Sunday, April 2, 2017

Mediocre Cyclical Economic Growth with GDP Two Trillion Dollars below Trend, Stagnating Real Private Fixed Investment, Swelling Undistributed Corporate Profits, United States Commercial Banks Assets and Liabilities, Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities, World Cyclical Slow Growth and Global Recession Risk: Part I

 

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Mediocre Cyclical Economic Growth with GDP Two Trillion Dollars below Trend, Stagnating Real Private Fixed Investment, Swelling Undistributed Corporate Profits, United States Commercial Banks Assets and Liabilities, Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities, World Cyclical Slow Growth and Global Recession Risk

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017

I Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend

IA Mediocre Cyclical United States Economic Growth

IA1 Stagnating Real Private Fixed Investment

IA2 Swelling Undistributed Corporate Profits

IIA United States Commercial Banks Assets and Liabilities

IA Transmission of Monetary Policy

IB Functions of Banking

IC United States Commercial Banks Assets and Liabilities

ID Theory and Reality of Economic History, Cyclical Slow Growth Not Secular Stagnation and Monetary Policy Based on Fear of Deflation

II Unresolved US Balance of Payments Deficits and Fiscal Imbalance Threatening Risk Premium on Treasury Securities

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

I Mediocre Cyclical United States Economic Growth with GDP Two Trillion Dollars below Trend. Section IA Mediocre Cyclical United States Economic Growth provides the analysis of long-term and cyclical growth of GDP in the US with GDP two trillion dollars or 14.1 percent below trend. Section IA1 Stagnating Real Private Fixed Investment analyzes weakness in investment. Section IA2 Swelling Undistributed Corporate Profits provides evidence and analysis of corporate profits. There is socio-economic stress in the combination of adverse events and cyclical performance:

Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.1 percent on average in the cyclical expansion in the 30 quarters from IIIQ2009 to IVQ2016. 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 IVQ2016 (https://www.bea.gov/newsreleases/national/gdp/2017/pdf/gdp4q16_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 dividing 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 (Section I and earlier https://cmpassocregulationblog.blogspot.com/2017/03/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/rising-valuations-of-risk-financial.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. 4.5 percent from IQ1983 to IQ1990, 4.4 percent from IQ1983 to IIQ1990 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier https://cmpassocregulationblog.blogspot.com/2017/03/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/rising-valuations-of-risk-financial.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 IVQ2016 would have accumulated to 30.5 percent. GDP in IVQ2016 would be $19,564.3 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2751.0 billion than actual $16,813.3 billion. There are about two trillion dollars of GDP less than at trend, explaining the 24.2 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.4 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2017/03/increasing-interest-rates-twenty-four.html and earlier https://cmpassocregulationblog.blogspot.com/2017/02/twenty-six-million-unemployed-or.html). US GDP in IVQ2016 is 14.1 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,813.3 billion in IVQ2016 or 12.1 percent at the average annual equivalent rate of 1.3 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 3.2 percent per year from Feb 1919 to Feb 2017. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 144.4892 in Feb 2017. The actual index NSA in Feb 2017 is 103.4436, which is 28.4 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Feb 2017. Using trend growth of 2.0 percent per year, the index would increase to 130.9602 in Feb 2017. The output of manufacturing at 103.4436 in Feb 2017 is 21.0 percent below trend under this alternative calculation.

The economy of the US can be summarized in growth of economic activity or GDP as fluctuating from mediocre growth of 2.5 percent on an annual basis in 2010 to 1.6 percent in 2011, 2.2 percent in 2012, 1.7 percent in 2013, 2.4 percent in 2014 and 2.6 percent in 2015. GDP growth was 1.6 percent in 2016. The following calculations show that actual growth is around 2.1 percent per year. The rate of growth of 1.3 percent in the entire cycle from 2007 to 2016 is well below 3 percent per year in trend from 1870 to 2010, which the economy of the US always attained for entire cycles in expansions after events such as wars and recessions (Lucas 2011May). Revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) provides valuable information on long-term growth and cyclical behavior. Table Summary provides relevant data.

Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita

 

GDP

  

Long-Term

    

1929-2016

3.2

  

1947-2016

3.2

  

Whole Cycles

    

1980-1989

3.5

  

2006-2016

1.3

  

2007-2016

1.3

  

Cyclical Contractions ∆%

    

IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982

-4.7

  

IVQ2007 to IIQ2009

-4.2

  

Cyclical Expansions Average Annual Equivalent ∆%

    

IQ1983 to IVQ1985

IQ1983-IQ1986

IQ1983-IIIQ1986

IQ1983-IVQ1986

IQ1983-IQ1987

IQ1983-IIQ1987

IQ1983-IIIQ1987

IQ1983 to IVQ1987

IQ1983 to IQ1988

IQ1983 to IIQ1988

IQ1983 to IIIQ1988

IQ1983 to IVQ1988

IQ1983 to IQ1989

IQ1983 to IIQ1989

IQ1983 to IIIQ1989

IQ1983 to IVQ1989

IQ1983 to IQ1990

IQ1983 to IIQ1990

5.9

5.7

5.4

5.2

5.0

5.0

4.9

5.0

4.9

4.9

4.8

4.8

4.8

4.7

4.7

4.5

4.5

4.4

  

First Four Quarters IQ1983 to IVQ1983

7.8

  

IIIQ2009 to IVQ2016

2.1

  

First Four Quarters IIIQ2009 to IIQ2010

2.7

  
 

Real Disposable Income

Real Disposable Income per Capita

Long-Term

    

1929-2016

3.2

2.0

1947-1999

3.7

2.3

Whole Cycles

    

1980-1989

3.5

2.6

2006-2016

1.8

1.0

Source: Bureau of Economic Analysis

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

The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace around 2.1 percent per year. Table Summary GDP provides the data.

1. Average Annual Growth in the Past Nineteen Quarters. GDP growth in the four quarters of 2012, the four quarters of 2013, the four quarters of 2014, the four quarters of Q2015 and the four quarters of 2016 accumulated to 10.7 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IVQ2016 of $16,813.3 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/20: {[($16,813.3/$15,190.3)4/20 -1]100 = 2.1 percent}.

2. Average Annual Growth in the Past Four Quarters. GDP growth in the four quarters of IVQ2015 to IVQ2016 accumulated to 2.0 percent that is equivalent to 2.0 percent in a year. This is obtained by dividing GDP in IVQ2016 of $16,813.3 billion by GDP in IVQ2015 of $16,490.7 billion and compounding by 4/4: {[($16,813.3.0/$16,490.7)4/4 -1]100 = 2.0%}. The US economy grew 2.0 percent in IVQ2016 relative to the same quarter a year earlier in IVQ2015. Growth was at annual equivalent 4.0 percent in IIQ2014 and 5.0 percent IIIQ2014 and only at 2.3 percent in IVQ2014. GDP grew at annual equivalent 2.0 percent in IQ2015, 2.6 percent in IIQ2015, 2.0 percent in IIIQ2015 and 0.9 percent in IVQ2015. GDP grew at annual equivalent 0.8 percent in IQ2016 and at 1.4 percent annual equivalent in IIQ2016. GDP increased at 3.5 percent annual equivalent in IIIQ2016 and at 2.1 percent in IVQ2016. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is in the borderline of contraction, and negative in IQ2014. US GDP fell 0.3 percent in IQ2014. The rate of growth of GDP in the revision of IIIQ2013 is 3.1 percent in seasonally adjusted annual rate (SAAR).

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

 

Real GDP, Billions Chained 2009 Dollars

∆% Relative to IVQ2007

∆% Relative to Prior Quarter

∆%
over
Year Earlier

IVQ2007

14,991.8

NA

0.4

1.9

IVQ2011

15,190.3

1.3

1.1

1.7

IQ2012

15,291.0

2.0

0.7

2.8

IIQ2012

15,362.4

2.5

0.5

2.5

IIIQ2012

15,380.8

2.6

0.1

2.4

IVQ2012

15,384.3

2.6

0.0

1.3

IQ2013

15,491.9

3.3

0.7

1.3

IIQ2013

15,521.6

3.5

0.2

1.0

IIIQ2013

15,641.3

4.3

0.8

1.7

IVQ2013

15,793.9

5.4

1.0

2.7

IQ2014

15,747.0

5.0

-0.3

1.6

IIQ2014

15,900.8

6.1

1.0

2.4

IIIQ2014

16,094.5

7.4

1.2

2.9

IVQ2014

16,186.7

8.0

0.6

2.5

IQ2015

16,269.0

8.5

0.5

3.3

IIQ2015

16,374.2

9.2

0.6

3.0

IIIQ2015

16,454.9

9.8

0.5

2.2

IVQ2015

16,490.7

10.0

0.2

1.9

IQ2016

16,525.0

10.2

0.2

1.6

IIQ2016

16,583.1

10.6

0.4

1.3

IIIQ2016

16,727.0

11.6

0.9

1.7

IVQ2016

16,813.3

12.1

0.5

2.0

Cumulative ∆% IQ2012 to IVQ2016

10.7

  

10.8

  

Annual Equivalent ∆%

2.1

  

2.1

  

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

Chart GDP of the US Bureau of Economic Analysis provides the rates of growth of GDP at SAAR (seasonally adjusted annual rate) in the 16 quarters from IQ2013 to IVQ2016. Growth has been fluctuating.

Chart GDP, Seasonally Adjusted Quarterly Rates of Growth of United States GDP, ∆%

Source: US Bureau of Economic Analysis

http://www.bea.gov/newsreleases/national/gdp/gdp_glance.htm

Historical parallels are instructive but have all the limitations of empirical research in economics. The more instructive comparisons are not with the Great Depression of the 1930s but rather with the recessions in the 1950s, 1970s and 1980s. The growth rates and job creation in the expansion of the economy away from recession are subpar in the current expansion compared to others in the past. Four recessions are initially considered, following the reference dates of the National Bureau of Economic Research (NBER) (http://www.nber.org/cycles/cyclesmain.html ): IIQ1953-IIQ1954, IIIQ1957-IIQ1958, IIIQ1973-IQ1975 and IQ1980-IIIQ1980. The data for the earlier contractions illustrate that the growth rate and job creation in the current expansion are inferior. The sharp contractions of the 1950s and 1970s are considered in Table I-1, showing the Bureau of Economic Analysis (BEA) quarter-to-quarter, seasonally adjusted (SA), yearly-equivalent growth rates of GDP. The recovery from the recession of 1953 consisted of four consecutive quarters of high percentage growth rates from IIIQ1954 to IIIQ1955: 4.6, 8.0, 11.9 and 6.7. The recession of 1957 was followed by four consecutive high percentage growth rates from IIIQ1958 to IIQ1959: 9.6, 9.7, 7.7 and 10.1. The recession of 1973-1975 was followed by high percentage growth rates from IIQ1975 to IQ1976: 3.1, 6.8, 5.5 and 9.3. The disaster of the Great Inflation and Unemployment of the 1970s, which made stagflation notorious, is even better in growth rates during the expansion phase in comparison with the current slow-growth recession.

Table I-1, US, Seasonally Adjusted Quarterly Percentage Growth Rates in Annual Equivalent of GDP in Cyclical Recessions and Following Four Quarter Expansions ∆%

 

IQ

IIQ

IIIQ

IV

R IIQ1953-IIQ1954

        

1953

    

-2.2

-5.9

1954

-1.8

      

E IIIQ1954-IIQ1955

        

1954

    

4.6

8.0

1955

11.9

6.7

    

R IIIQ1957-IIQ1958

        

1957

      

-4.0

1958

-10.0

      

E IIIQ1958-IIQ1959

        

1958

    

9.6

9.7

1959

7.7

10.1

    

R IVQ1969-IV1970

        

1969

      

-1.7

1970

-0.7

      

E IIQ1970-IQ1971

        

1970

  

0.7

3.6

-4.0

1971

11.1

      

R IVQ1973-IQ1975

        

1973

      

3.8

1974

-3.3

1.1

-3.8

-1.6

1975

-4.7

      

E IIQ1975-IQ1976

        

1975

  

3.1

6.8

5.5

1976

9.3

      

R IQ1980-IIIQ1980

        

1980

1.3

-7.9

-0.6

  

R IQ1981-IVQ1982

        

1981

8.5

-2.9

4.7

-4.6

1982

-6.5

2.2

-1.4

0.4

E IQ1983-IVQ1983

        

1983

5.3

9.4

8.1

8.5

R IVQ2007-IIQ2009

        

2008

-2.7

2.0

-1.9

-8.2

2009

-5.4

-0.5

    

E IIIQ2009-IIQ2010

        

2009

    

1.3

3.9

2010

1.7

3.9

    

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

The NBER dates another recession in 1980 that lasted about half a year. If the two recessions from IQ1980s to IIIQ1980 and IIIQ1981 to IVQ1982 are combined, the impact of lost GDP of 4.7 percent is more comparable to the latest revised 4.2 percent drop of the recession from IVQ2007 to IIQ2009. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.4 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7 and revisions in http://bea.gov/iTable/index_nipa.cfm). Table I-2 provides the Bureau of Economic Analysis (BEA) quarterly growth rates of GDP in SA yearly equivalents for the recessions of 1981 to 1982 and 2007 to 2009, using the latest major revision published on Jul 27, 2016 and the third estimate for IVQ2016 GDP (https://www.bea.gov/newsreleases/national/gdp/2017/pdf/gdp4q16_3rd.pdf), which are available in the dataset of the US Bureau of Economic Analysis (http://www.bea.gov/iTable/index_nipa.cfm). There were four quarters of contraction in 1981-1982 ranging in rate from -1.4 percent to -6.5 percent and five quarters of contraction in 2007-2009 ranging in rate from -0.5 percent to -8.2 percent. The striking difference is that in the first thirty quarters of expansion from IQ1983 to IIQ1990, shown in Table I-2 in relief, GDP grew at the high quarterly percentage growth rates of 5.3, 9.4, 8.1, 8.5, 8.2, 7.2, 4.0, 3.2, 4.0, 3.7, 6.4, 3.0, 3.8, 1.9, 4.1, 2.1, 2.8, 4.6, 3.7, 6.8, 2.3, 5.4, 2.3, 5.4, 4.1, 3.2, 3.0, 0.9, 4.5, 1.6, 0.1 and minus 3.4. The National Bureau of Economic Research dates another cycle from Jul 1990 (IIIQ1981) to Mar 1991 (IQ1991) (http://www.nber.org/cycles.html), showing in Table III-1 with weaker performance in IIQ1990 and IIIQ1990 and contraction of 3.4 percent in IVQ1990. In contrast, the percentage growth rates in the first thirty quarters of expansion from IIIQ2009 to IIQ2016 shown in relief in Table I-2 were mediocre: 1.3, 3.9, 1.7, 3.9, 2.7, 2.5, -1.5, 2.9, 0.8, 4.6, 2.7, 1.9, 0.5, 0.1, 2.8, 0.8, 3.1, 4.0, minus 1.2, 4.0, 5.0, 2.3, 2.0, 2.6, 2.0, 0.9, 0.8, 1.4, 3.5 and 2.1. Economic growth and employment creation continued at slow rhythm during 2012 and in 2013-2016 while much stronger growth would be required in movement to full employment. The cycle is now long by historical standards and growth rates are typically weaker in the final periods of cyclical expansions.

Table I-2, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA

Q

1981

1982

1983

1984

2008

2009

2010

I

8.5

-6.5

5.3

8.2

-2.7

-5.4

1.7

II

-2.9

2.2

9.4

7.2

2.0

-0.5

3.9

III

4.7

-1.4

8.1

4.0

-1.9

1.3

2.7

IV

-4.6

0.4

8.5

3.2

-8.2

3.9

2.5
       

1985

    

2011

I

      

4.0

    

-1.5

II

      

3.7

    

2.9

III

      

6.4

    

0.8

IV

      

3.0

    

4.6
       

1986

    

2012

I

      

3.8

    

2.7

II

      

1.9

    

1.9

III

      

4.1

    

0.5

IV

      

2.1

    

0.1

       

1987

    

2013

I

      

2.8

    

2.8

II

      

4.6

    

0.8

III

      

3.7

    

3.1

IV

      

6.8

    

4.0
       

1988

    

2014

I

      

2.3

    

-1.2

II

      

5.4

    

4.0

III

      

2.3

    

5.0

IV

      

5.4

    

2.3
       

1989

    

2015

I

      

4.1

    

2.0

II

      

3.2

    

2.6

III

      

3.0

    

2.0

IV

      

0.9

    

0.9
       

1990

    

2016

I

      

4.5

    

0.8

II

      

1.6

    

1.4

III

      

0.1

    

3.5

IV

      

-3.4

    

2.1

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

Chart I-1 of the Bureau of Economic Analysis (BEA) provides strong growth of real GDP in the US between 1929 and 1999 at the yearly average rate of 3.5 percent. There is an evident acceleration of the rate of GDP growth in the 1990s as shown by a much sharper slope of the growth curve. Cobet and Wilson (2002) define labor productivity as the value of manufacturing output produced per unit of labor input used (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). Between 1950 and 2000, labor productivity in the US grew less rapidly than in Germany and Japan. The major part of the increase in productivity in Germany and Japan occurred between 1950 and 1973 while the rate of productivity growth in the US was relatively subdued in several periods. While Germany and Japan reached their highest growth rates of productivity before 1973, the US accelerated its rate of productivity growth in the second half of the 1990s. Between 1950 and 2000, the rate of productivity growth in the US of 2.9 percent per year was much lower than 6.3 percent in Japan and 4.7 percent in Germany. Between 1995 and 2000, the rate of productivity growth of the US of 4.6 percent exceeded that of Japan of 3.9 percent and the rate of Germany of 2.6 percent.

Chart I-1, US, Real GDP 1929-1999

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

Chart I-1A provides real GDP annually from 1929 to 2016. Growth after the global recession from IVQ2007 to IIQ2009 has not been sufficiently high to compensate for the contraction as it had in past economic cycles. The drop of output in the recession from IVQ2007 to IIQ2009 has been followed by anemic recovery compared with return to trend at 3.0 percent from 1870 to 2010 after events such as wars and recessions (Lucas 2011May) and a standstill that can lead to growth recession, or low rates of economic growth. The expansion is relatively long compared to earlier expansion and there could be even another contraction or conventional recession in the future. The average rate of growth from 1947 to 2016 is 3.2 percent. The average growth rate from IV2007 to IVQ2016 is only 1.3 percent with 2.8 percent annual equivalent from the end of the recession in IVQ2001 to the end of the expansion in IVQ2007. 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 IVQ2016 would have accumulated to 30.5 percent. GDP in IVQ2016 would be $19,564.3 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2751.0 billion than actual $16,813.3 billion. There are about two trillion dollars of GDP less than at trend, explaining the 24.2 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.4 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2017/03/increasing-interest-rates-twenty-four.html and earlier https://cmpassocregulationblog.blogspot.com/2017/02/twenty-six-million-unemployed-or.html). US GDP in IVQ2016 is 14.1 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,813.3 billion in IVQ2016 or 12.1 percent at the average annual equivalent rate of 1.3 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 3.2 percent per year from Feb 1919 to Feb 2017. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 144.4892 in Feb 2017. The actual index NSA in Feb 2017 is 103.4436, which is 28.4 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Feb 2017. Using trend growth of 2.0 percent per year, the index would increase to 130.9602 in Feb 2017. The output of manufacturing at 103.4436 in Feb 2017 is 21.0 percent below trend under this alternative calculation.

Chart I-1A, US, Real GDP 1929-2016

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

Chart I-2 provides the growth of real quarterly GDP in the US between 1947 and 2016. The drop of output in the recession from IVQ2007 to IIQ2009 has been followed by anemic recovery compared with return to trend at 3.0 percent from 1870 to 2010 after events such as wars and recessions (Lucas 2011May) and a standstill that can lead to growth recession, or low rates of economic growth. The expansion is relatively long compared to earlier expansions and there could be another contraction or conventional recession in the future. The average rate of growth from 1947 to 2016 is 3.2 percent. The average growth rate from IVQ2007 to IVQ2016 is only 1.3 percent with 2.8 percent from the end of the recession in IVQ2001 to the end of the expansion in IVQ2007.

Chart I-2, US, Real GDP, Quarterly, 1947-2016

Source: US Bureau of Economic Analysis

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

Chart I-3 provides real GDP percentage change on the quarter a year earlier for 1983-1989. The objective is simply to compare expansion in two recoveries from sharp contractions as shown in Table I-5. Growth rates in the early phase of the recovery in 1983 and 1984 were very high, which is the opportunity to reduce unemployment that has characterized cyclical expansion in the postwar US economy.

Chart I-3, Real GDP Percentage Change on Quarter a Year Earlier 1983-1989

Source: US Bureau of Economic Analysis

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

In contrast, growth rates in the comparable first thirty quarters of expansion from 2009 to 2016 in Chart I-4 have been mediocre. As a result, growth has not provided the exit from unemployment and underemployment as in other cyclical expansions in the postwar period. Growth rates did not rise in V shape as in earlier expansions and then declined close to the standstill of growth recessions.

Chart I-4, US, Real GDP Percentage Change on Quarter a Year Earlier 2009-2016

Source: US Bureau of Economic Analysis

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

Table I-3 provides percentage change of real GDP in the United States in the 1930s, 1980s and 2000s. The recession in 1981-1982 is quite similar on its own to the 2007-2009 recession. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.4 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7 and revisions in http://bea.gov/iTable/index_nipa.cfm). Data are available for the 1930s only on a yearly basis. US GDP fell 4.7 percent in the two recessions (1) from IQ1980 to IIIQ1980 and (2) from III1981 to IVQ1982 and 4.2 percent cumulatively in the recession from IVQ2007 to IIQ2009. It is instructive to compare the first years of the expansions in the 1980s and the current expansion. GDP grew at 4.6 percent in 1983, 7.3 percent in 1984, 4.2 percent in 1985, 3.5 percent in 1986, 3.5 percent in 1987, 4.2 percent in 1988 and 3.7 percent in 1989. In contrast, GDP grew 2.5 percent in 2010, 1.6 percent in 2011, 2.2 percent in 2012, 1.7 percent in 2013, 2.4 percent in 2014 and 2.6 percent in 2015. GDP grew 1.6 percent in 2016. Actual annual equivalent GDP growth in the twenty quarters from 2012 to 2016 is 2.1 percent and 2.0 percent in the four quarters ending in IVQ2016. GDP grew at 4.2 percent in 1985, 3.5 percent in 1986, 3.5 percent in 1987, 4.2 percent in 1988 and 3.7 percent in 1989. The forecasts of the central tendency of participants of the Federal Open Market Committee (FOMC) are in the range of 2.0 to 2.2 percent in 2017 (https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20170315.pdf) with less reliable forecast of 1.8 to 2.3 percent in 2018 (https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20170315.pdf). Growth of GDP in the expansion from IIIQ2009 to IVQ2016 has been at average 2.1 percent in annual equivalent.

Table I-3, US, Percentage Change of GDP in the 1930s, 1980s and 2000s, ∆%

Year

GDP ∆%

Year

GDP ∆%

Year

GDP ∆%

1930

-8.5

1980

-0.2

2000

4.1

1931

-6.4

1981

2.6

2001

1.0

1932

-12.9

1982

-1.9

2002

1.8

1933

-1.3

1983

4.6

2003

2.8

1934

10.8

1984

7.3

2004

3.8

1935

8.9

1985

4.2

2005

3.3

1936

12.9

1986

3.5

2006

2.7

1937

5.1

1987

3.5

2007

1.8

1938

-3.3

1988

4.2

2008

-0.3

1939

8.0

1989

3.7

2009

-2.8

1940

8.8

1990

1.9

2010

2.5

1941

17.7

1991

-0.1

2011

1.6

1942

18.9

1992

3.6

2012

2.2

1943

17.0

1993

2.7

2013

1.7

1944

8.0

1994

4.0

2014

2.4

1945

-1.0

1995

2.7

2015

2.6

1946

-11.6

1996

3.8

2016

1.6

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

Chart I-5 provides percentage change of GDP in the US during the 1930s. There is vast literature analyzing the Great Depression (Pelaez and Pelaez, Regulation of Banks and Finance (2009), 198-217). Cole and Ohanian (1999) find that US real per capita output was lower by 11 percent in 1939 than in 1929 while the typical expansion of real per capita output in the US during a decade is 31 percent. Private hours worked in the US were 25 percent lower in 1939 relative to 1929.

Chart I-5, US, Percentage Change of GDP in the 1930s

Source: US Bureau of Economic Analysis

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

In contrast, Chart I-6 shows rapid recovery from the recessions in the 1980s. High growth rates in the initial quarters of expansion eliminated the unemployment and underemployment created during the contraction. The economy then returned to grow at the trend of expansion, interrupted by another contraction in 1991.

Chart I-6, US, Percentage Change of GDP in the 1980s

Source: US Bureau of Economic Analysis

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

Chart I-7 provides the rates of growth during the 2000s. Growth rates in the initial twenty-nine quarters of expansion have been relatively lower than during recessions after World War II. As a result, unemployment and underemployment continue at the rate of 14.4 percent of the effective US labor force (https://cmpassocregulationblog.blogspot.com/2017/03/increasing-interest-rates-twenty-four.html and earlier https://cmpassocregulationblog.blogspot.com/2017/02/twenty-six-million-unemployed-or.html).

Chart I-7, US, Percentage Change of GDP in the 2000s

Source: US Bureau of Economic Analysis

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

Characteristics of the four cyclical contractions are in Table I-4 with the first column showing the number of quarters of contraction; the second column the cumulative percentage contraction; and the final column the average quarterly rate of contraction. There were two contractions from IQ1980 to IIIQ1980 and from IIIQ1981 to IVQ1982 separated by three quarters of expansion. The drop of output combining the declines in these two contractions is 4.7 percent, which is almost equal to the decline of 4.2 percent in the contraction from IVQ2007 to IIQ2009. In contrast, during the Great Depression in the four years of 1930 to 1933, GDP in constant dollars fell 26.4 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7 and revisions in http://bea.gov/iTable/index_nipa.cfm). The comparison of the global recession after 2007 with the Great Depression is entirely misleading.

