CMP Associates Regulation Blog: Dollar Depreciation, Fluctuating Valuations of Risk Financial Assets, World Inflation Waves, United States Commercial Banks Assets and Liabilities, 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, Government Intervention in Globalization, and Global Recession Risk: Part IV

Dollar Depreciation, Fluctuating Valuations of Risk Financial Assets, World Inflation Waves, United States Commercial Banks Assets and Liabilities, 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, Government Intervention in Globalization, and Global Recession Risk

Carlos M. Pelaez

I World Inflation Waves

IA Appendix: Transmission of Unconventional Monetary Policy

IB1 Theory

IB2 Policy

IB3 Evidence

IB4 Unwinding Strategy

IC United States Inflation

IC Long-term US Inflation

ID Current US Inflation

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

II United States Commercial Banks Assets and Liabilities

IIA Transmission of Monetary Policy

IIB Functions of Banking

IIC United States Commercial Banks Assets and Liabilities

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

III World Financial Turbulence. Financial markets are being shocked by multiple factors including:

(1) World economic slowdown

(2) Slowing growth in China with political development and slowing growth in Japan and world trade

(3) Slow growth propelled by savings/investment reduction in the US with high unemployment/underemployment, falling wages, hiring collapse, contraction of real private fixed investment and loss of ten million full-time jobs. Wealth of households increased over the business cycle by total 31.8 percent adjusted for inflation from IVQ2007 to IIQ2019, while growing at 3.2 percent per year adjusted for inflation from IVQ1945 to IIQ2019 with unsustainable fiscal deficit/debt threatening prosperity that can cause risk premium on Treasury debt with Himalayan interest rate hikes. Growth of inflation-adjusted wealth at historical trend would have been 43.7 percent between 2007 and IIQ2019, which is much higher than actual 31.8 percent.

(4) Outcome of the sovereign debt crisis in Europe with complex financial, economic and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times).

This section provides current data and analysis. Subsection IIIA Financial Risks provides analysis of the evolution of valuations of risk financial assets during the week. There are various appendixes for convenience of reference of material related to the debt crisis of the euro area. Some of this material is updated in Subsection IIIA when new data are available and then maintained in the appendixes for future reference until updated again in Subsection IIIA. Subsection IIIB Appendix on Safe Haven Currencies discusses arguments and measures of currency intervention and is available in the Appendixes section at the end of the blog comment. Subsection IIIC Appendix on Fiscal Compact provides analysis of the restructuring of the fiscal affairs of the European Union in the agreement of European leaders reached on Dec 9, 2011 and is available in the Appendixes section at the end of the blog comment. Subsection IIID Appendix on European Central Bank Large Scale Lender of Last Resort considers the policies of the European Central Bank and is available in the Appendixes section at the end of the blog comment. Appendix IIIE Euro Zone Survival Risk analyzes the threats to survival of the European Monetary Union and is available following Subsection IIIA. Subsection IIIF Appendix on Sovereign Bond Valuation provides more technical analysis and is available following Subsection IIIA. Subsection IIIG Appendix on Deficit Financing of Growth and the Debt Crisis provides analysis of proposals to finance growth with budget deficits together with experience of the economic history of Brazil and is available in the Appendixes section at the end of the blog comment.

IIIA Financial Risks. Financial turbulence, attaining unusual magnitude in recent months, characterized the expansion from the global recession since IIIQ2009. Table III-1, updated with every comment in this blog, provides beginning values on Oct 11 and daily values throughout the week ending on Oct 18, 2019, of various financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at the close of business. The first column provides the value on Fri Oct 11, 2019 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Oct 11, 2019,” first row “USD/EUR 1.1038 -0.5% -0.3%,” provides the information that the US dollar (USD) depreciated 0.5 percent to USD 1.1038/EUR in the week ending on Oct 11 relative to the exchange rate on Oct 4 and depreciated 0.3 percent relative to Thu Oct 10. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in http://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing waves of inflation. An important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9 (European Council 2911Dec9), which is analyzed in IIIC Appendix on Fiscal Compact. European leaders reached a new agreement on Jan 30 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/127631.pdf) and another agreement on Jun 29, 2012 (http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf). There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). The most important source of financial turbulence is shifting toward fluctuating interest rates. The dollar/euro rate is quoted as number of US dollars USD per euro EUR, USD 1.1038/EUR in the first row, first column in the block for currencies in Table III-1 for Oct 11, appreciating to USD 1.1025/EUR on Mon Oct 14, 2019, or by 0.1 percent. The dollar appreciated because fewer dollars, $1.1025, were required on Mon Oct 14 to buy one euro than $1.1038 on Fri Oct 11. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the market closing exchange rate at New York time, such as USD 1.1038/EUR on Oct 11. The second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Oct 11, to the last business day of the current week, in this case Oct 18 such as depreciation of 1.2 percent to USD 1.1170/EUR by Oct 18. The third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (denoted by negative sign) by 1.2 percent from the rate of USD 1.1038/EUR on Fri Oct 11 to the rate of USD 1.1170 on Oct 18 {[(1.1170/1.1038) - 1]100 = 1.2%}. The dollar depreciated (denoted by negative sign) by 0.4 percent from the rate of USD 1.1124 on Thu Oct 17 to USD 1.1170/EUR on Fri Oct 18 {[(1.1170/1.1124) -1]100 = 0.4%}. Other factors constant, increasing risk aversion causes appreciation of the dollar relative to the euro, with rising uncertainty on European and global sovereign risks increasing dollar-denominated assets with sales of risk financial investments.

Table III-I, Weekly Financial Risk Assets Oct 14 to Oct 18, 2019

Fri 11

Mon 14

Tue 15

Wed 16

Thu 17

Fri 18

USD/EUR

1.1038

-0.5%

-0.3%

1.1025

0.1%

1.1032

0.1%

-0.1%

1.1073

-0.3%

-0.4%

1.1124

-0.8%

-0.5%

1.1170

-1.2%

-0.4%

JPY/ USD

108.38

-1.4%

-0.4%

108.40

0.0%

108.86

-0.4%

108.75

-0.3%

0.1%

108.64

-0.2%

0.1%

108.41

0.0%

0.2%

CHF/ USD

0.9967

-0.1%

0.0%

0.9970

0.0%

0.9986

-0.2%

0.9950

0.2%

0.4%

0.9879

0.9%

0.7%

0.9843

1.2%

0.4%

CHF/EUR

1.1002

-0.7%

-0.3%

1.0993

0.1%

1.1022

-0.2%

-0.3%

1.1016

-0.1%

0.1%

1.0988

0.1%

0.3%

1.0994

0.1%

-0.1%

USD/ AUD

0.6791

1.4725

0.3%

0.4%

0.6776

1.4758

-0.2%

0.6753

1.4808

-0.6%

-0.3%

0.6759

1.4795

-0.5%

0.1%

0.6823

1.4656

0.5%

0.9%

0.6854

1.4590

0.9%

0.5%

10Y Note

1.753

1.732

1.771

1.749

1.754

1.749

2Y Note

1.610

1.593

1.618

1.586

1.606

1.574

German Bond

2Y -0.72 10Y-0.44

2Y -0.71 10Y -0.45

2Y -0.69 10Y -0.42

2Y -0.67 10Y -0.38

2Y -0.66 10Y -0.41

2Y -0.67 10Y-0.38

DJIA

26816.59

0.9%

1.2%

26787.36

-0.1%

27024.80

0.8%

0.9%

27001.98

0.7%

-0.1%

27025.88

0.8%

0.1%

26770.20

-0.2%

-0.9%

Dow Global

3020.72

1.9%

1.8%

3014.52

-0.2%

3042.69

0.7%

0.9%

3046.16

0.8%

0.1%

3053.29

1.1%

0.2%

3045.56

0.8%

-0.3%

DJ Asia Pacific

Nikkei

21798.87

1.8%

1.1%

21798.87

0.0%

22207.21

1.9%

22472.92

3.1%

1.2%

22451.86

3.0%

-0.1%

22492.68

3.2%

0.2%

Shanghai

2973.66

2.4%

0.9%

3007.88

1.2%

2991.05

0.6%

-0.6%

2978.71

0.2%

-0.4%

2977.33

0.1%

0.0%

2938.14

-1.2%

-1.3%

DAX

12511.65

4.2%

2.9%

12486.56

-0.2%

12629.79

0.9%

1.1%

12670.11

1.3%

0.3%

12654.95

1.1%

-0.1%

12633.60

1.0%

-0.2%

DJ UBS Comm.

WTI $/B

54.70

3.6%

2.1%

53.59

-2.0%

52.81

-3.5%

-1.5%

53.36

-2.4%

1.0%

53.93

-1.4%

1.1%

53.78

-1.7%

-0.3%

Brent $/B

60.51

3.7%

2.4%

59.35

-1.9%

58.74

-2.9%

-1.0%

59.42

-1.8%

1.2%

59.91

-1.0%

0.8%

59.42

-1.8%

-0.8%

Gold

1488.7

-1.6%

-0.8%

1497.6

0.6%

1483.5

-0.3%

-0.9%

1494.0

0.4%

0.7%

1498.3

0.6%

0.3%

1494.1

0.4%

-0.3%

Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss

Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce

Sources: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

https://www.investing.com/rates-bonds/world-government-bonds

1 First, risk determining events. 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 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).”

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.”

Prior risk determining events are in an appendix below following Table III-1A. What is truly important is the fixing of the overnight fed funds at 1¾ to 2 percent with all measures depending on “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” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190918a.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 maximum employment objective and its symmetric 2 percent inflation objective. 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” (emphasis added). The “outlook is uncertain”: “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 1-3/4 to 2 percent. This action supports the Committee's view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190918a.htm) In the Opening Remarks to the Press Conference on Jan 30, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190130.pdf): “Today, the FOMC decided that the cumulative effects of those developments over the last several months warrant a patient, wait-and-see approach regarding future policy changes. In particular, our statement today says, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near … 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook. In addition, the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to Page 3 of 5 push headline inflation lower still in coming months. Further, as we noted in our post-meeting statement, while survey-based measures of inflation expectations have been stable, financial market measures of inflation compensation have moved lower. Similarly, the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms. In this environment, we believe we can best support the economy by being patient in evaluating the outlook before making any future adjustment to policy.” The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm) with significant changes (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf). In the opening remarks to the Mar 20, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf): “In discussing the Committee’s projections, it is useful to note what those projections are, as well as what they are not. The SEP includes participants’ individual projections of the most likely economic scenario along with their views of the appropriate path of the federal funds rate in that scenario. Views about the most likely scenario form one input into our policy discussions. We also discuss other plausible scenarios, including the risk of more worrisome outcomes. These and other scenarios and many other considerations go into policy, but are not reflected in projections of the most likely case. Thus, we always emphasize that the interest rate projections in the SEP are not a Committee decision. They are not a Committee plan. As Chair Yellen noted some years ago, the FOMC statement, rather than the dot plot, is the device that the Committee uses to express its opinions about the likely path of rates.”

In the Introductory Statement on Jul 25, 2019, in Frankfurt am Main, the President of the European Central Bank, Mario Draghi, stated (https://www.ecb.europa.eu/press/pressconf/2019/html/ecb.is190725~547f29c369.en.html): “Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. We expect them to remain at their present or lower levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to our aim over the medium term.

There is concern at the Federal Open Market Committee (FOMC) with the world economy and financial markets (http://www.federalreserve.gov/newsevents/press/monetary/20160127a.htm): “The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook” (emphasis added). This concern should include the effects on dollar revaluation of competitive easing by other central banks such as quantitative and qualitative easing with negative nominal interest rates (https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf).

At the 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.”

There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Focus is shifting from tapering quantitative easing by the Federal Open Market Committee (FOMC). There is sharp distinction between the two measures of unconventional monetary policy: (1) fixing of the overnight rate of fed funds at 0 to ¼ percent; and (2) outright purchase of Treasury and agency securities and mortgage-backed securities for the balance sheet of the Federal Reserve. Markets overreacted to the so-called “paring” of outright purchases to $25 billion of securities per month for the balance sheet of the Fed.

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).

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.”

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.”

Another critical concern in the statement of the FOMC on Sep 18, 2013, is on the effects of tapering expectations on interest rates (http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm):

“Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth” (emphasis added).

Will the FOMC increase purchases of mortgage-backed securities if mortgage rates increase?

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 ¾ and 1 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 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, 2018Oct19 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).

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):

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

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

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

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

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

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

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

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

W = Y/r (10

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

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

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

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

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

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 program of 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 3ECB interest rates are at their lower bound. They further ease monetary and financial conditions, making access to finance cheaper for firms and households. This tends to support investment and consumption, and ultimately contributes to a return of inflation rates towards 2%.”

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

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

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

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

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

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

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

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

Fri May 1

Mon 4

Tue 5

Wed 6

Thu 7

Fri 8

DJIA

18024.06

-0.3%

1.0%

18070.40

0.3%

17928.20

-0.5%

-0.8%

17841.98

-1.0%

-0.5%

17924.06

-0.6%

0.5%

18191.11

0.9%

1.5%

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

The second approach is by the Austrian School arguing that increases in asset prices can become bubbles if monetary policy allows their financing with bank credit. Professor Michael D. Bordo provides clear thought and empirical evidence on the role of “expansionary monetary policy” in inflating asset prices (Bordo2012Nov20, Bordo and Lane 2013). Bordo and Lane (2013) provide revealing narrative of historical episodes of expansionary monetary policy. Bordo and Lane (2013) conclude that policies of depressing interest rates below the target rate or growth of money above the target influences higher asset prices, using a panel of 18 OECD countries from 1920 to 2011. Bordo (2012Nov20) concludes: “that expansionary money is a significant trigger” and “central banks should follow stable monetary policies…based on well understood and credible monetary rules.” Taylor (2007, 2009) explains the housing boom and financial crisis in terms of expansionary monetary policy. 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, former 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 42.4 percent relative to the dollar from the high on Jul 15, 2008 to Oct 18, 2019.

Fri 27 Feb

Mon 3/2

Tue 3/3

Wed 3/4

Thu 3/5

Fri 3/6

USD/ EUR

1.1197

1.6%

0.0%

1.1185

0.1%

1.1176

0.2%

0.1%

1.1081

1.0%

0.9%

1.1030

1.5%

0.5%

1.0843

3.2%

1.7%

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

“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%

1.0700

1.3%

1.4%

1.0548

2.7%

1.4%

1.0637

1.9%

-0.8%

1.0497

3.2%

1.3%

Fri Mar 13

Mon 16

Tue 17

Wed 18

Thu 19

Fri 20

USD/ EUR

1.0497

3.2%

1.3%

1.0570

-0.7%

1.0598

-1.0%

-0.3%

1.0864

-3.5%

-2.5%

1.0661

-1.6%

1.9%

1.0821

-3.1%

-1.5%

Fri Apr 24

Mon 27

Tue 28

Wed 29

Thu 30

May Fri 1

USD/ EUR

1.0874

-0.6%

-0.4%

1.0891

-0.2%

1.0983

-1.0%

-0.8%

1.1130

-2.4%

-1.3%

1.1223

-3.2%

-0.8%

1.1199

-3.0%

0.2%

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

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

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

Fri May 15

Mon 18

Tue 19

Wed 20

Thu 21

Fri 22

USD/ EUR

1.1449

-2.2%

-0.3%

1.1317

1.2%

1.1150

2.6%

1.5%

1.1096

3.1%

0.5%

1.1113

2.9%

-0.2%

1.1015

3.8%

0.9%

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

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

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

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

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%

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%

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%

10188.13

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%

1.1348

0.0%

-0.2%

1.1340

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%

17217.11

0.0%

-0.1%

17168.61

-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%

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%

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%

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%

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%

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 (http://cmpassocregulationblog.blogspot.com/2015/11/live-possibility-of-interest-rates.html). The dollar revalued 2.4 percent during the week. The euro has devalued 42.4 percent relative to the dollar from the high on Jul 15, 2008 to Oct 18, 2019.

