CMP Associates Regulation Blog

Wealth of Households and Nonprofit Organizations Recovering In Second Quarter 2020 by Growing 7.0 Percent Inflation Adjusted Above Levels Relative to First Quarter 2020 and Equal in Inflation Adjusted Levels Relative to Fourth Quarter 2019, Financial Assets and Real Estate Lead Wealth Recovery, World Inflation Waves, Destruction of Household Nonfinancial Wealth with Cyclically Stagnating Total Real Wealth in the Lost Economic Cycle of the Global Recession with Economic Growth Underperforming Below Trend Worldwide, World Cyclical Slow Growth, and Government Intervention in Globalization: Part V

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

IIB D estruction of Household Nonfinancial Wealth with Stagnating Total Real Wealth 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

VI Valuation of Risk Financial Assets. The financial crisis and global recession were caused by interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html

Table VI-1 shows the phenomenal impulse to valuations of risk financial assets originating in the initial shock of near zero interest rates in 2003-2004 with the fed funds rate at 1 percent, in fear of deflation that never materialized, and quantitative easing in the form of suspension of the auction of 30-year Treasury bonds to lower mortgage rates. World financial markets were dominated by monetary and housing policies in the US. Between 2002 and 2008, the DJ UBS Commodity Index rose 165.5 percent largely because of unconventional monetary policy encouraging carry trades from low US interest rates to long leveraged positions in commodities, exchange rates and other risk financial assets. The charts of risk financial assets show sharp increase in valuations leading to the financial crisis and then profound drops that are captured in Table VI-1 by percentage changes of peaks and troughs. The first round of quantitative easing and near zero interest rates depreciated the dollar relative to the euro by 39.3 percent between 2003 and 2008, with revaluation of the dollar by 25.1 percent from 2008 to 2010 in the flight to dollar-denominated assets in fear of world financial risks. The dollar revalued 2.4 percent by Sep 25, 2020. Dollar devaluation is a major vehicle of monetary policy in reducing the output gap that is implemented in the probably erroneous belief that devaluation will not accelerate inflation, misallocating resources toward less productive economic activities and disrupting financial markets. The last row of Table VI-1 shows CPI inflation in the US rising from 1.9 percent in 2003 to 4.1 percent in 2007 even as monetary policy increased the fed funds rate from 1 percent in Jun 2004 to 5.25 percent in Jun 2006.

Table VI-1, Volatility of Assets

DJIA	10/08/02-10/01/07	10/01/07-3/4/09	3/4/09- 4/6/10
∆%	87.8	-51.2	60.3
NYSE Financial	1/15/04- 6/13/07	6/13/07- 3/4/09	3/4/09- 4/16/07
∆%	42.3	-75.9	121.1
Shanghai Composite	6/10/05- 10/15/07	10/15/07- 10/30/08	10/30/08- 7/30/09
∆%	444.2	-70.8	85.3
STOXX EUROPE 50	3/10/03- 7/25/07	7/25/07- 3/9/09	3/9/09- 4/21/10
∆%	93.5	-57.9	64.3
UBS Com.	1/23/02- 7/1/08	7/1/08- 2/23/09	2/23/09- 1/6/10
∆%	165.5	-56.4	41.4
10-Year Treasury	6/10/03	6/12/07	12/31/08	4/5/10
%	3.112	5.297	2.247	3.986
USD/EUR	6/26/03	7/14/08	6/07/10	09/25/2020
Rate	1.1423	1.5914	1.192	1.1632
CNY/USD	01/03 2000	07/21 2005	7/15 2008	09/25/ 2020
Rate	8.2798	8.2765	6.8211	6.8238
New House	1963	1977	2005	2009
Sales 1000s	560	819	1283	375
New House	2000	2007	2009	2010
Median Price $1000	169	247	217	222
	2003	2005	2007	2010
CPI	2.3	3.4	2.8	1.6

Sources: https://www.wsj.com/market-data

https://www.census.gov/construction/nrs/index.html

https://www.federalreserve.gov/data.htm

Table VI-2 provides the Euro/Dollar (EUR/USD) exchange rate and Chinese Yuan/Dollar (CNY/USD) exchange rate that reveal pursuit of exchange rate policies resulting from monetary policy in the US and capital control/exchange rate policy in China. The ultimate intentions are the same: promoting internal economic activity at the expense of the rest of the world. The easy money policy of the US was deliberately or not but effectively to devalue the dollar from USD 1.1423/EUR on Jun 26, 2003 to USD 1.5914/EUR on Jul 14, 2008, or by 39.3 percent. The flight into dollar assets after the global recession caused revaluation to USD 1.192/EUR on Jun 7, 2010, or by 25.1 percent. After the temporary interruption of the sovereign risk issues in Europe from Apr to Jul 2010, shown in Table VI-4 below, the dollar has revalued to USD 1.1632/EUR on Sep 25, 2020 or by 2.4 percent {[(1.1632/1.192)-1]100 = -2.4%}. 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. On Aug 27, 2020, the Federal Open Market Committee changed its Longer-Run Goals and Monetary Policy Strategy, including the following (https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm): “The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The new policy can affect relative exchange rates depending on relative inflation rates and country risk issues. China fixed the CNY to the dollar for an extended period at a highly undervalued level of around CNY 8.2765/USD subsequently revaluing to CNY 6.8211/USD until Jun 7, 2010, or by 17.6 percent. After fixing again the CNY to the dollar, China devalued to CNY 6.8238/USD on Fri Sep 25, 2020, or by 0.0 percent, for cumulative revaluation of 17.6 percent. The final row of Table VI-2 shows: revaluation of 0.3 percent in the week of Sep 4, 2020; revaluation of 0.1 percent in the week of Sep 11, 2020; revaluation of 1.0 percent in the week of Sep 18, 2020; and devaluation of 0.8 percent in the week of Sep 25, 2020. There could be reversal of revaluation to devalue the Yuan, but the outcome depends on ongoing negotiations.

Table VI-2, Dollar/Euro (USD/EUR) Exchange Rate and Chinese Yuan/Dollar (CNY/USD) Exchange Rate

USD/EUR	12/26/03	7/14/08	6/07/10	09/25/20
Rate	1.1423	1.5914	1.192	1.1632
CNY/USD	01/03 2000	07/21 2005	7/15 2008	09/25/20
Rate	8.2765	6.8211	6.8211	6.8238
Weekly Rates	09/04/2020	09/11/2019	09/18/2020	09/25/20
CNY/USD	6.8425	6.8344	6.7690	6.8238
∆% from Earlier Week*	0.3%	0.1%	1.0%	-0.8%

*Negative sign is depreciation; positive sign is appreciation

Source: http://professional.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000

Bob Davis and Lingling Wei, writing on “China shifts course, lets Yuan drop,” on Jul 25, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10000872396390444840104577548610131107868.html?mod=WSJPRO_hpp_LEFTTopStories), find that China is depreciating the CNY relative to the USD in an effort to diminish the impact of appreciation of the CNY relative to the EUR. Table VI-2A provides the CNY/USD rate from Oct 28, 2011 to Sep 25, 2020 in selected intervals on Fridays. The CNY/USD revalued by 0.9 percent from Oct 28, 2012 to Apr 27, 2012. The CNY was virtually unchanged relative to the USD by Aug 24, 2012 to CNY 6.3558/USD from the rate of CNY 6.3588/USD on Oct 28, 2011 and then revalued slightly by 1.1 percent to CNY 6.2858/USD on Sep 28, 2012. Devaluation of 0.6 percent from CNY 6.2858/USD on Sep 28, 2012 to CNY 6.3240/USD on Oct 5, 2012, reduced to 0.5 percent the cumulative revaluation from Oct 28, 2011 to Oct 5, 2012. Revaluation by 0.2 percent to CNY 6.2546/USD on Oct 12, 2012 and revalued the CNY by 1.6 percent relative to the dollar from CNY 6.3588/USD on Oct 29, 2011. By Sep 25, 2020, the CNY devalued 7.3 percent to CNY 6.8238/USD relative to CNY 6.3588/USD on Oct 28, 2011. There could be reversal of revaluation in favor of devaluation. Robin Harding and Josh Noble, writing on “US warns China after renminbi depreciation,” on Apr 8, 2014, published in the Financial Times (http://www.ft.com/intl/cms/s/0/3355dc74-bed7-11e3-a1bf-00144feabdc0.html?siteedition=intl#axzz2ynwr9l6s), quote concerns of a senior US Treasury official on possible change in China’s policy of revaluation. Meanwhile, the Senate of the US periodically considers a bill on China’s trade that could create a confrontation but may not be approved by the entire Congress. An important statement by the People’s Bank of China (PBC), China’s central bank, on Apr 14, 2012, announced the widening of the daily maximum band of fluctuation of the renminbi (RMB) yuan (http://www.pbc.gov.cn/publish/english/955/2012/20120414090756030448561/20120414090756030448561_.html):

“Along with the development of China’s foreign exchange market, the pricing and risk management capabilities of market participants are gradually strengthening. In order to meet market demands, promote price discovery, enhance the flexibility of RMB exchange rate in both directions, further improve the managed floating RMB exchange rate regime based on market supply and demand with reference to a basket of currencies, the People’s Bank of China has decided to enlarge the floating band of RMB’s trading prices against the US dollar and is hereby making a public announcement as follows:

Effective from April 16, 2012 onwards, the floating band of RMB’s trading prices against the US dollar in the inter-bank spot foreign exchange market is enlarged from 0.5 percent to 1 percent, i.e., on each business day, the trading prices of the RMB against the US dollar in the inter-bank spot foreign exchange market will fluctuate within a band of ±1 percent around the central parity released on the same day by the China Foreign Exchange Trade System. The spread between the RMB/USD selling and buying prices offered by the foreign exchange-designated banks to their customers shall not exceed 2 percent of the central parity, instead of 1 percent, while other provisions in the Circular of the PBC on Relevant Issues Managing the Trading Prices in the Inter-bank Foreign Exchange Market and Quoted Exchange Rates of Exchange-Designated Banks (PBC Document No.[2010]325) remain valid.”

