IMF View of World Economy and Finance, Recovery without Hiring, Ten Million Fewer Full-time Jobs, Youth and Middle-Age Unemployment, United States Producer Price Index, Collapse of United States Dynamism of Income Growth and Employment Creation, World Cyclical Slow Growth and Global Recession Risk
Carlos M. Pelaez
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016
I IMF View of World Economy and Finance
IA Recovery without Hiring
IA1 Hiring Collapse
IA2 Labor Underutilization
ICA3 Ten Million Fewer Full-time Jobs
IA4 Theory and Reality of Cyclical Slow Growth Not Secular Stagnation: Youth and
Middle-Age Unemployment
II United States Producer Price Index
II IB Collapse of United States Dynamism of Income Growth and Employment Creation
III World Financial Turbulence
IIIA Financial Risks
IIIE Appendix Euro Zone Survival Risk
IIIF Appendix on Sovereign Bond Valuation
IV Global Inflation
V World Economic Slowdown
VA United States
VB Japan
VC China
VD Euro Area
VE Germany
VF France
VG Italy
VH United Kingdom
VI Valuation of Risk Financial Assets
VII Economic Indicators
VIII Interest Rates
IX Conclusion
References
Appendixes
Appendix I The Great Inflation
IIIB Appendix on Safe Haven Currencies
IIIC Appendix on Fiscal Compact
IIID Appendix on European Central Bank Large Scale Lender of Last Resort
IIIG Appendix on Deficit Financing of Growth and the Debt Crisis
IIIGA Monetary Policy with Deficit Financing of Economic Growth
IIIGB Adjustment during the Debt Crisis of the 1980s
Executive Summary
Contents of Executive Summary
ESI Financial “Irrational Exuberance,” Increasing Interest Rate and Exchange Rate Risk, Duration Dumping, Competitive Devaluations, Steepening Yield Curve and Global Financial and Economic Risk
ESII Valuations of Risk Financial Assets
ESIII IMF View of World Economy and Finance
ESIV Recovery without Hiring
ESV Ten Million Fewer Full-time Jobs
ESVI Theory and Reality of Secular Stagnation: Youth and Middle-Age Unemployment
ESI “Financial “Irrational Exuberance,” Increasing Interest Rate and Exchange Rate Risk, Duration Dumping, Competitive Devaluations, Steepening Yield Curve and Global Financial and Economic Risk. The International Monetary Fund (IMF) provides an international safety net for prevention and resolution of international financial crises. The IMF’s Financial Sector Assessment Program (FSAP) provides analysis of the economic and financial sectors of countries (see Pelaez and Pelaez, International Financial Architecture (2005), 101-62, Globalization and the State, Vol. II (2008), 114-23). Relating economic and financial sectors is a challenging task for both theory and measurement. The IMF provides surveillance of the world economy with its Global Economic Outlook (WEO) (http://www.imf.org/external/ns/cs.aspx?id=29), of the world financial system with its Global Financial Stability Report (GFSR) (http://www.imf.org/external/pubs/ft/gfsr/index.htm) and of fiscal affairs with the Fiscal Monitor (http://www.imf.org/external/ns/cs.aspx?id=262). There appears to be a moment of transition in global economic and financial variables that may prove of difficult analysis and measurement. It is useful to consider a summary of global economic and financial risks, which are analyzed in detail in the comments of this blog in Section VI Valuation of Risk Financial Assets, Table VI-4.
Economic risks include the following:
- China’s Economic Growth. The National People’s Congress of China in Mar 2016 is reducing the GDP growth target to the range of 6.5 percent to 7.0 percent in guiding stable market expectations (http://news.xinhuanet.com/english/photo/2016-03/05/c_135157171.htm). President Xi Jinping announced on Nov 3, 2015 that “For China to double 2010 GDP and the per capita income of both urban and rural residents by 2010, annual growth for the 2016-2020 period must be at least 6.5 percent,” as quoted by Xinhuanet (http://news.xinhuanet.com/english/2015-11/03/c_134780377.htm). China lowered the growth target to approximately 7.0 percent in 2015, as analyzed by Xiang Bo, writing on “China lowers 2015 economic growth target to around 7 percent,” published on Xinhuanet on Mar 5, 2015 (http://news.xinhuanet.com/english/2015-03/05/c_134039341.htm). China had lowered its growth target to 7.5 percent per year. Lu Hui, writing on “China lowers GDP target to achieve quality economic growth, on Mar 12, 2012, published in Beijing by Xinhuanet (http://news.xinhuanet.com/english/china/2012-03/12/c_131461668.htm), informs that Premier Jiabao wrote in a government work report that the GDP growth target will be lowered to 7.5 percent to enhance the quality and level of development of China over the long term. The Third Plenary Session of the 18th Central Committee of the Communist Party of China adopted unanimously on Nov 15, 2013, a new round of reforms with 300 measures (Xinhuanet, “China details reform decision-making process,” Nov 19, 2013 http://news.xinhuanet.com/english/china/2013-11/19/c_125722517.htm). Growth rates of GDP of China in a quarter relative to the same quarter a year earlier have been declining from 2011 to 2016. China’s GDP grew 1.8 percent in IQ2012, annualizing to 7.4 percent, and 8.1 percent relative to a year earlier. The GDP of China grew at 2.2 percent in IIQ2012, which annualizes to 9.1 percent, and 7.6 percent relative to a year earlier. China grew at 1.8 percent in IIIQ2012, which annualizes at 7.4 percent, and 7.5 percent relative to a year earlier. In IVQ2012, China grew at 1.9 percent, which annualizes at 7.8 percent, and 8.1 percent in IVQ2012 relative to IVQ2011. In IQ2013, China grew at 1.9 percent, which annualizes at 7.8 percent, and 7.9 percent relative to a year earlier. In IIQ2013, China grew at 1.7 percent, which annualizes at 7.0 percent, and 7.6 percent relative to a year earlier. China grew at 2.1 percent in IIIQ2013, which annualizes at 8.7 percent, and increased 7.9 percent relative to a year earlier. China grew at 1.6 percent in IVQ2013, which annualized to 7.0 percent, and 7.7 percent relative to a year earlier. China’s GDP grew 1.7 percent in IQ2014, which annualizes to 7.0 percent, and 7.4 percent relative to a year earlier. China’s GDP grew 1.8 percent in IIQ2014, which annualizes at 7.4 percent, and 7.5 percent relative to a year earlier. China’s GDP grew 1.9 percent in IIIQ2014, which is equivalent to 7.8 percent in a year, and 7.1 percent relative to a year earlier. The GDP of China grew 1.7 percent in IVQ2014, which annualizes at 7.0 percent, and 7.2 percent relative to a year earlier. The GDP of China grew at 1.6 percent in IQ2015, which annualizes at 6.6 percent, and 7.0 percent relative to a year earlier. The GDP of China grew 1.8 percent in IIQ2015, which annualizes at 7.4 percent, and increased 7.0 percent relative to a year earlier. In IIIQ2015, China’s GDP grew at 1.8 percent, which annualizes at 7.4 percent, and increased 6.9 percent relative to a year earlier. The GDP of China grew at 1.5 percent in IVQ2015, which annualizes at 6.1 percent, and increased 6.8 percent relative to a year earlier. The GDP of China grew 1.2 percent in IQ2016, which annualizes at 4.9 percent, and increased 6.7 percent relative to a year earlier. In IIQ2016, the GDP of China increased 1.8 percent, which annualizes to 7.4 percent, and increased 6.7 percent relative to a year earlier. There is decennial change in leadership in China (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). (http://cmpassocregulationblog.blogspot.com/2016/07/unresolved-us-balance-of-payments.html and earlier http://cmpassocregulationblog.blogspot.com/2016/04/imf-view-of-world-economy-and-finance.html and earlier http://cmpassocregulationblog.blogspot.com/2016/01/uncertainty-of-valuations-of-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2015/07/valuation-of-risk-financial-assets.html and earlier (http://cmpassocregulationblog.blogspot.com/2016/04/imf-view-of-world-economy-and-finance.html and earlier (http://cmpassocregulationblog.blogspot.com/2015/04/imf-view-of-economy-and-finance-united.html and earlier http://cmpassocregulationblog.blogspot.com/2015/01/competitive-currency-conflicts-world.html and earlier http://cmpassocregulationblog.blogspot.com/2014/10/financial-oscillations-world-inflation.html and earlier http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html and earlier http://cmpassocregulationblog.blogspot.com/2014/04/imf-view-world-inflation-waves-squeeze.html and earlier http://cmpassocregulationblog.blogspot.com/2014/01/capital-flows-exchange-rates-and.html). There is also ongoing political development in China during a decennial political reorganization with new leadership (http://www.xinhuanet.com/english/special/18cpcnc/index.htm). Xinhuanet informs that Premier Wen Jiabao considers the need for macroeconomic stimulus, arguing that “we should continue to implement proactive fiscal policy and a prudent monetary policy, while giving more priority to maintaining growth” (http://news.xinhuanet.com/english/china/2012-05/20/c_131599662.htm). Premier Wen elaborates that “the country should properly handle the relationship between maintaining growth, adjusting economic structures and managing inflationary expectations” (http://news.xinhuanet.com/english/china/2012-05/20/c_131599662.htm). Bob Davis, writing on “At China’s NPC, Proposed Changes,” on Mar 5, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304732804579420743344553328?KEYWORDS=%22china%22&mg=reno64-wsj), analyzes the wide ranging policy changes in the annual work report by Prime Minister Li Keqiang to China’s NPC (National People’s Congress of the People’s Republic of China http://www.npc.gov.cn/englishnpc/news/). There are about sixty different fiscal and regulatory measures.
- United States Economic Growth, Labor Markets and Budget/Debt Quagmire. The US is growing slowly with 23.6 million in job stress, fewer 10 million full-time jobs, high youth unemployment, historically low hiring and declining/stagnating real wages. Actual GDP is about two trillion dollars lower than trend GDP.
- Economic Growth and Labor Markets in Advanced Economies. Advanced economies are growing slowly. There is still high unemployment in advanced economies.
- World Inflation Waves. Inflation continues in repetitive waves globally (http://cmpassocregulationblog.blogspot.com/2016/09/interest-rates-and-volatility-of-risk.html and earlier http://cmpassocregulationblog.blogspot.com/2016/08/interest-rate-policy-uncertainty-and.html). There is growing concern on capital outflows and currency depreciation of emerging markets.
A list of financial uncertainties includes:
- Euro Area Survival Risk. The resilience of the euro to fiscal and financial doubts on larger member countries is still an unknown risk. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times).
- Competitive Devaluations. Exchange rate struggles continue as zero interest rates and negative interest rates in advanced economies induce devaluation of their currencies with alternating episodes of revaluation.
- Valuation and Volatility of Risk Financial Assets. Valuations of risk financial assets have reached extremely high levels in markets with oscillating volumes. 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.”
- Duration Trap of the Zero Bound. The yield of the US 10-year Treasury rose from 2.031 percent on Mar 9, 2012, to 2.294 percent on Mar 16, 2012. Considering a 10-year Treasury with coupon of 2.625 percent and maturity in exactly 10 years, the price would fall from 105.3512 corresponding to yield of 2.031 percent to 102.9428 corresponding to yield of 2.294 percent, for loss in a week of 2.3 percent but far more in a position with leverage of 10:1. Min Zeng, writing on “Treasurys fall, ending brutal quarter,” published on Mar 30, 2012, in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052702303816504577313400029412564.html?mod=WSJ_hps_sections_markets), informs that Treasury bonds maturing in more than 20 years lost 5.52 percent in the first quarter of 2012.
- Credibility and Commitment of Central Bank Policy. There is a credibility issue of the commitment of monetary policy (Sargent and Silber 2012Mar20)
- Carry Trades. Commodity prices driven by zero interest rates have resumed their increasing path with fluctuations caused by intermittent risk aversion mixed with reallocations of portfolios of risk financial assets
There are collateral effects of unconventional monetary policy. Chart VIII-1 of the Board of Governors of the Federal Reserve System provides the rate on the overnight fed funds rate and the yields of the 10-year constant maturity Treasury and the Baa seasoned corporate bond. Table VIII-3 provides the data for selected points in Chart VIII-1. There are two important economic and financial events, illustrating the ease of inducing carry trade with extremely low interest rates and the resulting financial crash and recession of abandoning extremely low interest rates.
- The Federal Open Market Committee (FOMC) lowered the target of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85). Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment. The exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV). The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever-increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity by the penalty in the form of low interest rates and unsound credit decisions. The put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). The FOMC implemented increments of 25 basis points of the fed funds target from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006, as shown in Chart VIII-1. The gradual exit from the first round of unconventional monetary policy from 1.00 percent in Jun 2004 (http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040630/default.htm) to 5.25 percent in Jun 2006 (http://www.federalreserve.gov/newsevents/press/monetary/20060629a.htm) caused the financial crisis and global recession.
- On Dec 16, 2008, the policy determining committee of the Fed decided (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm): “The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.” Policymakers emphasize frequently that there are tools to exit unconventional monetary policy at the right time. 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 that: “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.” Perception of withdrawal of $2671 billion, or $2.7 trillion, of bank reserves (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1), would cause Himalayan increase in interest rates that would provoke another recession. There is no painless gradual or sudden exit from zero interest rates because reversal of exposures created on the commitment of zero interest rates forever.
In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):
“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differ from each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”
Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and re the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+re). Thus, g = [(r/re) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dre>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Friedman 1957). 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 (1)
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.
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% 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. Professor Martin Feldstein (2016), at Harvard University, writing on “A Federal Reserve oblivious to its effects on financial markets,” on Jan 13, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/a-federal-reserve-oblivious-to-its-effect-on-financial-markets-1452729166), analyzes how unconventional monetary policy drove values of risk financial assets to high levels. Quantitative easing and zero interest rates distorted calculation of risks with resulting vulnerabilities in financial markets.
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 44.9 percent relative to the dollar from the high on Jul 15, 2008 to Oct 14, 2016.
| 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% 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):
“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.”
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% -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% -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% -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% 1.2% | 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.”
The Chair of the Board of Governors of the Federal Reserve System, Janet L. Yellen, stated on Jul 10, 2015 that (http://www.federalreserve.gov/newsevents/speech/yellen20150710a.htm):
“Based on my outlook, I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy. But I want to emphasize that the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step. I currently anticipate that the appropriate pace of normalization will be gradual, and that monetary policy will need to be highly supportive of economic activity for quite some time. The projections of most of my FOMC colleagues indicate that they have similar expectations for the likely path of the federal funds rate. But, again, both the course of the economy and inflation are uncertain. If progress toward our employment and inflation goals is more rapid than expected, it may be appropriate to remove monetary policy accommodation more quickly. However, if progress toward our goals is slower than anticipated, then the Committee may move more slowly in normalizing policy.”
There is essentially the same view in the Testimony of Chair Yellen in delivering the Semiannual Monetary Policy Report to the Congress on Jul 15, 2015 (http://www.federalreserve.gov/newsevents/testimony/yellen20150715a.htm).
At the press conference after the meeting of the FOMC on Sep 17, 2015, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20150917.pdf 4):
“The outlook abroad appears to have become more uncertain of late, and heightened concerns about growth in China and other emerging market economies have led to notable volatility in financial markets. Developments since our July meeting, including the drop in equity prices, the further appreciation of the dollar, and a widening in risk spreads, have tightened overall financial conditions to some extent. These developments may restrain U.S. economic activity somewhat and are likely to put further downward pressure on inflation in the near term. Given the significant economic and financial interconnections between the United States and the rest of the world, the situation abroad bears close watching.”
Some equity markets fell on Fri Sep 18, 2015:
| Fri Sep 11 | Mon 14 | Tue 15 | Wed 16 | Thu 17 | Fri 18 |
| DJIA 16433.09 2.1% 0.6% | 16370.96 -0.4% -0.4% | 16599.85 1.0% 1.4% | 16739.95 1.9% 0.8% | 16674.74 1.5% -0.4% | 16384.58 -0.3% -1.7% |
| Nikkei 225 18264.22 2.7% -0.2% | 17965.70 -1.6% -1.6% | 18026.48 -1.3% 0.3% | 18171.60 -0.5% 0.8% | 18432.27 0.9% 1.4% | 18070.21 -1.1% -2.0% |
| DAX 10123.56 0.9% -0.9% | 10131.74 0.1% 0.1% | 10188.13 0.6% 0.6% | 10227.21 1.0% 0.4% | 10229.58 1.0% 0.0% | 9916.16 -2.0% -3.1% |
Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. Chair Yellen, in a lecture on “Inflation dynamics and monetary policy,” on Sep 24, 2015 (http://www.federalreserve.gov/newsevents/speech/yellen20150924a.htm), states that (emphasis added):
· “The economic outlook, of course, is highly uncertain”
· “Considerable uncertainties also surround the outlook for economic activity”
· “Given the highly uncertain nature of the outlook…”
Is there a “science” or even “art” of central banking under this extreme uncertainty in which policy does not generate higher volatility of money, income, prices and values of financial assets?
Lingling Wei, writing on Oct 23, 2015, on China’s central bank moves to spur economic growth,” published in the Wall Street Journal (http://www.wsj.com/articles/chinas-central-bank-cuts-rates-1445601495), analyzes the reduction by the People’s Bank of China (http://www.pbc.gov.cn/ http://www.pbc.gov.cn/english/130437/index.html) of borrowing and lending rates of banks by 50 basis points and reserve requirements of banks by 50 basis points. Paul Vigna, writing on Oct 23, 2015, on “Stocks rally out of correction territory on latest central bank boost,” published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2015/10/23/stocks-rally-out-of-correction-territory-on-latest-central-bank-boost/), analyzes the rally in financial markets following the statement on Oct 22, 2015, by the President of the European Central Bank (ECB) Mario Draghi of consideration of new quantitative measures in Dec 2015 (https://www.youtube.com/watch?v=0814riKW25k&rel=0) and the reduction of bank lending/deposit rates and reserve requirements of banks by the People’s Bank of China on Oct 23, 2015. The dollar revalued 2.8 percent from Oct 21 to Oct 23, 2015, following the intended easing of the European Central Bank. The DJIA rose 2.8 percent from Oct 21 to Oct 23 and the DAX index of German equities rose 5.4 percent from Oct 21 to Oct 23, 2015.
| Fri Oct 16 | Mon 19 | Tue 20 | Wed 21 | Thu 22 | Fri 23 |
| USD/ EUR 1.1350 0.1% 0.3% | 1.1327 0.2% 0.2% | 1.1348 0.0% -0.2% | 1.1340 0.1% 0.1% | 1.1110 2.1% 2.0% | 1.1018 2.9% 0.8% |
| DJIA 17215.97 0.8% 0.4% | 17230.54 0.1% 0.1% | 17217.11 0.0% -0.1% | 17168.61 -0.3% -0.3% | 17489.16 1.6% 1.9% | 17646.70 2.5% 0.9% |
| Dow Global 2421.58 0.3% 0.6% | 2414.33 -0.3% -0.3% | 2411.03 -0.4% -0.1% | 2411.27 -0.4% 0.0% | 2434.79 0.5% 1.0% | 2458.13 1.5% 1.0% |
| DJ Asia Pacific 1402.31 1.1% 0.3% | 1398.80 -0.3% -0.3% | 1395.06 -0.5% -0.3% | 1402.68 0.0% 0.5% | 1396.03 -0.4% -0.5% | 1415.50 0.9% 1.4% |
| Nikkei 225 18291.80 -0.8% 1.1% | 18131.23 -0.9% -0.9% | 18207.15 -0.5% 0.4% | 18554.28 1.4% 1.9% | 18435.87 0.8% -0.6% | 18825.30 2.9% 2.1% |
| Shanghai 3391.35 6.5% 1.6% | 3386.70 -0.1% -0.1% | 3425.33 1.0% 1.1% | 3320.68 -2.1% -3.1% | 3368.74 -0.7% 1.4% | 3412.43 0.6% 1.3% |
| DAX 10104.43 0.1% 0.4% | 10164.31 0.6% 0.6% | 10147.68 0.4% -0.2% | 10238.10 1.3% 0.9% | 10491.97 3.8% 2.5% | 10794.54 6.8% 2.9% |
Ben Leubsdorf, writing on “Fed’s Yellen: December is “Live Possibility” for First Rate Increase,” on Nov 4, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/feds-yellen-december-is-live-possibility-for-first-rate-increase-1446654282) quotes Chair Yellen that a rate increase in “December would be a live possibility.” The remark of Chair Yellen was during a hearing on supervision and regulation before the Committee on Financial Services, US House of Representatives (http://www.federalreserve.gov/newsevents/testimony/yellen20151104a.htm) and a day before the release of the employment situation report for Oct 2015 (Section I). The dollar revalued 2.4 percent during the week. The euro has devalued 44.9 percent relative to the dollar from the high on Jul 15, 2008 to Oct 14, 2016.
| Fri Oct 30 | Mon 2 | Tue 3 | Wed 4 | Thu 5 | Fri 6 |
| USD/ EUR 1.1007 0.1% -0.3% | 1.1016 -0.1% -0.1% | 1.0965 0.4% 0.5% | 1.0867 1.3% 0.9% | 1.0884 1.1% -0.2% | 1.0742 2.4% 1.3% |
The release on Nov 18, 2015 of the minutes of the FOMC (Federal Open Market Committee) meeting held on Oct 28, 2015 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20151028.htm) states:
“Most participants anticipated that, based on their assessment of the current economic situation and their outlook for economic activity, the labor market, and inflation, these conditions [for interest rate increase] could well be met by the time of the next meeting. Nonetheless, they emphasized that the actual decision would depend on the implications for the medium-term economic outlook of the data received over the upcoming intermeeting period… It was noted that beginning the normalization process relatively soon would make it more likely that the policy trajectory after liftoff could be shallow.”
Markets could have interpreted a symbolic increase in the fed funds rate at the meeting of the FOMC on Dec 15-16, 2015 (http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm) followed by “shallow” increases, explaining the sharp increase in stock market values and appreciation of the dollar after the release of the minutes on Nov 18, 2015:
| Fri Nov 13 | Mon 16 | Tue 17 | Wed 18 | Thu 19 | Fri 20 |
| USD/ EUR 1.0774 -0.3% 0.4% | 1.0686 0.8% 0.8% | 1.0644 1.2% 0.4% | 1.0660 1.1% -0.2% | 1.0735 0.4% -0.7% | 1.0647 1.2% 0.8% |
| DJIA 17245.24 -3.7% -1.2% | 17483.01 1.4% 1.4% | 17489.50 1.4% 0.0% | 17737.16 2.9% 1.4% | 17732.75 2.8% 0.0% | 17823.81 3.4% 0.5% |
| DAX 10708.40 -2.5% -0.7% | 10713.23 0.0% 0.0% | 10971.04 2.5% 2.4% | 10959.95 2.3% -0.1% | 11085.44 3.5% 1.1% | 11119.83 3.8% 0.3% |
In testimony before The Joint Economic Committee of Congress on Dec 3, 2015 (http://www.federalreserve.gov/newsevents/testimony/yellen20151203a.htm), Chair Yellen reiterated that the FOMC (Federal Open Market Committee) “anticipates that even after employment and inflation are near mandate-consistent levels, economic condition may, for some time, warrant keeping the target federal funds rate below the Committee views as normal in the longer run.” Todd Buell and Katy Burne, writing on “Draghi says ECB could step up stimulus efforts if necessary,” on Dec 4, 2015, published in the Wall Street Journal (http://www.wsj.com/articles/draghi-says-ecb-could-step-up-stimulus-efforts-if-necessary-1449252934), analyze that the President of the European Central Bank (ECB), Mario Draghi, reassured financial markets that the ECB will increase stimulus if required to raise inflation the euro area to targets. The USD depreciated 3.1 percent on Thu Dec 3, 2015 after weaker than expected measures by the European Central Bank. DJIA fell 1.4 percent on Dec 3 and increased 2.1 percent on Dec 4. DAX fell 3.6 percent on Dec 3.
| Fri Nov 27 | Mon 30 | Tue 1 | Wed 2 | Thu 3 | Fri 4 |
| USD/ EUR 1.0594 0.5% 0.2% | 1.0565 0.3% 0.3% | 1.0634 -0.4% -0.7% | 1.0616 -0.2% 0.2% | 1.0941 -3.3% -3.1% | 1.0885 -2.7% 0.5% |
| DJIA 17798.49 -0.1% -0.1% | 17719.92 -0.4% -0.4% | 17888.35 0.5% 1.0% | 17729.68 -0.4% -0.9% | 17477.67 -1.8% -1.4% | 17847.63 0.3% 2.1% |
| DAX 11293.76 1.6% -0.2% | 11382.23 0.8% 0.8% | 11261.24 -0.3% -1.1% | 11190.02 -0.9% -0.6% | 10789.24 -4.5% -3.6% | 10752.10 -4.8% -0.3% |
At the press conference following the meeting of the FOMC on Dec 16, 2015, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20151216.pdf page 8):
“And we recognize that monetary policy operates with lags. We would like to be able to move in a prudent, and as we've emphasized, gradual manner. It's been a long time since the Federal Reserve has raised interest rates, and I think it's prudent to be able to watch what the impact is on financial conditions and spending in the economy and moving in a timely fashion enables us to do this.”
