US GDP Grew at 2.0 Percent SAAR in IQ2023, 2.6 Percent SAAR in IVQ2022, Grew at 3.2 Percent SAAR in IIIQ2022, Contracting at SAAR of 0.6 Percent in IIQ2022 After Contracting at 1.6 Percent in IQ2022 and Growing at 1.8 Percent in IQ2023 Relative to a Year Earlier, 0.9 Percent Relative to a Year Earlier in IVQ2022, 1.9 Percent in IIIQ2022 and 1.8 Percent in IIQ2022 After Growing at 3.7 Percent in IQ2022 Relative to a Year Earlier, Real Fixed Investment Contracted at 0.4 Percent SAAR in IQ2023, Contracting at 3.8 Percent SAAR in IVQ2022 after Contracting at 3.5 Percent SAAR in IIIQ2022, Contracting at 5.0 Percent SAAR in IIQ2022 and Growing at 4.8 Percent SAAR in IQ2022, Stagflation, Mediocre Cyclical United States Economic Growth in the Lost Economic Cycle of the Global Recession with Economic Growth Underperforming Below Trend Worldwide, Real Private Fixed Investment, US Terms of International Trade, Worldwide Fiscal, Monetary and External Imbalances, Risk of Global Recession, World Cyclical Slow Growth, and Government Intervention in Globalization, Stagflation, Global Recession Risk, Worldwide Fiscal, Monetary and External Imbalances, World Cyclical Slow Growth, and Government Intervention in Globalization
Note: This Blog will post only one indicator of the US economy while we concentrate efforts in completing a book-length manuscript in the critically important subject of INFLATION.
Carlos M. Pelaez
© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019, 2020, 2021, 2022, 2023.
I Mediocre Cyclical United States Economic Growth
IA1 Stagnating Real Private Fixed Investment
IB Terms of Trade
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
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
Preamble. United States total public debt outstanding is $32.3 trillion and debt held by the public $25.5 trillion (https://fiscaldata.treasury.gov/datasets/debt-to-the-penny/debt-to-the-penny). The Net International Investment Position of the United States, or foreign debt, is $16.75 trillion at the end of IQ2023 (https://www.bea.gov/sites/default/files/2023-06/intinv123.pdf). The United States current account deficit is 3.3 percent of GDP in IQ2023, increasing from 3.2 percent in IVQ2022 (https://www.bea.gov/sites/default/files/2023-06/trans123.pdf). The Treasury deficit of the United States reached $2.8 trillion in fiscal year 2021 (https://fiscal.treasury.gov/reports-statements/mts/). Total assets of Federal Reserve Banks reached $8.3 trillion on Jul 5, 2023 and securities held outright reached $7.6 trillion (https://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). US GDP nominal NSA reached $26.5 trillion in IQ2023 (https://apps.bea.gov/iTable/index_nipa.cfm). US GDP contracted at the real seasonally adjusted annual rate (SAAR) of 1.6 percent in IQ2022 and contracted at the SAAR of 0.6 percent in IIQ2022, growing at 3.2 percent in IIIQ2022, growing at 2.6 percent in IVQ2022 and growing at 2.0 percent in IQ2023 (https://apps.bea.gov/iTable/index_nipa.cfm). Total Treasury interest-bearing, marketable debt held by private investors increased from $3635 billion in 2007 to $16,439 billion in Sep 2021 (Fiscal Year 2021) or increase by 352.2 percent (https://fiscal.treasury.gov/reports-statements/treasury-bulletin/). John Hilsenrath, writing on “Economists Seek Recession Cues in the Yield Curve,” published in the Wall Street Journal on Apr 2, 2022, analyzes the inversion of the Treasury yield curve with the two-year yield at 2.430 on Apr 1, 2022, above the ten-year yield at 2.374. Hilsenrath argues that inversion appears to signal recession in market analysis but not in alternative Fed approach. The Consumer Price index of the United States in Chart CPI-H increased 4.0 percent in May 2023 Relative to a Year Earlier, The Tenth Highest Since 8.9 percent in Dec 1981 was Followed by the Highest of 9.1 percent in Jun 2022, the Second Highest of 8.6 percent in May 2022, 8.5 percent in both Jul 2022 and Mar 2022, 8.3 percent in both Apr and Aug 2022, 8.2 percent in Sep 2022, 7.7 percent in Oct 2022, 7.1 percent in Nov 2022, 6.5 percent in Dec 2022, 6.4 percent in Jan 2023, 6.0 percent in Feb 2023, 5.0 percent in Mar 2023, 4.9 percent in Apr 2023 and 4.0 percent in May 2023.
