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r*®) Economic
tautii Review
SUMMER 1987
FEDERAL RESERVE BANK OF ATLANTA
Special Issue
Policy Challenges
in a
Global Economy
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I S S N 0732-1813
V O L U M E LXXII, NO. 3/4, S U M M E R I987, ECONOMIC R E V I E W
Constructing and
Using Exchange Rate Indexes
Jeffrey A. Rosensweig
Efficiency and the
Flexible Exchange Rate System
Russell S. Boyer
Direct Investment Activity
of Foreign Firms
William J. Kahley
By exploring the major issues entailed
in the creation of an exchange rate
index, this study helps users decide
which index best suits their purposes.
This article contends that, rather than
being frequently misaligned, the
exchange rate appears to move quickly
to its equilibrium value, suggesting that
proposals to control currency alignments
are at best unnecessary.
What motivates foreigners to invest in
the United States? The effects of market
size and market imperfections like
industry concentration are reviewed,
and new paths for inquiry are
suggested.
52
R. Mark Rogers
65
Book Review
In Whose Interest ? International
Steven P. Feinstein
and American
F.Y.I.
Effects of Oil Price Shocks on Measured
G N P Growth
Banking
Foreign Policy
by Benjamin J. Cohen
AO
Statistical Pages
Finance, Employment, General
Construction
f
FEDERAL RESERVE BAN K OF ATLANTA
2l
Exchange rate indexes have b e e n crucial indicators of currency values since the advent of
floating exchange rates in the early seventies.
The slow response of the U.S. trade balance to
recent declines in the dollar's value has stimulated still more interest in how exchange rate
indexes are constructed and what they tell us. In
the past year alone, a number of new dollar
indexes, including the three constructed at the
Federal Reserve Banks of Atlanta, Dallas, and
Chicago, have e m e r g e d alongside the more
familiar Federal Reserve Board and Morgan
Guaranty Trust indexes. Each of these reflects a
different way of dealing with the issues that
arise in exchange rate index construction, and
each therefore provides a slightly different picture of the dollar's value against other currencies. (Their features are outlined in Box I.)
Examining the major issues should help clarify
differences in exchange rate indexes and help
index users determine which one best suits
their purposes.
Exchange rate indexes summarize information contained in the many bilateral exchange
rates that apply to a particular currency in order
to gauge the average value of that currency
against others. 1 They are used to analyze or
forecast the influence of that currency's international value on important economic variables,
The author is an international economist in the Research
ment of the Federal Reserve Bank of Atlanta.
4
Depart-
such as international trade volumes and values,
asset demands, and prices. 2
W e need exchange rate indexes because the
value of a currency cannot b e counted upon to
move by the same amount or even in the same
direction against all other currencies. If, for
instance, the value of the dollar during the last
decade is measured by its movement against
the British pound, the J a p a n e s e yen, or the
Korean won, a variety of views emerges on the
dollar's changing fortunes (Chart I).
An exchange rate index is a summary statistic
that indicates a currency's average value in
terms of other currencies. Designing such a
summary may b e a complex process. Indeed,
the value of any single currency can b e expressed in terms of more than 200 rates of
exchange against other currencies. This number
includes the multiple exchange rates maintained by some countries to account for separate categories of economic transactions. The
number and variety of exchange rates defy comprehension, not to mention inclusion in economic models.
Compressing t h e disparate m o v e m e n t s of
many currencies into a single index involves
several important decisions. Since all currencies are not of equal importance in their influence on trade or capital flows, a weighting
scheme and a representative time period from
which weights are to b e measured must b e
selected. Deciding upon the currencies to b e
covered requires balancing breadth of coverage
both against distortions caused by inflation and
S U M M E R 1987, E C O N O M I C R E V I E W f
Constructing and
Using Exchange Rate
Indexes
Jeffrey A. Rosensweig
Exchange rate indexes are essential tools for determining the average value of a currency as compared with
other currencies. Because none of the available indexes is free of drawbacks, index users must choose the
constellation of features most closely matched to their particular needs.
against timeliness. The index builder must also
choose between an index computed in market
exchange rates and one in which exchange rate
movements are adjusted for international differences in inflation rates. Recently, the question of building subindexes that point out
regionally distinct movements in the exchange
rates included in an overall index has b e e n
broached. 3
Index designers typically decide these issues
on the basis of the expected use or uses of their
index. Their decisions have important implications for what their indexes measure. 4 Users
should b e aware of the major types of decisions
that go into an exchange rate index. In order to
provide a guide to these issues and implications, the remainder of this article discusses the
issues which w e r e outlined a b o v e and the
implications of various solutions to each.
Choosing a Weighting Scheme
The Basic Transactions. The weights or
emphases assigned to various currencies in an
exchange rate index should d e p e n d on its
i n t e n d e d application. Currency indexes are
used predominantly to summarize the effects of
various exchange rate changes on a nation's
trade balance, trade flows, or export and import
price levels. Indexes designed to answer traderelated questions (the focus of the discussion
f
FEDERAL RESERVE BAN K OF ATLANTA
that follows) are normally "trade-weighted." A
recent alternative approach to weighting exchange rates recognizes the importance of capital flows in the overall balance of payments. S e e
Box 2 and Ott (1987).
In constructing an index to answer questions
about trade flows and prices, one key decision is
whether to use weights based only on exports,
only on imports, or on exports plus imports.
Here again, construction should follow purpose.
To p r e d i c t import v o l u m e s or prices only,
weights derived solely from import shares are
most useful. Likewise, export shares alone are
the best basis for export or export price projections.
To evaluate overall trade balance and competitiveness, weights derived from shares of
total exports plus imports are generally more
appropriate, especially when the weights are
based on a recent year or are frequently updated. For example, a s s u m e that the local
currency depreciates sharply against another
country's currency. After some time, if flows are
relatively responsive to the price changes that
follow this depreciation, the local nation's
imports will plunge and exports will surge in
trade with the other country. U p d a t e d importonly weights would place only a small weight on
the significant movement of the other nation's
currency, b e c a u s e d e p r e c i a t i o n of the local
currency would have caused imports to shrink.
Conversely, updated export-only weights would
overweight the exchange rate change because
the depreciation would have boosted exports.
2l
Box 1.
Features of Various Dollar Indexes
Index
Originator
Number of
Countries
Trade-Weight
Period
Multilateral,
Bilateral, or Other
Weighting Scheme
Relative Price
Adjustment
(nominal or real)
Inclusion of
High-Inflation
Nations
Federal Reserve Board
10
1972-1976
Multilateral
Nominal
No
Federal Reserve Board
10
1972-1976
Multilateral
Real, CPI-based
No
Morgan Guaranty
15
1980
Bilateral (trade
in manufactures)
Nominal
No
Morgan Guaranty
15
1980
Bilateral (trade
in manufactures)
Real wholesale prices
of manufactured goods
No
Morgan Guaranty
40
1980
Bilateral: modified
Real wholesale prices
of manufactured goods
Yes
International
Monetary Fund
17
1972 (years through
1974); 1977 (years
1975 on)
Multilateral: structural
economic model
Nominal
No
Atlanta Fed
18
1984
Bilateral
Nominal
No
Dallas Fed
131
Moving average,
three-year
Bilateral
Nominal
Yes
Dallas Fed
101
Moving average,
three-year
Bilateral
Real, CPI-based
Yes
Chicago Fed
16
Moving average,
12 quarters
Bilateral
Nominal
No
Chicago Fed
16
Moving average,
12 quarters
Bilateral
Real, CPI-based
No
Chart 1.
Movement of the Dollar Against Three Different Currencies
(1978-June
1987,
1980
=
100)
During the last decade, the dollar's value has taken divergent turns against different currencies, as this comparison
ment in relation to the Japanese
yen, the British pound, and the Korean won
demonstrates.
of its move-
Source: Calculated by the Federal Reserve Bank of Atlanta with data from the Federal Reserve Bank of New York.
Fortunately, as long as there is significant twoway trade between the nations, the effects of
sharp changes in the exchange rate on weights
will b e minimized if weights are based on
exports plus imports. In this case, even if one
country's currency moves out of line, total trade
with that country should not change dramatically. Therefore, using weights based on exports
plus imports should mitigate the systematic
bias that can arise with updated weights. 5
ducted by all the countries in the index. Using a
multilateral approach, the weight for each country "k" is calculated as:
More specialized uses may dictate using special weights. For example, an index designed to
capture the dollar's effect on U.S. textile trade
should employ weights derived from exports
plus imports of textile products.
B i l a t e r a l weights are d e r i v e d from direct
trade between the local nation and other countries. If an index is being constructed for the
United States, for example, the weight of country k is determined by its trade with the United
States as a share of total trade between the
U n i t e d States and the various countries included in the index:
Alternative Forms of Trade Weights. Despite
their narrowed focus, trade-weighted indexes
still require crucial choices about the most apt
weighting scheme. The primary issue is whether
to use multilateral, bilateral, or even more complex trade weights.
M u l t i l a t e r a l trade weights are based on each
country's share of the total worldwide trade conf
FEDERAL RESERVE BAN K OF ATLANTA
_
W^ —
... _
W^
worldwide exports +
—
imports of country k
—
sum of the worldwide exports +
imports of all the included countries.
U. S. exports to +
imports from country k
—
sum of the U. S. exports to +
imports from all the included countries.
2l
Box 2
Exchange rate indexes can also be constructed to
ascertain the relative international price of all the assets
denominated in a particular currency. This "modern
asset market approach" holds that the worldwide demand for dollar-denominated assets relative to assets
denominated in other currencies, rather than trade flows,
determines the dollar's exchange rate. The relative
demand for the global supply of dollar-denominated
assets arises from the desires of investors worldwide to
hold particular shares of their portfolios in assets denominated in various currencies. Since from this perspective monetary policy changes induce portfolio shifts
(capital flows) that alter floating exchange rates, assetbased indexes are useful in evaluating current monetary
policy stances. Indexes can also measure the impact of
changes in relative interest rates or other asset market
variables on the average foreign exchange value of the
home currency. In either of these cases, weighting
exchange rates in proportion to capital flows between
countries may be appropriate.8
Each alternative has a major advantage, and
there is no a priori way to choose between them
on conceptual grounds. Multilateral weights, by
incorporating worldwide trade, attempt to capture competition between two nations in "third
countries" as well as with the products of various
third countries in both of their domestic markets.
For example, a change in the U.S. dollar-Dutch
guilder rate affects relative prices of American,
Dutch, and other countries' goods in Belgium as
well as in the United States and the Netherlands. Multilateral weights' inclusion of total
rather than one-on-one trade would s e e m to
take better account of t h e s e "third-country"
effects. The disadvantage of multilateral weights
is that they may give too much weight to nations
that trade extensively with each other. Because
the Netherlands and Belgium trade heavily with
each other, the Benelux nations receive a greater
weight in a multilateral U.S. dollar index than
does Canada, the largest U.S. trade partner.
Conversely, bilateral weights e m p h a s i z e the
direct trading patterns of the nation. 7
The choice between multilateral and bilateral weights may hinge on how well shares of
total worldwide trade happen to reflect a particular nation's competitors. If the reflection is
adequate, multilateral weights may b e preferable. In the case of the United States, however,
multilateral weights may place too much emphasis on Europe, where nations engage in substantial t r a d e a m o n g t h e m s e l v e s , a n d not
enough on Canada. 8
8
As Charts 2 and 3 show, the selection of a formula can affect weights and index performance
significantly. Chart 2 depicts the weights that
multilateral and bilateral versions of the Atlanta
Fed index assign to various world regions. Chart
3 portrays the recent patterns traced by the multilateral and bilateral versions of the Atlanta Fed
index. T h e main practical difference for the
dollar is that the large weight on Canada in the
bilateral dollar index significantly reduces the
magnitude of most changes, because in general
the U.S. dollar fluctuates by more against the
European currencies and the yen than it does
against the Canadian dollar. Particularly, t h e
dollar's decline since February 1985 is much
less pronounced in the bilateral index owing
to the dollar's relatively minor depreciation
against the Canadian dollar.
In the case of many countries, constructing a
multilateral as well as a bilateral index, and
monitoring both, ultimately could prove informative. Multilateral weights are useful when
third-country effects s e e m crucial, as in analyses
of the likely competition when d e v e l o p i n g
potential new export markets. Conversely, bilateral weights may b e more useful in analyzing
the short-run impact of exchange rate changes
on a nation's import prices.
Finally, there are also more complex approaches for deriving trade weights, including
"modified" bilateral weights or use of a structural economic m o d e l to g e n e r a t e weights.
These approaches, however, often rely on ad
hoc assumptions-regarding the elasticities of
various trade flows employed in structural models, for instance. They also usually require substantial resources to implement them. Therefore,
despite their theoretical appeal, more complex
a p p r o a c h e s are only m e n t i o n e d here, a n d
i n t e r e s t e d r e a d e r s are referred to primary
sources. 9
Selecting a Base Period. Another major
weighting issue in constructing an exchange rate
index is choice of a base period for the trade
flows on which weights are based. Should an
index employ fixed weights or ones that are continually updated to reflect current trade patterns? If fixed weights, should they b e from one
recent year or an average over a few years? If
one year, which o n e ?
Indexes recently presented by the Federal
Reserve Banks of Chicago and Dallas use continually updated weights in an attempt to portray current trade patterns. This procedure has a
major disadvantage. T h e practical effect of
employing changing weights is to confound
changes due to exchange rate shifts with changes
SUMMER 1987, ECONOMIC REVIEW f
d u e to shifting weights in the index. If the
weights assigned to various currencies are
revised because of shifts in trade shares, for
example, then the value of an aggregate index
can change even if no exchange rates change.
W h e n the val ue of one of these indexes changes,
a question always exists whether the movement
reflects alterations in exchange rates or merely
shifting trade weights.
Chart 2.
Comparative Weighting in
Multilateral and Bilateral Indexes
Bilateral Atlanta Fed Index1
Weights such as those used in the Federal
Reserve Board, Morgan Guaranty, and Atlanta
Fed indexes are derived from a fixed b a s e
period and avoid these problems of interpretation. However, if trade patterns shift, fixed
weights may become misleading over longer
periods of time. To offset this possibility, the
base period for the fixed weights can b e updated periodically, and the index, including historical data, can b e revised using the n e w
weights. This should make interpretation problems more tractable by eliminating occasions
when weights, as well as exchange rates, change.
Japan
21.3%
Asia 2
excluding
Japan
17.6%
28.8%
Multilateral Atlanta Fed Index1
W h e n using fixed weights from one period,
which p e r i o d should b e s e l e c t e d ? If t r a d e
shares have changed significantly, a fairly current period is best, but it should not b e too
current since very recent data are likely to be
substantially revised. Further, a single recent
year should be used only if it appears representative of trade structure over longer periods;
otherwise, use of a simple average of perhaps
three recent years is preferable. 10
How Exchange Rates Are Averaged. The final
weighting issue concerns the technique used to
aggregate or average t h e various w e i g h t e d
exchange rates. Of the two options available,
analytical arguments strongly favor the geometric over the arithmetic averaging technique. All
the recently d e v e l o p e d indexes use the geometric approach.
An arithmetic average merely multiplies each
currency's weight in the index by its percentage
change from an arbitrary starting point and sums
up these weighted changes. The major drawback of this approach is that it does not treat
increases and d e c r e a s e s symmetrically and,
further, it could result in an upward bias. 11 For
example, if an exchange rate moves from 2 to 4,
then back to 2, an arithmetic approach reports a
100 percent increase followed by a 50 percent
decrease—even though t h e actual d e c r e a s e
fully reversed the earlier increase.
A desirable method of averaging weighted
exchange rates emphasizes proportional, not
absolute, changes. Geometric averaging techniques satisfy this requirement. The geometric
technique, unlike the arithmetic, yields t h e
f
FEDERAL RESERVE BAN K OF ATLANTA
Japan
15%
Compared with the bilateral index, the multilateral Atlanta
Fed dollar index emphasizes Europe and places relatively
less weight on Canada and Asia.
Weights derived from International Monetary Fund and Central
Bank of China (Taiwan) data.
2 Includes Australia.
1
2l
same percentage change in an index even if the
base period for the index is changed, and even if
the exchange rates in the index are defined in
reciprocal terms.
For all these reasons, geometric averaging is
favored. This technique uses either of these two
equivalent formulas for the index at time t:
_
Index
t
W;
= 100 I I R it
or equivalently,
= 100
exp 2 Wj log e Rjt,
Chart 3.
Comparing Two Versions of the Atlanta Fed Dollar Index
(1980-May
1987, 1980 = 100)
200-i
190-
Bilateral
180-1
Multilateral
170-
/
160—1
^
150140
/
sS /
130120 —
110 —
100—
90
1980
1981
—p-
—
1982
1983
I
l
1984
1985
I
1986
1987
The emphasis on Canada in the bilateral index tends to reduce the magnitude of changes in the dollar's value, because the
dollar is more variable in Europe than in Canada.
Source: Constructed by the Federal Reserve Bank of Atlanta with data from the Board of Governors and the International Monetary Fund.
where
is the weight assigned the currency of
country i, R j t is the value at time t of the home
currency in terms of currency i divided by its
value in the base period, ? is the product over
all i, * the sum over all i, log e the natural log,
and exp means "take the anti-log e ."
Country C o v e r a g e
Choosing which countries to cover in an exchange rate index requires one to confront inflation and its impact on exchange rates and trade.
Exchange rate movements reflecting only inflation would b e likely to have little impact on
trade flows because relative prices of trading
nations' goods would not change. Movements
that do induce changes in relative prices, on the
other hand, would be expected to change trade
flows. Clearly, an index that purports to aid the
analysis of trade flows should attempt to cap10
ture changes in relative prices and not merely
track different inflation rates.
There are essentially two ways of handling differing rates of inflation. O n e is to deflate exchange rate changes by relative movements in
price levels, producing a real exchange rate
index. This is the subject of the next section. The
other way is to confine an index of market rates
to a set of countries with a weighted average
inflation rate similar to the home country's.
The selection of a proper sample of countries
to i n c l u d e is p r o b a b l y t h e most critical issue
in nominal index design. As with weighting
schemes, the purpose of the index should guide
the choice of the countries that are included.
Certainly, a multilateral index should cover major
w o r l d w i d e trading nations, a n d a bilateral
index, a country's major trading partners.
Beyond this consideration are several important issues that arise in deciding which countries to include in an index. A sufficient number
of countries must b e r e p r e s e n t e d to mirror
SUMMER 1987, ECONOMIC REVIEW f
Chart 4.
A Comparison of the Atlanta Fed Dollar Index and
the Atlanta Fed Index Plus Mexico
200
(1980-March
—
190—
180—
1987, 1980 = 100)
Atlanta Fed Index Plus Mexico
Atlanta Fed Dollar Index
—
170 —
160
—
150 —
M O ISO—
120—1
110 —
100
90
—
r ~
1980
1981
1982
1983
1984
1985
1986
1987
Adding even one hyperinflationary currency to a dollar index can create a misleading portrayal of the dollar's movement
Source: Constructed by the Federal Reserve Bank of Atlanta with data from the Board of Governors and the International Monetary Fund.
trade accurately. Using a very large number,
however, introduces an impractical degree of
complexity. W h i l e it is important to choose
countries that reflect the local nation's trade
patterns, distortions produced by high inflation
or multiple exchange rates must also b e heeded in deciding which countries to include. Treatment of these aspects of country coverage can
have a marked influence on how a particular
currency's value and movement appear in the
index.
Most dollar indexes contain between 10 and
20 nations typically accounting for between 50
and 80 percent of both U.S. and world trade,
though some new ones (Cox, 1986) try for virtually complete coverage. Including only 10 to
15 advanced nations, as some traditional indexes do, is perhaps too narrow for many purposes, especially considering the increasing
trade role of industrializing Asian nations. While
accounting for all major U.S. trading partners in a
bilateral dollar index might s e e m optimal,
f FEDERAL RESERVE BAN K OF ATLANTA2l
such inclusivenesscan lead to significant distortion of an index's portrayal of relative price
changes in two ways: some nations have very
high inflation relative to the United States and
some d e v e l o p i n g nations resort to m u l t i p l e
exchange rate regimes. In this latter case it is
extremely difficult to justify using only one of the
rates or to weight a weighted average of the multiple rates properly. 12
In constructing the Atlanta Fed index, for
example, 18 nations were chosen. The goal was
to broaden the index from some of the traditional models so that it would account for
increasing U.S. trade with industrializing Asian
nations, but to avoid including currencies that
would produce distortions. Mexico, Brazil, and
Venezuela were excluded from the Atlanta Fed
index even though they are important trading
partners, because they lead to one or both of
the two forms of distortion.
Certain new indexes with very broad coverage, including high-inflation nations, s e e m to
have found that, if previously omitted trading
partners are added, the dollar has barely declined since early 1985. Chart 4 illustrates how
a d d i n g e v e n o n e high-inflation nation to a
nominal dollar index leads to distortion. The
results in Chart 4 show that the surprising lack of
dollar decline in indexes with broad coverage
does not follow from broader coverage per se,
but rather reflects the distortions introduced by
high-inflation nations. In this case, when Mexico
was a d d e d to the Atlanta Fed index, a much
higher value for the dollar appeared. 1 3
The Atlanta Fed dollar index reported a dollar
decline of nearly 25 percent in the two years
following March 1985. However, merely adding
Mexico to the index, with its immense nominal
depreciation of 432 percent versus the dollar
during this two-year period, would cut t h e
reported overall dollar decline roughly in half.
Given the large dollar declines in most of the
world and the fact that Mexico has less than a 6
percent share of total U.S. trade, this halving
seems to reflect the skewed picture that results
from adding high-inflation nations, and not an
"improved view" as a result of broader coverage.
Further, omitting minor trading partners
should not harm the accuracy of an index and
may enhance it. For example, the Atlanta Fed
index happens to exclude all nations that account for less than 1 /120 of U.S. trade. Excluding
any o n e of t h e s e nations could not affect a
geometrically averaged index significantly (say
by more than one percent) unless the value of
that nation's currency moved by a margin of nearly 250 percent more or less than the weighted
average rates of the nations included. True
underlying relative price changes of this magnitude are exceedingly rare because they are
offset by international geographic (spatial) arbitrage and inflationary attempts by labor to
restore their real wages after huge nominal
devaluations. Hence, if encompassing such a
small partner really affects an index, it is probably by introducing "distortion," such as price
level measurement error in a real index or the
inclusion of a hyperinflating currency in a nominal index.
Nominal Versus Real Indexes
Another way of addressing the misrepresentation caused by high inflation is to compute a
real rather than a nominal index. In hyperin12
flationary cases, however, the price levels used
for adjustment frequently embody huge measurement errors. Real indexes also sacrifice
timeliness by relying on price level data reporte d with a significant lag. Unless one has the time
and resources to devote to a large-scale real
index based on consistent price data for every
nation included, a nominal index that excludes
any currencies that would create significant
measurement problems is probably preferable.
Indexes that are run in nominal, not real, terms
in order to serve as a daily indicator to b e considered in analyzing the economy may be justifiably narrow. Thus, while there are advantages
to the 18-country sample used in the Atlanta
Fed index, the 10-country sample in the Federal
Reserve Board dollar index allows a much more
sensible daily (nominal) index than many of the
more recent alternatives. 14
T h e Atlanta F e d index, as an illustration,
appears fairly accurate in nominal terms because converting data covering the past few
years into a real index does not make a significant difference. Because it purposely omitted
the few high-inflation nations among major U.S.
trading partners, U.S. inflation roughly equals
the weighted average inflation of nations included in the index. 15 Among the 18 nations are
a few with slightly higher inflation (e.g., Spain,
Canada, Australia) than the United States, and a
few with slightly less (e.g., Japan, Belgium,
Singapore).
T h e advantages of constructing a nominal
index, if it adequately proxies an underlying real
one, are numerous. First, the index is timely,
since it can b e r e p o r t e d with almost no lag
instead of the delay of several months n e e d e d
for the price data used in real indexes. Timely
availability is critical if the index is to b e useful
as an indicator for monetary policy, for example.
Forecasting and planning are also enhanced by
eliminating the several-months lag. Another
major benefit is the increased frequency of data
available in a nominal index. A nominal index
can b e reported daily, or almost instantly, as
market exchange rates are reported, whereas a
real index is limited by the frequency of price
level data. Real index data are available monthly at best, and perhaps only quarterly, or annually, d e p e n d i n g on the frequency of r e l i a b l e
price reports for each nation covered. A nominal
index thus yields more observations. This is a
useful feature for econometric applications such
as forecasting and for measuring changes from
specific dates.
Nominal indexes also minimize resource
costs. A real index with broad coverage deSUMMER 1987, ECONOMIC REVIEW f
Chart 5.
Atlanta Fed Dollar Index and Subindexes for Major European and
Asian Economies and Canada*
(1980-M ay 1987, 1980 = 100)
220-1
207—J
194-
EuropeanAtlanta Fed
Asia excluding J a p a n
Canada
181-
Asia
168-
155142129116-
103,
1980
1981
1
1982
1
1983
I
I
I
1984
1985
1986
The dollar's value moves divergently against currencies in different world regions.
*Based on bilateral weights derived from U.S. trade in 1984.
Source: Constructed by the Federal Reserve Bank of Atlanta with data from the Board of Governors and the International Monetary Fund.
mands that a significant amount of time b e
spent gathering price data and analyzing its
consistency across countries. This points to the
final benefit of a sample of nations that excludes
those with high inflation, such as a proper sample for a nominal index—the likely absence of
significant m e a s u r e m e n t error in the price
series used to construct real indexes. Measurement errors occur from using price series that
are not strictly comparable and using series that
contain large errors. The last problem is potentially most serious in high-inflation developing countries, e s p e c i a l l y t h o s e with few resources to d e v o t e to the collection of economic statistics.
Real Indexes: Which Price Level to Use?
There is no consensus about which price level
measure should b e used in real exchange rate
indexes, because no available price index is
ideal. Almost all the recently d e v e l o p e d real
dollar indexes use the Consumer Price index
f FEDERAL
RESERVE BAN K OF ATLANTA
(CPI), often without giving a justification, perhaps because CPI data are readily available on a
roughly consistent basis across countries. However, if the goal of a real index is to measure the
relative price of a nation's t r a d a b l e g o o d s
against those of other nations, the CPI may be a
flawed measure. It encompasses many nontraded goods and services, and prices of traded
and nontraded goods may not follow the same
path.
Wholesale (producer) price indexes are not as
heavily influenced by the prices of nontraded
products, and thus may b e more representative.
The various Morgan Guaranty real indexes use
w h o l e s a l e prices of manufactured products.
These could b e preferable to the CPI, but omission of nonmanufactured t r a d a b l e products
(various commodities and tradable services, for
example) and the varying composition of these
price indexes across countries are potential
pitfalls.
2l
Although a nominal index is often preferable,
it is not ideal in every situation. If a nominal
index cannot proxy well for a real index because
of significant inflation differences, then a relative price level adjustment is necessary. Again,
the CP1 is a convenient but hard-to-justify price
index, and producer price indexes or even unit
labor cost data should also b e considered if
they are available on a consistent basis for all
nations represented in the exchange rate index.
Chart 6.
The Dollar's Decline by Region
(in percent*)
February 1985 through February 1986
4 T
+2.49
-14.94
-17.65
T h e D e g r e e of A g g r e g a t i o n
An exchange rate index is a useful summary
statistic of a currency's value. Since any currency
faces more than 200 exchange rates—clearly too
many to monitor or include in planning or
forecasting exercises—summary statistics are
needed. Is it optimal, though, to aggregate all
the information for a currency into one index?
Further, is aggregation into an overall index conceptually justified, or does it hide too much
information by averaging what can be very disparate changes in various exchange rates?
The dollar actually often experiences divergent movements against different groups of
currencies. Therefore, reporting only one index
may involve an overly large degree of aggregation for s o m e users. Fortunately, currencies
often s e e m to move s o m e w h a t in "regional
blocs." There are U.S. dollar-linked blocs in the
C a r i b b e a n and Central America, the M i d d l e
East Gulf region, and Far East Asia. The European Monetary System forms the core of a larger
European bloc.
Regional blocs occur in part because some
countries within regions undertake foreign
exchange intervention or otherwise attempt to
align their currencies with those of certain other
nations, which, because of geographic proximity,
are often major trading partners. Perhaps because they also share similar structure, comparative advantage, and hence terms of trade,
various world regions exhibit fairly rigid relative
currency prices within regions, and thus aggregation seems appropriate within regions. 16
The advantages of monitoring a few regional
subindexes as well as an overall index are illustrated in Chart 5, which plots the Atlanta Fed
dollar index and its regional subindexes. The
dollar clearly moved divergently in the varying
world regions, as captured by the Asian, European, and Canadian subindexes. A separate
"Asia excluding Japan (Asia-no))" subindex,
14
+ a 6 3
-30.67
-38-
— r
<S -v
>3?
,<& -cy
°0?
<o
February 1986 through July 1987
4 T
-7.49
-12.74
-18.14
-38 •
r
//
r~
-5.74
-14.60
— I — — I —
/-V
T
<3*
<<5
In 1985, the dollar declined sharply according to European
and Asian subindexes but appreciated in relation to the Asiawithout-Japan and Canadian subindexes.
In 1986 and
through July 1987, the dollar's decline became a more
global event.
'Percentage changes are measured a s first differences of the natural
logarithm. Logarithmic changes are used because they treat percentage increases and decreases symmetrically. The data used are
averages for the months indicated.
comprising Australia and five industrializing
Pacific basin nations, shows that their exchange
rates often move together but change relative to
Japan's. The chart also indicates that the overall
Atlanta Fed index varied somewhat less than
the E u r o p e a n subindex but more than the
S U M M E R 1987, ECONOMIC R E V I E W f
Canadian and Asia-noJ subindexes, b e c a u s e
the overall index is a weighted average of its
component subindexes.
The rationale for subindexes is clear from the
chart. They add considerable, useful information that is otherwise subsumed through aggregation into an overall index. At the same
time, they still provide a manageable summary
of the information contained in the hundreds of
individual exchange rates. S u b i n d e x e s can b e
especially useful to p e o p l e interested in trade
in particular products that are concentrated in
certain geographic regions. Textiles and apparel in Asia are an example. These benefits
from constructing a few regional subindexes
apply to almost any national currency.
Summary
No single method of constructing an exchange rate index is ideal for every application.
This outline of the various choices involved in
index design portrays the viable options, but
suggests that each has pros and cons. Certain
generalizations about index construction are
possible, however.
Extending the coverage of an index to complex proportions tends to reduce timeliness
and clouds interpretation. Adding nations can
also create measurement p r o b l e m s such as
those that arise in the case of hyperinflating
currencies. Despite being less timely, "real"
indexes are preferable unless nominal alternatives exist that closely proxy the "real" values.
Fortunately, this is the case for a number of
widely-reported U.S. dollar indexes. Because
the dollar's value can follow disparate paths
against currencies in the different regions of the
globe, regional subindexes can b e v a l u a b l e
indicators, especially as they apply to traderelated questions.
Finally, the creation of regional subindexes
improves our understanding of the U.S. dollar's
decline since its peak in February 1985. Chart 6
shows that the subindexes display trends that
are not visible when inspecting only an overall
index. The chart splits the recent era of the
dollar's decline into two periods: the first year of
decline through February 1986 and the next 17
months through July 1987. T h e first item to
observe is the marked decline of the overall dollar
index in both periods. The European, particularly, but also the Asian subindex declined
sharply in both periods. However, the Canadian
and Asia-noJ subindexes point to very different
trends. T h e dollar actually rose slightly in these
two major regions during its first year of decline
on the overall indexes, but the subindexes show
that during the second year of overall dollar
decline the depreciation of the dollar belatedly
became a more global event.
As long as the major currencies have flexible
exchange rates, debates over which currency
index to use are likely to continue because no
index is perfect. In most cases, the particular
application planned for the index will finally
d e t e r m i n e which constellation of features is
critical.
Maria McGinnis and Shannon Mudd provided expert
research
assistance. I also thank Craig Hakkio, Frank King, Dianne Pauls,
Joseph Whitt. HarrietteCrissom, David Deephouse, and Christopher
Beshouri.
Notes
'Previously, researchers attempted to do this with only one summary aggregate index, but this paper will explore the new concept
of subindexes for various world regions.
7 For
a more detailed discussion of multilateral and bilateral weights,
see Rosensweig (1986a).
"Constructed to reflect direct U.S. trade patterns, the main Atlanta
2 See
for instance Whitt, Koch, and Rosensweig (1986) or Hooper
3See
Rosensweig (1986a and 1986b) for a discussion of this issue
a s well, the Atlanta Fed also maintains a dollar index identical to the
4See
Rosensweig (1986a, b) or Hervey and Strauss (1987) for
trade weights.
and Lowrey (1979).
and an example of subindexes.
detailed comparisons of various dollar indexes, including the
Atlanta Fed index.
5 For
example, the Atlanta Fed dollar indexes employ updated
weights compared with those used in traditional indexes, and the
focus of these Atlanta Fed indexes is the U.S. trade balance; thus
they use export plus import weights exclusively.
6See
M a c k Ott (1987) for an excellent and original analysis of capital
flow-based weights and other approaches, a s well as of traditional
trade-weighted index formulations. Indexes can be tailored to other
uses a s well. For instance, Rosensweig (1985) used U.S. bilateral
foreign tourism revenue-based weights to measure the dollar's
impact on the U.S. travel balance.
F E D E R A L R E S E R V E BAN K O F ATLANTA
f
Fed index and subindexes employ bilateral weights. However,
because strong arguments exist in support of a multilateral scheme
main one in all w a y s except that it employs multilateral-based
" S e e J . R . Artus and A.K. McGuirk (1981), Morgan Guaranty (1986),
and B. Dianne Pauls (1987).
'"Atlanta Fed researchers (see Rosensweig, Lium, and Welch, 1986)
found 1984 data to be reliable and representative of recent years;
therefore, the Atlanta Fed indexes employ U.S. trade data from the
single year 1984. The fixed weights will be updated if and when
trade patterns are found to change significantly.
"Therefore an arithmetic index will yield different results, unfortunately, if exchange rates are defined in reciprocal terms; for
instance, in dollars per yen rather than yen per dollar.
' 2 A few of the very broad coverage indexes issued recently attempt to
adjust for the inflation problem by constructing CPI-adjusted
2l
indexes, but their designers seem essentially unaware of the price
level measurement error and the multiple exchange rate problems.
