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The Regional

Economist

A Quarterly Review
of Business and
Economic Conditions

A Winning
Combination?

Vol. 17, No. 1

Economics and Sports

El Dorado Promise
Free College Education
Rejuvenates Arkansas Town

January 2009

The Federal Reserve Bank of St. Louis

Deficits, Debt

and Looming Disaster
Reform of Entitlement Programs
May Be the Only Hope

c o n t e n t s

4
The Regional

3

Deficits, Debt and Looming Disaster
By Michael Pakko

With government deficits and debt at record highs,
the long-term fiscal outlook for the U.S. requires
serious attention. The fix will most likely have to
include fundamental reforms of entitlement programs.

President’s Message

16

Economist
january 2009

|

El Dorado, Ark.
By Susan C. Thomson

VOL. 17, NO. 1

The Regional Economist is published
quarterly by the Research and Public
Affairs departments of the Federal
Reserve Bank of St. Louis. It addresses
the national, international and regional
economic issues of the day, particularly
as they apply to states in the Eighth
Federal Reserve District. Views
expressed are not necessarily those
of the St. Louis Fed or of the Federal
Reserve System.
Please direct your comments to
Michael R. Pakko at 314-444-8564 or
by e-mail at pakko@stls.frb.org. You can
also write to him at the address below.
Submission of a letter to the editor
gives us the right to post it to our web
site and/or publish it in The Regional
Economist unless the writer states
otherwise. We reserve the right to edit
letters for clarity and length.

c o mm u n i t y p r o f i l e

10

An oil company’s promise to
send local high school students
to college has sparked a comeback of sorts in this predominantly blue-collar town. The
so-called El Dorado Promise
has not only attracted new residents and businesses to town,
but it has inspired residents to
tax themselves more to boost
economic development and
improve the schools.

Economic Theory
Meets Sports
By Kristie M. Engemann
and Michael T. Owyang
In a change of pace, some economists have turned their attention
to sports, studying such topics
as racism in the NBA, coaches’
maximization of their chances
of winning, and the direction in
which soccer players and goalies
should move during penalty kicks.

Director of Research
Robert H. Rasche
Deputy Director of Research
Cletus C. Coughlin
Director of Public Affairs
Robert J. Schenk
Editor
Michael R. Pakko
Managing Editor
Al Stamborski
Art Director
Joni Williams
Single-copy subscriptions are free.
To subscribe, e-mail carol.a.musser
@stls.frb.org or sign up via www.
stlouisfed.org/publications. You can
also write to The Regional Economist,
Public Affairs Office, Federal Reserve
Bank of St. Louis, Box 442, St. Louis,
MO 63166.
The Eighth Federal Reserve District

includes all of Arkansas, eastern
Missouri, southern Illinois and Indiana,
western Kentucky and Tennessee, and
northern Mississippi. The Eighth District
offices are in Little Rock, Louisville,
Memphis and St. Louis.

2 The Regional Economist | January 2009

19

n at i o n a l o v e r v i e w
Man the Lifeboats!
By Kevin L. Kliesen

14

The Federal Reserve
as a Super Regulator
By Sharon K. Blei
If the Fed is granted broader
regulatory authority, it might
face new challenges in executing
its traditional responsibilities
and in preserving its independence against political pressure.

There’s no doubt now that the
economy has hit rocky waters.
The only question is whether
the recession will be as severe
as those seen in 1973-75 and
1981-82 or not much worse than
those in 1990-91 and 2001.

20

district overview
Little Rock Stands Out
By Subhayu Bandyopadhyay,
Rubén Hernández-Murillo,
Craig P. Aubuchon and
Christopher J. Martinek
Of the four major cities in the
Eighth Federal Reserve District,
only Little Rock showed growth
in jobs in the year ending in
October. Louisville, Memphis
and St. Louis all lost jobs—and
at a greater rate than did the
country as a whole.

22

economy
at a g l a n c e

22

re ader e xchange

p r e s i d e n t ’ s

m e s s a g e

Jim Bullard, President and CEO
Federal Reserve Bank of St. Louis

The Fed as Lender of Last Resort

B

ecause our central bank has relied on the
federal funds rate target for so long to
guide the economy, many people think that
the target rate is the only tool at the Fed’s
disposal. As we are seeing in the current
financial crisis, the Fed has other options.
Most visible so far have been the lending
programs that have been created in the past
year, along with established programs that
have been modified.
Among the tools the Fed can use is the discount window, which has been around since
the Fed was established in 1913. The window
was the primary instrument for central
banking operations for decades, just as open
market operations (the buying and selling of
U.S. Treasury and federal agency securities
to achieve a desired quantity of reserves or
the fed funds rate target) have dominated in
modern times. Traditionally, the discount
window has offered overnight lending for
generally sound depository institutions to
relieve short-term liquidity problems. Discount window loans must be fully secured.
Except in unusual circumstances, depository institutions rarely tapped into the
discount window for fear they would be
stigmatized as weak. But that attitude
changed beginning last year as financial
market turmoil intensified. The Fed notso-subtly reminded depository institutions
about the availability of the window, cut the
window’s interest rate (the discount or primary credit rate) and increased loan periods
to a maximum of 90 days. The line at the
window was soon long. Primary credit
lending exceeded $90 billion in November.
In December 2007, the Fed launched
the Term Auction Facility to help meet
depository institutions’ need for liquidity.
This facility auctions term funds against

collateral. Starting a bit more than a year
ago, auctions have been held several times
a month, with available amounts ranging
from $20 billion to many multiples of that.
Borrowing via the TAF has been substantial, reaching a level of $384.6 billion
in November.
Last March, the Fed began two lending
programs for primary dealers, those banks
and securities broker-dealers with whom
the Fed trades U.S. government securities
to carry out open market operations. The
Term Securities Lending Facility (TSLF)

“The lender of last resort
function of the central bank
is an important one during
a financial crisis, and the
Fed has been extraordinarily
active during the current
episode in fulfilling this
function.”

provides secured loans to primary dealers on
a 28-day term. The Primary Dealer Credit
Facility (PDCF) provides overnight loans.
Among the collateral that the Fed accepts for
these loans are mortgage-backed securities.
Both facilities lend at an interest rate equal
to the New York Fed’s discount rate.
This past fall, the Fed introduced another
set of lending programs. The Asset-Backed