The implication of this statement is that the state of the art is not accurate in analyzing the effects of monetary policy on financial markets and economic activity. The US dollar appreciated and equities fluctuated:
| Fri Dec 11 | Mon 14 | Tue 15 | Wed 16 | Thu 17 | Fri 18 |
| USD/ EUR 1.0991 -1.0% -0.4% | 1.0993 0.0% 0.0% | 1.0932 0.5% 0.6% | 1.0913 0.7% 0.2% | 1.0827 1.5% 0.8% | 1.0868 1.1% -0.4% |
| DJIA 17265.21 -3.3% -1.8% | 17368.50 0.6% 0.6% | 17524.91 1.5% 0.9% | 17749.09 2.8% 1.3% | 17495.84 1.3% -1.4% | 17128.55 -0.8% -2.1% |
| DAX 10340.06 -3.8% -2.4% | 10139.34 -1.9% -1.9% | 10450.38 -1.1% 3.1% | 10469.26 1.2% 0.2% | 10738.12 3.8% 2.6% | 10608.19 2.6% -1.2% |
On January 29, 2016, the Policy Board of the Bank of Japan introduced a new policy to attain the “price stability target of 2 percent at the earliest possible time” (https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf). The new framework consists of three dimensions: quantity, quality and interest rate. The interest rate dimension consists of rates paid to current accounts that financial institutions hold at the Bank of Japan of three tiers zero, positive and minus 0.1 percent. The quantitative dimension consists of increasing the monetary base at the annual rate of 80 trillion yen. The qualitative dimension consists of purchases by the Bank of Japan of Japanese government bonds (JGBs), exchange traded funds (ETFs) and Japan real estate investment trusts (J-REITS). The yen devalued sharply relative to the dollar and world equity markets soared after the new policy announced on Jan 29, 2016:
| Fri 22 | Mon 25 | Tue 26 | Wed 27 | Thu 28 | Fri 29 |
| JPY/ USD 118.77 -1.5% -0.9% | 118.30 0.4% 0.4% | 118.42 0.3% -0.1% | 118.68 0.1% -0.2% | 118.82 0.0% -0.1% | 121.13 -2.0% -1.9% |
| DJIA 16093.51 0.7% 1.3% | 15885.22 -1.3% -1.3% | 16167.23 0.5% 1.8% | 15944.46 -0.9% -1.4% | 16069.64 -0.1% 0.8% | 16466.30 2.3% 2.5% |
| Nikkei 16958.53 -1.1% 5.9% | 17110.91 0.9% 0.9% | 16708.90 -1.5% -2.3% | 17163.92 1.2% 2.7% | 17041.45 0.5% -0.7% | 17518.30 3.3% 2.8% |
| Shanghai 2916.56 0.5% 1.3 | 2938.51 0.8% 0.8% | 2749.79 -5.7% -6.4% | 2735.56 -6.2% -0.5% | 2655.66 -8.9% -2.9% | 2737.60 -6.1% 3.1% |
| DAX 9764.88 2.3% 2.0% | 9736.15 -0.3% -0.3% | 9822.75 0.6% 0.9% | 9880.82 1.2% 0.6% | 9639.59 -1.3% -2.4% | 9798.11 0.3% 1.6% |
In testimony on the Semiannual Monetary Policy Report to the Congress on Feb 10-11, 2016, Chair Yellen (http://www.federalreserve.gov/newsevents/testimony/yellen20160210a.htm) states: “U.S. real gross domestic product is estimated to have increased about 1-3/4 percent in 2015. Over the course of the year, subdued foreign growth and the appreciation of the dollar restrained net exports. In the fourth quarter of last year, growth in the gross domestic product is reported to have slowed more sharply, to an annual rate of just 3/4 percent; again, growth was held back by weak net exports as well as by a negative contribution from inventory investment.”
Jon Hilsenrath, writing on “Yellen Says Fed Should Be Prepared to Use Negative Rates if Needed,” on Feb 11, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/yellen-reiterates-concerns-about-risks-to-economy-in-senate-testimony-1455203865), analyzes the statement of Chair Yellen in Congress that the FOMC (Federal Open Market Committee) is considering negative interest rates on bank reserves. The Wall Street Journal provides yields of two and ten-year sovereign bonds with negative interest rates on shorter maturities where central banks pay negative interest rates on excess bank reserves:
| Sovereign Yields 2/12/16 | Japan | Germany | USA |
| 2 Year | -0.168 | -0.498 | 0.694 |
| 10 Year | 0.076 | 0.262 | 1.744 |
On Mar 10, 2016, the European Central Bank (ECB) announced (1) reduction of the refinancing rate by 5 basis points to 0.00 percent; decrease the marginal lending rate to 0.25 percent; reduction of the deposit facility rate to 0,40 percent; increase of the monthly purchase of assets to €80 billion; include nonbank corporate bonds in assets eligible for purchases; and new long-term refinancing operations (https://www.ecb.europa.eu/press/pr/date/2016/html/pr160310.en.html). The President of the ECB, Mario Draghi, stated in the press conference (https://www.ecb.europa.eu/press/pressconf/2016/html/is160310.en.html): “How low can we go? Let me say that rates will stay low, very low, for a long period of time, and well past the horizon of our purchases…We don’t anticipate that it will be necessary to reduce rates further. Of course, new facts can change the situation and the outlook.”
The dollar devalued relative to the euro and open stock markets traded lower after the announcement on Mar 10, 2016, but stocks rebounded on Mar 11:
| Fri 4 | Mon 7 | Tue 8 | Wed 9 | Thu10 | Fri 11 |
| USD/ EUR 1.1006 -0.7% -0.4% | 1.1012 -0.1% -0.1% | 1.1013 -0.1% 0.0% | 1.0999 0.1% 0.1% | 1.1182 -1.6% -1.7% | 1.1151 -1.3% 0.3% |
| DJIA 17006.77 2.2% 0.4% | 17073.95 0.4% 0.4% | 16964.10 -0.3% -0.6% | 17000.36 0.0% 0.2% | 16995.13 -0.1% 0.0% | 17213.31 1.2% 1.3% |
| DAX 9824.17 3.3% 0.7% | 9778.93 -0.5% 0.5% | 9692.82 -1.3% -0.9% | 9723.09 -1.0% 0.3% | 9498.15 -3.3% -2.3% | 9831.13 0.1% 3.5% |
At the press conference after the FOMC meeting on Sep 21, 2016, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20160921.pdf ): “However, the economic outlook is inherently uncertain.” In the address to the Jackson Hole symposium on Aug 26, 2016, Chair Yellen states: “I believe the case for an increase in in federal funds rate has strengthened in recent months…And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course” (http://www.federalreserve.gov/newsevents/speech/yellen20160826a.htm). In a speech at the World Affairs Council of Philadelphia, on Jun 6, 2016 (http://www.federalreserve.gov/newsevents/speech/yellen20160606a.htm), Chair Yellen finds that “there is considerable uncertainty about the economic outlook.” There are fifteen references to this uncertainty in the text of 18 pages double-spaced. In the Semiannual Monetary Policy Report to the Congress on Jun 21, 2016, Chair Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20160621a.htm), “Of course, considerable uncertainty about the economic outlook remains.” Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. Is there a “science” or even “art” of central banking under this extreme uncertainty in which policy does not generate higher volatility of money, income, prices and values of financial assets?
Chart VIII-1, Fed Funds Rate and Yields of Ten-year Treasury Constant Maturity and Baa Seasoned Corporate Bond, Jan 2, 2001 to Oct 6, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/
Chart VIII-1A, Fed Funds Rate and Yield of Ten-year Treasury Constant Maturity, Jan 2, 2001 to Oct 13, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/
Table VIII-3, Selected Data Points in Chart VIII-1, % per Year
| Fed Funds Overnight Rate | 10-Year Treasury Constant Maturity | Seasoned Baa Corporate Bond | |
| 1/2/2001 | 6.67 | 4.92 | 7.91 |
| 10/1/2002 | 1.85 | 3.72 | 7.46 |
| 7/3/2003 | 0.96 | 3.67 | 6.39 |
| 6/22/2004 | 1.00 | 4.72 | 6.77 |
| 6/28/2006 | 5.06 | 5.25 | 6.94 |
| 9/17/2008 | 2.80 | 3.41 | 7.25 |
| 10/26/2008 | 0.09 | 2.16 | 8.00 |
| 10/31/2008 | 0.22 | 4.01 | 9.54 |
| 4/6/2009 | 0.14 | 2.95 | 8.63 |
| 4/5/2010 | 0.20 | 4.01 | 6.44 |
| 2/4/2011 | 0.17 | 3.68 | 6.25 |
| 7/25/2012 | 0.15 | 1.43 | 4.73 |
| 5/1/13 | 0.14 | 1.66 | 4.48 |
| 9/5/13 | 0.089 | 2.98 | 5.53 |
| 11/21/2013 | 0.09 | 2.79 | 5.44 |
| 11/26/13 | 0.09 | 2.74 | 5.34 (11/26/13) |
| 12/5/13 | 0.09 | 2.88 | 5.47 |
| 12/11/13 | 0.09 | 2.89 | 5.42 |
| 12/18/13 | 0.09 | 2.94 | 5.36 |
| 12/26/13 | 0.08 | 3.00 | 5.37 |
| 1/1/2014 | 0.08 | 3.00 | 5.34 |
| 1/8/2014 | 0.07 | 2.97 | 5.28 |
| 1/15/2014 | 0.07 | 2.86 | 5.18 |
| 1/22/2014 | 0.07 | 2.79 | 5.11 |
| 1/30/2014 | 0.07 | 2.72 | 5.08 |
| 2/6/2014 | 0.07 | 2.73 | 5.13 |
| 2/13/2014 | 0.06 | 2.73 | 5.12 |
| 2/20/14 | 0.07 | 2.76 | 5.15 |
| 2/27/14 | 0.07 | 2.65 | 5.01 |
| 3/6/14 | 0.08 | 2.74 | 5.11 |
| 3/13/14 | 0.08 | 2.66 | 5.05 |
| 3/20/14 | 0.08 | 2.79 | 5.13 |
| 3/27/14 | 0.08 | 2.69 | 4.95 |
| 4/3/14 | 0.08 | 2.80 | 5.04 |
| 4/10/14 | 0.08 | 2.65 | 4.89 |
| 4/17/14 | 0.09 | 2.73 | 4.89 |
| 4/24/14 | 0.10 | 2.70 | 4.84 |
| 5/1/14 | 0.09 | 2.63 | 4.77 |
| 5/8/14 | 0.08 | 2.61 | 4.79 |
| 5/15/14 | 0.09 | 2.50 | 4.72 |
| 5/22/14 | 0.09 | 2.56 | 4.81 |
| 5/29/14 | 0.09 | 2.45 | 4.69 |
| 6/05/14 | 0.09 | 2.59 | 4.83 |
| 6/12/14 | 0.09 | 2.58 | 4.79 |
| 6/19/14 | 0.10 | 2.64 | 4.83 |
| 6/26/14 | 0.10 | 2.53 | 4.71 |
| 7/2/14 | 0.10 | 2.64 | 4.84 |
| 7/10/14 | 0.09 | 2.55 | 4.75 |
| 7/17/14 | 0.09 | 2.47 | 4.69 |
| 7/24/14 | 0.09 | 2.52 | 4.72 |
| 7/31/14 | 0.08 | 2.58 | 4.75 |
| 8/7/14 | 0.09 | 2.43 | 4.71 |
| 8/14/14 | 0.09 | 2.40 | 4.69 |
| 8/21/14 | 0.09 | 2.41 | 4.69 |
| 8/28/14 | 0.09 | 2.34 | 4.57 |
| 9/04/14 | 0.09 | 2.45 | 4.70 |
| 9/11/14 | 0.09 | 2.54 | 4.79 |
| 9/18/14 | 0.09 | 2.63 | 4.91 |
| 9/25/14 | 0.09 | 2.52 | 4.79 |
| 10/02/14 | 0.09 | 2.44 | 4.76 |
| 10/09/14 | 0.08 | 2.34 | 4.68 |
| 10/16/14 | 0.09 | 2.17 | 4.64 |
| 10/23/14 | 0.09 | 2.29 | 4.71 |
| 11/13/14 | 0.09 | 2.35 | 4.82 |
| 11/20/14 | 0.10 | 2.34 | 4.86 |
| 11/26/14 | 0.10 | 2.24 | 4.73 |
| 12/04/14 | 0.12 | 2.25 | 4.78 |
| 12/11/14 | 0.12 | 2.19 | 4.72 |
| 12/18/14 | 0.13 | 2.22 | 4.78 |
| 12/23/14 | 0.13 | 2.26 | 4.79 |
| 12/30/14 | 0.06 | 2.20 | 4.69 |
| 1/8/15 | 0.12 | 2.03 | 4.57 |
| 1/15/15 | 0.12 | 1.77 | 4.42 |
| 1/22/15 | 0.12 | 1.90 | 4.49 |
| 1/29/15 | 0.11 | 1.77 | 4.35 |
| 2/05/15 | 0.12 | 1.83 | 4.43 |
| 2/12/15 | 0.12 | 1.99 | 4.53 |
| 2/19/15 | 0.12 | 2.11 | 4.64 |
| 2/26/15 | 0.11 | 2.03 | 4.47 |
| 3/5/215 | 0.11 | 2.11 | 4.58 |
| 3/12/15 | 0.11 | 2.10 | 4.56 |
| 3/19/15 | 0.12 | 1.98 | 4.48 |
| 3/26/15 | 0.11 | 2.01 | 4.56 |
| 4/03/15 | 0.12 | 1.92 | 4.47 |
| 4/9/15 | 0.12 | 1.97 | 4.50 |
| 4/16/15 | 0.13 | 1.90 | 4.45 |
| 4/23/15 | 0.13 | 1.96 | 4.50 |
| 5/1/15 | 0.08 | 2.05 | 4.65 |
| 5/7/15 | 0.13 | 2.18 | 4.82 |
| 5/14/15 | 0.13 | 2.23 | 4.97 |
| 5/21/15 | 0.12 | 2.19 | 4.94 |
| 5/28/15 | 0.12 | 2.13 | 4.88 |
| 6/04/15 | 0.13 | 2.31 | 5.03 |
| 6/11/15 | 0.13 | 2.39 | 5.10 |
| 6/18/15 | 0.14 | 2.35 | 5.17 |
| 6/25/15 | 0.13 | 2.40 | 5.20 |
| 7/1/15 | 0.13 | 2.43 | 5.26 |
| 7/9/15 | 0.13 | 2.32 | 5.20 |
| 7/16/15 | 0.14 | 2.36 | 5.24 |
| 7/23/15 | 0.13 | 2.28 | 5.13 |
| 7/30/15 | 0.14 | 2.28 | 5.16 |
| 8/06/15 | 0.14 | 2.23 | 5.15 |
| 8/20/15 | 0.15 | 2.09 | 5.13 |
| 8/27/15 | 0.14 | 2.18 | 5.33 |
| 9/03/15 | 0.14 | 2.18 | 5.35 |
| 9/10/15 | 0.14 | 2.23 | 5.35 |
| 9/17/15 | 0.14 | 2.21 | 5.39 |
| 9/25/15 | 0.14 | 2.13 | 5.29 |
| 10/01/15 | 0.13 | 2.05 | 5.36 |
| 10/08/15 | 0.13 | 2.12 | 5.40 |
| 10/15/15 | 0.13 | 2.04 | 5.33 |
| 10/22/15 | 0.12 | 2.04 | 5.30 |
| 10/29/15 | 0.12 | 2.19 | 5.40 |
| 11/05/15 | 0.12 | 2.26 | 5.44 |
| 11/12/15 | 0.12 | 2.32 | 5.51 |
| 11/19/15 | 0.12 | 2.24 | 5.44 |
| 11/25/15 | 0.12 | 2.23 | 5.44 |
| 12/03/15 | 0.13 | 2.33 | 5.51 |
| 12/10/15 | 0.14 | 2.24 | 5.43 |
| 12/17/15 | 0.37 | 2.24 | 5.45 |
| 12/23/15 | 0.36 | 2.27 | 5.53 |
| 12/30/15 | 0.35 | 2.31 | 5.54 |
| 1/07/2016 | 0.36 | 2.16 | 5.44 |
| 01/14/16 | 0.36 | 2.10 | 5.46 |
| 01/20/16 | 0.37 | 2.01 | 5.41 |
| 01/29/16 | 0.38 | 2.00 | 5.48 |
| 02/04/16 | 0.38 | 1.87 | 5.40 |
| 02/11/16 | 0.38 | 1.63 | 5.26 |
| 02/18/16 | 0.38 | 1.75 | 5.37 |
| 02/25/16 | 0.37 | 1.71 | 5.27 |
| 03/03/16 | 0.37 | 1.83 | 5.30 |
| 03/10/16 | 0.36 | 1.93 | 5.23 |
| 03/17/16 | 0.37 | 1.91 | 5.11 |
| 03/24/16 | 0.37 | 1.91 | 4.97 |
| 03/31/16 | 0.25 | 1.78 | 4.90 |
| 04/07/16 | 0.37 | 1.70 | 4.76 |
| 04/14/16 | 0.37 | 1.80 | 4.79 |
| 04/21/16 | 0.37 | 1.88 | 4.79 |
| 04/28/16 | 0.37 | 1.84 | 4.73 |
| 05/05/16 | 0.37 | 1.76 | 4.62 |
| 05/12/16 | 0.37 | 1.75 | 4.66 |
| 05/19/16 | 0.37 | 1.85 | 4.70 |
| 05/26/16 | 0.37 | 1.83 | 4.69 |
| 06/02/16 | 0.37 | 1.81 | 4.64 |
| 06/09/16 | 0.37 | 1.68 | 4.53 |
| 06/16/16 | 0.38 | 1.57 | 4.47 |
| 06/23/16 | 0.39 | 1.74 | 4.60 |
| 06/30/16 | 0.36 | 1.49 | 4.41 |
| 07/07/16 | 0.40 | 1.40 | 4.19 |
| 07/14/16 | 0.40 | 1.53 | 4.23 |
| 07/21/16 | 0.40 | 1.57 | 4.25 |
| 07/28/16 | 0.40 | 1.52 | 4.20 |
| 08/04/16 | 0.40 | 1.51 | 4.27 |
| 08/11/16 | 0.40 | 1.57 | 4.27 |
| 08/18/16 | 0.40 | 1.53 | 4.23 |
| 08/25/16 | 0.40 | 1.58 | 4.21 |
| 09/01/16 | 0.40 | 1.57 | 4.19 |
| 09/08/16 | 0.40 | 1.61 | 4.28 |
| 09/15/16 | 0.40 | 1.71 | 4.43 |
| 09/22/16 | 0.40 | 1.63 | 4.32 |
| 09/29/16 | 0.40 | 1.56 | 4.23 |
| 10/06/16 | 0.40 | 1.75 | 4.36 |
| 10/13/16 | 0.40 | 1.75 | NA* |
*Note: the Board of Governors of the Federal Reserve System discontinued the publication of the BAA bond yield.
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/
Chart VIII-2 of the Board of Governors of the Federal Reserve System provides the rate of US dollars (USD) per euro (EUR), USD/EUR. The rate appreciated from USD 1.1282/EUR on Oct 7, 2015 to USD 1.1156/EUR on Oct 7, 2016 or 1.1 percent. The euro has devalued 44.9 percent relative to the dollar from the high on Jul 15, 2008 to Oct 14, 2016. US corporations with foreign transactions and net worth experience losses in their balance sheets in converting revenues from depreciated currencies to the dollar. Corporate profits with IVA and CCA decreased at $123.0 billion in IQ2015 and increased at $70.5 billion in IIQ2015. Corporate profits with IVA and CCA decreased at $33.1 billion in IIIQ2015. Corporate profits with IVA and CCA decreased at $17.0 billion in IIIQ2015. Corporate profits with IVA and CCA decreased at $127.9 billion in IVQ2015 and increased at $66.0 billion in IQ2016. Corporate profits with IVA and CCA fell at $12.5 billion in IIQ2016. Profits after tax with IVA and CCA decreased at $3.3 billion in IIIQ2015. Profits after tax with IVA and CCA fell at $172.7 billion in IVQ2015 and increased at $113.4 billion in IQ2016. Profits after tax with IVA and CCA fell at $28.9 billion in IIQ2016. There is increase in corporate profits from devaluing the dollar with unconventional monetary policy of zero interest rates and decrease of corporate profits in revaluing the dollar with attempts at “normalization” or increases in interest rates. Conflicts arise while other central banks differ in their adjustment process. The current account deficit seasonally adjusted increases from 2.3 percent of GDP in IVQ2014 to 2.7 percent in IQ2015. The current account deficit increases to 2.7 percent of GDP in IQ2015 and decreases to 2.5 percent of GDP in IIQ2015. The deficit increases to 2.9 percent of GDP in IIIQ2015, easing to 2.8 percent of GDP in IVQ2015. The net international investment position decreases from minus $7.0 trillion in IVQ2014 to minus $6.8 trillion in IQ2015, decreasing at minus $6.7 trillion in IIQ2015. The net international investment position increases to minus $7.6 trillion in IQ2016 and increases to minus $8.0 trillion in IIQ2016. The BEA explains as follows (http://www.bea.gov/newsreleases/international/intinv/2016/pdf/intinv216.pdf):
The U.S. net international investment position at the end of the second quarter of 2016 was -$8,042.8 billion (preliminary), according to statistics released today by the Bureau of Economic Analysis (BEA). The net investment position at the end of the first quarter was -$7,582.0 billion (revised). The net investment position decreased $460.8 billion or 6.1 percent in the second quarter, compared with a decrease of 4.1 percent in the first quarter, and an average quarterly decrease of 6.1 percent from the first quarter of 2011 through the fourth quarter of 2015. The $460.8 billion decrease in the net position reflected a $479.9 billion decrease in the net position excluding financial derivatives that was partly offset by a $19.1 billion increase in the net position in financial derivatives.”
The BEA explains further (http://www.bea.gov/newsreleases/international/intinv/2016/pdf/intinv216.pdf): “U.S. assets increased $404.1 billion to $24,465.9 billion at the end of the second quarter, reflecting increases in both financial derivatives and assets excluding financial derivatives. Financial derivatives with a positive fair value increased $241.4 billion to $3,223.7 billion, mostly in single-currency interest rate contracts. Assets excluding financial derivatives increased $162.7 billion to $21,242.1 billion, reflecting increases in other investment, portfolio investment, and reserve assets that were partly offset by a decrease in direct investment. Increases resulting from financial transactions were partly offset by depreciation of major foreign currencies against the U.S. dollar that lowered the value of U.S. assets in dollar terms.”
Chart VIII-2, Exchange Rate of US Dollars (USD) per Euro (EUR), Oct 7, 2015 to Oct 7, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
Chart VIII-3 of the Board of Governors of the Federal Reserve System provides the yield of the 10-year Treasury constant maturity note from 1.53 percent on Jul 13, 2016 to 1.75 percent on Jul 13, 2016. There is turbulence in financial markets originating in a combination of intentions of normalizing or increasing US policy fed funds rate, quantitative easing in Europe and Japan and increasing perception of financial/economic risks.
Chart VIII-3, Yield of Ten-year Constant Maturity Treasury, Jul 13, 2016 to Oct 13, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/
What is truly important is the fixing of the overnight fed funds at ¼ to ½ percent with gradual consideration of further rate increases (https://www.federalreserve.gov/newsevents/press/monetary/20160921a.htm): “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to 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. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data” (emphasis added).
There is concern at the Federal Open Market Committee (FOMC) with the world economy and financial markets (http://www.federalreserve.gov/newsevents/press/monetary/20160127a.htm): “The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook” (emphasis added). This concern should include the effects on dollar revaluation of competitive easing by other central banks such as quantitative and qualitative easing with negative nominal interest rates (https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf).
Chart S provides the yield of the two-year Treasury constant maturity from Mar 17, 2014, two days before the guidance of Chair Yellen on Mar 19, 2014, to Oct 13, 2016. Chart SA provides the yields of the seven-, ten- and thirty-year Treasury constant maturity in the same dates. Yields increased right after the guidance of Chair Yellen. The two-year yield remain at a higher level than before while the ten-year yield fell and increased again. There could be more immediate impact on two-year yields of an increase in the fed funds rates but the effects would spread throughout the term structure of interest rates (Cox, Ingersoll and Ross 1981, 1985, Ingersoll 1987). Yields converged toward slightly lower earlier levels in the week of Apr 24, 2014 with reallocation of portfolios of risk financial assets away from equities and into bonds and commodities. There is ongoing reshuffling of portfolios to hedge against geopolitical events and world/regional economic performance.
Chart S, US, Yield of Two-Year Treasury Constant Maturity, Mar 17, 2014 to Oct 13, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/
Chart SA, US, Yield of Seven-Year, Ten-Year and Thirty-Year Treasury Constant Maturity, Mar 17, 2014 to Oct 13, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/
Chair Yellen states (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.”
Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart VI-1B for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart VI-1B cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s. The loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy. This interpretation is consistent with the case of the 24 emerging market economies analyzed by Reinhart and Rogoff (2010GTD, 4), concluding that “higher debt levels are associated with significantly higher levels of inflation in emerging markets. Median inflation more than doubles (from less than seven percent to 16 percent) as debt rises from the low (0 to 30 percent) range to above 90 percent. Fiscal dominance is a plausible interpretation of this pattern.”
The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:
“So, inflation is caused by ‘tightness’ and deflation by ‘slack’ in the economy. This is not just a cause and forecasting variable, it is the cause, because given ‘slack’ we apparently do not have to worry about inflation from other sources, notwithstanding the weak correlation of [Phillips circuits]. These statements [by the Fed] do mention ‘stable inflation expectations. How does the Fed know expectations are ‘stable’ and would not come unglued once people look at deficit numbers? As I read Fed statements, almost all confidence in ‘stable’ or ‘anchored’ expectations comes from the fact that we have experienced a long period of low inflation (adaptive expectations). All these analyses ignore the stagflation experience in the 1970s, in which inflation was high even with ‘slack’ markets and little ‘demand, and ‘expectations’ moved quickly. They ignore the experience of hyperinflations and currency collapses, which happen in economies well below potential.”
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.”
Chart VI-1B provides the tortuous Phillips Circuit of Brazil from 1963 to 1987. There were no reliable consumer price index and unemployment data in Brazil for that period. Chart VI-1B used the more reliable indicator of inflation, the wholesale price index, and idle capacity of manufacturing as a proxy of unemployment in large urban centers.
ChVI1-B, Brazil, Phillips Circuit, 1963-1987
Source:
©Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.
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.”
There is concern at the Federal Open Market Committee (FOMC) with the world economy and financial markets (http://www.federalreserve.gov/newsevents/press/monetary/20160127a.htm): “The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook” (emphasis added). This concern should include the effects on dollar revaluation of competitive easing by other central banks such as quantitative and qualitative easing with negative nominal interest rates.”
