“Quite High” Equity Valuations and “Potential Dangers” in Bonds, Twenty Six Million Unemployed or Underemployed, Stagnating Real Wages, Rules, Discretionary Authorities and Slow Productivity Growth, United States International Trade, World Cyclical Slow Growth and Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015
I Twenty Six 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
IIA Rules, Discretionary Authorities and Slow Productivity Growth
IIB United States International Trade
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 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 new estimate for IQ2015, revision of the estimates for IVQ2014 and IIIQ2014 together with data for nonfarm business sector productivity and unit labor costs in seasonally adjusted annual equivalent (SAAE) rate and the percentage change from the same quarter a year earlier. Reflecting decrease in output of minus 0.2 percent and increase of 1.7 percent in hours worked, nonfarm business sector labor productivity decreased at the SAAE rate of 1.9 percent in IQ2015, as shown in column 2 “IQ2015 SAEE.” The increase of labor productivity from IQ2014 to IQ2015 was 0.6 percent, reflecting increases in output of 3.5 percent and of hours worked of 2.9 percent, as shown in column 3 “IQ2015 YoY.” Hours worked changed from 2.4 percent in IIIQ2014 in SAAE to 4.9 percent in IVQ2014 and decreased to 1.7 percent in IQ2015 while output growth decreased from 6.3 percent in IIIQ2014 to 2.6 percent in IVQ2014, easing to minus 0.2 percent in IQ2015. 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 5.0 percent in IQ2015 and increased 1.1 percent in IQ2015 relative to IQ2014. Hourly compensation increased at the SAAE rate of 3.1 percent in IQ2015, which deflating by the estimated consumer price increase SAAE rate in IQ2015 results in increase of real hourly compensation at 6.2 percent. Real hourly compensation increased 1.8 percent in IQ2015 relative to IQ2014.
Table II-1, US, Nonfarm Business Sector Productivity and Costs %
| IQ 2015 SSAE | IQ 2015 YOY | IVQ | IVQ | III 2014 SAAE | IIIQ 2014 YoY | |
| Productivity | -1.9 | 0.6 | -2.1 | -0.1 | 3.9 | 1.2 |
| Output | -0.2 | 3.5 | 2.6 | 2.9 | 6.3 | 3.5 |
| Hours | 1.7 | 2.9 | 4.9 | 3.0 | 2.4 | 2.2 |
| Hourly | 3.1 | 1.7 | 1.9 | 2.5 | 2.8 | 2.4 |
| Real Hourly Comp. | 6.2 | 1.8 | 2.8 | 1.3 | 1.7 | 0.7 |
| Unit Labor Costs | 5.0 | 1.1 | 4.2 | 2.6 | -1.0 | 1.2 |
| Unit Nonlabor Payments | -6.6 | 0.5 | -5.8 | -0.9 | 5.3 | 1.8 |
| Implicit Price Deflator | -0.1 | 0.8 | -0.3 | 1.1 | 1.7 | 1.5 |
Notes: SAAE: seasonally adjusted annual equivalent; Comp.: compensation; YoY: Quarter on Same Quarter Year Earlier
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:
Ut = Unt – α(πt – πe) α > 0 (1)
Where Ut is the rate of unemployment at current time t, Unt is the natural rate of unemployment, πt is the current rate of inflation and πe 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(πt, Ut) (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 (πt, Ut - 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 1.7 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 | 1.4 | -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
Table II-3, US, Nonfarm Business Output per Hour, Percent Change from Prior Quarter at Annual Rate, 1999-2015
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 2015. 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 2.1 percent in IVQ2014 and contracted at 1.9 percent in IQ2015.
Table II-3, US, Nonfarm Business Output per Hour, Percent Change from Prior Quarter at Annual Rate, 1999-2015
| 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 | -2.1 | 0.7 |
| 2015 | -1.9 |
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 2015. 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 2015 have been more frequent and sharper.
Chart II-1, US, Nonfarm Business Output per Hour, Percent Change from Prior Quarter at Annual Rate, 1999-2015
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. Unit labor costs increased at 5.0 percent in IQ2015.
Table II-4, US, Nonfarm Business Unit Labor Costs, Percent Change from Prior Quarter at Annual Rate 1999-2015
| 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 | 4.2 | 1.8 |
| 2015 | 5.0 |
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 1999-2015
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 32.9 percent in IQ2011 but fell at annual rates of 6.4 percent in IIQ2011 and 6.6 percent in IVQ2011. Real hourly compensation increased at 9.0 percent in IQ2012, decreasing at 0.1 percent in IIQ2012, declining at 1.9 percent in IIIQ2012 and increasing at 7.3 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 7.8 percent in IQ2013 and increased at 4.4 percent in IIQ2013, falling at 1.8 percent in IIIQ2013. Real hourly compensation increased at 0.2 percent in IVQ2013 and at 4.2 percent in IQ2014. Real hourly compensation decreased at 3.3 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 2.8 percent in IVQ2014. The annual rate of increase of real hourly compensation in 2014 is 0.8 percent. Real hourly compensation increased at 6.2 percent in IQ2015.
Table II-5, Nonfarm Business Real Hourly Compensation, Percent Change from Prior Quarter at Annual Rate 1999-2015
| Year | Qtr1 | Qtr2 | Qtr3 | Qtr4 | Annual |
| 1999 | 5.0 | -1.9 | 0.3 | 5.4 | 2.0 |
| 2000 | 11.3 | -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 | -4.0 | 4.8 | 4.3 | -2.5 | 1.8 |
| 2005 | 1.2 | -0.6 | -1.1 | -1.1 | 0.2 |
| 2006 | 6.4 | -3.3 | -3.3 | 9.2 | 0.7 |
| 2007 | 5.9 | -4.5 | -1.2 | -0.6 | 1.4 |
| 2008 | -0.4 | -4.7 | -2.6 | 14.5 | -1.1 |
| 2009 | -7.0 | 7.8 | -0.6 | -0.7 | 1.4 |
| 2010 | -3.3 | 4.9 | 0.7 | -1.5 | 0.3 |
| 2011 | 2.9 | -6.4 | -0.2 | -6.6 | -0.9 |
| 2012 | 9.0 | -0.1 | -1.9 | 7.3 | 0.6 |
| 2013 | -7.8 | 4.4 | -1.8 | 0.2 | -0.3 |
| 2014 | 4.2 | -3.3 | 1.7 | 2.8 | 0.8 |
| 2015 | 6.2 |
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 1999-2015
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 1999-2015
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 1999-2016
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.