Table VI-2A, Renminbi Yuan US Dollar Rate

	CNY/USD	∆% from CNY 6.3588/USD 0n 10/28/2011
09/25/20	6.8238	-7.3
09/18/20	6.7690	-6.5
09/11/20	6.8344	-7.5
09/04/20	6.8425	-7.6
08/28/20	6.8654	-8.0
08/21/20	6.9195	-8.8
08/14/20	6.9503	-9.3
08/07/20	6.9678	-9.6
07/31/20	6.9752	-9.7
07/24/20	7.0173	-10.4
07/17/20	6.9922	-10.0
07/10/20	7.0018	-10.1
07/03/20	7.0664	-11.1
06/26/20	7.0784	-11.3
06/19/20	7.0723	-11.2
06/12/20	7.0834	-11.4
06/05/20	7.0820	-11.4
05/29/20	7.1373	-12.2
05/22/20	7.1304	-12.1
05/15/20	7.1021	-11.7
05/08/20	7.0741	-11.2
05/01/20	7.0623	-11.1
04/24/20	7.0819	-11.4
04/17/20	7.0732	-11.2
04/10/20	7.0361	-10.7
04/03/20	7.0923	-11.5
03/27/20	7.0964	-11.6
03/20/20	7.0958	-11.6
03/13/20	7.0082	-10.2
03/06/20	6.9320	-9.0
02/28/20	6.9919	-10.0
02/21/20	7.0272	-10.5
02/14/20	6.9871	-9.9
02/07/20	7.0016	-10.1
01/31/20	6.9367	-9.1
01/24/20	6.9367	-9.1
01/17/20	6.8597	-7.9
01/10/20	6.9197	-8.8
01/03/20	6.9655	-9.5
12/27/19	6.9958	-10.0
12/20/19	7.0067	-10.2
12/13/19	6.9729	-9.7
12/06/19	7.0353	-10.6
11/29/19	7.0326	-10.6
11/22/19	7.0392	-10.7
11/15/19	7.0084	-10.2
11/08/19	6.9960	-10.0
11/01/19	7.0374	-10.7
10/25/19	7.0657	-11.1
10/18/19	7.0817	-11.4
10/11/19	7.0882	-11.5
10/04/19	7.1485	-12.4
09/27/19	7.1228	-12.0
09/20/19	7.0916	-11.5
09/13/19	7.0795	-11.3
09/06/19	7.1157	-11.9
08/30/19	7.1567	-12.5
08/23/19	7.0960	-11.6
08/16/19	7.0429	-10.8
08/09/19	7.0624	-11.1
08/02/19	6.9402	-9.1
07/26/19	6.8792	-8.2
07/19/19	6.8819	-8.2
07/12/19	6.8808	-8.2
07/05/19	6.8936	-8.4
06/28/19	6.8668	-8.0
06/21/19	6.8699	-8.0
06/14/19	6.9254	-8.9
06/07/19	6.9098	-8.7
05/31/19	6.9051	-8.6
05/24/19	6.9002	-8.5
05/17/19	6.9186	-8.8
05/10/19	6.8241	-7.3
05/03/19	6.7346	-5.9
04/26/19	6.7297	-5.8
04/19/19	6.7044	-5.4
04/12/19	6.7042	-5.4
04/05/19	6.7179	-5.6
03/29/19	6.7121	-5.6
03/22/19	6.7181	-5.7
03/15/19	6.7135	-5.6
03/08/19	6.7216	-5.7
03/01/19	6.7064	-5.5
02/22/19	6.7142	-5.6
02/15/19	6.7731	-6.5
02/08/19	6.7448	-6.1
02/01/19	6.7449	-6.1
01/25/19	6.7487	-6.1
01/18/19	6.7788	-6.6
01/11/19	6.7627	-6.4
01/04/19	6.8694	-8.0
12/28/18	6.8782	-8.2
12/21/18	6.9064	-8.6
12/14/18	6.9076	-8.6
12/07/18	6.8744	-8.1
11/30/18	6.9590	-9.4
11/23/18	6.9485	-9.3
11/16/18	6.9380	-9.1
11/09/18	6.9569	-9.4
11/02/18	6.8909	-8.4
10/26/18	6.9435	-9.2
10/19/18	6.9296	-9.0
10/12/18	6.9222	-8.9
10/05/18	6.8689	-8.0
09/28/18	6.8690	-8.0
09/21/18	6.8568	-7.8
09/14/18	6.8705	-8.0
09/07/18	6.8448	-7.6
08/31/18	6.8316	-7.4
08/24/18	6.8077	-7.1
08/17/18	6.8776	-8.2
08/10/18	6.8469	-7.7
08/03/18	6.8306	-7.4
07/27/18	6.8137	-7.2
07/20/18	6.7709	-6.5
07/13/18	6.6908	-5.2
07/06/18	6.6434	-4.5
06/29/18	6.6225	-4.1
06/22/18	6.5059	-2.3
06/15/18	6.4389	-1.3
06/08/18	6.4065	-0.8
06/01/18	6.4204	-1.0
05/25/18	6.3919	-0.5
05/18/18	6.3780	-0.3
05/11/18	6.3341	0.4
05/04/18	6.3627	-0.1
04/27/18	6.3336	0.4
04/20/18	6.2965	1.0
04/13/18	6.2788	1.3
04/06/18	6.3044	0.9
03/30/18	6.2911	1.1
03/23/18	6.3157	0.7
03/16/18	6.3346	0.4
03/09/18	6.3346	0.4
03/02/18	6.3485	0.2
02/23/18	6.3358	0.4
02/16/18	6.3458	0.2
02/09/18	6.2890	1.1
02/02/18	6.3033	0.9
01/26/18	6.3154	0.7
01/19/18	6.4058	-0.7
01/12/18	6.4518	-1.5
01/05/18	6.4891	-2.0
12/29/17	6.5030	-2.3
12/22/17	6.5744	-3.4
12/15/17	6.5989	-3.8
12/08/17	6.6179	-4.1
12/01/17	6.6134	-4.0
11/24/17	6.5983	-3.8
11/17/17	6.6287	-4.2
11/10/17	6.6415	-4.4
11/03/17	6.6387	-4.4
10/27/17	6.6507	-4.6
10/20/17	6.6221	-4.1
10/13/17	6.5901	-3.6
10/06/17	6.6534	-4.6
09/29/17	6.6366	-4.4
09/22/17	6.5935	-3.7
09/15/17	6.5537	-3.1
09/08/17	6.4817	-1.9
09/01/17	6.5591	-3.1
08/25/17	6.6482	-4.6
08/18/17	6.6719	-4.9
08/11/17	6.6647	-4.8
08/04/17	6.7305	-5.8
07/28/17	6.7374	-6.0
07/21/17	6.7670	-6.4
07/14/17	6.7840	-6.7
07/07/17	6.8128	-7.1
06/30/17	6.7787	-6.6
06/23/17	6.8359	-7.5
06/16/17	6.8103	-7.1
06/09/17	6.7987	-6.9
06/02/17	6.8105	-7.1
05/26/17	6.8556	-7.8
05/19/17	6.8839	-8.3
05/12/17	6.8998	-8.5
05/05/17	6.9031	-8.6
04/28/17	6.8940	-8.4
04/21/17	6.8848	-8.3
04/14/17	6.8854	-8.3
04/07/17	6.9044	-8.6
03/31/17	6.8866	-8.3
03/24/17	6.8772	-8.2
03/17/17	6.9093	-8.7
03/10/17	6.9071	-8.6
03/03/17	6.8955	-8.4
02/24/17	6.8668	-8.0
02/17/17	6.8650	-8.0
02/10/17	6.8776	-8.2
02/03/17	6.8661	-8.0
01/27/17	6.8811	-8.2
01/20/17	6.8765	-8.1
01/13/17	6.8998	-8.5
01/06/17	6.9185	-8.8
12/30/16	6.9448	-9.2
12/23/16	6.9463	-9.2
12/16/16	6.9593	-9.4
12/09/16	6.9077	-8.6
12/02/16	6.8865	-8.3
11/25/16	6.9236	-8.9
11/18/16	6.8883	-8.3
11/11/16	6.8151	-7.2
11/04/16	6.7540	-6.2
10/28/16	6.7983	-6.9
10/21/16	6.7624	-6.3
10/14/16	6.7296	-5.8
10/07/16	6.6728	-4.9
09/30/16	6.6711	-4.9
09/23/16	6.6724	-4.9
09/16/16	6.6701	-4.9
09/09/16	6.6876	-5.2
09/02/16	6.6822	-5.1
08/26/16	6.6685	-4.9
08/19/16	6.6523	-4.6
08/12/16	6.6408	-4.4
08/05/16	6.6438	-4.5
