CMP Associates Regulation Blog

http://www.stats.gov.cn/enGliSH/

The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace around 2.2 percent per year. Table Summary GDP provides the data.

1. Average Annual Growth in the Past Twelve Quarters. GDP growth in the four quarters of 2012, the four quarters of 2013, the four quarters of 2014 and IQ2015 accumulated to 7.1 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IQ2015 of $16,264.1 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/13: {[($16,264.1/$15,190.3)^4/13 -1]100 = 2.1 percent.

2. Average Annual Growth in the Past Four Quarters. GDP growth in the four quarters of IQ2014 to IQ2015 accumulated to 2.7 percent that is equivalent to 2.7 percent in a year. This is obtained by dividing GDP in IQ2015 of $16,264.1 billion by GDP in IQ2014 of $15,831.7 billion and compounding by 4/4: {[($16,264.1/$15,831.7)^4/4 -1]100 = 2.7 %}. The US economy grew 2.7 percent in IQ2015 relative to the same quarter a year earlier in IQ2014. Growth was at annual equivalent 4.6 percent in IIQ2014 and 5.0 percent IIIQ2014 and only at 2.2 percent in IVQ2014. GDP fell at annual equivalent 0.7 percent in IQ2015. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is in the borderline of contraction, and negative in IQ2014. US GDP fell 0.5 percent in IQ2014. The rate of growth of GDP in the revision of IIIQ2013 is 4.5 percent in seasonally adjusted annual rate (SAAR). Inventory accumulation contributed 1.49 percentage points to this rate of growth. The actual rate without this impulse of unsold inventories would have been 3.0 percent, or 0.74 percent in IIIQ2013, such that annual equivalent growth in 2013 is closer to 2.9 percent {[(1.007)(1.004)(1.0074)(1.010)^4/4-1]100 = 2.9%}, compounding the quarterly rates and converting into annual equivalent. Inventory divestment deducted 1.16 percentage points from GDP growth in IQ2014. Without this deduction of inventory divestment, GDP growth would have been minus 0.9 percent in IQ2014, such that the actual growth rates in the four quarters ending in IQ2014 is closer to 2.2 percent {[(1.004)(1.011)(1.009)(0.9977)]^4/4 -1]100 = 2.2%}.

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

	Real GDP, Billions Chained 2009 Dollars	∆% Relative to IVQ2007	∆% Relative to Prior Quarter	∆% over Year Earlier
IVQ2007	14,991.8	NA	0.4	1.9
IVQ2011	15,190.3	1.3	1.1	1.7
IQ2012	15,275.0	1.9	0.6	2.6
IIQ2012	15,336.7	2.3	0.4	2.3
IIIQ2012	15,431.3	2.9	0.6	2.7
IVQ2012	15,433.7	2.9	0.0	1.6
IQ2013	15,538.4	3.6	0.7	1.7
IIQ2013	15,606.6	4.1	0.4	1.8
IIIQ2013	15,779.9	5.3	1.1	2.3
IVQ2013	15,916.2	6.2	0.9	3.1
IQ2014	15,831.7	5.6	-0.5	1.9
IIQ2014	16,010.4	6.8	1.1	2.6
IIIQ2014	16,205.6	8.1	1.2	2.7
IVQ2014	16,294.7	8.7	0.5	2.4
IQ2015	16,264.1	8.5	-0.2	2.7
Cumulative ∆% IQ2012 to IQ2015	7.1		7.0
Annual Equivalent ∆%	2.1		2.1

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

In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is concern of the production and employment costs of controlling future inflation. Even if there is no inflation, QE→∞, or reinvestment of principal in securities and issue of bank reserves to maintain interest rates at zero, cannot be abandoned because of the fear of rising interest rates. The economy would operate in an inferior allocation of resources and suboptimal growth path, or interior point of the production possibilities frontier where the optimum of productive efficiency and wellbeing is attained, because of the distortion of risk/return decisions caused by perpetual financial repression. Not even a second-best allocation is feasible with the shocks to efficiency of financial repression in perpetuity.

The statement of the FOMC at the conclusion of its meeting on Dec 12, 2012, revealed policy intentions (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm) updated in the statement at its meeting on Jun 17, 2015 with maintenance of the current level of the balance sheet (http://www.federalreserve.gov/newsevents/press/monetary/20150617a.htm):

“Press Release

Release Date: June 17, 2015

For immediate release

Information received since the Federal Open Market Committee met in April suggests that economic activity has been expanding moderately after having changed little during the first quarter. The pace of job gains picked up while the unemployment rate remained steady. On balance, a range of labor market indicators suggests that underutilization of labor resources diminished somewhat. Growth in household spending has been moderate and the housing sector has shown some improvement; however, business fixed investment and net exports stayed soft. Inflation continued to run below the Committee's longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports; energy prices appear to have stabilized. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.

There are several important issues in this statement.

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

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

Open-ended Quantitative Easing or QE_∞ with End of Bond Purchases and Continuing Reinvestment of Principal in Securities. Earlier programs are continued with reinvestment of principal in securities and bank reserves at $2581 billion (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1): “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”
New Advance Guidance. “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” (emphasis added).
Policy Commitment with Maximum Employment. The emphasis of policy is in maintaining full employment: “When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

Focus is shifting from tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Markets overreacted to the so-called “paring” of outright purchases to $25 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent for which there is no end in sight as evident in the FOMC statement for Jun 17, 2015 (http://www.federalreserve.gov/newsevents/press/monetary/20150617a.htm):

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” (emphasis added). The FOMC added “readings” of “international developments after Jan 28, 2015.

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

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

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

Chair Yellen explained the removal of the word “patience” from the advanced guidance at the press conference following the FOMC meeting on Mar 18, 2015(http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20150318.pdf):

“In other words, just because we removed the word “patient” from the statement doesn’t mean we are going to be impatient. Moreover, even after the initial increase in the target funds rate, our policy is likely to remain highly accommodative to support continued progress toward our objectives of maximum employment and 2 percent inflation.”

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

There is a critical phrase in the statement of Sep 19, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm): “but mortgage rates have risen further.” Did the increase of mortgage rates influence the decision of the FOMC not to taper? Is FOMC “communication” and “guidance” successful? Will the FOMC increase purchases of mortgage-backed securities if mortgage rates increase? A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2015/01/peaking-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2014/01/theory-and-reality-of-secular.html). Matt Jarzemsky, writing on “Dow industrials set record,” on Mar 5, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324156204578275560657416332.html), analyzes that the DJIA broke the closing high of 14,164.53 set on Oct 9, 2007, and subsequently also broke the intraday high of 14,198.10 reached on Oct 11, 2007. The DJIA closed at 18,015.95 on Fri Jun 19, 2015, which is higher by 27.2 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 26.9 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial assets are approaching or exceeding historical highs.

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

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

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

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

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

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

Greenspan (1996) made similar warnings:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

W = Y/r (10

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

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

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

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

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

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

Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval of (1.99, 2.0). Symmetric targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output that is actually a target of growth forecast. The impact on the overall economy and the financial system of errors of policy are magnified by large-scale policy doses of trillions of dollars of quantitative easing and zero interest rates. The US economy has been experiencing financial repression as a result of negative real rates of interest during nearly a decade and programmed in monetary policy statements until 2015 or, for practical purposes, forever. The essential calculus of risk/return in capital budgeting and financial allocations has been distorted. If economic perspectives are doomed until 2015 such as to warrant zero interest rates and open-ended bond-buying by “printing” digital bank reserves (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html; see Shultz et al 2012), rational investors and consumers will not invest and consume until just before interest rates are likely to increase. Monetary policy statements on intentions of zero interest rates for another three years or now virtually forever discourage investment and consumption or aggregate demand that can increase economic growth and generate more hiring and opportunities to increase wages and salaries. The doom scenario used to justify monetary policy accentuates adverse expectations on discounted future cash flows of potential economic projects that can revive the economy and create jobs. If it were possible to project the future with the central tendency of the monetary policy scenario and monetary policy tools do exist to reverse this adversity, why the tools have not worked before and even prevented the financial crisis? If there is such thing as “monetary policy science”, why it has such poor record and current inability to reverse production and employment adversity? There is no excuse of arguing that additional fiscal measures are needed because they were deployed simultaneously with similar ineffectiveness. Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). If there were an infallible science of central banking, models and forecasts would provide accurate information to policymakers on the future course of the economy in advance. Such forewarning is essential to central bank science because of the long lag between the actual impulse of monetary policy and the actual full effects on income and prices many months and even years ahead (Romer and Romer 2004, Friedman 1961, 1953, Culbertson 1960, 1961, Batini and Nelson 2002). The transcripts of the Fed meetings in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm) analyzed by Jon Hilsenrath demonstrate that Fed policymakers frequently did not understand the current state of the US economy in 2008 and much less the direction of income and prices. The conclusion of Friedman (1953) is that monetary impulses increase financial and economic instability because of lags in anticipating needs of policy, taking policy decisions and effects of decisions. This is a fortiori true when untested unconventional monetary policy in gargantuan doses shocks the economy and financial markets.

In remarkable anticipation in 2005, Professor Raghuram G. Rajan (2005) warned of low liquidity and high risks of central bank policy rates approaching the zero bound (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 218-9). Professor Rajan excelled in a distinguished career as an academic economist in finance and was chief economist of the International Monetary Fund (IMF). Shefali Anand and Jon Hilsenrath, writing on Oct 13, 2013, on “India’s central banker lobbies Fed,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304330904579133530766149484?KEYWORDS=Rajan), interviewed Raghuram G Rajan, who is the current Governor of the Reserve Bank of India, which is India’s central bank (http://www.rbi.org.in/scripts/AboutusDisplay.aspx). In this interview, Rajan argues that central banks should avoid unintended consequences on emerging market economies of inflows and outflows of capital triggered by monetary policy. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows. Professor Rajan, in an interview with Kartik Goyal of Bloomberg (http://www.bloomberg.com/news/2014-01-30/rajan-warns-of-global-policy-breakdown-as-emerging-markets-slide.html), warns of breakdown of global policy coordination. Professor Raguram G Rajan, governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation.

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

“The Swiss National Bank (SNB) has decided to discontinue the minimum exchange rate of

CHF 1.20 per euro with immediate effect and to cease foreign currency purchases associated with enforcing it.”

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

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

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

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

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

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

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

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

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

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

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

Dan Strumpf and Pedro Nicolaci da Costa, writing on “Fed’s Yellen: Stock Valuations ‘Generally are Quite High,’” on May 6, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/feds-yellen-cites-progress-on-bank-regulation-1430918155?tesla=y ), quote Chair Yellen at open conversation with Christine Lagarde, Managing Director of the IMF, finding “equity-market valuations” as “quite high” with “potential dangers” in bond valuations. The DJIA fell 0.5 percent on May 6, 2015, after the comments and then increased 0.5 percent on May 7, 2015 and 1.5 percent on May 8, 2015.

Fri May 1

Mon 4

Tue 5

Wed 6

Thu 7

Fri 8

DJIA

18024.06

-0.3%

1.0%

18070.40

0.3%

17928.20

-0.5%

-0.8%

17841.98

-1.0%

-0.5%

17924.06

-0.6%

0.5%

18191.11

0.9%

1.5%

There are two approaches in theory considered by Bordo (2012Nov20) and Bordo and Lane (2013). The first approach is in the classical works of Milton Friedman and Anna Jacobson Schwartz (1963a, 1987) and Karl Brunner and Allan H. Meltzer (1973). There is a similar approach in Tobin (1969). Friedman and Schwartz (1963a, 66) trace the effects of expansionary monetary policy into increasing initially financial asset prices: “It seems plausible that both nonbank and bank holders of redundant balances will turn first to securities comparable to those they have sold, say, fixed-interest coupon, low-risk obligations. But as they seek to purchase these they will tend to bid up the prices of those issues. Hence they, and also other holders not involved in the initial central bank open-market transactions, will look farther afield: the banks, to their loans; the nonbank holders, to other categories of securities-higher risk fixed-coupon obligations, equities, real property, and so forth.”

The second approach is by the Austrian School arguing that increases in asset prices can become bubbles if monetary policy allows their financing with bank credit. Professor Michael D. Bordo provides clear thought and empirical evidence on the role of “expansionary monetary policy” in inflating asset prices (Bordo2012Nov20, Bordo and Lane 2013). Bordo and Lane (2013) provide revealing narrative of historical episodes of expansionary monetary policy. Bordo and Lane (2013) conclude that policies of depressing interest rates below the target rate or growth of money above the target influences higher asset prices, using a panel of 18 OECD countries from 1920 to 2011. Bordo (2012Nov20) concludes: “that expansionary money is a significant trigger” and “central banks should follow stable monetary policies…based on well understood and credible monetary rules.” Taylor (2007, 2009) explains the housing boom and financial crisis in terms of expansionary monetary policy.

Another hurdle of exit from zero interest rates is “competitive easing” that Professor Raghuram Rajan, governor of the Reserve Bank of India, characterizes as disguised “competitive devaluation” (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). The fed has been considering increasing interest rates. The European Central Bank (ECB) announced, on Mar 5, 2015, the beginning on Mar 9, 2015 of its quantitative easing program denominated as Public Sector Purchase Program (PSPP), consisting of “combined monthly purchases of EUR 60 bn [billion] in public and private sector securities” (http://www.ecb.europa.eu/mopo/liq/html/pspp.en.html). Expectation of increasing interest rates in the US together with euro rates close to zero or negative cause revaluation of the dollar (or devaluation of the euro and of most currencies worldwide). US corporations suffer currency translation losses of their foreign transactions and investments (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318) while the US becomes less competitive in world trade (Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), Government Intervention in Globalization (2008c)). The DJIA fell 1.5 percent on Mar 6, 2015 and the dollar revalued 2.2 percent from Mar 5 to Mar 6, 2015. The euro has devalued 40.1 percent relative to the dollar from the high on Jul 15, 2008 to Jun 19, 2015.

Fri 27 Feb

Mon 3/2

Tue 3/3

Wed 3/4

Thu 3/5

Fri 3/6

USD/ EUR

1.1197

1.6%

0.0%

1.1185

0.1%

1.1176

0.2%

0.1%

1.1081

1.0%

0.9%

1.1030

1.5%

0.5%

1.0843

3.2%

1.7%

Chair Yellen explained the removal of the word “patience” from the advanced guidance at the press conference following the FOMC meeting on Mar 18, 2015 (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20150318.pdf):

Exchange rate volatility is increasing in response of “impatience” in financial markets with monetary policy guidance and measures:

Fri Mar 6

Mon 9

Tue 10

Wed 11

Thu 12

Fri 13

USD/ EUR

1.0843

3.2%

1.7%

1.0853

-0.1%

1.0700

1.3%

1.4%

1.0548

2.7%

1.4%

1.0637

1.9%

-0.8%

1.0497

3.2%

1.3%

Fri Mar 13

Mon 16

Tue 17

Wed 18

Thu 19

Fri 20

USD/ EUR

1.0497

3.2%

1.3%

1.0570

-0.7%

1.0598

-1.0%

-0.3%

1.0864

-3.5%

-2.5%

1.0661

-1.6%

1.9%

1.0821

-3.1%

-1.5%

Fri Apr 24

Mon 27

Tue 28

Wed 29

Thu 30

May Fri 1

USD/ EUR

1.0874

-0.6%

-0.4%

1.0891

-0.2%

1.0983

-1.0%

-0.8%

1.1130

-2.4%

-1.3%

1.1223

-3.2%

-0.8%

1.1199

-3.0%

0.2%

In a speech at Brown University on May 22, 2015, Chair Yellen stated (http://www.federalreserve.gov/newsevents/speech/yellen20150522a.htm):

“For this reason, if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalizing monetary policy. To support taking this step, however, I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium term. After we begin raising the federal funds rate, I anticipate that the pace of normalization is likely to be gradual. The various headwinds that are still restraining the economy, as I said, will likely take some time to fully abate, and the pace of that improvement is highly uncertain.”

The US dollar appreciated 3.8 percent relative to the euro in the week of May 22, 2015:

Fri May 15

Mon 18

Tue 19

Wed 20

Thu 21

Fri 22

USD/ EUR

1.1449

-2.2%

-0.3%

1.1317

1.2%

1.1150

2.6%

1.5%

1.1096

3.1%

0.5%

1.1113

2.9%

-0.2%

1.1015

3.8%

0.9%

The Managing Director of the International Monetary Fund (IMF), Christine Lagarde, warned on Jun 4, 2015, that: (http://blog-imfdirect.imf.org/2015/06/04/u-s-economy-returning-to-growth-but-pockets-of-vulnerability/):

“The Fed’s first rate increase in almost 9 years is being carefully prepared and telegraphed. Nevertheless, regardless of the timing, higher US policy rates could still result in significant market volatility with financial stability consequences that go well beyond US borders. I weighing these risks, we think there is a case for waiting to raise rates until there are more tangible signs of wage or price inflation than are currently evident. Even after the first rate increase, a gradual rise in the federal fund rates will likely be appropriate.”

The President of the European Central Bank (ECB), Mario Draghi, warned on Jun 3, 2015 that (http://www.ecb.europa.eu/press/pressconf/2015/html/is150603.en.html):

“But certainly one lesson is that we should get used to periods of higher volatility. At very low levels of interest rates, asset prices tend to show higher volatility…the Governing Council was unanimous in its assessment that we should look through these developments and maintain a steady monetary policy stance.”

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

Table IA-1 provides annual equivalent rates of inflation for producer price indexes followed in this blog of countries and regions that account for close to three quarters of world output. The behavior of the US producer price index in 2011 and into 2012-2015 shows neatly multiple waves. (1) In Jan-Apr 2011, without risk aversion, US producer prices rose at the annual equivalent rate of 10.4 percent. (2) After risk aversion, producer prices increased in the US at the annual equivalent rate of 1.2 percent in May-Jun 2011. (3) From Jul to Sep 2011, under alternating episodes of risk aversion, producer prices increased at the annual equivalent rate of 4.5 percent. (4) Under the pressure of risk aversion because of the European debt crisis, US producer prices increased at the annual equivalent rate of minus 0.4 percent in Oct-Dec 2011. (5) Inflation of producer prices returned with 2.8 percent annual equivalent in Jan-Mar 2012. (6) With return of risk aversion from the European debt crisis, producer prices fell at the annual equivalent rate of 3.5 percent in Apr-May 2012. (7) New positions in commodity futures even with continuing risk aversion caused annual equivalent inflation of minus 0.6 percent in Jun-Jul 2012. (8) Relaxed risk aversion because of announcement of sovereign bond buying by the European Central Bank (http://www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html) induced carry trades that resulted in annual equivalent producer price inflation in the US of 14.0 percent in Aug-Sep 2012. (9) Renewed risk aversion caused unwinding of carry trades of zero interest rates to commodity futures exposures with annual equivalent inflation of minus 2.4 percent in Oct-Dec 2012. (10) In Jan-Feb 2013, producer prices rose at the annual equivalent rate of 6.2 percent with more relaxed risk aversion at the margin. (11) Return of risk aversion resulted in annual equivalent inflation of minus 7.0 percent in Mar-Apr 2013 with worldwide portfolio reallocation toward equities and high-yield bonds and away from commodity exposures. (12) Inflation of producer prices returned at 3.7 percent in annual equivalent in May-Aug 2013. (13) Continuing reallocation of investment portfolios away from commodities into equities is causing downward pressure on prices. In Sep-Nov 2013, the US producer price index changed at the annual equivalent rate of 0.0 percent. (14) Renewed carry trades caused annual equivalent inflation of 5.3 percent in US producer prices in Dec 2013-Feb 2014. (15) Annual equivalent inflation of producer prices was 3.7 percent in Mar 2014. (16) Annual equivalent inflation of producer prices moved at 2.7 percent in Apr-Jul 2014. (17) Annual equivalent inflation of producer prices fell at 3.5 percent in Aug-Nov 2014. (18) Annual equivalent inflation fell at 17.6 percent in Dec 2014-Jan 2015. (19) Annual equivalent inflation of producer prices fell at 2.4 percent in Feb 2015. (19) Annual equivalent inflation of producer prices increased at 6.2 percent in Mar 2015. (20) Producer prices in the US fell at annual equivalent 7.0 percent in Apr 2015. (21) US producer prices increased at annual equivalent 19.6 percent in May 2015. Resolution of the European debt crisis if there is not an unfavorable growth event with political development in China would result in jumps of valuations of risk financial assets. Increases in commodity prices would cause the same high producer price inflation experienced in Jan-Apr 2011 and Aug-Sep 2012. An episode of exploding commodity prices could ignite inflationary expectations that would result in an inflation phenomenon of costly resolution. There are ten producer-price indexes in Table IA-1 for seven countries (two for the US and two for the UK) and one region (euro area) showing very similar behavior. Zero interest rates without risk aversion cause increases in commodity prices that in turn increase input prices at a faster pace than output prices. Producer price inflation rose at very high rates during the first part of 2011 for the US, Japan, China, Euro Area, Germany, France, Italy and the UK when risk aversion was contained. With the increase in risk aversion in May and Jun 2011, inflation moderated because carry trades were unwound. Producer price inflation returned after Jul 2011, with alternating bouts of risk aversion. In the final months of the year producer price inflation collapsed because of the disincentive to exposures in commodity futures resulting from fears of resolution of the European debt crisis. There is renewed worldwide inflation in the early part of 2012 with subsequent collapse because of another round of sharp risk aversion and relative portfolio reallocation away from commodities and into equities and high-yield bonds. Sharp worldwide jump in producer prices occurred recently because of zero interest rates by reinvestment of principal in securities and issue of trillion of dollars of bank reserves in perpetuity or QE→∞ in almost continuous time with temporarily relaxed risk aversion. Alternating episodes of increase and decrease of inflation introduce uncertainty in household planning that frustrates consumption and home buying. Producer prices were moderating or falling in the final months of 2012 because of renewed risk aversion that causes unwinding of carry trades from zero interest rates to commodity futures exposures. In the first months of 2013, new carry trades caused higher worldwide inflation. Inflation of producer prices returned in the US and Japan in Dec 2013-Jan 2014. Lower inflation recently originates in portfolio reallocations away from commodity exposures into equities. Unconventional monetary policy fails in stimulating the overall real economy, merely introducing undesirable instability because monetary authorities cannot control allocation of floods of money at zero interest rates to carry trades into risk financial assets. The economy is constrained in a suboptimal allocation of resources that monetary policy perpetuates along a continuum of short-term periods. The result is long-term or dynamic inefficiency in the form of a trajectory of economic activity that is lower than what would be attained with rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html). Inflation of producer prices returned in the US and Japan in Dec 2013-Jan 2014 and fell in Mar 2014 as part of the general instability of economic and financial variables. Inflation returned in

Apr-Jun 2014 with reallocations of portfolios toward commodities during various geopolitical events. Inflation is subdued in Jul-2014-Apr 2015 with reallocations of portfolios away from commodities, returning in May 2015 for some countries. Inflation is returning at the margin with new exposures in the commodities carry trade.