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:
Ut = Unt – α(πt – πe) α > 0 (1)
Where Ut is the rate of unemployment at current time t, Unt is the natural rate of unemployment, πt is the current rate of inflation and πe 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(πt, Ut) (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 (πt, Ut - 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 May 6, 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 si of a demographic group in an industry i and unemployment rate yi of that demographic group (Lazear and Spletzer 2012JHJul22, 5-6):
Y = ∑isiyi (1)
This equation can be decomposed for analysis as (Lazear and Spletzer 2012JHJul22, 6):
∆Y = ∑i∆siy*i + ∑i∆yis*i (2)
The first term in (2) captures changes in the demographic and industrial composition of the economy ∆si 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 ∆yi, 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 2015. 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, 1947-2015, 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 2007-2014
| 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 | 1.4 | -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 2.2 percent on average in the cyclical expansion in the 23 quarters from IIIQ2009 to IQ2015. 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 first estimate of GDP for IQ2015 (http://www.bea.gov/newsreleases/national/gdp/2015/pdf/gdp1q15_adv.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/2015/05/dollar-devaluation-and-carry-trade.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/dollar-revaluation-and-financial-risk.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, 4.8 percent from IQ1983 to IIIQ1988 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2015/05/dollar-devaluation-and-carry-trade.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/dollar-revaluation-and-financial-risk.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 IQ2015 would have accumulated to 23.9 percent. GDP in IQ2015 would be $18,574.8 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2,270.0 billion than actual $16,304.8 billion. There are about two trillion dollars of GDP less than at trend, explaining the 25.6 million unemployed or underemployed equivalent to actual unemployment/underemployment of 15.4 percent of the effective labor force (Section I and earlier http://cmpassocregulationblog.blogspot.com/2015/04/volatility-of-valuations-of-financial.html and earlier (http://cmpassocregulationblog.blogspot.com/2015/03/global-competitive-devaluation-rules.html). US GDP in IQ2015 is 12.2 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,304.8 billion in IQ2015 or 8.8 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 Mar 1919 to Mar 2015. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 125.5771 in Mar 2015. The actual index NSA in Mar 2015 is 101.8045, which is 18.9 percent below trend. Manufacturing output grew at average 2.4 percent between Dec 1986 and Dec 2014, raising the index at trend to 117.2305 in Mar 2015. The output of manufacturing at 101.8045 in Mar 2015 is 13.2 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, 1947-2015, Index 2009=100
Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/
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-9, US, Nonfarm Business, Real Hourly Compensation, 1947-2015, Index 2009=100
Source: US Bureau of Labor Statistics http://www.bls.gov/lpc/
IIA United States International Trade. Table IIA-1 provides the trade balance of the US and monthly growth of exports and imports seasonally adjusted with the latest release and revisions (http://www.census.gov/foreign-trade/). Because of heavy dependence on imported oil, fluctuations in the US trade account originate largely in fluctuations of commodity futures prices caused by carry trades from zero interest rates into commodity futures exposures in a process similar to world inflation waves (http://cmpassocregulationblog.blogspot.com/2015/04/global-portfolio-reallocations-squeeze.html). The Census Bureau revised data for 2014, 2013 and 2012. Exports decreased 3.0 percent from Jan 2015 to Mar 2015 while imports decreased 0.5 percent. The trade deficit increased from $42,676 million in Jan 2015 to $51,367 million in Mar 2015. The US trade balance improved from deficits of $39,083 million in Oct 2013 and $42,263 million in Sep 2013 to deficit of $35,972 million in Nov 2013 but higher deficit of $37,393 million in Dec 2013. The trade deficit increased to $38,841million in Jan 2014 and deficit of $41,891 million in Feb 2014. The trade deficit increased to $42,784 million in Mar 2014 and $45,583 million in Apr 2014. The deficit improved to $43,231 million in May 2014 and $40,665 million in Jul 2014. The trade deficit improved to $39,916 million in Aug 2014, deteriorating to $43,368 million in Sep 2014 and $41,898 million in Oct 2014. The trade deficit improved to $39,529 million in Nov 2014, deteriorating to $45,601 million in Dec 2014 and improving to $42,676 million in Jan 2015 and $35,892 million in Feb 2015. The trade deficit deteriorated to $51,367 million in Mar 2015. Exports increased 2.9 percent from Jan-Dec 2013 to Jan-Dec 2014 while imports increased 3.4 percent. The trade balance deteriorated from cumulative deficit of $494,658 million in Jan-Dec 2010 to deficit of $548,625 million in Jan-Dec 2011 and improved to marginally lower deficit of $537,605 million in Jan-Dec 2012. The trade deficit improved to $476,392 million in Jan-Dec 2013, deteriorating to $504,711 million in Jan-Dec 2014.
Table IIA-1, US, Trade Balance of Goods and Services Seasonally Adjusted Millions of Dollars and ∆%
| Trade Balance | Exports | Month ∆% | Imports | Month ∆% | |
| Mar 2015 | -51,367 | 189,239 | 1.6 | 239,205 | 7.7 |
| Feb | -35,892 | 186,193 | -1.6 | 222,085 | -4.2 |
| Jan | -42,676 | 189,239 | -3.0 | 231,916 | -3.6 |
| Dec 2014 | -45,601 | 195,002 | -0.9 | 240,603 | 1.8 |
| Nov | -39,529 | 196,792 | -1.0 | 236,320 | -1.8 |
| Oct | -41,898 | 198,713 | 1.8 | 240,611 | 0.9 |
| Sep | -43,368 | 195,185 | -1.7 | 238,553 | 0.0 |
| Aug | -39,916 | 198,589 | 0.4 | 238,505 | 0.0 |
| Jul | -40,665 | 197,855 | 1.0 | 238,510 | 0.5 |
| Jun | -41,414 | 195,970 | -0.4 | 237,383 | -1.1 |
| May | -43,231 | 196,830 | 1.2 | 240,061 | 0.0 |
| Apr | -45,583 | 194,589 | 0.2 | 240,173 | 1.3 |
| Mar | -42,784 | 194,212 | 3.3 | 236,997 | 3.1 |
| Feb | -41,891 | 188,045 | -2.4 | 229,936 | -0.7 |
| Jan | -38,841 | 192,747 | 0.0 | 231,588 | 0.6 |
| Jan-Dec 2014 | -504,711 | 2,344,528 | 2.9 | 2,849,239 | 3.4 |
| Dec 2013 | -37,393 | 192,799 | -1.1 | 230,193 | -0.3 |
| Nov | -35,972 | 194,922 | 0.5 | 230,894 | -0.9 |
| Oct | -39,083 | 193,971 | 2.0 | 233,053 | 0.2 |
| Sep | -42,263 | 190,249 | -0.2 | 232,512 | 1.0 |
| Aug | -39,515 | 190,606 | 0.4 | 230,121 | 0.3 |
| Jul | -39,419 | 189,902 | -0.2 | 229,321 | 1.1 |
| Jun | -36,552 | 190,366 | 1.7 | 226,918 | -2.2 |
| May | -44,831 | 187,206 | -0.3 | 232,037 | 1.7 |
| Apr | -40,417 | 187,763 | 0.5 | 228,180 | 1.9 |
| Mar | -36,973 | 186,903 | -0.6 | 223,876 | -2.6 |
| Feb | -41,770 | 188,030 | 0.3 | 229,800 | 0.1 |
| Jan | -42,205 | 187,478 | -1.2 | 229,683 | 1.0 |
| Jan-Dec 2013 | -476,392 | 2,280,194 | 2,756,586 | ||
| Dec 2012 | -37,634 | 189,765 | 1.9 | 227,399 | -2.4 |
| Nov | -46,604 | 186,286 | 1.5 | 232,891 | 3.1 |
| Oct | -42,358 | 183,512 | -2.7 | 225,870 | -1.3 |
| Sep | -40,150 | 188,696 | 3.2 | 228,846 | 0.6 |
| Aug | -44,536 | 182,845 | -0.5 | 227,380 | -0.1 |
| Jul | -43,834 | 183,673 | -0.9 | 227,507 | -0.4 |
| Jun | -43,078 | 185,330 | 0.6 | 228,408 | -1.3 |
| May | -47,184 | 184,306 | -0.1 | 231,490 | -0.4 |
| Apr | -47,773 | 184,543 | -0.9 | 232,317 | -1.6 |
| Mar | -49,850 | 186,257 | 2.5 | 236,107 | 4.9 |
| Feb | -43,338 | 181,720 | 1.2 | 225,058 | -2.5 |
| Jan | -51,266 | 179,606 | 0.2 | 230,873 | 0.2 |
| Jan-Dec 2012 | -537,605 | 2,216,540 | 2,754,145 | ||
| Jan-Dec | -548,625 | 2,127,021 | 2,675,646 | ||
| Jan-Dec | -494,658 | 1,853,606 | 2,348,263 |
Note: Trade Balance of Goods = Exports of Goods less Imports of Goods. Trade balance may not add exactly because of errors of rounding and seasonality. Source: US Census Bureau, Foreign Trade Division
http://www.census.gov/foreign-trade/
Table IIA-1B provides US exports, imports and the trade balance of goods. The US has not shown a trade surplus in trade of goods since 1976. The deficit of trade in goods deteriorated sharply during the boom years from 2000 to 2007. The deficit improved during the contraction in 2009 but deteriorated in the expansion after 2009. The deficit could deteriorate sharply with growth at full employment.
