Showing papers in "Federal Reserve Bank of New York Economic policy review in 1997"

The Evolving External Orientation of Manufacturing: A Profile of Four Countries

Abstract: Changes in exchange rates, shifts in trade policy, and other international developments can significantly influence the profitability and performance of a country's manufacturing industries. To understand and measure the exposure of domestic manufacturing industries to international events, one must first examine the channels that transmit such shocks to production activity and, ultimately, to the economy as a whole. Capturing a country's industrial reliance on international markets--which we refer to as the "external orientation" of its industries--involves measuring the extent to which manufacturers sell products to foreign markets, use foreign-made inputs, and, more indirectly, compete with foreign manufacturers in domestic markets through imports. The growing internationalization of the production process and trade means that no single measure can. capture the importance of the world economy to a given industry. Today, the most widely used indicator of an industry's exposure to world events is its "openness to trade," typically calculated as import plus export revenues of final products divided by domestic production revenues. This measure has been used extensively in studies addressing industry exposure to external shocks such as exchange rate movements and trade policies. Although the openness to trade measure is useful in some contexts (for example, in understanding the reasons for growth in world trade),(1) it can be misleading because it fails to consider the growing use of foreign inputs in the manufacture of domestic goods. To some degree, the use of foreign inputs in domestic production works to offset the revenue exposure to foreign shocks that arises because of a manufacturer's dependence on foreign sales and the presence of import competition. Consider, for example, a shoe manufacturer in the United States that imports and exports small amounts of its finished product. Such a company would appear to have limited openness to trade. Suppose, however, that the same manufacturer relies heavily on imported leather as an input in production. An appreciation of the U.S. dollar would likely lead to a drop in the price of the imported leather used by the manufacturer and consequently an increase in profitability. The openness to trade measure would capture only the negative effect of the rising dollar on the manufacturer's profitability. Clearly, a broader assessment of industrial external orientation will prove informative to policymakers and economists seeking to understand the effects of external shocks on particular manufacturing industries. This article presents four measures of external orientation using industry-specific and time-varying data for manufacturing industries in four countries--the United States, Canada, the United Kingdom, and Japan. For each of these countries, we report export revenue share, imports relative to consumption, and imported input share in production of all manufacturing industries identified by two digits in the Standard Industrial Classification system. We also report an overall measure, net external orientation, defined as the difference between industry export share and imported input share in production.(2) We present approximately twenty years of data for the industries in each country from the early 1970s to the mid-1990s. Our discussion of the data and methodology used in constructing the external orientation measures is followed by country-specific histories of the export share, import share, imported input share, and net external orientation of each manufacturing industry. The country sections are followed by cross-country comparisons of industry trends in external orientation. The results we present are useful for predicting how particular international shocks will influence manufacturing industries over time. Measures of External Orientation The first of our four measures of external orientation is export share, the ratio of industry export revenues to industry shipments ([X. …

What Moves the Bond Market

Abstract: o what extent can movements in the financial markets be attributed to the arrival of new information? In a landmark 1989 study of the stock market, David Cutler, James Poterba, and Lawrence Summers found that it was surprisingly difficult to identify information that could account for the largest price movements. No similar effort has been made, however, to explain the largest price movements in the bond market, although both theory and a large literature on announcement effects suggest that the results for this market should be more promising. In this article, we take a close look at a single year in the U.S. Treasury securities market (which we refer to as the bond market) and attempt to identify information that may account for the sharpest price changes and the most active trading episodes. Sharp price moves may be attributed to changes in expectations shared by investors, and

The Round-the-Clock Market for U.S. Treasury Securities

Abstract: The US Treasury securities market is one of the most important financial markets in the world Treasury bills, notes, and bonds are issued by the federal government in the primary market to finance its budget deficits and meet its short-term cash-management needs In the secondary market, the Federal Reserve System conducts monetary policy through open market purchases and sales of Treasury securities Because the securities are near-risk-free instruments, they also serve as a benchmark for pricing numerous other financial instruments In addition, Treasury securities are used extensively for hedging, an application that improves the liquidity of other financial markets The Treasury market is also one of the world's largest and most liquid financial markets Daily trading volume in the secondary market averages $125 billion(1) Trading takes place overseas as well as in New York, resulting in a virtual round-the-clock market Positions are bought and sold in seconds in an interdealer market, with trade sizes starting at $1 million for notes and bonds and $5 million for bills Competition among dealers and interdealer brokers ensures narrow bid-ask spreads for most securities and minimal interdealer brokerage fees Despite the Treasury market's importance, size, and liquidity, there is little quantitative evidence on its intraday functioning Intraday analysis of trading volume and the bid-ask spread is valuable, however, for ascertaining how market liquidity changes throughout the day Such information is important to hedgers and other market participants who may need to trade at any moment and to investors who rely on a liquid Treasury market for the pricing of other securities or for tracking market sentiment Intraday analysis of price volatility can also reveal when new information gets incorporated into prices and shed light on the determinants of Treasury prices Finally, analysis of price behavior can be used to test the intraday efficiency of the Treasury market by determining, for example, whether overseas price changes reflect new information that is subsequently incorporated into prices in New York This article provides the first detailed intraday analysis of the round-the-clock market for US Treasury securities The analysis, covering the period from April 4 to August 19, 1994, uses comprehensive data on trading activity among the primary government securities dealers(2) Trading volume, price volatility, and bid-ask spreads are examined for the three major trading locations--New York, London, and Tokyo--as well as for each half-hour interval of the global trading day Price efficiency across trading locations is also tested by examining the relationship between price changes observed overseas and overnight price changes in New York The analysis reveals that trading volume and price volatility are highly concentrated in New York trading hours, with a daily peak between 8:30 am and 9 am and a smaller peak between 2:30 pm and 3 pm Bid-ask spreads are found to be wider overseas than in New York and wider in Tokyo than in London Despite lower overseas liquidity, overseas price changes in US Treasury securities emerge as unbiased predictors of overnight New York price changes THE STRUCTURE OF THE SECONDARY MARKET Secondary trading in US Treasury securities occurs primarily in an over-the-counter market rather than through an organized exchange(3) Although 1,700 brokers and dealers trade in the secondary market, the 39 primary government securities dealers account for the majority of trading volume (Appendix A)(4) Primary dealers are firms with which the Federal Reserve Bank of New York interacts directly in the course of its open market operations They include large diversified securities firms, money center banks, and specialized securities firms, and are foreign- as well as US-owned Over time, the number of primary dealers can change, as it did most recently with the addition of Dresdner Kleinwort Benson North America LLC …