Table I-4, US, Number of Quarters, GDP Cumulative Percentage Contraction and Average Percentage Annual Equivalent Rate in Cyclical Contractions   

 

Number of Quarters

Cumulative Percentage Contraction

Average Percentage Rate

IIQ1953 to IIQ1954

3

-2.4

-0.8

IIIQ1957 to IIQ1958

3

-3.0

-1.0

IVQ1973 to IQ1975

5

-3.1

-0.6

IQ1980 to IIIQ1980

2

-2.2

-1.1

IIIQ1981 to IVQ1982

4

-2.5

-0.64

IVQ2007 to IIQ2009

6

-4.2

-0.72

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

Table I-5 shows the mediocre average annual equivalent growth rate of 2.1 percent of the US economy in the thirty quarters of the current cyclical expansion from IIIQ2009 to IVQ2016. In sharp contrast, the average growth rate of GDP was:

  • 5.7 percent in the first thirteen quarters of expansion from IQ1983 to IQ1986
  • 5.4 percent in the first fifteen quarters of expansion from IQ1983 to IIIQ1986
  • 5.2 percent in the first sixteen quarters of expansion from IQ1983 to IVQ1986
  • 5.0 percent in the first seventeen quarters of expansion from IQ1983 to IQ1987
  • 5.0 percent in the first eighteen quarters of expansion from IQ1983 to IIQ1987
  • 4.9 percent in the first nineteen quarters of expansion from IQ1983 to IIIQ1987
  • 5.0 percent in the first twenty quarters of expansion from IQ1983 to IVQ1987
  • 4.9 percent in the first twenty-first quarters of expansion from IQ1983 to IQ1988
  • 4.9 percent in the first twenty-two quarters of expansion from IQ1983 to IIQ1988
  • 4.8 percent in the first twenty-three quarters of expansion from IQ1983 to IIIQ1988
  • 4.8 percent in the first twenty-four quarters of expansion from IQ1983 to IVQ1988
  • 4.8 percent in the first twenty-five quarters of expansion from IQ1983 to IQ1989
  • 4.7 percent in the first twenty-six quarters of expansion from IQ1983 to IIQ1989
  • 4.7 percent in the first twenty-seven quarters of expansion from IQ1983 to IIIQ1989
  • 4.5 percent in the first twenty-eight quarters of expansion from IQ1983 to IVQ1989
  • 4.5 percent in the first twenty-nine quarters of expansion from IQ1983 to IQ1990
  • 4.4 percent in the first thirty quarters of expansion from IQ1983 to IIQ1990

The line “average first four quarters in four expansions” provides the average growth rate of 7.7 percent with 7.8 percent from IIIQ1954 to IIQ1955, 9.2 percent from IIIQ1958 to IIQ1959, 6.1 percent from IIIQ1975 to IIQ1976 and 7.8 percent from IQ1983 to IVQ1983. The United States missed this opportunity of high growth in the initial phase of recovery. BEA data show the US economy in standstill relative to historical experience with annual growth of 2.5 percent in 2010 decelerating to 1.6 percent annual growth in 2011, 2.2 percent in 2012, 1.7 percent in 2013, 2.4 percent in 2014, 2.6 percent in 2015 and 1.6 percent in 2016 (http://www.bea.gov/iTable/index_nipa.cfm). The expansion from IQ1983 to IQ1986 was at the average annual growth rate of 5.7 percent, 5.2 percent from IQ1983 to IVQ1986, 4.9 percent from IQ1983 to IIIQ1987, 5.0 percent from IQ1983 to IVQ1987, 4.9 percent from IQ1983 to IQ1988, 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, 4.5 percent from IQ1983 to IQ1990, 4.4 percent from IQ1983 to IIQ1990 and at 7.8 percent from IQ1983 to IVQ1983. GDP grew 2.7 percent in the first four quarters of the expansion from IIIQ2009 to IIQ2010. GDP growth in the twenty quarters from 2012 to 2016 accumulated to 10.7 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IVQ2016 of $16,813.3 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/20: {[($16,813.3/$15,190.3)4/20 -1]100 = 2.1 percent}.

Table I-5 shows that GDP grew 17.1 percent in the first thirty quarters of expansion from IIIQ2009 to IVQ2016 at the annual equivalent rate of 2.1 percent.

Table I-5, US, Number of Quarters, Cumulative Growth and Average Annual Equivalent Growth Rate in Cyclical Expansions

 

Number
of
Quarters

Cumulative Growth

∆%

Average Annual Equivalent Growth Rate

IIIQ 1954 to IQ1957

11

12.8

4.5

First Four Quarters IIIQ1954 to IIQ1955

4

7.8

  

IIQ1958 to IIQ1959

5

10.0

7.9

First Four Quarters

IIIQ1958 to IIQ1959

4

9.2

  

IIQ1975 to IVQ1976

8

8.3

4.1

First Four Quarters IIIQ1975 to IIQ1976

4

6.1

  

IQ1983-IQ1986

IQ1983-IIIQ1986

IQ1983-IVQ1986

IQ1983-IQ1987

IQ1983-IIQ1987

IQ1983 to IIIQ1987

IQ1983 to IVQ1987

IQ1983 to IQ1988

IQ1983 to IIQ1988

IQ1983 to IIIQ1988

IQ1983 to IVQ1988

IQ1983 to IQ1989

IQ1983 to IIQ1989

IQ1983 to IIIQ1989

IQ1983 to IVQ1989

IQ1983 to IQ1990

IQ1983 to IIQ1990

13

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

19.9

21.6

22.3

23.1

24.5

25.6

27.7

28.4

30.1

30.9

32.6

34.0

35.0

36.0

36.3

37.8

38.3

5.7

5.4

5.2

5.0

5.0

4.9

5.0

4.9

4.9

4.8

4.8

4.8

4.7

4.7

4.5

4.5

4.4

First Four Quarters IQ1983 to IVQ1983

4

7.8

  

Average First Four Quarters in Four Expansions*

  

7.7

  

IIIQ2009 to IVQ2016

30

17.1

2.1

First Four Quarters IIIQ2009 to IIQ2010

  

2.7

  

*First Four Quarters: 7.8% IIIQ1954-IIQ1955; 9.2% IIIQ1958-IIQ1959; 6.1% IIIQ1975-IQ1976; 7.8% IQ1983-IVQ1983

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

Chart I-8 shows US real quarterly GDP growth from 1980 to 1989. The economy contracted during the recession and then expanded vigorously throughout the 1980s, rapidly eliminating the unemployment caused by the contraction.

Chart I-8, US, Real GDP, 1980-1989

Source: US Bureau of Economic Analysis

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

Chart I-9 shows the entirely different situation of real quarterly GDP in the US between 2007 and 2016. The economy has underperformed during the first thirty quarters of expansion for the first time in the comparable contractions since the 1950s. The US economy is now in a perilous standstill.

Chart I-9, US, Real GDP, 2007-2016

Source: US Bureau of Economic Analysis

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

As shown in Tables I-4 and I-5 above the loss of real GDP in the US during the contraction was 4.2 percent but the gain in the cyclical expansion has been only 17.1 percent (first to the last row in Table I-5), using all latest revisions. As a result, the level of real GDP in IVQ2016 with the second estimate and revisions is higher by only 12.1 percent than the level of real GDP in IVQ2007. 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 IVQ2016 would have accumulated to 30.5 percent. GDP in IVQ2016 would be $19,564.3 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2751.0 billion than actual $16,813.3 billion. There are about two trillion dollars of GDP less than at trend, explaining the 24.2 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.4 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2017/03/increasing-interest-rates-twenty-four.html and earlier https://cmpassocregulationblog.blogspot.com/2017/02/twenty-six-million-unemployed-or.html). US GDP in IVQ2016 is 14.1 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,813.3 billion in IVQ2016 or 12.1 percent at the average annual equivalent rate of 1.3 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 3.2 percent per year from Feb 1919 to Feb 2017. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 144.4892 in Feb 2017. The actual index NSA in Feb 2017 is 103.4436, which is 28.4 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Feb 2017. Using trend growth of 2.0 percent per year, the index would increase to 130.9602 in Feb 2017. The output of manufacturing at 103.4436 in Feb 2017 is 21.0 percent below trend under this alternative calculation.

Table I-6 shows that the contraction concentrated in two quarters: decline of 2.1 percent in IVQ2008 relative to the prior quarter and decline of 1.4 percent in IQ2009 relative to IVQ2008. The combined fall of GDP in IVQ2008 and IQ2009 was 3.5 percent {[(1-0.021) x (1-0.014) -1]100 = -3.5%}, or {[(IQ2009 $14,375.0)/(IIIQ2008 $14,891.6) – 1]100 = -3.5%} except for rounding. Those two quarters coincided with the worst effects of the financial crisis (Cochrane and Zingales 2009). GDP fell 0.1 percent in IIQ2009 but grew 0.3 percent in IIIQ2009, which is the beginning of recovery in the cyclical dates of the NBER. Most of the recovery occurred in five successive quarters from IVQ2009 to IVQ2010 of growth of 1.0 percent in IVQ2009, 0.4 percent in IQ2010, 1.0 percent in IIQ2010 and nearly equal growth at 0.7 percent in IIIQ2010 and 0.6 percent in IVQ2010 for cumulative growth in those five quarters of 3.8 percent, obtained by accumulating the quarterly rates {[(1.01 x 1.004 x 1.01 x 1.007 x 1.006) – 1]100 = 3.8%} or {[(IVQ2010 $14,939.0)/(IIIQ2009 $14,402.5) – 1]100 = 3.7%} with minor rounding difference. The economy then stalled during the first half of 2011 with decline of 0.4 percent in IQ2011 and growth of 0.7 percent in IIQ2011 for combined annual equivalent rate of 0.6 percent {(0.996 x 1.007)2}. The economy grew 0.2 percent in IIIQ2011 for annual equivalent growth of 0.7 percent in the first three quarters {[(0.996 x 1.007 x 1.002)4/3 -1]100 = 0.7%}. Growth picked up in IVQ2011 with 1.1 percent relative to IIIQ2011. Growth in a quarter relative to a year earlier in Table I-6 slows from over 2.7 percent during three consecutive quarters from IIQ2010 to IVQ2010 to 1.9 percent in IQ2011, 1.7 percent in IIQ2011, 1.2 percent in IIIQ2011 and 1.7 percent in IVQ2011. As shown below, growth of 1.1 percent in IVQ2011 was partly driven by inventory accumulation. In IQ2012, GDP grew 0.7 percent relative to IVQ2011 and 2.8 percent relative to IQ2011, decelerating to 0.5 percent in IIQ2012 and 2.5 percent relative to IIQ2011 and 0.1 percent in IIIQ2012 and 2.4 percent relative to IIIQ2011. Growth was 0.0 percent in IVQ2012 with 1.3 percent relative to a year earlier but mostly because of deduction of 1.54 percentage points of inventory divestment and 0.42 percentage points of reduction of one-time national defense expenditures. Growth was 0.7 percent in IQ2013 and 1.3 percent relative to IQ2012 in large part because of burning savings to consume caused by financial repression of zero interest rates. There is similar growth of 0.2 percent in IIQ2013 and 1.0 percent relative to a year earlier. In IIIQ2013, GDP grew 0.8 percent relative to the prior quarter and 1.7 percent relative to the same quarter a year earlier with inventory accumulation contributing 1.60 percentage points to growth at 3.1 percent SAAR in IIIQ2013. GDP increased 1.0 percent in IVQ2013 and 2.7 percent relative to a year earlier. GDP fell 0.3 percent in IQ2014 and grew 1.6 percent relative to a year earlier. Inventory divestment deducted 1.89 percentage points from GDP growth in IQ2014. GDP grew 1.0 percent in IIQ2014, 2.4 percent relative to a year earlier and at 4.0 SAAR with inventory change contributing 0.67 percentage points. GDP grew 1.2 percent in IIIQ2014 and 2.9 percent relative to a year earlier. GDP grew 0.6 percent in IVQ2014 and 2.5 percent relative to a year earlier. GDP increased 0.5 percent in IQ2015 and increased 3.3 percent relative to a year earlier partly because of low level during contraction of 0.3 percent in IQ2014. GDP grew 0.6 percent in IIQ2015 and 3.0 percent relative to a year earlier. GDP grew 0.5 percent in IIIQ2015 and 2.2 percent relative to a year earlier. GDP grew 0.2 percent in IVQ2015 and increased 1.9 percent relative to a year earlier. GDP grew 0.2 percent in IQ2016 and increased 1.6 percent relative to a year earlier. GDP grew 0.4 percent in IIQ2016 and increased 1.3 percent relative to a year earlier. GDP grew 0.9 percent in IIIQ2016 and increased 1.7 percent relative to a year earlier. GDP grew 0.5 percent in IVQ2016 and increased 2.0 percent relative to a year earlier. Rates of a quarter relative to the prior quarter capture better deceleration of the economy than rates on a quarter relative to the same quarter a year earlier. The critical question for which there is not yet definitive solution is whether what lies ahead is continuing growth recession with the economy crawling and unemployment/underemployment at extremely high levels or another contraction or conventional recession. Forecasts of various sources continued to maintain high growth in 2011 without taking into consideration the continuous slowing of the economy in late 2010 and the first half of 2011. The sovereign debt crisis in the euro area and growth in China are common sources of doubts on the rate and direction of economic growth in the US. There is weak internal demand in the US with almost no investment and spikes of consumption driven by burning saving because of financial repression in the form of zero interest rates and bloated balance sheet of the Fed.

Table I-6, US, Real GDP and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions Chained 2009 Dollars and ∆%

 

Real GDP, Billions Chained 2009 Dollars

∆% Relative to IVQ2007

∆% Relative to Prior Quarter

∆%
over
Year Earlier

IVQ2007

14,991.8

NA

0.4

1.9

IQ2008

14,889.5

-0.7

-0.7

1.1

IIQ2008

14,963.4

-0.2

0.5

0.8

IIIQ2008

14,891.6

-0.7

-0.5

-0.3

IVQ2008

14,577.0

-2.8

-2.1

-2.8

IQ2009

14,375.0

-4.1

-1.4

-3.5

IIQ2009

14,355.6

-4.2

-0.1

-4.1

IIIQ2009

14,402.5

-3.9

0.3

-3.3

IV2009

14,541.9

-3.0

1.0

-0.2

IQ2010

14,604.8

-2.6

0.4

1.6

IIQ2010

14,745.9

-1.6

1.0

2.7

IIIQ2010

14,845.5

-1.0

0.7

3.1

IVQ2010

14,939.0

-0.4

0.6

2.7

IQ2011

14,881.3

-0.7

-0.4

1.9

IIQ2011

14,989.6

0.0

0.7

1.7

IIIQ2011

15,021.1

0.2

0.2

1.2

IVQ2011

15,190.3

1.3

1.1

1.7

IQ2012

15,291.0

2.0

0.7

2.8

IIQ2012

15,362.4

2.5

0.5

2.5

IIIQ2012

15,380.8

2.6

0.1

2.4

IVQ2012

15,384.3

2.6

0.0

1.3

IQ2013

15,491.9

3.3

0.7

1.3

IIQ2013

15,521.6

3.5

0.2

1.0

IIIQ2013

15,641.3

4.3

0.8

1.7

IVQ2013

15,793.9

5.4

1.0

2.7

IQ2014

15,747.0

5.0

-0.3

1.6

IIQ2014

15,900.8

6.1

1.0

2.4

IIIQ2014

16,094.5

7.4

1.2

2.9

IVQ2014

16,186.7

8.0

0.6

2.5

IQ2015

16,269.0

8.5

0.5

3.3

IIQ2015

16,374.2

9.2

0.6

3.0

IIIQ2015

16,454.9

9.8

0.5

2.2

IVQ2015

16,490.7

10.0

0.2

1.9

IQ2016

16,525.0

10.2

0.2

1.6

IIQ2016

16,583.1

10.6

0.4

1.3

IIIQ2016

16,727.0

11.6

0.9

1.7

IVQ2016

16,813.3

12.1

0.5

2.0

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

Chart I-10 provides the percentage change of real GDP from the same quarter a year earlier from 1980 to 1989. There were two contractions almost in succession in 1980 and from 1981 to 1983. The expansion was marked by initial high rates of growth as in other recession in the postwar US period during which employment lost in the contraction was recovered. Growth rates continued to be high after the initial phase of expansion.

Chart I-10, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 1980-1989

Source: US Bureau of Economic Analysis

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

The experience of recovery after 2009 is not as complete as during the 1980s. Chart I-11 shows the much lower rates of growth in the early phase of the current expansion and sharp decline from an early peak. The US missed the initial high growth rates in cyclical expansions that eliminate unemployment and underemployment.

Chart I-11, Percentage Change of Real Gross Domestic Product from Quarter a Year Earlier 2007-2016

Source: US Bureau of Economic Analysis

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

Chart I-12 provides growth rates from a quarter relative to the prior quarter during the 1980s. There is the same strong initial growth followed by a long period of sustained growth.

Chart I-12, Percentage Change of Real Gross Domestic Product from Prior Quarter 1980-1989

Source: US Bureau of Economic Analysis

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

Chart I-13 provides growth rates in a quarter relative to the prior quarter from 2007 to 2016. Growth in the current expansion after IIIQ2009 has not been as strong as in other postwar cyclical expansions.

Chart I-13, Percentage Change of Real Gross Domestic Product from Prior Quarter 2007-2016

Source: US Bureau of Economic Analysis

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

The revised estimates and earlier estimates from IQ2008 to IQ2016 in seasonally adjusted annual equivalent rates are shown in Table I-7. The strongest revision is for IVQ2008 for which the contraction of GDP is revised from minus 6.8 percent to minus 8.9 percent and minus 8.2 percent. IQ2009 is also revised from contraction of minus 4.9 percent to minus 6.7 percent but then lowered to contraction of 5.3 percent and 5.4 percent. There is only minor revision in IIIQ2008 of the contraction of minus 4.0 percent to minus 3.7 percent and much lower to minus 1.9 percent. Growth of 5.0 percent in IV2009 is revised to 3.8 percent and then increased to 4.0 percent but lowered to 3.9 percent. Growth in IQ2010 is lowered from 3.9 percent to 2.3 percent and 1.7 percent. Growth in IIQ2010 is upwardly revised to 3.8 percent but then lowered to 2.2 percent. The final revision increased growth in IIQ2010 to 3.9 percent. Revisions lowered growth of 1.9 percent in IQ2011 to minus 1.5 percent. The revisions increased growth of 1.8 percent in IQ2013 to 2.7 percent and increased growth of 2.0 percent in IQ2012 to 2.3 percent. The revision reduced the decline of GDP from 2.9 percent in IQ2014 to 2.1 percent. The revision of Jul 20, 2015, reduced significantly the rate of growth in 2013. The revision of Jul 27, 2016, increased the growth rate in 2013 and 2014. The revisions do not alter the conclusion that the current expansion is much weaker than historical sharp contractions since the 1950s and is now changing into slow growth recession with higher risks of contraction and continuing underperformance.

Table I-7, US, Quarterly Growth Rates of GDP, % Annual Equivalent SA, Revised and Earlier Estimates

Quarters

Rev Jul 29, 2016

Rev Jul 30, 2015

Rev Jul 30, 2014

Rev

Jul 31, 2013

Rev

Jul 27, 2012

Rev

Jul 29, 2011

Earlier Estimate

2008

              

I

    

-2.7

-2.7

  

-1.8

-0.7

II

    

2.0

2.0

  

1.3

0.6

III

    

-1.9

-2.0

  

-3.7

-4.0

IV

    

-8.2

-8.3

  

-8.9

-6.8

2009

              

I

    

-5.4

-5.4

-5.3

-6.7

-4.9

II

    

-0.5

-0.4

-0.3

-0.7

-0.7

III

    

1.3

1.3

1.4

1.7

1.6

IV

    

3.9

3.9

4.0

3.8

5.0

2010

              

I

    

1.7

1.6

2.3

3.9

3.7

II

    

3.9

3.9

2.2

3.8

1.7

III

    

2.7

2.8

2.6

2.5

2.6

IV

    

2.5

2.8

2.4

2.3

3.1

2011

              

I

    

-1.5

-1.3

0.1

0.4

1.9

II

    

2.9

3.2

2.5

    

III

    

0.8

1.4

1.3

    

IV

    

4.6

4.9

4.1

    

2012

              

I

  

2.7

2.3

3.7

2.0

    

II

  

1.9

1.6

1.2

1.3

    

III

  

0.5

2.5

2.8

3.1

    

IV

  

0.1

0.1

0.1

0.4

    

2013

              

I

2.8

1.9

2.7

1.1

1.8

    

II

0.8

1.1

1.8

2.5

      

III

3.1

3.0

4.5

4.1

      

IV

4.0

3.8

3.5

2.6

      

2014

              

I

-1.2

-0.9

-2.1

-2.9

      

II

4.0

4.6

          

III

5.0

4.3

          

IV

2.3

2.1

          

2015

              

I

2.0

0.6

          

II

2.6

            

III

2.0

            

IV

0.9

            

2016

              

I

0.8

            

Note: Rev: Revision

Source: US Bureau of Economic Analysis

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

Aggregate demand, personal consumption expenditures (PCE) and gross private domestic investment (GDI) were much stronger during the expansion phase from IQ1983 to IQ1990 than from IIIQ2009 to IIIQ2016, as shown in Table I-8. GDI provided the impulse of growth in 1983 and 1984, which has not been the case from 2009 to 2016. The investment decision in the US economy has been frustrated in the current cyclical expansion. Growth of GDP in IIIQ2013 at seasonally adjusted annual rate of 3.1 percent consisted of positive contribution of 1.28 percentage points of personal consumption expenditures (PCE) plus positive contribution of 2.08 percentage points of gross private domestic investment (GDI) of which 1.60 percentage points of inventory investment (∆PI), contribution of net exports (trade or exports less imports) of 0.13 percentage points and deduction of 0.37 percentage points of government consumption expenditures and gross investment (GOV) partly because of one-time deduction of national defense expenditures of 0.31 percentage points. Growth at 4.0 percent in IVQ2013 had strongest contributions of 2.29 percentage points of PCE and 1.29 percentage points of trade. Growth of GDP at minus 1.2 percent in IQ2014 is mostly contribution of 1.26 percentage points by PCE with deduction of 1.10 percentage points by GDI, inventory divestment of 1.89 percentage points and trade deducting 1.16 percentage points. Growth at 4.0 percent in IIQ2014 consists of contributions of 2.56 percentage points by PCE and 1.79 percentage points by GDI with 0.67 percentage points by inventory change. Trade deducted 0.41 percentage points and government added 0.02 percentage points mostly because of contribution of 0.22 percentage points of expenditures by state and local government. Growth at 5.0 percent in IIIQ2014 consists of contribution of 2.52 percentage points by PCE, 1.49 percentage points by GDI, 0.50 percentage points by trade and 0.46 percentage points by government of which 0.17 percentage points by national defense expenditures growing at 4.0 percent in annual equivalent. Growth at 2.3 percent in IVQ2014 consists of contribution of 3.07 percentage points by PCE, 0.45 percentage points by GDI with contribution of 0.23 percentage points by inventory investment. Net trade deducted 1.14 percentage points while government deducted 0.07 percentage mostly because of deduction of 0.52 percentage points by national defense expenditure declining at 11.6 percent in IVQ2014. Growth of GDP at 2.0 percent in IQ2015 consisted mostly of contributions of 1.63 percentage points by personal consumption expenditures and 1.01 percentage points by inventory accumulation while trade deducted 1.65 percentage points and government contributed 0.45 percentage points. Growth at 2.6 percentage points in IIQ2015 consisted mostly of contributions of 1.94 percentage points by personal consumption expenditures, 0.18 percentage points by gross domestic investment, deduction of 0.08 percentage points by net trade and contribution of 0.57 percentage points by government consumption and expenditures. Growth at 2.0 percent in IIIQ2015 consisted mostly of contribution of personal consumption expenditures (PCE) of 1.81 percentage points with government adding 0.34 percentage points. Gross domestic investment (GDI) contributed 0.35 percentage points with deduction of inventory divestment of 0.57 percentage points while net trade deducted 0.52 percentage points. Growth at 0.9 percent in IVQ2015 consisted mostly of contribution of 1.53 percentage points by personal consumption expenditures (PCE). GDI deducted 0.39 percentage points while trade deducted 0.45 percentage points and inventory divestment deducted 0.36 percentage points. Growth at 0.8 percent in IQ2016 consisted mostly of contribution of 1.11 percentage points by personal consumption expenditures (PCE). There were deduction of 0.56 percentage points by gross domestic investment (GDI) and 0.41 percentage points by inventory change. Net trade contributed 0.01 percentage points and government added 0.28 percentage points. Growth at 1.4 percent in IIQ2016 consisted mostly of contribution of 2.88 percentage points by PCE with GDI deducting 1.34 percentage points. Inventory divestment deducted 1.16 percentage points. Growth at 3.5 percent in IIIQ2016 consisted mostly of contribution of 2.03 by PCE with GDI adding 0.50 percentage points. Inventory investment contributed 0.49 percentage points and trade added 0.85 percentage points. Growth at 2.1 percent in IVQ2016 had positive contributions of 2.40 percentage points of PCE, 1.47 of GDI and 0.03 of GOV. Inventory investment added 1.01 percentage points and net trade deducted 1.82 percentage points. The economy of the United States has lost the dynamic growth impulse of earlier cyclical expansions with mediocre growth resulting from consumption forced by one-time effects of financial repression, national defense expenditures and inventory accumulation.

