CMP Associates Regulation Blog: Global Competitive Devaluation, Rules, Discretionary Authorities and Slow Productivity Growth, Twenty Seven Million Unemployed or Underemployed, Stagnating Real Wages, Stagnating Real Disposable Income, Financial Repression, World Cyclical Slow Growth and Global Recession Risk: Part III

Global Competitive Devaluation, Rules, Discretionary Authorities and Slow Productivity Growth, Twenty Seven Million Unemployed or Underemployed, Stagnating Real Wages, Stagnating Real Disposable Income, Financial Repression, World Cyclical Slow Growth and Global Recession Risk

Carlos M. Pelaez

I Twenty Seven Million Unemployed or Underemployed

IA1 Summary of the Employment Situation

IA2 Number of People in Job Stress

IA3 Long-term and Cyclical Comparison of Employment

IA4 Job Creation

IB Stagnating Real Wages

II Stagnating Real Disposable Income and Consumption Expenditures

IB1 Stagnating Real Disposable Income and Consumption Expenditures

IB2 Financial Repression

IIA Rules, Discretionary Authorities and Slow Productivity Growth

III World Financial Turbulence

IIIA Financial Risks

IIIE Appendix Euro Zone Survival Risk

IIIF Appendix on Sovereign Bond Valuation

IV Global Inflation

V World Economic Slowdown

VA United States

VB Japan

VC China

VD Euro Area

VE Germany

VF France

VG Italy

VH United Kingdom

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

Appendixes

Appendix I The Great Inflation

IIIB Appendix on Safe Haven Currencies

IIIC Appendix on Fiscal Compact

IIID Appendix on European Central Bank Large Scale Lender of Last Resort

IIIG Appendix on Deficit Financing of Growth and the Debt Crisis

IIIGA Monetary Policy with Deficit Financing of Economic Growth

IIIGB Adjustment during the Debt Crisis of the 1980s

II IB Stagnating Real Disposable Income and Consumption Expenditures. The Bureau of Economic Analysis (BEA) provides important revisions and enhancements of data on personal income and outlays since 1929 (http://www.bea.gov/iTable/index_nipa.cfm). There are waves of changes in personal income and expenditures in Table IB-1 that correspond somewhat to inflation waves observed worldwide (http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html) because of the influence through price indexes. Data are distorted in Nov and Dec 2012 by the rush to realize income of all forms in anticipation of tax increases beginning in Jan 2013. There is major distortion in Jan 2013 because of higher contributions in payrolls to government social insurance that caused sharp reduction in personal income and disposable personal income. The Bureau of Economic Analysis (BEA) explains as follows (page 3 http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):

“The February and January [2013] changes in disposable personal income (DPI) mainly reflected the effect of special factors in January, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to November and to December [2012] in anticipation of changes in individual tax rates.”

In the first wave in Jan-Apr 2011 with relaxed risk aversion, nominal personal income (NPI) increased at the annual equivalent rate of 8.1 percent, nominal disposable personal income (NDPI) at 5.2 percent and nominal personal consumption expenditures (NPCE) at 5.9 percent. Real disposable income (RDPI) increased at the annual equivalent rate of 1.2 percent and real personal consumption expenditures (RPCE) rose at annual equivalent 1.5 percent. In the second wave in May-Aug 2011 under risk aversion, NPI rose at annual equivalent 4.9 percent, NPDI at 4.9 percent and NPCE at 3.7 percent. RDPI increased at 1.8 percent annual equivalent and RPCE at 0.9 percent annual equivalent. With mixed shocks of risk aversion in the third wave from Sep to Dec 2011, NPI rose at 2.4 percent annual equivalent, NDPI at 2.4 percent and NPCE at 2.1 percent. RDPI increased at 1.5 percent annual equivalent and RPCE at 1.5 percent annual equivalent. In the fourth wave from Jan to Mar 2012, NPI increased at 9.6 percent annual equivalent, NDPI at 8.7 percent and NPCE at 6.2 percent. Real disposable income (RDPI) is more dynamic in the revisions, growing at 5.7 percent annual equivalent and RPCE at 3.7 percent. The policy of repressing savings with zero interest rates stimulated growth of nominal consumption (NPCE) at the annual equivalent rate of 6.2 percent and real consumption (RPCE) at 3.7 percent. In the fifth wave in Apr-Jul 2012, NPI increased at annual equivalent 0.9 percent, NDPI at 0.9 percent and RDPI at 0.0 percent. Financial repression failed to stimulate consumption with NPCE growing at 2.1 percent annual equivalent and RPCE at 1.8 percent. In the sixth wave in Aug-Oct 2012, in another wave of carry trades into commodity futures, NPI increased at 7.9 percent annual equivalent and NDPI increased at 7.0 percent while real disposable income (RDPI) increased at 3.7 percent annual equivalent. NPCE increased at 4.9 percent and RPCE at 1.2 percent. Data for Nov-Dec 2012 have illusory increases: “Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf). In the seventh wave, anticipations of tax increases in Jan 2013 caused exceptional income gains that increased personal income to annual equivalent 28.3 percent in Nov-Dec 2012, nominal disposable income at 27.5 percent and real disposable personal income at 28.3 percent with likely effects on nominal personal consumption that increased at 2.4 percent and real personal consumption at 3.0 percent with subdued prices. The numbers in parentheses show that without the exceptional effects NDPI (nominal disposable personal income) increased at 5.5 percent and RDPI (real disposable personal income) at 8.7 percent. In the eighth wave, nominal personal income fell 5.1 percent in Jan 2013 or at the annual equivalent rate of decline of 46.6 percent; nominal disposable personal income fell 5.8 percent or at the annual equivalent rate of decline of 51.2 percent; real disposable income fell 5.9 percent or at the annual rate of decline of 51.8 percent; nominal personal consumption expenditures increased 0.5 percent or at the annual equivalent rate of 6.2 percent; and real personal consumption expenditures increased 0.4 percent or at the annual equivalent rate of 4.9 percent. The savings rate fell significantly from 10.5 percent in Dec 2012 to 4.5 percent in Jan 2013. The Bureau of Economic Analysis explains as follows (http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0113.pdf 3):

“Contributions for government social insurance -- a subtraction in calculating personal income -- increased $126.7 billion in January, compared with an increase of $6.3 billion in December. The

Further explanation is provided by the Bureau of Economic Analysis (http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf 2-3):

“Contributions for government social insurance -- a subtraction in calculating personal income --increased $6.4 billion in February, compared with an increase of $126.8 billion in January. The

January estimate reflected increases in both employer and employee contributions for government social insurance. The January estimate of employee contributions for government social insurance reflected the expiration of the “payroll tax holiday,” that increased the social security contribution rate for employees and self-employed workers by 2.0 percentage points, or $114.1 billion at an annual rate. For additional information, see FAQ on “How did the expiration of the payroll tax holiday affect personal income for January 2013?” at www.bea.gov. The January estimate of employee contributions for government social insurance also reflected an increase in the monthly premiums paid by participants in the supplementary medical insurance program, in the hospital insurance provisions of the Patient Protection and Affordable Care Act, and in the social security taxable wage base; together, these changes added $12.9 billion to January. Employer contributions were boosted $5.9 billion in January, which reflected increases in the social security taxable wage base (from $110,100 to $113,700), in the tax rates paid by employers to state unemployment insurance, and in employer contributions for the federal unemployment tax and for pension guaranty. The total contribution of special factors to the January change in contributions for government social insurance was $132.9 billion. The January change in disposable personal income (DPI) mainly reflected the effect of special factors, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to December in anticipation of changes in individual tax rates. Excluding these special factors and others, which are discussed more fully below, DPI increased $46.8 billion in February, or 0.4 percent, after increasing $15.8 billion, or 0.1 percent, in January.”

The increase was provided in the “fiscal cliff” law H.R. 8 American Taxpayer Relief Act of 2012 (http://www.gpo.gov/fdsys/pkg/BILLS-112hr8eas/pdf/BILLS-112hr8eas.pdf). In the ninth wave in Feb-Mar 2013, nominal personal income increased at 7.4 percent and nominal disposable income at 6.8 percent annual equivalent, while real disposable income increased at 5.5 percent annual equivalent. Nominal personal consumption expenditures grew at 4.3 percent annual equivalent and real personal consumption expenditures at 2.4 percent annual equivalent. The savings rate collapsed from 7.1 percent in Oct 2012, 8.2 percent in Nov 2012 and 10.5 percent in Dec 2012 to 4.5 percent in Jan 2013, 4.7 percent in Feb 2013 and 4.9 percent in Mar 2013. In the tenth wave from Apr to Sep 2013, personal income grew at 3.7 percent annual equivalent, nominal disposable income increased at annual equivalent 3.9 percent and nominal personal consumption expenditures at 3.2 percent. Real disposable income grew at 2.8 percent annual equivalent and real personal consumption expenditures at 2.2 percent. In the eleventh wave, nominal personal income fell at 1.2 percent annual equivalent in Oct 2013, nominal disposable income at 2.4 percent and real disposable income at 3.5 percent. Nominal personal consumption expenditures increased at 4.9 percent annual equivalent and real personal consumption expenditures at 3.7 percent. In the twelfth wave, nominal personal income increased at 3.7 percent annual equivalent in Nov 2013, nominal disposable income at 2.4 percent and nominal personal consumption expenditures at 7.4 percent. Real disposable income increased at annual equivalent 1.2 percent and real personal consumption expenditures at 6.2 percent. In the thirteenth wave, nominal personal income changed at 0.0 percent annual equivalent in Dec 2013 and nominal disposable income fell at 1.2 percent while real disposable income fell at 2.4 percent annual equivalent. Nominal personal consumption expenditures increased at 1.2 percent annual equivalent and 0.0 percent for real personal consumption expenditures. In the fourteenth wave, nominal personal income increased at 7.0 percent annual equivalent in Jan-Mar 2014, nominal disposable income at 7.4 percent and nominal consumption expenditures at 4.1 percent. Real disposable personal income increased at 6.2 percent and real personal consumption expenditures at 2.8 percent. In the fifteenth wave, nominal personal income increased at 3.9 percent in annual equivalent in Apr-Aug 2014 and nominal disposable income at 3.9 percent. Real disposable income increased at 2.2 percent in annual equivalent in Apr-Aug 2014. Nominal personal consumption increased at 4.4 percent annual equivalent in Apr-Aug 2014 and real personal consumption expenditures increased at 2.7 percent. In the sixteenth wave, nominal personal income increased at 3.9 percent annual equivalent in Sep 2014-Jan 2015, nominal disposable income at 3.4 percent and nominal personal consumption at 1.2 percent. Real disposable income increased at 5.7 percent in Sep 2014-Jan 2015 and real personal consumption expenditure at 3.2 percent.

The United States economy has grown at the average yearly rate of 3 percent per year and 2 percent per year in per capita terms from 1870 to 2010, as measured by Lucas (2011May). An important characteristic of the economic cycle in the US has been rapid growth in the initial phase of expansion after recessions.

Inferior performance of the US economy and labor markets is the critical current issue of analysis and policy design. 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 2.3 percent on average in the cyclical expansion in the 22 quarters from IIIQ2009 to IVQ2014. 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 IVQ2014 (http://www.bea.gov/newsreleases/national/gdp/2015/pdf/gdp4q14_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/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2015/02/financial-and-international.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, 4.9 percent from IQ1983 to IIQ1988 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier (http://cmpassocregulationblog.blogspot.com/2015/02/financial-and-international.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 IVQ2014 would have accumulated to 23.0 percent. GDP in IVQ2014 would be $18,438.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,144.3 billion than actual $16,293.7 billion. There are about two trillion dollars of GDP less than at trend, explaining the 27.2 million unemployed or underemployed equivalent to actual unemployment of 16.5 percent of the effective labor force (Section I and earlier http://cmpassocregulationblog.blogspot.com/2015/02/job-creation-and-monetary-policy-twenty.html and earlier http://cmpassocregulationblog.blogspot.com/2015/01/fluctuating-valuations-of-risk.html). US GDP in IVQ2014 is 11.6 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,293.7 billion in IVQ2014 or 8.7 percent at the average annual equivalent rate of 1.2 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. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jan 2015. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 124.8993 in Jan 2015. The actual index NSA in Jan 2015 is 99.8883, which is 20.0 percent below trend. Manufacturing output grew at average 2.4 percent between Dec 1986 and Dec 2014, raising the index at trend to 117.3927 in Jan 2015. The output of manufacturing at 99.8883 in Jan 2015 is 14.9 percent below trend under this alternative calculation.

Table IB-1, US, Percentage Change from Prior Month Seasonally Adjusted of Personal Income, Disposable Income and Personal Consumption Expenditures %

	NPI	NDPI	RDPI	NPCE	RPCE
2015
Jan	0.3	0.4	0.9	-0.2	0.3
2014
Dec	0.3	0.3	0.5	-0.3	-0.1
Nov	0.4	0.3	0.5	0.4	0.6
Oct	0.4	0.3	0.3	0.4	0.3
Sep	0.2	0.1	0.1	0.2	0.2
AE ∆% Sep-Jan	3.9	3.4	5.7	1.2	3.2
Aug	0.4	0.3	0.3	0.6	0.7
Jul	0.3	0.2	0.1	0.2	0.1
Jun	0.4	0.4	0.2	0.5	0.3
May	0.3	0.4	0.2	0.3	0.1
Apr	0.2	0.3	0.1	0.2	-0.1
AE ∆% Apr-Aug	3.9	3.9	2.2	4.4	2.7
Mar	0.6	0.6	0.5	0.8	0.6
Feb	0.6	0.6	0.5	0.4	0.4
Jan	0.5	0.6	0.5	-0.2	-0.3
AE ∆% Jan-Mar	7.0	7.4	6.2	4.1	2.8
2013
Dec	0.0	-0.1	-0.2	0.1	0.0
AE ∆% Dec	0.0	-1.2	-2.4	1.2	0.0
Nov	0.3	0.2	0.1	0.6	0.5
AE ∆% Nov	3.7	2.4	1.2	7.4	6.2
Oct	-0.1	-0.2	-0.3	0.4	0.3
AE ∆% Oct	-1.2	-2.4	-3.5	4.9	3.7
Sep	0.4	0.4	0.3	0.4	0.3
Aug	0.4	0.4	0.4	0.2	0.2
Jul	0.0	0.0	-0.1	0.2	0.1
Jun	0.4	0.5	0.2	0.5	0.2
May	0.4	0.5	0.4	0.3	0.2
Apr	0.2	0.1	0.2	0.0	0.1
AE ∆% Apr-Sep	3.7	3.9	2.8	3.2	2.2
Mar	0.3	0.3	0.4	0.1	0.1
Feb	0.9	0.8	0.5	0.6	0.3
AE ∆% Feb-Mar	7.4	6.8	5.5	4.3	2.4
Jan	-5.1	-5.8 (0.1)^a	-5.9	0.5	0.4
AE ∆% Jan	-46.6	-51.2 (3.7)^a	-51.8	6.2	4.9
2012
∆% Jan-Dec 2012***	9.0	8.6	7.0	3.9	2.3
Dec	2.8	2.8 (0.3)*	2.8 (0.5)*	0.2	0.2
Nov	1.4	1.3 (0.6)*	1.4 (0.9)*	0.2	0.3
AE ∆% Nov-Dec	28.3	27.5 (5.5)*	28.3 (8.7)*	2.4	3.0
Oct	0.8	0.8	0.6	0.2	-0.1
Sep	0.9	0.8	0.5	0.7	0.4
Aug	0.2	0.1	-0.2	0.3	0.0
AE ∆% Aug-Oct	7.9	7.0	3.7	4.9	1.2
Jul	-0.2	-0.2	-0.3	0.4	0.4
Jun	0.2	0.2	0.1	0.0	0.0
May	0.0	0.0	0.0	0.0	0.0
Apr	0.3	0.3	0.2	0.3	0.2
AE ∆% Apr-Jul	0.9	0.9	0.0	2.1	1.8
Mar	0.5	0.4	0.2	0.1	-0.1
Feb	0.8	0.7	0.5	0.7	0.5
Jan	1.0	1.0	0.7	0.7	0.5
AE ∆% Jan-Mar	9.6	8.7	5.7	6.2	3.7
2011
∆% Jan-Dec 2011*	5.1	4.1	1.2	4.3	1.8
Dec	0.8	0.8	0.8	0.0	0.0
Nov	0.0	0.0	-0.1	0.0	-0.1
Oct	0.1	0.1	0.1	0.3	0.3
Sep	-0.1	-0.1	-0.3	0.4	0.3
AE ∆% Sep-Dec	2.4	2.4	1.5	2.1	1.5
Aug	0.2	0.2	-0.1	0.2	-0.1
Jul	0.6	0.6	0.4	0.5	0.3
Jun	0.5	0.5	0.4	0.2	0.2
May	0.3	0.3	-0.1	0.3	-0.1
AE ∆% May-Aug	4.9	4.9	1.8	3.7	0.9
Apr	0.2	0.2	-0.3	0.4	0.0
Mar	0.3	0.2	-0.1	0.7	0.3
Feb	0.6	0.6	0.3	0.4	0.1
Jan	1.5	0.7	0.5	0.4	0.1
AE ∆% Jan-Apr	8.1	5.2	1.2	5.9	1.5
2010
∆% Jan-Dec 2010**	4.9	4.3	2.9	4.4	2.9
Dec	0.9	0.9	0.7	0.3	0.1
Nov	0.5	0.5	0.3	0.5	0.4
Oct	0.5	0.5	0.2	0.7	0.5
IVQ2010∆%	1.9	1.8	1.2	1.5	1.0
IVQ2010 AE ∆%	7.9	7.4	4.9	6.2	4.1