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%

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%

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%

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%

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%

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%

17719.92

-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%

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%

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%

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%

10450.38

-1.1%

3.1%

10469.26

1.2%

0.2%

10738.12

3.8%

2.6%

10608.19

2.6%

-1.2%

The Bank of Japan decided on Jan 29, 2016 to determine “a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank” and “will cut the interest rate further into negative territory if judged as necessary” (https://www.boj.or.jp/en/announcements/release_2016/k160129b.pdf). The new policy is quantitative and qualitative (QQE) with a negative interest rate “designed to enable the Bank to pursue additional monetary easing in terms of three dimensions, combining a negative interest rate with quantity and quality” (https://www.boj.or.jp/en/announcements/release_2016/k160129b.pdf). 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%

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%

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%

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%

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%

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 Sep 4, 2014, the European Central Bank lowered policy rates (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140904.en.html):

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%

1.1013

-0.1%

0.0%

1.0999

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%

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 1¾ to 2 percent with all measures depending on “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” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190918a.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 maximum employment objective and its symmetric 2 percent inflation objective. 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” (emphasis added). The “outlook is uncertain”: “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 1-3/4 to 2 percent. This action supports the Committee's view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain” (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190918a.htm) In the Opening Remarks to the Press Conference on Jan 30, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190130.pdf): “Today, the FOMC decided that the cumulative effects of those developments over the last several months warrant a patient, wait-and-see approach regarding future policy changes. In particular, our statement today says, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near … 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook. In addition, the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to Page 3 of 5 push headline inflation lower still in coming months. Further, as we noted in our post-meeting statement, while survey-based measures of inflation expectations have been stable, financial market measures of inflation compensation have moved lower. Similarly, the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms. In this environment, we believe we can best support the economy by being patient in evaluating the outlook before making any future adjustment to policy.” The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm) with significant changes (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf). In the opening remarks to the Mar 20, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf): “In discussing the Committee’s projections, it is useful to note what those projections are, as well as what they are not. The SEP includes participants’ individual projections of the most likely economic scenario along with their views of the appropriate path of the federal funds rate in that scenario. Views about the most likely scenario form one input into our policy discussions. We also discuss other plausible scenarios, including the risk of more worrisome outcomes. These and other scenarios and many other considerations go into policy, but are not reflected in projections of the most likely case. Thus, we always emphasize that the interest rate projections in the SEP are not a Committee decision. They are not a Committee plan. As Chair Yellen noted some years ago, the FOMC statement, rather than the dot plot, is the device that the Committee uses to express its opinions about the likely path of rates.”

We intend to continue reinvesting, in full, the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.” At its meeting on September 12, 2019, the Governing Council of the ECB (European Central Bank), decided to (https://www.ecb.europa.eu/press/pr/date/2019/html/ecb.mp190912~08de50b4d2.en.html): (1) decrease the deposit facility by 10 basis points to minus 0.50 percent while maintaining at 0.00 the main refinancing operations rate and at 0.25 percent the marginal lending facility rate; (2) restart net purchases of securities at the monthly rate of €20 billion beginning on Nov 1, 2019; (3) reinvest principal payments from maturing securities; (4) adapt long-term refinancing operations to maintain “favorable bank lending conditions;” and (5) exempt part of the “negative deposit facility rate” on bank excess liquidity. The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm) with significant changes (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf).The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm) with significant changes (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf).

In presenting the Semiannual Monetary Policy Report to Congress on Jul 17, 2018, the Chairman of the Board of Governors of the Federal Reserve System, Jerome H. Powell, stated (https://www.federalreserve.gov/newsevents/testimony/powell20180717a.htm): “With a strong job market, inflation close to our objective, and the risks to the outlook roughly balanced, the FOMC believes that--for now--the best way forward is to keep gradually raising the federal funds rate. We are aware that, on the one hand, raising interest rates too slowly may lead to high inflation or financial market excesses. On the other hand, if we raise rates too rapidly, the economy could weaken and inflation could run persistently below our objective. The Committee will continue to weigh a wide range of relevant information when deciding what monetary policy will be appropriate. As always, our actions will depend on the economic outlook, which may change as we receive new data.”

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

At an address to The Clearing House and The Bank Policy Institute Annual Conference (https://www.federalreserve.gov/newsevents/speech/clarida20181127a.htm), in New York City, on Nov 27, 2018, the Vice Chairman of the Fed, Richard H. Clarida, analyzes the data dependence of monetary policy. An important hurdle is critical unobserved parameters of monetary policy (https://www.federalreserve.gov/newsevents/speech/clarida20181127a.htm): “But what if key parameters that describe the long-run destination of the economy are unknown? This is indeed the relevant case that the FOMC and other monetary policymakers face in practice. The two most important unknown parameters needed to conduct‑‑and communicate‑‑monetary policy are the rate of unemployment consistent with maximum employment, u*, and the riskless real rate of interest consistent with price stability, r*. As a result, in the real world, monetary policy should, I believe, be data dependent in a second sense: that incoming data can reveal at each FOMC meeting signals that will enable it to update its estimates of r* and u* in order to obtain its best estimate of where the economy is heading.” Current robust economic growth, employment creation and inflation close to the Fed’s 2 percent objective suggest continuing “gradual policy normalization.” Incoming data can be used to update u^* and r^* in designing monetary policy that attains price stability and maximum employment. Clarida also finds that the current expansion will be the longest in history if it continues into 2019. In an address at The Economic Club of New York, New York City, Nov 28, 2018 (https://www.federalreserve.gov/newsevents/speech/powell20181128a.htm), the Chairman of the Fed, Jerome H. Powell, stated (https://www.federalreserve.gov/newsevents/speech/powell20181128a.htm): “For seven years during the crisis and its painful aftermath, the Federal Open Market Committee (FOMC) kept our policy interest rate unprecedentedly low--in fact, near zero--to support the economy as it struggled to recover. The health of the economy gradually but steadily improved, and about three years ago the FOMC judged that the interests of households and businesses, of savers and borrowers, were no longer best served by such extraordinarily low rates. We therefore began to raise our policy rate gradually toward levels that are more normal in a healthy economy. Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth. My FOMC colleagues and I, as well as many private-sector economists, are forecasting continued solid growth, low unemployment, and inflation near 2 percent.” The market focused on policy rates “just below the broad range of estimates of the level that would be neutral for the economy—that is, neither speeding up nor slowing down growth.” There was a relief rally in the stock market of the United States:

Fri 23

Mon 26

Tue 27

Wed 28

Thu 29

Fri 30

USD/EUR

1.1339

0.7%

0.6%

1.1328

0.1%

1.1293

0.4%

0.3%

1.1368

-0.3%

-0.7%

1.1394

-0.5%

-0.2%

1.1320

0.2%

0.6%

DJIA

24285.95

-4.4%

-0.7%

24640.24

1.5%

24748.73

1.9%

0.4%

25366.43

4.4%

2.5%

25338.84

4.3%

-0.1%

25538.46

5.2%

0.8%

At a meeting of the American Economic Association in Atlanta on Friday, January 4, 2019, the Chairman of the Fed, Jerome H. Powell, stated that the Fed would be “patient” with interest rate increases, adjusting policy “quickly and flexibly” if required (https://www.aeaweb.org/webcasts/2019/us-federal-reserve-joint-interview). Treasury yields declined and stocks jumped.

Fri 28	Mon 31	Tue 1	Wed 2	Thu 3	Fri 4
10Y Note 2.736	2.683	2.683	2.663	2.560	2.658
2Y Note 2.528	2.500	2.500	2.488	2.387	2.480
DJIA 23062.40 2.7% -0.3%	23327.46 1.1% 1.1%	23327.46 1.1% 0.0%	23346.24 1.2% 0.1%	22686.22 -1.6% -2.8%	23433.16 1.6% 3.3%
Dow Global 2718.19 1.3% 0.8%	2734.40 0.6% 0.6%	2734.40 0.6% 0.0%	2729.74 0.4% -0.2%	2707.29 -0.4% -0.8%	2773.12 2.0% 2.4%

In the Opening Remarks to the Press Conference on Jan 30, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190130.pdf): “Today, the FOMC decided that the cumulative effects of those developments over the last several months warrant a patient, wait-and-see approach regarding future policy changes. In particular, our statement today says, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.” This change was not driven by a major shift in the baseline outlook for the economy. Like many forecasters, we still see “sustained expansion of economic activity, strong labor market conditions, and inflation near … 2 percent” as the likeliest case. But the cross-currents I mentioned suggest the risk of a less-favorable outlook. In addition, the case for raising rates has weakened somewhat. The traditional case for rate increases is to protect the economy from risks that arise when rates are too low for too long, particularly the risk of too-high inflation. Over the past few months, that risk appears to have diminished. Inflation readings have been muted, and the recent drop in oil prices is likely to Page 3 of 5 push headline inflation lower still in coming months. Further, as we noted in our post-meeting statement, while survey-based measures of inflation expectations have been stable, financial market measures of inflation compensation have moved lower. Similarly, the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms. In this environment, we believe we can best support the economy by being patient in evaluating the outlook before making any future adjustment to policy.” The FOMC is initiating the “normalization” or reduction of the balance sheet of securities held outright for monetary policy (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190130c.htm).

Fri 25

Mon 28

Tue 29

Wed 30

Thu 31

Fri 1

DJIA

24737.20

0.1%

0.7%

24528.22

-0.8%

24579.96

-0.6%

0.2%

25014.86

1.1%

1.8%

24999.67

1.1%

-0.1%

25063.89

1.3%

0.3%

Dow Global

2917.27

0.5%

1.0%

2899.74

-0.6%

2905.29

-0.4%

0.2%

2927.10

0.3%

0.8%

2945.73

1.0%

0.6%

2947.87

1.0%

0.1%

DJ Asia Pacific

Nikkei

20773.56

0.5%

1.0%

20649.00

-0.6%

20664.64

-0.5%

0.1%

20556.54

-1.0%

-0.5%

20773.49

0.0%

1.1%

20788.39

0.1%

Shanghai

2601.72

0.2%

0.4%

2596.98

-0.2%

2594.25

-0.3%

-0.1%

2575.58

-1.0%

-0.7%

2584.57

-0.7%

0.3%

2618.23

0.6%

1.3%

DAX

11281.79

0.7%

1.4%

11210.31

-0.6%

11218.83

-0.6%

0.1%

11181.66

-0.9%

-0.3%

11173.10

-1.0%

-0.1%

11180.66

-0.9%

0.1%

BOVESPA

97677.19

1.6%

0.0%

95443.88

-2.3%

95639.33

-2.1%

0.2%

96996.21

-0.7%

1.4%

97393.75

-0.3%

0.4%

97861.27

0.2%

0.5%

Frank H. Knight (1963, 233), in Risk, uncertainty and profit, distinguishes between measurable risk and unmeasurable uncertainty. The FOMC statement on Jun 19, 2019 analyzes uncertainty in the outlook (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190619a.htm): “The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes, but uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.” In the Semiannual Monetary Policy Report to the Congress, on Jul 10, 2019, Chair Jerome H. Powell states (https://www.federalreserve.gov/newsevents/testimony/powell20190710a.htm): “Since our May meeting, however, these crosscurrents have reemerged, creating greater uncertainty. Apparent progress on trade turned to greater uncertainty, and our contacts in business and agriculture report heightened concerns over trade developments. Growth indicators from around the world have disappointed on net, raising concerns that weakness in the global economy will continue to affect the U.S. economy. These concerns may have contributed to the drop in business confidence in some recent surveys and may have started to show through to incoming data.

”(emphasis added). European Central Bank President, Mario Draghi, stated at a meeting on “Twenty Years of the ECB’s Monetary Policy,” in Sintra, Portugal, on Jun 18, 2019, that (https://www.ecb.europa.eu/press/key/date/2019/html/ecb.sp190618~ec4cd2443b.en.html): “In this environment, what matters is that monetary policy remains committed to its objective and does not resign itself to too-low inflation. And, as I emphasised at our last monetary policy meeting, we are committed, and are not resigned to having a low rate of inflation forever or even for now. In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required. In our recent deliberations, the members of the Governing Council expressed their conviction in pursuing our aim of inflation close to 2% in a symmetric fashion. Just as our policy framework has evolved in the past to counter new challenges, so it can again. In the coming weeks, the Governing Council will deliberate how our instruments can be adapted commensurate to the severity of the risk to price stability.” At its meeting on September 12, 2019, the Governing Council of the ECB (European Central Bank), decided to (https://www.ecb.europa.eu/press/pr/date/2019/html/ecb.mp190912~08de50b4d2.en.html): (1) decrease the deposit facility by 10 basis points to minus 0.50 percent while maintaining at 0.00 the main refinancing operations rate and at 0.25 percent the marginal lending facility rate; (2) restart net purchases of securities at the monthly rate of €20 billion beginning on Nov 1, 2019; (3) reinvest principal payments from maturing securities; (4) adapt long-term refinancing operations to maintain “favorable bank lending conditions;” and (5) exempt part of the “negative deposit facility rate” on bank excess liquidity. The harmonized index of consumer prices of the euro zone increased 1.2 percent in the 12 months ending in May 2019 and the PCE inflation excluding food and energy increased 1.6 percent in the 12 months ending in Apr 2019. Inflation below 2 percent with symmetric targets in both the United States and the euro zone together with apparently weakening economic activity could lead to interest rate cuts. Stock markets jumped worldwide in renewed risk appetite during the week of Jun 19, 2019 in part because of anticipation of major central bank rate cuts and also because of domestic factors:

Fri 14

Mon 17

Tue 18

Wed 19

Thu 20

Fri 21

DJIA

26089.61

0.4%

-0.1%

26112.53

0.1%

26465.54

1.4%

26504.00

1.6%

0.1%

26753.17

2.5%

0.9%

26719.13

2.4%

-0.1%

Dow Global

2998.79

0.2%

-0.4%

2999.93

0.0%

3034.59

1.2%

3050.80

1.7%

0.5%

3077.81

2.6%

0.9%

3081.62

2.8%

0.1%

DJ Asia Pacific

Nikkei

21116.89

1.1%

0.4%

21124.00

0.0%

20972.71

-0.7%

21333.87

1.0%

1.7%

21462.86

1.6%

0.6%

21258.64

0.7%

-1.0%

Shanghai

2881.97

1.9%

-1.0%

2887.62

0.2%

2890.16

0.3%

0.1%

2917.80

1.2%

1.0%

2987.12

3.6%

2.4%

3001.98

4.2%

0.5%

DAX

12096.40

0.4%

-0.6%

12085.82

-0.1%

12331.75

1.9%

2.0%

12308.53

1.8%

-0.2%

12355.39

2.1%

0.4%

12339.92

2.0%

-0.1%

BOVESPA

98040.06

0.2%

-0.7%

97623.25

-0.4%

99404.39

1.4%

1.8%

100303.41

2.3%

0.9%

100303.41

2.3%

0.0%

102012.64

4.1%

1.7%

“4 September 2014 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.05%, starting from the operation to be settled on 10 September 2014.
The interest rate on the marginal lending facility will be decreased by 10 basis points to 0.30%, with effect from 10 September 2014.
The interest rate on the deposit facility will be decreased by 10 basis points to -0.20%, with effect from 10 September 2014.”

The President of the European Central Bank announced on Sep 4, 2014, the decision to expand the balance sheet by purchases of asset-backed securities (ABS) in a new ABS Purchase Program (ABSPP) and covered bonds (http://www.ecb.europa.eu/press/pressconf/2014/html/is140904.en.html):

“Based on our regular economic and monetary analyses, the Governing Council decided today to lower the interest rate on the main refinancing operations of the Eurosystem by 10 basis points to 0.05% and the rate on the marginal lending facility by 10 basis points to 0.30%. The rate on the deposit facility was lowered by 10 basis points to -0.20%. In addition, the Governing Council decided to start purchasing non-financial private sector assets. The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP). This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter, as decided by the Governing Council in June. In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs domiciled in the euro area under a new covered bond purchase programme (CBPP3). Interventions under these programmes will start in October 2014. The detailed modalities of these programmes will be announced after the Governing Council meeting of 2 October 2014. The newly decided measures, together with the targeted longer-term refinancing operations which will be conducted in two weeks, will have a sizeable impact on our balance sheet.”

In a speech on “Monetary Policy in the Euro Area,” on Nov 21, 2014, the President of the European Central Bank, Mario Draghi, advised of the determination to bring inflation back to normal levels by aggressive holding of securities in the balance sheet (http://www.ecb.europa.eu/press/key/date/2014/html/sp141121.en.html):

“In short, there is a combination of policies that will work to bring growth and inflation back on a sound path, and we all have to meet our responsibilities in achieving that. For our part, we will continue to meet our responsibility – we will do what we must to raise inflation and inflation expectations as fast as possible, as our price stability mandate requires of us.

If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialise, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases.”

On Jun 5, 2014, the European Central Bank introduced cuts in interest rates and a negative rate paid on deposits of banks (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605.en.html):

“5 June 2014 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

The interest rate on the main refinancing operations of the Eurosystem will be decreased by 10 basis points to 0.15%, starting from the operation to be settled on 11 June 2014.
The interest rate on the marginal lending facility will be decreased by 35 basis points to 0.40%, with effect from 11 June 2014.
The interest rate on the deposit facility will be decreased by 10 basis points to -0.10%, with effect from 11 June 2014. A separate press release to be published at 3.30 p.m. CET today will provide details on the implementation of the negative deposit facility rate.”

The ECB also introduced new measures of monetary policy on Jun 5, 2014 (http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605_2.en.html):

“5 June 2014 - ECB announces monetary policy measures to enhance the functioning of the monetary policy transmission mechanism

In pursuing its price stability mandate, the Governing Council of the ECB has today announced measures to enhance the functioning of the monetary policy transmission mechanism by supporting lending to the real economy. In particular, the Governing Council has decided:

To conduct a series of targeted longer-term refinancing operations (TLTROs) aimed at improving bank lending to the euro area non-financial private sector ^[¹^], excluding loans to households for house purchase, over a window of two years.
To intensify preparatory work related to outright purchases of asset-backed securities (ABS).”

