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The Economy in Perspective
Pciladignz Lost.' . . . What should we nlalce of the
unexpectedly good macroeconomic performance of the U.S. economy in the last several
of u11de1--3%inflayears? Does the coml~i~lation
tion ancl uncles-5%)une~nployment mean that
str~~ctural
changes 1i;nie permanently transformed
the economy's business cycle characteristics?
I-Iave Lve enterecl a Golden Age that etern;llizes
not only lo\\/ inflation and unemployment hut
also higher rates of saving. capital investment,
and productivity? Is it ti~neto replace an ole1 paraclig~ll\vith a Imve new one?
I:,cono~iiiststypically divide macroeconomic
activity i ~ l t otwo "preclictable" componentstrellcl 2nd cycle. Trencls represent the economy's performance in the absence of cyclical
disturbances, :lnd cycles clescrihe the economy's moveme~ltarou~lcltre~lclsin response to
transient forces. The economy's real growth
trend is determined by the growth rates of
lahor ancl capital ancl by their proclc~ctivity.Its
~inclerlyinginflation rate is deternlincd hy the
excess of money supply over money demand.
The traclitional framework for describing
cyclical clynarnics requires an estimate of the
economy's maximum, noninflationary, real output level ancl gron.th trencl. Once the level and
trend gsmvth of "potential" output are establishecl. it is stmightforward to estirnate gaps between potential 2nd actual output. Knowi~lgthe
historical relationships between labor utilizatio~i
rates 2nd output, we can express these gaps in
terms of differences between the actual LIII~IIIplopment rate anel the NAIIIU! a theoretical
"tlonaccelerating inflation rate of ille employment" that corresponcls to potential output. Aclvocates of this approach expect that when the
economy's resources are stretched beyotid the
NAIRU thresholcl, the prevailing inflation rate
will accelerate as goocls ancl services markets
are strai~ieclby excess demancl.
Analysts who predict inflation exclusively on
the basis of current anel projected resource utilization gaps think that available lnoney supply
and demand estimates are not sufficiently reliable for their purposes. They consider wages
especially vulneral~leto excess demancl pressures because they IIelieve labor supply is relatively fixecl in the short run. But the location of
NAIIiU clepencls crucially on esti~natesof "potential output." which in turn are heavily reliant
on productivity assumptions.
Basic economic growth theol'y suggests that a
society raises its living stanclclrcl (output per
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capita) over time either 1 3 7 increasing the
amount of capital per worlier or by making
tech~lologychanges that enalde people to use
capital stocks more effectively. Generally, the
living standard increases slowly over tinie along
\vith the steady cliffusion of educatio11 :111d of
the capital equipment that accompanies technological aclva~lce.Once in a great while, however. tecl~nologicalinnovation anel cliffusion hecome highly co~~denseclin ti~ne, causing
procluctivity growth to accelerate.
As an econolny shifts fro111one procluctivity
level to another, investment outstrips labor force
growth. Domestic cotlsumption neeel not contract during the investment boom! however, if
society call import savitlgs from abroacl. 'Xihen
aclclitions to the capital stock expand productive
capacity: the output gar> may not widen, because a c t ~ ~output
al
is also growi~lg.R/loreover, if
employees at Inany sltill levels can use the new
technology, overall labor de~i~ancl
~villincrease
as the economic expa~lsioncontinues. Finally.
money clemancl may strengthen along ~viththe
expanded volume of econo~nicactivity. renclering current Inoney growth rates noninflationary
(or even clisinflationary!).
Traclitional econo~nicgro\vth theory can, in
other worcls, account for the si~nulta~leous
appearance of an investment-lecl expansion,
healthy domestic consu~nption,tracle deficits
(and corresponding capital inflows), greatertha11-expectecl labor force participation ancl
utilization, and declining inflation in the Elce of
stal~lemoney supply growth. It could also
account for a pickup in real wages, as a corollary to capital deepening. Thus, no new paradigm is neeeleel.
All of this ~llalcesperfect sense except for one
esse~ltialfact: Official clata for the U.S. economy
clo not support the proposition that procluctivity
growth is accelerating. These clata coulcl be misleacling: especially if a greater proportion of
current-clollar output consists of goods and
services that embocly enhanceel features ancl
quality. If so, we are underestimating real output growth anel overestimating inflation. But if
the reported data are esse~ltiallycorrect, temporary f ~ ~ c t omay
r s be suppressing an otherwise
yeasty inflation process. So we see that the difference of opinion about productivity growth is
not so much a clash of olcl versus new paracliglns as a commentary on the quality of current economic statistics. And on tlxit subject, at
least, all econo~nistscan agree.
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Percent. weeklv averaoes
Percent
585
580
IMPLIED YIELDS ON FEDERAL FUNDS FUTURES
-
5 35
July
Percent
Aug
Sepl
Oct
Nov
Dec
Conlracl month
Jan
Feb
March
I
I
lUSELECTED INTEREST RATES
5
I-year Treasury constant maturity
a. Pred~ctedrates are federal funds futures.
SOURCES: Board of Governors of the Federal Reserve System: and the Chicago Board of Trade
At its tli~gi~st
I9 meeting. the Fecleral
O p e n Mzu-liet Conurnittee (FObIC)
clecided to mxinuin the existing clegree of press~uc on the iecleral
fi111dsr:lte. expecting it to remxin
:~roi~ncl
S.SO/ii. This in:~ctionc;lme as
no surprise to the financiz~l~narkets.
.I.h e funcls Iate has heen :llterecl only
once in the pzst 10 ~nonths-an increase of 25 basis points th21t occurrecl at the FOL'IC's March 25,
1997 meeting. 7'he Conunittee \\-ill
recon\.ene on Septeml3er 50.
Implieel yielcls o n feclesal tc~riclsfilti~res-\vliich pro.i.icle m i~nl>iased
estimate of the market's expectilt i o ~ xabout the future course of
monetzlr), policy-swi~ng wiclel).
throughout the month of Ailgust.
Yielcls steepe~leclsignificantl). early
in the month. perhaps reflecting upivarcl re\-isions in the gro\\-th outlooli. Despite continuecl lo\\- inflation. m;~ny analysts relate strong
o ~ ~ t p ugro\\'th
t
to a11 nccelelxting
price level ~ l n dbelieve t11:lt the former necessarily prompts the FOMC
to saise the funds rate. By the encl of
Augr~st, ho\vever, implied yielcls
hacl begiln to flatten, ancl expectarate incre:lse \\.ere
tions for a fi~ti~se
pushecl I~lclito early nest ye:u-.