Notes: *Excluding exceptional income gains in Nov and Dec 2012 because of anticipated tax increases in Jan 2013 ((page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf). ^aExcluding employee contributions for government social insurance (pages 1-2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0113.pdf )Excluding NPI: current dollars personal income; NDPI: current dollars disposable personal income; RDPI: chained (2005) dollars DPI; NPCE: current dollars personal consumption expenditures; RPCE: chained (2005) dollars PCE; AE: annual equivalent; IVQ2010: fourth quarter 2010; A: annual equivalent

Percentage change month to month seasonally adjusted

*∆% Dec 2011/Dec 2010 **∆% Dec 2010/Dec 2009 *** ∆% Dec 2012/Dec 2011

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

The rates of growth of real disposable income decline in the final quarter of 2013 because of the increases in the last two months of 2012 in anticipation of the tax increases of the “fiscal cliff” episode. The increase was provided in the “fiscal cliff” law H.R. 8 American Taxpayer Relief Act of 2012 (http://www.gpo.gov/fdsys/pkg/BILLS-112hr8eas/pdf/BILLS-112hr8eas.pdf).

The 12-month rate of increase of real disposable income fell to 0.0 percent in Oct 2013 and minus 1.3 percent in Nov 2013 partly because of the much higher level in late 2012 in anticipation of incomes to avoid increases in taxes in 2013. Real disposable income fell 4.2 percent in the 12 months ending in Dec 2013 primarily because of the much higher level in late 2012 in anticipation of income to avoid increases in taxes in 2013. Real disposable income increased 2.3 percent in the 12 months ending in Jan 2014, partly because of the low level in Jan 2013 after anticipation of incomes in late 2012 in avoiding the fiscal cliff episode. Real disposable income increased 4.2 percent in the 12 months ending in Jan 2015.

RPCE growth decelerated less sharply from close to 3 percent in IVQ 2010 to 3.4 percent in Jan 2015. Subdued growth of RPCE could affect revenues of business. Growth rates of personal consumption have weakened. Goods and especially durable goods have been driving growth of PCE as shown by the much higher 12-month rates of growth of real goods PCE (RPCEG) and durable goods real PCE (RPCEGD) than services real PCE (RPCES). Growth of consumption of goods and, in particular, of consumer durable goods drives the faster expansion of the economy while growth of consumption of services is much more moderate. The 12-month rates of growth of RPCEGD have fallen from around 10 percent and even higher in several months from Sep 2010 to Feb 2011 to the range of 2.0 to 9.8 percent from Jan 2014 to Jan 2015. RPCEG growth rates have fallen from around 5 percent late in 2010 and early Jan-Feb 2011 to the range of 1.2 to 5.2 percent from Jan 2014 to Jan 2015. In Jan 2015, RPCEG increased 5.2 percent in 12 months and RPCEGD 9.8 percent while RPCES increased 2.5 percent. There are limits to sustained growth based on financial repression in an environment of weak labor markets and real labor remuneration.

Table IB-2, Real Disposable Personal Income and Real Personal Consumption Expenditures

Percentage Change from the Same Month a Year Earlier %

	RDPI	RPCE	RPCEG	RPCEGD	RPCES
2015
Jan	4.2	3.4	5.2	9.8	2.5
2014
Dec	3.8	2.8	4.0	8.8	2.2
Nov	3.0	2.8	4.2	7.9	2.1
Oct	2.6	2.8	3.8	7.4	2.2
Sep	2.1	2.7	3.7	8.5	2.2
Aug	2.3	2.9	4.4	8.4	2.1
Jul	2.3	2.4	3.3	7.0	1.9
Jun	2.1	2.4	3.5	7.0	1.8
May	2.1	2.3	3.2	7.2	1.9
Apr	2.3	2.4	3.8	6.5	1.7
Mar	2.4	2.5	3.8	8.2	1.9
Feb	2.3	2.0	2.1	3.5	2.0
Jan	2.3	1.9	1.2	2.0	2.3
2013
Dec	-4.2	2.7	3.1	3.5	2.4
Nov	-1.3	2.9	3.9	6.8	2.4
Oct	0.0	2.7	3.8	7.4	2.2
Sep	0.9	2.3	3.2	5.0	1.9
Aug	1.1	2.4	3.3	7.7	2.0
Jul	0.6	2.2	3.7	7.5	1.5
Jun	0.4	2.5	3.8	8.1	1.8
May	0.4	2.3	3.5	7.5	1.7
Apr	0.0	2.1	2.7	6.8	1.8
Mar	0.0	2.3	2.9	5.8	1.9
Feb	-0.2	2.0	3.3	7.0	1.4
Jan	-0.1	2.2	3.8	8.0	1.5
2012
Dec	7.0	2.3	3.8	8.8	1.6
Nov	4.8	2.0	3.1	8.2	1.5
Oct	3.2	1.6	2.2	5.4	1.3
Sep	2.7	1.9	3.5	8.5	1.1
Aug	1.9	1.8	3.5	8.7	0.9
Jul	2.0	1.8	2.8	7.3	1.3
Jun	2.7	1.7	2.6	8.4	1.2
May	3.0	1.9	3.0	7.6	1.3
Apr	2.9	1.8	2.4	6.5	1.5
Mar	2.4	1.5	2.2	5.8	1.2
Feb	2.1	1.9	2.4	6.9	1.7
Jan	1.8	1.5	1.8	5.8	1.4
Dec 2011	1.6	1.2	1.4	5.0	1.1
Dec 2010	2.9	2.9	4.7	8.4	2.1

Notes: RDPI: real disposable personal income; RPCE: real personal consumption expenditures (PCE); RPCEG: real PCE goods; RPCEGD: RPCEG durable goods; RPCES: RPCE services

Numbers are percentage changes from the same month a year earlier

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

Chart IB-1 shows US real personal consumption expenditures (RPCE) between 1999 and 2014. There is an evident drop in RPCE during the global recession in 2007 to 2009 but the slope is flatter during the current recovery than in the period before 2007.

Chart IB-1, US, Real Personal Consumption Expenditures, Quarterly Seasonally Adjusted at Annual Rates 1999-2014

Source: US Bureau of Economic Analysis

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

Percent changes from the prior period in seasonally adjusted annual equivalent quarterly rates (SAAR) of real personal consumption expenditures (RPCE) are provided in Chart IB-2 from 1995 to 2014. The average rate could be visualized as a horizontal line. Although there are not yet sufficient observations, it appears from Chart IB-2 that the average rate of growth of RPCE was higher before the recession than during the past twenty-two quarters of expansion that began in IIIQ2009.

Chart IB-2, Percent Change from Prior Period in Real Personal Consumption Expenditures, Quarterly Seasonally Adjusted at Annual Rates 1995-2014

Source: US Bureau of Economic Analysis

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

Personal income and its disposition are shown in Table IB-3. The latest estimates and revisions have changed movements in five forms. (1) Increase in Jan 2015 of personal income by $50.8 billion or 0.3 percent and increase of disposable income of $52.6 billion or 0.4 percent with increase of wages and salaries of 0.6 percent. (2) Decrease of personal income of $302.9 billion from Dec 2012 to Dec 2013 or by 2.1 percent and decrease of disposable income of $397.7 billion or by 3.1 percent. Wages and salaries increased $30.8 billion from Dec 2012 to Dec 2013 or by 0.4 percent. Large part of these declines occurred because of the comparison of high levels in late 2012 in anticipation of tax increases in 2013. In 2012, personal income increased $1203.0 billion or 9.0 percent while wages and salaries increased 7.5 percent and disposable income 8.6 percent. Significant part of these gains occurred in Dec 2012 in anticipation of incomes because of tax increases beginning in Jan 2013. (3) Increase of $651.3 billion of personal income in 2011 or by 5.1 percent with increase of salaries of 2.7 percent and disposable income of 4.1 percent. (4) Increase of the rate of savings as percent of disposable income from 5.9 percent in Dec 2010 to 6.4 percent in Dec 2011, decreasing to 4.1 percent in Dec 2013. The savings rate increased to 4.1 percent in Nov 2014, 5.0 percent in Dec 2014 and 5.5 percent in Jan 2015. (5) Increase of personal income of $741.8 billion or 5.2 percent from Dec 2013 to Dec 2014. Nominal disposable income increased $635.2 billion or 5.0 percent while wages and salaries increased $426.4 billion or 5.9 percent.

Table IB-3, US, Personal Income and its Disposition, Seasonally Adjusted at Annual Rates USD Billions

	Personal Income	Wages & Salaries	Personal Taxes	DPI	Savings Rate %
Jan 2015	15,061.8	7,640.5	1,801.8	13,260.0	5.5
Dec 2014	15,011.0	7,598.1	1,803.6	13,207.4	5.0
Change Jan 2015/ Dec 2014	50.8 ∆% 0.3	42.4 ∆% 0.6	-1.8 ∆% -0.1	52.6 ∆% 0.4
Dec 2014	15,061.8	7,640.5	1,801.8	13,260.0	5.0
Change Dec 2014/Dec 2013	741.8 ∆% 5.2	426.4 ∆% 5.9	106.5 ∆% 6.3	635.2 ∆% 5.0
Dec 2013	14,320.0	7,214.1	1,695.3	12,624.8	4.1
Dec 2012	14,622.9	7,183.3	1,600.4	13,022.5	10.5
Change Dec 2013/ Dec 2012	-302.9 ∆% -2.1	30.8 ∆% 0.4	94.9 ∆% 5.9	-397.7 ∆% -3.1
Change Dec 2012/ Dec 2011	1203.0 ∆% 9.0	500.4 ∆% 7.5	169.1 ∆% 11.8	1033.9 ∆% 8.6
Dec 2011	13,419.9	6,682.9	1,431.3	11,988.6	6.4
Dec 2010	12,768.6	6,506.0	1,254.2	11,514.5	5.9
Change Dec 2011/ Dec 2010	651.3 ∆% 5.1	176.9 ∆% 2.7	177.1 ∆% 14.1	474.1 ∆% 4.1

Source: US Bureau of Economic Analysis

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

The Bureau of Economic Analysis (BEA) provides a wealth of revisions and enhancements of US personal income and outlays since 1929 (http://www.bea.gov/iTable/index_nipa.cfm). Table IB-4 provides growth rates of real disposable income and real disposable income per capita in the long-term and selected periods. Real disposable income consists of after-tax income adjusted for inflation. Real disposable income per capita is income per person after taxes and inflation. There is remarkable long-term trend of real disposable income of 3.2 percent per year on average from 1929 to 2014 and 2.0 percent in real disposable income per capita. Real disposable income increased at the average yearly rate of 3.7 percent from 1947 to 1999 and real disposable income per capita at 2.3 percent. These rates of increase broadly accompany rates of growth of GDP. Institutional arrangements in the United States provided the environment for growth of output and income after taxes, inflation and population growth. There is significant break of growth by much lower 2.3 percent for real disposable income on average from 1999 to 2014 and 1.4 percent in real disposable per capita income. Real disposable income grew at 3.5 percent from 1980 to 1989 and real disposable per capita income at 2.6 percent. In contrast, real disposable income grew at only 1.5 percent on average from 2006 to 2014 and real disposable income per capita at 0.7 percent. The United States has interrupted its long-term and cyclical dynamism of output, income and employment growth. Recovery of this dynamism could prove to be a major challenge. Cyclical uncommonly slow growth explains weakness in the current whole cycle instead of the allegation of secular stagnation.

Table IB-4, Average Annual Growth Rates of Real Disposable Income (RDPI) and Real Disposable Income per Capita (RDPIPC), Percent per Year

RDPI Average ∆%
1929-2014	3.2
1947-1999	3.7
1999-2014	2.3
1999-2006	3.2
1980-1989	3.5
2006-2014	1.5
RDPIPC Average ∆%
1929-2014	2.0
1947-1999	2.3
1999-2014	1.4
1999-2006	2.2
1980-1989	2.6
2006-2014	0.7

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

Chart IB-3 provides personal income in the US between 1980 and 1989. These data are not adjusted for inflation that was still high in the 1980s in the exit from the Great Inflation of the 1960s and 1970s (see http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html). Personal income grew steadily during the 1980s after recovery from two recessions from Jan IQ1980 to Jul IIIQ1980 and from Jul IIIQ1981 to Nov IVQ1982.

Chart IB-3, US, Personal Income, Billion Dollars, Quarterly Seasonally Adjusted at Annual Rates, 1980-1989

Source: US Bureau of Economic Analysis

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

A different evolution of personal income is shown in Chart IB-4. Personal income also fell during the recession from Dec IVQ2007 to Jun IIQ2009 (http://www.nber.org/cycles.html). Growth of personal income during the expansion has been tepid even with the new revisions. In IVQ2012, nominal disposable personal income grew at the SAAR of 13.8 percent and real disposable personal income at 11.8 percent (Table 2.1 http://bea.gov/iTable/index_nipa.cfm). The BEA explains as follows: “Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf pages 1-2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0113.pdf). The Bureau of Economic Analysis explains as (http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf 2-3): “The January estimate of employee contributions for government social insurance reflected the expiration of the “payroll tax holiday,” that increased the social security contribution rate for employees and self-employed workers by 2.0 percentage points, or $114.1 billion at an annual rate. For additional information, see FAQ on “How did the expiration of the payroll tax holiday affect personal income for January 2013?” at www.bea.gov. The January estimate of employee contributions for government social insurance also reflected an increase in the monthly premiums paid by participants in the supplementary medical insurance program, in the hospital insurance provisions of the Patient Protection and Affordable Care Act, and in the social security taxable wage base.”

The increase was provided in the “fiscal cliff” law H.R. 8 American Taxpayer Relief Act of 2012 (http://www.gpo.gov/fdsys/pkg/BILLS-112hr8eas/pdf/BILLS-112hr8eas.pdf).

In IQ2013, personal income fell at the SAAR of minus 8.6 percent; real personal income excluding current transfer receipts at minus 11.9 percent; and real disposable personal income at minus 12.6 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi1014.pdf). The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):

“The February and January changes in disposable personal income (DPI) mainly reflected the effect of special factors in January, such as the expiration of the “payroll tax holiday” and the acceleration of bonuses and personal dividends to November and to December in anticipation of changes in individual tax rates.”