Table IIA-1B, US, International Trade Balance of Goods, Exports and Imports of Goods, Millions of Dollars, Census Basis
| Balance | ∆% | Exports | ∆% | Imports | ∆% | |
| 1960 | 4,608 | (X) | 19,626 | (X) | 15,018 | (X) |
| 1961 | 5,476 | 18.8 | 20,190 | 2.9 | 14,714 | -2.0 |
| 1962 | 4,583 | -16.3 | 20,973 | 3.9 | 16,390 | 11.4 |
| 1963 | 5,289 | 15.4 | 22,427 | 6.9 | 17,138 | 4.6 |
| 1964 | 7,006 | 32.5 | 25,690 | 14.5 | 18,684 | 9.0 |
| 1965 | 5,333 | -23.9 | 26,699 | 3.9 | 21,366 | 14.4 |
| 1966 | 3,837 | -28.1 | 29,379 | 10.0 | 25,542 | 19.5 |
| 1967 | 4,122 | 7.4 | 30,934 | 5.3 | 26,812 | 5.0 |
| 1968 | 837 | -79.7 | 34,063 | 10.1 | 33,226 | 23.9 |
| 1969 | 1,289 | 54.0 | 37,332 | 9.6 | 36,043 | 8.5 |
| 1970 | 3,224 | 150.1 | 43,176 | 15.7 | 39,952 | 10.8 |
| 1971 | -1,476 | -145.8 | 44,087 | 2.1 | 45,563 | 14.0 |
| 1972 | -5,729 | 288.1 | 49,854 | 13.1 | 55,583 | 22.0 |
| 1973 | 2,389 | -141.7 | 71,865 | 44.2 | 69,476 | 25.0 |
| 1974 | -3,884 | -262.6 | 99,437 | 38.4 | 103,321 | 48.7 |
| 1975 | 9,551 | -345.9 | 108,856 | 9.5 | 99,305 | -3.9 |
| 1976 | -7,820 | -181.9 | 116,794 | 7.3 | 124,614 | 25.5 |
| 1977 | -28,352 | 262.6 | 123,182 | 5.5 | 151,534 | 21.6 |
| 1978 | -30,205 | 6.5 | 145,847 | 18.4 | 176,052 | 16.2 |
| 1979 | -23,922 | -20.8 | 186,363 | 27.8 | 210,285 | 19.4 |
| 1980 | -19,696 | -17.7 | 225,566 | 21.0 | 245,262 | 16.6 |
| 1981 | -22,267 | 13.1 | 238,715 | 5.8 | 260,982 | 6.4 |
| 1982 | -27,510 | 23.5 | 216,442 | -9.3 | 243,952 | -6.5 |
| 1983 | -52,409 | 90.5 | 205,639 | -5.0 | 258,048 | 5.8 |
| 1984 | -106,702 | 103.6 | 223,976 | 8.9 | 330,678 | 28.1 |
| 1985 | -117,711 | 10.3 | 218,815 | -2.3 | 336,526 | 1.8 |
| 1986 | -138,279 | 17.5 | 227,159 | 3.8 | 365,438 | 8.6 |
| 1987 | -152,119 | 10.0 | 254,122 | 11.9 | 406,241 | 11.2 |
| 1988 | -118,526 | -22.1 | 322,426 | 26.9 | 440,952 | 8.5 |
| 1989 | -109,399 | -7.7 | 363,812 | 12.8 | 473,211 | 7.3 |
| 1990 | -101,719 | -7.0 | 393,592 | 8.2 | 495,311 | 4.7 |
| 1991 | -66,723 | -34.4 | 421,730 | 7.1 | 488,453 | -1.4 |
| 1992 | -84,501 | 26.6 | 448,164 | 6.3 | 532,665 | 9.1 |
| 1993 | -115,568 | 36.8 | 465,091 | 3.8 | 580,659 | 9.0 |
| 1994 | -150,630 | 30.3 | 512,626 | 10.2 | 663,256 | 14.2 |
| 1995 | -158,801 | 5.4 | 584,742 | 14.1 | 743,543 | 12.1 |
| 1996 | -170,214 | 7.2 | 625,075 | 6.9 | 795,289 | 7.0 |
| 1997 | -180,522 | 6.1 | 689,182 | 10.3 | 869,704 | 9.4 |
| 1998 | -229,758 | 27.3 | 682,138 | -1.0 | 911,896 | 4.9 |
| 1999 | -328,821 | 43.1 | 695,797 | 2.0 | 1,024,618 | 12.4 |
| 2000 | -436,104 | 32.6 | 781,918 | 12.4 | 1,218,022 | 18.9 |
| 2001 | -411,899 | -5.6 | 729,100 | -6.8 | 1,140,999 | -6.3 |
| 2002 | -468,263 | 13.7 | 693,103 | -4.9 | 1,161,366 | 1.8 |
| 2003 | -532,350 | 13.7 | 724,771 | 4.6 | 1,257,121 | 8.2 |
| 2004 | -654,830 | 23.0 | 814,875 | 12.4 | 1,469,704 | 16.9 |
| 2005 | -772,373 | 18.0 | 901,082 | 10.6 | 1,673,455 | 13.9 |
| 2006 | -827,971 | 7.2 | 1,025,967 | 13.9 | 1,853,938 | 10.8 |
| 2007 | -808,763 | -2.3 | 1,148,199 | 11.9 | 1,956,962 | 5.6 |
| 2008 | -816,199 | 0.9 | 1,287,442 | 12.1 | 2,103,641 | 7.5 |
| 2009 | -503,582 | -38.3 | 1,056,043 | -18.0 | 1,559,625 | -25.9 |
| 2010 | -635,362 | 26.2 | 1,278,495 | 21.1 | 1,913,857 | 22.7 |
| 2011 | -725,447 | 14.2 | 1,482,508 | 16.0 | 2,207,954 | 15.4 |
| 2012 | -730,599 | 0.7 | 1,545,703 | 4.3 | 2,276,302 | 3.1 |
| 2013 | -688,728 | -5.7 | 1,579,593 | 2.2 | 2,268,321 | -0.4 |
| 2014 | -722,504 | 4.9 | 1,623,273 | 2.8 | 2,345,778 | 3.4 |
Source: US Census Bureau, Foreign Trade Division
http://www.census.gov/foreign-trade/
Chart IIA-1 of the US Census Bureau of the Department of Commerce shows that the trade deficit (gap between exports and imports) fell during the economic contraction after 2007 but has grown again during the expansion. The low average rate of growth of GDP of 2.4 percent during the expansion beginning since IIIQ2009 does not deteriorate further the trade balance. Higher rates of growth may cause sharper deterioration.
Chart IIA-1, US, International Trade Balance, Exports and Imports of Goods and Services USD Billions
Source: US Census Bureau
http://www.census.gov/briefrm/esbr/www/esbr042.html
Table IIA-2B provides the US international trade balance, exports and imports of goods and services on an annual basis from 1992 to 2014. The trade balance deteriorated sharply over the long term. The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US not seasonally adjusted increased from $87 billion in IVQ2013 to $111 billion in IVQ2014 (http://www.bea.gov/international/index.htm). The current account deficit seasonally adjusted at annual rate increased from 2.0 percent of GDP in IVQ2013 to 2.4 percent of GDP in IQ2014, decreasing to 2.2 percent of GDP in IIQ2014 and 2.2 percent of GDP in IIIQ2014. The current account deficit increased to 2.6 percent of GDP in IVQ2014 (http://www.bea.gov/international/index.htm http://www.bea.gov/iTable/index_nipa.cfm). The ratio of the current account deficit to GDP has stabilized around 3 percent of GDP compared with much higher percentages before the recession (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71). The last row of Table IIA-2B shows marginal improvement of the trade deficit from $548,625 million in 2011 to lower $537,605 million in 2012 with exports growing 4.2 percent and imports 2.9 percent. The trade balance improved further to deficit of $476,392 million in 2013 with growth of exports of 2.9 percent while imports virtually stagnated. The trade deficit deteriorated in 2014 to $505,047 million with growth of exports of 2.9 percent and of imports of 3.4 percent. Growth and commodity shocks under alternating inflation waves (http://cmpassocregulationblog.blogspot.com/2015/04/global-portfolio-reallocations-squeeze.html) have deteriorated the trade deficit from the low of $383,774 million in 2009.