Table IA-1, Annual Equivalent Rates of Producer Price Indexes

INDEX 2011-2015	AE ∆%
US Producer Finished Goods Price Index
AE ∆% May 2015	19.6
AE ∆% Apr 2015	-7.0
AE ∆% Mar 2015	6.2
AE ∆% Feb 2015	-2.4
AE ∆% Dec 2014-Jan 2015	-17.6
AE ∆% Aug-Nov 2014	-3.5
AE ∆% Apr-Jul 2014	2.7
AE ∆% Mar 2014	3.7
AE ∆% Dec 2013-Feb 2014	5.3
AE ∆% Sep-Nov 2013	0.0
AE ∆% May-Aug 2013	3.7
AE ∆% Mar-Apr 2013	-7.0
AE ∆% Jan-Feb 2013	6.2
AE ∆% Oct-Dec 2012	-2.4
AE ∆% Aug-Sep 2012	14.0
AE ∆% Jun-Jul 2012	-0.6
AE ∆% Apr-May 2012	-3.5
AE ∆% Jan-Mar 2012	2.8
AE ∆% Oct-Dec 2011	-0.4
AE ∆% Jul-Sep 2011	4.5
AE ∆% May-Jun 2011	1.2
AE ∆% Jan-Apr 2011	10.4
US Final Demand Producer Price Index
AE ∆% May 2015	6.2
AE ∆% Apr 2015	-4.7
AE ∆% Mar 2015	2.4
AE ∆% Jan-Feb 2015	-7.0
AE ∆% Nov-Dec 2014	-3.5
AE ∆% Oct 2014	3.7
AE ∆% Aug-Sep 2014	-1.8
AE ∆% Mar-Jul 2014	2.7
AE ∆% Dec 2013-Feb 2014	2.4
AE ∆% Sep-Nov 2013	1.6
AE ∆% May-Aug 2013	2.1
AE ∆% Mar-Apr 2013	-1.8
AE ∆% Jan-Feb 2013	2.4
AE ∆% Oct-Dec 2012	1.2
AE ∆% Aug-Sep 2012	5.5
AE ∆% Jun-Jul 2012	-1.2
AE ∆% Apr-May 2012	0.6
AE ∆% Jan-Mar 2012	3.7
AE ∆% Oct-Dec 2011	-0.8
AE ∆% Jul-Sep 2011	3.2
AE ∆% May-Jun 2011	2.4
AE ∆% Jan-Apr 2011	7.4
Japan Corporate Goods Price Index
AE ∆% Mar-May 2015	2.8
AE ∆% Jan-Feb 2015	-8.1
AE ∆% Aug-Dec 2014	-4.2
AE ∆% Apr-Jul 2014	11.6
AE ∆% Feb-Mar 2014	-1.2
AE ∆% Dec 2013-Jan 2014	3.0
AE ∆% Oct-Nov 2013	-0.6
AE ∆% Dec 2012-Sep 2013	3.4
AE ∆% Oct-Nov 2012	-3.0
AE ∆% Aug-Sep 2012	2.4
AE ∆% May-Jul 2012	-5.5
AE ∆% Feb-Apr 2012	2.0
AE ∆% Dec 2011-Jan 2012	-0.6
AE ∆% Jul-Nov 2011	-2.1
AE ∆% May-Jun 2011	-1.2
AE ∆% Jan-Apr 2011	5.8
China Producer Price Index
AE ∆% Jan-May 2015	-5.4
AE ∆% Nov-Dev 2014	-6.4
AE ∆% Oct 2013-Oct 2014	-2.2
AE ∆% Aug-Sep 2013	1.8
AE ∆% Mar-Jul 2013	-4.9
AE ∆% Jan-Feb 2013	2.4
AE ∆% Nov-Dec 2012	-1.2
AE ∆% Oct 2012	2.4
AE ∆% May-Sep 2012	-5.8
AE ∆% Feb-Apr 2012	2.4
AE ∆% Dec 2011-Jan 2012	-2.4
AE ∆% Jul-Nov 2011	-3.1
AE ∆% Jan-Jun 2011	6.4
Euro Zone Industrial Producer Prices
AE ∆% Apr	-1.2
AE ∆% Feb-Mar 2015	4.9
AE ∆% Dec 2014-Jan 2015	-11.9
AE ∆% Oct-Nov 2014	-3.5
AE ∆% Sep 2014	2.4
AE ∆% Jul-Aug 2014	-2.4
AE ∆% Jun 2014	2.4
AE ∆% Jan-May 2014	-2.6
AE ∆% Dec 2013	2.4
AE ∆% Oct-Nov 2013	-3.0
AE ∆% Jul-Sep 2013	1.6
AE ∆% Mar-Jun 2013	-3.5
AE ∆% Jan-Feb 2013	2.4
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Sep-Oct 2012	0.6
AE ∆% Jul-Aug 2012	6.8
AE ∆% Apr-Jun 2012	-2.4
AE ∆% Jan-Mar 2012	7.9
AE ∆% Oct-Dec 2011	0.4
AE ∆% Jul-Sep 2011	2.4
AE ∆% May-Jun 2011	-0.6
AE ∆% Jan-Apr 2011	11.3
Germany Producer Price Index
AE ∆% Feb-May 2015	0.9 NSA 0.3 SA
AE ∆% Oct 2014-Jan 2015	-4.4 NSA -3.3 SA
AE ∆% Jan-Sep 2014	-1.2 NSA -1.3 SA
AE ∆% Dec 2013	1.2 NSA 2.4 SA
AE ∆% Oct-Nov 2013	-1.8 NSA –1.2 SA
AE ∆% Sep 2013	3.7 NSA 0.0 SA
AE ∆% May-Aug 2013	-1.8 NSA –1.2 SA
AE ∆% Feb-Apr 2013	-2.4 NSA –2.0 SA
AE ∆% Jan 2013	7.4 NSA 2.4 SA
AE ∆% Oct-Dec 2012	-0.8 NSA 0.8 SA
AE ∆% Aug-Sep 2012	4.3 NSA 2.4 SA
AE ∆% May-Jul 2012	-2.8 NSA -0.4 SA
AE ∆% Feb-Apr 2012	4.9 NSA 2.0 SA
AE ∆% Dec 2011-Jan 2012	0.0 NSA –0.6 SA
AE ∆% Oct-Nov 2011	0.6 NSA 1.8 SA
AE ∆% Jul-Sep 2011	2.4 NSA 3.2 SA
AE ∆% May-Jun 2011	0.6 NSA 3.7 SA
AE ∆% Jan-Apr 2011	10.4 NSA 5.9 SA
France Producer Price Index for the French Market
AE ∆% Apr 2015	-4.7
AE ∆% Feb-Mar 2015	5.5
AE ∆% Oct 2014-Jan 2015	-5.3
AE ∆% Sep 2014	7.4
AE ∆% Jan-Aug 2014	-4.0
AE ∆% Nov-Dec 2013	4.9
AE ∆% Oct 2013	-2.4
AE ∆% Jul-Sep 2013	4.5
AE ∆% Apr-Jun 2013	-10.7
AE ∆% Jan-Mar 2013	4.9
AE ∆% Nov-Dec 2012	-4.1
AE ∆% Jul-Oct 2012	7.4
AE ∆% Apr-Jun 2012	-4.3
AE ∆% Jan-Mar 2012	6.2
AE ∆% Oct-Dec 2011	2.8
AE ∆% Jul-Sep 2011	3.7
AE ∆% May-Jun 2011	-1.8
AE ∆% Jan-Apr 2011	10.4
Italy Producer Price Index
AE ∆% Apr 2015	-3.5
AE ∆% Feb-Mar 2015	3.7
AE ∆% Dec 2014-Jan 2015	-14.0
AE ∆% Oct-Nov 2014	-3.5
AE ∆% Sep 2014	1.2
AE ∆% Jul-Aug 2014	-3.5
AE ∆% Jun 2014	2.4
AE ∆% Oct 2013-May 2014	-2.7
AE ∆% Jun-Sep 2013	0.3
AE ∆% Apr-May 2013	-3.5
AE ∆% Feb-Mar 2013	1.2
AE ∆% Sep 2012-Jan 2013	-5.2
AE ∆% Jul-Aug 2012	9.4
AE ∆% May-Jun 2012	-0.6
AE ∆% Mar-Apr 2012	6.8
AE ∆% Jan-Feb 2012	8.1
AE ∆% Oct-Dec 2011	2.0
AE ∆% Jul-Sep 2011	4.9
AE ∆% May-Jun 2011	1.8
AE ∆% Jan-April 2011	10.7
UK Output Prices
∆% Feb-May 2015	1.5
AE ∆% Nov 2014-Jan 2015	-4.3
AE ∆% Sep-Oct 2014	-4.7
AE ∆% Apr-Aug 2014	-0.7
AE ∆% Jan-Mar 2014	2.0
AE ∆% Sep-Dec 2013	-1.5
AE ∆% Jun-Aug 2013	2.0
AE ∆% Apr-May 2013	-0.6
AE ∆% Jan-Mar 2013	4.9
AE ∆% Nov-Dec 2012	-2.4
AE ∆% Jul-Oct 2012	3.0
AE ∆% May-Jun 2012	-3.5
AE ∆% Feb-Apr 2012	5.3
AE ∆% Nov 2011-Jan-2012	1.2
AE ∆% May-Oct 2011	1.6
AE ∆% Jan-Apr 2011	10.0
UK Input Prices
AE ∆% May	-10.3
AE ∆% Feb-Apr 2015	7.0
AE ∆% Dec 2014-Jan 2015	-34.4
AE ∆% Jun-Nov 2014	-12.3
AE ∆% May 2014	2.4
AE ∆% Jan-Apr 2014	-7.8
AE ∆% Dec 2013	3.7
AE ∆% Aug-Nov 2013	-8.4
AE ∆% Jul 2013	18.2
AE ∆% Mar-Jun 2013	-9.5
AE ∆% Jan-Feb 2013	24.6
AE ∆% Sep-Dec 2012	3.0
AE ∆% Aug 2012	23.9
AE ∆% Apr-Jul 2012	-16.1
AE ∆% Jan-Mar 2012	14.9
AE ∆% Nov-Dec 2011	0.0
AE ∆% May-Oct 2011	-1.3
AE ∆% Jan-Apr 2011	30.6
AE ∆% Oct-Dec 2010	31.8

AE: Annual Equivalent

Sources: http://www.bls.gov/cpi/ http://www.boj.or.jp/en/

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

https://www.destatis.de/EN/Homepage.html

http://www.insee.fr/en/default.asp

http://www.istat.it/en/

http://www.ons.gov.uk/ons/index.html

Similar world inflation waves are in the behavior of consumer price indexes of six countries and the euro zone in Table IA-2. US consumer price inflation shows similar waves. (1) Under risk appetite in Jan-Apr 2011, consumer prices increased at the annual equivalent rate of 4.9 percent. (2) Risk aversion caused the collapse of inflation to annual equivalent 2.4 percent in May-Jun 2011. (3) Risk appetite drove the rate of consumer price inflation in the US to 3.7 percent in Jul-Sep 2011. (4) Gloomier views of carry trades caused the collapse of inflation in Oct-Nov 2011 to annual equivalent 1.8 percent. (5) Consumer price inflation resuscitated with increased risk appetite at annual equivalent of 1.8 percent in Dec 2011 to Jan 2012. (6) Consumer price inflation returned at 2.4 percent annual equivalent in Feb-Apr 2012. (7) Under renewed risk aversion, annual equivalent consumer price inflation in the US was minus 1.2 percent in May-Jul 2012. (8) Inflation jumped to annual equivalent 5.7 percent in Aug-Oct 2012. (9) Unwinding of carry trades caused negative annual equivalent inflation of minus 0.4 percent in Nov 2012-Jan 2013 but some countries experienced higher inflation in Dec 2012 and Jan 2013. (10) Inflation jumped again with annual equivalent inflation of 7.4 percent in Feb 2013 in a mood of relaxed risk aversion. (11) Inflation fell at 2.4 percent annual equivalent in Mar-Apr 2013. (12) Inflation rose at 2.4 percent in annual equivalent in May-Sep 2013. (13) Inflation moderated at the annual equivalent rate of 1.2 percent in Oct-Nov 2013. (14) Inflation stood at annual equivalent 2.4 percent in Dec 2013-Mar 2014. (5) Inflation returned at annual equivalent 2.4 percent in Apr-Jul 2014. (6) Annual equivalent inflation was minus 1.2 percent in Aug 2014. (7) Inflation was minus 1.2 percent in annual equivalent in Sep-Oct 2014. (7) Inflation fell at annual equivalent 5.1 percent in Nov 2014-Jan 2015. (8) Inflation increased at annual equivalent 2.7 percent in Feb-May 2015. Inflationary expectations can be triggered in one of these episodes of accelerating inflation because of commodity carry trades induced by unconventional monetary policy of zero interest rates by reinvestment of principal in securities and issue of trillion of dollars of bank reserves in perpetuity or QE→∞ in almost continuous time. Alternating episodes of increase and decrease of inflation introduce uncertainty in household planning that frustrates consumption and home buying. Announcement of purchases of impaired sovereign bonds by the European Central Bank (http://www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html) relaxed risk aversion that induced carry trades into commodity exposures, increasing prices of food, raw materials and energy. There is similar behavior in the other consumer price indexes in Table IA-2. China’s CPI increased at annual equivalent 8.3 percent in Jan-Mar 2011, 2.0 percent in Apr-Jun, 2.9 percent in Jul-Nov and resuscitated at 5.8 percent annual equivalent in Dec 2011 to Mar 2012, declining to minus 3.9 percent in Apr-Jun 2012 but resuscitating at 4.1 percent in Jul-Sep 2012, declining to minus 1.2 percent in Oct 2012 and 0.0 percent in Oct-Nov 2012. High inflation in China at annual equivalent 5.5 percent in Nov-Dec 2012 is attributed to inclement winter weather that caused increases in food prices. Continuing pressure of food prices caused annual equivalent inflation of 12.2 percent in China in Dec 2012 to Feb 2013. Inflation in China fell at annual equivalent 10.3 percent in Mar 2013 and increased at annual equivalent 2.4 percent in Apr 2013. Adjustment to lower food prices caused annual equivalent inflation of minus 7.0 percent in May 2013 and minus 3.5 percent in annual equivalent in May-Jun 2013. Inflation in China returned at annual equivalent 4.6 percent in Jul-Oct 2013, falling at 1.2 percent in annual equivalent in Nov 2013. As in many countries, inflation in China surged at 7.4 percent annual equivalent in Dec 2013-Feb 2014 with significant effects of local increases in food prices. Annual equivalent inflation in China fell at 4.7 percent in Mar-Apr 2014 and increased at 1.2 percent in May 2014. China’s inflation fell at annual equivalent 1.2 percent in Jun 2014 and increased at annual equivalent 2.4 percent in Jul-Oct 2014. Inflation in China fell at annual equivalent 2.4 percent in Nov 2014 and increased at annual equivalent 7.4 percent in Dec 2014-Feb 2015. Consumer prices in China fell at annual equivalent 3.5 percent in Mar-May 2015. The euro zone harmonized index of consumer prices (HICP) increased at annual equivalent 4.9 percent in Jan-Apr 2011, minus 2.4 percent in May-Jul 2011, 4.0 percent in Aug-Nov 2011, minus 3.0 percent in Dec 2011-Jan 2012 and then 9.6 percent in Feb-Apr 2012, falling to minus 2.8 percent annual equivalent in May-Jul 2012 but resuscitating at 5.3 percent in Aug-Oct 2012. The shock of risk aversion forced minus 2.4 percent annual equivalent in Nov 2012. As in several European countries, annual equivalent inflation jumped to 4.9 percent in the euro area in Dec 2012. The HICP price index fell at annual equivalent 11.4 percent in Jan 2013 and increased at 10.0 percent in Feb-Mar 2013. Prices in the euro zone fell at 1.2 percent in Apr 2013 and increased at 1.2 percent in May-Jun 2013. Inflation in the euro zone fell at annual equivalent 5.8 percent in Jul 2013. Inflation returned in the euro zone at annual equivalent 3.7 percent in Aug-Sep 2013. Euro zone inflation fell at the annual equivalent rate of 2.4 percent in Oct-Nov 2013. Euro zone inflation jumped at 4.9 percent annual equivalent in Dec 2013 as in many countries worldwide. Inflation in the euro zone fell at annual equivalent 12.4 percent in Dec 2013 and increased at annual equivalent 5.7 percent in Feb-Apr 2014. Inflation in the euro zone fell at 1.2 percent in May 2014 and increased at 1.2 percent in Jun 2014. Inflation in the euro area fell at annual equivalent 8.1 percent in Jul 2014 and increased at 3.0 percent in Aug-Sep 2014. Consumer prices of the euro zone fell at annual equivalent 5.6 percent in Oct 2014-Jan 2015. Euro zone consumer prices increased at annual equivalent 6.5 percent in Feb-May 2015. The price indexes of the largest members of the euro zone, Germany, France and Italy, and the euro zone as a whole, exhibit the same inflation waves. The United Kingdom CPI increased at annual equivalent 6.5 percent in Jan-Apr 2011, falling to only 0.4 percent in May-Jul 2011 and then increasing at 4.6 percent in Aug-Nov 2011. UK consumer prices fell at 0.6 percent annual equivalent in Dec 2011 to Jan 2012 but increased at 6.2 percent annual equivalent from Feb to Apr 2012. In May-Jun 2012, with renewed risk aversion, UK consumer prices fell at the annual equivalent rate of minus 3.0 percent. Inflation returned in the UK at average annual equivalent of 4.5 percent in Jul-Dec 2012 with inflation in Oct 2012 caused mostly by increases of university tuition fees. Inflation returned at 4.5 percent annual equivalent in Jul-Dec 2012 and was higher in annual equivalent inflation of producer prices in the UK in Jul-Oct 2012 at 3.0 percent for output prices and 23.9 percent for input prices in Aug 2012 (see Table IA-1). Consumer prices in the UK fell at annual equivalent 5.8 percent in Jan 2013. Inflation returned in the UK with annual equivalent 4.3 percent in Feb-May 2013 and fell at 1.2 percent in Jun-Jul 2013. UK annual equivalent inflation returned at 3.4 percent in Aug-Dec 2013. CPI inflation fell at annual equivalent 7.0 percent in Jan 2014. Consumer price inflation in the UK returned at annual equivalent 4.5 percent in Feb-Apr 2014. UK consumer prices fell at annual equivalent 1.2 percent in May 2014 and increased at 2.4 percent in Jun 2014. UK consumer prices fell at annual equivalent 3.5 percent in Jul 2014 and increased at 2.0 percent in Aug-Oct 2014. UK consumer prices fell at annual equivalent 4.7 percent in Nov 2014-Jan 2015. UK consumer prices increased at 2.7 percent annual equivalent in Feb-May 2015.

Table IA-2, Annual Equivalent Rates of Consumer Price Indexes

Index 2011-2014	AE ∆%
US Consumer Price Index
AE ∆% Feb-May 2015	2.7
AE ∆% Nov 2014-Jan 2015	-5.1
AE ∆% Sep-Oct 2014	-1.2
AE ∆% Aug	-1.2
AE ∆% Apr-Jul 2014	2.4
AE ∆% Dec 2013-Mar 2014	2.4
AE ∆% Oct-Nov 2013	1.2
AE ∆% May-Sep 2013	2.4
AE ∆% Mar-Apr 2013	-2.4
AE ∆% Feb 2013	7.4
AE ∆% Nov 2012-Jan 2013	-0.4
AE ∆% Aug-Oct 2012	5.7
AE ∆% May-Jul 2012	-1.2
AE ∆% Feb-Apr 2012	2.4
AE ∆% Dec 2011-Jan 2012	1.8
AE ∆% Oct-Nov 2011	1.8
AE ∆% Jul-Sep 2011	3.7
AE ∆% May-Jun 2011	2.4
AE ∆% Jan-Apr 2011	4.9
China Consumer Price Index
AE ∆% Mar-May 2015	-3.5
AE ∆% Dec 2014-Feb 2015	7.4
AE ∆% Nov 2014	-2.4
AE ∆% Jul-Oct 2014	2.4
AE ∆% Jun 2014	-1.2
AE ∆% May 2014	1.2
AE ∆% Mar-Apr 2014	-4.7
AE ∆% Dec 2013-Feb 2014	7.4
AE ∆% Nov 2013	-1.2
AE ∆% Jul-Oct 2013	4.6
AE ∆% May-Jun 2013	-3.5
AE ∆% Apr 2013	2.4
AE ∆% Mar 2013	-10.3
AE ∆% Dec 2012-Feb 2013	12.2
AE ∆% Oct-Nov 2012	0.0
AE ∆% Jul-Sep 2012	4.1
AE ∆% Apr-Jun 2012	-3.9
AE ∆% Dec 2011-Mar 2012	5.8
AE ∆% Jul-Nov 2011	2.9
AE ∆% Apr-Jun	2.0
AE ∆% Jan-Mar 2011	8.3
Euro Zone Harmonized Index of Consumer Prices
AE ∆% Feb-May 2015	6.5
AE ∆% Oct 2014-Jan 2015	-5.6
AE ∆% Aug-Sep 2014	3.0
AE ∆% Jul 2014	-8.1
AE ∆% Jun 2014	1.2
AE ∆% May 2014	-1.2
AE ∆% Feb-Apr 2014	5.7
AE ∆% Jan 2014	-12.4
AE ∆% Dec 2013	4.9
AE ∆% Oct-Nov 2013	-2.4
AE ∆% Aug-Sep 2013	3.7
AE ∆% Jul 2013	-5.8
AE ∆% May-Jun 2013	1.2
AE ∆% Apr 2013	-1.2
AE ∆% Feb-Mar 2013	10.0
AE ∆% Jan 2013	-11.4
AE ∆% Dec 2012	4.9
AE ∆% Nov 2012	-2.4
AE ∆% Aug-Oct 2012	5.3
AE ∆% May-Jul 2012	-2.8
AE ∆% Feb-Apr 2012	9.6
AE ∆% Dec 2011-Jan 2012	-3.0
AE ∆% Aug-Nov 2011	4.0
AE ∆% May-Jul 2011	-2.4
AE ∆% Jan-Apr 2011	4.9
Germany Consumer Price Index
AE ∆% Feb-May 2015	4.6 NSA 2.4 SA
AE ∆% Jan 2015	-11.4 NSA -2.4 SA
AE ∆% Aug-Dec 2014	-0.7 NSA 0.0 SA
AE ∆% Jun-Jul 2014	3.7 NSA 1.2 SA
AE ∆% Apr-May 2014	-1.8 NSA 0.0 SA
AE ∆% Feb-Mar 2014	4.9 NSA 0.0 SA
AE ∆% Jan 2014	-7.0 NSA 2.4 SA
AE ∆% Nov-Dec 2013	3.7 NSA 1.8 SA
AE ∆% Oct 2013	-2.4 NSA 1.2 SA
AE ∆% Aug-Sep 2013	0.0 NSA 0.6 SA
AE ∆% May-Jul 2013	4.1 NSA 2.4 SA
AE ∆% Apr 2013	-5.8 NSA 0.0 SA
AE ∆% Feb-Mar 2013	6.8 NSA 1.2 SA
AE ∆% Jan 2013	-5.8 NSA 1.2 SA
AE ∆% Sep-Dec 2012	1.5 NSA 1.5 SA
AE ∆% Jul-Aug 2012	4.9 NSA 3.0 SA
AE ∆% May-Jun 2012	-1.2 NSA 0.6 SA
AE ∆% Feb-Apr 2012	4.5 NSA 2.4 SA
AE ∆% Dec 2011-Jan 2012	0.6 NSA 1.8 SA
AE ∆% Jul-Nov 2011	1.7 NSA 1.9 SA
AE ∆% May-Jun 2011	0.6 NSA 3.0 SA
AE ∆% Feb-Apr 2011	3.0 NSA 2.4 SA
France Consumer Price Index
AE ∆% Feb-May 2015	5.2
AE ∆% Jan 2015	-11.4
AE ∆% Dec 2014	1.2
AE ∆% Sep-Nov 2014	-2.4
AE ∆% Aug 2014	4.9
AE ∆% Jul 2014	-3.5
AE ∆% Apr-Jun 2014	0.0
AE ∆% Feb-Mar 2014	6.8
AE ∆% Jan 2014	-7.0
AE ∆% Dec 2013	3.7
AE ∆% Sep-Nov 2013	-1.6
AE ∆% Aug 2013	6.2
AE ∆% Jul 2013	-3.5
AE ∆% May-Jun 2013	1.8
AE ∆% Apr 2013	-1.2
AE ∆% Feb-Mar 2013	6.8
AE ∆% Nov 2012-Jan 2013	-1.6
AE ∆% Aug-Oct 2012	2.8
AE ∆% May-Jul 2012	-2.4
AE ∆% Feb-Apr 2012	5.3
AE ∆% Dec 2011-Jan 2012	0.0
AE ∆% Aug-Nov 2011	3.0
AE ∆% May-Jul 2011	-1.2
AE ∆% Jan-Apr 2011	4.3
Italy Consumer Price Index
AE ∆% Feb-May 2015	2.4
AE ∆% Nov 2014-Jan 2015	-2.4
AE ∆% Oct 2014	1.2
AE ∆% Sep 2014	-4.7
AE ∆% Aug 2014	2.4
AE ∆% Jul 2014	-1.2
AE ∆% Jun 2014	1.2
AE ∆% May 2014	-1.2
AE ∆% Mar-Apr 2014	1.8
AE ∆% Feb 2014	-1.2
AE ∆% Dec 2013-Jan 2014	2.4
AE ∆% Sep-Nov 2013	-3.2
AE ∆% Dec 2012-Aug 2013	2.0
AE ∆% Sep-Nov 2012	-0.8
AE ∆% Jul-Aug 2012	3.0
AE ∆% May-Jun 2012	1.2
AE ∆% Feb-Apr 2012	5.7
AE ∆% Dec 2011-Jan 2012	4.3
AE ∆% Oct-Nov 2011	3.0
AE ∆% Jul-Sep 2011	2.4
AE ∆% May-Jun 2011	1.2
AE ∆% Jan-Apr 2011	4.9
UK Consumer Price Index
AE ∆% Feb-May 2015	2.7
AE ∆% Nov 2014-Jan 2015	-4.7
AE ∆% Aug-Oct 2014	2.0
AE ∆% Jul 2014	-3.5
AE ∆% Jun 2014	2.4
AE ∆% May 2014	-1.2
AE ∆% Feb-Apr	4.5
AE ∆% Jan 2014	-7.0
AE ∆% Aug-Dec 2013	3.4
AE ∆% Jun-Jul 2013	-1.2
AE ∆% Feb-May 2013	4.3
AE ∆% Jan 2013	-5.8
AE ∆% Jul-Dec 2012	4.5
AE ∆% May-Jun 2012	-3.0
AE ∆% Feb-Apr 2012	6.2
AE ∆% Dec 2011-Jan 2012	-0.6
AE ∆% Aug-Nov 2011	4.6
AE ∆% May-Jul 2011	0.4
AE ∆% Jan-Apr 2011	6.5

AE: Annual Equivalent

Sources: http://www.bls.gov/cpi/ http://www.boj.or.jp/en/

http://www.stats.gov.cn/enGliSH/

http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database

https://www.destatis.de/EN/Homepage.html

http://www.insee.fr/en/default.asp

http://www.istat.it/en/

http://www.ons.gov.uk/ons/index.html

IA Appendix: Transmission of Unconventional Monetary Policy. Janet L. Yellen, Vice Chair of the Board of Governors of the Federal Reserve System, provides analysis of the policy of purchasing large amounts of long-term securities for the Fed’s balance sheet. The new analysis provides three channels of transmission of quantitative easing to the ultimate objectives of increasing growth and employment and increasing inflation to “levels of 2 percent or a bit less that most Committee participants judge to be consistent, over the long run, with the FOMC’s dual mandate” (Yellen 2011AS, 4, 7):

“There are several distinct channels through which these purchases tend to influence aggregate demand, including a reduced cost of credit to consumers and businesses, a rise in asset prices that boost household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.”

