CANNOT UPLOAD CHARTS AND IMAGES: ERROR 403
United States Inflation, United States Commercial Banks Assets and Liabilities, Theory and Reality of Economic History, Cyclical Slow Growth Not Secular Stagnation and Monetary Policy Based on Fear of Deflation, United States International Trade, Collapse of United States Dynamism of Income Growth and Employment Creation in the Lost Economic Cycle of the Global Recession with Economic Growth Underperforming Below Trend Worldwide, World Cyclical Slow Growth and Global Recession Risk
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018
I United States Inflation
IIB United States Commercial Banks Assets and Liabilities
IA Transmission of Monetary Policy
IB Functions of Banking
IC United States Commercial Banks Assets and Liabilities
IIB United States International Trade
II IB Collapse of United States Dynamism of Income Growth and Employment Creation in the Lost Economic Cycle of the Global Recession with Economic Growth Underperforming Below Trend Worldwide
III World Financial Turbulence
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
I United States Inflation. C Long-term US Inflation. Key percentage average yearly rates of the US economy on growth and inflation are provided in Table I-1 updated with release of new data. The choice of dates prevents the measurement of long-term potential economic growth because of two recessions from IQ2001 (Mar) to IVQ2001 (Nov) with decline of GDP of 0.3 percent and the drop in GDP of 4.2 percent in the recession from IVQ2007 (Dec) to IIQ2009 (June) (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.html). Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. Key percentage average yearly rates of the US economy on growth and inflation are provided in Table I-1 updated with release of new data. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 34 quarters from IIIQ2009 to IVQ2017. 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 IVQ2017 (https://www.bea.gov/newsreleases/national/gdp/2018/pdf/gdp4q17_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 (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.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, 4.3 percent from IQ1983 to IIIQ1990, 4.0 percent from IQ1983 to IVQ1990, 3.8 percent from IQ1983 to IQ1991, 3.8 percent from IQ1983 to IIQ1991 and at 7.8 percent from IQ1983 to IVQ1983 (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.html). The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). 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 IVQ2017 would have accumulated to 34.4 percent. GDP in IVQ2017 would be $20,149.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2862.5 billion than actual $17,286.5 billion. There are about two trillion dollars of GDP less than at trend, explaining the 21.9 million unemployed or underemployed equivalent to actual unemployment/underemployment of 12.8 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2018/04/twenty-two-million-unemployed-or.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/twenty-three-million-unemployed-or.html). US GDP in IVQ2017 is 14.2 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $17,286.5 billion in IVQ2017 or 15.3 percent at the average annual equivalent rate of 1.4 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 2018. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 149.0946 in Feb 2018. The actual index NSA in Feb 2018 is 104.4525, which is 29.9 percent below trend. Manufacturing output grew at average 2.0 percent between Dec 1986 and Feb 2018. Using trend growth of 2.0 percent per year, the index would increase to 132.3793 in Feb 2018. The output of manufacturing at 104.4525 in Feb 2018 is 21.1 percent below trend under this alternative calculation. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. In the period from 1929 to 2017 the average growth rate of real GDP was 3.2 percent and 3.2 percent between 1947 to 2017, which is almost the same as 3.0 percent from 1870 to 2010 measured by Lucas (2011May), as shown in Table I-1. From 1929 to 2017, nominal GDP grew at the average rate of 6.1 percent and at 6.4 percent from 1947 to 2017. The implicit deflator increased at the average rate of 2.8 percent from 1929 to 2017 and at 3.2 percent from 1947 to 2017. Between 2000 and 2017, real GDP grew at the average rate of 1.8 percent per year, nominal GDP at 3.8 percent and the implicit deflator at 1.9 percent. The annual average rate of CPI increase was 3.1 percent from 1913 to 2017, 3.5 percent from 1947 to 2017 and 2.1 percent from 2000 to 2017. Between 2000 and 2017, the average rate of CPI inflation was 2.1 percent per year and 2.0 percent excluding food and energy. From 2000 to 2018, the average rate of CPI inflation was 2.1 percent and 2.0 percent excluding food and energy. The average annual rate of PPI inflation was 2.9 percent from 1947 to 2017 and 2.1 percent from 2000 to 2017. PPI inflation increased at 2.1 percent per year on average from 2000 to 2017, 2.2 percent on average from 2000 to 2018 and at 1.8 percent excluding food and energy from 2000 to 2017 and 1.8 percent from 2000 to 2018. Producer price inflation of finished energy goods increased at average 3.2 percent between 2000 and 2017 and at 3.4 percent between 2000 and 2018. There is also inflation in international trade. Import prices increased at 1.2 percent per year between 2000 and 2017 and 1.3 percent between 2000 and 2018. The commodity price shock is revealed by inflation of import prices of petroleum increasing at 3.8 percent per year between 2000 and 2017 and at 4.6 percent between 2000 and 2018. Import prices excluding petroleum increased at the average rate of 0.6 percent from 2000 to 2017 and at 0.7 percent from 2000 to 2018. The average percentage rates of increase of import prices excluding fuels are at 1.0 percent for 2002 to 2017 and 1.1 percent for 2002 to 2018. Export prices rose at the average rate of 1.2 percent between 2000 and 2017 and at 1.3 percent from 2000 to 2018. What spared the US of sharper decade-long deterioration of the terms of trade, (export prices)/(import prices), was its diversification and competitiveness in agriculture. Agricultural export prices grew at the average yearly rate of 3.5 percent from 2000 to 2017 and at 3.5 percent from 2000 to 2018. US nonagricultural export prices rose at 1.0 percent per year from 2000 to 2017 and at 1.1 percent from 2000 to 2018. The share of petroleum imports in US trade far exceeds that of agricultural exports. Unconventional monetary policy inducing carry trades in commodities has deteriorated US terms of trade, prices of exports relative to prices of imports, tending to restrict growth of US aggregate real income. These dynamic inflation rates are not similar to those for the economy of Japan where inflation was negative in seven of the 10 years in the 2000s. There is no reality of the proposition of need of unconventional monetary policy in the US because of deflation panic. There is reality in cyclical slow economic growth currently but not in secular stagnation.
Table I-1, US, Average Growth Rates of Real and Nominal GDP, Consumer Price Index, Producer Price Index and Import and Export Prices, Percent per Year
| Real GDP | 2000-2017: 1.8% 1929-2017: 3.2% 1947-2017: 3.2% |
| Nominal GDP | 2000-2017: 3.8% 1929-2017: 6.1% 1947-2017: 6.4% |
| Implicit Price Deflator | 2000-2017: 1.9% 1929-2017: 2.8% 1947-2017: 3.2% |
| CPI | 2000-2017: 2.1% Annual 1913-2017: 3.1% 1947-2017: 3.5% 2000-2017: 2.1% |
| CPI ex Food and Energy | 2000-2017: 2.0% |
| PPI | 2000-2017: 2.1% Annual 1947-2017: 2.9% 2000-2017: 2.1% |
| PPI ex Food and Energy | 2000-2017: 1.8% |
| PPI Finished Energy Goods | 2000-2017: 3.2% 2000-2018: 3.4% |
| Import Prices | 2000-2017: 1.2% |
| Import Prices of Petroleum and Petroleum Products | 2000-2017: 3.8% |
| Import Prices Excluding Petroleum | 2000-2017: 0.6% |
| Import Prices Excluding Fuels | 2002-2017: 1.0% |
| Export Prices | 2000-2017: 1.2% |
| Agricultural Export Prices | 2000-2017: 3.5% |
| Nonagricultural Export Prices | 2000-2017: 1.0% |
Note: rates for price indexes in the row beginning with “CPI” and ending in the row “Nonagricultural Export Prices” are for Mar 2000 to Mar 2017 and for Mar 2000 to Mar 2018.
Sources:
Unconventional monetary policy of zero interest rates and large-scale purchases of long-term securities for the balance sheet of the central bank is proposed to prevent deflation. The data of CPI inflation of all goods and CPI inflation excluding food and energy for the past six decades does not show even one negative change, as shown in Table CPIEX.
Table CPIEX, Annual Percentage Changes of the CPI All Items Excluding Food and Energy
| Year | Annual ∆% |
| 1958 | 2.4 |
| 1959 | 2.0 |
| 1960 | 1.3 |
| 1961 | 1.3 |
| 1962 | 1.3 |
| 1963 | 1.3 |
| 1964 | 1.6 |
| 1965 | 1.2 |
| 1966 | 2.4 |
| 1967 | 3.6 |
| 1968 | 4.6 |
| 1969 | 5.8 |
| 1970 | 6.3 |
| 1971 | 4.7 |
| 1972 | 3.0 |
| 1973 | 3.6 |
| 1974 | 8.3 |
| 1975 | 9.1 |
| 1976 | 6.5 |
| 1977 | 6.3 |
| 1978 | 7.4 |
| 1979 | 9.8 |
| 1980 | 12.4 |
| 1981 | 10.4 |
| 1982 | 7.4 |
| 1983 | 4.0 |
| 1984 | 5.0 |
| 1985 | 4.3 |
| 1986 | 4.0 |
| 1987 | 4.1 |
| 1988 | 4.4 |
| 1989 | 4.5 |
| 1990 | 5.0 |
| 1991 | 4.9 |
| 1992 | 3.7 |
| 1993 | 3.3 |
| 1994 | 2.8 |
| 1995 | 3.0 |
| 1996 | 2.7 |
| 1997 | 2.4 |
| 1998 | 2.3 |
| 1999 | 2.1 |
| 2000 | 2.4 |
| 2001 | 2.6 |
| 2002 | 2.4 |
| 2003 | 1.4 |
| 2004 | 1.8 |
| 2005 | 2.2 |
| 2006 | 2.5 |
| 2007 | 2.3 |
| 2008 | 2.3 |
| 2009 | 1.7 |
| 2010 | 1.0 |
| 2011 | 1.7 |
| 2012 | 2.1 |
| 2013 | 1.8 |
| 2014 | 1.7 |
| 2015 | 1.8 |
| 2016 | 2.2 |
| 2017 | 1.8 |
Source: Bureau of Labor Statistics
The history of producer price inflation in the past five decades does not provide evidence of deflation. The finished core PPI does not register even one single year of decline, as shown in Table PPIEX.
Table PPIEX, Annual Percentage Changes of the PPI Finished Goods Excluding Food and Energy
| Year | Annual ∆% |
| 1974 | 11.4 |
| 1975 | 11.4 |
| 1976 | 5.7 |
| 1977 | 6.0 |
| 1978 | 7.5 |
| 1979 | 8.9 |
| 1980 | 11.2 |
| 1981 | 8.6 |
| 1982 | 5.7 |
| 1983 | 3.0 |
| 1984 | 2.4 |
| 1985 | 2.5 |
| 1986 | 2.3 |
| 1987 | 2.4 |
| 1988 | 3.3 |
| 1989 | 4.4 |
| 1990 | 3.7 |
| 1991 | 3.6 |
| 1992 | 2.4 |
| 1993 | 1.2 |
| 1994 | 1.0 |
| 1995 | 2.1 |
| 1996 | 1.4 |
| 1997 | 0.3 |
| 1998 | 0.9 |
| 1999 | 1.7 |
| 2000 | 1.3 |
| 2001 | 1.4 |
| 2002 | 0.1 |
| 2003 | 0.2 |
| 2004 | 1.5 |
| 2005 | 2.4 |
| 2006 | 1.5 |
| 2007 | 1.9 |
| 2008 | 3.4 |
| 2009 | 2.6 |
| 2010 | 1.2 |
| 2011 | 2.4 |
| 2012 | 2.6 |
| 2013 | 1.5 |
| 2014 | 1.9 |
| 2015 | 2.0 |
| 2016 | 1.6 |
| 2017 | 1.8 |
Source: Bureau of Labor Statistics
Chart I-1 provides US nominal GDP from 1929 to 2017. The chart disguises the decline of nominal GDP during the 1930s from $104.6 billion in 1929 to $57.2 billion in 1933 or by 45.3 percent (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). The level of nominal GDP reached $102.9 billion in 1940 and exceeded the $104.6 billion of 1929 only with $129.4 billion in 1941. The only major visible bump in the chart occurred in the recession of IVQ2007 to IIQ2009 with revised cumulative decline of real GDP of 4.2 percent. US nominal GDP fell from $14,718.6 billion in 2008 to $14,418.7 billion in 2009 or by 2.0 percent. US nominal GDP rose to $14,964.4 billion in 2010 or by 3.8 percent and to $15,517.9 billion in 2011 for an additional 3.7 percent for cumulative increase of 7.6 percent relative to 2009 and to $16,155.3 billion in 2012 for an additional 4.1 percent and cumulative increase of 12.0 percent relative to 2009. US nominal GDP increased from $14,477.6 in 2007 to $19,390.6 billion in 2017 or by 33.9 percent at the average annual rate of 3.0 percent per year (http://www.bea.gov/iTable/index_nipa.cfm). Tendency for deflation would be reflected in persistent bumps. In contrast, during the Great Depression in the four years of 1929 to 1933, GDP in constant dollars fell 26.3 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7). The comparison of the global recession after 2007 with the Great Depression is entirely misleading (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.html).
Chart I-1, US, Nominal GDP 1929-2017
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-2 provides US real GDP from 1929 to 2017. The chart also disguises the Depression of the 1930s. In the four years of 1929 to 1933, GDP in constant dollars fell 26.3 percent cumulatively and fell 45.3 percent in current dollars (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 150-2, Pelaez and Pelaez, Globalization and the State, Vol. II (2009b), 205-7; data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). Persistent deflation threatening real economic activity would also be reflected in the series of long-term growth of real GDP. There is no such behavior in Chart I-2 except for periodic recessions in the US economy that have occurred throughout history.
Chart I-2, US, Real GDP 1929-2017
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Deflation would also be in evidence in long-term series of prices in the form of bumps. The GDP implicit deflator series in Chart I-3 from 1929 to 2017 shows sharp dynamic behavior over time. There is decline of the implicit price deflator of GDP by 25.8 percent from 1929 to 1933 (data from the US Bureau of Economic Analysis at http://www.bea.gov/iTable/index_nipa.cfm). In contrast, the implicit price deflator of GDP of the US increased from 97.337 (2009 =100) in 2007 to 100.00 in 2009 or by 2.7 percent and increased to 113.421 in 2017 or by 13.4 percent relative to 2009 and 16.5 percent relative to 2007. The implicit price deflator of US GDP increased in every quarter from IVQ2007 to IVQ2012 with only two declines from 100.062 in IQ2009 to 99.895 in IIQ2009 or by 0.2 percent and to 99.873 in IIIQ2009 for cumulative 0.2 percent relative to IQ2009 and -0.02 percent relative to IIQ2009 (http://www.bea.gov/iTable/index_nipa.cfm). Wars are characterized by rapidly rising prices followed by declines when peace is restored. The US economy is not plagued by deflation but by long-run inflation.
Chart I-3, US, GDP Implicit Price Deflator 1929-2017
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-4 provides percent change from preceding quarter in prices of GDP at seasonally adjusted annual rates (SAAR) from 1980 to 2017. There is one case of negative change by 0.6 percent in IIQ2009 that was adjustment from 2.8 percent in IIIQ2008 following 2.3 percent in IQ2008 and 1.8 percent IIQ2008 caused by carry trades from policy interest rates being moved to zero into commodity futures. These positions were reversed because of the fear of toxic assets in banks in the proposal of TARP in late 2008 (Cochrane and Zingales 2009). Prices of GDP increased at 0.6 percent in IVQ2014. GDP prices decreased at 0.1 percent in IQ2015, increasing at 2.2 percent in IIQ015 and at 1.4 percent in IIIQ2015. Prices of GDP increased at 0.8 percent in IVQ2015 and at 0.3 percent in IQ2016. Prices of GDP increased at 2.4 percent in IIQ2016 and increased at 1.4 percent in IIIQ2016. Prices of GDP increased at 2.0 percent in IVQ2016 and increased at 2.0 percent in IQ2017. Prices of GDP increased at 1.0 percent in IIQ2017 and increased at 2.1 percent in IIIQ2017. Prices of GDP increased at 2.3 percent in IVQ2017. There has not been actual deflation or risk of deflation threatening depression in the US that would justify unconventional monetary policy.
Chart I-4, Percent Change from Preceding Period in Prices for GDP Seasonally Adjusted at Annual Rates 1980-2017
Source: US Bureau of Economic Analysis
http://www.bea.gov/iTable/index_nipa.cfm
Chart I-5 provides percent change from preceding year in prices of GDP from 1929 to 2017. There are four consecutive years of declines of prices of GDP during the Great Depression: 3.8 percent in 1930, 9.9 percent in 1931, 11.4 percent in 1932 and 2.7 percent in 1933. There were two consecutive declines of 1.8 percent in 1938 and 1.3 percent in 1939. Prices of GDP fell 0.1 percent in 1949 after increasing 12.6 percent in 1946, 11.2 percent in 1947 and 5.6 percent in 1948, which is similar to experience with wars in other countries. There are no other negative changes of annual prices of GDP in 74 years from 1939 to 2017.
Chart I-5, Percent Change from Preceding Year in Prices for Gross Domestic Product 1930-2017
http://www.bea.gov/iTable/index_nipa.cfm
The producer price index of the US from 1947 to 2018 in Chart I-6 shows various periods of more rapid or less rapid inflation but no bumps. The major event is the decline in 2008 when risk aversion because of the global recession caused the collapse of oil prices from $148/barrel to less than $80/barrel with most other commodity prices also collapsing. The event had nothing in common with explanations of deflation but rather with the concentration of risk exposures in commodities after the decline of stock market indexes. Eventually, there was a flight to government securities because of the fears of insolvency of banks caused by statements supporting proposals for withdrawal of toxic assets from bank balance sheets in the Troubled Asset Relief Program (TARP), as explained by Cochrane and Zingales (2009). The bump in 2008 with decline in 2009 is consistent with the view that zero interest rates with subdued risk aversion induce carry trades into commodity futures.