No mention is made of which exchange rate they use. B y default
they may use the official reported rate, which in many developing
nations like Venezuela, Nicaragua, Egypt, Guatemala, and Paraguay differs from the free market rate by orders of magnitude. It is
argued here that the only options are to exclude these nations, a s
w a s done, or construct a weighted average rate for e a c h of these
nations if data are available on the magnitude of the flows sensitive
to e a c h exchange rate.
" M e x i c o ' s recent inflation rates certainly have been "high." For
instance, the annual rate has exceeded 100 percent during 1986-87.
'"For an excellent discussion of issues in exchange rate index con-
struction, with particular application to the prominent Federal
Reserve Board Index among others, see B. Dianne Pauls (1987).
,5 lndeed,
calculations show that for the first 20 months following the
dollar's peak in February 1985, the change in the U.S. producer
price index w a s virtually identical (differing by only .01 of a percentage point) to that of the weighted average of the 18 nations included
in the Atlanta Fed index.
16Therefore,
research at the Atlanta Fed into dollar indexes initiated
the concept of subindexes
that show a currency's value in various
world regions. This concept could prove useful for a wide variety of
countries. The I ndian rupee, for instance, could be found to be moving one w a y in Europe, and the other w a y in the dollar-linked blocs
in East Asia or in North America.
References
Artus, J a c q u e s R., and Anne K. McGuirk. " A Revised Version of the
Morgan Guaranty Trust C o m p a n y of N e w York. World
Financial
vol. 28
Markets (August 1976, May 1978, August 1983, and October/
Belongia, Michael T. "Estimating Exchange Rate Effects on Exports:
Ott, Mack. "The Dollar's Effective Exchange Rate: Assessing the
Multilateral Exchange Rate Model," IMF Staff Papers,
( J u n e 1981), pp. 275-309.
November 1986).
Review,
Impact of Alternative Weighting S c h e m e s , " Federal R e s e r v e
Board of Governors of the Federal Reserve System. "Index of the
Pauls, B. Dianne. "Measuring the Foreign-Exchange Value of the
A Cautionary Note," Federal Reserve Bank of St. Louis
vol. 68 (January 1986), pp. 5-16.
Weighted-Average Exchange Value of the U.S. Dollar. Revision,"
Federal Reserve
Bulletin, vol. 64 (August 1978), p. 700.
Cox, W . Michael. " A New Alternative Trade-Weighted Dollar Exchange Rate Index," Federal Reserve Bank of Dallas Economic
Review
(September 1986), pp. 20-28.
Deephouse, David. " U s i n g a Trade-Weighted Currency Index,"
Federal Reserve B a n k of Atlanta Economic Review, vol. 70 (June/
J u l y 1985), pp. 36-41.
Hervey, J a c k L., and William S. Strauss. "The New Dollar Indexes Are
No Different from the Old Ones," Federal Reserve Bank of Chicago
Economic
Perspectives,
vol. 11 (July/August 1987), pp. 3-22.
Bank of St. Louis Review, vol. 69 (February 1987), pp. 5-14.
Dollar," Federal Reserve Bulletin, vol. 73 (June 1987), pp. 411 -22.
Rosensweig, Jeffrey A. " A N e w Dollar Index: Capturing a More
Global Perspective," Federal Reserve Bank of Atlanta Economic
Review, vol. 71 (June/July 1986a), pp. 12-23.
. "The Atlanta Fed Dollar Index and Its Component Subin-
dexes," Federal Reserve Bank of Atlanta Working Paper no. 86-7
(August 1986b).
. "The Dollar and the U.S. Travel Deficit," Federal Reserve
B a n k of Atlanta Economic
pp. 4-13.
Review,
vol. 70 ( O c t o b e r 1985),
, Gretchen Lium, and Kelly Welch. "The Changing Pat-
Hooper, P., and B. Lowrey. "Impact of the Dollar Depreciation on the
tern of U.S. Trade: 1975 to 1985," Federal Reserve Bank of Atlanta
Staff Studies 103. Washington, D.C.: Board of Governors of the
Whitt, J o s e p h A., Jr., Paul D. Koch, and Jeffrey A. Rosensweig. "The
U.S. Price Level: An Analytical Survey of Empirical Estimates,"
Federal Reserve System, 1979.
16
Economic
Review, vol. 71 (October 1986), pp. 36-42.
Dollar and Prices: An Empirical Analysis," Federal Reserve Bank
of Atlanta Economic Review, vol. 71 (October 1986), pp. 4-18.
S U M M E R 1987, ECONOMIC R E V I E W f
Efficiency and
the Flexible Exchange Rate System
Russell S. Boyer
Since its introduction in 1973, the flexible exchange rate
system has managed to offset the disturbances to which it
has been subjected. However, the U.S. dollar's upsurge
in the period 1982-85 has led to
charges that the flexible regime
fosters a misalignment between the
dollar's market and
values and that this
equilibrium
misalignment
should be addressed by
instituting
exchange rate target zones. Aside
from the difficulty of choosing
an appropriate target zone
arrangement,
this study
maintains that such a plan
might divert attention
from pressing issues of
policy mix, which
ultimately
disciplines the macroeconomy.
The high value for the U.S. dollar during the
period 1982-85 has been cited as an example of
the misalignment that can occur under a flexible
exchange rate system. This article contends that
if the dollar's high value reflected temporary
divergence from its long-run sustainable value,
then the evidence would point to the tendency
for predictable movement toward that equilibrium value. The fact that it seldom does sug-
The author is a professor of economics at the University of Western
Ontario and a former visiting scholar at the Federal Reserve Bank of
Atlanta. He wishes to thank all the economists in the Research
Department for many fruitful discussions. In particular, he is grateful
to Harriette Crissom, Frank King, Bobbie McCrackin, and all members of the macropolicy team for helpful comments on earlier
drafts.
f
F E D E R A L R E S E R V E BAN K O F ATLANTA
gests that limited divergences exist between
market and equilibrium values of exchange
rates. This in turn raises questions about the
validity of the methods used to calculate target
zone parity values, including those whose criterion is either purchasing power parity or
balance in the current account. The lack of predictability also suggests that only minor differences separate flexible exchange rate advocates from proponents of target zones, for the
two groups acknowledge that exchange rate
values both derive from and provide discipline
for the underlying financial policies.
This analysis begins with a review of the performance of the flexible exchange rate system
since its introduction in 1973. The question is
raised whether the exchange rate has a life of its
2l
own, i n d e p e n d e n t of policy settings. Before
offering an answer, we look at the roles of participants in the forward and spot foreign exchange markets, explore the "overshooting"
model, and consider the relation of the forward
rate to the expected future spot rate for a
currency. Examination of t h e s e markets demonstrates that the foresight exercised by speculators tends to minimize the amount of the
exchange rate's initially exaggerated response
to a change in monetary policy. The notion that
such foresight can equally encourage speculative bubbles is discussed and rejected. Next,
the empirical evidence for independent movement of the exchange rate is weighed, and the
risk neutral ity of foreign exchange speculators is
challenged in light of the exchange rate's seeming "random walk" behavior. Finally, the arguments against various criteria for establishing
target zone parity values are reviewed from the
perspective of previous findings.
Overview of the Issues
During the past two decades the world economy has undergone dramatic internationalization. As a consequence, events that occur outside
the United States have a greater influence on
domestic economic conditions than formerly.
O P E C pricing arrangements, the L D C d e b t
crisis, and the trade imbalances among industrialized countries all are examples of foreign
events that have substantially affected the
U.S. economy.
O n e force essential to this internationalization has been the striking progress in computer
and communication technologies. While these
advances have b e e n felt throughout the global
trading system, their most consequential impact
shows in the hastened integration of securities
markets worldwide. C l o s e to perfect capital
mobility exists among those industrialized economies that have chosen to tie their domestic
financial markets into the global network.
The exchange rate regime has always played
an important role in the international transmission of economic disturbances. Many therefore
argue that it is no accident that the move to
greater exchange rate flexibility occurred in the
midst of the development toward increasing
global interdependence. But with some disappointment, these same observers lament that
the enhanced maneuverability such flexibility
promised has not materialized. 1
18
To a great extent, their chagrin merely echoes
an earlier, more realistic view: the exchange rate
is not a panacea for all problems of a particular
open economy, and certainly not for those of the
world economy as a whole. The present article
argues that during much of the period since the
advent of generalized floating in 1973, the
exchange rate regime has afforded policymakers increased leeway. This greater freedom
is qualified, however, by the fact that in the
eighties the system has had to cope with shocks
whose nature and complexity are quite different
from those of the seventies.
Some analysts view this enhanced freedom as
a weakness rather than a virtue. They argue that
a flexible exchange rate system does not provide sufficient discipline for policymakers and
thus can result in misaligned exchange rates. To
support their case, they point to the purported
overvaluation of the U.S. dollar in the 1980s.2
This article maintains that, to the contrary, the
swift movement of the dollar provided a clear
disciplining force both on U.S. monetary policy,
beginning in 1985, and on fiscal policy, as
e v i d e n c e d by t h e Gramm-Rudman-Hollings
budget law. However, the s p e e d of that exchange rate movement was such as to make it
appear that the exchange rate almost had a life
of its own, independent
of the behavior of the
underlying fundamentals. If this were indeed
the case, a divergence would open up between
the exchange rate's equilibrium value and its
current market val ue. O n e way to test this view is
to ascertain whether there is any evidence from
this period to indicate that the market exchange
rate tended to move predictably towards its
long-run equilibrium value. Since little if any
predictable movement is apparent, it would
seem that the criteria for evaluating equil ibrium
rates are faulty.
In cases where exchange rates do not move on
their own, the arguments put forward for implementing target zones resemble those espoused by advocates of flexible exchange rates.
In both sets of arguments, the costs and benefits
of the prevailing valuation of the exchange rate
are attributed to and, therefore, provide disc i p l i n e for the underlying financial policies
undertaken by the authorities.
Exchange Rates and Misalignment
In assessing how the flexible exchange rate
system functions, we should keep in mind that
SUMMER 1987, ECONOMIC REVIEW f
Chart 1.
Value of the U.S. Dollar*
January 1973 to September 1987
(1980 = 100)
*Based on nominal values of 18 major U.S. trading
partners, weighted bilaterally.
Source: Atlanta Fed Dollar Index.
vociferous complaints about its operation are
rather recent. 3 During much of the 1970s, the
system worked quite effectively in the face of
substantial shocks. Critics could readily b e
silenced by inquiring of them how they ventured the Bretton Woods System would have
fared under similar circumstances (Chart I).
Economic events of the seventies,- while undoubtedly tumultuous, were clearly favorable to
a flexible exchange rate system. Real shocks,
such as the first oil price shock, tended to affect
all industrialized countries in a similar fashion.
Consequently, the adjustment process did not
entail large changes in nominal exchange rates.
In contrast, monetary policy, which was the
paramount financial policy tool during this
period, operated in much the way that economists predicted it would. Exchange rates adjusted to reflect differing rates of inflation, and
so cushioned the resulting effects on output,
employment, and current account imbalances 4
By the beginning of the 1980s, the economies
of the industrialized West were not so fortuitously poised to absorb shocks. Capital mobility had increased apace, and expectations
were stronger factors than ever in the process of
exchange rate determination. Now the financial
policy shocks were country-specific and came in
the form of fiscal policy actions. The most notable of these occurred in the United States in
the form of the Kemp-Roth 1981 tax cut, the cent e r p i e c e of the Reagan economic program.
f
F E D E R A L R E S E R V E BAN K O F ATLANTA
As evidence of the shortcomings of the flexible exchange rate system, many analysts have
noted that the dollar exchange rate has failed to
maintain balance in the trade account and the
current account. But few economists promised
that it would. Indeed, the theme of the macromodels of the 1960s is that a flexible exchange
regime provides a mechanism that causes
pol icy actions to have swifter and more obvious
consequences than would occur if rates were
maintained at a set value.
In analyzing the effects of fiscal policy actions
on the trade account, Robert Mundell and). Marcus Fleming specifically m a d e this point.'5 They
emphasized that the limited impact of tax and
expenditure policies on economic activity in the
short run is due to their exaggerated consequences vis-a-vis the trade account, which is
affected far more under a flexible than under a
fixed exchange rate system. The events that the
Mundell-Fleming model foresaw flowing from
the Kemp-Roth tax cut have come to pass: the
foreign exchange value of the U.S. dollar temporarily rose, and the trade account worsened
by roughly t h e same amount that the fiscal
deficit increased.
It is generally agreed that the high value for
the U.S. dollar during the early eighties can be
attributed, at least in part, to U.S. financial
policies. 6 Both fiscal and monetary actions had a
hand in the U.S. dollarappreciation. The expansionary fiscal policy, in which tax cuts were not
followed by expenditure reduction, created an
u n p r e c e d e n t e d l y large federal government
budget deficit. In addition, monetary policy was
restrictive from late 1980 through mid-1982,
especially if measured in terms of real interest
rate levels. Therefore, a substantial portion of
the dollar's value resulted from a lack of complementarity in the underlying economic policies.
Calculations done in 1984 showed that the
U.S. dollar had increased in value from 1980 by
between 40 and 80 percent. 7 Now the size and
the swiftness of this upsurge were such as to
lend support to the popular notion that by 1984
the value of the exchange rate was unrealistic,
that it had taken on a life of its own and was no
longer related to the policies that were its usual
determinants. 8 This perspective was quite an
extraordinary one to many economists and
market participants, who see the asset markets
in industrialized e c o n o m i e s as s o m e of the
most efficient markets in existence. Typical of
market participants' reaction is the following:
O n e potential source of volatile prices . . . might
b e a thin, u n d e r c a p i t a l i z e d market. Lack of
2l
d e p t h a n d b r e a d t h c a n l e a d to sharp price
movements on very small speculative or fundamental f l o w s . . . . This is obviously not a description of t h e foreign exchange market. 9
In order to appreciate their point of view, one
n e e d s to understand t h e roles that participants play.
Arbitrageurs and the Forward Market
The market for foreign exchange is the largest
asset market in the world. Daily transactions
amount to over $200 billion, and most of these
transactions are in the forward market (or more
recently in the swap market). The forward market for foreign exchange is less familiar than the
spot market, in which all international travelers
buy foreign currencies. The spot market is so
called because receipt of the foreign exchange
occurs "on the spot," simultaneously with the
tendering of the remittance of payment. A
similar undertaking by a major institution would
also b e called a spot market transaction, but the
financial instruments exchanged would typically be transmitted electronically, and consummation would take place the next business day.
Quotations of prices for spot exchange are
familiar portions of the financial pages of newspapers. The New York Times, for example,
currently quotes spot prices on 48 different currencies.
In addition to the spot market, organized
foreign exchange trading includes a market for
delivery of foreign exchange at some specified
future date. This forward or future market is
more sophisticated than its spot counterpart,
but the basic mechanics are the same. Prices
quoted in the forward market are those agreed
upon at the time the transaction is initiated. A
contract specifies that on a particular future
date the participants will exchange currencies
with each other in an indicated ratio (exchange
rate). Since the contractual exchange rate, or forward rate, is binding on the participants, the
value of the spot exchange rate that holds at that
future date is not relevant to their exchange.
A rich array of maturities exists for the five
major currencies—West German mark, Japanese yen, U.K. pound sterling, Swiss franc, Canadian dollar—whose forward market quotations
are printed daily in major newspapers. In the
customized interbank market these maturities
typically include one month, two months, three
months, six months, and twelve months from the
20
current business day. In the organized auction
markets, where trading is similar to that for precious metals, the delivery dates are specific
days, which usually fall in the middle of a particular month.
The discussion below will examine the forward rate as a guide to the future value of the
spot exchange rate. This perspective on the forward rate contrasts with that of arbitrageurs,
market participants who attempt to nail down
profits as they undertake riskless transactions.
By exploring arbitrage activity, we can show the
efficient behavior of the forward market.
Arbitrageurs obtain profits by looking for
situations in which there is a typically small discrepancy between the buying price and the sel Iing price for equivalent items. If they simultaneously buy low and sell high, they avoid risk,
make profits, and carry out t h e socially useful
function of moving assets from locations at
which they have low productivity (low price) to
ones at which they have a higher productivity.
The role of arbitrageurs is most apparent in the
spot market, in which their actions maintain
uniformity of exchange rates internationally. In
addition, their actions provide orderly crossrates such that any currency can in effect b e
traded for any other currency, so long as there
are no controls on such transactions. Our interest here, however, is in the forward market,
w h e r e the role of the arbitrageur is not so
obvious.
T h e profit-generating rule in the forward
market is that the arbitrageur should borrow in
those currencies where after-cost interest rates
are low and lend in currencies where such rates
are high. Since the arbitrageur wishes to avoid
risk, he or she hedges the transactions, thus
generating the costs noted above. That is, the
arbitrageur essentially promises delivery of a
portion of the future receipts from the high-cost
funds that he l e n d s in exchange for a prespecified quantity of the currency n e e d e d to
repay his borrowings in the lower-cost currency.
Notice that no risk is involved here because all
prices (interest rates and both spot and forward
exchange rates) are known at the time the complex transaction is undertaken.
In order to understand how arbitrageurs
generate profits in the forward market, we need
to introduce the following notation:
i — interest rate at home (in currency I,
typically U.S. dollars);
i* — interest rate in a foreign country (in currency 2);
SUMMER 1987, ECONOMIC REVIEW
f
Table 1.
Spot and Forward Rates for the
West German Mark and the U.K. Pound Sterling
October 1,1987
October 1,1982
U.S. $/ DM
U.S. $ in
Foreign Currency
Rate
U.S. $/DM
U.S. $ in
Foreign Currency
Spot
Forward
3-Month
6-Month
12-Month
0.39670
2.5208
0.54264
1.8429
0.40045
0.40462
0.41330
2.4972
2.4714
2.4196
0.54765
0.55252
0.56368
1.8260
1.8099
1.7741
U.S. $/U.K. £
U.S. $ in
Foreign Currency
U.S. $/U.K. £
U.S. $ in
Foreign Currency
1.69976
0.5883
1.62351
0.6160
1.70454
1.71274
1.73076
0.5867
0.5839
0.5778
1.61559
1.60886
1.60069
0.6190
0.6216
0.6247
Spot
Forward
3-Month
6-Month
12-Month
S o u r c e : All rates p r o v i d e d by W h a r t o n E c o n o m e t r i c s .
s — spot exchange rate between currencies
(units m e a s u r e d as currency I per
unit of currency 2; e.g., U.S. $/DM);
f — forward exchange rate between currencies (units as for s).
In defining exchange rates in this manner, so
that they are prices of various foreign currencies
in terms of U.S. dollars (home currency), w e are
employing a convention that facil itates the comparison of different foreign currencies with each
other. This convention does have a major drawback, however, and we should be aware of it. The
drawback is that with this definition the exchange rate moves inversely with the value of
the home currency. Thus, during the period
1982-85, U.S. dollar exchange rates were low
because values of foreign currencies were depressed. Table l provides values for the West
German mark and the U.K. pound sterling exchange rates in both the spot and various forward markets. The values of the exchange rates
were much lower in October 1982 than they have
been recently. In order to assess how the U.S.
dollar's value fared during this period, we need
to invert t h e s e exchange rates (divide their
values into l). (Table l also provides values for
the U.S. dollar in terms of the West German mark
and the pound sterling.) Their depressed values
i
f
F E D E R A L R E S E R V E BAN K O F ATLANTA
at that time obviously are consistent with a high
value for the U.S. dollar, as is shown in Chart I.
To b e specific, picture the arbitrageur as starting off with one unit of currency l and wishing to
invest these funds for a while, perhaps for a year.
If he invests the money at home, the principal
will revert to him at the end of the year and he
will have earned interest. Thus, the arbitrageur's
total funds at year's e n d are l + i. If, instead, he
invests these funds abroad, he starts by converting his home currency, obtaining units
of
foreign currency. At the end of the year these
foreign funds will have earned interest and so
will amount t o ( I + i*). The arbitrageur covers
his foreign exchange exposure, so at year's end
these funds will be converted back to the home
currency at the guaranteed forward rate, f.
Clearly, the investor is just indifferent toward
the two investments if the amounts generated
from the two possible transactions (when valued in one of the two currencies) are equal. That
is, the no-profit condition, often called t h e
(closed) Fisher equation, is
(l + i) =4-0 + i*)f.
(I)
Thus, there is no incentive to borrow in one
country in order to lend in another.
The incentives described for any particular
investor apply to all such agents. Therefore, for
the market to b e in equilibrium this closed
2l
Fisher equation must hold, such that there
exists what is called "interest rate parity" among
countries. A simple interpretation of this parity
condition takes the spot rate and interest rates
as given; then this equation can b e viewed as
determining the forward rate. Its equilibrium
value has a particularly simple interpretation
when an approximation, based on the assumption that interest rates are much smaller than
one (100 percent per year), is made. Namely, the
forward rate differs from the spot rate by a percentage equal to the difference between the
two interest rates. Or, in terms of the notation
above, the Fisher equation can b e written
i l ^ s U
|i-(i.i*)| *
(i-i*),
(2)
which says that to a very close approximation
the difference between the forward and spot
exchange rates expressed in percentage terms
is equal to the difference between domestic
and foreign interest rates. That difference, 1 ^, is
called the forward premium, and it measures
the percentage by which foreign exchange for
future delivery is more expensive than spot
exchange.
Testing of the interest rate parity condition
has b e e n carried out mainly in the context of
Western industrialized countries, where near
perfection of capital markets exists.10 In that
context the parity condition holds so long as one
is careful to align data. That is, interest rates and
exchange rates must b e for comparable periods
(3-month Treasury bills and 90-day forward exchange rates) and, just as importantly, quotations must b e taken simultaneously. For example, mid-market quotations in Europe are
not comparable with mid-market rates in North
America since there is a five- or six-hour time
differential between these markets."
Because they failed to take account of the
t i m e differential, s o m e researchers thought
they had found evidence of unexploited profits
in the forward market. Their use of data that
e m b o d i e d this misalignment was inappropriate, for, by modern standards, there is an
enormous length of time between the readings.
For instance, evidence from the options markets in equities listed on the New York Stock
Exchange indicates that tremendous profits can
b e obtained if quotations are misaligned to the
extent of 30 seconds or less. In a notable example, enterprising stockbrokers m a d e profits on
I B M options by transmitting price data from the
trading floor to the Chicago Board of Options
Exchange just seconds before the transaction
appeared on the ticker tape.
22
Efficiency and Overshooting
Evidence of the sort cited in the previous section convinces most observers that, at least in
the arbitrage portion of the financial markets,
near perfect efficiency reigns. Specifically, they
find ridiculous the notion that disequilibrium
may exist in highly-organized financial markets
because of a failure of those markets to clear.12
W e have yet to consider the important speculative portion of the foreign exchange market, but
the arbitrage portion seems immune from the
inefficiency charges.
(
Now some individuals have combined the
notion of asset market efficiency with the view
that the goods markets, being less highly organized, can be in disequilibrium for substantial lengths of time. In such a framework, the
behavior of asset prices is determined not only
" / S / o m e individuals have combined the
notion of asset market efficiency
the view that the goods markets...
be in disequilibrium
for
lengths of time. In such a
with
can
substantial
framework,
the behavior of asset prices is deter-
mined not only by the need to clear the
asset markets
disequilibrium
but also by
in the goods
f
persistent
markets."
by the need to clear the asset markets but also
by persistent disequilibrium in the goods markets. As a result, asset prices at any time reflect
the influence of both their fundamental determinants and effects spilling over from other
markets. Specifically, asset prices will deviate
from their long-run equilibrium values so long
as disequilibrium persists in those other markets.
These ideas are incorporated in the overshooting model, first d e v e l o p e d by Rudiger
Dornbusch, which shows that in certain cases
the asset prices must move beyond their longrun equilibrium values before settling back to
them. 13 T h e framework is as follows.
Consider a small, open economy which produces a commodity that is not a perfect substitute for goods available from the rest of the
world. Assume that perfect capital mobility
exists in the sense that domestic interest rates,
i, are always equal to their foreign counterparts,
SUMMER 1987, ECONOMIC REVIEW f
•
i*. Finally, assume the demand for money in this
economy is of the standard form, such that it can
b e captured by the equation
M = |aPd + (1 - a) • s • P*I • L(Y,i).
(3)
In this equation, M is the quantity of money
supplied by the central bank; P<j is the price of
the domestically-produced good; and s is the
spot exchange rate, which converts the price of
imports expressed in foreign currency, P*, into
the domestic-currency price. T h e weights a
(where 0 ( a ( 1) and f I - a) are included to indicate that the price index is the weighted sum of
the price of domestic goods and the price of
imports. T h e function L(Y,i) represents the
effects of output and interest rates on the
demand for money. W e proceed with the assumptions that both of these arguments are
given in the short run: Y is given because pro-
(
I
>
i
f
"¡SJluggish movement of goods prices
forces the need for greater adjustment
upon... the exchange rate. Were goods
prices able to move
instantaneously,
such exaggerated
movement
would
not be needed, for the short-run equilibrium would be identical with that in
the long run."
duction cannot b e altered quickly, and i is equal
to t h e interest rate prevailing in t h e rest of
the world.
Now in this economy there are two identifiably different assets: money and bonds.
Although domestic and foreign bonds are distinguishable, the fact that they have the same
yield implies that individuals are indifferent or
neutral in their choice between these two assets. Furthermore, in the short run wealth acts as
a constraint on individuals' portfolios. As a
result, individuals can hold more o f o n e o f t h e s e
assets only by holding less of the other. Or, more
to our purpose, if individuals are satisfied in the
short run with their holdings of the one asset,
they must b e satisfied with those of the other as
well. In other words, the money market equilibrium equation above is the only (independent)
asset-market clearing equation.
To analyze this economy fully, w e w o u l d
introduce a goods-markets-clearing condition as
FEDERAL RESERVE BAN K OF ATLANTA
well. W e can dispense with such an equation,
however, since w e follow the standard assumptions about s p e e d of price movement: that
asset prices move quickly to clear asset markets, but that goods prices move sluggishly,
causing those markets to remain in disequilibrium for extended periods of time. Nonetheless, we do want to b e specific about the goodsmarkets condition to the extent that it should b e
homogeneous of degree zero in money and all
prices. Specifically, this means that, starting
from an equilibrium situation, an increase in the
quantity of domestic currency and an equal percentage increase of all domestic-currency prices
restores equilibrium to those markets.
Within this framework it is easy to show that
an increase in the money supply of 10 percent
causes the exchange rate to overshoot by increasing more than 10 percent. This is clear from
equation (3), because with M up by that percent
the price-index expression
a - P d + (1 - a) - s . P *
must increase equiproportionately. An important reason for this equality is that the function
L(Y,i) is unchanging, because the magnitudes on
which it d e p e n d s do not move. Now P d is constant in the short run because of the sluggish
behavior of goods prices. P*, too, is constant
because the foreign-currency price of imports is
determined by conditions in the rest of the
world. Therefore, the only way that the price
index can increase by 10 percent is for s itself to
increase by more than 10 percent.
According to this logic, sluggish movement of
goods prices forces the n e e d for greater adjustment upon asset prices, and in this example, the
exchange rate. Were goods prices able to move
instantaneously, such exaggerated movement
would not b e needed, for the short-run equilibrium would b e identical with that in the long run.
That is, the 10 percent increase in M causes s
and P d to increase in the long run by the same
percentage; it restores equilibrium with relative prices unchanged. Thus the exchange rate
in the short run moves beyond the value that it
attains eventually. 14
This argument shows that the mechanisms at
work in t h e arbitrage portion of t h e foreign
exchange market, even though fully consistent
with efficiency, do not rule out the possibility
that asset price m o v e m e n t is influenced by
spillovers from other markets, rather than being
determined solely by the fundamental driving
forces in the system. Whether speculators in the
forward foreign exchange market make this
2l
movement more closely al igned to the behavior
of the fundamentals is our next concern.
Speculators in the Forward Market
T h e forward foreign exchange market is
p e o p l e d not only by arbitrageurs but also by
ind ividuals who are wil I ing to take positions that
entail risk. Of course, these speculators, too, are
interested in obtaining profits, but because of
uncertainty they must base their actions on the
yields they expect to receive. A speculator is
said to be risk-averse if he demands a higher
expected yield from an investment that has
greater risks. In contrast, a risk-neutral speculator is willing to invest in any project that has a
positive expected yield.
In the case of the forward foreign exchange
market, profit is m a d e by following a very simple
operational rule. Namely, the speculatorshould
buy forward foreign exchange if its price is less
than the value he expects it to have at the time
of delivery—less, that is, than the expected
future spot rate. Conversely, he should sell such
currency if its price is greater than the expected
future spot value.
If risk-neutral speculators are an important
influence in the forward market, then forward
foreign exchange rates can naturally be interpreted as expected future values. The West German mark and the U.K. pound sterling serve this
interpretation well, as the numbers in Table I
exemplify. Being a strong currency, the mark is
expected to increase in value over time, as is
evidenced by forward prices being greater than
the current spot price. Thus, the West German
mark has a substantial positive forward premium. In contrast, the pound sterling has often
been a weak currency, and so its expected price
downturn is reflected in forward prices that are
lower than the current spot price. This is shown
in the data for October 1, 1987. Consequently, in
that case U.K. currency has a negative forward
premium, or, more euphoniously, it sells at a forward discount.
Overshooting and Bubbles
The preceding discussion demonstrated that
overshooting of the exchange rate can occur
even when market participants do not take the
future movement of the economy into account.
This section will show that when foresight an24
ticipates the long-run equilibrium, it causes the
exchange rate to overshoot less than otherwise,
resulting in a rate more closely keyed to its fundamental determinants. But foresight also can
induce the exchange rate to follow a speculative
bubble, so that its value is unrelated to the
underlying fundamentals.
O v e r s h o o t i n g . The simple monetary model
used earlier finds that the exchange rate moves
more than does the money supply in the short
run. That discussion is based on the assumption
that individuals d o not anticipate any change in
the exchange rate. W e need to modify those
results to take account of the fact that, following
its short-run, exaggerated movement, the exchange rate begins immediately to move back
slowly towards its long-run value. If that movement is foreseen in the context of risk-neutral
behavior, then the ensuing path is easily described.
[Tlhe important conclusion of the sim-
ple ImonetaryI
model is that the ex-
change rate rises more than proportionately in response
to an increase
money supply. As a consequence,
exchange
rate must subsequently
in order to attain its long-run
rium
value."
in the
the
fall
equilib-
Let us remember that the important conclusion of the simple model is that the exchange
rate rises more than proportionately in response to an increase in the money supply. As a
consequence, the exchange rate must subseq u e n t l y fall in o r d e r to attain its long-run
equilibrium value. A risk-neutral speculator
who foresees that fall offers a price equal to
that expected future value. In particular, the
price he pays for future delivery of foreign exchange is lower than the currently prevailing
spot exchange rate. If all market participants
behave in this fashion, then the forward rate f is
lower than the spot rate s, reflecting the expected change in the exchange rate.
Now this negative forward premium has implications for domestic rates of interest, as
equation (I) indicates. Arbitrageurs will force
domestic rates of interest to b e lower than
foreign rates so as to equate the yields in the
two e c o n o m i e s in after-cost terms. In other
SUMMER 1987, ECONOMIC REVIEW f
1
(
>
words, the domestic currency is anticipated to
increase in value relative to foreign currencies,
since its initial depreciation went too far, and
this expectation permits lower domestic rates
of interest. But these lower rates, in turn, have
consequences for the extent of overshooting.
Notice that equation (3) indicates that the
lower rates should increase demand for domestic money because they reduce the opportunity
cost of holding it. That is, a lower value for i
increases the value of the function L(Y,i(. This
higher value implies that the price index does
not increase by the full 10 percent. As a result,
the exchange rate does not need to increase as
much as it would have otherwise.
O n e might think it possible that the exchange
rate need not increase by more than 10 percent
in this case. Yet further reflection shows that
overshooting remains essential to this mechanism for the reason that the lower values for
If the leisurely
change
movement
of the ex-
rate from its short-run
towards its long-run equilibrium
value
is at
work,
then this tendency
should
which
should
explain
reflected
reasonable
in the forward
potentially
be
premium,
a
portion of the actual move-
ment in the exchange
rate."
domestic interest rates vis-a-vis foreign rates
are based on the exchange rate's moving lower
in the future. Such a movement, if we are to
arrive at the long-run equilibrium, in which the
exchange rate is 10 percent higher than initially,
requires that it exceed that value during the
transition period.
This discussion shows that incorporating expectations that foresee the movement to the
long-run equilibrium does not eliminate the
overshooting result. Instead, the extent of the
overshoot is somewhat reduced, so that the exchange rate moves more closely in tandem with
the fundamentals, that is, the money supply.
The forward rate is a crucial measure whose
movement needs to b e assessed in any empirical validation of the overshooting model..If the
leisurely movement of the exchange rate from
its short-run value towards its long-run equilibrium is at work, then this tendency should b e
reflected in the forward premium, which should
f
FEDERAL R E S E R V E BAN K OF ATLANTA
potentially explain a reasonable portion of the
actual movement in the exchange rate. As the
economy moves closer to its long-run equilibrium, t h e m o v e m e n t in t h e exchange rate
should diminish, as should the size of the forward premium.
Speculative Bubbles. When expectations are
based upon the dynamics of a return to the longrun equilibrium, then the exchange rate deviates from its long-run value less than it would
otherwise. But, by the same token, expectations
that are based on extraneous factors can b e selffulfillingand can lead the economy away from its
long-run equilibrium. Such paths are c a l l e d
b u b b l e s because, by their very nature, they
need to diverge ever further from the fundamental equilibrium in order to sustain themselves.
Now there are theoretical reasons why bubbles are unl ikely to exert an important influence
on exchange rate movements. 15 The most important is that market participants must anticipate that a true b u b b l e will continue
indefinitely. Were the b u b b l e expected to stop
in finite time, agents would incorporate that expectation into their decisions and the b u b b l e
would b e burst before it started. But most models show that a b u b b l e cannot b e sustained
indefinitely, for such continuity implies that
money would b e c o m e worthless in a finite
period. This development is inconsistent with
the manner in which fiat money is provided in
modern economies. Typically, there is s o m e
reserve backing of the currency, usually legislated as a gold clause, as well as some probability that the authorities will c o m p e n s a t e
money holders if inflation erodes the currency's
value too much. Only if such legislation were
meaningless could money become completely
worthless.