Table IIA-2B, US, International Trade Balance of Goods and Services, Exports and Imports of Goods and Services, SA, Millions of Dollars, Balance of Payments Basis
| Balance | Exports | ∆% | Imports | ∆% | |
| 1960 | 3,508 | 25,940 | NA | 22,432 | NA |
| 1961 | 4,195 | 26,403 | 1.8 | 22,208 | -1.0 |
| 1962 | 3,370 | 27,722 | 5.0 | 24,352 | 9.7 |
| 1963 | 4,210 | 29,620 | 6.8 | 25,410 | 4.3 |
| 1964 | 6,022 | 33,341 | 12.6 | 27,319 | 7.5 |
| 1965 | 4,664 | 35,285 | 5.8 | 30,621 | 12.1 |
| 1966 | 2,939 | 38,926 | 10.3 | 35,987 | 17.5 |
| 1967 | 2,604 | 41,333 | 6.2 | 38,729 | 7.6 |
| 1968 | 250 | 45,543 | 10.2 | 45,293 | 16.9 |
| 1969 | 91 | 49,220 | 8.1 | 49,129 | 8.5 |
| 1970 | 2,254 | 56,640 | 15.1 | 54,386 | 10.7 |
| 1971 | -1,302 | 59,677 | 5.4 | 60,979 | 12.1 |
| 1972 | -5,443 | 67,222 | 12.6 | 72,665 | 19.2 |
| 1973 | 1,900 | 91,242 | 35.7 | 89,342 | 23.0 |
| 1974 | -4,293 | 120,897 | 32.5 | 125,190 | 40.1 |
| 1975 | 12,404 | 132,585 | 9.7 | 120,181 | -4.0 |
| 1976 | -6,082 | 142,716 | 7.6 | 148,798 | 23.8 |
| 1977 | -27,246 | 152,301 | 6.7 | 179,547 | 20.7 |
| 1978 | -29,763 | 178,428 | 17.2 | 208,191 | 16.0 |
| 1979 | -24,565 | 224,131 | 25.6 | 248,696 | 19.5 |
| 1980 | -19,407 | 271,834 | 21.3 | 291,241 | 17.1 |
| 1981 | -16,172 | 294,398 | 8.3 | 310,570 | 6.6 |
| 1982 | -24,156 | 275,236 | -6.5 | 299,391 | -3.6 |
| 1983 | -57,767 | 266,106 | -3.3 | 323,874 | 8.2 |
| 1984 | -109,072 | 291,094 | 9.4 | 400,166 | 23.6 |
| 1985 | -121,880 | 289,070 | -0.7 | 410,950 | 2.7 |
| 1986 | -138,538 | 310,033 | 7.3 | 448,572 | 9.2 |
| 1987 | -151,684 | 348,869 | 12.5 | 500,552 | 11.6 |
| 1988 | -114,566 | 431,149 | 23.6 | 545,715 | 9.0 |
| 1989 | -93,141 | 487,003 | 13.0 | 580,144 | 6.3 |
| 1990 | -80,864 | 535,233 | 9.9 | 616,097 | 6.2 |
| 1991 | -31,135 | 578,344 | 8.1 | 609,479 | -1.1 |
| 1992 | -39,212 | 616,882 | 6.7 | 656,094 | 7.6 |
| 1993 | -70,311 | 642,863 | 4.2 | 713,174 | 8.7 |
| 1994 | -98,493 | 703,254 | 9.4 | 801,747 | 12.4 |
| 1995 | -96,384 | 794,387 | 13.0 | 890,771 | 11.1 |
| 1996 | -104,065 | 851,602 | 7.2 | 955,667 | 7.3 |
| 1997 | -108,273 | 934,453 | 9.7 | 1,042,726 | 9.1 |
| 1998 | -166,140 | 933,174 | -0.1 | 1,099,314 | 5.4 |
| 1999 | -258,617 | 969,867 | 3.9 | 1,228,485 | 11.8 |
| 2000 | -372,517 | 1,075,321 | 10.9 | 1,447,837 | 17.9 |
| 2001 | -361,511 | 1,005,654 | -6.5 | 1,367,165 | -5.6 |
| 2002 | -418,955 | 978,706 | -2.7 | 1,397,660 | 2.2 |
| 2003 | -493,890 | 1,020,418 | 4.3 | 1,514,308 | 8.3 |
| 2004 | -609,883 | 1,161,549 | 13.8 | 1,771,433 | 17.0 |
| 2005 | -714,245 | 1,286,022 | 10.7 | 2,000,267 | 12.9 |
| 2006 | -761,716 | 1,457,642 | 13.3 | 2,219,358 | 11.0 |
| 2007 | -705,375 | 1,653,548 | 13.4 | 2,358,922 | 6.3 |
| 2008 | -708,726 | 1,841,612 | 11.4 | 2,550,339 | 8.1 |
| 2009 | -383,774 | 1,583,053 | -14.0 | 1,966,827 | -22.9 |
| 2010 | -494,658 | 1,853,606 | 17.1 | 2,348,263 | 19.4 |
| 2011 | -548,625 | 2,127,021 | 14.8 | 2,675,646 | 13.9 |
| 2012 | -537,605 | 2,216,540 | 4.2 | 2,754,145 | 2.9 |
| 2013 | -476,392 | 2,280,194 | 2.9 | 2,756,586 | 0.1 |
| 2014 | -505,047 | 2,345,424 | 2.9 | 2,850,471 | 3.4 |
Source: US Census Bureau
http://www.census.gov/foreign-trade/
Chart IIA-2 of the US Census Bureau provides the US trade account in goods and services SA from Jan 1992 to Mar 2015. There is long-term trend of deterioration of the US trade deficit shown vividly by Chart IIA-2. The global recession from IVQ2007 to IIQ2009 reversed the trend of deterioration. Deterioration resumed together with incomplete recovery and was influenced significantly by the carry trade from zero interest rates to commodity futures exposures (these arguments are elaborated in Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4 http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html). Earlier research focused on the long-term external imbalance of the US in the form of trade and current account deficits (Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State Vol. II (2008b) 183-94, Government Intervention in Globalization (2008c), 167-71). US external imbalances have not been fully resolved and tend to widen together with improving world economic activity and commodity price shocks.
Chart IIA-2, US, Balance of Trade SA, Monthly, Millions of Dollars, Jan 1992-Mar 2015
Source: US Census Bureau
http://www.census.gov/foreign-trade/
Chart IIA-3 of the US Census Bureau provides US exports SA from Jan 1992 to Mar 2015. There was sharp acceleration from 2003 to 2007 during worldwide economic boom and increasing inflation. Exports fell sharply during the financial crisis and global recession from IVQ2007 to IIQ2009. Growth picked up again together with world trade and inflation but stalled in the final segment with less rapid global growth and inflation.
Chart IIA-3, US, Exports SA, Monthly, Millions of Dollars Jan 1992-Mar 2015
Source: US Census Bureau
http://www.census.gov/foreign-trade/
Chart IIA-4 of the US Census Bureau provides US imports SA from Jan 1992 to Mar 2015. Growth was stronger between 2003 and 2007 with worldwide economic boom and inflation. There was sharp drop during the financial crisis and global recession. There is stalling import levels in the final segment resulting from weaker world economic growth and diminishing inflation because of risk aversion and portfolio reallocations from commodity exposures to equities.
Chart IIA-4, US, Imports SA, Monthly, Millions of Dollars Jan 1992-Mar 2015
Source: US Census Bureau
http://www.census.gov/foreign-trade/
There is improvement of the US trade balance in goods in Table IIA-3 from deficit of $62,202 million in Mar 2014 to deficit of $70,561 million in Mar 2015. The nonpetroleum deficit increased by $20,215 million while the petroleum deficit shrank by $11,353 million. Total exports of goods decreased 6.5 percent in Mar 2015 relative to a year earlier while total imports decreased 0.2 percent. Nonpetroleum exports decreased 4.0 percent from Mar 2014 to Mar 2015 while nonpetroleum imports increased 9.3 percent. Petroleum imports fell 49.6 percent.