Chart I-6, US, Producer Price Index, Finished Goods, NSA, 1947-2018
Source: US Bureau of Labor Statistics
Chart I-17 provides 12-month percentage changes of the producer price index from 1948 to 2018. The distinguishing even in Chart I-7 is the Great Inflation of the 1970s. The shape of the two-hump Bactrian camel of the 1970’s resembles the double hump from 2007 to 2018.
Chart I-7, US, Producer Price Index, Finished Goods, 12-Month Percentage Change, NSA, 1948-2018
Source: US Bureau of Labor Statistics
Annual percentage changes of the producer price index from 1948 to 2017 are shown in Table I-1A. The producer price index fell 2.8 percent in 1949 following the adjustment to World War II and fell 0.6 percent in 1952 and 1.0 percent in 1953 around the Korean War. There are two other mild declines of 0.3 percent in 1959 and 0.3 percent in 1963. There are only few subsequent and isolated declines of the producer price index of 1.4 percent in 1986, 0.8 percent in 1998, 1.3 percent in 2002 and 2.6 percent in 2009. The decline of 2009 was caused by unwinding of carry trades in 2008 that had lifted oil prices to $140/barrel during deep global recession because of the panic of probable toxic assets in banks that would be removed with the Troubled Asset Relief Program (TARP) (Cochrane and Zingales 2009). Producer prices fell 3.2 percent in 2015 and declined 1.0 percent in 2016 during collapse of commodity prices form high prices induced by zero interest rates. Producer prices increased 3.2 percent in 2017. There is no evidence in this history of 66 years of the US producer price index suggesting that there is frequent and persistent deflation shock requiring aggressive unconventional monetary policy. The design of such anti-deflation policy could provoke price and financial instability because of lags in effect of monetary policy, model errors, inaccurate forecasts and misleading analysis of current economic conditions.
Table I-1A, US, Annual PPI Inflation ∆% 1948-2017
| Year | Annual ∆% |
| 1948 | 8.0 |
| 1949 | -2.8 |
| 1950 | 1.8 |
| 1951 | 9.2 |
| 1952 | -0.6 |
| 1953 | -1.0 |
| 1954 | 0.3 |
| 1955 | 0.3 |
| 1956 | 2.6 |
| 1957 | 3.8 |
| 1958 | 2.2 |
| 1959 | -0.3 |
| 1960 | 0.9 |
| 1961 | 0.0 |
| 1962 | 0.3 |
| 1963 | -0.3 |
| 1964 | 0.3 |
| 1965 | 1.8 |
| 1966 | 3.2 |
| 1967 | 1.1 |
| 1968 | 2.8 |
| 1969 | 3.8 |
| 1970 | 3.4 |
| 1971 | 3.1 |
| 1972 | 3.2 |
| 1973 | 9.1 |
| 1974 | 15.4 |
| 1975 | 10.6 |
| 1976 | 4.5 |
| 1977 | 6.4 |
| 1978 | 7.9 |
| 1979 | 11.2 |
| 1980 | 13.4 |
| 1981 | 9.2 |
| 1982 | 4.1 |
| 1983 | 1.6 |
| 1984 | 2.1 |
| 1985 | 1.0 |
| 1986 | -1.4 |
| 1987 | 2.1 |
| 1988 | 2.5 |
| 1989 | 5.2 |
| 1990 | 4.9 |
| 1991 | 2.1 |
| 1992 | 1.2 |
| 1993 | 1.2 |
| 1994 | 0.6 |
| 1995 | 1.9 |
| 1996 | 2.7 |
| 1997 | 0.4 |
| 1998 | -0.8 |
| 1999 | 1.8 |
| 2000 | 3.8 |
| 2001 | 2.0 |
| 2002 | -1.3 |
| 2003 | 3.2 |
| 2004 | 3.6 |
| 2005 | 4.8 |
| 2006 | 3.0 |
| 2007 | 3.9 |
| 2008 | 6.3 |
| 2009 | -2.6 |
| 2010 | 4.2 |
| 2011 | 6.1 |
| 2012 | 1.9 |
| 2013 | 1.2 |
| 2014 | 1.9 |
| 2015 | -3.2 |
| 2016 | -1.0 |
| 2017 | 3.2 |
Source: US Bureau of Labor Statistics
The producer price index excluding food and energy from 1973 to 2018, the first historical date of availability in the dataset of the Bureau of Labor Statistics (BLS), shows similarly dynamic behavior as the overall index, as shown in Chart I-8. There is no evidence of persistent deflation in the US PPI.
Chart I-8, US Producer Price Index, Finished Goods Excluding Food and Energy, NSA, 1973-2018
Source: US Bureau of Labor Statistics
Chart I-9 provides 12-month percentage rates of change of the finished goods index excluding food and energy. The dominating characteristic is the Great Inflation of the 1970s. The double hump illustrates how inflation may appear to be subdued and then returns with strength.
Chart I-9, US Producer Price Index, Finished Goods Excluding Food and Energy, 12-Month Percentage Change, NSA, 1974-2018
Source: US Bureau of Labor Statistics
The producer price index of energy goods from 1974 to 2018 is in Chart I-10. The first jump occurred during the Great Inflation of the 1970s analyzed in various comments of this blog (http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html) and in Appendix I. There is relative stability of producer prices after 1986 with another jump and decline in the late 1990s into the early 2000s. The episode of commodity price increases during a global recession in 2008 could only have occurred with interest rates dropping toward zero, which stimulated the carry trade from zero interest rates to leveraged positions in commodity futures. Commodity futures exposures were dropped in the flight to government securities after Sep 2008. Commodity future exposures were created again when risk aversion diminished around Mar 2010 after the finding that US bank balance sheets did not have the toxic assets that were mentioned in proposing TARP in Congress (see Cochrane and Zingales 2009). Fluctuations in commodity prices and other risk financial assets originate in carry trade when risk aversion ameliorates. There are also fluctuations originating in shifts in preference for asset classes such as between commodities and equities.
Chart I-10, US, Producer Price Index, Finished Energy Goods, NSA, 1974-2018
Source: US Bureau of Labor Statistics
Chart I-11 shows 12-month percentage changes of the producer price index of finished energy goods from 1975 to 2018. This index is only available after 1974 and captures only one of the humps of energy prices during the Great Inflation. Fluctuations in energy prices have occurred throughout history in the US but without provoking deflation. Two cases are the decline of oil prices in 2001 to 2002 that has been analyzed by Barsky and Kilian (2004) and the collapse of oil prices from over $140/barrel with shock of risk aversion to the carry trade in Sep 2008.
Chart I-11, US, Producer Price Index, Finished Energy Goods, 12-Month Percentage Change, NSA, 1974-2018
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
Chart I-12 provides the consumer price index NSA from 1918 to 2018. The dominating characteristic is the increase in slope during the Great Inflation from the middle of the 1960s through the 1970s. There is long-term inflation in the US and no evidence of deflation risks.
Chart I-12, US, Consumer Price Index, NSA, 1918-2018
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-13 provides 12-month percentage changes of the consumer price index from 1918 to 2018. The only episode of deflation after 1950 is in 2009, which is explained by the reversal of speculative commodity futures carry trades that were induced by interest rates driven to zero in a shock of monetary policy in 2008. The only persistent case of deflation is from 1930 to 1933, which has little if any relevance to the contemporary United States economy. There are actually three waves of inflation in the second half of the 1960s, in the mid-1970s and again in the late 1970s. Inflation rates then stabilized in a range with only two episodes above 5 percent.
Chart I-13, US, Consumer Price Index, All Items, 12- Month Percentage Change 1918-2018
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Table I-2 provides annual percentage changes of United States consumer price inflation from 1914 to 2017. There have been only cases of annual declines of the CPI after wars:
- World War I minus 10.5 percent in 1921 and minus 6.1 percent in 1922 following cumulative increases of 83.5 percent in four years from 1917 to 1920 at the average of 16.4 percent per year
- World War II: minus 1.2 percent in 1949 following cumulative 33.9 percent in three years from 1946 to 1948 at average 10.2 percent per year
- Minus 0.4 percent in 1955 two years after the end of the Korean War
- Minus 0.4 percent in 2009.
- The decline of 0.4 percent in 2009 followed increase of 3.8 percent in 2008 and is explained by the reversal of speculative carry trades into commodity futures that were created in 2008 as monetary policy rates were driven to zero. The reversal occurred after misleading statement on toxic assets in banks in the proposal for TARP (Cochrane and Zingales 2009).
There were declines of 1.7 percent in both 1927 and 1928 during the episode of revival of rules of the gold standard. The only persistent deflationary period since 1914 was during the Great Depression in the years from 1930 to 1933 and again in 1938-1939. Consumer prices increased only 0.1 percent in 2015 because of the collapse of commodity prices from artificially high levels induced by zero interest rates. Consumer prices increased 1.3 percent in 2016, increasing at 2.1 percent in 2017. Fear of deflation based on that experience does not justify unconventional monetary policy of zero interest rates that has failed to stop deflation in Japan. Financial repression causes far more adverse effects on allocation of resources by distorting the calculus of risk/returns than alleged employment-creating effects or there would not be current recovery without jobs and hiring after zero interest rates since Dec 2008 and intended now forever in a self-imposed forecast growth and employment mandate of monetary policy. Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval of (1.99, 2.0). Symmetric targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even with the economy growing at or close to potential output that is actually a target of growth forecast. The impact on the overall economy and the financial system of errors of policy are magnified by large-scale policy doses of trillions of dollars of quantitative easing and zero interest rates. The US economy has been experiencing financial repression as a result of negative real rates of interest during nearly a decade and programmed in monetary policy statements until 2015 or, for practical purposes, forever. The essential calculus of risk/return in capital budgeting and financial allocations has been distorted. If economic perspectives are doomed until 2015 such as to warrant zero interest rates and open-ended bond-buying by “printing” digital bank reserves (http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html; see Shultz et al 2012), rational investors and consumers will not invest and consume until just before interest rates are likely to increase. Monetary policy statements on intentions of zero interest rates for another three years or now virtually forever discourage investment and consumption or aggregate demand that can increase economic growth and generate more hiring and opportunities to increase wages and salaries. The doom scenario used to justify monetary policy accentuates adverse expectations on discounted future cash flows of potential economic projects that can revive the economy and create jobs. If it were possible to project the future with the central tendency of the monetary policy scenario and monetary policy tools do exist to reverse this adversity, why the tools have not worked before and even prevented the financial crisis? If there is such thing as “monetary policy science”, why it has such poor record and current inability to reverse production and employment adversity? There is no excuse of arguing that additional fiscal measures are needed because they were deployed simultaneously with similar ineffectiveness. Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). If there were an infallible science of central banking, models and forecasts would provide accurate information to policymakers on the future course of the economy in advance. Such forewarning is essential to central bank science because of the long lag between the actual impulse of monetary policy and the actual full effects on income and prices many months and even years ahead (Romer and Romer 2004, Friedman 1961, 1953, Culbertson 1960, 1961, Batini and Nelson 2002). Jon Hilsenrath, writing on “New view into Fed’s response to crisis,” on Feb 21, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303775504579396803024281322?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzed 1865 pages of transcripts of eight formal and six emergency policy meetings at the Fed in 2008 (http://www.federalreserve.gov/monetarypolicy/fomchistorical2008.htm). Jon Hilsenrath demonstrates that Fed policymakers frequently did not understand the current state of the US economy in 2008 and much less the direction of income and prices. The conclusion of Friedman (1953) that monetary impulses increase financial and economic instability because of lags in anticipating needs of policy, taking policy decisions and effects of decisions. This a fortiori true when untested unconventional monetary policy in gargantuan doses shocks the economy and financial markets.
Table I-2, US, Annual CPI Inflation ∆% 1914-2017
| Year | Annual ∆% |
| 1914 | 1.0 |
| 1915 | 1.0 |
| 1916 | 7.9 |
| 1917 | 17.4 |
| 1918 | 18.0 |
| 1919 | 14.6 |
| 1920 | 15.6 |
| 1921 | -10.5 |
| 1922 | -6.1 |
| 1923 | 1.8 |
| 1924 | 0.0 |
| 1925 | 2.3 |
| 1926 | 1.1 |
| 1927 | -1.7 |
| 1928 | -1.7 |
| 1929 | 0.0 |
| 1930 | -2.3 |
| 1931 | -9.0 |
| 1932 | -9.9 |
| 1933 | -5.1 |
| 1934 | 3.1 |
| 1935 | 2.2 |
| 1936 | 1.5 |
| 1937 | 3.6 |
| 1938 | -2.1 |
| 1939 | -1.4 |
| 1940 | 0.7 |
| 1941 | 5.0 |
| 1942 | 10.9 |
| 1943 | 6.1 |
| 1944 | 1.7 |
| 1945 | 2.3 |
| 1946 | 8.3 |
| 1947 | 14.4 |
| 1948 | 8.1 |
| 1949 | -1.2 |
| 1950 | 1.3 |
| 1951 | 7.9 |
| 1952 | 1.9 |
| 1953 | 0.8 |
| 1954 | 0.7 |
| 1955 | -0.4 |
| 1956 | 1.5 |
| 1957 | 3.3 |
| 1958 | 2.8 |
| 1959 | 0.7 |
| 1960 | 1.7 |
| 1961 | 1.0 |
| 1962 | 1.0 |
| 1963 | 1.3 |
| 1964 | 1.3 |
| 1965 | 1.6 |
| 1966 | 2.9 |
| 1967 | 3.1 |
| 1968 | 4.2 |
| 1969 | 5.5 |
| 1970 | 5.7 |
| 1971 | 4.4 |
| 1972 | 3.2 |
| 1973 | 6.2 |
| 1974 | 11.0 |
| 1975 | 9.1 |
| 1976 | 5.8 |
| 1977 | 6.5 |
| 1978 | 7.6 |
| 1979 | 11.3 |
| 1980 | 13.5 |
| 1981 | 10.3 |
| 1982 | 6.2 |
| 1983 | 3.2 |
| 1984 | 4.3 |
| 1985 | 3.6 |
| 1986 | 1.9 |
| 1987 | 3.6 |
| 1988 | 4.1 |
| 1989 | 4.8 |
| 1990 | 5.4 |
| 1991 | 4.2 |
| 1992 | 3.0 |
| 1993 | 3.0 |
| 1994 | 2.6 |
| 1995 | 2.8 |
| 1996 | 3.0 |
| 1997 | 2.3 |
| 1998 | 1.6 |
| 1999 | 2.2 |
| 2000 | 3.4 |
| 2001 | 2.8 |
| 2002 | 1.6 |
| 2003 | 2.3 |
| 2004 | 2.7 |
| 2005 | 3.4 |
| 2006 | 3.2 |
| 2007 | 2.8 |
| 2008 | 3.8 |
| 2009 | -0.4 |
| 2010 | 1.6 |
| 2011 | 3.2 |
| 2012 | 2.1 |
| 2013 | 1.5 |
| 2014 | 1.6 |
| 2015 | 0.1 |
| 2016 | 1.3 |
| 2017 | 2.1 |
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-14 provides the consumer price index excluding food and energy from 1957 to 2018. There is long-term inflation in the US without episodes of persistent deflation.
Chart I-14, US, Consumer Price Index Excluding Food and Energy, NSA, 1957-2018
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-15 provides 12-month percentage changes of the consumer price index excluding food and energy from 1958 to 2018. There are three waves of inflation in the 1970s during the Great Inflation. There is no episode of deflation.
Chart I-15, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 1958-2018
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
The consumer price index of housing is in Chart I-16. There was also acceleration during the Great Inflation of the 1970s. The index flattens after the global recession in IVQ2007 to IIQ2009. Housing prices collapsed under the weight of construction of several times more housing than needed. Surplus housing originated in subsidies and artificially low interest rates in the shock of unconventional monetary policy in 2003 to 2004 in fear of deflation.
Chart I-16, US, Consumer Price Index Housing, NSA, 1967-2017
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-17 provides 12-month percentage changes of the housing CPI. The Great Inflation also had extremely high rates of housing inflation. Housing is considered as potential hedge of inflation.
Chart I-17, US, Consumer Price Index, Housing, 12- Month Percentage Change, NSA, 1968-2017
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
ID Current US Inflation. Consumer price inflation has fluctuated in recent months. Table I-3 provides 12-month consumer price inflation in Mar 2018 and annual equivalent percentage changes for the months from Jan 2018 to Mar 2018 of the CPI and major segments. The final column provides inflation from Feb 2018 to Mar 2018. CPI inflation increased 2.4 percent in the 12 months ending in Mar 2018. The annual equivalent rate from Jan 2018 to Mar 2018 was 2.4 percent in the new episode of reversal and renewed positions of carry trades from zero interest rates to commodities exposures; and the monthly inflation rate of minus 0.1 percent annualizes at minus 1.2 percent with oscillating carry trades at the margin. These inflation rates fluctuate in accordance with inducement of risk appetite or frustration by risk aversion of carry trades from zero interest rates to commodity futures. At the margin, the decline in commodity prices in sharp recent risk aversion in commodities markets caused lower inflation worldwide (with return in some countries in Dec 2012 and Jan-Feb 2013) that followed a jump in Aug-Sep 2012 because of the relaxed risk aversion resulting from the bond-buying program of the European Central Bank or Outright Monetary Transactions (OMT) (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html). Carry trades moved away from commodities into stocks with resulting weaker commodity prices and stronger equity valuations. There is reversal of exposures in commodities but with preferences of equities by investors. Geopolitical events in Eastern Europe and the Middle East together with economic conditions worldwide are inducing risk concerns in commodities at the margin. With zero or very low interest rates, commodity prices would increase again in an environment of risk appetite, as shown in past oscillating inflation. Excluding food and energy, core CPI inflation was 2.1 percent in the 12 months ending in Mar 2018 and 2.8 percent in annual equivalent from Jan 2018 to Mar 2018. There is no deflation in the US economy that could justify further unconventional monetary policy, which is now open-ended or forever with very low interest rates and cessation of bond-buying by the central bank but with reinvestment of interest and principal, or QE→∞ even if the economy grows back to potential. The FOMC is engaging in gradual reduction of the Fed balance sheet. Financial repression of very low interest rates is now intended as a permanent distortion of resource allocation by clouding risk/return decisions, preventing the economy from expanding along its optimal growth path. The FOMC is initiating reduction of the positions in securities held outright in the Fed’s balance sheet. Consumer food prices in the US increased 1.3 percent in 12 months ending in Mar 2018 and increased at 1.2 percent in annual equivalent from Jan 2018 to Mar 2018. Monetary policies stimulating carry trades of commodities futures that increase prices of food constitute a highly regressive tax on lower income families for whom food is a major portion of the consumption basket especially with wage increases below inflation in a recovery without hiring (https://cmpassocregulationblog.blogspot.com/2018/03/decreasing-valuations-of-risk-financial.html and earlier https://cmpassocregulationblog.blogspot.com/2018/02/collateral-effects-of-unwinding.html). Energy consumer prices increased 7.0 percent in 12 months, increased at 0.9 percent in annual equivalent from Jan 2018 to Mar 2018 and decreased 2.8 percent in Mar 2018 or at 28.9 percent in annual equivalent. Waves of inflation are induced by carry trades from zero interest rates to commodity futures, which are unwound and repositioned during alternating risk aversion and risk appetite originating in the European debt crisis and increasingly in growth, soaring debt and politics in China. For lower income families, food and energy are a major part of the family budget. Inflation is not persistently low or threatening deflation in annual equivalent in any of the categories in Table I-2 but simply reflecting waves of inflation originating in carry trades. Zero interest rates induce carry trades into commodity futures positions with episodes of risk aversion and portfolio reallocations causing fluctuations that determine an upward trend of prices.