Table I-8, US, Contributions to the Rate of Growth of GDP in Percentage Points

 

GDP

PCE

GDI

∆ PI

Trade

GOV

2016

            

I

0.8

1.11

-0.56

-0.41

0.01

0.28

II

1.4

2.88

-1.34

-1.16

0.18

-0.30

III

3.5

2.03

0.50

0.49

0.85

0.14

IV

2.1

2.40

1.47

1.01

-1.82

0.03

2015

            

I

2.0

1.63

1.62

1.01

-1.65

0.45

II

2.6

1.94

0.18

-0.52

-0.08

0.57

III

2.0

1.81

-0.35

-0.57

-0.52

0.34

IV

0.9

1.53

-0.39

-0.36

-0.45

0.18

2014

            

I

-1.2

1.26

-1.10

-1.89

-1.16

-0.19

II

4.0

2.56

1.79

0.67

-0.41

0.02

III

5.0

2.52

1.49

0.32

0.50

0.46

IV

2.3

3.07

0.45

0.23

-1.14

-0.07

2013

            

I

2.8

1.32

2.04

0.92

0.30

-0.83

II

0.8

0.58

0.78

0.08

-0.21

-0.37

III

3.1

1.28

2.08

1.60

0.13

-0.37

IV

4.0

2.29

0.91

-0.11

1.29

-0.53

2012

            

I

2.7

1.63

1.47

-0.53

-0.02

-0.40

II

1.9

0.45

1.53

0.56

0.28

-0.39

III

0.5

0.72

-0.18

-0.18

0.16

-0.22

IV

0.1

0.78

-0.51

-1.54

0.58

-0.75

2011

            

I

-1.5

1.38

-1.07

-0.96

-0.24

-1.60

II

2.9

0.57

2.14

1.04

0.31

-0.08

III

0.8

1.20

0.15

-2.10

0.01

-0.52

IV

4.6

0.94

4.16

2.80

-0.21

-0.31

2010

            

I

1.7

1.46

1.77

1.66

-0.85

-0.63

II

3.9

2.23

2.86

1.09

-1.77

0.61

III

2.7

1.77

1.86

1.90

-0.83

-0.07

IV

2.5

2.79

-0.51

-1.63

1.12

-0.87

2009

            

I

-5.4

-0.86

-7.02

-2.26

2.30

0.15

II

-0.5

-1.19

-3.25

-1.12

2.34

1.56

III

1.3

1.68

-0.40

-0.38

-0.45

0.48

IV

3.9

-0.01

4.05

4.40

0.06

-0.17

1982

            

I

-6.5

1.61

-7.59

-5.33

-0.49

-0.05

II

2.2

0.89

-0.06

2.26

0.81

0.56

III

-1.4

1.88

-0.62

1.11

-3.22

0.53

IV

0.4

4.51

-5.37

-5.33

-0.10

1.35

1983

            

I

5.3

2.45

2.36

0.92

-0.29

0.82

II

9.4

5.06

5.96

3.43

-2.46

0.89

III

8.1

4.50

4.40

0.57

-2.25

1.42

IV

8.5

4.06

6.94

3.01

-1.14

-1.36

1984

            

I

8.2

2.26

7.23

4.94

-2.31

1.01

II

7.2

3.64

2.57

-0.29

-0.87

1.87

III

4.0

1.95

1.69

0.21

-0.36

0.70

IV

3.2

3.29

-1.08

-2.44

-0.56

1.58

1985

            

I

4.0

4.23

-2.14

-2.86

0.94

1.01

II

3.7

2.35

1.34

0.35

-1.90

1.93

III

6.4

4.82

-0.43

-0.15

-0.01

1.98

IV

3.0

0.62

2.80

1.40

-0.66

0.27

1986

            

I

3.8

2.10

0.04

-0.17

0.92

0.70

II

1.9

2.77

-1.30

-1.30

-1.33

1.70

III

4.1

4.55

-1.97

-1.62

-0.45

1.95

IV

2.1

1.62

0.24

-0.29

0.71

-0.48

1987

            

I

2.8

0.05

1.98

3.28

0.23

0.57

II

4.6

3.54

0.08

-0.99

0.14

0.81

III

3.7

2.97

0.03

-1.19

0.45

0.23

IV

6.8

0.57

4.94

4.95

0.18

1.08

1988

            

I

2.3

4.49

-3.62

-3.68

1.94

-0.54

II

5.4

1.89

1.72

0.33

1.44

0.34

III

2.3

2.17

0.38

0.05

-0.31

0.08

IV

5.4

2.93

1.11

0.27

-0.21

1.56

1989

            

I

4.1

1.18

2.41

1.80

0.85

-0.35

II

3.2

1.20

-0.70

-0.79

1.35

1.34

III

3.0

2.52

-0.64

-1.84

0.44

0.70

IV

0.9

1.13

-0.53

0.37

-0.20

0.45

1990

            

I

4.5

2.21

0.69

-0.10

0.25

1.30

Note: PCE: personal consumption expenditures; GDI: gross private domestic investment; ∆ PI: change in private inventories; Trade: net exports of goods and services; GOV: government consumption expenditures and gross investment; – is negative and no sign positive

GDP: percent change at annual rate; percentage points at annual rates

Source: US Bureau of Economic Analysis

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

The Bureau of Economic Analysis (BEA) (pages 1-2) explains growth of GDP in IVQ2016 as follows (https://www.bea.gov/newsreleases/national/gdp/2017/pdf/gdp4q16_3rd.pdf):

“Real gross domestic product (GDP) increased at an annual rate of 2.1 percent in the fourth quarter of 2016 (table 1), according to the "third" estimate released by the Bureau of Economic Analysis. In the third quarter of 2016, real GDP increased 3.5 percent. The GDP estimate released today is based on more complete source data than were available for the "second" estimate issued last month. In the second estimate, the increase in real GDP was 1.9 percent. With this third estimate for the fourth quarter, the general picture of economic growth remains largely the same; personal consumption expenditures (PCE) increased more than previously estimated (see "Updates to GDP" on page 2). The increase in real GDP in the fourth quarter reflected positive contributions from PCE, private inventory investment, residential fixed investment, nonresidential fixed investment, and state and local government spending that were partly offset by negative contributions from exports and federal government spending. Imports, which are a subtraction in the calculation of GDP, increased (table 2). The deceleration in real GDP in the fourth quarter reflected downturns in exports and in federal government spending, an acceleration in imports, and a deceleration in nonresidential fixed investment that were partly offset by accelerations in private inventory investment and in PCE, and upturns in residential fixed investment and in state and local government spending.”

There are positive contributions to growth in IVQ2016 shown in Table I-9:

  • Personal consumption expenditures (PCE) growing at 3.5 percent
  • Growth of consumption of durable goods at 11.4 percent
  • Growth of nonresidential fixed investment (NRFI) at 0.9 percent
  • Growth of residential fixed investment at 9.6 percent
  • Inventory investment contributing 1.01 percentage points
  • Growth of government expenditures at 0.2 percent of which growth of state and local government expenditures at 1.0 percent

There were negative contributions in IVQ2016:

  • Exports contracting at 4.5 percent
  • Imports, which are a deduction from growth, growing at 9.0 percent
  • Federal government expenditures contracting at 1.2 percent with contraction of national defense expenditures at 3.6 percent

The BEA explains deceleration in real GDP growth in IVQ2016 by:

  • Contraction of exports at 4.5 percent in IVQ2016 compared with increase at 10.0 percent in IIIQ2016
  • Growth of imports at 9.0 percent in IVQ2016 compared with growth at 2.2 percent in IIIQ2016
  • Growth of consumption of durable goods at 11.4 percent in IVQ2016 compared with growth at 11.6 percent in IIIQ2016
  • Contraction of federal government expenditures at 1.2 percent in IVQ2016 compared with growth at 2.4 percent in IIIQ2016
  • Contraction of national defense expenditures at 3.6 percent in IVQ2016 compared with growth at 2.0 percent in IIIQ2016

The BEA finds offsetting accelerating factors:

· Growth of residential fixed investment at 9.6 percent in IVQ2016 compared with contraction at 4.1 percent in IIIQ2016

· Growth of personal consumption expenditures at 3.5 percent compared with growth at 3.0 percent in IIIQ2016

· Inventory investment contribution of 1.01 percentage points in IVQ2016 compared with 0.49 percentage points in IIIQ2016

· Growth of expenditures of state and local government at 1.0 percent in IVQ2016 compared with contraction at 0.2 percent in IIIQ2016

An important aspect of growth in the US is the decline in growth of real disposable personal income, or what is left after taxes and inflation, which decreased at the rate of 0.5 percent in IIIQ2013 compared with a year earlier. Contraction of real disposable income of 2.8 percent in IVQ2013 relative to a year earlier is largely due to comparison with an artificially higher level in anticipations of income in Nov and Dec 2012 to avoid increases in taxes in 2013, an episode known as “fiscal cliff.” Real disposable personal income increased 2.5 percent in IQ2014 relative to a year earlier and 3.2 percent in IIQ2014 relative to a year earlier. Real disposable personal income increased 3.7 percent in IIIQ2014 relative to a year earlier and 4.5 percent in IVQ2014 compared with a year earlier. Real disposable personal income grew 3.9 percent in IQ2015 relative to a year earlier partly because of contraction of energy prices and increased at 3.6 percent in IIQ2015. Real disposable personal income grew at 3.3 percent in IIIQ2015 relative to a year earlier and at 3.0 percent in IVQ2015 relative to a year earlier. Real disposable income grew at 3.1 percent in IQ2016 relative to a year earlier and at 2.8 percent in IIQ2016 relative to a year earlier. Real disposable income grew at 2.7 percent in IIIQ2016 relative to a year earlier and at 2.5 percent in IVQ2016 compared with a year earlier. The effects of financial repression, or zero interest, are vividly shown in the decline of the savings rate, or personal saving as percent of disposable income from 9.2 percent in IVQ2012 to 5.3 percent in IIIQ2013 and 4.7 percent in IVQ2013. The savings rate eased to 5.3 percent in IQ2014, increasing to 5.7 percent in IIQ2014 and stabilizing to 5.7 percent in IIIQ2014. The savings rate fell to 5.6 percent in IVQ2014, increasing to 5.5 percent in IQ2015. The savings rate increased to 5.7 percent in IIQ2015, 5.9 percent in IIIQ2015 and 6.0 percent in IVQ2015. The savings ratio moved to 6.1 percent in IQ2016 and 5.9 percent in IIQ2016. The savings ratio stabilized at 5.9 percent in IIIQ2016 and at 5.5 percent in IVQ2016. Anticipation of income in IVQ2012 to avoid higher taxes in 2013 caused increases in income and savings while higher payroll taxes in 2013 restricted income growth and savings in IQ2013. Zero interest rates induce risky investments with high leverage and can contract balance sheets of families, business and financial institutions when interest rates inevitably increase in the future. There is a tradeoff of weaker economy in the future when interest rates increase by meager growth in the present with forced consumption by zero interest rates. Microeconomics consists of the analysis of allocation of scarce resources to alternative and competing ends. Zero interest rates cloud he calculus of risk and returns in consumption and investment, disrupting decisions that maintain the economy in its long-term growth path.

Table I-9, US, Percentage Seasonally Adjusted Annual Equivalent Quarterly Rates of Increase, %

 

IVQ 2015

IQ2016

IIQ   

2016

IIIQ 

2016

IVQ 

2016

GDP

0.9

0.8

1.4

3.5

2.1

PCE

2.3

1.6

4.3

3.0

3.5

Durable Goods

4.0

-0.6

9.8

11.6

11.4

NRFI

-3.3

-3.4

1.0

1.4

0.9

RFI

11.5

7.8

-7.7

-4.1

9.6

Exports

-2.7

-0.7

1.8

10.0

-4.5

Imports

0.7

-0.6

0.2

2.2

9.0

GOV

1.0

1.6

-1.7

0.8

0.2

Federal GOV

3.8

-1.5

-0.4

2.4

-1.2

National Defense

4.4

-3.2

-3.2

2.0

-3.6

Cont to GDP Growth % Points

0.17

-0.13

-0.13

0.08

-0.14

State/Local GOV

-0.6

3.5

-2.5

-0.2

1.0

∆ PI (PP)

-0.36

-0.41

-1.16

0.49

1.01

Final Sales of Domestic Product

1.2

1.2

2.6

3.0

1.1

Gross Domestic Purchases

1.3

0.8

1.2

2.6

3.9

Prices Gross
Domestic Purchases

0.3

0.2

2.1

1.5

1.9

Prices of GDP

0.8

0.5

2.3

1.4

2.1

Prices of GDP Excluding Food and Energy

0.9

1.5

2.1

1.9

1.8

Prices of PCE

0.4

0.3

2.0

1.5

2.0

Prices of PCE Excluding Food and Energy

1.2

2.1

1.8

1.7

1.3

Prices of Market Based PCE

0.2

-0.2

1.9

1.3

2.1

Prices of Market Based PCE Excluding Food and Energy

1.1

1.8

1.6

1.6

1.3

Real Disposable Personal Income*

3.0

3.1

2.8

2.7

2.5

Personal Saving As % Disposable Income

6.0

6.1

5.9

5.9

5.5

Note: PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment; GOV: government consumption expenditures and gross investment; ∆ PI: change in

private inventories; GDP - ∆ PI: final sales of domestic product; PP: percentage points; Personal savings rate: savings as percent of disposable income

*Percent change from quarter one year ago

Source: Bureau of Economic Analysis

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

Percentage shares of GDP are in Table I-10. PCE (personal consumption expenditures) is equivalent to 68.9 percent of GDP and is under pressure with stagnant real disposable income per person, elevated levels of unemployment and underemployment and higher savings rates than before the global recession, temporarily interrupted by financial repression in the form of zero interest rates. Gross private domestic investment is also growing slowly even with about two trillion dollars in cash holdings by companies. In a slowing world economy, it may prove more difficult to grow exports faster than imports to generate higher growth. Bouts of risk aversion revalue the dollar relative to most currencies in the world as investors increase their holdings of dollar-denominated assets.

Table I-10, US, Percentage Shares of GDP, %

 

IVQ2016

GDP

100.0

PCE

68.9

   Goods

22.2

            Durable

7.6

            Nondurable

14.6

   Services

46.7

Gross Private Domestic Investment

16.4

    Fixed Investment

16.2

        NRFI

12.3

            Structures

2.7

            Equipment & Software

5.6

            Intellectual Property

4.1

        RFI

3.8

     Change in Private
      Inventories

0.3

Net Exports of Goods and Services

-2.9

       Exports

12.0

                    Goods

7.8

                    Services

4.2

       Imports

14.9

                     Goods

12.2

                     Services

2.7

Government

17.5

        Federal

6.6

           National Defense

3.9

           Nondefense

2.8

        State and Local

10.9

PCE: personal consumption expenditures; NRFI: nonresidential fixed investment; RFI: residential fixed investment

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

Table I-11 shows percentage point (PP) contributions to the annual levels of GDP growth in the earlier recessions 1958-1959, 1975-1976, 1982-1983 and 2009, 2010, 2011, 2012, 2013, 2014 2015 and 2016. The data incorporate the new revisions released by the BEA. The most striking contrast is in the rates of growth of annual GDP in the expansion phases of 6.9 percent in 1959, 5.4 percent in 1976, and 4.6 percent in 1983 followed by 7.3 percent in 1984 and 4.2 percent in 1985. In contrast, GDP grew 2.5 percent in 2010 after six consecutive quarters of growth, 1.6 percent in 2011 after ten consecutive quarters of expansion, 2.2 percent in 2012 after 14 quarters of expansion, 1.7 percent in 2013 after 18 consecutive quarters of expansion, 2.4 percent in 2014 after 22 consecutive quarters of expansion and 2.6 percent in 2015 after twenty-six consecutive quarters of expansion. GDP grew at 1.6 percent in 2016 after thirty consecutive quarters of expansion. Annual levels also show much stronger growth of PCEs in the expansions after the earlier contractions than in the expansion after the global recession of 2007. Gross domestic investment was much stronger in the earlier expansions than in 2010, 2011, 2012, 2013, 2014, 2015 and 2016.

Table I-11, US, Percentage Point Contributions to the Annual Growth Rate of GDP

 

GDP

PCE

GDI

∆ PI

Trade

GOV

1958

-0.7

0.52

-1.16

-0.17

-0.87

0.77

1959

6.9

3.49

2.82

0.83

0.00

0.59

1975

-0.2

1.36

-2.90

-1.23

0.86

0.49

1976

5.4

3.41

2.91

1.37

-1.05

0.12

1982

-1.9

0.86

-2.55

-1.30

-0.59

0.38

1983

4.6

3.54

1.60

0.28

-1.32

0.81

1984

7.3

3.32

4.73

1.90

-1.54

0.76

1985

4.2

3.25

-0.01

-1.03

-0.39

1.38

1986

3.5

2.63

0.03

-0.31

-0.29

1.14

1987

3.5

2.14

0.53

0.41

0.17

0.63

1988

4.2

2.66

0.45

-0.13

0.81

0.28

1989

3.7

1.86

0.72

0.17

0.51

0.59

1990

1.9

1.31

-0.45

-0.21

0.40

0.66

2009

-2.8

-1.08

-3.52

-0.76

1.19

0.64

2010

2.5

1.32

1.66

1.45

-0.46

0.02

2011

1.6

1.55

0.73

-0.14

-0.02

-0.65

2012

2.2

1.01

1.52

0.14

0.08

-0.38

2013

1.7

1.00

0.95

0.19

0.29

-0.56

2014

2.4

1.95

0.73

-0.14

-0.15

-0.16

2015

2.6

2.16

0.82

0.17

-0.71

0.32

2016

1.6

1.86

-0.26

-0.37

-0.13

0.14

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

Table I-12 provides more detail of the contributions to growth of GDP from 2009 to 2016 using annual-level data. PCEs contributed 1.32 PPs to GDP growth in 2010 of which 0.77 percentage points (PP) in goods and 0.55 PP in services. Gross private domestic investment (GPDI) deducted 3.52 PPs of GDP growth in 2009 of which -2.77 PPs by fixed investment and -0.76 PPs of inventory change (∆PI) and added 1.66 PPs of GDI in 2010 of which 0.21 PPs of fixed investment and 1.45 PPs of inventory accumulation (∆PI). Trade, or exports of goods and services net of imports, contributed 1.19 PPs in 2009 of which exports deducted 1.07 PPs and imports added 2.26 PPs. In 2010, trade deducted 0.46 PPs with exports contributing 1.33 PPs and imports deducting 1.79 PPs likely benefitting from dollar revaluation. In 2009, government added 0.64 PP of which 0.44 PPs by the federal government and 0.20 PPs by state and local government; in 2010, government added 0.02 PPs of which 0.37 PPs by the federal government with state and local government deducting 0.35 PPs. Table I-12 provides the estimates for 2011, 2012, 2013, 2014, 2015 and 2016. PCE contributed 1.55 PPs in 2011 after 1.32 PPs in 2010. The contribution of PCE fell to 1.01 points in 2012 and to 1.00 PPs in 2013, increasing to 1.95 PPs in 2014. PCE contributed 2.16 percentage points in 2015 and added 1.86 PPs in 2016. The breakdown into goods and services is similar but with contributions in 2012 of 0.63 PPs of goods and 0.38 PPs of services. In 2013, goods contributed 0.71 PPs and services 0.28 PPs. Goods contributed 0.89 PPs in 2014 and services contributed 1.06 PPS. Goods contributed 0.91 percentage points in 2015 and services 1.26 percentage points. Gross private domestic investment contributed 1.66 PPs in 2010 with 1.45 PPs of change of private inventories but the contribution of gross private domestic investment was only 0.73 PPs in 2011. The contribution of GDI in 2012 increased to 1.52 PPs with fixed investment increasing its contribution to 1.38 PPs and residential investment contributing 0.33 PPs for the first time since 2009. GDI contributed 1.52 PPs in 2012 with 1.38 PPs from fixed investment and 0.14 PPs from inventory change. GDI contribute 0.95 PPs in 2013, 0.73 PPs in 2014 and 0.82 PPs in 2015. GDI deducted 0.26 PPs in 2016 with 0.11 PPs of fixed investment and deduction of 0.37 PPP by inventory change. Net exports of goods and services deducted marginally in 2011 with 0.02 PPs and added 0.08 PPs in 2012. Net trade contributed 0.29 PPs in 2013 and deducted 0.15 PPs in 2014. Net trade deducted 0.71 percentage points in 2015 and deducted 0.13 PPs in 2016. The contribution of exports fell from 1.33 PPs in 2010 and 0.87 PPs in 2011 to only 0.46 PPs in 2012, 0.47 PPs in 2013 and 0.58 PPs in 2014. Exports contributed only 0.01 percentage points in 2015 and 0.04 percentage points in 2016. Government deducted 0.65 PPs in 2011, 0.38 PPs in 2012 and 0.56 PPs in 2013. Government deducted 0.16 PPs in 2014 and contributed 0.32 PPs in 2015, contributing 0.14 PPs in 2016. Demand weakened in 2013 with lower contribution of personal consumption expenditures of 1.00 PPs and of gross domestic investment of 0.76 PPs. PCE contributed 1.95 PPs in 2014 and GDI 0.73 PPs. PCE contributed 2.16 PPs in 2015 and GDI contributed 0.82 PPs. PCE contributed 1.86 PPs in 2016 and GDI deducted 0.26 PPs. Net trade contributed only 0.29 PPs in 2013 and deducted 0.15 PPs in 2014, deducting 0.71 PPs in 2015. Net trade deducted 0.13 PPs in 2016. The expansion since IIIQ2009 has been characterized by weak contributions of aggregate demand, which is the sum of personal consumption expenditures plus gross private domestic investment. The US did not recover strongly from the global recessions as typical in past cyclical expansions. Recoveries tend to be more sluggish as expansions mature. At the margin in IVQ2011, the acceleration of expansion was driven by inventory accumulation instead of aggregate demand of consumption and investment. Growth of PCE was partly the result of burning savings because of financial repression, which may not be sustainable in the future while creating multiple distortions of resource allocation and growth restraint.

Table I-12, US, Contributions to Growth of Gross Domestic Product in Percentage Points

 

2009

2010

2011

2012

2013

2014

2015

GDP Growth ∆%

-2.8

2.5

1.6

2.2

1.7

2.4

2.6

Personal Consumption Expenditures (PCE)

-1.08

1.32

1.55

1.01

1.00

1.95

2.16

  Goods

-0.68

0.77

0.71

0.63

0.71

0.89

0.91

     Durable

-0.41

0.43

0.43

0.53

0.45

0.49

0.51

     Nondurable

-0.27

0.34

0.28

0.10

0.27

0.40

0.40

  Services

-0.40

0.55

0.84

0.38

0.28

1.06

1.26

Gross Private Domestic Investment (GPDI)

-3.52

1.66

0.73

1.52

0.95

0.73

0.82

Fixed Investment

-2.77

0.21

0.86

1.38

0.76

0.87

0.65

    Nonresidential

-2.04

0.28

0.85

1.05

0.43

0.76

0.27

      Structures

-0.70

-0.49

0.06

0.32

0.04

0.29

-0.13

     Equipment, software

-1.29

0.70

0.66

0.58

0.26

0.32

0.21

      Intellectual Property

-0.05

0.07

0.13

0.15

0.13

0.15

0.19

    Residential

-0.73

-0.07

0.01

0.33

0.33

0.11

0.39

Change Private Inventories

-0.76

1.45

-0.14

0.14

0.19

-0.14

0.17

Net Exports of Goods and Services

1.19

-0.46

-0.02

0.08

0.29

-0.15

-0.71

   Exports

-1.07

1.33

0.87

0.46

0.47

0.58

0.01

      Goods

-1.03

1.08

0.57

0.34

0.29

0.41

-0.06

      Services

-0.04

0.25

0.29

0.12

0.18

0.17

0.07

   Imports

2.26

-1.79

-0.89

-0.38

-0.18

-0.72

-0.73

      Goods

2.15

-1.69

-0.78

-0.30

-0.17

-0.65

-0.65

      Services

0.10

-0.10

-0.11

-0.09

-0.02

-0.07

-0.08

Government Consumption Expenditures and Gross Investment

0.64

0.02

-0.65

-0.38

-0.56

-0.16

0.32

  Federal

0.44

0.37

-0.24

-0.15

-0.46

-0.19

0.00

    National Defense

0.27

0.18

-0.13

-0.18

-0.34

-0.19

-0.09

    Nondefense

0.17

0.19

-0.11

0.03

-0.12

0.00

0.09

  State and Local

0.20

-0.35

-0.41

-0.22

-0.09

0.03

0.32
 

2013

2014

2015

2016

GDP Growth ∆%

1.7

2.4

2.6

1.6

Personal Consumption Expenditures (PCE)

1.00

1.95

2.16

1.86

  Goods

0.71

0.89

0.91

0.79

     Durable

0.45

0.49

0.51

0.42

     Nondurable

0.27

0.40

0.40

0.36

  Services

0.28

1.06

1.26

1.08

Gross Private Domestic Investment (GPDI)

0.95

0.73

0.82

-0.26

Fixed Investment

0.76

0.87

0.65

0.11

    Nonresidential

0.43

0.76

0.27

-0.07

      Structures

0.04

0.29

-0.13

-0.08

     Equipment, software

0.26

0.32

0.21

-0.17

      Intellectual Property

0.13

0.15

0.19

0.19

    Residential

0.33

0.11

0.39

0.18

Change Private Inventories

0.19

-0.14

0.17

-0.37

Net Exports of Goods and Services

0.29

-0.15

-0.71

-0.13

   Exports

0.47

0.58

0.01

0.04

      Goods

0.29

0.41

-0.06

0.05

      Services

0.18

0.17

0.07

0.00

   Imports

-0.18

-0.72

-0.73

-0.17

      Goods

-0.17

-0.65

-0.65

-0.09

      Services

-0.02

-0.07

-0.08

-0.08

Government Consumption Expenditures and Gross Investment

-0.56

-0.16

0.32

0.14

  Federal

-0.46

-0.19

0.00

0.04

    National Defense

-0.34

-0.19

-0.09

-0.03

    Nondefense

-0.12

0.00

0.09

0.07

  State and Local

-0.09

0.03

0.32

0.10

Source: US Bureau of Economic Analysis

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

Manufacturing jobs not seasonally adjusted decreased 11,000 from Feb 2016 to
Feb 2017 or at the average monthly rate of 917. Industrial production changed 0.0 percent in Feb 2017 and decreased 0.1 percent in Jan 2017 after increasing 0.6 percent in Dec 2016, with all data seasonally adjusted, as shown in Table I-1. The Board of Governors of the Federal Reserve System conducted the annual revision of industrial production released on Apr 1, 2016 (http://www.federalreserve.gov/releases/g17/revisions/Current/DefaultRev.htm):

“The Federal Reserve has revised its index of industrial production (IP) and the related measures of capacity and capacity utilization.[1] Total IP is now reported to have increased about 2 1/2 percent per year, on average, from 2011 through 2014 before falling 1 1/2 percent in 2015.[2] Relative to earlier reports, the current rates of change are lower, especially for 2014 and 2015. Total IP is now estimated to have returned to its pre-recession peak in November 2014, six months later than previously estimated. Capacity for total industry is now reported to have increased about 2 percent in 2014 and 2015 after having increased only 1 percent in 2013. Compared with the previously reported estimates, the gain in 2015 is 1/2 percentage point higher, and the gain in 2013 is 1/2 percentage point lower. Industrial capacity is expected to increase 1/2 percent in 2016.”