In IIQ2013, personal income grew at 4.5 percent, real personal income excluding current transfer receipts at 4.6 percent and real disposable income at 3.8 percent (http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi1114.pdf). In IIIQ2013, personal income grew at 3.3 percent, real personal income excluding current transfers at 1.5 percent and real disposable income at 2.0 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2015/pdf/pi0115.pdf). In IVQ2013, personal income grew at 1.8 percent and real disposable income at 0.2 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2015/pdf/pi0115.pdf). In IQ2014, personal income grew at 4.9 percent in nominal terms and 3.2 percent in real terms excluding current transfer receipts while nominal disposable income grew at 4.8 percent and real disposable income at 3.4 percent (http://www.bea.gov/newsreleases/national/pi/2015/pdf/pi0115.pdf). In IIQ2014, personal income grew at 4.9 percent and 2.2 percent in real terms excluding current transfers. Nominal disposable income grew at 5.5 percent and at 3.1 percent in real terms (http://www.bea.gov/newsreleases/national/pi/2015/pdf/pi0115.pdf). In IIIQ2014, personal income grew at 4.2 percent, real personal income excluding current transfers at 2.7 percent and real disposable personal income at 2.4 percent (http://www.bea.gov/newsreleases/national/pi/2015/pdf/pi0115.pdf). In IVQ2014, personal income grew at 4.1 percent in nominal terms and at 4.8 percent in real terms excluding current transfers while nominal disposable income grew at 3.3 percent in nominal terms and at 3.8 percent in real terms (http://www.bea.gov/newsreleases/national/pi/2015/pdf/pi0115.pdf).

Chart IB-4, US, Personal Income, Current Billions of Dollars, Quarterly Seasonally Adjusted at Annual Rates, 2007-2014

Source: US Bureau of Economic Analysis

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

Real or inflation-adjusted disposable personal income is provided in Chart IB-5 from 1980 to 1989. Real disposable income after allowing for taxes and inflation grew steadily at high rates during the entire decade.

Chart IB-5, US, Real Disposable Income, Billions of Chained 2009 Dollars, Quarterly Seasonally Adjusted at Annual Rates 1980-1989

Source: US Bureau of Economic Analysis

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

Chart IB-6 provides real disposable income from 2007 to 2014. In IQ2013, personal income fell at the SAAR of minus 8.6 percent; real personal income excluding current transfer receipts at minus 11.9 percent; and real disposable personal income at minus 12.6 percent (Table 6 at http://www.bea.gov/newsreleases/national/pi/2014/pdf/pi1014.pdf). The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):

Chart IB-6, US, Real Disposable Income, Billions of Chained 2009 Dollars, Quarterly Seasonally Adjusted at Annual Rates, 2007-2014

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

Chart IB-7 provides percentage quarterly changes in real disposable income from the preceding period at seasonally adjusted annual rates from 1980 to 1989. Rates of changes were high during the decade with few negative changes.

Chart IB-7, US, Real Disposable Income Percentage Change from Preceding Period at Quarterly Seasonally-Adjusted Annual Rates, 1980-1989

Source: US Bureau of Economic Analysis

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

Chart IB-8 provides percentage quarterly changes in real disposable income from the preceding period at seasonally adjusted annual rates from 2007 to 2014. There has been a period of positive rates followed by decline of rates and then negative and low rates in 2011. Recovery in 2012 has not reproduced the dynamism of the brief early phase of expansion. In IVQ2012, nominal disposable personal income grew at the SAAR of 13.8 percent and real disposable personal income at 11.8 percent (Table 2.1 http://bea.gov/iTable/index_nipa.cfm). The BEA explains as: “Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf). The BEA explains as follows (page 3 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0313.pdf):

Chart, IB-8, US, Real Disposable Income, Percentage Change from Preceding Period at Seasonally-Adjusted Annual Rates, 2007-2014

Source: US Bureau of Economic Analysis

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

The Bureau of Economic Analysis (BEA) estimates US personal income in Jan 2015 at the seasonally adjusted annual rate of $15,061.8 billion, as shown in Table IB-3 above (see Table 1 at http://www.bea.gov/newsreleases/national/pi/2015/pdf/pi0115.pdf). The major portion of personal income is compensation of employees of $9,449.5 billion, or 62.7 percent of the total. Wages and salaries are $7,640.5 billion, of which $6,406.8 billion by private industries and supplements to wages and salaries of $1,809.1 billion (contributions to social insurance are $557.7 billion). In Jul 1988 (at the comparable month after the end of the 22 quarter of cyclical expansion), US personal income was $4,292.9 billion at SAAR (http://www.bea.gov/iTable/index_nipa.cfm). Compensation of employees was $2,969.0 billion, or 69.2 percent of the total. Wages and salaries were $2,457.4 billion of which $2004.5 billion by private industries. Supplements to wages and salaries were $511.6 billion with employer contributions to pension and insurance funds of $325.7 billion and $185.9 billion to government social insurance. Chart IB-9 provides US wages and salaries by private industries in the 1980s. Growth was robust after the interruption of the recessions.

Chart IB-9, US, Wages and Salaries, Private Industries, Quarterly, Seasonally Adjusted at Annual Rates Billions of Dollars, 1980-1989

Source: US Bureau of Economic Analysis

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

The Bureau of Economic Analysis (BEA) estimates US personal income in Jan 2015 at the seasonally adjusted annual rate of $15,061.8 billion, as shown in Table IB-3 above (see Table 1 at http://www.bea.gov/newsreleases/national/pi/2015/pdf/pi0115.pdf). The major portion of personal income is compensation of employees of $9,449.5 billion, or 62.7 percent of the total. Wages and salaries are $7,640.5 billion, of which $6,406.8 billion by private industries and supplements to wages and salaries of $1,809.1 billion (contributions to social insurance are $562.8 billion). In Jul 1988 (at the comparable month after the end of the 22 quarter of cyclical expansion), US personal income was $4,292.9 billion at SAAR (http://www.bea.gov/iTable/index_nipa.cfm). Compensation of employees was $2,969.0 billion, or 69.2 percent of the total. Wages and salaries were $2,457.4 billion of which $2004.5 billion by private industries. Supplements to wages and salaries were $511.6 billion with employer contributions to pension and insurance funds of $325.7 billion and $185.9 billion to government social insurance. Chart IB-10 provides US wages and salaries by private industries from 2007 to 2014. Growth was mediocre in the weak expansion phase after IIIQ2009.

Chart IB-10, US, Wage and Salary Disbursement, Private Industries, Quarterly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2014

Source: US Bureau of Economic Analysis

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

Chart IB-11 provides finer detail with monthly wages and salaries of private industries from 2007 to 2015. Anticipations of income in late 2012 to avoid tax increases in 2013 cloud comparisons.

Chart IB-11, US, Wages and Salaries, Private Industries, Monthly, Seasonally Adjusted at Annual Rates, Billions of Dollars 2007-2015

Source: US Bureau of Economic Analysis

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

Chart IB-12 provides monthly real disposable personal income per capita from 1980 to 1989. This is the ultimate measure of wellbeing in receiving income by obtaining the value per inhabitant. The measure cannot adjust for the distribution of income. Real disposable personal income per capita grew rapidly during the expansion after 1983 and continued growing during the rest of the decade.

Chart IB-12, US, Real Disposable Per Capita Income, Monthly, Seasonally Adjusted at Annual Rates, Chained 2009 Dollars 1980-1989

Source: US Bureau of Economic Analysis

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

Table IB-5 provides the comparison between the cycle of the 1980s and the current cycle. Real per capita disposable income (RDPI-PC) increased 22.7 percent from Dec 1979 to Jul 1988. In the comparable period in the actual cycle from Dec 2007 to Jan 2015, real per capita disposable income increased 6.5 percent.

Table IB-5, Percentage Changes of Real Disposable Personal Income Per Capita

Month	RDPI-PC ∆% 12/79	RDPI-PC ∆% YOY	Month	RDPI-PC ∆% 12/07	RDPI-PC ∆% YOY
11/1982	2.4	0.6	6/2009	-0.6	-2.4
12/1982	2.9	1.3	9/2009	-1.3	-0.6
12/1983	7.8	4.8	6/2010	-0.4	0.2
12/1987	20.4	2.7	6/2014	4.2	1.4
1/1988	20.6	2.6	7/2014	4.2	1.6
2/1988	21.2	2.6	8/2014	4.5	1.6
3/1988	21.6	2.9	9/2014	4.5	1.4
4/1988	21.9	7.4	10/2014	4.7	1.9
5/1988	22.0	3.3	11/2014	5.2	2.3
6/1988	22.4	3.9	12/2014	5.7	3.1
7/1988	22.7	4.0	1/2015	6.5	3.4

RDPI: Real Disposable Personal Income; RDPI-PC, Real Disposable Personal Income Per Capita

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

National Bureau of Economic Research

http://www.nber.org/cycles.html

Chart IB-13 provides monthly real disposable personal income per capita from 2007 to 2015. There was initial recovery from the drop during the global recession followed by stagnation.

Chart IB-13, US, Real Disposable Per Capita Income, Monthly, Seasonally Adjusted at Annual Rates, Chained 2009 Dollars 2007-2015

Source: US Bureau of Economic Analysis

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

Table IB-6 provides data for analysis of the current cycle. Real disposable income (RDPI) increased 12.6 percent from Dec 2007 to Jan 2015 (column RDPI ∆% 12/07). In the same period, real disposable income per capita increased 6.5 percent (column RDPI-PC ∆% 12/07). The annual equivalent rate of increase of real disposable income per capita is 0.9 percent, only a fraction of 2.0 percent on average from 1929 to 2014, and 1.7 percent for real disposable income, much lower than 3.2 percent on average from 1929 to 2014.

Table IB-6, Percentage Changes of Real Disposable Personal Income and Real Disposable Personal Income Per Capita

Month	RDPI ∆% 12/07	RDPI ∆% Month	RDPI ∆% YOY	RDPI-PC ∆% 12/07	RDPI-PC ∆% Month	RDPI-PC ∆% YOY
6/09	0.8	-1.7	-1.5	-0.6	-1.8	-2.4
9/09	0.3	0.1	0.3	-1.3	0.1	-0.6
6/10	1.8	0.0	1.0	-0.4	0.0	0.2
12/10	3.4	0.7	2.9	0.7	0.6	2.1
6/11	4.2	0.4	2.3	1.2	0.4	1.5
12/11	5.0	0.8	1.6	1.6	0.7	0.8
6/12	6.9	0.1	2.7	3.1	0.1	1.9
10/12	7.7	0.6	3.2	3.5	0.5	2.5
11/12	9.2	1.4	4.8	4.9	1.4	4.1
12/12	12.3	2.8	7.0	7.9	2.8	6.2
6/13	7.4	0.2	0.4	2.7	0.1	-0.3
12/13	7.6	-0.2	-4.2	2.5	-0.3	-4.9
1/14	8.1	0.5	2.3	3.0	0.4	1.6
2/14	8.6	0.5	2.3	3.4	0.4	1.6
3/14	9.1	0.5	2.4	3.8	0.4	1.7
4/14	9.2	0.1	2.3	3.9	0.1	1.5
5/14	9.4	0.2	2.1	4.0	0.1	1.3
6/14	9.7	0.2	2.1	4.2	0.2	1.4
7/14	9.8	0.1	2.3	4.2	0.1	1.6
8/14	10.2	0.4	2.3	4.5	0.3	1.6
9/14	10.3	0.1	2.1	4.5	0.0	1.4
10/14	10.5	0.3	2.6	4.7	0.2	1.9
11/14	11.1	0.5	3.0	5.2	0.4	2.3
12/14	11.7	0.5	3.8	5.7	0.5	3.1
1/15	12.6	0.9	4.2	6.5	0.8	3.4

RDPI: Real Disposable Personal Income; RDPI-PC, Real Disposable Personal Income Per Capita

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

National Bureau of Economic Research

http://www.nber.org/cycles.html

IA2 Financial Repression. McKinnon (1973) and Shaw (1974) argue that legal restrictions on financial institutions can be detrimental to economic development. “Financial repression” is the term used in the economic literature for these restrictions (see Pelaez and Pelaez, Globalization and the State, Vol. II (2008b), 81-6; for historical analysis see Pelaez 1975). Excessive official regulation frustrates financial development required for growth (Haber 2011). Emphasis on disclosure can reduce bank fragility and corruption, empowering investors to enforce sound governance (Barth, Caprio and Levine 2006). Banking was important in facilitating economic growth in historical periods (Cameron 1961, 1967, 1972; Cameron et al. 1992). Banking is also important currently because small- and medium-size business may have no other form of financing than banks in contrast with many options for larger and more mature companies that have access to capital markets. Calomiris and Haber (2014) find that broad voting rights and institutions restricting coalitions of bankers and populists ensure stable banking systems and access to credit. Interest rate ceilings on deposits and loans have been commonly used. The Banking Act of 1933 imposed prohibition of payment of interest on demand deposits and ceilings on interest rates on time deposits. These measures were justified by arguments that the banking panic of the 1930s was caused by competitive rates on bank deposits that led banks to engage in high-risk loans (Friedman, 1970, 18; see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 74-5). The objective of policy was to prevent unsound loans in banks. Savings and loan institutions complained of unfair competition from commercial banks that led to continuing controls with the objective of directing savings toward residential construction. Friedman (1970, 15) argues that controls were passive during periods when rates implied on demand deposit were zero or lower and when Regulation Q ceilings on time deposits were above market rates on time deposits. The Great Inflation or stagflation of the 1960s and 1970s changed the relevance of Regulation Q.

Most regulatory actions trigger compensatory measures by the private sector that result in outcomes that are different from those intended by regulation (Kydland and Prescott 1977). Banks offered services to their customers and loans at rates lower than market rates to compensate for the prohibition to pay interest on demand deposits (Friedman 1970, 24). The prohibition of interest on demand deposits was eventually lifted in recent times. In the second half of the 1960s, already in the beginning of the Great Inflation (DeLong 1997), market rates rose above the ceilings of Regulation Q because of higher inflation. Nobody desires savings allocated to time or savings deposits that pay less than expected inflation. This is a fact currently with zero interest rates and consumer price inflation of 0.8 percent in the 12 months ending in Dec 2013 (http://www.bls.gov/cpi/) but rising during waves of carry trades from zero interest rates to commodity futures exposures (http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier

http://cmpassocregulationblog.blogspot.com/2015/01/competitive-currency-conflicts-world.html). Funding problems motivated compensatory measures by banks. Money-center banks developed the large certificate of deposit (CD) to accommodate increasing volumes of loan demand by customers. As Friedman (1970, 25) finds:

“Large negotiable CD’s were particularly hard hit by the interest rate ceiling because they are deposits of financially sophisticated individuals and institutions who have many alternatives. As already noted, they declined from a peak of $24 billion in mid-December, 1968, to less than $12 billion in early October, 1969.”

Banks created different liabilities to compensate for the decline in CDs. As Friedman (1970, 25; 1969) explains:

“The most important single replacement was almost surely ‘liabilities of US banks to foreign branches.’ Prevented from paying a market interest rate on liabilities of home offices in the United States (except to foreign official institutions that are exempt from Regulation Q), the major US banks discovered that they could do so by using the Euro-dollar market. Their European branches could accept time deposits, either on book account or as negotiable CD’s at whatever rate was required to attract them and match them on the asset side of their balance sheet with ‘due from head office.’ The head office could substitute the liability ‘due to foreign branches’ for the liability ‘due on CDs.”

Friedman (1970, 26-7) predicted the future:

“The banks have been forced into costly structural readjustments, the European banking system has been given an unnecessary competitive advantage, and London has been artificially strengthened as a financial center at the expense of New York.”

In short, Depression regulation exported the US financial system to London and offshore centers. What is vividly relevant currently from this experience is the argument by Friedman (1970, 27) that the controls affected the most people with lower incomes and wealth who were forced into accepting controlled-rates on their savings that were lower than those that would be obtained under freer markets. As Friedman (1970, 27) argues:

“These are the people who have the fewest alternative ways to invest their limited assets and are least sophisticated about the alternatives.”

Chart IB-14 of the Bureau of Economic Analysis (BEA) provides quarterly savings as percent of disposable income or the US savings rate from 1980 to 2014. There was a long-term downward sloping trend from 12 percent in the early 1980s to 2.0 percent in Jul 2005. The savings rate then rose during the contraction and in the expansion. In 2011 and into 2012 the savings rate declined as consumption is financed with savings in part because of the disincentive or frustration of receiving a few pennies for every $10,000 of deposits in a bank. The savings rate increased in the final segment of Chart IB-14 in 2012 followed by another decline because of the pain of the opportunity cost of zero remuneration for hard-earned savings.