07/29/16	6.6550	-4.7
07/22/16	6.6819	-5.1
07/15/16	6.6924	-5.2
07/08/16	6.6881	-5.2
07/01/16	6.6564	-4.7
06/24/16	6.6128	-4.0
06/17/16	6.5836	-3.5
06/10/16	6.5720	-3.4
06/03/16	6.5518	-3.0
05/27/16	6.5630	-3.2
05/20/16	6.5464	-3.0
05/13/16	6.5319	-2.7
05/06/16	6.4965	-2.2
04/29/16	6.4741	-1.8
04/22/16	6.5068	-2.3
04/15/16	6.4781	-1.9
04/08/16	6.4673	-1.7
04/01/16	6.4787	-1.9
03/25/16	6.5204	-2.5
03/18/16	6.4716	-1.8
03/11/16	6.4961	-2.2
03/04/16	6.5027	-2.3
02/26/16	6.5433	-2.9
02/19/16	6.5225	-2.6
02/12/16	6.5733	-3.4
02/05/16	6.5736	-3.4
01/29/16	6.5761	-3.4
01/22/16	6.5789	-3.5
01/15/16	6.5836	-3.5
01/08/16	6.5934	-3.7
01/01/16	6.4931	-2.1
12/25/15	6.4801	-1.9
12/18/15	6.4827	-1.9
12/11/15	6.4558	-1.5
12/04/15	6.4006	-0.7
11/27/15	6.3964	-0.6
11/20/15	6.3885	-0.5
11/13/15	6.3738	-0.2
11/06/15	6.3515	0.1
10/30/15	6.3161	0.7
10/23/15	6.3542	0.1
10/16/15	6.3529	0.1
10/09/15	6.3447	0.2
10/02/15	6.3552	0.1
09/25/15	6.3754	-0.3
09/18/15	6.3639	-0.1
09/11/15	6.3734	-0.2
09/04/15	6.3701	-0.2
08/28/15	6.3872	-0.4
08/21/15	6.3870	-0.4
08/14/15	6.3907	-0.5
08/07/15	6.2097	2.3
07/31/15	6.2077	2.4
07/24/15	6.2085	2.4
07/17/15	6.2110	2.3
07/10/15	6.2115	2.3
07/03/15	6.2048	2.4
06/26/15	6.2090	2.4
06/19/15	6.2098	2.3
06/12/15	6.2068	2.4
06/05/15	6.2016	2.5
05/29/15	6.2004	2.5
05/22/15	6.1974	2.5
05/15/15	6.2054	2.4
05/08/15	6.2143	2.3
05/01/15	6.2134	2.3
04/24/15	6.1935	2.6
04/17/15	6.1953	2.6
04/10/15	6.2063	2.4
04/03/15	6.1466	3.3
03/27/15	6.2150	2.3
03/20/15	6.2046	2.4
03/13/15	6.2599	1.6
03/06/15	6.2644	1.5
02/27/1 5	6.2671	1.4
02/20/15	6.2546	1.6
02/13/2015	6.2446	1.8
02/06/2015	6.2445	1.8
01/30/2015	6.2543	1.6
01/23/2015	6.2309	2.0
01/16/2015	6.2063	2.4
01/09/2015	6.2045	2.4
01/02/2015	6.2063	2.4
12/26/2014	6.2276	2.1
12/19/2014	6.2226	2.1
12/12/2014	6.1852	2.7
12/05/2014	6.1502	3.3
11/28/2014	6.1431	3.4
11/21/2014	6.1228	3.7
11/14/2014	6.1313	3.6
11/07/2014	6.1238	3.7
10/31/2014	6.1133	3.9
10/24/2014	6.1181	3.8
10/17/2014	6.1246	3.7
10/10/2014	6.1299	3.6
0/03/2014	6.1363	3.5
9/26/2014	6.1272	3.6
9/19/2014	6.1412	3.4
9/12/2014	6.1334	3.5
9/05/2014	6.1406	3.4
8/29/2014	6.1457	3.4
8/22/2014	6.1522	3.2
8/15/2014	6.1463	3.3
8/8/2014	6.1548	3.2
8/1/2014	6.1781	2.8
7/25/2014	6.1923	2.6
7/18/2014	6.2074	2.4
7/11/2014	6.2040	2.4
7/4/2014	6.2036	2.4
6/27/2014	6.2189	2.2
6/20/14	6.2238	2.1
6/13/2014	6.2097	2.3
6/6/2014	6.2507	1.7
5/30/2014	6.2486	1.7
5/23/2014	6.2354	1.9
5/16/2014	6.2340	2.0
5/9/2014	6.2281	2.1
5/3/2014	6.2595	1.6
4/28/2014	6.2539	1.6
4/18/2014	6.2377	1.9
4/11/2014	6.2111	2.3
4/4/2014	6.2102	2.3
3/28/2014	6.2130	2.3
3/21/2014	6.2247	2.1
3/14/2014	6.1496	3.3
3/7/2014	6.1260	3.7
2/28/2014	6.1481	3.3
2/21/2014	6.0913	4.2
2/14/2014	6.0670	4.6
2/7/2014	6.0634	4.6
1/31/2014	6.0589	4.7
1/24/2014	6.0472	4.9
1/17/2014	6.0503	4.9
1/10/2014	6.0503	4.9
1/3/2014	6.0516	4.8
12/27/2013	6.0678	4.6
12/20/2013	6.0725	4.5
12/13/2013	6.0691	4.6
12/6/2013	6.0801	4.4
11/29/2013	6.0914	4.2
11/22/2013	6.0911	4.2
11/15/2013	6.0928	4.2
11/8/2013	6.0912	4.2
11/1/2013	6.0996	4.1
10/25/2013	6.0830	4.3
10/18/2013	6.0973	4.1
10/11/2013	6.1210	3.7
10/4/2013	6.1226	3.7
9/27/2013	6.1196	3.8
9/20/2013	6.1206	3.7
9/13/2013	6.1190	3.8
9/6/2013	6.1209	3.7
8/30/2013	6.1178	3.8
8/23/2013	6.1211	3.7
8/16/2013	6.1137	3.9
8/9/2013	6.1225	3.7
8/2/2013	6.1295	3.6
7/26/2013	6.1305	3.6
7/19/2013	6.1380	3.5
7/12/2013	6.1382	3.5
7/5/2013	6.1316	3.6
6/28/2013	6.1910	2.6
6/21/2013	6.1345	3.5
6/14/2013	6.1323	3.6
6/7/2013	6.1334	3.5
5/31/2013	6.1347	3.5
5/24/2013	6.1314	3.6
5/17/2013	6.1395	3.4
5/10/2013	6.1395	3.4
5/3/2013	6.1553	3.2
4/26/2013	6.1636	3.1
4/19/13	6.1788	2.8
4/12/2013	6.1947	2.6
4/5/2013	6.2051	2.4
3/29/2013	6.2119	2.3
3/22/2013	6.2112	2.3
3/15/2013	6.2131	2.3
3/8/2013	6.2142	2.3
3/1/2013	6.2221	2.1
2/22/2013	6.2350	1.9
2/15/2013	6.2328	2.0
2/8/2013	6.2323	2.0
2/1/2013	6.2316	2.0
1/25/2013	6.2228	2.1
1/18/2013	6.2182	2.2
1/11/2013	6.2168	2.2
1/4/2013	6.2316	2.0
12/28/2012	6.2358	1.9
12/21/2012	6.2352	1.9
12/14/2012	6.2460	1.8
12/7/2012	6.2254	2.1
11/30/2012	6.2310	2.0
11/23/2012	6.2328	2.0
11/16/2012	6.2404	1.9
11/9/2012	6.2452	1.8
11/2/2012	6.2458	1.8
10/26/2012	6.2628	1.5
10/19/2012	6.2546	1.6
10/12/2012	6.2670	1.4
10/5/2012	6.3240	0.5
9/28/2012	6.2858	1.1
9/21/2012	6.3078	0.8
9/14/2012	6.3168	0.7
9/7/2012	6.3438	0.2
8/31/2012	6.3498	0.1
8/24/2012	6.3558	0.0
8/17/2012	6.3589	0.0
8/10/2012	6.3604	0.0
8/3/2012	6.3726	-0.2
7/27/2012	6.3818	-0.4
7/20/2012	6.3750	-0.3
7/13/2012	6.3868	-0.4
7/6/2012	6.3658	-0.1
6/29/2012	6.3552	0.1
6/22/2012	6.3650	-0.1
6/15/2012	6.3678	-0.1
6/8/2012	6.3752	-0.3
6/1/2012	6.3708	-0.2
4/27/2012	6.3016	0.9
3/23/2012	6.3008	0.9
2/3/2012	6.3030	0.9
12/30/2011	6.2940	1.0
11/25/2011	6.3816	-0.4
10/28/2011	6.3588	-