Interest sates began risitlg sh:1rldy
early in 1997 as marl.;et commentaly
revealecl :t sentiment for fi~rtlierpolicy tightening after the I\larch increxse. I~lipliecl yielcls o n fetler:ll
filncls f i ~ t ~ ~ also
s e s st:lrtecl to rise.
Sentiment re\;ersed cluring April, ancl
interest mtes pealieel. Since then. the
one-year ancl 10-year T1-e;tsury const:lnt mztti~ritiesh;l\-e fallen 43 ancl
59 basis points, respectively. Home
mortgage rates h;~\.e clroppecl 66
hasis points.
( C O I I ~ ~ I 0I 1~1 (I CI ~C Y I ~ L ~ ~ ~ C )
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Monetary Policy jcont.)
Bill~onsof dollars
[ T H E M I AGGREGATE
B~llionsof dollars
480
MONETARY BASE
5%.
440
410
-
"ll'"i"rl"l"**"""tl"*tl"l'L'
1995
1996
1997
a. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter bass. Annualized growth rate for 1997 is calculated on an estimated
August over 1996:IVQ basis.
b. Adjusted for sweep accounts.
NOTE: All data are seasonally adjusted. Last plot is estimated for August 1997. For M2 and M3, dotted lines ale FOMC-determined provisional ranges. For M I
and the monetary base, dotted lines represent growth rates and are for reference only.
SOURCE: Board of Governors of the Federal Reserve System.
PI2 continues to grow at the
upper I>ouncl of its provisional
range. expancling ;it :i.S1H/i,annual
rate through J L I ~
1'relimin:rry
~.
nilmbcss for the first 1i;llf of' i l ~ ~ g ~s i~s gt gest that the aggregate may esceecl
the ~rpperI~oundo f its I.:lnge 11)i the
e n d of the month. hI3 has been
gron.ing oi~tside its provision:il
range since the f o ~ ~ r tclu;lrter
h
of
1996, ancl continues to clo so.
.I .hrough jul).. the aggregate Ixras aclvancecl at :I 7.6'%,:i,annu:tl rate.
Fetler.:rl Reserv-e Chairman Alan
(>reensp;ran noted in his July
FI~~mphrc-y-Hawkinstestimony that
the once-stal~lerelationship between
changes in &I:! velocity and opport~lnity cost may have reasserted itself.
Me \vz~rnecl.ho\vever, that there ~ v a s
not enough evidence to justify placing more weight on this measure in
monetzury policy clelil~erzitions.
A41 continues to decline. nlainly
hecause clepository institutions are
"s\veeping" transaction account I~alances into Iiloney ~narltetcleposit
accounts to econorilize 011 their reser\.es. The clecline in the quantity
o f cleposits helcl in transaction ac-
counts has led M1 to fall at :l 2.5%
annual sate through July. Wihen adjustecl for sn.eep-zrccount b,1' I z~nces,
however, the aggregate continues to
es11:~ncl.The moneta1-j~base (which
reserves)
s
aclequals currency p l ~ ~
vanced at a 4.8% annual cite
through July, reflecting substantial
grcnvth in currency holdings.
i\Ioney cle1ll2111dis partially cleter~ninecl11y interest crates. When plottecl against the 10-yeas Treas~11-y
rate,
the r~ttioof the stock of 1,ase Inoney
(currency plus rese~ves)to nomin:~l
(co?zrii~~led
O H 12e.~tp~lgej
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Monetary Policy (cont.)
Ratio
0.065
Nominal 10-year Treasury, constant maturity, percent
Percent
Ratlo
h
MONETARY BASWNOMINAL GDP AND NOMINAL
INTEREST RATE. SUBPERIODS
Nom~nai10-year Treasury, constant maturity, percent
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; U.S. Department of Labor, Bureau of Labor Statistics; and Board of Governors of
the Federal Reserve System.
GIIP shows st do\vn\~u-elc1in.e. I'revious estinlates of Ixise clem;tncl.
ho\ve\.er, have shonm that it tencls to
IIe fairly imper\.ioiis to interest sate
changes, contmclicting the relative
responsiveness suggestecl 13y the
chart :tbove. A closer look reveals
that from 1781 to approxi111;itely
1989, base dernancl \ \ ~ t sinterestinelastic. As inflation, ancl hence
nominal interest rates. fcll fr.ori1 their
peak in 1980. I~asecleliiancl as a
share of' nominal GIlI' incre~tsecl
only slightly. Yet. fi-om arouncl 1990
t o 1993. the clem~unclfor currency
;ts inancl reserves gren. su1~st:mtiall~~
terest rates contin~ieclto kdl.
Histor). suggests that imporLant
changes affecting the clemancl for
currency occurred during this periocl. The collapse of the Soviet
IJnion in 1991 and the trdl of' the
13erlin \Vrtll in 1789 enclecl 44 ye:lrs
of Colcl W~IS
hostilities anel openecl
the floodg~ttesfor U.S. currency to
flo\v o\;erseas. The clemancl for U.S.
clollars acccleratecf as the ruble ancl
e:tstern European curre~lcieseroclecl
in value, causing foreigners to shirt
to the relatively stahle clollar. Concurrent \\;it11 this increaseci clernancl
n.as a clecline in U.S. nomin2tl interest sates, maliing it appear thitt the
monet:try base was more interestel;~sticthan previously thoi~ght.
.I.he higher foreign clem:t~lcl for
~ L I currency
S
may have helpecl s ~ i p press the U.S. inflation rate since
1970. For- a g i w n incre:tse in the
s~ipplyof I ~ a s emoney, a growing
clernancl for currency implies a
lower inflation rate. These potential
inflation s~lrprisesappear to be over,
lio\vever. Since ;tl>out 1794, hase de~nalclhas been fairly flat. suggesting
that tlie flow of I.i.S. currency
al~roaclhas slowecl. Approsirnately
t~vo-thircls of :ill L7.S. currency is
no\v helcl overseas.
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Financing the Investment Boom
Percent
CORPORATE BOND YIELD AND S&P 500
EARNINGSIPRICE RATIO
16 -
B~ilions01 dollars
35 NET FLOWS INTO EQUITY AND BOND
AND INCOME FUNDS, MONTHLY~
Percent change, annual rate
20 [COMMERCIAL AND INDUSTRIAL LOAN GROWTH
a. Profits from domestic operations with inventory valuation and capital consumption adjustments, divided by GDP of the nonfinancial corporate sector
b. Sum of net sales and net exchanges.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; DRIIMcGraw-Hill; and
Investment Company Institute.
