time”? At the press conference following the meeting on Mar 19, 2014, Chair Yellen answered a question of Jon Hilsenrath of the Wall Street Journal explaining “In particular, the Committee has endorsed the view that it anticipates that will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates. And of course on our present path, well, that's not utterly preset. We would be looking at next, next fall. So, I think that's important guidance” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140319.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”
At a speech on Mar 31, 2014, Chair Yellen analyzed labor market conditions as follows (http://www.federalreserve.gov/newsevents/speech/yellen20140331a.htm):
“And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress. The first of those goals is maximum sustainable employment, the highest level of employment that can be sustained while maintaining a stable inflation rate. Most of my colleagues on the Federal Open Market Committee and I estimate that the unemployment rate consistent with maximum sustainable employment is now between 5.2 percent and 5.6 percent, well below the 6.7 percent rate in February.
Let me explain what I mean by that word "slack" and why it is so important.
Slack means that there are significantly more people willing and capable of filling a job than there are jobs for them to fill. During a period of little or no slack, there still may be vacant jobs and people who want to work, but a large share of those willing to work lack the skills or are otherwise not well suited for the jobs that are available. With 6.7 percent unemployment, it might seem that there must be a lot of slack in the U.S. economy, but there are reasons why that may not be true.”
Yellen (2014Aug22) provides comprehensive review of the theory and measurement of labor markets. Monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):
“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”
Yellen (2014Aug22) finds that the unemployment rate is not sufficient in determining slack:
“One convenient way to summarize the information contained in a large number of indicators is through the use of so-called factor models. Following this methodology, Federal Reserve Board staff developed a labor market conditions index from 19 labor market indicators, including four I just discussed. This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.”
Yellen (2014Aug22) restates that the FOMC determines monetary policy on newly available information and interpretation of labor markets and inflation and does not follow a preset path:
“But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter. Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate. As I have noted many times, monetary policy is not on a preset path. The Committee will be closely monitoring incoming information on the labor market and inflation in determining the appropriate stance of monetary policy.”
Yellen (2014Aug22) states that “Historically, slack has accounted for only a small portion of the fluctuations in inflation. Indeed, unusual aspects of the current recovery may have shifted the lead-lag relationship between a tightening labor market and rising inflation pressures in either direction.”
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).
Matt Jarzemsky, writing on “Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 16,987.51 on Fr Sep 12, 2014, which is higher by 19.9 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 19.6 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial are approaching or exceeding historical highs. Perhaps one of the most critical statements on policy is the answer to a question of Peter Barnes by Chair Janet Yellen at the press conference following the meeting on Jun 18, 2014 (page 19 at http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf):
So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly” (emphasis added).
In a speech at the IMF on Jul 2, 2014, Chair Yellen analyzed the link between monetary policy and financial risks (http://www.federalreserve.gov/newsevents/speech/yellen20140702a.htm):
“Monetary policy has powerful effects on risk taking. Indeed, the accommodative policy stance of recent years has supported the recovery, in part, by providing increased incentives for households and businesses to take on the risk of potentially productive investments. But such risk-taking can go too far, thereby contributing to fragility in the financial system. This possibility does not obviate the need for monetary policy to focus primarily on price stability and full employment--the costs to society in terms of deviations from price stability and full employment that would arise would likely be significant. In the private sector, key vulnerabilities included high levels of leverage, excessive dependence on unstable short-term funding, weak underwriting of loans, deficiencies in risk measurement and risk management, and the use of exotic financial instruments that redistributed risk in nontransparent ways.”
Yellen (2014Jul14) warned again at the Committee on Banking, Housing and Urban Affairs on Jul 15, 2014:
“The Committee recognizes that low interest rates may provide incentives for some investors to “reach for yield,” and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance. More broadly, the financial sector has continued to become more resilient, as banks have continued to boost their capital and liquidity positions, and growth in wholesale short-term funding in financial markets has been modest” (emphasis added).
Greenspan (1996) made similar warnings:
“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy” (emphasis added).
Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. What is the success in evaluating deviations of valuations of risk financial assets from “historical norms”? What are the consequences on economic activity and employment of deviations of valuations of risk financial assets from those “historical norms”? What are the policy tools and their effectiveness in returning valuations of risk financial assets to their “historical norms”?
The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.
Professor Raguram G Rajan, governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation. Rajan (2005) anticipated the risks of the world financial crisis. Professor John B. Taylor (2014Jul15, 2014Jun26) building on advanced research (Taylor (1993, 1998LB, 1999, 1998LB, 1999, 2007JH, 2008Nov, 2009, 2012JMCB, 2014Jan3) finds that a monetary policy rule would function best in promoting an environment of low inflation and strong economic growth with stability of financial markets. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html).
The key policy is maintaining fed funds rate between 0 and ¼ percent. An increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.
The FOMC provides guidelines on the process of normalization of monetary policy at the meeting on Sep 17, 2014 (http://www.federalreserve.gov/newsevents/press/monetary/20140917c.htm):
“All FOMC participants but one agreed on the following key elements of the approach they intend to implement when it becomes appropriate to begin normalizing the stance of monetary policy:
- The Committee will determine the timing and pace of policy normalization--meaning steps to raise the federal funds rate and other short-term interest rates to more normal levels and to reduce the Federal Reserve's securities holdings--so as to promote its statutory mandate of maximum employment and price stability.
- When economic conditions and the economic outlook warrant a less accommodative monetary policy, the Committee will raise its target range for the federal funds rate.
- During normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve balances.
- During normalization, the Federal Reserve intends to use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the federal funds rate. The Committee will use an overnight reverse repurchase agreement facility only to the extent necessary and will phase it out when it is no longer needed to help control the federal funds rate.
- The Committee intends to reduce the Federal Reserve's securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA.
- The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.
- The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance.
- The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.
- The Committee is prepared to adjust the details of its approach to policy normalization in light of economic and financial developments.”
In testimony on the Semiannual Monetary Policy Report to the Congress before the Committee on Financial Services, US House of Representatives, on Feb 11, 2014, Chair Janet Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20140211a.htm):
“Turning to monetary policy, let me emphasize that I expect a great deal of continuity in the FOMC's approach to monetary policy. I served on the Committee as we formulated our current policy strategy and I strongly support that strategy, which is designed to fulfill the Federal Reserve's statutory mandate of maximum employment and price stability. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. That said, purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. In December of last year and again this January, the Committee said that its current expectation--based on its assessment of a broad range of measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments--is that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the 2 percent goal. I am committed to achieving both parts of our dual mandate: helping the economy return to full employment and returning inflation to 2 percent while ensuring that it does not run persistently above or below that level (emphasis added).”
At the confirmation hearing on nomination for Chair of the Board of Governors of the Federal Reserve System, Vice Chair Yellen (2013Nov14 http://www.federalreserve.gov/newsevents/testimony/yellen20131114a.htm), states needs and intentions of policy:
“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve's goal of 2 percent and is expected to continue to do so for some time.
For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”
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):
“The economy has continued to recover from the steep recession of 2008 and 2009. Real gross domestic product (GDP) growth stepped up to an average annual rate of about 3-1/4 percent over the second half of last year, a faster pace than in the first half and during the preceding two years. Although real GDP growth is currently estimated to have paused in the first quarter of this year, I see that pause as mostly reflecting transitory factors, including the effects of the unusually cold and snowy winter weather. With the harsh winter behind us, many recent indicators suggest that a rebound in spending and production is already under way, putting the overall economy on track for solid growth in the current quarter. One cautionary note, though, is that readings on housing activity--a sector that has been recovering since 2011--have remained disappointing so far this year and will bear watching.
Conditions in the labor market have continued to improve. The unemployment rate was 6.3 percent in April, about 1-1/4 percentage points below where it was a year ago. Moreover, gains in payroll employment averaged nearly 200,000 jobs per month over the past year. During the economic recovery so far, payroll employment has increased by about 8-1/2 million jobs since its low point, and the unemployment rate has declined about 3-3/4 percentage points since its peak.
While conditions in the labor market have improved appreciably, they are still far from satisfactory. Even with recent declines in the unemployment rate, it continues to be elevated. Moreover, both the share of the labor force that has been unemployed for more than six months and the number of individuals who work part time but would prefer a full-time job are at historically high levels. In addition, most measures of labor compensation have been rising slowly--another signal that a substantial amount of slack remains in the labor market.
Inflation has been quite low even as the economy has continued to expand. Some of the factors contributing to the softness in inflation over the past year, such as the declines seen in non-oil import prices, will probably be transitory. Importantly, measures of longer-run inflation expectations have remained stable. That said, the Federal Open Market Committee (FOMC) recognizes that inflation persistently below 2 percent--the rate that the Committee judges to be most consistent with its dual mandate--could pose risks to economic performance, and we are monitoring inflation developments closely.
Looking ahead, I expect that economic activity will expand at a somewhat faster pace this year than it did last year, that the unemployment rate will continue to decline gradually, and that inflation will begin to move up toward 2 percent. A faster rate of economic growth this year should be supported by reduced restraint from changes in fiscal policy, gains in household net worth from increases in home prices and equity values, a firming in foreign economic growth, and further improvements in household and business confidence as the economy continues to strengthen. Moreover, U.S. financial conditions remain supportive of growth in economic activity and employment.”
In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):
“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differ from each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”
Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and re the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+re). Thus, g = [(r/re) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dre>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:
W = Y/r (10
Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.
In delivering the biannual report on monetary policy (Board of Governors 2013Jul17), Chairman Bernanke (2013Jul17) advised Congress that:
“Instead, we are providing additional policy accommodation through two distinct yet complementary policy tools. The first tool is expanding the Federal Reserve's portfolio of longer-term Treasury securities and agency mortgage-backed securities (MBS); we are currently purchasing $40 billion per month in agency MBS and $45 billion per month in Treasuries. We are using asset purchases and the resulting expansion of the Federal Reserve's balance sheet primarily to increase the near-term momentum of the economy, with the specific goal of achieving a substantial improvement in the outlook for the labor market in a context of price stability. We have made some progress toward this goal, and, with inflation subdued, we intend to continue our purchases until a substantial improvement in the labor market outlook has been realized. We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low--our second tool--to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability.
The Committee's decisions regarding the asset purchase program (and the overall stance of monetary policy) depend on our assessment of the economic outlook and of the cumulative progress toward our objectives. Of course, economic forecasts must be revised when new information arrives and are thus necessarily provisional.”
Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html).
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.
Professor Ronald I. McKinnon (2013Oct27), writing on “Tapering without tears—how to end QE3,” on Oct 27, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304799404579153693500945608?KEYWORDS=Ronald+I+McKinnon), finds that the major central banks of the world have fallen into a “near-zero-interest-rate trap.” World economic conditions are weak such that exit from the zero interest rate trap could have adverse effects on production, investment and employment. The maintenance of interest rates near zero creates long-term near stagnation. The proposal of Professor McKinnon is credible, coordinated increase of policy interest rates toward 2 percent. Professor John B. Taylor at Stanford University, writing on “Economic failures cause political polarization,” on Oct 28, 2013, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303442004579121010753999086?KEYWORDS=John+B+Taylor), analyzes that excessive risks induced by near zero interest rates in 2003-2004 caused the financial crash. Monetary policy continued in similar paths during and after the global recession with resulting political polarization worldwide.
Table IV-2 provides economic projections of governors of the Board of Governors of the Federal Reserve and regional presidents of Federal Reserve Banks released at the meeting of Sep 17, 2014. The Fed releases the data with careful explanations (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf). Columns “∆% GDP,” “∆% PCE Inflation” and “∆% Core PCE Inflation” are changes “from the fourth quarter of the previous year to the fourth quarter of the year indicated.” The GDP report for 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 Sep 17, 2014 and the second row “PR” the projection of the Jun 18, 2014 meeting. There are three changes in the view.
1. Growth “∆% GDP.” The FOMC has changed the forecast of GDP growth in 2014. The FOMC decreased GDP growth in 2014 from 2.1 to 2.3 percent at the meeting in Jun 2014 to 2.0 to 2.2 percent at the meeting in Sep 2014.
2. Rate of Unemployment “UNEM%.” The FOMC reduced the forecast of the rate of unemployment for 2014 from 6.0 to 6.1 percent at the meeting on Jun 18, 2014 to 5.9 to 6.0 percent at the meeting on Sep 17, 2014. The projection for 2015 decreased to the range of 5.4 to 5.6 in Sep 2014 from 5.4 to 5.7 in Jun 2014. Projections of the rate of unemployment are moving closer to the desire 6.5 percent or lower with 4.9 to 5.3 percent in 2017 after the meeting on Sep 17, 2014.
3. Inflation “∆% PCE Inflation.” The FOMC did not change the forecast of personal consumption expenditures (PCE) inflation for 2014 from 1.5 to 1.7 percent at the meeting on Jun 18, 2014 to 1.5 to 1.7 percent at the meeting on Sep 17, 2014. There are no projections exceeding 2.0 percent in the central tendency but some in the range reach 2.4 percent in 2015. The longer run projection is at 2.0 percent.
4. Core Inflation “∆% Core PCE Inflation.” Core inflation is PCE inflation excluding food and energy. There is again not much of a difference of the projection for 2014, not changing from 1.5 to 1.6 percent at the meeting on Jun 18, 20134 to 1.5 to 1.6 percent at the meeting Sep 17, 2014. In 2015, there is minor change in the projection from 1.6 to 2.0 percent at the meeting on Jun 18, 2014 to 1.5 to 1.6 percent on Sep 17, 2014. The rate of change of the core PCE is below 2.0 percent in the central tendency with 2.4 percent at the top of the range in 2015.