Commercial Paper (ABCP) Money Market
Mutual Fund Liquidity Facility (sometimes
shortened to AMLF) extends collateralized
loans (from the Boston Fed) to finance purchases of ABCP in an attempt to encourage
secondary markets to lend long-term. A few
weeks later, the Commercial Paper Funding Facility (CPFF) was introduced to help
alleviate a shortage of term funding in the
commercial paper market. With financing
from the New York Fed, a special purpose
vehicle (SPV) was set up to buy three-month
unsecured and asset-backed paper.
This list is not exhaustive, and the Fed may
devise other lending facilities in an attempt
to mitigate the effects of financial market
turmoil. But it is important to emphasize
that all of the facilities mentioned above
are separate from the well-publicized loans
drawn up just for AIG, Bear Stearns and
Citigroup. These firms received special and
immediate handling because of fears that
their collapse could have a systemic effect.
In all, the Fed has made more than
$2 trillion in loans so far during this crisis.
No doubt, this is a staggering amount, but
all of it is collateralized or secured. The
lender of last resort function of the central
bank is an important one during a financial
crisis, and the Fed has been extraordinarily
active during the current episode in fulfilling
this function.
The Regional Economist | www.stlouisfed.org 3

f i s c a l

p o l i c y

Deficits, Debt
and Looming
Disaster
Reform of
Entitlement Programs
May Be the Only Hope
By Michael Pakko

The unofficial national debt clock
squeezed in to accommodate the

F

or the fiscal year 2008, the federal government’s deficit totaled $455 billion,
the largest ever for a single year. In the final
days of the fiscal year, which ended Sept. 30,
the total federal debt rose above $10 trillion
for the first time. Forecasts for 2009 anticipate an even larger deficit.1 As a new president and Congress take office, government
deficits and the public debt will undoubtedly be a factor in economic policy discussions, especially in light of ongoing financial
uncertainty and economic weakness.
From an economic perspective, the size of
the deficit and debt per se are not necessarily as important as the underlying policies
of spending and taxation. By their very
nature, deficits reflect an imbalance between
expenditures and receipts. Such imbalances
4 The Regional Economist | January 2009

Photo by Mario Tama / Get t y Images

in New York City is seen Oct. 9 with a makeshift “1” in the dollar sign box. The “1” had to be
federal government’s mushrooming debt, which topped $10 trillion at the end of the fiscal year.

need not be a concern and might, in fact, be
desirable under some circumstances. And
while rising government debt is often associated with direct economic costs, including
higher interest rates and lower rates of private investment, evidence on the significance
of these effects is mixed.
Nevertheless, when deficits are part of a
fundamental structural imbalance in the
long term, they signal a need for serious
attention and reform. In a long-run fiscal
analysis of U.S. federal government programs, this is demonstrably the case.
Government Accounting

The top panel of Figure 1 shows two
measures of the federal deficit. The blue
line is the official measure reported by the

government—$455 billion for fiscal 2008.
The red line tracks the change in the total
outstanding national debt from year to year.
By this measure, the deficit exceeded $1 trillion in 2008.2 Note that the reported unified
budget showed a surplus in 1998 through
2001; however, the change in the national
debt has recorded red ink in every fiscal year
since 1969. The difference between these
two measures primarily reflects the treatment of the Social Security trust funds.3
By conventional accounting standards,
the deficit is equal to the difference between
total government spending and total revenues
received, over a particular period of time. The
debt equals the sum of previously accumulated
deficits (or surpluses), plus interest accrued.
When it comes to government, however, the

accounting is slightly more complicated.
The spending and taxing policies of the
federal government are classified into “onbudget” and “off-budget” categories. Those
activities that are considered off-budget
include the Postal Service fund and, more
important, Social Security. The officially
reported deficit is a “unified budget,” which
includes the revenues and expenditures
of these off-budget activities. Because the
Social Security trust funds are currently
running large surpluses, their inclusion has
the effect of lowering the reported deficit.
For example, in 2008 the on-budget deficit
was $638 billion, while the off-budget surplus was $183 billion (due primarily to the
Social Security trust fund). As a result, the
unified budget deficit was $455 billion.
The Regional Economist | www.stlouisfed.org 5

figure 1
Federal Surplus/Deficit, 1950-2008

BILLIONS OF DOLLARS

400
200
0
–200
–400

Unified Budget

–600

Change in Federal Debt

–800
–1,000
–1,200

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

need to borrow from the public in order
to pay the obligations of the debt currently
held in the trust funds. This will result in
an increase in the debt held by the public,
with no change in the total outstanding
debt. In this sense, the total debt might
better represent the long-term obligations
of current government programs. In fact,
as will be discussed later, a proper accounting of the long-term obligations of federal
entitlement programs is far greater than
the value of government IOUs in the Social
Security trust funds.
Relative Size Matters

4

AS A PERCENT OF GDP

2
0
–2
–4
Unified Budget

–6

Change in Federal Debt

–8
–10

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

SOURCE: Economic Report of the President and Monthly Treasury Statement

The unified budget deficit/surplus figures represent the consolidated on-budget and off-budget balances as
officially reported. The change in federal debt is the change in gross federal debt from one year to the next
(with sign reversed).