.I.h e
current espansion has I x e n
retirement of eqnity through s t o ~ l i
ct1ar:~cterizecl 1,). a n estraorclil-iary
repiischases ancl mergers. l'he fin:~ncingg:ip for this sector-the exaclv:ince in lx~sinessin\.estment. fin:~nced thl-o~ighI>oth strong cash
cess of in\-estment over intern:~lly
f l o ~and
~ s ~ ~ i ~ s t ; ~ nl)orro\\-ing.
tial
ge~lerated f~ncls-has \videnecl
Econon~icprofits (I>ool.: profits d t e r
o\;er the past year. Nonfinancial corinventory \.aluation anel capital conp o ~ ~ t i o nha\-e
s tlli~sincreaseel their
s~lmption:~djustments)of not1fin:incleht ancl. gi\.en the plentiful S C I I > P I ~
ci:il clomcstic firms ha\,e incre:tsecl
of creclit. 11x1-e clone so at relati\.ely
to more than 13(H.;,
of their o ~ ~ t p ~ ~h ~t ~, . o r a l terms.
~Ie
the higl~estsl1:u.e in over LO yc:~rs.
Interest ~ x t e s011110th in~.estmenttiol>ust profit gro\vth. ho\\.evcr,
gmcle and higher-)-ielding I>oncls
11:1\.e stayecl Ion- it1 the face of' solicl
has not heen s~~tl'icient
to 1'in:lnce
170th the in\.estmcnt l~oornancl the
in\-esior clern;~ncl.Stocli :mcl I>oncl
mi~tual-fi~nclgron;th has heen
I,uoyecl l ~ ystrong sa\.ings llo\vs.
The Fecleral Reser\.e's most recent
si1n.e). of 1,usiness lending re\.ealecl
th:~t the spl-eacls I~et\veenloan ancl
market I-ates Ilave helcl steacly till- all
sizes o f loans, \\.ith spre:~clsSor large
10;111s near the lo\ver encl of the
lange seen in the p:ist clecade. Ancl
I>anlis
after ),c:~rsol' restr~~ct~lring.
:]re in a goocl position to Icncl. Their
profits have been strong. :~ndtheir
n t e s of return on ecl~~ity
and assets
are high.
0
.
.
0
.
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0
Interest Rates
Percent, weekly averages
75
Percent
YIELD C U R V E S ~
Years to maturity
Years to maturity
Percent
a. All instruments are constant-maturity series.
b. The real and expected inflation rates are from the Survey of Professional Forecasters and are calculated using the 30-day T-bill rate.
SOURCES: Board of Governors of the Federal Reserve System; the Federal Reserve Bank of Philadelphia; and The WallStreet Journal, various issues.
The yielcl curtie h:is steepenecl
since the encl of Jill)., with long
rates increasing alwut 20 hasis
points ( b . p . ) ancl the 3-1iion111
short rate inching LIPonly ~ O L I I - h.p.
Tlie closely I\-atcliecl spreatls-[lie
3-year, 3-month ancl the 10-year,
3-month-have niclenecl to 85 h.17.
:incl 110 I3.p.. respectivel)., st~idciling
their avenge values of SO anti 120.
This suggests that the cconom). \\ill
grow at :LII average Kite o\.es the
nest fo~lrqu;lrters.
'I'he yielcl c ~ ~ l - for
v e zero-coiipo~i
'l'reas~irysecurities is noticcal)l), fl:~t-
tes than the yielcl c u w e for coupon
sec~irities;however, since 3-month
T-hills tlo not have coupons, this
mainly reflects a lliarlcet segrnent:ition causecl 11). liquidity clifferences.
Nominal interest rates clepend ~ I
l>oth espectecl inflation iincl I-e;il
(inflation-acljusted) interest lates: uncertainty also has an effect. Before
~ n a t ~ ~ r iat yboncl's
.
yielcl c ; i ~be acljustecl for espected inflation. pro\.icling :in esti~nateof the real interest
wtc. S~lcha I,realcclo\vn for the 50clay '1'-l,ill sho\vs that comp;uecl to
~ ; L Syears,
L
1997 has been kiirly un-
I
eventful. The short-term real interest
sate stands at 2.200/i,,well ahove tlie
negati\.e le\lels of 1993 but belo\\the ~ ( W Ipostecl in 1991. Short-term
espectetl inflation has increasetl for
the first time in sis months, edging
up h o ~ nan annualizecl 2..3S% to
2.-il(%. A close looli at the hotton1
chart reveals the importance of 3ccounting h r ~incertaint).: Simply
siilxracting cspectecl inflation from
the nominal iniesest rate 01-erstatcs
tlie real rxte l>y a quarter of L: 1"sccntage point.
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Coffee Production and Prices
Cents per pound
300
COFFEE FUTURES PRICES~
Number of trading units: 37,000 Ib. (250 bags)
1
a. "C" contracts. "Nearby close" refers to the contract maturing the earliest, and "fifth contract close" refers to the contract maturing the latest.
b. Nearby contract.
NOTE: All data are for green coffee.
SOURCES: U.S. Department of Agriculture, Foreign Agricultural Service; U.S. Depariment of Commerce, Bureau of the Census; and Coffee, Sugar and Cocoa
Exchange, Inc.
has not been reflectecl in either
Fe:lr of incleme~lt contlitions in
Coffee prices-110th
spot ancl fuopen interest (the total number of
t3~izilancl Colombia-the worlcl's
tures-have
fl~~ctuated
wiclely in
open contracts) or vol~llne (the
top tn-o ~xoducers-has apparently
the 17ast year. The spot price for
n ~ ~ m b of
e r contracts tradecl over a
rllilcl ColomtIi~~n
aral~ica cloiiblecl
si~l~sicled,
as the nearby f~ituresprice
gi~.enperiod). In the case of coffee,
(the next maturing contract, usually
between May 1996 ancl Ma). 1097.
olx31 interest i~suallyesceeds vol;I maximum of three months awa).)
ancl other prices rose 11y nlore than
tlropped 33% between April ancl
~ i m e since
.
a colltr-act must exist to
50%. i\/Iost analysts attril~utecl this
June. These contracts still stancl k ~ r l ~ etradecl. Nowe\,er, volume c;ln
volatility to procluction iincel-taint);.
surpass open interest if contracts are
even t l l o ~ ~ giot:ll
h
p r ~ d ~ ~ c t\V:~S
i o ~ l :ihove I996 prices, however. The
tr.;lclecl more than once. The
longest :ictively traded contracts
expecteel to increase. (\Y;orlcl clestrongly seasonal pattern seen in
(currently clue in July 1993) show
mancl \\.as also expected to rise.)
many markets reflects the increase
much less variation. This hxs lecl
A l t l ~ o ~ ~coffee
gh
prodc~ctionhas
in \.olume :inel open itlterest :is a
cliversifiecl intern:~tionztlly, ~vexther to mther extreme bnck~carzl~~~ioii,
contract nears matiirity ancl be~ v h e r eshort-term futures prices exconclitions arouncl the \vorlcl remziin
comes the "nearby" contract.
ceecl long-term ones.
an important k~ctorin f ~ ~ t u r prices.
es
Interestingly, the surge in prices
I
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Inflation and Prices
12-month percent change
1J U I Price
~
Statistics
I
I
I
Annualized percent
change, last:
Irno.