The new analysis by Yellen (2011AS) is considered below in four separate subsections: IA1 Theory; IA2 Policy; IA3 Evidence; and IA4 Unwinding Strategy.

IA1 Theory. The transmission mechanism of quantitative easing can be analyzed in three different forms. (1) Portfolio choice theory. General equilibrium value theory was proposed by Hicks (1935) in analyzing the balance sheets of individuals and institutions with assets in the capital segment consisting of money, debts, stocks and productive equipment. Net worth or wealth would be comparable to income in value theory. Expected yield and risk would be the constraint comparable to income in value theory. Markowitz (1952) considers a portfolio of individual securities with mean μ_p and variance σ_p. The Markowitz (1952, 82) rule states that “investors would (or should” want to choose a portfolio of combinations of (μ_p, σ_p) that are efficient, which are those with minimum variance or risk for given expected return μ_p or more and maximum expected μ_p for given variance or risk or less. The more complete model of Tobin (1958) consists of portfolio choice of monetary assets by maximizing a utility function subject to a budget constraint. Tobin (1961, 28) proposes general equilibrium analysis of the capital account to derive choices of capital assets in balance sheets of economic units with the determination of yields in markets for capital assets with the constraint of net worth. A general equilibrium model of choice of portfolios was developed simultaneously by various authors (Hicks 1962; Treynor 1962; Sharpe 1964; Lintner 1965; Mossin 1966). If shocks such as by quantitative easing displace investors from the efficient frontier, there would be reallocations of portfolios among assets until another efficient point is reached. Investors would bid up the prices or lower the returns (interest plus capital gains) of long-term assets targeted by quantitative easing, causing the desired effect of lowering long-term costs of investment and consumption.

(2) General Equilibrium Theory. Bernanke and Reinhart (2004, 88) argue that “the possibility monetary policy works through portfolio substitution effects, even in normal times, has a long intellectual history, having been espoused by both Keynesians (James Tobin 1969) and monetarists (Karl Brunner and Allan Meltzer 1973).” Andres et al. (2004) explain the Tobin (1969) contribution by optimizing agents in a general-equilibrium model. Both Tobin (1969) and Brunner and Meltzer (1973) consider capital assets to be gross instead of perfect substitutes with positive partial derivatives of own rates of return and negative partial derivatives of cross rates in the vector of asset returns (interest plus principal gain or loss) as argument in portfolio balancing equations (see Pelaez and Suzigan 1978, 113-23). Tobin (1969, 26) explains portfolio substitution after monetary policy:

“When the supply of any asset is increased, the structure of rates of return, on this and other assets, must change in a way that induces the public to hold the new supply. When the asset’s own rate can rise, a large part of the necessary adjustment can occur in this way. But if the rate is fixed, the whole adjustment must take place through reductions in other rates or increases in prices of other assets. This is the secret of the special role of money; it is a secret that would be shared by any other asset with a fixed interest rate.”

Andrés et al. (2004, 682) find that in their multiple-channels model “base money expansion now matters for the deviations of long rates from the expected path of short rates. Monetary policy operates by both the expectations channel (the path of current and expected future short rates) and this additional channel. As in Tobin’s framework, interest rates spreads (specifically, the deviations from the pure expectations theory of the term structure) are an endogenous function of the relative quantities of assets supplied.”

The interrelation among yields of default-free securities is measured by the term structure of interest rates. This schedule of interest rates along time incorporates expectations of investors. (Cox, Ingersoll and Ross 1985). The expectations hypothesis postulates that the expectations of investors about the level of future spot rates influence the level of current long-term rates. The normal channel of transmission of monetary policy in a recession is to lower the target of the fed funds rate that will lower future spot rates through the term structure and also the yields of long-term securities. The expectations hypothesis is consistent with term premiums (Cox, Ingersoll and Ross 1981, 774-7) such as liquidity to compensate for risk or uncertainty about future events that can cause changes in prices or yields of long-term securities (Hicks 1935; see Cox, Ingersoll and Ross 1981, 784; Chung et al. 2011, 22).

(3) Preferred Habitat. Another approach is by the preferred-habitat models proposed by Culbertson (1957, 1963) and Modigliani and Sutch (1966). This approach is formalized by Vayanos and Vila (2009). The model considers investors or “clientele” who do not abandon their segment of operations unless there are extremely high potential returns and arbitrageurs who take positions to profit from discrepancies. Pension funds matching benefit liabilities would operate in segments above 15 years; life insurance companies operate around 15 years or more; and asset managers and bank treasury managers are active in maturities of less than 10 years (Ibid, 1). Hedge funds, proprietary trading desks and bank maturity transformation activities are examples of potential arbitrageurs. The role of arbitrageurs is to incorporate “information about current and future short rates into bond prices” (Ibid, 12). Suppose monetary policy raises the short-term rate above a certain level. Clientele would not trade on this information, but arbitrageurs would engage in carry trade, shorting bonds and investing at the short-term rate, in a “roll-up” trade, resulting in decline of bond prices or equivalently increases in yields. This is a situation of an upward-sloping yield curve. If the short-term rate were lowered, arbitrageurs would engage in carry trade borrowing at the short-term rate and going long bonds, resulting in an increase in bond prices or equivalently decline in yields, or “roll-down” trade. The carry trade is the mechanism by which bond yields adjust to changes in current and expected short-term interest rates. The risk premiums of bonds are positively associated with the slope of the term structure (Ibid, 13). Fama and Bliss (1987, 689) find with data for 1964-85 that “1-year expected returns for US Treasury maturities to 5 years, measured net of the interest rate on a 1-year bond, vary through time. Expected term premiums are mostly positive during good times but mostly negative during recessions.” Vayanos and Vila (2009) develop a model with two-factors, the short-term rate and demand or quantity. The term structure moves because of shocks of short-term rates and demand. An important finding is that demand or quantity shocks are largest for intermediate and long maturities while short-rate shocks are largest for short-term maturities.

IA2 Policy. A simplified analysis could consider the portfolio balance equations A_ij = f(r, x) where A_ij is the demand for i = 1,2,∙∙∙n assets from j = 1,2, ∙∙∙m sectors, r the 1xn vector of rates of return, r_i, of n assets and x a vector of other relevant variables. Tobin (1969) and Brunner and Meltzer (1973) assume imperfect substitution among capital assets such that the own first derivatives of A_ij are positive, demand for an asset increases if its rate of return (interest plus capital gains) is higher; and cross first derivatives are negative, demand for an asset decreases if the rate of return of alternative assets increases. Theoretical purity would require the estimation of the complete model with all rates of return. In practice, it may be impossible to observe all rates of return such as in the critique of Roll (1976). Policy proposals by the Fed have been focused on the likely impact of withdrawals of stocks of securities in specific segments, that is, of effects of one or several specific rates of return among the n possible rates. There have been at least seven approaches on the role of monetary policy in purchasing long-term securities that have increased the classes of rates of return targeted by the Fed:

(1) Suspension of Auctions of 30-year Treasury Bonds. Auctions of 30-year Treasury bonds were suspended between 2001 and 2005. This was Treasury policy not Fed policy. The effects were similar to those of quantitative easing: withdrawal of supply from the segment of 30-year bonds would result in higher prices or lower yields for close-substitute mortgage-backed securities with resulting lower mortgage rates. The objective was to encourage refinancing of house loans that would increase family income and consumption by freeing income from reducing monthly mortgage payments.

(2) Purchase of Long-term Securities by the Fed. Between Nov 2008 and Mar 2009 the Fed announced the intention of purchasing $1750 billion of long-term securities: $600 billion of agency mortgage-backed securities and agency debt announced on Nov 25 and $850 billion of agency mortgaged-backed securities and agency debt plus $300 billion of Treasury securities announced on Mar 18, 2009 (Yellen 2011AS, 5-6). The objective of buying mortgage-backed securities was to lower mortgage rates that would “support the housing sector” (Bernanke 2009SL). The FOMC statement on Dec 16, 2008 informs that: “over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and its stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant” (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). The Mar 18, 2009, statement of the FOMC explained that: “to provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities up to $1.25 trillion this year, and to increase its purchase of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months” (http://www.federalreserve.gov/newsevents/press/monetary/20090318a.htm). Policy changed to increase prices or reduce yields of mortgage-backed securities and Treasury securities with the objective of supporting housing markets and private credit markets by lowering costs of housing and long-term private credit.

(3) Portfolio Reinvestment. On Aug 10, 2010, the FOMC statement explains the reinvestment policy: “to help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in long-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature” (http://www.federalreserve.gov/newsevents/press/monetary/20100810a.htm). The objective of policy appears to be supporting conditions in housing and mortgage markets with slow transfer of the portfolio to Treasury securities that would support private-sector markets.

(4) Increasing Portfolio. As widely anticipated, the FOMC decided on Dec 3, 2010: “to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month” (http://www.federalreserve.gov/newsevents/press/monetary/20101103a.htm). The emphasis appears to shift from housing markets and private-sector credit markets to the general economy, employment and preventing deflation.

(5) Increasing Stock Market Valuations. Chairman Bernanke (2010WP) explained on Nov 4 the objectives of purchasing an additional $600 billion of long-term Treasury securities and reinvesting maturing principal and interest in the Fed portfolio. Long-term interest rates fell and stock prices rose when investors anticipated the new round of quantitative easing. Growth would be promoted by easier lending such as for refinancing of home mortgages and more investment by lower corporate bond yields. Consumers would experience higher confidence as their wealth in stocks rose, increasing outlays. Income and profits would rise and, in a “virtuous circle,” support higher economic growth. Bernanke (2000) analyzes the role of stock markets in central bank policy (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 99-100). Fed policy in 1929 increased interest rates to avert a gold outflow and failed to prevent the deepening of the banking crisis without which the Great Depression may not have occurred. In the crisis of Oct 19, 1987, Fed policy supported stock and futures markets by persuading banks to extend credit to brokerages. Collapse of stock markets would slow consumer spending.

(6) Devaluing the Dollar. Yellen (2011AS, 6) broadens the effects of quantitative easing by adding dollar devaluation: “there are several distinct channels through which these purchases tend to influence aggregate demand, including a reduced cost of credit to consumers and businesses, a rise in asset prices that boosts household wealth and spending, and a moderate change in the foreign exchange value of the dollar that provides support to net exports.”

(7) Let’s Twist Again Monetary Policy. The term “operation twist” grew out of the dance “twist” popularized by successful musical performer Chubby Chekker (http://www.youtube.com/watch?v=aWaJ0s0-E1o). Meulendyke (1998, 39) describes the coordination of policy by Treasury and the FOMC in the beginning of the Kennedy administration in 1961 (see Modigliani and Sutch 1966, 1967; http://cmpassocregulationblog.blogspot.com/2011/09/imf-view-of-world-economy-and-finance.html http://cmpassocregulationblog.blogspot.com/2011/09/collapse-of-household-income-and-wealth.html):

“In 1961, several developments led the FOMC to abandon its “bills only” restrictions. The new Kennedy administration was concerned about gold outflows and balance of payments deficits and, at the same time, it wanted to encourage a rapid recovery from the recent recession. Higher rates seemed desirable to limit the gold outflows and help the balance of payments, while lower rates were wanted to speed up economic growth.

To deal with these problems simultaneously, the Treasury and the FOMC attempted to encourage lower long-term rates without pushing down short-term rates. The policy was referred to in internal Federal Reserve documents as “operation nudge” and elsewhere as “operation twist.” For a few months, the Treasury engaged in maturity exchanges with trust accounts and concentrated its cash offerings in shorter maturities.

The Federal Reserve participated with some reluctance and skepticism, but it did not see any great danger in experimenting with the new procedure.

It attempted to flatten the yield curve by purchasing Treasury notes and bonds while selling short-term Treasury securities. The domestic portfolio grew by $1.7 billion over the course of 1961. Note and bond holdings increased by a substantial $8.8 billion, while certificate of indebtedness holdings fell by almost $7.4 billion (Table 2). The extent to which these actions changed the yield curve or modified investment decisions is a source of dispute, although the predominant view is that the impact on yields was minimal. The Federal Reserve continued to buy coupon issues thereafter, but its efforts were not very aggressive. Reference to the efforts disappeared once short-term rates rose in 1963. The Treasury did not press for continued Fed purchases of long-term debt. Indeed, in the second half of the decade, the Treasury faced an unwanted shortening of its portfolio. Bonds could not carry a coupon with a rate above 4 1/4 percent, and market rates persistently exceeded that level. Notes—which were not subject to interest rate restrictions—had a maximum maturity of five years; it was extended to seven years in 1967.”

As widely anticipated by markets, perhaps intentionally, the Federal Open Market Committee (FOMC) decided at its meeting on Sep 21 that it was again “twisting time” (http://www.federalreserve.gov/newsevents/press/monetary/20110921a.htm):

“Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.

The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate.”

The FOMC decided at its meeting on Jun 20, 2012, to continue “Let’s Twist Again” monetary policy until the end of 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120620a.htm http://www.newyorkfed.org/markets/opolicy/operating_policy_120620.html):

“The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

IA3 Evidence. There are multiple empirical studies on the effectiveness of quantitative easing that have been covered in past posts such as (Andrés et al. 2004, D’Amico and King 2010, Doh 2010, Gagnon et al. 2010, Hamilton and Wu 2010). On the basis of simulations of quantitative easing with the FRB/US econometric model, Chung et al (2011, 28-9) find that:

”Lower long-term interest rates, coupled with higher stock market valuations and a lower foreign exchange value of the dollar, provide a considerable stimulus to real activity over time. Phase 1 of the program by itself is estimated to boost the level of real GDP almost 2 percent above baseline by early 2012, while the full program raises the level of real GDP almost 3 percent by the second half of 2012. This boost to real output in turn helps to keep labor market conditions noticeably better than they would have been without large scale asset purchases. In particular, the model simulations suggest that private payroll employment is currently 1.8 million higher, and the unemployment rate ¾ percentage point lower, that would otherwise be the case. These benefits are predicted to grow further over time; by 2012, the incremental contribution of the full program is estimated to be 3 million jobs, with an additional 700,000 jobs provided by the most recent phase of the program alone.”

An additional conclusion of these simulations is that quantitative easing may have prevented actual deflation. Empirical research is continuing.

IA4 Unwinding Strategy. Fed Vice-Chair Yellen (2011AS) considers four concerns on quantitative easing discussed below in turn. First, Excessive Inflation. Yellen (2011AS, 9-12) considers concerns that quantitative easing could result in excessive inflation because fast increases in aggregate demand from quantitative easing could raise the rate of inflation, posing another problem of adjustment with tighter monetary policy or higher interest rates. The Fed estimates significant slack of resources in the economy as measured by the difference of four percentage points between the high current rate of unemployment above 9 percent and the NAIRU (non-accelerating rate of unemployment) of 5.75 percent (Ibid, 2). Thus, faster economic growth resulting from quantitative easing would not likely result in upward trend of costs as resources are bid up competitively. The Fed monitors frequently slack indicators and is committed to maintaining inflation at a “level of 2 percent or a bit less than that” (Ibid, 13), say, in the narrow open interval (1.9, 2.1).

Second, Inflation and Bank Reserves. On Jan 12, 2012, the line “Reserve Bank credit” in the Fed balance sheet stood at $2450.6 billion, or $2.5 trillion, with the portfolio of long-term securities of $2175.7 billion, or $2.2 trillion, composed of $987.6 billion of notes and bonds, $49.7 billion of inflation-adjusted notes and bonds, $146.3 billion of Federal agency debt securities, and $992.1 billion of mortgage-backed securities; reserves balances with Federal Reserve Banks stood at $1095.5 billion, or $1.1 trillion (http://federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The concern addressed by Yellen (2011AS, 12-4) is that this high level of reserves could eventually result in demand growth that could accelerate inflation. Reserves would be excessively high relative to the levels before the recession. Reserves of depository institutions at the Federal Reserve Banks rose from $45.6 billion in Aug 2008 to $1084.8 billion in Aug 2010, not seasonally adjusted, multiplying by 23.8 times, or to $1038.2 billion in Nov 2010, multiplying by 22.8 times. The monetary base consists of the monetary liabilities of the government, composed largely of currency held by the public plus reserves of depository institutions at the Federal Reserve Banks. The monetary base not seasonally adjusted, or issue of money by the government, rose from $841.1 billion in Aug 2008 to $1991.1 billion or by 136.7 percent and to $1968.1 billion in Nov 2010 or by 133.9 percent (http://federalreserve.gov/releases/h3/hist/h3hist1.pdf). Policy can be viewed as creating government monetary liabilities that ended mostly in reserves of banks deposited at the Fed to purchase $2.1 trillion of long-term securities or assets, which in nontechnical language would be “printing money” (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html). The marketable debt of the US government in Treasury securities held by the public stood at $8.7 trillion on Nov 30, 2010 (http://www.treasurydirect.gov/govt/reports/pd/mspd/2010/opds112010.pdf). The current holdings of long-term securities by the Fed of $2.1 trillion, in the process of converting fully into Treasury securities, are equivalent to 24 percent of US government debt held by the public, and would represent 29.9 percent with the new round of quantitative easing if all the portfolio of the Fed, as intended, were in Treasury securities. Debt in Treasury securities held by the public on Dec 31, 2009, stood at $7.2 trillion (http://www.treasurydirect.gov/govt/reports/pd/mspd/2009/opds122009.pdf), growing on Nov 30, 2010, to $1.5 trillion or by 20.8 percent. In spite of this growth of bank reserves, “the 12-month change in core PCE [personal consumption expenditures] prices dropped from about 2 ½ percent in mid-2008 to around 1 ½ percent in 2009 and declined further to less than 1 percent by late 2010” (Yellen 2011AS, 3). The PCE price index, excluding food and energy, is around 0.8 percent in the past 12 months, which could be, in the Fed’s view, too close for comfort to negative inflation or deflation. Yellen (2011AS, 12) agrees “that an accommodative monetary policy left in place too long can cause inflation to rise to undesirable levels” that would be true whether policy was constrained or not by “the zero bound on interest rates.” The FOMC is monitoring and reviewing the “asset purchase program regularly in light of incoming information” and will “adjust the program as needed to meet its objectives” (Ibid, 12). That is, the FOMC would withdraw the stimulus once the economy is closer to full capacity to maintain inflation around 2 percent. In testimony at the Senate Committee on the Budget, Chairman Bernanke stated that “the Federal Reserve has all the tools its needs to ensure that it will be able to smoothly and effectively exit from this program at the appropriate time” (http://federalreserve.gov/newsevents/testimony/bernanke20110107a.htm). The large quantity of reserves would not be an obstacle in attaining the 2 percent inflation level. Yellen (2011A, 13-4) enumerates Fed tools that would be deployed to withdraw reserves as desired: (1) increasing the interest rate paid on reserves deposited at the Fed currently at 0.25 percent per year; (2) withdrawing reserves with reverse sale and repurchase agreement in addition to those with primary dealers by using mortgage-backed securities; (3) offering a Term Deposit Facility similar to term certificates of deposit for member institutions; and (4) sale or redemption of all or parts of the portfolio of long-term securities. The Fed would be able to increase interest rates and withdraw reserves as required to attain its mandates of maximum employment and price stability.

Third, Financial Imbalances. Fed policy intends to lower costs to business and households with the objective of stimulating investment and consumption generating higher growth and employment. Yellen (2011A, 14-7) considers a possible consequence of excessively reducing interest rates: “a reasonable fear is that this process could go too far, encouraging potential borrowers to employ excessive leverage to take advantage of low financing costs and leading investors to accept less compensation for bearing risks as they seek to enhance their rates of return in an environment of very low yields. This concern deserves to be taken seriously, and the Federal Reserve is carefully monitoring financial indicators for signs of potential threats to financial stability.” Regulation and supervision would be the “first line of defense” against imbalances threatening financial stability but the Fed would also use monetary policy to check imbalances (Yellen 2011AS, 17).

Fourth, Adverse Effects on Foreign Economies. The issue is whether the now recognized dollar devaluation would promote higher growth and employment in the US at the expense of lower growth and employment in other countries.

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

C Long-term US Inflation. Key percentage average yearly rates of the US economy on growth and inflation are provided in Table I-1 updated with release of new data. The choice of dates prevents the measurement of long-term potential economic growth because of two recessions from IQ2001 (Mar) to IVQ2001 (Nov) with decline of GDP of 0.3 percent and the drop in GDP of 4.2 percent in the recession from IVQ2007 (Dec) to IIQ2009 (June) (http://www.nber.org/cycles.html) followed with unusually low economic growth for an expansion phase after recession (http://cmpassocregulationblog.blogspot.com/2015/06/dollar-revaluation-squeezing-corporate.html and earlier http://cmpassocregulationblog.blogspot.com/2015/05/dollar-devaluation-and-carry-trade.html). Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 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 second estimate of GDP for IQ2015 (http://www.bea.gov/newsreleases/national/gdp/2015/pdf/gdp1q15_2nd.pdf). The average of 7.7 percent in the first four quarters of major cyclical expansions is in contrast with the rate of growth in the first four quarters of the expansion from IIIQ2009 to IIQ2010 of only 2.7 percent obtained by diving GDP of $14,745.9 billion in IIQ2010 by GDP of $14,355.6 billion in IIQ2009 {[$14,745.9/$14,355.6 -1]100 = 2.7%], or accumulating the quarter on quarter growth rates (http://cmpassocregulationblog.blogspot.com/2015/06/dollar-revaluation-squeezing-corporate.html and earlier http://cmpassocregulationblog.blogspot.com/2015/05/dollar-devaluation-and-carry-trade.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/2015/06/dollar-revaluation-squeezing-corporate.html and earlier http://cmpassocregulationblog.blogspot.com/2015/05/dollar-devaluation-and-carry-trade.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 $2,310.7 billion than actual $16,264.1 billion. There are about two trillion dollars of GDP less than at trend, explaining the 24.7 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.9 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2015/06/higher-volatility-of-asset-prices-at.html and earlier http://cmpassocregulationblog.blogspot.com/2015/05/quite-high-equity-valuations-and.html). US GDP in IQ2015 is 12.4 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,264.1 billion in IQ2015 or 8.5 percent at the average annual equivalent rate of 1.1 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 May 1919 to May 2015. Growth at 3.3 percent per year would raise the NSA index of manufacturing output from 99.2392 in Dec 2007 to 126.2585 in May 2015. The actual index NSA in May 2015 is 101.5858, which is 19.5 percent below trend. Manufacturing output grew at average 2.4 percent between Dec 1986 and Dec 2014. Using trend growth of 2.4 percent per year, the index would increase to 118.3245 in May 2015. The output of manufacturing at 101.5858 in May 2015 is 14.1 percent below trend under this alternative calculation.