Table IIA-3, US, International Trade in Goods Balance, Exports and Imports $ Millions and ∆% SA
| Mar 2015 | Mar 2014 | ∆% | |
| Total Balance | -70,561 | -62,202 | |
| Petroleum | -7,671 | -19,024 | |
| Non Petroleum | -62,091 | -41,876 | |
| Total Exports | 127,069 | 135,910 | -6.5 |
| Petroleum | 7,698 | 11,472 | -32.9 |
| Non Petroleum | 118,333 | 123,259 | -4.0 |
| Total Imports | 197,630 | 198,112 | -0.2 |
| Petroleum | 15,369 | 30,496 | -49.6 |
| Non Petroleum | 180,424 | 165,136 | 9.3 |
Details may not add because of rounding and seasonal adjustment
Source: US Census Bureau
http://www.census.gov/foreign-trade/
US exports and imports of goods not seasonally adjusted in Jan-Mar 2015 and Jan-Mar 2014 are in Table IIA-4. The rate of growth of exports was minus 5.1 percent and minus 1.4 percent for imports. The US has partial hedge of commodity price increases in exports of agricultural commodities that decreased 12.1 percent and of mineral fuels that decreased 31.2 percent both because prices of raw materials and commodities increase and fall recurrently as a result of shocks of risk aversion and portfolio reallocations. The US exports an insignificant but growing amount of crude oil, decreasing 30.6 percent in cumulative Jan-Mar 2015 relative to a year earlier. US exports and imports consist mostly of manufactured products, with less rapidly increasing prices. US manufactured exports decreased 4.5 percent while manufactured imports increased 4.7 percent. Significant part of the US trade imbalance originates in imports of mineral fuels decreasing 42.6 percent and petroleum decreasing 44.3 percent with wide oscillations in oil prices. The limited hedge in exports of agricultural commodities and mineral fuels compared with substantial imports of mineral fuels and crude oil results in waves of deterioration of the terms of trade of the US, or export prices relative to import prices, originating in commodity price increases caused by carry trades from zero interest rates. These waves are similar to those in worldwide inflation.
Table IIA-4, US, Exports and Imports of Goods, Not Seasonally Adjusted Millions of Dollars and %, Census Basis
| Jan-Mar 2015 $ Millions | Jan-Mar 2014 $ Millions | ∆% | |
| Exports | 373,071 | 393,141 | -5.1 |
| Manufactured | 273,957 | 286,901 | -4.5 |
| Agricultural | 35,973 | 40,925 | -12.1 |
| Mineral Fuels | 26,388 | 38,338 | -31.2 |
| Petroleum | 21,468 | 30,943 | -30.6 |
| Imports | 539,860 | 547,713 | -1.4 |
| Manufactured | 461,033 | 440,186 | 4.7 |
| Agricultural | 28,860 | 27,183 | 6.2 |
| Mineral Fuels | 51,775 | 90,215 | -42.6 |
| Petroleum | 46,850 | 84,125 | -44.3 |
Source: US Census Bureau
http://www.census.gov/foreign-trade/
The current account of the US balance of payments is provided in Table IIA2-1 for IVQ2013 and IVQ2014. The Bureau of Economic Analysis analyzes as follows (http://www.bea.gov/newsreleases/international/transactions/2015/pdf/trans414.pdf):
“The U.S. current-account deficit—a net measure of transactions between the United States and the rest of the world in goods, services, primary income (investment income and compensation), and secondary income (current transfers)— increased to $113.5 billion (preliminary) in the fourth quarter of 2014 from $98.9 billion (revised) in the third quarter. The deficit increased to 2.6 percent of current dollar gross domestic product (GDP) from 2.2 percent in the third quarter. The increase in the current-account deficit was primarily accounted for by a decrease in the surplus on primary income. In addition, the deficits on goods and secondary income increased. These changes were partly offset by an increase in the surplus on services.”
The US has a large deficit in goods or exports less imports of goods but it has a surplus in services that helps to reduce the trade account deficit or exports less imports of goods and services. The current account deficit of the US not seasonally adjusted increased from $87.4 billion in IVQ2013 to $111.2 billion in IVQ2014. The current account deficit seasonally adjusted at annual rate increased from 2.0 percent of GDP in IVQ2013 to 2.2 percent of GDP in IIIQ2014, increasing to 2.6 percent of GDP in IIVQ2014. The ratio of the current account deficit to GDP has stabilized below 3 percent of GDP compared with much higher percentages before the recession but is combined now with much higher imbalance in the Treasury budget (see Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State, Vol. II (2008b), 183-94, Government Intervention in Globalization (2008c), 167-71).
Table IIA2-1, US, Balance of Payments, Millions of Dollars NSA
| IVQ2013 | IVQ2014 | Difference | |
| Goods Balance | -169,368 | -184,334 | 14,966 |
| X Goods | 413,725 | 417,333 | 0.9 ∆% |
| M Goods | -583,093 | -601,667 | 3.2 ∆% |
| Services Balance | 58,094 | 59,689 | 1,595 |
| X Services | 173,845 | 179,821 | 3.4 ∆% |
| M Services | -115,751 | -120,133 | 3.8 ∆% |
| Balance Goods and Services | -111,273 | -124,645 | 13,372 |
| Exports of Goods and Services and Income Receipts | 819,495 | 828,144 | |
| Imports of Goods and Services and Income Payments | -906,930 | -939,366 | |
| Current Account Balance | -87,434 | -111,222 | 23,788 |
| % GDP | IVQ2013 | IVQ2014 | IIIQ2014 |
| 2.0 | 2.6 | 2.2 |
X: exports; M: imports
Balance on Current Account = Exports of Goods and Services – Imports of Goods and Services and Income Payments
Source: Bureau of Economic Analysis
http://www.bea.gov/international/index.htm#bop
In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):
“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”
The alternative fiscal scenario of the CBO (2012NovCDR, 2013Sep17) resembles an economic world in which eventually the placement of debt reaches a limit of what is proportionately desired of US debt in investment portfolios. This unpleasant environment is occurring in various European countries.
The current real value of government debt plus monetary liabilities depends on the expected discounted values of future primary surpluses or difference between tax revenue and government expenditure excluding interest payments (Cochrane 2011Jan, 27, equation (16)). There is a point when adverse expectations about the capacity of the government to generate primary surpluses to honor its obligations can result in increases in interest rates on government debt.
First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:
D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)
Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,
{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:
N(t+1) = (1+n)N(t), n>-1 (2)
The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:
B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)
On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.
Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (4)
Equation (4) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+τ. The second equation of Cochrane (2011Jan, 5) is:
MtV(it, ·) = PtYt (5)
Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):
“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”
An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.
There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:
(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress
(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality
(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.
This analysis suggests that there may be a point of saturation of demand for United States financial liabilities without an increase in interest rates on Treasury securities. A risk premium may develop on US debt. Such premium is not apparent currently because of distressed conditions in the world economy and international financial system. Risk premiums are observed in the spread of bonds of highly indebted countries in Europe relative to bonds of the government of Germany.
The issue of global imbalances centered on the possibility of a disorderly correction (Pelaez and Pelaez, The Global Recession Risk (2007), Globalization and the State Vol. II (2008b) 183-94, Government Intervention in Globalization (2008c), 167-71). Such a correction has not occurred historically but there is no argument proving that it could not occur. The need for a correction would originate in unsustainable large and growing United States current account deficits (CAD) and net international investment position (NIIP) or excess of financial liabilities of the US held by foreigners net relative to financial liabilities of foreigners held by US residents. The IMF estimated that the US could maintain a CAD of two to three percent of GDP without major problems (Rajan 2004). The threat of disorderly correction is summarized by Pelaez and Pelaez, The Global Recession Risk (2007), 15):
“It is possible that foreigners may be unwilling to increase their positions in US financial assets at prevailing interest rates. An exit out of the dollar could cause major devaluation of the dollar. The depreciation of the dollar would cause inflation in the US, leading to increases in American interest rates. There would be an increase in mortgage rates followed by deterioration of real estate values. The IMF has simulated that such an adjustment would cause a decline in the rate of growth of US GDP to 0.5 percent over several years. The decline of demand in the US by four percentage points over several years would result in a world recession because the weakness in Europe and Japan could not compensate for the collapse of American demand. The probability of occurrence of an abrupt adjustment is unknown. However, the adverse effects are quite high, at least hypothetically, to warrant concern.”
The United States could be moving toward a situation typical of heavily indebted countries, requiring fiscal adjustment and increases in productivity to become more competitive internationally. The CAD and NIIP of the United States are not observed in full deterioration because the economy is well below trend. There are two complications in the current environment relative to the concern with disorderly correction in the first half of the past decade. In the release of Jun 14, 2013, the Bureau of Economic Analysis (http://www.bea.gov/newsreleases/international/transactions/2013/pdf/trans113.pdf) informs of revisions of US data on US international transactions since 1999:
“The statistics of the U.S. international transactions accounts released today have been revised for the first quarter of 1999 to the fourth quarter of 2012 to incorporate newly available and revised source data, updated seasonal adjustments, changes in definitions and classifications, and improved estimating methodologies.”