Table IV-2, US, Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents in FOMC, Mar 19, 2013 and Jun 18, 2014
| ∆% GDP | UNEM % | ∆% PCE Inflation | ∆% Core PCE Inflation | |
| Central | ||||
| 2014 | 2.0 to 2.2 | 5.9 to 6.0 | 1.5 to 1.7 | 1.5 to 1.6 |
| 2015 Jun PR | 2.6 to 3.0 3.0 to 3.2 | 5.4 to 5.6 5.4 to 5.7 | 1.6 to 1.9 1.5 to 2.0 | 1.6 to 1.9 1.6 to 2.0 |
| 2016 Jun PR | 2.6 to 2.9 2.5 to 3.0 | 5.1 to 5.4 5.1 to 5.5 | 1.7 to 2.0 1.6 to 2.0 | 1.8 to 2.0 1.7 to 2.0 |
| 2017 Jun PR | 2.3 to 2.5 NA | 4.9 to 5.3 NA | 1.9 to 2.0 NA | 1.9 to 2.0 NA |
| Longer Run Jun PR | 2.0 to 2.3 2.1 to 2.3 | 5.2 to 5.5 5.2 to 5.5 | 2.0 2.0 | |
| Range | ||||
| 2014 | 1.8 to 2.3 | 5.7 to 6.1 | 1.5 to 1.8 | 1.5 to 1.8 |
| 2015 Jun PR | 2.1 to 3.2 2.2 to 3.6 | 5.2 to 5.7 5.2 to 5.9 | 1.5 to 2.4 1.4 to 2.4 | 1.6 to 2.4 1.5 to 2.4 |
| 2016 Jun PR | 2.1 to 3.0 2.2 to 3.2 | 4.9 to 5.6 5.0 to 5.6 | 1.6 to 2.1 1.5 to 2.0 | 1.7 to 2.2 1.6 to 2.0 |
| 2017 Jun PR | 2.0 to 2.6 NA | 4.7 to 5.8 NA | 1.7 to 2.2 NA | 1.8 to 2.2 NA |
| Longer Run Jun PR | 1.8 to 2.6 1.8 to 2.5 | 5.0 to 6.0 5.0 to 6.0 | 2.0 2.0 |
Notes: UEM: unemployment; PR: Projection
Source: Board of Governors of the Federal Reserve System, FOMC
http://www.federalreserve.gov/newsevents/press/monetary/20140618b.htm
http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf
Another important decision at the FOMC meeting on Jan 25, 2012, is formal specification of the goal of inflation of 2 percent per year but without specific goal for unemployment (http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm):
“Following careful deliberations at its recent meetings, the Federal Open Market Committee (FOMC) has reached broad agreement on the following principles regarding its longer-run goals and monetary policy strategy. The Committee intends to reaffirm these principles and to make adjustments as appropriate at its annual organizational meeting each January.
The FOMC is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decision making by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.
Inflation, employment, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Moreover, monetary policy actions tend to influence economic activity and prices with a lag. Therefore, the Committee's policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the Committee's goals.
The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances.
The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision. The Committee considers a wide range of indicators in making these assessments. Information about Committee participants' estimates of the longer-run normal rates of output growth and unemployment is published four times per year in the FOMC's Summary of Economic Projections. For example, in the most recent projections, FOMC participants' estimates of the longer-run normal rate of unemployment had a central tendency of 5.2 percent to 6.0 percent, roughly unchanged from last January but substantially higher than the corresponding interval several years earlier.
In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate. ”
The probable intention of this specific inflation goal is to “anchor” inflationary expectations. Massive doses of monetary policy of promoting growth to reduce unemployment could conflict with inflation control. Economic agents could incorporate inflationary expectations in their decisions. As a result, the rate of unemployment could remain the same but with much higher rate of inflation (see Kydland and Prescott 1977 and Barro and Gordon 1983; http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html See Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-116). Strong commitment to maintaining inflation at 2 percent could control expectations of inflation.
The FOMC continues its efforts of increasing transparency that can improve the credibility of its firmness in implementing its dual mandate. Table IV-3 provides the views by participants of the FOMC of the levels at which they expect the fed funds rate in 2014, 2015, 2016 and the in the longer term. Table IV-3 is inferred from a chart provided by the FOMC with the number of participants expecting the target of fed funds rate (http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf). The rate would still remain at 0 to ¼ percent in 2014 for 16 participants with one expecting the rate to be in the range of 0.5 to 1.0. This table is consistent with the guidance statement of the FOMC that rates will remain at low levels. For 2015, 3 participants expect the rate to remain between 0.5 and 1.0 percent, 5 to be between 1.0 and 1.5 percent, 10 between 1 and 2 percent and 1 between 2 and 3 percent. For 2016, 2 participant expects the rate between 1.0 and 1 percent, 2 between 1 and 2 percent, 8 between 2 and 3 percent and 6 between 3 and 4.5 percent. In the long term, all 16 participants expect the fed funds rate in the range of 3.0 to 4.5 percent.
Table IV-3, US, Views of Target Federal Funds Rate at Year-End of Federal Reserve Board
Members and Federal Reserve Bank Presidents Participating in FOMC, Jun 18, 2014
| 0 to 0.25 | 0.5 to 1.0 | 1.0 to 1.5 | 1.0 to 2.0 | 2.0 to 3.0 | 3.0 to 4.5 | |
| 2014 | 16 | 1 | ||||
| 2015 | 3 | 3 | 5 | 10 | 1 | |
| 2016 | 1 | 2 | 2 | 8 | 6 | |
| 2017 | 1 | 1 | 17 | |||
| Longer Run | 17 |
Source: Board of Governors of the Federal Reserve System, FOMC
http://www.federalreserve.gov/newsevents/press/monetary/20140618b.htm
http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf
Additional information is provided in Table IV-4 with the number of participants expecting increasing interest rates in the years from 2014 to 2016. It is evident from Table IV-4 that the prevailing view of the FOMC is for interest rates to continue at low levels until 2015. This view is consistent with the economic projections of low economic growth, relatively high unemployment and subdued inflation provided in Table IV-2. The FOMC states that rates will continue to be low even after return of the economy to potential growth.
Table IV-4, US, Views of Appropriate Year of Increasing Target Federal Funds Rate of Federal Reserve Board Members and Federal Reserve Bank Presidents Participating in FOMC, Mar 19, 2014
| Appropriate Year of Increasing Target Fed Funds Rate | Number of Participants |
| 2014 | 1 |
| 2015 | 14 |
| 2016 | 2 |
Source: Board of Governors of the Federal Reserve System, FOMC
http://www.federalreserve.gov/newsevents/press/monetary/20140618b.htm
http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140917.pdf
There are two categories of responses in the Empire State Manufacturing Survey of the Federal Reserve Bank of New York (http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html): current conditions and expectations for the next six months. There are responses in the survey for two types of prices: prices received or inputs of production and prices paid or sales prices of products. Table IV-5 provides indexes for the two categories and within them for the two types of prices from Jan 2011 to Sep 2014. The index of current prices paid or costs of inputs increased from 16.13 in Dec 2012 to 23.91 in Sep 2014 while the index of current prices received or sales prices increased from 1.08 in Dec 2012 to 17.39 in Sep 2014. The farther the index is from the area of no change at zero, the faster the rate of change. Prices paid or of inputs at 23.91 in Sep 2014 are expanding at faster pace than prices received or of sales of products at 17.39. The index of future prices paid or expectations of costs of inputs in the next six months fell from 51.61 in Dec 2012 to 43.48 in Sep 2014 while the index of future prices received or expectation of sales prices in the next six months increased from 25.81 in Dec 2012 to 32.61 in Sep 2014. Priced paid or of inputs are expected to increase at a faster pace in the next six months than prices received or prices of sales products. Prices of sales of finished products are less dynamic than prices of costs of inputs during waves of increases. Prices of costs of costs of inputs fall less rapidly than prices of sales of finished products during waves of price decreases. As a result, margins of prices of sales less costs of inputs oscillate with typical deterioration against producers, forcing companies to manage tightly costs and labor inputs. Instability of sales/costs margins discourages investment and hiring.
Table IV-5, US, FRBNY Empire State Manufacturing Survey, Diffusion Indexes, Prices Paid and Prices Received, SA
| Current Prices Paid | Current Prices Received | Six Months Prices Paid | Six Months Prices Received | |
| Sep 2014 | 23.91 | 17.39 | 43.48 | 32.61 |
| Aug | 27.27 | 7.95 | 42.05 | 21.59 |
| Jul | 25.00 | 6.82 | 37.50 | 18.18 |
| Jun | 17.20 | 4.30 | 36.56 | 16.13 |
| May | 19.78 | 6.59 | 31.87 | 14.29 |
| Apr | 22.45 | 10.20 | 33.67 | 14.29 |
| Mar | 21.18 | 2.35 | 43.53 | 25.88 |
| Feb | 25.00 | 15.00 | 40.00 | 23.75 |
| Jan | 36.59 | 13.41 | 45.12 | 23.17 |
| Dec 2013 | 15.66 | 3.61 | 48.19 | 27.71 |
| Nov | 17.11 | -3.95 | 42.11 | 17.11 |
| Oct | 21.69 | 2.41 | 45.78 | 25.30 |
| Sep | 21.51 | 8.60 | 39.78 | 24.73 |
| Aug | 20.48 | 3.61 | 40.96 | 19.28 |
| Jul | 17.39 | 1.09 | 28.26 | 11.96 |
| Jun | 20.97 | 11.29 | 45.16 | 17.74 |
| May | 20.45 | 4.55 | 29.55 | 14.77 |
| Apr | 28.41 | 5.68 | 44.32 | 14.77 |
| Mar | 25.81 | 2.15 | 50.54 | 23.66 |
| Feb | 26.26 | 8.08 | 44.44 | 13.13 |
| Jan | 22.58 | 10.75 | 38.71 | 21.51 |
| Dec 2012 | 16.13 | 1.08 | 51.61 | 25.81 |
| Nov | 14.61 | 5.62 | 39.33 | 15.73 |
| Oct | 17.20 | 4.30 | 44.09 | 24.73 |
| Sep | 19.15 | 5.32 | 40.43 | 23.40 |
| Aug | 16.47 | 2.35 | 31.76 | 14.12 |
| Jul | 7.41 | 3.70 | 35.80 | 16.05 |
| Jun | 19.59 | 1.03 | 34.02 | 17.53 |
| May | 37.35 | 12.05 | 57.83 | 22.89 |
| Apr | 45.78 | 19.28 | 50.60 | 22.89 |
| Mar | 50.62 | 13.58 | 66.67 | 32.10 |
| Feb | 25.88 | 15.29 | 62.35 | 34.12 |
| Jan | 26.37 | 23.08 | 53.85 | 30.77 |
| Dec 2011 | 24.42 | 3.49 | 56.98 | 36.05 |
| Nov | 18.29 | 6.10 | 36.59 | 25.61 |
| Oct | 22.47 | 4.49 | 40.45 | 17.98 |
| Sep | 32.61 | 8.70 | 53.26 | 22.83 |
| Aug | 28.26 | 2.17 | 42.39 | 15.22 |
| Jul | 43.33 | 5.56 | 51.11 | 30.00 |
| Jun | 56.12 | 11.22 | 55.10 | 19.39 |
| May | 69.89 | 27.96 | 68.82 | 35.48 |
| Apr | 57.69 | 26.92 | 56.41 | 38.46 |
| Mar | 53.25 | 20.78 | 71.43 | 36.36 |
| Feb | 45.78 | 16.87 | 55.42 | 27.71 |
| Jan 2011 | 35.79 | 15.79 | 60.00 | 42.11 |
Source: http://www.newyorkfed.org/survey/empire/empiresurvey_overview.html
Price indexes of the Federal Reserve Bank of Philadelphia Outlook Survey are in Table IV-6. As inflation waves throughout the world (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html), indexes of both current and expectations of future prices paid and received were quite high until May 2011. Prices paid, or inputs, were more dynamic, reflecting carry trades from zero interest rates to commodity futures. All indexes softened after May 2011 with even decline of prices received in Aug 2011 during the first round of risk aversion. Current and future price indexes have increased again but not back to the intensity in the beginning of 2011 because of risk aversion frustrating carry trades even induced by zero interest rates. The index of prices paid or prices of inputs increased from 20.6 in Dec 2012 to 27.0 in Sep 2014. The index of current prices received was minus 7.2 in Apr 2013, indicating decrease of prices received. The index of current prices received decreased from 10.9 in Dec 2012 to 8.8 in Sep 2014. The farther the index is from the area of no change at zero, the faster the rate of change. The index of current prices paid or costs of inputs at 27.0 in Sep 2014 indicates faster increase than the index of current prices received or sales prices of production at 8.8. The index of future prices paid increased to 46.2 in Sep 2014 from 41.9 in Dec 2012 while the index of future prices received increased from 27.3 in Dec 2012 to 31.3 in Sep 2014. Expectations are incorporating faster increases in prices of inputs or costs of production, 46.2 in Sep 2014, than of sales prices of produced goods, 31.3 in Sep 2014, forcing companies to manage tightly costs and labor inputs. Volatility of margins of sales/costs discourages investment and hiring.
