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Business Review

Fourth Quarter 2012

Anecdotal evidence suggests that labor market conditions surrounding American workers had been worsening in recent decades, even before the severe recession in 2007-2009. However, studies by academic researchers have not found clear evidence that worker turnover has increased over time. In “Labor Market Anxiety and the Downward Trend in the Job Separation Rate,” PDF (388 KB, 7 pages) Shigeru Fujita shows that there is a long-run downward trend in the separation rate into unemployment and examines several factors that help account for this long-run decline. He argues that the aging of the labor force has played an important role for the trend. He also explains, using an economic model, how the declining separation rate can result from workers’ response to the increased sense of job insecurity.

A central premise of monetary policy in the U.S. throughout the first decade of the 21st century has been a firm commitment to avoid deflation. Indeed, it is the consensus view of policymakers and most economists. Nonetheless, Nobel laureate Milton Friedman proposed that optimal monetary policy should lead to a steady rate of deflation. For some economists, the Friedman rule is mainly a benchmark for thinking clearly about the assumptions underlying our models and a systematic guide for deciding how to modify our models, that is, a way of making scientific progress. However, it is not an exaggeration to say that most of the work in the field of monetary theory has focused on identifying situations in which Friedman’s insight does not apply. In “The Optimum Quantity of Money,” PDF (408 KB, 8 pages) Daniel Sanches discusses the Friedman rule and the main arguments that have been made against it.

Uncertainty about how the economy will evolve is a key concern for households and firms. People’s views on how likely it is that the economy will be growing, stagnating, or in recession help shape the actions they take today. Consequently, how households and firms respond to uncertainty has implications for economic activity. In addition, uncertainty matters to policymakers: Monetary policymakers recognize that if uncertainty about future inflation is high, decision-making by households and firms becomes more complicated. In “Measuring Economic Uncertainty Using the Survey of Professional Forecasters,” PDF (491 KB, 12 pages) Keith Sill describes how uncertainty can be measured using data from the Survey of Professional Forecasters and shows how these measures have changed over time for output growth and inflation. He also examines some links between the macroeconomy and measures of output and inflation uncertainty.

See also the latest issue of Research Rap PDF (181 KB, 7 pages).

Third Quarter 2012

Over the past few decades, several developed economies have experienced large changes in how much households and firms save. In fact, a sharp increase in firms’ savings behavior has changed the net position of the (nonfinancial) corporate sector vis-à-vis the rest of the economy. Why have firms in the business of producing goods or services become lenders? This is quite at odds with traditional models of corporate finance, which suggest that firms issue debt and equity to fund their operations and finance their investment projects. But successful firms appear to accumulate financial assets even when they are issuing equity, and these financial holdings are mainly in a very liquid form that pays a low return. This poses a conundrum, since holding financial assets while maintaining outstanding equity positions is expensive for the firm. In “The Rise of Corporate Savings,” PDF (8 pages, 502 KB) Roc Armenter looks carefully at the data to learn which firms have been responsible for the rise in corporate savings and then briefly discusses the costs and benefits of equity relative to debt.

Since the start of the financial crisis of 2007-09, a historically large number of household loans have become delinquent and residential houses have been foreclosed. This situation, coupled with households actively paying down their debt or cutting down on new borrowing, marked the beginning of household deleveraging. In “The Economics of Household Leveraging and Deleveraging,” PDF (9 pages, 503 KB) Wenli Li and Susheela Patwari discuss recent theoretical and empirical work by economists that sheds light on the process of leveraging and deleveraging and that helps to provide answers to a number of questions, such as: What determines when and how much a household borrows? What helps account for the widely noted increase in consumer debt levels in the run-up to the financial crisis? Finally, how has deleveraging progressed, and what are the implications for consumption and the broader economy?

Economists believe that people choose to live and work at sites that have productive or amenity value such as a river, harbor, or some other natural resource. Another factor that may determine the location of a city is the benefits derived from density itself: agglomeration economies. Although these complementary explanations both have something useful to say about the locations and sizes of cities, they also have important limitations. While natural features seem important, it is difficult to point to one or even several that are valuable enough to explain a very large metropolitan area. And if there are large economies of density, then any location could be the potential site for a city, since density itself provides a reason for further concentration. If you were to replay the settlement of some large expanse of land, perhaps cities in this alternative history would be of different sizes and locations. This “path dependence” or “history dependence” is a potentially important theoretical implication of models featuring economies of density. In “Geography, History, Economies of Density, and the Location of Cities,” PDF (7 pages, 747 KB) Jeffrey Lin helps shed light on why cities are located where they are.