The BEA introduced new concepts and methods (http://www.bea.gov/international/concepts_methods.htm) in comprehensive restructuring on Jun 18, 2014 (http://www.bea.gov/international/modern.htm):
“BEA introduced a new presentation of the International Transactions Accounts on June 18, 2014 and will introduce a new presentation of the International Investment Position on June 30, 2014. These new presentations reflect a comprehensive restructuring of the international accounts that enhances the quality and usefulness of the accounts for customers and bring the accounts into closer alignment with international guidelines.”
Table IIA2-3 provides data on the US fiscal and balance of payments imbalances incorporating all revisions and methods. In 2007, the federal deficit of the US was $161 billion corresponding to 1.1 percent of GDP while the Congressional Budget Office estimates the federal deficit in 2012 at $1087 billion or 6.8 percent of GDP. The estimate of the deficit for 2013 is $680 billion or 4.1 percent of GDP. The deficit fell to $483 billion in 2014 or 2.8 percent of GDP. The combined record federal deficits of the US from 2009 to 2012 are $5094 billion or 31.9 percent of the estimate of GDP for fiscal year 2012 implicit in the CBO estimate of debt/GDP. The deficits from 2009 to 2012 exceed one trillion dollars per year, adding to $5.094 trillion in four years, using the fiscal year deficit of $1087 billion for fiscal year 2012, which is the worst fiscal performance since World War II. Federal debt in 2007 was $5035 billion, less than the combined deficits from 2009 to 2012 of $5094 billion. Federal debt was 70.1 percent of GDP in 2012, 72.0 percent of GDP in 2013 and 74.1 percent of GDP in 2014 (http://www.cbo.gov/). This situation may worsen in the future (CBO 2013Sep17):
“Between 2009 and 2012, the federal government recorded the largest budget deficits relative to the size of the economy since 1946, causing federal debt to soar. Federal debt held by the public is now about 73 percent of the economy’s annual output, or gross domestic product (GDP). That percentage is higher than at any point in U.S. history except a brief period around World War II, and it is twice the percentage at the end of 2007. If current laws generally remained in place, federal debt held by the public would decline slightly relative to GDP over the next several years, CBO projects. After that, however, growing deficits would ultimately push debt back above its current high level. CBO projects that federal debt held by the public would reach 100 percent of GDP in 2038, 25 years from now, even without accounting for the harmful effects that growing debt would have on the economy. Moreover, debt would be on an upward path relative to the size of the economy, a trend that could not be sustained indefinitely.
The gap between federal spending and revenues would widen steadily after 2015 under the assumptions of the extended baseline, CBO projects. By 2038, the deficit would be 6½ percent of GDP, larger than in any year between 1947 and 2008, and federal debt held by the public would reach 100 percent of GDP, more than in any year except 1945 and 1946. With such large deficits, federal debt would be growing faster than GDP, a path that would ultimately be unsustainable.
Incorporating the economic effects of the federal policies that underlie the extended baseline worsens the long-term budget outlook. The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues and higher interest payments. With those effects included, debt under the extended baseline would rise to 108 percent of GDP in 2038.”
Table IIA2-2, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and %
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | |
| Goods & | -705 | -709 | -384 | -495 | -549 | -538 | -476 | -505 |
| Primary Income | 101 | 146 | 124 | 178 | 221 | 203 | 200 | 218 |
| Secondary Income | -114 | -124 | -121 | -127 | -132 | -126 | -124 | -124 |
| Current Account | -719 | -681 | -381 | -444 | -461 | -454 | -401 | -411 |
| NGDP | 14478 | 14719 | 14419 | 14964 | 15518 | 16163 | 16768 | 17419 |
| Current Account % GDP | -5.0 | -4.6 | -2.6 | -3.0 | -3.0 | -2.8 | -2.4 | -2.4 |
| NIIP | -1279 | -3995 | -2628 | -2512 | -4455 | -4578 | -5383 | -6915 |
| US Owned Assets Abroad | 20705 | 19423 | 19426 | 21768 | 22209 | 22520 | 23710 | 24693 |
| Foreign Owned Assets in US | 21984 | 23418 | 22054 | 24280 | 26664 | 27098 | 29093 | 31608 |
| NIIP % GDP | -8.8 | -27.1 | -18.2 | -16.8 | -28.7 | -28.3 | -32.1 | -39.7 |
| Exports | 2569 | 2751 | 2286 | 2631 | 2988 | 3085 | 3179 | 3291 |
| NIIP % | -50 | -145 | -115 | -95 | -149 | -148 | -169 | -210 |
| DIA MV | 5858 | 3707 | 4945 | 5486 | 5215 | 5938 | 7080 | 7162 |
| DIUS MV | 4134 | 3091 | 3619 | 4099 | 4199 | 4671 | 5791 | 6253 |
| Fiscal Balance | -161 | -459 | -1413 | -1294 | -1300 | -1087 | -680 | -483 |
| Fiscal Balance % GDP | -1.1 | -3.1 | -9.8 | -8.7 | -8.5 | -6.8 | -4.1 | -2.8 |
| Federal Debt | 5035 | 5803 | 7545 | 9019 | 10128 | 11281 | 11983 | 12779 |
| Federal Debt % GDP | 35.1 | 39.3 | 52.3 | 61.0 | 65.8 | 70.1 | 72.0 | 74.1 |
| Federal Outlays | 2729 | 2983 | 3518 | 3457 | 3603 | 3537 | 3455 | 3504 |
| ∆% | 2.8 | 9.3 | 17.9 | -1.7 | 4.2 | -1.8 | -2.3 | 1.4 |
| % GDP | 19.1 | 20.2 | 24.4 | 23.4 | 23.4 | 22.1 | 20.8 | 20.3 |
| Federal Revenue | 2568 | 2524 | 2105 | 2163 | 2304 | 2450 | 2775 | 3021 |
| ∆% | 6.7 | -1.7 | -16.6 | 2.7 | 6.5 | 6.3 | 13.3 | 8.9 |
| % GDP | 17.9 | 17.1 | 14.6 | 14.6 | 15.0 | 15.3 | 16.7 | 17.5 |
Sources:
Notes: NGDP: nominal GDP or in current dollars; NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. There are minor discrepancies in the decimal point of percentages of GDP between the balance of payments data and federal debt, outlays, revenue and deficits in which the original number of the CBO source is maintained. See Bureau of Economic Analysis, US International Economic Accounts: Concepts and Methods. 2014. Washington, DC: BEA, Department of Commerce, Jun 2014 http://www.bea.gov/international/concepts_methods.htm These discrepancies do not alter conclusions. Budget http://www.cbo.gov/ Balance of Payments and NIIP http://www.bea.gov/international/index.htm#bop Gross Domestic Product, Bureau of Economic Analysis (BEA) http://www.bea.gov/iTable/index_nipa.cfm
Table IIA2-4 provides quarterly estimates NSA of the external imbalance of the United States. The current account deficit seasonally adjusted increases from 2.0 percent of GDP in IVQ2013 to 2.4 percent in IVQ2013. The current account deficit decreases to 2.2 percent of GDP in IIQ2014 and stabilizes at 2.2 percent of GDP in IIIQ2014. The deficit increases to 2.6 percent of GDP in IVQ2014. The net international investment position increases from $5.4 trillion in IVQ2013 to $5.5 trillion in IQ2015, stabilizing at $5.5 trillion in IIQ2014. The net international investment position increases to $6.2 trillion in IIIQ2014 and increases to $6.9 trillion in IVQ2014.
Table IIA2-4, US, Current Account, NIIP, Fiscal Balance, Nominal GDP, Federal Debt and Direct Investment, Dollar Billions and % NSA
| IVQ2013 | IQ2014 | IIQ2014 | IIIQ2014 | IVQ2014 | |
| Goods & | -111 | -100 | -139 | -142 | -125 |
| Primary Income | 53 | 52 | 56 | 59 | 50 |
| Secondary Income | -29 | -31 | -21 | -36 | -37 |
| Current Account | -87 | -77 | -103 | -119 | -111 |
| Current Account % GDP | -2.0 | -2.4 | -2.2 | -2.2 | -2.6 |
| NIIP | -5383 | -5512 | -5475 | -6129 | -6915 |
| US Owned Assets Abroad | 23710 | 24020 | 24977 | 24617 | 24693 |
| Foreign Owned Assets in US | -29093 | -29532 | -30452 | -30747 | -31609 |
| DIA MV | 7080 | 7117 | 7489 | 7249 | 7162 |
| DIA MV Equity | 6070 | 6135 | 6429 | 6169 | 6075 |
| DIUS MV | 5791 | 5689 | 5999 | 6034 | 6253 |
| DIUS MV Equity | 4462 | 4387 | 4624 | 4665 | 4871 |
Notes: NIIP: Net International Investment Position; DIA MV: US Direct Investment Abroad at Market Value; DIUS MV: Direct Investment in the US at Market Value. See Bureau of Economic Analysis, US International Economic Accounts: Concepts and Methods. 2014. Washington, DC: BEA, Department of Commerce, Jun 2014 http://www.bea.gov/international/concepts_methods.htm
There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table VI-7G when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table VI-7G shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.