The Benefits of Branching Deregulation

Abstract: The Riegle-Neal Interstate Banking and Branching Efficiency Act, implemented in June 1997, enables banks to establish branches and buy other banks across the country. This legislation is the final stage of a quarter-century-long effort to relax geographic limits on banks. As recently as 1975, no state allowed out-of-state bank holding companies (BHCs) to buy in-state banks, and only fourteen states permitted statewide branching. By 1990, all states but Hawaii allowed out-of-state BHCs to buy in-state banks, and all but three states allowed statewide branching. The Riegle-Neal Act removes the remaining restrictions by permitting banks and BHCs to cross state lines freely.(1) Although the effects of the recent federal legislation will be known only over time, we can study the impact of geographic restrictions on the banking industry by examining an earlier stage of the deregulatory process. The states were most active in removing geographic limits on banks in the fifteen years from 1978 to 1992. By observing the changes in banking that followed the state initiatives, we can learn much about the impact of these limits.(2) Previous research has suggested that geographic restrictions destabilized the banking system by creating small, poorly diversified banks that were vulnerable to bank runs and portfolio shocks (Calomiris 1993). In this article, we focus instead on the effect of the restrictions on the efficiency of the banking system. We find that bank efficiency improved greatly once branching restrictions were lifted. Loan losses and operating costs fell sharply, and the reduction in banks' costs was largely passed along to bank borrowers in the form of lower loan rates. The relaxation of state limits on inter-state banking was also followed by improvements in bank performance, but the gains were smaller and the evidence of a causal relationship less robust. Our analysis suggests that much of the efficiency improvement brought about by branching was attributable to a selection process whereby better performing banks expanded at the expense of poorer performers. It appears that the branching restrictions acted as a ceiling on the size of well-managed banks, preventing their expansion and retarding a process of industry evolution in which less efficient firms routinely lose ground to more efficient ones. While the improvements to the banking system following deregulation helped bank customers directly, we also find important benefits to the rest of the economy. In particular, state economies grew significantly faster once branching was allowed--in part, we suggest, because deregulation permitted the expansion of those banks that were best able to route savings to the most productive uses. Although it is uncertain whether the observed acceleration in economic growth will last beyond ten years, the stimulative effect of branching deregulation on the economy has been considerable. A BRIEF HISTORY OF GEOGRAPHIC RESTRICTIONS ON BANKING States began imposing limits on branch office locations in the nineteenth century. Such limits were intended in part to prevent unscrupulous bankers from "choosing inaccessible office sites to deter customers from redeeming . . . circulating banknotes" (Kane 1996, p. 142). Geographic limits were also justified by the political argument that allowing banks to expand their operations freely could lead to an excessive concentration of financial power. Appearing before Congress in 1939, the Secretary of the Independent Bankers Association warned that branch banking would "destroy a banking system that is distinctively American and replace it with a foreign system . . . a system that is monopolistic, undemocratic and with tinges of fascism" (Chapman and Westerfield 1942, p. 238). Inefficient banks probably supported these restrictions because they prevented competition from other banks. Economides, Hubbard, and Palia (1995) show that states with many weakly capitalized small banks favored the 1927 McFadden Act, which gave states the authority to regulate national banks' branching powers. …

Bank Capital Requirements for Market Risk: The Internal Models Approach

Abstract: The increased prominence of trading activities at many large banking companies has highlighted bank exposure to market risk--the risk of loss from adverse movements in financial market rates and prices. Recognizing the importance of trading operations, banks have sought ways to measure and to manage the associated risks. At the same time, bank supervisors in the United States and abroad have taken steps to ensure that banks have adequate internal controls and capital resources to address these risks. Prominent among the steps taken by supervisors is the development of formal capital requirements for the market risk exposures arising from banks' trading activities. These market risk capital requirements, which will take full effect in January 1998, depart from earlier capital rules in two notable ways. First, the capital charge is based on the output of a bank's internal risk measurement model rather than on an externally imposed supervisory measure Second, the capital requirements incorporate qualitative standards for a bank's risk measurement system. This paper presents an overview of the new capital requirements. In the first section, we describe the structure of the requirements and the considerations that went into their design. In addition, we address some of the concerns that have been raised about the methods of calculating capital charges under the new rules. The paper's second section considers the probable impact of the market risk capital requirements. After performing a set of rough calculations to show that the effect of the internal models approach on required capital levels and capital ratios will probably be modest, we identify some significant benefits of the new approach. Most notably, the approach will lead to regulatory capital charges that conform more closely to banks' true risk exposures. Moreover, the information generated by the models will allow supervisors and financial market participants to compare risk exposures over time and across institutions. THE STRUCTURE OF THE MARKET RISK CAPITAL REQUIREMENTS The new capital requirements for market risk have been put forward as an amendment to existing capital rules. In late 1990, banks and bank holding companies in the United States became subject to a set of regulatory capital guidelines that defined minimum amounts of capital to be held against various categories of on- and off-balancesheet positions.(1) The guidelines also specified which debt and equity instruments on a bank's balance sheet qualified as regulatory capital. These guidelines were based on the 1988 Basle Accord adopted by the Basle Committee on Banking Supervision, a group made up of bank supervisors from the Group of Ten countries. While the original Basle Accord and U.S. risk-based capital guidelines primarily addressed banks' exposure to credit risk, the new requirements set minimum capital standards for banks' market risk exposure.(2) Broadly speaking, market risk is the risk of loss from adverse movements in the market values of assets, liabilities, or off-balance-sheet positions. Market risk generally arises from movements in the underlying risk factors--interest rates, exchange rates, equity prices, or commodity prices- that affect the value of these on- and off-balance-sheet positions. Thus, a bank's market risk exposure is determined both by the volatility of underlying risk factors and the sensitivity of the bank's portfolio to movements in those risk factors. Banks face market risk from the full range of positions held in their portfolios, but the capital standards focus largely on the market risks arising from banks' trading activities.(3) This focus reflects the idea that market risk is a major component of the risks arising from trading activities and, further, that market risk exposures are more visible and more easily measured within the trading portfolio because these positions are marked to market daily. …

