Cara S. Lown

An Indicator of Future Inflation Extracted from the Steepness of the Interest Rate Yield Curve Along its Entire Length

It is often suggested that the slope of the term structure of interest rates contains information about the expected future path of inflation. Mishkin (1990) has recently shown that the spread between the 12-month and 3-month interest rates helps to predict the difference between the 12-month and 3-month inflation rates. His approach however, lacks a theoretical foundation, other than the (rejected) hypothesis that the real interest rate is constant. This paper applies a simple existing theoretical framework, which allows the real interest rate to vary in the short run but converge to a constant in the long run, to the problem of predicting the inflation spread. It is shown that the appropriate indicator of expected inflation can make use of the entire length of the yield curve, in particular by estimating the steepness of a specific nonlinear transformation of the curve, rather than being restricted to a spread between two points. The resulting indicator, besides having a firmer theoretical foundation does a relatively good job of predicting the inflation rate over the period 1960 to 1988.

The behavior of consumer loan rates during the 1990 credit slowdown

Abstract This study re-examines the 1990 credit slowdown by investigating the loan pricing behavior of commercial banks. We find strong evidence that large, undercapitalized banks contributed to the credit slowdown by charging consumers a higher-than-average loan rate relative to better-capitalized institutions. This disparity in lending exists even after accounting for bank funding costs. Thus, we argue that there was a lending slowdown that occurred among large, undercapitalized banks. The reluctance to lend among undercapitalized banks is at least suggestive of behavior that is consistent with a credit crunch.

What Was Behind the M2 Breakdown

A deterioration in the link between the M2 monetary aggregate and GDP, along with large errors in predicting M2 growth, led the Board of Governors to downgrade the M2 aggregate as a reliable indicator of monetary policy in 1993. In this paper, we argue that the financial condition of depository institutions was a major factor behind the unusual pattern of M2 growth in the early 1990s. By constructing alternative measures of M2 based on banks’ and thrifts’ capital positions, we show that the anomalous behavior of M2 in the early 1990s disappears. Specifically, after accounting for the effect of capital constrained institutions on M2 growth, we are able to explain the unusual behavior of M2 velocity during this time period, obtain superior M2 forecasting results, and produce a more stable relationship between M2 and the ultimate goals of policy. Our work suggests that M2 may contain useful information about economic growth during periods of time when there are no major disturbances to depository institutions

Bank Credit and Economic Activity: Evidence from the Texas Banking Decline

In the latter half of the 1980s, banking difficulties were concentrated in Texas. Because of the magnitude of these financial difficulties, interest has focused on whether an alleged inability or unwillingness of Texas banks to extend loans hampered economic growth in the state. Using various measures of banking-sector activity and economic activity in Texas over the period 1976:I-1990:IV, a structural VAR model of the Texas economy is estimated. Variance decompositions measure the interdependence of the banking and real sectors of the economy. Our results indicate a strong effect from the real sector to the financial sector. We find little evidence, though, that the deterioration observed in the Texas banking sector contributed to reduced economic growth.