A more likely explanation for behavior that
appears to resemble a speculative bubble is
that market participants believe that economic
conditions may change at some future date.
W h i l e they hold these expectations, the market
will respond with ever greater force to anticipated future conditions, and with somewhat
less strength to present conditions. If the future
situation is in fact no different from the present
one, and if this information becomes known at a
particular time, markets will then revert to their
previous behavior. In retrospect, the markets'
behavior during the interim period appears to
b e a speculative b u b b l e that suddenly bursts,
whereas it was in reality a rational response to
uncertainties about the future. The theoretical
argument against the existence of bubbles and
2l
the observational equivalence of bubbles with
behavior that appears unusual because of an
omitted variable (missing information) have led
most observers to dismiss the possibility of
speculative bubbles.
Empirical Evidence
It seems clear that exchange rates can move
independently of the underlying determinants,
notably when speculative bubbles are present
or w h e n overshooting of t h e exchange rate
occurs. As emphasized above, theoretical reasons suggest that bubbles do not appear in the
foreign exchange market, and so our analysis of
the empirical results for that model can b e kept
quite brief. T h e possibility of overshooting has
firmer theoretical foundations, which fact demands a fuller discussion of empirical work relevant to that model.
Speculative Bubbles. These movements
ever further away from the asset price established by the fundamentals in the marketplace
are always in the same direction relative to that
equilibrium. Because the rate at which a speculative b u b b l e moves away is constant, as its
distance from the equilibrium lengthens the
b u b b l e increasingly comes to d o m i n a t e the
movement of the exchange rate. This situation
has two consequences that are amenable to
empirical tests. First, over time the movement
of the exchange rate should grow more predictable as the b u b b l e becomes the ever more
dominant force. Second, since the day-by-day
change in the exchange rate is mushrooming, so
is the size of that portion that is unpredictable.
Neither of these facts has shown up in the data.
T h e predictability of exchange rate change
does not s e e m to alter over time, nor is there an
explosion in the variance of forecast errors, even
when a number of different measures of its
magnitude are used.
Overshooting Model. The central result of the
overshooting model is that it reveals greater
short-run movement of the exchange rate than
of its fundamental determinants. This excessive
movement is attributable to the fact that asset
prices move quickly in order to clear asset
markets. But asset prices must respond also to
the relatively slow equilibration of goods markets. Thus asset prices move in part to comp e n s a t e for the lack of equilibrium in other
markets.
Now the counterpart to the short-run overshooting of the exchange rate is its leisurely
26
movement back towards its long run-equilibrium. Indeed, there is exact equality between
the amount of the excessive jump in the exchange rate and the extent of its subsequent
predictable movement. The importance of the
predictable path in this theory has encouraged
researchers to investigate the extent to which
the future movement of the exchange rate can
b e predicted. 16
If there were a contemporaneously observable magnitude that could b e reliably identified as the expected future exchange rate,
then a measure of that observable magnitude's
predictive power would b e a straightforward
exercise. However, even after the events have
transpired, there still is no reliable measure of
prior expectations.
In the case of risk-neutral behavior, the forward rate, which is contemporaneously observable, could serve the role. It is likely, though,
"The central result of the
overshooting
model is that it reveals greater
run movement
of the exchange
than of its fundamental
shortrate
determinants."
that speculators are risk-averse. As a result, the
forward rate cannot b e v i e w e d as reflecting
exclusively the expectation of the future spot
rate. To fill the void, most researchers employ
rational expectations theory, which argues that
realized values of the spot exchange rate are
unbiased estimates of previous expectations.
While this method is supportable in theory, in
practice economists are aware that any realization of the future exchange rate incorporates
responses to a lot of news that transpired between t h e time at which expectations w e r e
formed and the point at which the realization
occurred. As a result, it is generally agreed that
realizations give very noisy readings of prior
expectations.
W h e n the forward market measure of the
e x p e c t e d future spot rate is employed, one
finds that the forward premium explains a very
small proportion—less than 10 percent—of the
expected rate of change of the spot rate. 17
SUMMER 1987, ECONOMIC REVIEW f
Furthermore, that proportion tends to decline
as the time to maturity is increased. For example, the one-year forward premium explains
less of the exchange rate's movement over that
time than does the 30-day premium during a
comparable period.
Even more disconcerting is the fact that for
short-maturity forward foreign exchange contracts, the empirical results point to a negative
relationship between the forward premium and
the e x p e c t e d (and realized) change in the
exchange rate. Thus, currencies that have positive values for their forward premia tend to depreciate over time while currencies with negative values appreciate.
Clearly, this expression is an identity, in that the
magnitude s+, has b e e n a d d e d to and subtracte d from the forward premium. The magnitude
s+1 is defined as the exchange rate that, on the
basis of today's information, is expected to prevail in the spot marketplace next period.
The first component, ^J+i 1 , is often called the
risk premium in the forward market. It is the difference b e t w e e n the price today for future
delivery of the currency—a price known with
certainty—and the price expected to hold in the
marketplace at that future date. This risk premium is of negligible size if uncertainty is
minimal and/or if market participants are riskneutral.
'¡Pierhaps
Typically, however, agents are v i e w e d as
being risk-averse, and it is important to take
note of how the risk premium d e p e n d s on the
level of uncertainty in such a case. Of course,
low-risk currencies provide on average a rate of
return smaller than that available on higher risk
instruments. For currencies, as with bonds, the
lower rate of return is associated with a higher
current price. Specifically, for low-risk currencies t h e forward exchange rate exceeds the
expected future spot rate. Curiously, then, such
currencies have positive risk premia. This, therefore, demonstrates that the risk p r e m i u m is
inversely related to the level of risk: low-risk
currencies have positive risk premia; high-risk
currencies have negative risk premia.
Clearly the forward premium is providing a
measure of something more complicated than
merely the e x p e c t e d change in a currency's
value. What those further complications entail is
our immediate concern.
the forward
premium,
be-
ing equal to the international
interest
rate differential,
the ex-
is measuring
tent to which yields must differ
nationally
to compensate
inter-
for risk."
Risk Aversion and
the Forward Premium
T h e Forward R a t e . Given that the forward
premium tends to b e negatively related to the
change in the spot exchange rate, the risk neutrality assumption may be inappropriate. That
is, perhaps the forward premium, being equal to
the international interest rate differential, is
measuring the extent to which yields must differ
internationally to compensate for risk. To see
how the forward premium could play such a role
we need to return to the Fisher equation (1).
As w e noted above, the Fisher equation is a
standard arbitrage condition in the foreign
exchange market. It begins to yield further
insight when the forward premium is split up
into two components
(f-s)
s
f
=
(f - s + |)
s
+
FEDERAL RESERVE BAN K OF ATLANTA
(s + | -s)
s
(4)
For the second component in equation (4) a
briefer discussion suffices. That component is
equal to the expected rate of appreciation of
the foreign currency, being the percentage difference between the value of the spot exchange
rate expected to prevail in the future, s + ] , and
the value of the spot rate today, s.
Notice that in thecase of risk-neutral speculation, the risk premium is zero, meaning that the
first component of equation (4) can b e ignored.
In that case, the forward premium is precisely
equal to the expected rate of change of the
value of the foreign currency, as the earlier discussion argues. But w e know, too, that for shortmaturity forward contracts there is a negative
relationship between the forward premium and
the rate of change of the foreign currency's
value. Of necessity, this relationship implies a
role for risk aversion. Let us consider how that
role might appear.
The simplest case to examine is that in which
the risk premium is taken as independent of the
other components in equation (4). In that instance, Isard has pointed out that a s i m p l e
explanation for the negative relationship between the short-maturity forward premium and
2l
the expected rate of appreciation can b e found
in central bank behavior. 18 The monetary authorities' attempt to stabilize short-term interest rates and exchange rates by maintaining
rough constancy of international interest rate
differentials guarantees that movements in risk
premia will create the negative relationship.
To see how this interaction occurs, consider
equations (2) and (4) in the simple case in which
all bracketed elements are equal to zero initially—that is, interest rates are equal internationally and the spot exchange rate is not
expected to change in value. Now consider the
consequences when outside factors prompt a
s u d d e n , temporary rise in t h e risk p r e m i u m ,
lf " s+|1, to some positive value, and this value is
taken as given. This increase in the risk premium
puts upward pressure on the forward premium
and the interest rate differential, which both
rise by an equal amount initially. If central bank
action reduces the interest rate differential
back towards zero, the forward premium must
shrink as well. But that implies that the expect
e d rate of appreciation of the foreign currency
must become negative. In fact, the final equilibrium generated by the rise in the risk premium
is as follows: a positive value for the forward
premium, but one that is smaller than the risk
premium's value; and a negative value for the
expected rate of appreciation, again smaller, in
absolute value, than the risk premium's value.
This is the negative relationship sought.
Boyer and Adams have established that the
same sort of mechanism is at work if the authorities do not move administered interest
rates but rather let those rates adjust so that
they have consequences for asset holdings. 19
W h e n this occurs the same results are produced, and in a symmetric way, whether the
adjustment takes place through central bank
action on the supply of money or through interest rate effects on the demand for money.
The S p o t Rate. The foregoing argument sug-
gests that the forward premium's role may b e to
indicate the level of the risk premium rather
than the expected rate of change of the exchange rate. If this is the case, then it is better to
use the current value of the spot rate, as equation (4) suggests, instead of the forward rate
when forming expectations about the future
value of the exchange rate.
Independent empirical work shows this conjecture to b e correct: the spot rate has b e e n
identified as close to the optimal predictor of its
own future value. In this instance, of course, the
expected rate of change of the spot exchange
rate is zero, meaning that any change in the spot
28
rate that does occur was unanticipated. Furthermore, any such change is expected to b e permanent, in the sense that, starting from the new
rate value, the expected change is once again
zero. In the terminology of statisticians, the spot
exchange rate appears to follow a martingale
process, or, more commonly, a random walk.
Two sorts of data have been used to test the
d e g r e e to which a r a n d o m walk d e s c r i b e s
exchange rate behavior. For example, Michael
Mussa has estimated that over 95 percent of
annual changes in exchange rates of currencies
of industrialized e c o n o m i e s are unpredictable. 20 Looking at Canadian data two decades
ago, William Poole noted a small predictable
component in the movement of that nation's
exchange rate against the U.S. dollar. 21
1
More recently, M e e s e and Rogoff have looked
at the predictive power of various models of
exchange rate behavior. 2 2 In doing so, they
"¡T\he forward premium's
role
maybe
mium rather than the expected
rate of
to indicate
the level of the risk pre-
change of the exchange
rate. If this is
the case, then it is better
to use the
current value of the spot rate...
of the forward
instead
rate when forming ex-
pectations about the future value of the
exchange
rate."
address the argument that the exchange rate's
movements s e e m so unpredictable because
the factors causing those movements are themselves unpredictable. M e e s e and Rogoff eliminate this reasoning as a possible explanation
by conducting a "horse race" between a random
walk model and a number of other models of
exchange rate behavior. In assessing the other
models, they use the actual, rather than predicted, values for the arguments thought to determine exchange rates. Nonetheless, the random
walk proves most successful at predicting future
exchange rates. Note that using actual values is
the same as the forecaster's having perfect
knowledge of those values in terms of his ability
to forecast. Once again, the conclusion is that
the best predictor for the future value of the
exchange rate is its current value.
A simple rule for making profits in the foreign
exchange market suggests itself when the exchange rate moves randomly. In that case a riskSUMMER 1987, ECONOMIC REVIEW f
t
neutral speculator would need no compensation
to take a position in a currency. As a result he
could make expected profits by borrowing in
low-interest rate currencies and lending in highinterest rate ones. Furthermore, the risk-neutral
speculator would have no need to hedge his
transactions. With random walk behavior, there
are no costs to such transactions, and there are
substantial benefits equal to the interest rate
differential. 23 Whereas it is generally acknowledged that this method of speculation does
generate expected profits, there is also some
feeling that these profits are obtained only by
undertaking substantial risk.24
The reader will note that if the connection
between the forward premium and the expecte d rate of appreciation is a negative one, as
indicated in the work bylsard (1987) and that by
Boyer and Adams (1987), then this method will
yield profits even larger than the interest rate
"/Elxchange rate movements provide us
with clues as to likely conditions in the
distant future. In that sense,
change rate is a variable
of its time, a potentially
of information
fruitful
concerning
nomic conditions. "
the ex-
that is ahead
source
future eco-
differential. The reason is that the high-interest
rate currency, which the speculator favors, is
e x p e c t e d to a p p r e c i a t e relative to the lowinterest rate one. Thus, the anticipated rate of
appreciation adds to the expected profits from
using this rule.
The Bottom Line. The conclusion of these
efficiency tests is that neither the forward rate
nor the spot rate is a good pred ictor of the future
spot rate. But if one has to choose between the
two, the current spot rate dominates. Since the
exchange rate follows a random walk, its movements are unpredictable. This unpredictability
suggests that in the short run the exchange rate
is not a factor that either inhibits or helps the
economy's move toward eventual equilibrium.
Instead, the exchange rate appears to move
quickly to the value warranted by current expectations of future policies; it does not move from
that value unless some factor changes, thereby
causing a reassessment of that long-run value.
f
FEDERAL R E S E R V E BAN K OF ATLANTA
Using the criterion of predictability of exchange rate movement as an indicator of misalignment, we see that these results indicate
the existence of few identifiable periods of misalignment. Real exchange rates clearly do have
substantial movements, but it is inappropriate
to attribute these to errant changes in nominal
exchange rates. On the contrary, a more realistic
view is that exchange rate movements provide
us with clues as to likely conditions in the distant future. In that sense, the exchange rate is a
variable that is ahead of its time, a potentially
fruitful source of information concerning future
economic conditions. This view suggests that
both economists and pol icymakers may need to
interpret the exchange rate's role in a new
light.
The fact that the current value of the spot
exchange rate is a better predictor of its future
value than is the forward rate has a number of
implications for policymaking. W h a t we immediately infer from the spot rate's approximation of random walk behavior is that changes in
the exchange rate are unpredictable.
The overshooting model is only one example
of the way in which the market exchange rate can
diverge from its equilibrium value so that misalignment is present. But the random walk
result indicates that viewing the exchange rate
as moving predictably from its current value
towards an identifiable equilibrium value is
futile. Consequently, either there is so much
noise in the economic system that forecasting of
asset prices is hopeless, or the market exchange
rate is always aligned and at its equilibrium
value so that no predictable movement occurs.
Taking the latter view raises the question as to
how economists who have identified substantial misalignment have measured the equilibrium values of exchange rates. Perhaps their
conclusions are based upon the use of dubious
methods. We address these methods in the
accompanying box.
Difficulties with Identifying Parities
Of the two criteria for establ ish ing benchmark
valuations from which to determine exchange
rate misalignments—purchasing power parity
and external balance—the latter has p r i m e
claim on our attention for reasons both of history
and of theory.
Purchasing power parity calculations have
b e e n used as a basis for setting exchange rates
2l
Box
Methods of Identifying
Target Zone Parities
The speed and extent of the movement of the value of
the U.S. dollar during the 1980-85 period were such as to
make plausible the argument that the exchange rate had
a life of its own during that time. Estimates of the increase
in the dollar's value over those years are in the range of
40 to 80 percent. Although we can disagree about the
last few percentage points of these estimates, their order
of magnitude remains relatively uncontroversial.
What is a source of controversy, however, is that some
studies have found that the dollar was overvalued by between 40 and 50 percent during much of 1984.25 Since
this magnitude is twice as great as that which occurred
immediately before the breakdown of the Bretton Woods
accord on fixed exchange rates, the situation appeared
to pose a threat to the international trading system. These
numbers contrast with the view expressed here, that misalignment was small during this period because the
exchange rate's movement was unpredictable. Thus,
measures of the extent of misalignment are controversial, as is witnessed by the fact that many different criteria
have been employed to gauge it.
Two criteria have been prominently proposed as providing benchmark values for the exchange rate. On the
argument that relative inflation rates are important determinants of currencies' values, one proposed benchmark
is the purchasing power parity value of the exchange
rate. In contrast, others have noted that roughly balanced
trade is essential to a long-run equilibrium. They propose
that such an external target provides an appropriate
benchmark for the value of the currency.
During the year 1984 both of these criteria indicated
that the dollar was substantially overvalued. The 40 to 50
percent overvaluation cited above was estimated using
real effective exchange rate calculations.26 That is, the
s i n c e at l e a s t t h e t u r n of t h e c e n t u r y . T h i s long e v i t y is in s t a r k c o n t r a s t w i t h t h e l i f e s p a n of t h e
external
b a l a n c e criterion, which has
been
e m p l o y e d o n l y d u r i n g t h e l a s t d e c a d e . T h e diff e r e n c e in t h e l e n g t h s of t i m e t h e c r i t e r i a h a v e
b e e n e m p l o y e d is to b e s o u g h t in t h e s t r e n g t h
of t h e i r t h e o r e t i c a l f o u n d a t i o n s . W h i l e p u r c h a s i n g p o w e r p a r i t y is a val i d i n s i g h t t h a t h o l d s for a
s p e c i a l c l a s s of e v e n t s , t h e e x t e r n a l
balance
c r i t e r i o n is b a s e d o n a m i s u n d e r s t a n d i n g of t h e
r o l e of c a p i t a l m o v e m e n t s in t h e m o d e r n o p e n
economy. L e t us c o n s i d e r this misunderstanding.
exchange rate moved by an amount that caused U.S.
goods to be that much more expensive relative to foreign
goods. Or, in other words, it is the change in valuation
that remains once international inflation rate differentials
are removed. Looking to the second benchmark, calculations to determine how much lower the dollar's value
would have to be in order to establish balanced trade
arrived at the same estimates.27 That the purchasing
power parity and balanced trade criteria yield similar
estimates of overvaluation was a coincidence, as more
recent calculations demonstrate.
Among economists and policymakers alike, there is
debate today over the appropriate foreign exchange
value of the dollar. The reason is that under present circumstances the purchasing power parity and external
balance criteria for exchange rates yield qualitatively different answers. Indeed, even the parity approach finds
different measures of valuation, depending on the composition of the dollar index used. For example, McKinnon
and Mundell, using purchasing power parity and focusing on European currencies and the Japanese yen, find
that the U.S. dollar is now undervalued by 20 to 30 percent.28 Calculations that use a wider currency basket,
including newly-industrializing-countries' currencies and
giving heavier weight to the Canadian dollar, suggest on
the same basis that the dollar is close to its correct valuation. These conclusions contrast strongly with that of the
Cambridge School of economists (Dornbusch, Feldstein, and Krugman), who use balance in the current
account as their criterion. They find that the dollar continues to be overvalued by 30 percent. Obviously the
purchasing power parity and external balance criteria
can and do provide strikingly different assessments of a
currency's misalignment.
U n i t e d States was a relatively closed economy,
i n t e r n a t i o n a l c a p i t a l m a r k e t s w e r e in t h e i r form a t i v e s t a g e s , a n d c a p i t a l c o n t r o l s w e r e prev a l e n t in N o r t h A t l a n t i c e c o n o m i e s . W i t h l i m i t e d
c a p i t a l m o b i l i t y , t h e r o l e of t h e e x c h a n g e r a t e
c a n b e s u m m a r i z e d b y its i n f l u e n c e o n
the
current account.
D u r i n g t h e last four d e c a d e s , though,
the
s i t u a t i o n h a s c h a n g e d d r a m a t i c a l l y . C a p i t a l cont r o l s h a v e b e e n w e a k e n e d t h r o u g h o u t t h e industrialized
economies.
International
capital
markets have d e v e l o p e d very rapidly, so that
t h e r e n o w e x i s t s a b e w i l d e r i n g array of f i n a n c i a l
F r i e d m a n ' s (1953) a r g u m e n t for f l e x i b l e ex-
i n s t r u m e n t s a v a i l a b l e to investors. T h e
U.S.
c h a n g e r a t e s f o c u s e d its a t t e n t i o n o n t h e r o l e of
e c o n o m y is far m o r e o p e n t o d a y t h a n it w a s in
t h e t r a d e a c c o u n t in t h e a t t a i n m e n t of b a l a n c e
t h e l a t e f o r t i e s b y a n y y a r d s t i c k . ( I n t e r e s t i n g l y , it
of p a y m e n t s e q u i l i b r i u m . 2 9 T h i s f o c u s
was
was mainly the Canadian economists johnson,
n a t u r a l a t t h e t i m e for s e v e r a l r e a s o n s :
the
McKinnon, and Mundell
30
who did
pioneering
SUMMER 1987, ECONOMIC REVIEW f
work on the consequences these developments
were to have on the United States. Canada is a
good economy to study because of its openness, its freedom of capital movements, and its
prior experience with flexible exchange rates.)
The Mundell-Fleming model assumes perfect capital mobility, and is therefore much
more closely attuned to current circumstances
than is the Friedman setup. Complaints that the
capital account is the chief determinant of the
exchange rate make it clear that the current
account no longer holds its predominant role.
Indeed, we noted earlier that, in the face of
expansionary fiscal policy, the exchange rate
must adjust so as to push the trade account into
greater imbalance than obtains under fixed
rates. Thus, it would b e foolish to focus on the
maintenance of balance in the trade account as
a valid target for exchange rate policy.
The objections that are relevant to the naive
external balance approach apply as well to the
more sophisticated version, which s e e s t h e
equilibrium exchange rate as given by sustainable levels for the current account. Obviously,
the p r o b l e m with this approach is that the
degree of sustainability of any particular value
for the current account is difficult to assess.
Specifically, such an assessment must incorp o r a t e a s s u m p t i o n s a b o u t future financial
policies, economic growth, and inflation rates.
Referring to this current account criterion, Herbert S t e i n has humorously n o t e d that any
phenomenon that cannot continue indefinitely
is likely to e n d eventually.
In contrast, purchasing power parity theory
has strong theoretical underpinnings, even at
current levels of capital mobil ity.30 The reason is
that perfect capital mobility does not undermine the theory's validity in the special case in
which it holds. Namely, if the main source of
shocks to the economy is monetary (shifts in
money supply and money demand) and if the
method of manipulating the exchange rate is
through monetary policy, then the use of the
purchasing power parity exchange rate as a
target of policy is optimal. This observation has
a simple version when there is no inflation.- a
fixed exchange rate is appropriate in the face of
shocks to the money market.
Although purchasing power parity has val idity
attimes, it is not without flaws. Perhaps the most
difficult problem in its implementation is that
the conclusions one draws about the extent of
misalignment d e p e n d crucially upon thechoice
of base year during which parity is seen as holding initially. The real exchange rate calculations
indicating a substantial dollar overvaluation in
f
FEDERAL R E S E R V E BAN K OF ATLANTA
1984 proceeded on the assumption that 1980
was a year when purchasing power parity held. If,
instead, one takes a longer perspective by using
1973 or even 1960 as the base year, quite a different picture emerges: the U.S. dollar appears
to have had a much smaller overvaluation in
1984. The difference in these conclusions arises
from the fact that from the longer-term perspective 1980 is seen as a year of substantial undervaluation. T h e c h o i c e of b a s e year is thus
extremely important for purchasing p o w e r
parity calculations.
As was noted above, the parity theory is valid
in the face of monetary shocks. If one restricts
his attention to financial policy shocks, that is a
valid characterization of t h e d e c a d e of the
seventies. But during the 1980s fiscal actions
have attained paramount importance. As a
result, the applicability of purchasing power
parity to the assessment of currency values has
been substantially diminished.
Two aspects of fiscal policy actions suggest
that measuring the extent of overval uation using
a real exchange rate index is inappropriate. First
and foremost, the current stance of tax and
expenditure policies is a significant determinant of the equilibrium value of the real exchange rate, insofar as that stance has an impact
on the real nature of total expenditure flows in
the economy. Recently, administration policies
have continued to favor defense-related industries, which provide non-traded services at the
expense of traditional traded goods such as
agricultural products and manufactured items.
Consequently, it is far from surprising that
domestic prices have risen relative to those of
internationally traded goods. S e c o n d , fiscal
policies have an adjustment mechanism built
into them, because the budget deficit determines the rate at which government d e b t grows.
Furthermore, the link that has b e e n suggested
b e t w e e n t h e b u d g e t deficit a n d t h e trade
deficit points to another mechanism at work, in
that fiscal policy ultimately has an effect on our
net asset position in relation to the foreign sector. To the extent that fiscal excesses have shifte d our international position from creditor to
debtor status, even if our situation were otherwise restored to its initial state, a different real
exchange rate would prevail.
These arguments show that there are numerous specific difficulties with the prominent
criteria for target zone parity values. But, more
generally, each criterion individually captures
only a small aspect of the fundamental factors at
work. Rather than attributing any deviation from
the parity value to a misalignment, we could
2l
fruitfully attempt to discern what the market is
telling us about the nature of those factors that
have b e e n left out of the calculations.
Conclusions
The flexible exchange rate system has performed well over the last fifteen years. It had
greater success during t h e first half of this
period, when t h e system was s u b j e c t e d to disturbances that it had the capability to offset.
During the second half of this time span, real
shocks predominated and they were countryspecific. The flexible exchange rate system's
m o r e m o d e s t s u c c e s s of r e c e n t years has
brought calls for a return to a system in which the
sizes of exchange rate movements are more
limited. Proposals for target zones for exchange
rates provide frameworks for such a system.
A major problem for a target zone arrangement is the choice of parity exchange rates. This
essay argues that neither the external trade
balance target nor the purchasing power parity
target p r o v i d e s a r e l i a b l e g u i d e for parity
values. Consequently, both methods of calculation generate poor estimates of the extent of
misalignment of exchange rates. The external
target method is seriously flawed because there
is no justification for the notion that each country individually should have balanced trade. In
contrast, justification does exist for the use of
purchasing power parity targets, but only if the
main source of shocks is monetary in nature, and
then only if monetary policy is used to cushion
their effects. W h i l e such a system would have
b e e n useful for coping with the monetary disturbances of the seventies, the real shocks of the
eighties have caused changes in real exchange
rates that monetary policy should not attempt
to reverse. The major hazard of such an attempt
32
is that the regime would have a destabilizing
effect on the economy.
An alternative definition of misalignment is
the extent of p r e d i c t a b l e m o v e m e n t of t h e
exchange rate. On this criterion, "overshooting"
would b e an example of misalignment between
the current value and its long-run equilibrium
value. T h e exchange rate then follows a path
with a substantial predictable component in
moving toward that long run.
Empirical work has been done to assess the
degree to which the exchange rate moves predictably. A major conclusion of this work is that
the predictable component makes up only a
minor portion of the exchange rate's overall
movement. This finding suggests that there are
few periods when any substantial difference
exists b e t w e e n the market value of the exchange rate and the value that is dictated by the
underlying fundamentals, including the monetary and fiscal policies enacted by the authorities. As a result, the exchange rate, far from
lagging behind other prices, appears to move
quickly to its equilibrium value, and in that manner it provides timely information about the
current and future state of the economy.
T h e attribution of the exchange rate's value
and the costs attached thereto to the underlying
policies provides a quite forceful way of disciplining macroeconomic policies pursued by governments, even under a flexible exchange rate
regime. On this interpretation, there is very little
difference between stabilization of exchange
rates through appropriate policies and the coordination of economic policies that result in
exchange rate stability. Thus, a target zone plan
may b e a useful tool for initiating macroeconomic policies that are more predictable and
sustainable. But such a plan would b e disastrous if it were used to distract our attention
from these hard choices concerning underlying
policy mix, choices that must now b e made.
SUMMER 1987, ECONOMIC REVIEW f
Notes
'For example, Makin, "Fixed or Flexible Exchange Rates" (1986),
suggests that the differences between the capabilities of fixed and
flexible exchange rate regimes have been exaggerated.
2 Bergsten
(in Makin, 1986) presents the views of the Institute for
International Economics, which has been a prominent proponent of
the argument that the dollar is overvalued. The Plaza Agreement of
September 1985 has been widely interpreted a s being designed to
deal with this overvaluation.
3 Perhaps
a good indication of change of opinion on this matter is the
(forthcoming), indicates that even the small transactions costs reported there are exaggerated.
" M c C o r m i c k (1979) w a s the first to demonstrate the importance of
aligning the data drawn from various geographical locations.
, 2 Frankel
hand.
,3See
(1985), for example, dismisses such a suggestion out of
Dornbusch (1976). The argument is most succinct in the case
in which domestic output is constant in the short run.
seriousness that greeted the plank in the Republican party platform
'"Additionally, by implication, the spot rate would be expected to
people gave this proposal any c h a n c e of success. B y 1984, in con-
' 6 The discussion here and in the next section concerning speculative
national convention. R e c e n t comments by Treasury Secretary
" T h e Journal
calling for a return to a gold standard arrangement. In 1980, few
trast, the proposal w a s given a respectful hearing at the Republican
Baker suggest a more prominent role for gold a s a policy indicator
in the future.
in the specific titles of the conferences on international financial
topics organized during those periods. A good example of the
recent interest in fiscal policy is Frenkel (1987).
5 The
Mundell-Fleming model of the early 1960s w a s the workhorse
of international macroeconomics. The model is laid out in Fleming
(1962) or Mundell (1963).
T h e r e is now a long literature on the influence of U.S. policy action
on the value of the dollar. A good bibliography on this literature is
found in Frankel (1985).
'The precise measurement of the amount by which the dollar's value
changed depends upon the exchange rate index employed. There
is now wide agreement that the G-10 index publ ished by the Board
of Governors of the Federal Reserve System does not have a large
enough currency basket. S e e Rosensweig (1987) in this issue of
the Economic
Review
to understand the problems involved with
developing an improved index.
8 Williamson
9 Taken
, 0 Some
have a higher variance than the forward rate in this setting.
bubbles draws heavily upon Obstfeld (1987).
of International
Money and Finance
has published
numerous articles treating this research. S e e Boothe and Long-
worth (1986).
"The switch in focus between the 1970s and the 1980s can be seen
f
and Levich (1975). More recent research, for example that by Clinton
(1985) is a widely cited source for this point of view.
from J o h n s o n (1986) in the Makin (1986) volume.
of the earliest research in these areas w a s done by Frenkel
F E D E R A L R E S E R V E BAN K O F ATLANTA
" F o r a survey article on this topic s e e ibid.
,8See
Isard (forthcoming).
' 9 Boyer and Adams (1987) use a simple monetary model in which the
risk premium is assumed to be an exogenous temporary time
process.
" S e e Mussa (1979).
21 Interestingly,
Poole (1967) feels that deviations from random walk
behavior would be indicative of an inefficiency in this market. The
theoretical justification for such a claim is unclear.
" S e e Meese and Rogoff (1983).
23 This
method of making profits in the foreign exchange market is
usually associated with Bilson (1981).
24 Hodrick
25 See,
and Srivastava (1984), for example, report such findings.
in particular, the calculations in Williamson (1985).
^Ibid.
" K r u g m a n (1985) provides such an estimate.
2 8 These
conclusions are reported by Sylvia N a s a r in
(May 11,1987).
Magazine
Fortune
" F r i e d m a n (1953).
3 0 Camen
and Genberg (1987) c o m e to a similar conclusion.
2l
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The C a s e for Target Zones," in J o h n Makin, ed., Exchange
Targets: Desirable or Disastrous?
Rate
Washington, D.C.: American
Enterprise Institute for Public Policy Research, 1986.
Johnson, Thomas S. "Toward Foreign Exchange Rate Stability," in
J o h n Makin, ed., Exchange
Rate Targets: Desirable
or Disas-
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Bilson, J . F . O . "The 'Speculative Efficiency' Hypothesis," Journal of
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Research, 1986.
McCormick, Frank. "Covered Interest Arbitrage: Unexploited Profits? Comment," Journal of Political Economy, vol. 87 (April 1979),
pp. 411-17.
Meese, Richard, and Kenneth Rogoff. "Empirical Exchange Rate
Models of the Seventies: Do They Fit Out of S a m p l e ? " Journal of
Clinton, Kevin. "Transactions Costs and Covered Interest Arbitrage:
Theory and E v i d e n c e , " Journal
, ed. Exchange
Economy
(forth-
International Economics,
vol. 14 (February 1983), pp. 3-23.
Mundell, Robert A. "Capital Mobility and Stabilization Policy under
Fixed and Flexible E x c h a n g e R a t e s , "
Dornbusch, Rudiger. "Expectations and Exchange Rate Dynamics,"
Journal of Political Economy, vol. 84 (December 1976), pp. 1161 76.
Fleming, J . M . "Domestic Financial Policies under Fixed and Floating
E x c h a n g e Rates," International Monetary F u n d Staff Paper.
Washington, D.C.: International Monetary Fund, 1962.
Frankel, Jeffrey A. "Six Possible Meanings of 'Overvaluation': The
1981 -85 Dollar," E s s a y s in International Finance, no. 159. Prince-
ton University, Princeton, N.J., 1985.
Economics
pp. 475-85.
and Political
Science,
Canadian
Journal
of
vol. 29 (November 1963),
Mussa, Michael. "Empirical Regularities in the Behavior of Exchange
Rates and Theories of the Foreign Exchange Market," Carnegie-
Rochester Conference Series on Public Policy, vol. 11 (Autumn
1979), pp. 9-57.
Nasar, Sylvia. "Fortune Forecast: Is the Dollar Too High—or Too
L o w ? " Fortune Magazine,
May 11,1987, pp. 85-86.
Obstfeld, Maurice. " P e s o Problems, Bubbles, and Risk in the Empiri-
Frenkel, J a c o b A., ed. International Aspects of Fiscal Policy. Chicago:
cal Assessment of Exchange-Rate Behavior," National Bureau of
University of Chicago Press, for the National Bureau of Economic
Economic Research, Working Paper no. 2203, April 1987. This
, and Richard M. Levich. "Covered Interest Arbitrage:
Currency Risk Premiums" by Richard Meese, presented at the
Research, forthcoming.
Unexpected Profits?" Journal of Political Economy,
1975), pp. 325-38.
vol. 83 (April
Friedman, Milton. " T h e C a s e for Flexible E x c h a n g e Rates," in
Essays
in Positive Economics.
Press, 1953.
Chicago: University of Chicago
Hodrick, Robert J., and Sanjay Srivastava. "An Investigation of Risks
and Return in Forward Foreign Exchange," Journal
of Inter-
national Money and Finance, vol. 3 (April 1984), pp. 5-29.