The report of the Board of Governors of the Federal Reserve System states (https://www.federalreserve.gov/releases/g17/Current/default.htm):

“Industrial production was unchanged in February following a 0.1 percent decrease in January. In February, manufacturing output moved up 0.5 percent for its sixth consecutive monthly increase. Mining output jumped 2.7 percent, but the index for utilities fell 5.7 percent, as continued unseasonably warm weather further reduced demand for heating. At 104.7 percent of its 2012 average, total industrial production in February was 0.3 percent above its level of a year earlier. Capacity utilization for the industrial sector declined 0.1 percentage point in February to 75.4 percent, a rate that is 4.5 percentage points below its long-run (1972–2016) average.” In the six months ending in Feb 2017, United States national industrial production accumulated change of 0.2 percent at the annual equivalent rate of 0.4 percent, which is close to growth of 0.3 percent in the 12 months ending in Feb 2017. Excluding growth of 0.6 percent in Dec 2016, growth in the remaining five months from Sep to Feb 2017 accumulated to minus 0.4 percent or minus 1.0 percent annual equivalent. Industrial production declined in three of the past six months and increased 0.3 percent in one month and 0.6 percent in another month, changing 0 percent in one month. Industrial production grew at annual equivalent 2.0 percent in the most recent quarter from Dec 2016 to Feb and decreased at 1.2 percent in the prior quarter Sep 2016 to Nov 2016. Business equipment accumulated change of 1.1 percent in the six months from Sep 2016 to Feb 2017, at the annual equivalent rate of 2.2 percent, which is higher than growth of 1.5 percent in the 12 months ending in Feb 2017. The Fed analyzes capacity utilization of total industry in its report (https://www.federalreserve.gov/releases/g17/Current/default.htm): “Capacity utilization for the industrial sector declined 0.1 percentage point in February to 75.4 percent, a rate that is 4.5 percentage points below its long-run (1972–2016) average.” United States industry apparently decelerated to a lower growth rate followed by possible acceleration and weakening growth in past months.

Table I-13 provides national income by industry without capital consumption adjustment (WCCA). “Private industries” or economic activities have share of 87.0 percent in IVQ2016. Most of US national income is in the form of services. In Feb 2017, there were 144.271 million nonfarm jobs NSA in the US, according to estimates of the establishment survey of the Bureau of Labor Statistics (BLS) (http://www.bls.gov/news.release/empsit.nr0.htm Table B-1). Total private jobs of 121.650 million NSA in Feb 2017 accounted for 84.3 percent of total nonfarm jobs of 144.271 million, of which 12.301 million, or 10.1 percent of total private jobs and 8.5 percent of total nonfarm jobs, were in manufacturing. Private service-providing jobs were 102.204 million NSA in Feb 2017, or 70.8 percent of total nonfarm jobs and 84.0 percent of total private-sector jobs. Manufacturing has share of 10.2 percent in US national income in IVQ2016 and durable goods 6.0 percent, as shown in Table I-13. Most income in the US originates in services. Subsidies and similar measures designed to increase manufacturing jobs will not increase economic growth and employment and may actually reduce growth by diverting resources away from currently employment-creating activities because of the drain of taxation.

Table I-13, US, National Income without Capital Consumption Adjustment by Industry, Seasonally Adjusted Annual Rates, Billions of Dollars, % of Total

 

SAAR IIIQ2016

% Total

SAAR
IVQ2016

% Total

National Income WCCA

16,173.7

100.0

16,335.7

100.0

Domestic Industries

15,969.7

98.7

16,092.7

98.5

Private Industries

14,095.4

87.2

14,207.5

87.0

Agriculture

122.0

0.8

113.3

0.7

Mining

187.7

1.2

189.4

1.2

Utilities

172.0

1.1

173.9

1.1

Construction

771.3

4.8

788.6

4.8

Manufacturing

1676.5

10.4

1665.7

10.2

Durable Goods

977.4

6.0

980.7

6.0

Nondurable Goods

699.2

4.3

685.0

4.2

Wholesale Trade

957.9

5.9

951.8

5.8

Retail Trade

1136.2

7.0

1138.5

7.0

Transportation & WH

505.7

3.1

502.5

3.1

Information

596.0

3.7

593.0

3.6

Finance, Insurance, RE

2862.6

17.7

2922.5

17.9

Professional & Business Services

2293.6

14.2

2313.0

14.2

Education, Health Care

1651.7

10.2

1666.1

10.2

Arts, Entertainment

688.0

4.3

706.9

4.3

Other Services

474.2

2.9

482.4

3.0

Government

1874.3

11.6

1885.1

11.5

Rest of the World

204.0

1.3

243.0

1.5

Notes: SSAR: Seasonally-Adjusted Annual Rate; WCCA: Without Capital Consumption Adjustment by Industry; WH: Warehousing; RE, includes rental and leasing: Real Estate; Art, Entertainment includes recreation, accommodation and food services; BS: business services

Source: US Bureau of Economic Analysis

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

Table IA1-1 provides quarterly seasonally adjusted annual rates (SAAR) of growth of private fixed investment for the recessions of the 1980s and the current economic cycle. In the cyclical expansion beginning in IQ1983 (http://www.nber.org/cycles.html), real private fixed investment in the United States grew at the average annual rate of 14.7 percent in the first eight quarters from IQ1983 to IVQ1984. Growth rates fell to an average of 2.2 percent in the following eight quarters from IQ1985 to IVQ1986 and to an average of 1.9 percent in the 12 quarters of 1985, 1986 and 1987. The average rate of growth in the four quarters of 1988 was 3.7 percent. There were only four quarters of contraction of private fixed investment from IQ1983 to IVQ1987. The National Bureau of Economic Research dates another cycle from Jul 1990 (IIIQ1981) to Mar 1991 (IQ1991) (http://www.nber.org/cycles.html), showing in Table III-1 with contractions of fixed investment in the final three quarters of 1990. There is quite different behavior of private fixed investment in the thirty quarters of cyclical expansion from IIIQ2009 to IVQ2016. The average annual growth rate in the first eight quarters of expansion from IIIQ2009 to IIQ2011 was 3.2 percent, which is significantly lower than 14.7 percent in the first eight quarters of expansion from IQ1983 to IVQ1984. There is only robust growth of private fixed investment in the four quarters of expansion from IIQ2011 to IQ2012 at the average annual rate of 12.5 percent. Growth has fallen from the SAAR of 17.3 percent in IIIQ2011 to 0.1 percent in IIIQ2012, recovering to 6.9 percent in IVQ2012 and increasing to 7.0 percent in IQ2013. The SAAR of fixed investment fell to 2.9 percent in IIIQ2013 and to 6.6 percent in IVQ2013. The SAAR of fixed investment decreased to 5.3 percent in IQ2014. Fixed investment grew at the SAAR of 7.2 percent in IIQ2014 and at 7.4 percent in IIIQ2014. Fixed investment grew at 1.3 percent in IVQ2014, 3.7 percent in IQ2015 and 4.3 percent in IIQ2015. Fixed investment grew at 5.7 percent in IIIQ2015 and fell at 0.2 percent in IVQ2015. Fixed investment decreased at 0.9 percent in IQ2016 and fell at 1.1 percent in IIQ2016. Fixed investment increased at 0.1 percent in IIIQ2016 and increased at 2.9 percent in IVQ2016. Sudeep Reddy and Scott Thurm, writing on “Investment falls off a cliff,” on Nov 18, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324595904578123593211825394.html?mod=WSJPRO_hpp_LEFTTopStories) analyze the decline of private investment in the US and inform that a review by the Wall Street Journal of filing and conference calls finds that 40 of the largest publicly traded corporations in the US have announced intentions to reduce capital expenditures in 2012.

Table IA1-1, US, Quarterly Growth Rates of Real Private Fixed Investment, % Annual Equivalent SA

Q

1981

1982

1983

1984

2008

2009

2010

I

3.8

-12.2

9.4

13.1

-7.1

-27.4

0.8

II

3.2

-12.1

16.0

16.6

-5.5

-14.2

13.6

III

0.1

-9.3

24.4

8.2

-12.1

-0.5

-0.4

IV

-1.5

0.2

24.3

7.3

-23.9

-2.8

8.5
       

1985

    

2011

I

      

3.7

    

-0.9

II

      

5.2

    

8.2

III

      

-1.6

    

17.3

IV

      

7.8

    

9.9
       

1986

    

2012

I

      

1.1

    

14.7

II

      

0.1

    

6.9

III

      

-1.8

    

0.1

IV

      

3.1

    

6.9
       

1987

    

2013

I

      

-6.7

    

7.0

II

      

6.3

    

4.3

III

      

7.1

    

2.9

IV

      

-0.2

    

6.6
       

1988

    

2014

I

      

0.2

    

5.3

II

      

8.1

    

7.2

III

      

1.9

    

7.4

IV

      

4.8

    

1.3
       

1989

    

2015

IQ

      

3.6

    

3.7

IIQ

      

0.5

    

4.3

IIIQ

      

7.2

    

5.7

IVQ

      

-5.0

    

-0.2
       

1990

    

2016

IQ

      

4.8

    

-0.9

IIQ

      

-7.7

    

-1.1

IIIQ

      

-3.3

    

0.1

IVQ

      

-9.8

    

2.9

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

Chart IA1-1 of the US Bureau of Economic Analysis (BEA) provides seasonally adjusted annual rates of growth of real private fixed investment from 1981 to 1989. Growth rates recovered sharply during the first eight quarters, which was essential in returning the economy to trend growth and eliminating unemployment and most underemployment accumulated during the contractions.

Chart IA1-1, US, Real Private Fixed Investment, Seasonally-Adjusted Annual Rates Percent Change from Prior Quarter, 1980-1989

Source: US Bureau of Economic Analysis

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

Weak behavior of real private fixed investment from 2007 to 2016 is in Chart IA1-2. Growth rates of real private fixed investment were much lower during the initial phase of the current economic cycle and have entered sharp trend of decline.

Chart IA1-2, US, Real Private Fixed Investment, Seasonally-Adjusted Annual Rates Percent Change from Prior Quarter, 2007-2016

Source: US Bureau of Economic Analysis

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

Table IA1-2 provides real private fixed investment at seasonally adjusted annual rates from IVQ2007 to IVQ2016 or for the complete economic cycle. The first column provides the quarter, the second column percentage change relative to IVQ2007, the third column the quarter percentage change in the quarter relative to the prior quarter and the final column percentage change in a quarter relative to the same quarter a year earlier. In IQ1980, real gross private domestic investment in the US was $951.6 billion of chained 2009 dollars, growing to $1,270.4 billion in IIQ1990 or 33.5 percent. Real gross private domestic investment in the US increased 10.1 percent from $2605.2 billion in IVQ2007 to $2,868.2 billion in IVQ2016. Real private fixed investment increased 8.2 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,798.9 billion in IVQ2016. Private fixed investment fell relative to IVQ2007 in all quarters preceding IQ2014 and changed 0.0 percent in IIIQ2016, declining 0.3 percent in IIQ2016 and falling 0.2 percent in IQ2016. Private fixed investment changed 0.0 percent in IIIQ2016 and increased 0.7 percent in IVQ2016. 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.

Table IA1-2, US, Real Private Fixed Investment and Percentage Change Relative to IVQ2007 and Prior Quarter, Billions of Chained 2009 Dollars and ∆%

 

Real PFI, Billions Chained 2009 Dollars

∆% Relative to IVQ2007

∆% Relative to Prior Quarter

∆%
over
Year Earlier

IVQ2007

2586.3

NA

-0.9

-1.4

IQ2008

2539.1

-1.8

-1.8

-3.0

IIQ2008

2503.4

-3.2

-1.4

-4.6

IIIQ2008

2424.1

-6.3

-3.2

-7.1

IV2008

2263.8

-12.5

-6.6

-12.5

IQ2009

2089.3

-19.2

-7.7

-17.7

IIQ2009

2011.0

-22.2

-3.7

-19.7

IIIQ2009

2008.4

-22.3

-0.1

-17.1

IVQ2009

1994.1

-22.9

-0.7

-11.9

IQ2010

1997.9

-22.8

0.2

-4.4

IIQ2010

2062.8

-20.2

3.2

2.6

IIIQ2010

2060.8

-20.3

-0.1

2.6

IVQ2010

2103.1

-18.7

2.1

5.5

IQ2011

2098.4

-18.9

-0.2

5.0

IIQ2011

2140.2

-17.2

2.0

3.8

IIIQ2011

2227.5

-13.9

4.1

8.1

IVQ2011

2280.6

-11.8

2.4

8.4

IQ2012

2360.4

-8.7

3.5

12.5

IIQ2012

2399.8

-7.2

1.7

12.1

IIIQ2012

2400.4

-7.2

0.0

7.8

IVQ2012

2441.0

-5.6

1.7

7.0

IQ2013

2482.7

-4.0

1.7

5.2

IIQ2013

2508.8

-3.0

1.1

4.5

IIIQ2013

2526.7

-2.3

0.7

5.3

IVQ2013

2567.2

-0.7

1.6

5.2

IQ2014

2600.5

0.5

1.3

4.7

IIQ2014

2646.1

2.3

1.8

5.5

IIIQ2014

2693.4

4.1

1.8

6.6

IVQ2014

2702.3

4.5

0.3

5.3

IQ2015

2727.2

5.4

0.9

4.9

IIQ2015

2756.0

6.6

1.1

4.2

IIIQ2015

2794.5

8.1

1.4

3.8

IVQ2015

2793.3

8.0

0.0

3.4

IQ2016

2786.7

7.7

-0.2

2.2

IIQ2016

2778.8

7.4

-0.3

0.8

IIIQ2016

2779.3

7.5

0.0

-0.5

IVQ2016

2798.9

8.2

0.7

0.2

PFI: Private Fixed Investment

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

Chart IA1-3 provides real private fixed investment in chained dollars of 2009 from 2007 to 2016. Real private fixed investment increased 8.2 percent from $2,586.3 billion of chained 2009 dollars in IVQ2007 to $2,798.9 billion in IVQ2016.

Chart IA1-3, US, Real Private Fixed Investment, Billions of Chained 2009 Dollars, IQ2007 to IVQ2016

Source: US Bureau of Economic Analysis

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

Chart IA1-4 provides real gross private domestic investment in chained dollars of 2009 from 1980 to 1989. Real gross private domestic investment climbed 33.5 percent to $1,270.4 billion of 2009 dollars in IIQ1990 above the level of $951.6 billion in IQ1980.

Chart IA1-4, US, Real Gross Private Domestic Investment, Billions of Chained 2009 Dollars at Seasonally Adjusted Annual Rate, 1980-1989

Source: US Bureau of Economic Analysis

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

Chart IA1-5 provides real gross private domestic investment in the United States in billions of chained dollars of 2009 from 2006 to 2016. Real gross private domestic investment reached a level of $2,868.2 billion in IVQQ2016, which was only 10.1 percent higher than the level of $2605.2 billion in IVQ2007 (http://www.bea.gov/iTable/index_nipa.cfm).

Chart IA1-5, US, Real Gross Private Domestic Investment, Billions of Chained 2009 Dollars at Seasonally Adjusted Annual Rate, 2007-2016

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

Table IA1-3 shows that the share of gross private domestic investment in GDP has fallen from 19.7 percent in IVQ2000 and 18.8 percent in IVQ2006 to 16.4 percent in IVQ2016. There are declines in percentage shares in GDP of all components with sharp reduction of residential investment from 4.7 percent in IVQ2000 and 5.6 percent in IVQ2006 to 3.8 percent in IVQ2016. The share of fixed investment in GDP fell from 19.2 percent in IVQ2000 and 18.5 percent in IVQ2006 to 16.2 percent in IVQ2016.

Table IA1-3, Percentage Shares of Gross Private Domestic Investment and Components in Gross Domestic Product, % of GDP

 

IVQ2016

IVQ2006

IVQ2000

Gross Private Domestic Investment

16.4

18.8

19.7

  Fixed Investment

16.2

18.5

19.2

     Nonresidential

12.3

12.9

14.5

          Structures

2.7

3.1

3.2

          Equipment

          and Software

5.6

6.1

7.3

          Intellectual
           Property

4.1

3.7

4.0

     Residential

3.8

5.6

4.7

   Change in Private Inventories

0.3

0.3

0.5

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

Broader perspective is in Chart IA1-6 with the percentage share of gross private domestic investment in GDP in annual data from 1929 to 2016. There was sharp drop during the current economic cycle with almost no recovery in contrast with sharp recovery after the recessions of the 1980s.

Chart IA1-6, US, Percentage Share of Gross Private Domestic Investment in Gross Domestic Product, Annual, 1929-2016

Source: US Bureau of Economic Analysis

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

Chart IA1-7 provides percentage shares of private fixed investment in GDP with annual data from 1929 to 2016. The sharp contraction after the recessions of the 1980s was followed by sustained recovery while the sharp drop in the current economic cycle has not been recovered.

Chart IA1-7, US, Percentage Share of Private Fixed Investment in Gross Domestic Product, Annual, 1929-2016

Source: US Bureau of Economic Analysis

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

Chart IA1-8 provides percentage shares in GDP of nonresidential investment from 1929 to 2016. There is again recovery from sharp contraction in the 1980s but inadequate recovery in the current economic cycle.

Chart IA1-8, US, Percentage Share of Nonresidential Investment in Gross Domestic Product, Annual, 1929-2016

Source: US Bureau of Economic Analysis

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

Chart IA1-9 provides percentage shares of business equipment and software in GDP with annual data from 1929 to 2016. There is again inadequate recovery in the current economic cycle.

Chart IA1-9, US, Percentage Share of Business Equipment and Software in Gross Domestic Product, Annual, 1929-2016

Source: US Bureau of Economic Analysis

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

Chart IA1-10 provides percentage shares of residential investment in GDP with annual data from 1929 to 2016. The salient characteristic of Chart IA1-10 is the vertical increase of the share of residential investment in GDP up to 2006 and subsequent collapse.

Chart IA1-10, US, Percentage Share of Residential Investment in Gross Domestic Product, Annual, 1929-2016

Source: US Bureau of Economic Analysis

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

Finer detail is provided by the quarterly share of residential investment in GDP from 1979 to 2016 in Chart IA1-11. There was protracted growth of that share, accelerating sharply into 2006 followed with nearly vertical drop. The explanation of the sharp contraction of United States housing can probably be found in the origins of the financial crisis and global recession. Let V(T) represent the value of the firm’s equity at time T and B stand for the promised debt of the firm to bondholders and assume that corporate management, elected by equity owners, is acting on the interests of equity owners. Robert C. Merton (1974, 453) states:

“On the maturity date T, the firm must either pay the promised payment of B to the debtholders or else the current equity will be valueless. Clearly, if at time T, V(T) > B, the firm should pay the bondholders because the value of equity will be V(T) – B > 0 whereas if they do not, the value of equity would be zero. If V(T) ≤ B, then the firm will not make the payment and default the firm to the bondholders because otherwise the equity holders would have to pay in additional money and the (formal) value of equity prior to such payments would be (V(T)- B) < 0.”

Pelaez and Pelaez (The Global Recession Risk (2007), 208-9) apply this analysis to the US housing market in 2005-2006 concluding:

“The house market [in 2006] is probably operating with low historical levels of individual equity. There is an application of structural models [Duffie and Singleton 2003] to the individual decisions on whether or not to continue paying a mortgage. The costs of sale would include realtor and legal fees. There could be a point where the expected net sale value of the real estate may be just lower than the value of the mortgage. At that point, there would be an incentive to default. The default vulnerability of securitization is unknown.”

There are multiple important determinants of the interest rate: “aggregate wealth, the distribution of wealth among investors, expected rate of return on physical investment, taxes, government policy and inflation” (Ingersoll 1987, 405). Aggregate wealth is a major driver of interest rates (Ingersoll 1987, 406). Unconventional monetary policy, with zero fed funds rates and flattening of long-term yields by quantitative easing, causes uncontrollable effects on risk taking that can have profound undesirable effects on financial stability. Excessively aggressive and exotic monetary policy is the main culprit and not the inadequacy of financial management and risk controls.

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 restatement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption decisions 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→∞.

Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at close to zero interest rates, 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 to purchase default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4).

Chart IA1-11, US, Percentage Share of Residential Investment in Gross Domestic Product, Quarterly, 1979-2016

Source: US Bureau of Economic Analysis

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

Chart IA1-12 provides the share of intellectual property products investment in GDP with annual data from 1929 to 2016. This is an important addition in the revision and enhancement of GDP provided by the Bureau of Economic Analysis. The share rose sharply over time but stabilized at a lower level in the past decade.

Chart IA1-12, US, Percentage Share of Intellectual Property Products Investment in Gross Domestic Product, Annual, 1929-2016

Source: US Bureau of Economic Analysis

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

Chart IA1-13 provides the percentage share of intellectual property investment in GDP on a quarterly basis from 1979 to 2016. The share stabilized in the 2000s.

Chart IA1-13, US, Percentage Share of Intellectual Property Investment in Gross Domestic Product, Quarterly, 1979-2016

Source: US Bureau of Economic Analysis

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

Table IA1-4 provides the seasonally adjusted annual rate of real GDP percentage change and contributions in percentage points in annual equivalent rate of gross domestic investment (GDI), real private fixed investment (PFI), nonresidential investment (NRES), business equipment and software (BES), residential investment (RES), intellectual property products (IPP) and change in inventories (∆INV) for the cyclical expansions from IQ1983 to IVQ1988 and from IIIQ2009 to IVQ2016. GDI contributed 1.62 percentage points to GDP in IQ2015 with 0.61 percentage points by PFI, 1.01 percentage points by inventory accumulation and 0.03 percentage points by intellectual property products. GDI contributed 0.18 percentage points to GDP growth in IIQ2015: 0.70 percentage points in PFI, 0.21 percentage points in NRES and 0.49 percentage points in RES. Inventory investment deducted 0.52 percentage points and IPP added 0.31 percentage points. GDI added 0.35 percentage points to GDP growth in IIIQ2015 with deduction of 0.57 percentage points by inventory divestment while BSE deducted 0.12 percentage points. PFI added 0.92 percentage points, nonresidential investment added 0.49 percentage points and residential investment added 0.43 percentage points. IPP added 0.08 percentage points. GDI deducted 0.39 percentage points in IVQ2015 with percentage point deductions of 0.43 by NRES, 0.03 by PFI, 0.45 by BES, 0.45 by NRES and 0.36 by inventory divestment. Percentage point contributions were 0.18 by IPP and 0.40 by RES. GDI deducted 0.56 percentage points from GDP growth in IQ2016 with percentage point deduction of 0.15 by fixed investment, 0.44 by nonresidential investment and 0.41 by inventory change. Residential investment added 0.29 percentage points and intellectual property products contributed 0.15 percentage points. GDI deducted 1.34 percentage points from GDP growth in IIQ2016 with deductions of 0.18 by PFI, 0.06 by BES and 0.31 by RES. Inventory investment deducted 1.16. IPP added 0.35 and NRES contributed 0.12. GDI contributed 0.50 percentage points to GDP growth in IIIQ2016 with contributions by NRES, BES, IPP and inventory investment. PFI added 0.02 percentage points and RES deducted 0.16 percentage points. GDI contributed 1.47 percentage points to GDP growth in IVQ2016 with contributions by NRES, IPP, RES and inventory investment. PFI added 0.46 percentage points, RES added 0.35 percentage points and inventory investment added 1.01 percentage points.