A similar dichotomy applies to the measurement of the national debt: Total public
debt stood at $10 trillion at the end of fiscal
2008, but debt “held by the public” was
$5.8 trillion. The difference is attributable to $4.2 trillion held in government
trust funds and other intragovernmental
accounts, of which $2.4 trillion was held
by the Social Security trust funds.
As long as the balances in the Social Security trust funds are increasing, the on-budget
deficit is partly offset by off-budget surpluses.
When Social Security benefit payments begin
exceeding revenues—which latest estimates
suggest will begin in 2017—the off-budget
components will add to the overall unified
budget shortfall. (It will be interesting to see if
the federal government continues to report the
unified budget figures when this is the case.)
When the trust funds begin to be drawn
down, the government will be faced with the
6 The Regional Economist | January 2009

Although both the deficit and debt
for fiscal 2008 were the largest on record
in dollar terms, putting these figures in
proper perspective is important: A more
appropriate evaluation compares the
deficit and the debt with national income.
In the same sense that the manageability
of a household’s debt depends on income
(the ability of the household to make payments), evaluating the size of the government’s debt should be gauged against the
size of the national economy.
When expressed as a percent of GDP, as
shown in the lower panel of Figure 1, recent
deficits have not been exceptionally large.
In fact, official deficits in the mid-1980s
were nearly twice as large as the 3.2 percent
of GDP recorded for 2008. Even using the
alternative measure, last year’s change in
the national debt amounted to 7.6 percent
of GDP—only slightly greater than the
7.3 percent of GDP registered in 1986.4
Similarly, the $10 trillion national debt
represents 69.5 percent of GDP—only
slightly higher than the previous peak of
67.3 percent of GDP that was reached in
1996. Netting out intragovernmental
holdings, debt held by the public in 2008
represented 40.3 percent of GDP, well
below a previous peak of 49.4 percent
in 1993.5
U.S. government debt is also not particularly large compared with that of
other countries. In 2007, France’s government debt amounted to approximately
70 percent of GDP, Italy’s debt-to-GDP
ratio was nearly 120 percent and Japan’s
was over 170 percent.
Put in perspective, current deficits and debt levels are high, but not

Fear Not Foreign Ownership of U.S. Debt
Over the past decade, the borrowing needs of the U.S. Treasury have been met
increasingly by purchases of debt from abroad. At the end of fiscal year 1998, foreign
holdings of Treasury securities totaled about $1.2 trillion, amounting to approximately
37 percent of all debt held by the public. By 2008, the dollar value of foreign-owned
debt had risen to nearly $2.9 trillion, comprising almost 50 percent of outstanding
publicly held debt.
Not surprisingly, the largest foreign holders of U.S. debt are countries that run
persistent trade surpluses with the U.S. Japan had long been the largest holder
of Treasury debt, with its holdings rising from $276 billion in 1998 to $573 billion
by the end of fiscal year 2008. Reflecting the increasing presence of China
in the global economy (and its large current account surplus), Chinese investors
have been closing in on the Japanese as the largest financiers of the U.S. debt and
have recently overtaken Japan as the largest foreign holders of Treasury securities.
Chinese holdings of Treasury debt, which were $46 billion in 1998, skyrocketed to
$587 billion by the end of fiscal year 2008.
The increasing share of debt ownership by foreigners has raised concerns about
the prospect that foreign governments might use financial leverage as a creditor
against the U.S. and its foreign policy. For example, it has been suggested that if
China were to dump its holdings of Treasury debt, the resulting market disruption

MAJOR FOREIGN HOLDERS
OF TREASURY SECURITIES
As of september 2008

would likely lead to higher U.S. interest rates and a collapse of the dollar on foreign

$ Billions

exchange markets.

Percent of Debt
Held by the Public

However, a recent analysis by the Congressional Research Service suggests

China

587.0

10.1

that such a sudden and disruptive strategy is unlikely to be successful.9 Even the

Japan

573.2

9.8

largest foreign holdings of U.S. government debt are smaller than the daily volume

United Kingdom

338.3

5.8

of trade in Treasury securities. If such a strategy did disrupt the markets, the result-

Caribbean Banking Centers 1

185.3

3.2

ing decline in the value of U.S. Treasury securities would generate substantial losses

Oil Exporters

182.1

3.1

to all debt holders, including those in the country attempting to use their debt hold-

Brazil

141.9

2.4

ings as political leverage. Moreover, trade linkages between the U.S. and creditor

All Other

852.9

14.6

nations add to the self-destructive scenario of potential economic blackmail.

Total

2,860.7

49.0

The more grave risk is that investors in U.S. Treasury debt, foreign or domestic,
would lose faith in the ability of the U.S. government to meet its obligations in the
face of unsustainable, long-run structural deficits.

unprecedented. Should this red ink be a
cause for concern?
Economic Impact of Deficits

In principle, deficits can serve a useful role
by providing the ability to smooth the path
of distortionary taxes over time, particularly
over the business cycle. Longer-term deficits
can be justifiable if they finance long-term
expenditures (as with an individual who
finances the purchase of a home) or if they
are expected to pay off in higher national
income in the future (as an investment). In
a growing economy, even a permanently

2

SOURCE: U.S. Treasury (Treasury Bulletin, Table OFS-1)
Caribbean banking centers include Bahamas, Bermuda, Cayman Islands,
Netherlands Antilles, Panama and British Virgin Islands.
2
Oil exporters include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq,
Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria,
Gabon, Libya and Nigeria.
1

increasing deficit (if it is not increasing too
fast) is sustainable in the long run.
It is often argued that government
deficits, particularly longer-term deficits,
impose a direct economic cost. A conventional Keynesian analysis of this effect
begins from the fundamental national
income accounting relationship that total
domestic investment is equal to national
savings, which includes the total of saving
(or dissaving) by consumers, business and
government. When the government runs
a deficit, the borrowing needed to finance
the shortfall diverts the private savings
The Regional Economist | www.stlouisfed.org 7

figure 2
Budget Projections, 1970-2080
r e v e nu e s a nd e x p e nd i t u r e s
60

Total revenue

Expenditures
Interest
Other government
Medicaid
Medicare
Social Security

PERCENT OF GDP

50
40
30

2080 Deficit:
41% of GDP

20
10
0

1970

1980

1990

2000

2010

2020

2030

2040

2050

2060

2020

2030

2040

2070

2080

D EBT HE L D BY THE P U B L I C
700
600

PERCENT OF GDP

500
400
300
200
WWII 109% of GDP

100
0

1940

1950

1960

1970

1980

1990

2000

2010

2050

2060

2070

2080

Source: GAO, “A Citizen’s Guide to the 2007 Financial Report of the United States Government”

These projections use Medicare and Social Security data from their respective trustees’ reports. Medicaid is
assumed to grow at the same rate as Medicare. Discretionary spending from the war is phased out after 2010,
with remaining discretionary spending assumed to expand at the same rate as GDP. The data do not account for
any spending expected to be associated with the Emergency Economic Stabilization Act of 2008.