The President of the European Central Bank (ECB) Mario Draghi analyzed the measures at a press conference (http://www.ecb.europa.eu/press/pressconf/2014/html/is140605.en.html).

The President of the European Central Bank (ECB) Mario Draghi reaffirmed the policy stance at the press conference following the meeting on Feb 6, 2014 (http://www.ecb.europa.eu/press/pressconf/2014/html/is140206.en.html): “As I have said several times we are willing to act and we stand ready to act. We confirmed our forward guidance, so interest rates will stay at the present or lower levels for an extended period of time.”

The President of the European Central Bank (ECB) Mario Draghi explained the indefinite period of low policy rates during the press conference following the meeting on Jul 4, 2013 (http://www.ecb.int/press/pressconf/2013/html/is130704.en.html):

“Yes, that is why I said you haven’t listened carefully. The Governing Council has taken the unprecedented step of giving forward guidance in a rather more specific way than it ever has done in the past. In my statement, I said “The Governing Council expects the key…” – i.e. all interest rates – “…ECB interest rates to remain at present or lower levels for an extended period of time.” It is the first time that the Governing Council has said something like this. And, by the way, what Mark Carney [Governor of the Bank of England] said in London is just a coincidence.”

The European Central Bank (ECB) lowered the policy rates on Nov 7, 2013 (http://www.ecb.europa.eu/press/pr/date/2013/html/pr131107.en.html):

“PRESS RELEASE

7 November 2013 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.25%, starting from the operation to be settled on 13 November 2013.
The interest rate on the marginal lending facility will be decreased by 25 basis points to 0.75%, with effect from 13 November 2013.
The interest rate on the deposit facility will remain unchanged at 0.00%.

The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 2.30 p.m. CET today.”

Mario Draghi, President of the ECB, explained as follows (http://www.ecb.europa.eu/press/pressconf/2013/html/is131107.en.html):

“Based on our regular economic and monetary analyses, we decided to lower the interest rate on the main refinancing operations of the Eurosystem by 25 basis points to 0.25% and the rate on the marginal lending facility by 25 basis points to 0.75%. The rate on the deposit facility will remain unchanged at 0.00%. These decisions are in line with our forward guidance of July 2013, given the latest indications of further diminishing underlying price pressures in the euro area over the medium term, starting from currently low annual inflation rates of below 1%. In keeping with this picture, monetary and, in particular, credit dynamics remain subdued. At the same time, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%. Such a constellation suggests that we may experience a prolonged period of low inflation, to be followed by a gradual upward movement towards inflation rates below, but close to, 2% later on. Accordingly, our monetary policy stance will remain accommodative for as long as necessary. It will thereby also continue to assist the gradual economic recovery as reflected in confidence indicators up to October.”

The ECB decision together with the employment situation report on Fri Nov 8, 2013, influenced revaluation of the dollar. Market expectations were of relatively easier monetary policy in the euro area.

The statement of the meeting of the Monetary Policy Committee of the Bank of England on Jul 4, 2013, may be leading toward the same forward guidance (http://www.bankofengland.co.uk/publications/Pages/news/2013/007.aspx):

“At its meeting today, the Committee noted that the incoming data over the past couple of months had been broadly consistent with the central outlook for output growth and inflation contained in the May Report. The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent

developments in the domestic economy.” 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 26,770.20 on Oct 18, 2019, which is higher by 89.0 percent than the value of 14,164.53 reached on Oct 9, 2007 and higher by 88.5 percent than the value of 14,198.10 reached on Oct 11, 2007. Values of risk financial assets have been approaching or exceeding historical highs.

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):

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

Greenspan (1996) made similar warnings:

The key policy is maintaining fed funds rate between 1½ and 1¾ 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.

Professor Raguram G Rajan, former governor of the Reserve Bank of India, which is India’s central bank, warned about risks in high valuations of asset prices in an interview with Christopher Jeffery of Central Banking Journal on Aug 6, 2014 (http://www.centralbanking.com/central-banking-journal/interview/2358995/raghuram-rajan-on-the-dangers-of-asset-prices-policy-spillovers-and-finance-in-india). Professor Rajan demystifies in the interview “competitive easing” by major central banks as equivalent to competitive devaluation. Rajan (2005) anticipated the risks of the world financial crisis. Professor John B. Taylor (2014Jul15, 2014Jun26) building on advanced research (Taylor 2007, 2008Nov, 2009, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB, 2015, 2012 Oct 25; 2013Oct28, 2014 Jan01, 2014Jan3, 2014Jun26, 2014Jul15, 2015, 2016Dec7, 2016Dec20, 2018Oct19 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).

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. 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. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows.

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) finds compelling evidence that sovereign credibility is insufficient to develop financial intermediation required for economic growth in the presence of inadequate political institutions.

The President of the ECB Mario Draghi stated in a speech at the conference “The ECB and its Watchers XX,” in Frankfurt am Main, on Mar 27, 2019 (https://www.ecb.europa.eu/press/key/date/2019/html/ecb.sp190327~2b454e4326.en.html): “We will continue monitoring how banks can maintain healthy earning conditions while net interest margins are compressed. And, if necessary, we need to reflect on possible measures that can preserve the favourable implications of negative rates for the economy, while mitigating the side effects, if any. That said, low bank profitability is not an inevitable consequence of negative rates. ECB analysis finds that the best-performing banks in the euro area in terms of return on equity between 2009 and 2017 share three key features: they have been able to significantly reduce their cost-to-income ratios; they have embarked on large-scale investments in information technology; and they have been able to diversify their revenue sources in a low interest rate environment.” At its meeting on September 12, 2019, the Governing Council of the ECB (European Central Bank), decided to (https://www.ecb.europa.eu/press/pr/date/2019/html/ecb.mp190912~08de50b4d2.en.html): (1) decrease the deposit facility by 10 basis points to minus 0.50 percent while maintaining at 0.00 the main refinancing operations rate and at 0.25 percent the marginal lending facility rate; (2) restart net purchases of securities at the monthly rate of €20 billion beginning on Nov 1, 2019; (3) reinvest principal payments from maturing securities; (4) adapt long-term refinancing operations to maintain “favorable bank lending conditions;” and (5) exempt part of the “negative deposit facility rate” on bank excess liquidity. Tom Fairless and Brian Blackstone, “ECB’s Draghi hints at drawbacks of negative rates,” Wall Street Journal, Mar 27, 2019, argue that while negative interest rates may encourage spending and investing they create adverse effects such as banks paying for reserves and holders of government bonds paying to hold them such as the current negative yields of ten-year bonds of Germany. Extremely low interest rates also encouraged artificial booms in real estate, which was one of the causes of the financial crisis and global recession (Taylor 2018Nov20, 3-4). Unconventional monetary policy of extremely low interest rates and bloated central bank balance sheet is almost impossible to reverse without causing financial crisis and recession. Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and r^e the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+r^e). Thus, g = [(r/r^e) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dr^e>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Ibid). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (10

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 (https://www.hoover.org/research/economic-failure-causes-political-polarization), analyzes that excessive risks induced by near zero interest rates in 2003-2004 caused the financial crash. Monetary policy continued in similar paths during and after the global recession with resulting political polarization worldwide.

Table III-1A, Two- and Ten-Year Yields of Government Bonds of the US and Germany and US Dollar/EUR Exchange rate

