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Business Review

Fourth Quarter 2002

Does Philadelphia have what it takes to expand economic growth and attract more people? It's a challenge, says President Anthony Santomero in "Forces Shaping Philadelphia's Future." The city has many things to recommend it as a location. Nevertheless, it has faced some difficulties in cultivating a role in certain important segments of the economy, and the city's population has been declining. But good things are also happening. Ultimately, Philadelphia's success — and the success of the surrounding area — depends on the creativity and commitment of its civic and business leaders. If they stay focused on contributing to the city's future, Philadelphia, President Santomero believes, will succeed.

One of the things the Philadelphia area has going for it is a burgeoning biotechnology industry. Although basic biotechnology has been around a long time, recent events, such as the human genome project, have firmly anchored biotechnology and its applications in the public's mind and imagination. In "From Laboratory to Market: The Biotechnology Industry in the Third District," Tim Schiller describes major biotechnology products and reviews estimates of the industry's size and scope. He also outlines where the industry is most active in the United States, especially in the Third District states of Pennsylvania, New Jersey, and Delaware.

Speaking about biotechnology brings to mind contagion. Our next article discusses contagion of a different sort. When firms are linked, problems at one firm can quickly be transmitted to others in a process economists call contagion. Although such links benefit participants, this downside to a tightly interconnected marketplace has led many people to worry about excessive linkages, especially among financial institutions. In "A Lifeline for the Weakest Link? Financial Contagion and Network Design," Yaron Leitner describes how contagion can occur, explains why the threat of contagion is not necessarily a bad thing, and shows why some firms may choose to bail out other firms that are facing financial problems.

Our final article looks at the difference in wages between high-skill workers (such as those who might work in biotech) and low-skill workers. This skill premium has increased dramatically over the past 30 years. Although economists are still debating the causes of this increase, it seems likely that skill-biased technical change has played a large role. As companies have invested in new technologies, demand for workers who can use them has surged. In "Widening the Wage Gap: The Skill Premium and Technology," Keith Sill reviews the literature and tells us why some theories fall flat and why technology seems to be the key to the widening wage gap.

THIRD QUARTER 2002

How does a decentralized central bank work? The events of September 11 put the Federal Reserve System, the central bank of the United States, to the test and highlighted the benefits of its geographic diversification. In "The U.S. Experience with a Federal Central Bank System," President Anthony Santomero presents an overview of the Federal Reserve's design and explains how its structure helps the Fed carry out its various roles.

The next two articles summarize conferences held at the Federal Reserve Bank of Philadelphia. In "Summary of the 2001 Policy Forum and Announcement of the 2002 Policy Forum," Loretta Mester does just that: She sketches the main points of the papers presented at last year's Policy Forum and provides information about the next one, which will be held November 22. The article "Innovation in Financial Services and Payments," also the title of a conference held at the Bank in May of this year, outlines the presentations made there.

In our fourth article, Mitchell Berlin raises the question "Should Business Bankruptcy Be a One-Chapter Book?" The answer, in part, depends on the answers to other questions: What makes more economic sense? A bankruptcy system that auctions a firm's assets and distributes the proceeds among the creditors? Or one that allows the firm to seek to resume business after renegotiations between its stockholders and its creditors? Or is there room—or even a need—for both?

The subject of our next article, "The Taylor Curve and the Unemployment-Inflation Tradeoff," by Satyajit Chatterjee, is finding an optimal monetary policy menu. In the past, monetary policy options were described in terms of a tradeoff between the unemployment rate and the inflation rate, the so-called Phillips curve. Macroeconomists no longer view the Phillips curve as a viable "policy menu" because its use as such is inconsistent with mainstream macroeconomic theory. In the late 1970s, John Taylor suggested an alternative set of options for policymakers to consider, one that is consistent with macroeconomic theory. These alternative options involve a tradeoff between the variability of output and the variability of inflation.