that would otherwise flow into investment.
One of the expected manifestations of this
“crowding out” effect is that government
deficits, by increasing the competition for
loanable funds, put upward pressure on
interest rates.
This need not be the case, however. A
theoretical construct that often serves as a
baseline for evaluating the effect of deficits
is known as “Ricardian equivalence.” In
a closed economy with rational, forwardlooking consumers, Ricardian equivalence
suggests that deficits may have no effect at
all. For instance, suppose the government
were to implement a lump-sum tax cut,
8 The Regional Economist | January 2009

financing the resulting budget shortfall
by borrowing from the public, with the
resulting debt to be repaid in the future
with a tax increase. Rational consumers
would be expected to increase their savings in anticipation of higher future taxes,
which would be needed to pay off the
debt. The increase in government dissaving would be met by an increase in private
sector saving, leaving overall national
savings unchanged. With no change in
the balance between national savings and
investment demand, there would be no
upward pressure on interest rates.
The conditions under which Ricardian
equivalence holds—even from a theoretical perspective—are quite restrictive; so,
it is unlikely to be a literal description
of the impact of deficit financing on the
economy. Nevertheless, it serves as a
baseline for evaluating the relevance of
crowding out effects that might be present
if, for example, consumers are myopic
about their own future tax burden or fail
to consider the welfare of future generations, or if credit-market imperfections
prevent them from responding optimally
to government deficits.
In this regard, the economic relevance
of crowding out—and its consequent
effect on interest rates—is an empirical
matter. As the deficit has increased in
both size and public prominence over
the past quarter-century, there has been
a deluge of research on the subject. One
review of the literature in 2004 by William Gale and Peter Orszag reported on a
total of 66 previous analyses of the topic.
Of these, 33 found significant effects of
budget deficits, while 33 found insignificant or mixed effects. Gale and Orszag
went on to conduct their own analysis,
finding significant non-Ricardian effects:
They suggest that a deficit increase
amounting to 1 percent of GDP lowers
national savings by 0.5 to 0.8 percent and
that expected future deficits raise longterm interest rates by 25 to 35 basis points.
These findings have been controversial,
however. In fact, another paper circulating at the same time by Eric Engen and
Glenn Hubbard suggested that the debt,
rather than the deficit, was the appropriate measure to consider. They found that
a 1 percent increase in the debt-to-GDP

ratio led to an increase in interest rates of
only four to five basis points.
Recent experience has renewed skepticism
about the effect of government deficits on
interest rates. As the U.S. government deficit and debt have risen sharply over the past
few years, long-term interest rates remained
abnormally low relative to short-term rates.
One factor that has evidently contributed to
this phenomenon—not explicitly considered under the conventional Keynesian view
or in the Ricardian-equivalence analysis—
is the effect of savings coming into this
country from abroad. The increasing
demand for borrowing by the U.S. Treasury
in recent years has been met with a substantial foreign inflow. (See sidebar on Page 7.)
Even if U.S. residents are non-Ricardian in
their behavior, the demand for U.S. Treasury securities by foreigners is likely to have
mitigated upward pressure on interest rates
that might otherwise have been observed.
A Demographic Time Bomb

While the immediate impacts of government deficits and debt are a matter of some
controversy, most economists agree that
the long-term fiscal outlook for the U.S.
requires serious attention. The retirement
of the Baby Boom generation and a slowing rate of growth in the labor force will
create a demographic time bomb in which
entitlement growth threatens to swamp
available resources.
As mentioned earlier, the Social Security
trust funds are projected to begin running
down in 2017. By 2041, they are expected
to be depleted.6 One way of measuring
the long-run shortfall is to estimate the
present value of unfunded obligations, that
is, to estimate how much money would be
needed, in today’s dollars, to pay for future
promises in excess of expected tax revenues.
In the case of Social Security, the U.S. Treasury estimates that paying promised benefits
through the year 2081 would require $6.8
trillion, in addition to taxes collected under
current law.7
The situation is even more dire when we
consider health-care costs. The unfunded
obligations of Medicare parts A and B
amount to a present value of $25.7 trillion.
Medicare Part D (prescription drug coverage) adds another $8.4 trillion. All told, the
shortfall for government social insurance

programs comes to a present value of $40.9
trillion. This is the government’s official
estimate—some private sector economists
suggest that the total burden is even greater.
Economist Lawrence Kotlikoff has recently
estimated the total unfunded liabilities of
current federal programs at $70 trillion.8
Figure 2 displays recent forecasts from
the Government Accountability Office,
illustrating the budget implications of these
trends. The upper panel shows accelerating deficits over the next seven decades.
Assuming revenues held constant at the
historical average of 18 percent, these projections show the deficit rising to over
40 percent of GDP by 2080. The lower
panel of Figure 2 shows the implications
for the federal debt: an exponential rate of
increase that reaches over 600 percent of
GDP by 2080. This would far exceed any
level of government borrowing in history.
These projections are unlikely to actually
occur. The trends are unsustainable. Long
before reaching such unprecedented level
of borrowing, there would surely be a crisis
of confidence among U.S. creditors, both
domestic and foreign.
Current measures of the federal deficit
and the national debt, as dismal as they
might appear, fail to reflect full consequences of current-law fiscal policy. The
unfunded future liabilities of government
entitlement programs imply rising deficits
and a ballooning public debt far larger than
today’s shortfalls. And debates about the
immediate economic impact of government deficits on private savings and interest
rates, while of academic interest, fail to
address the full importance of these longrun consequences. Fundamental reform of
entitlement programs is critical for putting
U.S. fiscal policy on a long-run sustainable
path.