Table I-3, US, Consumer Price Index Percentage Changes 12 months NSA and Annual Equivalent ∆%
| % RI | ∆% 12 Months Mar 2018/ Mar | ∆% Annual Equivalent Jan 2017 to Mar 2018 SA | ∆% Mar 2018/Feb 2018 SA | |
| CPI All Items | 100.000 | 2.4 | 2.4 | -0.1 |
| CPI ex Food and Energy | 79.007 | 2.1 | 2.8 | 0.2 |
| Food | 13.306 | 1.3 | 1.2 | 0.1 |
| Food at Home | 7.327 | 0.4 | 0.0 | 0.1 |
| Food Away from Home | 5.978 | 2.5 | 2.8 | 0.1 |
| Energy | 7.687 | 7.0 | 0.9 | -2.8 |
| Gasoline | 3.971 | 11.1 | -1.5 | -4.9 |
| Electricity | 2.634 | 2.2 | 0.8 | 0.0 |
| Commodities less Food and Energy | 19.895 | -0.3 | 1.6 | -0.1 |
| New Vehicles | 3.775 | -1.2 | -2.4 | 0.0 |
| Used Cars and Trucks | 2.407 | 0.4 | -0.8 | -0.3 |
| Medical Care Commodities | 1.740 | 1.4 | -1.2 | 0.1 |
| Apparel | 3.136 | 0.3 | 10.8 | -0.6 |
| Services Less Energy Services | 59.112 | 2.9 | 3.2 | 0.3 |
| Shelter | 32.697 | 3.3 | 3.2 | 0.4 |
| Rent of Primary Residence | 7.779 | 3.6 | 3.2 | 0.3 |
| Owner’s Equivalent Rent of Residences | 23.606 | 3.3 | 3.2 | 0.3 |
| Transportation Services | 5.987 | 4.3 | 8.3 | 0.2 |
| Medical Care Services | 6.939 | 2.1 | 4.5 | 0.5 |
% RI: Percent Relative Importance
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
Table I-4 provides weights of components in the consumer price of the US in Dec 2012. Housing has a weight of 41.021 percent. The combined weight of housing and transportation is 57.867 percent or more than one-half of consumer expenditures of all urban consumers. The combined weight of housing, transportation and food and beverages is 73.128 percent of the US CPI. Table I-3 provides relative importance of key items in Mar 2018.
Table I-4, US, Relative Importance, 2009-2010 Weights, of Components in the Consumer Price Index, US City Average, Dec 2012
| All Items | 100.000 |
| Food and Beverages | 15.261 |
| Food | 14.312 |
| Food at home | 8.898 |
| Food away from home | 5.713 |
| Housing | 41.021 |
| Shelter | 31.681 |
| Rent of primary residence | 6.545 |
| Owners’ equivalent rent | 22.622 |
| Apparel | 3.564 |
| Transportation | 16.846 |
| Private Transportation | 15.657 |
| New vehicles | 3.189 |
| Used cars and trucks | 1.844 |
| Motor fuel | 5.462 |
| Gasoline | 5.274 |
| Medical Care | 7.163 |
| Medical care commodities | 1.714 |
| Medical care services | 5.448 |
| Recreation | 5.990 |
| Education and Communication | 6.779 |
| Other Goods and Services | 3.376 |
Refers to all urban consumers, covering approximately 87 percent of the US population (see http://www.bls.gov/cpi/cpiovrvw.htm#item1). Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/cpiri2011.pdf http://www.bls.gov/cpi/cpiriar.htm http://www.bls.gov/cpi/cpiri2012.pdf
Chart I-18 provides the US consumer price index for housing from 2001 to 2018. Housing prices rose sharply during the decade until the bump of the global recession and increased again in 2011-2012 with some stabilization in 2013. There is renewed increase in 2014 followed by stabilization and renewed increase in 2015-2018. The CPI excluding housing would likely show much higher inflation. The commodity carry trades resulting from unconventional monetary policy have compressed income remaining after paying for indispensable shelter.
Chart I-18, US, Consumer Price Index, Housing, NSA, 2001-2018
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/data.htm
Chart I-19 provides 12-month percentage changes of the housing CPI. Percentage changes collapsed during the global recession but have been rising into positive territory in 2011 and 2012-2013 but with the rate declining and then increasing into 2014. There is decrease into 2015 followed by stability and marginal increase in 2016-18.
Chart I-19, US, Consumer Price Index, Housing, 12-Month Percentage Change, NSA, 2001-2018
Source: US Bureau of Labor Statistics
http://www.bls.gov/cpi/data.htm
There have been waves of consumer price inflation in the US in 2011 and into 2018 (https://cmpassocregulationblog.blogspot.com/2018/03/decreasing-valuations-of-risk-financial.html and earlier https://cmpassocregulationblog.blogspot.com/2018/02/world-inflation-waves-united-states.html) that are illustrated in Table I-5. The first wave occurred in Jan-Apr 2011 and was caused by the carry trade of commodity prices induced by unconventional monetary policy of zero interest rates. Cheap money at zero opportunity cost in environment of risk appetite was channeled into financial risk assets, causing increases in commodity prices. The annual equivalent rate of increase of the all-items CPI in Jan-Apr 2011 was 4.9 percent and the CPI excluding food and energy increased at annual equivalent rate of 1.8 percent. The second wave occurred during the collapse of the carry trade from zero interest rates to exposures in commodity futures because of risk aversion in financial markets created by the sovereign debt crisis in Europe. The annual equivalent rate of increase of the all-items CPI dropped to 1.8 percent in May-Jun 2011 while the annual equivalent rate of the CPI excluding food and energy increased at 2.4 percent. In the third wave in Jul-Sep 2011, annual equivalent CPI inflation rose to 3.2 percent while the core CPI increased at 2.4 percent. The fourth wave occurred in the form of increase of the CPI all-items annual equivalent rate to 1.8 percent in Oct-Nov 2011 with the annual equivalent rate of the CPI excluding food and energy remaining at 2.4 percent. The fifth wave occurred in Dec 2011 to Jan 2012 with annual equivalent headline inflation of 1.8 percent and core inflation of 2.4 percent. In the sixth wave, headline CPI inflation increased at annual equivalent 2.4 percent in Feb-Apr 2012 and 2.0 percent for the core CPI. The seventh wave in May-Jul occurred with annual equivalent inflation of minus 1.2 percent for the headline CPI in May-Jul 2012 and 2.0 percent for the core CPI. The eighth wave is with annual equivalent inflation of 6.8 percent in Aug-Sep 2012 but 5.7 percent including Oct. In the ninth wave, annual equivalent inflation in Nov 2012 was minus 2.4 percent under the new shock of risk aversion and 0.0 percent in Dec 2012 with annual equivalent of 0.0 percent in Nov 2012-Jan 2013 and 2.0 percent for the core CPI. In the tenth wave, annual equivalent of the headline CPI was 6.2 percent in Feb 2013 and 1.2 percent for the core CPI. In the eleventh wave, annual equivalent was minus 3.0 percent in Mar-Apr 2013 and 0.6 percent for the core index. In the twelfth wave, annual equivalent inflation was 1.4 percent in May-Sep 2013 and 2.2 percent for the core CPI. In the thirteenth wave, annual equivalent CPI inflation in Oct-Nov 2013 was 1.8 percent and 1.8 percent for the core CPI. Inflation returned in the fourteenth wave at 2.7 percent for the headline CPI index and 1.8 percent for the core CPI in annual equivalent for Dec 2013 to Mar 2014. In the fifteenth wave, inflation moved to annual equivalent 1.8 percent for the headline index in Apr-Jul 2014 and 2.1 percent for the core index. In the sixteenth wave, annual equivalent inflation was 0.0 percent in Aug 2014 and 1.2 percent for the core index. In the seventeenth wave, annual equivalent inflation was 0.0 percent for the headline CPI and 2.4 percent for the core in Sep-Oct 2014. In the eighteenth wave, annual equivalent inflation was minus 4.3 percent for the headline index in Nov 2014-Jan 2015 and 1.2 percent for the core. In the nineteenth wave, annual equivalent inflation was 2.9 percent for the headline index and 2.2 percent for the core index in Feb-Jun 2015. In the twentieth wave, annual equivalent inflation was at 2.4 percent in Jul 2015 for the headline and core indexes. In the twenty-first wave, consumer prices decreased at 1.2 percent in annual equivalent in Aug-Sep 2015. In the twenty-second wave, consumer prices increased at annual equivalent 1.2 percent for the central index and 2.4 percent for the core in Oct-Nov 2015. In the twenty-third wave, annual equivalent inflation was 0.0 percent for the headline CPI in Dec 2015 to Jan 2016 and 1.8 percent for the core. In the twenty-fourth wave, annual equivalent was minus 2.4 percent and 2.4 percent for the core in Feb 2016. In the twenty-fifth wave, annual equivalent inflation was at 3.0 percent for the central index in Mar-Apr 2016 and at 1.8 percent for the core index. In the twenty-sixth wave, annual equivalent inflation was 3.0 percent for the central CPI in May-Jun 2016 and 2.4 percent for the core CPI. In the twenty-seventh wave, annual equivalent inflation was 0.0 percent for the central CPI and 2.4 percent for the core in Jul 2016. In the twenty-eighth wave, annual equivalent inflation was 2.4 percent for the headline CPI in Aug 2016 and 2.4 percent for the core. In the twenty-ninth wave, CPI prices increased at annual equivalent 3.0 percent in Sep-Oct 2016 while the core CPI increased at 1.2 percent. In the thirtieth wave, annual equivalent CPI prices increased at 3.0 percent in Nov-Dec 2016 while the core CPI increased at 2.4 percent. In the thirty-first wave, CPI prices increased at annual equivalent 6.2 percent in Jan 2017 while the core index increased at 3.7 percent. In the thirty-second wave, CPI prices changed at annual equivalent 0.0 percent in Feb 2017 while the core increased at 2.4 percent. In the thirty-third wave, CPI prices decreased at annual equivalent 2.4 percent in Mar 2017 while the core index fell at 1.2 percent. In the thirty-fourth wave, CPI prices increased at 2.4 percent annual equivalent in Apr 2017 while the core index increased at 1.2 percent. In the thirty-fifth wave, CPI prices fell at annual equivalent 0.6 in May-Jun 2017 while core prices increased at 1.2 percent. In the thirty-sixth wave, CPI prices increased at annual equivalent 1.2 percent in Jul 2017 while core prices increased at 1.2 percent. In the thirty-seventh wave, CPI prices increased at annual equivalent 5.5 percent in Aug-Sep 2017 while core prices increased at 1.8 percent. In the thirty-eighth wave, CPI prices increased at 2.4 percent annual equivalent in Oct-Nov 2017 while core prices increased at 1.8 percent. In the thirty-ninth wave, CPI prices increased at 3.7 percent annual equivalent in Dec 2017-Feb 2018 while core prices increased at 3.0 percent. In the fortieth wave, CPI prices decreased at 1.2 percent annual equivalent in Mar 2018 while core prices increased at 2.4 percent. The conclusion is that inflation accelerates and decelerates in unpredictable fashion because of shocks or risk aversion and portfolio reallocations in carry trades from zero interest rates to commodity derivatives.