Table IA1-4, US, Contributions to the Rate of Growth of Real GDP in Percentage Points

 

GDP

GDI

PFI

NRES

BES

IPP

RES

∆INV

2016

                

I

0.8

-0.56

-0.15

-0.44

0.00

0.15

0.29

-0.41

II

1.4

-1.34

-0.18

0.12

-0.06

0.35

-0.31

-1.16

III

3.5

0.50

0.02

0.18

0.30

0.13

-0.16

0.49

IV

2.1

1.47

0.46

0.11

-0.05

0.05

0.35

1.01

2015

                

I

2.0

1.62

0.61

0.18

-0.39

0.03

0.43

1.01

II

2.6

0.18

0.70

0.21

-0.07

0.31

0.49

-0.52

III

2.0

0.35

0.92

0.49

-0.12

0.08

0.43

-0.57

IV

0.9

-0.39

-0.03

-0.43

-0.45

0.18

0.40

-0.36

2014

                

I

-1.2

-1.10

0.79

0.84

0.66

0.18

-0.04

-1.89

II

4.0

1.79

1.12

0.76

0.22

0.17

0.36

0.67

III

5.0

1.49

1.16

1.05

-0.08

0.27

0.12

0.32

IV

2.3

0.45

0.22

-0.14

0.13

0.29

0.36

0.23

2013

                

I

2.8

2.04

1.12

0.72

-0.14

0.29

0.41

0.92

II

0.8

0.78

0.70

0.35

0.27

-0.13

0.35

0.08

III

3.1

2.08

0.48

0.29

0.44

0.14

0.18

1.60

IV

4.0

0.91

1.01

1.16

0.06

0.04

-0.15

-0.11

2012

                

I

2.7

1.47

2.00

1.37

0.48

0.07

0.63

-0.53

II

1.9

1.53

0.98

0.88

0.27

0.14

0.10

0.56

III

0.5

-0.18

0.00

-0.27

-0.12

0.05

0.27

-0.18

IV

0.1

-0.51

1.03

0.46

-0.21

0.26

0.57

-1.54

2011

                

I

-1.5

-1.07

-0.11

-0.09

-0.73

0.05

-0.02

-0.96

II

2.9

2.14

1.10

0.97

0.63

0.12

0.13

1.04

III

0.8

0.15

2.25

2.06

0.56

0.19

0.19

-2.10

IV

4.6

4.16

1.36

1.08

0.34

0.26

0.28

2.80

2010

                

I

1.7

1.77

0.11

0.46

1.25

-0.07

-0.35

1.66

II

3.9

2.86

1.76

1.21

1.02

-0.08

0.56

1.09

III

2.7

1.86

-0.04

0.90

0.83

0.22

-0.94

1.90

IV

2.5

-0.51

1.13

0.94

0.57

0.19

0.19

-1.63

2009

                

I

-5.4

-7.02

-4.75

-3.58

-2.25

-0.23

-1.17

-2.26

II

-0.5

-3.25

-2.13

-1.46

-0.60

0.16

-0.66

-1.12

III

1.3

-0.40

-0.02

-0.54

0.25

0.04

0.52

-0.38

IV

3.9

4.05

-0.36

-0.37

0.36

0.25

0.01

4.40

1982

                

I

-6.5

-7.59

-2.26

-1.45

-0.83

0.14

-0.81

-5.33

II

2.2

-0.06

-2.32

-1.89

-1.20

0.08

-0.44

2.26

III

-1.4

-0.62

-1.73

-1.72

-0.55

0.06

-0.02

1.11

IV

0.4

-5.37

-0.03

-1.05

-0.57

0.00

1.01

-5.33

1983

                

I

5.3

2.36

1.44

-0.92

-0.27

0.16

2.36

0.92

II

9.4

5.96

2.53

0.67

1.24

0.29

1.86

3.43

III

8.1

4.40

3.82

2.13

1.43

0.31

1.70

0.57

IV

8.5

6.94

3.93

3.14

2.32

0.35

0.79

3.01

1984

                

I

8.2

7.23

2.29

1.71

0.46

0.30

0.58

4.94

II

7.2

2.57

2.86

2.52

1.36

0.29

0.34

-0.29

III

4.0

1.69

1.48

1.70

0.88

0.25

-0.22

0.21

IV

3.2

-1.08

1.36

1.34

0.86

0.29

0.02

-2.44

1985

                

I

4.0

-2.14

0.72

0.67

-0.23

0.14

0.05

-2.86

II

3.7

1.34

0.99

0.83

0.64

0.20

0.16

0.35

III

6.4

-0.43

-0.28

-0.62

-0.38

0.13

0.34

-0.15

IV

3.0

2.80

1.40

1.00

0.53

0.26

0.40

1.40

1986

                

I

3.8

0.04

0.21

-0.55

-0.28

0.17

0.76

-0.17

II

1.9

-1.30

0.00

-1.12

0.34

0.15

1.12

-1.30

III

4.1

-1.97

-0.34

-0.63

-0.17

0.10

0.28

-1.62

IV

2.1

0.24

0.53

0.48

0.30

0.10

0.05

-0.29

1987

                

I

2.8

1.98

-1.30

-1.26

-0.97

0.07

-0.04

3.28

II

4.6

0.08

1.07

1.00

0.76

0.08

0.07

-0.99

III

3.7

0.03

1.22

1.39

0.70

0.11

-0.17

-1.19

IV

6.8

4.94

-0.01

-0.05

-0.48

0.16

0.04

4.95

1988

                

I

2.3

-3.62

0.06

0.41

0.82

0.15

-0.36

-3.68

II

5.4

1.72

1.39

1.14

0.67

0.18

0.25

0.33

III

2.3

0.38

0.33

0.32

0.29

0.22

0.01

0.05

IV

5.4

1.11

0.84

0.71

0.34

0.40

0.13

0.27

GDP: Gross Domestic Product; GDI: Gross Domestic Investment; PFI: Private Fixed Investment; NRES: Nonresidential; BES: Business Equipment and Software; IPP: Intellectual Property Products; RES: Residential; ∆INV: Change in Private Inventories.

GDI = PFI + ∆INV, may not add exactly because of errors of rounding.

GDP: Seasonally adjusted annual equivalent rate of growth in a quarter; components: percentage points at annual rate.

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

IA2 Swelling Undistributed Corporate Profits. Table IA1-5 provides value added of corporate business, dividends and corporate profits in billions of current dollars at seasonally adjusted annual rates (SAAR) in IVQ2007 and IVQ2016 together with percentage changes. The last three rows of Table IA1-5 provide gross value added of nonfinancial corporate business, consumption of fixed capital and net value added in billions of chained 2009 dollars at SAARs. Deductions from gross value added of corporate profits down the rows of Table IA1-5 end with undistributed corporate profits. Profits after taxes with inventory valuation adjustment (IVA) and capital consumption adjustment (CCA) increased 82.8 percent in nominal terms from IVQ2007 to IVQ2016 while net dividends increased 19.1 percent and undistributed corporate profits swelled 212.7 percent from $107.7 billion in IQ2007 to $336.8 billion in IVQ2016 and changed signs from minus $55.9 billion in current dollars in IVQ2007. The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Gross value added of nonfinancial corporate business adjusted for inflation increased 13.9 percent from IVQ2007 to IVQ2016, which is much lower than nominal increase of 32.0 percent in the same period for gross value added of total corporate business.

Table IA1-5, US, Value Added of Corporate Business, Corporate Profits and Dividends, IVQ2007-IVQ2016

 

IVQ2007

IVQ2016

∆%

Current Billions of Dollars Seasonally Adjusted Annual Rates (SAAR)

      

Gross Value Added of Corporate Business

8,165.9

10,781.8

32.0

Consumption of Fixed Capital

1,216.5

1,578.2

29.7

Net Value Added

6,949.4

9,203.6

32.4

Compensation of Employees

4,945.8

6,313.3

27.6

Taxes on Production and Imports Less Subsidies

688.5

843.4

22.5

Net Operating Surplus

1,315.1

2,046.9

55.6

Net Interest and Misc

204.2

196.1

-4.0

Business Current Transfer Payment Net

68.9

154.8

124.7

Corporate Profits with IVA and CCA Adjustments

1,042.0

1,696.0

62.8

Taxes on Corporate Income

408.8

538.6

31.8

Profits after Tax with IVA and CCA Adjustment

633.2

1,157.4

82.8

Net Dividends

689.1

820.6

19.1

Undistributed Profits with IVA and CCA Adjustment

-55.9

336.8

NA ∆% 212.7 relative to 107.7 in IQ2007

Billions of Chained USD 2009 SAAR

      

Gross Value Added of Nonfinancial Corporate Business

7,439.8

8,474.0

13.9

Consumption of Fixed Capital

1,066.0

1,299.9

21.9

Net Value Added

6,373.8

7,174.0

12.6

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Table IA1-6 provides comparable United States value added of corporate business, corporate profits and dividends from IQ1980 to IIQ1990. There is significant difference both in nominal and inflation-adjusted data. Between IQ1980 and IIQ1990, profits after tax with IVA and CCA increased 113.0 percent with dividends growing 245.5 percent and undistributed profits increasing 21.8 percent. There was much higher inflation in the 1980s than in the current cycle. For example, the consumer price index increased 62.2 percent from Mar 1980 to Jun 1990 but only 14.9 percent between Dec 2007 and Dec 2016 (http://www.bls.gov/cpi/data.htm). The comparison is still valid in terms of inflation-adjusted data: gross value added of nonfinancial corporate business adjusted for inflation increased 43.6 percent between IQ1980 and IIQ1990 but only 13.9 percent between IVQ2007 and IVQ2016 while net value added adjusted for inflation increased 42.4 percent between IQ1980 and IIQ1990 but only 12.6 percent between IVQ2007 and IVQ2016.

Table IA1-6, US, Value Added of Corporate Business, Corporate Profits and Dividends, IQ1980-IIQ1990

 

IQ1980

IIQ1990

∆%

Current Billions of Dollars Seasonally Adjusted Annual Rates (SAAR)

      

Gross Value Added of Corporate Business

1,654.1

3,489.5

111.0

Consumption of Fixed Capital

200.5

451.7

125.3

Net Value Added

1,453.6

3,037.8

109.0

Compensation of Employees

1,072.9

2,232.0

108.0

Taxes on Production and Imports Less Subsidies

121.5

281.4

131.6

Net Operating Surplus

259.2

524.4

102.3

Net Interest and Misc.

50.4

132.2

162.3

Business Current Transfer Payment Net

11.5

33.9

194.8

Corporate Profits with IVA and CCA Adjustments

197.2

358.3

81.7

Taxes on Corporate Income

97.0

144.9

49.4

Profits after Tax with IVA and CCA Adjustment

100.2

213.4

113.0

Net Dividends

40.9

141.2

245.5

Undistributed Profits with IVA and CCA Adjustment

59.3

72.2

21.8

Billions of Chained USD 2009 SAAR

      

Gross Value Added of Nonfinancial Corporate Business

2,971.4

4,267.2

43.6

Consumption of Fixed Capital

315.6

486.0

54.0

Net Value Added

2,655.8

3,781.2

42.4

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Chart IA1-14 of the US Bureau of Economic Analysis provides quarterly corporate profits after tax and undistributed profits with IVA and CCA from 1979 to 2016. There is tightness between the series of quarterly corporate profits and undistributed profits in the 1980s with significant gap developing from 1988 and to the present with the closest approximation peaking in IVQ2005 and surrounding quarters. These gaps widened during all recessions including in 1991 and 2001 and recovered in expansions with exceptionally weak performance in the current expansion.

Chart IA1-14, US, Corporate Profits after Tax and Undistributed Profits with Inventory Valuation Adjustment and Capital Consumption Adjustment, Quarterly, 1979-2016

Source: US Bureau of Economic Analysis

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

Table IA1-7 provides price, costs and profit per unit of gross value added of nonfinancial domestic corporate income for IVQ2007 and IVQ2016 in the upper block and for IQ1980 and IIQ1990 in the lower block. Compensation of employees or labor costs per unit of gross value added of nonfinancial domestic corporate income hardly changed from 0.583 in IVQ2007 to 0.656 in IVQ2016 in a fractured labor market but increased from 0.338 in IQ1980 to 0.488 in IIQ1990 in a more vibrant labor market. Unit nonlabor costs increased mildly from 0.273 per unit of gross value added in IVQ2007 to 0.304 in IVQ2016 but increased from 0.123 in IQ1980 to 0.211 in IIQ1990 in an economy closer to full employment of resources. Profits after tax with IVA and CCA per unit of gross value added of nonfinancial domestic corporate income increased from 0.077 in IVQ2007 to 0.101 in IVQ2016 and from 0.029 in IQ1980 to 0.043 in IIQ1990.

Table IA1-7, US, Price, Costs and Profit per Unit of Gross Value Added of Nonfinancial Domestic Corporate Income

 

IVQ2007

IVQ2016

Price per Unit of Real Gross Value Added of Nonfinancial Corporate Business

0.972

1.099

Compensation of Employees (Unit Labor Cost)

0.583

0.656

Unit Nonlabor Cost

0.273

0.304

Consumption of Fixed Capital

0.142

0.163

Taxes on Production and Imports less Subsidies plus Business Current Transfer Payments (net)

0.094

0.104

Net Interest and Misc. Payments

0.038

0.037

Corporate Profits with IVA and CCA Adjustment (Unit Profits from Current Production)

0.115

0.139

Taxes on Corporate Income

0.038

0.038

Profits after Tax with IVA and CCA Adjustment

0.077

0.101
 

IQ1980

IIQ1990

Price per Unit of Real Gross Value Added of Nonfinancial Corporate Business

0.515

0.763

Compensation of Employees (Unit Labor Cost)

0.338

0.488

Unit Nonlabor Cost

0.123

0.211

Consumption of Fixed Capital

0.063

0.100

Taxes on Production and Imports less Subsidies plus Business Current Transfer Payments (net)

0.042

0.073

Net Interest and Misc. Payments

0.018

0.038

Corporate Profits with IVA and CCA Adjustment (Unit Profits from Current Production)

0.055

0.064

Taxes on Corporate Income

0.026

0.021

Profits after Tax with IVA and CCA Adjustment

0.029

0.043

IVA: Inventory Valuation Adjustment; CCA: Capital Consumption Adjustment

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

Chart IA1-15 provides quarterly profits after tax with IVA and CCA per unit of gross value added of nonfinancial domestic corporate income from 1980 to 2016. In an environment of idle labor and other productive resources nonfinancial corporate income increased after tax profits with IVA and CCA per unit of gross value added at a faster pace in the weak economy from IVQ2007 to IVQ2016 than in the vibrant expansion following the cyclical contractions of the 1980s. Part of the profits was distributed as dividends and significant part was retained as undistributed profits in the current economic cycle with frustrated investment decision.

Chart IA1-15, US, Profits after Tax with Inventory Valuation Adjustment and Capital Consumption Adjustment per Unit of Gross Value Added of Nonfinancial Domestic Corporate Income, 1980-2016

Source: US Bureau of Economic Analysis

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

Corporate profits with IVA and CCA increased at 3.4 percent in IQ2016 and increased at 8.1 percent after taxes. Corporate profits with IVA and CCA decreased at 0.6 percent in IIQ2016 and decreased at 1.9 percent after taxes. Corporate profits with IVA and CCA increased at 5.8 percent in IIIQ2016 and increased at 6.7 percent after taxes. Corporate profits with IVA and CCA increased at 0.5 percent in IVQ2016 and increased at 15.7 percent after taxes. Corporate profits with IVA and CCA increased 9.3 percent in IVQ2016 relative to IVQ2015 and profits after tax with IVA and CCA increased 15.7 percent in IVQ2016 relative to IVQ2015. Net dividends increased at 0.8 percent in IQ2016. Net dividends fell at 1.0 percent in IIQ2016 and increased at 1.9 percent in IIIQ2016. Net dividends increased 1.0 percent in IVQ2016. Net dividends increased 2.7 percent in IVQ2016 relative to a year earlier. Undistributed profits increased at 24.3 percent in IQ2016. Undistributed profits fell at 3.6 percent in IIQ2016 and increased at 15.3 percent in IIIQ2016. Undistributed profits increased at 4.4 percent in IVQ2016. Undistributed profits increased at 44.2 percent in IVQ2016 relative to IVQ2015.

Table IA1-8, Quarterly Seasonally Adjusted Annual Equivalent Percentage Rates of Change of Corporate Profits, ∆%

 

2015

2016

IQ
2016

IIQ 2016

IIIQ

2016

IVQ 2016

IVQ16/ IVQ15

Corporate Profits with IVA and CCA

-3.0

-0.1

3.4

-0.6

5.8

0.5

9.3

Corporate Income Taxes

4.0

-1.9

-8.3

3.1

3.6

-4.4

-6.3

After Tax Profits with IVA and CCA

-5.3

0.5

8.1

-1.9

6.7

2.3

15.7

Net Dividends

0.1

-0.4

0.8

-1.0

1.9

1.0

2.7

Und Profits with IVA and CCA

-13.2

2.1

24.3

-3.6

15.3

4.4

44.2

Source: US Bureau of Economic Analysis

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

Table IA1-9 provides change from prior quarter of the level of seasonally adjusted annual rates of US corporate profits. There are three aspects. First, there is fluctuation in corporate profits. Corporate profits with IVA and CCA increased at $66.0 billion in IQ2016. Corporate profits with IVA and CCA fell at $12.5 billion in IIQ2016 and increased at $117.8 billion in IIIQ2016. Corporate profits increased at $11.2 billion in IVQ2016. Profits after tax with IVA and CCA increased at $113.4 billion in IQ2016. Profits after tax with IVA and CCA fell at $28.9 billion in IIQ2016 and increased at $98.3 billion in IIIQ2016. Profits after tax with IVA and CCA increased at $36.0 billion in IVQ2016. Net dividends increased at $7.3 billion in IQ2016. Net dividends fell at $9.3 billion in IIQ2016. Net dividends increased at $18.5 billion in IIIQ2016 and increased at $9.5 billion in IVQ2016. Undistributed profits with IVA and CCA increased at $106.1 billion in IQ2016. Undistributed corporate profits fell at $19.6 billion in IIQ2016. Undistributed corporate profits increased at $79.8 billion in IIIQ2016 and increased at $26.5 billion in IVQ2016. Undistributed corporate profits swelled 212.7 percent from $107.7 billion in IQ2007 to $336.8 billion in IVQ2016 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 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. Corporate profits with IVA and CCA increased at $117.8 billion in IIIQ2016. Profits from domestic industries increased at $116.5 billion and profits from nonfinancial business increased at $66.4 billion. Profits from the rest of the world increased at $1.3 billion. Corporate profits with IVA and CCA increased at $11.2 billion in IVQ2016. Profits from domestic industries decreased at $33.9 billion and profits from nonfinancial business decreased at $60.4 billion. Profits from the rest of the world increased at $45.1 billion. Total corporate profits with IVA and CCA were $2150.0 billion in IVQ2016 of which $1696.0 billion from domestic industries, or 78.9 percent of the total, and $454.0 billion, or 21.1 percent, from the rest of the world. Nonfinancial corporate profits of $1176.5 billion account for 54.7 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.

Table IA1-9, Change from Prior Quarter of Level of Seasonally Adjusted Annual Equivalent Rates of Corporate Profits, Billions of Dollars

 

2015

2016

IQ
2016

IIQ

2016

IIIQ      

2016

IVQ

2016

Corporate Profits with IVA and CCA

-64.0

-2.3

66.0

-12.5

117.8

11.2

Corporate Income Taxes

21.1

-10.5

-47.4

16.4

19.5

-24.8

After Tax Profits with IVA and CCA

-85.0

8.2

113.4

-28.9

98.3

36.0

Net Dividends

0.8

-3.4

7.3

-9.3

18.5

9.5

Und Profits with IVA and CCA

-85.8

11.6

106.1

-19.6

79.8

26.5

Corporate Profits with IVA and CCA

-64.0

-2.3

66.0

-12.5

117.8

11.2

Domestic Industries

-38.8

-26.5

92.9

-50.5

116.5

-33.9

Financial

8.5

20.5

8.1

5.6

50.1

26.5

Nonfinancial

-47.3

-47.0

84.8

-56.1

66.4

-60.4

Rest of the World

-25.2

24.3

-26.9

38.0

1.3

45.1

Receipts from Rest of the World

-40.0

22.4

8.7

37.5

-1.3

9.1

Payments to the Rest of the World

-14.8

-1.9

35.6

-0.5

-2.6

-36.0

Source: Bureau of Economic Analysis

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

I United States Commercial Banks Assets and Liabilities. Subsection IA

Transmission of Monetary Policy recapitulates the mechanism of transmission of monetary policy. Subsection IB Functions of Banking analyzes the functions of banks in modern banking theory. Subsection IC United States Commercial Bank Assets and Liabilities provides data and analysis of US commercial bank balance sheets in report H.8 of the Board of Governors of the Federal Reserve System on Assets and Liabilities of Commercial Banks in the United States (http://www.federalreserve.gov/releases/h8/current/default.htm). Subsection ID Theory and Reality of Economic History, Cyclical Slow Growth Not Secular Stagnation and Monetary Policy Based on Fear of Deflation analyzes and compares unconventional monetary policy.

IA Transmission of Monetary Policy. The critical fact of current world financial markets is the combination of “unconventional” monetary policy with intermittent shocks of financial risk aversion. There are two interrelated unconventional monetary policies. First, unconventional monetary policy consists primarily of reducing short-term policy interest rates toward the “zero bound” such as fixing the fed funds rate at 0 to ¼ percent by decision of the Federal Open Market Committee (FOMC) since Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). The FOMC increased the fed funds rate at ¼ to ½ percent on Dec 16, 2015 (http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm). Fixing policy rates at zero is the strongest measure of monetary policy with collateral effects of inducing carry trades from zero interest rates to exposures in risk financial assets such as commodities, exchange rates, stocks and higher yielding fixed income. Second, unconventional monetary policy also includes a battery of measures in also reducing long-term interest rates of government securities and asset-backed securities such as mortgage-backed securities.

When inflation is low, the central bank lowers interest rates to stimulate aggregate demand in the economy, which consists of consumption and investment. When inflation is subdued and unemployment high, monetary policy would lower interest rates to stimulate aggregate demand, reducing unemployment. When interest rates decline to zero, unconventional monetary policy would consist of policies such as large-scale purchases of long-term securities to lower their yields. Long-term asset-backed securities finance a major portion of credit in the economy. Loans for purchasing houses, automobiles and other consumer products are bundled in securities that in turn are sold to investors. Corporations borrow funds for investment by issuing corporate bonds. Loans to small businesses are also financed by bundling them in long-term bonds. Securities markets bridge the needs of higher returns by savers obtaining funds from investors that are channeled to consumers and business for consumption and investment. Lowering the yields of these long-term bonds could lower costs of financing purchases of consumer durables and investment by business. The essential mechanism of transmission from lower interest rates to increases in aggregate demand is portfolio rebalancing. Withdrawal of bonds in a specific maturity segment or directly in a bond category such as currently mortgage-backed securities causes reductions in yields that are equivalent to increases in the prices of the bonds. There can be secondary increases in purchases of those bonds in private portfolios in pursuit of their increasing prices. Lower yields translate into lower costs of buying homes and consumer durables such as automobiles and also lower costs of investment for business. There are two additional intended routes of transmission.

1. Unconventional monetary policy or its expectation can increase stock market valuations (Bernanke 2010WP). Increases in equities traded in stock markets can augment perceptions of the wealth of consumers inducing increases in consumption.

2. Unconventional monetary policy causes devaluation of the dollar relative to other currencies, which can cause increases in net exports of the US that increase aggregate economic activity (Yellen 2011AS).

Monetary policy can lower short-term interest rates quite effectively. Lowering long-term yields is somewhat more difficult. The critical issue is that monetary policy cannot ensure that increasing credit at low interest cost increases consumption and investment. There is a large variety of possible allocation of funds at low interest rates from consumption and investment to multiple risk financial assets. Monetary policy does not control how investors will allocate asset categories. A critical financial practice is to borrow at low short-term interest rates to invest in high-risk, leveraged financial assets. Investors may increase in their portfolios asset categories such as equities, emerging market equities, high-yield bonds, currencies, commodity futures and options and multiple other risk financial assets including structured products. If there is risk appetite, the carry trade from zero interest rates to risk financial assets will consist of short positions at short-term interest rates (or borrowing) and short dollar assets with simultaneous long positions in high-risk, leveraged financial assets such as equities, commodities and high-yield bonds. Low interest rates may induce increases in valuations of risk financial assets that may fluctuate in accordance with perceptions of risk aversion by investors and the public. During periods of muted risk aversion, carry trades from zero interest rates to exposures in risk financial assets cause temporary waves of inflation that may foster instead of preventing financial instability. During periods of risk aversion such as fears of disruption of world financial markets and the global economy resulting from events such as collapse of the European Monetary Union, carry trades are unwound with sharp deterioration of valuations of risk financial assets. More technical discussion is in IA Appendix: Transmission of Unconventional Monetary Policy.

In the effort to increase transparency, the Federal Open Market Committee (FOMC) provides both economic projections of its participants and views on future paths of the policy rate that in the US is the federal funds rate or interest on interbank lending of reserves deposited at Federal Reserve Banks. These policies and views are discussed initially followed with appropriate analysis.

Charles Evans, President of the Federal Reserve Bank of Chicago, proposed an “economic state-contingent policy” or “7/3” approach (Evans 2012 Aug 27):

“I think the best way to provide forward guidance is by tying our policy actions to explicit measures of economic performance. There are many ways of doing this, including setting a target for the level of nominal GDP. But recognizing the difficult nature of that policy approach, I have a more modest proposal: I think the Fed should make it clear that the federal funds rate will not be increased until the unemployment rate falls below 7 percent. Knowing that rates would stay low until significant progress is made in reducing unemployment would reassure markets and the public that the Fed would not prematurely reduce its accommodation.

Based on the work I have seen, I do not expect that such policy would lead to a major problem with inflation. But I recognize that there is a chance that the models and other analysis supporting this approach could be wrong. Accordingly, I believe that the commitment to low rates should be dropped if the outlook for inflation over the medium term rises above 3 percent.

The economic conditionality in this 7/3 threshold policy would clarify our forward policy intentions greatly and provide a more meaningful guide on how long the federal funds rate will remain low. In addition, I would indicate that clear and steady progress toward stronger growth is essential.”

Evans (2012Nov27) modified the “7/3” approach to a “6.5/2.5” approach:

“I have reassessed my previous 7/3 proposal. I now think a threshold of 6-1/2 percent for the unemployment rate and an inflation safeguard of 2-1/2 percent, measured in terms of the outlook for total PCE (Personal Consumption Expenditures Price Index) inflation over the next two to three years, would be appropriate.”

The Federal Open Market Committee (FOMC) decided at its meeting on Dec 12, 2012 to implement the “6.5/2.5” approach (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm):

“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”

Another rising risk is division within the Federal Open Market Committee (FOMC) on risks and benefits of current policies as expressed in the minutes of the meeting held on Jan 29-30, 2013 (http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20130130.pdf 13):

“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.”