Source:

http://professional.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000

http://federalreserve.gov/releases/h10/Hist/dat00_ch.htm

Professor Edward P Lazear (2013Jan7), writing on “Chinese ‘currency manipulation’ is not the problem,” on Jan 7, 2013, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323320404578213203581231448.html), provides clear thought on the role of the yuan in trade between China and the United States and trade between China and Europe. There is conventional wisdom that Chinese exchange rate policy causes the loss of manufacturing jobs in the United States, which is shown by Lazear (2013Jan7) to be erroneous. The fact is that manipulation of the CNY/USD rate by China has only minor effects on US employment. Lazear (2013Jan7) shows that the movement of monthly exports of China to its major trading partners, United States and Europe, since 1995 cannot be explained by the fixing of the CNY/USD rate by China. The period is quite useful because it includes rapid growth before 2007, contraction until 2009 and weak subsequent expansion. Professor Charles W. Calomiris, at Columbia University, writing in the Wall Street Journal on Apr 17, 2017, provides perceptive analysis of China’s exchange rate. According to Calomiris (2017Apr), long-run exchange rate appreciation in China originates in productivity growth in accordance with Harrod (1939), Balassa (1964) and Samuelson (1964). In this view, reforms allowing increasing participation of private economic activity caused an increase in productivity measured by Calomiris (2017Apr) as only about 3 percent of US productivity around 1978 to current 13 percent of US productivity. Calomiris (2017Apr) attributes recent depreciation of the Yuan to rapidly increasing debt, slowing growth and inflation motivating capital flight. Chart VI-1 of the Board of Governors of the Federal Reserve System provides the CNY/USD exchange rate from Jan 3, 1995 to Sep 18, 2020 together with US recession dates in shaded areas. China fixed the CNY/USD rate for an extended period as shown in the horizontal segment from 1995 to 2005. There was systematic revaluation of 17.6 percent from CNY 8.2765 on Jul 21, 2005 to CNY 6.8211 on Jul 15, 2008. China fixed the CNY/USD rate until Jun 7, 2010, to avoid adverse effects on its economy from the global recession, which is shown as a horizontal segment from 2009 until mid-2010. China then continued the policy of appreciation of the CNY relative to the USD with oscillations until the beginning of 2012 when the rate began to move sideways followed by a final upward slope of devaluation that is measured in Table VI-2A but virtually disappeared in the rate of CNY 6.3589/USD on Aug 17, 2012 and was nearly unchanged at CNY 6.3558/USD on Aug 24, 2012. China then appreciated 0.2 percent in the week of Dec 21, 2012, to CNY 6.2352/USD for cumulative 1.9 percent revaluation from Oct 28, 2011 and left the rate virtually unchanged at CNY 6.2316/USD on Jan 11, 2013, moving to CNY 6.7675/USD on Sep 18, 2020, which is the last data point in Chart VI-1. Revaluation of the CNY relative to the USD of 17.6 percent by Sep 25, 2020 has not reduced the trade surplus of China but reversal of the policy of revaluation could result in international confrontation. The interruption with upward slope in the final segment on the right of Chart VI-I is measured as virtually stability in Table VI-2A followed with decrease or revaluation and subsequent increase or devaluation. The final segment shows decline or revaluation with another upward move or devaluation. Linglin Wei, writing on “China intervenes to lower yuan,” on Feb 26, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702304071004579406810684766716?KEYWORDS=china+yuan&mg=reno64-wsj), finds from informed sources that the central bank of China conducted the ongoing devaluation of the yuan with the objective of driving out arbitrageurs to widen the band of fluctuation. There is concern if the policy of revaluation is changing to devaluation.

Chart VI-1, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 3, 1995-Sep 18, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-1A provides the daily CNY/USD rate from Jan 5, 1981 to Sep 18, 2020. The exchange rate was CNY 1.5418/USD on Jan 5, 1981. There is sharp cumulative depreciation of 107.8 percent to CNY 3.2031 by Jul 2, 1986, continuing to CNY 5.8145/USD on Dec 29, 1993 for cumulative 277.1 percent since Jan 5, 1981. China then devalued sharply to CNY 8.7117/USD on Jan 7, 1994 for 49.8 percent relative to Dec 29, 1993 and cumulative 465.0 percent relative to Jan 5, 1981. China then fixed the rate at CNY 8.2765/USD until Jul 21, 2005 and revalued as analyzed in Chart VI-1. The final data point in Chart VI-1A is CNY 6.7675/USD on Sep 18, 2020. To be sure, China fixed the exchange rate after substantial prior devaluation. It is unlikely that the devaluation could have been effective after many years of fixing the exchange rate with high inflation and multiple changes in the world economy. The argument of Lazear (2013Jan7) is still valid in view of the lack of association between monthly exports of China to the US and Europe since 1995 and the exchange rate of China.

Chart VI-1A, Chinese Yuan (CNY) per US Dollar (USD), Business Days, Jan 5, 1981-Sep 18, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-1B provides finer details with the rate of Chinese Yuan (CNY) to the US Dollar (USD) from Oct 28, 2011 to Sep 18, 2020. There have been alternations of revaluation and devaluation. The initial data point is CNY 6.5370 on Nov 3, 2011. There is an episode of devaluation from CNY 6.2790 on Apr 30, 2012 to CNY 6.3879 on Jul 25, 2012, or devaluation of 1.4 percent. Another devaluation is from CNY 6.0402/USD on Jan 21, 2014 to CNY 6.7675/USD on Sep 18, 2020, or devaluation of 12.0 percent. Calomiris (2017Apr) attributes recent depreciation of the Yuan to rapidly increasing debt, slowing growth and inflation motivating capital flight. China is the second largest holder of US Treasury securities with $1073.4 billion in Jul 2020, decreasing 0.1 percent from $1074.4 billion in Jun 2020 while decreasing $36.9 billion from Jul 2019 or 3.3 percent. The United States Treasury estimates US government debt held by private investors at $15,688 billion in Jun 2020 (Fiscal Year 2020). China’s holding of US Treasury securities represents 6.8 percent of US government marketable interest-bearing debt held by private investors (https://www.fiscal.treasury.gov/reports-statements/treasury-bulletin/). Min Zeng, writing on “China plays a big role as US Treasury yields fall,” on Jul 16, 2014, published in the Wall Street Journal (http://online.wsj.com/articles/china-plays-a-big-role-as-u-s-treasury-yields-fall-1405545034?tesla=y&mg=reno64-wsj), finds that acceleration in purchases of US Treasury securities by China has been an important factor in the decline of Treasury yields in 2014. Japan increased its holdings from $1131.2 billion in Jul 2019 to $1293.0 billion in Jul 2020 or 14.3 percent. The combined holdings of China and Japan in Jul 2020 add to $2366.4 billion, which is equivalent to 15.1 percent of US government marketable interest-bearing securities held by investors of $15,688 billion in Jun 2020 (Fiscal Year 2020) (https://www.fiscal.treasury.gov/reports-statements/treasury-bulletin/). Total foreign holdings of Treasury securities increased from $6625.9 billion in Jun 2019 to $7038.9 billion in Jun 2020, or 6.2 percent. The US continues to finance its fiscal and balance of payments deficits with foreign savings (see Pelaez and Pelaez, The Global Recession Risk (2007). Professor Martin Feldstein, at Harvard University, writing on “The Debt Crisis Is Coming Soon,” published in the Wall Street Journal on Mar 20, 2019 (https://www.wsj.com/articles/the-debt-crisis-is-coming-soon-11553122139?mod=hp_opin_pos3), foresees a US debt crisis with deficits moving above $1 trillion and debt above 100 percent of GDP. A point of saturation of holdings of US Treasury debt may be reached as foreign holders evaluate the threat of reduction of principal by dollar devaluation and reduction of prices by increases in yield, including possibly risk premium. Shultz et al (2012) find that the Fed financed three-quarters of the US deficit in fiscal year 2011, with foreign governments financing significant part of the remainder of the US deficit while the Fed owns one in six dollars of US national debt. Concentrations of debt in few holders are perilous because of sudden exodus in fear of devaluation and yield increases and the limit of refinancing old debt and placing new debt. In their classic work on “unpleasant monetarist arithmetic,” Sargent and Wallace (1981, 2) consider a regime of domination of monetary policy by fiscal policy (emphasis added):

“Imagine that fiscal policy dominates monetary policy. The fiscal authority independently sets its budgets, announcing all current and future deficits and surpluses and thus determining the amount of revenue that must be raised through bond sales and seignorage. Under this second coordination scheme, the monetary authority faces the constraints imposed by the demand for government bonds, for it must try to finance with seignorage any discrepancy between the revenue demanded by the fiscal authority and the amount of bonds that can be sold to the public. Suppose that the demand for government bonds implies an interest rate on bonds greater than the economy’s rate of growth. Then if the fiscal authority runs deficits, the monetary authority is unable to control either the growth rate of the monetary base or inflation forever. If the principal and interest due on these additional bonds are raised by selling still more bonds, so as to continue to hold down the growth of base money, then, because the interest rate on bonds is greater than the economy’s growth rate, the real stock of bonds will growth faster than the size of the economy. This cannot go on forever, since the demand for bonds places an upper limit on the stock of bonds relative to the size of the economy. Once that limit is reached, the principal and interest due on the bonds already sold to fight inflation must be financed, at least in part, by seignorage, requiring the creation of additional base money.”