Table IV-6, US, Federal Reserve Bank of Philadelphia Business Outlook Survey, Current and Future Prices Paid and Prices Received, SA
| Current Prices Paid | Current Prices Received | Future Prices Paid | Future Prices Received | |
| 10-Dec | 42.6 | 6.0 | 56.8 | 25.7 |
| 11-Jan | 47.9 | 12.1 | 58.7 | 34.1 |
| 11-Feb | 61.1 | 13.2 | 62.6 | 30.7 |
| 11-Mar | 57.6 | 17 | 62.1 | 32.4 |
| 11-Apr | 50.9 | 20.8 | 55.3 | 33.7 |
| 11-May | 49.3 | 20.5 | 54.6 | 28.5 |
| 11-Jun | 38.9 | 7.7 | 41.6 | 6.8 |
| 11-Jul | 35.6 | 6.3 | 48.3 | 16.7 |
| 11-Aug | 24.6 | -4 | 45.2 | 23.4 |
| 11-Sep | 32 | 7.1 | 40.9 | 22.2 |
| 11-Oct | 24.3 | 2.8 | 42.9 | 27.8 |
| 11-Nov | 22.8 | 6.3 | 35.4 | 28.3 |
| 11-Dec | 25 | 7 | 43.1 | 24.7 |
| 12-Jan | 25.3 | 8 | 47.5 | 20.8 |
| 12-Feb | 31.9 | 9.4 | 43.4 | 24.8 |
| 12-Mar | 14.1 | 5.3 | 37.8 | 22.6 |
| 12-Apr | 18.1 | 6.2 | 35.2 | 20.2 |
| 12-May | 7.7 | 0.7 | 39.5 | 9.7 |
| 12-Jun | 5.5 | -3.7 | 34.8 | 16.9 |
| 12-Jul | 10.8 | 4.9 | 27.9 | 20.3 |
| 12-Aug | 18 | 5.6 | 39.5 | 25 |
| 12-Sep | 15.8 | 3.5 | 42.2 | 27.5 |
| 12-Oct | 19.9 | 7.1 | 45.8 | 15.3 |
| 12-Nov | 23.6 | 6.5 | 47.6 | 12.8 |
| 12-Dec | 20.6 | 10.9 | 41.9 | 27.3 |
| 13-Jan | 11.8 | -1.6 | 33.9 | 20 |
| 13-Feb | 10.6 | -1.3 | 25.4 | 20.6 |
| 13-Mar | 7.6 | -1.3 | 32.4 | 16.8 |
| 13-Apr | 5 | -7.2 | 28.9 | 9.9 |
| 13-May | 9.7 | 0.2 | 33.5 | 19.9 |
| 13-Jun | 23.7 | 14.6 | 33.3 | 24.3 |
| 13-Jul | 22.7 | 8 | 41 | 25.6 |
| 13-Aug | 20.4 | 11.1 | 40.7 | 24.5 |
| 13-Sep | 25.9 | 12.5 | 43 | 31.6 |
| 13-Oct | 21 | 12.8 | 43.1 | 34.6 |
| 13-Nov | 25.4 | 9 | 43.5 | 38.1 |
| 13-Dec | 16.4 | 10.8 | 39.1 | 34.8 |
| 14-Jan | 18.7 | 5.1 | 35.3 | 11.8 |
| 14-Feb | 14.2 | 7.6 | 18.2 | 16.3 |
| 14-Mar | 13.9 | 4.3 | 29.4 | 15.9 |
| 14-Apr | 11.3 | 4.3 | 35.1 | 13 |
| 14-May | 23 | 17 | 36.1 | 29.5 |
| 14-Jun | 35 | 14.1 | 44.5 | 30 |
| 14-Jul | 34.7 | 16.8 | 38.2 | 23.5 |
| 14-Aug | 24.9 | 4.2 | 50.3 | 29.5 |
| 14-Sep | 27.0 | 8.8 | 46.2 | 31.3 |
Source: Federal Reserve Bank of Philadelphia
http://www.phil.frb.org/index.cfm
Chart IV-1 of the Business Outlook Survey of the Federal Reserve Bank of Philadelphia Outlook Survey provides the diffusion index of current prices paid or prices of inputs from 2006 to 2014. Recession dates are in shaded areas. In the middle of deep global contraction after IVQ2007, input prices continued to increase in speculative carry trades from central bank policy rates falling toward zero into commodities futures. The index peaked above 70 in the second half of 2008. Inflation of inputs moderated significantly during the shock of risk aversion in late 2008, even falling briefly into contraction territory below zero during several months in 2009 in the flight away from risk financial assets into US government securities (Cochrane and Zingales 2009) that unwound carry trades. Return of risk appetite induced carry trade with significant increase until return of risk aversion in the first round of the European sovereign debt crisis in Apr 2010. Carry trades returned during risk appetite in expectation that the European sovereign debt crisis was resolved. The various inflation waves originating in carry trades induced by zero interest rates with alternating episodes of risk aversion are mirrored in the prices of inputs after 2011, in particular after Aug 2012 with the announcement of the Outright Monetary Transactions Program of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). Subsequent risk aversion and flows of capital away from commodities into stocks and high-yield bonds caused sharp decline in the index of prices paid followed by another recent rebound with marginal decline and new increase. The index falls and then rebounds in the final segment but there are no episodes of contraction after 2009.
Chart IV-1, Federal Reserve Bank of Philadelphia Business Outlook Survey Current Prices Paid Diffusion Index SA
Source: Federal Reserve Bank of Philadelphia
http://www.philadelphiafed.org/index.cfm
Chart IV-2 of the Federal Reserve Bank of Philadelphia Outlook Survey provides the diffusion index of current prices received from 2006 to 2014. The significant difference between the index of current prices paid in Chart IV-1 and the index of current prices received in Chart IV-2 is that increases in prices paid are significantly sharper than increases in prices received. There were several periods of negative readings of prices received from 2010 to 2014 but none of prices paid. Prices paid relative to prices received deteriorate most of the time largely because of the carry trades from zero interest rates to commodity futures. Profit margins of business are compressed intermittently by fluctuations of commodity prices induced by unconventional monetary policy of zero interest rates, frustrating production, investment and hiring decisions of business, which is precisely the opposite outcome pursued by unconventional monetary policy.
Chart IV-2, Federal Reserve Bank of Philadelphia Business Outlook Survey Current Prices Received Diffusion Index SA
Source: Federal Reserve Bank of Philadelphia
http://www.philadelphiafed.org/index.cfm
The harmonized index of consumer prices of the euro area in Table IV-7 has similar inflation waves as in most countries (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html). In the first wave, consumer prices in the euro area increased at the annual equivalent rate of 5.2 percent in Jan-Apr 2011. In the second wave, risk aversion caused unwinding of commodity carry trades with inflation decreasing at the annual equivalent rate of minus 2.4 percent in May-Jul 2011. In the third wave, improved risk appetite resulted in annual equivalent inflation in Aug-Nov 2011 at 4.3 percent. In the fourth wave, return of risk aversion caused decline of consumer prices at the annual equivalent rate of minus 3.0 percent in Dec 2011 to Jan 2012. In the fifth wave, improved attitudes toward risk aversion resulted in higher consumer price inflation at the high annual equivalent rate of 9.6 percent in Feb-Apr 2012. In the sixth wave, annual equivalent inflation fell to minus 2.8 percent in May-Jul 2012. In the seventh wave, increasing risk appetite caused new carry trade exposures that resulted in annual equivalent inflation of 6.8 percent in Aug-Sep 2012 and 5.3 percent in Aug-Oct 2012. In the eighth wave, annual-equivalent inflation was minus 2.4 percent in Nov 2012. In the ninth wave, annual equivalent inflation was 4.9 percent in Dec 2012. In the tenth wave, annual equivalent inflation was minus 11.4 percent in Jan 2013. In the eleventh wave, annual equivalent inflation was 10.0 percent in Feb-Mar 2013. In the twelfth wave, annual equivalent inflation was minus 1.2 percent in Apr 2013. In the thirteenth wave, annual equivalent inflation rose to 1.2 percent in May-Jun 2013. In the fourteenth wave, annual equivalent inflation was minus 5.8 percent in Jul 2013. In the fifteenth wave, annual equivalent inflation was 3.7 percent in Aug-Sep 2013. In the sixteenth wave, annual equivalent inflation was minus 2.4 percent in Oct-Nov 2013. In the eighteenth wave, annual inflation returned at 4.9 percent in Dec 2013. In the nineteenth wave, inflation fell at annual equivalent 12.4 percent in Jan 2014. In the twentieth wave, annual equivalent inflation was at 5.7 percent in Feb-Apr 2014. In the twenty-first wave, annual equivalent inflation was minus 1.2 percent in May 2014. Inflation volatility around the world is confusing the information required in investment and consumption decisions. In the twenty-second wave, annual equivalent inflation was 1.2 percent in Jun 2014. In the twenty-third wave, annual equivalent inflation was at minus 8.1 percent in Jul 2014. The bottom part of Table IV-7 provides annual inflation in the euro area from 1999 to 2013. HICP inflation was 3.3 percent in 2008 mostly because of carry trades from interest rates falling to zero into commodity futures. Exposures in commodity futures were reversed in the flight to US government obligations with resulting inflation of 0.3 percent in 2009. Reallocations of portfolios of financial investors according to risk aversion caused high volatility of inflation in 2011, 2012, 2013 and 2014.
Table IV-7, Euro Area Harmonized Index of Consumer Prices Month and 12 Months ∆%
| Month ∆% | 12 Months ∆% | |
| Aug 2014 | 0.1 | 0.4 |
| AE ∆% Aug | 1.2 | |
| Jul | -0.7 | 0.4 |
| AE ∆% Jul | -8.1 | |
| Jun | 0.1 | 0.5 |
| AE ∆% Jun | 1.2 | |
| May | -0.1 | 0.5 |
| AE ∆% May | -1.2 | |
| Apr | 0.2 | 0.7 |
| Mar | 0.9 | 0.5 |
| Feb | 0.3 | 0.7 |
| AE ∆% Feb-Apr | 5.7 | |
| Jan | -1.1 | 0.8 |
| AE ∆% Jan | -12.4 | |
| Dec 2013 | 0.4 | 0.8 |
| AE ∆% Dec | 4.9 | |
| Nov | -0.1 | 0.8 |
| Oct | -0.1 | 0.7 |
| AE ∆% Oct-Nov | -2.4 | |
| Sep | 0.5 | 1.1 |
| Aug | 0.1 | 1.3 |
| AE ∆% Aug- Sep | 3.7 | |
| Jul 2013 | -0.5 | 1.6 |
| AE ∆% Jul | -5.8 | |
| Jun | 0.1 | 1.6 |
| May | 0.1 | 1.4 |
| AE ∆% May-Jun | 1.2 | |
| Apr | -0.1 | 1.2 |
| AE ∆% Apr | -1.2 | |
| Mar | 1.2 | 1.7 |
| Feb | 0.4 | 1.8 |
| AE ∆% Feb-Mar | 10.0 | |
| Jan | -1.0 | 2.0 |
| AE ∆% Jan | -11.4 | |
| Dec 2012 | 0.4 | 2.2 |
| AE ∆% Dec | 4.9 | |
| Nov | -0.2 | 2.2 |
| AE ∆% Nov | -2.4 | |
| Oct | 0.2 | 2.5 |
| Sep | 0.7 | 2.6 |
| Aug | 0.4 | 2.6 |
| AE ∆% Aug-Oct | 5.3 | |
| Jul 2012 | -0.5 | 2.4 |
| Jun | -0.1 | 2.4 |
| May | -0.1 | 2.4 |
| AE ∆% May-Jul | -2.8 | |
| Apr | 0.5 | 2.6 |
| Mar | 1.3 | 2.7 |
| Feb | 0.5 | 2.7 |
| AE ∆% Feb-Apr | 9.6 | |
| Jan | -0.8 | 2.6 |
| Dec 2011 | 0.3 | 2.8 |
| AE ∆% Dec-Jan | -3.0 | |
| Nov | 0.1 | 3.0 |
| Oct | 0.4 | 3.0 |
| Sep | 0.7 | 3.0 |
| Aug | 0.2 | 2.6 |
| AE ∆% Aug-Nov | 4.3 | |
| Jul | -0.6 | 2.6 |
| Jun | 0.0 | 2.7 |
| May | 0.0 | 2.7 |
| AE ∆% May-Jul | -2.4 | |
| Apr | 0.6 | 2.8 |
| Mar | 1.4 | 2.7 |
| Feb | 0.4 | 2.4 |
| Jan | -0.7 | 2.3 |
| AE ∆% Jan-Apr | 5.2 | |
| Dec 2010 | 0.6 | 2.2 |
| Annual ∆% | ||
| 2013 | 1.3 | |
| 2012 | 2.5 | |
| 2011 | 2.7 | |
| 2010 | 1.6 | |
| 2009 | 0.3 | |
| 2008 | 3.3 | |
| 2007 | 2.2 | |
| 2006 | 2.2 | |
| 2005 | 2.2 | |
| 2004 | 2.2 | |
| 2003 | 2.1 | |
| 2002 | 2.3 | |
| 2001 | 2.4 | |
| 2000 | 2.2 | |
| 1999 | 1.2 |
AE: annual equivalent Source: EUROSTAT
http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/
http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database
Table IV-8 provides weights and inflation of selected components of the HICP of the euro area. Inflation of all items excluding energy increased 0.7 percent in Aug 2014 relative to Aug 2013 and increased 0.2 percent in Aug 2014 relative to Jul 2014. Prices of non-energy industrial goods increased 0.3 percent in Aug 2014 relative to a year earlier and increased 0.4 percent in Aug 2014. Inflation of services was 1.3 percent in Aug 2014 relative to a year earlier and increased 0.3 percent in Aug 2014.
