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1996 Quarter 1 | Vol. 32, No. 1


Practical Issues in Monetary Policy Targeting
by Stephen G. Cecchetti

This paper outlines the considerable information requirements faced by monetary policymakers and looks at the data to see what we actually know and how well we know it. The author's main conclusion is that our forecasting ability is very poor, which creates uncertainty that leads to cautious policymaking. At a more practical level, he finds that nominal-income targeting rules are more robust than price-targeting rules in the sense that someone who cares about the aggregate price path loses little by targeting nominal income, but someone who cares about nominal income is made much worse off by moving to a price-level target, which substantially destabilizes real output.

PDF file 432K

The Reduced Form as an Empirical Tool: A Cautionary Tale from the Financial Veil
by Ben Craig and Christopher A. Richardson

The reduced-form empirical strategy has been used for more than 30 years to test the Modigliani-Miller model of corporate financial structure. Curiously, the early tests almost always accepted the model, whereas subsequent tests almost always reject it. This paper considers the limitations of the reduced-form strategy that led to the early, spurious results, and demonstrates why an empirical strategy that is not closely tied to an under-lying economic theory of behavior will usually yield estimates that are too imprecise or too unreliable to form a basis for policy.

PDF file 251K

Predicting Real Growth Using the Yield Curve
by Joseph G. Haubrich and Ann M. Dombrosky

The yield curve, which relates interest rates to notes and bonds of various maturities, is often used by economists and business analysts to predict future economic growth. But how reliable is it? This article uses out-of-sample regressions to determine how well the 10-year, three-month yield spread predicts future real GDP growth. The authors show that although the yield curve is a good predictor over the entire 30-year sample period, it has become much less accurate over the last decade.

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1996 Quarter 2 | Vol. 32, No. 2



The Benefits of Interest Rate Targeting: A Partial and a General Equilibrium Analysis
by Charles T. Carlstrom and Timothy S. Fuerst

The authors of this paper explore some of the benefits of interest rate targeting in both partial equilibrium and general equilibrium environments. They find that an interest rate peg is desirable because such a policy mitigates the distortions that arise in a monetary economy. In order to achieve the interest rate peg, money growth should be procyclical. This increase in output variability is actually welfare-improving.

PDF file 294K

MZM: A Monetary Aggregate for the 1990s?
by John B. Carlson and Benjamin D. Keen

Deregulation and financial innovation have wreaked havoc on the relationship of traditionally defined money measures with economic activity and interest rates. In this article, the authors present some tentative evidence that an alternative measure of money —MZM—has endured these events reasonably well. MZM is broader than M1 but essentially narrower than M2, comprising all instruments payable at par on demand. Since 1974, MZM has exhibited a fairly stable relationship with nominal GDP and with its own opportunity cost, suggesting that the aggregate has a potential role for policy.

PDF file 357K

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1996 Quarter 3 | Vol. 32, No. 3



The Impact of Depositor Preference Laws
by William P. Osterberg

The 1993 amendment to the Federal Deposit Insurance Corporation Act made depositors' claims on failed banks superior to those of general creditors. The legislation’s stated purpose was to reduce the cost to the FDIC of resolving bank failures, but how effective is it likely to be? This paper examines the impact of states' depositor preference laws from 1984 through 1992 and finds that although resolution costs were lower, creditors' responses may have partially offset the legislation's benefit to the FDIC.

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Cultural Affinity and Mortgage Discrimination
by Stanley D. Longhofer

In a 1994 study, Charles Calomiris, Charles Kahn, and Stanley Longhofer developed a theory of discrimination in the home mortgage market based on the idea that lenders find it easier to evaluate the creditworthiness of applicants with whom they have a common experiential background.

This article discusses the ideas behind their "cultural affinity hypothesis" and expands the theory to better match stylized facts about the home mortgage market.

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Full PDF version of this issue of the Economic Review 174K


1996 Quarter 4 | Vol. 32, No. 4



Earnings, Education, and Experience
by Peter Rupert, Mark E. Schweitzer, Eric Severance-Lossin, and Erin Turner

The value of additional education is typically measured by the increase in earnings that results. The largest gains are realized on completion of a degree, whether high school, college, or post-graduate. Failure to correctly specify an empirical earnings function can lead to substantial bias. In this article, the authors show that a common misspecification—combining college graduates with post-graduates—may bias the returns to a college education upward by as much as 12 percent.

PDF file 117K

Reducing Working Hours
by Terry J. Fitzgerald

The hours of U.S. workers have shown little, if any, decline over the past few decades, while working hours in most other industrialized countries have fallen substantially. As a result, working hours in the United States now appear to be among the longest in the industrialized world. In response to these observations, several proposals have been made for shortening U.S. workers' hours, both to increase their leisure time and to raise the number of jobs. In this article, the author documents historical trends in working hours, then examines how reducing weekly hours would affect employment and output. He finds that a shorter workweek may lead to a large decline in output with no increase in employment. Although these results are shown to be sensitive to modeling assumptions, they serve as a warning to policymakers.

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