Federal Reserve Bank of St. Louis Review

A quarterly research journal intended for an economically informed but broad readership—from the undergraduate student to the PhD. In print and online.

NOVEMBER/DECEMBER 2004 Vol. 86, No. 6

The Increasing Importance of Proximity for Exports from U.S. States

Changes in income, trade policies, transportation costs, technology, and many other variables affect the geographic pattern of international trade flows. This paper focuses on the changing geography of merchandise exports from individual U.S. states to foreign countries. Generally speaking, the geographic distribution of state exports has changed so that trade has become more intense with nearby countries relative to distant countries. All states, however, did not experience similar changes. As measured by the distance of trade, which is the average distance that a state’s international trade is transported, 40 states experienced a declining distance of trade, while 11 states (including Washington, D.C.) experienced an increasing distance of trade. Evidence, albeit far from definitive, suggests that declining transportation costs over land, the implementation of the North American Free Trade Agreement, and faster income growth by nearby trading partners relative to distant partners have contributed to the changing geography of state exports.

Monetary Policy and Asset Prices: A Look Back at Past U.S. Stock Market Booms

This article examines the economic environments in which past U.S. stock market booms occurred as a first step toward understanding how asset price booms come about and whether monetary policy should be used to defuse booms. The authors identify several episodes of sustained rapid rises in equity prices in the 19th and 20th centuries, and then assess the growth of real output, productivity, the price level, and money and credit stocks during each episode. Two booms stand out in terms of their length and rate of increase in market prices—the booms of 1923-29 and 1994-2000. In general, the authors find that booms occurred in periods of rapid real growth and productivity advancement, suggesting that booms are driven at least partly by fundamentals. They find no consistent relationship between inflation and stock market booms, though booms have typically occurred when money and credit growth were above average.

What Does the Federal Reserve’s Economic Value Model Tell Us About Interest Rate Risk at U.S. Community Banks?

The savings and loan crisis of the 1980s revealed the vulnerability of some depository institutions to changes in interest rates. Since that episode, U.S. bank supervisors have placed more emphasis on monitoring the interest rate risk of commercial banks. Economists at the Board of Governors of the Federal Reserve System developed a duration-based economic value model (EVM) designed to estimate the interest rate sensitivity of banks. The authors test whether measures derived from the Fed’s EVM are correlated with the interest rate sensitivity of U.S. community banks. The answer to this question is important because bank supervisors rely on EVM measures for monitoring and risk-scoping bank-level interest rate sensitivity. The authors find that the Federal Reserve’s EVM is indeed correlated with banks’ interest rate sensitivity and conclude that supervisors can rely on this tool to help assess a bank’s interest rate risk. These results are consistent with prior research that finds the average interest rate risk at banks to be modest, though the potential interaction between interest rate risk and other risk factors is not considered here.

Discrete Policy Changes and Empirical Models of the Federal Funds Rate

Empirical models of the federal funds rate almost uniformly use the quarterly or monthly average of the daily rates. One empirical question about the federal funds rate concerns the extent to which monetary policymakers smooth this interest rate. Under the hypothesis of rate smoothing, policymakers set the interest rate this period equal to a weighted average of the rate inherited from the previous quarter and the rate implied by current economic conditions, such as the Taylor rule rate. Perhaps surprisingly, however, little attention has been given to measuring the interest rate inherited from the previous quarter. Previous tests for interest rate smoothing have assumed that the quarterly or monthly average from the previous period is the inherited rate. The authors of this study, in contrast, suggest that the end-of-quarter level of the target federal funds rate is the inherited rate, and empirical tests support this proposition. The authors show that this alternative view of the rate inherited from the past affects empirical results concerning interest rate smoothing, even in relatively rich models that include regime switching.


SEPTEMBER/OCTOBER 2004 Vol. 86, No. 5

Free Trade: Why Are Economists and Noneconomists So Far Apart?

Free Trade Has Costs, but Who Really Wins and Loses? There’s a wide gap between economists’ and the public’s opinions of free trade: The vast majority of economists is for it, while a strong majority of the general public is against it. Bank president Bill Poole explains the gap and how diligent journalists can help close it.

Trends in the Efficiency of Federal Reserve Check Processing Operations

The Challenges of Checks. 17.1 billion: That’s how many checks the Federal Reserve processed in 1999. But that number continues to decline as electronic payments increase. David Wheelock and Paul Wilson report new information about the Fed’s efficiency and how to estimate it.

Testing the Expectations Hypothesis: Some New Evidence for Japan

The EH in Japan. Deregulation of financial markets in Japan has prompted several investigations of the expectation hypothesis (EH) of the term structure of interest rates. Daniel Thornton expands this literature by estimating a general VAR of the long- and short-term rates and testing restrictions implied by the EH under alternative assumptions about the stationarity of interest rates. He also considers the implications of nonstationarity of interest rates for the EH itself.

Asymmetric Effects of Monetary Policy in the United States

Using M1, economists Morten Ravn and Martin Sola achieve results that match previous findings on the size and sign of monetary policy shocks: Positive shocks have larger real effects. Using the federal funds rate, however, they find that only small negative shocks affect real aggregate activity.