Isard, Peter. " T h e Empirical Modeling of E x c h a n g e Rates: An
Assessment of Alternative Approaches," in Ralph Bryant et al.,
eds., Empirical Macroeconomics
of Interdependent
Economies.
Washington, D.C.: The Brookings Institute, forthcoming.
34
paper is a discussion of "Empirical A s s e s s m e n t of Foreign
Federal Reserve Bank of St. Louis conference on "Financial Risk:
Theory, Evidence and Implications," November 14-15, 1986.
Norwell, Mass.: Kluwer Academic Publishers, forthcoming.
Poole, William. "The Stability of the Canadian Flexible Exchange
Rate, 1950-62," Canadian
Science,
Journal
of Economics
vol. 33, no. 2 (May 1967), pages 205-17.
and
Political
Rosensweig, Jeffrey A. "Constructing and Using Exchange Rate
Indexes," Federal R e s e r v e B a n k of Atlanta Economic
vol. 72 (Summer 1987), pp. 4-16.
Review,
Williamson, John. "The Exchange Rate System," Policy Analyses in
International Economics, no. 5. Washington, D.C.: 1983; revised
J u n e 1985.
S U M M E R 1987, E C O N O M I C R E V I E W f
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FEDERAL RESERVE BAN K OF ATLANTA
2l
w
Direct Investment Activity
of Foreign Firms
William J. Kahley
Dramatic reversal in our nation's international investment position has a w a k e n e d
economists and the American public alike to a
new awareness of global capital flows. As recently as 1981, the United States was the world's
largest cred itor nation ; just five years later it had
taken on the o p p o s i t e role, b e c o m i n g the
foremost debtor. Reasons for this extreme shift
include the widening of our country's budget
and trade deficits as well as foreigners' positive
investment response to U.S. tax incentives and
growth prospects.
The waxing magnitude and accelerating pace
of such investment demand an understanding
and identification of the factors that motivate a
multinational corporation (MNC) to p r o d u c e
abroad. Unfortunately, attempts to find satisfactory survey or econometric tests of the factors'
importance have b e e n seriously impaired by
the limited data available. Even so, the industrial organization theory that d o m i n a t e s t h e
literature of recent decades does help inform
continuing efforts to discern why foreign MNCs
are drawn to particular U.S. industries.
Following an overview of the changing role of
M N C s in the lives of Americans a n d of the
upheaval in our nation's investment position,
this article will review the economic literature
on why an M N C invests abroad. Next, the discussion will turn to the issue of whether firmspecific attributes can b e disentangled from
industry characteristics as one attempts to
ferret out the reasons for foreign MNCs' investment directions. Finally, current research on
foreign direct investment in the United States
will b e considered. Throughout, the emphasis
of this article is on what motivates foreigners to
invest in this country. T h e broader question
about the desirability of U.S. d e b t is beyond the
article's scope.
MNCs and International Investment
The author is a regional economist in the Federal Reserve Bank of
Atlanta's Research
Department.
36
Multinational corporations—firms that control and manage production establishments in a
S U M M E R 1987, ECONOMIC R E V I E W f
Numerous and complex conditions dictate the direct
investment activity of foreign multinational corporations. Attempts to study these conditions are
plagued h y statistical problems, among them the difficulty of disentangling separate effects that are highly
correlated. Even so, continued empirical
investigation
of foreign direct investment in the United States may
eventually yield a better understanding of this important aspect of international
capital flows.
minimum of two countries—have existed since
at least the eighteenth century. The British East
India Company is a famous early example.
Today, many Americans have dealings with
MNCs on a daily basis. For example, the supermarket, gasoline station, or department store
we patronize might be a U.S. subsidiary of a
foreign parent corporation, or our American
auto manufacturer may also produce vehicles in
plants it owns abroad. In some instances, our
cars or consumer electronic devices are the products of joint ventures or partnerships between
a domestic and a foreign company. Additionally,
many millions of Americans are employed by
U.S. companies that own subsidiaries abroad,
and over three million Americans work in U.S.
affiliates of foreign companies.
Traditionally, the M N C has not been of much
interest or concern to American workers or consumers. In part, their attitude derived from U.S.
firms' s e e m i n g d o m i n a n c e of international
markets into the 1960s, when large American
c o m p a n i e s w e r e synonymous with t h e . t e r m
"multinational corporation." Moreover, few
American workers' jobs w e r e threatened by
foreign competition then, and consumer purf
FEDERAL RESERVE BAN K OF ATLANTA
chases of goods from foreign-controlled firms
amounted to only a small fraction of U.S. gross
national product (GNP). In the 1960s, however,
our merchandise trade balance with the rest of
the world began slipping persistently and ever
more deeply into the red until the mid-1970s.
Though still in deficit, the trade balance then
showed spurts of improvement before worsening again throughout the present decade.
Besides facing increasingly stiff competition
from foreign imports over the past couple of
decades—the ratio of U.S. merchandise imports
to G N P has tripled since t h e mid-1960sdomestic manufacturers also have come under
intensified pressure from foreign-owned affiliates in the U n i t e d States. For example, six
Japanese auto producers now own or are building assembly plants in this country. Developments such as these have sharpened Americans'
awareness of foreign producers. The difference
is that whereas imports were viewed as a threat
to American workers' jobs in American plants,
the more recent direct investment trend has
been welcomed as a source of employment. In
t a n d e m with this expanding awareness, the
public has shown h e i g h t e n e d concern over
2l
international t r a d e and capital flows, as the
scope and tone of the television news and popular print media make clear.
The growth of public interest in international
trade and capital flows a p p e a r s warranted.
Available data show that the nation's net international investment position, which denotes
the balance of U.S.-owned assets abroad minus
foreign-owned assets in the United States, has
shifted markedly over just the past few years as
the merchandise trade deficit has d e e p e n e d
(Table 1). In 1980 the United States was owed
about $106 billion and its trade deficit was a
" m e r e " $25 billion. Our creditor status peaked
at $141 billion in 1981, but subsequently slipp e d to a paltry $3.6 billion only three years later.
Thereafter, the United States became a debtor
nation, a position it had not held since the outbreak of World War I. By year's e n d 1986 the
nation's d e b t reached $264 billion, making the
United States the biggest debtor in the world. In
the same year, the country's merchandise trade
deficit swelled to $144 billion.
The negative net international investment
position of the United States is attributable only
partly to its mushrooming trade deficit over the
same period. As the trade deficit grew, the net
capital inflows helped to finance the "current
account" deficit, that is, our net purchases of
merchandise from abroad as well as services
and transfer payments. In addition, the means
and motivations for portfolio and direct investment abroad by Americans and foreigners alike
also have b e e n shifting. Consequently, our
perspective on the significance of foreign direct
investment has likewise changed.
Into the 1960s, economists generally shared
the public's nonchalance about capital flows
and the existence and impact of international
corporations. For most economists, the form of
international capital movement was not considered important and the motivation for all
capital flows s e e m e d clear. Before I960, both
direct and portfolio investment abroad were
treated in the same way, even though an important economic distinction exists between the
two types of international capital flows.
Foreign direct investment refers to an amount
that residents of a country invest in a foreign
establishment or enterprise over which they
have effective ownership or management control. An American business establishment under
such control is called a U.S. affiliate, and the
foreigner's investment is said to b e "direct."
Other foreign investment in a U.S. business,
such as the purchase of its stocks or bonds by
investors seeking to diversify their assets rather
38
than exercise an effective management role, is
called portfolio investment. 1
In 1980, U.S. private assets abroad in the form
of direct investment totaled $215 bil I ion, or $ 132
billion more than foreign direct investment in
this country. By year's end 1986 this net surplus
had narrowed to about $50 billion. Thus, more
than one-fifth of the nearly $370 billion total
change in the U.S. net international investment
position over the period is attributable to direct
investment flows. A net increase in foreigners'
portfolio holdings of U.S. c o r p o r a t e stocks
accounted for another one-fifth of the change,
while most of the remainder was due to net
increases in foreigners' holdings of U.S. government and corporate bonds.
Reasons for Foreign Investment
The large size of international capital flows
and recent rapid shifts point to the critical
importance of understand ing what governs them.
Over the years, numerous reasons have b e e n
cited to explain the accelerating pace of foreign
investment in the United States. Both the popular press and official U.S. sources suggest that a
relative rise in both the wealth of foreigners and
the number of their large companies has increased foreigners' ability to invest in this country. In addition, some argue that foreigners, such
as the Germans and lapanese, save more than
Americans do, further enabling them to invest
here.
The U.S. Department of Commerce maintains
that the appeal of investing in the United States
has b e e n e n h a n c e d by a n u m b e r of other
developments: (I) greater recognition among
foreign companies of the size and growth of the
U.S. market and an advancing perception of this
country as an economic and political safe haven;
(2) growing numbers of large foreign M N C s
whose experience contending with American
firms abroad convinced them that they could
c o m p e t e successfully in the U.S. domestic
market; (3) a narrowing spread between American and foreign production costs, which renders production here relatively more attractive
to foreign firms than exporting to the United
States; (4) concern about increasing U.S. protectionism and a feeling that investment in this
country offers an effective way to hurdle trade
barriers; and (5) the wooing of foreign investors
by state development agencies, particularly in
the South. 2
SUMMER 1987, ECONOMIC REVIEW f
Table 1.
U. S. International Investment Position
(billions of current dollars)
Type of Investment
1980
1986
Change
Net position
U. S. assets abroad
U. S. official reserve assets
U. S. government non-official reserve assets
U. S. private assets
Direct investment abroad
Foreign securities
Other U. S. bank and nonbank claims
106.3
607.1
26.8
63.8
516.6
215.4
62.6
238.5
-263.6
1,067.9
48.5
89.4
929.9
259.9
131.0
539.0
369.8
460.8
21.7
25.6
413.3
44.5
68.4
300.5
Foreign assets in the U. S.
Foreign official assets in the U. S.
Other foreign assets in the U. S.
Direct investment in the U. S.
U. S. securities
Other U. S. bank and nonbank liabilities
500.8
176.1
324.8
83.0
90.2
151.5
1,331.4
240.8
1,090.6
209.3
405.5
475.8
830.6
64.7
765.8
126.3
315.3
324.3
Source: Constructed by the author from data in R.B. Scholl, "The International Investment Position of the United States in 1986," Survey of
Current Business, vol. 67, no. 6 ( J u n e 1987), p. 40.
These and other factors may help to explain
the rapid growth of foreign investment, but they
fail to tell the whole story. Foreign investment
might naturally be expected to improve a firm's
profits. Indeed, until 1960 the M N C was viewed
by most economists simply as an arbitrageur of
capital, sending money to countries where it
could earn its highest risk-adjusted return. In its
arbitrageur role, the M N C contributed to efficient allocation of world resources.
The classic welfare argument contends that
international capital flows increase world income because capital is more equally productive at the margin as a consequence of the flow.
The home country gains in that it earns a higher
country-wide return on its capital abroad than it
would have earned domestically; the host country gains because, with more abundant capital,
higher returns accrue to its other domestic factors. At the firm level, of course, the advantage is
represented by larger profits (measured as present discounted value) than would b e earned
without t h e investment or with alternative
investments.
)ohn Dunning and Alan Rugman, leading contributors to the development of the modern,
post-1960s theory of foreign direct investment,
described the earlier view:
In I960 the prevailing explanation of international capital movements relied exclusively
f
F E D E R A L R E S E R V E BAN K O F ATLANTA
upon a neoclassical financial theory of portfolio
flows. In this frictionless world of perfect competition, with no transaction costs, capital
moves in response to changes in interest rate
(or profit) differentials. 3
In his important dissertation, Stephen Hymer
was first to observe that several features of the
multinational corporation and foreign direct
investment are inconsistent with the pre-1960
theory. 4 For individuals, the main determinants
of "portfolio" investment decisions are the
expected rate of return and the investment risk.
Corporations, however, are likely to concentrate
on the profitability or return on investment over
t h e m e d i u m or long term. Within this t i m e
frame, many industry-specific factors may combine to influence returns.
Today economists agree that the pre-1960
explanation of d irect investment was overly simplistic and that Hymer's redirection of thinking
about the M N C was a great contribution. Ind e e d , at its annual meeting a few years ago the
American Economic Association organized a
session, "In Honor of Stephen H. Hymer: The
First Quarter Century of the Theory of Foreign
Direct Investment"; the "quarter century" dates
from the publication of Hymer's dissertation.
The modern, "industrial organization" theory of
direct investment, while attributable primarily
to Hymer, was further refined by Charles Kin2l
dleberger, Harry G. johnson, Richard E. Caves,
and others. 5 In t h e s c h e m e of the theory,
"market imperfections" motivate M N C investment abroad.
As an illustration, consider a parent firm that
decides to produce abroad by building a new
plant or buying an existing one. To b e successful, the firm must overcome inherent disadvantages vis-a-vis foreigners producing on their
home turf. Among these disadvantages are the
higher transportation and c o m m u n i c a t i o n s
costs associated with managing from a distance
and less knowledge of the prevailing language
and customs, such as business and political
practices and processes. In addition, the producer from abroad must d e a l with another
currency and will b e taxed differently. Presumably, a firm that penetrates such a market
with production facilities must possess some
production or marketing edge that will enable it
to survive. 6 Hence, industrial organization analysis is warranted.
Note, too, that advantages generally develop
and erode as the international economic structure changes and adjustments occur. As an
example, improved and lower-cost communication via satellite transmissions can lower the
communication barrier to production abroad, or
"just-in-time" manufacturing and inventory
policy can spur geographic moves by suppliers,
enabling them to deliver materials promptly
when needed.
Following Kindleberger's taxonomy, countervailing advantages that outward-bound firms
might possess stem from one or more of the
following:
"In the real world, the many kinds of
market imperfections that exist for a
great range of goods and resources
provide ample opportunities
for direct investment"
•
lack of perfect competition in the goods
markets owing to product differentiation,
marketing skills, or administered prices;
•
imperfections in factor markets b e c a u s e
of proprietary technology, managerial
skills, or discriminatory access to capital ;
•
economies of scale internal or external to
the firm;
•
government limitations on production or
entry to the industry.
In the real world, the many kinds of market
imperfections that exist for a great range of
goods and resources provide ample opportunities for direct investment. For instance,
numerous firms own patents on products or
have established brand identifications that
make their product special to its buyers. Furthermore, many companies possess a unique or
unusual technical advantage in producing or
marketing particular goods. An administrative
ability to exploit potential cost advantages by
producing on a large scale for a big market also
might prompt a foreign company to produce in
the United States. Similarly, onerous government-imposed restrictions on output, market
entry, or product safety and production standards can encourage a firm to shift production
from one country to another.
40
Kindleberger illustrated the industrial organization theory and contrasted direct investment
with portfolio investment in a straightforward
and concise manner. H e m a d e use of the simple
formula for capitalizing an income stream, C = I/r,
where C is the present value of a capital asset, I
is the stream of income produced by the asset,
and r is the real, risk-adjusted rate of return on
investment in the asset. Portfolio investment
occurs when r differs among countries, while
direct investment typically corresponds to the
positive differential in I that can b e earned
abroad by an M N C compared with a local firm
abroad.
Generally, imperfections in the goods and
factor markets as well as economies of scale are
conditions that permit a foreigner to earn a
higher I than local producers. However, if the
M N C has an advantage in accessing cheap capital, perhaps because of its favorable position as
a large, trustworthy borrower, differences in r
also may contribute to direct investment. Finally, if M N C s have an advantage over local
firms, government policies—other than those
prohibiting direct investment—affect where the
M N C will produce goods for sale in the foreign
market. Government imposition of a tariff on
imported goods, for example, might cause the
M N C to shift from exporting its domesticallyproduced goods into a foreign market to producing goods there instead.
SUMMER 1987, ECONOMIC REVIEW f
A useful means to judge whether an M N C
investment is desirable is to consider the move
in light of the type of imperfection generating
the investment abroad. David T e e c e argues
that vertical integration—that is, direct investment across industries that relate to different
stages of production of a particular g o o d results from the MNC's development of internal
production and distribution systems as a substitute for inefficient markets. 7 For instance, vertical integration might enable a firm to install
specialized cost-saving equipment in two locations without the worry and risk that facilities
may b e idled by disagreements between enterprises of different nationality and facing different incentives. Horizontal direct investment,
or investment that is cross-border but within an
industry, also requires that the M N C possess an
advantage such as "know-how" or technology
and that contractual difficulties b e anticipated.
"Investments need to be examined on
a case-by-case
basis to
ascertain
whether MNCs create market imperfections or simply respond to them by
internalizing transactions, turning external economies into internal profits. "
Examples of contractual difficulties a r e t h e
MNC's ability to price know-how or to write,
execute, and enforce use restrictions governing
technology transfer arrangements. Thus, foreign
direct investment occurs when a firm possesses
a valuable asset and is better off directly controlling use of the asset abroad rather than selling or licensing it.
In both vertical and horizontal investments,
market imperfections motivate activity; however, whether M N C investments are efficient
from an overall perspective d e p e n d s upon the
type of imperfection. As Dunning and Rugman
summarized this condition:
If t h e market imperfections are natural transactions costs, then t h e M N C (multinational enterprise) is conceptually efficient. However, if t h e
market imperfections are structural and endogenized, leading to asset power, then t h e
M N C is b e s t v i e w e d as operating strategically,
f
FEDERAL RESERVE BAN K O F ATLANTA
a n d such a c t i o n s may or m a y not b e efficient. 8
In other words, M N C investment may improve or
reduce the efficiency with which the world's
resources are used, but it is impossible to draw
a general conclusion about its desirability.
Investments need to b e examined on a case-bycase basis to ascertain whether MNCs create
market imperfections or simply r e s p o n d to
t h e m by internalizing transactions, turning
external economies into internal profits.
Brief examination of some of the post-1960
refinements to the basic industrial organization
theory of direct investment will help to clarify
this conclusion. 9 In the goods market, oligopoly,
or domination of an industry by a few firms, is an
e x a m p l e of a "structural and e n d o g e n i z e d "
market imperfection. The firms' mutual recognition of their interdependence in the industry
promotes conscious rivalry: each firm reacts to
another's action. R a y m o n d Vernon explicitly
accounted for this interdependence in foreign
direct investment by arguing that, as a product
matures and its production technology becomes
diffused, firms counter the threat of losing
market share to imitators overseas in a kind of
preemptive strike. 10 Further refinements to this
defense were suggested by F.T. Knickerbocker's "follow-the-leader" investment strategy,
whereby an investment by one firm triggers an
investment response by rivals, a n d by E.M.
Graham's "exchange of threat" strategy, whereby
rivals invade each other's markets with subsidiaries to maintain overall shares."
On the other hand, several refinements to the
basic industrial organization theory have dev e l o p e d or elaborated on the beneficial role
firms play in those settings where it is especially
costly to coordinate economic activities via
e s t a b l i s h e d markets. T h e s e " m a r k e t failure"
imperfections, known by terms such as "appropriability" or "internalization" theory, are
variations on the theme that the market mechanism often is prevented from efficiently allocating the production and transfer of knowledge.
For example, transactions costs for enforcement
or monitoring may be very high for a record or
video company seeking to license its product
abroad, perhaps because the licensee could
pirate copies to avoid full payment of royalties
or owing to difficulties in establishing contractual terms for the lease. Under these conditions
the firm is likely to maintain internal control to
ensure that returns on its asset are appropriated rather than being gobbled up as transactions costs.
2l
S i n c e foreign operations provide a n oppor-
Motivations for Inter-Industry
Investment in the United States
The foregoing theoretical explanations of
MNC behavior have generated a growing amount
of empirical research into the motivations for
foreign direct investment. Research intensity
has b e e n heightened further by differences of
opinion about the relative importance of the
various influences; in some instances, hypotheses even conflict. Research also has b e e n kindled by the expanding awareness of how important it is to understand MNC behavior in our
increasingly integrated world economy. Unfortunately, numerous statistical and conceptual
p r o b l e m s h a m p e r a t t e m p t s to distinguish
among hypotheses about M N C activities. Even
so, these difficulties have fostered yet more
work on the topic as the available data base on
foreign direct investment has grown richer
over time.
Multinational firms differ from others in several distinct ways, some of which are firm-specific. Other differences, however, are better
attributable to differences among industries.
For example, Vernon concluded, and several
other researchers subsequently confirmed, that
large size effectively distinguishes MNCs from
other firms in their industries. 12 Alternatively,
some assert that such factors as high profitability and large expenditures on research and
development (R&D) or advertising are industry
characteristics that attract foreign investment.
In weighing all the attributes that may account
for foreign direct investment, it is often conceptually difficult to separate those features that
are firm-specific from those that pertain industry-wide. The following quotations testify to
this challenge:
Among t h e firm-specific advantages of t h e multinational emphasized by internalization theory
are those relating to R&D, product differentiation, management, economies of scale in production, and avoidance of tariff and non-tariff
barriers. 13
Advantages to b e gained by investing a b r o a d
instead of exporting include: obtaining lowercost factors of production; avoiding or reducing
tariff and nontariff barriers; reducing transportation costs and delivery time; avoiding political instability or government interference at
h o m e ; obtaining knowledge of foreign tastes,
marketing t e c h n i q u e s , etc.; a n d o b t a i n i n g
economies of scale by vertical integrationback to raw m a t e r i a l s production, for example. 1 4
42
tunity for the pooling of market risks, vertical
integration, sharing of research and development technology, and advertising costs, as well
as an additional tax advantage, t h e benefits
from such positions can b e used to strengthen
domestic market operations. 1 5
Clearly, attributes common to firms within an
industry and those that distinguish a firm from
its industry counterparts can be the same. As an
illustration, the chemical industry invests heavily in expensive plant and equipment relative to
many other industries; at the same time, investment levels of some chemical firms are above
the industry average. Research on what motivates foreign investment has b e e n hard pressed
to disentangle industry and firm effects, largely
because of data limitations.
Most of the empirical studies on M N C s have
examined the performance of U.S. MNCs, primarily b e c a u s e such firms have traditionally
b e e n the world's largest foreign direct investors.
Relatively few researchers have examined M N C
investments in the United States; hardly any
have done so in a rigorous empirical fashion.
According to D a v i d McClain's comprehensive survey of researchers' findings on foreign
direct investment in this country, prior to World
War I foreigners invested in U.S. land and railroads, cattle, mining, and finance chiefly on the
basis of their rates of return. 16 In manufacturing,
however, vertical integration and oligopolistic
rivalry considerations shaped their investment
decisions. For the post-World War II period,
McClain's review revealed that the considerations influencing foreign producers to
locate facilities in the United States included
raw materials, specialized knowledge, servicing
the market, jumping tariff or non-tariff barriers,
transport costs, or new technologies. 17
For the most part, these research findings on
foreign direct investment in the United States
have been based on surveys of foreign-controlled
firms or on case studies, anecdotal observations, or reasoned theoretical analysis. T h e
majority of econometric work on the topic has
either explained variations in the flow at the
aggregate level or has examined characteristics
at the firm level.
S o m e empirical work has addressed foreign
direct investment in the United States at the
industry level. In distinguishing the characteristics of foreign-owned subsidiaries in this country from those of subsidiaries located elsewhere,
McClain found that, among the factors that were
positively correlated with foreign direct investment, those relevant for U.S. industry included
SUMMER 1987, ECONOMIC REVIEW f
Box
Profile of Foreign Investment Activity
Comparable estimates covering operations of foreign
firms' U.S. affiliates with some industrial detail are available for 1977-85. Investment as measured by the gross
book value of property, plant, and equipment (PPE) in
U.S. manufacturing and nonmanufacturing affiliates
amounted to $293.6 billion in 1985 (Table 2). Employment at these affiliates amounted to 2.85 million, or 3.5
percent of all private, nonfarm jobs in the United States.
The overall growth rate of affiliate P P E in the 1977-85
period was 340 percent compared with a 100 percent
rate of increase for U.S. gross national product over the
same period, and a 92 percent rise in gross private
domestic investment. The rapid growth of affiliate P P E
attests to the growing importance and interest of foreign
MNCs in the U.S. economy, as does the rising number of
affiliate jobs in that period. Affiliate employment increased by 134 percent as opposed to the mere 21 percent rise in overall private, nonfarm U.S. employment.1
The industrial distributions of foreign affiliate investment and employment in 1985 were similar. Manufacturing accounted for the largest share of both; chemicals
and allied products accounted for the largest portion
within manufacturing. Moreover, many of the disparities
shown for the relative shares of affiliate investment versus employment are by no means surprising. For example, industries such as mining, petroleum, chemicals,
paper, and real estate are relatively capital-intensive
compared with industries such as retail trade or services,
which are labor-intensive. Similarly, the generally faster
growth of overall foreign direct investment versus overall
affiliate employment shown in this period simply reflects
upward bias in dollar investment figures resulting from
inflation. Yet, deflating by industry, while desirable, is difficult because component inflation is hard to measure.
(Measuring asset values by book value rather than
replacement cost also can distort comparisons of real
asset levels among industries.) Because they are not
directly affected by inflation, the employment data thus
may have the advantage of corresponding more closely
to changes in economic activity, even though they are
plagued by relative productivity shifts that alter the linkages between output and employment change in
industries.
Among industries, relatively slow growth of investment
and employment in mining and petroleum is traceable to
adverse business cycle effects. B y contrast, slow growth
in textiles and apparel, paper, and perhaps some other
manufacturing industries probably resulted from longterm employment declines. In these industries the overall
labor force contracted as a consequence of declining
competitiveness in world markets and/or plant modernization programs that reduced labor requirements.
Especially fast-growing industries in terms of foreign
direct investment and affiliate employment tended to
occur in the service sector, particularly among wholesalers of motor vehicles and other durable goods, food
f
FEDERAL R E S E R V E BAN K OF ATLANTA
store retailers, operators of eating and drinking establishments, and various purveyors of business, finance,
and real estate services. Even so, fabricated metals, electric and electronic equipment, and, especially, transportation equipment industries also experienced rapid
foreign direct investment and affiliate employment growth.
Overall, investment in manufacturing by foreigners
actually outpaced growth in theirtotal investment activity
in the United States in the 1977-1985 period.2
Industrial Concentration of Affiliate Employment
The above- and below- average rates of growth for different industries mirror overall industrial changes that
occurred nationally. At the same time, they represent
changing concentrations in foreigners' interest in different U.S. industries. As measured by employment
growth, the service sector generally outperformed the
goods sector for both the entire country and foreign
affiliates. This common experience reflects the continuing major shift in U.S. employment away from goods production and toward services. In the 1977-85 period,
national employment grew fastest in wholesale and retail
trade; finance, insurance, and real estate; and services
among the industries shown in Table 3. Overall employment in manufacturing declined nationally, and only
printing experienced the rapid growth shown by services. By contrast, employment for affiliates increased in
virtually all manufacturing industries from 1977 to 1985.
Affiliates' shares of different U.S. industries vary
markedly but in predictable ways. Because affiliate
employment growth exceeded overall employment
growth in almost all industries—therubberindustryisthe
exception—and by a wide margin, affiliates' industry
shares increased substantially over the 1977-85 period.
Moreover, shares tend to be highest in industries that
produce for world markets ("traded goods") and lowest
in industries producing goods and services primarily for
the domestic U.S. market ("non-tradables"). The chemicals and allied products, paper, food, metals, and
machinery industries are prominent examples of the former, while transportation, communications, and public
utilities, as well as several other service industries, typify
the latter.
On the basis of "concentration ratios"—that is, industrial employment shares for affiliates divided by comparable shares for the nation—the chemicals industry was
by far the most attractive to foreigners.3 Chemicals
affiliates accounted for over 15 percent of all affiliate
employment compared with chemicals' much smaller
1.3 percent share of all employment nationally. Two-fifths
of all U.S. chemicals industry jobs in 1985 were with
foreign affiliates. Other industries in which foreign affiliates enjoyed above-average concentrations included
manufacturing generally and such specific manufacturing industries as food, metals, machinery, paper, print-
2l
Table 2.
Foreign Affiliate Activity by Industry
Property, Plant, and Equipment
1977
Amount
($ billion)
Industry
Mining
1985
Share
Amount
($ billion)
Share
Employment
1977
Percent
Change
1977-85
(000s)
1985
Share
(000s)
Share
Percent
Change
1977-85
3.1
4.7
10.3
3.5
231
15.5
1.3
29.0
1.1
Petroleum1
23.7
35.5
75.9
25.9
220
89.9
7.4
125.3
4.4
39
Manufacturing
24.2
36.2
110.7
37.7
358
685.6
56.3
1,438.9
50.4
110
1.9
10.8
3.6
1.3
1.4
0.5
1.4
0.5
0.4
1.4
0.2
0.7
2.9
16.2
5.4
2.0
2.0
0.8
2.1
0.8
0.5
2.1
0.3
1.1
7.0
51.5
16.2
4.8
7.7
1.2
5.6
2.8
1.0
7.2
3.3
2.3
2.4
17.5
5.5
1.6
2.6
0.4
1.9
1.0
0.3
2.5
1.1
0.8
261
375
351
264
463
138
298
412
189
422
1,446
228
72.0
197.5
85.2
65.0
95.1
24.5
17.2
31.2
17.7
32.3
3.4
44.3
5.9
16.2
7.0
5.3
7.8
2.0
1.4
2.6
1.5
2.6
0.3
3.6
151.3
429.7
167.8
115.3
193.0
38.4
46.9
71.6
17.0
80.8
62.1
64.7
5.3
15.1
5.9
4.0
6.8
1.3
1.6
2.5
0.6
2.8
2.2
2.3
110
118
97
77
103
57
172
129
-4
150
1,739
46
Food and kindred products
Chemicals and allied products
Primary and fabricated metals
Machinery, except electrical
Electric and electronic equipment
Textile products and apparel
Paper and allied products
Printing and publishing
Rubber and plastics products
Stone, clay, and glass products
Transportation equipment
Other2
87
Wholesale trade
3.9
5.8
17.3
5.9
346
153.0
12.5
296.1
10.4
93
Retail trade
1.9
2.8
10.6
3.6
462
142.0
11.6
479.9
16.8
238
Finance (except banking), Insurance, and Real Estate
6.5
9.7
51.2
17.4
686
51.0
4.2
147.2
5.2
189
Services
1.4
2.0
9.1
3.1
565
37.1
3.0
217.1
7.6
486
Other industries3
Total4
2.2
3.3
8.5
2.9
286
44.7
3.7
120.0
4.2
168
66.8
100.0
293.6
100.0
340
1,218.7
100.0
2,853.6
100.0
134
1
Petroleum includes all three-digit S I C industries related to extraction, manufacturing, a n d marketing of petroleum products.
2
Other manufacturing includes lumber a n d furniture, instruments, a n d related products.
3
Other industries include agriculture, forestry, and fishing; construction; transportation, communication, a n d public utilities.
4
Totals may not match s u m of components d u e to rounding.
S o u r c e : Constructed by the author from data in U.S. Department of Commerce, B u r e a u of E c o n o m i c Analysis, Foreign Direct Investment in the United States: Operations
Foreign Companies,
Preliminary 1 9 8 5 Estimates ( J u n e 1987).
of U.S. Affiliates of
box continued
affiliate employment in transportation equipment jumped sharply. On the other hand, wholesale trade and mining experienced a dilution of concentration. Wholesale
trade's decline may have been associated with the
increased direct presence of foreign companies with
manufacturing affiliates and/or with retailing operations.
Mining's decline probably w a s precipitated by the
energy glut of the 1980s.
ing, arid stone, clay, and glass. Outside manufacturing,
wholesale trade w a s the only industry that was especially attractive to foreigners in 1985.
Industry concentrations in that year w e r e largely
unchanged from 1977, although a few notable shifts
occurred over the period. Manufacturing industries saw
an even greater concentration in foreign affiliates, and
Notes
changes in the amount of capital used per worker among indus-
'The best measure of the importance of affiliates of foreign M N C s
tries. Thus, employment is only an approximate measure of the
in the U.S. economy is their value added, or contribution to
relative importance of investment in different industries. Deter-
national output. In this sense, changes in industry investment
minants of the distribution of employment by industry also can
and/or employment by affiliates only approximately measure
vary from that of investment, but data limitations prevent
changes in their importance or contribution to the U.S. economy.
2 As
examination a n d analysis of these distinctions in this paper.
noted in the previous footnote, employment and investment
3 Limifed
changes only approximately measure changes in an industry's
data availability precludes calculation of concentration
ratios for other industries. Concentration ratios for omitted
importance in our economy. Similarly, although employment
industries are likely t o b e less than one, however, because onlya
a n d investment are correlated (they tend to move together), their
small amount of employment w a s generated in them by for-
patterns of c h a n g e c a n vary. Specifically, employment a n d
eign affiliates.
investment do not move in lockstep because of differences and
Table 3.
Foreign Affiliate Employment Shares and Concentrations, by Industry
1977
Affiliate
Share of U.S.
Employment
(percent)
Industry
1985
Affiliate
Concentration
Ratio
Affiliate
Share of U.S.
Employment
(percent)
Affiliate
Concentration
Ratio
Mining
4.4
2.50
4.9
1.42
Manufacturing
3.8
2.12
7.9
2.25
4.2
18.4
2.40
10.25
1.71
9.2
41.2
11.62
1.69
2.82
5.3
8.7
Food and kindred products
Chemicals and allied products
Primary and fabricated metals
Machinery, except electrical
Electric and electronic equipment
Textile products and apparel
Paper and allied products
Printing and publishing
Rubber and plastics products
Stone, clay, and glass products
3.1
3.0
5.1
1.1
2.5
2.7
2.5
4.8
.64
1.40
1.53
1.36
7.3
2.0
6.9
5.0
2.1
2.65
2.11
1.48
2.52
.57
2.13
1.47
.60
.2
2.60
.07
13.5
.88
3.1
2.4
4.00
.92
Wholesale trade
3.3
1.84
5.4
1.54
Retail trade
1.0
.57
2.8
.79
Finance (except banking),
Insurance, and Real Estate
1.1
.64
2.5
.71
Transportation equipment
Other 1
1.6
.74
Sen/ices
.2
.14
1.0
.28
Other industries2
.4
.24
1.1
.33
•Other manufacturing includes lumber and wood products, furniture and fixtures, instruments, tobacco, leather, petroleum, and miscellaneous manufacturing.
'Other industries include construction, transportation, communication, and public utilities.