Table I-5, US, Headline and Core CPI Inflation Monthly SA and 12 Months NSA ∆%
| All Items SA Month | All Items NSA 12 month | Core SA | Core NSA | |
| Mar 2018 | -0.1 | 2.4 | 0.2 | 2.1 |
| AE ∆% Mar | -1.2 | 2.4 | ||
| Feb | 0.2 | 2.2 | 0.2 | 1.8 |
| Jan | 0.5 | 2.1 | 0.3 | 1.8 |
| Dec 2017 | 0.2 | 2.1 | 0.2 | 1.8 |
| AE ∆% Dec-Feb | 3.7 | 3.0 | ||
| Nov | 0.3 | 2.2 | 0.1 | 1.7 |
| Oct | 0.1 | 2.0 | 0.2 | 1.8 |
| AE ∆% Oct-Nov | 2.4 | 1.8 | ||
| Sep | 0.5 | 2.2 | 0.1 | 1.7 |
| Aug | 0.4 | 1.9 | 0.2 | 1.7 |
| AE ∆% Aug-Sep | 5.5 | 1.8 | ||
| Jul | 0.1 | 1.7 | 0.1 | 1.7 |
| AE ∆% Jul | 1.2 | 1.2 | ||
| Jun | 0.0 | 1.6 | 0.1 | 1.7 |
| May | -0.1 | 1.9 | 0.1 | 1.7 |
| AE ∆% May-Jun | -0.6 | 1.2 | ||
| Apr | 0.2 | 2.2 | 0.1 | 1.9 |
| AE ∆% Apr | 2.4 | 1.2 | ||
| Mar | -0.2 | 2.4 | -0.1 | 2.0 |
| AE ∆% Mar | -2.4 | -1.2 | ||
| Feb | 0.0 | 2.7 | 0.2 | 2.2 |
| AE ∆% Feb | 0.0 | 2.4 | ||
| Jan | 0.5 | 2.5 | 0.3 | 2.3 |
| AE ∆% Jan | 6.2 | 3.7 | ||
| Dec 2016 | 0.3 | 2.1 | 0.2 | 2.2 |
| Nov | 0.2 | 1.7 | 0.2 | 2.1 |
| AE ∆% Nov-Dec | 3.0 | 2.4 | ||
| Oct | 0.3 | 1.6 | 0.1 | 2.1 |
| Sep | 0.2 | 1.5 | 0.1 | 2.2 |
| AE ∆% Sep-Oct | 3.0 | 1.2 | ||
| Aug | 0.2 | 1.1 | 0.2 | 2.3 |
| AE ∆ Aug | 2.4 | 2.4 | ||
| Jul | 0.0 | 0.8 | 0.2 | 2.2 |
| AE ∆% Jul | 0.0 | 2.4 | ||
| Jun | 0.3 | 1.0 | 0.2 | 2.2 |
| May | 0.2 | 1.0 | 0.2 | 2.2 |
| AE ∆% May-Jun | 3.0 | 2.4 | ||
| Apr | 0.3 | 1.1 | 0.2 | 2.1 |
| Mar | 0.2 | 0.9 | 0.1 | 2.2 |
| AE ∆% Mar-Apr | 3.0 | 1.8 | ||
| Feb | -0.2 | 1.0 | 0.2 | 2.3 |
| AE ∆% Feb | -2.4 | 2.4 | ||
| Jan | 0.1 | 1.4 | 0.2 | 2.2 |
| Dec 2015 | -0.1 | 0.7 | 0.1 | 2.1 |
| AE ∆% Dec-Jan | 0.0 | 1.8 | ||
| Nov | 0.1 | 0.5 | 0.2 | 2.0 |
| Oct | 0.1 | 0.2 | 0.2 | 1.9 |
| AE ∆% Oct-Nov | 1.2 | 2.4 | ||
| Sep | -0.2 | 0.0 | 0.2 | 1.9 |
| Aug | 0.0 | 0.2 | 0.1 | 1.8 |
| AE ∆% Aug-Sep | -1.2 | 1.8 | ||
| Jul | 0.2 | 0.2 | 0.2 | 1.8 |
| AE ∆% Jul | 2.4 | 2.4 | ||
| Jun | 0.3 | 0.1 | 0.2 | 1.8 |
| May | 0.3 | 0.0 | 0.1 | 1.7 |
| Apr | 0.1 | -0.2 | 0.2 | 1.8 |
| Mar | 0.3 | -0.1 | 0.3 | 1.8 |
| Feb | 0.2 | 0.0 | 0.1 | 1.7 |
| AE ∆% Feb-Jun | 2.9 | 2.2 | ||
| Jan | -0.6 | -0.1 | 0.1 | 1.6 |
| Dec 2014 | -0.3 | 0.8 | 0.1 | 1.6 |
| Nov | -0.2 | 1.3 | 0.1 | 1.7 |
| AE ∆% Nov-Jan | -4.3 | 1.2 | ||
| Oct | 0.0 | 1.7 | 0.2 | 1.8 |
| Sep | 0.0 | 1.7 | 0.2 | 1.7 |
| AE ∆% Sep-Oct | 0.0 | 2.4 | ||
| Aug | 0.0 | 1.7 | 0.1 | 1.7 |
| AE ∆% Aug | 0.0 | 1.2 | ||
| Jul | 0.1 | 2.0 | 0.2 | 1.9 |
| Jun | 0.1 | 2.1 | 0.1 | 1.9 |
| May | 0.2 | 2.1 | 0.2 | 2.0 |
| Apr | 0.2 | 2.0 | 0.2 | 1.8 |
| AE ∆% Apr-Jul | 1.8 | 2.1 | ||
| Mar | 0.2 | 1.5 | 0.2 | 1.7 |
| Feb | 0.1 | 1.1 | 0.1 | 1.6 |
| Jan | 0.3 | 1.6 | 0.1 | 1.6 |
| Dec 2013 | 0.3 | 1.5 | 0.2 | 1.7 |
| AE ∆% Dec-Mar | 2.7 | 1.8 | ||
| Nov | 0.2 | 1.2 | 0.2 | 1.7 |
| Oct | 0.1 | 1.0 | 0.1 | 1.7 |
| AE ∆% Oct-Nov | 1.8 | 1.8 | ||
| Sep | 0.0 | 1.2 | 0.2 | 1.7 |
| Aug | 0.2 | 1.5 | 0.2 | 1.8 |
| Jul | 0.2 | 2.0 | 0.2 | 1.7 |
| Jun | 0.2 | 1.8 | 0.2 | 1.6 |
| May | 0.0 | 1.4 | 0.1 | 1.7 |
| AE ∆% May-Sep | 1.4 | 2.2 | ||
| Apr | -0.2 | 1.1 | 0.0 | 1.7 |
| Mar | -0.3 | 1.5 | 0.1 | 1.9 |
| AE ∆% Mar-Apr | -3.0 | 0.6 | ||
| Feb | 0.5 | 2.0 | 0.1 | 2.0 |
| AE ∆% Feb | 6.2 | 1.2 | ||
| Jan | 0.2 | 1.6 | 0.2 | 1.9 |
| Dec 2012 | 0.0 | 1.7 | 0.2 | 1.9 |
| Nov | -0.2 | 1.8 | 0.1 | 1.9 |
| AE ∆% Nov-Jan | 0.0 | 2.0 | ||
| Oct | 0.3 | 2.2 | 0.2 | 2.0 |
| Sep | 0.5 | 2.0 | 0.2 | 2.0 |
| Aug | 0.6 | 1.7 | 0.1 | 1.9 |
| AE ∆% Aug-Oct | 5.7 | 2.0 | ||
| Jul | 0.0 | 1.4 | 0.2 | 2.1 |
| Jun | -0.1 | 1.7 | 0.2 | 2.2 |
| May | -0.2 | 1.7 | 0.1 | 2.3 |
| AE ∆% May-Jul | -1.2 | 2.0 | ||
| Apr | 0.2 | 2.3 | 0.2 | 2.3 |
| Mar | 0.2 | 2.7 | 0.2 | 2.3 |
| Feb | 0.2 | 2.9 | 0.1 | 2.2 |
| AE ∆% Feb-Apr | 2.4 | 2.0 | ||
| Jan | 0.3 | 2.9 | 0.2 | 2.3 |
| Dec 2011 | 0.0 | 3.0 | 0.2 | 2.2 |
| AE ∆% Dec-Jan | 1.8 | 2.4 | ||
| Nov | 0.2 | 3.4 | 0.2 | 2.2 |
| Oct | 0.1 | 3.5 | 0.2 | 2.1 |
| AE ∆% Oct-Nov | 1.8 | 2.4 | ||
| Sep | 0.2 | 3.9 | 0.1 | 2.0 |
| Aug | 0.3 | 3.8 | 0.3 | 2.0 |
| Jul | 0.3 | 3.6 | 0.2 | 1.8 |
| AE ∆% Jul-Sep | 3.2 | 2.4 | ||
| Jun | 0.0 | 3.6 | 0.2 | 1.6 |
| May | 0.3 | 3.6 | 0.2 | 1.5 |
| AE ∆% May-Jun | 1.8 | 2.4 | ||
| Apr | 0.5 | 3.2 | 0.1 | 1.3 |
| Mar | 0.5 | 2.7 | 0.1 | 1.2 |
| Feb | 0.3 | 2.1 | 0.2 | 1.1 |
| Jan | 0.3 | 1.6 | 0.2 | 1.0 |
| AE ∆% Jan-Apr | 4.9 | 1.8 | ||
| Dec 2010 | 0.4 | 1.5 | 0.1 | 0.8 |
| Nov | 0.3 | 1.1 | 0.1 | 0.8 |
| Oct | 0.3 | 1.2 | 0.1 | 0.6 |
| Sep | 0.2 | 1.1 | 0.1 | 0.8 |
| Aug | 0.1 | 1.1 | 0.1 | 0.9 |
| Jul | 0.2 | 1.2 | 0.1 | 0.9 |
| Jun | 0.0 | 1.1 | 0.1 | 0.9 |
| May | -0.1 | 2.0 | 0.1 | 0.9 |
| Apr | 0.0 | 2.2 | 0.0 | 0.9 |
| Mar | 0.0 | 2.3 | 0.0 | 1.1 |
| Feb | -0.1 | 2.1 | 0.0 | 1.3 |
| Jan | 0.1 | 2.6 | -0.1 | 1.6 |
Note: Core: excluding food and energy; AE: annual equivalent
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
The behavior of the US consumer price index NSA from 2001 to 2018 is in Chart I-20. Inflation in the US is very dynamic without deflation risks that would justify symmetric inflation targets. The hump in 2008 originated in the carry trade from interest rates dropping to zero into commodity futures. There is no other explanation for the increase of the Cushing OK Crude Oil Future Contract 1 from $55.64/barrel on Jan 9, 2007 to $145.29/barrel on July 3, 2008 during deep global recession, collapsing under a panic of flight into government obligations and the US dollar to $37.51/barrel on Feb 13, 2009 and then rising by carry trades to $113.93/barrel on Apr 29, 2012, collapsing again and then recovering again to $105.23/barrel, all during mediocre economic recovery with peaks and troughs influenced by bouts of risk appetite and risk aversion (data from the US Energy Information Administration EIA, http://www.eia.gov/). The unwinding of the carry trade with the TARP announcement of toxic assets in banks channeled cheap money into government obligations (see Cochrane and Zingales 2009).
Chart I-20, US, Consumer Price Index, NSA, 2001-2018
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
Chart I-21 provides 12-month percentage changes of the consumer price index from 2001 to 2018. There was no deflation or threat of deflation from 2008 into 2009. Commodity prices collapsed during the panic of toxic assets in banks. When stress tests in 2009 revealed US bank balance sheets in much stronger position, cheap money at zero opportunity cost exited government obligations and flowed into carry trades of risk financial assets. Increases in commodity prices drove again the all items CPI with interruptions during risk aversion originating in multiple fears but especially from the sovereign debt crisis of Europe.
Chart I-21, US, Consumer Price Index, 12-Month Percentage Change, NSA, 2001-2018
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
The trend of increase of the consumer price index excluding food and energy in Chart I-22 does not reveal any threat of deflation that would justify symmetric inflation targets. There are mild oscillations in a neat upward trend.
Chart I-22, US, Consumer Price Index Excluding Food and Energy, NSA, 2001-2018
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
Chart I-23 provides 12-month percentage change of the consumer price index excluding food and energy. Past-year rates of inflation fell toward 1 percent from 2001 into 2003 because of the recession and the decline of commodity prices beginning before the recession with declines of real oil prices. Near zero interest rates with fed funds at 1 percent between Jun 2003 and Jun 2004 stimulated carry trades of all types, including in buying homes with subprime mortgages in expectation that low interest rates forever would increase home prices permanently, creating the equity that would permit the conversion of subprime mortgages into creditworthy mortgages (Gorton 2009EFM; see http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html). Inflation rose and then collapsed during the unwinding of carry trades and the housing debacle of the global recession. Carry trades into 2011 and 2012 gave a new impulse to CPI inflation, all items and core. Symmetric inflation targets destabilize the economy by encouraging hunts for yields that inflate and deflate financial assets, obscuring risk/return decisions on production, investment, consumption and hiring.
Chart I-23, US, Consumer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2001-2018
Source: US Bureau of Labor Statistics
Headline and core producer price indexes are in Table I-6. The headline PPI SA increased 0.2 percent in Mar 2018 and increased 3.0 percent NSA in the 12 months ending in Mar 2018. The core PPI SA increased 0.2 percent in Mar 2018 and increased 2.4 percent in 12 months. Analysis of annual equivalent rates of change shows inflation waves similar to those worldwide. In the first wave, the absence of risk aversion from the sovereign risk crisis in Europe motivated the carry trade from zero interest rates into commodity futures that caused the annual equivalent rate of 11.1 percent in the headline PPI in Jan-Apr 2011 and 3.7 percent in the core PPI. In the second wave, commodity futures prices collapsed in Jun 2011 with the return of risk aversion originating in the sovereign risk crisis of Europe. The annual equivalent rate of headline PPI inflation collapsed to 0.6 percent in May-Jun 2011 but the core annual equivalent inflation rate was higher at 2.4 percent. In the third wave, headline PPI inflation resuscitated with annual equivalent at 4.1 percent in Jul-Sep 2011 and core PPI inflation at 3.2 percent. Core PPI inflation was persistent throughout 2011, jumping from annual equivalent at 2.0 percent in the first three months of 2010 to 3.0 percent in 12 months ending in Dec 2011. Unconventional monetary policy is based on the proposition that core rates reflect more fundamental inflation and are thus better predictors of the future. In practice, the relation of core and headline inflation is as difficult to predict as future inflation (see IIID Supply Shocks in http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html). In the fourth wave, risk aversion originating in the lack of resolution of the European debt crisis caused unwinding of carry trades with annual equivalent headline PPI inflation of 0.0 percent in Oct-Dec 2011 and 2.0 percent in the core annual equivalent. In the fifth wave from Jan to Mar 2012, annual equivalent inflation was 3.2 percent for the headline index but 3.2 percent for the core index excluding food and energy. In the sixth wave, annual equivalent inflation in Apr-May 2012 during renewed risk aversion was minus 4.1 percent for the headline PPI and 1.8 percent for the core. In the seventh wave, continuing risk aversion caused reversal of carry trades into commodity exposures with annual equivalent headline inflation of minus 1.2 percent in Jun-Jul 2012 while core PPI inflation was at annual equivalent 3.7 percent. In the eighth wave, relaxed risk aversion because of the announcement of the impaired bond buying program or Outright Monetary Transactions (OMT) of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html) induced carry trades that drove annual equivalent inflation of producer prices of the United States at 13.4 percent in Aug-Sep 2012 and 1.2 percent in the core index. In the ninth wave, renewed risk aversion caused annual equivalent inflation of minus 2.4 percent in Oct 2012-Dec 2012 in the headline index and 1.2 percent in the core index. In the tenth wave, annual equivalent inflation was 7.4 percent in the headline index in Jan-Feb 2013 and 1.8 percent in the core index. In the eleventh wave, annual equivalent inflation was minus 7.0 percent in Mar-Apr 2012 and 1.2 percent for the core index. In the twelfth wave, annual equivalent inflation returned at 2.7 percent in May-Aug 2013 and 1.2 percent in the core index. In the thirteenth wave, portfolio reallocations away from commodities and into equities reversed commodity carry trade with annual equivalent inflation of 0.8 percent in Sep-Nov 2013 in the headline PPI and 1.6 percent in the core. In the fourteenth wave, annual equivalent inflation returned at 5.3 percent annual equivalent for the headline index in Dec 2013-Feb 2014 and 4.1 percent for the core index. In the fifteenth wave, annual equivalent inflation was 3.7 percent for the general PPI index in Mar 2014 and 0.0 percent for the core PPI index. In the sixteenth wave, annual equivalent headline PPI inflation increased at 1.5 percent in Apr-Jul 2014 and 1.8 percent for the core PPI. In the seventeenth wave, annual equivalent inflation in Aug-Nov 2014 was minus 3.0 percent and 1.8 percent for the core index. In the eighteenth wave, annual equivalent inflation fell at 17.6 percent for the general index in Dec 2014 to Jan 2015 and increased at 3.0 percent in the core index. In the nineteenth wave, annual equivalent inflation increased at 1.2 percent in Feb 2015 and increased at 3.7 percent for the core index. In the twentieth wave, annual equivalent producer prices increased at 3.7 percent in Mar 2015 and the core at 2.4 percent. In the twenty-first wave, producer prices fell at 7.0 percent annual equivalent in Apr 2015 while the core index increased at 1.2 percent. In the twenty-second wave, producer prices increased at annual equivalent 12.0 percent in May-Jun 2015 and core producer prices at 2.4 percent. In the twenty-third wave, producer prices fell at 2.4 percent in Jul 2015 and the core index increased at 2.4 percent. In the twenty-fourth wave, annual equivalent inflation fell at 7.4 percent in Aug-Oct 2015 and the core index changed at 0.0 percent annual equivalent. In the twenty-fifth wave, annual equivalent inflation was 2.4 percent in Nov 2015 with the core at 1.2 percent. In the twenty-sixth wave, the headline PPI fell at annual equivalent 7.0 percent and the core increased at 2.0 percent in Dec 2015-Feb 2016. In the twenty-seventh wave, annual equivalent inflation was 4.5 percent for the central index in Mar-May 2016 and 1.6 percent for the core. In the twenty-eighth wave, annual equivalent inflation was 8.7 percent for the headline index in Jun 2016 and 3.7 percent for the core. In the twenty-ninth wave, producer prices fell at annual equivalent 1.2 percent in Jul 2016 and core producer prices changed at 0.0 percent. In the thirtieth wave, producer prices fell at 3.5 percent annual equivalent in Aug 2016 while core producer prices increased at 2.4 percent. In the thirty-first wave, producer prices increased at annual equivalent 5.5 percent in Sep-Oct 2016 while core prices increased at 1.2 percent. In the thirty-second wave, producer prices decreased at 3.5 percent annual equivalent in Nov 2016 and the core index increased at 1.2 percent. In the thirty-third wave, producer prices increased at 10.0 percent in Dec 2016 and the core index increased at 3.7 percent. In the thirty-fourth wave, producer prices increased at 11.4 percent in Jan 2017 while the core increased at 2.4 percent. In the thirty-fifth wave, producer prices increased at 1.2 percent in Feb 2017 while the core index increased at 1.2 percent. In the thirty-sixth wave, producer prices increased at annual equivalent 1.2 percent in Mar 2017 while core producer prices increased at 3.7 percent. In the thirty-seventh wave, annual equivalent inflation of the headline index was at 7.4 percent in Apr 2017 and 4.9 percent for the core. In the thirty-eighth wave, producer prices fell at 7.0 percent annual equivalent in May 2017 while core producer prices changed at 0.0 percent. In the thirty-ninth wave, producer prices increased at annual equivalent 1.2 percent in Jun 2017 while core producer prices increased at 2.4 percent. In the fortieth wave, headline producer prices fell at 1.2 percent annual equivalent in Jul 2017 while core prices increased at 1.2 percent. In the forty-first wave, central producer prices increased at 7.4 percent annual equivalent in Aug-Sep 2017 while core prices increased at 1.8 percent. In the forty-second wave, producer prices increased at annual equivalent 7.4 percent in Oct-Nov 2017 while core producer prices increased at 4.3 percent. In the forty-third wave, producer prices changed at annual equivalent 0.0 percent in Dec 2017 while core prices increased at 1.2 percent. In the forty-fourth wave, producer prices increased at 8.7 percent annual equivalent in Jan 2018 while core producer prices increased at 1.2 percent. In the forty-fifth wave, producer prices fell at annual equivalent 3.5 percent in Feb 2018 while core prices changed at 0.0 percent. In the forty-first wave, producer prices increased at 2.4 percent annual equivalent in Mar 2018 while core prices increased at 2.4 percent.It is almost impossible to forecast PPI inflation and its relation to CPI inflation. “Inflation surprise” by monetary policy could be proposed to climb along a downward sloping Phillips curve, resulting in higher inflation but lower unemployment (see Kydland and Prescott 1977, Barro and Gordon 1983 and past comments of this blog http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). The architects of monetary policy would require superior inflation forecasting ability compared to forecasting naivety by everybody else. In practice, we are all naïve in forecasting inflation and other economic variables and events.