Table IV-8, Euro Area, HICP Inflation and Selected Components, ∆%
| Weight 2014 | Aug 2014/ Aug 2013 | 12-month Average Rate Aug 2014-2013/ Aug 2013-2012 | ∆% Aug 2014/Jul 2014 | |
| All Items | 1000.0 | 0.4 | 0.7 | 0.1 |
| All Items ex Energy | 891.9 | 0.7 | 0.9 | 0.2 |
| All Items ex Energy, Food, Alcohol & Tobacco | 694.4 | 0.9 | 0.9 | 0.3 |
| All Items ex Energy & Unprocessed Food | 817.1 | 0.9 | 1.0 | 0.3 |
| All Items ex Energy & Seasonal Food | 853.5 | 0.9 | 1.0 | 0.3 |
| All Items ex Tobacco | 976.1 | 0.3 | 0.6 | 0.1 |
| Energy | 108.1 | -2.0 | -1.1 | -0.6 |
| Food, Alcohol & Tobacco | 197.6 | -0.3 | 1.0 | -0.3 |
| Non-energy Industrial Goods | 266.6 | 0.3 | 0.2 | 0.4 |
| Services | 427.8 | 1.3 | 1.3 | 0.3 |
AE: annual equivalent
Source: EUROSTAT
http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/
http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database
The index of producer prices for industrial products of Germany decreased 0.1 percent in Aug 2014, not seasonally adjusted (NSA), decreased 0.1 percent calendar and seasonally adjusted (CSA) in Aug 2014 and decreased 0.8 percent not seasonally adjusted (NSA) in the 12 months ending in Aug 2014, as shown in Table IV-9. The producer price index of Germany has similar waves of inflation as in many other countries (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html). In the first wave from Jan to Apr 2011, the annual equivalent rate of producer price inflation was 10.4 percent NSA and 6.2 percent CSA, propelled by carry trades from zero interest rates to exposures in commodity futures in a mood of risk appetite. In the second wave in May and Jun 2011, the annual equivalent rate of producer price inflation was only 0.6 percent NSA because of the collapse of the carry trade in fear of risks of European sovereign debt but 3.7 percent CSA. In the third wave from Jul to Sep 2011, annual-equivalent producer price inflation in Germany was 2.4 percent NSA and 3.2 percent CSA with fluctuations in commodity prices resulting from perceptions of the sovereign risk crisis in Europe. In the fourth wave from Oct to Nov 2011, annual equivalent inflation was 0.6 percent NSA and 1.8 percent CSA. In the fifth wave from Dec 2011 to Jan 2012, annual equivalent inflation was at 0.0 percent NSA and minus 0.6 percent CSA in return of risk aversion. In the sixth wave, annual equivalent inflation increased to 6.2 percent in Feb-Mar 2012 NSA and 4.9 percent in Feb-Apr and 2.4 percent CSA. In the seventh wave, annual equivalent inflation was minus 2.8 percent in May-Jul 2012 NSA and 0.0 percent CSA. In the eighth wave, annual equivalent inflation was 4.3 percent in Aug-Sep 2012 NSA and 2.4 percent CSA. In the ninth wave, renewed risk aversion resulted in annual equivalent inflation NSA of minus 0.8 percent in Oct-Dec 2012 and 0.8 percent CSA. In the tenth wave, annual equivalent inflation was 7.4 percent NSA and 2.4 percent CSA in Jan 2013. In the eleventh wave, annual equivalent inflation NSA was minus 2.4 percent in Feb-Apr 2013 and minus 2.4 percent CSA. In the twelfth wave, annual equivalent inflation was minus 1.8 percent in May-Aug 2013 and minus 0.6 percent CSA. In the thirteenth wave, annual equivalent inflation was 3.7 percent NSA and 0.0 CSA in Sep 2013. In the fourteenth wave, annual equivalent inflation was minus 1.8 percent in Oct-Nov 2013 NSA and minus 1.8 percent CSA. In the fifteenth wave, annual equivalent inflation was 1.2 NSA in Dec 2013 and 2.4 percent SA. In the sixteenth wave, annual equivalent was minus 1.3 percent in Jan-Aug 2014 NSA and minus 1.2 percent SA.
Table IV-9, Germany, Index of Producer Prices for Industrial Products ∆%
| 12 Months ∆% NSA | Month ∆% NSA | Month ∆% Calendar and SA | |
| Aug 2014 | -0.8 | -0.1 | -0.1 |
| Jul | -0.8 | -0.1 | -0.1 |
| Jun | -0.7 | 0.0 | 0.0 |
| May | -0.8 | -0.2 | 0.0 |
| Apr | -0.9 | -0.1 | -0.1 |
| Mar | -0.9 | -0.3 | -0.1 |
| Feb | -0.9 | 0.0 | 0.0 |
| Jan | -1.1 | -0.1 | -0.4 |
| AE ∆% Jan-Aug | -1.3 | -1.2 | |
| Dec 2013 | -0.5 | 0.1 | 0.2 |
| AE ∆% Dec | 1.2 | 2.4 | |
| Nov | -0.8 | -0.1 | -0.1 |
| Oct | -0.7 | -0.2 | -0.2 |
| AE ∆% Oct-Nov | -1.8 | -1.8 | |
| Sep | -0.5 | 0.3 | 0.0 |
| AE ∆% Sep | 3.7 | 0.0 | |
| Aug | -0.5 | -0.1 | -0.2 |
| Jul | 0.0 | -0.1 | 0.0 |
| Jun | 0.1 | -0.1 | 0.1 |
| May | -0.2 | -0.3 | 0.0 |
| AE ∆% May-Aug | -1.8 | -0.3 | |
| Apr | -0.2 | -0.1 | -0.1 |
| Mar | 0.1 | -0.3 | -0.1 |
| Feb | 0.9 | -0.2 | 0.1 |
| AE ∆% Feb-Apr | -2.4 | -0.4 | |
| Jan | 1.5 | 0.6 | 0.2 |
| AE ∆% Jan | 7.4 | 2.4 | |
| Dec 2012 | 1.4 | -0.3 | 0.0 |
| Nov | 1.2 | 0.0 | 0.1 |
| Oct | 1.1 | 0.1 | 0.1 |
| AE ∆% Oct-Dec | -0.8 | 0.8 | |
| Sep | 1.2 | 0.3 | 0.1 |
| Aug | 1.1 | 0.4 | 0.3 |
| AE ∆% Aug-Sep | 4.3 | 2.4 | |
| Jul | 0.6 | 0.0 | 0.0 |
| Jun | 1.1 | -0.4 | -0.1 |
| May | 1.6 | -0.3 | 0.1 |
| AE ∆% May-Jul | -2.8 | 0.0 | |
| Apr | 1.9 | 0.2 | 0.0 |
| Mar | 2.6 | 0.6 | 0.4 |
| Feb | 2.6 | 0.4 | 0.2 |
| AE ∆% Feb-Apr | 4.9 | 2.4 | |
| Jan | 2.9 | 0.5 | 0.0 |
| Dec 2011 | 3.5 | -0.5 | -0.1 |
| AE ∆% Dec-Jan | 0.0 | -0.6 | |
| Nov | 4.6 | -0.1 | 0.1 |
| Oct | 4.9 | 0.2 | 0.2 |
| AE ∆% Oct-Nov | 0.6 | 1.8 | |
| Sep | 5.1 | 0.2 | 0.2 |
| Aug | 5.2 | -0.2 | 0.1 |
| Jul | 5.3 | 0.6 | 0.5 |
| AE ∆% Jul-Sep | 2.4 | 3.2 | |
| Jun | 5.1 | 0.1 | 0.3 |
| May | 5.6 | 0.0 | 0.3 |
| AE ∆% May-Jun | 0.6 | 3.7 | |
| Apr | 6.1 | 0.9 | 0.5 |
| Mar | 6.2 | 0.6 | 0.3 |
| Feb | 6.1 | 0.7 | 0.6 |
| Jan | 5.3 | 1.1 | 0.6 |
| AE ∆% Jan-Apr | 10.4 | 6.2 |
Source:
Federal Statistical Agency of Germany (Statistiche Bundesamt Deutschland)
https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
Chart IV-3 of the Federal Statistical Agency of Germany Statistiche Bundesamt Deutschland provides the producer price index of Germany from 2008 to 2014. Producer price inflation peaked in 2008 with the rise of commodity prices induced by the carry trade from zero interest rates to commodity futures during a global contraction. Prices then declined with the flight away from risk financial assets to government obligations after the financial panic in Sep 2008. With zero interest rates and no risk aversion, the carry trade pushed commodity futures prices upwardly resulting in new rising trend of the producer price index. The right-hand side of the chart shows moderation and even decline in prices because of risk aversion and portfolio reallocations across financial risk assets frustrating carry trades from zero interest rates to commodity futures.
Chart IV-3, Germany, Index of Producer Prices for Industrial Products, 2010=100
Source: Statistisches Bundesamt Deutschland
https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
Chart IV-4 provides the index of producer finished goods in the US from 2006 to 2014. Chart IV-10 of the US mirrors behavior in Chart IV-9 of Germany. Carry trades from zero interest rates to exposures in commodity futures and risk financial assets have synchronized worldwide inflation during periods of risk appetite and disinflation during periods of risk aversion and portfolio reallocations.
Chart IV-4, US, Producer Price Index, Finished Goods, NSA, 2006-2014
Source: US Bureau of Labor Statistics
Chart IV-5 of the Federal Statistical Agency of Germany Statistiche Bundesamt Deutschland provides the unadjusted producer price index, trend and trend ends. There is a clear upward trend of prices after the end of risk aversion with zero interest rates in 2009. Oscillations of the actual curve relative to trend originate in carry trades from zero interest rates to commodity futures. The final segment shows declining trend in reallocation of carry trades toward stocks and high-yield bonds and away from commodities.
Chart IV-5, Germany, Index of Producer Prices for Industrial Products, Non-adjusted Value and Trend, 2010=100
Source: Statistiche Bundesamt Deutschland
https://www.destatis.de/EN/FactsFigures/Indicators/ShortTermIndicators/ShortTermIndicators.html
Inflation in the UK is somewhat higher than in many advanced economies, deserving more detailed analysis. Table IV-10 provides 12-month percentage changes of UK output prices for all manufactured products, excluding food, beverage and petroleum and excluding duty. The UK Office for National Statistics introduced rebasing for 2010=100 of the producer price index with important revisions (http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/producer-price-index-rebasing--2010-100-/index.html). The 12-month rates rose significantly in 2011 in all three categories, reaching 5.3 percent for all manufactured products in Sep 2011 but declining to 4.9 percent in Oct 2011, 4.6 percent in Nov 2011 and down to 1.3 percent in Jul 2012. Inflation of all manufactured products increased marginally to 1.7 percent in Aug 2012, 1.8 percent in Sep, 1.9 percent in Oct, 1.7 percent in Feb 2013, 1.5 percent in Mar 2013 and 1.0 percent in Apr 2013. Output prices increased 1.2 percent in the 12 months ending in May 2013, 1.7 percent in Jun 2013 and 1.8 percent in Jul 2013. Output price inflation was 1.5 percent in the 12 months ending in Aug 2013 and 1.2 percent in the 12 months ending in Sep 2013. Output price inflation was 0.8 percent in the 12 months ending in Oct 2013 and 0.8 percent in the 12 months ending in Nov 2013. Prices of output increased 1.0 percent in the 12 months ending in Dec 2013 and 0.9 percent in the 12 months ending in Jan 2014. Output prices increased 0.6 percent in the 12 months ending in Feb 2014 and 0.4 percent in the 12 months ending in Mar 2014. Output prices increased 0.6 percent in the 12 months ending in Apr 2014 and 0.5 percent in the 12 months ending in May 2014 down to minus 0.1 percent in Jul 2014. Output prices fell 0.3 percent in Aug 2014. Output price inflation is highly sensitive to commodity prices as shown by the increase by 6.7 percent in 2008 when oil prices rose over $140/barrel even in the midst of a global recession driven by the carry trade from zero interest rates to oil futures. The mirage episode of false deflation in 2001 and 2002 is also captured by output prices for the UK, which originated in decline of commodity prices (see Barsky and Killian 2004) but was used as an argument for unconventional monetary policy of zero interest rates and quantitative easing during the past decade. Arguments for symmetric up and down inflation targets are based on fear of deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, Pelaez and Pelaez, The Global Recession Risk (2007), 83-95).