Jon Hilsenrath, writing on “Fed maps exit from stimulus,” on May 11, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324744104578475273101471896.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the development of strategy for unwinding quantitative easing and how it can create uncertainty in financial markets. Jon Hilsenrath and Victoria McGrane, writing on “Fed slip over how long to keep cash spigot open,” published on Feb 20, 2013 in the Wall street Journal (http://professional.wsj.com/article/SB10001424127887323511804578298121033876536.html), analyze the minutes of the Fed, comments by members of the FOMC and data showing increase in holdings of riskier debt by investors, record issuance of junk bonds, mortgage securities and corporate loans. Jon Hilsenrath, writing on “Jobs upturn isn’t enough to satisfy Fed,” on Mar 8, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324582804578348293647760204.html), finds that much stronger labor market conditions are required for the Fed to end quantitative easing. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash.

Unconventional monetary policy, or reinvestment of principal in securities and issue of bank reserves to maintain policy interest rates near zero, will remain in perpetuity, or QE→∞, changing to a “growth mandate.” There are two reasons explaining unconventional monetary policy of QE→∞: insufficiency of job creation to reduce unemployment/underemployment at current rates of job creation; and growth of GDP at around 2.0 percent, which is well below 3.0 percent estimated by Lucas (2011May) from 1870 to 2010. Unconventional monetary policy interprets the dual mandate of low inflation and maximum employment as mainly a “growth mandate” of forcing economic growth in the US at a rate that generates full employment. A hurdle to this “growth mandate” is that long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent.

US economic growth has been at only 2.1 percent on average in the cyclical expansion in the 30 quarters from IIIQ2009 to IVQ2016. 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 IVQ2016 (https://www.bea.gov/newsreleases/national/gdp/2017/pdf/gdp4q16_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 dividing 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 (Section I and earlier https://cmpassocregulationblog.blogspot.com/2017/03/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/rising-valuations-of-risk-financial.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. 4.5 percent from IQ1983 to IQ1990, 4.4 percent from IQ1983 to IIQ1990 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier https://cmpassocregulationblog.blogspot.com/2017/03/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/rising-valuations-of-risk-financial.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 IVQ2016 would have accumulated to 30.5 percent. GDP in IVQ2016 would be $19,564.3 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2751.0 billion than actual $16,813.3 billion. There are about two trillion dollars of GDP less than at trend, explaining the 24.2 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.4 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2017/03/increasing-interest-rates-twenty-four.html and earlier https://cmpassocregulationblog.blogspot.com/2017/02/twenty-six-million-unemployed-or.html). US GDP in IVQ2016 is 14.1 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,813.3 billion in IVQ2016 or 12.1 percent at the average annual equivalent rate of 1.3 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 3.2 percent per year from Feb 1919 to Feb 2017. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 144.4892 in Feb 2017. The actual index NSA in Feb 2017 is 103.4436, which is 28.4 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Feb 2017. Using trend growth of 2.0 percent per year, the index would increase to 130.9602 in Feb 2017. The output of manufacturing at 103.4436 in Feb 2017 is 21.0 percent below trend under this alternative calculation.

First, total nonfarm payroll employment seasonally adjusted (SA) increased 235,000 in Feb 2017 and private payroll employment increased 227,000. The average monthly number of nonfarm jobs created from Feb 2015 to Feb 2016 was 217,000 using seasonally adjusted data, while the average number of nonfarm jobs created from Feb 2016 to Feb 2017 was 195,833, or decrease by 9.8 percent. The average number of private jobs created in the US from Feb 2015 to Feb 2016 was 203,583, using seasonally adjusted data, while the average from Feb 2016 to Feb 2017 was 179,667, or decrease by 11.7 percent. This blog calculates the effective labor force of the US at 168.311 million in Feb 2017 and 167,206 million in Feb 2016 (Table I-4), for growth of 1.105 million at average 92,083 per month. The difference between the average increase of 179,667 new private nonfarm jobs per month in the US from Feb 2016 to Feb 2017 and the 92,083-average monthly increase in the labor force from Feb 2016 to Feb 2017 is 87,584 monthly new jobs net of absorption of new entrants in the labor force. There are 24.212 million in job stress in the US currently. Creation of 87,584 new jobs per month net of absorption of new entrants in the labor force would require 276 months to provide jobs for the unemployed and underemployed (24.212 million divided by 87,584) or 23 years (276 divided by 12). The civilian labor force of the US in Feb 2017 not seasonally adjusted stood at 159.482 million with 7.887 million unemployed or effectively 16.716 million unemployed in this blog’s calculation by inferring those who are not searching because they believe there is no job for them for effective labor force of 168.311 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 0.9 years (1 million divided by product of 87,584 by 12, which is 1,051,008). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 7.974 million (0.05 times labor force of 159.482 million). New net job creation would be minus 0.087 million (7.887 million unemployed minus 7.974 million unemployed at rate of 5 percent) that at the current rate would take 0.0 years (0.087 million divided by 1,051,008). Under the calculation in this blog, there are 16.716 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 168.311 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 9.265 million jobs net of labor force growth that at the current rate would take 7.9 years (16.716 million minus 0.05(168.311 million) = 8.300 million divided by 1,051,008 using LF PART 66.2% and Total UEM in Table I-4). These calculations assume that there are no more recessions, defying United States economic history with periodic contractions of economic activity when unemployment increases sharply. The number employed in Feb 2017 was 151.594 million (NSA) or 4.279 million more people with jobs relative to the peak of 147.315 million in Jul 2007 while the civilian noninstitutional population of ages 16 years and over increased from 231.958 million in Jul 2007 to 254.246 million in Feb 2016 or by 22.288 million. The number employed increased 2.9 percent from Jul 2007 to Feb 2017 while the noninstitutional civilian population of ages of 16 years and over, or those available for work, increased 9.6 percent. The ratio of employment to population in Jul 2007 was 63.5 percent (147.315 million employment as percent of population of 231.958 million). The same ratio in Feb 2017 would result in 161.446 million jobs (0.635 multiplied by noninstitutional civilian population of 254.246 million). There are effectively 9.852 million fewer jobs in Feb 2017 than in Jul 2007, or 161.446 million minus 151.594 million. There is actually not sufficient job creation in merely absorbing new entrants in the labor force because of those dropping from job searches, worsening the stock of unemployed or underemployed in involuntary part-time jobs.

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

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

The argument that anemic population growth causes “secular stagnation” in the US (Hansen 1938, 1939, 1941) is as misplaced currently as in the late 1930s (for early dissent see Simons 1942). There is currently population growth in the ages of 16 to 24 years but not enough job creation and discouragement of job searches for all ages (https://cmpassocregulationblog.blogspot.com/2017/03/recovery-without-hiring-ten-million.html and earlier https://cmpassocregulationblog.blogspot.com/2017/02/recovery-without-hiring-ten-million.html).

Second, Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.1 percent on average in the cyclical expansion in the 30 quarters from IIIQ2009 to IVQ2016. 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 IVQ2016 (https://www.bea.gov/newsreleases/national/gdp/2017/pdf/gdp4q16_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 dividing 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 (Section I and earlier https://cmpassocregulationblog.blogspot.com/2017/03/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/rising-valuations-of-risk-financial.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. 4.5 percent from IQ1983 to IQ1990, 4.4 percent from IQ1983 to IIQ1990 and at 7.8 percent from IQ1983 to IVQ1983 (Section I and earlier https://cmpassocregulationblog.blogspot.com/2017/03/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/rising-valuations-of-risk-financial.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 IVQ2016 would have accumulated to 30.5 percent. GDP in IVQ2016 would be $19,564.3 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2751.0 billion than actual $16,813.3 billion. There are about two trillion dollars of GDP less than at trend, explaining the 24.2 million unemployed or underemployed equivalent to actual unemployment/underemployment of 14.4 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2017/03/increasing-interest-rates-twenty-four.html and earlier https://cmpassocregulationblog.blogspot.com/2017/02/twenty-six-million-unemployed-or.html). US GDP in IVQ2016 is 14.1 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $16,813.3 billion in IVQ2016 or 12.1 percent at the average annual equivalent rate of 1.3 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 3.2 percent per year from Feb 1919 to Feb 2017. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2316 in Dec 2007 to 144.4892 in Feb 2017. The actual index NSA in Feb 2017 is 103.4436, which is 28.4 percent below trend. Manufacturing output grew at average 2.1 percent between Dec 1986 and Feb 2017. Using trend growth of 2.0 percent per year, the index would increase to 130.9602 in Feb 2017. The output of manufacturing at 103.4436 in Feb 2017 is 21.0 percent below trend under this alternative calculation.

The economy of the US can be summarized in growth of economic activity or GDP as fluctuating from mediocre growth of 2.5 percent on an annual basis in 2010 to 1.6 percent in 2011, 2.2 percent in 2012, 1.7 percent in 2013, 2.4 percent in 2014 and 2.6 percent in 2015. GDP growth was 1.6 percent in 2016. The following calculations show that actual growth is around 2.1 percent per year. The rate of growth of 1.3 percent in the entire cycle from 2007 to 2016 is well below 3 percent per year in trend from 1870 to 2010, which the economy of the US always attained for entire cycles in expansions after events such as wars and recessions (Lucas 2011May). Revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) provides valuable information on long-term growth and cyclical behavior. Table Summary provides relevant data.

Table Summary, Long-term and Cyclical Growth of GDP, Real Disposable Income and Real Disposable Income per Capita

 

GDP

  

Long-Term

    

1929-2016

3.2

  

1947-2016

3.2

  

Whole Cycles

    

1980-1989

3.5

  

2006-2016

1.3

  

2007-2016

1.3

  

Cyclical Contractions ∆%

    

IQ1980 to IIIQ1980, IIIQ1981 to IVQ1982

-4.7

  

IVQ2007 to IIQ2009

-4.2

  

Cyclical Expansions Average Annual Equivalent ∆%

    

IQ1983 to IVQ1985

IQ1983-IQ1986

IQ1983-IIIQ1986

IQ1983-IVQ1986

IQ1983-IQ1987

IQ1983-IIQ1987

IQ1983-IIIQ1987

IQ1983 to IVQ1987

IQ1983 to IQ1988

IQ1983 to IIQ1988

IQ1983 to IIIQ1988

IQ1983 to IVQ1988

IQ1983 to IQ1989

IQ1983 to IIQ1989

IQ1983 to IIIQ1989

IQ1983 to IVQ1989

IQ1983 to IQ1990

IQ1983 to IIQ1990

5.9

5.7

5.4

5.2

5.0

5.0

4.9

5.0

4.9

4.9

4.8

4.8

4.8

4.7

4.7

4.5

4.5

4.4

  

First Four Quarters IQ1983 to IVQ1983

7.8

  

IIIQ2009 to IVQ2016

2.1

  

First Four Quarters IIIQ2009 to IIQ2010

2.7

  
 

Real Disposable Income

Real Disposable Income per Capita

Long-Term

    

1929-2016

3.2

2.0

1947-1999

3.7

2.3

Whole Cycles

    

1980-1989

3.5

2.6

2006-2016

1.8

1.0

Source: Bureau of Economic Analysis

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

The revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) also provide critical information in assessing the current rhythm of US economic growth. The economy appears to be moving at a pace around 2.1 percent per year. Table Summary GDP provides the data.

  1. Average Annual Growth in the Past Nineteen Quarters. GDP growth in the four quarters of 2012, the four quarters of 2013, the four quarters of 2014, the four quarters of Q2015 and the four quarters of 2016 accumulated to 10.7 percent. This growth is equivalent to 2.1 percent per year, obtained by dividing GDP in IVQ2016 of $16,813.3 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/20: {[($16,813.3/$15,190.3)4/20 -1]100 = 2.1 percent}.
  2. Average Annual Growth in the Past Four Quarters. GDP growth in the four quarters of IVQ2015 to IVQ2016 accumulated to 2.0 percent that is equivalent to 2.0 percent in a year. This is obtained by dividing GDP in IVQ2016 of $16,813.3 billion by GDP in IVQ2015 of $16,490.7 billion and compounding by 4/4: {[($16,813.3.0/$16,490.7)4/4 -1]100 = 2.0%}. The US economy grew 2.0 percent in IVQ2016 relative to the same quarter a year earlier in IVQ2015. Growth was at annual equivalent 4.0 percent in IIQ2014 and 5.0 percent IIIQ2014 and only at 2.3 percent in IVQ2014. GDP grew at annual equivalent 2.0 percent in IQ2015, 2.6 percent in IIQ2015, 2.0 percent in IIIQ2015 and 0.9 percent in IVQ2015. GDP grew at annual equivalent 0.8 percent in IQ2016 and at 1.4 percent annual equivalent in IIQ2016. GDP increased at 3.5 percent annual equivalent in IIIQ2016 and at 2.1 percent in IVQ2016. Another important revelation of the revisions and enhancements is that GDP was flat in IVQ2012, which is in the borderline of contraction, and negative in IQ2014. US GDP fell 0.3 percent in IQ2014. The rate of growth of GDP in the revision of IIIQ2013 is 3.1 percent in seasonally adjusted annual rate (SAAR).

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

 

Real GDP, Billions Chained 2009 Dollars

∆% Relative to IVQ2007

∆% Relative to Prior Quarter

∆%
over
Year Earlier

IVQ2007

14,991.8

NA

0.4

1.9

IVQ2011

15,190.3

1.3

1.1

1.7

IQ2012

15,291.0

2.0

0.7

2.8

IIQ2012

15,362.4

2.5

0.5

2.5

IIIQ2012

15,380.8

2.6

0.1

2.4

IVQ2012

15,384.3

2.6

0.0

1.3

IQ2013

15,491.9

3.3

0.7

1.3

IIQ2013

15,521.6

3.5

0.2

1.0

IIIQ2013

15,641.3

4.3

0.8

1.7

IVQ2013

15,793.9

5.4

1.0

2.7

IQ2014

15,747.0

5.0

-0.3

1.6

IIQ2014

15,900.8

6.1

1.0

2.4

IIIQ2014

16,094.5

7.4

1.2

2.9

IVQ2014

16,186.7

8.0

0.6

2.5

IQ2015

16,269.0

8.5

0.5

3.3

IIQ2015

16,374.2

9.2

0.6

3.0

IIIQ2015

16,454.9

9.8

0.5

2.2

IVQ2015

16,490.7

10.0

0.2

1.9

IQ2016

16,525.0

10.2

0.2

1.6

IIQ2016

16,583.1

10.6

0.4

1.3

IIIQ2016

16,727.0

11.6

0.9

1.7

IVQ2016

16,813.3

12.1

0.5

2.0

Cumulative ∆% IQ2012 to IVQ2016

10.7

  

10.8

  

Annual Equivalent ∆%

2.1

  

2.1

  

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

Chart GDP of the US Bureau of Economic Analysis provides the rates of growth of GDP at SAAR (seasonally adjusted annual rate) in the 16 quarters from IQ2013 to IVQ2016. Growth has been fluctuating.

Chart GDP, Seasonally Adjusted Quarterly Rates of Growth of United States GDP, ∆%

Source: US Bureau of Economic Analysis

http://www.bea.gov/newsreleases/national/gdp/gdp_glance.htm

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

The statement of the FOMC at the conclusion of its meeting on Dec 12, 2012, revealed policy intentions (http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm). The FOMC updated in the statement at its meeting on Dec 16, 2015 with maintenance of the current level of the balance sheet and liftoff of interest rates (http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm) followed by the statement of the meeting on Mar 14, 2017 (https://www.federalreserve.gov/newsevents/press/monetary/20170315a.htm):

Press Release

Release Date: March 15, 2017

For release at 2:00 p.m. EDT

Information received since the Federal Open Market Committee met in February indicates that the labor market has continued to strengthen and that economic activity has continued to expand at a moderate pace. Job gains remained solid and the unemployment rate was little changed in recent months. Household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat. Inflation has increased in recent quarters, moving close to the Committee's 2 percent longer-run objective; excluding energy and food prices, inflation was little changed and continued to run somewhat below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term. Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant 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.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action was Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.

Implementation Note issued March 15, 2017

There are several important issues in this statement.

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

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

2. Open-ended Quantitative Easing or QE∞ with End of Bond Purchases and Continuing Reinvestment of Principal in Securities. Earlier programs are continued with reinvestment of principal in securities and bank reserves at $2,368.1 billion on Mar 15, 2017 (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1): “The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

3. Increase of interest rates: “In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.”

4. New Advance Guidance. “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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant 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).

5. Policy Commitment with Maximum Employment. The emphasis of policy is in maintaining full employment: “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.”

6. World Financial and Economic Conditions. There is concern with the world economy and financial markets: “The Committee continues to closely monitor inflation indicators and global economic and financial developments.” (emphasis added).

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 ¼ to ½ percent and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Markets overreacted to the so-called “paring” of outright purchases to $25 billion of securities per month for the balance sheet of the Fed. What is truly important is the fixing of the overnight fed funds at ¾ to 1 percent with gradual consideration of further rate increases (https://www.federalreserve.gov/newsevents/press/monetary/20170315a.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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant 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).

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

There is a critical phrase in the statement of Sep 19, 2013 (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm): “but mortgage rates have risen further.” Did the increase of mortgage rates influence the decision of the FOMC not to taper? Is FOMC “communication” and “guidance” successful? Will the FOMC increase purchases of mortgage-backed securities if mortgage rates increase?

A competing event is the high level of valuations of risk financial assets (http://cmpassocregulationblog.blogspot.com/2017/01/unconventional-monetary-policy-and.html and earlier 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 20,663.22 on Mar 31, 2017, which is higher by 45.9 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 45.5 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 (2016Dec 7, 2016Dec20), in Testimony to the Subcommittee on Monetary Policy and Trade Committee on Financial Services, on Dec 7, 2016, analyzes the adverse effects of unconventional monetary policy:

“My research and that of others over the years shows that these policies were not effective, and may have been counterproductive. Economic growth was consistently below the Fed’s forecasts with the policies, and was much weaker than in earlier U.S. recoveries from deep recessions. Job growth has been insufficient to raise the percentage of the population that is working above pre-recession levels. There is a growing consensus that the extra low interest rates and unconventional monetary policy have reached diminishing or negative returns. Many have argued that these policies widen the income distribution, adversely affect savers, and increase the volatility of the dollar exchange rate. Experienced market participants have expressed concerns about bubbles, imbalances, and distortions caused by the policies. The unconventional policies have also raised public policy concerns about the Fed being transformed into a multipurpose institution, intervening in particular sectors and allocating credit, areas where Congress may have a role, but not a limited-purpose independent agency of government.”

Professor John B. Taylor (2014Jul15, 2014Jun26) building on advanced research (Taylor 2007, 2008Nov, 2009, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB, 2015, 2012 Oct 25; 2013Oct28, 2014 Jan01, 2014Jan3, 2014Jun26, 2014Jul15, 2015, 2016Dec7, 2016Dec20 http://www.johnbtaylor.com/) 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/2017/01/rules-versus-discretionary-authorities.html and earlier http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html).

The key policy is maintaining fed funds rate between ½ and ¾ percent. Accelerated increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. There are high costs and risks of this policy because indefinite financial repression induces carry trades with high leverage, risks and illiquidity.

The FOMC provides guidelines on the process of normalization of monetary policy at the meeting on Dec 16, 2015 (http://www.federalreserve.gov/newsevents/press/monetary/20151216a1.htm):

“The Federal Reserve has made the following decisions to implement the monetary policy stance announced by the Federal Open Market Committee in its statement on December 16, 2015:

  • The Board of Governors of the Federal Reserve System voted unanimously to raise the interest rate paid on required and excess reserve balances to 0.50 percent, effective December 17, 2015.
  • As part of its policy decision, the Federal Open Market Committee voted to authorize and direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed otherwise, to execute transactions in the System Open Market Account in accordance with the following domestic policy directive:1

"Effective December 17, 2015, the Federal Open Market Committee directs the Desk to undertake open market operations as necessary to maintain the federal funds rate in a target range of 1/4 to 1/2 percent, including: (1) overnight reverse repurchase operations (and reverse repurchase operations with maturities of more than one day when necessary to accommodate weekend, holiday, or similar trading conventions) at an offering rate of 0.25 percent, in amounts limited only by the value of Treasury securities held outright in the System Open Market Account that are available for such operations and by a per-counterparty limit of $30 billion per day; and (2) term reverse repurchase operations to the extent approved in the resolution on term RRP operations approved by the Committee at its March 17-18, 2015, meeting.

The Committee directs the Desk to continue rolling over maturing Treasury securities at auction and to continue reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve's agency mortgage-backed securities transactions."

More information regarding open market operations may be found on the Federal Reserve Bank of New York's website.

  • In a related action, the Board of Governors of the Federal Reserve System voted unanimously to approve a 1/4 percentage point increase in the discount rate (the primary credit rate) to 1.00 percent, effective December 17, 2015. In taking this action, the Board approved requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Kansas City, Dallas, and San Francisco.

This information will be updated as appropriate to reflect decisions of the Federal Open Market Committee or the Board of Governors regarding details of the Federal Reserve's operational tools and approach used to implement 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 testimony on the Semiannual Monetary Policy Report to the Congress before the Committee on Financial Services, US House of Representatives, on Feb 11, 2014, Chair Janet Yellen states (http://www.federalreserve.gov/newsevents/testimony/yellen20140211a.htm):

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

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

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

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

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

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

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

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

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

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

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

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

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

W = Y/r (10

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

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

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

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

Friedman (1953) argues there are three lags in effects of monetary policy: (1) between the need for action and recognition of the need; (2) the recognition of the need and taking of actions; and (3) taking of action and actual effects. Friedman (1953) finds that the combination of these lags with insufficient knowledge of the current and future behavior of the economy causes discretionary economic policy to increase instability of the economy or standard deviations of real income σy and prices σp. Policy attempts to circumvent the lags by policy impulses based on forecasts. We are all naïve about forecasting. Data are available with lags and revised to maintain high standards of estimation. Policy simulation models estimate economic relations with structures prevailing before simulations of policy impulses such that parameters change as discovered by Lucas (1977). Economic agents adjust their behavior in ways that cause opposite results from those intended by optimal control policy as discovered by Kydland and Prescott (1977). Advance guidance attempts to circumvent expectations by economic agents that could reverse policy impulses but is of dubious effectiveness. There is strong case for using rules instead of discretionary authorities in monetary policy (http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html and earlier http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html).

The key policy is maintaining the fed funds rate between ½ and ¾ percent with gradual increases. Accelerated increase in fed funds rates could cause flight out of risk financial markets worldwide. There is no exit from this policy without major financial market repercussions. Indefinite financial repression induces carry trades with high leverage, risks and illiquidity.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Fri May 1

Mon 4

Tue 5

Wed 6

Thu 7

Fri 8

DJIA

18024.06

-0.3%

1.0%

18070.40

0.3%

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 49.2 percent relative to the dollar from the high on Jul 15, 2008 to Mar 31, 2017.

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 49.2 percent relative to the dollar from the high on Jul 15, 2008 to Mar 31, 2017.

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?

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

It may be quite painful to exit QE∞ or use of the balance sheet of the central bank together with zero interest rates forever. 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 discount rates increase without bound, then V → 0, or

declines.

IB Functions of Banks. Modern banking theory analyzes three important functions provided by banks: monitoring of borrowers, provision of liquidity services and transformation of illiquid assets into immediately liquid assets (Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 51-60). These functions require valuation of alternative investment projects that may be distorted by zero interest rates of monetary policy and artificially low long-term interest rates. The QE∞ trap frustrates essential banking functions.

  1. Monitoring. Banks monitor projects to ensure that funds are allocated to their intended projects (Diamond 1984, 1996). Banks issue deposits, which are secondary assets, to acquire loans, which are primary assets. Monitoring reduces costs of participating in business projects. Acting as delegated monitor, banks obtain information on the borrower, allowing less costly participation through the issue of unmonitored deposits. Monitoring of borrowers provides enhanced less costly participation by investors through the issue of deposits. There is significant reduction of monitoring costs by delegating to a bank. If there are many potential investors, monitoring by the bank of a credit name is less costly than the sum of individual monitoring of the same credit name by all potential investors. Banks permit borrowers to reach many investors for their projects while affording investors less costly participation in the returns of projects of bank borrowers.
  2. Transformation of Illiquid Loans into Liquid Deposits. Diamond and Dybvig (1986) analyze bank services through bank balance sheets.

i. Assets. Banks provide loans to borrowers. The evaluation of borrowers prevents “adverse selection,” which consists of banks choosing unsound projects and failing to finance sound projects. Monitoring of loans prevents “moral hazard,” which consists of borrowers using the funds of the loan for purposes other than the project for which they were lent, as for example, using borrowed bank funds for speculative real estate instead of for the intended industrial project. Relationship banking improves the information on borrowers and the monitoring function.

ii. Liabilities. Banks provide numerous services to their clients such as holding deposits, clearing transactions, currency inventory and payments for goods, services and obligations.

iii. Assets and Liabilities: Transformation Function. The transformation function operates through both sides of the balance sheet: banks convert illiquid loans in the asset side into liquid deposits in the liability side. There is rich theory of banking (Diamond and Rajan 2000, 2001a,b). Securitized banking provides the same transformation function by bundling mortgage and other consumer loans into securities that are then sold to investors who finance them in short-dated sale and repurchase agreements (Pelaez and Pelaez, Regulation of Banks and Finance (2008b), 61-6).