Table I-6, US, Headline and Core PPI Inflation Monthly SA and 12-Month NSA ∆%
| Finished | Finished | Finished Core SA | Finished Core NSA | |
| Mar 2018 | 0.2 | 3.0 | 0.2 | 2.0 |
| AE Mar | 2.4 | 2.4 | ||
| Feb | -0.3 | 2.7 | 0.0 | 1.9 |
| AE Feb | -3.5 | 0.0 | ||
| Jan | 0.7 | 3.0 | 0.1 | 1.9 |
| AE Jan | 8.7 | 1.2 | ||
| Dec 2017 | 0.0 | 3.3 | 0.1 | 2.0 |
| AE Dec | 0.0 | 1.2 | ||
| Nov | 1.0 | 4.2 | 0.3 | 2.1 |
| Oct | 0.2 | 2.9 | 0.4 | 2.0 |
| AE Oct-Nov | 7.4 | 4.3 | ||
| Sep | 0.6 | 3.3 | 0.1 | 1.7 |
| Aug | 0.6 | 3.0 | 0.2 | 1.8 |
| AE Aug-Sep | 7.4 | 1.8 | ||
| Jul | -0.1 | 2.1 | 0.1 | 1.8 |
| AE Jul | -1.2 | 1.2 | ||
| Jun | 0.1 | 2.1 | 0.2 | 1.7 |
| AE Jun | 1.2 | 2.4 | ||
| May | -0.6 | 2.8 | 0.0 | 1.9 |
| AE May | -7.0 | 0.0 | ||
| Apr | 0.6 | 4.0 | 0.4 | 2.0 |
| AE Apr | 7.4 | 4.9 | ||
| Mar | 0.1 | 3.8 | 0.3 | 1.8 |
| AE Mar | 1.2 | 3.7 | ||
| Feb | 0.1 | 3.8 | 0.1 | 1.6 |
| AE Feb | 1.2 | 1.2 | ||
| Jan | 0.9 | 2.9 | 0.2 | 1.7 |
| AE Jan | 11.4 | 2.4 | ||
| Dec 2016 | 0.8 | 1.9 | 0.3 | 1.7 |
| AE Dec | 10.0 | 3.7 | ||
| Nov | -0.3 | 0.4 | 0.1 | 1.6 |
| AE Nov | -3.5 | 1.2 | ||
| Oct | 0.5 | 0.7 | 0.1 | 1.6 |
| Sep | 0.4 | -0.1 | 0.1 | 1.4 |
| AE Sep-Oct | 5.5 | 1.2 | ||
| Aug | -0.3 | -1.9 | 0.2 | 1.4 |
| AE Aug | -3.5 | 2.4 | ||
| Jul | -0.1 | -2.0 | 0.0 | 1.2 |
| AE Jul | -1.2 | 0.0 | ||
| Jun | 0.7 | -2.0 | 0.3 | 1.5 |
| AE Jun | 8.7 | 3.7 | ||
| May | 0.6 | -2.2 | 0.1 | 1.6 |
| Apr | 0.3 | -1.5 | 0.2 | 1.6 |
| Mar | 0.2 | -2.3 | 0.1 | 1.5 |
| AE Mar-May | 4.5 | 1.6 | ||
| Feb | -0.8 | -2.0 | 0.1 | 1.5 |
| Jan | -0.3 | -1.2 | 0.2 | 1.7 |
| Dec 2015 | -0.7 | -2.7 | 0.2 | 1.8 |
| AE Dec-Feb | -7.0 | 2.0 | ||
| Nov | 0.2 | -3.3 | 0.1 | 1.7 |
| AE Nov | 2.4 | 1.2 | ||
| Oct | -0.3 | -4.0 | -0.1 | 1.8 |
| Sep | -1.3 | -4.1 | 0.1 | 2.1 |
| Aug | -0.3 | -3.1 | 0.0 | 2.1 |
| AE ∆% Aug-Oct | -7.4 | 0.0 | ||
| Jul | -0.2 | -2.8 | 0.2 | 2.3 |
| AE ∆% Jul | -2.4 | 2.4 | ||
| Jun | 0.6 | -2.6 | 0.5 | 2.3 |
| May | 1.3 | -2.9 | 0.1 | 2.0 |
| AE ∆% May-Jun | 12.0 | 2.4 | ||
| Apr | -0.6 | -4.5 | 0.1 | 2.0 |
| AE ∆% Apr | -7.0 | 1.2 | ||
| Mar | 0.3 | -3.3 | 0.2 | 2.1 |
| AE ∆% Mar | 3.7 | 2.4 | ||
| Feb | 0.1 | -3.2 | 0.3 | 1.9 |
| AE ∆% Feb | 1.2 | 3.7 | ||
| Jan | -1.8 | -3.0 | 0.4 | 1.7 |
| Dec 2014 | -1.4 | -0.6 | 0.1 | 1.7 |
| AE ∆% Dec-Jan | -17.6 | 3.0 | ||
| Nov | -0.4 | 1.1 | 0.0 | 2.0 |
| Oct | -0.3 | 1.8 | 0.3 | 2.2 |
| Sep | -0.3 | 2.2 | 0.1 | 2.1 |
| Aug | 0.0 | 2.3 | 0.2 | 1.9 |
| AE ∆% Aug-Nov | -3.0 | 1.8 | ||
| July | 0.0 | 2.9 | 0.1 | 1.9 |
| Jun | 0.2 | 2.8 | 0.2 | 1.9 |
| May | -0.2 | 2.5 | 0.2 | 1.8 |
| Apr | 0.5 | 3.1 | 0.1 | 1.7 |
| AE ∆% Apr-Jul | 1.5 | 1.8 | ||
| Mar | 0.3 | 1.8 | 0.0 | 1.7 |
| AE ∆% Mar | 3.7 | 0.0 | ||
| Feb | 0.1 | 1.3 | 0.1 | 1.9 |
| Jan | 0.8 | 1.6 | 0.5 | 2.0 |
| Dec 2013 | 0.4 | 1.4 | 0.4 | 1.6 |
| AE ∆% Dec-Feb | 5.3 | 4.1 | ||
| Nov | 0.3 | 0.8 | 0.2 | 1.3 |
| Oct | 0.2 | 0.3 | 0.1 | 1.2 |
| Sep | -0.3 | 0.2 | 0.1 | 1.2 |
| AE ∆% Sep-Nov | 0.8 | 1.6 | ||
| Aug | 0.5 | 1.2 | 0.1 | 1.2 |
| Jul | -0.1 | 2.1 | 0.1 | 1.3 |
| Jun | 0.1 | 2.3 | 0.1 | 1.6 |
| May | 0.4 | 1.6 | 0.1 | 1.7 |
| AE ∆% May-Aug | 2.7 | 1.2 | ||
| Apr | -0.6 | 0.5 | 0.1 | 1.7 |
| Mar | -0.6 | 1.1 | 0.1 | 1.7 |
| AE ∆% Mar-Apr | -7.0 | 1.2 | ||
| Feb | 0.6 | 1.8 | 0.2 | 1.8 |
| Jan | 0.6 | 1.5 | 0.1 | 1.8 |
| AE ∆% Jan-Feb | 7.4 | 1.8 | ||
| Dec 2012 | -0.2 | 1.4 | 0.0 | 2.1 |
| Nov | -0.5 | 1.4 | 0.2 | 2.2 |
| Oct | 0.1 | 2.3 | 0.1 | 2.2 |
| AE ∆% Oct-Dec | -2.4 | 1.2 | ||
| Sep | 0.9 | 2.1 | 0.0 | 2.4 |
| Aug | 1.2 | 1.9 | 0.2 | 2.6 |
| AE ∆% Aug-Sep | 13.4 | 1.2 | ||
| Jul | 0.2 | 0.5 | 0.4 | 2.6 |
| Jun | -0.4 | 0.7 | 0.2 | 2.6 |
| AE ∆% Jun-Jul | -1.2 | 3.7 | ||
| May | -0.6 | 0.6 | 0.1 | 2.7 |
| Apr | -0.1 | 1.8 | 0.2 | 2.7 |
| AE ∆% Apr-May | -4.1 | 1.8 | ||
| Mar | 0.1 | 2.7 | 0.2 | 2.9 |
| Feb | 0.3 | 3.4 | 0.2 | 3.1 |
| Jan | 0.4 | 4.1 | 0.4 | 3.1 |
| AE ∆% Jan-Mar | 3.2 | 3.2 | ||
| Dec 2011 | -0.1 | 4.7 | 0.2 | 3.0 |
| Nov | 0.3 | 5.7 | 0.1 | 3.0 |
| Oct | -0.2 | 5.9 | 0.2 | 2.9 |
| AE ∆% Oct-Dec | 0.0 | 2.0 | ||
| Sep | 0.9 | 7.1 | 0.3 | 2.8 |
| Aug | -0.3 | 6.6 | 0.2 | 2.7 |
| Jul | 0.4 | 7.2 | 0.3 | 2.7 |
| AE ∆% Jul-Sep | 4.1 | 3.2 | ||
| Jun | -0.4 | 7.0 | 0.3 | 2.3 |
| May | 0.5 | 7.1 | 0.1 | 2.1 |
| AE ∆% May-Jun | 0.6 | 2.4 | ||
| Apr | 0.9 | 6.7 | 0.3 | 2.3 |
| Mar | 0.7 | 5.7 | 0.3 | 2.0 |
| Feb | 1.1 | 5.5 | 0.2 | 1.8 |
| Jan | 0.8 | 3.7 | 0.4 | 1.6 |
| AE ∆% Jan-Apr | 11.1 | 3.7 | ||
| Dec 2010 | 0.9 | 3.8 | 0.2 | 1.4 |
| Nov | 0.4 | 3.4 | 0.0 | 1.2 |
| Oct | 0.8 | 4.3 | 0.0 | 1.6 |
| Sep | 0.3 | 3.9 | 0.2 | 1.6 |
| Aug | 0.6 | 3.3 | 0.1 | 1.3 |
| Jul | 0.1 | 4.1 | 0.1 | 1.5 |
| Jun | -0.3 | 2.7 | 0.1 | 1.1 |
| May | 0.0 | 5.1 | 0.3 | 1.3 |
| Apr | 0.0 | 5.4 | 0.0 | 0.9 |
| Mar | 0.7 | 5.9 | 0.2 | 0.9 |
| Feb | -0.7 | 4.1 | 0.1 | 1.0 |
| Jan | 1.0 | 4.5 | 0.2 | 1.0 |
Note: Core: excluding food and energy; AE: annual equivalent
Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/data.htm
The US producer price index NSA from 2000 to 2018 is in Chart I-24. There are two episodes of decline of the PPI during recessions in 2001 and in 2008. Barsky and Kilian (2004) consider the 2001 episode as one in which real oil prices were declining when recession began. Recession and the fall of commodity prices instead of generalized deflation explain the behavior of US inflation in 2008. There is similar collapse of producer prices into 2015 as in 2009 caused by the drop of
commodity prices.
Chart I-24, US, Producer Price Index, NSA, 2000-2018
Source: US Bureau of Labor Statistics
Twelve-month percentage changes of the PPI NSA from 2000 to 2018 are in Chart I-25. It may be possible to forecast trends a few months in the future under adaptive expectations but turning points are almost impossible to anticipate especially when related to fluctuations of commodity prices in response to risk aversion. In a sense, monetary policy has been tied to behavior of the PPI in the negative 12-month rates in 2001 to 2003 and then again in 2009 to 2010. There is similar sharp decline of inflation into 2015 caused by the drop of commodities. Monetary policy following deflation fears caused by commodity price fluctuations would introduce significant volatility and risks in financial markets and eventually in consumption and investment.
Chart I-25, US, Producer Price Index, 12-Month Percentage Change NSA, 2000-2018
Source: US Bureau of Labor Statistics
The US PPI excluding food and energy from 2000 to 2018 is in Chart I-26. There is here again a smooth trend of inflation instead of prolonged deflation as in Japan.
Chart I-26, US, Producer Price Index Excluding Food and Energy, NSA, 2000-2018
Source: US Bureau of Labor Statistics
Twelve-month percentage changes of the producer price index excluding food and energy are in Chart I-27. Fluctuations replicate those in the headline PPI. There is an evident trend of increase of 12-month rates of core PPI inflation in 2011 but lower rates in 2012-2014. Prices rose less rapidly into 2015-2018 as during earlier fluctuations.
Chart I-27, US, Producer Price Index Excluding Food and Energy, NSA, 12-Month Percentage Changes, 2000-2018
Source: US Bureau of Labor Statistics
The US producer price index of energy goods from 2000 to 2018 is in Chart I-28. There is a clear upward trend with fluctuations, which would not occur under persistent deflation.
Chart I-28, US, Producer Price Index Finished Energy Goods, NSA, 2000-2018
Source: US Bureau of Labor Statistics
Chart I-29 provides 12-month percentage changes of the producer price index of energy goods from 2000 to 2018. Barsky and Killian (2004) relate the episode of declining prices of energy goods in 2001 to 2002 to the analysis of decline of real oil prices. Interest rates dropping to zero during the global recession in 2008 induced carry trades that explain the rise of the PPI of energy goods toward 30 percent. Bouts of risk aversion with policy interest rates held close to zero explain the fluctuations in the 12-month rates of the PPI of energy goods in the expansion phase of the economy. Symmetric inflation targets induce significant instability in inflation and interest rates with adverse effects on financial markets and the overall economy.
Chart I-29, US, Producer Price Index Energy Goods, 12-Month Percentage Change, NSA, 2000-2018
Source: US Bureau of Labor Statistics
Effective with the January 2014 Producer Price Index (PPI) data release in February 2014 (https://www.bls.gov/news.release/archives/ppi_02192014.pdf 8), “BLS transitions from the Stage of Processing (SOP) to the Final Demand-Intermediate Demand (FD-ID) aggregation system. This shift results in significant changes to the PPI news release, as well as other documents available from PPI. The transition to the FD-ID system is the culmination of a long-standing PPI objective to improve the current SOP aggregation system by incorporating PPIs for services, construction, government purchases, and exports. In comparison to the SOP system, the FD-ID system more than doubles PPI coverage of the United States economy to over 75 percent of in-scope domestic production. The FD-ID system was introduced as a set of experimental indexes in January 2011. Nearly all new FD-ID goods, services, and construction indexes provide historical data back to either November 2009 or April 2010, while the indexes for goods that correspond with the historical SOP indexes go back to the 1970s or earlier.”
Headline and core final demand producer price indexes are in Table I-6B. The headline FD PPI SA increased 0.3 percent in Mar 2018 and increased 3.0 percent NSA in the 12 months ending in Mar 2018. The core FD PPI SA increased 0.3 percent in Mar 2018 and increased 2.7 percent in 12 months. Analysis of annual equivalent rates of change shows inflation waves similar to those worldwide. In the first wave, the absence of risk aversion from the sovereign risk crisis in Europe motivated the carry trade from zero interest rates into commodity futures that caused the average equivalent rate of 7.4 percent in the headline FD PPI in Jan-Apr 2011 and 4.6 percent in the core FD PPI. In the second wave, commodity futures prices collapsed in Jun 2011 with the return of risk aversion originating in the sovereign risk crisis of Europe. The annual equivalent rate of headline FD PPI inflation collapsed to 2.4 percent in May-Jun 2011 but the core annual equivalent inflation rate was at 2.4 percent. In the third wave, headline FD PPI inflation resuscitated with annual equivalent at 3.2 percent in Jul-Sep 2011 and core PPI inflation at 3.2 percent. Core FD PPI inflation was persistent throughout 2011, from annual equivalent at 4.6 percent in the first four months of 2011 to 2.6 percent in 12 months ending in Dec 2011. Unconventional monetary policy is based on the proposition that core rates reflect more fundamental inflation and are thus better predictors of the future. In practice, the relation of core and headline inflation is as difficult to predict as future inflation (see IIID Supply Shocks in http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html). In the fourth wave, risk aversion originating in the lack of resolution of the European debt crisis caused unwinding of carry trades with annual equivalent headline FD PPI inflation of minus 0.8 percent in Oct-Dec 2011 and minus 0.4 percent in the core annual equivalent. In the fifth wave from Jan to Mar 2012, annual equivalent inflation was 3.7 percent for the headline index and 3.7 percent for the core index excluding food and energy. In the sixth wave, annual equivalent inflation in Apr-May 2012 during renewed risk aversion was 1.2 percent for the headline FD PPI and 3.0 percent for the core. In the seventh wave, continuing risk aversion caused reversal of carry trades into commodity exposures with annual equivalent headline inflation of minus 2.4 percent in Jun-Jul 2012 while core FD PPI inflation was at annual equivalent minus 1.2 percent. In the eighth wave, relaxed risk aversion because of the announcement of the impaired bond buying program or Outright Monetary Transactions (OMT) of the European Central Bank (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html) induced carry trades that drove annual equivalent inflation of final demand producer prices of the United States at 6.2 percent in Aug-Sep 2012 and 1.2 percent in the core index. In the ninth wave, renewed risk aversion caused annual equivalent inflation of 0.8 percent in Oct 2011-Dec 2012 in the headline index and 2.8 percent in the core index. In the tenth wave, annual equivalent inflation was 3.0 percent in the headline index in Jan-Feb 2013 and 0.6 percent in the core index. In the eleventh wave, annual equivalent price change was minus 1.2 percent in Mar-Apr 2013 and 2.4 percent for the core index. In the twelfth wave, annual equivalent inflation returned at 1.8 percent in May-Aug 2013 and 1.6 percent in the core index. In the thirteenth wave, portfolio reallocations away from commodities and into equities reversed commodity carry trade with annual equivalent inflation of 1.6 percent in Sep-Nov 2013 in the headline FD PPI and 2.0 percent in the core. In the fourteenth wave, annual equivalent inflation was 2.4 percent annual equivalent for the headline index in Dec 2013-Feb 2014 and 1.6 percent for the core index. In the fifteenth wave, annual equivalent inflation increased to 2.4 percent in the headline FD PPI and 2.7 percent in the core in Mar-Jul 2014. In the sixteenth wave, annual equivalent inflation was minus 1.2 percent for the headline FD index and minus 0.6 percent for the core FD index in Aug-Sep 2014. In the seventeenth wave, annual equivalent inflation was 2.4 percent for the headline FD and 4.9 percent for the core FD in Oct 2014. In the eighteenth wave, annual equivalent inflation was minus 3.0 percent for the headline FDI and 1.2 percent for the core in Nov-Dec 2014. In the nineteenth wave, annual equivalent inflation was minus 6.4 percent for the general index and minus 2.4 percent for the core in Jan-Feb 2015. In the twentieth wave, annual equivalent inflation was 1.2 percent for the general index in Mar 2015 and 0.0 percent for the core. In the twenty-first wave, final demand prices decreased at annual equivalent 1.2 percent for the headline index in Apr 2015 and increased at 2.4 percent for the core index. In the twenty-second wave, annual equivalent inflation returned at 3.7 percent for the headline index in May-Jul 2015 and at 2.0 percent for the core index. In the twenty-third wave, the headline final demand index fell at 2.4 percent annual equivalent in Aug 2015 and the core changed at 0.0 percent annual equivalent. In the twenty-fourth wave, FD prices fell at annual equivalent 4.1 percent in Sep-Oct 2015. In the twenty-fifth wave, FD prices increased at 1.2 percent annual equivalent in Nov 2015. In the twenty-sixth wave, FD prices decreased at 2.4 percent annual equivalent in Dec 2015. In the twenty-seventh wave, FD prices increased at 6.2 percent annual equivalent in Jan 2016 and the core FD increased at 6.2 percent. In the twenty-eighth wave, FD prices fell at annual equivalent 2.4 percent in Feb-Mar 2016 while the core decreased at 0.6 percent. In the twenty-ninth wave, FD prices increased at 4.1 percent annual equivalent in Apr-Jun 2016 and core FD increased at 2.4 percent. In the thirtieth wave, final demand prices changed at 0.0 percent in annual equivalent in Jul 2016 while the core changed at 0.0 percent. In the thirty-first wave, final demand prices decreased at annual equivalent 3.5 percent in Aug 2016 and the core decreased at 1.2 percent. In the thirty-second wave, final demand prices increased at annual equivalent 3.7 percent in Sep 2016 while core final demand increased at 2.4 percent. In the thirty-third wave, final demand prices increased at 3.7 percent and core final demand prices increased at 2.4 percent in Oct 2016. In the thirty-fourth wave, final demand producer prices increased at 3.0 percent annual equivalent in Nov-Dec 2016 while the core increased at 1.8 percent. In the thirty-fifth wave, final demand producer prices increased at 6.2 percent in Jan 2017 while core prices increased at 4.9 percent. In the thirty-sixth wave, final demand prices decreased at 1.2 percent annual equivalent in Feb 2017 while the core index decreased at 1.2 percent. In the thirty-seventh wave, final demand prices increased at 1.2 percent annual equivalent in Mar 2017 while the core index increased at 2.4 percent. In the thirty-eighth wave, final demand prices increased at 4.9 percent in Apr 2017 while the core increased at 4.9 percent. In the thirty-ninth wave, final demand prices increased at annual equivalent 1.2 percent in May-Jun 2017 while core prices increased at 1.8 percent. In the fortieth wave, final demand prices increased at 1.2 percent annual equivalent in Jul 2017 while core prices increased at 2.4 percent. In the forty-first wave, final demand prices increased at 4.3 percent annual equivalent in Aug-Nov 2017 while core prices increased at 2.7 percent. In the forty-second wave, final demand prices increased at annual equivalent 1.2 percent in Dec 2017 while core prices changed at 0.0 percent. In the forty-third wave, final demand prices increased at annual equivalent 3.7 percent in Jan-Mar 2018 while core prices increased at 3.7 percent. It is almost impossible to forecast PPI inflation and its relation to CPI inflation. “Inflation surprise” by monetary policy could be proposed to climb along a downward sloping Phillips curve, resulting in higher inflation but lower unemployment (see Kydland and Prescott 1977, Barro and Gordon 1983 and past comments of this blog http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html http://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html http://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html). The architects of monetary policy would require superior inflation forecasting ability compared to forecasting naivety by everybody else. In practice, we are all naïve in forecasting inflation and other economic variables and events.