Table IV-10, UK Output Prices 12 Months ∆% NSA
| All Manufactured Products | Excluding Food, Beverage, Tobacco and | All Excluding Duty | |
| Aug 2014 | -0.3 | 0.9 | -0.1 |
| Jul | -0.1 | 0.8 | 0.1 |
| Jun | 0.3 | 1.0 | 0.3 |
| May | 0.5 | 1.0 | 0.6 |
| Apr | 0.6 | 1.0 | 0.6 |
| Mar | 0.4 | 1.1 | 0.6 |
| Feb | 0.6 | 1.1 | 0.6 |
| Jan | 0.9 | 1.2 | 1.0 |
| Dec 2013 | 1.0 | 1.0 | 1.1 |
| Nov | 0.8 | 0.7 | 1.0 |
| Oct | 0.8 | 0.8 | 1.1 |
| Sep | 1.2 | 0.8 | 1.4 |
| Aug | 1.5 | 0.9 | 1.7 |
| Jul | 1.8 | 0.9 | 2.0 |
| Jun | 1.7 | 0.9 | 2.0 |
| May | 1.2 | 0.8 | 1.5 |
| Apr | 1.0 | 0.8 | 1.4 |
| Mar | 1.5 | 0.9 | 1.5 |
| Feb | 1.7 | 0.7 | 1.7 |
| Jan | 1.6 | 0.8 | 1.6 |
| Dec 2012 | 1.4 | 0.4 | 1.4 |
| Nov | 1.5 | 0.7 | 1.6 |
| Oct | 1.9 | 0.6 | 1.7 |
| Sep | 1.8 | 0.5 | 1.5 |
| Aug | 1.7 | 0.5 | 1.5 |
| Jul | 1.3 | 0.8 | 1.1 |
| Jun | 1.4 | 1.0 | 1.2 |
| May | 2.0 | 1.3 | 1.9 |
| Apr | 2.3 | 1.4 | 2.1 |
| Mar | 2.9 | 2.0 | 2.9 |
| Feb | 3.4 | 2.3 | 3.3 |
| Jan | 3.5 | 2.2 | 3.4 |
| Dec 2011 | 4.0 | 2.6 | 3.9 |
| Nov | 4.6 | 2.6 | 4.4 |
| Oct | 4.9 | 2.9 | 4.7 |
| Sep | 5.3 | 3.1 | 5.2 |
| Aug | 5.2 | 3.2 | 5.0 |
| Jul | 5.2 | 2.8 | 5.0 |
| Jun | 5.0 | 2.8 | 4.9 |
| May | 4.8 | 3.0 | 4.6 |
| Apr | 4.9 | 3.0 | 4.8 |
| Mar | 4.7 | 2.5 | 4.4 |
| Feb | 4.4 | 2.5 | 4.2 |
| Jan | 4.0 | 2.4 | 3.7 |
| Dec 2010 | 3.4 | 2.0 | 2.9 |
| Year ∆% | |||
| 2013 | 1.3 | 0.9 | 1.5 |
| 2012 | 2.1 | 1.1 | 1.9 |
| 2011 | 4.8 | 2.8 | 4.6 |
| 2010 | 2.7 | 1.5 | 2.1 |
| 2009 | 0.5 | 1.4 | -0.1 |
| 2008 | 6.7 | 3.6 | 6.8 |
| 2007 | 2.3 | 1.4 | 2.0 |
| 2006 | 2.1 | 1.5 | 2.0 |
| 2005 | 1.9 | 0.9 | 1.8 |
| 2004 | 1.1 | -0.1 | 0.7 |
| 2003 | 0.6 | 0.0 | 0.6 |
| 2002 | -0.1 | -0.3 | -0.1 |
| 2001 | -0.2 | -0.7 | -0.3 |
| 2000 | 1.4 | -0.4 | 0.8 |
| 1999 | 0.5 | -1.1 | -0.2 |
| 1998 | 0.1 | -0.9 | -1.0 |
| 1997 | 1.0 | 0.3 | 0.2 |
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/august-2014/index.html
Monthly and annual equivalent rates of change of output prices are shown in Table IV-11. There are waves of inflation similar to those in other countries (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html). In the first wave, annual equivalent inflation was 10.0 percent in Jan-Apr 2011 with relaxed risk aversion in commodity markets. In the second wave, intermittent risk aversion resulted in annual equivalent inflation of 1.6 percent in May-Oct 2011. In the third wave, alternation of risk aversion resulted in annual equivalent inflation of 1.2 percent in Nov 2011 to Jan 2012. In the fourth wave, the energy commodity shock processed through carry trades caused the jump of annual equivalent inflation to 5.3 percent in Feb-Apr 2012. A fifth wave occurred in May-Jun 2012 with decline of output inflation at 3.5 percent annual equivalent in an environment of risk aversion that caused decline of commodity prices. A sixth wave under commodity shocks induced by carry trades from zero interest rates resulted in annual equivalent inflation of 3.7 percent in Jul-Sep 2012 and 3.0 percent in Jul-Oct 2012. In the seventh wave, annual equivalent inflation in Nov-Dec 2012 fell to minus 2.4 percent. In the eighth wave, annual equivalent inflation returned at 4.9 percent in Jan-Mar 2013. In the ninth wave, risk aversion returned with annual equivalent inflation of minus 0.6 percent in Apr-May 2013. In the tenth wave, annual equivalent inflation was 2.0 percent in Jun-Aug 2013. In the eleventh wave, annual equivalent inflation was -1.5 percent in Sep-Dec 2013. In the twelfth wave, annual equivalent inflation returned at 2.0 percent in Jan-Mar 2014. In the thirteenth wave, annual equivalent inflation was minus 0.7 percent in Apr-Aug 2014.
Table IV-11, UK Output Prices Month ∆% NSA
| All Manufactured Products | Excluding Food, Beverage and | All Excluding Duty | |
| Aug 2014 | -0.1 | 0.1 | -0.1 |
| Jul | -0.1 | -0.1 | 0.0 |
| Jun | -0.1 | 0.0 | -0.2 |
| May | -0.1 | 0.0 | -0.1 |
| Apr | 0.1 | 0.0 | 0.0 |
| ∆% AE Apr-Aug | -0.7 | 0.0 | -1.0 |
| Mar | 0.1 | 0.2 | 0.3 |
| Feb | 0.1 | 0.2 | 0.1 |
| Jan | 0.3 | 0.5 | 0.3 |
| ∆% AE Jan-Mar | 2.0 | 3.7 | 2.8 |
| Dec 2013 | 0.0 | 0.1 | -0.1 |
| Nov | -0.2 | -0.1 | -0.1 |
| Oct | -0.3 | 0.0 | -0.2 |
| Sep | 0.0 | 0.0 | 0.0 |
| ∆% AE Sep-Dec | -1.5 | 0.0 | -1.2 |
| Aug | 0.1 | 0.0 | 0.1 |
| Jul | 0.3 | 0.1 | 0.2 |
| Jun | 0.1 | 0.0 | 0.1 |
| ∆% AE Jun-Aug | 2.0 | 0.4 | 1.6 |
| May | 0.0 | 0.0 | 0.0 |
| Apr | -0.1 | 0.1 | 0.0 |
| ∆% AE Apr-May | -0.6 | 0.6 | 0.0 |
| Mar | 0.3 | 0.3 | 0.3 |
| Feb | 0.5 | 0.2 | 0.5 |
| Jan | 0.4 | 0.3 | 0.4 |
| ∆% AE Jan-Mar | 4.9 | 3.2 | 4.9 |
| Dec 2012 | -0.2 | -0.2 | -0.2 |
| Nov | -0.2 | 0.0 | 0.0 |
| ∆% AE Nov-Dec | -2.4 | -1.2 | -1.2 |
| Oct | 0.1 | 0.0 | 0.1 |
| Sep | 0.3 | 0.1 | 0.3 |
| Aug | 0.4 | 0.0 | 0.4 |
| Jul | 0.2 | 0.1 | 0.2 |
| ∆% AE Jul-Oct | 3.0 | 0.6 | 3.0 |
| Jun | -0.4 | -0.1 | -0.4 |
| May | -0.2 | 0.0 | -0.1 |
| ∆% AE May-Jun | -3.5 | -0.6 | -3.0 |
| Apr | 0.4 | 0.2 | 0.1 |
| Mar | 0.5 | 0.1 | 0.5 |
| Feb | 0.4 | 0.3 | 0.4 |
| ∆% AE Feb-Apr | 5.3 | 2.4 | 4.1 |
| Jan | 0.2 | -0.1 | 0.2 |
| Dec 2011 | -0.1 | 0.1 | 0.0 |
| Nov | 0.2 | -0.1 | 0.1 |
| ∆% AE Nov-Jan | 1.2 | -0.4 | 1.2 |
| Oct | 0.0 | -0.1 | -0.1 |
| Sep | 0.2 | 0.1 | 0.3 |
| Aug | 0.0 | 0.3 | 0.0 |
| Jul | 0.3 | 0.3 | 0.3 |
| Jun | 0.2 | 0.2 | 0.3 |
| May | 0.1 | 0.1 | 0.1 |
| ∆% AE May-Oct | 1.6 | 1.8 | 1.8 |
| Apr | 1.0 | 0.8 | 0.9 |
| Mar | 1.0 | 0.4 | 0.9 |
| Feb | 0.5 | 0.2 | 0.5 |
| Jan | 0.7 | 0.3 | 0.7 |
| Jan-Apr | 10.0 | 5.2 | 9.4 |
| Dec 2010 | 0.5 | 0.1 | 0.4 |
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/august-2014/index.html
Input prices in the UK have been more dynamic than output prices until the current event of risk aversion and portfolio reallocations, as shown by Table IV-12, but with sharp oscillations because of the commodity and raw material content. The UK Office for National Statistics introduced rebasing for 2010=100 of the producer price index with important revisions (http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/producer-price-index-rebasing--2010-100-/index.html). The 12-month rates of increase of input prices, even excluding food, tobacco, beverages and petroleum, are very high, reaching 16.9 percent in Sep 2011 for materials and fuels purchased and 10.6 percent excluding food, beverages and petroleum. Inflation in 12 months of materials and fuels purchased moderated to 5.7 percent in Mar 2012 and 3.2 percent excluding food, tobacco, beverages and petroleum with the rates falling further in Apr 2012 to 1.5 percent for materials and fuels purchased and 1.1 percent excluding food, tobacco, beverages and petroleum. Input-price inflation collapsed in the 12 months ending in Jul 2012 to minus 2.5 percent for materials and fuels purchased and minus 2.5 percent excluding food, beverages and tobacco. Inflation returned at 0.7 percent in the 12 months ending in Aug 2012 but minus 2.6 percent excluding food, tobacco, beverages and petroleum. Inflation of input prices in Sep 2012 was minus 1.2 percent and minus 3.1 percent excluding food, beverages and petroleum. In Nov 2012, inflation of input prices of all manufacturing and materials purchased was minus 0.2 percent in 12 months and minus 1.6 percent in 12 months excluding food, tobacco, beverages and petroleum. Inflation of materials and fuels purchased in 12 months was 0.4 percent in Dec 2012 and minus 1.2 percent excluding tobacco, beverages and petroleum. Inflation of inputs returned with 1.6 percent in the 12 months ending in Jan 2013 and minus 0.2 percent excluding various items, increasing to 2.0 percent in Feb 2013 and 1.0 percent excluding various items. In Mar 2013, inflation of all manufacturing materials and fuels increased 0.9 percent in 12 months and 1.6 percent excluding various items. Prices of all manufacturing materials and fuels increased 0.3 percent in the 12 months ending in Apr 2013 and increased 0.9 percent excluding food and other items. Prices of all manufacturing increased 1.4 percent in the 12 months ending in May 2013 and 0.4 percent excluding various items. In Jul 2013, prices of manufactured products increased 4.7 percent in 12 months and 2.1 percent excluding food, tobacco, beverages and petroleum. In Aug 2013, prices of manufactured products increased 1.8 percent in 12 months and 1.4 percent excluding items. Inflation of input prices in the 12 months ending in Sep 2013 was 1.0 percent and 0.4 percent excluding items. Inflation collapsed in Oct 2013, with 0.0 percent for all manufacturing materials and fuels and minus 0.2 percent excluding various items. In Nov 2013, inflation of all manufacturing materials and fuels purchased fell 0.9 percent in 12 months and excluding items 1.0 percent. In Dec 2013, input prices for all manufacturing fell 0.9 percent in 12 months and fell 1.4 percent with exclusions. Inflation of all manufacturing fell 2.9 percent in the 12 months ending in Jan 2014 and 2.8 percent with exclusions. Inflation of input prices fell 5.8 percent in the 12 months ending in Feb 2014 and 5.1 percent with exclusions. Inflation of input prices fell 6.3 percent in the 12 months ending in Mar 2014 and 5.4 percent excluding items. In Apr 2014, inflation of input prices fell 5.3 percent in 12 months and 5.0 with exclusions. Inflation of input prices fell 7.2 percent in the 12 months ending in Aug 2014 and fell 4.1 percent with exclusions. There is comparable experience with 22.1 percent inflation of materials and fuels purchased in 2008 and 16.9 percent excluding food, beverages and petroleum followed in 2009 by decline of 5.7 percent for materials and fuels purchased and decrease of 1.2 percent for the index excluding items. UK input and output inflation is sensitive to commodity price increases driven by carry trades from zero interest rates. The mirage of false deflation is also observed in input prices in 1997-9 and then again from 2001 to 2003
Table IV-12, UK, Input Prices 12-Month ∆% NSA
| All Manufacturing Materials and Fuels Purchased | Excluding Food, Tobacco, Beverages and Petroleum | |
| Aug 2014 | -7.2 | -4.1 |
| Jul | -7.5 | -5.2 |
| Jun | -4.6 | -3.5 |
| May | -3.9 | -3.9 |
| Apr | -5.3 | -5.0 |
| Mar | -6.3 | -5.4 |
| Feb | -5.8 | -5.1 |
| Jan | -2.9 | -2.8 |
| Dec 2013 | -0.9 | -1.4 |
| Nov | -0.9 | -1.0 |
| Oct | 0.0 | -0.2 |
| Sep | 1.0 | 0.4 |
| Aug | 1.8 | 1.4 |
| Jul | 4.7 | 2.1 |
| Jun | 3.0 | 0.0 |
| May | 1.4 | 0.4 |
| Apr | 0.3 | 0.9 |
| Mar | 0.9 | 1.6 |
| Feb | 2.0 | 1.0 |
| Jan | 1.6 | -0.2 |
| Dec 2012 | 0.4 | -1.2 |
| Nov | -0.2 | -1.6 |
| Oct | -0.2 | -2.1 |
| Sep | -1.2 | -3.1 |
| Aug | 0.7 | -2.6 |
| Jul | -2.5 | -2.5 |
| Jun | -1.7 | -1.0 |
| May | 0.3 | -0.5 |
| Apr | 1.5 | 1.1 |
| Mar | 5.7 | 3.2 |
| Feb | 7.5 | 4.4 |
| Jan | 6.4 | 3.9 |
| Dec 2011 | 8.6 | 5.0 |
| Nov | 12.8 | 7.6 |
| Oct | 13.4 | 8.1 |
| Sep | 16.9 | 10.6 |
| Aug | 15.6 | 10.9 |
| Jul | 17.6 | 10.7 |
| Jun | 16.4 | 10.3 |
| May | 15.3 | 9.3 |
| Apr | 16.9 | 10.2 |
| Mar | 13.5 | 7.8 |
| Feb | 13.9 | 9.2 |
| Jan | 13.2 | 9.6 |
| Dec 2010 | 12.1 | 8.9 |
| Year ∆% | ||
| 2013 | 1.2 | 0.5 |
| 2012 | 1.3 | -0.3 |
| 2011 | 14.5 | 9.1 |
| 2010 | 8.0 | 4.6 |
| 2009 | -5.7 | -1.2 |
| 2008 | 22.1 | 16.9 |
| 2007 | 2.9 | 2.5 |
| 2006 | 9.8 | 7.2 |
| 2005 | 10.9 | 7.0 |
| 2004 | 3.4 | 1.7 |
| 2003 | 1.1 | -0.7 |
| 2002 | -4.5 | -4.8 |
| 2001 | -1.1 | -1.3 |
| 2000 | 7.3 | 3.8 |
| 1999 | -1.3 | -3.6 |
| 1998 | -8.9 | -4.6 |
| 1997 | -8.3 | -6.4 |
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/august-2014/index.html
Table IV-13 provides monthly percentage changes of UK input prices for materials and fuels purchased and excluding food, tobacco, beverages and petroleum. There are strong waves of inflation of input prices in the UK similar to those worldwide (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html). In the first wave, input prices rose at the high annual equivalent rate of 30.6 percent in Jan-Apr 2011, driven by carry trades from unconventional monetary policy into commodity exposures. Inflation of input prices was at 31.8 percent annual equivalent in Oct-Dec 2010. In the second wave, alternating risk aversion caused annual equivalent inflation of minus 1.3 percent in May-Oct 2011. In the third wave, renewed risk aversion resulted in annual equivalent inflation of 0.0 percent in Nov-Dec 2011. In the fourth wave, annual equivalent inflation of input prices in the UK surged at 14.9 percent in Jan-Mar 2012 under relaxed risk aversion. In the fifth wave, annual equivalent inflation was minus 16.1 percent in Apr-Jul 2012 because of collapse of commodity prices during increasing risk aversion. In the sixth wave, annual equivalent inflation of materials and fuels purchased jumped to 23.9 percent in Aug 2012. In the seventh wave, annual equivalent inflation moderated to 3.0 percent in Sep-Dec 2012. In the eighth wave, annual equivalent inflation in Jan-Feb 2013 jumped to 24.6 percent. In the eighth wave, annual equivalent inflation of materials and fuels purchased was minus 9.5 percent in Mar-Jun 2013. In the ninth wave, annual equivalent inflation returned at 18.2 percent in annual equivalent in Jul 2013. In the tenth wave, annual equivalent inflation was minus 8.4 percent in Aug-Nov 2013. In the eleventh wave, annual equivalent inflation of manufacturing materials and fuels was 3.7 percent in Dec 2013. In the twelfth wave, annual equivalent inflation was minus 8.4 percent in Jan-Aug 2014.
