Federal Reserve Bank of St. Louis Review
A bimonthly research journal intended for an economically informed but broad readershipfrom the undergraduate student to the PhD. In print and online.
NOVEMBER/DECEMBER 2007 Vol. 89, No. 6
The Decline in the U.S. Personal Saving Rate: Is It Real and Is It a Puzzle?
Since the mid-1990s, the national income and product accounts personal saving rate for the United States has been trending down, dropping into negative territory for three months during the past two years. This paper examines measurement problems surrounding two of the standard definitions of the personal saving rate. The authors conclude that, despite these measurement problems, the recent decline of the U.S. personal saving rate to low levels seems to be a real economic phenomenon and may be a cause for concern for several reasons. After examining several possible explanations for the trend advanced in the recent literature, the authors conclude that none of them provides a compelling explanation for the steep decline and negative levels of the U.S. personal saving rate.
Measuring Commercial Bank Profitability: Proceed with Caution
The federal tax code creates challenges for comparing the profit rates of different banks on a consistent basis. The earnings of banks that elect to operate under subchapter S of the federal tax code are not subject to federal corporate income tax, but shareholders of these “S-banks” are taxed on their pro rata share of the entire earnings of the bank. The number of banks electing subchapter S tax treatment has increased rapidly, especially among small banks. The authors use estimates of the federal corporate income tax that S-banks would pay if they were subject to the tax to show that the difference in the tax treatment of S-banks and other banks has a large impact on measures of U.S. banking system profitability. Further, the article shows that adjustment of S-bank earnings by estimates of federal income taxes to make them comparable with the earnings of other banks can markedly affect conclusions of studies that use net income as a measure of performance. Finally, the article shows that S-banks (even after their earnings are reduced by estimated federal taxes) tend to out-earn their peers; S-banks also tend to have higher earnings rates than their peers in the year before they elect S-bank status.
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The Determinants of Aid in the Post-Cold War Era
The authors estimate the responsiveness of aid to recipient countries’ economic and physical needs, civil/political rights, and government effectiveness. They look exclusively at the post-Cold War era and use fixed effects to control for the political, strategic, and other considerations of donors. They find that aid and per capita income have been negatively related, while aid has been positively related to infant mortality, rights, and government effectiveness.
Open Market Operations and the Federal Funds Rate
It is commonly believed that the Fed’s ability to control the federal funds rate stems from its ability to alter the supply of liquidity in the overnight market through open market operations. This paper uses daily data compiled by the author from the records of the Trading Desk of the Federal Reserve Bank of New York over the period March 1, 1984, through December 31, 1996: He analyzes the Desk’s use of its operating procedure in implementing monetary policy and the extent to which open market operations affect the federal funds rate—the liquidity effect. The author finds that the operating procedure was used to guide daily open market operations; however, there is little evidence of a liquidity effect at the daily frequency and even less evidence at lower frequencies. Consistent with the absence of a liquidity effect, open market operations appear to be a relatively unimportant source of liquidity to the federal funds market.
SEPTEMBER/OCTOBER 2007 Vol. 89, No. 5
Currency Design in the United States and Abroad: Counterfeit Deterrence and Visual Accessibility
Despite the increasing use of electronic payments, currency retains an important role in the payment system of every country. In this article, the authors compare and contrast trade-offs among currency design features, including those primarily intended to deter counterfeiting and those to improve usability by the visually impaired. The authors conclude that periodic changes in the design of currency are an important aspect of counterfeit deterrence and that currency designers worldwide generally have been successful in efforts to deter counterfeiting. At the same time, currency designers have sought to be sensitive to the needs of the visually impaired. Although trade-offs among goals sometimes have forced compromises, new technologies promise banknotes that are both more difficult to counterfeit and more accessible to the visually impaired. Among the world’s currencies, U.S. banknotes are the notes most widely used outside their country of issue and thus require special consideration.