Chart CPI-H, US, Consumer Price Index, 12-Month Percentage Change, NSA, 1981-2023
Source: US Bureau of Labor Statistics https://www.bls.gov/cpi/data.htm
Table CPI-H, US, Consumer Price Index, 12-Month Percentage Change, NSA, 1981-1982, 2019-2023
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec |
| 1981 | 11.8 | 11.4 | 10.5 | 10.0 | 9.8 | 9.6 | 10.8 | 10.8 | 11.0 | 10.1 | 9.6 | 8.9 |
| 1982 | 8.4 | 7.6 | 6.8 | 6.5 | 6.7 | 7.1 | 6.4 | 5.9 | 5.0 | 5.1 | 4.6 | 3.8 |
| 1983 | 3.7 | 3.5 | 3.6 | 3.9 | 3.5 | 2.6 | 2.5 | 2.6 | 2.9 | 2.9 | 3.3 | 3.8 |
| 2019 | 1.6 | 1.5 | 1.9 | 2.0 | 1.8 | 1.6 | 1.8 | 1.7 | 1.7 | 1.8 | 2.1 | 2.3 |
| 2020 | 2.5 | 2.3 | 1.5 | 0.3 | 0.1 | 0.6 | 1.0 | 1.3 | 1.4 | 1.2 | 1.2 | 1.4 |
| 2021 | 1.4 | 1.7 | 2.6 | 4.2 | 5.0 | 5.4 | 5.4 | 5.3 | 5.4 | 6.2 | 6.8 | 7.0 |
| 2022 | 7.5 | 7.9 | 8.5 | 8.3 | 8.6 | 9.1 | 8.5 | 8.3 | 8.2 | 7.7 | 7.1 | 6.5 |
| 2023 | 6.4 | 6.0 | 5.0 | 4.9 | 4.0 |
Source: US Bureau of Labor Statistics https://www.bls.gov/cpi
Chart VII-3 of the Energy Information Administration provides the US retail price of regular gasoline. The price moved to $3.527 per gallon on Jul 3, 2023 from $4.771 a year earlier or minus 26.1 percent.
Chart VII-3, US Retail Price of Regular Gasoline, Dollars Per Gallon
Source: US Energy Information Administration
https://www.eia.gov/petroleum/weekly/
Chart VII-3A provides the US retail price of regular gasoline, dollars per gallon, from $1.191 on Aug 20,1990 to $3.527 on Jul 3,2023 or 196.1 percent. The price of retail regular gasoline increased from $2.249/gallon on Jan 4,2021 to $3.527/gallon on Jul 3, 2023, or 56.8 percent. The price of retail regular gasoline decreased from $3.530/gallon on Feb 21, 2022, two days before the invasion of Ukraine, to $3.527/gallon on Jul 3,2023 or minus 0.1 percent and had increased 57.0 percent from $2.249/gallon on Jan 4,2021 to $3.530/gallon on Feb 21, 2022.
Chart VII-3A, US Retail Price of Regular Gasoline, Dollars Per Gallon
Source: US Energy Information Administration
https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=EMM_EPMR_PTE_NUS_DPG&f=W
Chart VII-4 of the Energy Information Administration provides the price of the Natural Gas Futures Contract increasing from $2.581 per million Btu on Jan 4, 2021 to $5.326 per million Btu on Dec 20, 2022 or 106.4 percent and closing at $2.657 on Jul 5, 2023 or increase of 2.9 percent.