Chart IB-14, US, Personal Savings as a Percentage of Disposable Personal Income, Quarterly, 1980-2014

Source: US Bureau of Economic Analysis

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

Chart IB-14A provides the US personal savings rate, or personal savings as percent of disposable personal income, on an annual basis from 1929 to 2014. The US savings rate shows decline from around 10 percent in the 1960s to around 5 percent currently.

Chart IB-14A, US, Personal Savings as a Percentage of Disposable Personal Income, Annual, 1929-2014

Source: US Bureau of Economic Analysis

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

Table IB-7 provides personal savings as percent of disposable income and annual change of real disposable personal income in selected years since 1930. Savings fell from 4.4 percent of disposable personal income in 1930 to minus 0.8 percent in 1933 while real disposable income contracted 6.3 percent in 1930 and 2.9 percent in 1933. Savings as percent of disposable personal income swelled during World War II to 27.9 percent in 1944 with increase of real disposable income of 3.1 percent. Savings as percent of personal disposable income fell steadily over decades from 11.5 percent in 1982 to 2.5 percent in 2005. Savings as percent of disposable personal income was 4.9 percent in 2013 while real disposable income fell 0.2 percent. The savings rate was 4.9 percent of GDP in 2014 with growth of real disposable income of 2.5 percent. The average ratio of savings as percent of disposable income fell from 9.3 percent 1980 to 1989 to 5.3 percent on average from 2007 to 2014. Real disposable income grew on average at 3.5 percent from 1980 to 1989 and at 1.4 percent on average from 2007 to 2014.

Table IB-7, US, Personal Savings as Percent of Disposable Personal Income, Annual, Selected Years 1929-1913

	Personal Savings as Percent of Disposable Personal Income	Annual Change of Real Disposable Personal Income
1930	4.4	-6.3
1933	-0.8	-2.9
1944	27.9	3.1
1947	6.3	-4.1
1954	10.3	1.4
1958	11.4	1.1
1960	10.0	2.6
1970	12.6	4.6
1975	13.0	2.5
1982	11.5	2.1
1989	7.8	3.0
1992	8.9	4.3
2002	5.0	3.1
2003	4.8	2.7
2004	4.6	3.6
2005	2.5	1.5
2006	3.3	4.0
2007	3.0	2.1
2008	4.9	1.5
2009	6.1	-0.4
2010	5.6	1.0
2011	6.0	2.5
2012	7.2	3.0
2013	4.9	-0.2
2014	4.9	2.5
Average Savings Ratio
1980-1989	9.3
2007-2014	5.3
Average Yearly ∆% Real Disposable Income
1980-1989		3.5
2007-2014		1.4

Source: US Bureau of Economic Analysis

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

Chart IB-15 of the US Bureau of Economic Analysis provides personal savings as percent of personal disposable income, or savings ratio, from Jan 2007 to Jan 2015. The uncertainties caused by the global recession resulted in sharp increase in the savings ratio that peaked at 7.9 percent in May 2008 (http://www.bea.gov/iTable/index_nipa.cfm). The second peak occurred at 8.1 percent in May 2009. There was another rising trend until 5.9 percent in Jun 2010 and then steady downward trend until 5.6 percent in Nov 2011. This was followed by an upward trend with 7.1 percent in Jun 2012 but decline to 6.4 percent in Aug 2012 followed by jump to 10.5 percent in Dec 2012. Swelling realization of income in Oct-Dec 2012 in anticipation of tax increases in Jan 2013 caused the jump of the savings rate to 10.5 percent in Dec 2012. The BEA explains as “Personal income in November and December was boosted by accelerated and special dividend payments to persons and by accelerated bonus payments and other irregular pay in private wages and salaries in anticipation of changes in individual income tax rates. Personal income in December was also boosted by lump-sum social security benefit payments” (page 2 at http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi1212.pdf). There was a reverse effect in Jan 2013 with decline of the savings rate to 4.5 percent. Real disposable personal income fell 5.9 percent and real disposable per capita income fell from $38,699 in Dec 2012 to $36.378 in Jan 2013 or by 6.0 percent (http://www.bea.gov/iTable/index_nipa.cfm), which is explained by the Bureau of Economic Analysis as follows (page 3 http://www.bea.gov/newsreleases/national/pi/2013/pdf/pi0213.pdf):

“Contributions for government social insurance -- a subtraction in calculating personal income --increased $6.4 billion in February, compared with an increase of $126.8 billion in January. The

Chart IB-15, US, Personal Savings as a Percentage of Disposable Income, Monthly 2007-2015

Source: US Bureau of Economic Analysis

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

Table IB-8 provides personal saving as percent of disposable income, change of real disposable income relative to Dec 2007 (RDPI ∆% 12/07), monthly percentage change of real disposable income (RDPI ∆% month) and percentage change of real disposable income in a month relative to the same month a year earlier (RDPI ∆% YOY). The ratio of personal saving to disposable income eased to 4.5 percent in Jan 2014 with cumulative growth of real disposable income of 12.6 percent since Dec 2007 at the rate of 1.7 percent annual equivalent, which is much lower than 3.2 percent over the long term from 1929 to 2014.

Table IB-8, US, Savings Ratio and Real Disposable Income, % and ∆%

	Personal Saving as % Disposable Income	RDPI ∆% 12/07	RDPI ∆% Month	RDPI ∆% YOY
May 2008	7.9	5.1	4.8	5.7
May 2009	8.1	2.5	1.6	-2.5
Jun 2010	5.9	1.8	0.0	1.0
Nov 2011	5.6	4.2	-0.1	1.5
Jun 2012	7.1	6.9	0.1	2.7
Aug 2012	6.4	6.5	-0.2	1.9
Dec 2012	10.5	12.3	2.8	7.0
Jan 2013	4.5	5.6	-5.9	-0.1
Feb 2013	4.7	6.2	0.5	-0.2
Mar 2013	4.9	6.5	0.4	0.0
Apr 2013	5.1	6.8	0.2	0.0
May 2013	5.2	7.2	0.4	0.4
Jun 2013	5.3	7.4	0.2	0.4
Jul 2013	5.1	7.3	-0.1	0.6
Aug 2013	5.3	7.7	0.4	1.1
Sep 2013	5.2	8.0	0.3	0.9
Oct 2013	4.7	7.7	-0.3	0.0
Nov 2013	4.3	7.8	0.1	-1.3
Dec 2013	4.1	7.6	-0.2	-4.2
Jan 2014	4.9	8.1	0.5	2.3
Feb 2014	5.0	8.6	0.5	2.3
Mar 2014	4.8	9.1	0.5	2.4
Apr 2014	5.0	9.2	0.1	2.3
May 2014	5.1	9.4	0.2	2.1
Jun 2014	5.1	9.7	0.2	2.1
Jul 2014	5.1	9.8	0.1	2.3
Aug 2014	4.7	10.2	0.4	2.3
Sep 2014	4.6	10.3	0.1	2.1
Oct 2014	4.5	10.5	0.3	2.6
Nov 2014	4.5	11.1	0.5	3.0
Dec 2014	5.0	11.7	0.5	3.8
Jan 2015	5.5	12.6	0.9	4.2

Source: US Bureau of Economic Analysis

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

II Rules, Discretionary Authorities and Slow Productivity Growth. The Bureau of Labor Statistics (BLS) of the Department of Labor provides the quarterly report on productivity and costs. The operational definition of productivity used by the BLS is (http://www.bls.gov/news.release/pdf/prod2.pdf 1): “Labor productivity, or output per hour, is calculated by dividing an index of real output by an index of hours worked of all persons, including employees, proprietors, and unpaid family workers.” The BLS has revised the estimates for productivity and unit costs. Table II-1 provides the revision of the estimate for IVQ2014 and revised data for nonfarm business sector productivity and unit labor costs for IIIQ2014 and IIQ2014 in seasonally adjusted annual equivalent (SAAE) rate and the percentage change from the same quarter a year earlier. Reflecting increases in output of 2.6 percent and increase of 4.9 percent in hours worked, nonfarm business sector labor productivity decreased at the SAAE rate of 2.2 percent in IVQ2014, as shown in column 2 “IVQ2014 SAEE.” The increase of labor productivity from IVQ2013 to IVQ2014 was minus 0.1 percent, reflecting increases in output of 2.9 percent and of hours worked of 3.0 percent, as shown in column 3 “IVQ2014 YoY.” Hours worked changed from 2.5 percent in IIQ2014 in SAAE to 2.2 percent in IIIQ2014 and increased to 4.9 percent in IVQ2014 while output growth increased from 5.5 percent in IIQ2014 to 6.3 percent in IIIQ2014, easing to 2.6 percent in IVQ2014. The BLS defines unit labor costs as (http://www.bls.gov/news.release/pdf/prod2.pdf 1): “BLS calculates unit labor costs as the ratio of hourly compensation to labor productivity; increases in hourly compensation tend to increase unit labor costs and increases in output per hour tend to reduce them.” Unit labor costs increased at the SAAE rate of 4.1 percent in IVQ2014 and increased 2.6 percent in IVQ2014 relative to IVQ2013. Hourly compensation increased at the SAAE rate of 1.9 percent in IVQ2014, which deflating by the estimated consumer price increase SAAE rate in IVQ2014 results in increase of real hourly compensation at 3.1 percent. Real hourly compensation increased 1.3 percent in IVQ2014 relative to IVQ2013.

Table II-1, US, Nonfarm Business Sector Productivity and Costs %

	IVQ 2014 SAAE	IVQ 2014 YoY	III 2014 SAAE	IIIQ 2014 YoY	IIQ 2014 SSAE	IIQ 2014 YOY
Productivity	-2.2	-0.1	3.9	1.2	2.9	1.1
Output	2.6	2.9	6.3	3.5	5.5	3.3
Hours	4.9	3.0	2.4	2.2	2.5	2.2
Hourly Comp.	1.9	2.5	2.8	2.4	-0.9	1.8
Real Hourly Comp.	3.1	1.3	1.7	0.6	-3.8	-0.2
Unit Labor Costs	4.1	2.6	-1.0	1.2	-3.7	0.7
Unit Nonlabor Payments	-5.8	-0.9	5.3	1.8	10.0	2.6
Implicit Price Deflator	-0.3	1.0	1.7	1.5	2.0	1.5

Notes: SAAE: seasonally adjusted annual equivalent; Comp.: compensation; YoY: Quarter on Same Quarter Year Earlier

http://www.bls.gov/lpc/

The analysis by Kydland (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2004/kydland-bio.html) and Prescott (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2004/prescott-bio.html) (1977, 447-80, equation 5) uses the “expectation augmented” Phillips curve with the natural rate of unemployment of Friedman (1968) and Phelps (1968), which in the notation of Barro and Gordon (1983, 592, equation 1) is:

U_t = Uⁿ_t – α(π_t – π^e) α > 0 (1)

Where U_t is the rate of unemployment at current time t, Uⁿ_t is the natural rate of unemployment, π_t is the current rate of inflation and π^e is the expected rate of inflation by economic agents based on current information. Equation (1) expresses unemployment net of the natural rate of unemployment as a decreasing function of the gap between actual and expected rates of inflation. The system is completed by a social objective function, W, depending on inflation, π, and unemployment, U:

W = W(π_t, U_t) (2)

The policymaker maximizes the preferences of the public, (2), subject to the constraint of the tradeoff of inflation and unemployment, (1). The total differential of W set equal to zero provides an indifference map in the Cartesian plane with ordered pairs (π_t, U_t- Uⁿ) such that the consistent equilibrium is found at the tangency of an indifference curve and the Phillips curve in (1). The indifference curves are concave to the origin. The consistent policy is not optimal. Policymakers without discretionary powers following a rule of price stability would attain equilibrium with unemployment not higher than with the consistent policy. The optimal outcome is obtained by the rule of price stability, or zero inflation, and no more unemployment than under the consistent policy with nonzero inflation and the same unemployment. Taylor (1998LB) attributes the sustained boom of the US economy after the stagflation of the 1970s to following a monetary policy rule instead of discretion (see Taylor 1993, 1999). It is not uncommon for effects of regulation differing from those intended by policy. Professors Edward C. Prescott and Lee E. Ohanian (2014Feb), writing on “US productivity growth has taken a dive,” on Feb 3, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303942404579362462611843696?KEYWORDS=Prescott), argue that impressive productivity growth over the long-term constructed US prosperity and wellbeing. Prescott and Ohanian (2014Feb) measure US productivity growth at 2.5 percent per year since 1948. Average US productivity growth has been only 1.1 percent on average since 2011. Prescott and Ohanian (2014Feb) argue that living standards in the US increased at 28 percent in a decade but with current slow growth of productivity will only increase 12 percent by 2024. There may be collateral effects on productivity growth from policy design similar to those in Kydland and Prescott (1977). The Bureau of Labor Statistics important report on productivity and costs released on Mar 5, 2015 (http://www.bls.gov/lpc/) supports the argument of decline of productivity growth in the US analyzed by Prescott and Ohanian (2014Feb). Table II-2 provides the annual percentage changes of productivity, real hourly compensation and unit labor costs for the entire economic cycle from 2007 to 2014. The data confirm the argument of Prescott and Ohanian (2014Feb): productivity increased cumulatively 2.8 percent from 2011 to 2014 at the average annual rate of 0.7 percent. The situation is direr by excluding growth of 1.0 percent in 2012, which leaves an average of 0.6 percent for 2011, 2012 and 2013. Average productivity growth for the entire economic cycle from 2007 to 2014 is only 1.5 percent. The argument by Prescott and Ohanian (2014Feb) is proper in choosing the tail of the business cycle because the increase in productivity in 2009 of 3.2 percent and 3.3 percent in 2013 consisted of reducing labor hours.

Table II-2, US, Revised Nonfarm Business Sector Productivity and Costs Annual Average, ∆% Annual Average

	2014 ∆%	2013 ∆%	2012 ∆%	2011 ∆%	2010 ∆%	2009 ∆%	2008 ∆%	2007 ∆%
Productivity	0.7	0.9	1.0	0.2	3.3	3.2	0.8	1.6
Real Hourly Compensation	0.8	-0.3	0.6	-0.9	0.3	1.5	-1.1	1.4
Unit Labor Costs	1.8	0.2	1.7	2.1	-1.3	-2.0	2.0	2.7

Source: US Bureau of Labor Statistics

http://www.bls.gov/lpc/

Productivity jumped in the recovery after the recession from Mar IQ2001 to Nov IVQ2001 (http://www.nber.org/cycles.html). Table II-3 provides quarter on quarter and annual percentage changes in nonfarm business output per hour, or productivity, from 1999 to 2014. The annual average jumped from 2.7 percent in 2001 to 4.3 percent in 2002. Nonfarm business productivity increased at the SAAE rate of 9.4 percent in the first quarter after the recession in IQ2002. Productivity increases decline later in the expansion period. Productivity increases were mediocre during the recession from Dec IVQ2007 to Jun IIIQ2009 (http://www.nber.org/cycles.html) and increased during the first phase of expansion from IIQ2009 to IQ2010, trended lower and collapsed in 2011 and 2012 with sporadic jumps and declines. Productivity increased at 3.0 percent in IVQ2013 and contracted at 4.7 percent in IQ2014. Productivity increased at 2.9 percent in IIQ2014 and at 3.9 percent in IIIQ2014. Productivity contracted at 2.2 percent in IVQ2014.

