US in liquidity trap?

I have re-read the FOMC statement. Its wording is somewhat contradictory and in some points is very similar to the set of conditions defining so-called liquidity trap. 

“To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent.” 

There are two statements in one sentence. The Federal Reserve has to keep the rate low in order to galvanize the economy. In turn, the economy did not show any reaction to the low rate during the past three years and is not expected to grow another two years:    

“The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”  

 To keep inflation in the target range one needs to be flexible and to have an opportunity to react when inflation expectations alter.  The rate fixed between 0 and ¼ percent is not a medicine any more. It can not counteract inflation rise because it is fixed. It can not counteract liquidity trap because the rate can not be negative. Hence, the Federal Reserve should not mix economic growth and inflation in one pot. This statement is self-contradictory and reveals a trivial misunderstanding of economics.  

All in all, the Federal Reserve admits that it has failed to improve real economic growth by near-zero rates and by pumping money into banks through the QE mechanism. Moreover, the FOMC does not see any real improvement at a mid-term horizon. Considering the experience of Japan who has been struggling through a liquidity trap for decades one may suggest that the U.S. is already in the trap and all current efforts are worthless.

FOMC has announced a new recession period

I do not understand the euphoria of the stock market participants yesterday. Formally, the FOMC has admitted that the US economy is sinking into a new recession period which will likely end in 2013:

“… The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013…”

There is no prospective of any economic recovery any time soon and deflation knocks the door. As we have shown in this blog the rate of unemployment will not fall below 9% with employment/population ratio fixed at 58%.

The market players should get to the point during the today’s session and the S&P 500 will be fall again.

Is gold a new bubble?

Gold price rockets up as a natural haven during the turbulent financial markets.  It is reflective type behaviour from the past when gold played a very specific role in finances. Currently, gold is a normal commodity with its price fully driven by the market. Therefore, the rocketing gold price likely repeats the trajectory of house prices before 2006. Some experts say that it was a bubble in sense that the house prices were speculative. Gold can not be an exclusion from  "normal" market behaviour . When the market players understand this simple rule the price will plummet down. I expect this fall in 2011 because the negative tendency in economic performace has no alternative and there is  no really safe haven for assets.

Oil price and deflation

The current turbulence in financial markets and the expectation of a poor economic performance (i.e. recession) in the biggest economies has been accompanied by a dramatic fall in oil price. We have predicted this drop several months ago and expect the price to fall to the level of $70 per barrel by the end of 2011.  We will address this prediction when the Bureau of Labor Statistics publishes the PPI and CPI estimates for July 2011. Here we would like to highlight the influence of oil price on the PPI and headline CPI.

            The price index of energy comprises approximately 10% of the headline CPI is highly correlated with oil price. The surge in oil price observed since the beginning of 2011 (Figure 1) has been the most important driver of the elevated consumer price inflation. Accordingly, many economic and financial experts expect a period of hyperinflation in the near future. However, oil price has been falling. This fall resulted in a negative rate of monthly inflation in June 2011. In July, the monthly rate of inflation is likely to be positive because the price index of energy (oil) did not fall much relative to June.  

            The monthly rate of inflation is an important but only a transient indicator of the overall price change. Therefore, we have calculated the annual rate from the curves in Figure 1, where red line is the original price index (black line) shifted by one year ahead. The ratio of black and red line is the rate of oil price inflation, as shown in Figure 2.  The rate of inflation is characterized by two peaks in 2008 and 2010. Obviously, the rate of inflation is defined by two factors: the current level of oil price and that one year ago. The difference between black and red line can be considered as a crude estimate of the inflation rate. When red line is above black line, the rate of inflation is negative. Otherwise, the rate is positive. What can we expect in 2012 with the price index of oil falling through the third and fourth quarters of 2011?  Almost inevitably, the rate of (oil price) inflation will be negative through 2012. Since other components of the headline CPI also demonstrate the tendency to fall one can expect a period of deflation in 2012.

Figure 3 presents our estimate of the oil price evolution in 2011. We expect the price to fall by $6 per month to the level of $70 in December 2011. We also expect the price to fall through 2016 and put the uncertainty bounds for the long-term trend in oil price. The level of oil price in 2016 is between $30 and $60 per barrel.

Figure 1. The (producer) price index of oil (domestic crude petroleum). Red line is the original price index shifted one year ahead. The ratio of black and red line is the rate of oil price inflation shown in Figure 2.    

 Figure 2. The annual rate of oil price growth.  

Figure 3. Oil price prediction in 2011. The price is expected to fall by $6 per month between June and December 2011. The price level is $70 in December 2011. We also show the range of expected price evolution by 2016.