Market Returns and Mutual Fund Flows

Abstract: The 1990s have seen unprecedented growth in mutual funds. Shares in the funds now represent a major part of household wealth, and the funds themselves have become important intermediaries for savings and investments. In the United States, more than 4,000 mutual funds currently hold stocks and bonds worth a total of more than $2 trillion (Chart 1). Household investment in these funds increased more than fivefold in the last ten years, making it the fastest growing item on the household financial balance sheet. Most of this growth came at the expense of more traditional forms of savings, particularly bank deposits. [Chart 1 ILLUSTRATION OMITTED] With the increased popularity of mutual funds come increased concerns--namely, could a sharp drop in stock or bond prices set off a cascade of redemptions by fund investors and could the redemptions exert further downward pressure on asset markets? In recent years, flows into funds have generally been highly correlated with market returns. That is, mutual fund inflows have tended to accompany market upturns and out-flows have tended to accompany downturns. This correlation raises the question whether a positive-feedback process is at work here, in which market returns cause the flows at the same time that the flows cause the returns. Observers such as Hale (1994) and Kaufman (1994) fear that such a process could turn a decline in the stock or bond market into a downward spiral in asset prices.(1) In this study, we use recent historical evidence to explore one dimension of the broad relationship between market returns and mutual fund flows: the effect of short-term market returns on mutual fund flows. Research on this issue has already confirmed high correlations between market returns and aggregate mutual fund flows (Warther 1995). A positive-feedback process, however, requires not just correlation but two-way causation between flows and returns, in which fund investors react to market movements while the market itself moves in response to the investors" behavior. Previous studies of causation have focused on the effects of past performance on flows into individual mutual funds, typically with a one-year lag separating cause and effect. In this article, however, we examine the effect of market-wide returns on aggregate mutual fund flows within a month, a level of aggregation and a time horizon that seem more consistent with the dynamics of a downward spiral in asset prices. Our statistical analysis uses instrumental variables, a technique that is particularly well suited for measuring causation when observed variables are likely to be determined simultaneously. The technique has not been applied before to mutual fund flows and market returns. Despite market observers' fears of a downward spiral, our study suggests that the short-term effect of market returns on mutual fund flows typically has been too weak to sustain a spiral. During unusually severe market declines, stock and bond movements have prompted proportionately greater outflows than under normal conditions, but even at these times, the effect has not seemed strong enough to perpetuate a sharp fall in asset prices. We begin by describing the nature of mutual funds and characterizing their recent growth. Next, we examine the data on aggregate mutual fund flows by dividing them into expected and unexpected components and investigating their correlations with market returns. The effects of returns on flows are then estimated using instrumental variables. Finally, we test the robustness of our estimates by looking at the flows during severe market declines. The Nature and Growth of Mutual Funds Mutual funds operate as tax-exempt financial institutions that pool resources from numerous shareholders to invest in a diversified portfolio of securities.(2) Unlike closed-end funds, which issue a fixed number of shares, open-end mutual funds are obligated to redeem shares at the request of the shareholder. …

Credit, Equity, and Mortgage Refinancings

Abstract: Homeowners typically have the option to prepay all or part of the outstanding balance of their mortgage loan at any time, usually without penalty. However, unless homeowners have sufficient wealth to pay off the balance, they must obtain a new loan in order to exercise this option. Studies examining refinancing behavior are finding more and more evidence that differences in homeowners' ability to qualify for new mortgage credit, as well as differences in the cost of that credit, account for a significant part of the observed variation in that behavior. Therefore, individual homeowner and property characteristics, such as personal credit ratings and changes in home equity, must be considered systematically, along with changes in mortgage interest rates, in the analysis and prediction of mortgage prepayments. Early research into the factors influencing prepayments focused almost exclusively on the difference between the interest rate on a homeowner's existing mortgage and the rates available on new loans. This approach arose in part because researchers most often had to rely on aggregate data on the pools of mortgages serving as the underlying collateral for mortgage-backed securities (for example, see Schorin {1992}). More recent research, however, has broadened the scope of this investigation through the utilization of loan-level data sets that include individual property, loan, and borrower characteristics. This article significantly advances the literature on mortgage prepayments by introducing quantitative measures of individual homeowner credit histories to the loan-level analysis of the factors influencing the probability that a homeowner will refinance. In addition to credit histories, we include in the analysis changes in individual homeowner's equity and in the overall lending environment. Our findings strongly support the hypothesis that, other things being equal, the worse a homeowner's credit rating, the lower the probability that he or she will refinance. We also confirm the finding of other researchers that changes in home equity strongly influence the probability of refinancing. Finally, we provide evidence of a change in the lending environment that, all else being equal, has increased the probability that a homeowner will refinance. These findings are important from an investment risk management perspective because they confirm that the responsiveness of mortgage cash flows to changes in interest rates will also be significantly influenced by the credit and equity conditions of individual borrowers. Moreover, evidence overwhelmingly indicates that these conditions are subject to dramatic changes. For example, although the sharp rise in personal bankruptcies since the mid-1980s (Chart 1) partly reflects changes in laws and attitudes, it nonetheless suggests that credit histories for a growing segment of the population are deteriorating. Furthermore, home price movements, the key determinant of changes in homeowners' equity, have differed considerably over time and in various regions of the country. Indeed, in the early to mid-1990s home price appreciation for the United States as a whole slowed dramatically while home prices actually fell for sustained periods in a few regions (Chart 2). [Chart 1-2 ILLUSTRATION OMITTED] In short, as mortgage rates fell during the first half of the 1990s, many households likely found it difficult, if not impossible, to refinance existing mortgages because of poor credit ratings or erosion of home equity.(1) Consequently, the prepayment experience of otherwise similar pools of mortgage loans may vary greatly depending on the pools' proportions of credit- and/or equity-constrained borrowers. Our findings also contribute to an understanding of how constraints on credit availability affect the transmission of monetary policy to the economy (for example, see Bernanke {1993}). Fazzari, Hubbard, and Petersen (1988) and others have found that investment expenditures by credit-constrained businesses are especially closely tied to those firms' cash flows and are relatively insensitive to changes in interest rates, reflecting constraints on their ability to obtain credit. …