Michael Pakko is an economist at the Federal
Reserve Bank of St. Louis. For more on his work,
see http://research.stlouisfed.org/econ/pakko/
index.html. Luke Shimek provided research
assistance.

endnotes
1

2

3

4

5

6
7
8
9

In its “Mid-Session Review” in July 2008, the
Office of Management and Budget projected
a deficit of $482 billion for fiscal year 2009,
which ends Sept. 30, 2009. Implementation
of the Emergency Economic Stabilization Act
is likely to add an additional several hundred
billion dollars to the Treasury’s upcoming
borrowing needs.
The change in national debt for 2008 includes
$300 billion in the new Supplementary
Financing Program Account. Through this
program, the Treasury issues additional debt,
depositing the proceeds into its account with
the Federal Reserve. Because the Treasury
records this as an increase in cash on-hand,
it should more accurately be subtracted from
the total change in debt. With this adjustment, the change in the national debt for 2008
would be just over $700 billion.
There are two Social Security trust funds,
Old Age and Survivor Insurance (OASI) and
Disability Insurance (DI). At the end of fiscal
year 2008, they stood at $2.15 trillion and
$216 billion, respectively.
Adjusting for the $300 billion described in
endnote 2, the increase in the national debt
for 2008 was 5.4 percent of GDP.
After adjusting for the $300 billion held in
the Supplementary Financing Program
Account, the total federal debt represented
68.2 percent of GDP, while debt held by the
public amounted to 38.7 percent.
See Social Security Administration.
Treasury Department, 2007 Financial Report
of the United States Government.
See Kotlikoff (2006 and 2008).
See Morrison and Labonte.

References
Engen, Eric M.; and Hubbard, R. Glenn. “Federal Government Debt and Interest Rates,” in
Mark Gertler and Kenneth Rogoff, eds., NBER
Macroeconomics Annual 2004, pp. 83-160.
Cambridge, Mass: MIT Press.
Gale, William G.; and Orszag, Peter R. “Budget
Deficits, National Saving, and Interest Rates,”
Brookings Papers on Economic Activity, 2004,
No. 2, pp. 101-210.
Government Accountability Office, The Federal
Government’s Financial Health: A Citizen’s
Guide to the 2007 Financial Report of the
United States Government, 2008. See www.
gao.gov/financial/citizensguide2008.pdf.
Kotlikoff, Laurence J. “Is the United States
Bankrupt?” Federal Reserve Bank of St. Louis
Review, Vol. 88, No. 4, July/August 2006,
pp. 235-49.
______. “Is the U.S. Going Broke?” Forbes,
Sept. 29, 2008, pp. 34-35.
Morrison, Wayne M.; and Labonte, Marc. “China’s
Holdings of U.S. Securities: Implications for
the U.S. Economy,” Congressional Research
Service, Order Code RL34314; May 19, 2008.
See www.fas.org/sgp/crs/row/RL34314.pdf.
Office of Management and Budget. Mid-Session
Review, Budget of the U.S. Government, Fiscal
Year 2009, July 2008. See www.whitehouse.
gov/omb/budget/fy2009/pdf/09msr.pdf.
Social Security Administration. The 2008 Annual
Report of the Board of Trustees of the Federal
Old-Age and Survivors Insurance and Federal
Disability Insurance Trust Funds, March 2008.
See www.ssa.gov/OACT/pubs.html.
The Regional Economist | www.stlouisfed.org 9

r e s e a r c h

A Winning Combination?
Economic Theory Meets Sports
By Kristie M. Engemann and Michael T. Owyang

U

nlike researchers in the natural sciences, economists often lack the ability
to conduct laboratory or controlled experiments to test theories or make inference.
In recent years, economists have begun to
study “natural experiments”—naturally
occurring events that provide a researcher
with a basis to analyze outcomes within a
clearly defined setting. One such artificial
laboratory that economists have discovered
is sports. Economists have used data from
sports to examine such diverse issues as
(1) risk behavior, (2) market efficiency,
(3) market power and (4) discrimination.
Risk Behavior: Does Maximization
Predict Coaches’ Decisions?

A basic assumption in economic models is
that, in competitive markets, firms maximize
profits. In the sports world, such maximiza-

seasons, but used only the first quarter of
the games in his analysis; later in the game,
teams may change their strategy based
on the score. Therefore, the first quarter
should yield the best insight as to whether
teams maximize their chances of winning.
Romer analyzed the expected payoff from
going for a first down on the fourth down
at every point on the field versus kicking
the ball (punting or a field goal attempt).
His analysis compared the expected values
of the outcome of a play, as well as the
expected value of leaving the opponent
with the ball at that spot on the field.
After taking all results into account, he
estimated that teams are better off going
for a first down than punting if they have
fewer than four yards to go in their half of
the field; if they have fewer than 6.5 yards
to go on the other team’s 45-yard line; and

In situations where teams were expected to be better off
kicking the ball on fourth down, they went for a first down
less than 1 percent of the time. However, when teams were
expected to be better off going for a first down, they kicked
the ball almost 90 percent of the time.
tion might be seen as a coach maximizing his
team’s chance of winning. Economist David
Romer tested whether coaches make the optimal choice in a fourth-down situation in the
National Football League (NFL). He argued
that this analysis should be similar to the
firm maximization model because winning
is highly valued, coaches have pressure to win
due to the competitive nature of the job and
teams can learn from past experiences.
Romer studied all of the regular-season
NFL games during the 1998, 1999 and 2000
10 The Regional Economist | January 2009

if they have fewer than 9.8 yards to go on
the other team’s 33-yard line, at which point
teams are within typical field-goal range.
After the other team’s 21-yard line, the value
of going for it frequently outweighs the
expected value of kicking a field goal, and at
the 5-yard line, the team is always better off
going for the first down or touchdown.
How did Romer’s predictions compare
with actual plays in the NFL games? In
situations where teams were expected to
be better off kicking the ball on fourth

down, they went for a first down less than
1 percent of the time. However, when teams
were expected to be better off going for
a first down, they kicked the ball almost
90 percent of the time. Romer estimated
that if a team optimized in these situations
throughout the whole game, it would win
one more game every three seasons.
Romer surmised that coaches’ previous
experiences might cause more conservative decisions than one would predict using
standard assumptions about optimizing
behavior. Alternatively, a coach’s objective
might be more complicated than simply
choosing plays that would result in the
highest expected outcome. For instance,
he might view activities that decrease the
chance of winning (e.g., a failed first-down
attempt) more negatively than he views a
successful activity positively, which could
stem from fan or owner preferences.
Risk Behavior: Does Game Theory
Predict Player Behavior?