	US 2Y	US 10Y	DE 2Y	DE 10Y	USD/ EUR
10/18/19	1.574	1.749	-0.67	-0.38	1.1170
10/11/19	1.610	1.753	-0.72	-0.44	1.1038
10/04/19	1.392	1.515	-0.78	-0.59	1.0980
09/27/19	1.620	1.676	-0.77	-0.57	1.0942
09/20/19	1.710	1.754	-0.71	-0.52	1.1018
09/13/19	1.794	1.894	-0.71	-0.45	1.1074
09/06/19	1.524	1.554	-0.87	-0.63	1.1031
08/30/19	1.504	1.504	-0.92	-0.70	1.0991
08/23/19	1.535	1.526	-0.89	-0.67	1.1145
08/16/19	1.468	1.540	-0.91	-0.68	1.1091
08/09/19	1.632	1.736	-0.86	-0.57	1.1201
08/02/19	1.718	1.860	-0.79	-0.49	1.1109
07/26/19	1.874	2.080	-0.75	-0.37	1.1128
07/19/19	1.822	2.049	-0.77	-0.32	1.1222
07/12/19	1.837	2.107	-0.72	-0.21	1.1270
07/05/18	1.872	2.045	-0.75	-0.36	1.1226
06/28/19	1.757	2.006	-0.74	-0.33	1.1372
06/21/19	1.778	2.062	-0.73	-0.28	1.1370
06/14/19	1.847	2.095	-0.70	-0.25	1.1211
06/07/19	1.849	2.082	-0.67	-0.25	1.1335
05/31/19	1.952	2.141	-0.66	-0.20	1.1171
05/24/19	2.158	2.323	-0.63	-0.11	1.1208
05/17/19	2.217	2.398	-0.65	-0.10	1.1159
05/10/19	2.250	2.457	-0.62	-0.04	1.1235
05/03/19	2.331	2.526	-0.58	0.03	1.1202
04/26/19	2.282	2.505	-0.60	-0.02	1.1149
04/19/19	2.390	2.564	-0.57	0.03	1.1244
04/12/19	2.398	2.557	-0.55	0.06	1.1301
04/05/19	2.343	2.503	-0.58	0.01	1.1218
03/29/19	2.274	2.416	-0.61	-0.07	1.1219
03/22/19	2.321	2.453	-0.56	-0.01	1.1305
03/15/19	2.450	2.593	-0.54	0.09	1.1326
03/08/19	2.455	2.630	-0.54	0.07	1.1236
03/01/19	2.557	2.747	-0.53	0.19	1.1368
02/22/19	2.487	2.652	-0.57	0.10	1.1335
02/15/19	2.516	2.667	-0.56	0.11	1.1298
02/08/19	2.467	2.636	-0.58	0.09	1.1326
02/01/19	2.504	2.691	-0.57	0.17	1.1459
01/25/19	2.604	2.750	-0.59	0.20	1.1413
01/18/19	2.612	2.780	-0.58	0.26	1.1364
01/11/19	2.549	2.700	-0.59	0.24	1.1469
01/04/19	2.480	2.658	-0.59	0.21	1.1398
12/28/18	2.528	2.736	-0.61	0.24	1.1443
12/21/18	2.637	2.791	-0.59	0.25	1.1370
12/14/18	2.737	2.892	-0.60	0.26	1.1309
12/07/18	2.705	2.848	-0.63	0.25	1.1387
11/30/18	2.827	3.014	-0.58	0.32	1.1320
11/23/18	2.816	3.039	-0.58	0.34	1.1339
11/16/18	2.812	3.075	-0.62	0.37	1.1418
11/09/18	2.932	3.188	-0.60	0.41	1.1336
11/02/18	2.912	3.216	-0.60	0.43	1.1388
10/26/18	2.819	3.077	-0.64	0.36	1.1404
10/19/18	2.908	3.198	-0.58	0.46	1.1514
10/12/18	2.845	3.137	-0.55	0.50	1.1560
10/05/18	2.881	3.231	-0.50	0.58	1.1523
09/28/18	2.811	3.055	-0.52	0.47	1.1605
09/21/18	2.813	3.067	-0.54	0.46	1.1749
09/14/18	2.778	2.987	-0.54	0.45	1.1622
09/07/18	2.703	2.936	-0.55	0.39	1.1553
08/31/18	2.625	2.850	-0.62	0.33	1.1604
08/24/18	2.612	2.823	-0.61	0.35	1.1622
08/17/18	2.625	2.870	-0.65	0.31	1.1438
08/10/18	2.600	2.859	-0.64	0.32	1.1412
08/03/18	2.641	2.952	-0.59	0.41	1.1568
07/27/18	2.673	2.959	-0.60	0.41	1.1656
07/20/18	2.604	2.890	-0.62	0.37	1.1722
07/13/18	2.574	2.830	-0.63	0.28	1.1685
07/06/18	2.537	2.821	-0.66	0.30	1.1744
06/29/18	2.524	2.850	-0.66	0.31	1.1683
06/22/18	2.554	2.902	-0.66	0.34	1.1656
06/15/18	2.553	2.922	-0.63	0.41	1.1609
06/08/18	2.492	2.938	-0.66	0.45	1.1771
06/01/18	2.484	2.889	-0.66	0.39	1.1659
05/25/18	2.480	2.928	-0.66	0.41	1.1645
05/18/18	2.549	3.065	-0.58	0.58	1.1771
05/11/18	2.531	2.970	-0.58	0.56	1.1942
05/04/18	2.509	2.943	-0.58	0.55	1.1963
04/27/18	2.484	2.955	-0.57	0.57	1.2131
04/20/18	2.449	2.953	-0.56	0.59	1.2289
04/13/18	2.369	2.825	-0.59	0.51	1.2331
04/06/18	2.262	2.778	-0.59	0.50	1.2283
03/30/18	2.266	2.739	-0.61	0.50	1.2324
03/23/18	2.262	2.826	-0.61	0.53	1.2356
03/16/18	2.295	2.845	-0.59	0.57	1.2291
03/09/18	2.270	2.893	-0.57	0.65	1.2307
03/02/18	2.226	2.855	-0.62	0.65	1.2321
02/23/18	2.242	2.870	-0.58	0.65	1.2298
02/16/18	2.194	2.877	-0.57	0.71	1.2409
02/09/18	2.061	2.830	-0.57	0.75	1.2252
02/02/18	2.149	2.848	-0.55	0.77	1.2459
01/26/18	2.128	2.661	-0.54	0.63	1.2427
01/19/18	2.053	2.638	-0.60	0.51	1.2220
01/12/18	2.002	2.550	-0.56	0.52	1.2200
01/05/18	1.964	2.475	-0.61	0.44	1.2032
12/29/17	1.891	2.411	-0.62	0.43	1.2003
12/22/17	1.899	2.487	-0.64	0.42	1.1862
12/15/17	1.836	2.355	-0.72	0.31	1.1748
12/08/17	1.799	2.383	-0.74	0.31	1.1774
12/01/17	1.774	2.361	-0.70	0.31	1.1896
11/24/17	1.740	2.343	-0.69	0.36	1.1932
11/17/17	1.726	2.354	-0.71	0.36	1.1793
11/10/17	1.662	2.404	-0.75	0.41	1.1665
11/03/17	1.621	2.343	-0.75	0.37	1.1610
10/27/17	1.600	2.423	-0.76	0.39	1.1610
10/20/17	1.572	2.379	-0.72	0.46	1.1783
10/13/17	1.501	2.278	-0.72	0.41	1.1821
10/06/17	1.532	2.368	-0.69	0.46	1.1732
09/29/17	1.475	2.327	-0.69	0.47	1.1814
09/22/17	1.443	2.263	-0.67	0.45	1.1948
09/15/17	1.384	2.201	-0.70	0.43	1.1947
09/08/17	1.262	2.061	-0.76	0.31	1.2037
09/01/17	1.358	2.157	-0.75	0.38	1.1863
08/25/17	1.342	2.171	-0.73	0.38	1.1924
08/18/17	1.314	2.196	-0.70	0.42	1.1762
08/11/17	1.290	2.189	-0.72	0.38	1.1823
08/04/17	1.355	2.268	-0.68	0.47	1.1774
07/28/17	1.359	2.288	-0.68	0.54	1.1751
07/21/17	1.344	2.233	-0.64	0.51	1.1666
07/14/17	1.339	2.323	-0.61	0.60	1.1470
07/07/17	1.403	2.393	-0.60	0.58	1.1403
06/30/17	1.394	2.304	-0.59	0.47	1.1427
06/23/17	1.345	2.144	-0.64	0.26	1.1193
06/16/17	1.331	2.154	-0.67	0.28	1.1198
06/09/17	1.339	2.199	-0.75	0.27	1.1197
06/02/17	1.282	2.161	-0.75	0.28	1.1282
05/26/17	1.298	2.247	-0.70	0.33	1.1182
05/19/17	1.279	2.243	-0.69	0.37	1.1207
05/12/17	1.299	2.333	-0.67	0.39	1.0932
05/05/17	1.322	2.352	-0.68	0.42	1.0999
04/28/17	1.266	2.286	-0.73	0.32	1.0897
04/21/17	1.184	2.233	-0.79	0.26	1.0727
04/14/17	1.210	2.234	-0.86	0.19	1.0614
04/07/17	1.282	2.373	-0.81	0.23	1.0591
03/31/17	1.262	2.396	-0.74	0.33	1.0656
03/24/17	1.248	2.399	-0.74	0.41	1.0800
03/17/17	1.317	2.502	-0.77	0.43	1.0738
03/10/17	1.364	2.584	-0.84	0.49	1.0674
03/03/17	1.305	2.492	-0.81	0.35	1.0623
02/24/17	1.157	2.314	-0.95	0.19	1.0562
02/17/17	1.203	2.425	-0.81	0.31	1.0615
02/10/17	1.198	2.408	-0.80	0.32	1.0642
02/03/17	1.201	2.488	-0.74	0.42	1.0786
01/27/17	1.224	2.479	-0.66	0.46	1.0699
01/20/17	1.189	2.466	-0.68	0.43	1.0703
01/13/17	1.189	2.381	-0.72	0.34	1.0645
01/06/17	1.226	2.416	-0.73	0.30	1.0533
12/30/16	1.210	2.447	-0.79	0.21	1.0520
12/23/16	1.202	2.542	-0.79	0.26	1.0456
12/16/16	1.269	2.597	-0.80	0.32	1.0451
12/09/16	1.129	2.466	-0.76	0.37	1.0563
12/02/16	1.120	2.389	-0.73	0.28	1.0668
11/25/16	1.115	2.358	-0.74	0.24	1.0591
11/18/16	1.052	2.340	-0.66	0.28	1.0591
11/11/16	0.919	2.152	-0.60	0.31	1.0857
11/04/16	0.810	1.784	-0.64	0.14	1.1141
10/28/16	0.861	1.843	-0.62	0.17	1.0987
10/21/16	0.844	1.738	-0.66	0.01	1.0884
10/14/16	0.835	1.791	-0.66	0.06	1.0972
10/07/16	0.834	1.732	-0.66	-0.02	1.1203
09/30/16	0.766	1.602	-0.68	-0.12	1.1240
09/23/16	0.758	1.614	-0.67	-0.08	1.1228
09/16/16	0.774	1.699	-0.65	0.01	1.1157
09/09/16	0.790	1.675	-0.63	-0.01	1.1234
09/02/16	0.798	1.597	-0.63	-0.04	1.1156
08/26/16	0.845	1.635	-0.61	-0.07	1.1197
08/19/16	0.742	1.580	-0.61	-0.03	1.1326
08/12/16	0.722	1.514	-0.63	-0.11	1.1163
08/05/16	0.722	1.583	-0.62	-0.06	1.1088
07/29/16	0.671	1.458	-0.63	-0.12	1.1176
07/22/16	0.703	1.567	-0.61	-0.03	1.0980
07/15/16	0.706	1.595	-0.65	0.01	1.1037
07/08/16	0.613	1.366	-0.69	-0.19	1.1052
07/01/16	0.597	1.443	-0.65	-0.12	1.1140
06/24/16	0.641	1.575	-0.64	-0.04	1.1117
06/17/16	0.697	1.618	-0.59	0.02	1.1277
06/10/16	0.751	1.638	-0.54	0.02	1.1252
06/03/16	0.784	1.704	-0.53	0.07	1.1364
05/27/16	0.915	1.851	-0.50	0.14	1.1115
05/20/16	0.893	1.849	-0.50	0.17	1.1226
05/13/16	0.746	1.706	-0.51	0.13	1.1309
05/06/16	0.738	1.780	-0.51	0.15	1.1405
04/29/16	0.774	1.820	-0.47	0.27	1.1450
04/22/17	0.826	1.886	-0.50	0.23	1.1227
04/15/17	0.734	1.752	-0.51	0.13	1.1285
04/08/16	0.707	1.722	-0.51	0.10	1.1399
03/25/16	0.885	1.900	-0.48	0.18	1.1168
03/18/16	0.843	1.871	-0.47	0.21	1.1270
03/11/16	0.960	1.977	-0.46	0.27	1.1151
03/04/16	0.878	1.884	-0.52	0.24	1.1006
02/26/16	0.793	1.766	-0.52	0.15	1.0933
02/19/16	0.746	1.748	-0.52	0.21	1.1131
02/12/16	0.694	1.744	-0.50	0.26	1.1256
02/05/16	0.726	1.848	-0.49	0.30	1.1158
01/29/16	0.778	1.923	-0.48	0.33	1.0833
01/22/16	0.881	2.048	-0.44	0.42	1.0799
01/15/16	0.858	2.036	-0.38	0.48	1.0917
01/08/16	0.948	2.135	-0.39	0.52	1.0926
01/01/16	1.060	2.269	-0.34	0.63	1.0861
12/25/15	0.998	2.242	-0.33	0.63	1.0965
12/18/15	0.944	2.197	-0.35	0.55	1.0868
12/11/15	0.903	2.134	-0.34	0.54	1.0991
12/04/15	0.951	2.276	-0.29	0.68	1.0885
11/27/15	0.922	2.223	-0.42	0.46	1.0594
11/20/15	0.905	2.260	-0.39	0.48	1.0647
11/13/15	0.855	2.278	-0.37	0.56	1.0774
11/06/15	0.890	2.332	-0.27	0.70	1.0742
10/30/15	0.736	2.150	-0.33	0.52	1.1007
10/23/15	0.645	2.083	-0.31	0.52	1.1018
10/16/15	0.605	2.024	-0.26	0.55	1.1350
10/09/15	0.641	2.096	-0.24	0.62	1.1359
10/02/15	0.578	1.998	-0.27	0.51	1.1214
09/25/15	0.688	2.168	-0.24	0.65	1.1199
09/18/15	0.678	2.131	-0.24	0.67	1.1303
09/11/15	0.701	2.181	-0.25	0.66	1.1338
09/04/15	0.709	2.127	-0.23	0.67	1.1153
08/28/15	0.716	2.182	-0.21	0.75	1.1185
08/21/15	0.633	2.052	-0.25	0.57	1.1389
08/14/15	0.738	2.196	-0.27	0.66	1.1109
08/07/15	0.729	2.164	-0.25	0.62	1.0967
07/31/15	0.669	2.207	-0.23	0.61	1.0984
07/24/15	0.682	2.268	-0.21	0.65	1.0985
07/17/15	0.666	2.346	-0.22	0.74	1.0831
07/10/15	0.653	2.414	-0.21	0.90	1.1156
07/03/15	0.629	2.383	-0.25	0.80	1.1115
06/26/15	0.704	2.473	-0.18	0.93	1.1167
06/19/15	0.629	2.270	-0.20	0.76	1.1352
06/12/15	0.726	2.388	-0.18	0.83	1.1268
06/05/15	0.733	2.400	-0.17	0.85	1.1166
05/29/15	0.605	2.092	-0.22	0.49	1.0993
05/22/15	0.618	2.211	-0.22	0.61	1.1015
05/15/15	0.544	2.136	-0.20	0.63	1.1449
05/08/15	0.580	2.153	-0.21	0.55	1.1202
05/01/15	0.607	2.118	-0.21	0.37	1.1199
04/24/15	0.512	1.917	-0.25	0.16	1.0874
04/17/15	0.512	1.864	-0.28	0.08	1.0807
04/10/15	0.560	1.950	-0.28	0.16	1.0603
04/02/15	0.544	1.911	-0.26	0.17	1.0973
03/27/15	0.590	1.951	-0.25	0.18	1.0890
03/20/15	0.589	1.927	-0.24	0.15	1.0821
03/13/15	0.660	2.103	-0.24	0.22	1.0497
03/06/15	0.723	2.238	-0.21	0.35	1.0843
02/27/15	0.634	2.016	-0.23	0.28	1.1197
02/20/15	0.642	2.119	-0.23	0.33	1.1381
02/13/15	0.640	2.043	-0.23	0.31	1.1391
02/06/15	0.640	1.941	-0.21	0.34	1.1316
01/30/15	0.450	1.683	-0.19	0.27	1.1291
01/23/15	0.495	1.804	-0.18	0.39	1.1206
01/16/15	0.488	1.826	-0.17	0.41	1.1567
01/09/15	0.577	1.973	-0.12	0.49	1.1843
01/02/15	0.670	2.126	-0.12	0.50	1.2003
12/26/14	0.739	2.248	-0.10	0.59	1.2182
12/19/14	0.654	2.185	-0.09	0.59	1.2229
12/12/14	0.546	2.086	-0.05	0.62	1.2464
12/05/14	0.641	2.306	-0.02	1.04	1.2285
11/28/14	0.470	2.165	-0.04	0.70	1.2452
11/21/14	0.507	2.307	-0.04	0.77	1.2390
11/14/21	0.510	2.319	-0.04	0.78	1.2525
11/7/14	0.501	2.302	-0.06	0.82	1.2455
10/31/14	0.495	2.332	-0.06	0.84	1.2773
10/24/14	0.380	2.263	-0.04	0.89	1.2671
10/17/14	0.373	2.197	-0.06	0.86	1.2760
10/10/14	0.434	2.292	-0.06	0.89	1.2629
10/03/14	0.562	2.437	-0.07	0.92	1.2514
09/26/14	0.581	2.527	-0.07	0.97	1.2683
09/19/14	0.567	2.576	-0.07	1.04	1.2829
09/12/14	0.562	2.606	-0.06	1.08	1.2965
09/05/14	0.510	2.457	-0.08	0.93	1.2952
08/29/14	0.490	2.342	-0.04	0.89	1.3133
08/22/14	0.490	2.399	0.00	0.98	1.3242
08/15/14	0.405	2.341	-0.02	0.95	1.3400
08/08/14	0.446	2.420	0.00	1.05	1.3411
08/01/14	0.470	2.497	0.02	1.13	1.3430
07/25/14	0.494	2.464	0.02	1.15	1.3431
07/18/14	0.478	2.484	0.02	1.15	1.3525
07/11/14	0.446	2.516	0.01	1.20	1.3608
07/04/14	0.502	2.641	0.02	1.26	1.3595
06/27/14	0.463	2.536	0.03	1.26	1.3649
06/20/14	0.458	2.609	0.03	1.34	1.3600
06/13/14	0.451	2.605	0.02	1.36	1.3540
06/06/14	0.405	2.598	0.05	1.35	1.3643
05/30/14	0.373	2.473	0.06	1.36	1.3632
05/23/14	0.345	2.532	0.06	1.41	1.3630
05/16/14	0.357	2.520	0.09	1.33	1.3694
05/09/14	0.385	2.624	0.13	1.45	1.3760
05/02/14	0.421	2.583	0.12	1.45	1.3873
04/25/14	0.432	2.668	0.17	1.48	1.3833
04/18/14	0.401	2.724	0.17	1.51	1.3813
04/11/14	0.357	2.628	0.16	1.50	1.3885
04/04/14	0.413	2.724	0.16	1.55	1.3704
03/28/14	0.448	2.721	0.14	1.55	1.3752
03/21/14	0.431	2.743	0.20	1.63	1.3793
03/14/14	0.340	2.654	0.15	1.54	1.3912
03/07/14	0.367	2.792	0.17	1.65	1.3877
02/28/14	0.323	2.655	0.13	1.62	1.3801
02/21/14	0.316	2.730	0.12	1.66	1.3739
02/14/14	0.313	2.743	0.11	1.68	1.3693
02/07/14	0.305	2.681	0.09	1.66	1.3635
1/31/14	0.330	2.645	0.07	1.66	1.3488
1/24/14	0.342	2.720	0.12	1.66	1.3677
1/17/14	0.373	2.818	0.17	1.75	1.3541
1/10/14	0.372	2.858	0.18	1.84	1.3670
1/3/14	0.398	2.999	0.20	1.94	1.3588
12/27/13	0.393	3.004	0.24	1.95	1.3746
12/20/13	0.377	2.891	0.22	1.87	1.3673
12/13/13	0.328	2.865	0.24	1.83	1.3742
12/6/13	0.304	2.858	0.21	1.84	1.3705
11/29/13	0.283	2.743	0.11	1.69	1.3592
11/22/13	0.280	2.746	0.13	1.74	1.3557
11/15/13	0.292	2.704	0.10	1.70	1.3497
11/8/13	0.316	2.750	0.10	1.76	1.3369
11/1/13	0.311	2.622	0.11	1.69	1.3488
10/25/13	0.305	2.507	0.18	1.75	1.3804
10/18/13	0.321	2.588	0.17	1.83	1.3686
10/11/13	0.344	2.688	0.18	1.86	1.3543
10/4/13	0.335	2.645	0.17	1.84	1.3557
9/27/13	0.335	2.626	0.16	1.78	1.3523
9/20/13	0.333	2.734	0.21	1.94	1.3526
9/13/13	0.433	2.890	0.22	1.97	1.3297
9/6/13	0.461	2.941	0.26	1.95	1.3179
8/23/13	0.401	2.784	0.23	1.85	1.3221
8/23/13	0.374	2.818	0.28	1.93	1.3380
8/16/13	0.341	2.829	0.22	1.88	1.3328
8/9/13	0.30	2.579	0.16	1.68	1.3342
8/2/13	0.299	2.597	0.15	1.65	1.3281
7/26/13	0.315	2.565	0.15	1.66	1.3279
7/19/13	0.300	2.480	0.08	1.52	1.3141
7/12/13	0.345	2.585	0.10	1.56	1.3068
7/5/13	0.397	2.734	0.11	1.72	1.2832
6/28/13	0.357	2.486	0.19	1.73	1.3010
6/21/13	0.366	2.542	0.26	1.72	1.3122
6/14/13	0.276	2.125	0.12	1.51	1.3345
6/7/13	0.304	2.174	0.18	1.54	1.3219
5/31/13	0.299	2.132	0.06	1.50	1.2996
5/24/13	0.249	2.009	0.00	1.43	1.2932
5/17/13	0.248	1.952	-0.03	1.32	1.2837
5/10/13	0.239	1.896	0.05	1.38	1.2992
5/3/13	0.22	1.742	0.00	1.24	1.3115
4/26/13	0.209	1.663	0.00	1.21	1.3028
4/19/13	0.232	1.702	0.02	1.25	1.3052
4/12/13	0.228	1.719	0.02	1.26	1.3111
4/5/13	0.228	1.706	0.01	1.21	1.2995
3/29/13	0.244	1.847	-0.02	1.29	1.2818
3/22/13	0.242	1.931	0.03	1.38	1.2988
3/15/13	0.246	1.992	0.05	1.46	1.3076
3/8/13	0.256	2.056	0.09	1.53	1.3003
3/1/13	0.236	1.842	0.03	1.41	1.3020
2/22/13	0.252	1.967	0.13	1.57	1.3190
2/15/13	0.268	2.007	0.19	1.65	1.3362
2/8/13	0.252	1.949	0.18	1.61	1.3365
2/1/13	0.26	2.024	0.25	1.67	1.3642
1/25/13	0.278	1.947	0.26	1.64	1.3459
1/18/13	0.252	1.84	0.18	1.56	1.3321
1/11/13	0.247	1.862	0.13	1.58	1.3343
1/4/13	0.262	1.898	0.08	1.54	1.3069
12/28/12	0.252	1.699	-0.01	1.31	1.3218
12/21/12	0.272	1.77	-0.01	1.38	1.3189
12/14/12	90.232	1.704	-0.04	1.35	1.3162
12/7/12	0.256	1.625	-0.08	1.30	1.2926
11/30/12	0.248	1.612	0.01	1.39	1.2987
11/23/12	0.273	1.691	0.00	1.44	1.2975
11/16/12	0.24	1.584	-0.03	1.33	1.2743
11/9/12	0.256	1.614	-0.03	1.35	1.2711
11/2/12	0.274	1.715	0.01	1.45	1.2838
10/26/12	0.299	1.748	0.05	1.54	1.2942
10/19/12	0.296	1.766	0.11	1.59	1.3023
10/12/12	0.264	1.663	0.04	1.45	1.2953
10/5/12	0.26	1.737	0.06	1.52	1.3036
9/28/12	0.236	1.631	0.02	1.44	1.2859
9/21/12	0.26	1.753	0.04	1.60	1.2981
9/14/12	0.252	1.863	0.10	1.71	1.3130
9/7/12	0.252	1.668	0.03	1.52	1.2816
8/31/12	0.225	1.543	-0.03	1.33	1.2575
8/24/12	0.266	1.684	-0.01	1.35	1.2512
8/17/12	0.288	1.814	-0.04	1.50	1.2335
8/10/12	0.267	1.658	-0.07	1.38	1.2290
8/3/12	0.242	1.569	-0.02	1.42	1.2387
7/27/12	0.244	1.544	-0.03	1.40	1.2320
7/20/12	0.207	1.459	-0.07	1.17	1.2158
7/13/12	0.24	1.49	-0.04	1.26	1.2248
7/6/12	0.272	1.548	-0.01	1.33	1.2288
6/29/12	0.305	1.648	0.12	1.58	1.2661
6/22/12	0.309	1.676	0.14	1.58	1.2570
6/15/12	0.272	1.584	0.07	1.44	1.2640
6/8/12	0.268	1.635	0.04	1.33	1.2517
6/1/12	0.248	1.454	0.01	1.17	1.2435
5/25/12	0.291	1.738	0.05	1.37	1.2518
5/18/12	0.292	1.714	0.05	1.43	1.2780
5/11/12	0.248	1.845	0.09	1.52	1.2917
5/4/12	0.256	1.876	0.08	1.58	1.3084
4/6/12	0.31	2.058	0.14	1.74	1.3096
3/30/12	0.335	2.214	0.21	1.79	1.3340
3/2/12	0.29	1.977	0.16	1.80	1.3190
2/24/12	0.307	1.977	0.24	1.88	1.3449
1/6/12	0.256	1.957	0.17	1.85	1.2720
12/30/11	0.239	1.871	0.14	1.83	1.2944
8/26/11	0.20	2.202	0.65	2.16	1.450
8/19/11	0.192	2.066	0.65	2.11	1.4390
6/7/10	0.74	3.17	0.49	2.56	1.192
3/5/09	0.89	2.83	1.19	3.01	1.254
12/17/08	0.73	2.20	1.94	3.00	1.442
10/27/08	1.57	3.79	2.61	3.76	1.246
7/14/08	2.47	3.88	4.38	4.40	1.5914
6/26/03	1.41	3.55	NA	3.62	1.1423

Note: DE: Germany

Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

http://www.bloomberg.com/markets/

http://www.federalreserve.gov/releases/h15

Appendix: Prior Risk Determining Events. Current risk analysis concentrates on deciphering what the Federal Open Market Committee (FOMC) may decide on quantitative easing. The week of May 24 was dominated by the testimony of Chairman Bernanke to the Joint Economic Committee of the US Congress on May 22, 2013 (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm), followed by questions and answers and the release on May 22, 2013 of the minutes of the meeting of the Federal Open Market Committee (FOMC) from Apr 30 to May 1, 2013 (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm). Monetary policy emphasizes communication of policy intentions to avoid that expectations reverse outcomes in reality (Kydland and Prescott 1977). Jon Hilsenrath, writing on “In bid for clarity, Fed delivers opacity,” on May 23, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath), analyzes discrepancies in communication by the Fed. The annotated chart of values of the Dow Jones Industrial Average (DJIA) during trading on May 23, 2013 provided by Hinselrath, links the prepared testimony of Chairman Bernanke at 10:AM, following questions and answers and the release of the minutes of the FOMC at 2PM. Financial markets strengthened between 10 and 10:30AM on May 23, 2013, perhaps because of the statement by Chairman Bernanke in prepared testimony (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm):

“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further. Such outcomes tend to be associated with extended periods of lower, not higher, interest rates, as well as poor returns on other assets. Moreover, renewed economic weakness would pose its own risks to financial stability.”