In the period from 1929 to 2014 the average growth rate of GDP was 3.3 percent and 3.2 percent between 1947 to 2013, which is almost the same as 3.0 percent from 1870 to 2010 measured by Lucas (2011May), as shown in Table I-1. From 1929 to 2014, nominal GDP grew at the average rate of 6.2 percent and at 6.5 percent from 1947 to 2014. The implicit deflator increased at the average rate of 2.9 percent from 1929 to 2014 and at 3.2 percent from 1947 to 2014. Between 2000 and 2014, real GDP grew at the average rate of 1.8 percent per year, nominal GDP at 3.8 percent and the implicit deflator at 2.0 percent. The annual average rate of CPI increase was 3.2 percent from 1913 to 2014, 3.6 percent from 1947 to 2014 and 2.3 percent from 2000 to 2014. Between 2000 and 2014, the average rate of CPI inflation was 2.4 percent per year and 2.0 percent excluding food and energy. From 2000 to 2015, the average rate of CPI inflation was 2.2 percent and 2.0 percent excluding food and energy. The average annual rate of PPI inflation was 3.1 percent from 1947 to 2014 and 2.7 percent from 2000 to 2014. PPI inflation increased at 2.8 percent per year on average from 2000 to 2014, 2.4 percent on average from 2000 to 2015 and at 1.7 percent excluding food and energy from 2000 to 2014 and 1.8 percent from 2000 to 2015. Producer price inflation of finished energy goods increased at average 5.8 percent between 2000 and 2014 and at 4.1 percent between 2000 and 2015. There is also inflation in international trade. Import prices increased at 2.5 percent per year between 2000 and 2014 and 1.7 percent between 2000 and 2015. The commodity price shock is revealed by inflation of import prices of petroleum increasing at 10.7 percent per year between 2000 and 2014 and at 6.2 percent between 2000 and 2015. Import prices excluding petroleum increased at the average rate of 1.1 percent from 2000 to 2014 and at 0.8 percent from 2000 to 2015. The average percentage rates of increase of import prices excluding fuels are at 1.5 percent for 2002 to 2014 and 1.2 percent for 2002 to 2015. Export prices rose at the average rate of 2.1 percent between 2000 and 2014 and at 1.5 percent from 2000 to 2015. What spared the US of sharper decade-long deterioration of the terms of trade, (export prices)/(import prices), was its diversification and competitiveness in agriculture. Agricultural export prices grew at the average yearly rate of 5.8 percent from 2000 to 2014 and at 4.2 percent from 2000 to 2015. US nonagricultural export prices rose at 1.7 percent per year from 2000 to 2014 and at 1.3 percent from 2000 to 2015. The share of petroleum imports in US trade far exceeds that of agricultural exports. Unconventional monetary policy inducing carry trades in commodities has deteriorated US terms of trade, prices of exports relative to prices of imports, tending to restrict growth of US aggregate real income. These dynamic inflation rates are not similar to those for the economy of Japan where inflation was negative in seven of the 10 years in the 2000s. There is no reality of the proposition of need of unconventional monetary policy in the US because of deflation panic. There is reality in cyclical slow economic growth currently but not in secular stagnation.

Table I-1, US, Average Growth Rates of Real and Nominal GDP, Consumer Price Index, Producer Price Index and Import and Export Prices, Percent per Year

Real GDP	2000-2014: 1.8% 1929-2014: 3.3% 1947-2014: 3.2%
Nominal GDP	2000-2014: 3.8% 1929-2014: 6.2% 1947-2014: 6.5%
Implicit Price Deflator	2000-2014: 2.0% 1929-2014: 2.9% 1947-2014: 3.2%
CPI	2000-2014: 2.4% 2000-2015: 2.2% Annual 1913-2014: 3.2% 1947-2014: 3.6% 2000-2014: 2.3%
CPI ex Food and Energy	2000-2014: 2.0% 2000-2015: 2.0%
PPI	2000-2014: 2.8% 2000-2015: 2.4% Annual 1947-2014: 3.1% 2000-2014: 2.7%
PPI ex Food and Energy	2000-2014: 1.7% 2000-2015: 1.8%
PPI Finished Energy Goods	2000-2014: 5.8% 2000-2015: 4.1%
Import Prices	2000-2014: 2.5% 2000-2015: 1.7%
Import Prices of Petroleum and Petroleum Products	2000-2014: 10.7% 2000-2015: 6.2%
Import Prices Excluding Petroleum	2000-2014: 1.1% 2000-2015: 0.8%
Import Prices Excluding Fuels	2002-2014: 1.5% 2002-2015: 1.2%
Export Prices	2000-2014: 2.1% 2000-2015: 1.5%
Agricultural Export Prices	2000-2014: 5.8% 2000-2015: 4.2%
Nonagricultural Export Prices	2000-2014: 1.7% 2000-2015: 1.3%

Note: rates for price indexes in the row beginning with “CPI” and ending in the row “Nonagricultural Export Prices” are for May 2000 to May 2014 and for Apr 2000 to Apr 2015 using not seasonally adjusted indexes. Import prices excluding fuels are not available before Dec 2001.

Sources: http://www.bea.gov/iTable/index_nipa.cfm http://www.bls.gov/ppi/ http://www.bls.gov/cpi/ http://www.bls.gov/mxp/home.htm

Unconventional monetary policy of zero interest rates and large-scale purchases of long-term securities for the balance sheet of the central bank is proposed to prevent deflation. The data of CPI inflation of all goods and CPI inflation excluding food and energy for the past six decades does not show even one negative change, as shown in Table CPIEX.

Table CPIEX, Annual Percentage Changes of the CPI All Items Excluding Food and Energy

Year	Annual ∆%
1958	2.4
1959	2.0
1960	1.3
1961	1.3
1962	1.3
1963	1.3
1964	1.6
1965	1.2
1966	2.4
1967	3.6
1968	4.6
1969	5.8
1970	6.3
1971	4.7
1972	3.0
1973	3.6
1974	8.3
1975	9.1
1976	6.5
1977	6.3
1978	7.4
1979	9.8
1980	12.4
1981	10.4
1982	7.4
1983	4.0
1984	5.0
1985	4.3
1986	4.0
1987	4.1
1988	4.4
1989	4.5
1990	5.0
1991	4.9
1992	3.7
1993	3.3
1994	2.8
1995	3.0
1996	2.7
1997	2.4
1998	2.3
1999	2.1
2000	2.4
2001	2.6
2002	2.4
2003	1.4
2004	1.8
2005	2.2
2006	2.5
2007	2.3
2008	2.3
2009	1.7
2010	1.0
2011	1.7
2012	2.1
2013	1.8
2014	1.7

Source: Bureau of Labor Statistics

The history of producer price inflation in the past five decades does not provide evidence of deflation. The finished core PPI does not register even one single year of decline, as shown in Table PPIEX.

Table PPIEX, Annual Percentage Changes of the PPI Finished Goods Excluding Food and Energy

Year	Annual ∆%
1974	11.4
1975	11.4
1976	5.7
1977	6.0
1978	7.5
1979	8.9
1980	11.2
1981	8.6
1982	5.7
1983	3.0
1984	2.4
1985	2.5
1986	2.3
1987	2.4
1988	3.3
1989	4.4
1990	3.7
1991	3.6
1992	2.4
1993	1.2
1994	1.0
1995	2.1
1996	1.4
1997	0.3
1998	0.9
1999	1.7
2000	1.3
2001	1.4
2002	0.1
2003	0.2
2004	1.5
2005	2.4
2006	1.5
2007	1.9
2008	3.4
2009	2.6
2010	1.2
2011	2.4
2012	2.6
2013	1.5
2014	1.9

Source: Bureau of Labor Statistics

Chart I-1 provides US nominal GDP from 1929 to 2013. The chart disguises the decline of nominal GDP during the 1930s from $104.6 billion in 1929 to $57.2 billion in 1933 or by 45.3 percent (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). The level of nominal GDP reached $102.9 billion in 1940 and exceeded the $104.6 billion of 1929 only with $129.4 billion in 1941. The only major visible bump in the chart occurred in the recession of IVQ2007 to IIQ2009 with revised cumulative decline of real GDP of 4.2 percent. US nominal GDP fell from $14,718.6 billion in 2008 to $14,418.7 billion in 2009 or by 2.0 percent. US nominal GDP rose to $14,964.4 billion in 2010 or by 3.8 percent and to $15,517.9 billion in 2011 for an additional 3.7 percent for cumulative increase of 7.6 percent relative to 2009 and to $16,163.2 billion in 2012 for an additional 4.2 percent and cumulative increase of 12.1 percent relative to 2009. US nominal GDP increased from $14,477.6 in 2007 to $17,418.9 billion in 2014 or by 20.3 percent at the average annual rate of 2.7 percent per year (http://www.bea.gov/iTable/index_nipa.cfm). Tendency for deflation would be reflected in persistent bumps. In contrast, during the Great Depression in the four years of 1929 to 1933, GDP in constant dollars fell 26.3 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). The comparison of the global recession after 2007 with the Great Depression is entirely misleading (http://cmpassocregulationblog.blogspot.com/2015/06/dollar-revaluation-squeezing-corporate.html and earlier http://cmpassocregulationblog.blogspot.com/2015/05/dollar-devaluation-and-carry-trade.html).

Chart I-1, US, Nominal GDP 1929-2014

Source: US Bureau of Economic Analysis

Chart I-2 provides US real GDP from 1929 to 2014. The chart also disguises the Great Depression of the 1930s. In the four years of 1929 to 1933, GDP in constant dollars fell 26.3 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7; data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). Persistent deflation threatening real economic activity would also be reflected in the series of long-term growth of real GDP. There is no such behavior in Chart I-2 except for periodic recessions in the US economy that have occurred throughout history.

Chart I-2, US, Real GDP 1929-2014

Source: US Bureau of Economic Analysis

Deflation would also be in evidence in long-term series of prices in the form of bumps. The GDP implicit deflator series in Chart I-3 from 1929 to 2014 shows sharp dynamic behavior over time. There is decline of the implicit price deflator of GDP by 25.8 percent from 1929 to 1933 (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). In contrast, the implicit price deflator of GDP of the US increased from 97.337 (2009 =100) in 2007 to 100.00 in 2009 or by 2.7 percent and increased to 108.289 in 2014 or by 8.3 percent relative to 2009 and 11.3 percent relative to 2007. The implicit price deflator of US GDP increased in every quarter from IVQ2007 to IVQ2012 with only two declines from 100.062 in IQ2009 to 99.895 in IIQ2009 or by 0.2 percent and to 99.873 in IIIQ2009 for cumulative 0.2 percent relative to IQ2009 and -0.02 percent relative to IIQ2009 (http://www.bea.gov/iTable/index_nipa.cfm). Wars are characterized by rapidly rising prices followed by declines when peace is restored. The US economy is not plagued by deflation but by long-run inflation.

Chart I-3, US, GDP Implicit Price Deflator 1929-2014

Source: US Bureau of Economic Analysis

Chart I-4 provides percent change from preceding quarter in prices of GDP at seasonally adjusted annual rates (SAAR) from 1980 to 2014. There is one case of negative change by 0.6 percent in IIQ2009 that was adjustment from 2.8 percent in IIIQ2008 following 2.3 percent in IQ2008 and 1.8 percent IIQ2008 caused by carry trades from policy interest rates being moved to zero into commodity futures. GDP prices fell 0.1 percent in IQ2015. These positions were reversed because of the fear of toxic assets in banks in the proposal of TARP in late 2008 (Cochrane and Zingales 2009). Prices of GDP increased 0.1 percent in IVQ2014. There has not been actual deflation or risk of deflation threatening depression in the US that would justify unconventional monetary policy.

Chart I-4, Percent Change from Preceding Period in Prices for GDP Seasonally Adjusted at Annual Rates 1980-2015

Source: US Bureau of Economic Analysis

Chart I-5 provides percent change from preceding year in prices of GDP from 1929 to 2014. There are four consecutive years of declines of prices of GDP during the Great Depression: 3.8 percent in 1930, 9.9 percent in 1931, 11.4 percent in 1932 and 2.7 percent in 1933. There were two consecutive declines of 1.8 percent in 1938 and 1.3 percent in 1939. Prices of GDP fell 0.1 percent in 1949 after increasing 12.6 percent in 1946, 11.2 percent in 1947 and 5.6 percent in 1948, which is similar to experience with wars in other countries. There are no other negative changes of annual prices of GDP in 74 years from 1939 to 2014.

Chart I-5, Percent Change from Preceding Year in Prices for Gross Domestic Product 1930-2014

The producer price index of the US from 1947 to 2015 in Chart I-6 shows various periods of more rapid or less rapid inflation but no bumps. The major event is the decline in 2008 when risk aversion because of the global recession caused the collapse of oil prices from $148/barrel to less than $80/barrel with most other commodity prices also collapsing. The event had nothing in common with explanations of deflation but rather with the concentration of risk exposures in commodities after the decline of stock market indexes. Eventually, there was a flight to government securities because of the fears of insolvency of banks caused by statements supporting proposals for withdrawal of toxic assets from bank balance sheets in the Troubled Asset Relief Program (TARP), as explained by Cochrane and Zingales (2009). The bump in 2008 with decline in 2009 is consistent with the view that zero interest rates with subdued risk aversion induce carry trades into commodity futures.

Chart I-6, US, Producer Price Index, Finished Goods, NSA, 1947-2015

Source: US Bureau of Labor Statistics

Chart I-7 provides 12-month percentage changes of the producer price index from 1948 to 2015. The distinguishing event in Chart I-7 is the Great Inflation of the 1970s. The shape of the two-hump Bactrian camel of the 1970s resembles the double hump from 2007 to 2015.

Chart I-7, US, Producer Price Index, Finished Goods, 12-Month Percentage Change, NSA, 1948-2015

Source: US Bureau of Labor Statistics

Annual percentage changes of the producer price index from 1948 to 2014 are shown in Table I-1A. The producer price index fell 2.8 percent in 1949 following the adjustment to World War II and fell 0.6 percent in 1952 and 1.0 percent in 1953 around the Korean War. There are two other mild decline of 0.3 percent in 1959 and 0.3 percent in 1963. There are only few subsequent and isolated declines of the producer price index of 1.4 percent in 1986, 0.8 percent in 1998, 1.3 percent in 2002 and 2.6 percent in 2009. The decline of 2009 was caused by unwinding of carry trades in 2008 that had lifted oil prices to $140/barrel during deep global recession because of the panic of probable toxic assets in banks that would be removed with the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009). There is no evidence in this history of 65 years of the US producer price index suggesting that there is frequent and persistent deflation shock requiring aggressive unconventional monetary policy. The design of such anti-deflation policy could provoke price and financial instability because of lags in effect of monetary policy, model errors, inaccurate forecasts and misleading analysis of current economic conditions.

Table I-1A, US, Annual PPI Inflation ∆% 1948-2014

Year	Annual ∆%
1948	8.0
1949	-2.8
1950	1.8
1951	9.2
1952	-0.6
1953	-1.0
1954	0.3
1955	0.3
1956	2.6
1957	3.8
1958	2.2
1959	-0.3
1960	0.9
1961	0.0
1962	0.3
1963	-0.3
1964	0.3
1965	1.8
1966	3.2
1967	1.1
1968	2.8
1969	3.8
1970	3.4
1971	3.1
1972	3.2
1973	9.1
1974	15.4
1975	10.6
1976	4.5
1977	6.4
1978	7.9
1979	11.2
1980	13.4
1981	9.2
1982	4.1
1983	1.6
1984	2.1
1985	1.0
1986	-1.4
1987	2.1
1988	2.5
1989	5.2
1990	4.9
1991	2.1
1992	1.2
1993	1.2
1994	0.6
1995	1.9
1996	2.7
1997	0.4
1998	-0.8
1999	1.8
2000	3.8
2001	2.0
2002	-1.3
2003	3.2
2004	3.6
2005	4.8
2006	3.0
2007	3.9
2008	6.3
2009	-2.6
2010	4.2
2011	6.0
2012	1.9
2013	1.2
2014	1.9

Source: US Bureau of Labor Statistics

The producer price index excluding food and energy from 1973 to 2015, the first historical date of availability in the dataset of the Bureau of Labor Statistics (BLS), shows similarly dynamic behavior as the overall index, as shown in Chart I-8. There is no evidence of persistent deflation in the US PPI.

Chart I-8, US Producer Price Index, Finished Goods Excluding Food and Energy, NSA, 1973-2015

Source: US Bureau of Labor Statistics

Chart I-9 provides 12-month percentage rates of change of the finished goods index excluding food and energy. The dominating characteristic is the Great Inflation of the 1970s. The double hump illustrates how inflation may appear to be subdued and then returns with strength.

Chart I-9, US Producer Price Index, Finished Goods Excluding Food and Energy, 12-Month Percentage Change, NSA, 1974-2015

Source: US Bureau of Labor Statistics

The producer price index of energy goods from 1974 to 2015 is provided in Chart I-10. The first jump occurred during the Great Inflation of the 1970s analyzed in various comments of this blog (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html) and in Appendix I. There is relative stability of producer prices after 1986 with another jump and decline in the late 1990s into the early 2000s. The episode of commodity price increases during a global recession in 2008 could only have occurred with interest rates dropping toward zero, which stimulated the carry trade from zero interest rates to leveraged positions in commodity futures. Commodity futures exposures were dropped in the flight to government securities after Sep 2008. Commodity future exposures were created again when risk aversion diminished around Mar 2010 after the finding that US bank balance sheets did not have the toxic assets that were mentioned in proposing TARP in Congress (see Cochrane and Zingales 2009). Fluctuations in commodity prices and other risk financial assets originate in carry trade when risk aversion ameliorates. There are also fluctuations originating in shifts in preference for asset classes such as between commodities and equities.

Chart I-10, US, Producer Price Index, Finished Energy Goods, NSA, 1974-2015

Source: US Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

Chart I-11 shows 12-month percentage changes of the producer price index of finished energy goods from 1975 to 2015. This index is only available after 1974 and captures only one of the humps of energy prices during the Great Inflation. Fluctuations in energy prices have occurred throughout history in the US but without provoking deflation. Two cases are the decline of oil prices in 2001 to 2002 that has been analyzed by Barsky and Kilian (2004) and the collapse of oil prices from over $140/barrel with shock of risk aversion to the carry trade in Sep 2008.

Chart I-11, US, Producer Price Index, Finished Energy Goods, 12-Month Percentage Change, NSA, 1974-2015

Source: US Bureau of Labor Statistics

Chart I-12 provides the consumer price index NSA from 1916 to 2015. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.

Chart I-12, US, Consumer Price Index, NSA, 1916-2015

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Chart I-13 provides 12-month percentage changes of the consumer price index from 1916 to 2015. The only episode of deflation after 1950 is in 2009, which is explained by the reversal of speculative commodity futures carry trades that were induced by interest rates driven to zero in a shock of monetary policy in 2008. The only persistent case of deflation is from 1930 to 1933, which has little if any relevance to the contemporary United States economy. There are actually three waves of inflation in the second half of the 1960s, in the mid-1970s and again in the late 1970s. Inflation rates then stabilized in a range with only two episodes above 5 percent.

Chart I-13, US, Consumer Price Index, All Items, 12- Month Percentage Change 1914-2015

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Table I-2 provides annual percentage changes of United States consumer price inflation from 1914 to 2014. There have been only cases of annual declines of the CPI after wars:

World War I minus 10.5 percent in 1921 and minus 6.1 percent in 1922 following cumulative increases of 83.5 percent in four years from 1917 to 1920 at the average of 16.4 percent per year
World War II: minus 1.2 percent in 1949 following cumulative 33.9 percent in three years from 1946 to 1948 at average 10.2 percent per year
Minus 0.4 percent in 1955 two years after the end of the Korean War
Minus 0.4 percent in 2009.
The decline of 0.4 percent in 2009 followed increase of 3.8 percent in 2008 and is explained by the reversal of speculative carry trades into commodity futures that were created in 2008 as monetary policy rates were driven to zero. The reversal occurred after misleading statement on toxic assets in banks in the proposal for TARP (Cochrane and Zingales 2009).

There were declines of 1.7 percent in both 1927 and 1928 during the episode of revival of rules of the gold standard. The only persistent deflationary period since 1914 was during the Great Depression in the years from 1930 to 1933 and again in 1938-1939. Fear of deflation on the basis of that experience does not justify unconventional monetary policy of zero interest rates that has failed to stop deflation in Japan. Financial repression causes far more adverse effects on allocation of resources by distorting the calculus of risk/returns than alleged employment-creating effects or there would not be current recovery without jobs and hiring after zero interest rates since Dec 2008 and intended now forever in a self-imposed forecast growth and employment mandate of monetary policy. Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval of (1.99, 2.0). Symmetric targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output that is actually a target of growth forecast. The impact on the overall economy and the financial system of errors of policy are magnified by large-scale policy doses of trillions of dollars of quantitative easing and zero interest rates. The US economy has been experiencing financial repression as a result of negative real rates of interest during nearly a decade and programmed in monetary policy statements until 2015 or, for practical purposes, forever. The essential calculus of risk/return in capital budgeting and financial allocations has been distorted. If economic perspectives are doomed until 2015 such as to warrant zero interest rates and open-ended bond-buying by “printing” digital bank reserves (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html; see Shultz et al 2012), rational investors and consumers will not invest and consume until just before interest rates are likely to increase. Monetary policy statements on intentions of zero interest rates for another three years or now virtually forever discourage investment and consumption or aggregate demand that can increase economic growth and generate more hiring and opportunities to increase wages and salaries. The doom scenario used to justify monetary policy accentuates adverse expectations on discounted future cash flows of potential economic projects that can revive the economy and create jobs. If it were possible to project the future with the central tendency of the monetary policy scenario and monetary policy tools do exist to reverse this adversity, why the tools have not worked before and even prevented the financial crisis? If there is such thing as “monetary policy science”, why it has such poor record and current inability to reverse production and employment adversity? There is no excuse of arguing that additional fiscal measures are needed because they were deployed simultaneously with similar ineffectiveness. Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). If there were an infallible science of central banking, models and forecasts would provide accurate information to policymakers on the future course of the economy in advance. Such forewarning is essential to central bank science because of the long lag between the actual impulse of monetary policy and the actual full effects on income and prices many months and even years ahead (Romer and Romer 2004, Friedman 1961, 1953, Culbertson 1960, 1961, Batini and Nelson 2002). Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzed 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). Jon Hilsenrath demonstrates that Fed policymakers frequently did not understand the current state of the US economy in 2008 and much less the direction of income and prices. The conclusion of Friedman (1953) that monetary impulses increase financial and economic instability because of lags in anticipating needs of policy, taking policy decisions and effects of decisions. This a fortiori true when untested unconventional monetary policy in gargantuan doses shocks the economy and financial markets.

Table I-2, US, Annual CPI Inflation ∆% 1914-2014

Year	Annual ∆%
1914	1.0
1915	1.0
1916	7.9
1917	17.4
1918	18.0
1919	14.6
1920	15.6
1921	-10.5
1922	-6.1
1923	1.8
1924	0.0
1925	2.3
1926	1.1
1927	-1.7
1928	-1.7
1929	0.0
1930	-2.3
1931	-9.0
1932	-9.9
1933	-5.1
1934	3.1
1935	2.2
1936	1.5
1937	3.6
1938	-2.1
1939	-1.4
1940	0.7
1941	5.0
1942	10.9
1943	6.1
1944	1.7
1945	2.3
1946	8.3
1947	14.4
1948	8.1
1949	-1.2
1950	1.3
1951	7.9
1952	1.9
1953	0.8
1954	0.7
1955	-0.4
1956	1.5
1957	3.3
1958	2.8
1959	0.7
1960	1.7
1961	1.0
1962	1.0
1963	1.3
1964	1.3
1965	1.6
1966	2.9
1967	3.1
1968	4.2
1969	5.5
1970	5.7
1971	4.4
1972	3.2
1973	6.2
1974	11.0
1975	9.1
1976	5.8
1977	6.5
1978	7.6
1979	11.3
1980	13.5
1981	10.3
1982	6.2
1983	3.2
1984	4.3
1985	3.6
1986	1.9
1987	3.6
1988	4.1
1989	4.8
1990	5.4
1991	4.2
1992	3.0
1993	3.0
1994	2.6
1995	2.8
1996	3.0
1997	2.3
1998	1.6
1999	2.2
2000	3.4
2001	2.8
2002	1.6
2003	2.3
2004	2.7
2005	3.4
2006	3.2
2007	2.8
2008	3.8
2009	-0.4
2010	1.6
2011	3.2
2012	2.1
2013	1.5
2014	1.6

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Chart I-14 provides the consumer price index excluding food and energy from 1957 to 2015. There is long-term inflation in the US without episodes of persistent deflation.

