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Business Review

Fourth Quarter 2005

In “Making Monetary Policy: What Do We Know and When Do We Know It?,” President Anthony Santomero points out that conducting a successful monetary policy presents real-world challenges, such as evaluating where the economy is, where it is going, and where it should be going. But how do monetary policymakers make decisions about the economy in a world with imperfect information? Santomero discusses how policymaking is affected by both the availability and reliability of economic information. He concludes that given the information constraints policymakers face, the challenges of setting monetary policy will not go away, so we must find a way to meet them.
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In “Whither Consumer Credit Counseling?,” Bob Hunt outlines the history of credit counseling in the U.S. He also observes that, despite its long track record, the credit counseling industry is not without controversy. For example, in recent years, concerns about conflicts of interest and the emergence of a new type of credit counseling agency have triggered significant legislative and regulatory activity. Hunt notes that there is evidence that credit counseling organizations are effective in helping some consumers. However, he points out that the lack of formal research in this area makes it difficult to interpret information and a lot more research needs to be done before we can reach any definitive conclusions.
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In “Underestimating Advertising: Innovation and Unpriced Entertainment,” Leonard Nakamura states that despite consumers’ lack of respect for advertising, it nonetheless plays a significant role in the economy. For one thing, it helps consumers find out about new products, and new products have been rising in economic importance. It also plays a role in subsidizing broadcast entertainment and news programs. Ultimately, Nakamura shows that although advertising contributes to consumer welfare, its contribution is missing from our measures of output.
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In “After the Baby Boom: Population Trends and the Labor Force of the Future,” Tim Schiller examines how the U.S. and the Third District labor force will change as the baby boomers start to retire in large numbers and women’s participation in the workforce levels off. These and other demographic shifts will affect the supply and demand for workers among different industries and occupations, potentially leading to shortages of workers in areas projected to grow, such as education and health care. Nationally, the average age of the work force will increase, its growth will slow, and its composition will be more diverse, and these factors will likely have a particular impact in Pennsylvania, New Jersey, and Delaware. But the good news is that the Third District, already a center of education and health care, may attract more workers than currently anticipated.
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Third Quarter 2005

In “The Changing Patterns of Payments in the United States,” President Anthony Santomero highlights the differences between U.S. and European payments infrastructure; discusses how the roots and evolution of the U.S. payments system differs from Europe’s; and outlines the likely path of the U.S. payment system and the Fed’s role in it. In the end, he observes, the two systems will look more alike, but they’ll get there from very different starting points.
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In “The Economic Role of Cities in the 21st Century,” Jerry Carlino focuses on the economic activities that make firms in cities more productive and that make cities more attractive to urban households. Carlino finds that although agglomeration economies will continue to play a large role in the life of 21st century cities, modern cities must offer a wide choice of amenities to attract the type of high-skill workers needed in the new urban economy.
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In “The Economics of Asset Securitization,” Ronel Elul explains why asset-backed securities exist and discusses some reasons for their common structure. Elul notes that despite well-developed theories on the what and why of securitization, more research is needed. In particular, additional research could uncover the effect that government regulation and bankruptcy law have on securitization.
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In “Do Budget Deficits Cause Inflation?,” Keith Sill examines the theory and evidence on the link between fiscal and monetary policy and, thus, between deficits and inflation. Sill concludes that whether deficits lead to inflation depends on the extent to which a country’s monetary policy is independent.
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"Challenges and Opportunities in a Global Economy: Perspectives on Outsourcing, Exchange Rates, and Free Trade” was the topic of our fourth annual Philadelphia Fed Policy Forum held on December 3, 2004. This event, sponsored by the Bank’s Research Department, brought together a group of highly respected academics, policymakers, and market economists, for discussion and debate about the macroeconomic impact of developments in the global economy. Our hope is that the 2004 Policy Forum serves as a catalyst for both greater understanding and further research on policymaking in an increasingly global economy.
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Second Quarter 2005