In that testimony, Chairman Bernanke (http://www.federalreserve.gov/newsevents/testimony/bernanke20130522a.htm) also analyzes current weakness of labor markets:

“Despite this improvement, the job market remains weak overall: The unemployment rate is still well above its longer-run normal level, rates of long-term unemployment are historically high, and the labor force participation rate has continued to move down. Moreover, nearly 8 million people are working part time even though they would prefer full-time work. High rates of unemployment and underemployment are extraordinarily costly: Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers' skills and--particularly relevant during this commencement season--by preventing many young people from gaining workplace skills and experience in the first place. The loss of output and earnings associated with high unemployment also reduces government revenues and increases spending on income-support programs, thereby leading to larger budget deficits and higher levels of public debt than would otherwise occur.”

Hilsenrath (op. cit. http://online.wsj.com/article/SB10001424127887323336104578501552642287218.html?KEYWORDS=articles+by+jon+hilsenrath) analyzes the subsequent decline of the market from 10:30AM to 10:40AM as Chairman Bernanke responded questions with the statement that withdrawal of stimulus would be determined by data but that it could begin in one of the “next few meetings.” The DJIA recovered part of the losses between 10:40AM and 2PM. The minutes of the FOMC released at 2PM on May 23, 2013, contained a phrase that troubled market participants (http://www.federalreserve.gov/monetarypolicy/fomcminutes20130501.htm): “A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.” The DJIA closed at 15,387.58 on May 21, 2013 and fell to 15,307.17 at the close on May 22, 2013, with the loss of 0.5 percent occurring after release of the minutes of the FOMC at 2PM when the DJIA stood at around 15,400. The concern about exist of the Fed from stimulus affected markets worldwide as shown in declines of equity indexes in Table III-1 with delays because of differences in trading hours. This behavior shows the trap of unconventional monetary policy with no exit from zero interest rates without risking financial crash and likely adverse repercussions on economic activity.

Financial markets worldwide were affected by the reduction of policy rates of the European Central Bank (ECB) on May 2, 2013. (http://www.ecb.int/press/pr/date/2013/html/pr130502.en.html):

“2 May 2013 - Monetary policy decisions

At today’s meeting, which was held in Bratislava, the Governing Council of the ECB took the following monetary policy decisions:

The interest rate on the main refinancing operations of the Eurosystem will be decreased by 25 basis points to 0.50%, starting from the operation to be settled on 8 May 2013.
The interest rate on the marginal lending facility will be decreased by 50 basis points to 1.00%, with effect from 8 May 2013.
The interest rate on the deposit facility will remain unchanged at 0.00%.”

Financial markets in Japan and worldwide were shocked by new bold measures of “quantitative and qualitative monetary easing” by the Bank of Japan (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The objective of policy is to “achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf). The main elements of the new policy are as follows:

Monetary Base Control. Most central banks in the world pursue interest rates instead of monetary aggregates, injecting bank reserves to lower interest rates to desired levels. The Bank of Japan (BOJ) has shifted back to monetary aggregates, conducting money market operations with the objective of increasing base money, or monetary liabilities of the government, at the annual rate of 60 to 70 trillion yen. The BOJ estimates base money outstanding at “138 trillion yen at end-2012) and plans to increase it to “200 trillion yen at end-2012 and 270 trillion yen at end 2014” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
Maturity Extension of Purchases of Japanese Government Bonds. Purchases of bonds will be extended even up to bonds with maturity of 40 years with the guideline of extending the average maturity of BOJ bond purchases from three to seven years. The BOJ estimates the current average maturity of Japanese government bonds (JGB) at around seven years. The BOJ plans to purchase about 7.5 trillion yen per month (http://www.boj.or.jp/en/announcements/release_2013/rel130404d.pdf). Takashi Nakamichi, Tatsuo Ito and Phred Dvorak, wiring on “Bank of Japan mounts bid for revival,” on Apr 4, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323646604578401633067110420.html), find that the limit of maturities of three years on purchases of JGBs was designed to avoid views that the BOJ would finance uncontrolled government deficits.
Seigniorage. The BOJ is pursuing coordination with the government that will take measures to establish “sustainable fiscal structure with a view to ensuring the credibility of fiscal management” (http://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf).
Diversification of Asset Purchases. The BOJ will engage in transactions of exchange traded funds (ETF) and real estate investment trusts (REITS) and not solely on purchases of JGBs. Purchases of ETFs will be at an annual rate of increase of one trillion yen and purchases of REITS at 30 billion yen.

The European sovereign debt crisis continues to shake financial markets and the world economy. Debt resolution within the international financial architecture requires that a country be capable of borrowing on its own from the private sector. Mechanisms of debt resolution have included participation of the private sector (PSI), or “bail in,” that has been voluntary, almost coercive, agreed and outright coercive (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Creditors and Debtors (2005), Chapter 4, 187-202). Private sector involvement requires losses by the private sector in bailouts of highly indebted countries. The essence of successful private sector involvement is to recover private-sector credit of the highly indebted country. Mary Watkins, writing on “Bank bailouts reshuffle risk hierarchy,” published on Mar 19, 2013, in the Financial Times (http://www.ft.com/intl/cms/s/0/7666546a-9095-11e2-a456-00144feabdc0.html#axzz2OSpbvCn8) analyzes the impact of the bailout or resolution of Cyprus banks on the hierarchy of risks of bank liabilities. Cyprus banks depend mostly on deposits with less reliance on debt, raising concerns in creditors of fixed-income debt and equity holders in banks in the euro area. Uncertainty remains as to the dimensions and structure of losses in private sector involvement or “bail in” in other rescue programs in the euro area. Alkman Granitsas, writing on “Central bank details losses at Bank of Cyprus,” on Mar 30, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324000704578392502889560768.html), analyzes the impact of the agreement with the €10 billion agreement with IMF and the European Union on the banks of Cyprus. The recapitalization plan provides for immediate conversion of 37.5 percent of all deposits in excess of €100,000 to shares of special class of the bank. An additional 22.5 percent will be frozen without interest until the plan is completed. The overwhelming risk factor is the unsustainable Treasury deficit/debt of the United States (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). 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.

An important risk event is the reduction of growth prospects in the euro zone discussed by European Central Bank President Mario Draghi in “Introductory statement to the press conference,” on Dec 6, 2012 (http://www.ecb.int/press/pressconf/2012/html/is121206.en.html):

“This assessment is reflected in the December 2012 Eurosystem staff macroeconomic projections for the euro area, which foresee annual real GDP growth in a range between -0.6% and -0.4% for 2012, between -0.9% and 0.3% for 2013 and between 0.2% and 2.2% for 2014. Compared with the September 2012 ECB staff macroeconomic projections, the ranges for 2012 and 2013 have been revised downwards.

The Governing Council continues to see downside risks to the economic outlook for the euro area. These are mainly related to uncertainties about the resolution of sovereign debt and governance issues in the euro area, geopolitical issues and fiscal policy decisions in the United States possibly dampening sentiment for longer than currently assumed and delaying further the recovery of private investment, employment and consumption.”

Reuters, writing on “Bundesbank cuts German growth forecast,” on Dec 7, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/8e845114-4045-11e2-8f90-00144feabdc0.html#axzz2EMQxzs3u), informs that the central bank of Germany, Deutsche Bundesbank reduced its forecast of growth for the economy of Germany to 0.7 percent in 2012 from an earlier forecast of 1.0 percent in Jun and to 0.4 percent in 2012 from an earlier forecast of 1.6 percent while the forecast for 2014 is at 1.9 percent.

The major risk event during earlier weeks was sharp decline of sovereign yields with the yield on the ten-year bond of Spain falling to 5.309 percent and that of the ten-year bond of Italy falling to 4.473 percent on Fri Nov 30, 2012 and 5.366 percent for the ten-year of Spain and 4.527 percent for the ten-year of Italy on Fri Nov 14, 2012 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata). Vanessa Mock and Frances Robinson, writing on “EU approves Spanish bank’s restructuring plans,” on Nov 28, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578146520774638316.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the European Union regulators approved restructuring of four Spanish banks (Bankia, NCG Banco, Catalunya Banc and Banco de Valencia), which helped to calm sovereign debt markets. Harriet Torry and James Angelo, writing on “Germany approves Greek aid,” on Nov 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323751104578150532603095790.html?mod=WSJ_hp_LEFTWhatsNewsCollection), inform that the German parliament approved the plan to provide Greece a tranche of €44 billion in promised financial support, which is subject to sustainability analysis of the bond repurchase program later in Dec 2012. A hurdle for sustainability of repurchasing debt is that Greece’s sovereign bonds have appreciated significantly from around 24 percent for the bond maturing in 21 years and 20 percent for the bond maturing in 31 years in Aug 2012 to around 17 percent for the 21-year maturity and 15 percent for the 31-year maturing in Nov 2012. Declining years are equivalent to increasing prices, making the repurchase more expensive. Debt repurchase is intended to reduce bonds in circulation, turning Greek debt more manageable. Ben McLannahan, writing on “Japan unveils $11bn stimulus package,” on Nov 30, 2012, published in the Financial Times (http://www.ft.com/intl/cms/s/0/adc0569a-3aa5-11e2-baac-00144feabdc0.html#axzz2DibFFquN), informs that the cabinet in Japan approved another stimulus program of $11 billion, which is twice larger than another stimulus plan in late Oct and close to elections in Dec. Henry Sender, writing on “Tokyo faces weak yen and high bond yields,” published on Nov 29, 2012 in the Financial Times (http://www.ft.com/intl/cms/s/0/9a7178d0-393d-11e2-afa8-00144feabdc0.html#axzz2DibFFquN), analyzes concerns of regulators on duration of bond holdings in an environment of likelihood of increasing yields and yen depreciation.

First, Risk-Determining Events. The European Council statement on Nov 23, 2012 asked the President of the European Commission “to continue the work and pursue consultations in the coming weeks to find a consensus among the 27 over the Union’s Multiannual Financial Framework for the period 2014-2020” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf) Discussions will continue in the effort to reach agreement on a budget: “A European budget is important for the cohesion of the Union and for jobs and growth in all our countries” (http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/133723.pdf). There is disagreement between the group of countries requiring financial assistance and those providing bailout funds. Gabrielle Steinhauser and Costas Paris, writing on “Greek bond rally puts buyback in doubt,” on Nov 23, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887324352004578136362599130992.html?mg=reno64-wsj) find a new hurdle in rising prices of Greek sovereign debt that may make more difficult buybacks of debt held by investors. European finance ministers continue their efforts to reach an agreement for Greece that meets with approval of the European Central Bank and the IMF. The European Council (2012Oct19 http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/133004.pdf ) reached conclusions on strengthening the euro area and providing unified financial supervision:

“The European Council called for work to proceed on the proposals on the Single Supervisory Mechanism as a matter of priority with the objective of agreeing on the legislative framework by 1st January 2013 and agreed on a number of orientations to that end. It also took note of issues relating to the integrated budgetary and economic policy frameworks and democratic legitimacy and accountability which should be further explored. It agreed that the process towards deeper economic and monetary union should build on the EU's institutional and legal framework and be characterised by openness and transparency towards non-euro area Member States and respect for the integrity of the Single Market. It looked forward to a specific and time-bound roadmap to be presented at its December 2012 meeting, so that it can move ahead on all essential building blocks on which a genuine EMU should be based.”

Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. The Bank of Spain released new data on doubtful debtors in Spain’s credit institutions (http://www.bde.es/bde/en/secciones/prensa/Agenda/Datos_de_credit_a6cd708c59cf931.html). In 2006, the value of doubtful credits reached €10,859 million or 0.7 percent of total credit of €1,508,626 million. In Aug 2012, doubtful credit reached €178,579 million or 10.5 percent of total credit of €1,698,714 million.

There are three critical factors influencing world financial markets. (1) Spain could request formal bailout from the European Stability Mechanism (ESM) that may also affect Italy’s international borrowing. David Roman and Jonathan House, writing on “Spain risks backlash with budget plan,” on Sep 27, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443916104578021692765950384.html?mod=WSJ_hp_LEFTWhatsNewsCollection) analyze Spain’s proposal of reducing government expenditures by €13 billion, or around $16.7 billion, increasing taxes in 2013, establishing limits on early retirement and cutting the deficit by €65 billion through 2014. Banco de España, Bank of Spain, contracted consulting company Oliver Wyman to conduct rigorous stress tests of the resilience of its banking system. (Stress tests and their use are analyzed by Pelaez and Pelaez Globalization and the State Vol. I (2008b), 95-100, International Financial Architecture (2005) 112-6, 123-4, 130-3).) The results are available from Banco de España (http://www.bde.es/bde/en/secciones/prensa/infointeres/reestructuracion/ http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). The assumptions of the adverse scenario used by Oliver Wyman are quite tough for the three-year period from 2012 to 2014: “6.5 percent cumulative decline of GDP, unemployment rising to 27.2 percent and further declines of 25 percent of house prices and 60 percent of land prices (http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf). Fourteen banks were stress tested with capital needs estimates of seven banks totaling €59.3 billion. The three largest banks of Spain, Banco Santander (http://www.santander.com/csgs/Satellite/CFWCSancomQP01/es_ES/Corporativo.html), BBVA (http://www.bbva.com/TLBB/tlbb/jsp/ing/home/index.jsp) and Caixabank (http://www.caixabank.com/index_en.html), with 43 percent of exposure under analysis, have excess capital of €37 billion in the adverse scenario in contradiction with theories that large, international banks are necessarily riskier. Jonathan House, writing on “Spain expects wider deficit on bank aid,” on Sep 30, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444138104578028484168511130.html?mod=WSJPRO_hpp_LEFTTopStories), analyzes the 2013 budget plan of Spain that will increase the deficit of 7.4 percent of GDP in 2012, which is above the target of 6.3 percent under commitment with the European Union. The ratio of debt to GDP will increase to 85.3 percent in 2012 and 90.5 percent in 2013 while the 27 members of the European Union have an average debt/GDP ratio of 83 percent at the end of IIQ2012. (2) Symmetric inflation targets appear to have been abandoned in favor of a self-imposed single jobs mandate of easing monetary policy even after the economy grows again at or close to potential output. Monetary easing by unconventional measures is now apparently open ended in perpetuity as provided in the statement of the meeting of the Federal Open Market Committee (FOMC) on Sep 13, 2012 (http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm):

“To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it 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. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

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 economic recovery strengthens.”

In fact, it is evident to the public that this policy will be abandoned if inflation costs rise. There is the concern of the production and employment costs of controlling future inflation.