Table IV-13, UK Input Prices Month ∆%
| All Manufacturing Materials and Fuels Purchased NSA | Excluding Food, Tobacco, Beverages and Petroleum SA | |
| Aug 2014 | -0.6 | 0.3 |
| Jul | -1.7 | -0.2 |
| Jun | -1.0 | 0.1 |
| May | 0.2 | 0.0 |
| Apr | -0.9 | -0.3 |
| Mar | -0.4 | -0.3 |
| Feb | -0.5 | -1.0 |
| Jan | -0.9 | -0.7 |
| ∆% Jan-Aug | -8.4 | -3.1 |
| Dec 2013 | 0.3 | -0.5 |
| ∆% Dec | 3.7 | -5.8 |
| Nov | -0.6 | -0.5 |
| Oct | -0.4 | -0.3 |
| Sep | -0.9 | -0.9 |
| Aug | -1.0 | -0.5 |
| ∆% Aug-Nov | -8.4 | -6.4 |
| Jul | 1.4 | 1.1 |
| ∆% Jul | 18.2 | 14.0 |
| Jun | -0.3 | -0.3 |
| May | -1.3 | -1.1 |
| Apr | -1.9 | -0.8 |
| Mar | 0.2 | 0.1 |
| ∆% Mar-Jun | -9.5 | -6.1 |
| Feb | 2.5 | 1.5 |
| Jan | 1.2 | 0.6 |
| ∆% Jan-Feb | 24.6 | 13.3 |
| Dec 2012 | 0.3 | 0.0 |
| Nov | 0.3 | 0.3 |
| Oct | 0.5 | 0.4 |
| Sep | -0.1 | 0.2 |
| ∆% Sep-Dec | 3.0 | 2.7 |
| Aug | 1.8 | 0.0 |
| ∆% Aug | 23.9 | 0.0 |
| Jul | -0.3 | -0.7 |
| Jun | -1.8 | 0.2 |
| May | -2.4 | -0.6 |
| Apr | -1.3 | -0.1 |
| ∆% Apr-Jul | -16.1 | -3.5 |
| Mar | 1.3 | -0.5 |
| Feb | 2.2 | 0.4 |
| Jan | 0.0 | -0.4 |
| ∆% AE Jan-Mar | 14.9 | -2.0 |
| Dec 2011 | -0.3 | -0.7 |
| Nov | 0.3 | -0.1 |
| ∆% AE Nov-Dec | 0.0 | -4.7 |
| Oct | -0.5 | -0.6 |
| Sep | 1.8 | 0.5 |
| Aug | -1.5 | 0.3 |
| Jul | 0.5 | 0.7 |
| Jun | 0.2 | 0.8 |
| May | -1.1 | 0.6 |
| ∆% AE May-Oct | -1.3 | 4.7 |
| Apr | 2.8 | 2.1 |
| Mar | 3.0 | 0.6 |
| Feb | 1.1 | 0.1 |
| Jan | 2.1 | 0.7 |
| ∆% AE Jan-Apr | 30.6 | 11.0 |
| Dec 2010 | 3.5 | 1.7 |
| Nov | 0.9 | 0.4 |
| Oct | 2.5 | 1.7 |
| ∆% AE Oct-Dec | 31.8 | 16.3 |
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/august-2014/index.html
The UK Office for National Statistics also provides contributions in percentage points to the monthly and 12-month rates of inflation of manufactured products, shown in Table IV-14. There are contributions to 12-month percentage changes of 0.30 percentage points by tobacco and alcohol, 0.05 percentage points by computer, electrical and optical and 0.07 percentage points by other manufactured products. There are diversified sources of contributions to 12 months output price inflation such as 0.33 percentage points by clothing, textile and leather and deduction of 0.01 percentage points by transport equipment. Petroleum deducted 0.71 percentage points. In general, contributions by products rich in commodities are the drivers of price changes. There were diversified contributions in percentage points to monthly inflation: 0.02 percentage points deducted by petroleum and 0.10 percentage points deducted by food products.
Table IV-14, UK, Contributions to Month and 12-Month Change in Prices of All Manufactured Products, Percentage Points, NSA
| Aug 2014 | 12 Months | 12 Months ∆% | Month % Points | Month ∆% |
| Total % | -0.3 | -0.1 | ||
| Food Products | -0.37 | -2.2 | -0.10 | -0.8 |
| Tobacco & Alcohol | 0.30 | 3.0 | -0.01 | -0.2 |
| Clothing, Textile & Leather | 0.33 | 2.7 | -0.01 | -0.1 |
| Paper and Printing | 0.03 | 0.8 | 0.00 | 0.1 |
| Petroleum | -0.71 | -7.1 | -0.02 | -0.4 |
| Chemicals & Pharmaceutical | -0.07 | -0.9 | -0.01 | -0.3 |
| Metal, Machinery & Equipment | 0.04 | 0.6 | 0.02 | 0.2 |
| Computer, Electrical & Optical | 0.05 | 0.4 | 0.02 | 0.2 |
| Transport Equipment | -0.01 | -0.1 | 0.01 | 0.1 |
| Other Manufactured Products | 0.07 | 0.4 | 0.01 | 0.0 |
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/august-2014/index.html
The UK Office for National Statistics also provides contributions in percentage points to the monthly and 12-month rates of inflation of input prices in Aug 2014, shown in Table IV-15. Crude oil is a large factor with deduction of 3.46 percentage points from the 12-month rate and deduction of 0.57 percentage points from the monthly rate in Aug 2014. Price changes also transfer to the domestic economy through the prices of imported inputs: imported metals deducted 0.20 percentage points from the 12-month rate and added 0.12 percentage points to the Aug rate. Domestic food materials deducted 1.28 percentage points from the 12-month rate and deducted 0.36 percentage points from the Aug rate. Exposures and reversals of commodity exposures in carry trades during risk aversion are a major source of price and financial instability.
Table IV-15, UK, Contributions to Month and 12-Month Change in Prices of Inputs, Percentage Points NSA
| Aug 2014 | 12 Months | 12 Months ∆% | Month % Points | Month ∆% |
| Total | -7.2 | -0.6 | ||
| Fuel | -0.67 | -6.3 | 0.02 | 0.3 |
| Crude Oil | -3.46 | -14.2 | -0.57 | -2.6 |
| Domestic Food Materials | -1.28 | -9.7 | -0.36 | -2.9 |
| Imported Food Materials | -0.35 | -5.1 | 0.03 | 0.5 |
| Other Domestic Produced Materials | 0.22 | 8.6 | 0.00 | 0.0 |
| Imported Metals | -0.20 | -2.8 | 0.12 | 1.9 |
| Imported Chemicals | -0.60 | -4.7 | 0.03 | 0.3 |
| Imported Parts and Equipment | -0.43 | -2.7 | 0.08 | 0.5 |
| Other Imported Materials | -0.45 | -5.7 | 0.05 | 0.7 |
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/ppi2/producer-price-index/august-2014/index.html
Consumer price inflation in the UK is shown in Table IV-15. The CPI index increased 0.4 percent in Aug 2014 and increased 1.5 percent in 12 months. The same inflation waves (Section I and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html) are present in UK CPI inflation. In the first wave in Jan-Apr 2011, annual equivalent inflation was at a high 6.5 percent. In the second wave in May-Jul 2011, annual equivalent inflation fell to only 0.4 percent. In the third wave in Aug-Nov 2011, annual equivalent inflation returned at 4.6 percent. In the fourth wave in Dec 2011 to Jan 2012, annual equivalent inflation was minus 0.6 percent because of decline of 0.5 percent in Jan 2012. In the fifth wave, annual equivalent inflation increased to 6.2 percent in Feb-Apr 2012. In the seventh wave, annual equivalent inflation was minus 3.0 percent in May-Jun 2012. In the eighth wave, annual equivalent inflation in Jul-Dec 2012 was 4.5 percent and 6.2 percent in Oct 2012 with the rate in Oct caused mostly by increases in university tuition payments. In the ninth wave, annual equivalent inflation was minus 5.8 percent in Jan 2013. In the tenth wave, annual equivalent inflation jumped to 4.3 percent in Feb-May 2013. In the eleventh wave, annual equivalent inflation was minus 1.2 percent in Jun-Jul 2013. In the twelfth wave, annual equivalent inflation was 3.4 percent in Aug-Dec 2013. In the thirteenth wave, annual equivalent inflation was minus 7.0 percent in Jan 2014. In the fourteenth wave, annual equivalent inflation returned at 4.5 percent in Feb-Apr 2014. In the fifteenth wave, annual equivalent inflation was minus 1.2 percent in May 2014. In the sixteenth wave, annual equivalent inflation was 2.4 percent in Jun 2014. In the seventeenth wave, annual equivalent inflation was minus 3.5 percent in Jul 2014. In the eighteenth wave, annual equivalent inflation was 4.9 percent in Aug 2014.