Table I-6B, US, Headline and Core Final Demand Producer Price Inflation Monthly SA and 12-Month NSA ∆%
| Final Demand | Final Demand | Final Demand Core SA | Final Demand Core NSA | |
| Mar 2018 | 0.3 | 3.0 | 0.3 | 2.7 |
| Feb | 0.2 | 2.8 | 0.2 | 2.5 |
| Jan | 0.4 | 2.7 | 0.4 | 2.2 |
| AE ∆% Jan-Mar | 3.7 | 3.7 | ||
| Dec 2017 | 0.1 | 2.6 | 0.0 | 2.3 |
| AE ∆% Dec | 1.2 | 0.0 | ||
| Nov | 0.4 | 3.0 | 0.2 | 2.3 |
| Oct | 0.4 | 2.8 | 0.4 | 2.4 |
| Sep | 0.3 | 2.6 | 0.1 | 2.2 |
| Aug | 0.3 | 2.4 | 0.2 | 2.2 |
| AE ∆% Aug-Nov | 4.3 | 2.7 | ||
| Jul | 0.1 | 2.0 | 0.2 | 1.9 |
| AE ∆% Jul | 1.2 | 2.4 | ||
| Jun | 0.1 | 1.9 | 0.0 | 1.8 |
| May | 0.1 | 2.3 | 0.3 | 2.0 |
| AE ∆% May-Jun | 1.2 | 1.8 | ||
| Apr | 0.4 | 2.5 | 0.4 | 1.9 |
| AE ∆% Apr | 4.9 | 4.9 | ||
| Mar | 0.1 | 2.2 | 0.2 | 1.5 |
| AE ∆% Mar | 1.2 | 2.4 | ||
| Feb | -0.1 | 2.0 | -0.1 | 1.3 |
| AE ∆% Feb | -1.2 | -1.2 | ||
| Jan | 0.5 | 1.7 | 0.4 | 1.4 |
| AE ∆% Jan | 6.2 | 4.9 | ||
| Dec 2016 | 0.4 | 1.7 | 0.1 | 1.7 |
| Nov | 0.1 | 1.3 | 0.2 | 1.7 |
| AE ∆% Nov-Dec | 3.0 | 1.8 | ||
| Oct | 0.3 | 1.1 | 0.2 | 1.5 |
| AE ∆% Oct | 3.7 | 2.4 | ||
| Sep | 0.3 | 0.6 | 0.2 | 1.2 |
| AE ∆% Sep | 3.7 | 2.4 | ||
| Aug | -0.3 | 0.0 | -0.1 | 1.0 |
| AE ∆% Aug | -3.5 | -1.2 | ||
| July | 0.0 | 0.0 | 0.0 | 0.9 |
| AE ∆% Jul | 0.0 | 0.0 | ||
| Jun | 0.5 | 0.2 | 0.3 | 1.2 |
| May | 0.3 | 0.0 | 0.1 | 1.2 |
| Apr | 0.2 | 0.2 | 0.2 | 1.1 |
| AE ∆% Apr-Jun | 4.1 | 2.4 | ||
| Mar | -0.1 | -0.1 | -0.1 | 1.1 |
| Feb | -0.3 | 0.1 | 0.0 | 1.3 |
| AE ∆% Mar-Feb | -2.4 | -0.6 | ||
| Jan | 0.5 | 0.0 | 0.5 | 0.8 |
| AE ∆% Jan | 6.2 | 6.2 | ||
| Dec 2015 | -0.2 | -1.1 | 0.2 | 0.2 |
| AE ∆% Dec | -2.4 | 2.4 | ||
| Nov | 0.1 | -1.3 | 0.1 | 0.3 |
| AE ∆% Nov | 1.2 | 1.2 | ||
| Oct | -0.2 | -1.4 | -0.2 | 0.2 |
| Sep | -0.5 | -1.1 | -0.1 | 0.7 |
| AE ∆% Sep-Oct | -4.1 | -1.8 | ||
| Aug | -0.2 | -1.0 | 0.0 | 0.6 |
| AE ∆% Aug | -2.4 | 0.0 | ||
| Jul | 0.1 | -0.7 | 0.2 | 0.8 |
| Jun | 0.3 | -0.5 | 0.3 | 1.1 |
| May | 0.5 | -0.8 | 0.0 | 0.7 |
| AE ∆% May-Jul | 3.7 | 2.0 | ||
| Apr | -0.1 | -1.1 | 0.2 | 1.0 |
| AE ∆% Apr | -1.2 | 2.4 | ||
| Mar | 0.1 | -0.9 | 0.0 | 0.8 |
| AE ∆% Mar | 1.2 | 0.0 | ||
| Feb | -0.5 | -0.5 | -0.4 | 1.0 |
| Jan | -0.6 | 0.0 | 0.0 | 1.7 |
| AE ∆% Jan-Feb | -6.4 | -2.4 | ||
| Dec 2014 | -0.3 | 0.9 | 0.2 | 2.0 |
| Nov | -0.2 | 1.3 | 0.0 | 1.7 |
| AE ∆% Nov-Dec | -3.0 | 1.2 | ||
| Oct | 0.2 | 1.5 | 0.4 | 1.9 |
| AE ∆% Oct | 2.4 | 4.9 | ||
| Sep | -0.2 | 1.6 | -0.1 | 1.6 |
| Aug | 0.0 | 1.9 | 0.0 | 1.9 |
| AE ∆% Aug-Sep | -1.2 | -0.6 | ||
| Jul | 0.3 | 1.9 | 0.5 | 1.9 |
| Jun | 0.0 | 1.8 | 0.0 | 1.6 |
| May | 0.2 | 2.1 | 0.3 | 2.1 |
| Apr | 0.1 | 1.8 | 0.0 | 1.5 |
| Mar | 0.4 | 1.6 | 0.3 | 1.6 |
| AE ∆% Mar-Jul | 2.4 | 2.7 | ||
| Feb | 0.2 | 1.2 | 0.2 | 1.6 |
| Jan | 0.3 | 1.3 | 0.2 | 1.4 |
| Dec 2013 | 0.1 | 1.2 | 0.0 | 1.2 |
| AE ∆% Dec-Feb | 2.4 | 1.6 | ||
| Nov | 0.2 | 1.1 | 0.2 | 1.4 |
| Oct | 0.2 | 1.3 | 0.2 | 1.7 |
| Sep | 0.0 | 1.1 | 0.1 | 1.6 |
| AE ∆% Sep-Nov | 1.6 | 2.0 | ||
| Aug | 0.1 | 1.7 | 0.0 | 1.8 |
| Jul | 0.2 | 2.0 | 0.3 | 1.7 |
| Jun | 0.4 | 1.7 | 0.4 | 1.3 |
| May | -0.1 | 0.9 | -0.3 | 0.9 |
| AE ∆% May-Aug | 1.8 | 1.6 | ||
| Apr | -0.2 | 0.9 | 0.2 | 1.3 |
| Mar | 0.0 | 1.3 | 0.2 | 1.5 |
| AE ∆% Mar-Apr | -1.2 | 2.4 | ||
| Feb | 0.2 | 1.6 | 0.0 | 1.4 |
| Jan | 0.3 | 1.6 | 0.1 | 1.7 |
| AE ∆% Jan-Feb | 3.0 | 0.6 | ||
| Dec 2012 | 0.0 | 1.9 | 0.1 | 2.0 |
| Nov | 0.1 | 1.7 | 0.5 | 1.8 |
| Oct | 0.1 | 1.9 | 0.1 | 1.6 |
| AE ∆% Oct-Dec | 0.8 | 2.8 | ||
| Sep | 0.7 | 1.5 | 0.3 | 1.4 |
| Aug | 0.3 | 1.2 | -0.1 | 1.2 |
| AE ∆% Aug-Sep | 6.2 | 1.2 | ||
| Jul | -0.1 | 1.0 | -0.1 | 1.7 |
| Jun | -0.3 | 1.3 | -0.1 | 1.9 |
| AE ∆% Jun-Jul | -2.4 | -1.2 | ||
| May | -0.1 | 1.6 | 0.2 | 2.2 |
| Apr | 0.3 | 2.0 | 0.3 | 2.1 |
| AE ∆% Apr-May | 1.2 | 3.0 | ||
| Mar | 0.2 | 2.4 | 0.2 | 2.3 |
| Feb | 0.3 | 2.8 | 0.3 | 2.6 |
| Jan | 0.4 | 3.1 | 0.4 | 2.5 |
| AE ∆% Jan-Mar | 3.7 | 3.7 | ||
| Dec 2011 | -0.1 | 3.2 | 0.0 | 2.6 |
| Nov | 0.3 | 3.7 | 0.2 | 2.7 |
| Oct | -0.4 | 3.7 | -0.3 | 2.7 |
| AE ∆% Oct-Dec | -0.8 | -0.4 | ||
| Sep | 0.4 | 4.5 | 0.2 | 2.9 |
| Aug | 0.2 | 4.4 | 0.4 | 3.0 |
| Jul | 0.2 | 4.5 | 0.2 | 2.7 |
| AE ∆% Jul-Sep | 3.2 | 3.2 | ||
| Jun | 0.1 | 4.3 | 0.2 | 2.6 |
| May | 0.3 | 4.2 | 0.2 | 2.3 |
| AE ∆% May-Jun | 2.4 | 2.4 | ||
| Apr | 0.5 | 4.2 | 0.3 | 2.5 |
| Mar | 0.7 | 4.0 | 0.5 | NA |
| Feb | 0.6 | 3.3 | 0.3 | NA |
| Jan | 0.6 | 2.4 | 0.4 | NA |
| AE ∆% Jan-Apr | 7.4 | 4.6 | ||
| Dec 2010 | 0.3 | 2.8 | 0.1 | NA |
| Nov | 0.3 | 2.6 | 0.1 | NA |
| Oct | 0.4 | NA | 0.1 | NA |
| Sep | 0.3 | NA | 0.2 | NA |
| Aug | 0.2 | NA | 0.0 | NA |
| Jul | 0.2 | NA | 0.2 | NA |
| Jun | -0.2 | NA | -0.1 | NA |
| May | 0.2 | NA | 0.3 | NA |
| Apr | 0.3 | NA | NA | NA |
| Mar | 0.1 | NA | NA | NA |
| Feb | -0.2 | NA | NA | NA |
| Jan | 0.9 | NA | NA | NA |
| Dec 2009 | 0.1 |
Note: Core: excluding food and energy; AE: annual equivalent
Source: US Bureau of Labor Statistics http://www.bls.gov/ppi/data.htm
Chart I-24B provides the FD PPI NSA from 2009 to 2018. There is persistent inflation with periodic declines in inflation waves similar to those worldwide.
Chart I-24B, US, Final Demand Producer Price Index, NSA, 2009-2018
Source: US Bureau of Labor Statistics
Twelve-month percentage changes of the FD PPI from 2010 to 2018 are in Chart I-25B. There are fluctuations in the rates with evident trend of decline to more subdued inflation. Reallocations of investment portfolios of risk financial assets from commodities to stocks explain much lower FD PPI inflation.
Chart I-25B, US, Final Demand Producer Price Index, 12-Month Percentage Change NSA, 2010-2018
Source: US Bureau of Labor Statistics
The core FD PPI NSA is in Chart I-26B. The behavior is similar to the headline index but with less fluctuation.
Chart I-26B, US, Final Demand Producer Price Index Excluding Food and Energy, NSA, 2009-2018
Source: US Bureau of Labor Statistics
Percentage changes in 12 months of the core FD PPI are in Chart I-27B. There are fluctuations in 12-month percentage changes but with evident declining trend to more moderate inflation.
Chart I-27B, US, Final Demand Producer Price Index Excluding Food and Energy, 12-Month Percentage Change, NSA, 2010-2018
Source: US Bureau of Labor Statistics
The energy FD PPI NSA is in Chart I-28B. The index increased during the reposition of carry trades after the discovery of lack of toxic assets in banks that caused flight away from risk financial assets into government obligations of the US (Cochrane and Zingales 2009). Alternating risk aversion and appetite with reallocations among classes of risk financial assets explain the behavior of the index after late 2010.
Chart I-28B, US, Final Demand Energy Producer Price Index, NSA, 2009-2018
Source: US Bureau of Labor Statistics
Twelve-month percentage changes of the FD energy PPI are in Chart I-29B. Rates moderated from late 2010 to the present. There are multiple negative rates. Investors create and reverse carry trades from zero interest rates to derivatives of commodities in accordance with relative risk evaluations of classes of risk financial assets.
Chart I-29B, US, Final Demand Energy Producer Price Index, 12-Month Percentage Change, NSA, 2010-2018
Source: US Bureau of Labor Statistics
Table I-7 provides 12-month percentage changes of the CPI all items, CPI core and CPI housing from 2001 to 2018. There is no evidence in these data supporting symmetric inflation targets that would only induce greater instability in inflation, interest rates and financial markets. Unconventional monetary policy drives wide swings in allocations of positions into risk financial assets that generate instability instead of intended pursuit of prosperity without inflation. There is insufficient knowledge and imperfect tools to maintain the gap of actual relative to potential output constantly at zero while restraining inflation in an open interval (1.99, 2.0). Symmetric targets appear to have been abandoned in a favor of a self-imposed single jobs mandate of easing
monetary policy even with the economy growing at or close to potential output.
Table I-7, CPI All Items, CPI Core and CPI Housing, 12-Month Percentage Change, NSA 2001-2018
| Mar | CPI All Items | CPI Core ex Food and Energy | CPI Housing |
| 2018 | 2.4 | 2.1 | 3.0 |
| 2017 | 2.4 | 2.0 | 3.1 |
| 2016 | 0.9 | 2.2 | 2.1 |
| 2015 | -0.1 | 1.8 | 1.9 |
| 2014 | 1.5 | 1.7 | 2.8 |
| 2013 | 1.5 | 1.9 | 1.9 |
| 2012 | 2.7 | 2.3 | 1.7 |
| 2011 | 2.7 | 1.2 | 0.8 |
| 2010 | 2.3 | 1.1 | -0.6 |
| 2009 | -0.4 | 1.8 | 1.4 |
| 2008 | 4.0 | 2.4 | 3.0 |
| 2007 | 2.8 | 2.5 | 3.4 |
| 2006 | 3.4 | 2.1 | 3.7 |
| 2005 | 3.1 | 2.3 | 3.3 |
| 2004 | 1.7 | 1.6 | 2.0 |
| 2003 | 3.0 | 1.7 | 2.9 |
| 2002 | 1.5 | 2.4 | 2.1 |
| 2001 | 2.9 | 2.7 | 4.5 |
Source: US Bureau of Labor Statistics http://www.bls.gov/cpi/
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 raised the fed funds rate to ¼ to ½ at its meeting on Dec 16, 2015 (http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm) and increased the fed funds rate to ½ to ¾ percent at its meeting on Dec 14, 2016 (https://www.federalreserve.gov/newsevents/press/monetary/20161214a.htm). The FOMC raised the fed funds rate to ¾ to 1 percent at its meeting on Mar 15, 2017 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20170315a.htm). The FOMC raised the fed funds rate to 1 to 1 ¼ percent at its meeting on Jun 14, 2017 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20170201a.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.