In “Changes in the Use of Electronic Means of Payment: 1995-2010,” PDF (12 pages, 858 KB) Loretta Mester updates the information originally published in an article she wrote in the March/April 2000 Business Review and subsequently updated in the Second Quarter 2006 and Third Quarter 2009 issues.

See also the latest issue of Research Rap PDF (334 KB, 4 pages).

Second Quarter 2012

In traditional banking arrangements, households hold their savings in the form of deposits at the bank, which makes loans to both firms and households and holds these loans to maturity. But in the United States, and to a lesser extent in other developed countries, markets have increasingly taken over the roles traditionally played by banks. The shift of financing activity from banks to financial markets, as well as their continued coexistence, raises a number of questions. In “Banks and Markets: Substitutes, Complements, or Both?” PDF (10 pages, 337 KB) Mitchell Berlin discusses some of these questions, such as: What factors determine the relative importance of banks and markets in a financial system in which the two types of finance coexist? Why do so many borrowers continue to use a mixture of bank loans and bonds? And perhaps most important: How does the mix of banks and market finance affect the real economy? That is, how much households save, how firms invest, and how fast the economy grows.

Government bailouts during the recent financial crisis were controversial because of the burden on taxpayers and because even if taxpayers eventually get their money back, such bailouts can undermine banks’ incentives not to take excessive risk in the future. New regulatory reforms aim to avoid such crises in the future. One proposal is to require banks to hold “contingent capital.” In “Contingent Capital,” PDF (369 KB, 8 pages) Yaron Leitner explains what contingent capital is and discusses some of the arguments in favor of it. He also discusses potential implementation problems and looks at some of the alternatives.

The economic crisis and its aftermath have posed significant challenges to policymakers. To help meet those challenges, the Federal Reserve deployed several innovative policy tools to help relieve the stress in financial markets during the crisis. These tools have created their own significant challenges for the conduct of monetary policy in the post-crisis era. The wider range of policy options now available to policymakers makes it more difficult to credibly commit to a particular policy course, and this discretion poses a problem. This is because monetary policy is subject to a time-inconsistency problem. The new monetary policy tools introduced during the crisis can make such time-inconsistency problems worse by reinforcing the incentives for financial institutions or other sectors of the economy to take on excessive risk. In “Time-Consistency and Credible Monetary Policy After the Crisis,” PDF (8 pages, 351 KB) Jim Nason and Charles Plosser discuss why it is important for central banks to consider ways in which they can limit discretion and use these new tools in a systematic way.

See also the latest issue of Research Rap. PDF (288 KB, 2 pages)

First Quarter 2012

A well-designed monetary policy can help the economy respond efficiently to economic disturbances by limiting the deviation of economic activity from its potential while keeping inflation close to its desired rate. But successful implementation of such strategies must confront significant challenges arising from various forms of economic uncertainty. In “Designing Monetary Policy Rules in an Uncertain Economic Environment,” PDF (9 pages, 396 KB) Michael Dotsey and Charles Plosser discuss the design of monetary policy rules in an environment in which policymakers face two distinct forms of uncertainty: the uncertainty surrounding the precise values of key policy variables that often appear as determinants in such rules, and learning uncertainty, which arises when people have only an incomplete knowledge of the economy itself.

Many news reports and economic experts talk about uncertainty. But what does the word mean in an economic context? Specifically, what do economists have in mind when they talk about it? In “Risk and Uncertainty,” PDF (9 pages, 334 KB) Pablo Guerron-Quintana discusses the concepts of risk and uncertainty, what the difference is between the two terms, and why their presence in the economy may have widespread effects. He also talks about measuring risk at the aggregate level — that is, risk that affects all participants in the economy — and he reviews the various types of risk measures that economists have proposed.

Most people have probably heard of reverse mortgage loans. But even though these loans have been getting more attention lately, it’s possible that many people still aren’t sure about what reverse mortgages really are. This is not surprising, since reverse mortgages are a relatively new type of mortgage loan. Although reverse mortgages are currently used by only a small fraction of people, their popularity has been growing in recent years. In “Everything You Always Wanted to Know About Reverse Mortgages But Were Afraid to Ask,”; PDF (13 pages, 429 KB) Makoto Nakajima discusses reverse mortgage loans, particularly the most popular type, which is administered by the government. He discusses who uses reverse mortgage loans and how they are used and compares the pros and cons.

There’s also a summary of the workshop PDF (9 pages, 255 KB) on Recent Developments in Consumer Credit and Payments, co-sponsored by the Bank’s Research Department and Payment Cards Center.

  • Last update: November 20, 2012

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