Banking was important in facilitating economic growth in historical periods (Cameron 1961, 1967, 1972; Cameron et al. 1992). Banking is also important currently because small- and medium-size business may have no other form of financing than banks in contrast with many options for larger and more mature companies that have access to capital markets. Calomiris and Haber (2014) find that broad voting rights and institutions restricting coalitions of bankers and populists ensure stable banking systems and access to credit. Summerhill (2015) provides convincing evidence that commitment to sovereign credibility is not sufficient to promote financial development in the presence of inadequate regulatory organization. Personal consumptions expenditures have share of 68.9 percent of GDP in IIQ2016 (http://cmpassocregulationblog.blogspot.com/2016/08/and-as-ever-economic-outlook-is.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/business-fixed-investment-has-been-soft.html). Most consumers rely on their banks for real estate loans, credit cards and personal consumer loans. Thus, it should be expected that success of monetary policy in stimulating the economy would be processed through bank balance sheets.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

IC United States Commercial Banks Assets and Liabilities. Selected assets and liabilities of US commercial banks, not seasonally adjusted, in billions of dollars, from Report H.8 of the Board of Governors of the Federal Reserve System are in Table I-1. Data are not seasonally adjusted to permit comparison between Feb 2016 and Feb 2017. Total assets of US commercial banks grew 2.8 percent from $15,751.0 billion in Feb 2016 to $16,187.2 billion in Feb 2017. The Bureau of Economic Analysis (BEA) estimates US GDP in 2016 at $18,569.1 billion (http://www.bea.gov/iTable/index_nipa.cfm). Thus, total assets of US commercial banks are equivalent to over 80 percent of US GDP. Bank credit grew 5.4 percent from $11,841.9 billion in Feb 2016 to $12,479.2 billion in Feb 2017. Securities in bank credit increased 6.5 percent from $3149 billion in Feb 2016 to $3354 billion in Feb 2017. A large part of securities in banking credit consists of US Treasury and agency securities, increasing 8.4 percent from $2261 billion in Feb 2016 to $2451 billion in Feb 2017. Credit to the government that issues or backs Treasury and agency securities of $2451 billion in Feb 2017 is about 19.6 percent of total bank credit of US commercial banks of $12,479.2 billion. Mortgage-backed securities, providing financing of home loans, increased 8.1 percent, from $1574 billion in Feb 2016 to $1701 billion in Feb 2017. Loans and leases are relatively dynamic, growing 5.0 percent from $8693 billion in Feb 2016 to $9125 billion in Feb 2017. A dynamic class is commercial and industrial loans, growing 5.4 percent from $1993 billion in Feb 2016 and providing $2101 billion or 23.0 percent of total loans and leases of $9125 billion in Feb 2017. Real estate loans increased 5.7 percent, providing $4129 billion in Feb 2017 or 45.2 percent of total loans and leases. Consumer loans increased 6.9 percent, providing $1361 billion in Feb 2016 or 14.9 percent of total loans. Cash assets are measured to “include vault cash, cash items in process of collection, balances due from depository institutions and balances due from Federal Reserve Banks” (https://www.federalreserve.gov/releases/h8/current/default.htm). Cash assets in US commercial banks decreased 7.1 percent from $2576 billion in Feb 2016 to $2394 billion in Feb 2017 but a single year of the series masks exploding cash in banks because of unconventional monetary policy, which is discussed below. Bank deposits increased 4.8 percent from $11,032 billion in Feb 2016 to $11,567 billion in Feb 2017. The difference between bank deposits and total loans and leases in banks increased from $2339 billion in Feb 2016 to $2442 billion in Feb 2017 or by $103 billion. Securities in bank credit increased $205 billion from $3149 billion in Feb 2016 to $3354 billion in Feb 2017 and Treasury and agency securities increased $190 billion from $2261 billion in Feb 2016 to $2451 billion in Feb 2017. Loans and leases increased $432 billion from $8693 billion in Feb 2016 to $9125 billion in Feb 2017. Banks expanded both lending and investment in lower risk securities partly because of the weak economy and credit disappointments during the global recession that has resulted in an environment of fewer sound lending opportunities. Investing in securities with high duration, or price elasticity of yields, is riskier because of the increase in yields that can cause loss of principal as investors shift away from bond funds into money market funds invested in short-term assets. Lower interest rates resulting from monetary policy may not necessarily encourage higher borrowing in the current loss of dynamism of the US economy. Real disposable income per capita in IVQ2016 is higher by only 10.2 percent than in IVQ2007 (Table IB-2 IX Conclusion and extended analysis in IB Collapse of United States Dynamism of Income Growth and Employment Creation), which is significantly lower than 19.5 percent higher if the economy had performed in long-term growth of per capita income in the United States at 2 percent per year from 1870 to 2010 (Lucas 2011May). In contrast, real disposable income per capita grew cumulatively 26.9 percent in the cycle from IQ1980 to IIQ1990 that was close to trend growth of 23.7 percent.

Table I-1, US, Assets and Liabilities of Commercial Banks, NSA, Billions of Dollars

 

Feb 2016

Feb 2017

∆%

Total Assets

15,751.0

16,187.2

2.8

Bank Credit

11,841.9

12,479.2

5.4

Securities in Bank Credit

3149

3354

6.5

Treasury & Agency Securities

2261

2451

8.4

Mortgage-Backed Securities

1574

1701

8.1

Loans & Leases

8693

9125

5.0

Real Estate Loans

3908

4129

5.7

Commercial Real Estate Loans

1815

1988

9.5

Consumer Loans

1273

1361

6.9

Commercial & Industrial Loans

1993

2101

5.4

Other Loans & Leases

1519

1535

1.1

Cash Assets*

2576

2394

-7.1

Total Liabilities

14,037

14,428

2.8

Deposits

11,032

11,567

4.8

Residual (Assets less Liabilities)

1714

1760

NA

Note: balancing item of residual assets less liabilities not included

*”Includes vault cash, cash items in process of collection, balances due from depository institutions and balances due from Federal Reserve Banks.”

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Seasonally adjusted annual equivalent rates (SAAR) of change of selected assets and liabilities of US commercial banks from the report H.8 of the Board of Governors of the Federal Reserve System are in Table I-2 annually from 2011 to 2016 and for Jan 2017 and Feb 2017. The global recession had strong impact on bank assets as shown by declines of total assets of 6.0 percent in 2009 and 2.6 percent in 2010. Loans and leases fell 10.2 percent in 2009 and 5.7 percent in 2010. Commercial and industrial loans fell 18.7 percent in 2009 and 9.2 percent in 2010. Unconventional monetary policy caused an increase of cash assets of banks of 159.2 percent in 2008, 49.5 percent in 2009 and 48.1 percent in 2011 followed by decline by 2.2 percent in 2012. Cash assets of banks increased 54.5 percent in 2013 and 12.3 percent in 2014, decreasing 7.8 percent in 2015. Cash assets of banks decreased 14.3 percent in 2016. Cash assets of banks increased at the SAAR of 22.5 percent in Aug 2012 but contraction by 49.6 percent in Sep 2012 and 6.3 percent in Oct 2012. Cash assets of banks increased at 56.0 percent in Nov 2012, minus 7.8 percent in Dec 2012, 38.8 percent in Jan 2013, 66.2 percent in Feb 2013, 66.0 percent in Mar 2013 and 14.5 percent in Apr 2013. Cash assets of banks increased at the SAAR of 63.2 percent in May 2013, 42.4 percent in Jun 2013, 28.6 percent in Jul 2013, 71.5 percent in Aug 2013, 57.5 percent in Sep 2013 and 50.2 percent in Oct 2013. Cash assets of banks increased at the rate of 29.0 percent in Nov 2013 and fell at 1.5 percent in Dec 2013. Cash assets of banks increased at 20.1 percent in Jan 2014 and at 20.5 percent in Feb 2014. Cash assets of banks increased at 24.4 percent in Mar 2014 and at 8.1 percent in Apr 2014. Cash assets of banks increased at 3.5 percent in May 2014 and 29.8 percent in Jun 2014. Cash assets of banks increased at 8.4 percent in Jul 2014 and 16.0 percent in Aug 2014. Cash assets of banks increased at 16.8 percent in Sep 2014. Cash assets of banks increased at 2.9 percent in Oct 2014 and fell at 1.0 percent in Nov 2014. Cash assets of banks fell at 32.1 percent in Dec 2014. Cash assets of banks increased at 5.0 percent in Jan 2015, declining at 14.1 percent in Feb 2015 and increasing at 5.3 percent in Mar 2015. Cash assets of banks fell at 1.9 percent in Apr 2015 and at 31.4 percent in May 2015. Cash assets of banks fell at 29.0 percent in Jun 2015 and increased at 8.8 percent in Jul 2015. Cash assets of banks increased at 11.8 percent in Aug 2015 and fell at 29.2 percent in Sep 2015. Cash assets of banks increased at 51.2 percent in Oct 2015 and fell at 33.0 percent in Nov 2015. Cash assets of banks fell at 37.7 percent in Dec 2015 and fell at 14.0 percent in Jan 2016. Cash assets of banks increased at 9.0 percent in Feb 2016 and fell at 4.6 percent in Mar 2016. Cash assets of banks increased at 12.7 percent in Apr 2016 and fell at 4.4 percent in May 2016. Cash assets of banks fell at 23.6 percent in Jun 2016 and fell at 13.1 percent in Jul 2016. Cash assets of banks decreased at 0.6 percent in Aug 2016 and decreased at 34.4 percent in Sep 2016. Cash assets of banks decreased at 59.5 percent in Oct 2016, increasing at 0.5 percent in Nov 2016. Cash assets of banks increased at 18.2 percent in Dec 2016 and increased at 12.6 percent in Jan 2017. Cash assets of banks increased at 39.0 percent in Feb 2017. Acquisitions of securities for the portfolio of the central bank injected reserves in depository institutions that banks held as cash and reserves at the central bank because of the lack of sound lending opportunities and the adverse expectations in the private sector on doing business. The truly dynamic investment of banks has been in securities in bank credit: growing at the SAAR of 15.4 percent in Jul 2012, 2.6 percent in Aug 2012, 5.3 percent in Sep 2012, 4.7 percent in Oct 2012, 1.7 percent in Nov 2012 and 20.5 percent in Dec 2012. There were declines of securities in bank credit at 1.1 percent in Jan 2013, 3.2 percent in Feb 2013 and 2.7 percent in Mar 2013 but growth of 1.5 percent in Apr 2013. Securities in bank credit fell at the SAAR of 2.6 percent in May 2013 and 5.7 percent in Jun 2013. Securities in bank credit fell at the SAAR of 11.9 percent in Jul 2013 and at 8.3 percent in Aug 2013. Securities in bank credit fell at the SAAR of 6.8 percent in Sep 2013 and increased at 3.0 percent in Oct 2013. Securities in bank credit increased at 5.2 percent in Nov 2013 and at 10.5 percent in Dec 2013. Securities in bank credit increased at 4.1 percent in Jan 2014 and at 8.3 percent in Feb 2014. Securities in bank credit increased at 7.8 percent in Mar 2014 and at 4.4 percent in Apr 2014. Securities in bank credit increased at 10.1 percent in May 2014 and at 7.9 percent in Jun 2014. Securities in bank credit increased at 10.1 percent in Jul 2014, at 0.3 percent in Aug 2014 and at 7.6 percent in Sep 2014. Securities in bank credit increased at 2.8 percent in Oct 2014 and at 5.3 percent in Nov 2014. Securities in bank credit jumped at 19.1 percent in Dec 2014. Securities in bank credit increased at 11.2 percent in Jan 2015 and at 7.8 percent in Feb 2015. Securities in bank credit increased at 0.5 percent in Mar 2015 and increased at 7.9 percent in Apr 2015. Securities in bank credit increased at 11.3 percent in May 2015 and at 0.8 percent in Jun 2015. Securities in bank credit fell at 1.9 percent in Jul 2015. Securities in bank credit increased at 5.2 percent in Aug 2015 and fell at 3.5 percent in Sep 2015. Securities in bank credit increased at 5.8 percent in Oct 2015 and increased at 6.5 percent in Nov 2015, increasing at 9.0 percent in Dec 2015. Securities in bank credit increased at 10.7 percent in Jan 2016 and changed at 0.0 percent in Feb 2016. Securities in bank credit increased at 0.8 percent in Mar 2016 and increased at 10.1 percent in Apr 2016. Securities in bank credit increased at 9.0 percent in May 2016 and increased at 7.1 percent in Jun 2016. Securities in bank credit increased at 15.8 percent in Jul 2016 and increased at 7.2 percent in Aug 2016. Securities in bank credit increased at 10.9 percent in Sep 2016 and increased at 10.6 percent in Oct 2016. Securities in bank credit increased at 0.9 percent in Nov 2016, decreasing at 2.3 percent in Dec 2016. Securities in bank credit increased at 5.4 percent in Jan 2017 and increased at 1.1 percent in Feb 2017. Fear of loss of principal in securities with high duration or price elasticity of yield is shifting investments away from bonds into cash and other assets with less price risk. Positions marked to market in balance sheets experience sharp declines. Throughout the crisis, banks allocated increasing part of their assets to the safety of Treasury and agency securities, or credit to the US government and government-backed credit: with growth of 13.5 percent in 2009 and 15.4 percent in 2010. Treasury and agency securities in bank credit increased at the rate of 16.3 percent in Jul 2012, declining to the rate of 3.4 percent in Aug 2012, 2.1 percent in Sep 2012 and 0.7 percent in Oct 2012. Treasury and agency securities in bank credit fell at the rate of 0.8 percent in Nov 2012, increasing at 17.2 percent in Dec 2012. Treasury and agency securities in bank credit fell at 5.9 percent in Jan 2013, 3.1 percent in Feb 2013, 7.0 percent in Mar 2013 and 5.4 percent in Apr 2013 and 8.3 percent in May 2013. Treasury and agency securities in US commercial banks fell at the SAAR of 6.8 percent in Jun 2013, 19.7 percent in Jul 2013 and 15.7 percent in Aug 2013. Treasury and agency securities fell at the SAAR of 5.6 percent in Sep 2013 and increased at 1.3 percent in Oct 2013. Treasury and agency securities increased at 5.6 percent in Nov 2013 and at 8.9 percent in Dec 2013. Treasury and agency securities increased at 4.2 percent in Jan 2014 and at 8.1 percent in Feb 2014. Treasury and agency securities increased at 9.3 percent in Mar 2014 and at 7.9 percent in Apr 2014. Treasury and agency securities increased at 17.4 percent in May 2014 and 10.1 percent in Jun 2014. Treasury and agency securities increased at 14.6 percent in Jul 2014, at 6.4 percent in Aug 2014 and at 19.5 percent in Sep 2014. Treasury and agency securities increased at 9.3 percent in Oct 2014 and at 6.5 percent in Nov 2014. Treasury and agency securities jumped at 24.0 percent in Dec 2014, 15.3 percent in Jan 2015 and 9.9 percent in Feb 2015, decreasing at 0.5 percent in Mar 2015. Treasury and agency securities increased at 8.1 percent in Apr 2015, at 18.3 percent in May 2015 and at 1.2 percent in Jun 2015. Treasury and agency securities fell at 0.4 percent in Jul 2015, increasing at 8.2 percent in Aug 2015 and decreasing at 0.2 percent in Sep 2015. Treasury and agency securities increased at 9.7 percent in Oct 2015 and increased at 9.0 percent in Nov 2015, increasing at 12.0 percent in Dec 2015. Treasury and agency securities increased at 12.3 percent in Jan 2016 and fell at 0.9 percent in Feb 2016. Treasury and agency securities fell at 1.4 percent in Mar 2016 and increased at 13.4 percent in Apr 2016. Treasury and agency securities increased at 11.5 percent in May 2016 and increased at 4.6 percent in Jun 2016. Treasury and agency securities increased at 19.9 percent in Jul 2016 and increased at 10.5 percent in Aug 2016. Treasury and agency securities increased at 13.9 percent in Sep 2016 and increased at 16.8 percent in Oct 2016. Treasury and agency securities increased at 4.1 percent in Nov 2016 and decreased at 2.7 percent in Dec 2016. Treasury and agency securities increased at 7.4 percent in Jan 2017 and decreased at 1.1 percent in Feb 2017. Increases in yield result in capital losses that may explain less interest in holding securities with higher duration. Deposits grew at the rate of 10.5 percent in Jul 2012, with the rate declining as for most assets of commercial banks to the rate of 6.2 percent in Aug 2012 but increasing to 7.2 percent in Sep 2012, 8.4 percent in Oct 2012, 5.7 percent in Nov 2012, 18.7 percent in Dec 2012, 2.7 percent in Jan 2013. Deposits grew at the rate of 4.4 percent in Feb 2013, 7.7 percent in Mar 2013, 3.5 percent in Apr 2013 and 2.4 percent in May 2013. Deposits increased at the SAAR of 6.3 percent in Jun 2013, 8.0 percent in Jul 2013 and 3.5 percent in Aug 2013. Deposits grew at the rate of 7.2 percent in Sep 2013 and at 9.0 percent in Oct 2013. Deposits grew at 9.1 percent in Nov 2013 and at 9.1 percent in Dec 2013. Deposits increased at 8.7 percent in Jan 2014 and at 9.6 percent in Feb 2014. Deposits grew at 6.7 percent in Mar 2014 and at 8.4 percent in Apr 2014. Deposits grew at 7.9 percent in May and 3.4 percent in Jun 2014. Deposits increased at 7.2 percent in Jul 2014, at 1.5 percent in Aug 2014 and at 9.9 percent in Sep 2014. Deposits fell at 4.4 percent in Oct 2014 and increased at 9.8 percent in Nov 2014. Deposits increased at 8.2 percent in Dec 2014, 7.0 percent in Jan 2015, 11.3 percent in Feb 2015 and 5.7 percent in Mar 2015. Deposits fell at 1.1 percent in Apr 2015 and increased at 4.8 percent in May 2015 and at 5.6 percent in Jun 2015. Deposits increased at 5.5 percent in Jul 2015, increasing at 7.3 percent in Aug 2015 and increasing at 0.6 percent in Sep 2015. Deposits increased at 6.0 percent in Oct 2015 and increased at 2.4 percent in Nov 2015. Deposits fell at 4.0 percent in Dec 2015 and increased at 5.4 percent in Jan 2016. Deposits increased at 6.2 percent in Feb 2016 and increased at 7.9 percent in Mar 2016. Deposits increased at 5.2 percent in Apr 2016 and increased at 4.3 percent in May 2016, increasing at 7.2 percent in Jun 2016. Deposits increased at 4.0 percent in Jul 2016 and increased at 8.9 percent in Aug 2016. Deposits fell at 1.0 percent in Sep 2016 and increased at 0.5 percent in Oct 2016. Deposits increased at 5.0 percent in Nov 2016 and increased at 4.6 percent in Dec 2016. Deposits increased at 8.5 percent in Jan 2017 and increased at 2.3 percent in Feb 2017. The credit intermediation function of banks is broken because of adverse expectations on future business and cannot be fixed by monetary and fiscal policy. Incentives to business and consumers are more likely to be effective in this environment in recovering willingness to assume risk on the part of the private sector, which is the driver of growth and job creation.

Table I-2, US, Selected Assets and Liabilities of Commercial Banks, at Break Adjusted, Seasonally Adjusted Annual Rate, ∆%

 

2011

2012

2013

2014

2015

2016

Jan 

2017

Feb   

2017

Total Assets

5.2

2.6

7.1

7.4

3.5

2.7

3.3

4.7

Bank Credit

1.6

4.1

1.2

6.9

7.3

6.8

2.5

0.0

Securities in Bank Credit

1.9

7.6

-1.5

7.1

5.9

7.9

5.4

1.1

Treasury & Agency Securities

3.2

8.4

-5.2

11.8

8.8

10.1

7.4

-1.1

Other Securities

-0.9

5.8

6.8

-2.3

-0.6

2.4

0.4

6.8

Loans & Leases

1.5

2.9

2.3

6.8

7.7

6.4

1.4

-0.4

Real Estate Loans

-3.7

-1.1

-1.0

2.5

5.0

6.5

4.2

1.7

Commercial Real Estate Loans

-6.3

-1.3

4.5

6.7

10.0

10.3

9.4

6.9

Consumer Loans

-1.7

0.5

3.2

5.3

5.8

7.0

2.9

4.9

Commercial & Industrial Loans

8.6

11.6

6.9

12.0

10.6

6.6

1.0

-1.3

Other Loans & Leases

18.6

8.1

6.0

14.6

13.1

5.5

-6.5

-9.3

Cash Assets

48.1

-2.2

54.5

12.3

-7.8

-14.3

12.6

39.0

Total Liabilities

5.5

2.4

8.2

7.6

3.3

2.7

5.1

4.7

Deposits

6.7

7.2

6.5

6.4

5.0

4.3

8.5

2.3

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-1 of the Board of Governors of the Federal Reserve System provides quarterly seasonally adjusted annual rates (SAAR) of cash assets in US commercial banks from 1973 to 2017. Unconventional monetary policy caused an increase in cash assets in late 2008 of close to 500 percent at SAAR and in following policy impulses. Such aggressive policies were not required for growth of GDP at the average rate of 4.4 percent in 30 quarters of cyclical expansion from IQ1983 to IIQ1990. In contrast, the average rate in 30 quarters of cyclical expansion from IIIQ2009 to IVQ2016 has been at the rate of 2.1 percent (Section I and earlier https://cmpassocregulationblog.blogspot.com/2017/03/rising-valuations-of-risk-financial.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/rising-valuations-of-risk-financial.html). The difference in magnitude of the recessions is not sufficient to explain weakness of the current cyclical expansion. Bordo (2012Sep27) and Bordo and Haubrich (2012DR) find that growth is higher after deeper contractions and contractions with financial crises. There were two consecutive contractions in the 1980s with decline of 2.2 percent in two quarters from IQ1980 to IIIQ1980 and 2.5 percent from IIIQ1981 to IVQ1982 that are almost identical to the contraction of 4.2 percent from IVQ2007 to IIIQ2009. There was also a decade-long financial and banking crisis during the 1980s. The debt crisis of 1982 (Pelaez 1986) wiped out a large part of the capital of large US money-center banks. Benston and Kaufman (1997, 139) find that there was failure of 1150 US commercial and savings banks between 1983 and 1990, or about 8 percent of the industry in 1980, which is nearly twice more than between the establishment of the Federal Deposit Insurance Corporation in 1934 through 1983. More than 900 savings and loans associations, representing 25 percent of the industry, were closed, merged or placed in conservatorships (see Pelaez and Pelaez, Regulation of Banks and Finance (2008b), 74-7). The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) created the Resolution Trust Corporation (RTC) and the Savings Association Insurance Fund (SAIF) that received $150 billion of taxpayer funds to resolve insolvent savings and loans. The GDP of the US in 1989 was $5657.7 billion (http://www.bea.gov/iTable/index_nipa.cfm), such that the partial cost to taxpayers of that bailout was around 2.65 percent of GDP in a year. The US Bureau of Economic Analysis estimates GDP of $18,569.1 billion in 2015, such that the bailout would be equivalent to cost to taxpayers of about $492.1 billion in current GDP terms. A major difference with the Troubled Asset Relief Program (TARP) for private-sector banks is that most of the costs were recovered with interest gains whereas in the case of savings and loans there was no recovery.

Chart I-1, US, Cash Assets, Commercial Banks, Seasonally Adjusted Annual Rate, Monthly, 1973-2017, ∆%

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-2 of the Board of Governors of the Federal Reserve System provides quarterly SAARs of bank credit at US commercial banks from 1947 to 2017. Rates collapsed sharply during the global recession as during the recessions of the 1980s and then rebounded. In both episodes, rates of growth of bank credit did not return to earlier magnitudes.

Chart I-2, US, Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, Monthly, 1947-2017, ∆%

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-3 of the Board of Governors of the Federal Reserve System provides deposits at US commercial banks from 1973 to 2017. Deposits fell sharply during and after the global recession but then rebounded in the cyclical expansion.

Chart I-3, US, Deposits, Commercial Banks, Seasonally Adjusted Annual Rate, Monthly, 1973-2017, ∆%

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

There is similar behavior in the 1980s and in the current cyclical expansion of SAARs holdings of Treasury and agency securities in US commercial banks provided in Chart I-4 of the Board of Governors of the Federal Reserve System for the period 1947 to 2017. Sharp reductions of holdings during the contraction were followed by sharp increases.

Chart I-4, US, Treasury and Agency Securities in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, Monthly, 1947-2017,

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-5 of the Board of Governors of the Federal Reserve System provides SAARs of change of total loans and leases in US commercial banks from 1947 to 2017. The decline of SAARs in the current cycle was much sharper and the rebound did not recover earlier growth rates. Part of the explanation originates in demand for loans that was high during rapid economic growth at 4.5 percent per year on average in the cyclical expansion of the 1980s in contrast with lower demand during tepid economic growth at 2.1 percent per year on average in the current weak expansion.

Chart I-5, US, Loans and Leases in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, Monthly, 1947-2017, ∆%

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

There is significant difference in the two cycles of the 1980s and the current one in quarterly SAARs of real estate loans in US commercial banks provided in Chart I-6 of the Board of Governors of the Federal Reserve System. The difference is explained by the debacle in real estate after 2006 compared to expansion during the 1980s even during the crisis of savings and loans and real estate credit. In both cases, government policy tried to influence recovery and avoid market clearing.

Chart I-6, US, Real Estate Loans in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, Monthly, 1947-2017, ∆%

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

There is significant difference in quarterly SAARs of change of consumer loans in US commercial banks in the 1980s and during the current cycle as shown in Chart I-7 of the Board of Governors of the Federal Reserve System. Quarterly SAARs of consumer loans in US commercial banks fell sharply during the contraction of 1980 and oscillated with upward trend during the contraction of 1983-1984 but increased sharply in the cyclical expansion. In contrast, SAARs of consumer loans in US commercial banks collapsed to high negative magnitudes during the contraction, increased at very low magnitudes during the current cyclical expansion with recent higher rates.

Chart I-7, US, Consumer Loans in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, Monthly, 1958-2017, ∆%

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

The departing theoretical framework of Bordo and Haubrich (2012DR) is the plucking model of Friedman (1964, 1988). Friedman (1988, 1) recalls, “I was led to the model in the course of investigating the direction of influence between money and income. Did the common cyclical fluctuation in money and income reflect primarily the influence of money on income or of income on money?” Friedman (1964, 1988) finds useful for this purpose to analyze the relation between expansions and contractions. Analyzing the business cycle in the United States between 1870 and 1961, Friedman (1964, 15) found that “a large contraction in output tends to be followed on the average by a large business expansion; a mild contraction, by a mild expansion.” The depth of the contraction opens up more room in the movement toward full employment (Friedman 1964, 17):

“Output is viewed as bumping along the ceiling of maximum feasible output except that every now and then it is plucked down by a cyclical contraction. Given institutional rigidities and prices, the contraction takes in considerable measure the form of a decline in output. Since there is no physical limit to the decline short of zero output, the size of the decline in output can vary widely. When subsequent recovery sets in, it tends to return output to the ceiling; it cannot go beyond, so there is an upper limit to output and the amplitude of the expansion tends to be correlated with the amplitude of the contraction.”