Table II-3, US, Nonfarm Business Output per Hour, Percent Change from Prior Quarter at Annual Rate, 1999-2014

Year	Qtr1	Qtr2	Qtr3	Qtr4	Annual
1999	3.8	0.7	3.4	6.8	3.3
2000	-1.4	8.6	0.1	4.1	3.3
2001	-1.2	6.8	2.2	5.0	2.7
2002	9.4	0.3	3.1	-0.6	4.3
2003	4.0	5.6	9.0	3.9	3.7
2004	-0.1	4.0	1.3	1.3	3.1
2005	4.4	-0.4	3.0	0.2	2.1
2006	2.5	-0.3	-1.8	3.2	0.9
2007	0.4	2.6	4.6	1.8	1.6
2008	-3.9	4.0	1.0	-2.5	0.8
2009	3.2	7.9	6.0	4.8	3.2
2010	2.1	1.5	2.1	1.6	3.3
2011	-3.3	1.5	-0.9	3.0	0.2
2012	0.0	2.0	1.8	-2.3	1.0
2013	0.6	0.9	3.4	3.0	0.9
2014	-4.7	2.9	3.9	-2.2	0.7

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Chart II-1 of the Bureau of Labor Statistics (BLS) provides SAAE rates of nonfarm business productivity from 1999 to 2014. There is a clear pattern in both episodes of economic cycles in 2001 and 2007 of rapid expansion of productivity in the transition from contraction to expansion followed by more subdued productivity expansion. Part of the explanation is the reduction in labor utilization resulting from adjustment of business to the sudden shock of collapse of revenue. Productivity rose briefly in the expansion after 2009 but then collapsed and moved to negative change with some positive changes recently at lower rates. Contractions in the cycle from 2007 to 2014 have been more frequent and sharper.

Chart II-1, US, Nonfarm Business Output per Hour, Percent Change from Prior Quarter at Annual Rate, 1999-2014

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Percentage changes from prior quarter at SAAE rates and annual average percentage changes of nonfarm business unit labor costs are provided in Table II-4. Unit labor costs fell during the contractions with continuing negative percentage changes in the early phases of the recovery. Weak labor markets partly explain the decline in unit labor costs. As the economy moves toward full employment, labor markets tighten with increase in unit labor costs. The expansion beginning in IIIQ2009 has been characterized by high unemployment and underemployment. Table II-4 shows continuing subdued increases in unit labor costs in 2011 but with increase at 11.4 percent in IQ2012 followed by decrease at 1.1 percent in IIQ2012, decline at 1.8 percent in IIIQ2012 and increase at 12.7 percent in IVQ2012. Unit labor costs decreased at 7.1 percent in IQ2013 and increased at 3.2 percent in IIQ2013. Unit labor costs decreased at 2.9 percent in IIIQ2013 and at 1.3 percent in IVQ2013. Unit labor costs increased at 11.5 percent in IQ2014 and at minus 3.7 percent in IIQ2014. Unit labor costs decreased at 1.0 percent in IIIQ2014 and increased at 4.1 percent in IVQ2014.

Table II-4, US, Nonfarm Business Unit Labor Costs, Percent Change from Prior Quarter at Annual Rate 1999-2014

Year	Qtr1	Qtr2	Qtr3	Qtr4	Annual
1999	2.8	0.2	0.0	1.7	0.9
2000	17.4	-6.8	8.2	-1.7	4.0
2001	11.4	-5.4	-1.7	-1.4	1.6
2002	-6.6	3.3	-1.1	1.7	-2.0
2003	-1.5	1.6	-2.6	1.5	0.1
2004	-0.5	3.9	5.6	0.5	1.4
2005	-1.3	2.6	1.9	2.3	1.6
2006	6.1	0.5	2.3	4.0	3.0
2007	9.8	-2.7	-3.2	2.6	2.7
2008	8.2	-3.6	2.4	7.1	2.0
2009	-12.3	2.1	-3.0	-2.3	-2.0
2010	-4.8	3.2	-0.2	0.2	-1.3
2011	11.0	-3.5	3.3	-7.7	2.1
2012	11.4	-1.1	-1.8	12.7	1.7
2013	-7.1	3.2	-2.9	-1.3	0.2
2014	11.5	-3.7	-1.0	4.1	1.8

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Chart II-2 provides percentage change from prior quarter at annual rate of nonfarm business real hourly compensation from 1999 to 2014. There are significant fluctuations in quarterly percentage changes oscillating between positive and negative. There is no clear pattern in the two contractions in the 2000s.

Chart II-2, US, Nonfarm Business Unit Labor Costs, Percent Change from Prior Quarter at Annual Rate 1999-2014

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Table II-5 provides percentage change from prior quarter at annual rates for nonfarm business real hourly worker compensation. The expansion after the contraction of 2001 was followed by strong recovery of real hourly compensation. Real hourly compensation increased at the rate of 3.0 percent in IQ2011 but fell at annual rates of 6.7 percent in IIQ2011 and 6.4 percent in IVQ2011. Real hourly compensation increased at 9.1 percent in IQ2012, decreasing at 0.5 percent in IIQ2012, declining at 1.7 percent in IIIQ2012 and increasing at 7.5 percent in IVQ2012. Real hourly compensation fell at 0.9 percent in 2011 and increased at 0.6 percent in 2012. Real hourly compensation fell at 7.5 percent in IQ2013 and increased at 3.7 percent in IIQ2013, falling at 1.6 percent in IIIQ2013. Real hourly compensation increased at 0.4 percent in IVQ2013 and at 4.3 percent in IQ2014. Real hourly compensation decreased at 3.8 percent in IIQ2014. Real hourly compensation increased at 1.7 percent in IIIQ2014. The annual rate of increase of real hourly compensation for 2013 is minus 0.3 percent. Real hourly compensation increased at 3.1 percent in IVQ2014. The annual rate of increase of real hourly compensation in 2014 is 0.8 percent.

Table II-5, Nonfarm Business Real Hourly Compensation, Percent Change from Prior Quarter at Annual Rate 1999-2014

Year	Qtr1	Qtr2	Qtr3	Qtr4	Annual
1999	5.0	-2.0	0.2	5.5	2.1
2000	11.5	-1.8	4.4	-0.5	3.9
2001	6.0	-1.7	-0.7	4.0	1.5
2002	0.7	0.4	-0.2	-1.4	0.7
2003	-1.5	8.0	2.9	3.9	1.5
2004	-3.9	4.8	4.2	-2.5	1.8
2005	1.2	-0.6	-1.1	-1.2	0.3
2006	6.4	-3.3	-3.4	9.2	0.6
2007	6.0	-4.6	-1.2	-0.5	1.4
2008	-0.5	-4.7	-2.7	14.6	-1.1
2009	-7.1	7.9	-0.6	-0.8	1.5
2010	-3.2	4.8	0.6	-1.3	0.3
2011	3.0	-6.7	-0.3	-6.4	-0.9
2012	9.1	-0.5	-1.7	7.5	0.6
2013	-7.5	3.7	-1.6	0.4	-0.3
2014	4.3	-3.8	1.7	3.1	0.8

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Chart II-3 provides percentage change from prior quarter at annual rate of nonfarm business real hourly compensation. There have been multiple negative percentage quarterly changes in the current cycle since IVQ2007.

Chart II-3, US, Nonfarm Business Real Hourly Compensation, Percent Change from Prior Quarter at Annual Rate 1999-2014

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Chart II-4 provides percentage change of nonfarm business output per hour in a quarter relative to the same quarter a year earlier. As in most series of real output, productivity increased sharply in 2010 but the momentum was lost after 2011 as with the rest of the real economy.

Chart II-4, US, Nonfarm Business Output per Hour, Percent Change from Same Quarter a Year Earlier 1999-2014

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Chart II-5 provides percentage changes of nonfarm business unit labor costs relative to the same quarter a year earlier. Softening of labor markets caused relatively high yearly percentage changes in the recession of 2001 repeated in the recession in 2009. Recovery was strong in 2010 but then weakened.

Chart II-5, US, Nonfarm Business Unit Labor Costs, Percent Change from Same Quarter a Year Earlier 1999-2014

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Chart II-6 provides percentage changes in a quarter relative to the same quarter a year earlier for nonfarm business real hourly compensation. Labor compensation eroded sharply during the recession with brief recovery in 2010 and another fall until recently.

Chart II-6, US, Nonfarm Business Real Hourly Compensation, Percent Change from Same Quarter a Year Earlier 1999-2014

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

In the analysis of Hansen (1939, 3) of secular stagnation, economic progress consists of growth of real income per person driven by growth of productivity. The “constituent elements” of economic progress are “(a) inventions, (b) the discovery and development of new territory and new resources, and (c) the growth of population” (Hansen 1939, 3). Secular stagnation originates in decline of population growth and discouragement of inventions. According to Hansen (1939, 2), US population grew by 16 million in the 1920s but grew by one half or about 8 million in the 1930s with forecasts at the time of Hansen’s writing in 1938 of growth of around 5.3 million in the 1940s. Hansen (1939, 2) characterized demography in the US as “a drastic decline in the rate of population growth.” Hansen’s plea was to adapt economic policy to stagnation of population in ensuring full employment. In the analysis of Hansen (1939, 8), population caused half of the growth of US GDP per year. Growth of output per person in the US and Europe was caused by “changes in techniques and to the exploitation of new natural resources.” In this analysis, population caused 60 percent of the growth of capital formation in the US. Declining population growth would reduce growth of capital formation. Residential construction provided an important share of growth of capital formation. Hansen (1939, 12) argues that market power of imperfect competition discourages innovation with prolonged use of obsolete capital equipment. Trade unions would oppose labor-savings innovations. The combination of stagnating and aging population with reduced innovation caused secular stagnation. Hansen (1939, 12) concludes that there is role for public investments to compensate for lack of dynamism of private investment but with tough tax/debt issues.

The current application of Hansen’s (1938, 1939, 1941) proposition argues that secular stagnation occurs because full employment equilibrium can be attained only with negative real interest rates between minus 2 and minus 3 percent. Professor Lawrence H. Summers (2013Nov8) finds that “a set of older ideas that went under the phrase secular stagnation are not profoundly important in understanding Japan’s experience in the 1990s and may not be without relevance to America’s experience today” (emphasis added). Summers (2013Nov8) argues there could be an explanation in “that the short-term real interest rate that was consistent with full employment had fallen to -2% or -3% sometime in the middle of the last decade. Then, even with artificial stimulus to demand coming from all this financial imprudence, you wouldn’t see any excess demand. And even with a relative resumption of normal credit conditions, you’d have a lot of difficulty getting back to full employment.” The US economy could be in a situation where negative real rates of interest with fed funds rates close to zero as determined by the Federal Open Market Committee (FOMC) do not move the economy to full employment or full utilization of productive resources. Summers (2013Oct8) finds need of new thinking on “how we manage an economy in which the zero nominal interest rates is a chronic and systemic inhibitor of economy activity holding our economies back to their potential.”

Former US Treasury Secretary Robert Rubin (2014Jan8) finds three major risks in prolonged unconventional monetary policy of zero interest rates and quantitative easing: (1) incentive of delaying action by political leaders; (2) “financial moral hazard” in inducing excessive exposures pursuing higher yields of risker credit classes; and (3) major risks in exiting unconventional policy. Rubin (2014Jan8) proposes reduction of deficits by structural reforms that could promote recovery by improving confidence of business attained with sound fiscal discipline.

Professor John B. Taylor (2014Jan01, 2014Jan3) provides clear thought on the lack of relevance of Hansen’s contention of secular stagnation to current economic conditions. The application of secular stagnation argues that the economy of the US has attained full-employment equilibrium since around 2000 only with negative real rates of interest of minus 2 to minus 3 percent. At low levels of inflation, the so-called full-employment equilibrium of negative interest rates of minus 2 to minus 3 percent cannot be attained and the economy stagnates. Taylor (2014Jan01) analyzes multiple contradictions with current reality in this application of the theory of secular stagnation:

Secular stagnation would predict idle capacity, in particular in residential investment when fed fund rates were fixed at 1 percent from Jun 2003 to Jun 2004. Taylor (2014Jan01) finds unemployment at 4.4 percent with house prices jumping 7 percent from 2002 to 2003 and 14 percent from 2004 to 2005 before dropping from 2006 to 2007. GDP prices doubled from 1.7 percent to 3.4 percent when interest rates were low from 2003 to 2005.
Taylor (2014Jan01, 2014Jan3) finds another contradiction in the application of secular stagnation based on low interest rates because of savings glut and lack of investment opportunities. Taylor (2009) shows that there was no savings glut. The savings rate of the US in the past decade is significantly lower than in the 1980s.
Taylor (2014Jan01, 2014Jan3) finds another contradiction in the low ratio of investment to GDP currently and reduced investment and hiring by US business firms.
Taylor (2014Jan01, 2014Jan3) argues that the financial crisis and global recession were caused by weak implementation of existing regulation and departure from rules-based policies.
Taylor (2014Jan01, 2014Jan3) argues that the recovery from the global recession was constrained by a change in the regime of regulation and fiscal/monetary policies.

U_t = Uⁿ_t – α(π_t – π^e) α > 0 (1)

W = W(π_t, U_t) (2)

The policymaker maximizes the preferences of the public, (2), subject to the constraint of the tradeoff of inflation and unemployment, (1). The total differential of W set equal to zero provides an indifference map in the Cartesian plane with ordered pairs (π_t, U_t- Uⁿ) such that the consistent equilibrium is found at the tangency of an indifference curve and the Phillips curve in (1). The indifference curves are concave to the origin. The consistent policy is not optimal. Policymakers without discretionary powers following a rule of price stability would attain equilibrium with unemployment not higher than with the consistent policy. The optimal outcome is obtained by the rule of price stability, or zero inflation, and no more unemployment than under the consistent policy with nonzero inflation and the same unemployment. Taylor (1998LB) attributes the sustained boom of the US economy after the stagflation of the 1970s to following a monetary policy rule instead of discretion (see Taylor 1993, 1999). It is not uncommon for effects of regulation differing from those intended by policy. Professors Edward C. Prescott and Lee E. Ohanian (2014Feb), writing on “US productivity growth has taken a dive,” on Feb 3, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303942404579362462611843696?KEYWORDS=Prescott), argue that impressive productivity growth over the long-term constructed US prosperity and wellbeing. Prescott and Ohanian (2014Feb) measure US productivity growth at 2.5 percent per year since 1948. Average US productivity growth has been only 1.1 since 2011. Prescott and Ohanian (2014Feb) argue that living standards in the US increased at 28 percent in a decade but with current slow growth of productivity will only increase 12 percent by 2024. There may be collateral effects on productivity growth from policy design similar to those in Kydland and Prescott (1977). The Bureau of Labor Statistics important report on productivity and costs released on Mar 5, 2015 (http://www.bls.gov/lpc/) supports the argument of decline of productivity in the US analyzed by Prescott and Ohanian (2014Feb). Table II-2 provides the annual percentage changes of productivity, real hourly compensation and unit labor costs for the entire economic cycle from 2007 to 2014. The data confirm the argument of Prescott and Ohanian (2014Feb): productivity increased cumulatively 2.8 percent from 2011 to 2014 at the average annual rate of 0.7 percent. The situation is direr by excluding growth of 1.0 percent in 2012, which leaves an average of 0.6 percent for 2011, 2013 and 2014. Average productivity growth for the entire economic cycle from 2007 to 2014 is only 1.5 percent. The argument by Prescott and Ohanian (2014Feb) is proper in choosing the tail of the business cycle because the increase in productivity in 2009 of 3.2 percent and 3.3 percent in 2013 consisted on reducing labor hours.

In revealing research, Edward P. Lazear and James R. Spletzer (2012JHJul22) use the wealth of data in the valuable database and resources of the Bureau of Labor Statistics (http://www.bls.gov/data/) in providing clear thought on the nature of the current labor market of the United States. The critical issue of analysis and policy currently is whether unemployment is structural or cyclical. Structural unemployment could occur because of (1) industrial and demographic shifts and (2) mismatches of skills and job vacancies in industries and locations. Consider the aggregate unemployment rate, Y, expressed in terms of share s_i of a demographic group in an industry i and unemployment rate y_i of that demographic group (Lazear and Spletzer 2012JHJul22, 5-6):

Y = ∑_is_iy_i (1)

This equation can be decomposed for analysis as (Lazear and Spletzer 2012JHJul22, 6):

∆Y = ∑_i∆s_iy*_i+ ∑_i∆y_is*_i (2)

The first term in (2) captures changes in the demographic and industrial composition of the economy ∆s_i multiplied by the average rate of unemployment y*_i, or structural factors. The second term in (2) captures changes in the unemployment rate specific to a group, or ∆y_i, multiplied by the average share of the group s*_i,or cyclical factors. There are also mismatches in skills and locations relative to available job vacancies. A simple observation by Lazear and Spletzer (2012JHJul22) casts intuitive doubt on structural factors: the rate of unemployment jumped from 4.4 percent in the spring of 2007 to 10 percent in October 2009. By nature, structural factors should be permanent or occur over relative long periods. The revealing result of the exhaustive research of Lazear and Spletzer (2012JHJul22) is:

“The analysis in this paper and in others that we review do not provide any compelling evidence that there have been changes in the structure of the labor market that are capable of explaining the pattern of persistently high unemployment rates. The evidence points to primarily cyclic factors.”