Consumer Prices
All items
Less food
and energy
Mediana
7 rno. 12 rno.
5 yr.
avg.
2.3
1.5
2.2
2.7
3.3
2.1
2.8
2.4
3.0
2.4
2.7
2.8
2.9
2.6
2.7
-0.9
-3.1
-0.2
1.2
2.9
-1.7
-0.5
0.0
1.1
0.7
Commodity futures
pr~cesb
-31.4
-4.4
-3.9
Producer Prices
Finished goods
Less food
and energy
2.9 -0.7
12-monih percent change
3.6
ITRENDS
IN THE CPI
TRENDS IN THE PPI
I
4-quarter percent change
2.8
GDP CHAIN-TYPE PRICE INDEX
2.7
2.6
2.5
2.4
2.3
2.2
-
a. Calculated by the Federal Reserve Bank of Cleveland.
b. As measured by the KR-CRB composite futures index, all commodities. Data reprinted with permission of the Commodity Research Bureau, a
Knight-Ridder Business Information Service.
c. Based on the PPI for all items.
d. Upper and lower bounds for CPI inflation path as implied by the central tendency growth ranges issued by the FOMC and nonvoting Reserve Bank presidents
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; U.S. Department of Labor, Bureau of Labor Statistics; the Federal Reserve Bank of
Cleveland; and the Commodity Research Bureau.
Inflation remaineel unespecteclly restrninecl in July, as the consume^
Price Incles (CI'I) rose a n anncl:ilizecl L . ~ ( Y ozinc1 the Prod~lcerI'rice
Index (PI'I) for finishecl goocls actw
ally fell HI. Nonetheless, data o n
the incliviclual components of these
incleses suggest that the o\.erall sate
of price incsease is son~c\vhatgreater
than the avel.;ige f i g ~ ~ r inclic~tte.
es
While the 1'PI for all goocls has
fallen nbout 1% over the past 11
months, the majority of price increzises at the procl~icerle\.el have
I x e n r ~ ~ n n i nabout
g
1%percentage
points lligher. The median 11' 1' is
L I ~ ):ir)proxinlately -%,%over the 12
l-nonths etidecl in July. Simil:trly, the
C1'I has ztcl\~:tnceclat an average rate
o f L.3(!4~cluring the past year-~~1st
l)eIo\\. the lo\\:er encl of the F e d e ~ t l
Ope11 &I:tr1<et Co1111nittee's (FOhIC)
latest central tendency projectionb i ~ the
t meclian CI'I has mo\.ecl ~111 to
2.7?41.\veil a l ~ o v eits expected range.
Still, inflation has been s c ~ h d u e d
tllis ye:ir. Vienred from its I~roaclest
1xrspcctive-ti1e
GDI' chain-type
p i c e incles. \\.hich incl~~cles
retail
:inti \\.holesale goods ancl sen.icesthe price le\.el rose :in a\-erage of
2. 1%) o\.er the past 12 ~ n o n t h s .the
snl:~llestirpticli in more th;ui 30 yex1-s.
(coi7lirrrlcclorr rzc>xtp~~ge)
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Inflation and Prices (cont.)
Diiiusion index, net percent rising
1 PURCHASING MANAGERS'PRICE SURVEY
12-month oercent chanae
I
Index, 1991=10
Percent of lorecasls
IDISTRIBUTION OF ECONOMISTS' 1998 CPI FORECASTS~ I
IASSET PRICES
January 10,1997
August 10,1997
so[
40
Annualized percent change
a. Median expected change in consumer prices as measured by the University of Michigan's Survey of Consumers.
b. Blue Chip panel of economists.
c. Handy and Harman base price, New York.
d. Standard & Poor's stock price index, composite.
e. Median sales price, existing single-family homes, not seasonally adjusted.
SOURCES: U.S. Depariment of Labor, Bureau of Labor Statistics; National Association of Realtors; Standard & Poor's Corporation; Metals Week; National
Association of Purchasing Management; the University of Michigan; and Blue Chip Economic Indicators. January 10 and August 10, 1997.
21 growing inflxtionary sentiment
Srom their projections over the past
Few expect tliis year's exceptional
3 1/r years. Allel economists. who
among in\.estors, sho\\~no clear ininflation performance to continue
over the year aheacl. On the other
have l x e n the lllost pessimistic inclication of speculative Ixhavior.
i \ l t h o ~ ~ g hthe stocli marliet has
f1;ltion forecasters since rnicl-clecacle,
hand, there :lppe:irs to he little sen11;lve recently revised their 1998
climbecl sharply in the last few years.
timent that prices will accelerate
scll,stantialIy. Iieports from p ~ ~ r c h ; ~ s -17rojectio1ls ~ I o w ~ w ~ ~ s c ~ .Last Janc~ar-y, other assets, such as home prices.
almost half of those participating in
have merely liept pace with inflzling managerxontini~eto sllow that.
tion. In fact, gold prices, \vhich are
the Blue Chip suwey saw \ithe CI'I rison net. inclustri:ll psices are holcling
s
a harbinger
ing 5(fi or more nest year. In ~ I L I ~ L I Ss o~~. n e t i ~ n econsitlerecl
steacly. I-Io~~seholcl
survey data inclionll. about o~le-thirdheld that view.
of gro\\-ing inflxtionary psycholcate that consumers expect retail
I h t a from asset rnarliets, \\.hich
ogy. Ila\-e act~lallyIxen declining.