Source: Constructed by the author from data in U.S. Department of Commerce, Bureau of Economic Analysis, Foreign Direct Investment
in the United States: Operations of U.S. Affiliates of Foreign Companies,
f
F E D E R A L R E S E R V E BAN K O F ATLANTA
Preliminary 1985 Estimates ( J u n e 1987).
2l
the share of an industry's total output attributable to the largest firms and an industry's contribution to national output. H e d i d not find that
U.S. subsidiaries were likely to b e in the "hightech" industries or that product differentiation
and capital intensity were useful explanatory
variables. Moreover, McClain was unable to discover evidence of "follow-the-leader" behavior
or tariff-jumping motivation.
By contrast, E.M. Graham and E.B. Flowers
both found that European investment in the
U n ited States at an industry 1 evel was correlated
with values of U.S. investment in Europe at an
earlier time period. Their finding supports
"exchange of threat" and "follow-the-leader"
theories. 18 J.M. Volpe maintained that foreign
subsidiaries in the United States were introducing new technology, e m b o d i e d in both labor
and capital. 19 Out of 19 U.S. industries at the
three-digit SIC (Standard Industrial Classification) level, V o l p e found that 14 p o s s e s s e d
above-average values of non-wage value-added
per production worker and wages per production worker man-hour, his respective measures
of physical and human capital intensity.
McClain concluded that "the results of the
empirical research on foreign direct investment
in the United States broadly substantiate the
industrial organization/market imperfections
approach to the theory of direct investment." 2 0
In addition, he noted the persistence of this
finding:
M o r e recent cases of direct investment in t h e
United States continue to b e consistent with
the industrial organization paradigm, as firms
enter to exploit—and s o m e t i m e s to acquire—a
technological or managerial advantage, or for
r e a s o n s of vertical integration. S o m e t i m e s
entry has b e e n p r o m p t e d by g o v e r n m e n t
policies at home. 21
Against this evidence, which is mixed but
generally supportive of the now orthodox industrial organization view, stands a study by Sanjaya Lall and N.S. Siddharthan. 22 They claim that
industry variables found to have a significant
impacton the pattern of U.S. MNCs' investments
abroad are not important in explaining the
industrial pattern of foreign investment in this
country. Their argument is that U.S.-based
MNCs and domestic industry leaders dominate
international markets with more powerful and
broadly-based advantages than d o M N C s of
other countries. Furthermore, while foreign
MNCs may have a technological edge in certain
narrow and specific instances, they are unlikely
to possess strong intangible advantages when
fairly broad industrial groups are considered.
46
Consequently, these restricted specializations
exploited by foreign MNCs in the United States
probably cannot b e captured by these same
characteristics at the industry level.
Specifically, Lall and Siddharthan expect U.S.
affiliates' industry shares not to b e related to an
industry's a d v a n c e d d e g r e e of technology,
marketing, or other types of skills. They also
expect plant-level economies to have a negative impact on foreign shares and believe that
foreign M N C s are likely to steer clear of industries with high seller concentration. Finally, the
researchers anticipate that tariff barriers will
spur M N C investment in the United States.
W h e n Lall and Siddharthan conducted statistical analysis of the foreign share of U.S. industry
sales in 1974 for a sample of 45 manufacturing
industries, they found support for their views. As
expected, none of the product differentiation
and skills set of "intangible" advantages were
"Against... the now orthodox industrial organization view, stands a study
... Iclaiming/ that industry
variables
found to have a significant impact on
the pattern of U.S. MNCs' investments
abroad are not important in explaining
the industrial pattern of foreign investment in this country."
significant in regression equations that the
authors estimated. They measured their product differentiation variables by research/development and advertising expenditures; their
skill and entrepreneurial variables were measured by average employee remuneration and
by non-production workers as a proportion of all
employees. Intangible advantages associated
with plant-level economies of scale, measured
by average value-added per plant, exerted a
significant negative influence on foreign share,
as Lall and Siddharthan expected. However, the
effect of multiplant operations in the United
States, measured by the percentage of industry
shipments accounted for by multiplant firms,
was not clear.
Lall and Siddharthan found "qualified support" for their prediction that foreign entrants to
the United States would avoid industries that
are highly concentrated here. In addition, they
discovered that the effective rate of protection,
SUMMER 1987, ECONOMIC REVIEW f
including tariff and non-tariff barriers, has positive and highly significant effects on the foreign
share of a U.S. industry. T h e latter finding confirms the importance of trade barriers in stimulating foreign firms to set up manufacturing
operations in the United States.
In summary, these two researchers concluded
that "the nature of monopolistic advantages of
foreign M N C s in the United States is so specialized and firm-specific that generalizations at
the industry level cannot b e drawn." Moreover,
in the case of foreign MNCs, "the local strength
of U.S. firms forces them to deploy a much narrower range of advantages and to stay away from
highly oligopolistic industries." 23 Pointing the
way to future research, Lall and Siddharthan
speculated that, after early stages of foreign
entry into the United States, further investment
might b e motivated by factors similar to those
for U.S. M N C investment abroad. However, they
"The multitude of potentially relevant
factors and the shifting importance of
recognized factors strongly suggest the
continuing need for empirical research
into foreign direct investment
Hallmarks of that research should be experimentation
and dynamic,
versus
static, analysis."
felt that the immediate research need is for
more disaggregated data that would help identify the elusive monopolistic advantages of
foreign MNCs in the United States.
Together, the research findings summarized
above would indicate that several firm, industry,
and country influences simultaneously prompt
a particular M N C to invest at a particular place.
For example, Japanese business leaders interviewed by the author over the past few years
have acknowledged a number of factors that
lure them to invest in the United States: access
to the large and dynamic American market;
proximity to innovative stimuli, including our
nation's high degree of innovation in new industries; and the ability to jump existing or potential tariff and non-tariff barriers. The desire to
secure raw materials is a factor of decreasing
significance.
The multitude of potentially relevant factors
and the shifting importance of recognized facf
FEDERAL R E S E R V E BAN K OF ATLANTA
tors strongly suggest the continuing need for
empirical research into foreign direct investment. Hallmarks of that research should b e
experimentation and dynamic, versus static,
analysis. As an example, foreign investment in
an industry might b e relatively high because
investors are seeking a resource that is scarce
domestically. Whether at a given time that resource is a special type of labor, capital, or raw
material is an empirical matter and one that
should b e considered over a period of time.
Unfortunately, the task of identifying relevant
influences is m a d e even more difficult because
direct measures of theoretically "correct" variables, such as a particular production or marketing edge, are unavailable, and "proxy" measures
may b e difficult to interpret unambiguously. In
addition to these conceptual and measurement
problems, data limitations also hamper efforts
to assess changes in the factors motivating
direct investment.
Current Research on Foreign Direct
Investment in the United States
In an effort to clarify the apparent conflicts
among foreign direct investment studies, the
author has b e e n conducting a more dynamic
analysis of direct investment in t h e U n i t e d
States using later data than most other studies. 24
This research has reexamined the hypothesis
that such investment is influenced by the familiar industrial organization variables categorized
by Kindleberger. Specifically, for a particular
industry it has attempted to explain why foreign
affiliate employment grew as it has relative to
overall U.S. employment in the 1975-82 period.
In addition to examining the industrial pattern
of employment growth generated by foreign
direct investment, this research has assessed
the importance of potential sources of the countervailing advantage which motivated that investment and employment.
The author's research differs from previous
studies on this subject in terms of its methodology and data. In this research, affiliate employment growth in the 1975-82 period is assumed
to have adjusted towards a new equilibrium
from a condition of disequilibrium that existed
in 1975. Methodologically, the first step in the
analysis was to measure how much affiliate
employment growth was attributable to industrial "countervailing advantage" factors—that is,
affiliate employment gain in an industry gauged
2l
relative to that industry's overall employment
change over the period.
As an example, affiliate employment in the
chemicals and allied products industry grew at a
much faster pace than employment throughout
the industry. T h e difference b e t w e e n actual
affiliate e m p l o y m e n t growth and that which
would have occurred had employment in that
segment e x p a n d e d at t h e overall chemicals
industry rate can b e attributed to factors that
m a d e the chemicals industry relatively attractive to foreigners. Using this concept ot employment gain as the relevant variable to explain is
unique in the foreign investment 1 iterature, as is
measuring such employment with data from the
U.S. Census Bureau's company organization survey. 25 Other researchers, assuming that industry
employment
levels were in equilibrium at a
point in time, attempted to explain differences
in e m p l o y m e n t levels; s o m e have tried to
account for the number of subsidiaries in an
industry or for whether a firm in an industry owns
a foreign affiliate.
T h e equilibration scenario is r e a s o n a b l e
given the high national unemployment rate during 1975 and the period just before, a rate that
rose from 4.6 percent in late 1973 to 9 percent in
mid-1975. Economists often argue that structural changes accelerate from economic recession to recovery, a situation that marked the
beginning of this seven-year period. Moreover,
tracing subsequent employment changes to differences in the levels of determining variables
in 1975 seems justifiable in light of the dramatic
jump in energy prices between 1973 and 1975.
As they absorbed this blow, firms m a d e major
adjustments over the next several years.
How do findings from this research compare
with conclusions drawn by other researchers?
Generally, results accord with t h e industrial
organization view of foreign investment. Thus,
they support the notion that in the 1975-82
period foreign direct investment in U.S. manufacturing tended to occur mostly in oligopolistic
industries. Moreover, according to our analysis
of the Census Bureau's employment data, the
desire to secure a source of raw materials or
have better access to other resources, which
may have motivated foreign investment in an
earlier period, does not seem to have spurred
investment in more recent years.
The conclusions from this research clash most
with t h e findings of Lall a n d S i d d h a r t h a n .
Whereas those authors concluded that foreign
MNCs shunned highly concentrated industries
and that product differentiation variables d o
not help explain the clustering of foreign direct
48
investment, this research concludes the opposite for the 1975-82 period. Specifically, in
this study advertising and industry size and concentration were found to b e significant factors
that positively influenced foreign direct investment in the United States.
It is not possible to determine exactly why
these two sets of conclusions differ so markedly.
Perhaps, as Lall and Siddharthan speculated,
the more recent data show that factors similar to
those that have attracted U.S. MNCs abroad now
also help explain later stages of foreign entry
into the United States. Alternatively, comparable factors may have b e e n operating to influe n c e investment by U.S. M N C s and foreign
direct investment in the United States all along,
but they were masked by the lack of dynamic
analysis of changes over a specific period.
The author's results also are consistent with
conclusions about foreign direct investment
"[Findings from this research ... support the notion that in the 1975-82
period foreign direct investment in U.S.
manufacturing tended to occur mostly in
oligopolistic industries
ITjhe desire
to secure a source of raw materials or
have better access to other resources
... does not seem to have
spurred
investment in more recent years. "
based on more casual observation. The importance of industry and firm asset size in determining foreigners' direct investment activity in
the 1975-82 period is in keeping with the image
of large M N C s c o n v e y e d in the press. T h e
chemicals and allied products industry, a good
example of a U.S. industry that attracted foreign
investment, is a large industry composed of
relatively large firms. Similarly, the significance
of high advertising budgets is perhaps consistent with the heavy affiliate employment gains
in industries such as non-electrical machinery
and electronic equipment manufacturing; within these industries, product image and brand
identification help distinguish manufacturers'
products.
These size and advertising influences, together with the apparent lack of investor interest in acquiring either highly skilled labor or
raw materials, a d d to the impression that foreign multinational activities in t h e U n i t e d
SUMMER 1987, ECONOMIC REVIEW f
States arise from characteristics of the U.S.
market. T h e attractiveness of investing in this
country has b e e n enhanced by foreign companies' wider recognition of the size of the U.S.
market, as measured by industry size. Moreover,
the success of growing numbers of large foreign
M N C s in c o n t e n d i n g with U.S. c o m p a n i e s
a b r o a d has c o n v i n c e d t h e m that they can
c o m p e t e equally well in the U.S. domestic
market.
Do t h e s e s a m e influences explain foreign
direct investment in nonmanufacturing industries or at a more detailed industrial level? The
tentative answer is yes, but data limitations
have prevented estimation of the model except
for very broadly defined manufacturing industries. Consequently, one cannot compare exactly the statistical results for different groupings
such as manufacturing versus nonmanufacturing
industries.
"¡Multinational
corporation
activity
can be motivated by numerous and
complex conditions, suggesting that
explaining MNC behavior via precise
relationships
is inherently
difficult.
From a technical and statistical perspective, the modest amount of information that is available gives rise to
further ambiguity. "
cedures and data confidentiality requirements,
while the components of the chemicals and
machinery industries represented one-fourth of
the three-digit manufacturing industries' sample. Furthermore, information on firm size,
sales, advertising, and net income was available
forfewerthan half of the industries, and the R & D
variable could not b e constructed at this level of
industrial detail.
Data constraints limited analysis of the nonmanufacturing industries even more seriously.
Nonetheless, s o m e other variables, such as
changes in the foreign exchange value of the
dollar and flight capital or safe haven considerations, may b e better predictors of nonmanufacturing investment than those used
here. Specifically, real estate, financial, a n d
trade activities may b e more " l i q u i d " than
manufacturing investments and also less readily identifiable with foreign ownership. Such a
finding might also accord with the industrial
organization view of foreign direct investment. It
is possible that more liquid assets are 1 ikelier to
b e subject to the profitability criterion associated with portfolio investment than is longerterm foreign i n v e s t m e n t in manufacturing.
Pursuit of this line of reasoning is an important
direction for future research, since foreign d irect
investment activity in the U.S. service sector has
been growing even faster than in manufacturing.
Concluding Comments
Multiple regression analysis of the limited
data available for all industries and for threedigit manufacturing industries produced statistical results that were sensitive (in terms of signs
and significance of regression coefficients) to
the model specification used. These equations
explained much less of the industrial variation
in affiliate employment than d i d the equation
for two-digit manufacturing industries. Among
explanatory variables, the advertising and size
variables tended to b e the most robust.
There are, perhaps, at least a few good reasons why the model tested was able to explain
employment change best at the two-digit manufacturing level. First, for the three-digit manufacturing industries there actually was less
industry variation than for two-digit manufacturing industries. The reason is that the apparel,
lumber, paper, printing, and leather industries
were completely unrepresented at the threedigit level, both because of sampling prof
FEDERAL RESERVE BAN K OF ATLANTA
Empirical research on foreign direct investment in the United States appears to support
the industrial organization view. However, we
still cannot conclude with confidence very much
about the exact linkages and impacts of the
various factors causing such investment. As the
literature reviewed above amply shows, multinational corporation activity can be motivated
by numerous and complex conditions, suggesting that explaining M N C behavior via precise
relationships is inherently difficult. From a
technical and statistical perspective, the modest amount of information that is available gives
rise to further ambiguity.
Because theories of foreign d irect investment
are not strong enough to tell us just which
explanatory variables should be included informal statistical tests, or the form in which they
should b e introduced, experimentation and
trial-and-error analysis are m a n d a t e d w h e n
econometric methods are used. Unfortunately,
2l
drawn when only investors are asked about
investment influences because of the selection
bias involved in excluding non-investors. Consequently, the determinants of foreign investment remain elusive.
Notwithstanding these difficulties, continued
empirical study of the foreign direct investment
phenomenon may eventually offer a promising
research strategy. Survey design and sampling
efforts can b e improved to produce more meaningful analysis and interpretation of responses.
Burgeoning foreign investment in the United
States and efforts by the U.S. Department of
C o m m e r c e to d e v e l o p a useful, consistent
data b a s e will expand the pool of information
on U.S. affiliate activities. As more information b e c o m e s available, formal econometric
model-building and testing of hypotheses will
b e facilitated. Researchers must likewise continue to improve the theoretical and modelbuilding aspects of foreign direct investment
studies as a complement to better data.
major statistical problems arise in attempts to
disentangle separate effects because several of
the factors are highly correlated.
O n e specific statistical problem is that results
are b i a s e d if a statistical regression m o d e l
omits a relevant variable that is correlated with
variables included in the model. Alternatively,
including the variable can make it difficult to
obtain reliable estimates of the effects of other
variables, owing to the high degree of multicollinearity among the variables. Another major
drawback with those formal statistical regression models that have b e e n tried is the possible
i n t e r d e p e n d e n c e of foreign investment and
"explanatory" variables. For example, high profitability in an industry may attract M N C investment, but profitability could also b e high because of effective barriers to investment.
W h i l e these and other statistical problems
plague econometric studies of foreign direct
investment, surveys of foreign investors have
problems, too. Misleading conclusions can b e
Notes
'In the United States, ownership interest by a single investor of at
least 10 percent of the voting securities, or the equivalent, specifies
the investment a s "direct."
JSee
U.S. Department of Commerce (1984) for a further discussion
of these developments.
3 Dunning
and Rugman (1985), p. 228.
(1985), Teece (1985), and Kindleberger (1984).
,0See
Vernon (1966).
" S e e Knickerbocker (1974) and Graham (1974).
,2See
Vernon (1971).
1 3 Owen
(1983), p. 16.
'"Little (1978), p. 45.
" S e e Hymer (1960).
, 5 Gaspari
5See
1 6 See
6 The
Kindleberger (1969), J o h n s o n (1970), and C a v e s (1971).
firm could also serve these markets with exports or could
,7 lbid.
(1983), p. 77.
McClain (1983).
license a foreign firm to produce its, presumably, proprietary pro-
'«See Graham (1974) and Flowers (1976).
depends on the additional cost of doing business abroad versus
MMcClain
about transactions costs below.
" S e e Lall and Siddharthan (1982).
duct. The choice between direct investment and sale of knowledge
,9See
the cost and feasibility of selling the knowledge. S e e the discussion
21 Ibid.,
7See
Teece (1985).
"Dunning and Rugman (1985), p. 230.
9 For
general surveys of the literature on foreign direct investment the
reader is referred to Calvet (1981) and McClain (1983). Succinct
criticisms and evaluations of the various theoretical contributions
Volpe (1975).
(1983), p. 311.
p. 315.
^Ibid., p. 679.
"Statistics pertaining to these research findings will be available in a
forthcoming paper from the Research Department of the Federal
Reserve Bank of Atlanta.
" U . S . Department of Commerce (1978).
that are recommended to the reader include: Dunning and Rugman
50
S U M M E R 1987, ECONOMIC R E V I E W f
References
Calvet, A.L. " A Synthesis of Foreign Direct Investment Theories and
Theories of the Multinational Firm," Journal of International Business Studies, vol. 12, no. 1 (Spring/Summer 1981), pp. 43-59.
Knickerbocker, F.T. Oligopolistic Reaction and Multinational Enterprise. Cambridge, Mass.: Harvard Business School, 1974.
Lall, Sanjaya, and N.S. Siddharthan. "The Monopolistic Advantages
Caves, Richard. "International Corporations: The Industrial Econo-
of Multinationals: Lessons from Foreign Investment in the United
Dunning, J o h n H., and Alan M. Rugman. "The Influence of Hymer's
pp. 668-83.
mics of Foreign Investment" Economica, vol. 38 (1971), pp. 1-27.
Dissertation on the Theory of Foreign Direct I n v e s t m e n t , "
American
Economic
pp. 228-32.
Review,
vol. 75, no. 2 ( M a y
1985),
Direct Investment in the U.S.," Journal of International
Studies, vol. 7, no. 2 (Fall/Winter 1976), pp. 43-55.
Business
Gaspari, K. Celeste. "Foreign Market Operations and Domestic
Market Power." In The Multinational
Corporation in the 1980s,
edited by C.P. Kindleberger a n d D.A. Audretsch. Cambridge,
Mass.: MIT Press, 1983.
S t a t e s , " New England
Direct Invest-
ment in the United States. Ph.D. Thesis, Harvard Business School,
1974.
Economic
Review
(July/August 1978),
Currents, New Waves, and the Theory of Direct Investment." In
The Multinational Corporation in the 1980s, edited by C.P. Kindleberger and D.A Audretsch. Cambridge, Mass.: MIT Press, 1983.
O w e n , Robert F. "Inter-Industry Determinants of Foreign Direct
Investments: A Canadian Perspective." In New Theories of the
Enterprise,
St. Martin's Press, 1983.
edited by A.M. R u g m a n . N e w York:
Teece, David J . "Multinational Enterprise, Internal Governance,
a n d Industrial Organization," American
Horst, Thomas. "Firm and Industry Determinants of the Decision to
Invest Abroad: An Empirical Study," Review
Statistics, vol. 54, no. 3 (1972), pp. 258-66.
Hymer, Stephen H. International Operations
of Economics
and
vol. 75, no. 2 (May 1985), pp. 233-38.
Characteristics
of National
Firms—A
Economic
Review,
U.S. Department of Commerce. Bureau of the Census.
of Foreign-Owned
U.S. Firms:
Selected
1975-1976.
Washington, D.C.: U.S. Government Printing Office, November
Study of Direct Foreign Investment. Ph.D. Thesis, Massachusetts
1978.
1976.
Investment: Global Trends and the U.S. Role. Washington, D.C.:
Institute of Technology, 1960: Cambridge, Mass.: MIT Press,
Johnson, Harry G. "The Efficiency and Welfare Implications of the
International Corporation." In The International
Corporation,
edited by Charles P. Kindleberger. Cambridge, Mass.: MIT
Press, 1970.
tures on Direct Investment.
Press, 1969.
. Multinational
Press, 1984.
International Trade Administration. International
Direct
U.S. Government Printing Office, 1984.
Vernon, Raymond. "International Investment and International Trade
in the Product Cycle," Quarterly Journal of Economics, vol. 80, no. 2
(May 1966), pp. 190-247.
Kindleberger, Charles P. American
f
vol. 9 2 ( S e p t e m b e r 1982),
McClain, David. "Foreign Direct Investment in the United States: Old
Multinational
Imitation and European
Journal,
Little, J . S . "Locational Decisions of Foreign Investors in the United
pp. 43-63.
Flowers, E.B. "Oligopolistic Reactions in European and Canadian
Graham, E.M. Oligopolistic
S t a t e s , " The Economic
Business
Abroad:
Six
Lec-
New Haven, Conn.: Yale University
Sovereignty
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at Bay: The Multinational Spread
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of U.S.
Volpe, J.M. " S o m e Preliminary Findings on the Factor Intensity of
Excursions.
F E D E R A L R E S E R V E BAN K O F ATLANTA
Cambridge, Mass.: MIT
Foreign Direct Investment in U.S. Manufacturing,"
Economist,
vol. 19, no. 1 (Spring 1975), pp. 67-73.
American
2l
Effects of Oil Price Shocks
On Measured GNP Growth
R. Mark Rogers
Economic indicators such as real gross national product (GNP) can b e indispensable
guides for making strategic business decisions
as well as for economic policy—whether trading
on Wall Street, expanding an auto plant, changing economic policy, or simply determining the
best time to make a home purchase. Yet economic data series, no matter how carefully
defined, do not always conform to the theoretical constructs w e wish to measure. Changes
in the economy likewise can have unexpected
or o v e r l o o k e d effects on m e a s u r e d G N P —
simply because the popular notion of G N P may
diverge from the strictly defined official construct. In fact, this article will show that the direct
effect of lower imported oil prices and inflation
adjustment (rebasing) was actually to reduce
measured real G N P growth in 1985 and 1986.
G N P is typically referred to as a measure of
national output—which is approximately true.
Consequently, whatever changes in the economy are favorable for production and income
are also generally thought to b e favorable for
G N P as measured. This relationship might hold
true in a definitional sense if G N P were measured directly by adding up all domestically
produced goods and services for final consumption. H o w e v e r , G N P is d e r i v e d indirectly,
through measures of expenditure.
This article presents a close examination of
the impact of a specific, large price change on
measured GNP. In essence, we assume that
other things are held constant in order to look at
the effects of such a price change on the data
series. Of course, in reality such static conditions do not hold. The actual dynamic macroeconomic impacts of lower imported oil
prices are diverse, bearing on both supply and
demand. While these often complex macroeconomic effects merit attention, such considerations are beyond the scope of this article. 1
In calculations of G N P , all domestic expenditures, whether by consumers, business, or
state and local governments, are estimated and
then adjusted for expenditures on imports and
for production that is sold abroad (that is,
exports). Of course, inventory changes also are
taken into account so as not to confuse current
expenditures for goods produced in the present period with outlays for goods produced in
previous periods. The feature that we will explain about this indirect method of construction
is that it can l e a d to m o v e m e n t in official
measures of output, or G N P, that are often unexpected or simply inexplicable to the average
observer. Nonetheless, since the financial and
business communities attach such importance
to changes in G N P , these instances of misunderstood effects can b e important in themselves.
The author is an assistant economist in the macropolicy
the Atlanta Fed's Research
Department.
The confusion surrounding the composition
of economic statistics weakens the public's
grasp of how a number of recent events, par-
52
section of
SUMMER 1987. ECONOMIC REVIEW
ticularly the declines in oil prices and in the exchange value of the dollar, affect measures of
output. Only with a thorough examination of the
construction of economic statistics can the
economic consequences of these changes b e
understood and, often, anticipated. This article
demonstrates that oil price shocks may have
substantial effects on measured G N P statistics
that defy the intuition of the average follower of
business conditions. A somewhat closer look at
the construction of the G N P accounts, and oil
imports' place within them, will help demonstrate why measured G N P is affected in such unexpected ways.
Most of us understand that oil price changes
can affect economic activity through impacts on
the cost of production and on consumers' discretionary income. However, in a less straightforward and often overlooked manner, oil price
changes also can have a significant bearing on
real G N P growth. This effect has been particularly important since late 1985, when the
G N P statistics began to reflect a combination of
the U.S. Commerce Department's updating of
the valuation p e r i o d for G N P c o m p o n e n t s
(rebasing) and the fall in oil prices. The coincidence of these two events had an impact on
measured G N P which is not obvious—indeed,
the outcome seems paradoxical on the surface.
Again, o n e might expect a price cut for oil
imports to bolster real G N P growth, b u t it
actually had the opposite effect—at least in the
short run.
Over time, oil price shocks can cause a significant divergence in the direction in which oil
prices and oil imports affect nominal and real, or
inflation-adjusted, economic growth. This divergence is attributable simply to the way real G N P
is defined. It is important to note that oil price
shocks may lead to either a significant overstating or understating of real G N P growth owing to
typically overlooked "definitional" effects. In
fact, in 1986 oil price reductions appear to have
led to a decline in economic activity as measured by constant-dollar GNP. These effects,
which are discussed below, are generally described as counterintuitive, given the positive
impacts on economic activity that are usually
associated with lowered resource costs. In the
present context, the terms understatement and
overstatement do not refer to some failure of
the G N P statistic to account for the change taking place. Rather than a technical distortion,
understatement or overstatement is a clear
divergence from the impacts that generally are
expected by a casual user of the data.
f
FEDERAL RESERVE BAN K OF ATLANTA
GNP Measurement
and Price Changes
2l
To c o m p r e h e n d fully the impact of oil price
shocks on measured nominal and real economic
growth, one must first understand the basics of
how G N P is measured and how price changes
affect G N P estimates. In addition, the concept
of rebasing G N P must b e grasped. Defined as
the value of all final goods and services prod u c e d in t h e U n i t e d States, G N P i n c l u d e s
exports and excludes imports, as the latter are
produced elsewhere. G N P is measured in current dollars, reflecting present prices, but also
can b e measured in constant, or real, dollars.
Measures of real G N P allow comparison of the
actual volume of output in different years by
eliminating those differences that are strictly
attributable to price changes. In the process of
adjusting nominal G N P to yield real G N P , the
numerous G N P components are deflated. T h e
deflator for each component (for example, consumption and investment) is a price index,
which is used to remove whatever price change
has occurred since the base period—that is, the
point in time from which price movements are
calculated. W h e n the U.S. Department of Commerce rebases the G N P accounts, it adjusts the
base year forward; in December of 1985 the
department rebased G N P from 1972 to 1982.
The latest rebasing had a significant impact on
measured G N P growth for the year 1986 because substantially lower oil prices led to highervolume oil imports in that year.
The base period chosen for real G N P statistics critically influences m e a s u r e d real G N P
growth, primarily because of marked changes in
relative prices in some important components.
S o m e G N P c o m p o n e n t s are eventually deflated
or inflated far more than others when translated
from current-dollar into constant-dollar measures. In e s s e n c e , changing t h e b a s e year
specifically changes the valuation of constantdollar G N P components relative to each other.
Certain components receive greater weight in
real G N P calculations depending on their relative importance in the base year. W h i l e this
phenomenon can occur in any component, the
most obvious current example is oil and petroleum product imports. In combination with
recent dramatic declines in oil prices, the statistical impact of rebasing was quite large.
Considering the economic history of the postWorld War II U n i t e d States, it is natural to
BOX
How Changes in Oil Prices and Base Year
Affect Measured Growth of Real GNP
For illustration, let us imagine a simple, four-component economy:
(1) good A is a non-oil good that is domestically produced for domestic consumption;
(2) good B is domestically consumed oil (both domestically produced and imported);
(3) good C is imported oil;
(4) good D is a non-oil good that is domestically produced for export.
O n e major assumption is critical: as the price of
imported oil falls, domestic consumers respond by buying more oil from abroad and consuming more oil overall;
they do just the reverse when faced with a price hike.
Domestically produced oil is found to be total domestic
consumption of oil minus oil imports. For simplicity, let us
also assu me that the on ly price change to occu r is that for
the price of oil. In Year 1, w e assume that the real per-unit
price of each good is $1 and that in this economy 100
units of A are consumed, 50 units of oil are consumed
domestically, 25 units of imported oil are consumed, and
25 units of D are exported. W e find that domestic oil production is $25 ($50 for total consumption of oil minus
$25 for imports). Using an expenditure approach, real
G N P is defined as $A + $ B - $ C + $D, or
Year 1; Base A
A: 100 x $1.00 = $100
B: 50 x $ 1 . 0 0 = +50
C: 25 x $ 1 . 0 0 = -25
D: 25 x $1.00 = + 2 5
$150 of G N P in Year 1.
In Year 2, let us make different assumptions: no change
in the price of oil and a 10 percent growth over Year 1 in
all components. Real G N P would be a s follows:
Year 2; Example A; Base A
A: 100 x 1.10 x $1.00 = $110.00
B : 50 x 1.10 x $ 1 . 0 0 = +55.00
C: 25 x 1.10 x $1.00 = -27.50
D: 25 x 1.10 x $1.00 = +27.50
$165.00 Of G N P
in Year 2.
Real G N P growth would be [$165/$150] - 1 X 100 =
10 percent.
Now, let us assume a 20 percent cut in the price of
imported oil. Two factors are important in the following
example. Since w e are discussing real components, w e
still use the Year 1 figure for oil (domestic and imported)—even though w e assume the nominal price fails. W e
also go back to the assumption that oil imports rise and
consumption of domestic oil falls. (Domestic supplies
are at a cost disadvantage and, with an upturn in oil
imports, provide relatively less of overall oil consumption,
54
though at a competitive price.) The price cut sparks
growth in overall oil consumption in real terms. Let us
assume this increase is 15 percent. Also, let us assume
that as the price of imported oil falls—and domestic in
turn—imported oil consumption rises 40 percent and
domestic consumption of domestic oil drops, therebyfilling the residual demand. W e see that domestically produced oil falls to $22.50 ($57.50 - $35.00).
Year 2; Example B; Base A
A: 100 x 1.10 x $1.00
B : 50 x 1.15 x $1.00
C : 2 5 x 1.40 x $1.00
D: 25 x 1.10 x $1.00
= $110.00
= +57.50
= -35.00
= +27.50
$160.00 of real G N P
in Year 2.
Notice that the growth rates are the same for A and D
but differ for B and C to reflect the drop and rise, respectively, for domestic and imported oil. Real G N P would be
$160.00 in Year 2 assuming the above real response to
oil price changes. Real G N P advances only 6.7 percent
instead of the 10 percent in Example A for Year 2. Of
course, this example is dramatic because of the relative
size of oil compared with overall G N P . Notice that real net
exports (exports minus imports) went from zero, both in
Year 1 and in Example A of Year 2, to a minus $7.50 in
Example B, thereby decreasing measured growth.
T h e Effect of Different B a s e Years. W e have gone
through one set of examples using real prices of $1 for
each good, with the prices in Year 1 as the base. What if
w e chose to use a base year in which the relative price of
oil were cheaper? For example, in 1972 the price of oil
certainly w a s cheaper than in 1982. In July 1986, the U.S.
Department of Commerce switched the base year for
G N P measurements from 1972 to 1982. To illustrate the
impact of this move, let us recalculate the three earlier
examples by changing only the price of oil from $1 to
$.10, which actually is similar to the relative price of oil in
1972 compared with 1982. 1 Units consumed remain
the same.
Year 1; Base B
A: 100 x $1.00 = $100.00
B : 50 x $ . 1 0 =
+5.00
C: 25 x $ . 1 0 =
-2.50
D: 25 x $ 1 . 0 0 = +25.00
$127.50 of real G N P in Year 1.
Real G N P would now be $127.50 instead of $150 as
in B a s e A. The lower price of oil in the base year has
reduced the relative importance of oil. However, our real
interest is in growth rates more than levels. Note that
domestic oil production is $2.50 ($5.00 - $2.50) and net
exports are $22.50 ($25.00 - $2.50) in Year 1.
SUMMER 1987, ECONOMIC REVIEW f
box continued
Using B a s e B, if the volume rose 10 percent for each
component—no price change for oil—we would find
the following:
Year 2; Example A; Base B
A: 100 x 1.10 x $1.00 = $110.00
B : 50 x 1.10 x $ .10 =
+5.50
C: 25 x 1.10 x $ .10 =
-2.75
D: 25 x 1.10 x $ 1 . 0 0 = +27.50
$140.25 of real G N P
in Year 2.
Real growth remains 10 percent. The change in the base
period has no effect on the growth rate since there is no
change in relative shares of goods consumed. (This
would change if there were a net surplus or deficit.)
O n c e again, consider what happens to real G N P
growth if the price of imported oil falls, thereby raising oil
imports and lowering domestic oil production. W e can
assume the same quantity (units) response as in Example B for Year 2 in B a s e A. The only difference is relative
prices from the base year.
With the price decline for oil—and quantity response—
in B a s e B , real G N P in Year 2 is only slightly below that
with no price change. Real G N P growth is 9.6 percent
versus the 6.7 percent growth in B a s e A. Because the
lower relative price reduced the significance of oil in
these G N P accounts, percentage changes in the oil
components have a smaller impact on real G N P growth.