Kim and Nelson (1999) test the asymmetric plucking model of Friedman (1964, 1988) relative to a symmetric model using reference cycles of the NBER and find evidence supporting the Friedman model. Bordo and Haubrich (2012DR) analyze 27 cycles beginning in 1872, using various measures of financial crises while considering different regulatory and monetary regimes. The revealing conclusion of Bordo and Haubrich (2012DR, 2) is that:

“Our analysis of the data shows that steep expansions tend to follow deep contractions, though this depends heavily on when the recovery is measured. In contrast to much conventional wisdom, the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis. In fact, on average, it is cycles without a financial crisis that show the weakest relation between contraction depth and recovery strength. For many configurations, the evidence for a robust bounce-back is stronger for cycles with financial crises than those without.”

The average rate of growth of real GDP in expansions after recessions with financial crises was 8 percent but only 6.9 percent on average for recessions without financial crises (Bordo 2012Sep27). Real GDP declined 12 percent in the Panic of 1907 and increased 13 percent in the recovery, consistent with the plucking model of Friedman (Bordo 2012Sep27). Bordo (2012Sep27) finds two probable explanations for the weak recovery during the current economic cycle: (1) collapse of United States housing; and (2) uncertainty originating in fiscal policy, regulation and structural changes. There are serious doubts if monetary policy is adequate to recover the economy under these conditions.

Lucas (2011May) estimates US economic growth in the long-term at 3 percent per year and about 2 percent per year in per capita terms. There are displacements from this trend caused by events such as wars and recessions but the economy grows much faster during the expansion, compensating for the contraction and maintaining trend growth over the entire cycle. Historical US GDP data exhibit remarkable growth: Lucas (2011May) estimates an increase of US real income per person by a factor of 12 in the period from 1870 to 2010. The explanation by Lucas (2011May) of this remarkable growth experience is that government provided stability and education while elements of “free-market capitalism” were an important driver of long-term growth and prosperity. Lucas sharpens this analysis by comparison with the long-term growth experience of G7 countries (US, UK, France, Germany, Canada, Italy and Japan) and Spain from 1870 to 2010. Countries benefitted from “common civilization” and “technology” to “catch up” with the early growth leaders of the US and UK, eventually growing at a faster rate. Significant part of this catch up occurred after World War II. Lucas (2011May) finds that the catch up stalled in the 1970s. The analysis of Lucas (2011May) is that the 20-40 percent gap that developed originated in differences in relative taxation and regulation that discouraged savings and work incentives in comparison with the US. A larger welfare and regulatory state, according to Lucas (2011May), could be the cause of the 20-40 percent gap. Cobet and Wilson (2002) provide estimates of output per hour and unit labor costs in national currency and US dollars for the US, Japan and Germany from 1950 to 2000 (see Pelaez and Pelaez, The Global Recession Risk (2007), 137-44). The average yearly rate of productivity change from 1950 to 2000 was 2.9 percent in the US, 6.3 percent for Japan and 4.7 percent for Germany while unit labor costs in USD increased at 2.6 percent in the US, 4.7 percent in Japan and 4.3 percent in Germany. From 1995 to 2000, output per hour increased at the average yearly rate of 4.6 percent in the US, 3.9 percent in Japan and 2.6 percent in Germany while unit labor costs in USD fell at minus 0.7 percent in the US, 4.3 percent in Japan and 7.5 percent in Germany. There was increase in productivity growth in Japan and France within the G7 in the second half of the 1990s but significantly lower than the acceleration of 1.3 percentage points per year in the US. The key indicator of growth of real income per capita, which is what a person earns after inflation, measures long-term economic growth and prosperity. A refined concept would include real disposable income per capita, which is what a person earns after inflation and taxes.

Table IB-1 provides the data required for broader comparison of long-term and cyclical performance of the United States economy. Revisions and enhancements of United States GDP and personal income accounts by the Bureau of Economic Analysis (BEA) (http://bea.gov/iTable/index_nipa.cfm) provide important information on long-term growth and cyclical behavior. First, Long-term performance. Using annual data, US GDP grew at the average rate of 3.2 percent per year from 1929 to 2016 and at 3.2 percent per year from 1947 to 2016. Real disposable income grew at the average yearly rate of 3.2 percent from 1929 to 2016 and at 3.7 percent from 1947 to 1999. Real disposable income per capita grew at the average yearly rate of 2.0 percent from 1929 to 2016 and at 2.3 percent from 1947 to 1999. US economic growth was much faster during expansions, compensating contractions in maintaining trend growth for whole cycles. Using annual data, US real disposable income grew at the average yearly rate of 3.5 percent from 1980 to 1989 and real disposable income per capita at 2.6 percent. The US economy has lost its dynamism in the current cycle: real disposable income grew at the yearly average rate of 1.8 percent from 2006 to 2016 and real disposable income per capita at 1.0 percent. Real disposable income grew at the average rate of 1.8 percent from 2007 to 2016 and real disposable income per capita at 1.0 percent. Table IB-1 illustrates the contradiction of long-term growth with the proposition of secular stagnation (Hansen 1938, 1938, 1941 with early critique by Simons (1942). Secular stagnation would occur over long periods. Table IB-1 also provides the corresponding rates of population growth that is only marginally lower at 0.8 to 0.9 percent recently from 1.1 percent over the long-term. GDP growth fell abruptly from 2.6 percent on average from 2000 to 2006 to 1.3 percent from 2006 to 2016 and 1.3 percent from 2007 to 2016 and real disposable income growth fell from 2.9 percent on average from 2000 to 2006 to 1.8 percent from 2006 to 2016. The decline of growth of real per capita disposable income is even sharper from average 2.0 percent from 2000 to 2006 to 1.0 percent from 2006 to 2016 and 1.0 percent from 2007 to 2016 while population growth was 0.8 percent on average. Lazear and Spletzer (2012JHJul122) provide theory and measurements showing that cyclic factors explain currently depressed labor markets. This is also the case of the overall economy. Second, first four quarters of expansion. Growth in the first four quarters of expansion is critical in recovering loss of output and employment occurring during the contraction. In the first four quarters of expansion from IQ1983 to IVQ1983: GDP increased 7.8 percent, real disposable personal income 5.3 percent and real disposable income per capita 4.4 percent. In the first four quarters of expansion from IIIQ2009 to IIQ2010: GDP increased 2.7 percent, real disposable personal income 0.2 percent and real disposable income per capita decreased 0.7 percent. Third, first 30 quarters of expansion. In the expansion from IQ1983 to IIQ1990: GDP grew 38.3 percent at the annual equivalent rate of 4.4 percent; real disposable income grew 32.5 percent at the annual equivalent rate of 3.8 percent; and real disposable income per capita grew 23.7 percent at the annual equivalent rate of 2.9 percent. In the expansion from IIIQ2009 to IVQ2016: GDP grew 17.1 percent at the annual equivalent rate of 2.1 percent; real disposable income grew 16.1 percent at the annual equivalent rate of 2.0 percent; and real disposable personal income per capita grew 9.9 percent at the annual equivalent rate of 1.3 percent. Fourth, entire quarterly cycle. In the entire cycle combining contraction and expansion from IQ1980 to IIQ1990: GDP grew 38.1 percent at the annual equivalent rate of 3.0 percent; real disposable personal income grew 40.2 percent at the annual equivalent rate of 3.2 percent; and real disposable personal income per capita 27.0 percent at the annual equivalent rate of 2.2 percent. In the entire cycle combining contraction and expansion from IVQ2007 to IVQ2016: GDP grew 12.1 percent at the annual equivalent rate of 1.3 percent; real disposable personal income increased 18.0 percent at the annual equivalent rate of 1.9 percent; and real disposable personal income per capita grew 10.2 percent at the annual equivalent rate of 1.1 percent. The United States grew during its history at high rates of per capita income that made its economy the largest in the world. That dynamism is disappearing. Bordo (2012 Sep27) and Bordo and Haubrich (2012DR) provide strong evidence that recoveries have been faster after deeper recessions and recessions with financial crises, casting serious doubts on the conventional explanation of weak growth during the current expansion allegedly because of the depth of the contraction of 4.2 percent from IVQ2007 to IIQ2009 and the financial crisis. The proposition of secular stagnation should explain a long-term process of decay and not the actual abrupt collapse of the economy and labor markets currently.

Table IB-1, US, GDP, Real Disposable Personal Income, Real Disposable Income per Capita and Population Long-term and in 1983-89 and 2007-2016, %

Long-term Average ∆% per Year

GDP

Population

 

1929-2016

3.2

1.1

  

1947-2016

3.2

1.2

  

1947-1999

3.6

1.3

  

1980-1989

3.5

0.9

  

2000-2016

1.8

0.9

  

2000-2006

2.6

0.9

  

2006-2016

1.3

0.8

  

2007-2016

1.3

0.8

  

Long-term

Average ∆% per Year

Real Disposable Income

Real Disposable Income per Capita

Population

1929-2016

3.2

2.0

1.1

1947-1999

3.7

2.3

1.3

2000-2016

2.2

1.4

0.9

2000-2006

2.9

2.0

0.9

2006-2016

1.8

1.0

0.8

2007-2016

1.8

1.0

0.8

Whole Cycles

Average ∆% per Year

      

1980-1989

3.5

2.6

0.9

2006-2016

1.8

1.0

0.8

2007-2016

1.8

1.0

0.8

Comparison of Cycles

# Quarters

∆%

∆% Annual Equivalent

GDP

      

I83 to IV83

I83 to IQ87

I83 to II87

I83 to III87

I83 to IV87

I83 to I88

I83 to II88

I83 to III88

I83 to IV88

I83 to I89

I83 to II89

I83 to III89

I83 to IV89

I83 to I90

I83 to II90

4

17

18

19

20

21

22

23

24

25

26

27

28

29

30

7.8

23.1

24.5

25.6

27.7

28.4

30.1

30.9

32.6

34.0

35.0

36.0

36.3

37.8

38.3

7.8

5.0

5.0

4.9

5.0

4.9

4.9

4.8

4.8

4.8

4.7

4.7

4.5

4.5

4.4

RDPI

      

I83 to IV83

I83 to I87

I83 to III87

I83 to IV87

I83 to I88

I83 to II88

I83 to III88

I83 to IV88

I83 to I89

I83 to II89

I83 to III89

I83 to IV89

I83 to I90

I83 to II90

4

17

19

20

21

22

23

24

25

26

27

28

29

30

5.3

19.5

20.5

22.1

23.8

25.1

26.3

27.5

29.1

28.7

29.6

30.7

31.8

32.5

5.3

4.3

4.0

4.1

4.2

4.2

4.1

4.1

4.2

4.0

3.9

3.9

3.9

3.8

RDPI Per Capita

      

I83 to IV83

I83 to I87

I83 to III87

I83 to IV87

I83 to I88

I83 to II88

I83 to III88

I83 to IV88

I83 to I89

I83 to II89

I83 to III89

I83 to IV89

I83 to I90

I83 to II90

4

17

19

20

21

22

23

24

25

26

27

28

29

30

4.4

15.1

15.5

16.7

18.2

19.2

20.0

20.9

22.1

21.5

22.0

22.6

23.4

23.7

4.4

3.4

3.1

3.1

3.2

3.2

3.2

3.2

3.2

3.0

3.0

3.0

2.9

2.9

Whole Cycle IQ1980 to IIQ1990

      

GDP

43

38.1

3.0

RDPI

43

40.2

3.2

RDPI per Capita

43

27.0

2.2

Population

43

10.4

0.9

GDP

      

III09 to II10

III09 to IV16

4

30

2.7

17.1

2.7

2.1

RDPI

      

III09 to II10

III09 to IV16

4

30

0.2

16.1

0.2

2.0

RDPI per Capita

      

III09 to II10

III09 to IV16

4

30

-0.7

9.9

-0.7

1.3

Population

      

III09 to II10

III09 to IV16

4

30

0.8

5.7

0.8

0.7

IVQ2007 to IVQ2016

36

    

GDP

36

12.1

1.3

RDPI

36

18.0

1.9

RDPI per Capita

36

10.2

1.1

Population

36

7.1

0.8

RDPI: Real Disposable Personal Income

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

Chart I-8 of the Board of Governors of the Federal Reserve System provides cash assets in commercial banks not seasonally adjusted in billions of dollars from 1973 to 2017. Increases in bank cash reserves processed acquisitions of securities for the portfolio of the central bank. There is no comparable experience in US economic history and such flood of money was never required to return US economic growth to trend of 3 percent per year and 2 percent per year in per capita income after events such as recessions and wars (Lucas 2011May). It is difficult to argue that higher magnitudes of monetary and fiscal policy impulses would have been more successful. Discovery of such painless and fast adjustment by gigantic impulses of monetary policy of zero interest rates and trillions of dollars of bond buying would have occurred earlier with prior cases of successful implementation. Selective incentives to the private sector of a long-term nature could have been more effective.

Chart I-8, US, Cash Assets in Commercial Banks, Not Seasonally Adjusted, Monthly, 1973-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-9 of the Board of Governors of the Federal Reserve System provides total assets of Federal Reserve Banks in millions of dollars on Wednesdays from Dec 18, 2002 to Mar 22, 2017. This is what is referred as the leverage of the central bank balance sheet in monetary policy (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-62, Regulation of Banks and Finance (2009b) 224-27). Consecutive rounds of unconventional monetary policy increased total assets by purchase of mortgage-backed securities, agency securities and Treasury securities. Bank reserves in cash and deposited at the central bank swelled as shown in Chart I-8. The central bank created assets in the form of securities financed with creation of liabilities in the form of reserves of depository institutions.

Chart I-9, US, Total Assets of Federal Reserve Banks, Wednesday Level, Millions of Dollars, Dec 18, 2002 to Mar 22, 2017

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1

Chart I-10 of the Board of Governors of the Federal Reserve System provides deposits in US commercial banks not seasonally adjusted in billions of dollars from 1973 to 2017. Deposit growth clearly accelerated after 2001 and continued during the current cyclical expansion after bumps during the global recession.

Chart I-10, US, Deposits in Commercial Banks, Not Seasonally Adjusted, Monthly, 1973-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-11 of the Board of Governors of the Federal Reserve System provides Treasury and agency securities in US commercial banks, not seasonally adjusted, in billions of dollars from 1947 to 2017. Holdings stabilized between the recessions of 2001 and after IVQ2007. There was rapid growth during the global contraction especially after unconventional monetary policy in 2008 and nearly vertical increase without prior similar historical experience during the various bouts of unconventional monetary policy. Banks hoard cash and less risky Treasury and agency securities instead of risky lending because of the weakness of the economy and the lack of demand for financing sound business projects. Banks and investors in general are avoiding exposures to high-duration fixed-income securities because of possible price losses during increases in yields. There is decline of bank holdings of Treasury and agency securities in the final segment with subsequent sharp recovery.

Chart I-11, US, Treasury and Agency Securities in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, Monthly, 1947-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-12 of the Board of Governors of the Federal Reserve System provides total loans and leases in US commercial banks not seasonally adjusted in billions of dollars from 1947 to 2017. Total loans and leases of US commercial banks contracted sharply, stalled during the cyclical expansion and resumed growth.

Chart I-12, US, Loans and Leases in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, Monthly, 1947-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-13 of the Board of Governors of the Federal Reserve System provides real estate loans in US commercial banks not seasonally adjusted in billions of dollars from 1947 to 2017. Housing subsidies and low interest rates caused a point of inflexion to higher, nearly vertical growth until 2007. Real estate loans have contracted in downward trend partly because of adverse effects of uncertainty on the impact on balance sheets of the various mechanisms of resolution imposed by policy. Nick Timiraos, writing on “Push for cheaper credit hits wall,” on Dec 24, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324660404578197782701079650.html), provides important information and analysis on housing finance. Quantitative easing consists of withdrawing supply of mortgage-backed securities by acquiring them as assets in the Fed balance sheet. Lending banks obtain funds for mortgages by bundling them according to risk and other characteristics and selling them to investors, using the proceeds from the sale to provide the loans to homebuyers or refinancing homeowners. Banks earn net revenue to remunerate capital required for operations from the spread between the rate received from mortgage debtors and the rate implicit in the yield of the mortgage-backed securities. Nick Timiraos (Ibid) finds that the spread was around 0.5 percentage points before the financial crisis of 2007, widening to 1 percentage point after the crisis but jumping to 1.6 percentage points after the Fed engaged in another program of buying mortgage-backed securities, oscillating currently around 1.3 percentage points. The spread has widened because banks have higher costs originating in regulation, litigation on repurchasing defaulted mortgages, loss in case of default and more prudent but more costly scrutiny of property appraisals and income verification. As a result, even if quantitative easing had lowered yields of mortgage-backed securities there would not be proportionate reduction in mortgage rates and even less likely construction and sales of houses. There is sharp recovery in the final segment.

Chart I-13, US, Real Estate Loans in Bank Credit, Not Seasonally Adjusted, Monthly, 1947-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-14 of the Board of Governors of the Federal Reserve System provides consumer loans in US commercial banks not seasonally adjusted in billions of dollars from 1947 to 2017. Consumer loans even increased during the contraction then declined and increased vertically to decline again. There is renewed growth. There was high demand for reposition of durable goods that exhausted and limited consumption again with increase in savings rates in recent periods. 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, 2014, 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 I-14, US, Consumer Loans in Bank Credit, Not Seasonally Adjusted, US Commercial Banks, Monthly, 1947-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-15 of the Board of Governors of the Federal Reserve System provides commercial and industrial loans not seasonally adjusted in billions of dollars from 1947 to 2017. Commercial and industrial loans fell sharply during both contractions in 2001 and after IVQ2007 and then rebounded with accelerated growth. Commercial and industrial loans have not reached again the trend extrapolated from the peak during the global recession.

Chart I-15, US, Commercial and Industrial Loans in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, Monthly, 1947-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-16 and Chart I-16A are quite revealing in analyzing the state of bank credit in the US economy. The upper curves are (1) deposits and (2) loans and leases in bank credit. Historically since 1973, the level and rate of change of deposits and loans and leases in bank credit were almost identical. The lower two curves are Treasury and agency securities in bank credit and cash assets with treasury and agency securities moving closely with cash assets until the 1990s when Treasury and agency securities exceeded cash assets. There is convergence in the final segment after cash assets exceeded treasury and agency securities. The shaded area of the recession from IV2007 to IIQ2009 shows a break in the level and rate of movement of the series. Deposits continued to expand rapidly through the recession and the following expansion period. Loans and leases fell and barely recovered the level of trend before the recession while deposits moved nearly vertically well above the level before the recession. While Treasury and agency securities in bank credit continued to expand at a higher rate, reaching a level well above that before the recession, cash assets jumped as the counterpart of excess reserves in banks that financed quantitative easing or massive outright purchases of securities for the balance sheet of the Fed. Unconventional monetary policy of zero interest rates and outright purchases of securities caused sharp increases of deposits, cash assets and Treasury and agency securities in bank credit but not in loans and leases. There is much discussion about the almost impossible task of evaluating monetary policy in terms of costs and benefits. Before the financial crisis, Chairman Greenspan (2004) analyzes monetary policy and its limitations (see Pelaez and Pelaez, The Global Recession Risk (2007), 13-4, 212-13) that do not differ from those of private financial institutions:

“The Federal Reserve’s experiences over the past two decades make it clear that uncertainty is not just a pervasive feature of the monetary policy landscape; it is the defining characteristic of that landscape. The term “uncertainty” is meant here to encompass both “Knightian uncertainty,” in which the probability distribution of outcomes is unknown, and “risk,” in which uncertainty of outcomes is delimited by a known probability distribution. In practice, one is never quite sure what type of uncertainty one is dealing with in real time, and it may be best to think of a continuum ranging from well-defined risks to the truly unknown.

As a consequence, the conduct of monetary policy in the United States has come to involve, at its core, crucial elements of risk management. This conceptual framework emphasizes understanding as much as possible the many sources of risk and uncertainty that policymakers face, quantifying those risks when possible, and assessing the costs associated with each of the risks. In essence, the risk management approach to monetary policymaking is an application of Bayesian decision making.

This framework also entails devising, in light of those risks, a strategy for policy directed at maximizing the probabilities of achieving over time our goals of price stability and the maximum sustainable economic growth that we associate with it. In designing strategies to meet our policy objectives, we have drawn on the work of analysts, both inside and outside the Fed, who over the past half century have devoted much effort to improving our understanding of the economy and its monetary transmission mechanism. A critical result has been the identification of a relatively small set of key relationships that, taken together, provide a useful approximation of our economy’s dynamics. Such an approximation underlies the statistical models that we at the Federal Reserve employ to assess the likely influence of our policy decisions.

However, despite extensive efforts to capture and quantify what we perceive as the key macroeconomic relationships, our knowledge about many of the important linkages is far from complete and, in all likelihood, will always remain so. Every model, no matter how detailed or how well designed, conceptually and empirically, is a vastly simplified representation of the world that we experience with all its intricacies on a day-to-day basis.

Given our inevitably incomplete knowledge about key structural aspects of an ever-changing economy and the sometimes asymmetric costs or benefits of particular outcomes, a central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path. The decision makers then need to reach a judgment about the probabilities, costs, and benefits of the various possible outcomes under alternative choices for policy.”

Risk management tools are as likely to fail in private financial institutions as in central banks because of the difficulty of modeling risk during uncertainty. There is no such thing as riskless financial management. “Whale” trades at official institutions causing wide swings of financial and economic variables do not receive the same attention as those in large private banking institutions such as the teapot storm over JP Morgan Chase.

The post of this blog on Nov 8, 2009 is currently relevant (https://cmpassocregulationblog.blogspot.com/2009/11/how-big-bank-carlos-manuel-pelaezs.html):

Sunday, November 8, 2009

How Big a Bank
Carlos Manuel Peláez's Latest Blog Posts
How Big a Bank
5:56 PM PST, November 8, 2009
Agendas of financial regulation in parliaments, international official institutions and monetary authorities include limits on the size of banks or how big a bank should be. These proposals imply that regulators would decide the total value of assets held by banks. Assets would have to be weighted by risk, which is the best practice applied in the Basel capital accords. Regulators would decide not only the total value of assets but also the structure or percentage share of assets by risk class and credit rating such as how much in consumer credit, real estate lending, securities holding, corporate lending and so on. If the regulators decide on the total value of assets and their risk, they effectively micro manage bank decisions on risk and return. Managers would only implement regulatory criteria with little decision power on how best to reward shareholder capital. Regulators would mandate maximum assets and their risk distribution by leverage, credit and liquidity regulation. There are two concerns on the regulation of how big a bank should be. First, there is the issue of best practice in bank management and its consequences for financing prosperity. Banking is characterized by declining costs because of bulky fixed investments required for initiation of lines of business (Pelaez and Pelaez, Regulation of Banks and Finance, 82-9, Financial Regulation after the Global Recession, 63-9). There has been a new industrial/technological revolution in the past three decades centered on information technology (IT). Banking is highly intensive in the creation, processing, transmission and decision use of information. The first transaction of a $100 million IT facility costs $100 million but the hundred millionth costs only one dollar. Competitive banking requires a large volume of transactions to reach the minimum cost of operations. At the time of the call report for the implementation of Basel II in 2006, 11 banking organizations had total assets of $4.6 trillion, equivalent to 44 percent of total US banking assets of $10.5 trillion, and about $978 billion in foreign assets, equivalent to 96 percent of US foreign banking assets of $1 trillion (Pelaez and Pelaez, Globalization and the State: Vol. II, 147). Concentration likely increased during the credit/dollar crisis and its reversal by regulation could cause another confidence shock. The regulation of how big a bank should be would disrupt investment in the best practice of using technology and delivery of products at lowest cost by US banking organizations. It would also undermine the competitiveness of US banks in international business, violating the essential principle of the Basel capital accords of maintaining fair competitive international banking. Second, the regulation of how big a bank should be is based on an inadequate interpretation of the credit crisis/global recession. The panic of confidence in financial markets is commonly attributed to the failure of Lehman Bros. in September 2008. Cochrane and Zingales have shown that the crisis of confidence originated in the proposal of the Troubled Asset Relief Program (TARP) of $700 billion two weeks after the failure of Lehman Bros. TARP was proposed in negative terms of: withdraw "toxic" assets from bank balance sheets of banks or there would be an economic catastrophe similar to the Great Depression. Counterparty risk perception rose sharply because of fear of banking panics, paralyzing sale and repurchase transactions and causing illiquidity of multiple market segments. The "toxin" was introduced by zero interest rates in 2003-4 that induced high leverage and risk, low liquidity and imprudent credit together with the purchase or guarantee of $1.6 trillion of nonprime mortgages by Fannie and Freddie on the good faith and credit of the US. Regulatory micro management of the volume and structure of risk of banks and financial markets will weaken banks, reducing the volume of credit required for steering the world economy from currently low levels of activity. It will also restructure markets with arbitrary concession of monopolistic power to less efficient banks, creating vulnerabilities to new crises. There is need for less intrusive regulation that induces a sustainable path of prosperity, using effectively the staff, expertise and resources of existing regulatory agencies.

Chart I-16, US, Deposits, Loans and Leases in Bank Credit, Cash Assets and Treasury and Agency Securities in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, Monthly, 1973-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h8/current/default.htm

Chart I-16A, Deposits, Loans and Leases in Bank Credit, Cash Assets and Treasury and Agency Securities in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, Monthly, 1995-2017, Billions of Dollars

Source: Board of Governors of the Federal Reserve System

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017.

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