prices to rise only 2.8%) in the next
can pro\;icle a warllislg signal of
12 months-not
much different
I
http://clevelandfed.org/research/trends
September 1997
Best available copy
EconomicActivity
Percent change from preceding quarter
7
GDP AND BLUE CHIP FORECAST
Real GDP and Components, 1 9 9 7 : l l ~ ~
(Preliminary estimateb)
change,
63.5
11.9
-8.8
-8.3
27.0
3.6
1.O
-5.4
-2.3
4.0
3.5
2.5
2.3
1.3
3.2
33.6
Equipment
33.8
Structures
-2.0
Res~dent~al
investment
4.7
Government spendlng
9.5
National defense
5.6
Net exports
-6.4
Exports
42.3
Imports
48.8
Change in business
~nventortes
14.0
13.0
23.8
-4.0
7.1
3.0
7.6
19.6
19.9
7.4
12.7
4.5
0.3
0.4
-4.2
13.9
14.3
-
-
Real GDP
Consumer spending
Durables
Nondurables
Services
Business fixed
t
Percent change, last:
Four
Quarter
quarters
b~llions
of 1992$
investment
fZJ Actual
fl Blue Ch~pforecast August 10
10
110
IlIQ
IVQ
IQ
llQ
1997
Percent change from corresponding month oi prevlous year
6
REAL PERSONAL INCOME AND SPENDING
I
IVQ
Percent change from corresponding month of previous year
TRENDS^^^
I \ - Real disposable
L \
IlIQ
1998
personal Income
-
I
I
"" CONSUMER CONFIDENCE
h
I
I
a. Chain-weighted data in billions of 1992 dollars.
b. Seasonally adjusted annual rate.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; The Conference Board; and Blue Chip Economic Indicators, August 10, 1997
Altho~~gli
tile rn;tjor inclic:~tors of
U.S. economic ;tclivit\' continue to
an:ilysts are I<eeping
point ~~p\v;wd.
a wary eye o n in\.entories. Lxst
month. the Co~nmerceI>epartment
releasecl a re\.isecl esti~nate of
secon<l-cl~~;lrter
real C;1)1'
growth
s l ~ o l ~ i nthat
g
the economy expandecl ~ t t 2117 anni~alized 12te
of 3.6'!/(1- I ..i(Ni l~igtierthan pre\.io ~ t s l j rcportecl.
l'lie revisio~l \vas
attrihi~teclto higher-tl1an-es13ectecI
gron.th in both exports ancl J L I I I ~
inventories.
O \ . e ~ ~ lthe
l , second cluarter's kl\.ol.:thle 1,erformance was led Ily increases in inventory investment,
exports, proclucers' clurahle equipment. ancl se~vicesspending. Economists p;uticip:tting in August's Blue
Chip survey expect the first half's
:tI,o\.e-itver;tge grc)wth to Ile offset
1,). :t slo\\.clorvn cluring the remaincler of 1097. l'heir consensus forecasl places C;I>I' at 3.4% for the jle:tr.
The consumer sector rel>o~incled
in July after heading clo\\jn in the
seconcl clu:trter. Fueleel by increased
e s , personal
outlays o n c l ~ i ~ ~ b lreal
cons~lnlption spencling rose
11e:llthy O.h(M,for the month. Retail
store sxles :ilso climbeel O.(,(N,. follon.ing a 0.794 gztin in June. The
Conkrence I3oarcl reportecl th:lt
consumers remain ~lpl,eat about the
state of the economy, with confi(coiitit~ltcd
o11I I L J X ~ ~ L I ~ ~ C )
http://clevelandfed.org/research/trends
September 1997
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Economic Activity (cont.)
Percent change from prevlous month
1.5
Index, 1987 = 1.OO
1.25
INDUSTRIAL PRODUCTION
-
I
I
I
I
I
I
I
Percent change from prevlous month
25
IWHOLESALE INVENTORIES
NOTE: All data are seasonally adjusted.
SOURCES: U.S. Department of Commerce, Bureau of the Census; and Board of Governors of the Federal Reserve System.
clence levels holcling close to June's
28-yens high.
The Cornrnerce Department's upwarcl revision of seconci-cluarter output IS widely anticipatecl because
l y inventory
of June's u n ~ ~ s u a l high
num1,ers. l ~ interpreting
t
this rise
is somewhat clifficult. Inventories
surgecl a nonannualized 0.7% in
June. their steepest aclvance in
rllore tlxtn t ~ v oyears. Hox~:ever,it is
still ilncle:~r Iio\v much of this
retlects :In intentional stockpiling
versus an unanticipated drop-off in
clemancl (which i~npliesfuture procluction cuts).
For n o ~ v .industrial procluction
continues to pick up, rising 0.2% in
July ancl 0.3% in June. Sales are also
increasing. The overall inventory-tosales ratio stood unchangecl at 1.37
in July, ~ v i t hn o obvious imlxdance
at either the manufacturing. \\/holesale, or retail level.
Taliing into account these current
s:lles :11id production numl>ers.
June's inventory surge cloes not appear to be a cause for alarrn. The
vast majority of the stockpiling
canle in the wholesale sector ( u p
l.c)(X). the largest rise in five years)specifically, ill the automotive :\sea.
Some analysts believe that a marlted
increase in auto imports, spurreel Ily
the strong cloll;lr, may Ile responsible. Incleecl. auto imports in the seconcl quarter were u p 8.4% from :I
year ago and followed a first-quarter
advance of lit.7%1.
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September 1997
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Labor Markets
Change, thousands of workersa
woJAVERAGEMONTHLY NONFARM EMPLOYMENT GROW
Labor Market Conditionsa
I
Average monthly change
(thousands of employees)
1996
1997
Year
IIQ
June
July
Payroll employment
Goods-producing
Manufacturing
Service-producing
TPU~
Services
Personnel supply
Retail trade
Government
Federal
Household employ.
212
19
-5
192
9
99
14
48
14
-5
232
237 222
15 12
10 20
223 210
10
3
115 71
-13
4
45 53
31 74
-5 -9
63 -275
Aug.
365
49
-18
55
-17
47
383
-6
19 -160
155
32
15 -19
71
31
88
72
-5
2
344
96
Average for period
1
-200
1
1
1
1
1
1
1991 1992 1993 1994 1995 1996 1997
to date
I
I
I
Civilian unemployment
rate (%)
5.4 4.9 5.0
4.8 4.9
Nonfarm workweek
hour^)^
34.4 34.5 34.6 34.5 34.7
I
110. June July Aug
1997
Percent
Percenl
Mill~onsof personsa
a.
b.
c.
d.
Seasonally adjusted.
Transportation and public utilities.