Also, note that the trade account improved in real terms
from $22.50 in Year 1 to $24.00 in Year 2—the non-oil
export component w a s of greater importance since the
B a s e B G N P level w a s lower than in B a s e A.
In sum, the base year is important because it can affect
the relative size of oil imports. More specifically, 1982base G N P accounts weight oil imports more heavily than
1972 base year accounts simply because the price of oil
w a s markedly cheaper in the earlier year. W e c a n
extrapolate from these simple illustrations to using actual
G N P data to estimate the impact of oil price changes.
Year 2; Example B; Base B
A: 100 x 1.10 x $1.00 = $110.00
B: 50 x 1.15 x $ . 1 0 =
+5.75
C: 25 x 1.40 x $ .10 =
-3.50
D: 25 x 1.10 x $1.00 = +27.50
Note
1 This
$139.75 of real G N P
in Year 2.
assume that nominal G N P will regularly exceed
real G N P since general price changes are always
positive. The G N P deflator is typically more than
100—that is, rising from the base period—as are
most of the component deflators. O n e of the
complications of studying the impact of oil price
changes on measured G N P is that the oil component price fell from the level prevailing in
1982, the new base period, while the overall
deflator rose. Since we are unaccustomed to
adjusting for lower levels of prices, the oil
import deflator may look "unreasonable."
A s i d e from t h e intuitive versus m e a s u r e d
G N P effects issue, the fact that oil imports are
production inputs as well as final products
further complicates efforts to assess the impact
of oil price swings on economic growth. Since
imports are negatives in the G N P accounts,
maintaining the concept of G N P as a measure of
final output is somewhat more difficult in the
case of oil. Certainly, it is relatively straightforward that expenditures on imported autos
should b e subtracted from total expenditures
on autos to isolate domestic auto production for
fFEDERALR E S E R V E
BAN K OF ATLANTA
is similar to the actual difference in oil import prices between
1982 and 1972. According to the implicit deflator for either the
1982- or 1972-based data, oil import prices were about 12 times
higher in 1982 than in 1972.
the G N P accounts. This is similarly true for petroleum imports used at the retail level. However, when p e t r o l e u m imports are used for
inputs and the price falls, it seems that the
reduction should constitute a positive from a
cost perspective. This would be the case, except
that the price drop encourages a rise in real oil
imports, which immediately registers as a negative in the G N P accounts; the positive impact on
production may take much longer to show up.
W h i l e this w e b of relationships is anything but
straightforward, it is important to understand,
for oil price shocks have reverberated widely
throughout the U.S. economy three times in
recent history. T h e two earlier e p i s o d e s are
reviewed below before the latest price change
is considered.
Recent Oil Price Hikes
T h e 1 9 7 0 s . Two oil price shocks occurred in
the previous decade—in late 1973/early 1974
and in 1979. Oil prices rose dramatically in each
2l
Table 1.
Deflator for Imports of Petroleum and Petroleum Products
1982 Base (1982 = 100)
1972 Base (1972 = 100)
Percent
Change,
SAAR*
Level
Percent
Change
13.0
29.2
45.7
209.4
1,875.5
172.2
1.4
-5.8
8.8
9.3
10.2
13.5
28.7
36.5
36.6
36.2
2.3
6.2
10.2
32.1
111.8
27.2
0.4
-1.1
9.6
27.3
47.6
204.2
1,911.9
162.1
1.8
-4.5
5.3
17.0
12.6
19.7
8.7
2.9
3.2
7.1
22.9
87.4
169.5
60.6
105.2
39.5
11.9
13.6
43.7
50.7
65.3
74.0
87.9
96.4
98.7
102.1
4.8
16.2
28.7
13.4
18.7
9.7
2.4
3.4
20.8
82.5
174.2
65.2
98.6
44.8
10.1
14.2
-2.1
-1.4
-3.7
N.A.
-8.1
-5.4
-13.9
N.A.
85.4
86.2
82.4
84.3
68.7
42.1
36.4
40.8
50.1
55.5
-3.3
0.9
-4.4
2.2
-18.4
-38.7
-13.5
11.8
22.8
10.8
-12.4
3.8
-16.4
9.2
-55.8
-85.9
-44.0
56.5
127.6
50.7
Level
Percent
Change
1973:1
II
111
IV
1974:1
II
111
IV
105.2
112.1
123.2
163.4
344.4
442.4
443.9
437.3
3.4
6.6
9.9
32.6
110.8
28.4
0.3
-1.4
1979:1
II
III
IV
1980:1
II
III
IV
526.4
615.9
789.2
888.4
1,063.3
1,155.6
1,188.5
1,227.0
1985:1
II
III
IV
1986:1
II
III
IV
1987:1
11
1,064.2
1,041.9
1,027.5
N.A.
Year: Quarter
Percent
Change,
SAAR*
* Seasonally adjusted annual rate.
Source: U.S. Department of Commerce.
period, though especially so during the first. In
the initial quarter of 1974 alone, the deflator for
imports of petroleum and derivative products
more than doubled, rising 111.8 percent (see
Table I). As a result of oil price hikes, the dollar
value of oil imports shot upward while their
volume, measured in barrels, at first remained
stable but then declined (see Table 2, cols. 5
and 6). In nominal terms, the oil price shocks
raised oil imports markedly and, in turn, lowered
net exports and nominal G N P growth. (Of course,
in t h e s e highly inflationary years other factors
greatly offset this negative impact on nominal
G N P growth.2)
In contrast to nominal oil imports, real oil
imports in the mid- and late 1970s were affected
in an opposite manner. The higher prices for
imported oil induced conservation as well as
substitution of domestic for imported oil; other
energy sources were likewise substituted. Con56
sequently, real oil imports, in terms of volume or
barrels, fell following the initial oil price hikes,
so that real net exports were higher than otherwise. Through the 1970s, real oil imports as
expressed in 1972 dollars were a minute share
of domestic demand, and so they had a very
small weight in G N P estimates. Hence, the oil
price shocks' net estimated effect on real G N P
growth, while minimal, was positive. The small
weight in real terms was due to the fact that this
component was deflated heavily to reflect the
upsurge in price from the base year through the
oil embargo period. Overall, the sizable oil price
hikes of the 1970s produced significantly opposite effects on nominal and real oil imports.
Although other factors obscured the overall net
effects, the marginal impacts—that is, the direct,
most recent impacts—were also opposite on
nominal and real net exports and on nominal
and real G N P growth.
S U M M E R 1987, ECONOMIC R E V I E W f
Table 2.
Petroleum and Petroleum Products Imports
Nominal Dollars
Year: Quarter
1972 Base
Quarterly Absolute
Level*
Percent
Change
(billion $) Change (billion $)
Real Dollars
Nominal Dollars
Quarterly Absolute
Level* Percent Change
(billion $) Change (billion $)
1982 Base
Quarterly Absolute
Level*
Percent
Change
(billion $) Change (billion $)
Real Dollars
Quarterly Absolute
Level*
Percent Change
(billion $) Change (billion $)
1973:1
II
III
IV
1974:1
II
III
IV
6.1
7.4
8.5
11.6
18.6
29.2
29.3
29.3
19.6
21.3
14.9
36.5
60.3
57.0
0.3
0.0
1.0
1.3
1.1
3.1
7.0
10.6
0.1
0.0
5.8
6.6
6.9
7.1
5.4
6.6
6.6
6.7
16.0
13.8
4.5
2.9
-23.9
22.2
0.0
1.5
0.8
0.8
0.3
0.2
-1.7
1.2
0.0
0.1
6.1
7.4
8.3
11.8
18.6
29.1
28.9
29.8
17.3
21.3
12.2
42.2
57.6
56.5
-0.7
3.1
0.9
1.3
0.9
3.5
6.8
10.5
-0.2
0.9
69.7
79.6
81.0
87.2
64.9
79.8
78.9
82.3
14.6
14.2
1.8
7.7
-25.6
23.0
-1.1
4.3
8.9
9.9
1.4
6.2
-22.3
14.9
-0.9
3.4
1979:1
II
III
IV
1980:1
II
Hi
IV
45.8
54.2
65.5
76.4
84.0
83,2
72.5
77.3
5.3
18.3
20.8
16.6
9.9
-1.0
-12.9
6.6
2.3
8.4
11.3
10.9
7.6
-0.8
-10.7
4.8
8.7
8.8
8.3
8.6
7.9
7.2
6.1
6.3
0.0
1.1
-5.7
3.6
-8.1
-8.9
-15.3
3.3
0.0
0.1
-0.5
0.3
-0.7
-0.7
-1.1
0.2
45.8
54.2
65.5
76.4
84.1
83.2
70.8
79.0
5.0
18.3
20.8
16.6
10.1
-1.1
-14.9
11.6
2.2
8.4
11.3
10.9
7.7
-0.9
-12.4
8.2
104.9
106.8
100.3
103.2
95.7
86.3
71.7
77.4
0.2
1.8
-6.1
2.9
-7.3
-9.8
-16.9
7.9
0.2
1.9
-6.5
2.9
-7.5
-9.4
-14.6
5.7
1985:1
II
III
IV
1986:1
II
III
IV
1987:1
II
44.8
52.4
48.5
N.A
-20.6
17.0
-7.4
N.A.
-11.6
7.6
-3.9
N.A.
4.3
5.1
4.9
N.A.
-18.9
18.6
-3.9
N.A.
-0.1
0.8
-0.2
N.A.
43.4
52.6
49.3
56.3
40.9
30.5
31.6
32.0
34.8
40.0
-24.4
21.2
-6.3
14.2
-27.4
-25.4
3.6
1.3
8.8
14.9
-14.0
9.2
-3.3
7.0
-15.4
-10.4
1.1
0.4
2.8
5.2
50.8
61.0
59.8
66.8
59.5
72.4
86.7
78.5
69.5
72.1
-21.8
20.1
-2.0
11.7
-10.9
21.7
19.8
-9.5
-11.5
3.7
-14.2
10.2
-1.2
7.0
-7.3
12.9
14.3
-8.2
-9.0
2.6
* Levels are annualized.
Source: U.S. Department of C o m m e r c e .
An important element in the masking of these
effects was t h e n e e d to deflate nominal oil
imports substantially to arrive at real oil imports. In 1974, for instance, nominal oil imports
had to b e deflated by a factor of about 4 to get
real oil imports (1972 base). A deflator of such
high magnitude meant that changes in real
import volume were considerably smaller than
corresponding changes in nominal volume (see
Table 2; compare cols. 3 and 4 with 5 and 6).
In summary, the oil price hikes of 1973-74 and
1979 (1972 base figures) resulted in the following:
(1) The deflator for oil imports rose sharply.
(2) Nominal oil imports rose dramatically.
(3) Real oil imports eventually declined in response to higher prices and resultant substitution effects.
(4) Real oil imports declined, although oil imports' share of domestic demand changed
little since t h e dollar share was small
initially.
(5) T h e large absolute change in nominal oil
imports implied large adverse impacts on
nominal net exports and on nominal G N P
growth.
(6) The marginal impact of the oil price change
on nominal G N P growth was adverse, although other factors more than offset the
decline.
(7) The marginal impact on real G N P growth
was positive d u e to lower real oil imports,
but the net effect appeared to be minuscule. Other factors offset this positive effect
on real G N P growth.
None of these effects is startling, but together
they create a useful basis for comparison when
discussing the impact of the oil price plunge in
the next period.
T h e 1 9 8 0 s . In a reversal of the events of the
early 1970s, oil prices plummeted in late 1985
and through the first part of 1986. Whereas the
marginal impacts on economic activity are likely
to b e the opposite of those of the price increases, the effects on measured G N P did not
reverse the earlier pattern. This asymmetry
stems both from the rebasing (or changes in
c o m p o n e n t valuation) of G N P accounts from
1972 dollars to 1982 dollars, a process that
magnified the oil import effects on real GNP,
and from the fact that oil prices were significantly higher in 1982 than in the period following
the 1985-86 oil price cuts. Therefore, "deflating"
1986 nominal oil imports to yield real figures
actually "inflates" the data, thus making net
exports a larger negative and reducing real G N P
58
growth. Lower oil prices actually encouraged
greater importation of oil, which resulted in
deterioration in real trade. The combination of
rebasing G N P to 1982 dollars along with oil price
cuts led to notably higher estimates of real
imports and lower estimates for both net exports and real G N P growth than would have
b e e n the case with the 1972 base year.
Before looking at actual data for 1986, let us
review a few hypothetical examples to see how
rebasing and the plunge in oil prices might
affect nominal G N P . For example, w e might
compare how 1986 would look had the only
change in G N P growth from 1985 b e e n the
volume change in oil imports. That is, for the
sake of simplicity we will assume that all other
components of G N P (personal consumption,
investment, and so on) grow at exactly the same
rates in 1986 as in 1985.
Effects of Oil Price Cuts
in Hypothetical 1986
First, w e must make various assumptions
about the extent of oil price declines, taking 25,
30, and 35 percent price drops just for illustration. Second, w e will assume that all non-oil
import components of G N P experienced the
s a m e growth rate in hypothetical 1986 as in
actual 1985. Doing so gives us a reasonable
baseline for comparing hypothetical 1986 growth
excluding oil price cuts with growth rates including the assumed cuts (see middle row of Tables
3a-3c). Rates for nominal and real growth in 1986
are identical to those in 1985, assuming no
changes in the overall price level; of course,
absolute dollar changes differ for the two years.
Since the only variable in hypothetical 1986
thatchanged was petroleum imports, G N P must
b e calculated, or assumed, for 1986 on the basis
of continuing 1985 growth rates for the other
components. This calculation can be done in a
"back-door" fashion using the concept of domestic demand. Domestic demand (DD) equals
G N P minus net exports (X - M; see equation 1).
W e can further separate oil imports from net
exports and calculate these two components
from 1985 levels and growth rates. In this way,
G N P e q u a l s domestic d e m a n d plus exports
minus non-oil imports (M non-oil) and minus oil
imports (M oil; s e e equations 2 and 3).
DD = G N P - (X - M)
DD = G N P - |X- (M non-oil) - (M oil)]
G N P = D D + |X - (M non-oil) - (M oil)]
(I)
(2)
(3)
SUMMER 1987, ECONOMIC REVIEW f
Table 3a.
Estimated Impact of Oil Price Changes on Nominal and Real GNP Growth in Hypothetical 1986
Assuming a 25 Percent Annual Decrease in the Deflator for Imports of Oil and Petroleum Products*
Imports: Petroleum and
Petroleum Products—1982 Base
Imports: Petroleum and
Petroleum Products—1972 Base
Physical
Volume
Nominal Dollar
Volume
Real Dollar
Volume
Nominal Dollar
Volume
Real Dollar
Volume
Percent
Change
Absolute
Percent Change
Change (billion $)
Absolute
Percent Change
Change (billion $)
Absolute
Percent Change
Change (billion $)
Absolute
Percent Change
Change (billion $)
Gross National Product
Annual Average Percent Change
1982 Base
Nominal
Real
1972 Base
Nominal
Real
10
15
20
25
30
35
-17.5
-13.8
-10.0
-6.3
-2.5
1.3
-8.8
-6.9
-5.0
-3.2
-1.3
0.6
10.0
15.0
20.0
25.0
30.0
35.0
6.0
8.9
11.9
14.9
17.9
20.9
-17.5
-13.8
-10.0
-6.3
-2.5
1.3
-8.4
-6.6
-4.8
-3.0
-1.2
0.6
10.0
15.0
20.0
25.0
30.0
35.0
0.5
0.7
1.0
1.2
1.4
1.7
6.42
6.37
6.32
6.28
6.23
6.18
2.75
2.67
2.59
2.50
2.42
2.34
6.18
6.13
6.09
6.04
5.99
5.95
2.46
2.44
2.43
2.42
2.40
2.39
Baseline**
-6.9, -10.5
(1982) (1972)
-12.1
-6.1
-6.9
-4.1
-16.3
-7.8
-10.5
-0.5
6.35
3.03
6.16
2.52
16.9
21.9
26.9
31.9
36.9
41.9
10.1
13.0
16.0
19.0
22.0
25.0
-1.2
2.5
6.3
10.0
13.8
17.6
-0.6
1.2
3.0
4.8
6.6
8.4
20.5
25.5
30.5
35.5
40.5
45.5
1.0
1.2
1.5
1.7
1.9
2.2
0.07
0.02
-0.03
-0.07
-0.12
-0.17
-0.28
-0.36
-0.44
-0.53
-0.61
-0.69
0.02
-0.03
-0.07
-0.12
-0.17
-0.21
-0.06
-0.08
-0.09
-0.10
-0.12
-0.13
10
15
20
25
30
35
Difference from Baseline
-5.4
-1.7
2.1
5.8
9.6
13.4
-2.7
-0.8
0.9
2.9
4.8
6.7
Assumptions:
(1) Except forthe petroleum and petroleum products component, all G N P components rise at the same rate in 1986 as in 1985. The percentage changes for 1972
and 1982 base figures are calculated independently. Fourth-quarter data for 1985 in 1972 base figures are extrapolated from the first three quarters.
(2) The deflator for imports of oil and petroleum products falls 25 percent from its 1985 average.
(3) In response to the price decrease, physical import volume rises by the various percentages as shown above in the first column.
* Figures are for annual averages.
** A s s u m e s s a m e trend in oil imports a s in 1985. Hence, percent c h a n g e s are the s a m e a s in 1985, s a v e for rounding errors. Of course, absolute c h a n g e s do differ from 1985. In real terms,
volume fell 10.5 percent in 1 9 8 5 for the 1972 b a s e series a n d 6.9 percent for the 1982 b a s e series.
Table 3b.
Estimated Impact of Oil Price Changes on Nominal and Real GNP Growth in Hypothetical 1986
Assuming a 30 Percent Annual Decrease in the Deflator for Imports of Oil and Petroleum Products*
Imports: Petroleum and
Petroleum Products—1982 Base
Imports: Petroleum and
Petroleum Products—1972 Base
Physical
Volume
Nominal Dollar
Volume
Real Dollar
Volume
Nominal Dollar
Volume
Real Dollar
Volume
Percent
Change
Absolute
Percent Change
Change (billion $)
Absolute
Percent Change
Change (billion $)
Absolute
Percent Change
Change (billion S)
Absolute
Percent Change
Change (billion $)
10
15
20
25
30
35
ìaseline**
-6.9, -10.5
982) (1972)
10
15
20
25
30
35
Gross National Product
Annual Average Percent Change
1982 Base
Nominal
Real
1972 Base
Nominal
Real
-23.0
-19.5
-16.0
-12.5
-9.0
-5.5
-11.6
-9.8
-8.1
-6.3
-4.3
-2.8
10.0
15.0
20.0
25.0
30.0
35.0
6.0
8.9
11.9
14.9
17.9
20.9
-23.0
-19.5
-16.0
-12.5
-9.0
-5.5
-11.0
-9.4
-7.7
-6.0
-4.5
-2.6
10.0
15.0
20.0
25.0
30.0
35.0
0.5
0.7
1.0
1.2
1.4
1.7
6.49
6.44
6.40
6.35
6.31
6.27
2.75
2.67
2.59
2.50
2.42
2.34
6.25
6.20
6.16
6.12
6.07
6.03
2.46
2.44
2.43
2.42
2.40
2.39
-12.1
-6.1
-6.9
-4.1
-16.3
-7.8
-10.5
-0.5
6.35
3.03
6.16
2.52
16.9
21.9
26.9
31.9
36.9
41.9
10.4
13.0
16.0
19.0
22.0
25.0
-6.7
-3.2
0.3
3.8
7.3
10.8
-3.2
-1.6
0.1
1.8
3.5
5.2
20.5
25.5
30.5
35.5
40.5
45.5
1.0
1.2
1.5
1.7
1.9
2.2
0.14
0.09
0.05
0.00
-0.04
-0.08
-0.28
-0.36
-0.44
-0.53
-0.61
-0.69
0.09
0.04
0.00
0.04
-0.09
-0.13
-0.06
-0.08
-0.09
-0.10
-0.12
-0.13
Difference from Baseline
-10.9
-7.4
-3.9
-0.4
3.1
0.6
-5.5
-3.7
-6.0
-0.2
1.6
3.3
Assumptions:
(1) Except for the petroleum and petroleum products component, all G N P components rise at the same rate in 1986 as in 1985. The percentage changes for 1972
and 1982 base figures are calculated independently. Fourth-quarter data for 1985 in 1972 base figures are extrapolated from the first three quarters.
(2) The deflator for imports of oil and petroleum products falls 30 percent from its 1985 average.
(3) In response to the price decrease, physical import volume rises by the various percentages as shown above in the first column.
* Figures are for annual averages.
** A s s u m e s s a m e trend in oil imports a s in 1985. Hence, percent c h a n g e s are the s a m e a s in 1985, s a v e for rounding errors. Of course, absolute c h a n g e s do differfrom 1985. In real terms,
volume fell 10.5 percent in 1 9 8 5 for the 1972 b a s e series a n d 6.9 percent for the 1982 b a s e series.
Table 3c.
Estimated Impact of Oil Price Changes on Nominal and Real GNP Growth in Hypothetical 1986
Assuming a 35 Percent Annual Decrease in the Deflator for Imports of Oil and Petroleum Products*
Imports: Petroleum and
Petroleum Products—1982 Base
Imports: Petroleum and
Petroleum Products—1972 Base
Physical
Volume
Nominal Dollar
Volume
Real Dollar
Volume
Nominal Dollar
Volume
Real Dollar
Volume
Percent
Change
Absolute
Percent Change
Change (billion $)
Absolute
Percent Change
Change (billion $)
Absolute
Percent Change
Change (billion $)
Absolute
Percent Change
Change (billion $)
Gross National Product
Annual Average Percent Change
1982 Base
Nominal
Real
1972 Base
Nominal
Real
10
15
20
25
30
35
-28.5
-25.3
-22.0
-18.8
-15.5
-12.3
-14.4
-12.7
-11.1
-9.5
-7.8
-6.2
10.0
15.0
20.0
25.0
30.0
35.0
6.0
8.9
11.9
14.9
17.9
20.9
-28.5
-25.3
-22.0
-18.8
-15.5
-12.3
-13.7
-12.1
-10.6
-9.0
-7.4
-5.9
10.0
15.0
20.0
25.0
30.0
35.0
0.5
0.7
1.0
1.2
1.4
1.7
6.56
6.51
6.47
6.43
6.39
6.35
2.75
2.67
2.59
2.50
2.42
2.34
6.31
6.27
6.23
6.19
6.15
6.11
2.46
2.44
2.43
2.42
2.40
2.39
Baseline**
-6.9, -10.5
(1982) (1972)
-12.1
-6.1
-6.9
-4.1
-16.3
-7.8
-10.5
-0.5
6.35
3.03
6.16
2.52
16.9
21.9
26.9
31.9
36.9
41.9
10.1
13.0
16.0
19.0
22.0
25.0
-12.2
-9.0
-5.7
-2.5
0.8
4.0
-5.9
-4.3
-2.8
-1.2
0.4
1.9
20.5
25.5
30.5
35.5
40.5
45.5
1.0
1.2
1.5
1.7
1.9
2.2
0.21
0.16
0.12
0.08
0.04
0.00
-0.28
-0.36
-0.44
-0.53
-0.61
-0.69
0.15
0.11
0.07
0.03
-0.01
-0.05
-0.06
-0.08
-0.09
-0.10
-0.12
-0.13
10
15
20
25
30
35
Difference from Baseline
-16.4
-13.2
-9.9
-6.7
-3.4
-0.2
-8.3
-6.6
-5.1
-3.5
-1.7
-0.1
Assumptions:
(1) Except for the petroleum and petroleum products component, all G N P components rise at the same rate in 1986 as in 1985. The percentage changes for 1972
and 1982 base figures are calculated independently. Fourth-quarter data for 1985 in 1972 base figures are extrapolated from the first three quarters.
(2) The deflator for imports of oil and petroleum products falls 35 percent from its 1985 average.
(3) In response to the price decrease, physical import volume rises by the various percentages as shown above in the first column.
* Figures are for annual averages.
** A s s u m e s same trend in oil imports a s in 1985. Hence, percent c h a n g e s are the s a m e a s in 1985, s a v e for rounding errors. Of course, absolute c h a n g e s do differfrom 1985. .In real terms,
volume fell 10.5 percent in 1 9 8 5 for the 1972 b a s e series and 6.9 percent for the 1982 b a s e series.
Only the last component (M oil) is based on a
rate unlike the previous year's. For control, w e
assume that the physical volume of oil imports
grew at the same rate in hypothetical 1986 as in
1985. These measures of oil imports and G N P
are calculated in nominal and real terms in both
1972 and 1982 base figures.3 The calculations
are presented in Tables 3a, 3b, and 3c, which,
respectively, assume a 25, 30, and 35 percent
decline in oil price from 1985 through 1986. On
the left-hand side of each of these tables are a
number of possible responses to oil price cuts
in terms of the increase in oil import volume,
ranging from 10 percent to 35 percent. Each of
the major G N P components was assumed to
continue to grow in the fourth quarter of 1985
at the compound rate that occurred from the
fourth quarter of 1984 through the third quarter
of 1985. Hence, 1972 b a s e figures for 1985and hypothetical 1986 in turn—are estimates,
though quite usable ones, for our baseline
comparisons. 4
A few examples from Tables 3a-3c best illustrate the impact of oil price reductions on
nominal a n d real G N P growth. First, l e t us
assume that a 25 percent drop in the oil import
deflator occurred for 1986 (see Table 3a). Let us
also assume that the 25 percent "price" cut led
to a 10 percent increase in oil imports (row I). By
assumption, real oil imports rose 10 percent,
while nominal oil imports fell by 17.5 percent.
For this one specific G N P c o m p o n e n t (oil
imports, nominal and real), the base period d i d
not affect the percentage changes in the series
to any significant degree. Although base-period
differences e m e r g e for the a b s o l u t e dollar
changes in the nominal value of oil imports,
these simply reflect the Commerce Department's "improvements in measurement." New
data sources and revised estimates are embodied in the more recent current dollar series.
In contrast, the real dollar changes for oil
imports present dramatic differences by base
period. In 1972 dollars, a 10 percent physical
v o l u m e increase led to only a $500 million
upturn in real oil imports, while in 1982 dollars
the a b s o l u t e i n c r e a s e was $6.0 billion. Of
course, 1982-based real G N P is higher than
1972-based real G N P for 1986-but only by a little more than twice as much. Because relative oil
prices changed far more from 1972 to 1982 than
did economy-wide prices, oil imports have a
greater weight in G N P calculations in the later
base data. Hence, we see a more forceful impact
on real G N P from changes in oil imports in the
1982 b a s e series c o m p a r e d with the 1972 b a s e
series.
62
Looking to the right side of Table 3a, we find
that a 25 percent decrease in oil prices and a 10
percent increase in oil imports resulted in
nominal GNPgrowth in hypothetical 1986 of 6.42
percent (1982 base) and 6.18 percent (1972
base). These rates are 0.07 percent and 0.02 percent higher than their respective baseline growth
rates, indicating that the price cut and assumed
modest increase in oil imports led to a slight improvement in nominal G N P growth.
Once again, the real figures tell quite a different story. As lower nominal prices induced
growth in real oil imports in hypothetical 1986,
real net exports for the year worsened. As a
result, real G N P came in at 2.75 percent (1982
base) and 2.46 percent (1972 base), rates that
were 0.28 and 0.06 percentage points lower than
their respective b a s e l i n e growth rates. T h e
1982-based real growth rate is more adversely
affected than the 1972-based growth rate because the real oil import component is much
larger relative to other G N P components in the
later year. Thus, a given percentage change in
1982 dollar oil imports has a larger negative
impact on real G N P growth than the same percentage change in the 1972 base series.
The right side of Table 3a yields other generalizations. A price cut is favorable, however
slightly, on nominal G N P growth only up to the
point at which the beneficial price effect offsets
the increase in the import's physical volume.
S h o u l d w e assume a 30 percent increase in
imports, nominal as well as real growth rates are
adversely affected c o m p a r e d with b a s e l i n e
figures. Also, as w e revise upward the assumption about the rise in oil imports, the adverse
impact on real, and eventually nominal, G N P
growth worsens. For example, if oil imports
increase by 35 percent while all other conditions remain the same, real G N P growth will
recede by 0.69 percentage points and 0.13 percentage points for the 1982 and 1972 base
periods, respectively. Clearly, the impact of rising oil imports on 1982 base growth rates can
b e pronounced.
As the size of oil price cuts becomes larger,
nominal oil imports drop lower than otherwise
a n d nominal G N P growth rates inch slightly
higher (see Tables 3b and 3c). This holds true for
both 1982 and 1972 base periods. Furthermore,
the greater the reduction in the oil import
deflator, the more likely w e are to see the percentage change in real oil imports reach into the
higher end of the range. In turn, real GNPgrowth
will register lower than otherwise.
In summary, for hypothetical 1986 we see the
following effects of oil price changes:
SUMMER 1987, ECONOMIC REVIEW f
(1) The oil import deflator declines significantly.
(2) Nominal oil imports rise or fall, depending
on the size of the response to price declines.
(3) Real oil imports rise in response to lower
prices.
(4) Nominal net exports may or may not b e
positively affected by the oil price cuts,
depending on the relative size of the price
cuts compared with the quantity increases
in oil imports.
(5) Real net exports are negatively affected by
oil price cuts, assuming any v o l u m e increase in imports occurs.
(6) Nominal G N P growth may or may not be
adversely affected for the same reasons as
in (4) above.
(7) Real GNPgrowth is adversely affected by oil
price cuts, assuming any moderate increase
in imports occurs. (Real G N P growth was
modest enough for this statistical quirk to
stand out.)
Effects of Oil Price Cuts
in Actual 1986
Having already shown s o m e w e a k n e s s in
1985, the implicit deflator for imports of petroleum and related products fell significantly in
the first three quarters of 1986. From the fourth
quarter of 1985 through the third quarter of 1986,
the deflator plunged by 57 percent (not annualized) before firming somewhat in subsequent quarters. The second and third quarters
of 1986 provide dramatic contrasts in nominal
versus real terms. In the second quarter, nominal oil imports dropped an annualized $10.4
billion (1982 base), while in real terms this component j u m p e d $12.9 billion (see T a b l e 2).
Prices began steadying in the third quarter, and
the divergence b e t w e e n nominal and real
trends narrowed but still remained significant.
During that period nominal oil imports e d g e d
up $1.1 billion, as real oil imports increased by
$14.3 billion. These third-quarter effects were
minimal in that the worsening in real oil imports
from the second quarter level was only $1.4
billion. However, a $20.0 billion dollar "swing" in
real oil imports knocked 0.5 percentage points
off real G N P g r o w t h in the second quarter, leaving the figure at 0.6 percent. 5
The last quarter of 1986 and the first of 1987
saw a modest reversal of earlier trends as oil
prices continued to rebound moderately. Nomf
F E D E R A L R E S E R V E BAN K O F ATLANTA
inal oil imports crept upward even though real
imports for these commodities fell a yearly $8.2
billion and $9.0 billion in the fourth quarter of
1986 and first quarter of 1987, respectively. The
decline in real terms occurred too quickly to b e
entirely attributable to price effects. Likely supplemental explanations are that real economic
activity slowed in the last two quarters of 1986,
and oil inventories became somewhat overbuilt.
Quarterly effects can b e difficult to distinguish because of the inherent quarter-toquarter volatility of imports. For t h e year,
however, changes in the import components d o
stand out. Using annual averages, the implicit
deflator for oil imports fell 44.4 percent in 1986,
following a 5.6 percent decline the year before.
Nominal oil imports in 1986 decreased by $ 16.6
billion, following a $7.0 bill ion drop in 1985, for a
swing in contribution to nominal G N P of $9.6
billion. This new figure a d d e d 0.2 percentage
points to nominal G N P growth in 1986. In contrast, after falling $4.4 billion in 1985, real oil
imports rose $14.7 billion the next year. This
movement produced a swing in contribution to
real G N P of $ 14.0 billion, which actually reduced
real G N P growth for the year by 0.4 percentage
points. These contrasting effects on nominal
and real G N P growth rates w e r e significant,
especiallyconsideringthatreal G N P g r o w t h had
already moderated considerably from 1984.
Summary
Notwithstanding the somewhat technical
nature of this p a p e r and its reliance on an
accounting-type framework rather than a behavioral model, its assumptions are reasonable
and its implications important. Clearly, a significant fall in oil prices can lead to a period of
d a m p e n e d growth in measured real GNP. On
the other hand, such price cuts probably should
b e v i e w e d as having a p o s i t i v e impact on
economic growth and general welfare since they
lower input costs for production. Yet, because of
the way real G N P is measured, the opposite
effect is a p p a r e n t for at least a short-run
period—real G N P g r o w t h is suppressed. From a
policy perspective, w e should b e willing to
explain a good portion of any such weakness in
real G N P growth as a technicality.
The author would like to thank Maria McCinnis and Amy Bailey for
their valuable research assistance.
2l
Notes
1
For discussion of the actual macroeconomic effects, see J o h n A.
Tatom, "The Macroeconomic Effects of the Recent Fall in Oil Prices,"
Federal Reserve Bank of St. Louis Review, vol. 69, no. 6 (June/July
1987), pp. 34-45.
2Here
and throughout this article the analysis of oil price s h o c k s is
static in the sense that the primary impacts on import prices are
examined, while the impacts on the domestic petroleum industry,
manufacturing productivity, and investment in nonresidential struc-
tures (oil drilling equipment), for example, are not taken into
account.
64
3Note
that, since 1972 base data exist only through the third quarter
of 1985, the fourth quarter is extrapolated.
E s t i m a t e s for fourth quarter 1972 b a s e components are based on
the following formula: D D ( = j [(DD H /DD,_ 4 ) "(4/3)] " 0 . 2 5 1 * DD,_ 1 ,
where DD is domestic demand and t is the fourth quarter of 1985.
Other components using comparable formulas are exports, non-oil
imports, and oil imports.
^ h i s swing is the change from a $7.3 billion decline in the second
quarter to a $12.9 billion jump in the third quarter.
S U M M E R 1987, ECONOMIC R E V I E W f
Book Review
In Whose Interest?
international Banking and American Foreign Policy
by Benjamin j. Cohen.
N e w Haven and London: Yale University Press,
1986. 347 p a g e s . $19.95.
