John A. Tatom

U.S. monetary policy in disarray

Monetary policy became more difficult to characterize during and after the mortgage foreclose and financial crises because of a shift to a new credit policy focused on private sector credit and that relies on traditional commercial banking strategies. The new credit policy broke the tight link that had existed between Fed credit and its effective monetary base, the monetary base that affects monetary aggregates. The Fed has adopted an exit strategy, but the discretionary powers that it followed remain in place as does a mistaken policy on the payment of interest on excess reserves.

The P-Star Approach to the Link Between Money and Prices

This paper examines several specification errors in the M2-based P* model and develops an M1-based estimate of this model. The apparent statistical significance of M2 is shown to arise from a spurious regression that uses a non-stationary regressor and because the significance test for M2 is biased by including the influence of a lagged dependent variable whose coefficient is not normally distributed. When these problems are addressed, M2 is not statistically significant related to the price level. The M1-based P* model exhibits a significant relationship between M1 and the price level, however.

Predicting Failure in the Commercial Banking Industry

The ability to predict bank failure has become much more important since the mortgage foreclosure crisis began in 2007. The model proposed in this study uses proxies for the regulatory standards embodied in the so-called CAMELS rating system, as well as several local or national economic variables to produce a model that is robust enough to forecast bank failure for the entire commercial bank industry in the United States. This model is able to predict failure (survival) accurately for commercial banks during both the savings and loan and the mortgage foreclosure crises. Other important results include the insignificance of several factors proposed in the literature, including total assets, real price of energy, currency ratio and the interest rate spread.

Monetary and Exchange Rate Policy in Austria: An Early Example of Policy Coordination

This paper describes the evolution of Austrian exchange rate and monetary policy as an example of the benefits of policy coordination and credibility. This policy proved the performance of the Central Bank in achieving its twin objective of stabilizing the internal and external value of the currency. In this process, policymakers have sought to exploit the advantages of credibility by building a reputation for sticking to their policy. The evidence presented exhibits the increased coordination between Austrian and German nominal aggregates in the course of time. These accomplishments have apparently not tequired tying the real performance of the Austrian economy to any adverse permanent real consequences of German monetary policy, in particular, to its inflation-unemployment trade off.

The Link Between Monetary Aggregates and Prices

This paper examines the P-star model of the link between M2 and prices recently developed by Haliman, Porter and Small (1989, 1990) (HPS). It also develops an Ml-based variant of the P-star model. The analysis points out and corrects, for the most part, several major shortcomings in the P-star approach. When these corrections are made, the P-star model shows no statistically significant linkage between M2 and prices; there is, however, a significant link between Ml and prices in the Mi-based version of the P-star model.

Financial Legislation: The Promise and Record of the Financial Modernization Act of 1999

On November 12, 1999, President Clinton signed the most significant piece of financial services regulation to be enacted since the Great Depression, at least up to that time. When the Financial Service Modernization Act of 1999, better known as the Gramm-Leach-Bliley Act (GLBA), was signed, the financial services industry faced strong pressures for deregulation of the rigid structure imposed during the Great Depression. During the 2007-08 financial crises and ensuing debate regarding financial services regulation, the GLBA became a target as members of the financial sector, academia and government considered possible triggers that may have precipitated the crisis.

Is Inequality Growing as American Workers Fall Behind

This article looks at reasons why income inequality could rise and then explores whether, in fact, workers are losing out. It examines whether workers are falling behind relative to the wealthy and whether real wages have been falling or perhaps only manufacturing wages. It also examines whether there is a growing “wealth gap” and why it could be developing. Finally, it examines the hypothesis that relatively inexperienced or unskilled workers are falling behind. The paper concludes that there is a wealth gap, but that it is due to falling real interest rates not declining compensation. Other indicators of inequality may be growing as well, but it is not because compensation is falling short of rapid productivity growth or because workers are falling behind other income recipients.

Why Have Interest Rates Been so Low

This paper looks at interest rate developments in the US and argues that long-term real interest rates are at lows not seen in the past 50 years. It explores competing hypotheses that there is a global saving glut, there is conundrum or that global capital formation has slowed. The dominant view is a glut of saving, especially in China and Asia, that is depressing global real interest rates and boosting growth. While private sector capital formation remains at historic strong levels in the US, the same is not the case abroad. Unfortunately strong saving in China had not resulted in a boom in saving in Asia or globally. A decline in global capital formation is the proximate cause of depressed real interest rates. This is not a cyclical problem that is likely to go away with a rebound in economic activity in Asia or Europe. The implications for economic growth are dismal, despite notable exceptions in China and the US.

Will China Surpass the United States

Extrapolations of China’s growth suggest that China will soon surpass in size and prosperity the leading developed economies, even the United States. China has several advantages that suggest such convergence possibilities, including its land mass, large population, and rapid transformation over nearly three decades. However, there are serious disadvantages that will lessen the pace of convergence in future. This chapter provides several scenarios for the relative size of China’s GDP and for convergence of her income per capita. Under plausible assumptions, China will not reach the US standard of living until late in this century, at the earliest. Nonetheless, due to the size of its economy and markets, it will have a relatively large share of production and consumption of most goods and services in a few decades. Experience elsewhere, especially among China’s richest neighbors, indicates that convergence is unlikely even by then. China faces four trends that make even this possibility unlikely: urbanization, the transition from state ownership to private sector control of capital, slowing population growth, and rising political risks. The first two forces have been important to China’s success but are transitory and will work to reduce growth in the future. The financial sector’s development could extend the period of rapid productivity growth in China and could even allow the country to become the financial center of Asia. This would not alter the basic conclusions for the relative size of the economy or its convergence, however.

The United States–China Currency Dispute: Is a Rise in the Yuan Necessary, Inevitable, or Desirable?

China-bashing has become a popular media and political sport. This is largely due to the US trade imbalance and the belief, by some, that China is responsible for it because it manipulates its currency to hold down the dollar prices of its goods, unfairly creating a trade advantage that has contributed to the loss of US businesses and jobs. This chapter reviews the problem of the large trade imbalance that the United States has with China and its relationship to Chinese exchange rate policy. It examines the link between a Chinese renminbi appreciation and the trade balance and also whether a generalized dollar decline could solve the global or Chinese–US trade imbalance. The consensus view explained here is that a renminbi appreciation is not likely to fix either the trade imbalance with China or overall. If these perceived benefits of a managed float are small or nonexistent, then perhaps they should be pursued anyway because of small costs or even benefits for China. Section 4 looks at the costs of a managed float in terms of the benefits of the earlier peg. Opponents of a fixed dollar/yuan exchange rate ignore the costs of a managed float for China, especially with limits on currency convertibility. These costs are outlined here in order to provide an economic basis for the earlier fixed rate and China’s reluctance to appreciate. Finally it is suggested that the necessary convertibility on capital account, toward which China is moving, could easily result in yuan depreciation under a floating rate regime. This is hardly the end that China critics have in mind, and it is not one that would improve US or other trade imbalances with China.