Chart I-14, US, Consumer Price Index Excluding Food and Energy, NSA, 1957-2015

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Chart I-15 provides 12-month percentage changes of the consumer price index excluding food and energy from 1958 to 2015. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.

Chart I-15, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 1958-2015

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

The consumer price index of housing is provided in Chart I-16. There was also acceleration during the Great Inflation of the 1970s. The index flattens after the global recession in IVQ2007 to IIQ2009. Housing prices collapsed under the weight of construction of several times more housing than needed. Surplus housing originated in subsidies and artificially low interest rates in the shock of unconventional monetary policy in 2003 to 2004 in fear of deflation.

Chart I-16, US, Consumer Price Index Housing, NSA, 1967-2015

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Chart I-17 provides 12-month percentage changes of the housing CPI. The Great Inflation also had extremely high rates of housing inflation. Housing is considered as potential hedge of inflation.

Chart I-17, US, Consumer Price Index, Housing, 12- Month Percentage Change, NSA, 1968-2014

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

ID Current US Inflation. Consumer price inflation has fluctuated in recent months. Table I-3 provides 12-month consumer price inflation in May 2015 and annual equivalent percentage changes for the months of Mar 2015 to May 2015 of the CPI and major segments. The final column provides inflation from Apr 2015 to May 2015. CPI inflation changed 0.0 percent in the 12 months ending in May 2015. The annual equivalent rate from Apr 2015 to May 2015 was 2.8 percent in the new episode of reversal of carry trades from zero interest rates to commodities exposures; and the monthly inflation rate of 0.4 percent annualizes at 4.9 percent with oscillating carry trades at the margin. These inflation rates fluctuate in accordance with inducement of risk appetite or frustration by risk aversion of carry trades from zero interest rates to commodity futures. At the margin, the decline in commodity prices in sharp recent risk aversion in commodities markets caused lower inflation worldwide (with return in some countries in Dec 2012 and Jan-Feb 2013) that followed a jump in Aug-Sep 2012 because of the relaxed risk aversion resulting from the bond-buying program of the European Central Bank or Outright Monetary Transactions (OMT) (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). Carry trades moved away from commodities into stocks with resulting weaker commodity prices and stronger equity valuations. There is reversal of exposures in commodities but with preferences of equities by investors. Geopolitical events in Eastern Europe and the Middle East are inducing risk concerns in commodities at the margin. With zero interest rates, commodity prices would increase again in an environment of risk appetite, as shown in inflation in Apr 2014-Jun 2014. Excluding food and energy, CPI inflation was 1.7 percent in the 12 months ending in May 2015 and 2.4 percent in annual equivalent in Mar 2015 to May 2015. There is no deflation in the US economy that could justify further unconventional monetary policy, which is now open-ended or forever with zero interest rates and cessation of bond-buying by the central bank but with reinvestment of interest and principal, or QE→∞ even if the economy grows back to potential. Financial repression of zero interest rates is now intended as a permanent distortion of resource allocation by clouding risk/return decisions, preventing the economy from expanding along its optimal growth path. Consumer food prices in the US have risen 1.6 percent in 12 months ending in May 2015 and at minus 0.8 percent in annual equivalent in Mar 2015 to May 2015. Monetary policies stimulating carry trades of commodities futures that increase prices of food constitute a highly regressive tax on lower income families for whom food is a major portion of the consumption basket especially with wage increases below inflation in a recovery without hiring (http://cmpassocregulationblog.blogspot.com/2015/06/volatility-of-financial-asset.html). Energy consumer prices decreased 16.3 percent in 12 months, increased at 17.3 percent in annual equivalent in Mar 2015 to May 2015 and increased 4.3 percent in May 2015 or at 65.7 percent in annual equivalent. Waves of inflation are induced by carry trades from zero interest rates to commodity futures, which are unwound and repositioned during alternating risk aversion and risk appetite originating in the European debt crisis and increasingly in growth, soaring debt and politics in China. For lower income families, food and energy are a major part of the family budget. Inflation is not persistently low or threatening deflation in annual equivalent in Mar 2015 to May 2015 in any of the categories in Table I-2 but simply reflecting waves of inflation originating in carry trades. Zero interest rates induce carry trades into commodity futures positions with episodes of risk aversion and portfolio reallocations causing fluctuations that determine an upward trend of prices.

Table I-3, US, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%

	% RI	∆% 12 Months May 2015/May 2014 NSA	∆% Annual Equivalent Mar 2015 to May 2015 SA	∆% May 2015/Apr 2015 SA
CPI All Items	100.000	0.0	2.8	0.4
CPI ex Food and Energy	78.104	1.7	2.4	0.1
Food	14.157	1.6	-0.8	0.0
Food at Home	8.323	0.6	-3.5	-0.2
Food Away from Home	5.834	3.0	2.4	0.2
Energy	7.739	-16.3	17.3	4.3
Gasoline	3.737	-25.0	61.6	10.4
Electricity	2.945	0.5	-8.8	-1.2
Commodities less Food and Energy	19.550	-0.3	1.2	-0.1
New Vehicles	3.556	0.8	2.0	0.2
Used Cars and Trucks	1.666	-0.5	5.7	-0.4
Medical Care Commodities	1.782	3.9	2.4	0.4
Apparel	3.443	-1.5	-1.2	-0.5
Services Less Energy Services	58.553	2.4	2.8	0.2
Shelter	32.865	2.9	3.2	0.2
Rent of Primary Residence	7.174	3.5	3.7	0.3
Owner’s Equivalent Rent of Residences	24.381	2.8	3.7	0.3
Transportation Services	5.648	1.5	3.2	0.7
Medical Care Services	5.997	2.5	6.2	0.2

% RI: Percent Relative Importance

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

The weights of the CPI, US city average for all urban consumers representing about 87 percent of the US population (http://www.bls.gov/cpi/cpiovrvw.htm#item1), are shown in Table I-4 with the BLS update for Dec 2012 (http://www.bls.gov/cpi/cpiri2012.pdf). Housing has a weight of 41.021 percent. The combined weight of housing and transportation is 57.867 percent or more than one-half of consumer expenditures of all urban consumers. The combined weight of housing, transportation and food and beverages is 73.128 percent of the US CPI. Table I-3 provides relative importance of key items in May 2015.

Table I-4, US, Relative Importance, 2009-2010 Weights, of Components in the Consumer Price Index, US City Average, Dec 2012

All Items	100.000
Food and Beverages	15.261
Food	14.312
Food at home	8.898
Food away from home	5.713
Housing	41.021
Shelter	31.681
Rent of primary residence	6.545
Owners’ equivalent rent	22.622
Apparel	3.564
Transportation	16.846
Private Transportation	15.657
New vehicles	3.189
Used cars and trucks	1.844
Motor fuel	5.462
Gasoline	5.274
Medical Care	7.163
Medical care commodities	1.714
Medical care services	5.448
Recreation	5.990
Education and Communication	6.779
Other Goods and Services	3.376

Refers to all urban consumers, covering approximately 87 percent of the US population (see http://www.bls.gov/cpi/cpiovrvw.htm#item1). Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/cpiri2011.pdf http://www.bls.gov/cpi/cpiriar.htm http://www.bls.gov/cpi/cpiri2012.pdf

Chart I-18 provides the US consumer price index for housing from 2001 to 2015. Housing prices rose sharply during the decade until the bump of the global recession and increased again in 2011-2012 with some stabilization in 2013. There is renewed increase in 2014 followed by stabilization and renewed increase. The CPI excluding housing would likely show much higher inflation. The commodity carry trades resulting from unconventional monetary policy have compressed income remaining after paying for indispensable shelter.

Chart I-18, US, Consumer Price Index, Housing, NSA, 2001-2015

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Chart I-19 provides 12-month percentage changes of the housing CPI. Percentage changes collapsed during the global recession but have been rising into positive territory in 2011 and 2012-2013 but with the rate declining and then increasing into 2014. There is decrease into 2015.

Chart I-19, US, Consumer Price Index, Housing, 12-Month Percentage Change, NSA, 2001-2015

Source: US Bureau of Labor Statistics

http://www.bls.gov/cpi/data.htm

There have been waves of consumer price inflation in the US in 2011 and into 2015 (Section IA and earlier http://cmpassocregulationblog.blogspot.com/2015/05/interest-rate-policy-and-dollar.html) that are illustrated in Table I-5. The first wave occurred in Jan-Apr 2011 and was caused by the carry trade of commodity prices induced by unconventional monetary policy of zero interest rates. Cheap money at zero opportunity cost in environment of risk appetite was channeled into financial risk assets, causing increases in commodity prices. The annual equivalent rate of increase of the all-items CPI in Jan-Apr 2011 was 4.9 percent and the CPI excluding food and energy increased at annual equivalent rate of 2.1 percent. The second wave occurred during the collapse of the carry trade from zero interest rates to exposures in commodity futures because of risk aversion in financial markets created by the sovereign debt crisis in Europe. The annual equivalent rate of increase of the all-items CPI dropped to 2.4 percent in May-Jun 2011 while the annual equivalent rate of the CPI excluding food and energy increased at 2.4 percent. In the third wave in Jul-Sep 2011, annual equivalent CPI inflation rose to 3.7 percent while the core CPI increased at 2.4 percent. The fourth wave occurred in the form of increase of the CPI all-items annual equivalent rate to 1.8 percent in Oct-Nov 2011 with the annual equivalent rate of the CPI excluding food and energy remaining at 2.4 percent. The fifth wave occurred in Dec 2011 to Jan 2012 with annual equivalent headline inflation of 1.8 percent and core inflation of 2.4 percent. In the sixth wave, headline CPI inflation increased at annual equivalent 2.4 percent in Feb-Apr 2012 and 2.0 percent for the core CPI. The seventh wave in May-Jul occurred with annual equivalent inflation of minus 1.2 percent for the headline CPI in May-Jul 2012 and 2.0 percent for the core CPI. The eighth wave is with annual equivalent inflation of 6.8 percent in Aug-Sep 2012 but 5.7 percent including Oct. In the ninth wave, annual equivalent inflation in Nov 2012 was minus 2.4 percent under the new shock of risk aversion and 0.0 percent in Dec 2012 with annual equivalent of minus 0.4 percent in Nov 2012-Jan 2013 and 2.0 percent for the core CPI. In the tenth wave, annual equivalent of the headline CPI was 7.4 percent in Feb 2013 and 2.4 percent for the core CPI. In the eleventh wave, annual equivalent was minus 2.4 percent in Mar-Apr 2013 and 0.6 percent for the core index. In the twelfth wave, annual equivalent inflation was 2.4 percent in May-Sep 2013 and 1.9 percent for the core CPI. In the thirteenth wave, annual equivalent CPI inflation in Oct-Nov 2013 was 1.2 percent and 1.8 percent for the core CPI. Inflation returned in the fourteenth wave at 2.4 percent for the headline CPI index and 1.8 percent for the core CPI in annual equivalent for Dec 2013 to Mar 2014. In the sixteenth wave, inflation accelerated to annual equivalent 2.4 percent for the headline index in Apr-Jul 2014 and 1.8 percent for the core index. In the seventeenth wave, annual equivalent inflation was minus 1.2 percent in Aug 2014 and 1.2 percent for the core index. In the sixteenth wave, annual equivalent inflation was minus 1.2 percent for the headline CPI and 1.8 percent for the core in Sep-Oct 2014. In the eighteenth wave, annual equivalent inflation was minus 5.1 percent for the headline index in Nov 2014-Jan 2015 and 1.6 percent for the core. In the nineteenth wave, annual equivalent inflation was 2.7 percent for the headline index and 2.8 percent for the core index in Feb-May 2015. The conclusion is that inflation accelerates and decelerates in unpredictable fashion because of shocks or risk aversion and portfolio reallocations in carry trades from zero interest rates to commodity derivatives.

Table I-5, US, Headline and Core CPI Inflation Monthly SA and 12 Months NSA ∆%

	All Items SA Month	All Items NSA 12 month	Core SA Month	Core NSA 12 months
May 2015	0.4	0.0	0.1	1.7
Apr	0.1	-0.2	0.3	1.8
Mar	0.2	-0.1	0.2	1.8
Feb	0.2	0.0	0.2	1.7
AE ∆% Feb-May	2.7		2.8
Jan	-0.7	-0.1	0.2	1.6
Dec 2014	-0.3	0.8	0.1	1.6
Nov	-0.3	1.3	0.1	1.7
AE ∆% Nov-Jan	-5.1		1.6
Oct 2014	0.1	1.7	0.2	1.8
Sep	0.1	1.7	0.1	1.7
AE ∆% Sep-Oct	-1.2		1.8
Aug	-0.1	1.7	0.1	1.7
AE ∆% Aug	-1.2		1.2
Jul	0.1	2.0	0.1	1.9
Jun	0.2	2.1	0.1	1.9
May	0.3	2.1	0.2	2.0
Apr	0.2	2.0	0.2	1.8
AE ∆% Apr-Jul	2.4		1.8
Mar	0.2	1.5	0.2	1.7
Feb	0.1	1.1	0.1	1.6
Jan	0.2	1.6	0.1	1.6
Dec 2013	0.3	1.5	0.2	1.7
AE ∆% Dec-Mar	2.4		1.8
Nov	0.1	1.2	0.2	1.7
Oct	0.1	1.0	0.1	1.7
AE ∆% Oct-Nov	1.2		1.8
Sep	0.2	1.2	0.1	1.7
Aug	0.2	1.5	0.2	1.8
Jul	0.2	2.0	0.2	1.7
Jun	0.3	1.8	0.2	1.6
May	0.1	1.4	0.1	1.7
AE ∆% May-Sep	2.4		1.9
Apr	-0.2	1.1	0.0	1.7
Mar	-0.2	1.5	0.1	1.9
AE ∆% Mar-Apr	-2.4		0.6
Feb	0.6	2.0	0.2	2.0
AE ∆% Feb	7.4		2.4
Jan	0.1	1.6	0.3	1.9
Dec 2012	0.0	1.7	0.1	1.9
Nov	-0.2	1.8	0.1	1.9
AE ∆% Nov-Jan	-0.4		2.0
Oct	0.3	2.2	0.2	2.0
Sep	0.5	2.0	0.2	2.0
Aug	0.6	1.7	0.1	1.9
AE ∆% Aug-Oct	5.7		2.0
Jul	0.0	1.4	0.1	2.1
Jun	-0.1	1.7	0.2	2.2
May	-0.2	1.7	0.2	2.3
AE ∆% May-Jul	-1.2		2.0
Apr	0.1	2.3	0.2	2.3
Mar	0.3	2.7	0.2	2.3
Feb	0.2	2.9	0.1	2.2
AE ∆% Feb-Apr	2.4		2.0
Jan	0.3	2.9	0.2	2.3
Dec 2011	0.0	3.0	0.2	2.2
AE ∆% Dec-Jan	1.8		2.4
Nov	0.2	3.4	0.2	2.2
Oct	0.1	3.5	0.2	2.1
AE ∆% Oct-Nov	1.8		2.4
Sep	0.3	3.9	0.1	2.0
Aug	0.3	3.8	0.3	2.0
Jul	0.3	3.6	0.2	1.8
AE ∆% Jul-Sep	3.7		2.4
Jun	0.0	3.6	0.2	1.6
May	0.4	3.6	0.2	1.5
AE ∆% May-Jun	2.4		2.4
Apr	0.5	3.2	0.2	1.3
Mar	0.5	2.7	0.1	1.2
Feb	0.3	2.1	0.2	1.1
Jan	0.3	1.6	0.2	1.0
AE ∆% Jan-Apr	4.9		2.1
Dec 2010	0.4	1.5	0.1	0.8
Nov	0.3	1.1	0.1	0.8
Oct	0.3	1.2	0.1	0.6
Sep	0.2	1.1	0.1	0.8
Aug	0.1	1.1	0.1	0.9
Jul	0.2	1.2	0.1	0.9
Jun	0.0	1.1	0.1	0.9
May	-0.1	2.0	0.1	0.9
Apr	0.0	2.2	0.0	0.9
Mar	0.0	2.3	0.0	1.1
Feb	-0.1	2.1	0.0	1.3
Jan	0.1	2.6	-0.1	1.6

Note: Core: excluding food and energy; AE: annual equivalent

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

The behavior of the US consumer price index NSA from 2001 to 2015 is provided in Chart I-20. Inflation in the US is very dynamic without deflation risks that would justify symmetric inflation targets. The hump in 2008 originated in the carry trade from interest rates dropping to zero into commodity futures. There is no other explanation for the increase of the Cushing OK Crude Oil Future Contract 1 from $55.64/barrel on Jan 9, 2007 to $145.29/barrel on July 3, 2008 during deep global recession, collapsing under a panic of flight into government obligations and the US dollar to $37.51/barrel on Feb 13, 2009 and then rising by carry trades to $113.93/barrel on Apr 29, 2012, collapsing again and then recovering again to $105.23/barrel, all during mediocre economic recovery with peaks and troughs influenced by bouts of risk appetite and risk aversion (data from the US Energy Information Administration EIA, http://www.eia.gov/). The unwinding of the carry trade with the TARP announcement of toxic assets in banks channeled cheap money into government obligations (see Cochrane and Zingales 2009).

Chart I-20, US, Consumer Price Index, NSA, 2001-2015

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

Chart I-21 provides 12-month percentage changes of the consumer price index from 2001 to 2015. There was no deflation or threat of deflation from 2008 into 2009. Commodity prices collapsed during the panic of toxic assets in banks. When stress tests in 2009 revealed US bank balance sheets in much stronger position, cheap money at zero opportunity cost exited government obligations and flowed into carry trades of risk financial assets. Increases in commodity prices drove again the all items CPI with interruptions during risk aversion originating in multiple fears but especially from the sovereign debt crisis of Europe.

Chart I-21, US, Consumer Price Index, 12-Month Percentage Change, NSA, 2001-2015

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

The trend of increase of the consumer price index excluding food and energy in Chart I-22 does not reveal any threat of deflation that would justify symmetric inflation targets. There are mild oscillations in a neat upward trend.

Chart I-22, US, Consumer Price Index Excluding Food and Energy, NSA, 2001-2015

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

Chart I-23 provides 12-month percentage change of the consumer price index excluding food and energy. Past-year rates of inflation fell toward 1 percent from 2001 into 2003 because of the recession and the decline of commodity prices beginning before the recession with declines of real oil prices. Near zero interest rates with fed funds at 1 percent between Jun 2003 and Jun 2004 stimulated carry trades of all types, including in buying homes with subprime mortgages in expectation that low interest rates forever would increase home prices permanently, creating the equity that would permit the conversion of subprime mortgages into creditworthy mortgages (Gorton 2009EFM; see http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Inflation rose and then collapsed during the unwinding of carry trades and the housing debacle of the global recession. Carry trades into 2011 and 2012 gave a new impulse to CPI inflation, all items and core. Symmetric inflation targets destabilize the economy by encouraging hunts for yields that inflate and deflate financial assets, obscuring risk/return decisions on production, investment, consumption and hiring.

Chart I-23, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2001-2015

Source: US Bureau of Labor Statistics

Headline and core producer price indexes are in Table I-6. The headline PPI SA increased 1.5 percent in May 2015 and decreased 3.0 percent NSA in the 12 months ending in May 2015. The core PPI SA increased 0.3 percent in May 2015 and rose 2.0 percent in 12 months. Analysis of annual equivalent rates of change shows inflation waves similar to those worldwide. In the first wave, the absence of risk aversion from the sovereign risk crisis in Europe motivated the carry trade from zero interest rates into commodity futures that caused the annual equivalent rate of 10.4 percent in the headline PPI in Jan-Apr 2011 and 3.7 percent in the core PPI. In the second wave, commodity futures prices collapsed in Jun 2011 with the return of risk aversion originating in the sovereign risk crisis of Europe. The annual equivalent rate of headline PPI inflation collapsed to 1.2 percent in May-Jun 2011 but the core annual equivalent inflation rate was higher at 2.4 percent. In the third wave, headline PPI inflation resuscitated with annual equivalent at 4.5 percent in Jul-Sep 2011 and core PPI inflation at 3.7 percent. Core PPI inflation was persistent throughout 2011, jumping from annual equivalent at 2.0 percent in the first three months of 2010 to 3.0 percent in 12 months ending in Dec 2011. Unconventional monetary policy is based on the proposition that core rates reflect more fundamental inflation and are thus better predictors of the future. In practice, the relation of core and headline inflation is as difficult to predict as future inflation (see IIID Supply Shocks in http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html). In the fourth wave, risk aversion originating in the lack of resolution of the European debt crisis caused unwinding of carry trades with annual equivalent headline PPI inflation of minus 0.4 percent in Oct-Dec 2011 and 2.0 percent in the core annual equivalent. In the fifth wave from Jan to Mar 2012, annual equivalent inflation was 2.8 percent for the headline index but 3.2 percent for the core index excluding food and energy. In the sixth wave, annual equivalent inflation in Apr-May 2012 during renewed risk aversion was minus 3.5 percent for the headline PPI and 1.8 percent for the core. In the seventh wave, continuing risk aversion caused reversal of carry trades into commodity exposures with annual equivalent headline inflation of minus 0.6 percent in Jun-Jul 2012 while core PPI inflation was at annual equivalent 3.7 percent. In the eighth wave, relaxed risk aversion because of the announcement of the impaired bond buying program or Outright Monetary Transactions (OMT) of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html) induced carry trades that drove annual equivalent inflation of producer prices of the United States at 14.0 percent in Aug-Sep 2012 and 0.6 percent in the core index. In the ninth wave, renewed risk aversion caused annual equivalent inflation of minus 2.4 percent in Oct 2011-Dec 2012 in the headline index and 1.2 percent in the core index. In the tenth wave, annual equivalent inflation was 6.2 percent in the headline index in Jan-Feb 2013 and 2.4 percent in the core index. In the eleventh wave, annual equivalent inflation was minus 7.0 percent in Mar-Apr 2012 and 1.8 percent for the core index. In the twelfth wave, annual equivalent inflation returned at 3.7 percent in May-Aug 2013 and 1.2 percent in the core index. In the thirteenth wave, portfolio reallocations away from commodities and into equities reversed commodity carry trade with annual equivalent inflation of 0.0 percent in Sep-Nov 2013 in the headline PPI and 0.8 percent in the core. In the fourteenth wave, annual equivalent inflation returned at 5.3 percent annual equivalent for the headline index in Dec 2013-Feb 2014 and 4.1 percent for the core index. In the fifteenth wave, annual equivalent inflation was 3.7 percent for the general PPI index in Mar 2014 and 0.0 percent for the core PPI index. In the sixteenth wave, annual equivalent headline PPI inflation increased at 2.7 percent in Apr-Jul 2014 and 1.8 percent for the core PPI. In the seventeenth wave, annual equivalent inflation in Aug-Nov 2014 was minus 3.5 percent and 1.5 percent for the core index. In the eighteenth wave, annual equivalent inflation fell at 17.6 percent for the general index in Dec 2014 to Jan 2015 and increased at 2.4 percent in the core index. In the nineteenth wave, annual equivalent inflation fell at 2.4 percent in Feb 2015 and decreased at 1.2 percent for the core index. In the twentieth wave, annual equivalent producer prices increased at 6.2 percent in Mar 2015 and the core at 6.2 percent. In the twenty-first wave, producer prices fell at 7.0 percent annual equivalent in Apr 2015 while the core index increased at 1.2 percent. In the twenty-second wave, producer prices increased at annual equivalent 19.6 percent in May 2015 and core producer prices at 3.7 percent. It is almost impossible to forecast PPI inflation and its relation to CPI inflation. “Inflation surprise” by monetary policy could be proposed to climb along a downward sloping Phillips curve, resulting in higher inflation but lower unemployment (see Kydland and Prescott 1977, Barro and Gordon 1983 and past comments of this blog 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 http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). The architects of monetary policy would require superior inflation forecasting ability compared to forecasting naivety by everybody else. In practice, we are all naïve in forecasting inflation and other economic variables and events.