It is quite difficult to measure inflationary expectations because they tend to break abruptly from past inflation. There could still be an influence of past and current inflation in the calculation of future inflation by economic agents. Table VIII-1 provides inflation of the CPI. In the three months from Jun 2016 to Aug 2016, CPI inflation for all items seasonally adjusted was 1.6 percent in annual equivalent, obtained by calculating accumulated inflation from Jun 2016 to Aug 2016 and compounding for a full year. In the 12 months ending in Aug 2016, CPI inflation of all items not seasonally adjusted was 1.1 percent. Inflation in Aug 2016 seasonally adjusted was 0.2 percent relative to Jul 2016, or 2.4 percent annual equivalent (http://www.bls.gov/cpi/). The second row provides the same measurements for the CPI of all items excluding food and energy: 2.3 percent in 12 months, 2.4 percent in annual equivalent Jun 2016-Aug 2016 and 0.3 percent in Aug 2016 or 3.7 percent in annual equivalent. The Wall Street Journal provides the yield curve of US Treasury securities (http://professional.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3000). The shortest term is 0.244 percent for one month, 0.310 percent for three months, 0.462 percent for six months, 0.669 percent for one year, 0.843 percent for two years, 1.008 percent for three years, 1.288 percent for five years, 1.594 percent for seven years, 1.801 percent for ten years and 2.561 percent for 30 years. The Irving Fisher (1930) definition of real interest rates is approximately the difference between nominal interest rates, which are those estimated by the Wall Street Journal, and the rate of inflation expected in the term of the security, which could behave as in Table VIII-1. Inflation in Jan 2016 is low in 12 months because of the unwinding of carry trades from zero interest rates to commodity futures prices but could ignite again with subdued risk aversion. Real interest rates in the US have been negative during substantial periods in the past decade while 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”
Negative real rates of interest distort calculations of risk and returns from capital budgeting by firms, through lending by financial intermediaries to decisions on savings, housing and purchases of households. Inflation on near zero interest rates misallocates resources away from their most productive uses and creates uncertainty of the future path of adjustment to higher interest rates that inhibit sound decisions.
Table I-3, US, Consumer Price Index Percentage Changes 12 months NSA and Annual
| % RI | ∆% 12 Months Aug 2016/Aug | ∆% Annual Equivalent Jun 2016 to Aug 2016 SA | ∆% Aug 2016/Jul 2016 SA | |
| CPI All Items | 100.000 | 1.1 | 1.6 | 0.2 |
| CPI ex Food and Energy | 79.086 | 2.3 | 2.4 | 0.3 |
Source: US Bureau of Labor Statistics
Professionals use a variety of techniques in measuring interest rate risk (Fabozzi, Buestow and Johnson, 2006, Chapter Nine, 183-226):
- Full valuation approach in which securities and portfolios are shocked by 50, 100, 200 and 300 basis points to measure their impact on asset values
- Stress tests requiring more complex analysis and translation of possible events with high impact even if with low probability of occurrence into effects on actual positions and capital
- Value at Risk (VaR) analysis of maximum losses that are likely in a time horizon
- Duration and convexity that are short-hand convenient measurement of changes in prices resulting from changes in yield captured by duration and convexity
- Yield volatility
Analysis of these methods is in Pelaez and Pelaez (International Financial Architecture (2005), 101-162) and Pelaez and Pelaez, Globalization and the State, Vol. (I) (2008a), 78-100). Frederick R. Macaulay (1938) introduced the concept of duration in contrast with maturity for analyzing bonds. Duration is the sensitivity of bond prices to changes in yields. In economic jargon, duration is the yield elasticity of bond price to changes in yield, or the percentage change in price after a percentage change in yield, typically expressed as the change in price resulting from change of 100 basis points in yield. The mathematical formula is the negative of the yield elasticity of the bond price or –[dB/d(1+y)]((1+y)/B), where d is the derivative operator of calculus, B the bond price, y the yield and the elasticity does not have dimension (Hallerbach 2001). The duration trap of unconventional monetary policy is that duration is higher the lower the coupon and higher the lower the yield, other things being constant. Coupons and yields are historically low because of unconventional monetary policy. Duration dumping during a rate increase may trigger the same crossfire selling of high duration positions that magnified the credit crisis. Traders reduced positions because capital losses in one segment, such as mortgage-backed securities, triggered haircuts and margin increases that reduced capital available for positioning in all segments, causing fire sales in multiple segments (Brunnermeier and Pedersen 2009; see Pelaez and Pelaez, Regulation of Banks and Finance (2008b), 217-24). Financial markets are currently experiencing fear of duration and riskier asset classes resulting from the debate within and outside the Fed on tapering quantitative easing. Table VIII-2 provides the yield curve of Treasury securities on Oct 14, 2016, Dec 31, 2013, May 1, 2013, Oct 14, 2015 and Oct 13, 2006. There is oscillating steepening of the yield curve for longer maturities, which are also the ones with highest duration. The 10-year yield increased from 1.45 percent on Jul 26, 2012 to 3.04 percent on Dec 31, 2013 and 1.80 percent on Oct 14, 2016, as measured by the United States Treasury. Assume that a bond with maturity in 10 years were issued on Dec 31, 2013, at par or price of 100 with coupon of 1.45 percent. The price of that bond would be 86.3778 with instantaneous increase of the yield to 3.04 percent for loss of 13.6 percent and far more with leverage. Assume that the yield of a bond with exactly ten years to maturity and coupon of 1.80 percent would jump instantaneously from yield of 1.80 percent on Oct 14, 2016 to 4.81 percent as occurred on Oct 13, 2006 when the economy was closer to full employment. The price of the hypothetical bond issued with coupon of 1.80 percent would drop from 100 to 76.3264 after an instantaneous increase of the yield to 4.81 percent. The price loss would be 23.7 percent. Losses absorb capital available for positioning, triggering crossfire sales in multiple asset classes (Brunnermeier and Pedersen 2009). What is the path of adjustment of zero interest rates on fed funds and artificially low bond yields? There is no painless exit from unconventional monetary policy. Chris Dieterich, writing on “Bond investors turn to cash,” on Jul 25, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323971204578625900935618178.html), uses data of the Investment Company Institute (http://www.ici.org/) in showing withdrawals of $43 billion in taxable mutual funds in Jun, which is the largest in history, with flows into cash investments such as $8.5 billion in the week of Jul 17 into money-market funds.
Table VIII-2, United States, Treasury Yields
| 10/14/16 | 12/31/13 | 5/01/13 | 10/14/15 | 10/13/06 | |
| 1 M | 0.26 | 0.00 | 0.03 | 0.00 | 4.93 |
| 3 M | 0.32 | 0.01 | 0.06 | 0.00 | 5.05 |
| 6 M | 0.46 | 0.07 | 0.08 | 0.08 | 5.13 |
| 1 Y | 0.66 | 0.25 | 0.11 | 0.21 | 5.05 |
| 2 Y | 0.84 | 0.56 | 0.20 | 0.57 | 4.87 |
| 3 Y | 1.00 | 0.91 | 0.30 | 0.84 | 4.79 |
| 5 Y | 1.28 | 1.43 | 0.65 | 1.29 | 4.77 |
| 7 Y | 1.58 | 1.80 | 1.07 | 1.66 | 4.77 |
| 10 Y | 1.80 | 3.04 | 1.66 | 1.99 | 4.81 |
| 20 Y | 2.22 | 3.72 | 2.44 | 2.42 | 5.02 |
| 30 Y | 2.55 | 3.96 | 2.83 | 2.84 | 4.94 |
M: Months; Y: Years
Source: United States Treasury
Interest rate risk is increasing in the US with amplifying fluctuations. Chart VI-13 of the Board of Governors provides the conventional mortgage rate for a fixed-rate 30-year mortgage. The rate stood at 5.87 percent on Jan 8, 2004, increasing to 6.79 percent on Jul 6, 2006. The rate bottomed at 3.35 percent on May 2, 2013. Fear of duration risk in longer maturities such as mortgage-backed securities caused continuing increases in the conventional mortgage rate that rose to 4.51 percent on Jul 11, 2013, 4.58 percent on Aug 22, 2013 and 3.42 percent on Oct 6, 2016, which is the last data point in Chart VI-13. The conventional mortgage rate was 3.47 percent on Oct 13, 2016 (http://www.freddiemac.com/finance/). The current decline of yields is encouraging a surge in mortgage applications that could be reversed in a new increase. Shayndi Raice and Nick Timiraos, writing on “Banks cut as mortgage boom ends,” on Jan 9, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303754404579310940019239208), analyze the drop in mortgage applications to a 13-year low, as measured by the Mortgage Bankers Association. Nick Timiraos, writing on “Demand for home loans plunges,” on Apr 24, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304788404579522051733228402?mg=reno64-wsj), analyzes data in Inside Mortgage Finance that mortgage lending of $235 billion in IQ2014 is 58 percent lower than a year earlier and 23 percent below IVQ2013. Mortgage lending collapsed to the lowest level in 14 years. 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): “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.”
Chart VI-13, US, Conventional Mortgage Rate, Jan 8, 2004 to Oct 6, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update
There is a false impression of the existence of a monetary policy “science,” measurements and forecasting with which to steer the economy into “prosperity without inflation.” Market participants are remembering the Great Bond Crash of 1994 shown in Table VI-7G when monetary policy pursued nonexistent inflation, causing trillions of dollars of losses in fixed income worldwide while increasing the fed funds rate from 3 percent in Jan 1994 to 6 percent in Dec. The exercise in Table VI-7G shows a drop of the price of the 30-year bond by 18.1 percent and of the 10-year bond by 14.1 percent. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). The pursuit of nonexistent deflation during the past ten years has resulted in the largest monetary policy accommodation in history that created the 2007 financial market crash and global recession and is currently preventing smoother recovery while creating another financial crash in the future. The issue is not whether there should be a central bank and monetary policy but rather whether policy accommodation in doses from zero interest rates to trillions of dollars in the fed balance sheet endangers economic stability.
Table VI-7G, Fed Funds Rates, Thirty and Ten Year Treasury Yields and Prices, 30-Year Mortgage Rates and 12-month CPI Inflation 1994
| 1994 | FF | 30Y | 30P | 10Y | 10P | MOR | CPI |
| Jan | 3.00 | 6.29 | 100 | 5.75 | 100 | 7.06 | 2.52 |
| Feb | 3.25 | 6.49 | 97.37 | 5.97 | 98.36 | 7.15 | 2.51 |
| Mar | 3.50 | 6.91 | 92.19 | 6.48 | 94.69 | 7.68 | 2.51 |
| Apr | 3.75 | 7.27 | 88.10 | 6.97 | 91.32 | 8.32 | 2.36 |
| May | 4.25 | 7.41 | 86.59 | 7.18 | 88.93 | 8.60 | 2.29 |
| Jun | 4.25 | 7.40 | 86.69 | 7.10 | 90.45 | 8.40 | 2.49 |
| Jul | 4.25 | 7.58 | 84.81 | 7.30 | 89.14 | 8.61 | 2.77 |
| Aug | 4.75 | 7.49 | 85.74 | 7.24 | 89.53 | 8.51 | 2.69 |
| Sep | 4.75 | 7.71 | 83.49 | 7.46 | 88.10 | 8.64 | 2.96 |
| Oct | 4.75 | 7.94 | 81.23 | 7.74 | 86.33 | 8.93 | 2.61 |
| Nov | 5.50 | 8.08 | 79.90 | 7.96 | 84.96 | 9.17 | 2.67 |
| Dec | 6.00 | 7.87 | 81.91 | 7.81 | 85.89 | 9.20 | 2.67 |
Notes: FF: fed funds rate; 30Y: yield of 30-year Treasury; 30P: price of 30-year Treasury assuming coupon equal to 6.29 percent and maturity in exactly 30 years; 10Y: yield of 10-year Treasury; 10P: price of 10-year Treasury assuming coupon equal to 5.75 percent and maturity in exactly 10 years; MOR: 30-year mortgage; CPI: percent change of CPI in 12 months
Sources: yields and mortgage rates http://www.federalreserve.gov/releases/h15/data.htm CPI ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.t
Chart VI-14 provides the overnight fed funds rate, the yield of the 10-year Treasury constant maturity bond, the yield of the 30-year constant maturity bond and the conventional mortgage rate from Jan 1991 to Dec 1996. In Jan 1991, the fed funds rate was 6.91 percent, the 10-year Treasury yield 8.09 percent, the 30-year Treasury yield 8.27 percent and the conventional mortgage rate 9.64 percent. Before monetary policy tightening in Oct 1993, the rates and yields were 2.99 percent for the fed funds, 5.33 percent for the 10-year Treasury, 5.94 for the 30-year Treasury and 6.83 percent for the conventional mortgage rate. After tightening in Nov 1994, the rates and yields were 5.29 percent for the fed funds rate, 7.96 percent for the 10-year Treasury, 8.08 percent for the 30-year Treasury and 9.17 percent for the conventional mortgage rate.
Chart VI-14, US, Overnight Fed Funds Rate, 10-Year Treasury Constant Maturity, 30-Year Treasury Constant Maturity and Conventional Mortgage Rate, Monthly, Jan 1991 to Dec 1996
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
Chart VI-15 of the Bureau of Labor Statistics provides the all items consumer price index from Jan 1991 to Dec 1996. There does not appear acceleration of consumer prices requiring aggressive tightening.
Chart VI-15, US, Consumer Price Index All Items, Jan 1991 to Dec 1996
Source: Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart IV-16 of the Bureau of Labor Statistics provides 12-month percentage changes of the all items consumer price index from Jan 1991 to Dec 1996. Inflation collapsed during the recession from Jul 1990 (III) and Mar 1991 (I) and the end of the Kuwait War on Feb 25, 1991 that stabilized world oil markets. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). Policy tightening had adverse collateral effects in the form of emerging market crises in Mexico and Argentina and fixed income markets worldwide.
Chart VI-16, US, Consumer Price Index All Items, Twelve-Month Percentage Change, Jan 1991 to Dec 1996
Source: Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Table VI-2 provides the Euro/Dollar (EUR/USD) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 25.1 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul, 2010, shown in Table VI-4 below, the dollar has revalued to USD 1.0972 EUR on Oct 14, 2016 or by 8.0 percent {[(1.0972/1.192)-1]100 = -6.0%}. 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. China fixed the CNY to the dollar for a long period at a highly undervalued level of around CNY 8.2765/USD subsequently revaluing to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent. After fixing again the CNY to the dollar, China revalued to CNY 6.7296/USD on Fri Oct 14, 2016, or by an additional 1.3 percent, for cumulative revaluation of 18.7 percent. The final row of Table VI-2 shows: change of 0.0 percent in the week of Sep 23, 2016; change of 0.0 percent in the week of Sep 30, 2016; change of 0.0 percent in the week of Oct 7, 2016; and devaluation of 0.9 percent in the week of Oct 14. There could be reversal of revaluation to devalue the Yuan.
Professor Edward P Lazear (2013Jan7), writing on “Chinese ‘currency manipulation’ is not the problem,” on Jan 7, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323320404578213203581231448.html), provides clear thought on the role of the yuan in trade between China and the United States and trade between China and Europe. There is conventional wisdom that Chinese exchange rate policy causes the loss of manufacturing jobs in the United States, which is shown by Lazear (2013Jan7) to be erroneous. The fact is that manipulation of the CNY/USD rate by China has only minor effects on US employment. Lazear (2013Jan7) shows that the movement of monthly exports of China to its major trading partners, United States and Europe, since 1995 cannot be explained by the fixing of the CNY/USD rate by China. The period is quite useful because it includes rapid growth before 2007, contraction until 2009 and weak subsequent expansion. Chart VI-1 of the Board of Governors of the Federal Reserve System provides the CNY/USD exchange rate from Jan 3, 1995 to Oct 7, 2016 together with US recession dates in shaded areas. China fixed the CNY/USD rate for a long period as shown in the horizontal segment from 1995 to 2005. There was systematic revaluation of 17.6 percent from CNY 8.2765 on Jul 21, 2005 to CNY 6.8211 on Jul 15, 2008. China fixed the CNY/USD rate until Jun 7, 2010, to avoid adverse effects on its economy from the global recession, which is shown as a horizontal segment from 2009 until mid 2010. China then continued the policy of appreciation of the CNY relative to the USD with oscillations until the beginning of 2012 when the rate began to move sideways followed by a final upward slope of devaluation that is measured in Table VI-2A but virtually disappeared in the rate of CNY 6.3589/USD on Aug 17, 2012 and was nearly unchanged at CNY 6.3558/USD on Aug 24, 2012. China then appreciated 0.2 percent in the week of Dec 21, 2012, to CNY 6.2352/USD for cumulative 1.9 percent revaluation from Oct 28, 2011 and left the rate virtually unchanged at CNY 6.2316/USD on Jan 11, 2013, appreciating to CNY 6.6685/USD on Oct 7, 2016, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD by 18.7 percent by Oct 14, 2016 has not reduced the trade surplus of China but reversal of the policy of revaluation could result in international confrontation. The interruption with upward slope in the final segment on the right of Chart VI-I is measured as virtually stability in Table VI-2A followed with decrease or revaluation and subsequent increase or devaluation. The final segment shows decline or revaluation with another upward move or devaluation. Linglin Wei, writing on “China intervenes to lower yuan,” on Feb 26, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304071004579406810684766716?KEYWORDS=china+yuan&mg=reno64-wsj), finds from informed sources that the central bank of China conducted the ongoing devaluation of the yuan with the objective of driving out arbitrageurs to widen the band of fluctuation. There is concern if the policy of revaluation is changing to devaluation.
Chart VI-1, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 3, 1995-Oct 7, 2016
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
Chart VI-1A provides the daily CNY/USD rate from Jan 5, 1981 to Oct 7, 2016. The exchange rate was CNY 1.5418/USD on Jan 5, 1981. There is sharp cumulative depreciation of 107.8 percent to CNY 3.2031 by Jul 2, 1986, continuing to CNY 5.8145/USD on Dec 29, 1993 for cumulative 277.1 percent since Jan 5, 1981. China then devalued sharply to CNY 8.7117/USD on Jan 7, 1994 for 49.8 percent relative to Dec 29, 1993 and cumulative 465.0 percent relative to Jan 5, 1981. China then fixed the rate at CNY 8.2765/USD until Jul 21, 2005 and revalued as analyzed in Chart VI-1. The final data point in Chart VI-1A is CNY 6.6685/USD on Oct 7, 2016. To be sure, China fixed the exchange rate after substantial prior devaluation. It is unlikely that the devaluation could have been effective after many years of fixing the exchange rate with high inflation and multiple changes in the world economy. The argument of Lazear (2013Jan7) is still valid in view of the lack of association between monthly exports of China to the US and Europe since 1995 and the exchange rate of China.
Chart VI-1A, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 5, 1981-Oct 7 2016
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
Chart VI-1B provides finer details with the rate of Chinese Yuan (CNY) to the US Dollar (USD) from Oct 28, 2011 to Oct 7, 2016. There have been alternations of revaluation and devaluation. The initial data point is CNY 6.5370 on Oct 28, 2011. There is an episode of devaluation from CNY 6.2790 on Apr 30, 2012 to CNY 6.3879 on Jul 25, 2012, or devaluation of 1.4 percent. Another devaluation is from CNY 6.0402/USD on Jan 21, 2014 to CNY 6.6685/USD on Oct 7, 2016, or devaluation of 10.4 percent. The United States Treasury estimates US government debt held by private investors at $10,955 billion in Jun 2016. China’s holding of US Treasury securities represent 11.1 percent of US government marketable interest-bearing debt held by private investors (http://www.fms.treas.gov/bulletin/index.html). Min Zeng, writing on “China plays a big role as US Treasury yields fall,” on Jul 16, 2014, published in the Wall Street Journal (http://online.wsj.com/articles/china-plays-a-big-role-as-u-s-treasury-yields-fall-1405545034?tesla=y&mg=reno64-wsj), finds that acceleration in purchases of US Treasury securities by China has been an important factor in the decline of Treasury yields in 2014. Japan decreased its holdings from $1200.8 billion in Jul 2015 to $1154.6 billion in Jul 2016 or 3.8 percent. The combined holdings of China and Japan in Jul 2016 add to $2373.4 billion, which is equivalent to 21.7 percent of US government marketable interest-bearing securities held by investors of $10,955 billion in Jun 2016 (http://www.fms.treas.gov/bulletin/index.html). Total foreign holdings of Treasury securities increased from $6120.0 billion in Jul 2015 to $6247.9 billion in Jul 2016, or 2.1 percent. The US continues to finance its fiscal and balance of payments deficits with foreign savings (see Pelaez and Pelaez, The Global Recession Risk (2007)). A point of saturation of holdings of US Treasury debt may be reached as foreign holders evaluate the threat of reduction of principal by dollar devaluation and reduction of prices by increases in yield, including possibly risk premium. Shultz et al (2012) find that the Fed financed three-quarters of the US deficit in fiscal year 2011, with foreign governments financing significant part of the remainder of the US deficit while the Fed owns one in six dollars of US national debt. Concentrations of debt in few holders are perilous because of sudden exodus in fear of devaluation and yield increases and the limit of refinancing old debt and placing new debt. In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):
“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”
Chart VI-1B, Chinese Yuan (CNY) per US Dollar (US), Business Days, Oct 28, 2011-Oct 7, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
There are major ongoing and unresolved realignments of exchange rates in the international financial system as countries and regions seek parities that can optimize their productive structures. Seeking exchange rate parity or exchange rate optimizing internal economic activities is complex in a world of unconventional monetary policy of zero interest rates and even negative nominal interest rates of government obligations such as negative yields for the two-year government bond of Germany. Regulation, trade and devaluation conflicts should have been expected from a global recession (Pelaez and Pelaez (2007), The Global Recession Risk, Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008a)): “There are significant grounds for concern on the basis of this experience. International economic cooperation and the international financial framework can collapse during extreme events. It is unlikely that there will be a repetition of the disaster of the Great Depression. However, a milder contraction can trigger regulatory, trade and exchange wars” (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 181). Chart VI-2 of the Board of Governors of the Federal Reserve System provides the key exchange rate of US dollars (USD) per euro (EUR) from Jan 4, 1999 to Oct 7, 2016. US recession dates are in shaded areas. The rate on Jan 4, 1999 was USD 1.1812/EUR, declining to USD 0.8279/EUR on Oct 25, 2000, or appreciation of the USD by 29.9 percent. The rate depreciated 21.9 percent to USD 1.0098/EUR on Jul 22, 2002. There was sharp devaluation of the USD of 34.9 percent to USD 1.3625/EUR on Dec 27, 2004 largely because of the 1 percent interest rate between Jun 2003 and Jun 2004 together with a form of quantitative easing by suspension of auctions of the 30-year Treasury, which was equivalent to withdrawing supply from markets. Another depreciation of 17.5 percent took the rate to USD 1.6010/EUR on Apr 22, 2008, already inside the shaded area of the global recession. The flight to the USD and obligations of the US Treasury appreciated the dollar by 22.3 percent to USD 1.2446/EUR on Oct 27, 2008. In the return of the carry trade after stress tests showed sound US bank balance sheets, the rate depreciated 21.2 percent to USD 1.5085/EUR on Nov 25, 2009. The sovereign debt crisis of Europe in the spring of 2010 caused sharp appreciation of 20.7 percent to USD 1.1959/EUR on Jun 6, 2010. Renewed risk appetite depreciated the rate 24.4 percent to USD 1.4875/EUR on May 3, 2011. The rate appreciated 6.7 percent to USD 1.1156/EUR on Oct 7, 2016, which is the last point in Chart VI-2. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).
Chart VI-2, US Dollars (USD) per Euro (EUR), Jan 4, 1999 to Oct 7, 2016
Note: US Recessions in Shaded Areas
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
Chart VI-3 provides three indexes of the US Dollars (USD) from Jan 4, 1995 to Oct 7, 2016.
Chart VI-3A provides the overnight fed funds rate and yields of the three-month constant maturity Treasury bill, the ten-year constant maturity Treasury note and Moody’s Baa bond from Jan 4, 1995 to Jul 7, 2016. Chart VI-3B provides the overnight fed funds rate and yields of the three-month constant maturity Treasury bill and the ten-year constant maturity Treasury from Jan 5, 2001 to Oct 13, 2016. The first phase from 1995 to 2001 shows sharp trend of appreciation of the USD while interest rates remained at relatively high levels. The dollar revalued partly because of the emerging market crises that provoked inflows of financial investment into the US and partly because of a deliberate strong dollar policy. DeLong and Eichengreen (2001, 4-5) argue:
“That context was an economic and political strategy that emphasized private investment as the engine for U.S. economic growth. Both components of this term, "private" and "investment," had implications for the administration’s international economic strategy. From the point of view of investment, it was important that international events not pressure on the Federal Reserve to raise interest rates, since this would have curtailed capital formation and vitiated the effects of the administration’s signature achievement: deficit reduction. A strong dollar -- or rather a dollar that was not expected to weaken -- was a key component of a policy which aimed at keeping the Fed comfortable with low interest rates. In addition, it was important to create a demand for the goods and services generated by this additional productive capacity. To the extent that this demand resided abroad, administration officials saw it as important that the process of increasing international integration, of both trade and finance, move forward for the interest of economic development in emerging markets and therefore in support of U.S. economic growth.”