Is There an Inflation Puzzle

Abstract: Historically, inflation has followed a fairly predictable course in relation to the business cycle. Inflation typically rises during an economic expansion, peaks slightly after the onset of recession, and then continues to decline through the first year or two of recovery. During the present U.S. expansion, however, inflation has taken a markedly different path. Although more than six years have passed since the 1990-91 recession, inflation in the core CPI (the consumer price index excluding its volatile food and energy components) has yet to accelerate (Chart 1). Moreover, during the last three years, inflation has remained stable despite projections of higher expected inflation from the Blue Chip Consensus forecast and contrary to traditional signals such as the run-up in commodity prices experienced from late 1993 to early 1995. Economists and policymakers have referred to the restrained behavior of prices during this long expansion as an "inflation puzzle." In a recent interview, Robert T. Parry, president of the Federal Reserve Bank of San Francisco, commented, "I have a question mark, and it leads me to recommend vigilance with regard to inflation, but I do have to note that things have turned out well.... {We've}either been lucky, in which case the old relationships will reassert themselves, or {we've}got a new regime under way. And I don't think we know enough at this point to know which of those two things is operative.(1) As Parry suggests, two different types of explanations could account for the recent behavior of inflation. The failure of inflation to accelerate may reflect the effects of temporary factors unique to this expansion. Alternatively, the unexpectedly low level of inflation may indicate a permanent change in the way inflation reacts to economic growth and other related variables. Each of these explanations holds important implications for the conduct of monetary policy. The Phillips curve, the principal tool used by economists to explain inflation, has been subject to systematic overprediction errors during the past few years. If these errors reflect the influence of temporary factors, then the Phillips curve relationship should ultimately regain its stability. However, if these errors reflect a permanent change in the dynamics of the inflation process, then economists could no longer view the Phillips curve as a reliable guide in forecasting inflation. Because labor costs are an important factor in determining prices, the recent slowdown in compensation growth has been cited in both types of explanations for the inflation puzzle. Some commentators argue that this slowdown in compensation growth, attributable largely to declining benefit costs, has acted as a supply shock and has temporarily lowered inflation relative to its historical proximate determinants. Others contend that a permanent change in compensation growth, resulting from heightened job insecurity and its constrictive effect on wage growth, has led to a fundamental shift in the inflation process. This article explores the inflation puzzle and investigates whether compensation has acted as either a temporary restraint on inflation or as the underlying source of a new inflation regime.(2) After reviewing the recent behavior of inflation, we specify and estimate a traditional price-inflation Phillips curve model over the 1965-96 period. Our results show that in late 1993 the model begins to systematically overpredict inflation and appears to break down. We then modify our traditional Phillips curve specification by incorporating compensation growth as an additional determinant of inflation. With this variable, the model's explanatory power improves significantly, and it tracks inflation much more accurately over the current expansion. The restored stability of the model appears to rule out the view that inflation's recent behavior reflects a fundamental shift in the inflation process. …

A Framework for the Pursuit of Price Stability

Abstract: It is often said that there is a worldwide community of central bankers. I certainly feel that way. Central bankers in all countries share a number of concerns. Perhaps the most important of these is the desire for price stability. While central bankers may differ in the ways they seek to achieve price stability--differences grounded in our respective histories, customs, and institutions--the goal we all strive for is no less important. Recognizing that no one country's central bank has a monopoly on the right answers, I would like to share with you my views on why I believe price stability is so important and what approaches can be taken to achieve this goal. Before turning to these issues, we must first be clear about what we mean by price stability and how to recognize it when we see it. In my view, a goal of price stability requires that monetary policy be oriented beyond the horizon of its immediate impact on inflation and the economy. This immediate horizon is on the order of two to three years. This orientation properly puts the focus of a forward-looking policy on the time horizon over which monetary policy moves today will have their effect and households and businesses will do most of their planning. This is the horizon that is relevant for the definition of price stability articulated by Chairman Greenspan: that price stability exists when inflation is not a consideration in household and business decisions. A central bank's commitment to price stability over the longer term, however, does not mean that the monetary authorities can ignore the short-term impact of economic events. It is important to recognize that, even if we set ourselves successfully on the path to price stability and even if, as a result, price expectations are contained, we still will not have eliminated all sources of potential inflationary shocks. The reality is that monetary policy can never put the economy exactly where we want it to be. For example, supply shocks that drive prices up sharply and suddenly--such as the two oil shocks of the 1970s--are always possible. In such an eventuality, the appropriate monetary policy consistent with a goal of price stability would not be to tighten precipitously, but rather to bring inflation down gradually over time, as the economy adjusts to the shift in relative prices. In the event of a shock to the financial system, the appropriate monetary policy might require a temporary reflation. As you can see, I believe that monetary policy must be exercised cautiously. Why do I say this? Because contracts, especially wage contracts, can outlast a good part of, or even exceed, short-term shocks in duration. In the short term, therefore, monetary policy must accept as given the rigidities in wages and prices that these contracts create. Abrupt shifts in policy, given these rigidities, especially a monetary tightening in the face of wages that are unlikely to be cut, can cause unacceptable rises in unemployment and drops in output. WHY PRICE STABILITY IS SO IMPORTANT AND SO DESIRABLE In my view, a key principle for monetary policy is that price stability is a means to an end--to promote sustainable economic growth. Price stability is both important and desirable because a rising price level--inflation--even at moderate rates, imposes substantial economic costs on society. All countries incur these costs. They entail, for example: * increased uncertainty about the outcome of business decisions and profitability; * negative effects on the cost of capital resulting from the interaction of inflation with the tax system; * reduced effectiveness of the price and market systems; and * in particular, distortions that create perverse incentives to engage in nonproductive activities. Let me be even more explicit about the negative effects of one particular type of nonproductive activity induced by inflation's distortion of incentives--the overinvestment of resources in the financial sector. …

Sources of New York Employment Fluctuations

Abstract: New York's economy depends heavily on developments elsewhere in the United States, usually contracting when the rest of the nation is in a recession and expanding when the nation is growing rapidly. It is far from a lockstep relationship, however. In some episodes, such as the 1970s, the region fared considerably worse than the United States. In other periods, such as the early 1980s, it performed better than the nation. This paper investigates employment fluctuations in the New York metropolitan area with the goal of understanding the similarities and differences between the region and the rest of the nation. The investigation has two parts. The first part describes cyclical movements and long-run shifts in regional employment and compares them with employment fluctuations in the nation as a whole. The second part quantifies the relative importance of aggregate, industry-specific, and region-specific factors in explaining the region's fluctuations. The investigation focuses on two key industries: manufacturing, and the finance, insurance, and real estate (FIRE) sector. Much of the persistent job loss in the region has been in these two industries--first, with the exodus of manufacturing jobs in the 1970s, and more recently, with the restructuring of financial services in the late 1980.(1) One potentially important implication of the evolution of employment shares is a change in the region's response to aggregate factors. As New York's employment base shifts from highly cyclical manufacturing jobs to relatively acyclical financial services, one would expect changes in the relationship between the region and the nation like those documented by McCarthy and Steindel (1996). To assess the importance of these factors, we use a statistical model that can, by virtue of its factor structure, attribute New York employment fluctuations to readily interpretable aggregate, industry-specific, and regional factors. Our approach also relates the regions response to aggregate and industry shocks to irs industry mix, allowing us to characterize changes in the behavior of regional employment resulting from changes in its employment base. Our results reveal some significant changes in the region's relationship to the rest of the nation. While New York employment shares a strong cyclical component with U.S. employment, the region has experienced major shifts in its trend growth rate: the largest are associated with negative shocks in the mid-1970s and the late 1980s. Some of these can be traced to specific industries, such as the FIRE-related weakness in the late 1980s. Others, such as the stagnation in the mid-1970s, seem to be due primarily to region-specific factors. At the same time, the region's declining reliance on cyclical industries has made the region's fortunes less closely tied to those of the nation. TRENDS AND CYCLES IN THE NEW YORK ECONOMY The quarterly growth (at quarterly rates) of national and regional employment and their decomposition into trend and cyclical components appear in Chart 1. The regional payroll employment figures used here and elsewhere in the paper are taken from the data set compiled by McCarthy and Steindel (1996). As in their paper, the New York metropolitan area refers to the New York City, Nassau-Suffolk, Duchess County, Jersey City, Bergen-Passaic, Newark, Middlesex-Somerset-Hunterdon, Monmouth-Ocean, Trenton, and New Haven-Bridgeport-Stamford-Danbury-Waterbury metropolitan statistical areas. Further details on the data set construction appear in their paper. U.S. employment data by industry are taken from the payroll employment survey. All data are seasonally adjusted. [Chart 1 OMITTED] These decompositions utilize a classification of economic fluctuations dating back to Burns and Mitchell (1946): fluctuations lasting between six and thirty-two quarters are defined as "cyclical," while those lasting more than thirty-two quarters are defined as "trend" components. …