Chart VII-4, US, Natural Gas Futures Contract 1
Source: US Energy Information Administration
https://www.eia.gov/dnav/ng/hist/rngc1d.htm
Chart VII-5 of the US Energy Administration provides US field production of oil decreasing from a peak of 13.000 thousand barrels per day in Nov 2019 to the final point of 12.615 thousand barrels per day in Apr 2023.
Chart VII-5, US, US, Field Production of Crude Oil, Thousand Barrels Per Day
Source: US Energy Information Administration
https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MCRFPUS2&f=M
Chart VII-6 of the US Energy Information Administration provides imports of crude oil. Imports increased from 245,473 thousand barrels per day in Jan 2021 to 260,412 thousand barrels in Jan 2022, moving to 254,095 thousand barrels in Apr 2023.
Chart VII-6, US, US, Imports of Crude Oil and Petroleum Products, Thousand Barrels
Source: US Energy Information Administration
https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MTTIMUS1&f=M
Chart VI-7 of the EIA provides US Petroleum Consumption, Production, Imports, Exports and Net Imports 1950-2021. There was sharp increase in production in the final segment that reached consumption by 2020. There is reversal in 2021 with consumption exceeding production.
Chart VI-7, US Petroleum Consumption, Production, Imports, Exports and Net Imports 1950-2021, Million Barrels Per Day
https://www.eia.gov/energyexplained/oil-and-petroleum-products/imports-and-exports.php
Chart VI-8 provides the US average retail price of electricity at 12.78 cents per kilowatthour in Dec 2020 increasing to 16.11 cents per kilowatthour in Apr 2023 or 26.1 per cent.
Chart VI-8, US Average Retail Price of Electricity, Monthly, Cents per Kilowatthour,
Chart VII-9 provides the fed funds rate and Three Months, Two-Year and Ten-Year Treasury Constant Maturity Yields. Unconventional monetary policy of near zero interest rates is typically followed by financial and economic stress with sharp increases in interest rates.
Chart VII-9, US Fed Funds Rate and Three-Month, Two-Year and Ten-Year Treasury Constant Maturity Yields, Jan 2, 1994 to 2022-2023
Source: Federal Reserve Board of the Federal Reserve System
https://www.federalreserve.gov/releases/h15/
Note: program does not download the entire right-side of the chart.
Chart VII-9A, US Fed Funds Rate and Three-Month, Two-Year and Ten-Year Treasury Constant Maturity Yields, Jan 2, 2022 to May 30, 2023
Source: Federal Reserve Board of the Federal Reserve System
https://www.federalreserve.gov/releases/h15/
Note: Chart is shortened of current dates in download.
Chart VI-14 provides the overnight fed funds rate, the yield of the 10-year Treasury constant maturity bond, the yield of the 30-year constant maturity bond and the conventional mortgage rate from Jan 1991 to Dec 1996. In Jan 1991, the fed funds rate was 6.91 percent, the 10-year Treasury yield 8.09 percent, the 30-year Treasury yield 8.27 percent and the conventional mortgage rate 9.64 percent. Before monetary policy tightening in Oct 1993, the rates and yields were 2.99 percent for the fed funds, 5.33 percent for the 10-year Treasury, 5.94 for the 30-year Treasury and 6.83 percent for the conventional mortgage rate. After tightening in Nov 1994, the rates and yields were 5.29 percent for the fed funds rate, 7.96 percent for the 10-year Treasury, 8.08 percent for the 30-year Treasury and 9.17 percent for the conventional mortgage rate.
Chart VI-14, US, Overnight Fed Funds Rate, 10-Year Treasury Constant Maturity, 30-Year Treasury Constant Maturity and Conventional Mortgage Rate, Monthly, Jan 1991 to Dec 1996
Source: Board of Governors of the Federal Reserve System
http://www.federalreserve.gov/releases/h15/update/
Chart VI-15 of the Bureau of Labor Statistics provides the all items consumer price index from Jan 1991 to Dec 1996. There does not appear acceleration of consumer prices requiring aggressive tightening.