The theory of secular stagnation cannot explain sudden collapse of the US economy and labor markets. The theory of secular stagnation departs from an aggregate production function in which output grows with the use of labor, capital and technology (see Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 11-6). Simon Kuznets (1971) analyzes modern economic growth in his Lecture in Memory of Alfred Nobel:

“The major breakthroughs in the advance of human knowledge, those that constituted dominant sources of sustained growth over long periods and spread to a substantial part of the world, may be termed epochal innovations. And the changing course of economic history can perhaps be subdivided into economic epochs, each identified by the epochal innovation with the distinctive characteristics of growth that it generated.Without considering the feasibility of identifying and dating such economic epochs, we may proceed on the working assumption that modern economic growth represents such a distinct epoch - growth dating back to the late eighteenth century and limited (except in significant partial effects) to economically developed countries. These countries, so classified because they have managed to take adequate advantage of the potential of modern technology, include most of Europe, the overseas offshoots of Western Europe, and Japan—barely one quarter of world population.”

Chart II-7 provides nonfarm-business labor productivity, measured by output per hour, from 1947 to 2014. The rate of productivity increase continued in the early part of the 2000s but then softened and fell during the global recession. The interruption of productivity increases occurred exclusively in the current business cycle. Lazear and Spletzer (2012JHJul22) find “primarily cyclic” factors in explaining the frustration of currently depressed labor markets in the United States. Stagnation of productivity is another cyclic event and not secular trend. The theory and application of secular stagnation to current US economic conditions is void of reality.

Chart II-7, US, Nonfarm Business Labor Productivity, Output per Hour, 1947-2014, Index 2005=100

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Table II-6 expands Table II-2 providing more complete measurements of the Productivity and Cost research of the Bureau of Labor Statistics. The proper emphasis of Prescott and Ohanian (2014Feb) is on the low productivity increases from 2011 to 2014. Labor productivity increased 3.3 percent in 2010 and 3.2 percent in 2009. There is much stronger yet not sustained performance in 2010 with productivity growing 3.3 percent because of growth of output of 3.2 percent with decline of hours worked of 0.1 percent. Productivity growth of 3.2 percent in 2009 consists of decline of output by 4.3 percent while hours worked collapsed 7.2 percent, which is not a desirable route to progress. The expansion phase of the economic cycle concentrated in one year, 2010, with underperformance in the remainder of the expansion from 2011 to 2014 of productivity growth at average 0.7 percent per year.

Table II-6, US, Productivity and Costs, Annual Percentage Changes 2007-2013

	2014	2013	2012	2011	2010	2009	2008	2007
Productivity	0.7	0.9	1.0	0.2	3.3	3.2	0.8	1.6
Output	3.0	2.6	3.2	2.2	3.2	-4.3	-1.3	2.3
Hours Worked	2.3	1.7	2.2	2.0	-0.1	-7.2	-2.0	0.7
Employment	2.1	1.9	2.0	1.6	-1.2	-5.7	-1.5	0.9
Average Weekly Hours Worked	0.2	-0.1	0.2	0.5	1.1	-1.6	-0.6	-0.2
Unit Labor Costs	1.8	0.2	1.7	2.1	-1.3	-2.0	2.0	2.7
Hourly Compensation	2.5	1.1	2.7	2.2	2.0	1.1	2.7	4.3
Consumer Price Inflation	1.6	1.5	2.1	3.2	1.6	-0.4	3.8	2.8
Real Hourly Compensation	0.8	-0.3	0.6	-0.9	0.3	1.5	-1.1	1.4
Non-labor Payments	3.9	5.5	5.3	3.7	7.5	0.0	-0.4	3.4
Output per Job	0.9	0.7	1.2	0.6	4.5	1.5	0.2	1.4

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Productivity growth can bring about prosperity while productivity regression can jeopardize progress. Cobet and Wilson (2002) provide estimates of output per hour and unit labor costs in national currency and US dollars for the US, Japan and Germany from 1950 to 2000 (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). The average yearly rate of productivity change from 1950 to 2000 was 2.9 percent in the US, 6.3 percent for Japan and 4.7 percent for Germany while unit labor costs in USD increased at 2.6 percent in the US, 4.7 percent in Japan and 4.3 percent in Germany. From 1995 to 2000, output per hour increased at the average yearly rate of 4.6 percent in the US, 3.9 percent in Japan and 2.6 percent in Germany while unit labor costs in USD fell at minus 0.7 percent in the US, 4.3 percent in Japan and 7.5 percent in Germany. There was increase in productivity growth in Japan and France within the G7 in the second half of the 1990s but significantly lower than the acceleration of 1.3 percentage points per year in the US. Table II-7 provides average growth rates of indicators in the research of productivity and growth of the US Bureau of Labor Statistics. There is dramatic decline of productivity growth from 2.2 percent per year on average from 1947 to 2014 to 1.4 percent per year on average in the whole cycle from 2007 to 2014. Productivity increased at the average rate of 2.3 percent from 1947 to 2007. There is profound drop in the average rate of output growth from 3.4 percent on average from 1947 to 2014 to 1.2 percent from 2007 to 2014. Output grew at 3.7 percent per year on average from 1947 to 2007. 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 2.3 percent on average in the cyclical expansion in the 22 quarters from IIIQ2009 to IVQ2014. 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 IVQ2014 (http://www.bea.gov/newsreleases/national/gdp/2015/pdf/gdp4q14_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/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2015/02/financial-and-international.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, 4.9 percent from IQ1983 to IIQ1988 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier (http://cmpassocregulationblog.blogspot.com/2015/02/financial-and-international.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 IVQ2014 would have accumulated to 23.0 percent. GDP in IVQ2014 would be $18,438.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,144.3 billion than actual $16,293.7 billion. There are about two trillion dollars of GDP less than at trend, explaining the 27.2 million unemployed or underemployed equivalent to actual unemployment of 16.5 percent of the effective labor force (Section I and earlier http://cmpassocregulationblog.blogspot.com/2015/02/job-creation-and-monetary-policy-twenty.html and earlier http://cmpassocregulationblog.blogspot.com/2015/01/fluctuating-valuations-of-risk.html). US GDP in IVQ2014 is 11.6 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,293.7 billion in IVQ2014 or 8.7 percent at the average annual equivalent rate of 1.2 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. There is classic research on analyzing deviations of output from trend (see for example Schumpeter 1939, Hicks 1950, Lucas 1975, Sargent and Sims 1977). The long-term trend is growth at average 3.3 percent per year from Jan 1919 to Jan 2015. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 124.8993 in Jan 2015. The actual index NSA in Jan 2015 is 99.8883, which is 20.0 percent below trend. Manufacturing output grew at average 2.4 percent between Dec 1986 and Dec 2014, raising the index at trend to 117.3927 in Jan 2015. The output of manufacturing at 99.8883 in Jan 2015 is 14.9 percent below trend under this alternative calculation.

Table II-7, US, Productivity and Costs, Average Annual Percentage Changes 2007-2014 and 1947-2014

	Average Annual Percentage Rate 2007-2014	Average Annual Percentage Rate 1947-2007	Average Annual Percentage Rate 1947-2014
Productivity	1.4	2.3	2.2
Output	1.2	3.7	3.4
Hours	-1.5*	1.4	1.2
Employment	-1.2*	1.6	1.5
Average Weekly Hours	-0.3*	-14.6*	-14.8*
Hourly Compensation	2.0	5.4	5.0
Consumer Price Inflation	1.9	3.8	3.6
Real Hourly Compensation	0.1	1.7	1.5
Unit Labor Costs	0.6	3.0	2.8
Unit Non-labor Payments	2.4	3.5	3.4
Output per Job	1.4	2.0	1.9

* Percentage Change

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Unit labor costs increased sharply during the Great Inflation from the late 1960s to 1981 as shown by sharper slope in Chart II-8. Unit labor costs continued to increase but at a lower rate because of cyclic factors and not because of imaginary secular stagnation.

Real hourly compensation increased at relatively high rates after 1947 to the early 1970s but reached a plateau that lasted until the early 1990s, as shown in Chart II-9. There were rapid increases until the global recession. Cyclic factors and not alleged secular stagnation explain the interruption of increases in real hourly compensation.

Chart II-8, US, Nonfarm Business, Unit Labor Costs, 1947-2014, Index 2009=100

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

Chart II-9, US, Nonfarm Business, Real Hourly Compensation, 1947-2014, Index 2009=100

Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/

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. Wealth of households increased over the business cycle by total 7.5 percent adjusted for inflation from IVQ2007 to IIIQ2014 while growing at 3.1 percent per year adjusted for inflation from IVQ1945 to IIIQ2014 with 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 Feb 27 and daily values throughout the week ending on Mar 6, 2015 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 Feb 27 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Feb 27, 2015”, first row “USD/EUR 1.1197 1.6% 0.0%,” provides the information that the US dollar (USD) appreciated 1.6 percent to USD 1.1197/EUR in the week ending on Fri Feb 27 relative to the exchange rate on Fri Feb 20 and changed 0.0 percent relative to Thu Feb 26. 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 1.1197/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Feb 27, appreciating to USD 1.1185/EUR on Mon Mar 2, 2015, or by 0.1 percent. The dollar appreciated because fewer dollars, 1.1185, were required on Mon Mar 2 to buy one euro than $1.1197 on Fri Feb 27. 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 1.1197/EUR on Feb 27. 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 Feb 27, to the last business day of the current week, in this case Fri Mar 6, such as appreciation of 3.2 percent to USD 1.0843/EUR by Mar 6. 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 3.2 percent from the rate of USD 1.1197/EUR on Fri Feb 27 to the rate of USD 1.0843/EUR on Fri Mar 6 {[(1.0843/1.1197) - 1]100 = -3.2%}. The dollar appreciated (denoted by positive sign) by 1.7 percent from the rate of USD 1.1030 on Thu Feb 5 to USD 1.0843/EUR on Fri Mar 6 {[(1.0843/1.1030) -1]100 = -1.7 %}. 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.

Table III-I, Weekly Financial Risk Assets Mar 2 to Mar 6, 2015

Fri 27

Mon 2

Tue 3

Wed 4

Thu 5

Fri 6

USD/ EUR

1.1197

1.6%

0.0%

1.1185

0.1%

1.1176

0.2%

0.1%

1.1081

1.0%

0.9%

1.1030

1.5%

0.5%

1.0843

3.2%

1.7%

JPY/ USD

119.64

-0.5%

-0.2%

120.13

-0.4%

119.73

-0.1%

0.3%

119.69

0.0%

120.13

-0.4%

120.84

-1.0%

-0.6%

CHF/ USD

0.9540

-1.7%

-0.1%

0.9585

-0.5%

0.9613

-0.8%

-0.3%

0.9632

-1.0%

-0.2%

0.9741

-2.1%

-1.1%

0.9860

-3.4%

-1.2%

CHF/ EUR

1.0681

0.0%

-0.1%

1.0720

-0.4%

1.0743

-0.6%

-0.2%

1.0673

0.1%

0.7%

1.0744

-0.6%

-0.7%

1.0691

-0.1%

0.5%

USD/ AUD

0.7810

1.2804

-0.4%

0.1%

0.7765

1.2878

-0.6%

0.7816

1.2794

0.1%

0.7%

0.7818

1.2791

0.1%

0.0%

0.7782

1.2850

-0.4%

-0.5%

0.7718

1.2957

-1.2%

-0.8%

10Y Note

2.016

2.089

2.122

2.120

2.124

2.238

2Y Note

0.634

0.662

0.682

0.666

0.647

0.723

German Bond

2Y -0.23 10Y 0.28

2Y -0.21 10Y 0.31

2Y -0.22 10Y 0.31

2Y -0.20 10Y 0.33

2Y -0.20 10Y 0.30

2Y -0.21 10Y 0.35

DJIA

18132.70

0.0%

-0.4%

18288.63

0.9%

18203.37

0.4%

-0.5%

18096.90

-0.2%

-0.6%

18135.72

0.0%

0.2%

17856.78

-1.5%

Dow Global

2581.89

0.1%

-0.1%

2585.58

0.1%

2572.56

-0.4%

-0.5%

2558.35

-0.9%

-0.6%

2560.08

-0.8%

0.1%

2531.33

-2.0%

-1.1%

DJ Asia Pacific

1507.78

0.8%

0.0%

1506.92

0.1%

-0.1%

1510.66

0.2%

1502.34

-0.4%

-0.6%

1498.96

-0.6%

-0.2%

1501.88

-0.4%

0.2%

Nikkei 225

18797.94

2.5%

0.1%

18826.88

0.2%

18815.16

0.1%

-0.1%

18703.60

-0.5%

-0.6%

18751.84

-0.2%

0.3%

18971.00

0.9%

1.2%

Shanghai

3310.30

2.0%

0.4%

3336.28

0.8%

3263.05

1.4%

-2.2%

3279.53

-0.9%

0.5%

3248.48

-1.9%

-0.9%

3241.19

-2.1%

-0.2%

DAX

11401.66

3.2%

0.7%

11410.36

0.1%

11280.36

-1.1%

11390.38

-0.1%

1.0%

11504.01

0.9%

1.0%

11550.97

1.3%

0.4%

DJ UBS Comm.

WTI $/B

49.76

-1.2%

3.3%

49.59

-0.3%

50.52

1.5%

1.9%

51.53

3.6%

2.0%

50.76

2.0%

-1.5%

49.61

-0.3%

-2.3%

Brent $/B

62.58

4.2%

59.54

-4.9%

61.02

-2.5%

2.5%

60.55

-3.2%

-0.8%

60.48

-3.4%

-0.1%

59.73

-4.6%

-1.2%

Gold $/OZ

1212.6

0.7%

0.2%

1207.7

-0.4%

1204.0

-0.7%

-0.3%

1200.6

-1.0%

-0.3%

1195.9

-1.4%

-0.4%

1164.1

-4.0%

-2.7%

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 the Semiannual Monetary Policy Report to Congress on Feb 24, 2015, Chair Yellen analyzes the timing of interest rate increases (http://www.federalreserve.gov/newsevents/testimony/yellen20150224a.htm):

“The FOMC's assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee's judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting. Provided that labor market conditions continue to improve and further improvement is expected, the Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when, on the basis of incoming data, the Committee is reasonably confident that inflation will move back over the medium term toward our 2 percent objective.”

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).”

The minutes of the meeting of the Federal Open Market Committee (FOMC) on Sep 16-17, 2014, reveal concern with global economic conditions (http://www.federalreserve.gov/monetarypolicy/fomcminutes20140917.htm):

“Most viewed the risks to the outlook for economic activity and the labor market as broadly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.”

There is similar concern in the minutes of the meeting of the FOMC on Dec 16-17, 2014 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20141217.htm):

“In their discussion of the foreign economic outlook, participants noted that the implications of the drop in crude oil prices would differ across regions, especially if the price declines affected inflation expectations and financial markets; a few participants said that the effect on overseas employment and output as a whole was likely to be positive. While some participants had lowered their assessments of the prospects for global economic growth, several noted that the likelihood of further responses by policymakers abroad had increased. Several participants indicated that they expected slower economic growth abroad to negatively affect the U.S. economy, principally through lower net exports, but the net effect of lower oil prices on U.S. economic activity was anticipated to be positive.”

Prior risk determining events are in an appendix below following Table III-1A. 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. 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 $25 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Jan 28, 2015 (http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm):

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, 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 and international developments. Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.” (emphasis added). The FOMC added “readings” of “international developments.”