Creating an Integrated Payment System: The Evolution of Fedwire

Abstract: The following paper is adapted from remarks given by Adam M. Gilbert before the Seminar on Payment Systems in the European Union. The seminar, sponsored by the European Monetary Institute, was held in Frankfurt, Germany, on February 27, 1997. On January 1, 1999, the countries participating in the European Union are expected to adopt a single currency and monetary policy. To support the creation of an integrated money market and the conduct of a unified monetary policy, the European Monetary Institute (EMI) and the national central banks in the European Union are developing a new payment system, the Trans-European Automated Real-Time Gross Settlement Express Transfer (TARGET) system. TARGET will interlink the advanced payment systems that the central banks of the European Union have agreed to implement in their own countries. This linkage will enable the banking sector to process cross-border payments in the new currency, the euro. As the European Union moves forward with TARGET, it is an appropriate time to reconsider the U.S. experience with Fedwire, the large-dollar funds and securities transfer system linking the twelve district Banks of the Federal Reserve System. (See the box for a brief overview of Fedwire.) Just as TARGET is designed to ease the flow of funds among financial institutions throughout Europe, Fedwire allows U.S. financial institutions to send and receive funds anywhere in the country through accounts at their local Reserve Banks. This paper Braces the evolution of Fedwire from twelve separate payment operations, linked only by an interdistrict communications arrangement, to a more unified and efficient system. Our account highlights both the difficulties the Federal Reserve encountered as it sought to standardize and consolidate payment services and the lessons it drew from its experience. These lessons may prove useful to the European Union and to other nations undertaking a similar integration of payment systems. ORIGINS OF THE FEDWIRE SYSTEM The motives for linking the payment systems of the twelve Reserve Banks in the early part of this century were not unlike the current goals of TARGET. Prior to and immediately following the creation of the Federal Reserve System in 1913, exchange rates governed payments across regions in the United States. Like foreign exchange rates under a gold standard, the regional exchange rates for the U.S. dollar moved in a narrow band established by the costs of shipping gold or currency--costs that included freight charges and the interest lost during the time it took for payments to be received (Garbade and Silber 1979, pp. 1-10). To address the regional differences in the value of the U.S. dollar and their perceived negative effect on business, the Federal Reserve took two steps shortly after its establishment. First, to eliminate the transit costs in payments, the Federal Reserve created the Gold Settlement Fund. Thereafter, commercial banks could settle both intradistrict and interdistrict transfers through their local Reserve Bank, which in turn would settle with other Reserve Banks through the Gold Settlement Fund. The arrangement permitted interdistrict balances to settle through book-entry transfers--a method of effecting settlements whereby debits and credits are posted to accounts--and made the physical shipment of gold or currency unnecessary. Second, the Federal Reserve inaugurated leased-wire communications among the Reserve Banks and transferred funds daily over the wire at no cost to member banks. This practice eliminated the interest losses that occurred during the time it took to transfer funds. By 1918, these two services helped abolish regional exchange rates and formed the basic structure of the modern Fedwire system (Garbade and Silber 1979, p. 10). NEW CHALLENGES: FEDWIRE IN RECENT DECADES Over the years, Fedwire grew more sophisticated as advances in technology were applied, but it remained structured as a system that linked twelve operationally unique units. …

National and Regional Factors in the New York Metropolitan Economy

Abstract: his paper explores the connections between broad economic indicators in the New York metropolitan region and their national counterparts. It compares the performance of the region in recent years with that of the nation and assesses

Business Services and the Economic Performance of the New York Metropolitan Region

Abstract: As correctly noted by Matthew Drennan in his paper for this conference, the nature of the transformation that has occurred in the New York metropolitan region since 1989 is rather mixed. Although the region has regained only half of the 625,000 jobs it lost during the 1989-92 period, aggregate earnings for the region, in real terms, are higher today than they were in 1989. This discrepancy does indicate steady gains in overall productivity for the metropolitan region as a result of both a continuing change in industry mix (from lower-productivity to higher-productivity industries) and productivity gains within individual industries (resulting from a relative shift from lower skilled to higher skilled work). In addition, data on per