The U.S. economy enjoyed a remarkable run in the 1990s. As it moved into the new century, however, the economy underwent various fits and starts before entering its current expansion phase. In this quarter’s message, President Anthony Santomero shares his views on the U.S. economy and outlines some of the “Lessons Learned from the Recent Business Cycle.”
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There's a common belief among economists that when there’s slack in the economy — that is, when labor and capital are not fully employed — the economy can expand without an increase in inflation. One measure of the intensity with which labor and capital are used in producing output is the capacity utilization rate. According to some economists, when capacity utilization is low, firms can increase employment and their use of capital without incurring large increases in the costs of production. So firms will not be forced to raise prices in order to make profits on additional output. But this theory is not universally accepted. In “The Relationship Between Capacity Utilization and Inflation,” Mike Dotsey and Tom Stark investigate some of the problems with what, at first glance, seems a compelling story.
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Sylvain Leduc notes that the extent of international risk-sharing remains surprisingly small. This appears to be the case even though the development of international financial markets should better equip households to pool their resources so that their level of consumption varies less from year to year. In “International Risk-Sharing: Globalization Is Weaker Than You Think,” Leduc digs a little further into the data to uncover why, in spite of recent trends, risk-sharing doesn’t occur more often.
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Although innovative contracts are important for economic growth, when firms face uncertainty as to whether contracts will be enforced, they may choose not to innovate. Legal uncertainty can arise if a judge interprets the terms of a contract in a way that is antithetical to the intentions of the parties to the contract. Or sometimes a judge may understand the contract but overrule it for other reasons. How does legal uncertainty affect firms’ decisions to innovate? In “Legal Uncertainty and Contractual Innovation,” Yaron Leitner explores issues related to legal uncertainty, particularly the amount of discretion judges have and the types of evidence they consider.
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First Quarter 2005

After 30 years of university teaching and almost five years as a Reserve Bank president, Anthony M. Santomero knows the importance of education to a well-functioning economy. In recent years, he has seen several broad, long-term trends emerge-trends that will undoubtedly shape our environment and our economic fortunes. In "Preparing for the 21st Century Economy," he talks about two trends he deems to be of particular importance. First is the steady increase in international trade that has spilled over from the second half of the 20th century into the new millennium. Second is the revolution in information and communications technology that has spurred productivity and spawned a need for knowledge workers.
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Although iron ore mining and public schools may seem to have nothing in common, you may be surprised. Recent research suggests that the labor productivity of ore producers and teachers may respond similarly to competitive pressure. To date, most macroeconomic research on the determinants of labor productivity has generally focused on variables such as capital stock per worker, technology, the quality of the workforce, and laws and regulations that govern production. However, this conventional view may leave something out: the degree of competitive pressure faced by a production unit. In "Ores and Scores: Two Cases of How Competition Led to Productivity 'Miracles'," Satyajit Chatterjee examines two cases in which increased competition in the product market caused dramatic improvements in labor productivity: iron mines in the Midwest and public schools in Milwaukee.
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In recent years, more than 1 million people a year have immigrated to the U.S., a level not seen since before the Great Depression. This boom is most apparent in the urban areas where immigrants tend to cluster. Given their numbers, these newly arrived residents must have some effect on local labor markets. Yet economists have been puzzled by the evidence that immigration has little impact on the wages and employment of native-born workers. So how great is immigration's impact on local labor markets? Is it limited to markets where immigrants settle, or is it spread across the country? In "How Do Local Labor Markets in the U.S. Adjust to Immigration?," Ethan Lewis sifts through the theory and evidence to answer these questions.
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Since the mid-1980s, important developments have taken place in the housing finance system. In the 1990s, the U.S. economy experienced the longest expansion in its history, marked by substantial growth in household income and wealth. In addition, Congress passed the Tax Reform Act of 1986 and the Taxpayer Relief Act of 1997, two laws favorable to homeowners. Therefore, it's not surprising that homeownership rates and the mortgage indebtedness of American families have also changed significantly. In "Moving Up: Trends in Homeownership and Mortgage Indebtedness," Wenli Li uses the University of Michigan's Panel Study of Income Dynamics to examine the effects of these changes and how they vary across households.
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