Production and nonsupervisory workers.
Vertical line indicates break In data series due to survey redesign.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.
Despite :i slight slowclown. the nation's l;it~or m;irliets reruained
strong it1 August. l'he smaller-thanexpected p i n in nonfrlrm payroll
e~nployment(49.000) resultccl pri1n:irily from the '1'e:iiusters' strilie
against IJIIS, which c:~~~sccl
a
1j3,000 decline in tGinsF>orkitioi~
industry jolx. Esclc~clingtl.:insportation, pri\.ate payr.oll employment
pickecl (11) by 130,000.
Losses in the air tr;lnsport;ition inelustry fueled johs esp;tnsion in
tr~icliingancl other areas. notahly
the U.S. I'ostal Sen.ice. Fecleral goy-
ernment employment saw its first
gain (2.000) in eight months. The
goods-p~)cl~ci11g
sector 2ilso fareci
well, aclcling j 5,000 new jol>s47,000 of them in manufacturing.
Changes in the service-~7rocluci11gind~lsrrieswere mixed. Health se~vices
;ind engineering and management
services 170th turned in strong perk)rmances (up 21.000 ancl 17,000,
respectively). hut help supply services (a sulxet of personnel s ~ ~ p p l y
services) was down by 16,000, ancl
e2iting ancl clrinking establishments
lost 10,000 jol,s.
bIean\vhile, the unemployment
rate inchecl up to 4.9% as the
e~llp~oyment-to-pop~i~:~tion
ratio
stallecl at 63.S(X1. Of those includecl
in the jol2less ranks, C)15.000 were
cl:tssifiecl as "voluntary" (striliing
\\,orkers are not incluclecl in this
category). This represents 13.7% of
all unemployed n,orliers ailel is the
highest share since December 1990.
Overall, the total nuinber of jobless
\\.orliers contin~lesto drop even 21s
the I:il>or force expancls. The reduction has been sharpest a ~ n o n gthose
who 1laL.e heen out of \vorli for 15
\veelis or inore.
http://clevelandfed.org/research/trends
September 1997
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a. Vertical line indicates break in data series due to survey redesign.
NOTE: All data are seasonally adjusted.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics: and Federal Reserve Bank of Cleveland. For afuller treatment of the part-time employment
issue, see Max Dupuy and Mark E. Schweitzer, "Another Look at Part-time Employment." Federal Reserve Bank of Cleveland. Economic Commentary,
February 1. 1995.
A number of commentators have
clescribecl the recent Te:umsters'
strike against LIPS as a \vatershecl
moment in II.S. lal,or history. One
of the strike's unusu:il features was
the union's contention that p:irt-time
work is an rlnLtir m;un:tgen~entpraclice. Incleecl, the most notecl concess i o n won l ~ ythe 7'e:lmsters was
UI'S's agreement to convert 10.000
part-time \\-orkers to 1UI1-time status.
Ilid the stsilie represent the :lmbi[ i o n s o f millions of part-time em-
ployees throughout the economy, or
\\;as it the result of \~.orlterconcerns
:it an atypical employer? Along several climensions. the answer appears
to IIe that e~nploymentat UPS is not
representative of the lal,or m~trketas
3 whole.
In the ovelall economy. part-time
employees ~nalieu p a fairly constant share of the 1i.S. \vorliforcehet\v-een 18%1 ancl 20%). Subtle
changes to the Lahos I>epxrtment's
employment survey. instit~~tecl
in
1994. ses~~ltecl
in a one-time jump in
reportecl part-time \i~orli.Since then.
I~owever,the number of Americ:tns
\\~orlting part time has remaineel
steacly :it a little o\.er 23 million,
while the full-time \ ~ o ~ l i f o r chas
e
;tciciecl H million jo17s. iimong \vorl<ers clescrihecl as part time, the vast
majority are considered "vo1~1ntar.y"
(they have other commitments that
Ixevent them from ~ o r l i i n g full
time, or they report that they are not
employment).
interested in f~~ll-time
(co~lti~~lieclo~z
t~e.~tp~igeJ
9
9
.
.
O
0
http://clevelandfed.org/research/trends
September 1997
Best available copy
.
The UPS Strike (cont.)
Dollars
Percent
100
0
Full i ~ m e
Full time
Part time
Percent
Part time
Percent
,,
9
Percent
'?
I UNION MEMBERSHIP AS A SHARE OF TOTAL EMPLOYMENT
blales
Females
UPS
Full time
Part time
a. Seasonally adjusted.
b. U.S. data are for 1997:IQ; UPS data are as of March 31, 1997.
c. As of April 30, 1997.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics, Employment and Earnings, various issues; The Bureau of National Affairs, Inc.; and UPS
LIPS stands out as a11 at).pical
employer in se\-el-al\\.a).s. 12irst,the
fraction of' the comp:~ny's ~ v o r k f ) r c e thzt is cmployccl p:ut time is
m ~ ~ higher
ch
than lor the econolny
21s a 1vhole-57?41 \.ersils lS(!O.Seconel, p;~).211 IJI'S is higher f'or I>oth
full- anel part-time \\.orliers. While
part-timers at 1715 earn :ilmost the
s:inle aver:ige lloc~rlyn.:ige a s fulltime worliers in the o\.cr;ill economy, they e:irn onl). Si(Xi :i,s much
:is their full-time colle;~g~les
at tills.
(N;ttion\vicle, part-time n-orliers iypically earn :tl~)ut68% of f~~ll-time
hourly wages.) Thircl, most 17;1rttirlle worliers in the U.S. are Sem;ile.
yet :I( [TI'S, more than half of' the
p;irt-time \\~orkforce is rn~ile. Although this is not significant o n its
on-11.it does suggest clifkre11t moti\-;itions h r accepting part-time
\\-orli :it UI'S, because men are
ITILICII less liliely tha11wornen to cite
chilcl cztrc ;is a reason for \vorliing
less than .4O hours per week.
:I final, critical way in which I!l-'S
cliffers froln the rest of' the U.S.