Experiments in Financial Liberalization: The Mexican Banking Sector
Since the liberalization of its trade in the mid-1980s, Mexico has pursued an aggressive globalization strategy, which today makes it the country with the most free trade agreements in the world. This liberalization strategy has also included the banking sector, particularly since 1997, when all restrictions to the entry of foreign banks were removed. The history of the banking sector in Mexico includes episodes of nationalization in 1982, privatization in 1992, and near-complete failure in 1995. Since then, however, the Mexican government has undertaken a series of bold reforms that have contributed to the modernization of its financial system. This paper documents the evolution of Mexico’s banking sector starting from its nationalization in 1982 and culminating with the increased entry of foreign banks in recent years that has driven the recovery of bank credit to the private sector.
How Well Does Employment Predict Output?
Economists, policymakers, and financial market analysts typically pay close attention to aggregate employment trends because employment is thought to be an important indicator of macroeconomic conditions. One difficulty is that there are two separate surveys of employment, which can diverge widely from one another, as the previous and current economic expansions demonstrate. The conventional wisdom is that, for assessing economic conditions, the survey that counts the number of jobs (establishment survey) is preferable to the survey that counts the number of people employed (household survey). However, results from a one-quarter-ahead forecasting exercise presented in this paper suggest that analysts should question whether employment is a useful indicator for predicting output growth.
The Effectiveness of Monetary Policy
This analysis addresses changing views of the role and effectiveness of monetary policy, inflation targeting as an “effective monetary policy,” monetary policy and short-run (output) stabilization, and problems in implementing a short-run stabilization policy.
JULY/AUGUST 2007 Vol. 89, No. 4
Frontiers in Monetary Policy Research
Proceedings of the Thirty-First Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis
The July/August issue of Review includes the proceedings from the 31st economic policy conference of the Federal Reserve Bank of St. Louis, "Frontiers in Monetary Policy Research." Economists working at this frontier bring forward new ideas from research in general equilibrium modeling and highlight both the promise and the limitations of recent advances.
An Estimated DSGE Model for the United Kingdom
The authors estimate the dynamic stochastic general equilibrium model of Christiano, Eichenbaum, and Evans (2005) on U.K. data. Their estimates suggest that price stickiness is a more important source of nominal rigidity in the United Kingdom than wage stickiness. Their estimates of parameters governing investment behavior are only well behaved when post-1979 observations are included, which reflects government policies until the late 1970s that obstructed the influence of market forces on investment.
Commentary on "An Estimated DSGE Model for the United Kingdom"
Macroeconomic Implications of Changes in the Term Premium
Linearized New Keynesian models and empirical no-arbitrage macro-finance models offer little insight regarding the implications of changes in bond term premiums for economic activity. This paper investigates these implications using both a structural model and a reduced-form framework. The authors show that there is no structural relationship running from the term premium to economic activity, but a reduced-form empirical analysis does suggest that a decline in the term premium has typically been associated with stimulus to real economic activity, which contradicts earlier results in the literature.
Commentary on "Macroeconomic Implications of Changes in the Term Premium"
Long-Run Risks and Financial Markets
The recently developed long-run risks asset pricing model shows that concerns about long-run expected growth and time-varying uncertainty (i.e., volatility) about future economic prospects drive asset prices. These two channels of economic risks can account for the risk premia and asset price fluctuations. In addition, the model can empirically account for the cross-sectional differences in asset returns. Hence, the long-run risks model provides a coherent and systematic framework for analyzing financial markets.