Table I-6, US, Headline and Core PPI Inflation Monthly SA and 12-Month NSA ∆%

	Finished Goods SA Month	Finished Goods NSA 12 months	Finished Core SA Month	Finished Core NSA 12 months
May 2015	1.5	-3.0	0.3	2.0
AE ∆% May	19.6		3.7
Apr	-0.6	-4.4	0.1	2.0
AE ∆% Apr	-7.0		1.2
Mar	0.5	-3.3	0.5	2.0
AE ∆% Mar	6.2		6.2
Feb	-0.2	-3.4	-0.1	1.5
AE ∆% Feb	-2.4		-1.2
Jan	-1.9	-3.0	0.5	1.7
Dec 2014	-1.3	-0.6	-0.1	1.7
AE ∆% Dec-Jan	-17.6		2.4
Nov	-0.8	1.1	0.1	2.0
Oct	-0.2	1.7	0.1	2.2
Sep	-0.1	2.2	0.2	2.1
Aug	-0.1	2.3	0.1	1.9
AE ∆% Aug-Nov	-3.5		1.5
July	0.0	2.9	0.1	1.9
Jun	0.4	2.8	0.2	1.9
May	0.1	2.5	0.2	1.8
Apr	0.4	3.1	0.1	1.7
AE ∆% Apr-Jul	2.7		1.8
Mar	0.3	1.9	0.0	1.7
AE ∆% Mar	3.7		0.0
Feb	0.1	1.3	0.1	1.9
Jan	0.6	1.6	0.5	2.0
Dec 2013	0.6	1.4	0.4	1.6
AE ∆% Dec-Feb	5.3		4.1
Nov	-0.2	0.8	0.2	1.3
Oct	0.2	0.3	0.0	1.2
Sep	0.0	0.3	0.0	1.2
AE ∆% Sep-Nov	0.0		0.8
Aug	0.3	1.3	0.1	1.2
Jul	0.0	2.1	0.1	1.3
Jun	0.2	2.3	0.1	1.6
May	0.7	1.6	0.1	1.7
AE ∆% May-Aug	3.7		1.2
Apr	-0.7	0.5	0.1	1.7
Mar	-0.5	1.1	0.2	1.7
AE ∆% Mar-Apr	-7.0		1.8
Feb	0.6	1.8	0.2	1.8
Jan	0.4	1.5	0.2	1.8
AE ∆% Jan-Feb	6.2		2.4
Dec 2012	-0.1	1.4	0.1	2.1
Nov	-0.7	1.5	0.2	2.2
Oct	0.2	2.3	0.0	2.2
AE ∆% Oct-Dec	-2.4		1.2
Sep	1.0	2.1	0.0	2.4
Aug	1.2	1.9	0.1	2.6
AE ∆% Aug-Sep	14.0		0.6
Jul	0.2	0.5	0.4	2.6
Jun	-0.3	0.7	0.2	2.6
AE ∆% Jun-Jul	-0.6		3.7
May	-0.4	0.6	0.1	2.7
Apr	-0.2	1.8	0.2	2.7
AE ∆% Apr-May	-3.5		1.8
Mar	0.1	2.8	0.2	2.9
Feb	0.3	3.4	0.2	3.1
Jan	0.3	4.1	0.4	3.1
AE ∆% Jan-Mar	2.8		3.2
Dec 2011	-0.1	4.7	0.2	3.0
Nov	0.2	5.6	0.1	3.0
Oct	-0.2	5.8	0.2	2.9
AE ∆% Oct-Dec	-0.4		2.0
Sep	0.8	7.0	0.3	2.8
Aug	-0.1	6.6	0.1	2.7
Jul	0.4	7.1	0.5	2.7
AE ∆% Jul-Sep	4.5		3.7
Jun	-0.3	6.9	0.2	2.3
May	0.5	7.1	0.2	2.1
AE ∆% May-Jun	1.2		2.4
Apr	0.8	6.6	0.3	2.3
Mar	0.7	5.6	0.3	2.0
Feb	1.0	5.4	0.2	1.8
Jan	0.8	3.6	0.4	1.6
AE ∆% Jan-Apr	10.4		3.7
Dec 2010	0.8	3.8	0.2	1.4
Nov	0.4	3.4	0.0	1.2
Oct	0.8	4.3	0.0	1.6
Sep	0.4	3.9	0.2	1.6
Aug	0.5	3.3	0.1	1.3
Jul	0.1	4.1	0.1	1.5
Jun	-0.3	2.7	0.1	1.1
May	0.0	5.1	0.3	1.3
Apr	0.0	5.4	0.0	0.9
Mar	0.7	5.9	0.2	0.9
Feb	-0.7	4.2	0.1	1.0
Jan	1.0	4.5	0.2	1.0

Note: Core: excluding food and energy; AE: annual equivalent

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/data.htm

The US producer price index NSA from 2000 to 2015 is shown in Chart I-24. There are two episodes of decline of the PPI during recessions in 2001 and in 2008. Barsky and Kilian (2004) consider the 2001 episode as one in which real oil prices were declining when recession began. Recession and the fall of commodity prices instead of generalized deflation explain the behavior of US inflation in 2008. There is similar collapse of producer prices into 2015 as in 2009 caused by the drop of commodity prices.

Chart I-24, US, Producer Price Index, NSA, 2000-2015

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the PPI NSA from 2000 to 2015 are shown in Chart I-25. It may be possible to forecast trends a few months in the future under adaptive expectations but turning points are almost impossible to anticipate especially when related to fluctuations of commodity prices in response to risk aversion. In a sense, monetary policy has been tied to behavior of the PPI in the negative 12-month rates in 2001 to 2003 and then again in 2009 to 2010. There is similar sharp decline of inflation into 2015 caused by the drop of commodities. Monetary policy following deflation fears caused by commodity price fluctuations would introduce significant volatility and risks in financial markets and eventually in consumption and investment.

Chart I-25, US, Producer Price Index, 12-Month Percentage Change NSA, 2000-2015

Source: US Bureau of Labor Statistics

The US PPI excluding food and energy from 2000 to 2015 is in Chart I-26. There is here again a smooth trend of inflation instead of prolonged deflation as in Japan.

Chart I-26, US, Producer Price Index Excluding Food and Energy, NSA, 2000-2015

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the producer price index excluding food and energy are in Chart I-27. Fluctuations replicate those in the headline PPI. There is an evident trend of increase of 12 months rates of core PPI inflation in 2011 but lower rates in 2012-2014. Prices rose less rapidly into 2015 as during earlier fluctuations.

Chart I-27, US, Producer Price Index Excluding Food and Energy, NSA, 12-Month Percentage Changes, 2000-2015

Source: US Bureau of Labor Statistics

The US producer price index of energy goods from 2000 to 2015 is in Chart I-28. There is a clear upward trend with fluctuations, which would not occur under persistent deflation.

Chart I-28, US, Producer Price Index Finished Energy Goods, NSA, 2000-2015

Source: US Bureau of Labor Statistics

Chart I-29 provides 12-month percentage changes of the producer price index of energy goods from 2000 to 2015. Barsky and Killian (2004) relate the episode of declining prices of energy goods in 2001 to 2002 to the analysis of decline of real oil prices. Interest rates dropping to zero during the global recession in 2008 induced carry trades that explain the rise of the PPI of energy goods toward 30 percent. Bouts of risk aversion with policy interest rates held close to zero explain the fluctuations in the 12-month rates of the PPI of energy goods in the expansion phase of the economy. Symmetric inflation targets induce significant instability in inflation and interest rates with adverse effects on financial markets and the overall economy.

Chart I-29, US, Producer Price Index Energy Goods, 12-Month Percentage Change, NSA, 2000-2015

Source: US Bureau of Labor Statistics

The Bureau of Labor Statistics (BLS) is enhancing the producer price index of the US with the final demand producer price index (FD PPI) beginning in Jan 2014 (http://www.bls.gov/ppi/fdidtransition.htm):

“Effective with the January 2014 Producer Price Index (PPI) data release in February 2014, BLS transitioned from the Stage of Processing (SOP) to the Final Demand-Intermediate Demand (FD-ID) aggregation system. This shift resulted in significant changes to the PPI news release, as well as other documents available from PPI. The transition to the FD-ID system was the culmination of a long-standing PPI objective to improve the current SOP aggregation system by incorporating PPIs for services, construction, government purchases, and exports. In comparison to the SOP system, the FD-ID system more than doubled PPI coverage of the United States economy to over 75 percent of in-scope domestic production. The FD-ID system was first introduced as a set of experimental indexes in January 2011. Nearly all new FD-ID goods, services, and construction indexes provide historical data back to either November 2009 or April 2010, while the indexes for goods that correspond with the historical SOP indexes go back to the 1970s or earlier.”

Headline and core final demand producer price indexes are in Table I-6A. The headline FD PPI SA increased 0.5 percent in May 2015 and decreased 1.1 percent NSA in the 12 months ending in Apr 2015. The core FD PPI SA increased 0.1 percent in May 2015 and increased 0.6 percent in 12 months. Analysis of annual equivalent rates of change shows inflation waves similar to those worldwide. In the first wave, the absence of risk aversion from the sovereign risk crisis in Europe motivated the carry trade from zero interest rates into commodity futures that caused the average equivalent rate of 7.4 percent in the headline FD PPI in Jan-Apr 2011 and 4.9 percent in the core FD PPI. In the second wave, commodity futures prices collapsed in Jun 2011 with the return of risk aversion originating in the sovereign risk crisis of Europe. The annual equivalent rate of headline FD PPI inflation collapsed to 2.4 percent in May-Jun 2011 but the core annual equivalent inflation rate was lower at 1.8 percent. In the third wave, headline FD PPI inflation resuscitated with annual equivalent at 3.2 percent in Jul-Sep 2011 and core PPI inflation at 3.2 percent. Core FD PPI inflation was persistent throughout 2011, from annual equivalent at 4.9 percent in the first four months of 2011 to 2.6 percent in 12 months ending in Dec 2011. Unconventional monetary policy is based on the proposition that core rates reflect more fundamental inflation and are thus better predictors of the future. In practice, the relation of core and headline inflation is as difficult to predict as future inflation (see IIID Supply Shocks in http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html). In the fourth wave, risk aversion originating in the lack of resolution of the European debt crisis caused unwinding of carry trades with annual equivalent headline FD PPI inflation of minus 0.8 percent in Oct-Dec 2011 and minus 0.4 percent in the core annual equivalent. In the fifth wave from Jan to Mar 2012, annual equivalent inflation was 3.7 percent for the headline index and 3.7 percent for the core index excluding food and energy. In the sixth wave, annual equivalent inflation in Apr-May 2012 during renewed risk aversion was 0.6 percent for the headline FD PPI and 3.0 percent for the core. In the seventh wave, continuing risk aversion caused reversal of carry trades into commodity exposures with annual equivalent headline inflation of minus 1.2 percent in Jun-Jul 2012 while core FD PPI inflation was at annual equivalent minus 1.2 percent. In the eighth wave, relaxed risk aversion because of the announcement of the impaired bond buying program or Outright Monetary Transactions (OMT) of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html) induced carry trades that drove annual equivalent inflation of final demand producer prices of the United States at 5.5 percent in Aug-Sep 2012 and 1.2 percent in the core index. In the ninth wave, renewed risk aversion caused annual equivalent inflation of 1.2 percent in Oct 2011-Dec 2012 in the headline index and 2.8 percent in the core index. In the tenth wave, annual equivalent inflation was 2.4 percent in the headline index in Jan-Feb 2013 and 0.6 percent in the core index. In the eleventh wave, annual equivalent was minus 1.8 percent in Mar-Apr 2012 and 2.4 percent for the core index. In the twelfth wave, annual equivalent inflation returned at 2.1 percent in May-Aug 2013 and 1.2 percent in the core index. In the thirteenth wave, portfolio reallocations away from commodities and into equities reversed commodity carry trade with annual equivalent inflation of 1.6 percent in Sep-Nov 2013 in the headline FD PPI and 2.0 percent in the core. In the fourteenth wave, annual equivalent inflation was 2.4 percent annual equivalent for the headline index in Dec 2013-Feb 2014 and 1.6 percent for the core index. In the fifteenth wave, annual equivalent inflation increased to 2.7 percent in the headline FD PPI and 2.7 percent in the core in Mar-Jul 2014. In the sixteenth wave, annual equivalent inflation was minus 1.8 percent for the headline FD index and minus 1.2 percent for the core FD index in Aug-Sep 2014. In the seventeenth wave, annual equivalent inflation was 3.7 percent for the headline FD and 6.2 percent for the core FD in Oct 2014. In the eighteenth wave, annual equivalent inflation was minus 3.5 percent for the headline FDI and 1.2 percent for the core in Nov-Dec 2014. In the nineteenth wave, annual equivalent inflation was minus 7.0 percent for the general index and minus 3.0 percent for the core in Jan-Feb 2015. In the twentieth wave, annual equivalent inflation was 2.4 percent for the general index in Mar 2015 and 2.4 percent for the core. In the twenty-first wave, final demand prices fell at annual equivalent 4.7 for the headline index and fell at 2.4 percent for the core index. In the twenty-second wave, annual equivalent inflation returned at 6.2 percent for the headline index in May 2015 and at 1.2 percent for the core index. It is almost impossible to forecast PPI inflation and its relation to CPI inflation. “Inflation surprise” by monetary policy could be proposed to climb along a downward sloping Phillips curve, resulting in higher inflation but lower unemployment (see Kydland and Prescott 1977, Barro and Gordon 1983 and past comments of this blog 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 http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). The architects of monetary policy would require superior inflation forecasting ability compared to forecasting naivety by everybody else. In practice, we are all naïve in forecasting inflation and other economic variables and events.

Table I-6B, US, Headline and Core Final Demand Producer Price Inflation Monthly SA and 12-Month NSA ∆%

	Final Demand SA Month	Final Demand NSA 12 months	Final Demand Core SA Month	Final Demand Core NSA 12 months
May 2015	0.5	-1.1	0.1	0.6
AE ∆% May	6.2		1.2
Apr	-0.4	-1.3	-0.2	0.8
AE ∆% Apr	-4.7		-2.4
Mar	0.2	-0.8	0.2	0.9
AE ∆% Mar	2.4		2.4
Feb	-0.5	-0.6	-0.5	1.0
Jan	-0.7	0.0	-0.0	1.7
AE ∆% Jan-Feb	-7.0		-3.0
Dec 2014	-0.3	0.9	0.2	2.0
Nov	-0.3	1.3	0.0	1.7
AE ∆% Nov-Dec	-3.5		1.2
Oct	0.3	1.5	0.5	1.9
AE ∆% Oct	3.7		6.2
Sep	-0.2	1.6	-0.2	1.6
Aug	-0.1	1.9	0.0	1.9
AE ∆% Aug-Sep	-1.8		-1.2
Jul	0.3	1.9	0.5	1.9
Jun	0.1	1.8	0.0	1.6
May	0.3	2.1	0.3	2.1
Apr	0.1	1.8	0.0	1.5
Mar	0.3	1.6	0.3	1.6
AE ∆% Mar-Jul	2.7		2.7
Feb	0.2	1.2	0.2	1.6
Jan	0.3	1.3	0.3	1.4
Dec 2013	0.1	1.2	-0.1	1.2
AE ∆% Dec-Feb	2.4		1.6
Nov	0.1	1.1	0.2	1.4
Oct	0.2	1.3	0.2	1.7
Sep	0.1	1.1	0.1	1.6
AE ∆% Sep-Nov	1.6		2.0
Aug	0.0	1.7	-0.1	1.8
Jul	0.3	2.0	0.3	1.7
Jun	0.4	1.7	0.5	1.3
May	0.0	0.9	-0.3	0.9
AE ∆% May-Aug	2.1		1.2
Apr	-0.2	0.9	0.2	1.3
Mar	-0.1	1.3	0.2	1.5
AE ∆% Mar-Apr	-1.8		2.4
Feb	0.3	1.6	0.0	1.4
Jan	0.1	1.6	0.1	1.7
AE ∆% Jan-Feb	2.4		0.6
Dec 2012	0.1	1.9	0.2	2.0
Nov	0.1	1.7	0.4	1.8
Oct	0.1	1.9	0.1	1.6
AE ∆% Oct-Dec	1.2		2.8
Sep	0.7	1.5	0.3	1.4
Aug	0.2	1.2	-0.1	1.2
AE ∆% Aug-Sep	5.5		1.2
Jul	0.0	1.0	-0.1	1.7
Jun	-0.2	1.3	-0.1	1.9
AE ∆% Jun-Jul	-1.2		-1.2
May	-0.1	1.6	0.2	2.2
Apr	0.2	2.0	0.3	2.1
AE ∆% Apr-May	0.6		3.0
Mar	0.2	2.4	0.2	2.3
Feb	0.3	2.8	0.3	2.6
Jan	0.4	3.1	0.4	2.5
AE ∆% Jan-Mar	3.7		3.7
Dec 2011	-0.1	3.2	0.0	2.6
Nov	0.2	3.7	0.2	2.7
Oct	-0.3	3.7	-0.3	2.7
AE ∆% Oct-Dec	-0.8		-0.4
Sep	0.4	4.5	0.2	2.9
Aug	0.2	4.4	0.3	3.0
Jul	0.2	4.5	0.3	2.7
AE ∆% Jul-Sep	3.2		3.2
Jun	0.1	4.3	0.2	2.6
May	0.3	4.2	0.1	2.3
AE ∆% May-Jun	2.4		1.8
Apr	0.5	4.2	0.4	2.5
Mar	0.7	4.0	0.5	NA
Feb	0.6	3.3	0.3	NA
Jan	0.6	2.4	0.4	NA
AE ∆% Jan-Apr	7.4		4.9
Dec 2010	0.3	2.8	0.1	NA
Nov	0.3	2.6	0.1	NA
Oct	0.4	NA	0.1	NA
Sep	0.3	NA	0.2	NA
Aug	0.2	NA	0.0	NA
Jul	0.2	NA	0.2	NA
Jun	-0.2	NA	-0.1	NA
May	0.2	NA	0.3	NA
Apr	0.3	NA	NA	NA
Mar	0.1	NA	NA	NA
Feb	-0.2	NA	NA	NA
Jan	0.9	NA	NA	NA

Note: Core: excluding food and energy; AE: annual equivalent

Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/data.htm

Chart I-24B provides the FD PPI NSA from 2009 to 2015. There is persistent inflation with periodic declines in inflation waves similar to those worldwide.

Chart I-24B, US, Final Demand Producer Price Index, NSA, 2009-2015

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the FD PPI from 2010 to 2015 are in Chart I-25B. There are fluctuations in the rates with evident trend of decline to more subdued inflation. Reallocations of investment portfolios of risk financial assets from commodities to stocks explain much lower FD PPI inflation.

Chart I-25B, US, Final Demand Producer Price Index, 12-Month Percentage Change NSA, 2010-2015

Source: US Bureau of Labor Statistics

The core FD PPI NSA is in Chart I-26B. The behavior is similar to the headline index but with much less cumulative inflation.

Chart I-26B, US, Final Demand Producer Price Index Excluding Food and Energy, NSA, 2009-2015

Source: US Bureau of Labor Statistics

Percentage changes in 12 months of the core FD PPI are in Chart I-27B. There are fluctuations in 12 months percentage changes but with evident declining trend to more moderate inflation.

Chart I-27B, US, Final Demand Producer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2010-2015

Source: US Bureau of Labor Statistics

The energy FD PPI NSA is in Chart I-28B. The index increased during the reposition of carry trades after the discovery of lack of toxic assets in banks that caused flight away from risk financial assets into government obligations of the US (Cochrane and Zingales 2009). Alternating risk aversion and appetite with reallocations among classes of risk financial assets explain the behavior of the index after late 2010.

Chart I-28B, US, Final Demand Energy Producer Price Index, NSA, 2009-2015

Source: US Bureau of Labor Statistics

Twelve-month percentage changes of the FD energy PPI are in Chart I-29B. Rates moderated from late 2010 to the present. There are multiple negative rates. Investors create and reverse carry trades from zero interest rates to derivatives of commodities in accordance with relative risk evaluations of classes of risk financial assets.

Chart I-29B, US, Final Demand Energy Producer Price Index, 12-Month Percentage Change, NSA, 2010-2015

Source: US Bureau of Labor Statistics

Table I-7 provides 12-month percentage changes of the CPI all items, CPI core and CPI housing from 2001 to 2015. There is no evidence in these data supporting symmetric inflation targets that would only induce greater instability in inflation, interest rates and financial markets. Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval (1.99, 2.0). Symmetric targets appear to have been abandoned in a favor of a self-imposed single jobs mandate of easing

monetary policy even with the economy growing at or close to potential output.

Table I-7, CPI All Items, CPI Core and CPI Housing, 12-Month Percentage Change, NSA 2001-2013

May	CPI All Items	CPI Core ex Food and Energy	CPI Housing
2015	0.0	1.7	1.9
2014	2.1	2.0	2.6
2013	1.4	1.7	2.2
2012	1.7	2.3	1.6
2011	3.6	1.5	1.2
2010	2.0	0.9	-0.5
2009	-1.3	1.8	0.5
2008	4.2	2.3	3.3
2007	2.7	2.2	3.3
2006	4.2	2.4	4.0
2005	2.8	2.2	3.0
2004	3.1	1.7	2.4
2003	2.1	1.6	2.7
2002	1.2	2.5	2.2
2001	3.6	2.5	4.6

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

IE Theory and Reality of Economic History, Cyclical Slow Growth Not Secular Stagnation and Monetary Policy Based on Fear of Deflation. Fear of deflation as had occurred during the Great Depression and in Japan was used as an argument for the first round of unconventional monetary policy with 1 percent interest rates from Jun 2003 to Jun 2004 and quantitative easing in the form of withdrawal of supply of 30-year securities by suspension of the auction of 30-year Treasury bonds with the intention of reducing mortgage rates (for fear of deflation see Pelaez and Pelaez, International Financial Architecture (2005), 18-28, and Pelaez and Pelaez, The Global Recession Risk (2007), 83-95). The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

If the forecast of the central bank is of recession and low inflation with controlled inflationary expectations, monetary policy should consist of lowering the short-term policy rate of the central bank, which in the US is the fed funds rate. The intended effect is to lower the real rate of interest (Svensson 2003LT, 146-7). The real rate of interest, r, is defined as the nominal rate, i, adjusted by expectations of inflation, π*, with all variables defined as proportions: (1+r) = (1+i)/(1+π*) (Fisher 1930). If i, the fed funds rate, is lowered by the Fed, the numerator of the right-hand side is lower such that if inflationary expectations, π*, remain unchanged, the left-hand (1+r) decreases, that is, the real rate of interest, r, declines. Expectations of lowering short-term real rates of interest by policy of the Federal Open Market Committee (FOMC) fixing a lower fed funds rate would lower long-term real rates of interest, inducing with a lag investment and consumption, or aggregate demand, that can lift the economy out of recession. Inflation also increases with a lag by higher aggregate demand and inflation expectations (Fisher 1933). This reasoning explains why the FOMC lowered the fed funds rate in Dec 2008 to 0 to 0.25 percent and left it unchanged.

The fear of the Fed is expected deflation or negative π*. In that case, (1+ π*) < 1, and (1+r) would increase because the right-hand side of the equation would be divided by a fraction. A simple numerical example explains the effect of deflation on the real rate of interest. Suppose that the nominal rate of interest or fed funds rate, i, is 0.25 percent, or in proportion 0.25/100 = 0.0025, such that (1+i) = 1.0025. Assume now that economic agents believe that inflation will remain at 1 percent for a long period, which means that π* = 1 percent, or in proportion 1/100 =0.01. The real rate of interest, using the equation, is (1+0.0025)/(1+0.01) = (1+r) = 0.99257, such that r = 0.99257 - 1 = -0.00743, which is a proportion equivalent to –(0.00743)100 = -0.743 percent. That is, Fed policy has created a negative real rate of interest of 0.743 percent with the objective of inducing aggregate demand by higher investment and consumption. This is true if expected inflation, π*, remains at 1 percent. Suppose now that expectations of deflation become generalized such that π* becomes -1 percent, that is, the public believes prices will fall at the rate of 1 percent in the foreseeable future. Then the real rate of interest becomes (1+0.0025) divided by (1-0.01) equal to (1.0025)/(0.99) = (1+r) = 1.01263, or r = (1.01263-1) = 0.01263, which results in positive real rate of interest of (0.01263)100 = 1.263 percent.