Chart VI-1B, Chinese Yuan (CNY) per US Dollar (US), Business Days, Oct 28, 2011-Sep 18, 2020

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-1C provides two exchange rates. Measured on the left axis is the Yuan (CNY) per US Dollar (US) rate and measured on the right axis is the US Dollar (US) per Euro rate from Jan 2, 2020 to Sep 18, 2020. In the past few months since May 2020, the Yuan has revalued relative to the dollar while the dollar has devalued relative to the euro. On Aug 27, 2020, the Federal Open Market Committee changed its Longer-Run Goals and Monetary Policy Strategy, including the following (https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm): “The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The new policy can affect relative exchange rates depending on relative inflation rates and country risk issues.

Chart VI-1C, Chinese Yuan (CNY) per US Dollar (US) and US Dollar (US) per Euro, Business Days, Jan 2, 2020-Sep 18, 2020

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Inflation and unemployment in the period 1966 to 1985 is analyzed by Cochrane (2011Jan, 23) by means of a Phillips circuit joining points of inflation and unemployment. Chart VI-1B for Brazil in Pelaez (1986, 94-5) was reprinted in The Economist in the issue of Jan 17-23, 1987 as updated by the author. Cochrane (2011Jan, 23) argues that the Phillips circuit shows the weakness in Phillips curve correlation. The explanation is by a shift in aggregate supply, rise in inflation expectations or loss of anchoring. The case of Brazil in Chart VI-1B cannot be explained without taking into account the increase in the fed funds rate that reached 22.36 percent on Jul 22, 1981 (http://www.federalreserve.gov/releases/h15/data.htm) in the Volcker Fed that precipitated the stress on a foreign debt bloated by financing balance of payments deficits with bank loans in the 1970s. The loans were used in projects, many of state-owned enterprises with low present value in long gestation. The combination of the insolvency of the country because of debt higher than its ability of repayment and the huge government deficit with declining revenue as the economy contracted caused adverse expectations on inflation and the economy. This interpretation is consistent with the case of the 24 emerging market economies analyzed by Reinhart and Rogoff (2010GTD, 4), concluding that “higher debt levels are associated with significantly higher levels of inflation in emerging markets. Median inflation more than doubles (from less than seven percent to 16 percent) as debt rises frm the low (0 to 30 percent) range to above 90 percent. Fiscal dominance is a plausible interpretation of this pattern.”

The reading of the Phillips circuits of the 1970s by Cochrane (2011Jan, 25) is doubtful about the output gap and inflation expectations:

“So, inflation is caused by ‘tightness’ and deflation by ‘slack’ in the economy. This is not just a cause and forecasting variable, it is the cause, because given ‘slack’ we apparently do not have to worry about inflation from other sources, notwithstanding the weak correlation of [Phillips circuits]. These statements [by the Fed] do mention ‘stable inflation expectations. How does the Fed know expectations are ‘stable’ and would not come unglued once people look at deficit numbers? As I read Fed statements, almost all confidence in ‘stable’ or ‘anchored’ expectations comes from the fact that we have experienced a long period of low inflation (adaptive expectations). All these analyses ignore the stagflation experience in the 1970s, in which inflation was high even with ‘slack’ markets and little ‘demand, and ‘expectations’ moved quickly. They ignore the experience of hyperinflations and currency collapses, which happen in economies well below potential.”

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

Chart VI-1B provides the tortuous Phillips Circuit of Brazil from 1963 to 1987. There were no reliable consumer price index and unemployment data in Brazil for that period. Chart VI-1B used the more reliable indicator of inflation, the wholesale price index, and idle capacity of manufacturing as a proxy of unemployment in large urban centers.

Chart VI1-B, Brazil, Phillips Circuit, 1963-1987

Source:

©Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo: Editora Atlas, 1986, pages 94-5. Reprinted in: Brazil. Tomorrow’s Italy, The Economist, 17-23 January 1987, page 25.

The key to success in stabilizing an economy with significant risk aversion is finding parity of internal and external interest rates. Brazil implemented fiscal consolidation and reforms that are advisable in explosive foreign debt environments. In addition, Brazil had the capacity to find parity in external and internal interest rates to prevent capital flight and disruption of balance sheets (for analysis of balance sheets, interest rates, indexing, devaluation, financial instruments and asset/liability management in that period see Pelaez and Pelaez (2007), The Global Recession Risk: Dollar Devaluation and the World Economy, 178-87). Table VI-2C provides monthly percentage changes of inflation, devaluation and indexing and the monthly percent overnight interest rate. Parity was attained by means of a simple inequality:

Cost of Domestic Loan ≥ Cost of Foreign Loan

This ordering was attained in practice by setting the domestic interest rate of the overnight interest rate plus spread higher than indexing of government securities with lower spread than loans in turn higher than devaluation plus spread of foreign loans. Interest parity required equality of inflation, devaluation and indexing. Brazil devalued the cruzeiro by 30 percent in 1983 because the depreciation of the German mark DM relative to the USD had eroded the competitiveness of Brazil’s products in Germany and in competition with German goods worldwide. The database of the Board of Governors of the Federal Reserve System quotes DM 1.7829/USD on Mar 3 1980 and DM 2.4425/USD on Mar 15, 1983 (http://www.federalreserve.gov/releases/h10/hist/dat89_ge.htm) for devaluation of 37.0 percent. Parity of costs and rates of domestic and foreign loans and assets required ensuring that there would not be appreciation of the exchange rate, inducing capital flight in expectation of future devaluation that would have reversed stabilization. Table VI-2C provides inflation, devaluation, overnight interest rate and indexing. One of the main problems of adjustment of members of the euro area with high debts is that they cannot adjust the exchange rate because of the common euro currency. This is not an argument in favor of breaking the euro area because there would be also major problems of adjustment such as exiting the euro in favor of a new Drachma in the case of Greece. Another hurdle of adjustment in the euro area is that Brazil could have moved swiftly to adjust its economy in 1983 but the euro area has major sovereignty and distribution of taxation hurdles in moving rapidly.

Table VI-2C, Brazil, Inflation, Devaluation, Overnight Interest Rate and Indexing, Percent per Month, 1984

1984	Inflation IGP ∆%	Devaluation ∆%	Overnight Interest Rate %	Indexing ∆%
Jan	9.8	9.8	10.0	9.8
Feb	12.3	12.3	12.2	12.3
Mar	10.0	10.1	11.3	10.0
Apr	8.9	8.8	10.1	8.9
May	8.9	8.9	9.8	8.9
Jun	9.2	9.2	10.2	9.2
Jul	10.3	10.2	11.9	10.3
Aug	10.6	10.6	11.0	10.6
Sep	10.5	10.5	11.9	10.5
Oct	12.6	12.6	12.9	12.6
Nov	9.9	9.9	10.9	9.9
Dec	10.5	10.5	11.5	10.5

Source: Carlos Manuel Pelaez, O Cruzado e o Austral: Análise das Reformas Monetárias do Brasil e da Argentina. São Paulo, Editora Atlas, 1986, 86.

Table VI-6, updated with every blog comment, shows that exchange rate valuations affect a large variety of countries, in fact, almost the entire world, in magnitudes that cause major problems for domestic monetary policy and trade flows. Dollar devaluation/fluctuation is expected to continue because of zero fed funds rate, expectations of rising inflation, large budget deficit of the federal government (http://professional.wsj.com/article/SB10001424052748703907004576279321350926848.html?mod=WSJ_hp_LEFTWhatsNewsCollection) and now near zero interest rates indefinitely but with interruptions caused by risk aversion events. On Aug 27, 2020, the Federal Open Market Committee changed its Longer-Run Goals and Monetary Policy Strategy, including the following (https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm): “The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The new policy can affect relative exchange rates depending on relative inflation rates and country risk issues. The euro has devalued 36.7 percent relative to the US dollar from the high on Jul 15, 2008 to Sep 25, 2020. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). The British pound (GBP) devalued 8.9 percent from the trough of USD/₤1.388 on Jan 2, 2009 to USD/₤1.2746 on Sep 25, 2020 and devalued 57.4 percent from the high of USD/₤2.006 on Jul 15, 2008, exchange rate changes measuring ₤/USD. Such similar event occurred in the week of Sep 23, 2011 reversing the devaluation of the dollar in the form of sharp appreciation of the dollar relative to other currencies from all over the world including the offshore Chinese yuan market. The Bank of England reduced the Bank Rate to 0.25 percent on Aug 4, 2016, and announced new measures of quantitative easing