Chart VI-15, US, Consumer Price Index All Items, Jan 1991 to Dec 1996
Source: Bureau of Labor Statistics
https://www.bls.gov/cpi/data.htm
Chart IV-16 of the Bureau of Labor Statistics provides 12-month percentage changes of the all items consumer price index from Jan 1991 to Dec 1996. Inflation collapsed during the recession from Jul 1990 (III) and Mar 1991 (I) and the end of the Kuwait War on Feb 25, 1991 that stabilized world oil markets. CPI inflation remained almost the same and there is no valid counterfactual that inflation would have been higher without monetary policy tightening because of the long lag in effect of monetary policy on inflation (see Culbertson 1960, 1961, Friedman 1961, Batini and Nelson 2002, Romer and Romer 2004). Policy tightening had adverse collateral effects in the form of emerging market crises in Mexico and Argentina and fixed income markets worldwide.
Chart VI-16, US, Consumer Price Index All Items, Twelve-Month Percentage Change, Jan 1991 to Dec 1996
Source: Bureau of Labor Statistics
https://www.bls.gov/cpi/data.htm
Chart USFX provides the exchange rate of US Dollars per EURO from 2007 to 2023. Barry Eichengreen and Jeffrey Sachs, Exchange Rates and Economic Recovery in the 1930s, The Journal of Economic History, Vol. 45, No. 4 (Dec 1985), argue that foreign exchange “depreciation was clearly beneficial for initiating countries” during the Great Depression of the 1930s and that it was no equivalent to “beggar my neighbor” policies such as tariffs.
Chart USFX, Exchange Rate USD/EURO 2007-2023
Source: https://www.federalreserve.gov/releases/h10/current/
Chart USFX, Exchange Rate USD/EURO 2000-2023
Source: https://www.federalreserve.gov/releases/h10/current/
Federal Reserve Bank of St. Louis https://fred.stlouisfed.org/
Chart USFX, Exchange Rate USD/EURO 2018-2023
Source: https://www.federalreserve.gov/releases/h10/current/
Federal Reserve Bank of St. Louis https://fred.stlouisfed.org/
Table USFX provides the rate of USD/EURO in selected months. The dollar appreciated sharply from USD 1.2254 on Jan 4, 2021 to 1.0920 on Jun 30, 2023.
Table USFX, USD/EURO Selected Months
| Date | USD/EUR |
| 1/4/2021 | 1.2254 |
| 1/5/2021 | 1.2295 |
| 1/6/2021 | 1.229 |
| 1/7/2021 | 1.2265 |
| 1/8/2021 | 1.2252 |
| 1/11/2021 | 1.2169 |
| 1/12/2021 | 1.2168 |
| 1/13/2021 | 1.2159 |
| 1/14/2021 | 1.2156 |
| 1/15/2021 | 1.2099 |
| 1/31/2023 | 1.0858 |
| 2/1/2023 | 1.0917 |
| 2/2/2023 | 1.0918 |
| 2/3/2023 | 1.0825 |
| 2/6/2023 | 1.0722 |
| 2/7/2023 | 1.0705 |
| 2/8/2023 | 1.0734 |
| 2/9/2023 | 1.0761 |
| 2/10/2023 | 1.067 |
| 2/13/2023 | 1.0718 |
| 2/14/2023 | 1.0722 |
| 2/15/2023 | 1.0683 |
| 2/16/2023 | 1.0684 |
| 2/17/2023 | 1.0678 |
| 2/24/2023 | 1.0545 |
| 3/03/2023 | 1.0616 |
| 3/10/2023 | 1.0659 |
| 3/17/2023 | 1.0647 |
| 3/24/2023 | 1.0762 |
| 3/31/2023 | 1.0872 |
| 4/7/2023 | 1.0913 |
| 4/14/2023 | 1.0980 |
| 4/21/2023 | 1.0973 |
| 4/28/2023 | 1.1040 |
| 5/5/2023 | 1.1026 |
| 5/26/2023 | 1.0713 |
| 6/2/2023 | 1.0724 |
| 6/9/2023 | 1.0749 |
| 6/16/2023 | 1.0925 |
| 6/23/2023 | 1.0887 |
| 6/30/2023 | 1.0920 |
Source: https://www.federalreserve.gov/releases/h10/current/
Table B provides the exchange rate of Brazil and the trade balance from 1927 to 1939. “Currency depreciation in the 1930s…benefitted the initiating countries…There can be no presumption that depreciation was beggar-thy-neighbor…competitive devaluation taken by a group of countries had they been even more widely adopted and coordinated internationally would have hasted recovery from the Great Depression,” Barry Eichengreen and Jeffrey Sachs, “Exchange Rates and Economic Recovery in the1930s,” Journal of Economic History, Vol. 45, No. 4 (Dec., 1985), pp.925-946.