(2) The European Central Bank (ECB) approved a new program of bond purchases under the name “Outright Monetary Transactions” (OMT). The ECB will purchase sovereign bonds of euro zone member countries that have a program of conditionality under the European Financial Stability Facility (EFSF) that is converting into the European Stability Mechanism (ESM). These programs provide enhancing the solvency of member countries in a transition period of structural reforms and fiscal adjustment. The purchase of bonds by the ECB would maintain debt costs of sovereigns at sufficiently low levels to permit adjustment under the EFSF/ESM programs. Purchases of bonds are not limited quantitatively with discretion by the ECB as to how much is necessary to support countries with adjustment programs. Another feature of the OMT of the ECB is sterilization of bond purchases: funds injected to pay for the bonds would be withdrawn or sterilized by ECB transactions. The statement by the European Central Bank on the program of OTM is as follows (http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html):

“6 September 2012 - Technical features of Outright Monetary Transactions

As announced on 2 August 2012, the Governing Council of the European Central Bank (ECB) has today taken decisions on a number of technical features regarding the Eurosystem’s outright transactions in secondary sovereign bond markets that aim at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy. These will be known as Outright Monetary Transactions (OMTs) and will be conducted within the following framework:

Conditionality

A necessary condition for Outright Monetary Transactions is strict and effective conditionality attached to an appropriate European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) programme. Such programmes can take the form of a full EFSF/ESM macroeconomic adjustment programme or a precautionary programme (Enhanced Conditions Credit Line), provided that they include the possibility of EFSF/ESM primary market purchases. The involvement of the IMF shall also be sought for the design of the country-specific conditionality and the monitoring of such a programme.

The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.

Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.

Coverage

Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above. They may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access.

Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.

No ex ante quantitative limits are set on the size of Outright Monetary Transactions.

Creditor treatment

The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.

Sterilisation

The liquidity created through Outright Monetary Transactions will be fully sterilised.

Transparency

Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis. Publication of the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis.

Securities Markets Programme

Following today’s decision on Outright Monetary Transactions, the Securities Markets Programme (SMP) is herewith terminated. The liquidity injected through the SMP will continue to be absorbed as in the past, and the existing securities in the SMP portfolio will be held to maturity.”

Jon Hilsenrath, writing on “Fed sets stage for stimulus,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390443864204577623220212805132.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes the essay presented by Chairman Bernanke at the Jackson Hole meeting of central bankers, as defending past stimulus with unconventional measures of monetary policy that could be used to reduce extremely high unemployment. Chairman Bernanke (2012JHAug31, 18-9) does support further unconventional monetary policy impulses if required by economic conditions (http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm):

“Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

Professor John H Cochrane (2012Aug31), at the University of Chicago Booth School of Business, writing on “The Federal Reserve: from central bank to central planner,” on Aug 31, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444812704577609384030304936.html?mod=WSJ_hps_sections_opinion), analyzes that the departure of central banks from open market operations into purchase of assets with risks to taxpayers and direct allocation of credit subject to political influence has caused them to abandon their political independence and accountability. Cochrane (2012Aug31) finds a return to the proposition of Milton Friedman in the 1960s that central banks can cause inflation and macroeconomic instability.

Mario Draghi (2012Aug29), President of the European Central Bank, also reiterated the need of exceptional and unconventional central bank policies (http://www.ecb.int/press/key/date/2012/html/sp120829.en.html):

“Yet it should be understood that fulfilling our mandate sometimes requires us to go beyond standard monetary policy tools. When markets are fragmented or influenced by irrational fears, our monetary policy signals do not reach citizens evenly across the euro area. We have to fix such blockages to ensure a single monetary policy and therefore price stability for all euro area citizens. This may at times require exceptional measures. But this is our responsibility as the central bank of the euro area as a whole.

The ECB is not a political institution. But it is committed to its responsibilities as an institution of the European Union. As such, we never lose sight of our mission to guarantee a strong and stable currency. The banknotes that we issue bear the European flag and are a powerful symbol of European identity.”

Buiter (2011Oct31) analyzes that the European Financial Stability Fund (EFSF) would need a “bigger bazooka” to bail out euro members in difficulties that could possibly be provided by the ECB. Buiter (2012Oct15) finds that resolution of the euro crisis requires full banking union together with restructuring the sovereign debt of at least four and possibly total seven European countries. Table III-7 in IIIE Appendix Euro Zone Survival Risk below provides the combined GDP in 2012 of the highly indebted euro zone members estimated in the latest World Economic Outlook of the IMF at $4167 billion or 33.1 percent of total euro zone GDP of $12,586 billion. Using the WEO of the IMF, Table III-8 in IIIE Appendix Euro Zone Survival Risk below provides debt of the highly indebted euro zone members at $3927.8 billion in 2012 that increases to $5809.9 billion when adding Germany’s debt, corresponding to 167.0 percent of Germany’s GDP. There are additional sources of debt in bailing out banks. The dimensions of the problem may require more firepower than a bazooka perhaps that of the largest conventional bomb of all times of 44,000 pounds experimentally detonated only once by the US in 1948 (http://www.airpower.au.af.mil/airchronicles/aureview/1967/mar-apr/coker.html).

Chart III-1A of the Board of Governors of the Federal Reserve System provides the ten-year, two-year and one-month Treasury constant maturity yields together with the overnight fed funds rate, and the yield of the corporate bond with Moody’s rating of Baa. The riskier yield of the Baa corporate bond exceeds the relatively riskless yields of the Treasury securities. The beginning yields in Chart III-1A for Jan 2, 1962, are 2.75 percent for the fed fund rates and 4.06 percent for the ten-year Treasury constant maturity. On July 31, 2001, the yields in Chart III-1A are 3.67 percent for one month, 3.79 percent for two years, 5.07 percent for ten years, 3.82 percent for the fed funds rate and 7.85 percent for the Baa corporate bond. On July 30, 2007, yields inverted with the one-month at 4.95 percent, the two-year at 4.59 percent and the ten-year at 5.82 percent with the yield of the Baa corporate bond at 6.70 percent. Another interesting point is for Oct 31, 2008, with the yield of the Baa jumping to 9.54 percent and the Treasury yields declining: one month 0.12 percent, two years 1.56 percent and ten years 4.01 percent during a flight to the dollar and government securities analyzed by Cochrane and Zingales (2009). Another spike in the series is for Apr 4, 2006 with the yield of the corporate Baa bond at 8.63 and the Treasury yields of 0.12 percent for one month, 0.94 for two years and 2.95 percent for ten years. During the beginning of the flight from risk financial assets to US government securities (see Cochrane and Zingales 2009), the one-month yield was 0.07 percent, the two-year yield 1.64 percent and the ten-year yield 3.41. The combination of zero fed funds rate and quantitative easing caused sharp decline of the yields from 2008 and 2009. Yield declines have also occurred during periods of financial risk aversion, including the current one of stress of financial markets in Europe. The final point of Chart III1-A is for Jul 7, 2016, with the one-month yield at 0.27 percent, the two-year at 0.58 percent, the ten-year at 1.40 percent, the fed funds rate at 0.40 percent and the

Chart III-1A, Yield of Moody’s Baa Corporate Bond and US Ten-Year, Two-Year and One-Month Treasury Constant Maturity Yields and Overnight Fed Funds Rate, Jan 2, 1962-Jul 21, 2016

Note: US Recessions in shaded areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h15/

Chart III-1B provides the same data as Chart III-1A from Jan 3, 2001 to Oct 6, 2016. The last point of Chart III1-A is for Oct 6, 2016, with the one-month yield at 0.26 percent, the two-year at 0.86 percent, the ten-year at 1.75 percent, the fed funds rate at 0.40 percent and the corporate Baa bond at 4.36 percent.

Chart III-1B, Yield of Moody’s Baa Corporate Bond and US Ten-Year, Two-Year and One-Month Treasury Constant Maturity Yields and Overnight Fed Funds Rate, Jan 1, 2001-Oct 6, 2016

Note: US Recessions in shaded areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h15/

Chart III-1C provides the yields of the ten-year, two-year, one-month Treasury Constant Maturity, and the overnight Fed funds rate from Jan 2, 1962 to Oct 17, 2019. The final data point is for Oct 17, 2019 with the Fed funds rate at 1.85 percent, the one-month Treasury constant

maturity at 1.74 percent, the two-year at 1.60 percent and the ten-year at 1.76 percent. The causes of the financial crisis and global recession were interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html 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. The yields of Treasury securities inverted on Mar 22, 2019 with the ten-year yield at 2.44 percent below those of 2.49 percent for one-month, 2.48 percent for two months, 2.46 percent for three months, 2.48 percent for six months and 2.45 percent for one year (https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield). There was some flattening on Mar 29, 2019, with the 10-year at 2.41 percent, the 1-month at 2.43 percent, the 3-month at 2.40 percent, the 6-month at 2.44 percent and the 1-year at 2.40 percent. There was further mild steepening on Apr 12, 2019, with the 10-year at 2.568 percent, the 1-month at 2.419 percent, the 3-month at 2.440 percent, the 6-month at 2.463 percent and the 1-year at 2.453 percent. The final segment after 2001 shows the effects of unconventional monetary policy of extremely low, below inflation fed funds rate in lowering yields. This was an important cause of the global recession and financial crisis inducing as analyzed by Taylor (2018Oct 19, 2) “search for yield, excessive risk taking, a boom and bust in the housing market, and eventually the financial crisis and recession.” Monetary policy deviated from the Taylor Rule (Taylor 2018Oct19 see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB, 2019Oct19 and http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html)). An explanation is in the research of Adrian, Estrella and Shin (2018, 21-22): “Our findings suggest that the monetary tightening of 2004-2006 period ultimately did achieve a slowdown in real activity not because of its impact on the level of longer term interest rates, but rather because of its impact on the slope of the yield curve. In fact, while the level of the 10-year yield only increased 38 basis points between June 2004 and 2006, the term spread declined 325 basis points (from 3.44 to .19 percent). The fact that the slope flattened meant that intermediary profitability was compressed, thus shifting the supply of credit, and hence inducing changes in real activity. The 18 month lag between the end of the tightening cycle, and the beginning of the recession is perfectly compatible with effective monetary tightening.” See (https://www.newyorkfed.org/research/capital_markets/ycfaq.html). A major difference in the current cycle is the balance sheet of the Fed with purchases used to lower interest rates in specific segments and maturities such as mortgage-backed securities and longer terms.

Chart III-1C, Yield US Ten-Year, Two-Year and One-Month Treasury Constant Maturity Yields and Overnight Fed Funds Rate, Jan 3, 1962-Oct 17, 2019

Note: US Recessions in shaded areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h15/

Sharp and continuing strengthening of the dollar, with recent oscillation of dollar devaluation, is affecting balance sheets of US corporations with foreign operations (http://www.fasb.org/jsp/FASB/Pronouncement_C/SummaryPage&cid=900000010318). Recently, the dollar is depreciating. The Federal Open Market Committee (FOMC) is following “financial and international developments” as part of the process of framing interest rate policy (http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm). Kate Linebaugh, writing on “Corporate profits set to shrink for fourth consecutive quarter,” on Jul 17, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/corporate-profits-set-to-shrink-for-fourth-consecutive-quarter-1468799278), quotes forecasts of Thomson Reuters of 4.7 decline of adjusted earnings per share in the S&P 500 index in IIQ2016 relative to a year earlier. That would be the fourth consecutive quarterly decline. Theo Francis and Kate Linebaugh, writing on “US corporate profits on pace for third straight decline,” on Apr 28, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/u-s-corporate-profits-on-pace-for-third-straight-decline-1461872242), analyze three consecutive quarters of decline of corporate earnings and revenue in companies in S&P 500. They quote Thomson Reuters on expected decline of earnings of 6.1 percent in IQ2016 based on 55 percent of reporting companies. Weakness of economic activity shows in decline of revenues in IQ2016 of 1.4 percent, increasing 1.7 percent excluding energy, and contraction of profits of 0.5 percent. Justin Lahart, writing on “S&P 500 Earnings: far worse than advertised,” on Feb 24, 2016, published in the Wall Street Journal (http://www.wsj.com/articles/s-p-500-earnings-far-worse-than-advertised-1456344483), analyzes S&P 500 earnings in 2015. Under data provided by companies, earnings increased 0.4 percent in 2015 relative to 2014 but under GAAP (Generally Accepted Accounting Principles), earnings fell 12.7 percent, which is the worst decrease since 2008. Theo Francis e Kate Linebaugh, writing on Oct 25, 2015, on “US Companies Warn of Slowing Economy, published in the Wall Street Journal (http://www.wsj.com/articles/u-s-companies-warn-of-slowing-economy-1445818298) analyze the first contraction of earnings and revenue of big US companies. Production, sales and employment are slowing in a large variety of companies with some contracting. Corporate profits also suffer from revaluation of the dollar that constrains translation of foreign profits into dollar balance sheets. Francis and Linebaugh quote Thomson Reuters that analysts expect decline of earnings per share of 2.8 percent in IIIQ2015 relative to IIIQ2014 based on reports by one third of companies in the S&P 500. Sales would decline 4.0% in a third quarter for the first joint decline of earnings per share and revenue in the same quarter since IIIQ2009. Dollar revaluation also constrains corporate results.

Inyoung Hwang, writing on “Fed optimism spurs record bets against stock volatility,” on Aug 21, 2014, published in Bloomberg.com (http://www.bloomberg.com/news/2014-08-21/fed-optimism-spurs-record-bets-against-stock-voalitlity.html), informs that the S&P 500 is trading at 16.6 times estimated earnings, which is higher than the five-year average of 14.3 Tom Lauricella, writing on Mar 31, 2014, on “Stock investors see hints of a stronger quarter,” published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304157204579473513864900656?mod=WSJ_smq0314_LeadStory&mg=reno64-wsj), finds views of stronger earnings among many money managers with positive factors for equity markets in continuing low interest rates and US economic growth. There is important information in the Quarterly Markets review of the Wall Street Journal (http://online.wsj.com/public/page/quarterly-markets-review-03312014.html) for IQ2014. Alexandra Scaggs, writing on “Tepid profits, roaring stocks,” on May 16, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323398204578487460105747412.html), analyzes stabilization of earnings growth: 70 percent of 458 reporting companies in the S&P 500 stock index reported earnings above forecasts but sales fell 0.2 percent relative to forecasts of increase of 0.5 percent. Paul Vigna, writing on “Earnings are a margin story but for how long,” on May 17, 2013, published in the Wall Street Journal (http://blogs.wsj.com/moneybeat/2013/05/17/earnings-are-a-margin-story-but-for-how-long/), analyzes that corporate profits increase with stagnating sales while companies manage costs tightly. More than 90 percent of S&P components reported moderate increase of earnings of 3.7 percent in IQ2013 relative to IQ2012 with decline of sales of 0.2 percent. Earnings and sales have been in declining trend. In IVQ2009, growth of earnings reached 104 percent and sales jumped 13 percent. Net margins reached 8.92 percent in IQ2013, which is almost the same at 8.95 percent in IIIQ2006. Operating margins are 9.58 percent. There is concern by market participants that reversion of margins to the mean could exert pressure on earnings unless there is more accelerated growth of sales. Vigna (op. cit.) finds sales growth limited by weak economic growth. Kate Linebaugh, writing on “Falling revenue dings stocks,” on Oct 20, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444592704578066933466076070.html?mod=WSJPRO_hpp_LEFTTopStories), identifies a key financial vulnerability: falling revenues across markets for United States reporting companies. Global economic slowdown is reducing corporate sales and squeezing corporate strategies. Linebaugh quotes data from Thomson Reuters that 100 companies of the S&P 500 index have reported declining revenue only 1 percent higher in Jun-Sep 2012 relative to Jun-Sep 2011 but about 60 percent of the companies are reporting lower sales than expected by analysts with expectation that revenue for the S&P 500 will be lower in Jun-Sep 2012 for the entities represented in the index. Results of US companies are likely repeated worldwide. Future company cash flows derive from investment projects. Table IA1-2 provides real private fixed investment at seasonally adjusted annual rates from IVQ2007 to IQ2019 or for the complete economic cycle. The first column provides the quarter, the second column percentage change relative to IVQ2007, the third column the quarter percentage change in the quarter relative to the prior quarter and the final column percentage change in a quarter relative to the same quarter a year earlier. In IQ1980, real gross private domestic investment in the US was $933.1 billion of chained 2012 dollars, growing to $1,274.9 billion in IVQ1992 or 36.6 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). Real gross private domestic investment in the US increased 29.1 percent from $2653.1 billion in IVQ2007 to $3,424.7 billion in IIQ2019. Real private fixed investment increased 26.9 percent from $2,630.0 billion of chained 2012 dollars in IVQ2007 to $3,337.4 billion in IIQ2019. Private fixed investment fell relative to IVQ2007 in all quarters preceding IVQ2012 and increased 0.9 percent in IIIQ2016, increasing 0.7 percent in IIQ2016 and increasing 0.6 percent in IQ2016. Private fixed investment increased 0.5 percent in IVQ2016. Private fixed investment increased 1.9 percent in IQ2017 and increased 0.7 percent in IIQ2017. Private fixed investment increased 0.4 percent in IIIQ2017 and increased 2.1 percent in IVQ2017. Private fixed investment increased 1.3 percent in IQ2018, increasing 1.3 percent in IIQ2018. Private fixed investment increased 0.2 percent in IIIQ2018, increasing 0.7 percent in IVQ2018. Private fixed investment increased 0.8 percent in IQ2019, decreasing 0.4 percent in IIQ2019. Growth of real private investment in Table IA1-2 is mediocre for all but four quarters from IIQ2011 to IQ2012. There is recent robust growth. The investment decision of United States corporations is fractured in the current economic cycle in preference of cash.