What role did bankers play in gaining release
of the American hostages in Iran? Did American
banks' financial stake in Polish loans constrain
U.S. support of the labor union Solidarity? Has
American foreign pol icy in the M i d d l e East b e e n
affected by Arab deposits in our nation's banks?
How have Latin American loans complicated
U.S. foreign policy in that region? Conversely,
how have foreign policymakers helped to determine the international activities of American
banks in all of these instances?
Benjamin J. Cohen addresses these questions a n d many others in his far-reaching
analytical study, In Whose Interest?
International Banking and American Foreign Policy.
Benjamin Cohen is Professor of International
Economic Affairs at Tufts University's Fletcher
School of Law and Diplomacy. T h e book was
commissioned by the Council on Foreign Relations, "a nonprofit and nonpartisan organization d e v o t e d to promoting improved understanding of international affairs through the free
exchange of ideas."
Today, international banking and international politics are inextricably entangled. W h a t
makes the matter most interesting and most
complex is that, although international bankers
and the makers of foreign policy share the same
turf, they are not playing the same game. Banks
are rightfully profit-motivated; foreign policymakers have an agenda that includes other
national interests. " T h e essence of the probFEDERAL
RESERVE BAN K OF
Digitized ffor
FRASER
ATLANTA
lem," Cohen writes, "is that bankers and policymakers do not share all the same motivations
or goals. W h i l e their activities have b e c o m e
increasingly intertwined and interdependent, a
potential for conflicting interests exists—and
such conflict could severely handicap the public
authorities in their ability to formulate and
implement an effective foreign policy" (p. 4).
Recent events, most notably the Latin American
d e b t situation, urgently bespeak our need to
understand the relationship between international bankers and foreign policymakers.
Cohen's book is a response: "[it] is written in the
hope of promoting better general understanding of the complex issues involved in bankgovernment relations in the foreign pol icy area"
(p. 5). Toward this e n d he succeeds.
Cohen has p r o d u c e d an informative, evenh a n d e d treatise that d e a l s comprehensively
with the interrelatedness of international banking and international politics. The book is void
of histrionics. Not only is Cohen's style more
sober and academic than that, but the subject
matter simply does not call for an account of
intrigue and conspiracy. Cohen explains convincingly why "conspiratorial social theories . . .
have little intellectual or empirical substance"
(p. 60). Banks' direct efforts to influence government as it forges foreign policy or, on the other
hand, direct attempts by government "to shape
the commercial decisions of banks" are rarely
rational strategies in the overseas arena. Con2l
siderations of effectiveness, efficiency, equity,
and external relations, "the four e's" as Cohen
calls them, serve as restraints.
Indirect influences are the more fundamental
factors governing interactions between international bankers and policymakers. "Inevitably, if
unintentionally, each side has an impact on the
decision-making e n v i r o n m e n t of t h e other
through the ongoing pursuit of its own legitimate responsibilities and objectives" (p. 68).
Cohen goes on to add: "Banks may have become more sensitive to noneconomic (political)
considerations and influences and increasingly
factor t h e s e into their ongoing commercial
decisions. Banks, conversely, through their
ongoing commercial decisions, may have impacts on the general foreign pol icy environment
that alter the issues of sal ience for pol icy and/or
the nature and scope of policy options available
to government officials" (p. 59). The analysis of
the book is focused on this more subtle but
richer type of interrelationship.
Cohen couples his theoretical analysis with a
historical discussion. Reaching as far back in
time as ancient Babylonia, he recounts the rise
and fall of history's great banks through tales
that are both entertaining and illuminating.
Parallels are easy to draw between events of the
past and conditions today. For example, d e b t
crises arose in the fourteenth century and again
in the fifteenth century as the world's most
powerful banking houses, then in Florence,
faced default on loans to a then-developing
country—England. In the seventeenth century
the Hapsburgs could not repay their debts, a
development that shook the Fugger bank of
Germany. By the nineteenth century British
banks took their turn at losing money on sovereign loans; the debtors were the newly ind e p e n d e n t nations of Latin America.
The author's historical digression serves two
purposes. First, it puts into perspective the
events of the " I n c r e d i b l e Quarter Century"
(1957-1982) when international banking seemed
to emerge and take off. International banking
and lending to sovereign states are not new
phenomena; their problems and pitfalls have
b e e n e x p e r i e n c e d before. History reveals a
cycle of boom and bust in sovereign lending,
followed by retreat from international banking.
Subsequently, when the previous history has
been forgotten, the cycle begins afresh.
Second, Cohen draws valuable lessons from
the historical discussion. H e emphasizes—and
it must b e emphasized—that international
banking and lending to sovereign states are not
66
inherently bad. On the contrary, mobilization of
capital is extremely important for world prosperity. In order to grow, d e v e l o p i n g nations
need investment funds, which cannot always b e
raised domestically. Foreign investors, on the
other hand, benefit from the high returns development promises. The lesson to draw, rather,
is that international banking, and sovereign
lending in particular, is inherently dangerous.
Sovereigns are not always good credit risks. Certainly countries do not go bankrupt, out-ofbusiness, and into oblivion the way firms might,
but it is precisely because they risk no financial
death penalty that independent nations are
often less restrained in their borrowing than
they ought to be.
The historical experience, according to Cohen,
yields further lessons in relation to the shortcomings of lenders. Cohen calls for increased
regulation of international financial activity " t o
"International banking and lending
to sovereign states are not new phenomena
History reveals a cycle of
boom and bust in sovereign lending,
followed
by retreat
from
international banking."
temper the drives that naturally result from the
intensity of competition in the financial sector.
Lenders' animal spirits must b e kept firmly in
check" (p. 115).
Analyzing the historical record, Cohen notes
that "foreign lending manias have b e e n closely
associated with an oversupply of capital. Investors have b e e n driven to find outlets for surplus
funds" (p. 116). H e therefore recommends more
restraint on the part of governments in their
management of liquidity. From the standpoint
of economic theory, this observation is one of
Cohen's most interesting contributions. Traditional monetary theory dictates that, as liquidity increases, funds are directed to investment projects offering highest returns, and any
surplus funds are c h a n n e l e d to those with
slightly lower returns. By satisfying the need for
credit in t h e highest returning projects, an
expansion of liquidity draws down the marginal
productivity of capital and thus brings down
SUMMER 1987, ECONOMIC REVIEW f
>
l
^
i
interest rates. Cohen's point is that surplus
funds, rather than flowing to lower yielding projects, instead flow to riskier projects. On a riskadjusted basis, interest rates will b e lower, but
the aggregate portfolio of investments will certainly b e riskier. O n e way government can
manage systemic risk, therefore, is via restraint
in monetary policy. Cohen's argument is unconventional yet plausible, one that warrants further empirical research.
Four c a s e studies illustrate t h e c o m p l e x
interactions of high finance and high politics in
the modern era. Cohen describes and analyzes
1) the threat that Arab deposits in American
banks could b e m a n i p u l a t e d to disrupt our
d o m e s t i c economy, 2) t h e Iranian hostage
e p i s o d e during which Iranian assets in U.S.
banks were frozen, 3) the Polish debt crisis coinciding with the suppression of rights in Poland,
and 4) the Latin American d e b t situation. In
"Foreign policy ends are served when
international financiers do not overextend, and economic ends are served
when government officiais refrain from
intervening. "
intricate cases such as these, international
bankers and policymakers sometimes hinder
one another and at other times support one
another. At all times they must b e aware of
one another.
Cohen concludes his study with several prescriptions. " T h e ultimate goal is maximization of
joint benefits. If the relationship between bankers and foreign policymakers cannot be ignored,
why not, then, make the most of it?" (p. 280). To
do so, he asserts, requires enhanced information, communication, and moderation. International bankers and government officials must
gather and share pertinent information. Second, they must engage in a "structured dialogue" through which the two parties can discuss
conflicts and mutual interests in a forwardlooking manner. Such communication would
enable them to plan strategically, eliminating
the steady need to deal extemporaneously with
problems stemming from past mistakes. Third,
\
FEDERAL RESERVE BANK OF
ATLANTA
Cohen admonishes bankers and governments
alike to curb their excesses and practice moderation. Foreign policy ends are served when
international financiers d o not overextend, and
economic ends are served when government
officials refrain from intervening.
The author labels these recommendations
"an ounce of prevention," adding, however, that
existing problems require "a pound of cure."
The stubborn Latin d e b t crisis, Cohen claims, is
an example of a market failure and consequently warrants government initiative. The solution
to the global d e b t crisis is negotiated settlement wherein burdens are shared by all parties.
This may seem unfair, but, as Cohen reminds us,
the poor judgment that caused the problem was
exercised by all parties, too. And, of course, he
a d d s that a r e d u c e d federal budget deficit
would bring down interest rates, thus making
Third World debt service more manageable.
Cohen's work is indeed remarkable. H e organizes a vast body of information, analyzes it,
draws inferences, and relates these inferences
to the pressing problems of today. Nonetheless,
the author leaves room for marginal improvements. First, he limits the scope of the analysis
to banks. Banks are special, according to Cohen,
because they are highly leveraged and because
their successes or failures have systemic implications. Granted, Cohen defines banking
through function and not form, and thus inc l u d e s s o m e financial institutions that have
increasingly entered into bank-like activities.
But he excludes still other kinds of firms that are
vulnerable and whose failures also would jeopardize the greater economy's health. Congress
bailed out Chrysler and Lockheed when prospects of their bankruptcies threatened system ic
well-being. W h e n such industrial firms invest
directly overseas, and when foreign multinationals buy assets inside the United States, d o
they not then satisfy the same criteria for special
consideration that Cohen laid down for banks?
Calls for self-restraint by banks and for stricter
supervision both are problematic. Theoretically,
banks act in their own self-interest. A vague
directive to practice self-restraint, which is
e q u i v a l e n t to acting against one's own selfinterest, cannot succeed. The request for stricter supervision, however, also misses the mark.
Observations that banks may have acted imprudently in the past motivate Cohen's call. But,
as he has shown, it is in an individual bank's own
best interests to act prudently. If the profit
motive does not encourage appropriate caution, then the challenge is to identify the rea67
sons for this market failure. Regulators then can
intervene minimally, altering the market environment just enough to prevent the failure.
Cohen argues that banks were myopic in their
lending practices, partly b e c a u s e managers
were enticed by quick short-term profits accruable before those managers moved on to different jobs. A more likely explanation is that
bank accounting standards and reporting practices bias managers toward seeking short-term
returns. In either case, the questions arise: Why
do bank stockholders and boards of directors
allow such behavior? What minimal intervention would alter the incentive structure and
thereby eliminate the inefficiency? Addressing
these questions, and undertaking this sort of
specific analysis, should prove more effective
than structuring additional supervision and
demanding greater self-restraint. Agencies for
this type of intervention are already in place.
The author's call for more sharing of information and increased communication poses problems as well. A "structured d i a l o g u e " might
evolve into yet another government agency intent on regulating banks—a prospect that banks
are hardly likely to encourage. Moreover, one
wonders where it will stop. S h o u l d foreign
68
p o l i c y m a k e r s b e c o m e involved with every
enterprise that bears on international relations?
Is banking really that special? Agriculture, the
energy industry, even universities may affect
foreign policy today; should foreign policymakers not engage them in a dialogue, too?
C o h e n should expect s o m e disagreement
over his policy r e c o m m e n d a t i o n s and s o m e
resistance to his singl ing out of banks for special
treatment. Yet it is to his credit that the book is
provocative, for this quality i n d i c a t e s that
Cohen has succeeded in his primary task. The
careful reader is rewarded with an "understanding of the complex issues involved in
bank-government relations in the foreign pol icy
area"—so much so that he should feel qualified
to disagree with the specifics of Cohen's recommendations. For t h e interested and patient
reader, In Whose Interest?
is a v a l u a b l e resource and well worth the investment.
—Steven P. Feinstein
The reviewer, a specialist in stock and options markets, is an
economist in the financial section of the Atlanta Fed's Research
Department. He wishes to express his appreciation to Sheila Tschinkel
for her helpful comments and suggestions.
S U M M E R 1987, ECONOMIC R E V I E W f
IMPORTANT MESSAGE FOK DATA USERS
FINANCE
i r i r l r
JUL.
1986
ANN.
%
CHG.
1,727,186 1 ,704,535 :L,590,928
372,770
369,769
363,959
157,756
154,886
124,027
518,060
518,358
463,264
711,213
705,211
684,208
+ 9
+ ?
+27
+12
+ 4
JUL.
1987
Commercial Bank Deposits
Demand
NOW
Savings
Time
«
Commercial Bank Deposits
Demand
NOW
Savings
Time
In June of each year, changes are m a d e to the deposit and reserve requirement criteria used to select
institutions for inclusion in the sample on which these data are based. As of September 1986,
current and previous monthly data are from institutions with over $26.8 million in deposits and $2.6
million of reserve requirements. Previously, data were based on a different sample of institutions.
For publication purposes, monthly year-ago computations are m a d e on the basis of these current reporting
criteria. Therefore, they are not entirely comparable to or consistent with previously published data
covering the past periods. Moreover, percent changes shown do not control for the sample change.
Data users needing further detail should contact Cheryl Cornish, Database Coordinator, 404-521-8816.
JUN.
1987
JUL.
1987
JUN.
1987
JUL.
1986
S&Ls Total Deposits
NOW
Savings
Time
Credit Union Deposits
Share Drafts
Savings & Time
676,831
34,476
161,526
478,457
66,391
9,336
56,225
673,822
33,938
163,676
473,667
65,046
8,898
55,291
611,053
27,606
138,174
443,370
46,793
6,861
38,993
ANN.
%
CHG.
»
203,670
41,298
21,969
57,851
86,328
201.,920
41.,543
21.,743
58.,277
85,,103
187,079
40,205
16,757
52,107
82,972
+ 9
+ 3
+31
+11
+ 4
S&Ls Total Deposits
NOW
Savings
Time
Credit Union Deposits
Share Drafts
Savings & Time
86,424
5,524
20,021
60,246
7,435
922
6,223
87,646
5,535
20,607
60,847
7,290
861
6,120
77,829
4,267
17,715
55,379
5,261
671
4,343
Commercial Bank Deposits
Demand
NOW
Savings
Time
20,806
4,117
2,184
4,688
10,197
20,644
4,178
2,167
4,726
10,057
18,599
4,075
1,583
3,908
9,562
+12
+ 1
+38
+20
+ 7
S&Ls Total Deposits
NOW
Savings
Time
Credit Union Deposits
Share Drafts
Savings & Time
4,302
260
784
3,307
983
148
808
6,008
376
1,139
4,520
970
143
793
WM&MßM
4,713
257
904
3,564
830
163
688
Commercial Bank Deposits
Demand
NOW
Savings
Time
78,773
16,000
9,853
27,029
27,445
77,847
16,033
9,696
27,110
26,864
70,848
15,083
7,300
23,949
26,520
+11
+ 6
+35
+13
+ 3
S&Ls Total Deposits
NOW
Savings
Time
Credit Union Deposits
Share Drafts
Savings & Time
56,210
3,476
13,852
38,245
3,888
481
3,142
55,895
3,388
14,024
37,840
3,809
449
3,095
54,818
2,869
12,942
38,511
3,093
362
2,477
Commercial Bank Deposits
Demand
NOW
Savings
Time
32,751
8,628
3,129
8,939
13,443
32,417
8,739
3,090
9,069
13,186
29,735
8,519
2,317
8,454
12,036
+10
+ 1
+35
+ 6
+12
S&Ls Total Deposits
NOW
Savings
Time
Credit Union Deposits
Share Drafts
Savings & Time
7,510
903
1,624
5,013
1,426
164
1,244
7,468
906
1,628
4,978
1,398
151
1,221
5,981
538
1,305
4,181
476
56
407
+ 26
+ 68
+ 24
+ 20
+200
+193
+206
Commercial Bank Deposits
Demand
NOW
Savings
Time
28,129
5,109
2,270
8,112
13,048
28,213
5,133
2,303
8,175
13,067
28,035
5,233
1,897
7,585
13,814
0
- 2
+20
+ 7
- 6
s&Ls Total Deposits
NOW
Savings
Time
Credit Union Deposits
Share Drafts
Savings & Time
9,919
403
2,146
7,374
9,843
396
2,181
7,261
5,780
282
1,384
4,124
*
*
*
*
+
+
+
+
72
43
55
79
*
*
*
*
*
S&Ls Total Deposits
NOW
Savings
Time
Credit Union Deposits
Share Drafts
Savings & Time
1,805
98
272
1,343
'1,812
99
279
1,343
760
53
107
566
M
R
*
*
*
*
*
*
S&Ls Total Deposits
NOW
Savings
Time
Credit Union Deposits
Share Drafts
Savings & Time
6,678
384
1,343
4,964
1,138
129
1,029
6,620
370
1,356
4,905
1,113
118
1,011
5,777
268
1,073
4,433
862
90
771
+
+
+
+
+
+
+
16
43
25
12
32
43
33
Commercial Bank Deposits
Demand
NOW
Savings
Time
Commercial Bank Deposits
Demand
NOW
Savings
Time
14,102
2,355
1,421
3,042
7,512
29,109
5,089
3,112
6,041
14,683
14,159
2,365
1,418
3,099
7,510
28,640
5,095
3,069
6,098
14,419
13,520
2,485
1,160
2,747
7,435
26,342
4,810
2,500
5,464
13,605
+ 4
- 5
+23
+11
+ 1
+11
+ 6
+24
+11
+ 8
*
*
*
11
29
13
9
41
37
43
- g
+ 1
- 13
- 7
+ 18
- 9
+ 17
+
+
+
+
+
+
3
21
7
1
26
33
27
+138
+ 85
+154
+137
Notes: All deposit data are extracted from the Federal Reserve Report of Transaction Accounts, other Deposits and Vault Cash (FR2900),
and are reported for the average of the week ending the 1st Monday of the month. Most recent data, reported by institutions with over
$26.8 million in deposits and $2.6 million of reserve requirements as of June 1986, represents 95K of deposits in the six state area.
The major differences between this report and the "call report" are size, the treatment of interbank deposits, and the treatment of float.
The total deposit data generated from the Report of Transaction Accounts eliminates interbank deposits by reporting the net of deposits
"due to" and "due from" other depository institutions. The Report of Transaction Accounts subtracts cash in process of collection from
demand deposits, while the call report does not. The Southeast data represent the total of the six states. Subcategories were chosen
on a selective basis and do not add to total.
* = fewer than four institutions reporting.
f
FEDERAL RESERVE BAN K OF ATLANTA
2l
EMPLOYMENT
ANN.
MAY
1987
APR
1987
MAY
1986
u N i i t u biAiti.
mmmm • H M M M wsB&m
• ¡ • M
118,347
117,199
Civilian Labor Force - thous.
119.,695
111,041
109,041
Total Employed - thous.
112.,3//
7,,318
Total Unemployed - thous.
7,306
8,158
t
WBÊm
+2
+3
-10
Unemployment Rate - % SA
6.2
6.2
7.1
M f g . A v g . W k l y . Hours
Mfg. A v g . Wkly. Earn. - $
t10.9
4U3
40.4
399
40.6
395
+1
+2
16,270
15,208
1,063
16,119
15,006
1,113
15,916
14,701
1,215
+2
+3
-13
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
6.8
7.1
7.8
M f g . A v g . Wkly. Hours
M f g . A v g . Wkly. Earn. - $
41.1
359
40.5
355
40.9
350
+0
+3
1,889
1,740
150
1,870
1,716
154
1,899
1,714
185
-1
+2
-19
Unemployment Rate - % SA
8.5
8.6
10.3
M f g . A v g . Wkly. Hours
Mfg. A v g . W k l y . Earn. - $
41.1
359
40.6
355
41.0
354
+0
+1
5,879
5,581
297
5,768
5,469
299
5,550
5,256
293
+6
+6
+1
Unemployment Rate - % SA
5.4
5.5
5.7
M f g . A v g . W k l y . Hours
M f g . A v g . Wkly. Earn. - $
40.6
329
40.3
326
40.6
322
0
+2
3,089
2,939
150
3,083
2,921
161
3,005
2,833
172
+3
+4
-13
vi1ian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
5.0
5.4
5.9
M f g . A v g . Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
41.7
350
40.3
339
40.7
341
+2
+3
1,932
1,716
216
1,928
1,695
233
2,010
1,749
261
-4
-2
-17
Unemployment Rate - % SA
11.4
11.9
13.2
M f g . A v g . Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
41.7
452
41.5
450
41.3
438
+1
+3
1,157
1,054
103
1,147
1,041
107
1,176
1,039
138
-2
+1
-25
Unemployment Rate - % SA
9.0
9.6
11.9
M f g . A v g . W k l y . Hours
M f g . A v g . W k l y . Earn. - $
39.9
302
39.4
297
40.2
299
-1
+1
2,325
2,178
147
2,323
2,164
159
2,276
2,110
166
+2
+3
-11
Unemployment Rate - % SA
6.7
7.0
7.1
M f g . A v g . Wkly. Hours
Mfg. A v g . Wkly. E a r n . - $
41.5
364
40.6
361
41.4
347
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
+0
+5
ANN.
X
CHG
MAY
1987
APR
1987
MAY
1986
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & Real. Est.
Trans., Com. & Pub. U t i l .
102,164
18,983
5,041
23,999
17,367
24,118
6,576
5,349
101,390
18,924
4,840
23,758
17,352
23,950
6,532
5,311
99,815
18,981
4,950
23,541
16,981
23,072
6,257
5,252
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
T r a n s . , Com. & Pub. U t i l .
13,405
2,336
790
3,351
2,351
2,947
794
734
13.,376
2.,330
787
3.,341
2.,350
2.,945
791
731
13,029
2,318
778
3,229
2,303
2,803
767
720
+3
+1
+2
+4
+2
+5
+4
+2
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., Com. & Pub. U t i l .
1,486
357
77
329
303
267
71
72
1,482
356
77
327
302
267
71
72
1,466
360
75
318
302
259
68
71
+1
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., Com. & Pub. U t i l .
4,797
525
338
1,309
735
1,276
354
250
4,797
524
337
1,312
734
1,279
353
249
4,584
517
338
1,228
708
1,200
339
245
+5
+2
+7
+4
+6
+4
+2
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
T r a n s . , Com. & Pub. U t i l .
2,754
569
157
695
471
535
150
169
2,749
567
157
693
469
536
150
168
2,663
563
154
662
456
501
144
166
iïM'-'s/'&iÏy
+3
+1
+2
+5
+3
+7
+4
+2
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., Com. & Pub. Util.
1,493
166
84
357
319
318
85
106
1,489
166
83
355
320
317
85
105
1,534
168
91
373
327
321
86
107
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
T r a n s . , C o m . & Pub. U t i l .
864
223
35
187
194
139
39
40
861
223
35
186
195
138
38
40
850
222
36
183
191
134
37
39
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
T r a n s . , C o m . & Pub. Util.
2,011
496
98
474
330
412
96
98
1,998
494
97
469
331
408
94
98
1,932
488
84
465
319
388
92
92
CHG
• .
tm
+?
+0
+2
+?
+2
+5
+5
+2
-1
+3
+3
+0
+3
+3
+0
0
+2
+0
-1
+2
+2
+4
+4
+2
+4
+2
+17
+2
+3
+6
+4
+7
NOTES: All labor force data are from Bureau of Labor Statistics reports supplied by state agencies.
Only the unemployment rate data are seasonally adjusted.
The Southeast data represent the total of the six states.
70
S U M M E R 1987, E C O N O M I C R E V I E W
EMPLOYMENT
UNITED STATES
Civilian Labor Force - thous.
Total Employed .- thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . Earn. - $
juu i n u u
Civilian
Total
Total
i
Labor Force - thous.
Employed - thous.
Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . E a r n . - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
JUN
1987
MAY
1987
JUN
1986
ANN.
%
CHG
121,153
113,498
7,655
119,695
112,377
7,318
119,644
110,869
8,775
+1
+2
-13
6.3
6.1
7.1
41.1
406
40.9
403
40.8
396
+1
+3
16,317
15,210
1,092
16,279
15,213
1,084
16,065
14,740
1,327
+2
+3
-18
6.9
6.6
8.1
41.3
362
41.1
359
41.1
352
+0
+3
1,890
1,744
146
1,892
1,741
151
1,895
1,702
192
-0
+2
-24
Unemployment Rate - % SA
8.6
7.8
10.3
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
41.4
362
41.1
358
41.2
355
+0
+2
5,883
5,570
297
5,879
5,581
313
5,656
5,315
342
+4
+5
-13
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
M f g . A v g . Wkly. E a r n . - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
5.4
5.0
5.8
40.8
332
40.6
328
41.0
325
-0
+2
3,102
2,943
158
3,089
2,938
151
3,025
2,842
183
+3
+4
-14
5.0
5.0
5.9
42.2
355
41.6
349
41.1
341
+3
+4
1,950
1,731
219
1,935
1,719
219
2,007
1,727
280
-3
+0
-22
Unemployment Rate - % SA
11.5
10.8
13.6
Mfg. A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
41.6
451
41.8
455
41.4
439
+0
+3
1,158
1,045
113
1,158
1,055
103
1,178
1,028
150
-2
+2
-25
9.0
9.2
12.0
40.2
304
39.9
301
40.5
302
-1
+1
2,335
2,177
158
2,326
2,179
148
2,306
2,126
181
+1
+2
-13
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . Earn. - $
Civilian Labor Force - t h o u s .
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . E a r n . - $
6.7
6.7
7.1
41.7
367
41.3
364
41.3
348
+1
+5
JUN
1987
MAY
1987
JUN
1986
ANN.
X
CHG
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
T r a n s . , Com. & Pub. Util.
102,670
19,151
5,208
24,171
17,104
24,260
6,648
5,393
102,103
18,991
5,040
23,976
17,345
24,093
6,575
5,352
100,133
19,081
5,098
23 , 705
16,716
23,280
6,347
5,184
+2
+0
+2
+2
+2
+4
+5
+4
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., Com. & Pub. U t i l .
1,490
2,344
795
3,360
2,304
2,948
800
739
1,486
2,336
790
3,351
2,352
2,942
795
734
1,466
2,317
783
3,237
2,261
2,813
773
709
+2
+1
+2
+4
+2
+5
+3
+•4
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., Com. & Pub. Util.
1,490
359
78
331
297
270
71
72
1,486
357
77
329
303
267
71
72
1,466
363
75
319
296
259
69
72
+2
-1
+4
+4
+0
+4
+3
+2
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., Com. & Pub. U t i l .
4,787
525
341
1,308
723
1,274
357
250
4,796
525
340
1,309
735
1,274
355
249
4,564
516
341
1,227
690
1,201
342
238
+5
+2
0
+7
+5
+6
+4
+5
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & Real.. Est.
Trans., Com. & Put). Util.
2,756
570
157
696
467
537
150
171
2,753
569
157
694
471
534
150
169
2,676
563
157
669
457
507
146
164
+3
+1
0
+4
+2
+6
+3
+4
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., Com. & Pub. Util.
1,489
168
84
359
312
315
85
107
1,491
166
84
356
319
317
85
105
1,518
166
89
373
319
318
86
106
-2
+1
-5
-4
-2
-1
-2
+1
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., C o m . & Pub. Util.
856
224
36
188
185
138
39
40
864
223
35
187
194
139
39
40
848
224
36
183
186
135
38
39
+1
0
-2
+3
-1
+2
+4
+3
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., Com. & Pub. U t i l .
2,015
498
99
480
320
415
97
99
2,011
496
98
475
330
411
96
99
1,931
485
84
467
313
393
91
91
+4
+3
+17
+3
+2
+6
+6
+9
NOTES: All labor force data are from Bureau of Labor Statistics reports supplied by state agencies.
Only the unemployment rate data are seasonally adjusted.
The Southeast data represent the total of the six states.
F E D E R A L R E S E R V E B A N K O F ATLANTA
71
EMPLOYMENT
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . Wkly. Hours
Mfg. Avg. Wkly. Earn. - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . E a r n . - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
M f g . A v g . Wkly. E a r n . - $
GEORGIA
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
JUL
1987
JUN
1987
JUL
1986
ANN.
X
CHG
114,652
116,372
7,453
113,498
115,216
7,655
Til,832
113,504
8,471
+3
-12
5.9
6.0
6.9
40.6
401
41.1
406
40.2
392
+1
+2
16,425
15,273
1,147
16,345
15,233
1,112
16,176
14,761
1,415
+2
+4
-19
6.5
6.6
8.3
40.8
358
41.4
361
40.6
350
+0
+2
1,907
1,760
146
1,899
1,753
147
1,909
1,712
198
-0
+3
-26
7.2
7.8
9.9
41.1
360
41.5
362
41.0
352
+0
+2
5,985
5,630
356
5,883
5,570
313
5,721
5,329
392
+5
+6
-y
5.3
5.0
6.5
40.2
328
40.8
331
40.5
326
-l
+i
3,075
2,917
158
3,104
2,945
160
3,041
2,848
193
+1
+2
-18
4.7
5.0
6.0
42.3
351
42.4
352
40.3
335
+5
+5
1,960
1,750
210
1,964
1,742
222
1,995
1,717
279
-2
+2
-25
Unemployment Rate - % SA
10.3
10.9
13.6
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
41.1
450
41.7
450
41.6
446
-1
+1
1,162
1,050
113
1,163
1,050
113
1,181
1,026
154
-2
+2
-27
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . E a r n . - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
MISSISSIPPI
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - X SA
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
9.2
9.2
12.3
39.9
300
40.2
304
39.3
292
+2
+3
2,335
2,171
164
2,332
2,174
159
2,329
2,130
199
+0
+2
-18
6.7
6.7
8.3
40.4
360
41.7
367
40.8
350
-1
+3
JUL
1987
JUN
1987
JUL
1986
ANN.
X
CHG
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., Com. & Pub. Util.
101,932
19,017
5,315
23,702
16,277
24,350
6,705
5,351
102,696
19,152
5,210
24,172
17,105
24,267
6,658
5,392
99,440
18,867
5,227
23,711
15,811
23,402
6,409
5,243
+3
+1
+2
-0
+3
+4
+b
+2
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
Fin., Ins. & R e a l . Est.
T r a n s . , Com. & Pub. U t i l .
13,310
2,330
801
3,361
2,232
2,940
803
741
13,390
2,345
794
3,357
2,306
2,948
799
739
12,948
2,298
797
3,246
2,182
2,813
777
727
+3
+1
+1
+4
+2
+5
+3
+2
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., Com. & Pub. U t i l .
1,488
360
79
329
296
270
71
72
1,488
359
78
330
297
269
71
72
1,470
358
78
323
297
260
70
72
+1
+1
+1
*2
-0
+4
+2
0
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., C o m . & Pub. U t i l .
4,741
521
343
1,304
687
1,269
358
250
4,787
525
341
1,305
725
1,276
356
250
4,b3U
512
343
1,227
654
1,196
343
246
+5
+2
0
+6
+5
+6
+4
+2
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
T r a n s . , C o m . & P u b . Util.
2,747
568
158
699
456
535
152
171
2,757
571
156
696
468
536
151
170
2,673
556
161
674
442
510
148
168
+
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., Com. & Pub. Util.
4Mb
167
83
358
308
316
85
108
1,491
168
84
358
313
316
85
107
1,506
166
91
370
309
316
86
108
-1
+1
-8
-3
-0
0
-2
0
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
T r a n s . , Com. & Pub. Util.
851
221
36
189
179
140
39
40
856
224
36
188
185
138
39
40
840
222
37
183
180
135
38
40
+1
-0
-1
+3
-1
+4
+3
+1
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
T r a n s . , C o m . & P u b . Util.
1,998
494
102
483
306
411
98
99
2,011
498
99
480
319
412
97
99
1,929
485
88
470
300
396
92
92
+4
+2
+16
+3
+2
+4
+6
+7
3
+2
-2
+4
+3
+5
+3
+2
NOTES: All labor force data are from Bureau of Labor Statistics reports supplied by state agencies.
Only the unemployment rate data are seasonally adjusted.
The Southeast data represent the total of the six states.
72
S U M M E R 1987, ECONOMIC R E V I E W
EMPLOYMENT
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
AUG
1987
JUL
1987
AUG
1986
ANN.
%
CHG
121,614
114,527
7,088
122,105
114,652
7,453
119,471
111,515
7,955
+2
+3
-11
6.0
6.0
6.8
40.9
403
40.6
401
40.7
394
+0
+2
16,353
15,254
1,099
16,414
15,261
1,154
16,186
14,864
1,303
+1
+3
-lb
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . E a r n . - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
Mfg. A v g . W k l y . Hours
Mfg. Avg. W k l y . E a r n . - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . E a r n . - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - S
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. Avg. Wkly. Earn. - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
Mfg. A v g . W k l y . E a r n . - $
Civilian Labor Force - thous.
Total Employed - thous.
Total Unemployed - thous.
Unemployment Rate - % SA
M f g . A v g . W k l y . Hours
M f g . A v g . W k l y . Earn. - $
6.8
6.5
8.2
41.2
360
40.9
359
41.0
352
+0
+2
1,902
1,764
137
1,901
1,754
147
1,910
1,702
190
-0
+4
-28
7.4
7.3
10.1
41.5
363
41.2
361
41.1
349
+1
+4
5,925
5,589
336
5,985
5,630
356
5,698
5,361
337
+4
+4
-0
5.7
5.3
6.0
40.3
329
40.1
327
40.6
326
-1
+1
3,083
2,927
156
3,078
2,917
161
3,089
2,906
183
-0
+1
-15
5.1
4.8
6.0
41.6
344
42.1
350
41.2
341
+1
+1
1,962
1,759
202
1,956
1,744
212
2,004
1,728
276
-2
+2
-27
10.4
10.4
13.8
449
41.3
450
41.8
442
-0
+2
1,158
1,045
113
1,158
1,045
113
1,171
1,025
146
-1
+2
-23
9.2
12.5
9.8
40.4
307
39.9
301
40.2
300
+0
+2
2,323
2,170
153
2,336
2,170
166
2,314
2,142
172
+0
+1
-11
7.1
6.7
8.2
41.5
364
40.8
363
41.2
352
+1
+3
ANN.
AUG
1987
JUL
1987
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., Com. & Pub. Util.
102,148
19,198
5,368
23,761
16,072
24,457
6,710
5,385
LOI,934
19,023
5,313
24,169
16,200
24,416
6,698
5,367
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., Com. & Pub. Util.