Table IV-16, UK, Consumer Price Index All Items, Month and 12-Month ∆%
| Month ∆% | 12 Months ∆% | |
| Aug 2014 | 0.4 | 1.5 |
| AE ∆% Aug | 4.9 | |
| Jul | -0.3 | 1.6 |
| AE ∆% Jul | -3.5 | |
| Jun | 0.2 | 1.9 |
| AE ∆% Jun | 2.4 | |
| May | -0.1 | 1.5 |
| AE ∆% May | -1.2 | |
| Apr | 0.4 | 1.8 |
| Mar | 0.2 | 1.6 |
| Feb | 0.5 | 1.7 |
| AE ∆% Feb-Apr | 4.5 | |
| Jan | -0.6 | 1.9 |
| AE ∆% Jan | -7.0 | |
| Dec 2013 | 0.4 | 2.0 |
| Nov | 0.1 | 2.1 |
| Oct | 0.1 | 2.2 |
| Sep | 0.4 | 2.7 |
| Aug | 0.4 | 2.7 |
| AE ∆% Aug-Dec | 3.4 | |
| Jul | 0.0 | 2.8 |
| Jun | -0.2 | 2.9 |
| AE ∆% Jun-Jul | -1.2 | |
| May | 0.2 | 2.7 |
| Apr | 0.2 | 2.4 |
| Mar | 0.3 | 2.8 |
| Feb | 0.7 | 2.8 |
| AE ∆% Feb-May | 4.3 | |
| Jan 2013 | -0.5 | 2.7 |
| AE ∆% Jan | -5.8 | |
| Dec 2012 | 0.5 | 2.7 |
| Nov | 0.2 | 2.7 |
| Oct | 0.5 | 2.7 |
| Sep | 0.4 | 2.2 |
| Aug | 0.5 | 2.5 |
| Jul | 0.1 | 2.6 |
| AE ∆% Jul-Dec | 4.5 | |
| Jun | -0.4 | 2.4 |
| May | -0.1 | 2.8 |
| AE ∆% May-Jun | -3.0 | |
| Apr | 0.6 | 3.0 |
| Mar | 0.3 | 3.5 |
| Feb | 0.6 | 3.4 |
| AE ∆% Feb-Apr | 6.2 | |
| Jan | -0.5 | 3.6 |
| Dec 2011 | 0.4 | 4.2 |
| AE ∆% Dec-Jan | -0.6 | |
| Nov | 0.2 | 4.8 |
| Oct | 0.1 | 5.0 |
| Sep | 0.6 | 5.2 |
| Aug | 0.6 | 4.5 |
| AE ∆% Aug-Nov | 4.6 | |
| Jul | 0.0 | 4.4 |
| Jun | -0.1 | 4.2 |
| May | 0.2 | 4.5 |
| May-Jul | 0.4 | |
| Apr | 1.0 | 4.5 |
| Mar | 0.3 | 4.0 |
| Feb | 0.7 | 4.4 |
| Jan | 0.1 | 4.0 |
| AE ∆% Jan-Apr | 6.5 | |
| Dec 2010 | 1.0 | 3.7 |
| Nov | 0.4 | 3.3 |
| Oct | 0.3 | 3.2 |
| Sep | 0.0 | 3.1 |
| Aug | 0.5 | 3.1 |
| Jul | -0.2 | 3.1 |
| Jun | 0.1 | 3.2 |
| May | 0.2 | 3.4 |
| Apr | 0.6 | 3.7 |
| Mar | 0.6 | 3.4 |
| Feb | 0.4 | 3.0 |
| Jan | -0.2 | 3.5 |
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/august-2014/index.html
Inflation has been unusually high in the UK since 2006, as shown in Table IV-17. There were no rates of inflation close to 2.0 percent in the period from 1997 to 2004. Inflation has exceeded 2 percent since 2005, reaching 3.6 percent in 2008, 3.3 percent in 2010, 4.5 percent in 2011 and 2.8 percent in 2012. Annual inflation in 2013 was 2.6 percent.
Table IV-17, UK, Consumer Price Index, Annual ∆%
| Annual ∆% | |
| 1998 | 1.6 |
| 1999 | 1.3 |
| 2000 | 0.8 |
| 2001 | 1.2 |
| 2002 | 1.3 |
| 2003 | 1.4 |
| 2004 | 1.3 |
| 2005 | 2.1 |
| 2006 | 2.3 |
| 2007 | 2.3 |
| 2008 | 3.6 |
| 2009 | 2.2 |
| 2010 | 3.3 |
| 2011 | 4.5 |
| 2012 | 2.8 |
| 2013 | 2.6 |
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/august-2014/index.html
Table IV-18 provides the analysis of inflation in Aug 2014 by the UK Office for National Statistics. In the rate of 0.4 percent for Aug 2014, clothing and footwear added 0.18 percentage points, furniture and household goods contributed 0.06 percentage points and transport added 0.13 percentage points. Contributions of percentage points to the 12-month rate of consumer price inflation of 1.5 percent are in the second column in Table IV-18. Food and nonalcoholic beverages deducted 0.12 percentage points, alcohol and tobacco added 0.21 percentage points, housing and household services added 0.43 percentage points and transport added 0.20 percentage points.
Table IV-18, UK, Consumer Price Index Month and Twelve-month Percentage Point Contributions to Change by Components
| Aug 2014 | Percentage Point Contribution 12 Months Aug | Percentage Point Contribution Aug |
| CPI All Items ∆% | 1.5 | 0.4 |
| Food & Non-Alcoholic Beverages | -0.12 | -0.02 |
| Alcohol & Tobacco | 0.21 | 0.04 |
| Clothing & Footwear | 0.03 | 0.18 |
| Housing & Household Services | 0.43 | 0.01 |
| Furniture & Household Goods | 0.02 | 0.06 |
| Health | 0.07 | 0.01 |
| Transport | 0.20 | 0.13 |
| Communication | 0.03 | 0.00 |
| Recreation & Culture | 0.20 | -0.02 |
| Education | 0.21 | 0.00 |
| Restaurants & Hotels | 0.31 | -0.02 |
| Miscellaneous Goods & Services | -0.04 | 0.02 |
| Rounding Effects | -0.05 | 0.01 |
Note: there are rounding effects in contributions
Source: UK Office for National Statistics
http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/august-2014/index.html
V World Economic Slowdown. Table V-1 is constructed with the database of the IMF (http://www.imf.org/external/ns/cs.aspx?id=28) to show GDP in dollars in 2012 and the growth rate of real GDP of the world and selected regional countries from 2013 to 2016. The data illustrate the concept often repeated of “two-speed recovery” of the world economy from the recession of 2007 to 2009. The IMF has changed its forecast of the world economy to 3.0 percent in 2013 but accelerating to 3.6 percent in 2014, 3.9 percent in 2015 and 3.9 percent in 2016. Slow-speed recovery occurs in the “major advanced economies” of the G7 that account for $34,543 billion of world output of $72,106 billion, or 47.9 percent, but are projected to grow at much lower rates than world output, 2.0 percent on average from 2013 to 2016 in contrast with 3.6 percent for the world as a whole. While the world would grow 15.2 percent in the four years from 2013 to 2016, the G7 as a whole would grow 8.5 percent. The difference in dollars of 2012 is rather high: growing by 15.2 percent would add around $11.0 trillion of output to the world economy, or roughly, two times the output of the economy of Japan of $5,938 billion but growing by 8.5 percent would add $6.1 trillion of output to the world, or about the output of Japan in 2012. The “two speed” concept is in reference to the growth of the 150 countries labeled as emerging and developing economies (EMDE) with joint output in 2012 of $27,080 billion, or 37.6 percent of world output. The EMDEs would grow cumulatively 21.9 percent or at the average yearly rate of 5.1 percent, contributing $5.9 trillion from 2013 to 2016 or the equivalent of somewhat less than the GDP of $8,229 billion of China in 2012. The final four countries in Table V-1 often referred as BRIC (Brazil, Russia, India, China), are large, rapidly growing emerging economies. Their combined output in 2012 adds to $14,340 billion, or 19.9 percent of world output, which is equivalent to 41.5 percent of the combined output of the major advanced economies of the G7.
Table V-1, IMF World Economic Outlook Database Projections of Real GDP Growth
| GDP USD 2012 | Real GDP ∆% | Real GDP ∆% | Real GDP ∆% | Real GDP ∆% | |
| World | 72,106 | 3.0 | 3.6 | 3.9 | 3.9 |
| G7 | 34,543 | 1.4 | 2.2 | 2.3 | 2.3 |
| Canada | 1,821 | 2.0 | 2.3 | 2.4 | 2.4 |
| France | 2,613 | 0.3 | 1.0 | 1.5 | 1.7 |
| DE | 3,428 | 0.5 | 1.7 | 1.6 | 1.4 |
| Italy | 2,014 | -1.8 | 0.6 | 1.1 | 1.3 |
| Japan | 5,938 | 1.5 | 1.4 | 1.0 | 0.7 |
| UK | 2,484 | 1.8 | 2.9 | 2.5 | 2.4 |
| US | 16,245 | 1.9 | 2.8 | 3.0 | 3.0 |
| Euro Area | 12,192 | -0.5 | 1.2 | 1.5 | 1.5 |
| DE | 3,428 | 0.5 | 1.7 | 1.6 | 1.4 |
| France | 2,613 | 0.3 | 1.0 | 1.5 | 1.7 |
| Italy | 2,014 | -1.8 | 0.6 | 1.1 | 1.3 |
| POT | 212 | -1.4 | 1.2 | 1.5 | 1.7 |
| Ireland | 211 | -0.3 | 1.7 | 2.5 | 2.5 |
| Greece | 249 | -3.9 | 0.6 | 2.9 | 3.7 |
| Spain | 1,323 | -1.2 | 0.9 | 1.0 | 1.1 |
| EMDE | 27,080 | 4.7 | 4.9 | 5.3 | 5.4 |
| Brazil | 2,248 | 2.3 | 1.8 | 2.7 | 3.0 |
| Russia | 2,004 | 1.3 | 1.3 | 2.3 | 2.5 |
| India | 1,859 | 4.4 | 5.4 | 6.4 | 6.5 |
| China | 8,229 | 7.7 | 7.5 | 7.3 | 7.0 |
Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries); POT: Portugal
Source: IMF World Economic Outlook databank http://www.imf.org/external/ns/cs.aspx?id=28
Continuing high rates of unemployment in advanced economies constitute another characteristic of the database of the WEO (http://www.imf.org/external/ns/cs.aspx?id=28). Table V-2 is constructed with the WEO database to provide rates of unemployment from 2012 to 2016 for major countries and regions. In fact, unemployment rates for 2013 in Table V-2 are high for all countries: unusually high for countries with high rates most of the time and unusually high for countries with low rates most of the time. The rates of unemployment are particularly high in 2013 for the countries with sovereign debt difficulties in Europe: 16.3 percent for Portugal (POT), 13.1 percent for Ireland, 27.3 percent for Greece, 26.4 percent for Spain and 12.2 percent for Italy, which is lower but still high. The G7 rate of unemployment is 7.1 percent. Unemployment rates are not likely to decrease substantially if slow growth persists in advanced economies.
Table V-2, IMF World Economic Outlook Database Projections of Unemployment Rate as Percent of Labor Force
| % Labor Force 2012 | % Labor Force 2013 | % Labor Force 2014 | % Labor Force 2015 | % Labor Force 2016 | |
| World | NA | NA | NA | NA | NA |
| G7 | 7.4 | 7.1 | 6.7 | 6.5 | 6.3 |
| Canada | 7.3 | 7.0 | 7.0 | 6.9 | 6.8 |
| France | 10.2 | 10.8 | 11.0 | 10.7 | 10.3 |
| DE | 5.5 | 5.3 | 5.2 | 5.2 | 5.2 |
| Italy | 10.7 | 12.2 | 12.4 | 11.9 | 11.1 |
| Japan | 4.3 | 4.0 | 3.9 | 3.9 | 3.9 |
| UK | 8.0 | 7.6 | 6.9 | 6.6 | 6.3 |
| US | 8.1 | 7.4 | 6.4 | 6.2 | 6.1 |
| Euro Area | 11.4 | 12.1 | 11.9 | 11.6 | 11.1 |
| DE | 5.5 | 5.3 | 5.2 | 5.2 | 5.2 |
| France | 10.2 | 10.8 | 11.0 | 10.7 | 10.3 |
| Italy | 10.7 | 12.2 | 12.4 | 11.9 | 11.1 |
| POT | 15.7 | 16.3 | 15.7 | 15.1 | 14.5 |
| Ireland | 14.7 | 13.1 | 11.2 | 10.5 | 10.1 |
| Greece | 24.2 | 27.3 | 26.3 | 24.4 | 21.4 |
| Spain | 25.0 | 26.4 | 25.5 | 24.9 | 24.2 |
| EMDE | NA | NA | NA | NA | NA |
| Brazil | 5.5 | 5.4 | 5.6 | 5.8 | 6.0 |
| Russia | 5.5 | 5.5 | 6.2 | 6.2 | 6.0 |
| India | NA | NA | NA | NA | NA |
| China | 4.1 | 4.1 | 4.1 | 4.1 | 4.1 |
Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)
Source: IMF World Economic Outlook databank http://www.imf.org/external/ns/cs.aspx?id=28
Table V-3 provides the latest available estimates of GDP for the regions and countries followed in this blog from IQ2012 to IVQ2013 available now for all countries. There are preliminary estimates for all countries for IIQ2014. Growth is weak throughout most of the world.
- Japan. The GDP of Japan increased 1.0 percent in IQ2012, 4.1 percent at SAAR (seasonally adjusted annual rate) and 3.3 percent relative to a year earlier but part of the jump could be the low level a year earlier because of the Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Japan is experiencing difficulties with the overvalued yen because of worldwide capital flight originating in zero interest rates with risk aversion in an environment of softer growth of world trade. Japan’s GDP fell 0.5 percent in IIQ2012 at the seasonally adjusted annual rate (SAAR) of minus 2.2 percent, which is much lower than 4.1 percent in IQ2012. Growth of 3.2 percent in IIQ2012 in Japan relative to IIQ2011 has effects of the low level of output because of Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011. Japan’s GDP contracted 0.7 percent in IIIQ2012 at the SAAR of minus 2.7 percent and decreased 0.2 percent relative to a year earlier. Japan’s GDP decreased 0.1 percent in IVQ2012 at the SAAR of minus 0.5 percent and decreased 0.3 percent relative to a year earlier. Japan grew 1.2 percent in IQ2013 at the SAAR of 5.1 percent and increased 0.1 percent relative to a year earlier. Japan’s GDP increased 0.8 percent in IIQ2013 at the SAAR of 3.4 percent and increased 1.2 percent relative to a year earlier. Japan’s GDP grew 0.4 percent in IIIQ2013 at the SAAR of 1.8 percent and increased 2.3 percent relative to a year earlier. In IVQ2013, Japan’s GDP decreased 0.1 percent at the SAAR of minus 0.5 percent, increasing 2.5 percent relative to a year earlier. Japan’s GDP increased 1.5 percent in IQ2014 at the SAAR of 6.0 percent and increased 3.0 percent relative to a year earlier. In IIQ2014, Japan’s GDP fell 1.8 percent at the SAAR of minus 7.1 percent and fell 0.1 percent relative to a year earlier.