What happens when only two players are
involved rather than entire teams? Economists Pierre-André Chiappori, Steven Levitt
and Timothy Groseclose tested whether
kickers and goalies used mixed strategies
(i.e., chose strategies at random) to optimize
their chances of being successful during
penalty kicks in soccer. Even though soccer
is a team sport, the penalty kicks involve
just those two players and thus allow for
a test of economic game theory. For each
penalty kick, the kicker should maximize his
chance of scoring, while the goalie should
maximize his chance of preventing a score.
The authors studied all penalty kicks over
a two-year period in the elite French league
and over a three-year period in the elite Italian league. For each penalty kick, they had

the names of the kicker and the goalie, the
direction the kicker kicked (right, left or center) and which foot he used, and the direction the goalie jumped (right, left or center).
Due to the high speed of the ball, each player
must decide which direction to kick/jump
before the other player makes a move.
The authors contended that a goalie’s
strategy should depend on the kicker’s
past kicks, but a kicker’s strategy should be
independent of the goalie. In the authors’
sample, when both players chose the kicker’s
natural side (which is the left side in most
cases because the kickers usually kick
with their right foot), the kicker scored 64
percent of the time, and when both chose
the kicker’s non-natural side, the kicker
scored about 44 percent of the time. When
the goalie jumped to the wrong side, the
kicker scored 94 percent of the time when he
kicked to his natural side and 89 percent of
the time when he kicked to his non-natural
side. Obvious from these data is that kickers are substantially more successful when
kicking to their natural side.
The authors showed that, over their
sample of 459 penalty kicks, the players
used mixed strategies that one would expect
in order to maximize behavior. Indeed, a
kicker went to the center more often than
the goalie did (17 percent versus 2 percent),
and a kicker went to his natural side less
often than the goalie did (45 percent versus
57 percent). Both players were more likely
to go to the kicker’s natural side than his
non-natural side, and the case where they
simultaneously went to the kicker’s natural
side was the most common (25 percent),
followed by the goalie jumping to the
kicker’s natural side but the kicker going
to the opposite (21 percent).
Based on all of these results, Chiappori,
Levitt and Groseclose could not rule out
that soccer players successfully optimize
their behavior during penalty kicks.
Do Markets Work?

Many aspects of the sports labor market have been analyzed. The competitive
environment of sports provides a setting
in which one would expect merit-based
outcomes to prevail.
Along this line, researchers Edward Fee,
Charles Hadlock and Joshua Pierce studied
promotions among coaches in the NFL.

The authors assessed whether promotions
within teams were based on different
criteria than promotions from outside.
The researchers focused on promotions of
offensive and defensive coordinators (level 2
coaches) to head coaches (level 1 coaches).
Examining data for NFL coaches from
1970 to 2001, the authors used a team’s
winning percentage as a measure of team
performance. The authors used points
scored for offensive coordinators and
points allowed for defensive coordinators as a measure of individual
performance. In assessing promotions of level 2 coaches to head
coach on another team, the
hiring decision depended on
individual performance rather
than team performance. In
contrast, both team performance and individual performance mattered for promotion
to head coach on the same team. A strong
team performance actually decreased the
likelihood of such a promotion, mostly
because teams with winning records were
less likely to replace their head coach. After
controlling for the team, the highest individual performers were more likely to be
promoted. However, the two effects essentially canceled each other out, leaving virtually no effect of individual performance on
internal promotions.
Fee, Hadlock and Pierce likened this
situation to top management at firms.1
For senior management excluding CEOs,
strong performers are more likely to obtain
the position of CEO at a different firm
rather than their own firm due to “slot
constraints.” The authors’ findings do not
support the theory that internal promotions
serve as incentives for the best performers,
at least not for top-level positions.
Market Power and the Labor Market

A sports league can be viewed as a monopsony—there is one buyer but many sellers
of a product (players’ services, in this case).
A sports league, such as Major League Baseball (MLB), has market power because it
can pay players less than their contribution
to the team generates in revenue. However,
the league cannot exercise as much market
power for players who are eligible for salary
arbitration or free agency.2
The Regional Economist | www.stlouisfed.org 11

Annual and Total Compensation Differences for MLB Groups

the possibility of losing a player, thus avoiding a “bidding war” with other teams.

C o mp a r i s o n g r o up i s pl a y e r s w i t h l e s s t h a n t h r e e y e a r s o f s e r v i c e

Nonpitchers

Pitchers

Whites

Nonwhites

Whites

Nonwhites

3 or 4 years of service

36

43

36

28

5 years of service

48

44

28

53

Free agency

44

35

4

31

3 or 4 years of service

36

36

34

27

5 years of service

62

56

54

76

Free agency

68

59

51

66

Annual compensation (% difference)
Players with:

Total compensation (% difference)
Players with:

SOURCE: Kahn (1993).

To study the effect of free agency and
salary arbitration on salary and contract
length, economist Lawrence Kahn looked at
all players from 1987 to 1990. He obtained
data on each player’s salary, contract, total
compensation, performance statistics and
local demographics (e.g., population and
per capita income of the team’s metropolitan statistical area) and performed separate
analyses on nonpitchers and pitchers. Compared to players with less than three years of
service, free agents earned about five times
more each year and players with five years
of service earned between five and six times
more each year during this time period.
The table shows the results of Kahn’s
analysis after controlling for performance
statistics, years of experience, etc. The top
panel shows that players with arbitration
and free agency earned higher annual salaries than players with fewer than three years
of service. A notable exception is white
pitchers who were free agents—they earned
roughly the same amount as those with
fewer than three years of service. However,
free agents were the only group with consistently longer contract length, which would
affect total compensation (bottom panel)
perhaps more than annual salary alone.
Kahn argued that his results are in line
with free agents’ willingness to accept
a lower annual salary for the insurance
that comes with longer contracts. He also
argued that the significant effect of free
agency on contract length shows that teams
are willing to sign longer contracts only at
12 The Regional Economist | January 2009