The process of integration consisted of restructuring “international financial architecture” (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Debtors and Creditors (2005)). Policy concerns subsequently shifted to the external imbalances, or current account deficits, and internal imbalances, or government deficits (Pelaez and Pelaez, The Global Recession Risk: Dollar Devaluation and the World Economy (2007)). Fed policy consisted of lowering the policy rate or fed funds rate, which is close to the marginal cost of funding of banks, toward zero during the past decade. Near zero interest rates induce carry trades of selling dollar debt (borrowing), shorting the USD and investing in risk financial assets. Without risk aversion, near zero interest rates cause devaluation of the dollar. Chart VI-3 shows the weakening USD between the recession of 2001 and the contraction after IVQ2007. There was a flight to dollar assets and especially obligations of the US government after Sep 2008. Cochrane and Zingales (2009) show that flight was coincident with proposals of TARP (Troubled Asset Relief Program) to withdraw “toxic assets” in US banks (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a) and Regulation of Banks and Finance (2009b)). There are shocks to globalization in the form of regulation, trade and devaluation wars and breakdown of international cooperation (Pelaez and Pelaez, Globalization and the State: Vol. I (2008a), Globalization and the State: Vol. II (2008b) and Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c)). As evident in Chart VI-3A, there is no exit from near zero interest rates without a financial crisis and economic contraction, verified by the increase of interest rates from 1 percent in Jun 2004 to 5.25 percent in Jun 2006. The Federal Open Market Committee (FOMC) lowered the target of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85). The FOMC implemented increments of 25 basis points of the fed funds target from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006, as shown in Chart VI-3A. The gradual exit from the first round of unconventional monetary policy from 1.00 percent in Jun 2004 (http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040630/default.htm) to 5.25 percent in Jun 2006 (http://www.federalreserve.gov/newsevents/press/monetary/20060629a.htm) caused the financial crisis and global recession. There are conflicts on exchange rate movements among central banks.
At the press conference after the FOMC meeting on Sep 21, 2016, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20160921.pdf ): “However, the economic outlook is inherently uncertain.” In the address to the Jackson Hole symposium on Aug 26, 2016, Chair Yellen states: “I believe the case for an increase in in federal funds rate has strengthened in recent months…And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course” (http://www.federalreserve.gov/newsevents/speech/yellen20160826a.htm). In a speech at the World Affairs Council of Philadelphia, on Jun 6, 2016 (http://www.federalreserve.gov/newsevents/speech/yellen20160606a.htm), Chair Yellen finds that “there is considerable uncertainty about the economic outlook.” There are fifteen references to this uncertainty in the text of 18 pages double-spaced. In the Semiannual Monetary Policy Report to the Congress on Jun 21, 2016, Chair Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20160621a.htm), “Of course, considerable uncertainty about the economic outlook remains.” Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. Is there a “science” or even “art” of central banking under this extreme uncertainty in which policy does not generate higher volatility of money, income, prices and values of financial assets?
Chart VI-3, US Dollar Currency Indexes, Jan 4, 1995-Oct 7, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/H10/default.htm
Chart VI-3A, US, Overnight Fed Funds Rate, Yield of Three-Month Treasury Constant Maturity, Yield of Ten-Year Treasury Constant Maturity and Yield of Moody’s Baa Bond, Jan 4, 1995 to Jul 7, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15
Chart VI-3B, US, Overnight Fed Funds Rate, Yield of Three-Month Treasury Constant Maturity and Yield of Ten-Year Treasury Constant Maturity, Jan 5, 2001 to Oct 13, 2016
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15
The major reason and channel of transmission of unconventional monetary policy is through expectations of inflation. Fisher (1930) provided theoretical and historical relation of interest rates and inflation. Let in be the nominal interest rate, ir the real or inflation-adjusted interest rate and πe the expectation of inflation in the time term of the interest rate, which are all expressed as proportions. The following expression provides the relation of real and nominal interest rates and the expectation of inflation:
(1 + ir) = (1 + in)/(1 + πe) (1)
That is, the real interest rate equals the nominal interest rate discounted by the expectation of inflation in time term of the interest rate. Fisher (1933) analyzed the devastating effect of deflation on debts. Nominal debt contracts remained at original principal interest but net worth and income of debtors contracted during deflation. Real interest rates increase during declining inflation. For example, if the interest rate is 3 percent and prices decline 0.2 percent, equation (1) calculates the real interest rate as:
(1 +0.03)/(1 – 0.02) = 1.03/(0.998) = 1.032
That is, the real rate of interest is (1.032 – 1)100 or 3.2 percent. If inflation were 2 percent, the real rate of interest would be 0.98 percent, or about 1.0 percent {[(1.03/1.02) -1]100 = 0.98%}.
The yield of the one-year Treasury security was quoted in the Wall Street Journal at 0.114 percent on Fri May 17, 2013 (http://online.wsj.com/mdc/page/marketsdata.html?mod=WSJ_topnav_marketdata_main). The expected rate of inflation πe in the next twelve months is not observed. Assume that it would be equal to the rate of inflation in the past twelve months estimated by the Bureau of Economic Analysis (BLS) at 1.1 percent (http://www.bls.gov/cpi/). The real rate of interest would be obtained as follows:
(1 + 0.00114)/(1 + 0.011) = (1 + rr) = 0.9902
That is, ir is equal to 1 – 0.9902 or minus 0.98 percent. Investing in a one-year Treasury security results in a loss of 0.98 percent relative to inflation. The objective of unconventional monetary policy of zero interest rates is to induce consumption and investment because of the loss to inflation of riskless financial assets. Policy would be truly irresponsible if it intended to increase inflationary expectations or πe. The result could be the same rate of unemployment with higher inflation (Kydland and Prescott 1977).
Focus is shifting from tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Markets overreacted to the so-called “paring” of outright purchases to $15 billion of securities per month for the balance sheet of the Fed.
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.”
What is truly important is the fixing of the overnight fed funds at ¼ to ½ percent with gradual consideration of further rate increases (https://www.federalreserve.gov/newsevents/press/monetary/20160921a.htm): “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to 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. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data” (emphasis added).
There is concern at the Federal Open Market Committee (FOMC) with the world economy and financial markets (http://www.federalreserve.gov/newsevents/press/monetary/20160127a.htm): “The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook” (emphasis added). This concern should include the effects on dollar revaluation of competitive easing by other central banks such as quantitative and qualitative easing with negative nominal interest rates (https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf).
At the press conference following the meeting on Mar 19, 2014, Chair Yellen answered a question of Jon Hilsenrath of the Wall Street Journal explaining “In particular, the Committee has endorsed the view that it anticipates that will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates. And of course on our present path, well, that's not utterly preset. We would be looking at next, next fall. So, I think that's important guidance” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140319.pdf). Many focused on “next fall,” ignoring that the path of increasing rates is not “utterly preset.”
At the press conference following the meeting on Dec 17, 2014, Chair Yellen answered a question by Jon Hilseranth of the Wall Street Journal explaining “patience” (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20141217.pdf):
“So I did say that this statement that the committee can be patient should be interpreted as meaning that it is unlikely to begin the normalization process, for at least the next couple of meetings. Now that doesn't point to any preset or predetermined time at which normalization is -- will begin. There are a range of views on the committee, and it will be dependent on how incoming data bears on the progress, the economy is making. First of all, I want to emphasize that no meeting is completely off the table in the sense that if we do see faster progress toward our objectives than we currently expect, then it is possible that the process of normalization would occur sooner than we now anticipated. And of course the converse is also true. So at this point, we think it unlikely that it will be appropriate, that we will see conditions for at least the next couple of meetings that will make it appropriate for us to decide to begin normalization. A number of committee participants have indicated that in their view, conditions could be appropriate by the middle of next year. But there is no preset time.”
At a speech on Mar 31, 2014, Chair Yellen analyzed labor market conditions as follows (http://www.federalreserve.gov/newsevents/speech/yellen20140331a.htm):
“And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress. The first of those goals is maximum sustainable employment, the highest level of employment that can be sustained while maintaining a stable inflation rate. Most of my colleagues on the Federal Open Market Committee and I estimate that the unemployment rate consistent with maximum sustainable employment is now between 5.2 percent and 5.6 percent, well below the 6.7 percent rate in February.
Let me explain what I mean by that word "slack" and why it is so important.
Slack means that there are significantly more people willing and capable of filling a job than there are jobs for them to fill. During a period of little or no slack, there still may be vacant jobs and people who want to work, but a large share of those willing to work lack the skills or are otherwise not well suited for the jobs that are available. With 6.7 percent unemployment, it might seem that there must be a lot of slack in the U.S. economy, but there are reasons why that may not be true.”
Yellen (2014Aug22) provides comprehensive review of the theory and measurement of labor markets. Monetary policy pursues a policy of attaining its “dual mandate” of (http://www.federalreserve.gov/aboutthefed/mission.htm):
“Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates”
Yellen (2014Aug22) finds that the unemployment rate is not sufficient in determining slack:
“One convenient way to summarize the information contained in a large number of indicators is through the use of so-called factor models. Following this methodology, Federal Reserve Board staff developed a labor market conditions index from 19 labor market indicators, including four I just discussed. This broadly based metric supports the conclusion that the labor market has improved significantly over the past year, but it also suggests that the decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.”
Yellen (2014Aug22) restates that the FOMC determines monetary policy on newly available information and interpretation of labor markets and inflation and does not follow a preset path:
“But if progress in the labor market continues to be more rapid than anticipated by the Committee or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter. Of course, if economic performance turns out to be disappointing and progress toward our goals proceeds more slowly than we expect, then the future path of interest rates likely would be more accommodative than we currently anticipate. As I have noted many times, monetary policy is not on a preset path. The Committee will be closely monitoring incoming information on the labor market and inflation in determining the appropriate stance of monetary policy.”
Yellen (2014Aug22) states that “Historically, slack has accounted for only a small portion of the fluctuations in inflation. Indeed, unusual aspects of the current recovery may have shifted the lead-lag relationship between a tightening labor market and rising inflation pressures in either direction.”
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?
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 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 his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):
“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differ from each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”
Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and re the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+re). Thus, g = [(r/re) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dre>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:
W = Y/r (10
Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.
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/2016/08/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/oscillating-valuations-of-risk.html). This is merely another case of theory without reality with dubious policy proposals. The current reality is cyclical slow growth.
Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/search?q=rules+versus+authorities http://cmpassocregulationblog.blogspot.com/2014/07/financial-irrational-exuberance.html http://cmpassocregulationblog.blogspot.com/2014/07/world-inflation-waves-united-states.html). 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. A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2016/01/unconventional-monetary-policy-and.html and earlier 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 18,138.38 on Oct 14, 2016, which is higher by 28.1 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 27.8 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial assets have been 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, former 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).
Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.
At the press conference after the FOMC meeting on Sep 21, 2016, Chair Yellen states (http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20160921.pdf ): “However, the economic outlook is inherently uncertain.” In the address to the Jackson Hole symposium on Aug 26, 2016, Chair Yellen states: “I believe the case for an increase in in federal funds rate has strengthened in recent months…And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course” (http://www.federalreserve.gov/newsevents/speech/yellen20160826a.htm). In a speech at the World Affairs Council of Philadelphia, on Jun 6, 2016 (http://www.federalreserve.gov/newsevents/speech/yellen20160606a.htm), Chair Yellen finds that “there is considerable uncertainty about the economic outlook.” There are fifteen references to this uncertainty in the text of 18 pages double-spaced. In the Semiannual Monetary Policy Report to the Congress on Jun 21, 2016, Chair Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20160621a.htm), “Of course, considerable uncertainty about the economic outlook remains.” Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. Is there a “science” or even “art” of central banking under this extreme uncertainty in which policy does not generate higher volatility of money, income, prices and values of financial assets?
The carry trade from zero interest rates to leveraged positions in risk financial assets had proved strongest for commodity exposures but US equities have regained leadership. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). The DJIA has increased 87.3 percent since the trough of the sovereign debt crisis in Europe on Jul 16, 2010 to Oct 14, 2016; S&P 500 has gained 108.6 percent and DAX 86.6 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 10/14/16” had double digit gains relative to the trough around Jul 2, 2010 followed by negative performance but now some valuations of equity indexes show varying behavior. China’s Shanghai Composite is 28.6 percent above the trough. Japan’s Nikkei Average is 91.0 percent above the trough. DJ Asia Pacific TSM is 27.2 percent above the trough. Dow Global is 42.6 percent above the trough. STOXX 50 of 50 blue-chip European equities (http://www.stoxx.com/indices/index_information.html?symbol=sx5E) is 23.3 percent above the trough. NYSE Financial Index is 42.6 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 86.6 percent above the trough. Japan’s Nikkei Average is 91.0 percent above the trough on Aug 31, 2010 and 47.9 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 16,856.37 on Oct 14, 2016 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 64.4 percent higher than 10,254.43 on Mar 11, 2011, on the date of the Tōhoku or Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar appreciated 8.0 percent relative to the euro. The dollar devalued before the new bout of sovereign risk issues in Europe. The column “∆% week to 10/14/16” in Table VI-4 shows
increase of 2.0 percent in the week for China’s Shanghai Composite. The Nikkei changed 0.0 percent. DJ Asia Pacific decreased 1.7 percent. NYSE Financial decreased 0.6 percent in the week. Dow Global decreased 1.4 percent in the week of Oct 14, 2016. The DJIA decreased 0.6 percent and S&P 500 decreased 1.0 percent. DAX of Germany increased 0.9 percent. STOXX 50 changed 0.0 percent. The USD appreciated 2.1 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table VI-4 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 10/14/16” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Oct 14, 2016. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 10/14/16” but also relative to the peak in column “∆% Peak to 10/14/16.” There are now several equity indexes above the peak in Table VI-4: DJIA 61.9 percent, S&P 500 75.2 percent, DAX 67.1 percent, NYSE Financial Index (http://www.nyse.com/about/listed/nykid.shtml) 15.9 percent, Dow Global 16.3 percent, and Nikkei Average 47.9 percent. Shanghai Composite is 3.2 percent below the peak; STOXX 50 is 4.5 percent above the peak; and DJ Asia Pacific TSM is 11.4 percent above the peak. The Shanghai Composite increased 55.2 percent from March 12, 2014, to Oct 14, 2016. The US dollar strengthened 27.5 percent relative to the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul 2010 because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010. Sharp and continuing strengthening of the dollar is affecting balance sheets of US corporations with foreign operations (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318). The Federal Open Market Committee (FOMC) is following “financial and international developments” as part of the process of framing interest rate policy (http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm). Kate Linebaugh, writing on “Corporate profits set to shrink for fourth consecutive quarter,” on Jul 17, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/corporate-profits-set-to-shrink-for-fourth-consecutive-quarter-1468799278), quotes forecasts of Thomson Reuters of 4.7 decline of adjusted earnings per share in the S&P 500 index in IIQ2016 relative to a year earlier. That would be the fourth consecutive quarterly decline. Theo Francis and Kate Linebaugh, writing on “US corporate profits on pace for third straight decline,” on Apr 28, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/u-s-corporate-profits-on-pace-for-third-straight-decline-1461872242), analyze three consecutive quarters of decline of corporate earnings and revenue in companies in S&P 500. They quote Thomson Reuters on expected decline of earnings of 6.1 percent in IQ2016 based on 55 percent of reporting companies. Weakness of economic activity shows in decline of revenues in IQ2016 of 1.4 percent, increasing 1.7 percent excluding energy, and contraction of profits of 0.5 percent. Justin Lahart, writing on “S&P 500 Earnings: far worse than advertised,” on Feb 24, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/s-p-500-earnings-far-worse-than-advertised-1456344483), analyzes S&P 500 earnings in 2015. Under data provided by companies, earnings increased 0.4 percent in 2015 relative to 2014 but under GAAP (Generally Accepted Accounting Principles), earnings fell 12.7 percent, which is the worst decrease since 2008. Theo Francis e Kate Linebaugh, writing on Oct 25, 2015, on “US Companies Warn of Slowing Economy, published in the Wall Street Journal (http://www.wsj.com/articles/u-s-companies-warn-of-slowing-economy-1445818298) analyze the first contraction of earnings and revenue of big US companies. Production, sales and employment are slowing in a large variety of companies with some contracting. Corporate profits also suffer from revaluation of the dollar that constrains translation of foreign profits into dollar balance sheets. Francis and Linebaugh quote Thomson Reuters that analysts expect decline of earnings per share of 2.8 percent in IIIQ2015 relative to IIIQ2014 based on reports by one third of companies in the S&P 500. Sales would decline 4.0% in a third quarter for the first joint decline of earnings per share and revenue in the same quarter since IIIQ2009. Dollar revaluation also constrains corporate results.
Inyoung Hwang, writing on “Fed optimism spurs record bets against stock volatility,” on Aug 21, 2014, published in Bloomberg.com (http://www.bloomberg.com/news/2014-08-21/fed-optimism-spurs-record-bets-against-stock-voalitlity.html), informs that the S&P 500 is trading at 16.6 times estimated earnings, which is higher than the five-year average of 14.3 Tom Lauricella, writing on Mar 31, 2014, on “Stock investors see hints of a stronger quarter,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304157204579473513864900656?mod=WSJ_smq0314_LeadStory&mg=reno64-wsj), finds views of stronger earnings among many money managers with positive factors for equity markets in continuing low interest rates and US economic growth. There is important information in the Quarterly Markets review of the Wall Street Journal (http://online.wsj.com/public/page/quarterly-markets-review-03312014.html) for IQ2014. Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. Future company cash flows derive from investment projects. In IQ1980, real gross private domestic investment in the US was $951.6 billion of chained 2009 dollars, growing to $1,257.7 billion in IVQ1989 or 32.2 percent. Real gross private domestic investment in the US increased 6.9 percent from $2605.2 billion in IVQ2007 to $2,783.8 billion in IIQ2016. As shown in Table IAI-2, real private fixed investment increased 7.4 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,778.8 billion in IIQ2016. Private fixed investment fell relative to IVQ2007 in all quarters preceding IIQ2014 and fell 0.3 percent in IIQ2016. Growth of real private investment in Table IA1-2 is mediocre for all but four quarters from IIQ2011 to IQ2012. The investment decision of United States corporations is fractured in the current economic cycle in preference of cash.
There are three aspects. First, there is decrease in corporate profits. Corporate profits with IVA and CCA decreased at $17.0 billion in IIIQ2015. Corporate profits with IVA and CCA decreased at $127.9 billion in IVQ2015 and increased at $66.0 billion in IQ2016. Corporate profits with IVA and CCA fell at $12.5 billion in IIQ2016. Profits after tax with IVA and CCA decreased at $3.3 billion in IIIQ2015. Profits after tax with IVA and CCA fell at $172.7 billion in IVQ2015 and increased at $113.4 billion in IQ2016. Profits after tax with IVA and CCA fell at $28.9 billion in IIQ2016. Net dividends increased at $13.8 billion in IIIQ2015. Net dividends fell at $20.8 billion in IVQ2015 and increased at $7.3 billion in IQ2016. Net dividends fell at $9.3 billion in IIQ2016. Undistributed profits with IVA and CCA decreased at $17.0 billion in IIIQ2015. Undistributed corporate profits with IVA and CCA fell at $152.0 billion in IVQ2015 and increased at $106.1 billion in IQ2016. Undistributed corporate profits fell at $19.6 billion in IIQ2016. Undistributed corporate profits swelled 149.4 percent from $107.7 billion in IQ2007 to $268.6 billion in IIQ2016 and changed signs from minus $55.9 billion in current dollars in IVQ2007. Uncertainty originating in fiscal, regulatory and monetary policy causes wide swings in expectations and decisions by the private sector with adverse effects on investment, real economic activity and employment. Second, sharp and continuing strengthening of the dollar is affecting balance sheets of US corporations with foreign operations (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318) and the overall US economy. The bottom part of Table IA1-9 provides the breakdown of corporate profits with IVA and CCA in domestic industries and the rest of the world. Corporate profits with IVA and CCA fell at $127.9 billion in IVQ2015 with decrease of domestic industries at $149.8 billion, mostly because of decrease of nonfinancial business at $131.7 billion, and increase of profits from operations in the rest of the world at $22.0 billion. Receipts from the rest of the world fell at $19.9 billion. Corporate profits with IVA and CCA increased at $66.0 billion in IQ2016 with increase of domestic industries at $92.9 billion. Profits from operations from the rest of the world fell at $26.9 billion and payments to the rest of the world increased at $35.6 billion. Corporate profits with IVA and CCA decreased at $12.5 billion in IIQ2016. Profits from domestic industries fell at $50.5 billion and profits from nonfinancial business fell at $56.1 billion. Profits from the rest of the world increased at $38.0 billion. Total corporate profits with IVA and CCA were $2021.0 billion in IIQ2016 of which $1613.4 billion from domestic industries, or 79.8 percent of the total, and $407.6 billion, or 20.2 percent, from the rest of the world. Nonfinancial corporate profits of $1170.5 billion account for 57.9 percent of the total. Third, there is reduction in the use of corporate cash for investment. Vipal Monga, David Benoit and Theo Francis, writing on “Companies send more cash back to shareholders,” published on May 26, 2015 in the Wall Street Journal (http://www.wsj.com/articles/companies-send-more-cash-back-to-shareholders-1432693805?tesla=y), use data of a study by Capital IQ conducted for the Wall Street Journal. This study shows that companies in the S&P 500 reduced investment in plant and equipment to median 29 percent of operating cash flow in 2013 from 33 percent in 2003 while increasing dividends and buybacks to median 36 percent in 2013 from 18 percent in 2003. The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:
Where Rτ is expected revenue in the time horizon from τ =1 to T; Cτ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that interest rates increase without bound, then V → 0, or
declines. Equally, decline in expected revenue from the stock or project, Rτ, causes decline in valuation.
An intriguing issue is the difference in performance of valuations of risk financial assets and economic growth and employment. Paul A. Samuelson (http://www.nobelprize.org/nobel_prizes/economics/laureates/1970/samuelson-bio.html) popularized the view of the elusive relation between stock markets and economic activity in an often-quoted phrase “the stock market has predicted nine of the last five recessions.” In the presence of zero interest rates forever, valuations of risk financial assets are likely to differ from the performance of the overall economy. The interrelations of financial and economic variables prove difficult to analyze and measure.
Table VI-4, Stock Indexes, Commodities, Dollar and 10-Year Treasury
| Peak | Trough | ∆% to Trough | ∆% Peak to 10/014/ /16 | ∆% Week 10/14/16 | ∆% Trough to 10/14/ 16 | |
| DJIA | 4/26/ | 7/2/10 | -13.6 | 61.9 | -0.6 | 87.3 |
| S&P 500 | 4/23/ | 7/20/ | -16.0 | 75.2 | -1.0 | 108.6 |
| NYSE Finance | 4/15/ | 7/2/10 | -20.3 | 15.9 | -0.6 | 45.5 |
| Dow Global | 4/15/ | 7/2/10 | -18.4 | 16.3 | -1.4 | 42.6 |
| Asia Pacific | 4/15/ | 7/2/10 | -12.5 | 11.4 | -1.7 | 27.2 |
| Japan Nikkei Aver. | 4/05/ | 8/31/ | -22.5 | 47.9 | 0.0 | 91.0 |
| China Shang. | 4/15/ | 7/02 | -24.7 | -3.2 | 2.0 | 28.6 |
| STOXX 50 | 4/15/10 | 7/2/10 | -15.3 | 4.5 | 0.0 | 23.3 |
| DAX | 4/26/ | 5/25/ | -10.5 | 67.1 | 0.9 | 86.6 |
| Dollar | 11/25 2009 | 6/7 | 21.2 | 27.5 | 2.1 | 8.0 |
| DJ UBS Comm. | 1/6/ | 7/2/10 | -14.5 | NA | NA | NA |
| 10-Year T Note | 4/5/ | 4/6/10 | 3.986 | 2.784 | 1.791 |
T: trough; Dollar: positive sign appreciation relative to euro (less dollars paid per euro), negative sign depreciation relative to euro (more dollars paid per euro)
Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
ESII Valuations of Risk Financial Assets. The most important source of financial turbulence is shifting toward fluctuating interest rates. The dollar/euro rate is quoted as number of US dollars USD per one euro EUR, USD 1.1203/EUR in the first row, first column in the block for currencies in Table III-1 for Fri Oct 7, appreciating to USD 1.1140/EUR on Mon Oct 10, 2016, or by 0.6 percent. The dollar appreciated because fewer dollars, 1.1140, were required on Mon Oct 10 to buy one euro than $1.1203 on Fri Oct 7. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the exchange rate at 5 PM New York time, such as USD 1.1203/EUR on Oct 7. The second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Fri Oct 7, to the last business day of the current week, in this case Oct 14, such as appreciation of 2.1 percent to USD 1.0972/EUR by Oct 14. The third row provides the percentage change from the prior business day to the current business day. For example, the USD appreciated (denoted by positive sign) by 2.1 percent from the rate of USD 1.1203/EUR on Fri Oct 7 to the rate of USD 1.0972/EUR on Oct 14 {[(1.0972/1.1203) - 1]100 = -2.1%}. The dollar appreciated (denoted by positive sign) by 0.8 percent from the rate of USD 1.1059 on
Thu Oct 13 to USD 1.0972/EUR on Fri Oct 14 {[(1.0972/1.1059) -1]100 = -0.8%}. Other factors constant, increasing risk aversion causes appreciation of the dollar relative to the euro, with rising uncertainty on European and global sovereign risks increasing dollar-denominated assets with sales of risk financial investments. Funds move away from higher yielding risk assets to the safety of dollar-denominated assets.
There is mixed performance in equity indexes with several indexes in Table III-1 decreasing in the week ending on Oct 14, 2016, after wide swings caused by reallocations of investment portfolios worldwide. Stagnating revenues, corporate cash hoarding, effects of currency oscillations on corporate earnings and declining investment are causing reevaluation of discounted net earnings with deteriorating views on the world economy and United States fiscal sustainability but investors have been driving indexes higher. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). DJIA increased 0.2 percent on Oct 14, decreasing 0.6 percent in the week. Germany’s DAX increased 1.6 percent on Oct 14 and increased 0.9 percent in the week. Dow Global increased 0.5 percent on Oct 14 and decreased 1.4 percent in the week. Japan’s Nikkei Average increased 0.5 percent on Oct 14 and changed 0.0 percent in the week as the yen continues oscillating but relatively weaker and the stock market gains in expectations of success of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Dow Asia Pacific TSM increased 0.2 percent on Oct 14 and decreased 1.7 percent in the week. Shanghai Composite that decreased 1.0 percent on Mar 8 and decreased 1.7 percent in the week of Mar 8, falling below 2000 at 1974.38 on Mar 12, 2014 but closing at 3063.81 on Oct 14, 2016, for increase of 0.1 percent and increasing 2.0 percent in the week. The Shanghai Composite increased 55.2 percent from March 12, 2014 to Oct 14, 2016. Markets did not open in China during national holidays in Oct 1-7. There is deceleration with oscillations of the world economy that could affect corporate revenue and equity valuations, causing fluctuations in equity markets with increases during favorable risk appetite. The global hunt for yield induced by central bank policy rates of near zero percent motivates wide portfolio reshufflings among classes of risk financial assets.