Commentary on "Long-Run Risks and Financial Markets"
Arbitrage-Free Bond Pricing with Dynamic Macroeconomic Models
The authors examine the relationship between changes in short-term interest rates induced by monetary policy and the yields on long-maturity default-free bonds. The volatility of the long end of the term structure and its relationship with monetary policy are puzzling from the perspective of simple structural macroeconomic models. The authors explore whether richer models of risk premiums, specifically stochastic volatility models combined with Epstein-Zin recursive utility, can account for such patterns. They study the properties of the yield curve when inflation is an exogenous process and compare this with the yield curve when inflation is endogenous and determined through an interest rate (Taylor) rule. When inflation is exogenous, it is difficult to match the shape of the historical average yield curve. Capturing its upward slope is especially difficult because the nominal pricing kernel with exogenous inflation does not exhibit any negative autocorrelation—a necessary condition for an upward-sloping yield curve, as shown in Backus and Zin. Endogenizing inflation provides a substantially better fit of the historical yield curve because the Taylor rule provides additional flexibility in introducing negative autocorrelation into the nominal pricing kernel. Additionally, endogenous inflation provides for a flatter term structure of yield volatilities, which better fits historical bond data.
Commentary on "Arbitrage-Free Bond Pricing with Dynamic Macroeconomic Models"
Monetary Policy as Equilibrium Selection
Can monetary policy guide expectations toward desirable outcomes when equilibrium and welfare are sensitive to alternative, commonly held rational beliefs? This paper studies this question in an exchange economy with endogenous debt limits in which dynamic complementarities between dated debt limits support two Pareto-ranked steady states: a suboptimal, locally stable autarkic state and a constrained optimal, locally unstable trading state. The authors identify feedback policies that reverse the stability properties of the two steady states and ensure rapid convergence to the constrained optimal state.
Commentary on "Monetary Policy as Equilibrium Selection"
Model Fit and Model Selection
This paper uses an example to show that a model that fits the available data perfectly may provide worse answers to policy questions than an alternative, imperfectly fitting model. The author argues that, in the context of Bayesian estimation, this result can be interpreted as being due to the use of an inappropriate prior over the parameters of shock processes. He urges the use of priors that are obtained from explicit auxiliary information, not from the desire to obtain identification.
Commentary on "Model Fit and Model Selection"
MAY/JUNE 2007 Vol. 89, No. 3
The GSEs: Where Do We Stand?
This article was originally presented as a speech to the Chartered Financial Analysts of St. Louis, St. Louis, Missouri, January 17, 2007.
Milton Friedman and U.S. Monetary History: 1961-2006
This paper, using extensive archival material from several countries, brings together scattered information about Milton Friedman’s views and predictions regarding U.S. monetary policy developments after 1960 (i.e., the period beyond that covered by his and Anna Schwartz’s Monetary History of the United States). The author evaluates these interpretations and predictions in light of subsequent events.
The Lower and Upper Bounds of the Federal Open Market Committee’s Long-Run Inflation Objective
It is widely acknowledged that the Fed can control the average inflation rate over a period of time reasonably well. Because of this and the Federal Open Market Committee’s (FOMC’s) long-standing commitment to price stability, the author argues that the FOMC has an implicit long-run inflation objective (LIO)—lower and upper bounds to the long-run inflation rate. He shows that the statements made by the FOMC in 2003 clarified the lower bound of its LIO and that the average of long-run inflation expectations responded by rising about 80 basis points. Moreover, consistent with reducing the market’s uncertainty about the FOMC’s LIO, long-run inflation expectations became more stable. The FOMC has recently been more specific about the upper bound of its LIO as well. The FOMC could eliminate the remaining uncertainty by establishing an explicit, numerical inflation objective.
Granger Causality and Equilibrium Business Cycle Theory
Postwar U.S. data show that consumption growth “Granger-causes” output and investment growth, which is puzzling if technology is the driving force of the business cycle. The author asks whether general equilibrium models with information frictions and non-technology shocks can rationalize the observed causal relationships. His conclusion is they cannot.
MARCH/APRIL 2007 Vol. 89, No. 2
This article was originally presented as a speech at the Middle Tennessee State University Annual Economic Outlook Conference, Murfreesboro, Tennessee, September 29, 2006.
Data, Data, and Yet More Data
This article was originally presented as a speech at the Association for University Business and Economic Research (AUBER) Annual Meeting, University of Memphis, Memphis, Tennessee, October 16, 2006.