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. 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 $25 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Jan 28, 2015 (http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm):

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 the press conference following the meeting on Dec 17, 2014, Chair Yellen answered a question by Jon Hilseranth of the Wall Street Journal explaining “patience” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20141217.pdf):

“So I did say that this statement that the committee can be patient should be interpreted as meaning that it is unlikely to begin the normalization process, for at least the next couple of meetings. Now that doesn't point to any preset or predetermined time at which normalization is -- will begin. There are a range of views on the committee, and it will be dependent on how incoming data bears on the progress, the economy is making. First of all, I want to emphasize that no meeting is completely off the table in the sense that if we do see faster progress toward our objectives than we currently expect, then it is possible that the process of normalization would occur sooner than we now anticipated. And of course the converse is also true. So at this point, we think it unlikely that it will be appropriate, that we will see conditions for at least the next couple of meetings that will make it appropriate for us to decide to begin normalization. A number of committee participants have indicated that in their view, conditions could be appropriate by the middle of next year. But there is no preset time.”

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

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

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

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

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

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

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

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

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

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

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

Another critical concern in the statement of the FOMC on Sep 18, 2013, is on the effects of tapering expectations on interest rates (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):

“Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth” (emphasis added).

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

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

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

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

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

Greenspan (1996) made similar warnings:

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

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

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

The Communiqué of the Istanbul meeting of G20 Finance Ministers and Central Bank Governors on February 10, 2015, sanctions the need of unconventional monetary policy with warning on collateral effects (http://www.g20.utoronto.ca/2015/150210-finance.html):

“We agree that consistent with central banks' mandates, current economic conditions require accommodative monetary policies in some economies. In this regard, we welcome that central banks take appropriate monetary policy action. The recent policy decision by the ECB aims at fulfilling its price stability mandate, and will further support the recovery in the euro area. We also note that some advanced economies with stronger growth prospects are moving closer to conditions that would allow for policy normalization. In an environment of diverging monetary policy settings and rising financial market volatility, policy settings should be carefully calibrated and clearly communicated to minimize negative spillovers.”

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

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

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

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

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

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

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

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

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

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

W = Y/r (10

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

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

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

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

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

The Swiss National Bank (SNB) announced on Jan 15, 2015, the termination of its peg of the exchange rate of the Swiss franc to the euro (http://www.snb.ch/en/mmr/speeches/id/ref_20150115_tjn/source/ref_20150115_tjn.en.pdf):

“The Swiss National Bank (SNB) has decided to discontinue the minimum exchange rate of CHF 1.20 per euro with immediate effect and to cease foreign currency purchases associated with enforcing it.”

The SNB also lowered interest rates to nominal negative percentages (http://www.snb.ch/en/mmr/speeches/id/ref_20150115_tjn/source/ref_20150115_tjn.en.pdf):

“At the same time as discontinuing the minimum exchange rate, the SNB will be lowering the interest rate for balances held on sight deposit accounts to –0.75% from 22 January. The exemption thresholds remain unchanged. Further lowering the interest rate makes Swiss-franc investments considerably less attractive and will mitigate the effects of the decision to discontinue the minimum exchange rate. The target range for the three-month Libor is being lowered by 0.5 percentage points to between –1.25% and –0.25%.”

The Swiss franc rate relative to the euro (CHF/EUR) appreciated 18.7 percent on Jan 15, 2015. The Swiss franc rate relative to the dollar (CHF/USD) appreciated 17.7 percent. Central banks are taking measures in anticipation of the quantitative easing program of the European Central Bank.

On Jan 22, 2015, the European Central Bank (ECB) decided to implement an “expanded asset purchase program” with combined asset purchases of €60 billion per month “until at least Sep 2016 (http://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html). The objective of the program is that (http://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html):

“Asset purchases provide monetary stimulus to the economy in a context where key 3ECB interest rates are at their lower bound. They further ease monetary and financial conditions, making access to finance cheaper for firms and households. This tends to support investment and consumption, and ultimately contributes to a return of inflation rates towards 2%.”

The President of the ECB, Mario Draghi, explains the coordination of asset purchases with NCBs (National Central Banks) of the euro area and risk sharing (http://www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html):

“In March 2015 the Eurosystem will start to purchase euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary market. The purchases of securities issued by euro area governments and agencies will be based on the Eurosystem NCBs’ shares in the ECB’s capital key. Some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme. As regards the additional asset purchases, the Governing Council retains control over all the design features of the programme and the ECB will coordinate the purchases, thereby safeguarding the singleness of the Eurosystem’s monetary policy. The Eurosystem will make use of decentralised implementation to mobilise its resources. With regard to the sharing of hypothetical losses, the Governing Council decided that purchases of securities of European institutions (which will be 12% of the additional asset purchases, and which will be purchased by NCBs) will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will not be subject to loss sharing. The ECB will hold 8% of the additional asset purchases. This implies that 20% of the additional asset purchases will be subject to a regime of risk sharing.”

The President of the ECB, Mario Draghi, rejected the possibility of seigniorage in the new asset purchase program, or central bank financing of fiscal expansion (http://www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html):

“As I just said, it would be a big mistake if countries were to consider that the presence of this programme might be an incentive to fiscal expansion. They would undermine the confidence, so it’s not directed to monetary financing at all. Actually, it’s been designed as to avoid any monetary financing.”

The President of the ECB, Mario Draghi, does not find effects of monetary policy in inflating asset prices (http://www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html):

“On the first question, we monitor closely any potential instance of risk to financial stability. So we're very alert to that risk. So far we don't see bubbles. There may be some local episodes of certain specific markets where prices are going up fast. But to have a bubble, besides having that, one should also identify, detect an increase, dramatic increase in leverage or in bank credit, and we don't see that now. However, we, as I said, we are alert. If bubbles are of a local nature, they should be addressed by local instruments, namely macro-prudential instruments rather than by monetary policy.”

The DAX index of German equities increased 1.3 percent on Jan 22, 2015 and 2.1 percent on Jan 23, 2015. The euro depreciated from EUR 1.1611/USD (EUR 0.8613/USD) on Wed Jan 21, 2015, to EUR 1.1206/USD (EUR 0.8924/USD) on Fri Jan 23, 2015, or 3.6 percent. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. Risk aversion erodes devaluation of the dollar.

Another hurdle of exit from zero interest rates is “competitive easing” that Professor Raghuram Rajan, governor of the Reserve Bank of India, characterizes as disguised “competitive devaluation” (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). The fed has been considering increasing interest rates. The European Central Bank (ECB) announced, on Mar 5, 2015, the beginning on Mar 9, 2015 of its quantitative easing program denominated as Public Sector Purchase Program (PSPP), consisting of “combined monthly purchases of EUR 60 bn [billion] in public and private sector securities” (http://www.ecb.europa.eu/mopo/liq/html/pspp.en.html). Expectation of increasing interest rates in the US together with euro rates close to zero or negative cause revaluation of the dollar (or devaluation of the euro and of most currencies worldwide). US corporations suffer currency translation losses of their foreign transactions and investments (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318) while the US becomes less competitive in world trade (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), Government Intervention in Globalization (2008c)). The DJIA fell 1.5 percent on Mar 6, 2015 and the dollar revalued 2.2 percent from Mar 5 to Mar 6, 2015. The euro has devalued 46.7 percent relative to the dollar from the high on Jul 15, 2008 to Mar 6, 2015.

Fri 27 Feb

Mon 3/2

Tue 3/3

Wed 3/4

Thu 3/5

Fri 3/6

USD/ EUR

1.1197

1.6%

0.0%

1.1185

0.1%

1.1176

0.2%

0.1%

1.1081

1.0%

0.9%

1.1030

1.5%

0.5%

1.0843

3.2%

1.7%

In the Introductory Statement to the press conference on Dec 4, 2014, the President of the European Central Bank Mario Draghi advised that (http://www.ecb.europa.eu/press/pressconf/2014/html/is141204.en.html):

“In this context, early next year the Governing Council will reassess the monetary stimulus achieved, the expansion of the balance sheet and the outlook for price developments. We will also evaluate the broader impact of recent oil price developments on medium-term inflation trends in the euro area. Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council remains unanimous in its commitment to using additional unconventional instruments within its mandate. This would imply altering early next year the size, pace and composition of our measures.”

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.”

At the Thirtieth Meeting of the International Monetary and Financial Committee of the IMF (IMFC), the President of the European Central Bank (ECB), Mario Draghi stated (http://www.ecb.europa.eu/press/key/date/2014/html/sp141010.en.html):

“Our monetary policy continues to aim at firmly anchoring medium to long-term inflation expectations, in line with our objective of maintaining inflation rates below, but close to, 2% over the medium term. In this context, we have taken both conventional and unconventional measures that will contribute to a return of inflation rates to levels closer to our aim. Our unconventional measures, more specifically our TLTROs (Targeted Longer-Term Refinancing Operations) and our new purchase programmes for ABSs and covered bonds, will further enhance the functioning of our monetary policy transmission mechanism and facilitate credit provision to the real economy. Should it become necessary to further address risks of too prolonged a period of low inflation, the ECB’s Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate.”

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.”

In a speech on “Monetary Policy in the Euro Area,” on Nov 21, 2014, the President of the European Central Bank, Mario Draghi, advised of the determination to bring inflation back to normal levels by aggressive holding of securities in the balance sheet (http://www.ecb.europa.eu/press/key/date/2014/html/sp141121.en.html):

“In short, there is a combination of policies that will work to bring growth and inflation back on a sound path, and we all have to meet our responsibilities in achieving that. For our part, we will continue to meet our responsibility – we will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us.

If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialise, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases.”

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/2015/01/peaking-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2014/01/theory-and-reality-of-secular.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 17,856.78 on Fri Mar 6, 2015, which is higher by 26.1 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 25.8 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial assets 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):

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

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

Greenspan (1996) made similar warnings:

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

Banking was important in facilitating economic growth in historical periods (Cameron 1961, 1967, 1972; Cameron et al. 1992). Banking is also important currently because small- and medium-size business may have no other form of financing than banks in contrast with many options for larger and more mature companies that have access to capital markets. Calomiris and Haber (2014) find that broad voting rights and institutions restricting coalitions of bankers and populists ensure stable banking systems and access to credit.

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 17, 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 1.286 percent on Mar 6, 2014, and that of the ten-year sovereign bond of Italy at 1.315 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 Mar 6, 2015, the yield of the two-year Treasury increased to 0.723 percent and that of the ten-year Treasury increased to 2.238 percent while the yield of the two-year bond of Germany stabilized at minus 0.21 percent and the ten-year yield increased to 0.35 percent; and the dollar appreciated at USD 1.0843/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 2.238 percent is higher than consumer price inflation of minus 0.1 percent in the 12 months ending in Jan 2015 (http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier http://www.bls.gov/cpi/ http://cmpassocregulationblog.blogspot.com/2015/01/competitive-currency-conflicts-world.html) and the expectation of higher inflation if risk aversion diminishes. The one-year Treasury yield of 0.257 percent (http://online.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3002) is above the 12-month consumer price inflation of minus 0.1 percent, which appears to be temporary. 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
03/06/15	0.723	2.238	-0.21	0.35	1.0843
02/27/15	0.634	2.016	-0.23	0.28	1.1197
02/20/15	0.642	2.119	-0.23	0.33	1.1381
02/13/15	0.640	2.043	-0.23	0.31	1.1391
02/06/15	0.640	1.941	-0.21	0.34	1.1316
01/30/15	0.450	1.683	-0.19	0.27	1.1291
01/23/15	0.495	1.804	-0.18	0.39	1.1206
01/16/15	0.488	1.826	-0.17	0.41	1.1567
01/09/15	0.577	1.973	-0.12	0.49	1.1843
01/02/15	0.670	2.126	-0.12	0.50	1.2003
12/26/14	0.739	2.248	-0.10	0.59	1.2182
12/19/14	0.654	2.185	-0.09	0.59	1.2229
12/12/14	0.546	2.086	-0.05	0.62	1.2464
12/05/14	0.641	2.306	-0.02	1.04	1.2285
11/28/14	0.470	2.165	-0.04	0.70	1.2452
11/21/14	0.507	2.307	-0.04	0.77	1.2390
11/14/21	0.510	2.319	-0.04	0.78	1.2525
11/7/14	0.501	2.302	-0.06	0.82	1.2455
10/31/14	0.495	2.332	-0.06	0.84	1.2773
10/24/14	0.380	2.263	-0.04	0.89	1.2671
10/17/14	0.373	2.197	-0.06	0.86	1.2760
10/10/14	0.434	2.292	-0.06	0.89	1.2629
10/03/14	0.562	2.437	-0.07	0.92	1.2514
09/26/14	0.581	2.527	-0.07	0.97	1.2683
09/19/14	0.567	2.576	-0.07	1.04	1.2829
09/12/14	0.562	2.606	-0.06	1.08	1.2965
09/05/14	0.510	2.457	-0.08	0.93	1.2952
08/29/14	0.490	2.342	-0.04	0.89	1.3133
08/22/14	0.490	2.399	0.00	0.98	1.3242
08/15/14	0.405	2.341	-0.02	0.95	1.3400
08/08/14	0.446	2.420	0.00	1.05	1.3411
08/01/14	0.470	2.497	0.02	1.13	1.3430
07/25/14	0.494	2.464	0.02	1.15	1.3431
07/18/14	0.478	2.484	0.02	1.15	1.3525
07/11/14	0.446	2.516	0.01	1.20	1.3608
07/04/14	0.502	2.641	0.02	1.26	1.3595
06/27/14	0.463	2.536	0.03	1.26	1.3649
06/20/14	0.458	2.609	0.03	1.34	1.3600
06/13/14	0.451	2.605	0.02	1.36	1.3540
06/06/14	0.405	2.598	0.05	1.35	1.3643
05/30/14	0.373	2.473	0.06	1.36	1.3632
05/23/14	0.345	2.532	0.06	1.41	1.3630
05/16/14	0.357	2.520	0.09	1.33	1.3694
05/09/14	0.385	2.624	0.13	1.45	1.3760
05/02/14	0.421	2.583	0.12	1.45	1.3873
04/25/14	0.432	2.668	0.17	1.48	1.3833
04/18/14	0.401	2.724	0.17	1.51	1.3813
04/11/14	0.357	2.628	0.16	1.50	1.3885
04/04/14	0.413	2.724	0.16	1.55	1.3704
03/28/14	0.448	2.721	0.14	1.55	1.3752
03/21/14	0.431	2.743	0.20	1.63	1.3793
03/14/14	0.340	2.654	0.15	1.54	1.3912
03/07/14	0.367	2.792	0.17	1.65	1.3877
02/28/14	0.323	2.655	0.13	1.62	1.3801
02/21/14	0.316	2.730	0.12	1.66	1.3739
02/14/14	0.313	2.743	0.11	1.68	1.3693
02/07/14	0.305	2.681	0.09	1.66	1.3635
1/31/14	0.330	2.645	0.07	1.66	1.3488
1/24/14	0.342	2.720	0.12	1.66	1.3677
1/17/14	0.373	2.818	0.17	1.75	1.3541
1/10/14	0.372	2.858	0.18	1.84	1.3670
1/3/14	0.398	2.999	0.20	1.94	1.3588
12/27/13	0.393	3.004	0.24	1.95	1.3746
12/20/13	0.377	2.891	0.22	1.87	1.3673
12/13/13	0.328	2.865	0.24	1.83	1.3742
12/6/13	0.304	2.858	0.21	1.84	1.3705
11/29/13	0.283	2.743	0.11	1.69	1.3592
11/22/13	0.280	2.746	0.13	1.74	1.3557
11/15/13	0.292	2.704	0.10	1.70	1.3497
11/8/13	0.316	2.750	0.10	1.76	1.3369
11/1/13	0.311	2.622	0.11	1.69	1.3488
10/25/13	0.305	2.507	0.18	1.75	1.3804
10/18/13	0.321	2.588	0.17	1.83	1.3686
10/11/13	0.344	2.688	0.18	1.86	1.3543
10/4/13	0.335	2.645	0.17	1.84	1.3557
9/27/13	0.335	2.626	0.16	1.78	1.3523
9/20/13	0.333	2.734	0.21	1.94	1.3526
9/13/13	0.433	2.890	0.22	1.97	1.3297
9/6/13	0.461	2.941	0.26	1.95	1.3179
8/23/13	0.401	2.784	0.23	1.85	1.3221
8/23/13	0.374	2.818	0.28	1.93	1.3380
8/16/13	0.341	2.829	0.22	1.88	1.3328
8/9/13	0.30	2.579	0.16	1.68	1.3342
8/2/13	0.299	2.597	0.15	1.65	1.3281
7/26/13	0.315	2.565	0.15	1.66	1.3279
7/19/13	0.300	2.480	0.08	1.52	1.3141
7/12/13	0.345	2.585	0.10	1.56	1.3068
7/5/13	0.397	2.734	0.11	1.72	1.2832
6/28/13	0.357	2.486	0.19	1.73	1.3010
6/21/13	0.366	2.542	0.26	1.72	1.3122
6/14/13	0.276	2.125	0.12	1.51	1.3345
6/7/13	0.304	2.174	0.18	1.54	1.3219
5/31/13	0.299	2.132	0.06	1.50	1.2996
5/24/13	0.249	2.009	0.00	1.43	1.2932
5/17/13	0.248	1.952	-0.03	1.32	1.2837
5/10/13	0.239	1.896	0.05	1.38	1.2992
5/3/13	0.22	1.742	0.00	1.24	1.3115
4/26/13	0.209	1.663	0.00	1.21	1.3028
4/19/13	0.232	1.702	0.02	1.25	1.3052
4/12/13	0.228	1.719	0.02	1.26	1.3111
4/5/13	0.228	1.706	0.01	1.21	1.2995
3/29/13	0.244	1.847	-0.02	1.29	1.2818
3/22/13	0.242	1.931	0.03	1.38	1.2988
3/15/13	0.246	1.992	0.05	1.46	1.3076
3/8/13	0.256	2.056	0.09	1.53	1.3003
3/1/13	0.236	1.842	0.03	1.41	1.3020
2/22/13	0.252	1.967	0.13	1.57	1.3190
2/15/13	0.268	2.007	0.19	1.65	1.3362
2/8/13	0.252	1.949	0.18	1.61	1.3365
2/1/13	0.26	2.024	0.25	1.67	1.3642
1/25/13	0.278	1.947	0.26	1.64	1.3459
1/18/13	0.252	1.84	0.18	1.56	1.3321
1/11/13	0.247	1.862	0.13	1.58	1.3343
1/4/13	0.262	1.898	0.08	1.54	1.3069
12/28/12	0.252	1.699	-0.01	1.31	1.3218
12/21/12	0.272	1.77	-0.01	1.38	1.3189
12/14/12	90.232	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 Mar 5, 2014, with the one-month yield at 0.02 percent, the two-year at 0.65 percent, the ten-year at 2.11 percent, the fed funds rate at 0.11 percent and the corporate Baa bond at 4.58 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-Mar 6, 2015