Discrimination in Pay

Many economists have studied discrimination in the labor market, including the
sports labor market. Researchers Kahn
and Peter Sherer examined pay differentials between white and black players in
the National Basketball Association (NBA)
during the 1985-86 season. In 1985-86,
about 75 percent of players were black, and,
on average, black players earned almost 3
percent more than white players. In fact,
the only three players during that season
who earned more than $2 million were
black (Magic Johnson, Moses Malone and
Kareem Abdul-Jabbar). Also, white players
tended to play in cities with lower population, a higher white share of population
and higher home-game attendance.
Kahn and Sherer reached a different
conclusion regarding pay differentials
after controlling for players’ performance
statistics (e.g., points, minutes per game
and number of seasons played), team characteristics (winning percentage and home
attendance) and some local demographics
(total population and the percentage black,
and per capita income). White players
earned about 20 percent more than black
players, all else equal, in the mid-1980s.
In addition, the authors found that a white
player with the same performance level
as a black player would bring in a total of
8,000 to 13,000 more fans at home games,
which they estimated was an extra $80,000
to $130,000 in revenue. The authors
argued that their results reflect customer
discrimination (rather than employer or
co-worker discrimination) because fans
appeared to be willing to pay a premium
to watch white players.
Economist Barton Hamilton studied
whether this “white premium” continued into the 1990s by examining salaries
during the 1994-95 NBA season. For this
season, the average black player earned
about 17 percent more than the average
white player, and nine of the 10 highestpaid players were black. Like Kahn and
Sherer, Hamilton controlled for players’
performance, team characteristics and
local demographics to determine the true
impact of race on a player’s salary. Unlike

the previous authors, he found no significant pay differential between the average
white and black player. However, among the
stars and the superstars (i.e., those players
in the top 25 percent and top 10 percent
of the salary distribution, respectively),
whites earned about 18 percent more
than blacks. Because the stars are
the most visible players on a team,
Hamilton argued that this pay differential continued to reflect customer
discrimination.

endnotes
1

2

3

Discrimination in Play

Economists Joseph Price and Justin
Wolfers performed a different evaluation of discrimination in the NBA. They
estimated the amount of racial bias from
referees when calling fouls on players of
the opposite race, which can influence the
on-court performance of the players. They
examined every NBA game from the 199192 to the 2003-04 seasons and obtained
statistics for each player and the race of the
(randomly assigned) three referees for every
game. The economists were able to compare the number of personal fouls a player
received depending on the racial composition of the officiating crew.
About one-third of the referees during
this time period were black, and black players accounted for over 80 percent of total
minutes played. At first glance, the data
showed that black players had more playing
time and fewer fouls per 48 minutes played
(the “foul rate”) than white players. Moreover, players had slightly lower foul rates
when the officiating crew was of the same
race, on average. A more in-depth analysis
with controls for various characteristics
(e.g., player position, height, weight, all-star
status) showed that the foul rate for black
players increased by about 4 percent when
all three referees were white rather than
black. As a consequence, playing time and
points scored decreased slightly. Overall,
the authors found that 62 percent of the
black referees appeared to have a pro-black
bias (by calling fewer fouls on black players), while 78 percent of the white referees
appeared to have a pro-white bias (by calling more fouls on black players).
With these impacts on individual players,
the authors tested the effect that this apparent referee bias had on the most important

However, head coaches have a higher average
turnover rate (22 percent) than CEOs
(10 percent).
In the MLB, players are not eligible for free
agency, which allows them to negotiate a
contract with multiple teams, until they have
six years of major league service. Players with
three, four or five years of major league service are eligible for salary arbitration. Under
salary arbitration, the player and the team
each submit a final offer, and an arbitrator
must choose one of them. See Kahn (1993).
One conclusion that Price and Wolfers
drew is that a potential bias by the referees
for their own race exists. They argued that
because NBA referees are heavily scrutinized
after each of their games, it is most likely an
unconscious bias.

References

outcome: winning. During the sample
period, the margin of victory was one point
in 4 percent of the games; thus, the seemingly small referee bias could have a large
effect on the overall outcome. Indeed, Price
and Wolfers argued that changing the racial
composition of the referees to match that
of the players on the team would lead to an
increase in winning percentage for the team
with more time played by black players from
48.6 percent to 50.5 percent.3
Not Just Fun and Games

Because economists do not generally
have the opportunity to conduct laboratory
experiments, sports provide an excellent
opportunity to test theories, ranging from
the existence of discrimination in the labor
market to whether firms or individuals
optimize their behavior to achieve a certain
goal. With the high level of data availability
that sports provides, undoubtedly there will
be more natural experiments to analyze.

Chiappori, Pierre-André; Levitt, Steven; and
Groseclose, Timothy. “Testing Mixed-Strategy Equilibria When Players Are Heterogeneous: The Case of Penalty Kicks in Soccer.”
American Economic Review, September 2002,
Vol. 92, No. 4, pp. 1138-51.
Fee, C. Edward; Hadlock, Charles J.; and Pierce,
Joshua R. “Promotions in the Internal and
External Labor Market: Evidence from
Professional Football Coaching Careers.”
Journal of Business, March 2006, Vol. 79,
No. 2, pp. 821-50.
Hamilton, Barton Hughes. “Racial Discrimination and Professional Basketball Salaries in
the 1990s.” Applied Economics, March 1997,
Vol. 29, No. 3, pp. 287-96.
Kahn, Lawrence M. “Free Agency, Long-term
Contracts and Compensation in Major
League Baseball: Estimates from Panel Data.”
Review of Economics and Statistics, February
1993, Vol. 75, No. 1, pp. 157-64.
Kahn, Lawrence M.; and Sherer, Peter D. “Racial
Differences in Professional Basketball Players’
Compensation.” Journal of Labor Economics,
January 1988, Vol. 6, No. 1, pp. 40-61.
Price, Joseph; and Wolfers, Justin. “Racial Discrimination among NBA Referees.” National
Bureau of Economic Research Working Paper
No. 13206, June 2007.
Romer, David. “Do Firms Maximize? Evidence
from Professional Football.” Journal of Political Economy, April 2006, Vol. 114, No. 2,
pp. 340-65.

Kristie Engemann is a research analyst, and
Michael Owyang is an economist, both at the
Federal Reserve Bank of St. Louis. For more on
Owyang’s work, see http://research.stlouisfed.
org/econ/owyang/index.html.