Commodities were mixed in the week of Oct 14, 2016. Table III-1 shows that WTI increased 1.1 percent in the week of Oct 14 while Brent changed 0.0 percent in the week with turmoil in oil producing regions but lack of action by OPEC. Gold decreased 0.2 percent on Oct 14 and increased 0.3 percent in the week.
Table III-I, Weekly Financial Risk Assets Oct 10 to Oct 14, 2016
| Fri 7 | Mon 10 | Tue 11 | Wed 12 | Thu 13 | Fri 14 |
| USD/ EUR 1.1203 0.3% -0.5% | 1.1140 0.6% 0.6% | 1.1055 1.3% 0.8% | 1.1008 1.7% 0.4% | 1.1059 1.3% -0.5% | 1.0972 2.1% 0.8% |
| JPY/ USD 102.96 -1.6% 1.0% | 103.61 -0.6% -0.6% | 103.50 -0.5% 0.1% | 104.20 -1.2% -0.7% | 103.70 -0.7% 0.5% | 104.17 -1.2% -0.5% |
| CHF/ USD 0.9774 -0.6% 0.3% | 0.9824 -0.5% -0.5% | 0.9888 -1.2% -0.7% | 0.9908 -1.4% -0.2% | 0.9862 -0.9% 0.5% | 0.9904 -1.3% -0.4% |
| CHF/ EUR 1.0949 -0.3% -0.1% | 1.0943 0.1% 0.1% | 1.0931 0.2% 0.1% | 1.0906 0.4% 0.2% | 1.0906 0.4% 0.0% | 1.0866 0.8% 0.4% |
| USD/ AUD 0.7586 1.3182 -1.0% 0.0% | 0.7606 1.3148 0.3% 0.3% | 0.7539 1.3264 -0.6% -0.9% | 0.7562 1.3224 -0.3% 0.3% | 0.7569 1.3212 -0.2% 0.1% | 0.7617 1.3129 0.4% 0.6% |
| 10Y Note 1.732 | 1.722 | 1.760 | 1.780 | 1.738 | 1.791 |
| 2Y Note 0.834 | 0.834 | 0.874 | 0.871 | 0.835 | 0.835 |
| German Bond 2Y -0.66 10Y -0.02 | 2Y -0.66 10Y 0.06 | 2Y -0.67 10Y 0.02 | 2Y -0.66 10Y 0.07 | 2Y -0.66 10Y 0.04 | 2Y -0.66 10Y 0.06 |
| DJIA 18240.49 -0.4% -0.2% | 18329.04 0.5% 0.5% | 18128.66 -0.6% -1.1% | 18144.20 -0.5% 0.1% | 18098.94 -0.8% -0.2% | 18138.38 -0.6% 0.2% |
| Dow Global 2463.46 0.2% -0.2% | 2474.04 0.4% 0.4% | 2444.60 -0.8% -1.2% | 2432.37 -1.3% -0.5% | 2415.96 -1.9% -0.7% | 2427.89 -1.4% 0.5% |
| DJ Asia Pacific 1481.44 0.5% 0.0% | 1480.62 -0.1% -0.1% | 1472.73 -0.6% -0.5% | 1461.21 -1.4% -0.8% | 1454.21 -1.8% -0.5% | 1456.40 -1.7% 0.2% |
| Nikkei 16860.09 2.5% -0.2% | 16860.09 0.0% 0.0% | 17024.76 1.0% 1.0% | 16840.00 -0.1% -1.1% | 16774.24 -0.5% -0.4% | 16856.37 0.0% 0.5% |
| Shanghai 3004.70 0.0% 0.0% | 3048.14 1.4% 1.4% | 3065.25 2.0% 0.6% | 3058.50 1.8% -0.2% | 3061.35 1.9% 0.1% | 3063.81 2.0% 0.1% |
| DAX 10490.86 -0.2% -0.7% | 10624.08 1.3% 1.3% | 10577.16 0.8% -0.4% | 10523.07 0.3% -0.5% | 10414.07 -0.7% -1.0% | 10580.38 0.9% 1.6% |
| DJ UBS Comm. NA | NA | NA | NA | NA | NA |
| WTI $/B 49.81 3.3% -1.2% | 51.35 3.1% 3.1% | 50.79 2.0% -1.1% | 50.18 0.7% -1.2% | 50.44 1.3% 0.5% | 50.35 1.1% -0.2% |
| Brent $/B 51.93 5.8% -1.1% | 53.14 2.3% 2.3% | 52.41 0.9% -1.4% | 51.81 -0.2% -1.1% | 52.03 0.2% 0.4% | 51.95 0.0% -0.2% |
| 44Gold $/OZ 1248.9 -4.9% -0.1% | 1257.5 0.7% 0.7% | 1253.0 0.3% -0.4% | 1251.1 0.2% -0.2% | 1255.0 0.5% 0.3% | 1253.1 0.3% -0.2% |
Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss
Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce
Sources: http://www.bloomberg.com/markets/
http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata
Table VI-6, updated with every blog comment, shows that exchange rate valuations affect a large variety of countries, in fact, almost the entire world, in magnitudes that cause major problems for domestic monetary policy and trade flows. Dollar devaluation/fluctuation is expected to continue because of zero fed funds rate, expectations of rising inflation, large budget deficit of the federal government (http://professional.wsj.com/article/SB10001424052748703907004576279321350926848.html?mod=WSJ_hp_LEFTWhatsNewsCollection) and now near zero interest rates indefinitely but with interruptions caused by risk aversion events. The euro has devalued 44.9 percent relative to the dollar from the high on Jul 15, 2008 to Oct 14, 2016. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). The British pound (GBP) devalued 13.9 percent from the trough of ₤1.388 on Jan 2, 2009 to ₤1.2188 on Oct 14, 2016 and devalued 64.6 percent from the high of ₤2.006 on Sep 15, 2008. Such similar event actually occurred in the week of Sep 23, 2011 reversing the devaluation of the dollar in the form of sharp appreciation of the dollar relative to other currencies from all over the world including the offshore Chinese yuan market. The Bank of England reduced the Bank Rate to 0.25 percent on Aug 4, 2016, and announced new measures of quantitative easing (http://www.bankofengland.co.uk/publications/Pages/news/2016/008.aspx). Column “Peak” in Table VI-6 shows exchange rates during the crisis year of 2008.
Table VI-6, Exchange Rates
| Peak | Trough | ∆% P/T | Oct 14, 2016 | ∆% T Oct 14, 2016 | ∆% P Oct 14, 2016 | |
| EUR USD | 7/15 | 6/7 2010 | 10/14/ 2016 | |||
| Rate | 1.59 | 1.192 | 1.0972 | |||
| ∆% | -33.4 | -8.7 | -44.9 | |||
| JPY USD | 8/18 | 9/15 | 10/14/ 2016 | |||
| Rate | 110.19 | 83.07 | 104.17 | |||
| ∆% | 24.6 | -25.4 | 5.5 | |||
| CHF USD | 11/21 2008 | 12/8 2009 | 10/14/ 2016 | |||
| Rate | 1.225 | 1.025 | 0.9904 | |||
| ∆% | 16.3 | 3.4 | 19.2 | |||
| USD GBP | 7/15 | 1/2/ 2009 | 10/14/ 2016 | |||
| Rate | 2.006 | 1.388 | 1.2188 | |||
| ∆% | -44.5 | -13.9 | -64.6 | |||
| USD AUD | 7/15 2008 | 10/27 2008 | 10/14/ 2016 | |||
| Rate | 1.0215 | 1.6639 | 0.7617 | |||
| ∆% | -62.9 | 21.1 | -28.5 | |||
| ZAR USD | 10/22 2008 | 8/15 | 10/14/ 2016 | |||
| Rate | 11.578 | 7.238 | 14.3207 | |||
| ∆% | 37.5 | -97.9 | -23.7 | |||
| SGD USD | 3/3 | 8/9 | 10/14/ 2016 | |||
| Rate | 1.553 | 1.348 | 1.3903 | |||
| ∆% | 13.2 | -3.1 | 10.5 | |||
| HKD USD | 8/15 2008 | 12/14 2009 | 10/14/ 2016 | |||
| Rate | 7.813 | 7.752 | 7.7586 | |||
| ∆% | 0.8 | -0.1 | 0.7 | |||
| BRL USD | 12/5 2008 | 4/30 2010 | 10/14/ 2016 | |||
| Rate | 2.43 | 1.737 | 3.2059 | |||
| ∆% | 28.5 | -84.6 | -31.9 | |||
| CZK USD | 2/13 2009 | 8/6 2010 | 10/14/ 2016 | |||
| Rate | 22.19 | 18.693 | 24.630 | |||
| ∆% | 15.7 | -31.8 | -11.0 | |||
| SEK USD | 3/4 2009 | 8/9 2010 | 10/14/ 2016 | |||
| Rate | 9.313 | 7.108 | 8.8401 | |||
| ∆% | 23.7 | -24.4 | 5.1 | |||
| CNY USD | 7/20 2005 | 7/15 | 10/14/ 2016 | |||
| Rate | 8.2765 | 6.8211 | 6.7296 | 1.3 | 18.7 | |
| ∆% | 17.6 |
Symbols: USD: US dollar; EUR: euro; JPY: Japanese yen; CHF: Swiss franc; GBP: UK pound; AUD: Australian dollar; ZAR: South African rand; SGD: Singapore dollar; HKD: Hong Kong dollar; BRL: Brazil real; CZK: Czech koruna; SEK: Swedish krona; CNY: Chinese yuan; P: peak; T: trough
Note: percentages calculated with currencies expressed in units of domestic currency per dollar; negative sign means devaluation and no sign appreciation
Source:
http://professional.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000
ESIII IMF View of World Economy and Finance. The International Financial Institutions (IFI) consist of the International Monetary Fund, World Bank Group, Bank for International Settlements (BIS) and the multilateral development banks, which are the European Investment Bank, Inter-American Development Bank and the Asian Development Bank (Pelaez and Pelaez, International Financial Architecture (2005), The Global Recession Risk (2007), 8-19, 218-29, Globalization and the State, Vol. II (2008b), 114-48, Government Intervention in Globalization (2008c), 145-54). There are four types of contributions of the IFIs:
1. Safety Net. The IFIs contribute to crisis prevention and crisis resolution.
i. Crisis Prevention. An important form of contributing to crisis prevention is by surveillance of the world economy and finance by regions and individual countries. The IMF and World Bank conduct periodic regional and country evaluations and recommendations in consultations with member countries and also jointly with other international organizations. The IMF and the World Bank have been providing the Financial Sector Assessment Program (FSAP) by monitoring financial risks in member countries that can serve to mitigate them before they can become financial crises.
ii. Crisis Resolution. The IMF jointly with other IFIs provides assistance to countries in resolution of those crises that do occur. Currently, the IMF is cooperating with the government of Greece, European Union and European Central Bank in resolving the debt difficulties of Greece as it has done in the past in numerous other circumstances. Programs with other countries involved in the European debt crisis may also be developed.
2. Surveillance. The IMF conducts surveillance of the world economy, finance and public finance with continuous research and analysis. Important documents of this effort are the World Economic Outlook (http://www.imf.org/external/ns/cs.aspx?id=29), Global Financial Stability Report (http://www.imf.org/external/pubs/ft/gfsr/index.htm) and Fiscal Monitor (http://www.imf.org/external/ns/cs.aspx?id=262).
3. Infrastructure and Development. The IFIs also engage in infrastructure and development, in particular the World Bank Group and the multilateral development banks.
4. Soft Law. Significant activity by IFIs has consisted of developing standards and codes under multiple forums. It is easier and faster to negotiate international agreements under soft law that are not binding but can be very effective (on soft law see Pelaez and Pelaez, Globalization and the State, Vol. II (2008c), 114-25). These norms and standards can solidify world economic and financial arrangements.
The objective of this section is to analyze current projections of the IMF database for the most important indicators.
Table I-1 is constructed with the database of the IMF (http://www.imf.org/external/ns/cs.aspx?id=29) to show GDP in dollars in 2015 and the growth rate of real GDP of the world and selected regional countries from 2015 to 2018. The data illustrate the concept often repeated of “two-speed recovery” of the world economy from the recession of 2007 to 2009. The IMF has changed its forecast of the world economy to 3.2 percent in 2015 and 3.1 percent in 2016 but accelerating to 3.4 percent in 2017 and 3.6 percent in 2018. Slow-speed recovery occurs in the “major advanced economies” of the G7 that account for $34.171 billion of world output of $73,599 billion, or 46.4 percent, but are projected to grow at much lower rates than world output, 1.7 percent on average from 2015 to 2018, in contrast with 3.3 percent for the world as a whole. While the world would grow 14.0 percent in the four years from 2015 to 2017, the G7 as a whole would grow 6.9 percent. The difference in dollars of 2015 is high: growing by 14.0 percent would add around $10.3 trillion of output to the world economy, or roughly, two times the output of the economy of Japan of $4,124 billion but growing by 6.9 percent would add $5.1 trillion of output to the world, or about the output of Japan in 2015. The “two speed” concept is in reference to the growth of the 150 countries labeled as emerging and developing economies (EMDE) with joint output in 2019 of $29,039 billion, or 39.5 percent of world output. The EMDEs would grow cumulatively 18.8 percent or at the average yearly rate of 4.4 percent, contributing $5.5 trillion from 2015 to 2017 or the equivalent of somewhat more than one half the GDP of $11,182 billion of China in 2014. The final four countries in Table I-1 often referred as BRIC (Brazil, Russia, India, China), are large, rapidly growing emerging economies. Their combined output in 2015 adds to $16,354 billion, or 22.2 percent of world output, which is equivalent to 47.9 percent of the combined output of the major advanced economies of the G7.
Table I-1, IMF World Economic Outlook Database Projections of Real GDP Growth
| GDP USD 2015 | Real GDP ∆% | Real GDP ∆% | Real GDP ∆% | Real GDP ∆% | |
| World | 73,599 | 3.2 | 3.1 | 3.4 | 3.6 |
| G7 | 34,171 | 1.9 | 1.4 | 1.7 | 1.7 |
| Canada | 1,551 | 1.1 | 1.2 | 1.9 | 1.9 |
| France | 2,420 | 1.3 | 1.3 | 1.4 | 1.6 |
| DE | 3,365 | 1.5 | 1.7 | 1.4 | 1.4 |
| Italy | 1,816 | 0.8 | 0.8 | 0.9 | 1.1 |
| Japan | 4,124 | 0.5 | 0.5 | 0.6 | 0.5 |
| UK | 2,858 | 2.2 | 1.8 | 1.1 | 1.7 |
| US | 18,037 | 2.6 | 1.6 | 2.2 | 2.1 |
| Euro Area | 11,601 | 2.1 | 1.7 | 1.5 | 1.6 |
| DE | 3,365 | 1.5 | 1.7 | 1.4 | 1.4 |
| France | 2,420 | 1.3 | 1.3 | 1.4 | 1.6 |
| Italy | 1,816 | 0.8 | 0.8 | 0.9 | 1.1 |
| POT | 199 | 1.5 | 1.1 | 1.1 | 1.2 |
| Ireland | 283 | 26.3 | 4.9 | 3.2 | 3.1 |
| Greece | 195 | -0.2 | 0.1 | 2.8 | 3.1 |
| Spain | 1,200 | 3.2 | 3.1 | 2.2 | 1.9 |
| EMDE | 29,039 | 4.0 | 4.2 | 4.6 | 4.8 |
| Brazil | 1,773 | -3.8 | -3.3 | 0.5 | 1.5 |
| Russia | 1,326 | -3.7 | -0.8 | 1.1 | 1.2 |
| India | 2,073 | 7.6 | 7.6 | 7.6 | 7.7 |
| China | 11,182 | 6.9 | 6.6 | 6.2 | 6.0 |
Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries); POT: Portugal
Source: IMF World Economic Outlook databank
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
Continuing high rates of unemployment in advanced economies constitute another characteristic of the database of the WEO (http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx). Table I-2 is constructed with the WEO database to provide rates of unemployment from 2014 to 2018 for major countries and regions. In fact, unemployment rates for 2014 in Table I-2 are high for all countries: unusually high for countries with high rates most of the time and unusually high for countries with low rates most of the time. The rates of unemployment are particularly high in 2014 for the countries with sovereign debt difficulties in Europe: 13.9 percent for Portugal (POT), 11.3 percent for Ireland, 26.5 percent for Greece, 24.4 percent for Spain and 12.6 percent for Italy, which is lower but still high. The G7 rate of unemployment is 6.4 percent. Unemployment rates are not likely to decrease substantially if slow growth persists in advanced economies.
Table I-2, IMF World Economic Outlook Database Projections of Unemployment Rate as Percent of Labor Force
| % Labor Force 2014 | % Labor Force 2015 | % Labor Force 2016 | % Labor Force 2017 | % Labor Force 2018 | |
| World | NA | NA | NA | NA | NA |
| G7 | 6.4 | 5.8 | 5.5 | 5.4 | 5.4 |
| Canada | 6.9 | 6.9 | 7.0 | 7.1 | 6.9 |
| France | 10.3 | 10.4 | 9.8 | 9.6 | 9.3 |
| DE | 5.0 | 4.6 | 4.3 | 4.5 | 4.6 |
| Italy | 12.6 | 11.9 | 11.5 | 11.2 | 10.8 |
| Japan | 3.6 | 3.4 | 3.2 | 3.2 | 3.2 |
| UK | 6.2 | 5.4 | 5.0 | 5.2 | 5.4 |
| US | 6.2 | 5.3 | 5.0 | 4.8 | 4.7 |
| Euro Area | 11.7 | 10.9 | 10.0 | 9.7 | 9.3 |
| DE | 5.0 | 4.6 | 4.3 | 4.5 | 4.6 |
| France | 10.3 | 10.4 | 9.8 | 9.6 | 9.3 |
| Italy | 12.6 | 11.9 | 11.5 | 11.2 | 10.8 |
| POT | 13.9 | 12.4 | 11.2 | 10.7 | 10.3 |
| Ireland | 11.3 | 9.5 | 8.3 | 7.7 | 7.2 |
| Greece | 26.5 | 25.0 | 23.3 | 21.5 | 20.7 |
| Spain | 24.4 | 22.1 | 19.4 | 18.0 | 17.0 |
| EMDE | NA | NA | NA | NA | NA |
| Brazil | 6.8 | 8.5 | 11.2 | 11.5 | 11.1 |
| Russia | 5.2 | 5.6 | 5.8 | 5.9 | 5.5 |
| India | NA | NA | NA | NA | NA |
| China | 4.1 | 4.1 | 4.1 | 4.1 | 4.1 |
Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)
Source: IMF World Economic Outlook
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
The database of the WEO (http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx) is used to construct the debt/GDP ratios of regions and countries in Table I-3. The concept used is general government debt, which consists of central government debt, such as Treasury debt in the US, and all state and municipal debt. Net debt is provided for all countries except for the only available gross debt for China, Russia and India. The net debt/GDP ratio of the G7 increases from 82.8 in 2014 to 84.4 in 2017. G7 debt is pulled by the high debt of Japan that grows from 126.2 percent of GDP in 2014 to 132.6 percent of GDP in 2018. US general government debt increases from 80.3 percent of GDP in 2014 to 82.1 percent of GDP in 2018. Debt/GDP ratios of countries with sovereign debt difficulties in Europe are particularly worrisome. General government net debts of Italy, Greece and Portugal exceed 100 percent of GDP or are expected to exceed 100 percent of GDP by 2018. The only country with relatively lower debt/GDP ratio is Spain with 78.6 in 2015, increasing to 82.3 in 2018. Ireland’s debt/GDP ratio decreases from 86.3 in 2014 to 59.8 in 2018. Fiscal adjustment, voluntary or forced by defaults, may squeeze further economic growth and employment in many countries as analyzed by Blanchard (2012WEOApr). Defaults could feed through exposures of banks and investors to financial institutions and economies in countries with sounder fiscal affairs.
Table I-3, IMF World Economic Outlook Database Projections, General Government Net Debt as Percent of GDP
| % Debt/ | % Debt/ | % Debt/ | % Debt/ | % Debt/ | |
| World | NA | NA | NA | NA | NA |
| G7 | 82.8 | 82.1 | 84.3 | 84.7 | 84.4 |
| Canada | 28.1 | 26.3 | 26.9 | 25.3 | 23.6 |
| France | 87.4 | 88.2 | 89.2 | 89.8 | 90.0 |
| DE | 50.1 | 47.5 | 45.4 | 43.7 | 42.0 |
| Italy | 112.5 | 113.3 | 113.8 | 113.9 | 112.7 |
| Japan | 126.2 | 125.3 | 127.9 | 130.7 | 132.6 |
| UK | 79.5 | 80.4 | 80.5 | 80.3 | 80.0 |
| US | 80.3 | 79.8 | 82.2 | 82.3 | 82.1 |
| Euro Area | 68.3 | 67.6 | 67.4 | 67.0 | 66.2 |
| DE | 50.1 | 47.5 | 45.4 | 43.7 | 42.0 |
| France | 87.4 | 88.2 | 89.2 | 89.8 | 90.0 |
| Italy | 112.5 | 113.3 | 113.8 | 113.9 | 112.7 |
| POT | 120.0 | 121.6 | 121.9 | 122.2 | 122.2 |
| Ireland | 86.3 | 67.0 | 63.8 | 62.3 | 59.8 |
| Greece* | 180.1 | 176.9 | 183.4 | 184.7 | 184.7 |
| Spain | 78.6 | 79.7 | 81.4 | 82.1 | 82.3 |
| EMDE* | 40.7 | 44.6 | 47.2 | 48.9 | 50.3 |
| Brazil | 33.1 | 36.2 | 45.8 | 50.4 | 53.6 |
| Russia* | 15.9 | 16.4 | 17.1 | 17.9 | 18.6 |
| India* | 68.3 | 69.1 | 68.5 | 67.2 | 65.6 |
| China* | 39.8 | 42.9 | 46.3 | 49.9 | 52.6 |
Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries); *General Government Gross Debt as percent of GDP
Source: IMF World Economic Outlook databank
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
The primary balance consists of revenues less expenditures but excluding interest revenues and interest payments. It measures the capacity of a country to generate sufficient current revenue to meet current expenditures. There are various countries with primary surpluses in 2014: Germany 1.7 percent and Italy 1.4 percent. There are also various countries with expected primary surpluses by 2018: Portugal 1.2 percent, Italy 2.1 percent and so on. Most countries in Table I-4 face significant fiscal adjustment in the future without “fiscal space.” Investors in government securities may require higher yields when the share of individual government debts hit saturation shares in portfolios. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:
(Mt + Bt)/Pt = Et∫(1/Rt, t+τ)st+τdτ (1)
Equation (1) expresses the monetary, Mt, and debt, Bt, liabilities of the government, divided by the price level, Pt, in terms of the expected value discounted by the ex-post rate on government debt, Rt, t+τ, of the future primary surpluses st+τ, which are equal to Tt+τ – Gt+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post Rt, t+τ. Expectations by investors of future primary balances of indebted governments may be less optimistic than those in Table I-4 because of government revenues constrained by low growth and government expenditures rigid because of entitlements. Political realities may also jeopardize structural reforms and fiscal austerity.
Table I-4, IMF World Economic Outlook Database Projections of General Government Primary Net Lending/Borrowing as Percent of GDP
| % GDP 2014 | % GDP 2015 | % GDP 2016 | % GDP 2017 | % GDP 2018 | |
| World | NA | NA | NA | NA | NA |
| G7 | -2.0 | -1.5 | -1.9 | -1.8 | -1.4 |
| Canada | 0.0 | -0.6 | -2.0 | -2.0 | -1.9 |
| France | -1.9 | -1.6 | -1.5 | -1.5 | -1.2 |
| DE | 1.7 | 2.0 | 1.2 | 1.0 | 0.9 |
| Italy | 1.4 | 1.4 | 1.3 | 1.4 | 2.1 |
| Japan | -5.6 | -4.9 | -5.2 | -5.3 | -4.7 |
| UK | -3.8 | -2.8 | -1.6 | -1.0 | -0.4 |
| US | -2.2 | -1.5 | -2.1 | -1.8 | -1.3 |
| Euro Area | -0.2 | 0.1 | -0.1 | 0.0 | 0.3 |
| DE | 1.7 | 2.0 | 1.2 | 1.0 | 0.9 |
| France | -1.9 | -1.6 | -1.5 | -1.5 | -1.2 |
| Italy | 1.4 | 1.4 | 1.3 | 1.4 | 2.1 |
| POT | -2.8 | -0.2 | 1.3 | 1.2 | 1.2 |
| Ireland | -0.3 | 0.3 | 1.3 | 1.4 | 1.5 |
| Greece | 0.0 | 0.7 | 0.1 | 0.7 | 1.6 |
| Spain | -2.9 | -2.4 | -2.0 | -0.8 | -0.5 |
| EMDE | -0.9 | -2.7 | -2.9 | -2.4 | -1.7 |
| Brazil | -0.6 | -1.9 | -2.8 | -2.2 | -1.2 |
| Russia | -0.7 | -3.2 | -3.4 | -0.8 | 0.1 |
| India | -2.8 | -2.3 | -2.1 | -2.1 | -1.8 |
| China | -0.4 | -2.1 | -2.2 | -2.3 | -1.7 |
*General Government Net Lending/Borrowing
Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)
Source: IMF World Economic Outlook databank
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
The database of the World Economic Outlook of the IMF (http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx) is used to obtain government net lending/borrowing as percent of GDP in Table I-5. Interest on government debt is added to the primary balance to obtain overall government fiscal balance in Table I-5. For highly indebted countries there is an even tougher challenge of fiscal consolidation. Adverse expectations on the success of fiscal consolidation may drive up yields on government securities that could create hurdles to adjustment, growth and employment.