Irving Fisher also identified the impact of deflation on debts as an important cause of deepening contraction of income and employment during the Great Depression illustrated by an actual example (Fisher 1933, 346):

“By March, 1933, liquidation had reduced the debts about 20 percent, but had increased the dollar about 75 percent, so that the real debt, that is the debt measured in terms of commodities, was increased about 40 percent [100%-20%)X(100%+75%) =140%]. Unless some counteracting cause comes along to prevent the fall in the price level, such a depression as that of 1929-1933 (namely when the more the debtors pay the more they owe) tends to continue, going deeper, in a vicious spiral, for many years. There is then no tendency of the boat to stop tipping until it has capsized”

The nominal rate of interest must always be nonnegative, that is, i ≥ 0 (Hicks 1937, 154-5):

“If the costs of holding money can be neglected, it will always be profitable to hold money rather than lend it out, if the rate of interest is not greater than zero. Consequently the rate of interest must always be positive. In an extreme case, the shortest short-term rate may perhaps be nearly zero. But if so, the long-term rate must lie above it, for the long rate has to allow for the risk that the short rate may rise during the currency of the loan, and it should be observed that the short rate can only rise, it cannot fall”

The interpretation by Hicks of the General Theory of Keynes is the special case in which at interest rates close to zero liquidity preference is infinitely or perfectly elastic, that is, the public holds infinitely large cash balances at that near zero interest rate because there is no opportunity cost of foregone interest. Increases in the money supply by the central bank would not decrease interest rates below their near zero level, which is called the liquidity trap. The only alternative public policy would consist of fiscal policy that would act similarly to an increase in investment, increasing employment without raising the interest rate.

An influential view on the policy required to steer the economy away from the liquidity trap is provided by Paul Krugman (1998). Suppose the central bank faces an increase in inflation. An important ingredient of the control of inflation is the central bank communicating to the public that it will maintain a sustained effort by all available policy measures and required doses until inflation is subdued and price stability is attained. If the public believes that the central bank will control inflation only until it declines to a more benign level but not sufficiently low level, current expectations will develop that inflation will be higher once the central bank abandons harsh measures. During deflation and recession the central bank has to convince the public that it will maintain zero interest rates and other required measures until the rate of inflation returns convincingly to a level consistent with expansion of the economy and stable prices. Krugman (1998, 161) summarizes the argument as:

“The ineffectuality of monetary policy in a liquidity trap is really the result of a looking-glass version of the standard credibility problem: monetary policy does not work because the public expects that whatever the central bank may do now, given the chance, it will revert to type and stabilize prices near their current level. If the central bank can credibly promise to be irresponsible—that is, convince the market that it will in fact allow prices to rise sufficiently—it can bootstrap the economy out of the trap”

This view is consistent with results of research by Christina Romer that “the rapid rates of growth of real output in the mid- and late 1930s were largely due to conventional aggregate demand stimulus, primarily in the form of monetary expansion. My calculations suggest that in the absence of these stimuli the economy would have remained depressed far longer and far more deeply than it actually did” (Romer 1992, 757-8, cited in Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 210-2). The average growth rate of the money supply in 1933-1937 was 10 percent per year and increased in the early 1940s. Romer calculates that GDP would have been much lower without this monetary expansion. The growth of “the money supply was primarily due to a gold inflow, which was in turn due to the devaluation in 1933 and to capital flight from Europe because of political instability after 1934” (Romer 1992, 759). Gold inflow coincided with the decline in real interest rates in 1933 that remained negative through the latter part of the 1930s, suggesting that they could have caused increases in spending that was sensitive to declines in interest rates. Bernanke finds dollar devaluation against gold to have been important in preventing further deflation in the 1930s (Bernanke 2002):

“There have been times when exchange rate policy has been an effective weapon against deflation. A striking example from US history is Franklin Roosevelt’s 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the US deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market”

Fed policy is seeking what Irving Fisher proposed “that great depressions are curable and preventable through reflation and stabilization” (Fisher 1933, 350).

The President of the Federal Reserve Bank of Chicago argues that (Charles Evans 2010):

“I believe the US economy is best described as being in a bona fide liquidity trap. Highly plausible projections are 1 percent for core Personal Consumption Expenditures (PCE) inflation at the end of 2012 and 8 percent for the unemployment rate. For me, the Fed’s dual mandate misses are too large to shrug off, and there is currently no policy conflict between improving employment and inflation outcomes”

There are two types of monetary policies that could be used in this situation. First, the Fed could announce a price-level target to be attained within a reasonable time frame (Evans 2010):

“For example, if the slope of the price path is 2 percent and inflation has been underunning the path for some time, monetary policy would strive to catch up to the path. Inflation would be higher than 2 percent for a time until the path was reattained”

Optimum monetary policy with interest rates near zero could consist of “bringing the price level back up to a level even higher than would have prevailed had the disturbance never occurred” (Gauti Eggertsson and Michael Woodford 2003, 207). Bernanke (2003JPY) explains as follows:

“Failure by the central bank to meet its target in a given period leads to expectations of (and public demands for) increased effort in subsequent periods—greater quantities of assets purchased on the open market for example. So even if the central bank is reluctant to provide a time frame for meetings its objective, the structure of the price-level objective provides a means for the bank to commit to increasing its anti-deflationary efforts when its earlier efforts prove unsuccessful. As Eggertsson and Woodford show, the expectations that an increasing price level gap will give rise to intensified effort by the central bank should lead the public to believe that ultimately inflation will replace deflation, a belief that supports the central bank’s own objectives by lowering the current real rate of interest”

Second, the Fed could use its balance sheet to increase purchases of long-term securities together with credible commitment to maintain the policy until the dual mandates of maximum employment and price stability are attained. Policy continues with reinvestment of principal in securities.

In the restatement of the liquidity trap and large-scale policies of monetary/fiscal stimulus, Krugman (1998, 162) finds:

“In the traditional open economy IS-LM model developed by Robert Mundell [1963] and Marcus Fleming [1962], and also in large-scale econometric models, monetary expansion unambiguously leads to currency depreciation. But there are two offsetting effects on the current account balance. On one side, the currency depreciation tends to increase net exports; on the other side, the expansion of the domestic economy tends to increase imports. For what it is worth, policy experiments on such models seem to suggest that these effects very nearly cancel each other out.

Krugman (1998) uses a different dynamic model with expectations that leads to similar conclusions.

The central bank could also be pursuing competitive devaluation of the national currency in the belief that it could increase inflation to a higher level and promote domestic growth and employment at the expense of growth and unemployment in the rest of the world. An essay by Chairman Bernanke in 1999 on Japanese monetary policy received attention in the press, stating that (Bernanke 2000, 165):

“Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and experiment—in short, to do whatever it took to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done”

Quantitative easing has never been proposed by Chairman Bernanke or other economists as certain science without adverse effects. What has not been mentioned in the press is another suggestion to the Bank of Japan (BOJ) by Chairman Bernanke in the same essay that is very relevant to current events and the contentious issue of ongoing devaluation wars (Bernanke 2000, 161):

“Because the BOJ has a legal mandate to pursue price stability, it certainly could make a good argument that, with interest rates at zero, depreciation of the yen is the best available tool for achieving its mandated objective. The economic validity of the beggar-thy-neighbor thesis is doubtful, as depreciation creates trade—by raising home country income—as well as diverting it. Perhaps not all those who cite the beggar-thy-neighbor thesis are aware that it had its origins in the Great Depression, when it was used as an argument against the very devaluations that ultimately proved crucial to world economic recovery. A yen trading at 100 to the dollar is in no one’s interest”

Chairman Bernanke is referring to the argument by Joan Robinson based on the experience of the Great Depression that: “in times of general unemployment a game of beggar-my-neighbour is played between the nations, each one endeavouring to throw a larger share of the burden upon the others” (Robinson 1947, 156). Devaluation is one of the tools used in these policies (Robinson 1947, 157). Banking crises dominated the experience of the United States, but countries that recovered were those devaluing early such that competitive devaluations rescued many countries from a recession as strong as that in the US (see references to Ehsan Choudhri, Levis Kochin and Barry Eichengreen in Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 205-9; for the case of Brazil that devalued early in the Great Depression recovering with an increasing trade balance see Pelaez, 1968, 1968b, 1972; Brazil devalued and abandoned the gold standard during crises in the historical period as shown by Pelaez 1976, Pelaez and Suzigan 1981). Beggar-my-neighbor policies did work for individual countries but the criticism of Joan Robinson was that it was not optimal for the world as a whole.

Chairman Bernanke (2013Mar 25) reinterprets devaluation and recovery from the Great Depression:

“The uncoordinated abandonment of the gold standard in the early 1930s gave rise to the idea of "beggar-thy-neighbor" policies. According to this analysis, as put forth by important contemporary economists like Joan Robinson, exchange rate depreciations helped the economy whose currency had weakened by making the country more competitive internationally. Indeed, the decline in the value of the pound after 1931 was associated with a relatively early recovery from the Depression by the United Kingdom, in part because of some rebound in exports. However, according to this view, the gains to the depreciating country were equaled or exceeded by the losses to its trading partners, which became less internationally competitive--hence, ‘beggar thy neighbor.’ Economists still agree that Smoot-Hawley and the ensuing tariff wars were highly counterproductive and contributed to the depth and length of the global Depression. However, modern research on the Depression, beginning with the seminal 1985 paper by Barry Eichengreen and Jeffrey Sachs, has changed our view of the effects of the abandonment of the gold standard. Although it is true that leaving the gold standard and the resulting currency depreciation conferred a temporary competitive advantage in some cases, modern research shows that the primary benefit of leaving gold was that it freed countries to use appropriately expansionary monetary policies. By 1935 or 1936, when essentially all major countries had left the gold standard and exchange rates were market-determined, the net trade effects of the changes in currency values were certainly small. Yet the global economy as a whole was much stronger than it had been in 1931. The reason was that, in shedding the strait jacket of the gold standard, each country became free to use monetary policy in a way that was more commensurate with achieving full employment at home.”

Nurkse (1944) raised concern on the contraction of trade by competitive devaluations during the 1930s. Haberler (1937) dwelled on the issue of flexible exchange rates. Bordo and James (2001) provide perceptive exegesis of the views of Haberler (1937) and Nurkse (1944) together with the evolution of thought by Haberler. Policy coordination among sovereigns may be quite difficult in practice even if there were sufficient knowledge and sound forecasts. Friedman (1953) provided strong case in favor of a system of flexible exchange rates.

Eichengreen and Sachs (1985) argue theoretically with measurements using a two-sector model that it is possible for series of devaluations to improve the welfare of all countries. There were adverse effects of depreciation on other countries but depreciation by many countries could be beneficial for all. The important counterfactual is if depreciations by many countries would have promoted faster recovery from the Great Depression. Depreciation in the model of Eichengreen and Sachs (1985) affected domestic and foreign economies through real wages, profitability, international competitiveness and world interest rates. Depreciation causes increase in the money supply that lowers world interest rates, promoting growth of world output. Lower world interest rates could compensate contraction of output from the shift of demand away from home goods originating in neighbor’s exchange depreciation. Eichengreen and Sachs (1985, 946) conclude:

“This much, however, is clear. We do not present a blanket endorsement of the competitive devaluations of the 1930s. Though it is indisputable that currency depreciation conferred macroeconomic benefits on the initiating country, because of accompanying policies the depreciations of the 1930s had beggar-thy-neighbor effects. Though it is likely that currency depreciation (had it been even more widely adopted) would have worked to the benefit of the world as a whole, the sporadic and uncoordinated approach taken to exchange-rate policy in the 1930s tended, other things being equal, to reduce the magnitude of the benefits.”

There could major difference in the current world economy. The initiating impulse for depreciation originates in zero interest rates on the fed funds rate. The dollar is the world’s reserve currency. Risk aversion intermittently channels capital flight to the safe haven of the dollar and US Treasury securities. In the absence of risk aversion, zero interest rates induce carry trades of short positions in dollars and US debt (borrowing) together with long leveraged exposures in risk financial assets such as stocks, emerging stocks, commodities and high-yield bonds. Without risk aversion, the dollar depreciates against every currency in the world. The dollar depreciated against the euro by 39.3 percent from USD 1.1423/EUR con Jun 26, 2003 to USD 1.5914/EUR on Jun 14, 2008 during unconventional monetary policy before the global recession (Table VI-1). Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can increases net exports of the US that increase aggregate economic activity (Yellen 2011AS). The country issuing the world’s reserve currency appropriates the advantage from initiating devaluation that in policy intends to generate net exports that increase domestic output.

The Swiss franc rate relative to the euro (CHF/EUR) appreciated 18.7 percent on Jan 15, 2015. The Swiss franc rate relative to the dollar (CHF/USD) appreciated 17.7 percent. Central banks are taking measures in anticipation of the quantitative easing by the European Central Bank. On Jan 22, 2015, the European Central Bank (ECB) decided to implement an “expanded asset purchase program” with combined asset purchases of €60 billion per month “until at least Sep 2016 (http://www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html). The DAX index of German equities increased 1.3 percent on Jan 22, 2015 and 2.1 percent on Jan 23, 2015. The euro depreciated from EUR 1.1611/USD (EUR 0.8613/USD) on Wed Jan 21, 2015, to EUR 1.1206/USD (EUR 0.8924/USD) on Fri Jan 23, 2015, or 3.6 percent. Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment. Risk aversion erodes devaluation of the dollar.

Pelaez and Pelaez (Regulation of Banks and Finance (2009b), 208-209) summarize the experience of Brazil as follows:

“During 1927–9, Brazil accumulated ￡30 million of foreign exchange of which ￡20 million were deposited at its stabilization fund (Pelaez 1968, 43–4). After the decline in coffee prices and the first impact of the Great Depression in Brazil a hot money movement wiped out foreign exchange reserves. In addition, capital inflows stopped entirely. The deterioration of the terms of trade further complicated matters, as the value of exports in foreign currency declined abruptly. Because of this exchange crisis, the service of the foreign debt of Brazil became impossible. In August 1931, the federal government was forced to cancel the payment of principal on certain foreign loans. The balance of trade in 1931 was expected to yield ￡20 million whereas the service of the foreign debt alone amounted to ￡22.6 million. Part of the solution given to these problems was typical of the 1930s. In September 1931, the government of Brazil required that all foreign transactions were to be conducted through the Bank of Brazil. This monopoly of foreign exchange was exercised by the Bank of Brazil for the following three years. Export permits were granted only after the exchange derived from sales abroad was officially sold to the Bank, which in turn allocated it in accordance with the needs of the economy. An active black market in foreign exchange developed. Brazil was in the first group of countries that abandoned early the gold standard, in 1931, and suffered comparatively less from the Great Depression. The Brazilian federal government, advised by the BOE, increased taxes and reduced expenditures in 1931 to compensate a decline in custom receipts (Pelaez 1968, 40). Expenditures caused by a revolution in 1932 in the state of Sao Paulo and a drought in the northeast explain the deficit. During 1932–6, the federal government engaged in strong efforts to stabilize the budget. Apart from the deliberate efforts to balance the budget during the 1930s, the recovery in economic activity itself may have induced a large part of the reduction of the deficit (Ibid, 41). Brazil’s experience is similar to that of the United States in that fiscal policy did not promote recovery from the Great Depression.”

Is depreciation of the dollar the best available tool currently for achieving the dual mandate of higher inflation and lower unemployment? Bernanke (2002) finds dollar devaluation against gold to have been important in preventing further deflation in the 1930s (http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm):

“Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.¹⁷ The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”

Should the US devalue following Roosevelt? Alternatively, has monetary policy intended devaluation? Fed policy is seeking, deliberately or as a side effect, what Irving Fisher proposed “that great depressions are curable and preventable through reflation and stabilization” (Fisher, 1933, 350). The Fed has created not only high volatility of assets but also what many countries are regarding as a competitive devaluation similar to those criticized by Nurkse (1944). Yellen (2011AS, 6) admits that Fed monetary policy results in dollar devaluation with the objective of increasing net exports, which was the policy that Joan Robinson (1947) labeled as “beggar-my-neighbor” remedies for unemployment.

Table CPIEX, Annual Percentage Changes of the CPI All Items Excluding Food and Energy

Year	Annual ∆%
1958	2.4
1959	2.0
1960	1.3
1961	1.3
1962	1.3
1963	1.3
1964	1.6
1965	1.2
1966	2.4
1967	3.6
1968	4.6
1969	5.8
1970	6.3
1971	4.7
1972	3.0
1973	3.6
1974	8.3
1975	9.1
1976	6.5
1977	6.3
1978	7.4
1979	9.8
1980	12.4
1981	10.4
1982	7.4
1983	4.0
1984	5.0
1985	4.3
1986	4.0
1987	4.1
1988	4.4
1989	4.5
1990	5.0
1991	4.9
1992	3.7
1993	3.3
1994	2.8
1995	3.0
1996	2.7
1997	2.4
1998	2.3
1999	2.1
2000	2.4
2001	2.6
2002	2.4
2003	1.4
2004	1.8
2005	2.2
2006	2.5
2007	2.3
2008	2.3
2009	1.7
2010	1.0
2011	1.7
2012	2.1
2013	1.8
2014	1.7

Source: Bureau of Labor Statistics

Table PPIEX, Annual Percentage Changes of the PPI Finished Goods Excluding Food and Energy

Year	Annual ∆%
1974	11.4
1975	11.4
1976	5.7
1977	6.0
1978	7.5
1979	8.9
1980	11.2
1981	8.6
1982	5.7
1983	3.0
1984	2.4
1985	2.5
1986	2.3
1987	2.4
1988	3.3
1989	4.4
1990	3.7
1991	3.6
1992	2.4
1993	1.2
1994	1.0
1995	2.1
1996	1.4
1997	0.3
1998	0.9
1999	1.7
2000	1.3
2001	1.4
2002	0.1
2003	0.2
2004	1.5
2005	2.4
2006	1.5
2007	1.9
2008	3.4
2009	2.6
2010	1.2
2011	2.4
2012	2.6
2013	1.5
2014	1.9

Source: Bureau of Labor Statistics

Chart I-6, US, Producer Price Index, Finished Goods, NSA, 1947-2015

Source: US Bureau of Labor Statistics

Chart I-7, US, Producer Price Index, Finished Goods, 12-Month Percentage Change, NSA, 1948-2015

Source: US Bureau of Labor Statistics

Table I-1A, US, Annual PPI Inflation ∆% 1948-2014

Year	Annual ∆%
1948	8.0
1949	-2.8
1950	1.8
1951	9.2
1952	-0.6
1953	-1.0
1954	0.3
1955	0.3
1956	2.6
1957	3.8
1958	2.2
1959	-0.3
1960	0.9
1961	0.0
1962	0.3
1963	-0.3
1964	0.3
1965	1.8
1966	3.2
1967	1.1
1968	2.8
1969	3.8
1970	3.4
1971	3.1
1972	3.2
1973	9.1
1974	15.4
1975	10.6
1976	4.5
1977	6.4
1978	7.9
1979	11.2
1980	13.4
1981	9.2
1982	4.1
1983	1.6
1984	2.1
1985	1.0
1986	-1.4
1987	2.1
1988	2.5
1989	5.2
1990	4.9
1991	2.1
1992	1.2
1993	1.2
1994	0.6
1995	1.9
1996	2.7
1997	0.4
1998	-0.8
1999	1.8
2000	3.8
2001	2.0
2002	-1.3
2003	3.2
2004	3.6
2005	4.8
2006	3.0
2007	3.9
2008	6.3
2009	-2.6
2010	4.2
2011	6.0
2012	1.9
2013	1.2
2014	1.9

Source: US Bureau of Labor Statistics

Chart I-12, US, Consumer Price Index, NSA, 1916-2015

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Chart I-13, US, Consumer Price Index, All Items, 12- Month Percentage Change 1914-2015

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Table I-2 provides annual percentage changes of United States consumer price inflation from 1914 to 2014. There have been only cases of annual declines of the CPI after wars:

World War I minus 10.5 percent in 1921 and minus 6.1 percent in 1922 following cumulative increases of 83.5 percent in four years from 1917 to 1920 at the average of 16.4 percent per year
World War II: minus 1.2 percent in 1949 following cumulative 33.9 percent in three years from 1946 to 1948 at average 10.2 percent per year
Minus 0.4 percent in 1955 two years after the end of the Korean War
Minus 0.4 percent in 2009.
The decline of 0.4 percent in 2009 followed increase of 3.8 percent in 2008 and is explained by the reversal of speculative carry trades into commodity futures that were created in 2008 as monetary policy rates were driven to zero. The reversal occurred after misleading statement on toxic assets in banks in the proposal for TARP (Cochrane and Zingales 2009).

Table I-2, US, Annual CPI Inflation ∆% 1914-2014

Year	Annual ∆%
1914	1.0
1915	1.0
1916	7.9
1917	17.4
1918	18.0
1919	14.6
1920	15.6
1921	-10.5
1922	-6.1
1923	1.8
1924	0.0
1925	2.3
1926	1.1
1927	-1.7
1928	-1.7
1929	0.0
1930	-2.3
1931	-9.0
1932	-9.9
1933	-5.1
1934	3.1
1935	2.2
1936	1.5
1937	3.6
1938	-2.1
1939	-1.4
1940	0.7
1941	5.0
1942	10.9
1943	6.1
1944	1.7
1945	2.3
1946	8.3
1947	14.4
1948	8.1
1949	-1.2
1950	1.3
1951	7.9
1952	1.9
1953	0.8
1954	0.7
1955	-0.4
1956	1.5
1957	3.3
1958	2.8
1959	0.7
1960	1.7
1961	1.0
1962	1.0
1963	1.3
1964	1.3
1965	1.6
1966	2.9
1967	3.1
1968	4.2
1969	5.5
1970	5.7
1971	4.4
1972	3.2
1973	6.2
1974	11.0
1975	9.1
1976	5.8
1977	6.5
1978	7.6
1979	11.3
1980	13.5
1981	10.3
1982	6.2
1983	3.2
1984	4.3
1985	3.6
1986	1.9
1987	3.6
1988	4.1
1989	4.8
1990	5.4
1991	4.2
1992	3.0
1993	3.0
1994	2.6
1995	2.8
1996	3.0
1997	2.3
1998	1.6
1999	2.2
2000	3.4
2001	2.8
2002	1.6
2003	2.3
2004	2.7
2005	3.4
2006	3.2
2007	2.8
2008	3.8
2009	-0.4
2010	1.6
2011	3.2
2012	2.1
2013	1.5
2014	1.6

Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm

Friedman (1969) finds that the optimal rule for the quantity of money is deflation at a rate that results in a zero nominal interest rate (see Ireland 2003 and Cole and Kocherlakota 1998). Atkeson and Kehoe (2004) argue that central bankers are not inclined to implement policies that could result in deflation because of the interpretation of the Great Depression as closely related to deflation. They use panel data on inflation and growth of real output for 17 countries over more than 100 years. The time-series data for each individual country are broken into five-year events with deflation measured as average negative inflation and depression as average negative growth rate of real output. Atkeson and Kehoe (2004) find that the Great Depression from 1929 to 1934 is the only case of association between deflation and depression without any evidence whatsoever of such relation in any other period. Their conclusion is (Atkeson and Kehoe 2004, 99): “Our finding thus suggests that policymakers’ fear of anticipated policy-induced deflation that would result from following, say, the Friedman rule is greatly overblown.” Their conclusion on the experience of Japan is (Atkeson and Kehoe 2004, 99):

“Since 1960, Japan’s average growth rates have basically fallen monotonically, and since 1970, its average inflation rates have too. Attributing this 40-year slowdown to monetary forces is a stretch. More reasonable, we think, is that much of the slowdown is the natural pattern for a country that was far behind the world leaders and had begun to catch up.”

In the sample of Atkeson and Kehoe (2004), there are only eight five-year periods besides the Great Depression with both inflation and depression. Deflation and depression is shown in 65 cases with 21 of depression without deflation. There is no depression in 65 of 73 five-year periods and there is no deflation in 29 episodes of depression. There is a remarkable result of no depression in 90 percent of deflation episodes. Excluding the Great Depression, there is virtually no relation of deflation and depression. Atkeson and Kehoe (2004, 102) find that the average growth rate of Japan of 1.41 percent in the 1990s is “dismal” when compared with 3.20 percent in the United States but is not “dismal” when compared with 1.61 percent for Italy and 1.84 percent for France, which are also catch-up countries in modern economic growth (see Atkeson and Kehoe 1998). The conclusion of Atkeson and Kehoe (2004), without use of controls, is that there is no association of deflation and depression in their dataset.

Benhabib and Spiegel (2009) use a dataset similar to that of Atkeson and Kehoe (2004) but allowing for nonlinearity and inflation volatility. They conclude that in cases of low and negative inflation an increase of average inflation of 1 percent is associated with an increase of 0.31 percent of average annual growth. The analysis of Benhabib and Spiegel (2009) leads to the significantly different conclusion that inflation and economic performance are strongly associated for low and negative inflation. There is no claim of causality by Atkeson and Kehoe (2004) and Benhabib and Spiegel (2009).