Stock Market Booms and Monetary Policy in the Twentieth Century
This article examines the association between stock market booms and monetary policy in the United States and nine other developed countries during the 20th century. The authors find, as was true of the U.S. stock market boom of 1994-2000, that booms typically arose during periods of above-average growth of real output and below-average inflation, suggesting that booms reflected both real macroeconomic phenomena and monetary policy. They find little evidence that booms were fueled by excessive liquidity. Booms often ended within a few months of an increase in inflation and consequent monetary policy tightening. They find few differences across the different monetary policy regimes of the century.
Trends in Neighborhood-Level Unemployment in the United States: 1980 to 2000
Although the average rate of unemployment across U.S. metropolitan areas declined between 1980 and 2000, the geographic concentration of the unemployed rose sharply over this period. That is, residential neighborhoods throughout the nation’s metropolitan areas became increasingly divided into high- and low-unemployment areas. This paper documents this trend using data on more than 165,000 U.S. Census block groups (neighborhoods) in 361 metropolitan areas over the years 1980, 1990, and 2000; it also examines three potential explanations: (i) urban decentralization, (ii) industrial shifts and declining unionization, and (iii) increasing segregation by income and education. The results offer little support for either of the first two explanations. Rising residential concentration of the unemployed shows little association with changes in population density, industrial composition, or union activity. It does, however, show a significant association with both the degree of segregation according to income as well as education, suggesting that decreases in the extent to which individuals with different levels of income and education live in the same neighborhood may help account for this trend.
JANUARY/FEBRUARY 2007 Vol. 89, No. 1
Understanding the Fed
This article was originally presented as a speech at the Dyer County Chamber of Commerce Annual Membership Luncheon, Dyersburg, Tennessee, August 31, 2006. The Federal Reserve has the responsibility to provide leadership. The ideal situation is when the market can reasonably predict what the Fed is going to do because the Fed has provided the leadership to make clear its objectives and how it pursues those objectives. The Fed is not and ought not to be viewed as an adversary of the markets. Policy actions and statements do have market effects. Those are unavoidable, but the Fed strives to make policy as clear as it can so that what is really surprising the markets is not Fed actions but the arrival of new information that surprises the Fed and markets together.
The Rise in Personal Bankruptcies: The Eighth Federal Reserve District and Beyond
Personal bankruptcy filings in the United States increased, per capita, nearly 350 percent between 1980 and 2005. This paper first addresses the changes in economic and institutional factors that have occurred over the past 100 years, many of which have occurred in the past 30 years, which are likely contributors to the dramatic rise in personal bankruptcy filings seen across the country. These factors include a reduction in personal savings, an increase in consumer debt, the proliferation of revolving credit, changes to bankruptcy law, and a reduced social stigma associated with filing for bankruptcy. Given the availability of bankruptcy data at various levels of aggregation, the remaining sections of the paper contain results from several different empirical analyses of bankruptcy filings using various data sets. Careful attention is paid to personal bankruptcy filings in counties located in Eighth Federal Reserve District states.
The Varying Effects of Predatory Lending Laws on High-Cost Mortgage Applications
Federal, state, and local predatory lending laws are designed to restrict and in some cases prohibit certain types of high-cost mortgage credit in the subprime market. Empirical evidence using the spatial variation in these laws shows that the aggregate flow of high-cost mortgage credit can increase, decrease, or be unchanged after these laws are enacted. Although it may seem counterintuitive to find that a law that prohibits lending could be associated with more lending, it is hypothesized that a law may reduce the cost of sorting honest loans from dishonest loans and lessen the borrowers’ fears of predation, thus stimulating the high-cost mortgage market.
Regional Business Cycle Phases in Japan
This paper uses a Markov-switching model with structural breaks to characterize and compare regional business cycles in Japan for the period 1976-2005. An early-1990s structural break meant a reduction in national and regional growth rates in expansion and recession, usually resulting in an increase in the spread between the two phases. Although recessions tended to be experienced across a majority of regions throughout the sample period, the occurrence and lengths of recessions at the regional level have increased over time.
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