Table I-5, IMF World Economic Outlook Database Projections of General Government Net Lending/Borrowing as Percent of GDP
| % GDP 2014 | % GDP 2015 | % GDP 2016 | % GDP 2017 | % GDP 2018 | |
| World | NA | NA | NA | NA | NA |
| G7 | -3.8 | -3.2 | -3.6 | -3.3 | -2.8 |
| Canada | -0.5 | -1.3 | -2.5 | -2.3 | -2.0 |
| France | -4.0 | -3.5 | -3.4 | -3.0 | -2.7 |
| DE | 0.3 | 0.7 | 0.1 | 0.1 | 0.2 |
| Italy | -3.0 | -2.6 | -2.5 | -2.2 | -1.3 |
| Japan | -6.2 | -5.2 | -5.2 | -5.1 | -4.4 |
| UK | -5.6 | -4.2 | -3.3 | -2.7 | -2.2 |
| US | -4.2 | -3.5 | -4.1 | -3.7 | -3.3 |
| Euro Area | -2.6 | -2.1 | -2.0 | -1.7 | -1.4 |
| DE | 0.3 | 0.7 | 0.1 | 0.1 | 0.2 |
| France | -4.0 | -3.5 | -3.4 | -3.0 | -2.7 |
| Italy | -3.0 | -2.6 | -2.5 | -2.2 | -1.3 |
| POT | -7.2 | -4.4 | -3.0 | -3.0 | -2.9 |
| Ireland | -3.7 | -1.9 | -0.7 | -0.5 | -0.3 |
| Greece | -4.1 | -3.1 | -3.4 | -2.7 | -1.7 |
| Spain | -5.9 | -5.1 | -4.5 | -3.1 | -2.7 |
| EMDE | -2.5 | -4.5 | -4.7 | -4.4 | -3.8 |
| Brazil | -6.0 | -10.3 | -10.4 | -9.1 | -8.0 |
| Russia | -1.1 | -3.5 | -3.9 | -1.5 | -0.8 |
| India | -7.3 | -6.9 | -6.7 | -6.6 | -6.2 |
| China | -0.9 | -2.7 | -3.0 | -3.3 | -3.0 |
Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)
Source: IMF World Economic Outlook databank
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
There were some hopes that the sharp contraction of output during the global recession would eliminate current account imbalances. Table I-6 constructed with the database of the WEO (http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx) shows that external imbalances have been maintained in the form of current account deficits and surpluses. China’s current account surplus is 2.6 percent of GDP for 2014 and is projected to stabilize at 1.4 percent of GDP in 2018. At the same time, the current account deficit of the US is 2.3 percent of GDP in 2015 and is projected at 2.8 percent of GDP in 2018. The current account surplus of Germany is 7.3 percent for 2014 and remains at a high 7.7 percent of GDP in 2018. Japan’s current account surplus is 0.8 percent of GDP in 2015 and increases to 3.3 percent of GDP in 2018.
Table I-6, IMF World Economic Outlook Databank Projections, Current Account of Balance of Payments as Percent of GDP
| % CA/ | % CA/ | % CA/ | % CA/ | % CA/ | |
| World | NA | NA | NA | NA | NA |
| G7 | -0.7 | -0.6 | -0.5 | -0.5 | -0.6 |
| Canada | -2.3 | -3.2 | -3.7 | -3.1 | -2.8 |
| France | -1.1 | -0.2 | -0.5 | -0.4 | -0.3 |
| DE | 7.3 | 8.4 | 8.6 | 8.1 | 7.7 |
| Italy | 1.9 | 2.2 | 2.2 | 1.9 | 1.5 |
| Japan | 0.8 | 3.3 | 3.7 | 3.3 | 3.3 |
| UK | -4.7 | -5.4 | -5.9 | -4.3 | -3.9 |
| US | -2.3 | -2.6 | -2.5 | -2.7 | -2.8 |
| Euro Area | 2.5 | 3.2 | 3.4 | 3.1 | 2.9 |
| DE | 7.3 | 8.4 | 8.6 | 8.1 | 7.7 |
| France | -1.1 | -0.2 | -0.5 | -0.4 | -0.3 |
| Italy | 1.9 | 2.2 | 2.2 | 1.9 | 1.5 |
| POT | 0.1 | 0.4 | 0.0 | -0.7 | -0.8 |
| Ireland | 1.7 | 10.2 | 9.5 | 9.1 | 8.8 |
| Greece | -2.1 | 0.0 | 0.0 | 0.0 | 0.1 |
| Spain | 1.0 | 1.3 | 1.9 | 1.7 | 1.7 |
| EMDE | 0.6 | -0.1 | -0.3 | -0.4 | -0.5 |
| Brazil | -4.3 | -3.3 | -0.8 | -1.3 | -1.5 |
| Russia | 2.8 | 5.2 | 3.0 | 3.5 | 3.9 |
| India | -1.3 | -1.1 | -1.4 | -2.0 | -2.2 |
| China | 2.6 | 3.0 | 2.4 | 1.6 | 1.4 |
Notes; DE: Germany; EMDE: Emerging and Developing Economies (150 countries)
Source: IMF World Economic Outlook databank
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
The G7 meeting in Washington on Apr 21 2006 of finance ministers and heads of central bank governors of the G7 established the “doctrine of shared responsibility” (G7 2006Apr):
“We, Ministers and Governors, reviewed a strategy for addressing global imbalances. We recognized that global imbalances are the product of a wide array of macroeconomic and microeconomic forces throughout the world economy that affect public and private sector saving and investment decisions. We reaffirmed our view that the adjustment of global imbalances:
- Is shared responsibility and requires participation by all regions in this global process;
- Will importantly entail the medium-term evolution of private saving and investment across countries as well as counterpart shifts in global capital flows; and
- Is best accomplished in a way that maximizes sustained growth, which requires strengthening policies and removing distortions to the adjustment process.
In this light, we reaffirmed our commitment to take vigorous action to address imbalances. We agreed that progress has been, and is being, made. The policies listed below not only would be helpful in addressing imbalances, but are more generally important to foster economic growth.
- In the United States, further action is needed to boost national saving by continuing fiscal consolidation, addressing entitlement spending, and raising private saving.
- In Europe, further action is needed to implement structural reforms for labor market, product, and services market flexibility, and to encourage domestic demand led growth.
- In Japan, further action is needed to ensure the recovery with fiscal soundness and long-term growth through structural reforms.
Others will play a critical role as part of the multilateral adjustment process.
- In emerging Asia, particularly China, greater flexibility in exchange rates is critical to allow necessary appreciations, as is strengthening domestic demand, lessening reliance on export-led growth strategies, and actions to strengthen financial sectors.
- In oil-producing countries, accelerated investment in capacity, increased economic diversification, enhanced exchange rate flexibility in some cases.
- Other current account surplus countries should encourage domestic consumption and investment, increase micro-economic flexibility and improve investment climates.
We recognized the important contribution that the IMF can make to multilateral surveillance.”
The concern at that time was that fiscal and current account global imbalances could result in disorderly correction with sharp devaluation of the dollar after an increase in premiums on yields of US Treasury debt (see Pelaez and Pelaez, The Global Recession Risk (2007)). The IMF was entrusted with monitoring and coordinating action to resolve global imbalances. The G7 was eventually broadened to the formal G20 in the effort to coordinate policies of countries with external surpluses and deficits.
The database of the WEO (http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx) is used to construct Table I-7 with fiscal and current account imbalances projected for 2016 and 2018. The WEO finds the need to rebalance external and domestic demand (IMF 2011WEOSep xvii):
“Progress on this front has become even more important to sustain global growth. Some emerging market economies are contributing more domestic demand than is desirable (for example, several economies in Latin America); others are not contributing enough (for example, key economies in emerging Asia). The first set needs to restrain strong domestic demand by considerably reducing structural fiscal deficits and, in some cases, by further removing monetary accommodation. The second set of economies needs significant currency appreciation alongside structural reforms to reduce high surpluses of savings over investment. Such policies would help improve their resilience to shocks originating in the advanced economies as well as their medium-term growth potential.”
The IMF (2012WEOApr, XVII) explains decreasing importance of the issue of global imbalances as follows:
“The latest developments suggest that global current account imbalances are no longer expected to widen again, following their sharp reduction during the Great Recession. This is largely because the excessive consumption growth that characterized economies that ran large external deficits prior to the crisis has been wrung out and has not been offset by stronger consumption in .surplus economies. Accordingly, the global economy has experienced a loss of demand and growth in all regions relative to the boom years just before the crisis. Rebalancing activity in key surplus economies toward higher consumption, supported by more market-determined exchange rates, would help strengthen their prospects as well as those of the rest of the world.”
The IMF (http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/c4.pdf) analyzes global imbalances as:
- Global current account imbalances have narrowed by more than a third from
their peak in 2006. Key imbalances—the large deficit of the United States and
the large surpluses of China and Japan—have more than halved.
- The narrowing in imbalances has largely been driven by demand contraction
(“expenditure reduction”) in deficit economies.
- Exchange rate adjustment has facilitated rebalancing in China and the United
States, but in general the contribution of exchange rate changes (“expenditure
switching”) to current account adjustment has been relatively modest.
- The narrowing of imbalances is expected to be durable, as domestic demand in
deficit economies is projected to remain well below pre-crisis trends.
- Since flow imbalances have narrowed but not reversed, net creditor and debtor
positions have widened further. Weak growth has also contributed to still high
ratios of net external liabilities to GDP in some debtor economies.
- Risks of a disruptive adjustment in global current account balances have
decreased, but global demand rebalancing remains a policy priority. Stronger
external demand will be instrumental for reviving growth in debtor countries and
reducing their net external liabilities.”
Table I-7, Fiscal Deficit, Current Account Deficit and Government Debt as % of GDP and 2015 Dollar GDP
| GDP 2016 | FD | CAD | Debt | FD%GDP | CAD%GDP | Debt | |
| US | 18562 | -2.1 | -2.5 | 82.2 | -1.3 | -2.8 | 82.1 |
| Japan | 4730 | -5.2 | 3.7 | 127.9 | -4.7 | 3.3 | 132.6 |
| UK | 2650 | -1.6 | -5.9 | 80.5 | -0.4 | -3.9 | 80.0 |
| Euro | 11991 | -0.1 | 3.4 | 67.4 | 0.3 | 2.9 | 66.2 |
| Ger | 3495 | 1.2 | 8.6 | 45.4 | 0.9 | 7.7 | 42.0 |
| France | 2488 | -1.5 | -0.5 | 89.2 | -1.2 | -0.3 | 90.0 |
| Italy | 1853 | 1.3 | 2.2 | 113.8 | 2.1 | 1.5 | 112.7 |
| Can | 1532 | -2.0 | -3.7 | 26.9 | -1.9 | -2.8 | 23.6 |
| China | 11392 | -2.2 | 2.4 | 46.3 | -1.7 | 1.4 | 52.6 |
| Brazil | 1770 | -2.8 | -0.8 | 45.8 | -1.2 | -1.5 | 53.6 |
Note: GER = Germany; Can = Canada; FD = fiscal deficit; CAD = current account deficit
FD is primary except total for China; Debt is net except gross for China
Source: IMF World Economic Outlook databank
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
Brazil faced in the debt crisis of 1982 a more complex policy mix. Between 1977 and 1983, Brazil’s terms of trade, export prices relative to import prices, deteriorated 47 percent and 36 percent excluding oil (Pelaez 1987, 176-79; Pelaez 1986, 37-66; see Pelaez and Pelaez, The Global Recession Risk (2007), 178-87). Brazil had accumulated unsustainable foreign debt by borrowing to finance balance of payments deficits during the 1970s. Foreign lending virtually stopped. The German mark devalued strongly relative to the dollar such that Brazil’s products lost competitiveness in Germany and in multiple markets in competition with Germany. The resolution of the crisis was devaluation of the Brazilian currency by 30 percent relative to the dollar and subsequent maintenance of parity by monthly devaluation equal to inflation and indexing that resulted in financial stability by parity in external and internal interest rates avoiding capital flight. With a combination of declining imports, domestic import substitution and export growth, Brazil followed rapid growth in the US and grew out of the crisis with surprising GDP growth of 4.5 percent in 1984.
The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the Subsection IIIF Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 30, 2011, the yield of the 2-year bond of the government of Greece was quoted around 100 percent. In contrast, the 2-year US Treasury note traded at 0.239 percent and the 10-year at 2.871 percent while the comparable 2-year government bond of Germany traded at 0.14 percent and the 10-year government bond of Germany traded at 1.83 percent. There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt exceeding 100 percent of GDP, which is the third largest in the world after the US and Japan. Appendix IIIE links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).
Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.
Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:
“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”
If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.
The prospects of survival of the euro zone are dire. Table I-8 is constructed with IMF World Economic Outlook database (http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx) for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2016.
Table I-8, World and Selected Regional and Country GDP and Fiscal Situation
| GDP 2016 | Primary Net Lending Borrowing | General Government Net Debt | |
| World | 75,213 | ||
| Euro Zone | 11,991 | -0.1 | 67.4 |
| Portugal | 206 | 1.3 | 121.9 |
| Ireland | 308 | 1.3 | 63.8 |
| Greece | 195 | -3.4 | 183.4** |
| Spain | 1,252 | -2.0 | 81.4 |
| Major Advanced Economies G7 | 35,310 | -1.9 | 84.3 |
| United States | 18,562 | -2.1 | 82.2 |
| UK | 2,650 | -1.6 | 80.5 |
| Germany | 3,495 | 1.2 | 45.4 |
| France | 2,488 | -1.5 | 89.2 |
| Japan | 4,730 | -5.2 | 127.9 |
| Canada | 1,532 | -2.0 | 26.9 |
| Italy | 1,852 | 1.3 | 113.8 |
| China | 11,392 | -2.2 | 46.3*** |
*Net Lending/borrowing**Gross Debt
Source: IMF World Economic Outlook
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
The data in Table I-8 are used for some very simple calculations in Table I-9. The column “Net Debt USD Billions 2016” in Table I-9 is generated by applying the percentage in Table I-8 column “General Government Net Debt % GDP 2016” to the column “GDP 2016 USD Billions.” The total debt of France and Germany in 2016 is $3806.0 billion, as shown in row “B+C” in column “Net Debt USD Billions 2016.” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $3391.9 billion, adding rows D+E+F+G+H in column “Net Debt USD billions 2016.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table I-9. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $7197.9 billion, which would be equivalent to 120.3 percent of their combined GDP in 2016. Under this arrangement, the entire debt of selected members of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 205.9 percent if including debt of France and 142.4 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks. Analysis of fiscal stress is quite difficult without including another global recession in an economic cycle that is already mature by historical experience.
Table I-9, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %
| Net Debt USD Billions 2016 | Debt as % of Germany Plus France GDP | Debt as % of Germany GDP | |
| A Euro Area | 8,081.9 | ||
| B Germany | 1,586.7 | $7197.9 as % of $3495 =205.9% $4978.6 as % of $3495 =142.4% | |
| C France | 2,219.3 | ||
| B+C | 3,806.0 | GDP $5983 Total Debt $7,197.9 Debt/GDP: 120.3% | |
| D Italy | 2,107.6 | ||
| E Spain | 1,019.1 | ||
| F Portugal | 251.1 | ||
| G Greece | 357.6 | ||
| H Ireland | 196.5 | ||
| Subtotal D+E+F+G+H | 3,391.9 |
Source: calculation with IMF data IMF World Economic Outlook databank
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
World trade projections of the IMF are in Table I-10. There is decreasing growth of the volume of world trade of goods and services from 2.6 percent in 2015 to 2.3 percent in 2016, increasing to 3.8 percent in 2017. Growth improves to 4.1 percent on average from 2017 to 2021. World trade would be slower for advanced economies while emerging and developing economies (EMDE) experience faster growth. World economic slowdown would be more challenging with lower growth of world trade.
Table I-10, IMF, Projections of World Trade, USD Billions, USD/Barrel and Annual ∆%
| 2015 | 2016 | 2017 | Average ∆% 2017-2021 | |
| World Trade Volume (Goods and Services) | 2.6 | 2.3 | 3.8 | 4.1 |
| Exports Goods & Services | 2.7 | 2.2 | 3.5 | 4.0 |
| Imports Goods & Services | 2.4 | 2.3 | 4.0 | 4.2 |
| Average Oil Price USD/Barrel | 50.79 | 42.96 | 50.64 | Average ∆% 2008-2017 79.16 |
| Average Annual ∆% Export Unit Value of Manufactures | -2.9 | -2.1 | 1.4 | Average ∆% 2008-2017 0.4 |
| Exports of Goods & Services | 2015 | 2016 | 2017 | Average ∆% 2008-2017 |
| EMDE | 1.3 | 2.9 | 3.6 | 3.7 |
| G7 | 3.6 | 1.8 | 3.5 | 2.5 |
| Imports Goods & Services | ||||
| EMDE | -0.6 | 2.3 | 4.1 | 4.5 |
| G7 | 4.2 | 2.4 | 3.9 | 2.1 |
| Terms of Trade of Goods & Services | ||||
| EMDE | -4.1 | -1.0 | -0.1 | -0.1 |
| G7 | 1.8 | 0.9 | 0.1 | 0.1 |
| Terms of Trade of Goods | ||||
| EMDE | -4.0 | -1.0 | 0.1 | -0.1 |
| G7 | 1.8 | 1.2 | 0.2 | 0.0 |
Notes: Commodity Price Index includes Fuel and Non-fuel Prices; Commodity Industrial Inputs Price includes agricultural raw materials and metal prices; Oil price is average of WTI, Brent and Dubai
Source: International Monetary Fund World Economic Outlook databank
http://www.imf.org/external/pubs/ft/weo/2016/02/weodata/index.aspx
ESIV Recovery without Hiring. Professor Edward P. Lazear (2012Jan19) at Stanford University finds that recovery of hiring in the US to peaks attained in 2007 requires an increase of hiring by 30 percent while hiring levels increased by only 4 percent from Jan 2009 to Jan 2012. The high level of unemployment with low level of hiring reduces the statistical probability that the unemployed will find a job. According to Lazear (2012Jan19), the probability of finding a new job in early 2012 is about one third of the probability of finding a job in 2007. Improvements in labor markets have not increased the probability of finding a new job. Lazear (2012Jan19) quotes an essay coauthored with James R. Spletzer in the American Economic Review (Lazear and Spletzer 2012Mar, 2012May) on the concept of churn. A dynamic labor market occurs when a similar amount of workers is hired as those who are separated. This replacement of separated workers is called churn, which explains about two-thirds of total hiring. Typically, wage increases received in a new job are higher by 8 percent. Lazear (2012Jan19) argues that churn has declined 35 percent from the level before the recession in IVQ2007. Because of the collapse of churn, there are no opportunities in escaping falling real wages by moving to another job. As this blog argues, there are meager chances of escaping unemployment because of the collapse of hiring and those employed cannot escape falling real wages by moving to another job (Section II and earlier http://cmpassocregulationblog.blogspot.com/2016/09/interest-rate-uncertainty-and-valuation.html). Lazear and Spletzer (2012Mar, 1) argue that reductions of churn reduce the operational effectiveness of labor markets. Churn is part of the allocation of resources or in this case labor to occupations of higher marginal returns. The decline in churn can harm static and dynamic economic efficiency. Losses from decline of churn during recessions can affect an economy over the long-term by preventing optimal growth trajectories because resources are not used in the occupations where they provide highest marginal returns. Lazear and Spletzer (2012Mar 7-8) conclude that: “under a number of assumptions, we estimate that the loss in output during the recession [of 2007 to 2009] and its aftermath resulting from reduced churn equaled $208 billion. On an annual basis, this amounts to about .4% of GDP for a period of 3½ years.”
There are two additional facts discussed below: (1) there are about ten million fewer full-time jobs currently than before the recession of 2008 and 2009; and (2) the extremely high and rigid rate of youth unemployment is denying an early start to young people ages 16 to 24 years while unemployment of ages 45 years or over has swelled. There are four subsections. IA1 Hiring Collapse provides the data and analysis on the weakness of hiring in the United States economy. IA2 Labor Underutilization provides the measures of labor underutilization of the Bureau of Labor Statistics (BLS). Statistics on the decline of full-time employment are in IA3 Ten Million Fewer Full-time Jobs. IA4 Theory and Reality of Cyclical Slow Growth Not Secular Stagnation: Youth and Middle-Age Unemployment provides the data on high unemployment of ages 16 to 24 years and of ages 45 years or over.
Total nonfarm hiring (HNF), total private hiring (HP) and their respective rates are in Table I-3 for the month of Aug in the years from 2001 to 2016. Hiring numbers are in thousands. There is recovery in HNF from 4185 thousand (or 4.2 million) in Aug 2009 to 4317 thousand in Aug 2010, 4602 thousand in Aug 2011, 4918 thousand in Aug 2012, 5256 thousand in Aug 2013, 5264 thousand in Aug 2014, 5640 thousand in Aug 2015 and 5761 thousand in Aug 2016 for cumulative gain of 37.7 percent at average rate of 4.7 percent per year. HP rose from 3702 thousand in Aug 2009 to 3888 thousand in Aug 2010, 4189 thousand in Aug 2011, 4381 thousand in Aug 2012, 4713 thousand in Aug 2013, 4792 thousand in Aug 2014, 5011 in Aug 2015 and 5119 thousand in Aug 2016 for cumulative gain of 38.3 percent at the average yearly rate of 4.7 percent. HNF has decreased from 5772 thousand in Aug 2006 to 5761 thousand in Aug 2016 or by 0.2 percent. HP has decreased from 5142 thousand in Aug 2006 to 5119 thousand in Aug 2016 or by 0.4 percent. The civilian noninstitutional population of the US, or those in condition of working, rose from 229.167 million in Aug 2006 to 253.854 million in Aug 2016, by 24.687 million or 10.8 percent. There is often ignored ugly fact that hiring decreased by around 0.4 percent while population available for working increased around 10.8 percent. Private hiring of 59.206 million in 2006 was equivalent to 25.9 percent of the civilian noninstitutional population of 228.815, or those in condition of working, falling to 57.557 million in 2015 or 22.9 percent of the civilian noninstitutional population of 250.801 million in 2015. The percentage of hiring in civilian noninstitutional population of 25.9 percent in 2006 would correspond to 64.957 million of hiring in 2015, which would be 7.400 million higher than actual 57.557 million in 2015. 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. Cyclical slow growth over the entire business cycle from IVQ2007 to the present in comparison with earlier cycles and long-term trend (http://cmpassocregulationblog.blogspot.com/2016/10/mediocre-cyclical-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2016/08/and-as-ever-economic-outlook-is.html) explains the fact that there are many million fewer hires in the US than before the global recession. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.
Table I-3, US, Total Nonfarm Hiring (HNF) and Total Private Hiring (HP) in the US in
Thousands and in Percentage of Total Employment Not Seasonally Adjusted
| HNF | Rate RNF | HP | Rate HP | |
| 2001 Aug | 5421 | 4.1 | 4867 | 4.4 |
| 2002 Aug | 5238 | 4.0 | 4696 | 4.3 |
| 2003 Aug | 4985 | 3.8 | 4621 | 4.2 |
| 2004 Aug | 5540 | 4.2 | 5057 | 4.5 |
| 2005 Aug | 5903 | 4.4 | 5394 | 4.7 |
| 2006 Aug | 5772 | 4.2 | 5142 | 4.4 |
| 2007 Aug | 5662 | 4.1 | 5011 | 4.3 |
| 2008 Aug | 4964 | 3.6 | 4504 | 3.9 |
| 2009 Aug | 4185 | 3.2 | 3702 | 3.4 |
| 2010 Aug | 4317 | 3.3 | 3888 | 3.6 |
| 2011 Aug | 4602 | 3.5 | 4189 | 3.8 |
| 2012 Aug | 4918 | 3.7 | 4381 | 3.9 |
| 2013 Aug | 5256 | 3.9 | 4713 | 4.1 |
| 2014 Aug | 5264 | 3.8 | 4792 | 4.0 |
| 2015 Aug | 5640 | 4.0 | 5011 | 4.1 |
| 2016 Aug | 5761 | 4.0 | 5119 | 4.2 |
Source: Bureau of Labor Statistics
Chart I-6 provides total nonfarm hiring on a monthly basis from 2001 to 2016. Nonfarm hiring rebounded in early 2010 but then fell and stabilized at a lower level than the early peak not-seasonally adjusted (NSA) of 4815 in May 2010 until it surpassed it with 5006 in Jun 2011 but declined to 3092 in Dec 2012. Nonfarm hiring fell to 2997 in Dec 2011 from 3814 in Nov 2011 and to revised 3629 in Feb 2012, increasing to 4197 in Mar 2012, 3092 in Dec 2012 and 4238 in Jan 2013 and declining to 3690 in Feb 2013. Nonfarm hires not seasonally adjusted increased to 4257 in Nov 2013 and 3223 in Dec 2013. Nonfarm hires reached 3730 in Dec 2014, 3919 in Dec 2015 and 5761 in Aug 2016. Chart I-6 provides seasonally adjusted (SA) monthly data. The number of seasonally-adjusted hires in Oct 2011 was 4239 thousand, increasing to revised 4470 thousand in Feb 2012, or 5.4 percent, moving to 4345 in Dec 2012 for cumulative increase of 2.6 percent from 4234 in Dec 2011 and 4488 in Dec 2013 for increase of 3.3 percent relative to 4345 in Dec 2012. The number of hires not seasonally adjusted was 5006 in Jun 2011, falling to 2997 in Dec 2011 but increasing to 4110 in Jan 2012 and declining to 3092 in Dec 2012. The number of nonfarm hiring not seasonally adjusted fell by 40.1 percent from 5006 in Jun 2011 to 2997 in Dec 2011 and fell 40.1 percent from 5162 in Jun 2012 to 3092 in Dec 2012 in a yearly-repeated seasonal pattern. The number of nonfarm hires not seasonally adjusted fell from 5114 in Jun 2013 to 3223 in Dec 2013, or decline of 37.0 percent, showing strong seasonality. The number of nonfarm hires not seasonally adjusted fell from 5570 in Jun 2014 to 3730 in Dec 2014 or 33.0 percent. The level of nonfarm hires fell from 5918 in Jun 2015 to 3919 in Dec 2015 or 33.8 percent.
