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Economic Review

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1991 Quarter 1 | Vol. 27, No. 1


Why a Rule for Stable Prices May Dominate a Rule for Zero Inflation
by William T.Gavin and Alan C. Stockman

There is a technical distinction between a zero-inflation rule and a price-level rule. The former allows bygones to be bygones; random shocks to the price level are allowed to accumulate over time. A price-level rule would require the Federal Reserve to offset these accumulated effects eventually. This paper shows that a rule for the price level may dominate a rule for the inflation rate, even in the case where, for purely economic reasons, an inflation rule is preferred. A price-level rule constrains the current behavior of policymakers because today's choices directly affect tomorrow's options.

PDF file 260K

Predicting Bank Failures in the 1980s
by James B.Thomson

Opinions stated in Economic Review are those of the authors and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. This paper uses a single-equation logit model to discriminate between samples of failed and nonfailed banks over the 1984-1989 period. Previous failure prediction studies had to pool bank failures across years to obtain an adequate sample. The historically high number of failed banks over the past decade, however, allows each year in the sample period to be examined separately. The author incorporates measures of economic conditions in the failure prediction equation, along with the traditional balance-sheet risk measures, and finds that the majority of these variables are significantly related to bank failure as much as four years before an institution actually folds.

PDF file 530K

A Proportional Hazards Model of Bank Failure: An Examination of Its Usefulness as an Early Warning Tool
by Gary Whalen

The large number of bank failures in recent years has created incentives for both regulators and providers of funds to identify high-risk banks accurately. One potentially cost-effective way to do this is through use of a statistical "early warning model." In this article, the author shows that a Cox proportional hazards model can identify both failed and healthy banks with a high degree of accuracy using a relatively small set of publicly available data.

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1991 Quarter 2 | Vol. 27, No. 2



The Demand for M2, Opportunity Cost, and Financial Change
by John B.Carlson and Sharon E. Parrott

Weakness in M2 growth in recent years has been largely unexplained by estimated models of M2 demand. This paper examines two hypotheses concerning the shortfall in this aggregate. The results are consistent both with the theory that the restructuring of the thrift industry has played a role in the recent weakness of M2 and with the belief that this restructuring will have only a minimal effect on long-run velocity.

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Central-Bank Intervention: Recent Literature, Continuing Controversy
by Owen F. Humpage

Over the past two decades, during which floating exchange rates have been in effect, central banks have invested billions of dollars in an attempt to influence the path of exchange rates or the volatility of exchange rates around that path. The effectiveness of these efforts remains a controversial topic among both academic economists and policymakers. This review of recent literature on the subject finds some qualified support for intervention, but nothing to endorse the active interventionist policy undertaken in late 1985, mid-1987, and 1989.

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A Regional Perspective on the Credit View
by Katherine A. Samolyk

This paper develops a regional credit view to explain how regional credit-market performance can affect local economic activity. The existence of asymmetric information costs implies that a region's capability to fund local investments is related to the creditworthiness of local borrowers. Imbalances in financial capacity across regions can affect the mix of aggregate investment, causing capitalpoor regions to be underfunded. The author tests the empirical relevance of this credit view for the period 1980 to 1986 using state-level data and finds that reduced financial capacity is related to economic activity in states that are experiencing low growth.

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1991 Quarter 3 | Vol. 27, No. 3



Is There Any Rationale for Reserve Requirements?
by E.J. Stevens

Resetve requirements have been part of the regulatory apparatus of banking in the United States for more than 150 years. Currently, however, more than half of all depository institutions are exempt from the regulation, and a growing number of others meet their requirements with voluntary holdings of vault cash. In searching for a contemporary rationale for reserve requirements, the author finds little to recommend them other than an aversion to complete reliance on the discount window for meeting banks' day-to-day liquidity needs.

PDF file 860K

Government Consumption, Taxation, and Economic Activity
by Charles T. Carlstrom and Jagadeesh Gokhale

Most increases in U.S. government consumption since World War II, except for those associated with wars, have been permanent. This paper uses a stylized model of the economy to analyze how permanent and temporary increases in government expenditure- and the timing of taxation used to finance them-affect aggregate output and other variables that describe the economy.

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Deregulation and the Location of Financial Institution Offices
by Robert B. Avery

Changes in the regulation and structure of the U.S. financial services industry over the last 15 years have led to allegations t hat the banking system has weakened its commitment to poor and minority consumers, yet little solid evidence has been produced to support this claim. The author examines this accusation by looking at the pattern of financial office closures in five metropolitan areas between 1977 and 1990 and finds mixed results.

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1991 Quarter 4 | Vol. 27, No. 4



A Conference on Price Stability
by Charles T. Carlstrom and William T. Gavin

In November 1990, the Federal Reserve Bank of Cleveland sponsored a Conference on Price Stability. The participating economists were asked to explain how recent developments in macroeconomic research have changed the way we think about optimal inflation policy. In particular, the discussions center on the implications for the optimal inflation trend (the Friedman-Phelps debate) and for the degree of variability of inflation around the trend. The six papers presented at the conference, though limited in practical policy dimensions, provide a detailed evaluation of the issues surrounding the Friedman-Phelps debate.

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Components of City-Size Wage Differentials, 1973-1988
by Patricia E. Beeson and Erica L. Groshen

It has long been noted that workers in large cities are more highly paid than their rural counterparts. In studying this phenomenon, most researchers control for differences in work-force attributes between cities, but do not investigate whether these attributes are priced differently in cities of varying size. This paper examines the empirical regularity in the 1973-1988 Current Population Surveys to see if city-size-related wage differentials arise from intercity differences in wage structures. The authors find that higher economic rewards for education, experience, and other skil Is in larger cities account for the bulk of the earnings disparity, and that recent changes in these differentials mainly reflect diverging returns to skills.

PDF file 685K

Financial Efficiency and Aggregate Fluctuations: An Exploration
by Joseph G. Haubrich

Changes in the efficiency of the financial system can greatly affect the overall economy. A simple real business cycle framework shows how banks can be a source, rather than just a filter, for output shocks. This paper develops and tests predictions about cointegration between several bank and output series, as well as explores the comovement of output and combined banking variables. Use of the vector error-correcting model provides additional information on the role of banks as both transmission mechanisms and originators of cyclical disturbances.

PDF file 540K

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