In "Does Lower Unemployment Reduce Poverty?" Bob DeFina considers the link between unemployment and poverty. How strong the link is depends critically on how we measure poverty. During the past two decades, researchers have identified numerous shortcomings in the government's official procedures for determining the extent of poverty. DeFina presents empirical evidence that improved measures of poverty are less strongly related to changes in unemployment than the headcount rate, the government's official measure.

SECOND QUARTER 2002

"Does Bank Regulation Help Bank Customers?" The answer, says Federal Reserve Bank of Philadelphia President Anthony Santomero, is yes, no, and maybe. Yes, the government must absorb some of the risks inherent in the banking system in order to maintain the system's stability. No, regulations that ignore the self-interested reactions of both bankers and their customers will not serve those customers well. And maybe, bank regulations, in principle, can help if they increase competition or the flow of information. In practice, however, some regulations designed to improve the quality of information have met with mixed success. President Santomero suggests that focusing on improving both financial literacy and information disclosure might be more productive.

In the second article, "Housing Policy and the Social Benefits of Homeownership," Ed Coulson states that the major subsidies to homeownership arise from the U.S. tax code, and the costs of these subsidies are high. Coulson asks whether the social benefits from homeownership are sufficient to warrant such subsidies. To answer the question, he reviews the research on the social benefits of ownership and some related issues. The evidence indicates that homeownership does carry substantial social benefits, but their dollar value remains uncertain.

In "What's in the File? The Economics and Law of Consumer Credit Bureaus," author Bob Hunt points out that lenders in the United States have voluntarily shared information about their customers — through credit bureaus — for nearly a century. Hunt explains how sharing information about consumers' indebtedness and payment histories can benefit both consumers and lenders. These benefits depend, however, on the accuracy of the information reported and the care taken to ensure that information is disclosed only when appropriate. Hunt also describes the Fair Credit Reporting Act, which attempts to address these concerns. He closes by reviewing a number of challenges consumer credit bureaus may face in the early years of this new century

In the final article this quarter, Aubhik Khan wonders: What determines whether a manufacturing plant survives? Is it access to credit markets? Or does learning about plants' profitability over time determine survival? Should government policy play a role in helping plants survive? In "Understanding the Life-Cycle of a Manufacturing Plant," Khan discusses the collateral and learning views as two possible explanations for a typical plant's life-cycle. He concludes that although it remains unclear as to which explanation is more relevant, the two views have very different implications for what government can do and what it should do.

FIRST QUARTER 2002

When we consider monetary policy, there are some issues on which most economists can readily agree. But there are also more contentious issues that offer legitimate room for disagreement. In "What Monetary Policy Can and Cannot Do," President Santomero reviews both the areas of agreement and those open to debate and offers his perspective on them. He concludes with some thoughts about the implications for the conduct of monetary policy.

In October 2001, the Federal Reserve Bank of Philadelphia hosted a conference on the use of real-time data by macroeconomists. The conference focused on five topics: data revisions, forecasting, policy analysis, financial research, and macroeconomic research. In "A Summary of the Conference on Real-Time Data Analysis," Tom Stark reviews the papers presented at the conference.

And on the subject of data, last year the government began to release data from the 2000 census. Thus far, several patterns have emerged about the changing demographics of the Third District states — Pennsylvania, New Jersey, and Delaware. In "The Changing Faces of the Third District: A Snapshot of the Region from the 2000 Census," Ted Crone describes some of these patterns and tells us what they mean for economic growth in this region.

Our fourth article this quarter returns to monetary policy. In "Oil Prices Strike Back," Sylvain Leduc raises the questions: When oil prices rise, how should monetary policy respond? Or should it respond at all to developments in the oil markets? Leduc argues in favor of a central bank that follows an inflation-targeting rule. To shed some light on the issues involved, he reviews what has happened historically to oil prices and output in the U.S.

Our final article considers the question of bankruptcy reform. In "Is the Personal Bankruptcy System Bankrupt?" Loretta Mester outlines the components of reform proposals. She then looks at the empirical research on personal bankruptcy to evaluate the rationale for reforming the system and the effectiveness of proposed changes.

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