Chart I-6, US, Total Nonfarm Hiring (HNF), 2001-2016 Month SA
Source: Bureau of Labor Statistics
Similar behavior occurs in the rate of nonfarm hiring in Chart I-7. Recovery in early 2010 was followed by decline and stabilization at a lower level but with stability in monthly SA estimates of 3.2 in Aug 2011 to 3.2 in Jan 2012, increasing to 3.3 in May 2012 and stabilizing to 3.3 in Jun 2012. The rate stabilized at 3.2 in Jul 2012, increasing to 3.3 in Aug 2012 but falling to 3.2 in Dec 2012 and 3.3 in Dec 2013. The rate not seasonally adjusted fell from 3.8 in Jun 2011 to 2.2 in Dec 2011, climbing to 3.8 in Jun 2012 but falling to 2.3 in Dec 2012. The rate of nonfarm hires not seasonally adjusted fell from 3.7 in Jun 2013 to 2.3 in Dec 2013. The NSA rate of nonfarm hiring fell from 4.0 in Jun 2014 to 2.6 in Dec 2014. The NSA rate fell from 4.1 in Jun 2015 to 2.7 in Dec 2015. Rates of nonfarm hiring NSA were in the range of 2.7 (Dec) to 4.4 (Jun) in 2006. The rate of nonfarm hiring SA stood at 3.6 in Aug 2016 and at 4.0 NSA.
Chart I-7, US, Rate Total Nonfarm Hiring, Month SA 2001-2016
Source: Bureau of Labor Statistics
There is only milder improvement in total private hiring shown in Chart I-8. Hiring private (HP) rose in 2010 with stability and renewed increase in 2011 followed by almost stationary series in 2012. The number of private hiring seasonally adjusted fell from 4043 thousand in Sep 2011 to 3933 in Dec 2011 or by 2.7 percent, decreasing to 4015 in Jan 2012 or decline by 0.7 percent relative to the level in Sep 2011. Private hiring fell to 3961 in Sep 2012 or lower by 2.0 percent relative to Sep 2011, moving to 4049 in Dec 2012 for increase of 0.8 percent relative to 4015 in Jan 2012. The number of private hiring not seasonally adjusted fell from 4626 in Jun 2011 to 2817 in Dec 2011 or by 39.1 percent, reaching 3855 in Jan 2012 or decline of 16.7 percent relative to Jun 2011 and moving to 2911 in Dec 2012 or 38.8 percent lower relative to 4757 in Jun 2012. Hires not seasonally adjusted fell from 4761 in Jun 2013 to 3059 in Dec 2013. The level of private hiring NSA fell from 5151 in Jun 2014 to 3532 in Dec 2014 or 31.4 percent. The level of private hiring fell from 5475 in Jun 2015 to 3697 in Dec 2015 or 32.5 percent. Companies reduce hiring in the latter part of the year that explains the high seasonality in year-end employment data. For example, NSA private hiring fell from 5614 in Jun 2006 to 3579 in Dec 2006 or by 36.2 percent. Private hiring NSA data are useful in showing the huge declines from the period before the global recession. HNF has decreased from 5772 thousand in Aug 2006 to 5761 thousand in Aug 2016 or by 0.2 percent. HP has decreased from 5142 thousand in Aug 2006 to 5119 thousand in Aug 2016 or by 0.4 percent. The civilian noninstitutional population of the US, or those in condition of working, rose from 229.167 million in Aug 2006 to 253.854 million in Aug 2016, by 24.687 million or 10.8 percent. There is often ignored ugly fact that hiring decreased by around 0.4 percent while population available for working increased around 10.8 percent. Private hiring of 59.206 million in 2006 was equivalent to 25.9 percent of the civilian noninstitutional population of 228.815, or those in condition of working, falling to 57.557 million in 2015 or 22.9 percent of the civilian noninstitutional population of 250.801 million in 2015. The percentage of hiring in civilian noninstitutional population of 25.9 percent in 2006 would correspond to 64.957 million of hiring in 2015, which would be 7.400 million higher than actual 57.557 million in 2015. 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. Cyclical slow growth over the entire business cycle from IVQ2007 to the present in comparison with earlier cycles and long-term trend (http://cmpassocregulationblog.blogspot.com/2016/10/mediocre-cyclical-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2016/08/and-as-ever-economic-outlook-is.html) explains the fact that there are many million fewer hires in the US than before the global recession. The labor market continues to be fractured, failing to provide an opportunity to exit from unemployment/underemployment or to find an opportunity for advancement away from declining inflation-adjusted earnings.
Chart I-8, US, Total Private Hiring Month SA 2001-2016
Source: Bureau of Labor Statistics
Chart I-9 shows similar behavior in the rate of private hiring. The rate in 2011 in monthly SA data did not rise significantly above the peak in 2010. The rate seasonally adjusted fell from 3.7 in Sep 2011 to 3.5 in Dec 2011 and reached 3.6 in Dec 2012 and 3.6 in Dec 2013. The rate not seasonally adjusted (NSA) fell from 3.7 in Sep 2011 to 2.5 in Dec 2011, increasing to 3.8 in Oct 2012 but falling to 2.6 in Dec 2012 and 3.4 in Mar 2013. The NSA rate of private hiring fell from 4.8 in Jul 2006 to 3.4 in Aug 2009 but recovery was insufficient to only 3.9 in Aug 2012, 2.6 in Dec 2012 and 2.6 in Dec 2013. The NSA rate increased to 3.0 in Dec 2015 and 4.6 in Aug
2016.
Chart I-9, US, Rate Total Private Hiring Month SA 2001-2016
Source: Bureau of Labor Statistics
ESV Ten Million Fewer Full-time Jobs. There is strong seasonality in US labor markets around the end of the year.
- Seasonally adjusted part-time for economic reasons. The number employed part-time for economic reasons because they could not find full-time employment fell from 9.166 million in Sep 2011 to 7.793 million in Mar 2012, seasonally adjusted, or decline of 1.373 million in six months, as shown in Table I-9. The number employed part-time for economic reasons rebounded to 8.667 million in Sep 2012 for increase of 669,000 in one month from Aug to Sep 2012. The number employed part-time for economic reasons declined to 8.229 million in Oct 2012 or by 438,000 again in one month, further declining to 8.150 million in Nov 2012 for another major one-month decline of 79,000 and 7.922 million in Dec 2012 or fewer 228,000 in just one month. The number employed part-time for economic reasons increased to 8.030 million in Jan 2013 or 108,000 more than in Dec 2012 and to 8.089 million in Feb 2013, declining to 7.901 million in May 2013 but increasing to 8.104 million in Jun 2013. The number employed part-time for economic reasons fell to 7.837 million in Aug 2013 for decline of 256,000 in one month from 8.093 million in Jul 2013. The number employed part-time for economic reasons increased 171,000 from 7.837 million in Aug 2013 to 8.008 million in Sep 2013. The number part-time for economic reasons rose to 8.028 million in Oct 2013, falling by 320,000 to 7.708 million in Nov 2013. The number part-time for economic reasons increased to 7.763 million in Dec 2013, decreasing to 7.250 million in Jan 2014. The number employed part-time for economic reasons fell from 7.250 million in Jan 2014 to 7.230 million in Feb 2014. The number employed part-time for economic reasons increased to 7.428 million in Mar 2014 and 7.452 million in Apr 2014. The number employed part-time for economic reasons fell to 7.219 million in May 2014, increasing to 7.473 million in Jun 2014. The level employed part-time for economic reasons fell to 7.440 million in Jul 2014 and 7.213 million in Aug 2014. The level employed part-time for economic reasons fell to 7.124 million in Sep 2014, 7.065 million in Oct 2014 and 6.844 million in Nov 2014. The level employed part-time for economic reasons fell to 6.786 million in Dec 2014, increasing to 6.784 million in Jan 2015. The level employed part-time for economic reasons fell to 6.630 million in Feb 2015, increasing to 6.673 million in Mar 2015. The level of employed part-time for economic reasons fell to 6.549 million in Apr 2015, increasing to 6.600 million in May 2015. The level employed part-time for economic reasons fell to 6.465 million in Jun 2015 and 6.300 million in Jul 2015. The level employed part-time for economic reasons increased to 6.481 million in Aug 2015, declining to 6.034 million in Sep 2015. The level employed part-time for economic reasons fell to 5.761 million in Oct 2015, increasing to 6.085 million in Nov 2015. The level of part-time for economic reasons fell to 6.022 million in Dec 2015, decreasing to 5.998 million in Jan 2016. The level employed part-time for economic reasons did not change to 5.988 in Feb 2016 and increased to 6.123 million in Mar 2016. The level employed part-time for economic reasons fell to 5.962 million in Apr 2016 and increased to 6.430 million in May 2016. The level of part-time for economic reasons fell to 5.843 million in Jun 2016, increasing to 5.940 million in Jul 2016. The level of part-time for economic reasons increased to 6.053 million in Aug 2016, decreasing to 5.894 million in Sep 2016. There is an increase of 231,000 in part-time for economic reasons from Aug 2012 to Oct 2012 and of 152,000 from Aug 2012 to Nov 2012.
- Seasonally adjusted full-time. The number employed full-time increased from 112.923 million in Oct 2011 to 115.023 million in Mar 2012 or 2.100 million but then fell to 114.224 million in May 2012 or 0.799 million fewer full-time employed than in Mar 2012. The number employed full-time increased from 114.750 million in Aug 2012 to 115.558 million in Oct 2012 or increase of 0.808 million full-time jobs in two months and further to 115.759 million in Jan 2013 or increase of 1.009 million more full-time jobs in five months from Aug 2012 to Jan 2013. The number of full time jobs decreased slightly to 115.689 million in Feb 2013, increasing to 116.211 million in May 2013 and 116.120 million in Jun 2013. Then number of full-time jobs increased to 116.156 million in Jul 2013, 116.475 million in Aug 2013 and 116.907 million in Sep 2013. The number of full-time jobs fell to 116.345 million in Oct 2013 and increased to 117.044 in Nov 2013. The level of full-time jobs increased to 117.307 million in Dec 2013, increasing to 117.568 million in Jan 2014 and 117.765 million in Feb 2014. The level of employment full-time increased to 117.950 million in Mar 2014 and 118.466 million in Apr 2014. The level of full-time employment reached 118.746 million in May 2014, decreasing to 118.233 million in Jun 2014. The level of full-time jobs increased to 118.454 million in Jul 2014 and 118.778 million in Aug 2014. The level of full-time jobs increased to 119.364 million in Sep 2014, 119.745 million in Oct 2014 and 119.641 million in Nov 2014. The level of full-time jobs increased to 119.999 million in Dec 2014 and 120.662 million in Jan 2015. The level of full-time jobs increased to 120.788 million in Feb 2015 and 120.976 million in Mar 2015. The level of full-time jobs decreased to 120.799 million in Apr 2015, increasing to 121.415 million in May 2015 and decreasing to 121.056 million in Jun 2015. The level of full-time jobs increased to 121.641 million in Jul 2015 and increased to 122.045 million in Aug 2015, decreasing to 121.873 million in Sep 2015. The level of full-time jobs increased to 122.054 million in Oct 2015 and increased to 122.099 million in Nov 2015. The level of full-time jobs increased to 122.603 million in Dec 2015 and 123.141 million in Jan 2016. The level of full-time jobs increased to 123.206 million in Feb 2016 and increased to 123.447 million in Mar 2016. The level of full-time jobs decreased to 123.194 million in Apr 2016 and 123.135 million in May 2016. The level of full-time jobs increased to 123.586 million in Jun 2016, increasing to 123.892 million in Jul 2016. The level of full-time jobs increased to 124.301 million in Aug 2016, decreasing to 124.296 million in Sep 2016. Adjustments of benchmark and seasonality-factors at the turn of every year could affect comparability of labor market indicators (http://cmpassocregulationblog.blogspot.com/2016/02/fluctuating-risk-financial-assets-in.html http://cmpassocregulationblog.blogspot.com/2015/02/job-creation-and-monetary-policy-twenty.html http://cmpassocregulationblog.blogspot.com/2014/02/financial-instability-rules.html http://cmpassocregulationblog.blogspot.com/2013/02/thirty-one-million-unemployed-or.html).
- Not seasonally adjusted part-time for economic reasons. The number of employed part-time for economic reasons actually increased without seasonal adjustment from 8.271 million in Nov 2011 to 8.428 million in Dec 2011 or by 157,000 and then to 8.918 million in Jan 2012 or by an additional 490,000 for cumulative increase from Nov 2011 to Jan 2012 of 647,000. The level of employed part-time for economic reasons then fell from 8.918 million in Jan 2012 to 7.867 million in Mar 2012 or by 1.051 million and to 7.694 million in Apr 2012 or 1.224 million fewer relative to Jan 2012. In Aug 2012, the number employed part-time for economic reasons reached 7.842 million NSA or 148,000 more than in Apr 2012. The number employed part-time for economic reasons increased from 7.842 million in Aug 2012 to 8.110 million in Sep 2012 or by 3.4 percent. The number part-time for economic reasons fell from 8.110 million in Sep 2012 to 7.870 million in Oct 2012 or by 240.000 in one month. The number employed part-time for economic reasons NSA increased to 8.628 million in Jan 2013 or 758,000 more than in Oct 2012. The number employed part-time for economic reasons fell to 8.298 million in Feb 2013, which is lower by 330,000 relative to 8.628 million in Jan 2013 but higher by 428,000 relative to 7.870 million in Oct 2012. The number employed part time for economic reasons fell to 7.734 million in Mar 2013 or 564,000 fewer than in Feb 2013 and fell to 7.709 million in Apr 2013. The number employed part-time for economic reasons reached 7.618 million in May 2013. The number employed part-time for economic reasons jumped from 7.618 million in May 2013 to 8.440 million in Jun 2013 or 822,000 in one month. The number employed part-time for economic reasons fell to 8.324 million in Jul 2013 and 7.690 million in Aug 2013. The number employed part-time for economic reasons NSA fell to 7.522 million in Sep 2013, increasing to 7.700 million in Oct 2013. The number employed part-time for economic reasons fell to 7.563 million in Nov 2013 and increased to 7.990 million in Dec 2013. The number employed part-time for economic reasons fell to 7.771 million in Jan 2014 and 7.397 million in Feb 2014. The level of part-time for economic reasons increased to 7.455 million in Mar 2014 and fell to 7.243 million in Apr 2014. The number of part-time for economic reasons fell to 6.960 million in May 2014, increasing to 7.805 million in Jun 2014. The level of part-time for economic reasons fell to 7.665 million in Jul 2014 and 7.083 million in Aug 2014. The level of part-time for economic reasons fell to 6.711 million in Sep 2014 and increased to 6.787 million in Oct 2014. The level of part-time for economic reasons reached 6.713 million in Nov 2014 and 6.970 million in Dec 2014, increasing to 7.269 million in Jan 2015. The level of part-time for economic reasons fell to 6.772 million in Feb 2015 and 6.672 million in Mar 2015, falling to 6.356 million in Apr 2015. The level of part-time for economic reasons increased to 6.363 million in May 2015 and to 6.776 million in Jun 2015, decreasing to 6.511 million in Jul 2015. The level of part-time for economic reasons fell to 6.361 million in Aug 2015 and 5.693 million in Sep 2015. The level of part-time for economic reasons fell to 5.536 million in Oct 2015, increasing to 5.967 million in Nov 2015. The level of part-time for economic reasons increased to 6.179 million in Dec 2015, increasing to 6.406 million in Jan 2016. The level of part-time for economic reasons decreased to 6.106 million in Feb 2016 and increased to 6.138 million in Mar 2016. The level of part-time for economic reasons decreased to 5.771 million in Apr 2016 and increased to 6.238 million in May 2016. The level of part-time for economic reasons decreased to 6.119 million in Jun 2016, increasing to 6.157 million in Jul 2016. The level of part-time for economic reasons fell to 5.963 million in Aug 2016, decreasing to 5.550 million in Sep 2016.
- Not seasonally adjusted full-time. The number employed full time without seasonal adjustment fell from 113.138 million in Nov 2011 to 113.050 million in Dec 2011 or by 88,000 and fell further to 111.879 in Jan 2012 for cumulative decrease of 1.259 million. The number employed full-time not seasonally adjusted fell from 113.138 million in Nov 2011 to 112.587 million in Feb 2012 or by 551.000 but increased to 116.214 million in Aug 2012 or 3.076 million more full-time jobs than in Nov 2011. The number employed full-time not seasonally adjusted decreased from 116.214 million in Aug 2012 to 115.678 million in Sep 2012 for loss of 536,000 full-time jobs and rose to 116.045 million in Oct 2012 or by 367,000 full-time jobs in one month relative to Sep 2012. The number employed full-time NSA fell from 116.045 million in Oct 2012 to 115.515 million in Nov 2012 or decline of 530.000 in one month. The number employed full-time fell from 115.515 in Nov 2012 to 115.079 million in Dec 2012 or decline by 436,000 in one month. The number employed full time fell from 115.079 million in Dec 2012 to 113.868 million in Jan 2013 or decline of 1.211 million in one month. The number of full time jobs increased to 114.191 in Feb 2012 or by 323,000 in one month and increased to 114.796 million in Mar 2013 for cumulative increase from Jan by 928,000 full-time jobs but decrease of 283,000 from Dec 2012. The number employed full time reached 117.400 million in Jun 2013 and increased to 117.688 in Jul 2013 or by 288,000. The number employed full-time reached 117.868 million in Aug 2013 for increase of 180,000 in one month relative to Jul 2013. The number employed full-time fell to 117.308 million in Sep 2013 or by 560,000. The number employed full-time fell to 116.798 million in Oct 2013 or decline of 510.000 in one month. The number employed full-time rose to 116.875 million in Nov 2013, falling to 116.661 million in Dec 2013. The number employed full-time fell to 115.744 million in Jan 2014 but increased to 116.323 million in Feb 2014. The level of full-time jobs increased to 116.985 in Mar 2014 and 118.073 million in Apr 2014. The number of full-time jobs increased to 119.179 million in May 2014, increasing to 119.472 million in Jun 2014. The level of full-time jobs increased to 119.900 million in Jul 2014. Comparisons over long periods require use of NSA data. 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 number with full-time jobs in Sep 2016 is 124.278 million, which is higher by 1.059 million relative to the peak of 123.219 million in Jul 2007.
- Loss of full-time jobs. 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 254.091 million in Sep 2016 or by 22.133 million (http://www.bls.gov/data/). The number with full-time jobs in Sep 2016 is 124.278 million, which is higher by 1.059 million relative to the peak of 123.219 million in Jul 2007. The ratio of full-time jobs of 123.219 million in Jul 2007 to civilian noninstitutional population of 231.958 million was 53.1 percent. If that ratio had remained the same, there would be 134.922 million full-time jobs with population of 254.091 million in Sep 2016 (0.531 x 254.091) or 10.644 million fewer full-time jobs relative to actual 124.278 million. There appear to be around 10 million fewer full-time jobs in the US than before the global recession while population increased around 20 million. Mediocre GDP growth is the main culprit of the fractured US labor market. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. US economic growth has been at only 2.1 percent on average in the cyclical expansion in the 28 quarters from IIIQ2009 to IIQ2016. 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 third estimate of GDP for IIQ2016 (http://www.bea.gov/newsreleases/national/gdp/2016/pdf/gdp2q16_3rd.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/2016/10/mediocre-cyclical-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2016/08/and-as-ever-economic-outlook-is.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, 4.8 percent from IQ1983 to IVQ1988, 4.8 percent from IQ1983 to IQ1989, 4.7 percent from IQ1983 to IIQ1989, 4.7 percent from IQ1983 to IIIQ1989, 4.5 percent from IQ1983 to IVQ1989 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2016/10/mediocre-cyclical-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2016/08/and-as-ever-economic-outlook-is.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 IIQ2016 would have accumulated to 28.6 percent. GDP in IIQ2016 would be $19,279.5 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2696.4 billion than actual $16,583.1 billion. There are about two trillion dollars of GDP less than at trend, explaining the 23.6 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.0 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2016/10/twenty-four-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2016/09/interest-rates-and-valuations-of-risk.html). US GDP in IIQ2016 is 14.0 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,583.1 billion in IIQ2016 or 10.6 percent at the average annual equivalent rate of 1.2 percent. Professor John H. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. Cochrane (2016May02) measures GDP growth in the US at average 3.5 percent per year from 1950 to 2000 and only at 1.76 percent per year from 2000 to 2015 with only at 2.0 percent annual equivalent in the current expansion. Cochrane (2016May02) proposes drastic changes in regulation and legal obstacles to private economic activity. 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 of manufacturing at average 3.1 percent per year from Aug 1919 to Aug 2016. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 141.0258 in Aug 2016. The actual index NSA in Aug 2016 is 104.6251, which is 27.6 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Dec 2015. Using trend growth of 2.1 percent per year, the index would increase to 129.5532 in Aug 2016. The output of manufacturing at 104.6251 in Aug 2016 is 19.2 percent below trend under this alternative calculation.