Employment in Japan

We continue modeling the evolution of the employment rate in developed countries with Japan. In this study we use the trade-off between the change in unemployment and employment and Okun’s law. Figure 1 compares the change in the rate of employment (the employment/population ratio), de, and the rate of unemployment, du, in Japan. The change in the rate of unemployment is as volatile as that of unemployment and they differ drastically compared to the synchronized evolution of these variables in the U.S. That’s why we have failed to obtain a reasonable Okun’s law for Japan. As before, all data sets on unemployment and employment have been retrieved from the U.S. Bureau of Labor Statistics. The estimates of real GDP per capita have been retrieved from the database provided by the Conference Board.

Figure 1. The (negative) change in the rate of unemployment compared to the change in the rate of employment in Japan.

In this blog, we have already presented several empirical relationships predicting the employment/population ratio from the growth rate of real GDP per capita. This was a natural extension of Okun’s law for unemployment.

Here we estimate an employment/GDP model for Japan similar to Okun’s law. For Japan, the best-fit model has been obtained by the least-squares (applied to the cumulative sums):

det = 0.02dlnGt – 0.53, t<1978

det = 0.14dlnGt – 0.42, t>1977 (1)

 

where dlnGt is the change rate of real GDP per capita at time t. Figure 2 shows the cumulative curves for the time series in (1). There is a structural break near 1978 which is expressed by a dramatic shift in slope and a slight break in intercept. The employment/population ratio varies between from 64%% in 1970 and 56% in 2010. The agreement is excellent. Figure 3 present results of a linear regression with R2=0.95 for the period between 1971 and 2010. We consider both variables as stationary ones over the long run despite the obviously negative trend since 1970.

Figure 2. The cumulative curves for the observed and predicted change in the employment/population ratio, de.

Figure 3. Linear regression of the measured and predicted curves in Figure 2.

Employment in Australia

There is a trade-off between the change in unemployment and employment. Figure 1 compares the change in the rate of employment (the employment/population ratio), de, and the rate of unemployment, du, in Australia. As expected, the change in the rate of unemployment is more volatile. All data sets on unemployment and employment have been retrieved from the U.S. Bureau of Labor Statistics.

Figure 1. The (negative) change in the rate of unemployment compared to the change in the rate of employment in Australia.

In this blog, we have already presented several empirical relationships predicting the employment/population ratio from the growth rate of real GDP per capita. This was a natural extension of Okun’s law for unemployment.

Here we estimate an employment/GDP model for Australia similar to Okun’s law. For Australia, the best-fit model has been obtained by the least-squares (applied to the cumulative sums):

det = 0.50dlnGt – 0.92, t<1983

det = 0.41dlnGt – 1.08, t>1982 (1)

where dlnGt is the change rate of real GDP per capita at time t. Figure 2 shows the cumulative curves for the time series in (1). There is a structural break near 1994 which is expressed by significant shifts in slope and intercept. The employment/population ratio varies between from 55%% in 1983 and 64% in 2008. The agreement is very good. Figure 3 present results of a linear regression with R2=0.84 for the period between 1971 and 2010.

Figure 2. The cumulative curves for the observed and predicted change in the employment/population ratio, de.

Figure 3. Linear regression of the measured and predicted curves in Figure 2.

Employment in France

There is a trade-off between the change in unemployment and employment. Figure 1 compares the change in the rate of employment (the employment/population ratio), de, and the rate of unemployment, du, in France. As expected, the change in the rate of unemployment is more volatile except the shift in the employment rate near 1982. This is a completely artificial break from 53.2% in 1981 to 55.3% in 1982, and we do not need to model it. All data sets on unemployment and employment have been retrieved from the U.S. Bureau of Labor Statistics.

Figure 1. The (negative) change in the rate of unemployment compared to the change in the rate of employment in France.

In this blog, we have already presented several empirical relationships predicting the employment/population ratio from the growth rate of real GDP per capita. This was a natural extension of Okun’s law for unemployment.

Here we estimate an employment/GDP model for France similar to Okun’s law. For France, the best-fit model has been obtained by the least-squares (applied to the cumulative sums):

de = 0.155dlnG– 0.65, t<1994

de= 0.25dlnG – 0.30, t>1993 (1)

where dlnG is the change rate of real GDP per capita at time t. Figure 2 shows the cumulative curves for the time series in (1). There is a structural break near 1994 which is expressed by significant shifts in slope and intercept. The employment/population ratio varies between from ~56%% in 1970 and 50.4% in 1992. The agreement is very good. Figure 3 present results of a linear regression with R2=0.91 for the period between 1971 and 2010.

Figure 2. The cumulative curves for the observed and predicted change in the employment/population ratio, de.

Figure 3. Linear regression of the measured and predicted curves in Figure 2.