- China. China’s GDP grew 1.4 percent in IQ2012, annualizing to 5.7 percent, and 8.1 percent relative to a year earlier. The GDP of China grew at 2.1 percent in IIQ2012, which annualizes to 8.7 percent and 7.6 percent relative to a year earlier. China grew at 2.0 percent in IIIQ2012, which annualizes at 8.2 percent and 7.4 percent relative to a year earlier. In IVQ2012, China grew at 1.9 percent, which annualizes at 7.8 percent, and 7.9 percent in IVQ2012 relative to IVQ2011. In IQ2013, China grew at 1.6 percent, which annualizes at 6.6 percent and 7.7 percent relative to a year earlier. In IIQ2013, China grew at 1.8 percent, which annualizes at 7.4 percent and 7.5 percent relative to a year earlier. China grew at 2.3 percent in IIIQ2013, which annualizes at 9.5 percent and 7.8 percent relative to a year earlier. China grew at 1.7 percent in IVQ2013, which annualized to 7.0 percent and 7.7 percent relative to a year earlier. China’s GDP grew 1.5 percent in IQ2014, which annualizes to 6.1 percent, and 7.4 percent relative to a year earlier. China’s GDP grew 2.0 percent in IIQ2014, which annualizes at 8.2 percent, and 7.5 percent relative to a year earlier. There is decennial change in leadership in China (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). Growth rates of GDP of China in a quarter relative to the same quarter a year earlier have been declining from 2011 to 2014.
- Euro Area. GDP fell 0.1 percent in the euro area in IQ2012 and decreased 0.2 in IQ2012 relative to a year earlier. Euro area GDP contracted 0.3 percent IIQ2012 and fell 0.5 percent relative to a year earlier. In IIIQ2012, euro area GDP fell 0.2 percent and declined 0.7 percent relative to a year earlier. In IVQ2012, euro area GDP fell 0.5 percent relative to the prior quarter and fell 1.0 percent relative to a year earlier. In IQ2013, the GDP of the euro area fell 0.2 percent and decreased 1.1 percent relative to a year earlier. The GDP of the euro area increased 0.3 percent in IIQ2013 and fell 0.6 percent relative to a year earlier. In IIIQ2013, euro area GDP increased 0.1 percent and fell 0.3 percent relative to a year earlier. The GDP of the euro area increased 0.3 percent in IVQ2013 and increased 0.5 percent relative to a year earlier. In IQ2014, the GDP of the euro area increased 0.2 percent and 0.9 percent relative to a year earlier. The GDP of the euro area changed 0.0 percent in IIQ2014 and increased 0.7 percent relative to a year earlier.
- Germany. The GDP of Germany increased 0.3 percent in IQ2012 and 1.5 percent relative to a year earlier. In IIQ2012, Germany’s GDP increased 0.1 percent and increased 0.3 percent relative to a year earlier but 0.8 percent relative to a year earlier when adjusted for calendar (CA) effects. In IIIQ2012, Germany’s GDP increased 0.1 percent and 0.1 percent relative to a year earlier. Germany’s GDP contracted 0.4 percent in IVQ2012 and decreased 0.3 percent relative to a year earlier. In IQ2013, Germany’s GDP decreased 0.4 percent and fell 1.8 percent relative to a year earlier. In IIQ2013, Germany’s GDP increased 0.8 percent and 0.5 percent relative to a year earlier. The GDP of Germany increased 0.3 percent in IIIQ2013 and 0.8 percent relative to a year earlier. In IVQ2013, Germany’s GDP increased 0.4 percent and 1.0 percent relative to a year earlier. The GDP of Germany increased 0.7 percent in IQ2014 and 2.5 percent relative to a year earlier. In IIQ2014, Germany’s GDP contracted 0.2 percent and increased 0.8 percent relative to a year earlier.
- United States. Growth of US GDP in IQ2012 was 0.6 percent, at SAAR of 2.3 percent and higher by 2.6 percent relative to IQ2011. US GDP increased 0.4 percent in IIQ2012, 1.6 percent at SAAR and 2.3 percent relative to a year earlier. In IIIQ2012, US GDP grew 0.6 percent, 2.5 percent at SAAR and 2.7 percent relative to IIIQ2011. In IVQ2012, US GDP grew 0.0 percent, 0.1 percent at SAAR and 1.6 percent relative to IVQ2011. In IQ2013, US GDP grew at 2.7 percent SAAR, 0.7 percent relative to the prior quarter and 1.7 percent relative to the same quarter in 2013. In IIQ2013, US GDP grew at 1.8 percent in SAAR, 0.4 percent relative to the prior quarter and 1.8 percent relative to IIQ2012. US GDP grew at 4.5 percent in SAAR in IIIQ2013, 1.1 percent relative to the prior quarter and 2.3 percent relative to the same quarter a year earlier (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitical-and-financial-risks.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/fluctuating-financial-valuations.html) with weak hiring (http://cmpassocregulationblog.blogspot.com/2014/09/geopolitics-monetary-policy-and.html). In IVQ2013, US GDP grew 0.9 percent at 3.5 percent SAAR and 3.1 percent relative to a year earlier. In IQ2014, US GDP decreased 0.5 percent, increased 1.9 percent relative to a year earlier and fell 2.1 percent at SAAR. In IIQ2014, US GDP increased 1.0 percent at 4.2 percent SAAR and increased 2.5 percent relative to a year earlier.
- United Kingdom. In IQ2012, UK GDP changed 0.0 percent, increasing 0.6 percent relative to a year earlier. UK GDP fell 0.4 percent in IIQ2012 and increased 0.1 percent relative to a year earlier. UK GDP increased 0.8 percent in IIIQ2012 and increased 0.3 percent relative to a year earlier. UK GDP fell 0.2 percent in IVQ2012 relative to IIIQ2012 and increased 0.2 percent relative to a year earlier. UK GDP increased 0.5 percent in IQ2013 and 0.7 percent relative to a year earlier. UK GDP increased 0.7 percent in IIQ2013 and 1.8 percent relative to a year earlier. In IIIQ2013, UK GDP increased 0.8 percent and 1.8 percent relative to a year earlier. UK GDP increased 0.7 percent in IVQ2013 and 2.7 percent relative to a year earlier. In IQ2014, UK GDP increased 0.8 percent and 3.0 percent relative to a year earlier. UK GDP increased 0.8 percent in IIQ2014 and 3.1 percent relative to a year earlier.
- Italy. Italy has experienced decline of GDP in nine consecutive quarters from IIIQ2011 to IIIQ2013 and in IQ2014 and IIQ2014. Italy’s GDP fell 1.1 percent in IQ2012 and declined 1.7 percent relative to IQ2011. Italy’s GDP fell 0.5 percent in IIQ2012 and declined 2.4 percent relative to a year earlier. In IIIQ2012, Italy’s GDP fell 0.4 percent and declined 2.6 percent relative to a year earlier. The GDP of Italy contracted 0.9 percent in IVQ2012 and fell 2.9 percent relative to a year earlier. In IQ2013, Italy’s GDP contracted 0.6 percent and fell 2.4 percent relative to a year earlier. Italy’s GDP fell 0.3 percent in IIQ2013 and 2.2 percent relative to a year earlier. The GDP of Italy decreased 0.1 percent in IIIQ2013 and declined 1.9 percent relative to a year earlier. Italy’s GDP increased 0.1 percent in IVQ2013 and decreased 0.9 percent relative to a year earlier. In IQ2014, Italy’s GDP decreased 0.1 percent and fell 0.4 percent relative to a year earlier. The GDP of Italy fell 0.2 percent in IIQ2014 and declined 0.2 percent relative to a year earlier.
- France. France’s GDP increased 0.2 percent in IQ2012 and increased 0.6 percent relative to a year earlier. France’s GDP decreased 0.3 percent in IIQ2012 and increased 0.4 percent relative to a year earlier. In IIIQ2012, France’s GDP increased 0.3 percent and increased 0.5 percent relative to a year earlier. France’s GDP fell 0.3 percent in IVQ2012 and changed 0.0 percent relative to a year earlier. In IQ2013, France GDP changed 0.0 percent and declined 0.2 percent relative to a year earlier. The GDP of France increased 0.7 percent in IIQ2013 and 0.7 percent relative to a year earlier. France’s GDP decreased 0.1 percent in IIIQ2013 and increased 0.3 percent relative to a year earlier. The GDP of France increased 0.2 percent in IVQ2013 and 0.8 percent relative to a year earlier. In IQ2014, France’s GDP changed 0.0 percent and increased 0.8 percent relative to a year earlier. In IIQ2014, France’s GDP changed 0.0 percent and increased 0.1 percent relative to a year earlier.
Table V-3, Percentage Changes of GDP Quarter on Prior Quarter and on Same Quarter Year Earlier, ∆%
| IQ2012/IVQ2011 | IQ2012/IQ2011 | |
| United States | QOQ: 0.6 SAAR: 2.3 | 2.6 |
| Japan | QOQ: 1.0 SAAR: 4.1 | 3.3 |
| China | 1.4 | 8.1 |
| Euro Area | -0.1 | -0.2 |
| Germany | 0.3 | 1.5 |
| France | 0.2 | 0.6 |
| Italy | -1.1 | -1.7 |
| United Kingdom | 0.0 | 0.6 |
| IIQ2012/IQ2012 | IIQ2012/IIQ2011 | |
| United States | QOQ: 0.4 SAAR: 1.6 | 2.3 |
| Japan | QOQ: -0.5 | 3.2 |
| China | 2.1 | 7.6 |
| Euro Area | -0.3 | -0.5 |
| Germany | 0.1 | 0.3 0.8 CA |
| France | -0.3 | 0.4 |
| Italy | -0.5 | -2.4 |
| United Kingdom | -0.4 | 0.1 |
| IIIQ2012/ IIQ2012 | IIIQ2012/ IIIQ2011 | |
| United States | QOQ: 0.6 | 2.7 |
| Japan | QOQ: –0.7 | -0.2 |
| China | 2.0 | 7.4 |
| Euro Area | -0.2 | -0.7 |
| Germany | 0.1 | 0.1 |
| France | 0.3 | 0.5 |
| Italy | -0.4 | -2.6 |
| United Kingdom | 0.8 | 0.3 |
| IVQ2012/IIIQ2012 | IVQ2012/IVQ2011 | |
| United States | QOQ: 0.0 | 1.6 |
| Japan | QOQ: -0.1 SAAR: -0.5 | -0.3 |
| China | 1.9 | 7.9 |
| Euro Area | -0.5 | -1.0 |
| Germany | -0.4 | -0.3 |
| France | -0.3 | 0.0 |
| Italy | -0.9 | -2.9 |
| United Kingdom | -0.2 | 0.2 |
| IQ2013/IVQ2012 | IQ2013/IQ2012 | |
| United States | QOQ: 0.7 | 1.7 |
| Japan | QOQ: 1.2 SAAR: 5.1 | 0.1 |
| China | 1.6 | 7.7 |
| Euro Area | -0.2 | -1.1 |
| Germany | -0.4 | -1.8 |
| France | 0.0 | -0.2 |
| Italy | -0.6 | -2.4 |
| UK | 0.5 | 0.7 |
| IIQ2013/IQ2013 | IIQ2013/IIQ2012 | |
| United States | QOQ: 0.4 SAAR: 1.8 | 1.8 |
| Japan | QOQ: 0.8 SAAR: 3.4 | 1.2 |
| China | 1.8 | 7.5 |
| Euro Area | 0.3 | -0.6 |
| Germany | 0.8 | 0.5 |
| France | 0.7 | 0.7 |
| Italy | -0.3 | -2.2 |
| UK | 0.7 | 1.8 |
| IIIQ2013/IIQ2013 | III/Q2013/ IIIQ2012 | |
| USA | QOQ: 1.1 | 2.3 |
| Japan | QOQ: 0.4 SAAR: 1.8 | 2.3 |
| China | 2.3 | 7.8 |
| Euro Area | 0.1 | -0.3 |
| Germany | 0.3 | 0.8 |
| France | -0.1 | 0.3 |
| Italy | -0.1 | -1.9 |
| UK | 0.8 | 1.8 |
| IVQ2013/IIIQ2013 | IVQ2013/IVQ2012 | |
| USA | QOQ: 0.9 SAAR: 3.5 | 3.1 |
| Japan | QOQ: -0.1 SAAR: -0.5 | 2.5 |
| China | 1.7 | 7.7 |
| Euro Area | 0.3 | 0.5 |
| Germany | 0.4 | 1.0 |
| France | 0.2 | 0.8 |
| Italy | 0.1 | -0.9 |
| UK | 0.7 | 2.7 |
| IQ2014/IVQ2013 | IQ2014/IQ2013 | |
| USA | QOQ -0.5 SAAR -2.1 | 1.9 |
| Japan | QOQ: 1.5 SAAR: 6.0 | 3.0 |
| China | 1.5 | 7.4 |
| Euro Area | 0.2 | 1.0 |
| Germany | 0.7 | 2.5 |
| France | 0.0 | 0.8 |
| Italy | -0.1 | -0.4 |
| UK | 0.8 | 3.0 |
| IIQ2014/IQ2014 | IIQ2014/IIQ2013 | |
| USA | QOQ 1.0 SAAR 4.2 | 2.5 |
| Japan | QOQ: -1.8 SAAR: -7.1 | -0.1 |
| China | 2.0 | 7.5 |
| Euro Area | 0.0 | 0.7 |
| Germany | -0.2 | 0.8 |
| France | 0.0 | 0.1 |
| Italy | -0.2 | -0.2 |
| UK | 0.8 | 3.2 |
QOQ: Quarter relative to prior quarter; SAAR: seasonally adjusted annual rate
Source: Country Statistical Agencies http://www.census.gov/aboutus/stat_int.html
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014.
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