The Performance of Metropolitan Area Industries

Abstract: The economy of the metropolitan region centered around New York City went into a sharp decline at the end of the 1980s. That decline was linked to the national recession, which began in 1989. The economic losses in the region were more severe than in most other metropolitan areas. (The reasons are documented in an earlier paper, Drennan {1996}.) The recovery of the region's economy has been slower than in most other regions as well. In the 1989-92 decline, the region lost 624,000 jobs, and in the recovery since 1992, the region has gained only 291,000 jobs, or less than half of those lost. But the aggregate employment numbers tell only part of the story. A more interesting, and less pessimistic, story is revealed in the earnings by sector and industry. Indeed, the aggregate earnings of the region are higher now, in real terms, than they were in 1988. That reflects higher productivity and, possibly, a shift in industry composition from less productive to more productive industries. In this paper, I analyze the performance of the region's industries over the recent economic decline and recovery. In the next section, I present the taxonomy of industries employed here. That taxonomy, adopted from international trade theory, displaces economic base theory, which sorts industries into basic (export) and nonbasic (local). The region's economy is compared with the national economy in the context of the taxonomy developed. I then present a model of regional economic growth based on trade, specialization, and agglomeration economies. That model, which seeks to explain growth of real per capita income, has been estimated with annual data for the region. The cross-section version of that model was developed in another paper (Drennan and Lobo 1996). A second model develops the exogenous character of the traded goods and services sector for aggregate regional growth. I conclude the paper by describing recent employment trends in the two-digit Standard Industrial Classification (SIC) industries of the region. TRADED GOODS AND SERVICES INDUSTRIES: BROAD TRENDS INTERNATIONAL TRADE THEORY AND ECONOMIC BASE THEORY International trade theory identifies two sectors in an economy: traded goods and services and nontraded goods and services. The first is subject to competition from other economies for both foreign markets and the local market. Changes in incomes, relative prices, demand, and exchange rates, both at home and abroad, affect the fortunes of the traded goods and services sector. The nontraded goods and services sector is not subject to competition from other economies and only produces for the local market. Wage levels in the nontraded goods and services sector, however, are determined by wages in the traded goods and services sector (Caves, Frankel, and Jones 1996). Economic base theory applies to regions, states, or urban areas within a nation. Again, the economy is split into two sectors: basic and nonbasic. The basic sector is engaged in competition for markets beyond the home region and is affected by changes in incomes, relative prices, and demand in other markets as well as in the home market. The nonbasic sector is not subject to competition from other economies, and its growth or decline depends entirely on the fortunes of the basic sector through a Keynesian-type multiplier. The crudest form of the economic base model assumes that all goods production (manufacturing and mining, as well as agriculture in a region that is not just urban) is basic, while everything else is nonbasic. Although that assumption may have been roughly right when it was first promulgated (Haig 1928), it is now silly and wrong. Private higher education in Boston, financial services in New York, tourism in Las Vegas, and even retirement communities in Fort Lauderdale are major "basic" industries for those cities, drawing in large revenues from nonresidents. A less crude form of the economic base model sorts industries into export and local based on location quotients. …

Industrial Restructuring in the New York Metropolitan Area

Abstract: Industrial restructuring is the ongoing process of reallocating workers among jobs in the economy as industries expand and contract. The New York metropolitan area economy underwent a significant amount of restructuring during the first half of the 1990s as a variety of factors--including new products, increased competition from other areas, and deregulation and fiscal problems--caused area firms and entire segments of industries to make permanent adjustments to employment levels. Downsizings, the sharp reductions in staffing by firms, were a prominent feature of the process. The area's steep 1989-92 downturn prompted many of these downsizings, but their persistence well into the recovery period contributed to a weakening job picture for several major sectors in the first half of the 1990s, particularly for manufacturing, finance, insurance, communications, chemicals, and the public sector. Industrial restructuring is not new to the metropolitan area; jobs in manufacturing have been giving way to employment in the service sector since the late 1960s, and back-office functions have been on the move to other regions for more than a decade. In addition, bouts of restructuring naturally accompany periods of economic instability. The fact that employment downsizings have, however, continued well past the start of the area's economic recovery in 1992 raises questions about the fundamental soundness of the metropolitan economy. Moreover, the downsizings have been more pervasive in the 1990s than in the past, affecting a wide range of metropolitan area industries and increasing the risk of job loss for a significant fraction of the area's work force. This paper analyzes the industrial restructuring process in the New York metropolitan area in the first half of the 1990s.(1) It shows that the restructuring was accompanied by a decline in the labor force, particularly in New York, where the decline persisted through the first half of the 1990s. The analysis also shows that a significant part of the area's restructuring in this period represents a continuation of the long-term trend away from manufacturing toward a service-oriented economy. This shift, while broadly in line with nationwide trends, has been somewhat more intense in the metropolitan area. Downsizings in government employment, especially in New York City, have also been a key feature of the area's restructuring process. Together, job losses in government and manufacturing have lowered job growth in the area over the past three years by an average of 0.5 percentage point annually. As a result of these industrial restructuring patterns, the service sector has become significantly more important in shaping the area's economic performance. THE CAUSES AND SCOPE OF RESTRUCTURING IN THE NEW YORK METROPOLITAN AREA Like the nation, the New York metropolitan area has been undergoing gradual but steady restructuring of its industries for several decades. The relatively high cost of doing business in the New York metropolitan area, changes in technology, population growth trends, and industrial location patterns are driving these long-term trends in regional employment. A variety of economic "shocks" emanating from local, industry, and national sources have also significantly influenced the industrial landscape and caused layoffs in the metropolitan area.(2) To assess the extent of restructuring in the New York metropolitan area in the first half of the 1990s, we examine two measures: the number of permanent job losses of metropolitan area workers and mass layoff announcements in the region. Determining the scale of job losses is the first step in identifying and estimating the impact of industrial restructuring on the work force. ESTIMATES OF PERMANENTLY DISPLACED WORKERS Our first measure of restructuring, the number of permanently displaced workers, comprises those workers of at least twenty years of age who have been displaced from a job held for three years or more because of plant closings, job eliminations, or lack of work. …

German Monetary Targeting: A Precursor to Inflation Targeting

Abstract: Many features of the German monetary targeting regime are also key elements of inflation targeting in the other countries examined in this study. Indeed, as pointed out in Bernanke and Mishkin (1997), Germany might best be thought of as a "hybrid" inflation targeter, in that it has more in common with inflation targeting than with a rigid application of a monetary targeting rule. The German experience with monetary targeting, which spans more than twenty years, provides useful lessons for the successful operation of inflation targeting, and this is why we study the German experience here. Several themes emerge from our review of Germany's experience with monetary targeting:(1) * A numerical inflation goal is a key element in German monetary targeting, suggesting that the differences between monetary targeting as actually practiced by Germany and inflation targeting as conducted by other countries are not that great. * German monetary targeting is quite flexible: convergence of the medium-term inflation goal to the long-term goal has often been quite gradual. * Under the monetary targeting regime, monetary policy has been somewhat responsive in the short run to real output growth as well as to other considerations such as the exchange rate. * The long-term goal of price stability has been defined as a measured inflation rate greater than zero. * A key element of the targeting regime is a strong commitment to transparency and to communication of monetary policy strategy to the general public. THE ADOPTION OF MONETARY TARGETING The decision to adopt monetary targeting in Germany, though prompted by the breakdown of the Bretton Woods fixed exchange rate regime, was a matter of choice. Germany was not under any pressure at the time to reform either its economy in general or its monetary regime in particular--in fact, the breakdown of Bretton Woods was in part due to the extreme relative credibility of the German central bank's commitment to price stability and the concomitant appreciation of the deutsche mark. Under these circumstances, the loss of the exchange rate anchor was not the sort of credibility crisis where macroeconomic effects demanded an immediate response, as demonstrated by the slow (two-to-three-year-long) move to the new regime. Close analysis of the historical record suggests that two main factors motivated the adoption of monetary targeting in Germany. The first factor was an intellectual argument in favor of a nominal anchor for monetary policy grounded in an underlying belief that monetary policy should neither accommodate inflation nor pursue medium-term output goals.(2) The second factor was the perception that medium-term inflation expectations had to be locked in when monetary policy eased as inflation came down after the first oil shock. The generalization over time of this latter motivation--that monetary targeting provides a means of transparently and credibly communicating the relationship between current developments and medium-term goals--was the guiding principle of the newly adopted framework in Germany. On December 5, 1974, the Central Bank Council of the Deutsche Bundesbank announced that "from the present perspective it regards a growth of about 8% in the central bank money stock over the whole of 1975 as acceptable in the light of its stability goals."(3) The Bundesbank considered this target to "provide the requisite scope . . . for the desired growth of the real economy," while at the same time the target had been chosen "in such a way that no new inflationary strains are likely to arise as a result of monetary developments." Since 1973, the Bundesbank had used the central bank money stock (CBM) as its primary indicator of monetary developments, but never before had it announced a target for the growth of CBM or any other monetary aggregate.(4) Although this was a unilateral announcement on the part of the Bundesbank, the announcement stressed that "in formulating its target for the growth of the central bank money stock [the Bundesbank] found itself in full agreement with the federal government. …