\vorliforce is its highlj. ~ ~ n i o u i z e t l
st~if'f.?'he \\.Liges paicl at Lil'S. :inel
therelore the mix of \v-orliers hirecl,
ha1.e Ixen cletern~ineclt ~ yyears of
n
contract negotiations t ~ e t ~ v e el:ibor
ancl mas1:igement. Although ~ l n i o n
organizers have espressecl I ~ L I 017C ~
timism in light of the settlement. the
share of the private-sector \vorliforce that is ~tnionizeclis just over
10(Hi,anel that numl~eris frilling.
http://clevelandfed.org/research/trends
September 1997
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OhioAgriculture
VALUE OF OHlO CORN AND SOYBEAN PRODUCTION, 1995
Degrees Fahrenheit
PERCENT OF OHlO FARM MARKETING BY VALUE OF
COMMODITY, 1995
Inches per month
10~10
MONTHLY RAINFALLAND AVERAGE TEMPERATURE
I
8
I CROP PROGRESS TIMETABLE: CORN
jEzq
1-1
IEEjiq
F
V
1-
I
Jan
l
l
Feb Mar
l
Apr
l
l
l
l
j
l
l
May June July Aug Sepi
l
l
Nov Dec
Oci
CROP PROGRESS TIMETABLE: SOYBEANS
[Planted1
leroomingl
jGiz-1
1-1
I
Jan
Feb
Mar.
Apr.
May
June
July
Aug.
I
Jan. Feb. Mar
I
I
I
I
I
I
I
I
I
Apr. May June July Aug. Sept. Ocl. Nov Dec.
SOURCES: U.S. Department of Agriculture, National Agr~cultureStatistics Service; Ohio Department of Agriculture; Ohio Department of Development, "Ohio
Statistical Abstract," June 1997; National Weather Service; and Midwestern Climate Center.
Unseasonalde summer \\,eather Ilas
11ce11 of' great concern to Ohio
frirmers. Rainfall has v;uriecl witlely
fi-0111 month to ~ n o n t h ,ancl ternperatures ha\-e generally heen
I,elo.w normal. It appears, ho\vever,
that the state's tn-o most important
crops-corn ancl soyl>eans-have
h e e n sparecl h). :I hit o f genetic
tinkering.
T h e critical growing period for
c o r n is the sillting, or pollination,
stage, n.hich occ~~rreclthis year
w h e n rainh~llwzus I~elo\\.tiorrnal.
Nonetheless, as of August 24. the
LTSIIA ratecl 67% of the state's corn
crop as good to excellellt and another 26% as fair. ("Fair" means that
yield loss is possible, but the estent
is ~inlino\vn.)
So)rl,eans reach their critical
growing period at the end of ALIgust. \\;hen they set in pocls. Icleal
g r o ~ - i n gconditions tvoulcl be temperatures in the mid-80s ancl average soil moisture. As of late August,
68% of the state's soybean crop 1x1s
categorizecl as good to excellent,
\\~liileonly 7%~ 2 1 j~~clged
s
as poor
to very- poor.
The reason these crops :use thriving
despite atlverse weather is that the
seeds were genetically 1,recl to be resist:tnt to stressf~~l
contlitions, inclc~cling clroughts. heat rixves. f~rngi.ancl
cliseases. Their recoven; capabilities
are also better than ever. With the
harvest season fast appro:tching, the
USIIA is preclicting that this yezlr's
).ielcls will esceecl 1996 levels by
seven I>ushels per acre l i ~ soybeztns
r
:u~icl1,). 17% for corn.
http://clevelandfed.org/research/trends
September 1997
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Housing Finance
Percent
95
MORTGAGE RATES
I
Share of mortgages
70
ADJUSTABLE MORTGAGE RATE SHARE
Percenlage points
4.0
Blll~onsof dollars
90
[MORTGAGE ORIGINATION BY TYPE OF LENDER
I
J F M A M J J A S O N D J F M A M J J A S O N D
SOURCES: U.S. Department of Housing and Urban Development; Federal Home Loan Mortgage Corporation; Office of Thrift Supervision; Mortgage Bankers
Association of America; and Bank Rate Monitor, various issues.
Until recent ~veelis,snortgage interest rates had I ~ e e no n a steady
clo\vnn.;ircl trencl. n.ith 30-year sates
falling to 7.37% at the encl ofsuly
(their lo~vest level since bi:irch
1996). Coml~inecl wit11 the relatively small spreacl between fisecl
ancl acljustal>le r:ite ~ i ~ o r t g a g e s ,
these consumer-fr.ienc11y sates have
kept the share o f new mortgiges
with adjclstable r:ites at re1:ttively
low levels (25% in J i ~ n c ) .
The recent clrop in fisecl mortgage I-ates h:~s also lecl to an 11pticIi
in ~nortgage refin~uncing :~cti\.ity.
xvith many borro\xers \vho misseci
out o n previous rate drops attesllpting to lock in what they believe are
favomble mortgage terms. Augt~st's
6.78 refinancing illcler; mas the highest posting since the refinancing
.'l,oomlet" of late 1995.
Mortg:lge originations thro~ighthe
1:1st c~u;irterof 1996 (the latest avail:~ble cl:ita) appear to ha1.e reI~oc~ncled
frorn their thircl-q~ls~rter
declille. with comrllercial h:inks
ancl mortgage companies picliing
1112 tlw tx.llk of the new hi~siness.
'l'lle relatively weaker performance
of the nation's savings ancl loans
can IIe expl;linecl I3y two factors.
First, s:~\.ings I~anlistypically originate 111ol.e aclj~lstable sate lo:ins,
holding them in their portfolios
1 2 t h than
~ ~ selling them on the seconcl:t~ym:u.liet. Tllus. \ye \voulcl espect the declining Sraction of origin:~rions \\.ith acljustable rates to
:iclversely affect these instit~~tions'
mxrl<et share. Second, mortgage
Ixinks are often the lender of
clloice Sor refinsincings. which were
f':~irl\-1,risli at the encl of 1996.
http://clevelandfed.org/research/trends
September 1997
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Consumer Bankruptcies
1
Thousands of iil~ngsper quarter
'0°
U S . BANKRUPTClES AND DELINQUENCIES
Percent of loans outstanding
4.50
Percent oi loans outstanding
Thousands of iilings per quarter
5
15
OHIO BANKRUPTCIES AND DELINQUENCIES
Credit card delinquenciesa
lnstallnient loan delinquenciesb
a. "Bank credit card" data. U.S. data are seasonally adjusted; state data are not.
b. "Summary of accounts (closed-end only)" data. U.S. data are seasonally adjusted; state data are not.
SOURCES: Administrative Office of the U.S. Courts; American Bankers Association, Consumer Credit Delinquency Bulletin; and Mortgage Bankers
Association of America, National Delinquency Survey.