13,316
2,347
804
3,359
2,217
2,942
802
741
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . E s t .
Trans., Com. & P u b . Util
w
t
CHG
19,042
5,301
23,797
15,674
23,435
6,428
5,211
+1
+1
13.,310
?. ,331
802
3 ,357
2 ,234
? ,942
802
740
12,962
2,310
802
3,254
2,169
2,817
778
725
+3
+2
+0
+3
+2
+4
+3
+2
1,491
362
79
331
294
271
71
72
1 ,490
360
78
330
298
270
/I
72
l,4bU
355
78
324
290
259
70
72
+2
+1
+2
+1
+b
+2
0
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., Com. & Pub. Util.
4,734
524
342
1,301
677
1,272
358
251
4,737
521
342
1,300
687
1,270
358
250
514
344
1,230
651
1,199
343
246
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
T r a n s . , Com. & Pub. U t i l .
2,753
571
159
697
457
537
152
171
?,/4/
568
158
697
456
536
152
171
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
T r a n s . , Com. & Pub. U t i l .
1,484
168
85
359
304
316
84
107
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
Trans., Com. & Pub. Util.
Nonfarm Employment - thous.
Manufacturing
Construction
Trade
Government
Services
F i n . , Ins. & R e a l . Est.
T r a n s . , Com. & Pub. Util.
563
162
676
443
514
149
169
•W1W
-0
+3
+4
+4
+3
+2
-1
+6
+4
+6
+4
+2
+1
-2
+3
+3
+4
+2
+1
167
84
359
309
316
85
107
166
91
368
307
316
86
106
+1
-7
853
225
36
189
180
137
39
40
851
+2
+1
36
189
179
140
39
40
835
223
37
184
176
131
38
38
2,002
498
103
482
305
409
98
100
,998
494
102
482
305
411
98
99
,943
488
90
473
301
399
92
93
221
NOTES: All labor force data are from Bureau of Labor Statistics reports supplied by state agencies.
Only the unemployment rate data are seasonally adjusted.
The Southeast data represent the total of the six states.
FEDERAL
BANK OF ATLANTA
Digitized
forRESERVE
FRASER
AUG
1986
73
-2
-1
0
-2
+1
-2
+3
+2
+5
+3
+2
+2
+14
+2
+1
+3
+6
+7
m
GENERAL
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. Arr. (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
SOUTHEAST
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. Arr. (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. Arr. (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
FLORIDA
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. Arr. (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1977=100
MIAMI
Kilowatt Hours - mils.
6E0R6IA
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. Arr. (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
PREV.
PERIOD
YEAR
AGO
3.,589.7
N.A.
N.A.
,444.0
8:
3:,529.7
N.A.
N.A.
8,,413.3
3,,430.6
N.A.
N.A.
8.,848.0
+ 5
340.1
185.0
338.7
193.7
327.9
193.0
+ 4
- 4
428.9
N.A.
6.,438.0
1,,422.5
419.2
N.A.
4.,928.1
1,417.0
+ 4
MAY
MAY
436.8
N.A.
6.,059.0
1:,426.0
APR
N.A.
29.2
N.A.
29.0
N.A.
30.9
MAY
MAY
45.9
N.A.
182.0
56.0
45.2
N.A.
170.8
55.0
44.8
N.A.
146.1
62.0
APR
N.A.
4.1
N.A.
4.1
N.A.
3.8
+ 8
Ql
171.6
169.2
163.6
+ 5
2.,787.5
23.0
MAY
179.1
8.5
3.,263.5
21.0
MAR
178.4
8.3
2.,391.2
31.0
MAY
173.0
8.1
+17
+26
Q1
MAY
JUNE
APR
Q1
Ql
MAY
MAY
APR
mmmSMÊ, mmmmH
H
+ 5
+23
+ 1
- 6
+ 2
+24
-10
U
M
82.2
N.A.
2.,190.5
N.A.
79.4
N.A.
1.,765.9
N.A.
N.A.
5.0
N.A.
5.0
N.A.
4.7
50.3
N.A.
346.7
1,268.0
49.4
N.A.
372.2
1,267.0
50.8
N.A.
314.7
1,240.0
+10
+ 2
N.A.
4.2
N.A.
4.1
N.A.
4.3
- 2
MAY
MAY
26.0
N.A.
48.0
79.0
25.0
N.A.
46.1
79.0
24.9
N.A.
38.1
84.0
APR
N.A.
2.0
N.A.
1.9
N.A.
1.9
59.4
N.A.
393.0
N.A.
57.9
N.A.
394.9
N.A.
55.7
N.A.
272.1
N.A.
N.A.
5.4
N.A.
5.6
N.A.
8.0
MAY
APR
Ql
+ 5
+30
+ 6
- 1
+ 4
+26
- 6
+ 5
TENNESSEE
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. Arr. (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
Ql
MAY
APR
+ 7
+44
-32
JUNE
1987
R
MAY
1987
Agriculture
Prices Rec'd by Farmers
Index (1977=100)
131
Broiler Placements (thous.)
92,068
Calf Prices ($ per cwt.)
78.80
Broiler Prices (t per lb.)
27.60
Soybean Prices ($ per bu.)
5.36
Broiler Feed Cost ($ per ton) (Q2)183
129
91,353
77.60
30.00
5.33
(Ql)174
121
86,019
58.10
34.00
5.19
(Q2)189
+ 8
+ 7
+36
-19
+ 3
- 3
Agriculture
Prices Rec'd by Farmers
Index (1977=100)
117
Broiler Placements (thous.)
38,481
Calf Prices ($ per cwt.)
77.51
Broiler Prices (i per lb.)
25.84
Soybean Prices ($ per bu.)
5.53
Broiler Feed Cost (Î per ton) (Q2)173
118
37,944
75.11
28.83
5.41
(Ql)168
115
35,815
54.96
32.93
5.22
(Q2)181
+ 2
+ 7
+41
-22
+ 6
- 4
Agriculture
Farm Cash Receipts - $ mil.
Dates: MAR., MAR.
416
Broiler Placements (thous.)
13,317
Calf Prices ($ per cwt.)
76.00
Broiler Prices (t per lb.)
25.00
Soybean Prices ($ per bu.)
5.61
Broiler Feed Cost ($ per ton)
177
13,292
76.80
29.00
5.43
175
447
12,342
52.80
33.10
5.20
181
- 7
+ 8
+44
-24
+ 8
- 2
2,401
81.10
29.00
5.43
175
1,554
2,388
58.50
32.00
5.20
181
- 1
+ 4
+38
-22
+ 8
- 2
Agriculture
Farm Cash Receipts - $ mil.
Dates: MAR., MAR.
Broiler Placements (thous.)
Calf Prices ($ per cwt.)
Broiler Prices (i per lb.)
Soybean Prices ($ per bu.)
Broiler Feed Cost ($ per ton)
+ 4
+ 5
83.6
N.A.
2 ,301.8
N.A.
Ql
Personal Income
($ bil. - SAAR)
Ql
Taxable Sales - $ bil.
Plane Pass. A r r . (thous.) MAY
MAY
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
APR
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. Arr. (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - mils.
ANN.
%
CHG.
LATEST CURR.
DATA PERIOD
!
1,537
2,488
80.70
25.00
5.61
177
wmmmmmmmmmmmimm
wmm mmmmI
ANN.
JUNE
%
1986 CHG.
M
M
H
Agriculture
Farm Cash Receipts - $ mil.
Dates: MAR., MAR.
585
Broiler Placements (thous.)
15,489
Calf Prices ($ per cwt.)
73.30
Broiler Prices (t per lb.)
25.00
Soybean Prices (S per bu.)
5.45
Broiler Feed Cost ($ per ton)
177
15,178
72.80
28.00
5.31
175
607
14,191
51.70
32.00
5.20
181
- 4
+ 9
+42
-22
+ 5
- 2
Agriculture
Farm Cash Receipts - $ m i l .
Dates: MAR., MAR.
256
Broiler Placements (thous.)
N.A.
Calf Prices ($ per cwt.)
83.50
Broiler Prices (i per lb.)
28.30
Soybean Prices ($ per bu.)
5.51
Broiler Feed Cost ($ per ton)
159
73.50
29.80
5.32
147
308
N.A.
58.00
35.50
5.20
181
+44
-20
+ 6
-12
Agriculture
Farm Cash Receipts - $ mil.
Dates: MAR., MAR.
Broiler Placements (thous.)
Calf Prices ($ per cwt.)
Broiler Prices (i per lb.)
Soybean Prices ($ per bu.)
Broiler Feed Cost ($ per ton)
307
7,186
77.90
28.20
5.62
159
7,073
74.00
29.80
5.38
147
438
6,874
55.60
34.40
5.20
181
-30
+ 5
+40
-18
+ 8
-12
Agriculture
Farm Cash Receipts - $ mil.
Dates: MAR., MAR.
Broiler Placements (thous.)
Calf Prices ($ per cwt.)
Broiler Prices (t per lb.)
Soybean Prices ($ per bu.)
Broiler Feed Cost ($ per ton)
397
N.A.
74.70
27.00
5.40
205
71.80
29.10
5.41
187
418
N.A.
53.30
30.50
5.31
189
+40
-11
+ 2
+ 8
-17
-5
NOTES:
Personal Income data supplied by U . S . Department of Commerce. Taxable Sales are reported as a 12-month cumulative total. Plane
Passenger Arrivals are collected from 26 airports. Petroleum Production data supplied by U . S . Bureau of Mines. Consumer Price Index data
supplied by Bureau of Labor Statistics. Agriculture data supplied by U . S . Department of Agriculture. Farm Cash Receipts data are reported
as cumulative for the calendar year through the month shown. Broiler placements are an average weekly rate. The Southeast data represent
the total of the six states. N . A . = not available. The annual percent change calculation is based on most recent data over prior year.
R = revised.
http://fraser.stlouisfed.org/
74
Federal Reserve Bank of St. Louis
SUMMER 1987, ECONOMIC REVIEW f
:Ü
GENERAL
ANN.
JULY
%
1986 CHG.
ANN.
LATEST CURR.
DATA PERIOD
PREV.
PERIOD
YEAR
AGO
%
CHG.
JULY
1987
JUNE
1987
•mmmpm m®m
fflBHSS
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. A r r . (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - m i l s .
SOUTHEAST
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane P a s s . A r r . (thous.)
Petroleum P r o d , (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - m i l s .
ALABAMA
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane P a s s . A r r . (thous.)
Petroleum P r o d , (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - m i l s .
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane P a s s . A r r . (thous.)
Petroleum P r o d , (thous.)
Consumer Price Index
1977=100
MIAMI
Kilowatt Hours - m i l s .
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane P a s s . A r r . (thous.)
Petroleum P r o d , (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - m i l s .
Personal Income
($ b i l . - SAAR)
Taxable Sales - $ bil.
Plane P a s s . A r r . (thous.)
Petroleum P r o d , (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - m i l s .
Personal Income
($ bil. - SAAR)
Taxable Sales - $ bil.
Plane Pass. A r r . (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - m i l s .
Personal Income
($ b i l . - SAAR)
Taxable Sales - $ bil.
Plane P a s s . A r r . (thous.)
Petroleum Prod, (thous.)
Consumer Price Index
1967=100
Kilowatt Hours - m i l s .
3,529.7
N.A.
N.A.
8,444.0
3 ,430.6
N.A.
N.A.
8.,808.1
+ 5
JUNE
3,589.7
N.A.
N.A.
8,358.9
JULY
MAY
340.8
189.0
340.1
185.0
328.0
179.4
+ 4
+ 5
436.8
N.A.
5,635.2
1,423.0
428.9
N.A.
6,058.9
1,426.0
419.2
N.A.
5 ,089.4
1 ,408.0
+ 4
+11
+ 1
N.A.
31.3
N.A.
29.2
N.A.
28.9
+ 8
JUNE
JUNE
45.9
N.A.
175.8
56.0
45.2
N.A.
182.0
56.0
44.8
N.A.
151.8
57.0
+16
- 2
MAY
N.A.
4.5
N.A.
4.1
N.A.
3.9
+15
Q1
171.6
169.2
163.6
+ 5
2,639.5
22.0
JUL
180.5
9.3
2,787.5
23.0
HAY
179.1
8.5
2,340.2
29.0
JUL
171.2
8.3
+13
-24
83.6
N.A.
2,177.6
N.A.
82.2
N.A.
2,301.8
N.A.
79.4
N.A.
1,999.5
N.A.
+ 5
N.A.
5.5
N.A.
5.0
N.A.
5.1
50.3
N.A.
304.3
1,267.0
49.4
N.A.
346.7
1,268.0
50.8
N.A.
285.8
1,238.0
N.A.
4.7
N.A.
4.2
N.A.
4.5
JUNE
JUNE
26.0
N.A.
47.3
78.0
25.0
N.A.
48.0
79.0
24.9
N.A.
40.0
84.0
MAY
N.A.
2.1
N.A.
2.0
N.A.
2.0
59.4
N.A.
290.7
N.A.
57.9
N.A.
392.9
N.A.
55.7
N.A.
272.1
N.A.
N.A.
5.2
N.A.
5.4
N.A.
5.1
Q1
Q1
JUNE
JUNE
MAY
Q1
JUNE
JUNE
MAY
Q1
JUNE
MAY
Q1
JUNE
JUNE
MAY
Q1
Q1
JUNE
MAY
- 5
+ 2
+ 5
+12
+ 9
+ 4
- 1
+ 6
+ 2
+ 4
- 4
+18
- 7
+ 5
+ 7
+ 7
+ 2
Agriculture
Prices Rec'd by Farmers
Index (1977=100)
128
Broiler Placements (thous.)
89,586
Calf Prices ($ per cwt.)
80.70
Broiler Prices (i per lb.)
28.10
Soybean Prices ($ per bu.)
5.20
Broiler Feed Cost ($ per ton) (Q3)193
131
92,068
78.80
27.60
5.36
(Q2)183
125
84,208
59.80
42.40
5.07
(Q3)190
+ 2
+ 6
+35
-34
+ 3
+ 2
Agriculture
Prices Rec'd by Farmers
Index (1977=100)
114
Broiler Placements (thous.)
37,388
80.79
Calf Prices ($ per cwt.)
Broiler Prices (t per lb.)
26.28
Soybean Prices ($ per bu.)
5.35
Broiler Feed Cost ($ per ton) (Q3)181
117
38,481
77.51
25.84
5.53
(02)173
119
34,924
57.28
41.85
5.19
(03)184
- 4
+ 7
+41
-37
+ 3
- 2
Agriculture
Farm Cash Receipts - Î mil.
Dates: A P R . , A P R .
564
Broiler Placements (thous.)
13,024
79.00
Calf Prices ($ per cwt.)
Broiler Prices (£ per lb.)
25.00
Soybean Prices ($ per bu.)
5.29
8roiler Feed Cost ($ per ton) (Q3)185
13,317
76.00
25.00
5.61
(02)177
592
12,112
54.10
42.00
5.20
(Q3)189
- 5
+ 8
+46
-40
+ 2
- 2
Agriculture
Farm Cash Receipts - $ m i l .
Dates: A P R . , A P R .
2,197
Broiler Placements (thous.)
2,430
Calf Prices ($ per cwt.)
84.20
Broiler Prices (i per lb.)
25.50
Soybean Prices ($ per bu.)
5.29
Broiler Feed Cost ($ per ton) (Q3)185
2,488
80.70
25.00
5.61
(Q2)177
2,450
2,241
63.00
48.00
5.20
(Q3)189
-10
+ 8
+34
-47
+ 2
- 2
Agriculture
Farm Cash Receipts - $ m i l .
Dates: A P R . , A P R .
781
Broiler Placements (thous.)
14,951
Calf Prices ($ per cwt.)
76.70
Broiler Prices (t per lb.)
25.50
Soybean Prices ($ per bu.)
5.15
Broiler Feed Cost ($ per ton) (Q3)185
15,489
73.30
25.00
5.45
(Q2)177
808
13,969
53.20
42.00
5.20
(03)189
- 3
+ 7
+44
-39
- 1
- 2
Agriculture
Farm Cash Receipts - $ m i l .
Dates: A P R . , A P R .
299
Broiler Placements (thous.)
N.A.
Calf Prices ($ per cwt.)
86.00
Broiler Prices (i per lb.)
29.30
Soybean Prices ($ per bu.)
5.46
Broiler Feed Cost ($ per ton) (Q3)165
83.50
28.30
5.51
(Q2)159
371
N.A.
60.00
44.00
5.20
(Q3)169
Agriculture
Farm Cash Receipts - $ m i l .
Dates: A P R . , A P R .
393
Broiler Placements (thous.)
6,982
Calf Prices ($ per cwt.)
80.20
Broiler Prices (t per lb.)
29.30
Soybean Prices ($ per bu.)
5.37
Broiler Feed Cost ($ per ton) (Q3)165
7,186
77.90
28.20
5.62
(Q2)159
547
6,602
58.90
40.80
5.14
(Q3)169
-28
+ 6
+36
-28
+ 4
- 2
- 3
74.70
27.00
5.40
(02)205
549
N.A.
54.30
41.00
5.24
(03)205
Agriculture
Farm Cash Receipts - $ mil
Dates: A P R . , APR
531
Broiler Placements (thous.)
N.A.
Calf Prices ($ per cwt.)
79.30
Broiler Prices'(t per lb.)
26.80
Soybean Prices ($ per bu.)
5.38
Broiler Feed Cost ($ per ton) (03)208
+43
-33
+ 5
-
2
+46
-35
+ 3
+ 1
NOTES:
Personal Income data supplied by U . S . Department of Commerce. Taxable Sales are reported as a 12-month cumulative total. Plane
Passenger Arrivals are collected from 26 airports. Petroleum Production data supplied by U . S . Bureau of Mines. Consumer Price Index data
supplied by Bureau of Labor Statistics. Agriculture data supplied by U . S . Department of Agriculture. Farm Cash Receipts data are reported
as cumulative for the calendar year through the month shown. Broiler placements are an average weekly r a t e . The Southeast data represent
the total of the six states. N . A . = not available. The annual percent change calculation is based on most recent data over prior y e a r .
R = revised.
f F E D E R A L R E S E R V E BAN K O F
ATLANTA
2l
CONSTRUCTION
MAY
1987
APR
1987
MAY
1986
ANN.
%
CHG
Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
47,289
8,250
13,840
12,095
2,449
1,192
47.,290
s;,374
13.,849
11.,991
2.,513
1.,180
61,149
8,846
15,823
11,644
2,403
1,090
-23
-7
-13
+4
+2
+9
Residential Building Permits
Value - $ M i l .
Residential Permits - T h o u s .
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
I Mil.
7,787
1,058
1,868
2,412
416
146
7,866
1,125
1,883
2,397
445
152
10,361
1,178
2,482
2,343
420
161
-25
-10
-25
+3
-1
-9
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
Nonresidential Building Permits - $ M i l .
Total Nonresidential
570
Industrial Bldgs.
67
Offices
169
Stores
185
Hospitals
14
Schools
21
561
72
164
174
17
21
632
59
149
181
21
17
-10
+13
+13
+2
-36
+25
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
3,752
399
841
1,154
288
34
3,852
407
891
1,162
314
32
5,349
469
1,197
1,203
243
53
-30
-15
-30
-4
+19
-37
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - S M i l .
1,788
Total Nonresidential
Industrial Bldgs.
310
Offices
446
548
Stores
Hospitals
20
42
Schools
1,752
350
411
532
21
42
1,979
352
524
393
35
26
-10
-12
-15
+39
-43
+60
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
Nonresidential Building Permits - $ M i l .
Total Nonresidential
445
37
Industrial Bldgs.
91
Offices
Stores
135
34
Hospitals
Schools
36
448
38
91
130
36
41
955
37
325
215
34
43
-53
0
-72
-37
0
-16
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
MAY
1987
APR
1987
MAY
1986
ANN.
%
CHG
12-month cumulative rate
Nonresidential Building Permits Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
Nonresidential Building Permits - $ M i l .
233
Total Nonresidential
22
Industrial Bldgs.
55
Offices
82
Stores
24
Hospitals
Schools
8
240
21
59
81
24
8
307
31
69
79
16
6
-24
-30
-21
+3
+45
+28
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
TENNESSEE
Nonresidential Building Permits - $ M i l .
Total Nonresidential
1,001
223
Industrial Bldgs.
267
Offices
Stores
308
37
Hospitals
6
Schools
1,012
235
267
317
33
7
1,138
229
218
272
69
15
-12
-3
+22
+13
-47
-59
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
96,230
96,859
88,225
+9
1,069.4
589.2
1,082.6
610.0
1,005.0
770.4
+6
-24
143,520
144,149
149,374
-4
15,765
15,797
15,564
+1
205.0
120.6
206.2
123.8
203.7
157.6
+0
-23
23,552
23,663
25,925
-8
667
678
607
+10
11.0
6.1
11.2
6.7
10.2
8.2
+8
-26
1,237
1,239
1,239
-0
8,772
8,733
8,696
+1
108.3
78.3
108.0
80.0
106.2
94.7
+2
-17
12,523
12,585
14,045
-11
3,613
3,682
3,546
+2
49.5
19.8
50.7
20.6
50.3
28.4
-2
-30
5,400
5,434
5,525
-2
479
493
707
-32
7.3
1.7
7.5
1.8
10.7
4.7
-32
-64
941
1,662
923
mamsm
-44
m
i
320
323
350
-9
5.3
1.7
5.4
1.6
5.8
2.7
-9
-37
553
563
658
+49
1,915
1,889
1,658
+16
23.6
13.0
23.4
13.1
20.5
18.8
+15
-31
2,916
2,901
2,796
+4
NOTES: Data supplied by the U.S. Bureau of the Census, Housing Units Authorized by Building Permits and Public Contracts, C-40.
Nonresidential data excludes the cost of construction for publicly owned buildings.
The southeast data represents the total of the six states.
76
S U M M E R 1987, E C O N O M I C R E V I E W
CONSTRUCTION
JUN
1987
MAY
1987
JUN
1986
ANN.
%
CHG
Nonresidential Building Permits - $ M i l .
Total Nonresidential
47,747
Industrial Bldgs.
8,127
Offices
14,071
Stores
12,230
Hospitals
2,531
Schools
1,204
47.,289
8.,250
13.,840
12,,095
2.,449
1 . ,192
59.,517
8.,866
15.,573
11.,850
2,,405
1 , ,126
-20
-8
-10
+3
+5
+7
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
Nonresidential Building Permits - $ M i l .
Total Nonresidential
7,836
Industrial Bldgs.
1,050
Offices
1,833
Stores
2,428
Hospitals
436
Schools
174
7,787
1,058
1,868
2,412
416
146
10.,120
1.,1/b
2.,402
2.,415
4U4
159
-23
-11
-24
+1
+8
+9
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
H M M H
m,
Nonresidential Building Permits - $ M i l .
Total Nonresidential
566
Industrial Bldgs.
59
Offices
166
Stores
185
Hospitals
14
Schools
26
570
67
169
185
14
21
630
63
155
180
21
17
-10
-5
+7
+3
-33
+54
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
Nonresidential Building Permits - $ Mil.
Total Nonresidential
3,776
Industrial Bldgs.
426
Offices
814
Stores
1,167
Hospitals
302
Schools
35
3,752
399
841
1,154
288
34
5,227
448
1,187
1,212
236
52
-28
-5
-31
-4
+28
-32
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - $ Mil.
Total Nonresidential
1,792
Industrial Bldgs.
276
Offices
440
Stores
548
Hospitals
20
Schools
60
1,788
310
446
548
20
42
1,945
351
510
427
33
28
-8
-21
-14
+28
-41
+115
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family uni ts
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - $ M i l .
Total Nonresidential
453
Industrial Bldgs.
37
Offices
91
Stores
143
Hospitals
34
Schools
35
445
37
91
135
34
36
872
36
267
215
34
43
-48
+2
-66
-33
-1
-17
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - $ Mil.
Total Nonresidential
237
Industrial Bldgs.
31
Offices
55
Stores
75
Hospitals
24
Schools
9
233
22
55
81
28
8
309
31
69
90
16
6
-23
-1
-21
-17
+48
+57
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - $ M i l .
Total Nonresidential
1,012
Industrial Bldgs.
221
Offices
267
Stores
311
Hospitals
43
Schools
8
1,001
223
267
308
40
6
1,137
246
214
291
63
13
-11
-10
+25
+7
-33
-42
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
JUN
1987
12-month cumulative rate
MAY
1987
JUN
1986
ANN.
X
CHG
96,733
96,230
90,028
+7
1,068.8
572.1
1,069.4
589.2
1,026.9
765.4
+4
-25
144,480
143,520
149,545
-3
15,882
15,765
15,818
+0
207.1
115.0
205.0
120.6
204.4
159.0
-28
23,718
23,552
25,938
-9
+1
685
667
615
+11
10.9
6.5
11.0
6.1
10.4
8.2
+5
-21
1,252
1,237
1,245
+1
8,934
8,772
8,796
+2
111.1
73.4
108.3
78.3
105.4
96.9
+6
-24
12,710
12,523
14,023
-9
3,555
3,613
3,692
-4
48.9
19.8
49.5
19.8
51.5
28.6
-5
-31
5,346
5,400
5,637
-5
480
479
673
-29
7.4
1.7
7.3
1.7
10.4
3.9
-29
-56
933
923
1,545
-40
320
320
358
-11
5.3
1.5
5.3
1.7
5.9
2.9
-10
-48
558
553
666
-16
1,907
1,915
1,684
+13
23.4
12.1
23.6
13.0
20.9
18.6
+12
-35
2,919
2,916
2,821
+3
mgf
m
NOTES: Data supplied by the U . S . Bureau of the Census, Housing Units Authorized by Building Permits and Public Contracts, C-40.
Nonresidential data excludes the cost of construction for publicly owned buildings.
The southeast data represents the total of the six states.
F E D E R A L R E S E R V E BANK O F ATLANTA
77
1 !
1) C
h
CONSTRUCTION
!
' — ~
JUL
1987
JUN
1987
JUL
1986
ANN.
X
CHG
JUL
1987
JUN
1987
JUL
1986
ANN.
%
CHG
12-month cumulative rate
Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
47,615
8,183
13,974
12,237
2,488
1,170
47.1747
8.,12/
14.,071
1 ?.,230
2., 531
1.,204
57,224
8,851
15,405
11,929
2,503
1,112
-17
-8
-9
+3
-1
+5
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
Mil.
7.,802
1.,001
1 ,855
? ,465
432
182
7,836
1,050
1,833
2,428
436
174
9.,312
1.,218
2.,339
2.,3/4
3/8
143
-16
-18
-21
+4
+14
+2/
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
Nonresidential Building Permits
Total Nonresidential
Industrial Bldgs.
Offices
Stores
Hospitals
Schools
Mil.
553
53
159
184
15
27
566
59
166
185
14
26
608
64
155
173
21
10
-9
-1/
+3
+6
-2b
+156
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - S Mil.
Nonresidential Building Permits - S Mil.
3,791
Total Nonresidential
391
Industrial Bldgs.
851
Offices
1,157
Stores
307
Hospitals
37
Schools
3,776
426
814
1,167
302
35
4.,582
468
1 .,15/
1 .,216
213
43
-17
-lb
-2b
-b
+44
-13
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - S Mil.
wamsssm
Nonresidential Building Permits - $ M i l .
1,769
Total Nonresidential
2/4
Industrial Bldgs.
464
Offices
Stores
559
Hospitals
21
Schools
72
1,792
2/6
440
548
20
60
1,934
366
483
433
34
29
-9
-25
-4
+29
-38
+ 150
Nonresidential Building Permits - $ Mil.
Total Nonresidential
464
Industrial Bldgs.
37
Offices
89
Stores
176
Hospitals
22
Schools
28
453
36.9
91
143
34
35
790
33.8
246
186
41
44
-41
+9
-64
-5
-47
-37
¡»MP PI"
Nonresidential Building Permits - S Mil.
Total Nonresidential
242
Industrial Bldgs.
31
Offices
58
Stores
73
Hospitals
22
Schools
10
Nonresidential Building Permits - $ M i l .
983
Total Nonresidential
215
Industrial Bldgs.
233
Offices
316
Stores
44
Hospitals
Schools
8
WMë
¿mm
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
237
31
55
75
24
9
278
27
67
86
8
3
-13
+12
-14
-15
+159
+215
Residential Building Permits
Value - S Mil.
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
1,012
221
26/
311
42
8
1,120
259
231
2/9
61
14
-12
-1/
+1
+13
-2/
-44
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
96,424
96,733
91,483
+5
1,059.3
557.1
1,068.8
572.1
1,040.3
759./
+2
-2/
144,040
144,480
148,707
-3
15,805
15,882
16,001
-1
206.0
109.6
20/. 1
115.0
205.1
159.5
+0
-31
23,606
23,718
25,313
-7
689
685
631
+9
11.0
5.7
10.9
6.5
10.4
8.6
+6
-34
1,242
1,252
1,239
+0
8,914
8,934
8,887
+0
111.2
69.8
111.1
73.4
105.2
99.0
+6
-29
12,705
12,710
13,469
-6
3,577
3,555
3,720
-4
-7
48.3
20.3
48.9
19.8
52.0
27.6
5,346
5,346
5,654
461
480
660
-30
7.1
1.5
/ .4
1.7
10.0
3.6
-29
-58
925
933
1,450
-36
311
320
363
-14
5.2
1.3
b.3
1.5
5.9
3.0
-12
-57
552
558
641
-14
:, 854
1,907
1,740
+7
23.1
23.4
12.1
21.6
17.8
+7
-38
2,837
2,919
11.0
-26
-1
NOTES- Data supplied by the U . S . Bureau of the Census, Housing Units Authorized by Building Permits and Public Contracts, C-40.
Nonresidential data excludes the cost of construction for publicly owned buildings.
The southeast data represents the total of the six states.
78
S U M M E R 1987, E C O N O M I C R E V I E W
CONSTRUCTION
AUG
1987
JUL
1987
AUG
1986
ANN.
X
CHG
Nonresidential Building Permits - $ M i l .
Total Nonresidential
47,265
Industrial Bldgs.
8,032
Offices
13,715
Stores
12,450
Hospitals
2,425
Schools
1,070
47,615
8,183
13,974
12,237
2,488
1,170
55,031
8,758
15,093
11,952
2,526
1,181
-14
-8
-9
+4
-4
-9
Residential Building Permits
Value - $ Mil.
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mil.
n u n r e s l a e n n a i i>ui icnng permits - i nil.
Total Nonresidential
7,722
Industrial Bldgs.
993
Offices
1,871
Stores
2,474
Hospitals
397
Schools
174
7,802
1,001
1,855
2,465
432
182
8,903
1,197
2,196
2,328
404
138
-13
-17
-15
+6
-2
+26
Residential Building Hermits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ Mi 1.
Nonresidential Building Permits - $ Mil.
Total Nonresidential
545
Industrial Bldgs.
52
Offices
164
Stores
180
Hospitals
15.8
Schools
26
553
53
159
184
15.5
27
581
62
146
162
22
12
-6
-16
+12
+11
-28
+112
Residential Building Permits
Value - $ M i l .
Residential Permits - T h o u s .
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - $ M i l .
Total Nonresidential
3,740
Industrial Bldgs.
399
Offices
837
Stores
1,147
Hospitals
289
Schools
39
3,791
391
851
1,157
307
37
4,398
454
1,089
1,214
227
42
-15
-12
-23
-6
+27
-6
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - $ M i l .
Total Nonresidential
1,748
Industrial Bldgs.
267
Offices
496
Stores
568
Hospitals
17
Schools
65
1,769
274
464
559
21
72
1,868
362
392
446
39
36
-6
-26
+27
+27
-55
+80
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - 1 Mil.
Total Nonresidential
465
Industrial Bldgs.
36.9
Offices
94
Stores
179
Hospitals
16
Schools
26
464
37
89
176
22
28
703
27
233
174
42
30
-34
+37
-60
+3
-62
-14
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - $ M i l .
Total Nonresidential
238
Industrial Bldgs.
29
Offices
61
Stores
75
Hospitals
17
Schools
7
242
31
58
73
22
10
266
26
71
83
12
7
-11
+11
-14
-10
+47
+3
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
Nonresidential Building Permits - $ M i l .
Total Nonresidential
986
Industrial Bldgs.
209
Offices
219
Stores
325
Hospitals
42
Schools
11
983
215
233
316
44
7
1,087
267
265
248
62
11
-9
-22
-17
+31
-33
-2
Residential Building Permits
Value - $ M i l .
Residential Permits - Thous.
Single-family units
Multifamily units
Total Building Permits
Value - $ M i l .
AUG
1987
JUL
1987
AUG
1986
ANN.
%
CHG
96,711
96,424
91,586
+6
1,057.2
543.2
1,059.3
557.1
1,040.3
744.3
+2
-27
143,976
144,040
146,617
-2
15,909
15,805
15,917
-0
206.3
116.7
206.0
109.6
204.6
157.4
+0
-25
23,631
23,606
24,820
-5
656
689
668
-2
10.9
4.5
11.0
5.7
10.5
9.7
+4
-54
1,200
1,242
1,249
-4
9,073
8,914
8,806
+3
111.6
80.2
111.2
69.8
105.2
97.8
+7
-18
12,813
12,705
13,203
-3
3,573
3,577
3,708
-4
48.3
19.0
48.3
20.3
51.7
27.7
-7
-31
5,321
5,346
5,577
-5
454
461
626
-27
7.0
1.4
7.1
1.5
9.6
3.0
-27
-53
920
925
1,330
-31
308
311
360
-14
5.1
1.2
5.2
1.3
5.8
2.9
-12
-59
546
552
626
-13
1,845
1,854
1,749
+5
23.3
10.4
23.1
11.1
21.8
16.3
+7
-36
2,831
2,837
2,836
-0
12-raonth cumulative rate
NOTES: Data supplied by the U . S . Bureau of the Census,, Housing Units Authorized by Building Permits and Public Contracts , C - 4 0 .
Nonresidential data excludes the cost of construction for publicly owned buildings."
The southeast data represents the total of the six states.
F E D E R A L R E S E R V E BANK O F ATLANTA
79
Federal Reserve Bank of Atlanta
104 Marietta St, N.W.
Atlanta, Georgia 30303-2713
Address Correction Requested
Bulk Rate
U.S. Postage
PAID
Atlanta, Ga.
Permit 292
@FedFRASER