Technological Trends Affecting the Manufacturing Sector of New York City

Abstract: For almost half a century, manufacturing has been declining in New York City. In 1950, there were about 1 million manufacturing jobs in New York City; in June 1994, there were 286,000 manufacturing jobs in the city. During the past two decades, from 1974 to 1994, manufacturing jobs in the city declined by more than 50 percent. The loss of manufacturing jobs has created a widespread sense that manufacturing in New York City has no future, that the decline is unstoppable and "largely inevitable and foreordained" (Fitch 1993, p. 107). Even the optimistic report of the Commission on the Year 2000, New York Ascendant, predicted "an ongoing decline in manufacturing," though it recognized that high-value manufacturing could compete in New York City and that "the city should make every effort to support the manufacturing that can be successful here" (Commission on the Year 2000 1987, pp. 30-1). Despite the substantial losses in manufacturing over the past two decades, manufacturing is still a vital though diminished - part of New York City's economy. Within the context of a massive decline in manufacturing jobs, there has been a remarkable change in the structure and character of manufacturing activities in New York City that warrants serious attention by researchers and policymakers. The manufacturing sector - because it is dispersed throughout neighborhoods in all five boroughs and predominantly consists of small businesses - is not well situated to act as a strong presence in the city's most prominent civic and business organizations. As a result, leaders of the city's business community often inadvertently overlook the needs of manufacturing firms in their lobbying and advocacy activities. The factors that have contributed to the outmigration of manufacturing firms from New York City are frequently cited, such as high taxes, inadequate rail infrastructure, union work rules, excessive regulation, unskilled labor, and crime. But remarkably little attention is given to the forces that have allowed manufacturing firms to remain, expand, and even start up in New York City. Recent technological and market trends have helped trigger the growth of small-scale manufacturing firms in New York City. Three forces are crucial to the future of manufacturing in New York City: First, technological change has undermined traditional economies of scale and is favoring small firms that adopt innovations and invest in advanced computer and telecommunications systems. In the post-World War II environment, the advent of the mass assembly factory - which required large amounts of horizontal space - forced many firms to leave the loft factories of the Bronx, Brooklyn, and Manhattan for suburban sites in New Jersey, on Long Island, and in other states. While many plants still produce large batches of standardized products, there has been a "shift of the production system in the direction of a complex of smaller, specialized plants focusing on small batch outputs and able to move rapidly in and out of particular market niches" (Scott and Storper 1990, p. 10). Productivity is no longer associated with the size of the production run. Furthermore, computer-based systems used for the design, control, and tracking of production processes have often reduced the amount of physical space required for manufacturing operations, making it possible to locate manufacturing within the confines of urban factories and warehouse buildings. The advantage of specialization is apparent to a Brooklyn-based manufacturer of specialty glass who said, "We are small and very versatile. We're able to turn a job around in two-and-a-half to three weeks. We're quicker basically because we handle smaller, more specialized jobs than most of our competitors." In the food industry, a firm that produces specialty hors d'oeuvres and desserts has acquired space once used for meat cutting, storage, and refrigeration in Manhattan's Fourteenth-Street meat market district. …

The Outlook for the Metropolitan Area

Abstract: Much of the discourse about regional and local economic development strategies in the United States over the past twenty-five years has looked like a search for general rules. Very few such rules have emerged, in part because--like all policy debates--there have been large inputs of ideology and self-interest, as well as professional inquiry, but in part because the appropriate strategies really are time- and place-specific. The strategies that are right depend on, first, the diagnosis of the economic problems and potential of that region or city at that time and, second, an assessment of just what it is that intervention can achieve in the circumstances of time and place. The authors of the other papers presented at this conference deal systematically and exhaustively with the fundamentals of the New York region's economic conditions and prospects, but it is essential that this paper start with an exposition of the economic setting for the discussion of policy intervention that comprises the bulk of the paper. THE NEW YORK ECONOMY IN THE LONG TERM: THE PAST Twenty years ago, most observers projected continual decline in the New York economy, and almost any economic development strategy seemed pointless.(1) Indeed, in the mid-1970s--beginning before the fiscal crisis of 1975--the city and state governments of New York were making virtually no capital expenditures remotely related to economic development. Instead, capital budgets were devoted to subsidized housing, public office buildings, and current operating expenditures like "transit fare stabilization." The scattered tax incentive measures (in the midst of" frequent tax increases) involved extremely deep subsidies, sometimes providing for recovery of more than 100 percent of the private investment from reductions in taxes that would have been payable in the absence of the new investment, in addition to exemption from much of the taxes that should have been triggered by the investment. The first major commercial building project after the slump--Donald Trump's conversion of the old Commodore Vanderbilt Hotel into the Grand Hyatt--involved incentives that virtually eliminated any risk for Trump and his partners. In contrast, less than ten years ago, projections were so optimistic that many critics of the city government saw no need for public subsidies or tax preferences to foster economic growth.(2) The critics often urged not only the elimination of subsidies but also increases in business property taxes. Although at the extremes of despair and optimism no economic development strategies may make sense, between those extremes the long-term economic prognosis does make considerable difference in prescribing economic development strategies. It helps, in thinking about the economic future of the region, to briefly review the past. New York's economic history since the completion of the Erie Canal in 1825 has been one of almost continuous rise and fall of particular industries and sectors, with the sectors that were the well-springs of the economy in one generation fading and being displaced by new sectors (see Hoover and Vernon {1959} for the classic statement of this idea). Through the 1940s, the result of the displacement process was net growth in the aggregates (employment being the only one that really was measured in those years): the increases in economic activity in the rising sectors, together with the multipliers in local consumer-serving activities, exceeded the declines in the shrinking sectors. In the 1950s, for the first time ever in a period of national economic prosperity there was almost no net growth in employment in New York City, as fairly strong growth in office activities was balanced by the onset of substantial losses in a wide range of manufacturing and other goods-handling activities. There was, however, considerable growth in the rest of the New York region. The Vernon study of the economic future of the New York region, published in 1959 and 1960, projected more of the same through 1985, but with net growth in New York City from very strong office activities and a large consumer-sector multiplier and considerable growth in the rest of the region. …