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 below what would be without central bank intervention, will remain in perpetuity, or QE→∞, changing to a “growth mandate.” The FOMC is implementing gradual reduction of the portfolio of government securities in the balance sheet of the Fed beginning in Oct 2017. 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 2.2 percent on average in the cyclical expansion in the 34 quarters from IIIQ2009 to IVQ2017. 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 IVQ2017 (https://www.bea.gov/newsreleases/national/gdp/2018/pdf/gdp4q17_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 (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.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, 4.3 percent from IQ1983 to IIIQ1990, 4.0 percent from IQ1983 to IVQ1990, 3.8 percent from IQ1983 to IQ1991, 3.8 percent from IQ1983 to IIQ1991 and at 7.8 percent from IQ1983 to IVQ1983 (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.html). The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). 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 IVQ2017 would have accumulated to 34.4 percent. GDP in IVQ2017 would be $20,149.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2862.5 billion than actual $17,286.5 billion. There are about two trillion dollars of GDP less than at trend, explaining the 21.9 million unemployed or underemployed equivalent to actual unemployment/underemployment of 12.8 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2018/04/twenty-two-million-unemployed-or.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/twenty-three-million-unemployed-or.html). US GDP in IVQ2017 is 14.2 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $17,286.5 billion in IVQ2017 or 15.3 percent at the average annual equivalent rate of 1.4 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 2018. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 149.0946 in Feb 2018. The actual index NSA in Feb 2018 is 104.4525, which is 29.9 percent below trend. Manufacturing output grew at average 2.0 percent between Dec 1986 and Feb 2018. Using trend growth of 2.0 percent per year, the index would increase to 132.3793 in Feb 2018. The output of manufacturing at 104.4525 in Feb 2018 is 21.1 percent below trend under this alternative calculation.
First, Total nonfarm payroll employment seasonally adjusted (SA) increased 103,000 in Mar 2018 and private payroll employment increased 102,000. The Bureau of Labor Statistics states (https://www.bls.gov/news.release/empsit.nr0.htm): “Our analysis suggests that the net effect of these hurricanes [Harvey and Irma] was to reduce the estimate of total nonfarm payroll employment for September. There was no discernible effect on the national unemployment rate. No changes were made to either the establishment or household survey estimation procedures for the September figures.” The average monthly number of nonfarm jobs created from Mar 2016 to Mar 2017 was 190,083 using seasonally adjusted data, while the average number of nonfarm jobs created from Mar 2017 to Mar 2018 was 188,417 or decrease by 0.9 percent. The average number of private jobs created in the US from Mar 2016 to Mar 2017 was 178,333, using seasonally adjusted data, while the average from Mar 2017 to Mar 2018 was 187,417 or increase by 5.1 percent. This blog calculates the effective labor force of the US at 170.198 million in Mar 2018 and 168.422 million in Mar 2017 (Table I-4), for growth of 1.776 million at average 148,000 per month. The difference between the average increase of 187,417 new private nonfarm jobs per month in the US from Feb 2017 to Feb 2018 and the 148,000-average monthly increase in the labor force from Mar 2017 to Mar 2018 is 39,417 monthly new jobs net of absorption of new entrants in the labor force. There are 21.855 million in job stress in the US currently. Creation of 39,417 new jobs per month net of absorption of new entrants in the labor force would require 554 months to provide jobs for the unemployed and underemployed (21.855 million divided by 39,417) or 46 years (554 divided by 12). The civilian labor force of the US in Mar 2018 not seasonally adjusted stood at 161.548 million with 6.671 million unemployed or effectively 15.321 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 170.198 million. Reduction of one million unemployed at the current rate of job creation without adding more unemployment requires 2.114 years (1 million divided by product of 39,417 by 12, which is 473,000). Reduction of the rate of unemployment to 5 percent of the labor force would be equivalent to unemployment of only 8.077 million (0.05 times labor force of 161.548 million). New net job creation would be minus 1.406 million (6.671 million unemployed minus 8.077 million unemployed at rate of 5 percent) that at the current rate would take 0.0 years (-1.406 million divided by 0.473). Under the calculation in this blog, there are 15.321 million unemployed by including those who ceased searching because they believe there is no job for them and effective labor force of 170.198 million. Reduction of the rate of unemployment to 5 percent of the labor force would require creating 6.811 million jobs net of labor force growth that at the current rate would take 14.4 years (15.321 million minus 0.05
(170.190 million) = 6.811 million divided by 0.473000 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 Mar 2018 was 154.877 million (NSA) or 7.562 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 257.097 million in Mar 2018 or by 25.139 million. The number employed increased 5.1 percent from Jul 2007 to Mar 2018 while the noninstitutional civilian population of ages of 16 years and over, or those available for work, increased 10.8 percent. The ratio of employment to population in Jul 2007 was 63.5 percent (147.315 million employed as percent of population of 231.958 million). The same ratio in Mar 2018 would result in 163.257 million jobs (0.635 multiplied by noninstitutional civilian population of 257.097 million). There are effectively 8.380 million fewer jobs in Mar 2018 than in Jul 2007, or 163.257 million minus 154.877 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/2018/03/decreasing-valuations-of-risk-financial.html and earlier https://cmpassocregulationblog.blogspot.com/2018/02/collateral-effects-of-unwinding.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 2.2 percent on average in the cyclical expansion in the 34 quarters from IIIQ2009 to IVQ2017. 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 IVQ2017 (https://www.bea.gov/newsreleases/national/gdp/2018/pdf/gdp4q17_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 (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.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, 4.3 percent from IQ1983 to IIIQ1990, 4.0 percent from IQ1983 to IVQ1990, 3.8 percent from IQ1983 to IQ1991, 3.8 percent from IQ1983 to IIQ1991 and at 7.8 percent from IQ1983 to IVQ1983 (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.html). The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). 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 IVQ2017 would have accumulated to 34.4 percent. GDP in IVQ2017 would be $20,149.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2862.5 billion than actual $17,286.5 billion. There are about two trillion dollars of GDP less than at trend, explaining the 21.9 million unemployed or underemployed equivalent to actual unemployment/underemployment of 12.8 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2018/04/twenty-two-million-unemployed-or.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/twenty-three-million-unemployed-or.html). US GDP in IVQ2017 is 14.2 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $17,286.5 billion in IVQ2017 or 15.3 percent at the average annual equivalent rate of 1.4 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 2018. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 149.0946 in Feb 2018. The actual index NSA in Feb 2018 is 104.4525, which is 29.9 percent below trend. Manufacturing output grew at average 2.0 percent between Dec 1986 and Feb 2018. Using trend growth of 2.0 percent per year, the index would increase to 132.3793 in Feb 2018. The output of manufacturing at 104.4525 in Feb 2018 is 21.1 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, 2.6 percent in 2014 and 2.9 percent in 2015. GDP growth was 1.5 percent in 2016 and 2.3 percent in 2017. The following calculations show that actual growth is around 2.2 percent per year. The rate of growth of 1.4 percent in the entire cycle from 2007 to 2017 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 | ||
| 1929-2017 | 3.2 | |
| 1947-2017 | 3.2 | |
| Whole Cycles | ||
| 1980-1989 | 3.5 | |
| 2006-2017 | 1.4 | |
| 2007-2017 | 1.4 | |
| 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 IQ1983 to IIIQ1990 IQ1983 to IVQ1990 | 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 4.3 4.0 | |
| IQ1983 to IQ1991 IQ1983 to IIQ1991 | 3.8 | |
| First Four Quarters IQ1983 to IVQ1983 | 7.8 | |
| IIIQ2009 to IVQ2017 | 2.2 | |
| First Four Quarters IIIQ2009 to IIQ2010 | 2.7 | |
| Real Disposable Income | Real Disposable Income per Capita | |
| Long-Term | ||
| 1929-2017 | 3.1 | 2.0 |
| 1947-1999 | 3.7 | 2.3 |
| Whole Cycles | ||
| 1980-1989 | 3.5 | 2.6 |
| 2006-2017 | 1.7 | 0.9 |
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 2.2 percent per year. Table Summary GDP provides the data.
1. Average Annual Growth in the Past Twenty-Four Quarters. GDP growth in the four quarters of 2012, the four quarters of 2013, the four quarters of 2014, the four quarters of 2015, the four quarters of 2016 and the four quarters of 2017 accumulated to 13.8 percent. This growth is equivalent to 2.2 percent per year, obtained by dividing GDP in IVQ2017 of $17,286.5 billion by GDP in IVQ2011 of $15,190.3 billion and compounding by 4/24: {[($17,286.5/$15,190.3)4/24 -1]100 = 2.2 percent}.
2. Average Annual Growth in the Past Four Quarters. GDP growth in the four quarters from IVQ2016 to IVQ2017 accumulated to 2.6 percent that is equivalent to 2.6 percent in a year. This is obtained by dividing GDP in IVQ2017 of $17,286.5 billion by GDP in IVQ2006 of $16,851.4 billion and compounding by 4/4: {[($17,286.5/$16,851.4)4/4 -1]100 = 2.6%}. The US economy grew 2.6 percent in IVQ2017 relative to the same quarter a year earlier in IVQ2016. Growth was at annual equivalent 4.6 percent in IIQ2014 and 5.2 percent IIIQ2014 and only at 2.0 percent in IVQ2014. GDP grew at annual equivalent 3.2 percent in IQ2015, 2.7 percent in IIQ2015, 1.6 percent in IIIQ2015 and 0.5 percent in IVQ2015. GDP grew at annual equivalent 0.6 percent in IQ2016 and at 2.2 percent annual equivalent in IIQ2016. GDP increased at 2.8 percent annual equivalent in IIIQ2016 and at 1.8 percent in IVQ2016. GDP grew at annual equivalent 1.2 percent in IQ2017 and at annual equivalent 3.1 percent in IIQ2017. GDP grew at annual equivalent 3.2 percent in IIIQ2017. GDP grew at annual equivalent 2.9 percent in IVQ2017. 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 0.2 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 2009 Dollars and ∆%
| Real GDP, Billions Chained 2009 Dollars | ∆% Relative to IVQ2007 | ∆% Relative to Prior Quarter | ∆% | |
| 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 | 15,757.6 | 5.1 | -0.2 | 1.7 |
| IIQ2014 | 15,935.8 | 6.3 | 1.1 | 2.7 |
| IIIQ2014 | 16,139.5 | 7.7 | 1.3 | 3.2 |
| IVQ2014 | 16,220.2 | 8.2 | 0.5 | 2.7 |
| IQ2015 | 16,350.0 | 9.1 | 0.8 | 3.8 |
| IIQ2015 | 16,460.9 | 9.8 | 0.7 | 3.3 |
| IIIQ2015 | 16,527.6 | 10.2 | 0.4 | 2.4 |
| IVQ2015 | 16,547.6 | 10.4 | 0.1 | 2.0 |
| IQ2016 | 16,571.6 | 10.5 | 0.1 | 1.4 |
| IIQ2016 | 16,663.5 | 11.2 | 0.6 | 1.2 |
| IIIQ2016 | 16,778.1 | 11.9 | 0.7 | 1.5 |
| IVQ2016 | 16,851.4 | 12.4 | 0.4 | 1.8 |
| IQ2017 | 16,903.2 | 12.7 | 0.3 | 2.0 |
| IIQ2017 | 17,031.1 | 13.6 | 0.8 | 2.2 |
| IIIQ2017 | 17,163.9 | 14.5 | 0.8 | 2.3 |
| IVQ2017 | 17,286.5 | 15.3 | 0.7 | 2.6 |
| Cumulative ∆% IQ2012 to IVQ2017 | 13.8 | 13.9 | ||
| Annual Equivalent ∆% | 2.2 | 2.2 |
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 IQ2014 to IVQ2017. 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 below what would be without central bank intervention, cannot be abandoned because of the fear of rising interest rates. The FOMC is implementing gradual reduction of the portfolio of government securities in the balance sheet of the Fed. 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 21, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180321a.htm):
March 21, 2018
Federal Reserve issues FOMC statement
For release at 2:00 p.m. EDT
Information received since the Federal Open Market Committee met in January indicates that the labor market has continued to strengthen and that economic activity has been rising at a moderate rate. Job gains have been strong in recent months, and the unemployment rate has stayed low. Recent data suggest that growth rates of household spending and business fixed investment have moderated from their strong fourth-quarter readings. On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but 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 economic outlook has strengthened in recent months. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong. Inflation on a 12-month basis is expected to move up in coming months and to stabilize around the Committee's 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.
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 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative, thereby supporting strong 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 further 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.
Voting for the FOMC monetary policy action were Jerome H. Powell, Chairman; William C. Dudley, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Lael Brainard; Loretta J. Mester; Randal K. Quarles; and John C. Williams.
Implementation Note issued March 21, 2018
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. Increased Policy 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 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.”
3. 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 further 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).
4. Policy Commitment with Maximum 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.”
5. Concern with Inflation and Symmetric Inflation Goal. “The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal” (emphasis added).
6. All Measures Depend on Data. “However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data” (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 now currently at 1½ to 1¾ 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 1½ to 1¾ percent with gradual consideration of further rate increases with all measures depending on “incoming data” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180321a.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). The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy.
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 (https://cmpassocregulationblog.blogspot.com/2018/01/twenty-three-million-unemployed-or.html and earlier https://cmpassocregulationblog.blogspot.com/2017/12/twenty-one-million-unemployed-or.html and earlier 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 24,360.14 on Apr 13, 2018, which is higher by 72.0 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 71.6 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 1 and 1 ½ 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 1 and 1¼ 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 29.0 percent relative to the dollar from the high on Jul 15, 2008 to Apr 13, 2018.
| 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 29.0 percent relative to the dollar from the high on Jul 15, 2008 to Apr 13, 2018.
| 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?
What is truly important is the fixing of the overnight fed funds at 1¼ to 1½ percent with gradual consideration of further rate increases with all measures depending on “incoming data” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180131a.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 further 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). The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy.
The decisions of the FOMC (Federal Open Market Committee) depend on incoming data. There are unexpected swings in valuations of risk financial assets by “carry trades” from interest rates below inflation to exposures in stocks, commodities and their derivatives. Another issue is the unexpected “data surprises” such as the sharp decline in 12 months rates of increase of real disposable income, or what is left after taxes and inflation, and the price indicator of the FOMC, prices of personal consumption expenditures (PCE) excluding food and energy. There is no science or art of monetary policy that can deal with this uncertainty.
| Real Disposable Personal Income | Real Personal Consumption Expenditures | Prices of Personal Consumption Expenditures | PCE Prices Excluding Food and Energy |
| ∆%12M | ∆%12M | ∆%12M | ∆%12M |
| 6/2017 | 6/2017 | 6/2017 | 6/2017 |
| 1.2 | 2.4 | 1.4 | 1.5 |
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.
- 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.
- 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 2017 and Feb 2018. Total assets of US commercial banks grew 3.4 percent from $16,195.2 billion in Feb 2016 to $16,738.2 billion in Feb 2018. The Bureau of Economic Analysis (BEA) estimates US GDP in 2017 at $19,390.6 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 3.3 percent from $12,155.3 billion in Feb 2017 to $12,556.1 billion in Feb 2018. Securities in bank credit increased 1.7 percent from $3355 billion in Feb 2017 to $3411 billion in Feb 2018. A large part of securities in banking credit consists of US Treasury and agency securities, increasing 2.5 percent from $2445 billion in Feb 2017 to $2505 billion in Feb 2018. Credit to the government that issues or backs Treasury and agency securities of $2505 billion in Feb 2018 is about 20.0 percent of total bank credit of US commercial banks of $12,556.1 billion. Mortgage-backed securities, providing financing of home loans, increased 5.6 percent, from $1694 billion in Feb 2017 to $1789 billion in Feb 2018. Loans and leases are relatively dynamic, growing 3.9 percent from $8801 billion in Feb 2017 to $9145 billion in Feb 2018. A dynamic class historically, currently slowing, is commercial and industrial loans, growing 1.2 percent from $2099 billion in Feb 2017 and providing $2124 billion or 23.2 percent of total loans and leases of $9145 billion in Feb 2018. Real estate loans increased 4.1 percent, providing $4304 billion in Feb 2018 or 47.1 percent of total loans and leases. Consumer loans increased 5.4 percent, providing $1436 billion in Feb 2018 or 15.7 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 1.0 percent from $2389 billion in Feb 2017 to $2364 billion in Feb 2018 but a single year of the series masks exploding cash in banks because of unconventional monetary policy, which is discussed below. Bank deposits increased 3.6 percent from $11,565 billion in Feb 2017 to $11,986 billion in Feb 2018. The difference between bank deposits and total loans and leases in banks increased from $2764 billion in Feb 2017 to $2841 billion in Feb 2018 or by $77 billion. Securities in bank credit increased $56 billion from $3355 billion in Feb 2017 to $3411 billion in Feb 2018 and Treasury and agency securities increased $60 billion from $2445 billion in Feb 2017 to $2505 billion in Feb 2018. Loans and leases increased $344 billion from $8801 billion in Feb 2017 to $9145 billion in Feb 2018. 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 IVQ2017 is higher by only 9.5 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 21.9 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 25.4 percent in the cycle from IQ1980 to IIQ1991 that was close to trend growth of 26.2 percent. The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm).