Table B, Brazil, Exchange Rate and Trade Balance, 1927-1939
| Year | Exchange Rate Mil-Réis per £ | Trade Balance 1000 Contos | ||
| 1927 | 40.6 | 370.9 | ||
| 1928 | 40.3 | 275.3 | ||
| 1929 | 40.6 | 332.7 | ||
| 1930 | 49.4 | 563.6 | ||
| 1931 | 62.4 | 1517.2 | ||
| 1932 | 48.1 | 1018.1 | ||
| 1933 | 52.6 | 655 | ||
| 1934 | 59.7 | 956.2 | ||
| 1935 | 57.9 | 248.1 | ||
| 1936 | 58.4 | 626.8 | ||
| 1937 | 56.9 | -222.5 | ||
| 1938 | 57.6 | -98.7 | ||
| 1939 | 71.1 | 631.9 |
Source: Carlos Manuel Peláez, Análise Econômica do Programa Brasileiro de Sustentação do Café 1906-1945: Teoria, Política e Medição, Revista Brasileira de Economia, Vol. 25, N 4, Out/Dez 1971, 5-213.
Christina D. Romer argues that growth of the money stock was critical in the recovery of the United States from the Great Depression (Christina D. Romer, What ended the Great Depression? The Journal of Economic History, Volume 52, Number 4, Dec 1992, pp 757-784).
Table C, Brazil, Yearly Percentage Changes of the Money Stock, M1 and M2, Exchange Rate, Terms of Trade, Industrial Production, Real Gross National Product and Real Gross Income Per Capita, 1930-1939
| Period | M1 | M2 | Exchange Rate | Terms of Trade | Industrial Production | Real GNP | Real Gross Income Per Capita |
| 1929/30 | -9 | -4 | 22 | -34 | -5 | -1 | -10 |
| 1930/31 | 4 | 1 | 26 | -5 | 8 | -3 | -6 |
| 1931/32 | 15 | 7 | -23 | 8 | 0 | 6 | 2 |
| 1932/33 | 10 | 4 | 10 | -15 | 16 | 10 | 7 |
| 1933/34 | 5 | 6 | 13 | 5 | 13 | 7 | 5 |
| 1934/35 | 7 | 8 | -3 | -28 | 14 | 1 | -4 |
| 1935/36 | 10 | 11 | 1 | 2 | 14 | 12 | 9 |
| 1936/37 | 10 | 9 | -3 | 2 | 7 | 3 | 0 |
| 1937/38 | 19 | 13 | 1 | -11 | 6 | 4 | -1 |
| 1938/39 | 0 | 8 | 23 | -12 | 14 | 4 | 2 |
Source: Carlos Manuel Peláez and Wilson Suzigan, História Monetária do Brasil. Segunda Edição Revisada e Ampliada. Coleção Temas Brasileiros, Universidade de Brasília, 1981.