Table VI-7G, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994
| 1994 | FF | 30Y | 30P | 10Y | 10P | MOR | CPI |
| Jan | 3.00 | 6.29 | 100 | 5.75 | 100 | 7.06 | 2.52 |
| Feb | 3.25 | 6.49 | 97.37 | 5.97 | 98.36 | 7.15 | 2.51 |
| Mar | 3.50 | 6.91 | 92.19 | 6.48 | 94.69 | 7.68 | 2.51 |
| Apr | 3.75 | 7.27 | 88.10 | 6.97 | 91.32 | 8.32 | 2.36 |
| May | 4.25 | 7.41 | 86.59 | 7.18 | 88.93 | 8.60 | 2.29 |
| Jun | 4.25 | 7.40 | 86.69 | 7.10 | 90.45 | 8.40 | 2.49 |
| Jul | 4.25 | 7.58 | 84.81 | 7.30 | 89.14 | 8.61 | 2.77 |
| Aug | 4.75 | 7.49 | 85.74 | 7.24 | 89.53 | 8.51 | 2.69 |
| Sep | 4.75 | 7.71 | 83.49 | 7.46 | 88.10 | 8.64 | 2.96 |
| Oct | 4.75 | 7.94 | 81.23 | 7.74 | 86.33 | 8.93 | 2.61 |
| Nov | 5.50 | 8.08 | 79.90 | 7.96 | 84.96 | 9.17 | 2.67 |
| Dec | 6.00 | 7.87 | 81.91 | 7.81 | 85.89 | 9.20 | 2.67 |
Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months
Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t
Chart VI-10 of the Board of Governors of the Federal Reserve System provides the overnight Fed funds rate on business days from Jul 1, 1954 at 1.13 percent through Jan 10, 1979, at 9.91 percent per year, to May 7, 2015, at 0.13 percent per year. US recessions are in shaded areas according to the reference dates of the NBER (http://www.nber.org/cycles.html). In the Fed effort to control the “Great Inflation” of the 1930s (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), the fed funds rate increased from 8.34 percent on Jan 3, 1979 to a high in Chart VI-10 of 22.36 percent per year on Jul 22, 1981 with collateral adverse effects in the form of impaired savings and loans associations in the United States, emerging market debt and money-center banks (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7; Pelaez 1986, 1987). Another episode in Chart VI-10 is the increase in the fed funds rate from 3.15 percent on Jan 3, 1994, to 6.56 percent on Dec 21, 1994, which also had collateral effects in impairing emerging market debt in Mexico and Argentina and bank balance sheets in a world bust of fixed income markets during pursuit by central banks of non-existing inflation (Pelaez and Pelaez, International Financial Architecture (2005), 113-5). Another interesting policy impulse is the reduction of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of equally non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85), followed by increments of 25 basis points from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006 in Chart VI-10. Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).
The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever-increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). A final episode in Chart VI-10 is the reduction of the fed funds rate from 5.41 percent on Aug 9, 2007, to 2.97 percent on October 7, 2008, to 0.12 percent on Dec 5, 2008 and close to zero throughout a long period with the final point at 0.13 percent on May 7, 2015. Evidently, this behavior of policy would not have occurred had there been theory, measurements and forecasts to avoid these violent oscillations that are clearly detrimental to economic growth and prosperity without inflation. Current policy consists of forecast mandate of maintaining policy accommodation until the forecast of the rate of unemployment reaches 6.5 percent and the rate of personal consumption expenditures excluding food and energy reaches 2.5 percent (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm). The FOMC dropped the numbers but affirmed guidance (http://www.federalreserve.gov/newsevents/press/monetary/20140319a.htm): “With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee's guidance does not indicate any change in the Committee's policy intentions as set forth in its recent statements.” It is a forecast mandate because of the lags in effect of monetary policy impulses on income and prices (Romer and Romer 2004). The intention is to reduce unemployment close to the “natural rate” (Friedman 1968, Phelps 1968) of around 5 percent and inflation at or below 2.0 percent. If forecasts were reasonably accurate, there would not be policy errors. A commonly analyzed risk of zero interest rates is the occurrence of unintended inflation that could precipitate an increase in interest rates similar to the Himalayan rise of the fed funds rate from 9.91 percent on Jan 10, 1979, at the beginning in Chart VI-10, to 22.36 percent on Jul 22, 1981. There is a less commonly analyzed risk of the development of a risk premium on Treasury securities because of the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/12/patience-on-interest-rate-increases.html
and earlier http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/02/theory-and-reality-of-cyclical-slow.html and earlier (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). There is not a fiscal cliff or debt limit issue ahead but rather free fall into a fiscal abyss. The combination of the fiscal abyss with zero interest rates could trigger the risk premium on Treasury debt or Himalayan hike in interest rate.
Chart VI-10, US, Fed Funds Rate, Business Days, Jul 1, 1954 t0 May 7, 2015, Percent per Year
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table VI-7G when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table VI-7G shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.
Table VI-7G, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994
| 1994 | FF | 30Y | 30P | 10Y | 10P | MOR | CPI |
| Jan | 3.00 | 6.29 | 100 | 5.75 | 100 | 7.06 | 2.52 |
| Feb | 3.25 | 6.49 | 97.37 | 5.97 | 98.36 | 7.15 | 2.51 |
| Mar | 3.50 | 6.91 | 92.19 | 6.48 | 94.69 | 7.68 | 2.51 |
| Apr | 3.75 | 7.27 | 88.10 | 6.97 | 91.32 | 8.32 | 2.36 |
| May | 4.25 | 7.41 | 86.59 | 7.18 | 88.93 | 8.60 | 2.29 |
| Jun | 4.25 | 7.40 | 86.69 | 7.10 | 90.45 | 8.40 | 2.49 |
| Jul | 4.25 | 7.58 | 84.81 | 7.30 | 89.14 | 8.61 | 2.77 |
| Aug | 4.75 | 7.49 | 85.74 | 7.24 | 89.53 | 8.51 | 2.69 |
| Sep | 4.75 | 7.71 | 83.49 | 7.46 | 88.10 | 8.64 | 2.96 |
| Oct | 4.75 | 7.94 | 81.23 | 7.74 | 86.33 | 8.93 | 2.61 |
| Nov | 5.50 | 8.08 | 79.90 | 7.96 | 84.96 | 9.17 | 2.67 |
| Dec | 6.00 | 7.87 | 81.91 | 7.81 | 85.89 | 9.20 | 2.67 |
Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months
Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t
Chart VI-14 provides the overnight fed funds rate, the yield of the 10-year Treasury constant maturity bond, the yield of the 30-year constant maturity bond and the conventional mortgage rate from Jan 1991 to Dec 1996. In Jan 1991, the fed funds rate was 6.91 percent, the 10-year Treasury yield 8.09 percent, the 30-year Treasury yield 8.27 percent and the conventional mortgage rate 9.64 percent. Before monetary policy tightening in Oct 1993, the rates and yields were 2.99 percent for the fed funds, 5.33 percent for the 10-year Treasury, 5.94 for the 30-year Treasury and 6.83 percent for the conventional mortgage rate. After tightening in Nov 1994, the rates and yields were 5.29 percent for the fed funds rate, 7.96 percent for the 10-year Treasury, 8.08 percent for the 30-year Treasury and 9.17 percent for the conventional mortgage rate.
Chart VI-14, US, Overnight Fed Funds Rate, 10-Year Treasury Constant Maturity, 30-Year Treasury Constant Maturity and Conventional Mortgage Rate, Monthly, Jan 1991 to Dec 1996
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
Chart VI-15 of the Bureau of Labor Statistics provides the all items consumer price index from Jan 1991 to Dec 1996. There does not appear acceleration of consumer prices requiring aggressive tightening.