There are three aspects. First, there is fluctuation in corporate profits. Corporate profits increased at $47.8 billion in IIIQ2018. Corporate profits decreased at $18.6 billion in IVQ2018. Corporate profits decreased at $78.7 billion in IQ2019. Corporate profits increased at $75.8 billion in IIQ2019. Profits after tax with IVA and CCA increased at $40.1 billion in IIIQ2018. Profits after tax with IVA and CCA decreased at $6.8 billion in IVQ2018. Profits after tax with IVA and CCA decreased at $75.7 billion in IQ2019. Profits after tax with IVA and CCA increased at $66.1 billion in IIQ2019. Net dividends increased at $37.8 billion in IIIQ2018. Net dividends increased at $32.8 billion in IVQ2018. Net dividends decreased at $37.9 billion in IQ2019. Net dividends increased at $22.3 billion in IIQ2019. Undistributed corporate profits increased at $2.3 billion in IIIQ2018. Undistributed corporate profits decreased at $39.6 billion in IVQ2018. Undistributed corporate profits decreased at $37.8 billion in IQ2019. Undistributed corporate profits increased at $43.9 billion in IIQ2019. Undistributed corporate profits swelled 212.9 percent from $138.0 billion in IQ2007 to $431.8 billion in IIQ2019 and changed signs from minus $4.3 billion in current dollars in IVQ2007. The investment decision of United States corporations has been fractured in the current economic cycle in preference of cash. Second, sharp and continuing strengthening of the dollar, with recent depreciation at the margin, is affecting balance sheets of US corporations with foreign operations (https://www.fasb.org/summary/stsum52.shtml) and the overall US economy. The bottom part of Table IA1-9 provides the breakdown of corporate profits with IVA and CCA in domestic industries and the rest of the world. Corporate profits with IVA and CCA increased at $47.8 billion in IIIQ2018. Profits from domestic industries increased at $31.2 billion and profits from nonfinancial business increased at $53.0 billion. Profits from the rest of the world increased at $16.6 billion. Corporate profits with IVA and CCA decreased at $18.6 billion in IVQ2018. Profits from domestic industries increased at $0.7 billion and profits from nonfinancial business increased at $7.4 billion. Profits from the rest of the world decreased at $19.3 billion. Corporate profits with IVA and CCA decreased at $78.7 billion in IQ2019. Profits from domestic industries decreased at $86.0 billion and profits from nonfinancial business decreased at $108.2 billion. Profits from the rest of the world increased at $7.3 billion. Corporate profits with IVA and CCA increased at $75.8 billion in IIQ2019. Profits from domestic industries increased at $37.2 billion and profits from nonfinancial business increased at $34.7 billion. Profits from the rest of the world increased at 38.7 billion. Total corporate profits with IVA and CCA were $2082.7 billion in IIQ2019 of which $1544.5 billion from domestic industries, or 74.2 percent of the total, and $538.2 billion, or 25.8 percent, from the rest of the world. Nonfinancial corporate profits of $1143.6 billion account for 54.1 percent of the total. Third, there is reduction in the use of corporate cash for investment. Vipal Monga, David Benoit and Theo Francis, writing on “Companies send more cash back to shareholders,” published on May 26, 2015 in the Wall Street Journal (http://www.wsj.com/articles/companies-send-more-cash-back-to-shareholders-1432693805?tesla=y), use data of a study by Capital IQ conducted for the Wall Street Journal. This study shows that companies in the S&P 500 reduced investment in plant and equipment to median 29 percent of operating cash flow in 2013 from 33 percent in 2003 while increasing dividends and buybacks to median 36 percent in 2013 from 18 percent in 2003.

The basic valuation equation that is also used in capital budgeting postulates that the value of stocks or of an investment project is given by:

Where R_τ is expected revenue in the time horizon from τ =1 to T; C_τ denotes costs; and ρ is an appropriate rate of discount. In words, the value today of a stock or investment project is the net revenue, or revenue less costs, in the investment period from τ =1 to T discounted to the present by an appropriate rate of discount. In the current weak economy, revenues have been increasing more slowly than anticipated in investment plans. An increase in interest rates would affect discount rates used in calculations of present value, resulting in frustration of investment decisions. If V represents value of the stock or investment project, as ρ → ∞, meaning that interest rates increase without bound, then V → 0, or

declines. Equally, decline in expected revenue from the stock or project, R_τ, causes decline in valuation.

There is mixed performance in equity indexes with several indexes in Table III-1 increasing in the week ending on Oct 18, 2019, after wide swings caused by reallocations of investment portfolios worldwide. Stagnating revenues, corporate cash hoarding, effects of currency oscillations on corporate earnings and declining investment are causing reevaluation of discounted net earnings with deteriorating views on the world economy and United States fiscal sustainability but investors have been driving indexes higher. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). Nuclear conflicts in the Korean Peninsula and global geopolitics are also affecting financial markets. An immediate factor is the path of raising interest rates by the Fed, becoming a path of decreasing interest rates. DJIA decreased 0.9 percent on Oct 18, decreasing 0.2 percent in the week. Germany’s DAX decreased 0.2 percent on Oct 18 and increased 1.0 percent in the week. Dow Global decreased 0.3 percent on Oct 18 and increased 0.8 percent in the week. Japan’s Nikkei Average increased 0.2 percent on Oct 18 and increased 3.2 percent in the week of Oct 18, as the yen continues oscillating but relatively weaker and the stock market gains in expectations of success of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Shanghai Composite that decreased 1.0 percent on Mar 8 and decreased 1.7 percent in the week of Mar 8, falling below 2000 at 1974.38 on Mar 12, 2014 but closing at 2938.14 on Oct 18, 2019 for decrease of 1.3 percent and decreasing 1.2 percent in the week. The Shanghai Composite increased 48.8 percent from March 12, 2014 to Oct 18, 2019. There is deceleration with oscillations of the world economy that could affect corporate revenue and equity valuations, causing fluctuations in equity markets with increases during favorable risk appetite. The global hunt for yield induced by central bank policy rates of near zero percent motivates wide portfolio reshufflings among classes of risk financial assets.

Commodities were mixed in the week of Oct 18, 2019. Table III-1 shows that WTI decreased 1.7 percent in the week of Oct 18 while Brent decreased 1.8 percent in the week with turmoil in oil producing regions but oscillating action by OPEC. Gold decreased 0.3 percent on Oct 18 and increased 0.4 percent in the week.

Table III-2 provides an update of the consolidated financial statement of the Eurosystem. The balance sheet has swollen with the long-term refinancing operations (LTROs). Line 5 “Lending to Euro Area Credit Institutions Related to Monetary Policy” increased from €546,747 million on Dec 31, 2010, to €879,130 million on Dec 28, 2011 and €666,052 million on Oct 11, 2019, with increase of loans from €665,578 million in the prior week of Oct 4, 2019. The sum of line 5 and line 7 (“Securities of Euro Area Residents Denominated in Euro”) has reached €3,496,703 million in the statement of Oct 11, 2019, with increase from €3,495,409 million in the prior week of Oct 4. There is high credit risk in these transactions with capital of only €107,201 million as analyzed by Cochrane (2012Aug31).

Table III-2, Consolidated Financial Statement of the Eurosystem, Million EUR

	Dec 31, 2010	Dec 28, 2011	Oct 11, 2019
1 Gold and other Receivables	367,402	419,822	474,074
2 Claims on Non-Euro Area Residents Denominated in Foreign Currency	223,995	236,826	358,925
3 Claims on Euro Area Residents Denominated in Foreign Currency	26,941	95,355	18,382
4 Claims on Non-Euro Area Residents Denominated in Euro	22,592	25,982	17,174
5 Lending to Euro Area Credit Institutions Related to Monetary Policy Operations Denominated in Euro	546,747	879,130	666,052 10/04/19: 665,578 09/27/19: 666,583 09/20/19 694,327 09/13/19: 694,673 09/06/19: 694,672 08/30/19: 695,654
6 Other Claims on Euro Area Credit Institutions Denominated in Euro	45,654	94,989	29,981
7 Securities of Euro Area Residents Denominated in Euro	457,427	610,629	2,830,651 10/04/19: 2,829,831 09/27/19: 2,833,325 09/20/19: 2,831,211 09/13/19: 2,831,930 09/06/19: 2,832,957 08/30/19: 2,835,533
8 General Government Debt Denominated in Euro	34,954	33,928	23,434
9 Other Assets	278,719	336,574	273,588
TOTAL ASSETS	2,004, 432	2,733,235	4,692,260
Memo Items
Sum of 5 and 7	1,004,174	1,489,759	3,496,703 10/04/19: 3,495,409 09/27/19: 3,499,908 09/20/19: 3,525,538 09/13/19: 3,526,603 09/06/19: 3,527,629 08/30/19: 3,531,187
Capital and Reserves	78,143	81,481	107,201

Source: European Central Bank

http://www.ecb.int/press/pr/wfs/2011/html/fs110105.en.html

http://www.ecb.int/press/pr/wfs/2011/html/fs111228.en.html

https://www.ecb.europa.eu/press/pr/wfs/2019/html/ecb.fst191015.en.html

IIIE Appendix Euro Zone Survival Risk. Professors Ricardo Caballero and Francesco Giavazzi (2012Jan15) find that the resolution of the European sovereign crisis with survival of the euro area would require success in the restructuring of Italy. Growth of the Italian economy would ensure that success. A critical problem is that the common euro currency prevents Italy from devaluing the exchange rate to parity or the exchange rate that would permit export growth to promote internal economic activity, which could generate fiscal revenues for primary fiscal surpluses that ensure creditworthiness. Fiscal consolidation and restructuring are important but of long-term gestation. Immediate growth of the Italian economy would consolidate the resolution of the sovereign debt crisis. Caballero and Giavazzi (2012Jan15) argue that 55 percent of the exports of Italy are to countries outside the euro area such that devaluation of 15 percent would be effective in increasing export revenue. Newly available data in Table III-3 providing Italy’s trade with regions and countries supports the argument of Caballero and Giavazzi (2012Jan15). Italy’s exports to the European Monetary Union (EMU), or euro area, are only 41.1 percent of the total in Jan-Aug 2019 (using total 2018 data). Exports to the non-European Union area with share of 43.7 percent in Italy’s total exports are increasing at 3.4 percent in Jan-Jul 2019 relative to Jan-Aug 2018 while those to EMU are growing at 2.1 percent.

Table III-3, Italy, Exports and Imports by Regions and Countries, % Share and 12-Month ∆%

Aug 2019	Exports % Share^a	∆% Jan-Aug 2019/ Jan-Aug 2018	Imports % Share^a	∆% Jan-Aug 2019/ Jan-Aug 2018
EU	56.3	2.0	59.0	0.4
EMU 19	41.1	1.4	46.9	0.4
France	10.5	2.1	8.6	0.4
Germany	12.6	0.4	16.6	0.1
Spain	5.2	1.4	4.9	3.7
UK	5.1	7.6	2.6	-0.5
Non-EU Countries	43.7	3.4	41.0	1.8
Europe non- EU Countries	10.5	4.5	9.9	1.7
USA	9.2	8.3	3.8	7.1
China	2.8	-2.4	7.3	6.8
OPEC	3.8	-10.9	6.5	-15.3
Total	100.0	2.6	100.0	1.0

Notes: EU: European Union; EMU: European Monetary Union (euro zone)

^aCalculated on 2018 total foreign trade

Source: Istituto Nazionale di Statistica

https://www.istat.it/it/archivio/234445

Table III-4 provides Italy’s trade balance by regions and countries. Italy had trade deficit of €905 million with the 19 countries of the euro zone (EMU 19) in Aug 2019 and cumulative deficit of €2,420 million in Jan-Aug 2019. Depreciation to parity could permit greater competitiveness in improving the trade surplus of €5,476 million in Jan-Aug 2019 with Europe non-European Union, the trade surplus of €18,177 million with the US and improving the trade surplus with non-European Union of €20,187 million in Jan-Aug 2019. There is significant rigidity in the trade deficit in Jan-Aug 2019 of €12,748 million with China. There is a trade deficit of €5,195 million in Jan-Aug 2019 with members of the Organization of Petroleum Exporting Countries (OPEC). Higher exports could drive economic growth in the economy of Italy that would permit less onerous adjustment of the country’s fiscal imbalances, raising the country’s credit rating.

Table III-4, Italy, Trade Balance by Regions and Countries, Millions of Euro

Regions and Countries	Trade Balance Aug 2019 Millions of Euro	Trade Balance Cumulative Jan-Aug 2019 Millions of Euro
EU	259	12,094
EMU 19	-905	-2,420
France	460	8,513
Germany	-535	-6,841
Spain	-54	1,883
UK	713	9,283
Non-EU	2,326	20,187
Europe non-EU	952	5,476
USA	1,748	18,177
China	-1,366	-12,748
OPEC	-603	-5,195
Total	2,585	32,282

Notes: EU: European Union; EMU: European Monetary Union (euro zone)

Source: Istituto Nazionale di Statistica

https://www.istat.it/it/archivio/234445

Growth rates of Italy’s trade and major products are in Table III-5 for the period Jan-Aug 2019 relative to Jan-Aug 2018. Growth rates of cumulative imports relative to a year earlier are negative for energy with minus 3.7 percent. Exports of durable goods increased 2.4 percent and exports of capital goods decreased 1.2 percent. The rate of growth of exports of 2.6 percent in Jan-Aug 2019/Jan-Aug 2018 relative to that of imports of 1.0 percent may partly reflect weak demand in Italy with GDP declining during seven consecutive quarters from IIIQ2011 through IQ2013 together with softening commodity prices. GDP increased 0.4 percent in IIIQ2013, decreased 0.2 percent in IVQ2013, increased 0.1 percent in IQ2014 and decreased 0.1 percent in IIQ2014. Italy’s GDP increased 0.2 percent in IIIQ2014 and changed 0.0 percent in IVQ2014. Italy’s GDP increased 0.2 percent in IQ2015 and increased 0.4 percent in IIQ2015. Italy’s GDP increased 0.3 percent in IIIQ2015 and increased 0.4 percent in IVQ2015. GDP increased 0.2 percent in IQ2016. The GDP of Italy increased 0.2 percent in IIQ2016 and increased 0.4 percent in IIIQ2016. GDP increased 0.5 percent in IVQ2016 and increased 0.6 percent in IQ2017. The GDP of Italy increased 0.4 percent in IIQ2017, increasing 0.4 percent in IIIQ2017. Italy’s GDP increased 0.4 percent in IVQ2017, increasing 0.2 percent in IQ2018. The GDP of Italy changed 0.0 percent in IIQ2018, decreasing 0.1 percent in IIIQ2018. Italy’s GDP decreased 0.1 percent in IVQ2018, increasing 0.1 percent in IQ2019. The GDP of Italy changed 0.0 percent in IIQ2019.

Table III-5, Italy, Exports and Imports % Share of Products in Total and ∆%

	Exports Share %	Exports ∆% Jan-Aug 2019/ Jan-Aug 2018	Imports Share %	Imports ∆% Jan-Aug 2019/ Jan-Aug 2018
Consumer Goods	32.1	9.8	28.0	4.0
Durable	5.7	2.4	3.5	2.0
Non-Durable	26.4	11.5	24.5	4.2
Capital Goods	33.2	-1.2	25.3	0.7
Inter- mediate Goods	31.3	1.4	33.3	0.5
Energy	3.4	-17.2	13.4	-3.7
Total ex Energy	96.6	3.3	86.6	1.7
Total	100.0	2.6	100.0	1.0

Note: % Share for 2018 total trade.

Source: Istituto Nazionale di Statistica

https://www.istat.it/it/archivio/234445

Table III-6 provides Italy’s trade balance by product categories in Jun and cumulative Jan-Aug 2019. Italy’s trade balance excluding energy, generated surplus of €5,641 million in Aug 2019 and €59,112 million cumulative in Jan-Aug 2019 but the energy trade balance created deficit of €3,056 million in Aug 2019 and cumulative deficit of €26,830 million in Jan-Aug 2019. The overall surplus in Aug 2018 was €2,585 million with cumulative surplus of €32,282 million in Jan-Aug 2019. Italy has significant competitiveness in various economic activities in contrast with some other countries with debt difficulties.