Table I-1, US, Assets and Liabilities of Commercial Banks, NSA, Billions of Dollars
| Feb 2017 | Feb 2018 | ∆% | |
| Total Assets | 16,195.2 | 16,738.2 | 3.4 |
| Bank Credit | 12,155.3 | 12,556.1 | 3.3 |
| Securities in Bank Credit | 3355 | 3411 | 1.7 |
| Treasury & Agency Securities | 2445 | 2505 | 2.5 |
| Mortgage-Backed Securities | 1694 | 1789 | 5.6 |
| Loans & Leases | 8801 | 9145 | 3.9 |
| Real Estate Loans | 4135 | 4304 | 4.1 |
| Commercial Real Estate Loans | 1991 | 2101 | 5.5 |
| Consumer Loans | 1363 | 1436 | 5.4 |
| Commercial & Industrial Loans | 2099 | 2124 | 1.2 |
| Other Loans & Leases | 1204 | 1282 | 6.5 |
| Cash Assets* | 2389 | 2364 | -1.0 |
| Total Liabilities | 14,423 | 14,922 | 3.5 |
| Deposits | 11,565 | 11,986 | 3.6 |
| Residual (Assets less Liabilities) | 1772 | 1816 | 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 2012 to 2017 and for Jan 2018 and Feb 2018. 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 54.4 percent in 2013 and 12.2 percent in 2014, decreasing 7.9 percent in 2015. Cash assets of banks decreased 14.4 percent in 2016 and increased 7.8 percent in 2017. 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 38.9 percent in Feb 2017 and increased at 31.2 percent in Mar 2017. Cash assets of banks decreased at 28.3 percent in Apr 2017 and decreased at 31.7 percent in May 2017. Cash assets of banks increased at 5.3 percent in Jun 2017 and increased at 18.0 percent in Jul 2017. Cash assets of banks increased at 35.9 percent in Aug 2017 and decreased at 3.0 percent in Sep 2017. Cash assets of banks decreased at 0.2 percent in Oct 2017. Cash assets of banks increased at 9.0 percent in Nov 2017 and increased at 25.6 percent in Dec 2017. Cash assets of banks decreased at 37.9 percent in Jan 2018 and decreased at 21.6 percent in Feb 2018. 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 5.5 percent in Jan 2017 and increased at 1.2 percent in Feb 2017. Securities in bank credit increased at 1.3 percent in Mar 2017. Securities in bank credit increased at 1.3 percent in Apr 2017 and increased at 6.2 percent in May 2017. Securities in bank credit increased at 0.2 percent in Jun 2017 and increased at 2.4 percent in Jul 2017. Securities in bank credit increased at 1.1 percent in Aug 2017 and increased at 0.7 percent in Sep 2017. Securities in bank credit increased at 2.9 percent in Oct 2017.
Securities in bank credit increased at 3.4 percent in Nov 2017 and increased at 4.4 percent in Dec 2017. Securities in bank credit decreased at 0.1 percent in Jan 2018 and decreased at 10.0 percent in Feb 2018. 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 1.0 percent in Feb 2017. Treasury and agency securities decreased at 2.2 percent in Mar 2017. Treasury and agency securities increased at 2.7 percent in Apr 2017 and increased at 7.3 percent in May 2017. Treasury and agency secure ties increased at 0.8 percent in Jun 2017 and increased at 5.6 percent in Jul 2017. Treasury and agency securities increased at 1.4 percent in Aug 2017 and increased at 1.5 percent in Sep 2017. Treasury and agency securities increased at 6.0 percent in Oct 2017. Treasury and agency securities increased at 0.8 percent in Nov 2017 and increased at 4.3 percent in Dec 2017. Treasury and agency securities decreased at 2.8 percent in Jan 2018 and decreased at 10.3 percent in Feb 2018. 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. Deposits increased at 6.5 percent in Mar 2017. Deposits increased at 3.5 percent in Apr 2017 and increased at 8.1 percent in May 2017. Deposits increased at 1.0 percent in Jun 2017 and increased at 6.9 percent in Jul 2017. Deposits increased at 3.4 percent in Aug 2017 and increased at 3.3 percent in Sep 2017. Deposits increased at 5.9 percent in Oct 2017. Deposits increased at 1.1 percent in Nov 2017 and increased at 2.2 percent in Dec 2017. Deposits increased at 3.1 percent in Jan 2018 and decreased at 1.3 percent in Feb 2018. 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, ∆%
| 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | Jan 2018 | Feb 2018 | |
| Total Assets | 2.6 | 6.7 | 7.3 | 3.5 | 2.8 | 3.6 | -2.8 | -2.4 |
| Bank Credit | 4.1 | 1.6 | 6.5 | 7.3 | 6.9 | 2.8 | 2.2 | 0.0 |
| Securities in Bank Credit | 7.6 | -1.9 | 6.8 | 6.1 | 8.0 | 1.7 | -0.1 | -10.0 |
| Treasury & Agency Securities | 8.4 | -5.8 | 11.3 | 8.9 | 10.1 | 2.6 | -2.8 | -10.3 |
| Other Securities | 5.8 | 6.9 | -2.3 | -0.5 | 2.7 | -0.8 | 7.6 | -9.0 |
| Loans & Leases | 2.9 | 3.0 | 6.4 | 7.8 | 6.5 | 3.3 | 3.1 | 3.7 |
| Real Estate Loans | -1.1 | -1.0 | 2.4 | 5.3 | 6.5 | 3.6 | 3.2 | 2.9 |
| Commercial Real Estate Loans | -1.3 | 4.5 | 6.8 | 10.5 | 10.3 | 6.1 | 4.4 | 4.6 |
| Consumer Loans | 0.6 | 3.2 | 4.9 | 5.9 | 7.0 | 4.2 | 4.2 | 4.6 |
| Commercial & Industrial Loans | 11.6 | 6.9 | 12.0 | 10.6 | 6.5 | 0.7 | 2.5 | 1.6 |
| Other Loans & Leases | 8.1 | 13.7 | 14.8 | 14.6 | 6.0 | 5.5 | 2.2 | 8.6 |
| Cash Assets | -2.2 | 54.4 | 12.2 | -7.9 | -14.4 | 7.8 | -37.9 | -21.6 |
| Total Liabilities | 2.3 | 8.1 | 7.6 | 3.1 | 2.7 | 3.5 | -0.3 | -1.6 |
| Deposits | 7.2 | 6.5 | 6.4 | 4.9 | 4.4 | 4.5 | 3.1 | -1.3 |
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 2018. 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 3.8 percent in 34 quarters of cyclical expansion from IQ1983 to IIQ1991. The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). In contrast, the average rate in 34 quarters of cyclical expansion from IIIQ2009 to IVQ2017 has been at the rate of 2.2 percent (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.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. The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). 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 $19,390.6 billion in 2017, such that the bailout would be equivalent to cost to taxpayers of about $513.9 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, 1973-2018, ∆%
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 2018. 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, 1947-2018, ∆%
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 2018. 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, 1973-2018, ∆%
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 2018. 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, 1947-2018,
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 2018. 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 2.2 percent annual equivalent in the current weak expansion.
Chart I-5, US, Loans and Leases in Bank Credit, Commercial Banks, Seasonally Adjusted Annual Rate, Monthly, 1947-2018, ∆%
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, 1947-2018, ∆%
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, 1958-2018, ∆%
Source: Board of Governors of the Federal Reserve System
https://www.federalreserve.gov/releases/h8/current/default.htm
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
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 valuable 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 2017 and at 3.2 percent per year from 1947 to 2017. Real disposable income grew at the average yearly rate of 3.1 percent from 1929 to 2017 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 2017 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 1.7 percent from 2006 to 2017 and real disposable income per capita at 0.9 percent. Real disposable income grew at the average rate of 1.7 percent from 2007 to 2017 and real disposable income per capita at 0.9 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 1.4 percent from 2006 to 2017 and 1.4 percent from 2007 to 2017 and real disposable income growth fell from 2.9 percent on average from 2000 to 2006 to 1.7 percent from 2006 to 2017 and 1.7 percent from 2007 to 2017. The decline of growth of real per capita disposable income is even sharper from average 2.0 percent from 2000 to 2006 to 0.9 percent from 2006 to 2017 and 0.9 percent from 2007 to 2017 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 34 quarters of expansion. In the expansion from IQ1983 to IIQ1991: GDP grew 37.6 percent at the annual equivalent rate of 3.8 percent; real disposable income grew 32.7 percent at the annual equivalent rate of 3.4 percent; and real disposable income per capita grew 22.2 percent at the annual equivalent rate of 2.4 percent. The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm).
In the expansion from IIIQ2009 to IVQ2017: GDP grew 20.4 percent at the annual equivalent rate of 2.2 percent; real disposable income grew 16.3 percent at the annual equivalent rate of 1.8 percent; and real disposable personal income per capita grew 9.2 percent at the annual equivalent rate of 1.0 percent. Fourth, entire quarterly cycle. In the entire cycle combining contraction and expansion from IQ1980 to IIQ1991: GDP grew 37.4 percent at the annual equivalent rate of 2.7 percent; real disposable personal income grew 40.4 percent at the annual equivalent rate of 2.9 percent; and real disposable personal income per capita 25.5 percent at the annual equivalent rate of 2.0 percent. The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (https://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). In the entire cycle combining contraction and expansion from IVQ2007 to IVQ2017: GDP grew 15.3 percent at the annual equivalent rate of 1.4 percent; real disposable personal income increased 18.2 percent at the annual equivalent rate of 1.7 percent; and real disposable personal income per capita grew 9.5 percent at the annual equivalent rate of 0.9 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 convincing 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.
| Long-term Average ∆% per Year | GDP | Population | |
| 1929-2017 | 3.2 | 1.1 | |
| 1947-2017 | 3.2 | 1.2 | |
| 1947-1999 | 3.6 | 1.3 | |
| 1980-1989 | 3.5 | 0.9 | |
| 2000-2017 | 1.8 | 0.8 | |
| 2000-2006 | 2.6 | 0.9 | |
| 2006-2017 | 1.4 | 0.8 | |
| 2007-2017 | 1.4 | 0.8 | |
| Long-term Average ∆% per Year | Real Disposable Income | Real Disposable Income per Capita | Population |
| 1929-2017 | 3.1 | 2.0 | 1.1 |
| 1947-1999 | 3.7 | 2.3 | 1.3 |
| 2000-2017 | 2.1 | 1.3 | 0.8 |
| 2000-2006 | 2.9 | 2.0 | 0.9 |
| 2006-2017 | 1.7 | 0.9 | 0.8 |
| 2007-2017 | 1.7 | 0.9 | 0.8 |
| Whole Cycles Average ∆% per Year | |||
| 1980-1989 | 3.5 | 2.6 | 0.9 |
| 2006-2017 | 1.7 | 0.9 | 0.8 |
| 2007-2017 | 1.7 | 0.9 | 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 I83 to III90 I83 to IV90 I83 to I91 I83 to II91 | 4 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 | 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 38.4 37.2 36.5 37.6 | 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 4.3 4.0 3.8 3.8 |
| 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 I83 to III90 I83 to IV90 I83 to I91 I83 to II91 | 4 17 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 | 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 32.6 31.5 31.8 32.7 | 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 3.7 3.5 3.4 3.4 |
| 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 I83 to III90 I83 to IV90 I83 to I91 I83 to II91 | 4 17 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 | 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 23.3 21.9 21.8 22.2 | 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 2.7 2.5 2.4 2.4 |
| Whole Cycle IQ1980 to IIQ1991 | |||
| GDP | 47 | 37.4 | 2.7 |
| RDPI | 47 | 40.4 | 2.9 |
| RDPI per Capita | 47 | 25.5 | 2.0 |
| Population | 47 | 11.9 | 1.0 |
| GDP | |||
| III09 to II10 III09 to IV17 | 4 34 | 2.7 20.4 | 2.7 2.2 |
| RDPI | |||
| III09 to II10 III09 to IVI7 | 4 34 | 0.2 16.3 | 0.2 1.8 |
| RDPI per Capita | |||
| III09 to II10 III09 to IV17 | 4 34 | -0.7 9.2 | -0.7 1.0 |
| Population | |||
| III09 to II10 III09 to IV17 | 4 34 | 0.8 6.5 | 0.8 0.7 |
| IVQ2007 to IVQ2017 | 40 | ||
| GDP | 40 | 15.3 | 1.4 |
| RDPI | 40 | 18.2 | 1.7 |
| RDPI per Capita | 40 | 9.5 | 0.9 |
| Population | 40 | 8.0 | 0.8 |
RDPI: Real Disposable Personal Income
Source: US Bureau of Economic Analysis http://www.bea.gov/iTable/index_nipa.cfm
There are seven basic facts illustrating the current economic disaster of the United States:
- GDP maintained trend growth in the entire business cycle from IQ1980 to IIQ1991, including contractions and expansions. The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). GDP is well below trend in the entire business cycle from IVQ2007 to IVQ2017, including contractions and expansions
- Per capita real disposable income exceeded trend growth in the 1980s but is substantially below trend in IVQ2017
- Level of employed persons increased in the 1980s but declined/stagnated cyclically into IVQ2017
- Level of full-time employed persons increased in the 1980s but declined/stagnated cyclically into IVQ2017
- Level unemployed, unemployment rate and employed part-time for economic reasons fell in the recovery from the recessions in the 1980s but not substantially in relative cyclical terms in the recovery since IIQ2009
- Wealth of households and nonprofit organizations soared in the 1980s but stagnated in historically-relative real terms into IVQ2017
- Gross private domestic investment increased sharply from IQ1980 to IIQ1991 but gross private domestic investment stagnated and private fixed investment stagnated in relative cyclical terms from IVQ2007 into IVQ2017
There are references to adverse periods as “lost decades.” There is a more prolonged and adverse period in Table V-3A: the lost economic cycle of the Global Recession with economic growth underperforming below trend worldwide. Economic contractions were relatively high but not comparable to the decline of GDP during the Great Depression. In fact, during the Great Depression in the four years of 1930 to 1933, US 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. The contraction of GDP in the current cycle of the Global Recession was much lower, 4.2 percent (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.html). Contractions were deeper in Japan, 8.7 percent, the euro area (19 members), 5.8 percent, Germany, 6.9 percent and the UK 6.1 percent. The contraction in France was 4.0 percent. There is adversity in low rates of growth during the expansion that did not compensate for the contraction such that for the whole cycle performance is disappointingly low. As a result, GDP is substantially below what it would have been in trend growth in all countries and regions in the world. Long-term economic performance in the United States consisted of trend growth of GDP at 3 percent per year and of per capita GDP at 2 percent per year as measured for 1870 to 2010 by Robert E Lucas (2011May). The economy returned to trend growth after adverse events such as wars and recessions. The key characteristic of adversities such as recessions was much higher rates of growth in expansion periods that permitted the economy to recover output, income and employment losses that occurred during the contractions. Over the business cycle, the economy compensated the losses of contractions with higher growth in expansions to maintain trend growth of GDP of 3 percent and of GDP per capita of 2 percent. The US maintained growth at 3.0 percent on average over entire cycles with expansions at higher rates compensating for contractions. US economic growth has been at only 2.2 percent on average in the cyclical expansion in the 34 quarters from IIIQ2009 to IVQ2017. 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 IVQ2017 (https://www.bea.gov/newsreleases/national/gdp/2018/pdf/gdp4q17_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 (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.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, 4.3 percent from IQ1983 to IIIQ1990, 4.0 percent from IQ1983 to IVQ1990, 3.8 percent from IQ1983 to IQ1991, 3.8 percent from IQ1983 to IIQ1991 and at 7.8 percent from IQ1983 to IVQ1983 (https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states_31.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/mediocre-cyclical-united-states.html). The National Bureau of Economic Research (NBER) dates a contraction of the US from IQ1990 (Jul) to IQ1991 (Mar) (http://www.nber.org/cycles.html). The expansion lasted until another contraction beginning in IQ2001 (Mar). US GDP contracted 1.3 percent from the pre-recession peak of $8983.9 billion of chained 2009 dollars in IIIQ1990 to the trough of $8865.6 billion in IQ1991 (http://www.bea.gov/iTable/index_nipa.cfm). 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 IVQ2017 would have accumulated to 34.4 percent. GDP in IVQ2017 would be $20,149.0 billion (in constant dollars of 2009) if the US had grown at trend, which is higher by $2862.5 billion than actual $17,286.5 billion. There are about two trillion dollars of GDP less than at trend, explaining the 21.9 million unemployed or underemployed equivalent to actual unemployment/underemployment of 12.8 percent of the effective labor force (https://cmpassocregulationblog.blogspot.com/2018/04/twenty-two-million-unemployed-or.html and earlier https://cmpassocregulationblog.blogspot.com/2018/03/twenty-three-million-unemployed-or.html). US GDP in IVQ2017 is 14.2 percent lower than at trend. US GDP grew from $14,991.8 billion in IVQ2007 in constant dollars to $17,286.5 billion in IVQ2017 or 15.3 percent at the average annual equivalent rate of 1.4 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 2018. Growth at 3.2 percent per year would raise the NSA index of manufacturing output from 108.2393 in Dec 2007 to 149.0946 in Feb 2018. The actual index NSA in Feb 2018 is 104.4525, which is 29.9 percent below trend. Manufacturing output grew at average 2.0 percent between Dec 1986 and Feb 2018. Using trend growth of 2.0 percent per year, the index would increase to 132.3793 in Feb 2018. The output of manufacturing at 104.4525 in Feb 2018 is 21.1 percent below trend under this alternative calculation.
Table V-3A, Cycle 2007-2017, Percentage Contraction, Average Growth Rate in Expansion, Average Growth Rate in Whole Cycle and GDP Percent Below Trend
| Contraction ∆% | Expansion AV ∆% | Whole Cycle AV ∆% | Below Trend Percent | |
| USA | 4.2 | 2.2 | 1.4 | 14.2 |
| Japan | 8.7 | 1.7 | 0.6 | NA |
| Euro Area (19) | 5.8 | 1.4 | 0.6 | 15.4 |
| France | 4.0 | 1.3 | 0.7 | 9.9 |
| Germany | 6.9 | 2.2 | 1.1 | NA |
| UK | 6.1 | 2.0 | 1.0 | 14.7 |
Note: AV: Average. Expansion and Whole Cycle AV ∆% calculated with quarterly growth, seasonally adjusted and quarterly adjusted when applicable, rates and converted into annual equivalent.
Data reported periodically in this blog.
Source: Country Statistical Agencies http://www.census.gov/aboutus/stat_int.html
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 1, 2018. 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 Apr 11, 2018
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 2018. 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, 1973-2018, 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 2018. 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 2018. 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 2018. 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, 1947-2018, 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 2018. 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, 1947-2018, 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 2018. 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 and appear to vacillate in the final segment.
Chart I-15, US, Commercial and Industrial Loans in Bank Credit, US Commercial Banks, Not Seasonally Adjusted, Monthly, 1947-2018, 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, 1973-2016, 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, 1995-2018, Billions of Dollars
Source: Board of Governors of the Federal Reserve System
https://www.federalreserve.gov/releases/h8/current/default.htm
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018.
No comments:
Post a Comment