Chart VI-15, US, Consumer Price Index All Items, Jan 1991 to Dec 1996
Source: Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart IV-16 of the Bureau of Labor Statistics provides 12-month percentage changes of the all items consumer price index from Jan 1991 to Dec 1996. Inflation collapsed during the recession from Jul 1990 (III) and Mar 1991 (I) and the end of the Kuwait War on Feb 25, 1991 that stabilized world oil markets. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). Policy tightening had adverse collateral effects in the form of emerging market crises in Mexico and Argentina and fixed income markets worldwide.
Chart VI-16, US, Consumer Price Index All Items, Twelve-Month Percentage Change, Jan 1991 to Dec 1996
Source: Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
The Congressional Budget Office (CBO 2014BEOFeb4) estimates potential GDP, potential labor force and potential labor productivity provided in Table IB-3. The CBO estimates average rate of growth of potential GDP from 1950 to 2014 at 3.3 percent per year. The projected path is significantly lower at 2.1 percent per year from 2015 to 2025. The legacy of the economic cycle expansion from IIIQ2009 to IQ2015 at 2.2 percent on average is in contrast with 4.8 percent on average in the expansion from IQ1983 to IIIQ1988 (http://cmpassocregulationblog.blogspot.com/2015/03/dollar-revaluation-and-financial-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html). Subpar economic growth may perpetuate unemployment and underemployment estimated at 25.6 million or 15.4 percent of the effective labor force in Apr 2015 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2015/04/volatility-of-valuations-of-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/global-competitive-devaluation-rules.html) with much lower hiring than in the period before the current cycle (http://cmpassocregulationblog.blogspot.com/2015/04/dollar-revaluation-recovery-without.html).
Table IB-3, US, Congressional Budget Office History and Projections of Potential GDP of US Overall Economy, ∆%
| Potential GDP | Potential Labor Force | Potential Labor Productivity* | |
| Average Annual ∆% | |||
| 1950-1973 | 4.0 | 1.6 | 2.4 |
| 1974-1981 | 3.3 | 2.5 | 0.8 |
| 1982-1990 | 3.2 | 1.6 | 1.6 |
| 1991-2001 | 3.2 | 1.3 | 1.9 |
| 2002-2007 | 2.8 | 0.9 | 1.9 |
| 2008-2014 | 1.4 | 0.5 | 0.9 |
| Total 1950-2014 | 3.3 | 1.5 | 1.8 |
| Projected Average Annual ∆% | |||
| 2015-2019 | 2.1 | 0.5 | 1.6 |
| 2019-2025 | 2.2 | 0.6 | 1.6 |
| 2015-2025 | 2.1 | 0.5 | 1.6 |
*Ratio of potential GDP to potential labor force
Source: CBO (2014BEOFeb4), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014. CBO, The budget and economic outlook: 2015 to 2025. Washington, DC, Congressional Budget Office, Jan 26, 2015.
Chart IB-1A of the Congressional Budget Office provides historical and projected potential and actual US GDP. The gap between actual and potential output closes by 2017. Potential output expands at a lower rate than historically. Growth is even weaker relative to trend.
Chart IB-1A, Congressional Budget Office, Estimate of Potential GDP and Gap
Source: Congressional Budget Office
https://www.cbo.gov/publication/49890
Chart IB-1 of the Congressional Budget Office (CBO 2013BEOFeb5) provides actual and potential GDP of the United States from 2000 to 2011 and projected to 2024. Lucas (2011May) estimates trend of United States real GDP of 3.0 percent from 1870 to 2010 and 2.2 percent for per capita GDP. The United States successfully returned to trend growth of GDP by higher rates of growth during cyclical expansion as analyzed by Bordo (2012Sep27, 2012Oct21) and Bordo and Haubrich (2012DR). Growth in expansions following deeper contractions and financial crises was much higher in agreement with the plucking model of Friedman (1964, 1988). The unusual weakness of growth at 2.2 percent on average from IIIQ2009 to IQ2015 during the current economic expansion in contrast with 4.8 percent on average in the cyclical expansion from IQ1983 to IIIQ1988 (http://cmpassocregulationblog.blogspot.com/2015/03/dollar-revaluation-and-financial-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html) cannot be explained by the contraction of 4.2 percent of GDP from IVQ2007 to IIQ2009 and the financial crisis. Weakness of growth in the expansion is perpetuating unemployment and underemployment of 25.6 million or 15.4 percent of the labor force as estimated for Apr 2015 (Section I and earlier http://cmpassocregulationblog.blogspot.com/2015/04/volatility-of-valuations-of-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/global-competitive-devaluation-rules.html). There is no exit from unemployment/underemployment and stagnating real wages because of the collapse of hiring (http://cmpassocregulationblog.blogspot.com/2015/04/dollar-revaluation-recovery-without.html). The US economy and labor markets collapsed without recovery. Abrupt collapse of economic conditions can be explained only with cyclic factors (Lazear and Spletzer 2012Jul22) and not by secular stagnation (Hansen 1938, 1939, 1941 with early dissent by Simons 1942).
Chart IB-1, US, Congressional Budget Office, Actual and Projections of Potential GDP, 2000-2024, Trillions of Dollars
Source: Congressional Budget Office, CBO (2013BEOFeb5). The last year in common in both projections is 2017. The revision lowers potential output in 2017 by 7.3 percent relative to the projection in 2007.
Chart IB-2 provides differences in the projections of potential output by the CBO in 2007 and more recently on Feb 4, 2014, which the CBO explains in CBO (2014Feb28).
Chart IB-2, Congressional Budget Office, Revisions of Potential GDP
Source: Congressional Budget Office, 2014Feb 28. Revisions to CBO’s Projection of Potential Output since 2007. Washington, DC, CBO, Feb 28, 2014.
Chart IB-3 provides actual and projected potential GDP from 2000 to 2024. The gap between actual and potential GDP disappears at the end of 2017 (CBO2014Feb4). GDP increases in the projection at 2.5 percent per year.
Chart IB-3, Congressional Budget Office, GDP and Potential GDP
Source: CBO (2013BEOFeb5), CBO, Key assumptions in projecting potential GDP—February 2014 baseline. Washington, DC, Congressional Budget Office, Feb 4, 2014.
Chart IIA2-3 of the Bureau of Economic Analysis of the Department of Commerce shows on the lower negative panel the sharp increase in the deficit in goods and the deficits in goods and services from 1960 to 2012. The upper panel shows the increase in the surplus in services that was insufficient to contain the increase of the deficit in goods and services. The adjustment during the global recession has been in the form of contraction of economic activity that reduced demand for goods.
Chart IIA2-3, US, Balance of Goods, Balance on Services and Balance on Goods and Services, 1960-2013, Millions of Dollars
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_ita.cfm
Chart IIA2-4 of the Bureau of Economic Analysis shows exports and imports of goods and services from 1960 to 2012. Exports of goods and services in the upper positive panel have been quite dynamic but have not compensated for the sharp increase in imports of goods. The US economy apparently has become less competitive in goods than in services.
Chart IIA2-4, US, Exports and Imports of Goods and Services, 1960-2013, Millions of Dollars
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_ita.cfm
Chart IIA2-5 of the Bureau of Economic Analysis shows the US balance on current account from 1960 to 2012. The sharp devaluation of the dollar resulting from unconventional monetary policy of zero interest rates and elimination of auctions of 30-year Treasury bonds did not adjust the US balance of payments. Adjustment only occurred after the contraction of economic activity during the global recession.
Chart IIA2-5, US, Balance on Current Account, 1960-2013, Millions of Dollars
Source: Bureau of Economic Analysis http://www.bea.gov/iTable/index_ita.cfm
Chart IIA2-6 of the Bureau of Economic Analysis provides real GDP in the US from 1960 to 2014. The contraction of economic activity during the global recession was a major factor in the reduction of the current account deficit as percent of GDP.
Chart IIA2-6, US, Real GDP, 1960-2014, Billions of Chained 2009 Dollars
Source: Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart IIA-7 provides the US current account deficit on a quarterly basis from 1980 to IQ1983. The deficit is at a lower level because of growth below potential not only in the US but worldwide. The combination of high government debt and deficit with external imbalance restricts potential prosperity in the US.
Chart IIA-7, US, Balance on Current Account, Quarterly, 1980-2013
Source: Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015.
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