Table III-6, Italy, Trade Balance by Product Categories, € Millions

	Aug 2019	Cumulative Jan-Aug 2019
Consumer Goods	1,875	24,731
Durable	657	7,989
Nondurable	1,218	16,742
Capital Goods	3,021	30,392
Intermediate Goods	745	3,988
Energy	-3,056	-26,830
Total ex Energy	5,641	59,112
Total	2,585	32,282

Source: Istituto Nazionale di Statistica

https://www.istat.it/it/archivio/234445

Brazil faced in the debt crisis of 1982 a more complex policy mix. Between 1977 and 1983, Brazil’s terms of trade, export prices relative to import prices, deteriorated 47 percent and 36 percent excluding oil (Pelaez 1987, 176-79; Pelaez 1986, 37-66; see Pelaez and Pelaez, The Global Recession Risk (2007), 178-87). Brazil had accumulated unsustainable foreign debt by borrowing to finance balance of payments deficits during the 1970s. Foreign lending virtually stopped. The German mark devalued strongly relative to the dollar such that Brazil’s products lost competitiveness in Germany and in multiple markets in competition with Germany. The resolution of the crisis was devaluation of the Brazilian currency by 30 percent relative to the dollar and subsequent maintenance of parity by monthly devaluation equal to inflation and indexing that resulted in financial stability by parity in external and internal interest rates avoiding capital flight. With a combination of declining imports, domestic import substitution and export growth, Brazil followed rapid growth in the US and grew out of the crisis with surprising GDP growth of 4.5 percent in 1984.

The euro zone faces a critical survival risk because several of its members may default on their sovereign obligations if not bailed out by the other members. The valuation equation of bonds is essential to understanding the stability of the euro area. An explanation is provided in this paragraph and readers interested in technical details are referred to the Subsection IIIF Appendix on Sovereign Bond Valuation. Contrary to the Wriston doctrine, investing in sovereign obligations is a credit decision. The value of a bond today is equal to the discounted value of future obligations of interest and principal until maturity. On Dec 30, 2011, the yield of the 2-year bond of the government of Greece was quoted around 100 percent. In contrast, the 2-year US Treasury note traded at 0.239 percent and the 10-year at 2.871 percent while the comparable 2-year government bond of Germany traded at 0.14 percent and the 10-year government bond of Germany traded at 1.83 percent. There is no need for sovereign ratings: the perceptions of investors are of relatively higher probability of default by Greece, defying Wriston (1982), and nil probability of default of the US Treasury and the German government. The essence of the sovereign credit decision is whether the sovereign will be able to finance new debt and refinance existing debt without interrupting service of interest and principal. Prices of sovereign bonds incorporate multiple anticipations such as inflation and liquidity premiums of long-term relative to short-term debt but also risk premiums on whether the sovereign’s debt can be managed as it increases without bound. The austerity measures of Italy are designed to increase the primary surplus, or government revenues less expenditures excluding interest, to ensure investors that Italy will have the fiscal strength to manage its debt exceeding 100 percent of GDP, which is the third largest in the world after the US and Japan. Appendix IIIE links the expectations on the primary surplus to the real current value of government monetary and fiscal obligations. As Blanchard (2011SepWEO) analyzes, fiscal consolidation to increase the primary surplus is facilitated by growth of the economy. Italy and the other indebted sovereigns in Europe face the dual challenge of increasing primary surpluses while maintaining growth of the economy (for the experience of Brazil in the debt crisis of 1982 see Pelaez 1986, 1987).

Much of the analysis and concern over the euro zone centers on the lack of credibility of the debt of a few countries while there is credibility of the debt of the euro zone as a whole. In practice, there is convergence in valuations and concerns toward the fact that there may not be credibility of the euro zone as a whole. The fluctuations of financial risk assets of members of the euro zone move together with risk aversion toward the countries with lack of debt credibility. This movement raises the need to consider analytically sovereign debt valuation of the euro zone as a whole in the essential analysis of whether the single-currency will survive without major changes.

Welfare economics considers the desirability of alternative states, which in this case would be evaluating the “value” of Germany (1) within and (2) outside the euro zone. Is the sum of the wealth of euro zone countries outside of the euro zone higher than the wealth of these countries maintaining the euro zone? On the choice of indicator of welfare, Hicks (1975, 324) argues:

“Partly as a result of the Keynesian revolution, but more (perhaps) because of statistical labours that were initially quite independent of it, the Social Product has now come right back into its old place. Modern economics—especially modern applied economics—is centered upon the Social Product, the Wealth of Nations, as it was in the days of Smith and Ricardo, but as it was not in the time that came between. So if modern theory is to be effective, if it is to deal with the questions which we in our time want to have answered, the size and growth of the Social Product are among the chief things with which it must concern itself. It is of course the objective Social Product on which attention must be fixed. We have indexes of production; we do not have—it is clear we cannot have—an Index of Welfare.”

If the burden of the debt of the euro zone falls on Germany and France or only on Germany, is the wealth of Germany and France or only Germany higher after breakup of the euro zone or if maintaining the euro zone? In practice, political realities will determine the decision through elections.

The prospects of survival of the euro zone are dire. Table III-7 is constructed with IMF World Economic Outlook database (https://www.imf.org/external/pubs/ft/weo/2019/01/weodata/index.aspx) for GDP in USD billions, primary net lending/borrowing as percent of GDP and general government debt as percent of GDP for selected regions and countries in 2019.

Table III-7, World and Selected Regional and Country GDP and Fiscal Situation

	GDP 2019 USD Billions	Primary Net Lending Borrowing % GDP 2019	General Government Net Debt % GDP 2019
World	87,265
Euro Zone	13,596	0.6	67.9
Portugal	240	2.5	107.0
Ireland	382	1.5	53.6
Greece	220	3.5	176.9**
Spain	1,429	-0.2	83.5
Major Advanced Economies G7	39,841	-1.8	87.3
United States	21,345	-2.9	83.4
UK	2,829	0.1	76.2
Germany	3,964	1.8	38.6
France	2,762	-1.7	88.2
Japan	5,176	-2.7	153.6
Canada	1,739	-0.2	26.6
Italy	2,026	0.9	121.5
China	14,217	-4.9	55.4***

*Net Lending/borrowing**Gross Debt

Source: IMF World Economic Outlook

https://www.imf.org/external/pubs/ft/weo/2019/01/weodata/index.aspx

The data in Table III-7 are used for some very simple calculations in Table IIII-8. The column “Net Debt USD Billions 2019” in Table III-8 is generated by applying the percentage in Table III-7 column “General Government Net Debt % GDP 2019” to the column “GDP 2019 USD Billions.” The total debt of France and Germany in 2019 is $3966.2 billion, as shown in row “B+C” in column “Net Debt USD Billions 2019.” The sum of the debt of Italy, Spain, Portugal, Greece and Ireland is $4505.6 billion, adding rows D+E+F+G+H in column “Net Debt USD billions 2019.” There is some simple “unpleasant bond arithmetic” in the two final columns of Table I-9. Suppose the entire debt burdens of the five countries with probability of default were to be guaranteed by France and Germany, which de facto would be required by continuing the euro zone. The sum of the total debt of these five countries and the debt of France and Germany is shown in column “Debt as % of Germany plus France GDP” to reach $8471.8 billion, which would be equivalent to 126.0 percent of their combined GDP in 2019. Under this arrangement, the entire debt of selected members of the euro zone including debt of France and Germany would not have nil probability of default. The final column provides “Debt as % of Germany GDP” that would exceed 213.7 percent if including debt of France and 152.3 percent of German GDP if excluding French debt. The unpleasant bond arithmetic illustrates that there is a limit as to how far Germany and France can go in bailing out the countries with unsustainable sovereign debt without incurring severe pains of their own such as downgrades of their sovereign credit ratings. A central bank is not typically engaged in direct credit because of remembrance of inflation and abuse in the past. There is also a limit to operations of the European Central Bank in doubtful credit obligations. Wriston (1982) would prove to be wrong again that countries do not bankrupt but would have a consolation prize that similar to LBOs the sum of the individual values of euro zone members outside the current agreement exceeds the value of the whole euro zone. Internal rescues of French and German banks may be less costly than bailing out other euro zone countries so that they do not default on French and German banks. Analysis of fiscal stress is quite difficult without including another global recession in an economic cycle that is already mature by historical experience.

Table III-8, Guarantees of Debt of Sovereigns in Euro Area as Percent of GDP of Germany and France, USD Billions and %

	Net Debt USD Billions 2019	Debt as % of Germany Plus France GDP	Debt as % of Germany GDP
A Euro Area	9,231.7
B Germany	1,530.1		$8471.8 as % of $3964 =213.7% $6035.7as % of $3964 =152.3%
C France	2,436.1
B+C	3,966.2	GDP $6726 Total Debt $8,471.8 Debt/GDP: 126.0%
D Italy	2,461.6
E Spain	1,193.2
F Portugal	256.8
G Greece	389.2
H Ireland	204.8
Subtotal D+E+F+G+H	4,505.6

Source: calculation with IMF data IMF World Economic Outlook databank

https://www.imf.org/external/pubs/ft/weo/2019/01/weodata/index.aspx

There is extremely important information in Table III-9 for the current sovereign risk crisis in the euro zone. Table III-9 provides the structure of regional and country relations of Germany’s exports and imports with newly available data for Aug 2019. German exports to other European Union (EU) members are 56.8 percent of total exports in Aug 2019 and 58.6 percent in cumulative Jan-Aug 2019. Exports to the euro area are 34.7 percent of the total in Aug and 37.2 percent cumulative in Jan-Aug. Exports to third countries are 43.2 percent of the total in Aug and 41.4 percent cumulative in Jan-Aug. There is similar distribution for imports. Exports to non-euro countries are decreasing 2.6 percent in the 12 months ending in Aug 2019, decreasing 1.4 percent cumulative in Jan-Aug 2019 relative to a year earlier while exports to the euro area are decreasing 3.7 percent in the 12 months ending in Aug 2019 and decreasing 0.2 percent cumulative in Jan-Aug 2019. Exports to third countries, accounting for 43.2 percent of the total in Aug 2019, are decreasing 4.8 percent in the 12 months ending in Aug 2019 and increasing 2.0 percent cumulative in Jan- 2019, accounting for 41.4 percent of the cumulative total in Jan-Aug 2019. Price competitiveness through devaluation could improve export performance and growth. Economic performance in Germany is closely related to Germany’s high competitiveness in world markets. Weakness in the euro zone and the European Union in general could affect the German economy. This may be the major reason for choosing the “fiscal abuse” of the European Central Bank considered by Buiter (2011Oct31) over the breakdown of the euro zone. There is a tough analytical, empirical and forecasting doubt of growth and trade in the euro zone and the world with or without maintenance of the European Monetary Union (EMU) or euro zone. Germany could benefit from depreciation of the euro because of high share in its exports to countries not in the euro zone but breakdown of the euro zone raises doubts on the region’s economic growth that could affect German exports to other member states.

Table III-9, Germany, Structure of Exports and Imports by Region, € Billions and ∆%

	Aug 2019 € Billions	Aug 12-Month ∆%	Cumulative Jan-Aug 2019 € Billions	Cumulative Jan-Aug 2019/ Jan-Aug 2018 ∆%
Total Exports	101.2	-3.9	882.6	0.4
A. EU Members	57.5 % 56.8	-3.3	517.3 % 58.6	-0.6
Euro Area	35.1 % 34.7	-3.7	328.1 % 37.2	-0.2
Non-euro Area	22.4 % 22.1	-2.6	189.2 % 21.4	-1.4
B. Third Countries	43.7 % 43.2	-4.8	365.3 % 41.4	2.0
Total Imports	85.0	-3.1	735.1	1.8
C EU Members	47.2 % 55.5	-2.7	422.3 % 57.4	2.2
Euro Area	30.2 % 35.5	-3.8	276.0 % 37.5	2.6
Non-euro Area	17.0 % 20.0	-0.6	146.3 % 19.9	1.5
D Third Countries	37.8 % 44.5	-3.6	312.8 % 42.6	1.2

Notes: Total Exports = A+B; Total Imports = C+D

Source: Statistisches Bundesamt Deutschland

https://www.destatis.de/EN/Press/2019/10/PE19_395_51.html

IIIF Appendix on Sovereign Bond Valuation. There are two approaches to government finance and their implications: (1) simple unpleasant monetarist arithmetic; and (2) simple unpleasant fiscal arithmetic. Both approaches illustrate how sovereign debt can be perceived riskier under profligacy.

First, Unpleasant Monetarist Arithmetic. Fiscal policy is described by Sargent and Wallace (1981, 3, equation 1) as a time sequence of D(t), t = 1, 2,…t, …, where D is real government expenditures, excluding interest on government debt, less real tax receipts. D(t) is the real deficit excluding real interest payments measured in real time t goods. Monetary policy is described by a time sequence of H(t), t=1,2,…t, …, with H(t) being the stock of base money at time t. In order to simplify analysis, all government debt is considered as being only for one time period, in the form of a one-period bond B(t), issued at time t-1 and maturing at time t. Denote by R(t-1) the real rate of interest on the one-period bond B(t) between t-1 and t. The measurement of B(t-1) is in terms of t-1 goods and [1+R(t-1)] “is measured in time t goods per unit of time t-1 goods” (Sargent and Wallace 1981, 3). Thus, B(t-1)[1+R(t-1)] brings B(t-1) to maturing time t. B(t) represents borrowing by the government from the private sector from t to t+1 in terms of time t goods. The price level at t is denoted by p(t). The budget constraint of Sargent and Wallace (1981, 3, equation 1) is:

D(t) = {[H(t) – H(t-1)]/p(t)} + {B(t) – B(t-1)[1 + R(t-1)]} (1)

Equation (1) states that the government finances its real deficits into two portions. The first portion, {[H(t) – H(t-1)]/p(t)}, is seigniorage, or “printing money.” The second part,

{B(t) – B(t-1)[1 + R(t-1)]}, is borrowing from the public by issue of interest-bearing securities. Denote population at time t by N(t) and growing by assumption at the constant rate of n, such that:

N(t+1) = (1+n)N(t), n>-1 (2)

The per capita form of the budget constraint is obtained by dividing (1) by N(t) and rearranging:

B(t)/N(t) = {[1+R(t-1)]/(1+n)}x[B(t-1)/N(t-1)]+[D(t)/N(t)] – {[H(t)-H(t-1)]/[N(t)p(t)]} (3)

On the basis of the assumptions of equal constant rate of growth of population and real income, n, constant real rate of return on government securities exceeding growth of economic activity and quantity theory equation of demand for base money, Sargent and Wallace (1981) find that “tighter current monetary policy implies higher future inflation” under fiscal policy dominance of monetary policy. That is, the monetary authority does not permanently influence inflation, lowering inflation now with tighter policy but experiencing higher inflation in the future.

Second, Unpleasant Fiscal Arithmetic. The tool of analysis of Cochrane (2011Jan, 27, equation (16)) is the government debt valuation equation:

(M_t + B_t)/P_t = E_t∫(1/R_t_{, t+τ})s_t_+τdτ (4)

Equation (4) expresses the monetary, M_t, and debt, B_t, liabilities of the government, divided by the price level, P_t, in terms of the expected value discounted by the ex-post rate on government debt, R_t_{, t+τ}, of the future primary surpluses s_t_+τ, which are equal to T_t_+τ – G_t_+τ or difference between taxes, T, and government expenditures, G. Cochrane (2010A) provides the link to a web appendix demonstrating that it is possible to discount by the ex post R_t_{, t+τ}. The second equation of Cochrane (2011Jan, 5) is:

M_tV(i_t, ·) = P_tY_t (5)

Conventional analysis of monetary policy contends that fiscal authorities simply adjust primary surpluses, s, to sanction the price level determined by the monetary authority through equation (5), which deprives the debt valuation equation (4) of any role in price level determination. The simple explanation is (Cochrane 2011Jan, 5):

“We are here to think about what happens when [4] exerts more force on the price level. This change may happen by force, when debt, deficits and distorting taxes become large so the Treasury is unable or refuses to follow. Then [4] determines the price level; monetary policy must follow the fiscal lead and ‘passively’ adjust M to satisfy [5]. This change may also happen by choice; monetary policies may be deliberately passive, in which case there is nothing for the Treasury to follow and [4] determines the price level.”

An intuitive interpretation by Cochrane (2011Jan 4) is that when the current real value of government debt exceeds expected future surpluses, economic agents unload government debt to purchase private assets and goods, resulting in inflation. If the risk premium on government debt declines, government debt becomes more valuable, causing a deflationary effect. If the risk premium on government debt increases, government debt becomes less valuable, causing an inflationary effect.

There are multiple conclusions by Cochrane (2011Jan) on the debt/dollar crisis and Global recession, among which the following three:

(1) The flight to quality that magnified the recession was not from goods into money but from private-sector securities into government debt because of the risk premium on private-sector securities; monetary policy consisted of providing liquidity in private-sector markets suffering stress

(2) Increases in liquidity by open-market operations with short-term securities have no impact; quantitative easing can affect the timing but not the rate of inflation; and purchase of private debt can reverse part of the flight to quality

(3) The debt valuation equation has a similar role as the expectation shifting the Phillips curve such that a fiscal inflation can generate stagflation effects similar to those occurring from a loss of anchoring expectations.

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