“In the period of the free coffee market 1857-1906, international coffee prices fluctuated in cycles of increasing amplitude. British export prices decreased at a low average rate, and physical exports of coffee by Brazil increased at the average rate of 2.9 percent per year. The income terms of trade of the coffee economy of Brazil improved at the average compound rate of 4.0 percent per year. But the actual rate must have been much higher because of drastic improvements in the quality of manufactures while the quality of coffee remained relatively constant,” Carlos Manuel Peláez, “The Theory and Reality of Imperialism in the Coffee Economy of Nineteenth-Century Brazil,” The Economic History Review, Second Series, Volume XXIX, No. 2, May 1976. 276-290. See Carlos Manuel Peláez, “A Comparison of Long-Term Monetary Behavior and Institutions in Brazil, Europe and the United States,” The Journal of European Economic History, Volume 5, Number 2, Fall 1976, 439-450, Presented at the Sixth International Congress of Economic History, Section on Monetary Inflation in Historical Perspective, Copenhagen, 22 Aug 1974.
In his classic restatement of the Keynesian demand function in terms of “liquidity preference as behavior toward risk,” James Tobin (http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1981/tobin-bio.html) identifies the risks of low interest rates in terms of portfolio allocation (Tobin 1958, 86):
“The assumption that investors expect on balance no change in the rate of interest has been adopted for the theoretical reasons explained in section 2.6 rather than for reasons of realism. Clearly investors do form expectations of changes in interest rates and differ from each other in their expectations. For the purposes of dynamic theory and of analysis of specific market situations, the theories of sections 2 and 3 are complementary rather than competitive. The formal apparatus of section 3 will serve just as well for a non-zero expected capital gain or loss as for a zero expected value of g. Stickiness of interest rate expectations would mean that the expected value of g is a function of the rate of interest r, going down when r goes down and rising when r goes up. In addition to the rotation of the opportunity locus due to a change in r itself, there would be a further rotation in the same direction due to the accompanying change in the expected capital gain or loss. At low interest rates expectation of capital loss may push the opportunity locus into the negative quadrant, so that the optimal position is clearly no consols, all cash. At the other extreme, expectation of capital gain at high interest rates would increase sharply the slope of the opportunity locus and the frequency of no cash, all consols positions, like that of Figure 3.3. The stickier the investor's expectations, the more sensitive his demand for cash will be to changes in the rate of interest (emphasis added).”
Tobin (1969) provides more elegant, complete analysis of portfolio allocation in a general equilibrium model. The major point is equally clear in a portfolio consisting of only cash balances and a perpetuity or consol. Let g be the capital gain, r the rate of interest on the consol and re the expected rate of interest. The rates are expressed as proportions. The price of the consol is the inverse of the interest rate, (1+re). Thus, g = [(r/re) – 1]. The critical analysis of Tobin is that at extremely low interest rates there is only expectation of interest rate increases, that is, dre>0, such that there is expectation of capital losses on the consol, dg<0. Investors move into positions combining only cash and no consols. Valuations of risk financial assets would collapse in reversal of long positions in carry trades with short exposures in a flight to cash. There is no exit from a central bank created liquidity trap without risks of financial crash and another global recession. The net worth of the economy depends on interest rates. In theory, “income is generally defined as the amount a consumer unit could consume (or believe that it could) while maintaining its wealth intact” (Friedman 1957, 10). Income, Y, is a flow that is obtained by applying a rate of return, r, to a stock of wealth, W, or Y = rW (Friedman 1957). According to a subsequent statement: “The basic idea is simply that individuals live for many years and that therefore the appropriate constraint for consumption is the long-run expected yield from wealth r*W. This yield was named permanent income: Y* = r*W” (Darby 1974, 229), where * denotes permanent. The simplified relation of income and wealth can be restated as:
W = Y/r (1)
Equation (1) shows that as r goes to zero, r→0, W grows without bound, W→∞. Unconventional monetary policy lowers interest rates to increase the present value of cash flows derived from projects of firms, creating the impression of long-term increase in net worth. An attempt to reverse unconventional monetary policy necessarily causes increases in interest rates, creating the opposite perception of declining net worth. As r→∞, W = Y/r →0. There is no exit from unconventional monetary policy without increasing interest rates with resulting pain of financial crisis and adverse effects on production, investment and employment.
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.
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