The Securities Industry and the New York-New Jersey Region

Abstract: The securities industry in the New York--New Jersey region is currently enjoying strong growth in employment and salaries. The industry is particularly important to the region because it is concentrated locally and pays high wages. Although vulnerable to stock and bond market fluctuations, the industry has positive long-term prospects. The benefits from future growth, however, will likely flow predominantly to highly skilled workers as rapid technological change continues to widen existing income differentials. RECENT DEVELOPMENTS IN THE REGION Employment and salaries in the region's securities industry have recovered since coming off their previous peaks in the late 1980s. Chart 1 presents data on employment (top panel) and real salaries (bottom panel) in the securities industry for both New York State and New Jersey. Securities industry employment peaked at more than 180,000 jobs in 1987, then dropped to 155,000 at its trough in 1991. Since then, employment growth has increased steadily and may reach 190,000 jobs by year-end 1996. Annual salaries have recovered even more strongly: after rising above $18 billion (1995 dollars) in 1988, they dropped to $16 billion in 1989-91, then surged above $22 billion in 1992. Between 1993 and 1995, salaries averaged more than $21 billion and are expected to be strong again in 1996. [Chart 1 OMITTED] THE INDUSTRY'S IMPORTANCE IN THE REGION The economic impact of the securities industry is greater than suggested by its job numbers alone. First, the industry is heavily concentrated within the region. While it provides about 2.5 percent of all private sector jobs in New York State, about 90 percent of these jobs are in New York City, where the industry accounts for 5.3 percent of all private sector jobs. In New Jersey, the securities industry provides only 0.9 percent of private sector jobs, but the state's share of securities industry employment is growing. The industry provides a very significant share of the region's private salaries, 7.5 percent in New York State and 1.9 percent in New Jersey. In addition, the industry's impact extends into other sectors of the economy through the demand for ancillary services. For the past several years, employment and salaries have been moving out of New York into New Jersey, reflecting the gradual shift of back-office jobs from the higher cost to the lower cost state. The recent performance of the region's securities industry contrasts sharply with the performance of the financial sector as a whole (Chart 2). Over the past fifteen years, the shares of regional employment held by the banking and insurance industries have been shrinking, while the share of the securities industry has been rising. An even greater difference, however, is evident in the shares of private salaries held by the three industries. The banking and insurance shares have been relatively flat, while the securities share has been rising sharply. [Chart 2 OMITTED] Chart 3 provides another perspective on the importance of the securities industry to the region's broader economy. The chart depicts the annual growth in total private compensation and salaries for all workers in New York State and for employees of the securities industry subset of the larger group. …

How Successful Has Inflation Targeting Been

Abstract: An initial look suggests that inflation targeting has been a success: inflation was within or below the target range for all targeting countries, and noticeably below the countries' average inflation levels of the 1970s and 1980s. The macroeconomic baselines shown in the chart series in Parts III-VI of this study indicate that the reduced inflation levels in these countries were sustained without benefit or harm from unusual macroeconomic conditions. In New Zealand, the disinflation during the four years prior to target adoption was accompanied by a period of sluggish GDP growth and, since 1988, rising unemployment. The continuation of the disinflation during 1990-91, amid recession in many other Organization for Economic Cooperation and Development (OECD) economies, led to recession and sharply rising unemployment. In Canada, the disinflation was achieved along with continued progress in lowering unemployment, only a brief spike in nominal interest rates, and continued positive, though slowing, growth. Similarly, in the United Kingdom, the disinflation begun two years prior to target adoption (during membership in the Exchange Rate Mechanism) continued against a background of improving growth, falling unemployment, and much lower nominal interest rates in the wake of the United Kingdom's exit from the European Monetary System. Yet, while the reduction of inflation in these three countries represents a genuine achievement, it is not clear whether the reduction was the result of forces that had already been put in place before inflation targeting was adopted. Did the adoption of an inflation target in the countries considered here have an effect on inflation and on its interaction with real economic variables? In this section, we provide some tentative evidence on this question by undertaking a very simple forecasting exercise. (Additional evidence from a wider range of statistical investigations on a larger set of countries is found in Laubach and Posen [1997b].) We estimate a three-variable unrestricted vector autoregression (VAR) model of core inflation, GDP growth, and the central bank's overnight instrument interest rate from the second quarter of 1971 to the date of target adoption; we then allow the system to run forward five years from the time of target adoption, plugging in the model's forecast values as lagged values.(1) This exercise is meant to give a quantitative impression of whether the interaction between inflation and short-term interest rates exhibits a pattern of behavior after the adoption of the inflation target that differs markedly from the pattern before.(2) The unconditional forecast of each variable represents the way we would expect the system to behave in the absence of shocks from the situation at the time of target adoption. The comparison between what actually happened to these variables and their unconditional forecast is reasonable for the early 1990s, given the absence of major supply and demand shocks since adoption for the three inflation targeters we examine.(3) In the three countries adopting inflation targets, disinflation through tighter monetary policy had largely been completed by the time the target was adopted, allowing interest rates to come down. (The year or so of further disinflation appears to be attributable to prior monetary policy moves, given policy lags.) This sequence of events is consistent with our finding in the case studies that countries adopted targets when they wished to lock in inflation expectations at a low level after a disinflation. …

Potential Employment Effects of the Restructuring of Retail Banking

Abstract: The largest U.S. commercial banks are currently in the process of restructuring their retail operations. A stagnant deposit base and intense competition in the marketplace for financial services have made the overhead costs of an extensive branch network increasingly onerous. At the same time, advances in electronic communications technology are making low-cost remote delivery of banking services more of a reality. In response, banks are taking several important steps to restructure their branch systems. This presentation will focus on two of these steps: the substitution of supermarket (also called in-store) branches for traditional offices and the expansion of telephone banking through twenty-four-hour phone centers. 1