JULY/AUGUST 2004 Vol. 86, No. 4

Inflation Targeting: Prospects and Problems

Proceedings of the Twenty-Eighth Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis

Complete Issue

Includes proceedings of the Twenty-Eighth Annual Economic Policy Conference of the Federal Reserve Bank of St. Louis, "Inflation Targeting: Prospects and Problems".

Editors' Introduction

Inflation Targeting and Optimal Monetary Policy


Commentary on "Inflation Targeting and Optimal Monetary Policy"

The Macroeconomic Effects of Inflation Targeting


Commentary on "The Macroeconomic Effects of Inflation Targeting"

The Role of Policy Rules in Inflation Targeting


Commentary on "The Role of Policy Rules in Inflation Targeting"

Is Inflation Targeting Best-Practice Monetary Policy?


Commentary on "Is Inflation Targeting Best-Practice Monetary Policy?"


Commentary on "Practical Problems and Obstacles to Inflation Targeting"

Panel Discussion: Inflation Targeting


MAY/JUNE 2004 Vol. 86, No. 3

Best Guesses and Surprises

This article was originally presented as a speech at the Charlotte Economics Club, Charlotte, North Carolina, February 25, 2004.

Monetary Policy Actions, Macroeconomic Data Releases, and Inflation Expectations

This article analyzes how announced surprises in monetary policy actions and macroeconomic data releases affect the average rate of inflation that economic agents expect to prevail over the 10-year period following the surprise. The analysis also addresses the effect of Federal Reserve communication and surprises in monetary policy actions on perceived inflation risk over this 10-year period. The study shows that surprises in macroeconomic data releases and monetary policy actions indeed affect the expected rate of inflation. Further, there is evidence that surprises in monetary policy actions increase perceived inflation risk, whereas Federal Reserve communication reduces it.

A Rational Pricing Explanation for the Failure of CAPM

Many authors have found that the capital asset pricing model (CAPM) does not explain stock returns—possibly because it is only a special case of Merton’s (1973) intertemporal CAPM under the assumption of constant investment opportunities (e.g., a constant expected equity premium). This paper explains the progress that has been made by dropping the assumption that expected returns are constant. First, the evidence on the predictability of returns is summarized; then, an example from Campbell (1993) is used to show how time-varying expected returns can lead to the rejection of the CAPM.

How Costly is Sustained Low Inflation for the U.S. Economy?

The authors study the welfare cost of inflation in a general equilibrium life-cycle model that includes households that live for many periods, production and capital, simple monetary and financial sectors, and a fairly elaborate government sector. The government’s taxation of capital income is not indexed for inflation. They find that a plausibly calibrated version of this model has a steady state that matches a variety of facts about the postwar U.S. economy. They use the model to estimate the welfare cost of permanent, policy-induced changes in the inflation rate and find that most of the costs of inflation are direct and indirect consequences of the fact that inflation increases the effective tax rate on capital income. The cost estimates are an order of magnitude larger than other estimates in the literature.


MARCH/APRIL 2004 Vol. 86, No. 2

State Government Finances: World War II to the Current Crises

The State of the States: This article examines the current state budget crises against the historical backdrop of past crises and states’ evolving recipes for tax revenue.

The Federal Reserve Responds to Crises: September 11th Was Not the First

A Fed for All Seasons: This article examines the role the Fed has played in mitigating the financial impact of recent crises (including the 9/11 attacks).

Timeless Perspective vs. Discretionary Monetary Policy in Forward-Looking Models

On the Timeless Perspective: This article examines the distinction between the timeless perspective and discretionary modes of monetary policymaking.

To request copies of the programs used to generate Tables 1-8, please contact the authors at edward.nelson@stls.frb.org or bm05@andrew.cmu.edu. You may also visit Bennett McCallum's web page at http://public.tepper.cmu.edu/facultydirectory/FacultyDirectoryProfile.aspx?id=96.


JANUARY/FEBRUARY 2004 Vol. 86, No. 1

Casino Gaming and Local Employment Trends

When the chips are down. Cities and rural counties alike are increasingly looking to casino gambling to boost employment and growth. Tom Garrett examines when that bet pays off and when it doesn’t.

U.S. Regional Business Cycles and the Natural Rate of Unemployment

Unemployment: separate and unequal. Economic forecasters and policy advisors look closely at unemployment. The authors suggest that regional differences deserve a closer look when calculating the country’s overall “natural” rate of unemployment.

Subjective Probabilities: Psychological Theories and Economic Applications

The psychology gap. In their models, economists assume people plan their lives rationally. Psychologists show that people rely on loose rules of thumb to predict the future. In this article, the authors discuss the gap.

The Efficient Market Hypothesis and Identification in Structural VARs

The EMH and the SVAR. The authors add to the literature on structural vector autoregression models by showing that, if it includes one or more variables efficient in the strong form of the efficient market hypothesis, the identifying restrictions frequently imposed in SVARs cannot be satisfied.


Subscribers: Our Review policy has changed. Use the Subscription Renewal Form to submit a request to continue your print subscription to Review.

Email changes in your subscription information to webmaster@research.stlouisfed.org.

Subscribe to our newsletter for updates on published research, data news, and latest econ information.
Name:   Email:  
Twitter logo Google Plus logo Facebook logo YouTube logo LinkedIn logo