T h e recent rise in consumer banliruptcies contini~ecl in the second
cli~arter.with more than 367.000
slew filings nationn.icle. This represents nearl>-;I 10(x1increitse over the
first-cli~:trterle\.el ancl ;~lmosta 30i!fr
rise compared to 1 0 9 6 : I I Q . Ohio
l~as?li~-~~~'tcie"iave
~nirroreclnational
trends, with 13.815 filings in the seconcl cluarter, :t 12%) aclvance from
the first three montlls o f tile year.
Ilespite these recorcl-setting statistics, many analysts are 1?ecos1ii11g
less concertlecl a h o i ~ thoi~seliolcls'
near-term fin:tlcial oi~tl(~oli.
I3oth
bIasterCarcl 1nter1lation:ll ancl Visa
I l.S.i\. are preclicting that I,2tnliri1ptcy
filings \\.ill grow at a slower 1 7 ; ~ ' is1
1997 than they clid l;tst ye:tr. F~~rthel.Illore. recent eviclence suggests that
consumer delinquency rates may
have pealieel. In particular, creclit
carcl clelincluencies elsopped to
3.51941 of all accounts outstancling in
bI;~rch,clo\vn from a high of 3.72'H)
in No\.eml,er ancl 13ecember 1996.
I1Iortgage clelincluencies also 212pear to I,e moclemting. In tlie first
c1i1;trter of 1007. 2.8SiH/o o f all con\.entionxl mortgage loans outstancling
were is1 arrears, clown slightly f'rorn
the 2.00?41 recorcleci in I 0 9 6 : I Q . 'l'lie
geog~tpliicclistril~~~tion
of mortg~tge
clelincluencies seetiis to h e continuing its recent pattern, n-it11 the liighest clelillcl~~ellcy
rates occurring in
tlie Soi~thand E:tst. a11cl the lo\\-est
rates occi~rring is1 the h~ficl\\;est,
Great Plains. ancl kloiultain states.
http://clevelandfed.org/research/trends
September 1997
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Floating Exchange Rates
Index, 1965:lQ= 1.0
"' I YENIDOLLAR EXCHANGE RATES
I
15
13
11
Yen per U S dollar (real)
09
07
05
03
01
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
Index, 1965:lQ= 1.0
I
' I MARWDOLLAR EXCHANGE RATES
I
a. Ratio of foreign M2 to output divided by U.S. M2 to output.
SOURCES: International Monetary Fund, International Financial Statistfcs; DRIIMcGraw-Hill; and Jeffrey A. Frankel and Andrew K. Rose, "Empirical Research
on Nominal Exchange Rates," in Gene M. Grossman and Kenneth Rogoff, eds., Handbook of International Economics, vol. 3. Amsterdam: Elsevier, 1995.
Since the encl of the Bretton \Xfc)ocls
fixed-exchange-r:~teregirne, cloll;lr
exchange rates have mo\lecl in response to m:~rliet forces. 1sol;lting
and explaining these forces is ;I task
that still baffles eco~lomists.
An exc11:~nge rate is the relative
price of one tiation's currency in
terms o f :ul~othernation's currency.
Accortlingly, if the Fecleral Kesel-ve
creates excessive money (that is.
more money than the pi~blic ants
to I ~ o l d )at a faster rate tll~unclocs
the 13unclesbank or the I3a11k of
Ji~lxin,the clollar will deprecizlte relative to the marli or yen. Theory
not\vithst3nding, exchange sates clo
not nlove in close alignment ~ v i t h
hnclzunental cletermin:lnts of excessive money growth, except over
long periods. This klilure may reflect
the crucial role o f expectations in
clctermining exchange rates. Foreign
exc1i:tnge tsaclers face strong incentives to accluire all possible infixmation ahout current and anticipated
econo~nicclevelopr~ientsthxt nlight
influence their cpotes. To the extent
that t~.aclersformulate their expectations \vithout systematic errors. revisions will be r:tnclom ant1 \\rill imp:"~ ;I zigzag pattern to exchange
mte movements.
The tanclem movements of nominal :tncl re:tl exchange rates are a n
:tclclitional piizzle. This correlation
implies either that prices are sticky in
the short run or that real economic
sl~ocksare more pervasive than previo~islythought.
0
0
0
0
0
0
0
Fixed Exchange Rates: The Thai Baht
http://clevelandfed.org/research/trends
September 1997
Best available copy
THAILAND'S MAJOR TRADING PARTNERS, 1995
Jan
Feb.
March
April
May
June
July
Aug.
Sepl.
Jaoanese yen per Tha~baht
8
Scalea
Billions of U.S. dollars
I
40 FOREIGN EXCHANGE RESERVES
7
6
5
4
3
1990
1991
1992
1993
1994
1995
1996
1997
a. Japanese yen per U.S. dollar and the index value of the nominal trade-weighted U.S. dollar (March 1973 = 100).
b. Monthly average of daily data.
SOURCES: Board of Governors of the Federal Reserve System; Morgan Stanley Capital International; and International Monetary Fund, International Financial
Statistics and Direction of Trade Statistics.
'I'hailancl, lilie many nexvly cleveloping countries, closely links its currency to the U.S. doll;ir. 13y rying
their currencies to that of a lowinfation ind~istri;ilizedcountry \\,it11
a repc~tation for ["ice stahilitysuch as the U.S.. Japan, or Germany-developing cocintries limit
their al~ility to unclertalie discretionary monetary policies. 7'he exchange rate then pro\;icles a visilAe
check against inflation. In aclclition,
fiixecl or stable exchange rates re-
duce the tlxnsaction costs :tssociatecl
n.ith e x c h a n ~ erate volatility. This is
p;~rticul:irly important to countries
that rely heavily on international
track for economic growth. inclclcling Thailancl.
I'hese Ixnefits entail some costs,
hoxvever. If managed, an exchange
rate cannot act as a buffer to economic shocks. In aclclition, the cleveloping country 111ay lose its competitive edge. Thailancl conclucts
approximately 24% of its intcrn:itional tr:icIe with Japan. As the clol1:u
;ippreci:ltecl relati\-e to the yen hetn.een c:u-ly 1995 ancl early 1997, the
t7:illt fo~~o\veci.
'1.0 psevel~tits currency from cle1xeci;~tingin the face of capital flight.
'1'h;iil;incl nus st sell its foreign exchange reses\,es for hahts. But foreign exchange reserves are limiteel.
If the rnarliet t~elie\,esthat reserves
are insufficient to nleet the problelii
at hancl. the fisecl exchange I.:ite pro\-icles spec~~l;itors
xvith a one-way l ~ e t
o n future exchange-rate mo\;ements.
@FedFRASER