(http://www.bankofengland.co.uk/publications/Pages/news/2016/008.aspx). The Bank of England increased the policy interest rate by 0.25 percentage points to 0.75 percent at the meeting of its Monetary Policy Committee on Aug 1, 2018 (https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2018/august-2018). Column “Peak” in Table VI-6 shows exchange rates during the crisis year of 2008. There was a flight to safety in dollar-denominated government assets because of the arguments in favor of TARP (Cochrane and Zingales 2009). This is evident in various exchange rates that depreciated sharply against the dollar such as the South African rand (ZAR) at the peak of depreciation of ZAR 11.578/USD on Oct 22, 2008. Subsequently, the ZAR appreciated to the trough of ZAR 7.238/USD by Aug 15, 2010 but now depreciating 136.7 percent to ZAR 17.1311/USD on Sep 25, 2020, which is depreciation of 48.0 percent relative to Oct 22, 2008. An example from Asia is the Singapore Dollar (SGD) that depreciated at the peak of SGD 1.553/USD on Mar 3, 2009. The SGD depreciated by 13.2 percent to the trough of SGD 1.348/USD on Aug 9, 2010 but is now depreciating 2.2 percent at SGD 1.3774/USD on Sep 25, 2020 relative to the trough of depreciation but still stronger by 11.3 percent relative to the peak of depreciation on Mar 3, 2009. Another example is the Brazilian real (BRL) that depreciated at the peak to BRL 2.43/USD on Dec 5, 2008. The BRL appreciated 28.5 percent to the trough at BRL 1.737/USD on Apr 30, 2010, showing depreciation of 220.2 percent relative to the trough to BRL 5.5622/USD on Sep 25, 2020 but depreciating by 128.9 percent relative to the peak on Dec 5, 2008. At one point in 2011, the Brazilian real traded at BRL 1.55/USD and in the week of Sep 23 surpassed BRL 1.90/USD in intraday trading for depreciation of more than 20 percent. The Banco Central do Brasil (BCB), Brazil’s central bank, decreased its policy rate SELIC for ten consecutive meetings (http://www.bcb.gov.br/?INTEREST) of its monetary policy committee, COPOM. Brazil’s central bank did not change the SELIC rate at its most recent meeting (https://www.bcb.gov.br/en/pressdetail/2355/nota):

“233^rd Meeting of the Monetary Policy Committee (COPOM) of the Central Bank of Brazil Press Release

09/15/2020

In its 233^rd meeting, the COPOM unanimously decided to maintain the Selic rate to 2.00 percent per year” (https://www.bcb.gov.br/en/pressdetail/2355/nota). The Banco Central do Brasil is engaging in repurchase operations in foreign currency beginning Mar 18, 2020 (https://www.bcb.gov.br/en/pressdetail/2319/nota). The monetary authorities also provides multiple measures to face the COVID-19 event (https://www.bcb.gov.br/en/pressdetail/2322/nota). The Banco Central do Brasil also engaged in FX auctions (http://www.bcb.gov.br/en/#!/c/news/1828):

“BC announces FX auctions program 22/08/2013 6:44:00 PM

With the aim of providing FX ‘hedge” (protection) to the economic agents and liquidity to the FX market, the Banco Central do Brasil informs that a program of FX swap auctions and US dollar sale auctions with repurchase program will begin, as of Friday, August 23. This program will last, at least, until December 31, 2013. The swap auctions will occur every Monday, Tuesday, Wednesday and Thursday, when US$500 million will be offered per day. On Fridays, a credit line of US$1 billion will be offered to the market, through sale auctions with repurchase agreement. If it is considered appropriate, the Banco Central do Brasil will carry out additional operations.”

Jeffrey T. Lewis, writing on “Brazil steps up battle to curb real’s rise,” on Mar 1, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052970203986604577255793224099580.html?mod=WSJ_hp_LEFTWhatsNewsCollection), analyzes new measures by Brazil to prevent further appreciation of its currency, including the extension of the tax on foreign capital for three years terms, subsequently broadened to five years, and intervention in the foreign exchange market by the central bank. Jeff Fick, writing on “Brazil shifts tack to woo wary investors,” on Jun 5, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887324299104578527000680111188.html), analyzes the lifting in the week of Jun 7, 2013, of the tax on foreign transactions designed in Oct 2010 to contain the flood of foreign capital into Brazil that overvalued its currency. Jeffrey T. Lewis, writing on “Brazil’s real closes weaker,” on Jun 14, 2013, published in the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323734304578545680335302180.html), analyzes measures to contain accelerated depreciation such as currency swaps and the lifting of the 1 percent tax on exchange derivatives on Jun 12, 2013. Unconventional monetary policy of zero interest rates and quantitative easing creates trends such as the depreciation of the dollar followed by Table VI-6 but with abrupt reversals during risk aversion. The main effects of unconventional monetary policy are on valuations of risk financial assets and not necessarily on consumption and investment or aggregate demand.

Table VI-6, Exchange Rates

	Peak	Trough	∆% P/T	Sep 25, 2020	∆% T Sep 25, 2020	∆% P Sep 25, 2020
EUR USD	7/15 2008	6/7 2010		09/25/2020
Rate	1.59	1.192		1.1632
∆%			-33.4		-2.5	-36.7
JPY USD	8/18 2008	9/15 2010		09/25/2020
Rate	110.19	83.07		105.58
∆%			24.6		-27.1	4.2
CHF USD	11/21 2008	12/8 2009		09/25/2020
Rate	1.225	1.025		0.9292
∆%			16.3		9.3	24.1
USD GBP	7/15 2008	1/2/ 2009		09/25/2020
Rate	2.006	1.388		1.2746
∆%			-44.5		-8.9	-57.4
USD AUD	7/15 2008	10/27 2008		09/25/2020
Rate	1.0215	1.6639		0.7028
∆%			-62.9		14.5	-39.3
ZAR USD	10/22 2008	8/15 2010		09/25/2020
Rate	11.578	7.238		17.1311
∆%			37.5		-136.7	-48.0
SGD USD	3/3 2009	8/9 2010		09/25/2020
Rate	1.553	1.348		1.3774
∆%			13.2		-2.2	11.3
HKD USD	8/15 2008	12/14 2009		09/25/2020
Rate	7.813	7.752		7.7503
∆%			0.8		0.0	0.8
BRL USD	12/5 2008	4/30 2010		09/25/2020
Rate	2.43	1.737		5.5622
∆%			28.5		-220.2	-128.9
CZK USD	2/13 2009	8/6 2010		09/25/2020
Rate	22.19	18.693		23.312
∆%			15.7		-24.7	-5.1
SEK USD	3/4 2009	8/9 2010		09/25/2020
Rate	9.313	7.108		9.1264
∆%			23.7		-28.4	2.0
CNY USD	7/20 2005	7/15 2008		09/25/2020
Rate	8.2765	6.8211		6.8238	0.0	17.6
∆%			17.6

Symbols: USD: US dollar; EUR: euro; JPY: Japanese yen; CHF: Swiss franc; GBP: UK pound; AUD: Australian dollar; ZAR: South African rand; SGD: Singapore dollar; HKD: Hong Kong dollar; BRL: Brazil real; CZK: Czech koruna; SEK: Swedish krona; CNY: Chinese yuan; P: peak; T: trough

Note: percentages calculated with currencies expressed in units of domestic currency per dollar; negative sign means devaluation and no sign appreciation

Source:

http://professional.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000

https://markets.ft.com/data/currencies

There are major ongoing and unresolved realignments of exchange rates in the international financial system as countries and regions seek parities that can optimize their productive structures. Seeking exchange rate parity or exchange rate optimizing internal economic activities is complex in a world of unconventional monetary policy of zero interest rates and even negative nominal interest rates of government obligations such as negative yields for the two-year government bond of Germany. Regulation, trade and devaluation conflicts should have been expected from a global recession (Pelaez and Pelaez (2007), The Global Recession Risk, Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008a)): “There are significant grounds for concern on the basis of this experience. International economic cooperation and the international financial framework can collapse during extreme events. It is unlikely that there will be a repetition of the disaster of the Great Depression. However, a milder contraction can trigger regulatory, trade and exchange wars” (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c), 181). Chart VI-2 of the Board of Governors of the Federal Reserve System provides the key exchange rate of US dollars (USD) per euro (EUR) from Jan 4, 1999 to Sep 18, 2020. US recession dates are in shaded areas. The rate on Jan 4, 1999 was USD 1.1812/EUR, declining to USD 0.8279/EUR on Oct 25, 2000, or appreciation of the USD by 29.9 percent. The rate depreciated 21.9 percent to USD 1.0098/EUR on Jul 22, 2002. There was sharp devaluation of the USD of 34.9 percent to USD 1.3625/EUR on Dec 27, 2004 largely because of the 1 percent interest rate between Jun 2003 and Jun 2004 together with a form of quantitative easing by suspension of auctions of the 30-year Treasury, which was equivalent to withdrawing supply from markets. Another depreciation of 17.5 percent took the rate to USD 1.6010/EUR on Apr 22, 2008, already inside the shaded area of the global recession. The flight to the USD and obligations of the US Treasury appreciated the dollar by 22.3 percent to USD 1.2446/EUR on Oct 27, 2008. In the return of the carry trade after stress tests showed sound US bank balance sheets, the rate depreciated 21.2 percent to USD 1.5085/EUR on Nov 25, 2009. The sovereign debt crisis of Europe in the spring of 2010 caused sharp appreciation of 20.7 percent to USD 1.1959/EUR on Jun 6, 2010. Renewed risk appetite depreciated the rate 24.4 percent to USD 1.4875/EUR on May 3, 2011. The rate appreciated 0.9 percent to USD 1.1857/EUR on Sep 18, 2020, which is the last point in Chart VI-2. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-2, US Dollars (USD) per Euro (EUR), Jan 4, 1999 to Sep 11, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI 3 provides three currency indexes of the dollar from Jan 4, 1995 to Sep 18, 2020. Chart VI-3A provides the overnight fed funds rate and yields of the three-month constant maturity Treasury bill, the ten-year constant maturity Treasury note and Moody’s Baa bond from Jan 4, 1995 to Jul 7, 2016. Chart VI-3B provides the overnight fed funds rate and yields of the three-month constant maturity Treasury bill and the ten-year constant maturity Treasury from Jan 4, 1995 to Sep 24, 2020. The first phase from 1995 to 2001 shows sharp trend of appreciation of the USD while interest rates remained at relatively high levels. The dollar revalued partly because of the emerging market crises that provoked inflows of financial investment into the US and partly because of a deliberate strong dollar policy. DeLong and Eichengreen (2001, 4-5) argue:

“That context was an economic and political strategy that emphasized private investment as the engine for U.S. economic growth. Both components of this term, "private" and "investment," had implications for the administration’s international economic strategy. From the point of view of investment, it was important that international events not pressure on the Federal Reserve to raise interest rates, since this would have curtailed capital formation and vitiated the effects of the administration’s signature achievement: deficit reduction. A strong dollar -- or rather a dollar that was not expected to weaken -- was a key component of a policy which aimed at keeping the Fed comfortable with low interest rates. In addition, it was important to create a demand for the goods and services generated by this additional productive capacity. To the extent that this demand resided abroad, administration officials saw it as important that the process of increasing international integration, of both trade and finance, move forward for the interest of economic development in emerging markets and therefore in support of U.S. economic growth.”

The process of integration consisted of restructuring “international financial architecture” (Pelaez and Pelaez, International Financial Architecture: G7, IMF, BIS, Debtors and Creditors (2005)). Policy concerns subsequently shifted to the external imbalances, or current account deficits, and internal imbalances, or government deficits (Pelaez and Pelaez, The Global Recession Risk: Dollar Devaluation and the World Economy (2007)). Fed policy consisted of lowering the policy rate or fed funds rate, which is close to the marginal cost of funding of banks, toward zero during the past decade. Near zero interest rates induce carry trades of selling dollar debt (borrowing), shorting the USD and investing in risk financial assets. Without risk aversion, near zero interest rates cause devaluation of the dollar. Chart VI-3 shows the weakening USD between the recession of 2001 and the contraction after IVQ2007. There was a flight to dollar assets and especially obligations of the US government after Sep 2008. Cochrane and Zingales (2009) show that flight was coincident with proposals of TARP (Troubled Asset Relief Program) to withdraw “toxic assets” in US banks (see Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a) and Regulation of Banks and Finance (2009b)). There are shocks to globalization in the form of regulation, trade and devaluation wars and breakdown of international cooperation (Pelaez and Pelaez, Globalization and the State: Vol. I (2008a), Globalization and the State: Vol. II (2008b) and Government Intervention in Globalization: Regulation, Trade and Devaluation Wars (2008c)). As evident in Chart VI-3A, there is no exit from near zero interest rates without a financial crisis and economic contraction, verified by the increase of interest rates from 1 percent in Jun 2004 to 5.25 percent in Jun 2006. The Federal Open Market Committee (FOMC) lowered the target of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85). The FOMC implemented increments of 25 basis points of the fed funds target from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006, as shown in Chart VI-3A. The gradual exit from the first round of unconventional monetary policy from 1.00 percent in Jun 2004 (http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040630/default.htm) to 5.25 percent in Jun 2006 (http://www.federalreserve.gov/newsevents/press/monetary/20060629a.htm) caused the financial crisis and global recession. There are conflicts on exchange rate movements among central banks. There is concern of declining inflation in the euro area and appreciation of the euro. 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). At the press conference following the meeting of the ECB on Jul 3, 2014, Mario Draghi stated (http://www.ecb.europa.eu/press/pressconf/2014/html/is140703.en.html): “In fact, as I said, interest rates will stay low for an extended period of time, and the Governing Council is unanimous in its commitment to use also nonstandard, unconventional measures to cope with the risk of a too-prolonged period of time of low inflation.”

The President of the ECB Mario Draghi analyzed unemployment in the euro area and the policy response policy in a speech at the Jackson Hole meeting of central bankers on Aug 22, 2014 (http://www.ecb.europa.eu/press/key/date/2014/html/sp140822.en.html):

“We have already seen exchange rate movements that should support both aggregate demand and inflation, which we expect to be sustained by the diverging expected paths of policy in the US and the euro area (Figure 7). We will launch our first Targeted Long-Term Refinancing Operation in September, which has so far garnered significant interest from banks. And our preparation for outright purchases in asset-backed security (ABS) markets is fast moving forward and we expect that it should contribute to further credit easing. Indeed, such outright purchases would meaningfully contribute to diversifying the channels for us to generate liquidity.”

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

“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.”

At the Thirtieth Meeting of the International Monetary and Financial Committee of the IMF (IMFC), the President of the European Central Bank (ECB), Mario Draghi stated (http://www.ecb.europa.eu/press/key/date/2014/html/sp141010.en.html):

“Our monetary policy continues to aim at firmly anchoring medium to long-term inflation expectations, in line with our objective of maintaining inflation rates below, but close to, 2% over the medium term. In this context, we have taken both conventional and unconventional measures that will contribute to a return of inflation rates to levels closer to our aim. Our unconventional measures, more specifically our TLTROs (Targeted Longer-Term Refinancing Operations) and our new purchase programmes for ABSs and covered bonds, will further enhance the functioning of our monetary policy transmission mechanism and facilitate credit provision to the real economy. Should it become necessary to further address risks of too prolonged a period of low inflation, the ECB’s Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate.”

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.”

In the Introductory Statement to the press conference on Dec 4, 2014, the President of the European Central Bank Mario Draghi advised that (http://www.ecb.europa.eu/press/pressconf/2014/html/is141204.en.html):

“In this context, early next year the Governing Council will reassess the monetary stimulus achieved, the expansion of the balance sheet and the outlook for price developments. We will also evaluate the broader impact of recent oil price developments on medium-term inflation trends in the euro area. Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council remains unanimous in its commitment to using additional unconventional instruments within its mandate. This would imply altering early next year the size, pace and composition of our measures.”

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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 36.7 percent relative to the dollar from the high on Jul 15, 2008 to Sep 25, 2020.

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 (Section I). The dollar revalued 2.4 percent during the week. The euro has devalued 36.7 percent relative to the dollar from the high on Jul 15, 2008 to Sep 25, 2020.

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%

On January 29, 2016, the Policy Board of the Bank of Japan introduced a new policy to attain the “price stability target of 2 percent at the earliest possible time” (https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf). The new framework consists of three dimensions: quantity, quality and interest rate. The interest rate dimension consists of rates paid to current accounts that financial institutions hold at the Bank of Japan of three tiers zero, positive and minus 0.1 percent. The quantitative dimension consists of increasing the monetary base at the annual rate of 80 trillion yen. The qualitative dimension consists of purchases by the Bank of Japan of Japanese government bonds (JGBs), exchange traded funds (ETFs) and Japan real estate investment trusts (J-REITS). The yen devalued sharply relative to the dollar and world equity markets soared after the new policy announced on Jan 29, 2016:

Fri 22

Mon 25

Tue 26

Wed 27

Thu 28

Fri 29

JPY/ USD

118.77

-1.5%

-0.9%

118.30

0.4%

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 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

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

What is truly important is the fixing of the overnight fed funds at 0 to ¼ percent (https://www.federalreserve.gov/newsevents/pressreleases/monetary20200916a.htm): “The Committee decided to keep the target range for the federal funds rate at 0 to ¼ percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time. In addition, over coming months the Federal Reserve will increase its holdings of Treasury securities and agency mortgage-backed securities at least at the current pace to sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses. In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.” (emphasis added).” There are multiple new policy measures, including purchases of Treasury securities and mortgage-backed securities for the balance sheet of the Fed (https://www.federalreserve.gov/newsevents/pressreleases/monetary20200610a.htm): “To support the flow of credit to households and businesses, over coming months the Federal Reserve will increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace to sustain smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions. In addition, the Open Market Desk will continue to offer large-scale overnight and term repurchase agreement operations. The Committee will closely monitor developments and is prepared to adjust its plans as appropriate.”In the Opening Remarks to the Press Conference on Oct 30, 2019, the Chairman of the Federal Reserve Board, Jerome H. Powell, stated (https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20191030.pdf): “We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook of moderate economic growth, a strong labor market, and inflation near our symmetric 2 percent objective. We believe monetary policy is in a good place to achieve these outcomes. Looking ahead, we will be monitoring the effects of our policy actions, along with other information bearing on the outlook, as we assess the appropriate path of the target range for the fed funds rate. Of course, if developments emerge that cause a material reassessment of our outlook, we would respond accordingly. Policy is not on a preset course.” 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.

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 Federal Open Market Committee (FOMC) decided to lower the target range of the federal funds rate by 0.50 percent to 1.0 to 1¼ percent on Mar 3, 2020 in a decision outside the calendar meetings (https://www.federalreserve.gov/newsevents/pressreleases/monetary20200303a.htm):

March 03, 2020

Federal Reserve issues FOMC statement

For release at 10:00 a.m. EST

The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. In light of these risks and in support of achieving its maximum employment and price stability goals, the Federal Open Market Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1‑1/4 percent. The Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Loretta J. Mester; and Randal K. Quarles.