Delfim Netto (1959) partly reprinted in Pelaez (1973) conducted two classical nonparametric tests (Mann 1945, Wallis and Moore 1941; see Kendall and Stuart 1968) with coffee-price data in the period of free markets from 1857 to 1906 with the following conclusions (Pelaez, 1976a, 280):

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

In his classic work on the theory of international trade, Jacob Viner (1937, 563) analyzed the “index of total gains from trade,” or “amount of gain per unit of trade,” denoted as T:

T= (∆P^e/∆Pⁱ)∆Q

Where ∆P^e is the change in export prices, ∆Pⁱ is the change in import prices and ∆Q is the change in export volume. Dorrance (1948, 52) restates “Viner’s index of total gain from trade” as:

“What should be done is to calculate an index of the value (quantity multiplied by price) of exports and the price of imports for any country whose foreign accounts are to be analysed. Then the export value index should be divided by the import price index. The result would be an index which would reflect, for the country concerned, changes in the volume of imports obtainable from its export income (i.e. changes in its "real" export income, measured in import terms). The present writer would suggest that this index be referred to as the ‘income terms of trade’ index to differentiate it from the other indexes at present used by economists.”

What really matters for an export activity especially during modernization is the purchasing value of goods that it exports in terms of prices of imports. For a primary producing country, the purchasing power of exports in acquiring new technology from the country providing imports is the critical measurement. The barter terms of trade of Brazil improved from 1857 to 1906 because international coffee prices oscillated without trend (Delfim Netto 1959) while import prices from the United Kingdom declined at the rate of 0.5 percent per year (Imlah 1958). The accurate measurement of the opportunity afforded by the coffee exporting economy was incomparably greater when considering the purchasing power in British prices of the value of coffee exports, or Dorrance’s (1948) income terms of trade.

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

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

Imlah (1958) provides decline of British export prices at 0.5 percent in the nineteenth century and there were no lost decades, depressions or unconventional monetary policies in the highly dynamic economy of England that drove the world’s growth impulse. Inflation in the United Kingdom between 1857 and 1906 is measured by the composite price index of O’Donoghue and Goulding (2004) at minus 7.0 percent or average rate of decline of 0.2 percent per year.

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.”

Cameron (1961) analyzes the mechanism by which the Industrial Revolution in Great Britain spread throughout Europe and Cameron (1967) analyzes the financing by banks of the Industrial Revolution in Great Britain. O’Donoghue and Goulding (2004) provide consumer price inflation in England since 1750 and MacFarlane and Mortimer-Lee (1994) analyze inflation in England over 300 years. Lucas (2004) estimates world population and production since the year 1000 with sustained growth of per capita incomes beginning to accelerate for the first time in English-speaking countries and in particular in the Industrial Revolution in Great Britain. The conventional theory is unequal distribution of the gains from trade and technical progress between the industrialized countries and developing economies (Singer 1950, 478):

“Dismissing, then, changes in productivity as a governing factor in changing terms of trade, the following explanation presents itself: the fruits of technical progress may be distributed either to producers (in the form of rising incomes) or to consumers (in the form of lower prices). In the case of manufactured commodities produced in more developed countries, the former method, i.e., distribution to producers through higher incomes, was much more important relatively to the second method, while the second method prevailed more in the case of food and raw material production in the underdeveloped countries. Generalizing, we may say -that technical progress in manufacturing industries showed in a rise in incomes while technical progress in the production of food and raw materials in underdeveloped countries showed in a fall in prices”

Temin (1997, 79) uses a Ricardian trade model to discriminate between two views on the Industrial Revolution with an older view arguing broad-based increases in productivity and a new view concentration of productivity gains in cotton manufactures and iron:

“Productivity advances in British manufacturing should have lowered their prices relative to imports. They did. Albert Imlah [1958] correctly recognized this ‘severe deterioration’ in the net barter terms of trade as a signal of British success, not distress. It is no surprise that the price of cotton manufactures fell rapidly in response to productivity growth. But even the price of woolen manufactures, which were declining as a share of British exports, fell almost as rapidly as the price of exports as a whole. It follows, therefore, that the traditional ‘old-hat’ view of the Industrial Revolution is more accurate than the new, restricted image. Other British manufactures were not inefficient and stagnant, or at least, they were not all so backward. The spirit that motivated cotton manufactures extended also to activities as varied as hardware and haberdashery, arms, and apparel.”

Phyllis Deane (1968, 96) estimates growth of United Kingdom gross national product (GNP) at around 2 percent per year for several decades in the nineteenth century. The facts that the terms of trade of Great Britain deteriorated during the period of epochal innovation and high rates of economic growth while the income terms of trade of the coffee economy of nineteenth-century Brazil improved at the average yearly rate of 4.0 percent from 1857 to 1906 disprove the hypothesis of weakness of trade as an explanation of relatively lower income and wealth. As Temin (1997) concludes, Britain did pass on lower prices and higher quality the benefits of technical innovation. Explanation of late modernization must focus on laborious historical research on institutions and economic regimes together with economic theory, data gathering and measurement instead of grand generalizations of weakness of trade and alleged neocolonial dependence (Stein and Stein 1970, 134-5):

“Great Britain, technologically and industrially advanced, became as important to the Latin American economy as to the cotton-exporting southern United States. [After Independence in the nineteenth century] Latin America fell back upon traditional export activities, utilizing the cheapest available factor of production, the land, and the dependent labor force.”

The experience of the United Kingdom with deflation and economic growth is relevant and rich. Table IE-1 uses yearly percentage changes of the composite index of prices of the United Kingdom of O’Donoghue and Goulding (2004). There are 73 declines of inflation in the 145 years from 1751 to 1896. Prices declined in 50.3 percent of 145 years. Some price declines were quite sharp and many occurred over several years. Table IE-1 also provides yearly percentage changes of the UK composite price index of O’Donoghue and Goulding (2004) from 1929 to 1934. Deflation was much sharper in continuous years in earlier periods than during the Great Depression. The United Kingdom could not have led the world in modern economic growth if there were meaningful causality from deflation to depression.

Table IE-1, United Kingdom, Negative Percentage Changes of Composite Price Index, 1751-1896, 1929-1934, Yearly ∆%

Year	∆%	Year	∆%	Year	∆%	Year	∆%
1751	-2.7	1797	-10.0	1834	-7.8	1877	-0.7
1753	-2.7	1798	-2.2	1841	-2.3	1878	-2.2
1755	-6.0	1802	-23.0	1842	-7.6	1879	-4.4
1758	-0.3	1803	-5.9	1843	-11.3	1881	-1.1
1759	-7.9	1806	-4.4	1844	-0.1	1883	-0.5
1760	-4.5	1807	-1.9	1848	-12.1	1884	-2.7
1761	-4.5	1811	-2.9	1849	-6.3	1885	-3.0
1768	-1.1	1814	-12.7	1850	-6.4	1886	-1.6
1769	-8.2	1815	-10.7	1851	-3.0	1887	-0.5
1770	-0.4	1816	-8.4	1857	-5.6	1893	-0.7
1773	-0.3	1819	-2.5	1858	-8.4	1894	-2.0
1775	-5.6	1820	-9.3	1859	-1.8	1895	-1.0
1776	-2.2	1821	-12.0	1862	-2.6	1896	-0.3
1777	-0.4	1822	-13.5	1863	-3.6	1929	-0.9
1779	-8.5	1826	-5.5	1864	-0.9	1930	-2.8
1780	-3.4	1827	-6.5	1868	-1.7	1931	-4.3
1785	-4.0	1828	-2.9	1869	-5.0	1932	-2.6
1787	-0.6	1830	-6.1	1874	-3.3	1933	-2.1
1789	-1.3	1832	-7.4	1875	-1.9	1934	0.0
1791	-0.1	1833	-6.1	1876	-0.3

Source:

O’Donoghue, Jim and Louise Goulding, 2004. Consumer Price Inflation since 1750. UK Office for National Statistics Economic Trends 604, Mar 2004, 38-46.

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

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

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.

Table SE1 provides contributions to growth of GDP in the 1930s. These data were not available until much more recently. Residential investment (RSI) contributed 1.03 percentage points to growth of GDP of 8.0 percent in 1939, which is a high percentage of the contribution of gross private domestic investment of 2.39 percentage points. Residential investment contributed 0.42 percentage points to GDP growth of 8.8 percent in 1940 with gross private domestic investment contributing 3.99 percentage points.

Table SE1, US, Contributions to Growth of GDP

	GDP ∆%	PCE PP	GDI PP	NRI PP	RSI PP	Net Trade PP	GOVT PP
1930	-8.5	-3.96	-5.18	-1.84	-1.50	-0.31	0.94
1931	-6.4	-2.37	-4.28	-3.32	-0.40	-0.22	0.48
1932	-12.9	-7.00	-5.28	-2.78	-1.02	-0.20	-0.42
1933	-1.3	-1.79	1.16	-0.44	-0.24	-0.11	-0.52
1934	10.8	5.71	2.83	1.31	0.38	0.33	1.91
1935	8.9	4.69	4.54	1.41	0.56	-0.83	0.50
1936	12.9	7.68	2.58	2.10	0.47	0.24	2.44
1937	5.1	2.72	2.57	1.42	0.17	0.45	-0.64
1938	-3.3	-1.15	-4.13	-2.13	0.01	0.88	1.09
1939	8.0	4.11	2.39	0.71	1.03	0.07	1.41
1940	8.8	3.72	3.99	1.60	0.42	0.52	0.57

GDP ∆%: Annual Growth of GDP; PCE PP: Percentage Points Contributed by Personal Consumption Expenditures (PCE); GDI PP: Percentage Points Contributed by Gross Private Domestic Investment (GDI); NRI PP: Percentage Points Contributed by Nonresidential Investment (NRI); RSI: Percentage Points Contributed by Residential Investment; Net Trade PP: Percentage Points Contributed by Net Exports less Imports of Goods and Services; GOVT PP: Percentage Points Contributed by Government Consumption and Gross Investment

Source: Bureau of Economic Analysis

Table ES2 provides percentage shares of GDP in 1929, 1939, 1940, 2006 and 2013. The share of residential investment was 3.9 percent in 1929, 3.4 percent in 1939 and 6.0 percent in 2006 at the peak of the real estate boom. The share of residential investment in GDP has not been very high historically.

Table ES2, Percentage Shares in GDP

	1929	1939	1940	2006	2013
GDP	100.00	100.00	100.00	100.00	100.00
PCE	74.0	71.9	69.2	67.1	68.5
GDI	16.4	10.9	14.2	19.3	15.9
NRI	11.1	7.3	8.3	12.8	12.2
RSI	3.9	3.4	3.5	6.0	3.1
Net Trade	0.4	0.9	1.4	-5.5	-3.0
GOVT	9.2	16.3	15.2	19.1	18.6

PCE: Personal Consumption Expenditures; GDI: Gross Domestic Investment; NRI: Nonresidential Investment; RSI: Residential Investment; Net Trade: Net Exports less Imports of Goods and Services; GOVT: Government Consumption and Gross Investment

Source: Bureau of Economic Analysis

PCE: Personal Consumption Expenditures; GDI: Gross Private Domestic Investment; NRI: Nonresidential Investment; RSI: Residential Investment; Net Trade: Net Exports less Imports of Goods and Services; GOVT: Government Consumption and Gross Investment

Source: Bureau of Economic Analysis

An interpretation of the New Deal is that fiscal stimulus must be massive in recovering growth and employment and that it should not be withdrawn prematurely to avoid a sharp second contraction as it occurred in 1937 (Christina Romer 2009). Proposals for another higher dose of stimulus explain the current weakness by insufficient fiscal expansion and warn that failure to spend more can cause another contraction as in 1937. According to a different interpretation, private hours worked declined by 25 percent by 1939 compared with the level in 1929, suggesting that the economy fell to a lower path of expansion than in 1929 (works by Harold Cole and Lee Ohanian (1999) (cited in Pelaez and Pelaez, Regulation of Banks and Finance, 215-7). Major real variables of output and employment were below trend by 1939: -26.8 percent for GNP, -25.4 percent for consumption, -51 percent for investment and -25.6 percent for hours worked. Surprisingly, total factor productivity increased by 3.1 percent and real wages by 21.8 percent (Cole and Ohanian 1999). The policies of the Roosevelt administration encouraged increasing unionization to maintain high wages with lower hours worked and high prices by lax enforcement of antitrust law to encourage cartels or collusive agreements among producers. The encouragement by the government of labor bargaining by unions and higher prices by collusion depressed output and employment throughout the 1930s until Roosevelt abandoned the policies during World War II after which the economy recovered full employment (Cole and Ohanian 1999). The fortunate ones who worked during the New Deal received higher real wages at the expense of many who never worked again. In a way, the administration behaved like the father of the unionized workers and the uncle of the collusive rich, neglecting the majority in the middle. Inflation-adjusted GDP increased by 10.8 percent in 1934, 8.9 percent in 1935, 12.9 percent in 1936 but only 5.1 percent in 1937, contracting by -3.3 percent in 1938 (US Bureau of Economic Analysis cited in Pelaez and Pelaez, Financial Regulation after the Global Recession, 151, Globalization and the State, Vol. II, 206). The competing explanation is that the economy did not decline from 1937 to 1938 because of lower government spending in 1937 but rather because of the expansion of unions promoted by the New Deal and increases in tax rates (Thomas Cooley and Lee Ohanian 2010). Government spending adjusted for inflation fell only 0.7 percent in 1936 and 1937 and could not explain the decline of GDP by 3.4 percent in 1938. In 1936, the administration imposed a tax on retained profits not distributed to shareholders according to a sliding scale of 7 percent for retaining 1 percent of total net income up to 27 percent for retaining 70 percent of total net income, increasing costs of investment that were mostly financed in that period with retained earnings (Cooley and Ohanian 2010). The tax rate on dividends jumped from 10.1 percent in 1929 to 15.9 percent in 1932 and doubled by 1936. A recent study finds that “tax rates on dividends rose dramatically during the 1930s and imply significant declines in investment and equity values and nontrivial declines in GDP and hours of work” (Ellen McGrattan 2010), explaining a significant part of the decline of 26 percent in business fixed investment in 1937-1938. The National Labor Relations Act of 1935 caused an increase in union membership from 12 percent in 1934 to 25 percent in 1938. The alternative lesson from the 1930s is that capital income taxes and higher unionization caused increases in business costs that perpetuated job losses of the recession with current risks of repeating the 1930s (Cooley and Ohanian 1999).

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.

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

Y = ∑_is_iy_i (1)

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

∆Y = ∑_i∆s_iy*_i+ ∑_i∆y_is*_i (2)

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

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

Table I-4b and Chart I-12-b provide the US labor force participation rate or percentage of the labor force in population. It is not likely that simple demographic trends caused the sharp decline during the global recession and failure to recover earlier levels. The civilian labor force participation rate dropped from the peak of 66.9 percent in Jul 2006 to 62.6 percent in Dec 2013, 62.5 percent in Dec 2014 and 63.0 percent in May 2015. The civilian labor force participation rate was 63.7 percent on an annual basis in 1979 and 63.4 percent in Dec 1980 and Dec 1981, reaching even 62.9 percent in both Apr and May 1979. The civilian labor force participation rate jumped with the recovery to 64.8 percent on an annual basis in 1985 and 65.9 percent in Jul 1985. Structural factors cannot explain these sudden changes vividly shown visually in the final segment of Chart I-12b. Seniors would like to delay their retiring especially because of the adversities of financial repression on their savings. Labor force statistics are capturing the disillusion of potential workers with their chances in finding a job in what Lazear and Spletzer (2012JHJul22) characterize as accentuated cyclical factors. The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). There is currently population growth in the ages of 16 to 24 years but not enough job creation and discouragement of job searches for all ages (http://cmpassocregulationblog.blogspot.com/2015/05/fluctuating-valuations-of-financial.html). “Secular stagnation” would be a process over many years and not from one year to another. This is merely another case of theory without reality with dubious policy proposals.

Table I-4b, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1979-2015

Year	Jan	Feb	Mar	Apr	May	Aug	Sep	Oct	Nov	Dec	Annual
1979	62.9	63.0	63.2	62.9	62.9	64.5	63.8	64.0	63.8	63.8	63.7
1980	63.3	63.2	63.2	63.2	63.5	64.5	63.6	63.9	63.7	63.4	63.8
1981	63.2	63.2	63.5	63.6	63.9	64.6	63.5	64.0	63.8	63.4	63.9
1982	63.0	63.2	63.4	63.3	63.9	64.9	64.0	64.1	64.1	63.8	64.0
1983	63.3	63.2	63.3	63.2	63.4	65.1	64.3	64.1	64.1	63.8	64.0
1984	63.3	63.4	63.6	63.7	64.3	65.2	64.4	64.6	64.4	64.3	64.4
1985	64.0	64.0	64.4	64.3	64.6	65.4	64.9	65.1	64.9	64.6	64.8
1986	64.2	64.4	64.6	64.6	65.0	66.1	65.3	65.5	65.4	65.0	65.3
1987	64.7	64.8	65.0	64.9	65.6	66.5	65.5	65.9	65.7	65.5	65.6
1988	65.1	65.2	65.2	65.3	65.5	66.8	65.9	66.1	66.2	65.9	65.9
1989	65.8	65.6	65.7	65.9	66.2	67.2	66.3	66.6	66.7	66.3	66.5
1990	66.0	66.0	66.2	66.1	66.5	67.1	66.4	66.5	66.3	66.1	66.5
1991	65.5	65.7	65.9	66.0	66.0	66.6	66.1	66.1	66.0	65.8	66.2
1992	65.7	65.8	66.0	66.0	66.4	67.2	66.3	66.2	66.2	66.1	66.4
1993	65.6	65.8	65.8	65.6	66.3	67.0	66.1	66.4	66.3	66.2	66.3
1994	66.0	66.2	66.1	66.0	66.5	67.2	66.5	66.8	66.7	66.5	66.6
1995	66.1	66.2	66.4	66.4	66.4	67.1	66.5	66.7	66.5	66.2	66.6
1996	65.8	66.1	66.4	66.2	66.7	67.2	66.8	67.1	67.0	66.7	66.8
1997	66.4	66.5	66.9	66.7	67.0	67.6	67.0	67.1	67.1	67.0	67.1
1998	66.6	66.7	67.0	66.6	67.0	67.3	67.0	67.1	67.1	67.0	67.1
1999	66.7	66.8	66.9	66.7	67.0	67.3	66.8	67.0	67.0	67.0	67.1
2000	66.8	67.0	67.1	67.0	67.0	67.2	66.7	66.9	66.9	67.0	67.1
2001	66.8	66.8	67.0	66.7	66.6	66.8	66.6	66.7	66.6	66.6	66.8
2002	66.2	66.6	66.6	66.4	66.5	66.8	66.6	66.6	66.3	66.2	66.6
2003	66.1	66.2	66.2	66.2	66.2	66.3	65.9	66.1	66.1	65.8	66.2
2004	65.7	65.7	65.8	65.7	65.8	66.2	65.7	66.0	66.1	65.8	66.0
2005	65.4	65.6	65.6	65.8	66.0	66.5	66.1	66.2	66.1	65.9	66.0
2006	65.5	65.7	65.8	65.8	66.0	66.5	66.1	66.4	66.4	66.3	66.2
2007	65.9	65.8	65.9	65.7	65.8	66.1	66.0	66.0	66.1	65.9	66.0
2008	65.7	65.5	65.7	65.7	66.0	66.4	65.9	66.1	65.8	65.7	66.0
2009	65.4	65.5	65.4	65.4	65.5	65.6	65.0	64.9	64.9	64.4	65.4
2010	64.6	64.6	64.8	64.9	64.8	65.0	64.6	64.4	64.4	64.1	64.7
2011	63.9	63.9	64.0	63.9	64.1	64.3	64.2	64.1	63.9	63.8	64.1
2012	63.4	63.6	63.6	63.4	63.8	63.7	63.6	63.8	63.5	63.4	63.7
2013	63.3	63.2	63.1	63.1	63.5	63.4	63.2	62.9	62.9	62.6	63.2
2014	62.5	62.7	62.9	62.6	62.9	63.0	62.8	63.0	62.8	62.5	62.9
2015	62.5	62.5	62.5	62.6	63.0

Source: US Bureau of Labor Statistics

http://www.bls.gov/cps/

Chart I-12b, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1979-2015

Source: Bureau of Labor Statistics

http://www.bls.gov/cps/

Broader perspective is provided by Chart I-12c of the US Bureau of Labor Statistics. The United States civilian noninstitutional population has increased along a consistent trend since 1948 that continued through earlier recessions and the global recession from IVQ2007 to IIQ2009 and the cyclical expansion after IIIQ2009.

Chart I-12c, US, Civilian Noninstitutional Population, Thousands, NSA, 1948-2015

Sources: US Bureau of Labor Statistics

The labor force of the United States in Chart I-12d has increased along a trend similar to that of the civilian noninstitutional population in Chart I-12c. There is an evident stagnation of the civilian labor force in the final segment of Chart I-12d during the current economic cycle. This stagnation is explained by cyclical factors similar to those analyzed by Lazear and Spletzer (2012JHJul22) that motivated an increasing population to drop out of the labor force instead of structural factors. Large segments of the potential labor force are not observed, constituting unobserved unemployment and of more permanent nature because those afflicted have been seriously discouraged from working by the lack of opportunities.

Chart I-12d, US, Labor Force, Thousands, NSA, 1948-2015

Sources: US Bureau of Labor Statistics

The rate of labor force participation of the US is in Chart I-12E from 1948 to 2015. There is sudden decline during the global recession after 2007 without recovery explained by cyclic factors (Lazear and Spletzer 2012JHJul22) as many potential workers stopped their job searches disillusioned that there could be an opportunity for them in sharply contracted labor markets.

Chart I-12E, US, Labor Force Participation Rate, Percent of Labor Force in Population, NSA, 1948-2015

Sources: US Bureau of Labor Statistics

The number with full-time jobs fell from a high of 123.219 million in Jul 2007 to 108.777 million in Jan 2010 or by 14.442 million. The magnitude of the stress in US labor markets is magnified by the increase in the civilian noninstitutional population of the United States from 231.958 million in Jul 2007 to 250.455 million in May 2015 or by 18.497 million (http://www.bls.gov/data/) while in the same period the number of full-time jobs fell 1.356 million. The ratio of full-time jobs of 123.219 million Jul 2007 to civilian noninstitutional population of 231.958 million was 53.1 percent. If that ratio had remained the same, there would be 132.992 million full-time jobs with population of 250.266 million in May 2015 (0.531 x 250.455) or 11.129 million fewer full-time jobs relative to actual 121.863 million. There appear to be around 10 million fewer full-time jobs in the US than before the global recession while population increased around 18 million. Mediocre GDP growth is the main culprit of the fractured US labor market.

Chart I-20 provides unadjusted full-time jobs in the US from 2001 to 2015 with sharp drop and incomplete recovery. There is current interest in past theories of “secular stagnation.” Alvin H. Hansen (1939, 4, 7; see Hansen 1938, 1941; for an early critique see Simons 1942) argues:

Inferior performance of the US economy and labor markets, during cyclical slow growth not secular stagnation, is the critical current issue of analysis and policy design.

Chart I-20, US, Full-time Employed, Thousands, NSA, 2001-2015

Sources: US Bureau of Labor Statistics

Chart I-20A provides the noninstitutional civilian population of the United States from 2001 to 2015. There is clear trend of increase of the population while the number of full-time jobs collapsed after 2008 without sufficient recovery as shown in the preceding Chart I-20.

Chart I-20A, US, Noninstitutional Civilian Population, Thousands, 2001-2015

Sources: US Bureau of Labor Statistics

Chart I-20B provides number of full-time jobs in the US from 1968 to 2015. There were multiple recessions followed by expansions without contraction of full-time jobs and without recovery as during the period after 2008. The problem is specific of the current cycle and not secular.

Chart I-20B, US, Full-time Employed, Thousands, NSA, 1968-2015

Sources: US Bureau of Labor Statistics

Chart I-20C provides the noninstitutional civilian population of the United States from 1968 to 2015. Population expanded at a relatively constant rate of increase with the assurance of creation of full-time jobs that has been broken since 2008.

Chart I-20C, US, Noninstitutional Civilian Population, Thousands, 1968-2015

Sources: US Bureau of Labor Statistics