Table I-9, US, Employed Part-time for Economic Reasons, Thousands, and Full-time, Millions
| Part-time Thousands | Full-time Millions | |
| Seasonally Adjusted | ||
| Sep 2016 | 5,894 | 124.296 |
| Aug 2016 | 6,053 | 124.301 |
| Jul 2016 | 5,940 | 123.892 |
| Jun 2016 | 5,843 | 123.586 |
| May 2016 | 6,430 | 123.135 |
| Apr 2016 | 5,962 | 123.194 |
| Mar 2016 | 6,123 | 123.447 |
| Feb 2016 | 5,988 | 123.206 |
| Jan 2016 | 5,988 | 123.141 |
| Dec 2015 | 6,022 | 122.603 |
| Nov 2015 | 6,085 | 122.099 |
| Oct 2015 | 5,761 | 122.054 |
| Sep 2015 | 6,034 | 121.873 |
| Aug 2015 | 6,481 | 122.045 |
| Jul 2015 | 6,300 | 121.641 |
| Jun 2015 | 6,465 | 121.056 |
| May 2015 | 6,600 | 121.415 |
| Apr 2015 | 6,549 | 120.799 |
| Mar 2015 | 6,673 | 120.976 |
| Feb 2015 | 6,630 | 120.788 |
| Jan 2015 | 6,784 | 120.662 |
| Dec 2014 | 6,786 | 119.999 |
| Nov 2014 | 6,844 | 119.641 |
| Oct 2014 | 7,065 | 119.745 |
| Sep 2014 | 7,124 | 119.364 |
| Aug 2014 | 7,213 | 118.778 |
| Jul 2014 | 7,440 | 118.454 |
| Jun 2014 | 7,473 | 118.233 |
| May 2014 | 7,219 | 118.746 |
| Apr 2014 | 7,452 | 118.466 |
| Mar 2014 | 7,428 | 117.950 |
| Feb 2014 | 7,230 | 117.765 |
| Jan 2014 | 7,250 | 117.568 |
| Dec 2013 | 7,763 | 117.307 |
| Nov 2013 | 7,708 | 117.044 |
| Oct 2013 | 8,028 | 116.345 |
| Sep 2013 | 8,008 | 116.907 |
| Aug 2013 | 7,837 | 116.475 |
| Jul 2013 | 8,093 | 116.156 |
| Jun 2013 | 8,104 | 116.120 |
| May 2013 | 7,901 | 116.211 |
| Apr 2013 | 7,924 | 116.017 |
| Mar 2013 | 7,682 | 115.789 |
| Feb 2013 | 8,089 | 115.689 |
| Jan 2013 | 8,030 | 115.759 |
| Dec 2012 | 7,922 | 115.774 |
| Nov 2012 | 8,150 | 115.656 |
| Oct 2012 | 8,229 | 115.558 |
| Sep 2012 | 8,667 | 115.254 |
| Aug 2012 | 7,998 | 114.750 |
| Jul 2012 | 8,092 | 114.575 |
| Jun 2012 | 8,081 | 114.742 |
| May 2012 | 8,123 | 114.224 |
| Apr 2012 | 7,907 | 114.358 |
| Mar 2012 | 7,793 | 115.023 |
| Feb 2012 | 8,214 | 114.151 |
| Jan 2012 | 8,267 | 113.767 |
| Dec 2011 | 8,171 | 113.774 |
| Nov 2011 | 8,447 | 113.213 |
| Oct 2011 | 8,657 | 112.923 |
| Sep 2011 | 9,166 | 112.544 |
| Aug 2011 | 8,788 | 112.723 |
| Jul 2011 | 8,281 | 112.193 |
| Not Seasonally Adjusted | ||
| Sep 2016 | 5,550 | 124.278 |
| Aug 2016 | 5,963 | 125.892 |
| Jul 2016 | 6,157 | 125.507 |
| Jun 2016 | 6,119 | 124.903 |
| May 2016 | 6,238 | 123.548 |
| Apr 2016 | 5,771 | 122.742 |
| Mar 2016 | 6,138 | 122.522 |
| Feb 2016 | 6,106 | 121.757 |
| Jan 2016 | 6,406 | 121.411 |
| Dec 2015 | 6,179 | 122.013 |
| Nov 2015 | 5,967 | 121.897 |
| Oct 2015 | 5,536 | 122.466 |
| Sep 2015 | 5,693 | 122.303 |
| Aug 2015 | 6,361 | 123.420 |
| Jul 2015 | 6,511 | 123.142 |
| Jun 2015 | 6,776 | 122.268 |
| May 2015 | 6,363 | 121.863 |
| Apr 2015 | 6,356 | 120.402 |
| Mar 2015 | 6,672 | 119.981 |
| Feb 2015 | 6,772 | 119.313 |
| Jan 2015 | 7,269 | 118.840 |
| Dec 2014 | 6,970 | 119.394 |
| Nov 2014 | 6,713 | 119.441 |
| Oct 2014 | 6,787 | 120.176 |
| Sep 2014 | 6,711 | 119.791 |
| Aug 2014 | 7,083 | 120.110 |
| Jul 2014 | 7,665 | 119.900 |
| Jun 2014 | 7,805 | 119.472 |
| May 2014 | 6,960 | 119.179 |
| Apr 2014 | 7,243 | 118.073 |
| Mar 2014 | 7,455 | 116.985 |
| Feb 2014 | 7,397 | 116.323 |
| Jan 2014 | 7,771 | 115.774 |
| Dec 2013 | 7,990 | 116.661 |
| Nov 2013 | 7,563 | 116.875 |
| Oct 2013 | 7,700 | 116.798 |
| Sep 2013 | 7,522 | 117.308 |
| Aug 2013 | 7,690 | 117.868 |
| Jul 2013 | 8,324 | 117.688 |
| Jun 2013 | 8,440 | 117.400 |
| May 2013 | 7,618 | 116.643 |
| Apr 2013 | 7,709 | 115.674 |
| Mar 2013 | 7,734 | 114.796 |
| Feb 2013 | 8,298 | 114.191 |
| Jan 2013 | 8,628 | 113.868 |
| Dec 2012 | 8,166 | 115.079 |
| Nov 2012 | 7,994 | 115.515 |
| Oct 2012 | 7,870 | 116.045 |
| Sep 2012 | 8,110 | 115.678 |
| Aug 2012 | 7,842 | 116.214 |
| Jul 2012 | 8,316 | 116.131 |
| Jun 2012 | 8,394 | 116.024 |
| May 2012 | 7,837 | 114.634 |
| Apr 2012 | 7,694 | 113.999 |
| Mar 2012 | 7,867 | 113.916 |
| Feb 2012 | 8,455 | 112.587 |
| Jan 2012 | 8,918 | 111.879 |
| Dec 2011 | 8,428 | 113.050 |
| Nov 2011 | 8,271 | 113.138 |
| Oct 2011 | 8,258 | 113.456 |
| Sep 2011 | 8,541 | 112.980 |
| Aug 2011 | 8,604 | 114.286 |
| Jul 2011 | 8,514 | 113.759 |
| Jun 2011 | 8,738 | 113.255 |
| May 2011 | 8,270 | 112.618 |
| Apr 2011 | 8,425 | 111.844 |
| Mar 2011 | 8,737 | 111.186 |
| Feb 2011 | 8,749 | 110.731 |
| Jan 2011 | 9,187 | 110.373 |
| Dec 2010 | 9,205 | 111.207 |
| Nov 2010 | 8,670 | 111.348 |
| Oct 2010 | 8,408 | 112.342 |
| Sep 2010 | 8,628 | 112.385 |
| Aug 2010 | 8,628 | 113.508 |
| Jul 2010 | 8,737 | 113.974 |
| Jun 2010 | 8,867 | 113.856 |
| May 2010 | 8,513 | 112.809 |
| Apr 2010 | 8,921 | 111.391 |
| Mar 2010 | 9,343 | 109.877 |
| Feb 2010 | 9,282 | 109.100 |
| Jan 2010 | 9,290 | 108.777 (low) |
| Dec 2009 | 9,354 (high) | 109.875 |
| Nov 2009 | 8,894 | 111.274 |
| Oct 2009 | 8,474 | 111.599 |
| Sep 2009 | 8,255 | 111.991 |
| Aug 2009 | 8,835 | 113.863 |
| Jul 2009 | 9,103 | 114.184 |
| Jun 2009 | 9,301 | 114.014 |
| May 2009 | 8,785 | 113.083 |
| Apr 2009 | 8,648 | 112.746 |
| Mar 2009 | 9,305 | 112.215 |
| Feb 2009 | 9,170 | 112.947 |
| Jan 2009 | 8,829 | 113.815 |
| Dec 2008 | 8,250 | 116.422 |
| Nov 2008 | 7,135 | 118.432 |
| Oct 2008 | 6,267 | 120.020 |
| Sep 2008 | 5,701 | 120.213 |
| Aug 2008 | 5,736 | 121.556 |
| Jul 2008 | 6,054 | 122.378 |
| Jun 2008 | 5,697 | 121.845 |
| May 2008 | 5,096 | 120.809 |
| Apr 2008 | 5,071 | 120.027 |
| Mar 2008 | 5,038 | 119.875 |
| Feb 2008 | 5,114 | 119.452 |
| Jan 2008 | 5,340 | 119.332 |
| Dec 2007 | 4,750 | 121.042 |
| Nov 2007 | 4,374 | 121.846 |
| Oct 2007 | 4,028 | 122.006 |
| Sep 2007 | 4,137 | 121.728 |
| Aug 2007 | 4,494 | 122.870 |
| Jul 2007 | 4,516 | 123.219 (high) |
| Jun 2007 | 4,469 | 122.150 |
| May 2007 | 4,315 | 120.846 |
| Apr 2007 | 4,205 | 119.609 |
| Mar 2007 | 4,384 | 119.640 |
| Feb 2007 | 4,417 | 119.041 |
| Jan 2007 | 4,726 | 119.094 |
| Dec 2006 | 4,281 | 120.371 |
| Nov 2006 | 4,054 | 120.507 |
| Oct 2006 | 4,010 | 121.199 |
| Sep 2006 | 3,735 (low) | 120.780 |
| Aug 2006 | 4,104 | 121.979 |
| Jul 2006 | 4,450 | 121.951 |
| Jun 2006 | 4,456 | 121.070 |
| May 2006 | 3,968 | 118.925 |
| Apr 2006 | 3,787 | 118.559 |
| Mar 2006 | 4,097 | 117.693 |
| Feb 2006 | 4,403 | 116.823 |
| Jan 2006 | 4,597 | 116.395 |
Source: US Bureau of Labor Statistics
People lose their marketable job skills after prolonged unemployment and face increasing difficulty in finding another job. Chart I-18 shows the sharp rise in unemployed over 27 weeks and stabilization at an extremely high level.
Chart I-18, US, Number Unemployed for 27 Weeks or Over, Thousands SA Month 2001-2016
Sources: US Bureau of Labor Statistics
Another segment of U6 consists of people marginally attached to the labor force who continue to seek employment but less frequently on the frustration there may not be a job for them. Chart I-19 shows the sharp rise in people marginally attached to the labor force after 2007 and subsequent stabilization.
Chart I-19, US, Marginally Attached to the Labor Force, NSA Month, Thousands, 2001-2016
Sources: US Bureau of Labor Statistics
Chart I-20 provides the level of full-time jobs from 2001 to 2016. 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 254.091 million in Sep 2016 or by 22.133 million (http://www.bls.gov/data/). The number with full-time jobs in Sep 2016 is 124.278 million, which is higher by 1.059 million relative to the peak of 123.219 million in Jul 2007. The ratio of full-time jobs of 123.219 million in Jul 2007 to civilian noninstitutional population of 231.958 million was 53.1 percent. If that ratio had remained the same, there would be 134.922 million full-time jobs with population of 254.091 million in Sep 2016 (0.531 x 254.091) or 10.644 million fewer full-time jobs relative to actual 124.278 million. There appear to be around 10 million fewer full-time jobs in the US than before the global recession while population increased around 20 million. Mediocre GDP growth is the main culprit of the fractured US labor market.
There is current interest in past theories of “secular stagnation.” Alvin H. Hansen (1939, 4, 7; see Hansen 1938, 1941; for an early critique see Simons 1942) argues:
“Not until the problem of full employment of our productive resources from the long-run, secular standpoint was upon us, were we compelled to give serious consideration to those factors and forces in our economy which tend to make business recoveries weak and anaemic (sic) and which tend to prolong and deepen the course of depressions. This is the essence of secular stagnation-sick recoveries which die in their infancy and depressions which feed on them-selves and leave a hard and seemingly immovable core of unemployment. Now the rate of population growth must necessarily play an important role in determining the character of the output; in other words, the com-position of the flow of final goods. Thus a rapidly growing population will demand a much larger per capita volume of new residential building construction than will a stationary population. A stationary population with its larger proportion of old people may perhaps demand more personal services; and the composition of consumer demand will have an important influence on the quantity of capital required. The demand for housing calls for large capital outlays, while the demand for personal services can be met without making large investment expenditures. It is therefore not unlikely that a shift from a rapidly growing population to a stationary or declining one may so alter the composition of the final flow of consumption goods that the ratio of capital to output as a whole will tend to decline.”
The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). This is merely another case of theory without reality with dubious policy proposals.
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, 2001-2016
Sources: US Bureau of Labor Statistics
Chart I-20A provides the noninstitutional civilian population of the United States from 2001 to 2016. 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, 2001-2016
Sources: US Bureau of Labor Statistics
Chart I-20B provides number of full-time jobs in the US from 1968 to 2016. 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, 1968-2016
Sources: US Bureau of Labor Statistics
Chart I-20C provides the noninstitutional civilian population of the United States from 1968 to 2016. 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, 1968-2016
Sources: US Bureau of Labor Statistics
ESVI Theory and Reality of Secular Stagnation: Youth and Middle-Age Unemployment. Table EMP provides the comparison between the labor market in the current whole cycle from 2007 to 2015 and the whole cycle from 1979 to 1989. In the entire cycle from 2007 to 2015, the number employed increased 2.787 million, full-time employed increased 0.401 million, part-time for economic reasons increased 1.970 million and population increased 18.934 million. The number employed increased 1.9 percent, full-time employed increased 0.3 percent, part-time for economic reasons increased 44.8 percent and population increased 8.2 percent. There is sharp contrast with the contractions of the 1980s and with most economic history of the United States. In the whole cycle from 1979 to 1989, the number employed increased 18.518 million, full-time employed increased 14.715 million, part-time for economic reasons increased 1.317 million and population increased 21.530 million. In the entire cycle from 1979 to 1989, the number employed increased 18.7 percent, full-time employed increased 17.8 percent, part-time for economic reasons increased 36.8 percent and population increased 13.1 percent. The difference between the 1980s and the current cycle after 2007 is in the high rate of growth after the contraction that maintained trend growth around 3.0 percent for the entire cycle and per capital growth at 2.0 percent. The evident fact is that current weakness in labor markets originates in cyclical slow growth and not in imaginary secular stagnation.
Table EMP, US, Annual Level of Employed, Full-Time Employed, Employed Part-Time for Economic Reasons and Noninstitutional Civilian Population, Millions
| Employed | Full-Time Employed | Part Time Economic Reasons | Noninstitutional Civilian Population | |
| 2000s | ||||
| 2000 | 136.891 | 113.846 | 3.227 | 212.577 |
| 2001 | 136.933 | 113.573 | 3.715 | 215.092 |
| 2002 | 136.485 | 112.700 | 4.213 | 217.570 |
| 2003 | 137.736 | 113.324 | 4.701 | 221.168 |
| 2004 | 139.252 | 114.518 | 4.567 | 223.357 |
| 2005 | 141.730 | 117.016 | 4.350 | 226.082 |
| 2006 | 144.427 | 119.688 | 4.162 | 228.815 |
| 2007 | 146.047 | 121.091 | 4.401 | 231.867 |
| 2008 | 145.362 | 120.030 | 5.875 | 233.788 |
| 2009 | 139.877 | 112.634 | 8.913 | 235.801 |
| 2010 | 139.064 | 111.714 | 8.874 | 237.830 |
| 2011 | 139.869 | 112.556 | 8.560 | 239.618 |
| 2012 | 142.469 | 114.809 | 8.122 | 243.284 |
| 2013 | 143.929 | 116.314 | 7.935 | 245.679 |
| 2014 | 146.305 | 118.718 | 7.213 | 247.947 |
| 2015 | 148.834 | 121.492 | 6.371 | 250.801 |
| ∆2007-2015 | 2.787 | 0.401 | 1.970 | 18.934 |
| ∆% 2007-2015 | 1.9 | 0.3 | 44.8 | 8.2 |
| 1980s | ||||
| 1979 | 98.824 | 82.654 | 3.577 | 164.863 |
| 1980 | 99.303 | 82.562 | 4.321 | 167.745 |
| 1981 | 100.397 | 83.243 | 4.768 | 170.130 |
| 1982 | 99.526 | 81.421 | 6.170 | 172.271 |
| 1983 | 100.834 | 82.322 | 6.266 | 174.215 |
| 1984 | 105.005 | 86.544 | 5.744 | 176.383 |
| 1985 | 107.150 | 88.534 | 5.590 | 178.206 |
| 1986 | 109.597 | 90.529 | 5.588 | 180.587 |
| 1987 | 112.440 | 92.957 | 5.401 | 182.753 |
| 1988 | 114.968 | 95.214 | 5.206 | 184.613 |
| 1989 | 117.342 | 97.369 | 4.894 | 186.393 |
| ∆1979-1989 | 18.518 | 14.715 | 1.317 | 21.530 |
| ∆% 1979-1989 | 18.7 | 17.8 | 36.8 | 13.1 |
Source: Bureau of Labor Statistics
The theory of secular stagnation cannot explain sudden collapse of the US economy and labor markets. There are accentuated cyclic factors for both the entire population and the young population of ages 16 to 24 years. Table Summary Total provides the total noninstitutional population (ICP) of the US, full-time employment level (FTE), employment level (EMP), civilian labor force (CLF), civilian labor force participation rate (CLFP), employment/population ratio (EPOP) and unemployment level (UNE). Secular stagnation would spread over long periods instead of immediately. All indicators of the labor market weakened sharply during the contraction and did not recover. Population continued to grow but all other variables collapsed and did not recover. The theory of secular stagnation departs from an aggregate production function in which output grows with the use of labor, capital and technology (see Pelaez and Pelaez, Globalization and the State, Vol. I (2008a), 11-16). Hansen (1938, 1939) finds secular stagnation in lower growth of an aging population. In the current US economy, Table Summary shows that population is dynamic while the labor market is fractured. There is key explanation in the behavior of the civilian labor force participation rate (CLFP) and the employment population ratio (EPOP) that collapsed during the global recession with inadequate recovery. Abandoning job searches are difficult to capture in labor statistics but likely explain the decline in the participation of the population in the labor force. Allowing for abandoning job searches, the total number of people unemployed or underemployed is 23.6 million or 14.0 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2016/10/twenty-four-million-unemployed-or.html).
Table Summary Total, US, Total Noninstitutional Civilian Population, Full-time Employment, Employment, Civilian Labor Force, Civilian Labor Force Participation Rate, Employment Population Ratio, Unemployment, NSA, Millions and Percent
| ICP | FTE | EMP | CLF | CLFP | EPOP | UNE | |
| 2006 | 228.8 | 119.7 | 144.4 | 151.4 | 66.2 | 63.1 | 7.0 |
| 2009 | 235.8 | 112.6 | 139.9 | 154.1 | 65.4 | 59.3 | 14.3 |
| 2012 | 243.3 | 114.8 | 142.5 | 155.0 | 63.7 | 58.6 | 12.5 |
| 2013 | 245.7 | 116.3 | 143.9 | 155.4 | 63.2 | 58.6 | 11.5 |
| 2014 | 247.9 | 118.7 | 146.3 | 155.9 | 62.9 | 59.0 | 9.6 |
| 2015 | 250.8 | 121.5 | 148.8 | 157.1 | 62.7 | 59.3 | 8.3 |
| 12/07 | 233.2 | 121.0 | 146.3 | 153.7 | 65.9 | 62.8 | 7.4 |
| 9/09 | 236.3 | 112.0 | 139.1 | 153.6 | 65.0 | 58.9 | 14.5 |
| 9/16 | 254.1 | 124.7 | 152.0 | 159.6 | 62.8 | 59.8 | 7.7 |
ICP: Total Noninstitutional Civilian Population; FT: Full-time Employment Level, EMP: Total Employment Level; CLF: Civilian Labor Force; CLFP: Civilian Labor Force Participation Rate; EPOP: Employment Population Ratio; UNE: Unemployment
Source: Bureau of Labor Statistics
The same situation is present in the labor market for young people in ages 16 to 24 years with data in Table Summary Youth. The youth noninstitutional civilian population (ICP) continued to increase during and after the global recession. There is the same disastrous labor market with decline for young people in employment (EMP), civilian labor force (CLF), civilian labor force participation rate (CLFP) and employment population ratio (EPOP). There are only increases for unemployment of young people (UNE) and youth unemployment rate (UNER). If aging were a factor of secular stagnation, growth of population of young people would attract a premium in remuneration in labor markets. The sad fact is that young people are also facing tough labor markets. The application of the theory of secular stagnation to the US economy and labor markets is void of reality in the form of key facts, which are best explained by accentuated cyclic factors analyzed by Lazear and Spletzer (2012JHJul22).
Table Summary Youth, US, Youth, Ages 16 to 24 Years, Noninstitutional Civilian Population, Full-time Employment, Employment, Civilian Labor Force, Civilian Labor Force Participation Rate, Employment Population Ratio, Unemployment, NSA, Millions and Percent
| ICP | EMP | CLF | CLFP | EPOP | UNE | UNER | |
| 2006 | 36.9 | 20.0 | 22.4 | 60.6 | 54.2 | 2.4 | 10.5 |
| 2009 | 37.6 | 17.6 | 21.4 | 56.9 | 46.9 | 3.8 | 17.6 |
| 2012 | 38.8 | 17.8 | 21.3 | 54.9 | 46.0 | 3.5 | 16.2 |
| 2013 | 38.8 | 18.1 | 21.4 | 55.0 | 46.5 | 3.3 | 15.5 |
| 2014 | 38.7 | 18.4 | 21.3 | 55.0 | 47.6 | 2.9 | 13.4 |
| 2015 | 38.6 | 18.8 | 21.2 | 55.0 | 48.6 | 2.5 | 11.6 |
| 12/07 | 37.5 | 19.4 | 21.7 | 57.8 | 51.6 | 2.3 | 10.7 |
| 9/09 | 37.6 | 17.0 | 20.7 | 55.2 | 45.1 | 3.8 | 18.2 |
| 9/16 | 38.4 | 18.7 | 20.8 | 54.2 | 48.7 | 2.1 | 10.2 |
ICP: Youth Noninstitutional Civilian Population; EMP: Youth Employment Level; CLF: Youth Civilian Labor Force; CLFP: Youth Civilian Labor Force Participation Rate; EPOP: Youth Employment Population Ratio; UNE: Unemployment; UNER: Youth Unemployment Rate
Source: Bureau of Labor Statistics
Chart I-24 provides longer perspective with the rate of youth unemployment in ages 16 to 24 years from 1948 to 2016. The rate of youth unemployment rose to 20 percent during the contractions of the early 1980s and also during the contraction of the global recession in 2008 and 2009. The data illustrate again the argument in this blog that the contractions of the early 1980s are the valid framework for comparison with the global recession of 2008 and 2009 instead of misleading comparisons with the 1930s. During the initial phase of recovery, the rate of youth unemployment 16 to 24 years NSA fell from 18.9 percent in Jun 1983 to 14.5 percent in Jun 1984. In contrast, the rate of youth unemployment 16 to 24 years was nearly the same during the expansion after IIIQ2009: 17.5 percent in Dec 2009, 16.7 percent in Dec 2010, 15.5 percent in Dec 2011, 15.2 percent in Dec 2012, 17.6 percent in Jan 2013, 16.7 percent in Feb 2013, 15.9 percent in Mar 2013, 15.1 percent in Apr 2013. The rate of youth unemployment was 16.4 percent in May 2013, 18.0 percent in Jun 2013, 16.3 percent in Jul 2013 and 15.6 percent in Aug 2013. In Sep 2006, the rate of youth unemployment was 10.5 percent, increasing to 14.8 percent in Sep 2013. The rate of youth unemployment was 10.3 in Oct 2007, increasing to 14.4 percent in Oct 2013. The rate of youth unemployment was 10.3 percent in Nov 2007, increasing to 13.1 percent in Nov 2013. The rate of youth unemployment was 10.7 percent in Dec 2013, increasing to 12.3 percent in Dec 2013. The rate of youth unemployment was 10.9 percent in Jan 2007, increasing to 14.9 percent in Jan 2014. The rate of youth unemployment was 10.3 percent in Feb 2007, increasing to 14.9 percent in Feb 2014. The rate of youth unemployment was 9.7 percent in Mar 2007, increasing to 14.3 percent in Mar 2014. The rate of youth unemployment was 9.7 percent in Apr 2007, increasing to 11.9 percent in Apr 2014. The rate of youth unemployment was 10.2 percent in May 2007, increasing to 13.4 percent in May 2014. The rate of youth unemployment was 12.0 percent in Jun 2007, increasing to 15.0 percent in Jun 2014. The rate of youth unemployment was 10.8 percent in Jul 2007, increasing to 14.3 percent in Jul 2014. The rate of youth unemployment was 10.5 percent in Aug 2007, increasing to 13.0 percent in Aug 2014. The rate of youth unemployment was 11.0 percent in Sep 2007, increasing to 13.6 percent in Sep 2014. The rate of youth unemployment increased from 10.3 in Oct 2007 to 12.2 in Oct 2014. The rate of youth unemployment increased from 10.3 percent in Nov 2007 to 11.7 percent in Nov 2014. The rate of youth unemployment increased from 10.7 in Dec 2007 to 11.2 in Dec 2014. The rate of youth unemployment increased from 9.7 in Mar 2007 to 12.3 in Mar 2015. The rate of youth unemployment increased from 9.7 in Apr 2007 to 10.7 in Apr 2015. The rate of youth unemployment increased from 10.2 in May 2007 to 12.3 in May 2015. The rate of youth unemployment increased from 12.0 in Jun 2007 to 13.7 in Jun 2015. The rate of youth unemployment increased from 10.8 in Jul 2007 to 12.2 in Jul 2015. The rate of youth unemployment increased from 10.5 in Aug 2007 to 10.9 in Aug 2015. The rate of youth unemployment decreased from 11.0 in Sep 2007 to 10.9 in Sep 2015. The rate of youth unemployment increased from 10.3 in Oct 2007 to 10.6 in Oct 2015, decreasing to 10.4 in Nov 2015. The rate of youth unemployment decreased to 10.1 in Dec 2015. The rate of youth unemployment stood at 10.8 in Jan 2016, 10.8 in Feb 2016, 10.4 in Mar 2016 and 9.9 in Apr 2016. The rate of youth unemployment increased to 10.6 in May 2016 and 12.3 in Jun 2016. The rate of youth unemployment fell to 11.5 in Jul 2016, decreasing to 10.1 in Aug 2016. The rate of youth unemployment increased to 10.2 in Sep 2016. The actual rate is higher because of the difficulty in counting those dropping from the labor force because they believe there are no jobs available for them. The difference originates in the vigorous seasonally adjusted annual equivalent average rate of GDP growth of 5.9 percent during the recovery from IQ1983 to IVQ1985 and 4.5 percent from IQ1983 to IVQ1989 compared with 2.1 percent on average during the first 28 quarters of expansion from IIIQ2009 to IIQ2016. US economic growth has been at only 2.1 percent on average in the cyclical expansion in the 28 quarters from IIIQ2009 to IIQ2016. 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 third estimate of GDP for IIQ2016 (http://www.bea.gov/newsreleases/national/gdp/2016/pdf/gdp2q16_3rd.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/2016/10/mediocre-cyclical-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2016/08/and-as-ever-economic-outlook-is.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, 4.8 percent from IQ1983 to IVQ1988, 4.8 percent from IQ1983 to IQ1989, 4.7 percent from IQ1983 to IIQ1989, 4.7 percent from IQ1983 to IIIQ1989, 4.5 percent from IQ1983 to IVQ1989 and at 7.8 percent from IQ1983 to IVQ1983 (http://cmpassocregulationblog.blogspot.com/2016/10/mediocre-cyclical-united-states.html and earlier http://cmpassocregulationblog.blogspot.com/2016/08/and-as-ever-economic-outlook-is.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 IIQ2016 would have accumulated to 28.6 percent. GDP in IIQ2016 would be $19,279.5 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2696.4 billion than actual $16,583.1 billion. There are about two trillion dollars of GDP less than at trend, explaining the 23.6 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.0 percent of the effective labor force (http://cmpassocregulationblog.blogspot.com/2016/10/twenty-four-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2016/09/interest-rates-and-valuations-of-risk.html). US GDP in IIQ2016 is 14.0 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,583.1 billion in IIQ2016 or 10.6 percent at the average annual equivalent rate of 1.2 percent. Professor John H. Cochrane (2014Jul2) estimates US GDP at more than 10 percent below trend. Cochrane (2016May02) measures GDP growth in the US at average 3.5 percent per year from 1950 to 2000 and only at 1.76 percent per year from 2000 to 2015 with only at 2.0 percent annual equivalent in the current expansion. Cochrane (2016May02) proposes drastic changes in regulation and legal obstacles to private economic activity. 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 of manufacturing at average 3.1 percent per year from Aug 1919 to Aug 2016. Growth at 3.1 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 141.0258 in Aug 2016. The actual index NSA in Aug 2016 is 104.6251, which is 27.6 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Dec 2015. Using trend growth of 2.1 percent per year, the index would increase to 129.5532 in Aug 2016. The output of manufacturing at 104.6251 in Aug 2016 is 19.2 percent below trend under this alternative calculation.
Chart I-24, US, Unemployment Rate 16-24 Years, Percent NSA, 1948-2016
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
Chart I-25 provides the level unemployed ages 45 years and over. There was an increase in the recessions of the 1980s, 1991 and 2001 followed by declines to earlier levels. The current expansion of the economy after IIIQ2009 has not been sufficiently vigorous to reduce significantly middle-age unemployment. Recent improvements could be illusory because many abandoned job searches in frustration that there may not be jobs for them and are not counted as unemployed.
Chart I-25, US, Unemployment Level Ages 45 Years and Over, Thousands, NSA, 1976-2016
Source: US Bureau of Labor Statistics http://www.bls.gov/data/
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016.
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