Note: US Recessions in shaded areas

Source: Board of Governors of the Federal Reserve System

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

Sharp and continuing strengthening of the dollar is affecting balance sheets of US corporations with foreign operations (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318). The Federal Open Market Committee (FOMC) is following “financial and international developments” as part of the process of framing interest rate policy (http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm). 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 $1,222.9 billion in IIQ1988 or 28.5 percent. Real gross private domestic investment in the US increased 7.5 percent from $2605.2 billion in IVQ2007 to $2,800.2 billion in IVQ2014. Real private fixed investment increased 3.3 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,672.7 billion in IVQ2014. Private fixed investment fell relative to IVQ2007 in all quarters preceding 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.

Corporate profits with IVA and CCA rebounded with $3.1 billion in IVQ2013. Corporate profits with IVA and CCA fell $201.7 billion in IQ2014 and increased $164.1 billion in IIQ2014. Corporate profits with IVA and CCA increased $64.5 billion in IIIQ2014. In IVQ2013, profits after tax with IVA and CCA decreased $24.7 billion. In IQ2014, profits after tax with IVA and CCA decreased $268.6 billion. Profits after tax with IVA and CCA increased at $118.4 billion in IIQ2014 and at $70.1 billion in IIIQ2014. 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 IQ2014 and fell at $0.5 billion in IIQ2014. Net dividends fell at $3.9 billion in IIIQ2014. Undistributed profits with IVA and CCA fell at $105.5 billion in IVQ2013. Undistributed profits with IVA and CCA fell $178.9 percent in IQ2014 and increased at $118.8 billion in IIQ2014 and at $73.9 billion in IIIQ2014. Undistributed corporate profits swelled 315.9 percent from $107.7 billion in IQ2007 to $447.9 billion in IIIQ2014 and changed signs from minus $55.9 billion in current dollars in IVQ2007. Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment.

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

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

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

There is mixed performance in equity indexes with several indexes in Table III-1 increasing in the week ending on Mar 6, 2014, after wide swings caused by reallocations of investment portfolios worldwide. Stagnating revenues, corporate cash hoarding, effects of currency oscillations on corporate earnings 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 decreased 1.5 percent on Mar 6, decreasing 1.5 percent in the week. Germany’s DAX increased 0.4 percent on Mar 6 and increased 1.3 percent in the week. Dow Global decreased 1.1 percent on Mar 6 and decreased 2.0 percent in the week. Japan’s Nikkei Average increased 1.2 percent on Mar 6 and increased 0.9 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 0.2 percent on Mar 6 and decreased 0.4 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 1974.38 on Mar 12 but closing at 3241.19 on Mar 6 for decrease of 0.2 percent and decreasing 2.1 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 Mar 6, 2015. Table III-1 shows that WTI decreased 0.3 percent in the week of Mar 6 while Brent decreased 4.6 percent in the week with turmoil in oil producing regions but lack of action by OPEC. Gold decreased 2.7 percent on Mar 6 and decreased 4.0 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 €488,659 million on Feb 27, 2015, with decrease of loans from €502,548 million in the prior week of Feb 20, 2015. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has reached €1,100,244 million in the statement of Feb 27, 2014, with marginal decrease from €1,112,682 million in the prior week of Feb 20. There is high credit risk in these transactions with capital of only €95,464 million as analyzed by Cochrane (2012Aug31).

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

	Dec 31, 2010	Dec 28, 2011	Feb 27, 2015
1 Gold and other Receivables	367,402	419,822	343,867
2 Claims on Non Euro Area Residents Denominated in Foreign Currency	223,995	236,826	278,539
3 Claims on Euro Area Residents Denominated in Foreign Currency	26,941	95,355	33,043
4 Claims on Non-Euro Area Residents Denominated in Euro	22,592	25,982	22,023
5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro	546,747	879,130	488,659 02/20/15 502,548
6 Other Claims on Euro Area Credit Institutions Denominated in Euro	45,654	94,989	124,869
7 Securities of Euro Area Residents Denominated in Euro	457,427	610,629	611,585 2/20/15 610,134
8 General Government Debt Denominated in Euro	34,954	33,928	26,665
9 Other Assets	278,719	336,574	226,586
TOTAL ASSETS	2,004, 432	2,733,235	2,155,836
Memo Items
Sum of 5 and 7	1,004,174	1,489,759	1,100,244 02/20/2015 1,112,682
Capital and Reserves	78,143	81,481	95,464

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/2015/html/fs150303.en.html

IIIE Appendix Euro Zone Survival Risk. 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 VG-7 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 Dec 2014. Exports to the non-European Union area with share of 46.2 percent in Italy’s total exports are growing at minus 0.1 percent in Jan-Dec 2014 relative to Jan-Dec 2013 while those to EMU are growing at 2.7 percent.

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

Dec 2014	Exports % Share	∆% Jan-Dec 2014/ Jan-Dec 2013	Imports % Share	∆% Jan-Dec 2014/ Jan-Dec 2013
EU	53.8	3.7	55.4	1.3
EMU 18	39.8	2.7	44.3	0.3
France	10.8	-0.7	8.5	0.4
Germany	12.4	3.3	14.8	2.5
Spain	4.4	4.6	4.5	4.1
UK	5.0	6.6	2.7	4.1
Non EU	46.2	-0.1	44.6	-5.4
Europe non EU	13.0	-7.2	12.1	-8.3
USA	6.9	10.2	3.2	8.3
China	2.5	6.6	6.4	8.6
OPEC	6.0	-2.6	8.1	-29.4
Total	100.0	2.0	100.0	-1.6

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

Source: Istituto Nazionale di Statistica

http://www.istat.it/it/archivio/149478

Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €586 million with the 18 countries of the euro zone (EMU 18) in Dec 2014 and cumulative deficit of €775 million in Jan-Dec 2014. Depreciation to parity could permit greater competitiveness in improving the trade surplus of €6862 million in Jan-Dec 2014 with Europe non-European Union, the trade surplus of €17,307 million with the US and the trade surplus with non-European Union of €28,056 million in Jan-Dec 2014. There is significant rigidity in the trade deficit in Jan-Dec 2014 of €14,560 million with China. There is a trade surplus of €2201 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 Dec 2014 Millions of Euro	Trade Balance Cumulative Jan-Dec 2014 Millions of Euro
EU	506	14,840
EMU 18	-586	-775
France	989	11,367
Germany	-773	-4,559
Spain	108	924
UK	907	10,831
Non EU	5,249	28,056
Europe non EU	1,027	6,862
USA	1,647	17,307
China	-1,008	-14,560
OPEC	813	2,201
Total	5,756	42,897

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

Source: Istituto Nazionale di Statistica

http://www.istat.it/it/archivio/149478

Growth rates of Italy’s trade and major products are in Table III-5 for the period Jan-Dec 2014 relative to Jan-Dec 2013. Growth rates of cumulative imports relative to a year earlier are negative for energy with minus 19.5 percent. Exports of durable goods grew 2.0 percent and exports of capital goods increased 4.5 percent. The higher rate of growth of exports of 2.0 percent in Jan-Dec 2014/Jan-Dec 2013 relative to that of imports of minus 1.6 percent may reflect weak demand in Italy with GDP declining during nine consecutive quarters from IIIQ2011 through IIIQ2013 together with softening commodity prices. GDP decreased marginally 0.1 percent in IVQ2013, changed 0.0 percent in IQ2014 and fell 0.2 percent in IIQ2014. Italy’s GDP fell 0.1 percent in IIIQ2014 and changed 0.0 percent in IVQ2014.

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

	Exports Share %	Exports ∆% Jan-Dec 2014/ Jan-Dec 2013	Imports Share %	Imports ∆% Jan-Dec 2014/ Jan-Dec 2013
Consumer Goods	31.0	3.7	27.3	3.1
Durable	6.0	2.0	2.9	8.6
Non-Durable	25.1	4.1	24.4	2.4
Capital Goods	32.3	4.5	20.5	5.2
Inter- mediate Goods	32.3	0.0	32.4	1.0
Energy	4.4	-14.4	19.9	-19.5
Total ex Energy	95.6	2.7	80.1	2.8
Total	100.0	2.0	100.0	-1.6

Note: % Share for 2012 total trade.

Source: Istituto Nazionale di Statistica

http://www.istat.it/it/archivio/149478

Table III-6 provides Italy’s trade balance by product categories in Dec 2014 and cumulative Jan-Dec 2014. Italy’s trade balance excluding energy, generated surplus of €8748 million in Dec 2014 and €86,021 million cumulative in Jan-Dec 2014 but the energy trade balance created deficit of 2993 million in Dec 2014 and cumulative €43,124 million in Jan-Dec 2014. The overall surplus in Dec 2014 was €5756 million with cumulative surplus of €42,897 million in Jan-Dec 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

	Dec 2014	Cumulative Jan-Dec 2014
Consumer Goods	2,231	24,017
Durable	1,037	12,446
Nondurable	1,193	11,571
Capital Goods	5,314	53,774
Intermediate Goods	1,204	8,230
Energy	-2,993	-43,124
Total ex Energy	8,748	86,021
Total	5,756	42,897

Source: Istituto Nazionale di Statistica

http://www.istat.it/it/archivio/149478

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 2015.

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

	GDP 2015 USD Billions	Primary Net Lending Borrowing % GDP 2015	General Government Net Debt % GDP 2015
World	81,544
Euro Zone	13,466	0.0	74.0
Portugal	232	1.8	123.6
Ireland	253	1.2	93.1
Greece	252	3.0	166.6
Spain	1,422	-1.7	68.8
Major Advanced Economies G7	37,042	-1.8	86.5
United States	18,287	-2.2	80.9
UK	3,003	-1.9	85.0
Germany	3,909	1.5	51.6
France	2,935	-2.2	90.6
Japan	4,882	-5.0	140.0
Canada	1,873	-1.6	39.1
Italy	2,153	2.9	114.0
China	11,285	-0.3	41.8**

*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 2015” in Table III-8 is generated by applying the percentage in Table III-7 column “General Government Net Debt % GDP 2015” to the column “GDP 2015 USD Billions.” The total debt of France and Germany in 2015 is $4676.1 billion, as shown in row “B+C” in column “Net Debt USD Billions 2015” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $4374.8 billion, adding rows D+E+F+G+H in column “Net Debt USD billions 2015.” 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 $9050.9 billion, which would be equivalent to 132.2 percent of their combined GDP in 2015. 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 231.5 percent if including debt of France and 163.5 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 2015	Debt as % of Germany Plus France GDP	Debt as % of Germany GDP
A Euro Area	9,964.8
B Germany	2,017.0		$9050.9 as % of $3909 =231.5% $6391.8 as % of $3909 =163.5%
C France	2,659.1
B+C	4,676.1	GDP $6,844.0 Total Debt $9,050.9 Debt/GDP: 132.2%
D Italy	2,454.4
E Spain	978.3
F Portugal	286.8
G Greece	419.8
H Ireland	235.5
Subtotal D+E+F+G+H	4,374.8

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 Dec 2014. German exports to other European Union (EU) members are 50.8 percent of total exports in Dec 2014 and 58.0 percent in cumulative Jan-Dec 2014. Exports to the euro area are 35.5 percent of the total in Dec and 36.5 percent cumulative in Jan-Dec. Exports to third countries are 43.6 percent of the total in Dec and 42.0 percent cumulative in Jan-Dec. There is similar distribution for imports. Exports to non-euro countries are increasing 15.5 percent in the 12 months ending in Dec 2014, increasing 10.2 percent cumulative in Jan-Dec 2014 while exports to the euro area are increasing 6.3 percent in the 12 months ending in Dec 2014 and increasing 2.7 percent cumulative in Jan-Dec 2014. Exports to third countries, accounting for 43.6 percent of the total in Dec 2014, are increasing 10.5 percent in the 12 months ending in Dec 2014 and increasing 1.5 percent cumulative in Jan-Dec 2014, accounting for 42.0 percent of the cumulative total in Jan-Dec 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 III-9, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	Dec 2014 € Billions	Dec 12-Month ∆%	Cumulative Jan-Dec 2014 € Billions	Cumulative Jan-Dec 2014/ Jan-Dec 2013 ∆%
Total Exports	90.1	10.0	1,133.6	3.7
A. EU Members	50.8 % 56.4	9.5	657.3 % 58.0	5.4
Euro Area	32.0 % 35.5	6.3	414.2 % 36.5	2.7
Non-euro Area	18.8 % 20.9	15.5	243.1 % 21.4	10.2
B. Third Countries	39.3 % 43.6	10.5	476.2 % 42.0	1.5
Total Imports	71.1	4.0	916.5	2.0
C EU Members	46.3 % 65.1	3.0	599.9 % 65.5	3.6
Euro Area	31.7 % 44.6	0.8	411.4 % 44.9	2.3
Non-euro Area	14.7 % 20.7	3.4	188.5 % 20.6	6.3
D Third Countries	24.7 % 34.7	6.0	316.6 % 34.5	-0.9

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

Source: Statistisches Bundesamt Deutschland

https://www.destatis.de/EN/PressServices/Press/pr/2015/02/PE15_038_51.html

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

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

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

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

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

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

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

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

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

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

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

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

M_tV(i_t, ·) = P_tY_t (5)

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

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

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

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

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

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

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

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Monday, March 9, 2015

Global Competitive Devaluation, Rules, Discretionary Authorities and Slow Productivity Growth, Twenty Seven Million Unemployed or Underemployed, Stagnating Real Wages, Stagnating Real Disposable Income, Financial Repression, World Cyclical Slow Growth and Global Recession Risk: Part III

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