For media inquiries, call 202-452-2955.

Implementation Note issued March 3, 2020

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 (Friedman 1957). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:

W = Y/r (1)

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

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%

Chart VI-3, US Dollar Currency Indexes, Jan 4, 1995-Sep 18, 2020

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-3A, US, Overnight Fed Funds Rate, Yield of Three-Month Treasury Constant Maturity, Yield of Ten-Year Treasury Constant Maturity and Yield of Moody’s Baa Bond, Jan 4, 1995 to Jul 25, 2016

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

Chart VI-3B, US, Overnight Fed Funds Rate, Yield of Three-Month Treasury Constant Maturity and Yield of Ten-Year Treasury Constant Maturity, Jan 4, 1995 to Sep 24, 2020

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

Chart VI-4 of the Board of Governors of the Federal Reserve System provides the exchange rate of the US relative to the euro, or USD/EUR. During maintenance of the policy of zero fed funds rates the dollar appreciates in periods of significant risk aversion such as flight into US government obligations in late 2008 and early 2009 and in the various risks concerns generated by the European sovereign debt crisis. There was depreciation of the dollar followed by recent appreciation.

Chart VI-4, US Dollars per Euro, 2015-2020

Source: Board of Governors of the Federal Reserve System

http://www.federalreserve.gov/DataDownload/Chart.aspx?rel=H10&series=e85cfb140ce469e13bec458013262fa1&lastObs=780&from=&to=&filetype=csv&label=include&layout=seriescolumn&pp=Download&names=%7bH10/H10/RXI$US_N.B.EU%7d

Carry trades induced by zero interest rates increase capital flows into emerging markets that appreciate exchange rates. Portfolio reallocations away from emerging markets depreciate their exchange rates in reversals of capital flows. Chart VI-4A provides the exchange rate of the Mexican peso (MXN) per US dollar from Nov 8, 1993 to Sep 18, 2020. The first data point in Chart VI-4A is MXN 3.1520 on Nov 8, 1993. The rate devalued to 11.9760 on Nov 14, 1995 during emerging market crises in the 1990s and the increase of interest rates in the US in 1994 that stressed world financial markets (Pelaez and Pelaez, International Financial Architecture 2005, The Global Recession Risk 2007, 147-77). The MXN depreciated sharply to MXN 15.4060/USD on Mar 2, 2009, during the global recession. The rate moved to MXN 11.5050/USD on May 2, 2011, during the sovereign debt crisis in the euro area. The rate depreciated to 11.9760 on May 9, 2013. The final data point is MXN 20.9490/USD on Sep 18, 2020.

Chart VI-4A, Mexican Peso (MXN) per US Dollar (USD), Nov 8, 1993 to Sep 18, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

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 former 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. Professor Willem Buiter (2014Feb4), a distinguished economist currently Global Chief Economist at Citigroup (http://www.willembuiter.com/resume.pdf), writing on “The Fed’s bad manners risk offending foreigners,” on Feb 4, 2014, published in the Financial Times (http://www.ft.com/intl/cms/s/0/fbb09572-8d8d-11e3-9dbb-00144feab7de.html#axzz2suwrwkFs), concurs with Raghuram Rajan. Buiter (2014Feb4) argues that international policy cooperation in monetary policy is both in the interest of the world and the United States. Portfolio reallocations induced by combination of zero interest rates and risk events stimulate carry trades that generate wide swings in world capital flows. In a speech at the Brookings Institution on Apr 10, 2014, Raghuram G. Rajan (2014Apr10, 1, 10) argues:

“As the world seems to be struggling back to its feet after the great financial crisis, I want to draw attention to an area we need to be concerned about: the conduct of monetary policy in this integrated world. A good way to describe the current environment is one of extreme monetary easing through unconventional policies. In a world where debt overhangs and the need for structural change constrain domestic demand, a sizeable portion of the effects of such policies spillover across borders, sometimes through a weaker exchange rate. More worryingly, it prompts a reaction. Such competitive easing occurs both simultaneously and sequentially, as I will argue, and both advanced economies and emerging economies engage in it. Aggregate world demand may be weaker and more distorted than it should be, and financial risks higher. To ensure stable and sustainable growth, the international rules of the game need to be revisited. Both advanced economies and emerging economies need to adapt, else I fear we are about to embark on the next leg of a wearisome cycle. A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have.”

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.

Chart VI-4B provides the rate of the Indian rupee (INR) per US dollar (USD) from Jan 2, 1973 to Sep 18, 2020. The first data point is INR 8.0200 on Jan 2, 1973. The rate depreciated sharply to INR 51.9600 on Mar 3, 2009, during the global recession. The rate appreciated to INR 44.0300/USD on Jul 28, 2011 in the midst of the sovereign debt event in the euro area. The rate overshot to INR 68.8000 on Aug 28, 2013. The final data point is INR 73.5400/USD on Sep 18, 2020.

Chart VI-4B, Indian Rupee (INR) per US Dollar (USD), Jan 2, 1973 to Sep 18, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-5 provides the exchange rate of JPY (Japan yen) per USD (US dollars). The first data point on the extreme left is JPY 357.7300/USD for Jan 14, 1971. The JPY has appreciated over the long term relative to the USD with fluctuations along an evident long-term appreciation. Before the global recession, the JPY stood at JPY 124.0900/USD on Jun 22, 2007. The use of the JPY as safe haven is evident by sharp appreciation during the global recession to JPY 110.4800/USD on Aug 15, 2008, and to JPY 87.8000/USD on Jan 21, 2009. The final data point in Chart VI-5 is JPY 104.4400/USD on Sep 18, 2020 for appreciation of 15.8 percent relative to JPY 124.0900/USD on Jun 29, 2007 before the global recession and expansion characterized by recurring bouts of risk aversion. Takashi Nakamichi and Eleanor Warnock, writing on “Japan lashes out over dollar, euro,” on Dec 29, 2012, published in the Wall Street Journal (http://professional.wsj.com/article/SB10001424127887323530404578207440474874604.html?mod=WSJ_markets_liveupdate&mg=reno64-wsj), analyze the “war of words” launched by Japan’s new Prime Minister Shinzo Abe and his finance minister Taro Aso, arguing of deliberate devaluations of the USD and EUR relative to the JPY, which are hurting Japan’s economic activity. Gerard Baker and Jacob M. Shlesinger, writing on “Bank of Japan’s Kuroda signals impatience with Abe government,” on May 23, 2014, published in the Wall Street Journal (http://online.wsj.com/news/articles/SB10001424052702303480304579579311491068756?KEYWORDS=bank+of+japan+kuroda&mg=reno64-wsj), analyze concerns of the Governor of the Bank of Japan Haruhiko Kuroda that the JPY has strengthened relative to the USD, partly eroding earlier depreciation. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-5, Japanese Yen JPY per US Dollars USD, Monthly, Jan 4, 1971-Sep 18, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

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

Zero interest rates in the United States forever tend to depreciate the dollar against every other currency if there is no risk aversion preventing portfolio rebalancing toward risk financial assets, which include the capital markets and exchange rates of emerging-market economies. The objective of unconventional monetary policy as argued by Yellen 2011AS) is to devalue the dollar to increase net exports that increase US economic growth. Increasing net exports and internal economic activity in the US is equivalent to decreasing net exports and internal economic activity in other countries.

Continental territory, rich endowment of natural resources, investment in human capital, teaching and research universities, motivated labor force and entrepreneurial initiative provide Brazil with comparative advantages in multiple economic opportunities. Exchange rate parity is critical in achieving Brazil’s potential but is difficult in a world of zero interest rates. Chart IV-6 of the Board of Governors of the Federal Reserve System provides the rate of Brazilian real (BRL) per US dollar (USD) from BRL 1.2074/USD on Jan 4, 1999 to BRL 5.3056/USD on Sep 18, 2020. The rate reached BRL 3.9450/USD on Oct 10, 2002 appreciating 60.5 percent to BRL 1.5580/USD on Aug 1, 2008. The rate depreciated 68.1 percent to BRL 2.6187/USD on Dec 5, 2008 during worldwide flight from risk. The rate appreciated again by 41.3 percent to BRL 1.5375/USD on Jul 26, 2011. The final data point in Chart VI-6 is BRL 5.3056/USD on Sep 18, 2020 for depreciation of 245.1 percent. The data in Table VI-6 is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-6, Brazilian Real (BRL) per US Dollar (USD) Jan 4, 1999 to Sep 18, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

Chart VI-7 of the Board of Governors of the Federal Reserve System provides the history of the BRL beginning with the first data point of BRL 0.8400/USD on Jan 2, 1995. The rate jumped to BRL 2.0700/USD on Jan 29, 1999 after changes in exchange rate policy and then to BRL 2.2000/USD on Mar 3, 1999. The rate depreciated 26.7 percent to BRL 2.7880 on Sep 21, 2001 relative to Mar 3, 1999.

Chart VI-7, Brazilian Real (BRL) per US Dollar (USD), Jan 2, 1995 to Sep 18, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=h10

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