The Regional Economist | www.stlouisfed.org 13

c e n t r a l

b a n k

By Sharon K. Blei

D

rawing upon long-dormant emergency
powers as lender of last resort, the Federal Reserve has taken unprecedented steps to
shore up the financial system. If, as a result of
these precedents, the Federal Reserve’s role as
a regulator is expanded, the central bank will
probably face new challenges in executing its
traditional responsibilities and preserving its
independence against political pressure. Thus,
changes in the role of the Federal Reserve
should be carefully considered, bearing in
mind the importance of its role in monetary
policy and the payment system—and the
importance of protecting these functions from
political and financial pressures.

expanded reciprocal currency arrangements
with foreign central banks; engineered and
backed JP Morgan’s takeover of ailing investment bank Bear Stearns; agreed to lend to
Fannie Mae and Freddie Mac; provided an
emergency credit line to AIG; and worked
out with the U.S. Treasury an ambitious
$700 billion emergency rescue package for
the American financial services industry.
Thus, the Federal Reserve, established
nearly a century ago as lender of last resort
to tackle financial panics, emerged in a new,
broader guise—that of the nation’s financial
system savior.
A Systemwide Regulator?

The Fed Responds to Crisis

The challenges presented by the subprime
meltdown and the subsequent strain in global
financial markets have dramatically reshaped
the financial landscape in the U.S. Since
the onset of the crisis in August 2007, the
country has witnessed a series of prominent
bank failures: Countrywide, IndyMac and
Washington Mutual (by far the largest commercial bank failure in American history);
the demise of America’s five major investment
banks; the bailout of mega-insurer American
International Group (AIG); and the decline of
mortgage titans Fannie Mae and Freddie Mac.
Faced with these extraordinary developments,
the Federal Reserve—to which all eyes were
turned for rescue—took upon itself the mission of managing and containing the crisis.
Assuming responsibility not only for those
banks under its supervision, but for the
financial system as a whole, the central bank
drew upon long-dormant emergency powers
and took bold steps: It enhanced financial
institutions’ access to liquidity by deploying
an array of new short-term liquidity facilities;
14 The Regional Economist | January 2009

Why has the Federal Reserve assumed
this extended role? The reasons appear to
be multiple. First, the Federal Reserve is the
lender of last resort and has a monopoly over
the supply of liquidity to the financial system.
This role provides the central bank with both
the tools and the expertise for managing and
containing systemic disruptions. Second, the
Federal Reserve plays a key role in providing
payment services and overseeing the payment
system, the integrity of which is essential to
financial stability. The Federal Reserve also
enjoys an unmatched reputation for technical
skill and nonpartisanship, the ability to wield
moral suasion and a unique “primus inter
pares” (first among equals) status among
federal regulators, placing it in the prime
position for leading national rescue efforts.
In the global arena, its close relationship with
foreign central banks and its high international acclaim enable the Federal Reserve to
coordinate multinational endeavors to shore
up crumbling financial markets. Faced with
the dramatic developments in the financial
system, the Federal Reserve answered a call

no other federal agency was better-suited—
or willing—to answer.
To date, regulators of financial institutions
in the U.S. have been mandated to focus on
the prudential issues, namely, business conduct and financial conditions of individual
institutions. The recent financial shakeout
vividly demonstrates the need for a systemwide, “macro-prudential” approach to financial regulation. Unlike micro-prudential
regulation, which focuses on the financial
condition of single institutions, the systemwide approach’s field of vision is the financial
system as a whole, focusing on common
exposures, linkages and interdependencies
among financial institutions.
It has been suggested that a systemwide
regulator, entrusted with the responsibility for
maintaining financial system stability, should
be able to either collect or access the information required for the evaluation of the systemic
risks associated with certain industry-wide
practices, common exposures or default by
a financial institution, and should be able
to wield both the authority and the tools to
intervene when needed. In the eyes of many,
the Federal Reserve is the natural candidate
for the role. A “blueprint” for regulatory
overhaul released by the U.S. Department of
the Treasury last March (the Paulson plan)
recommends mandating the Federal Reserve
as “market stability regulator.”1
Whether formalized or not, the Federal
Reserve’s extended role in financial oversight,
alongside its long-existing roles in maintaining price stability and promoting economic
performance, raises important challenges.
One such challenge is the potential conflict between micro- and macro-prudential
regulatory objectives. Micro-prudential
regulation is pro-cyclical by nature—both

because capital requirements and accounting rules enhance the pro-cyclicality already
inherent in credit markets and also because
prudential regulators tend to be stricter in
times of economic weakness and laxer during expansion. The systemwide approach
to regulation, on the other hand, aims to
stabilize systemic shocks to financial markets
and is, therefore, counter-cyclical by definition. Regulatory measures that are desirable
from a micro-prudential point of view may
seem, therefore, detrimental from a systemic
standpoint. (For example, taking corrective
action against a financial institution might be
well-justified as far as prudential regulation
goes, yet undesirable from a system-wide perspective, since doing so may further deteriorate that institution’s financial condition and
increase the risk it poses to the system.)
Acquiring the information essential to
executing the role of systemwide regulator—
namely, real-time data about a vast array
of financial institutions, their financial
condition, structure and the contractual
linkages between them—presents additional
challenges. First, there are the technical difficulties and non-negligible costs associated
with collecting and processing such complex
data—both to supervisors and institutions.
Then, there’s the need for close collaboration
with other regulators (public, private and
even foreign), who may not be willing
to cooperate.
Whither Independence?

Another major concern is that broader
responsibilities over the financial system
might subject the Federal Reserve to excessive
political pressure and, thereby, compromise
its independence in the conduct of monetary
policy. Independence against narrow political and commercial pressures, that is, being
relatively immune to the danger of “captivity”
by interested parties, is crucial to the Federal
Reserve’s monetary policy role. Politicians
have always sought influence on the Federal
Reserve, especially at times of economic
turmoil; they have pressured it to favor certain
sectors or industries or to lower interest rates.
An extended role in financial regulation
could arouse an even greater appetite for
influence among politicians. In addition,
such a role entails using taxpayer money
and affecting the allocation of credit in the
economy and, thus, would inevitably lend

fiscal and political nuances to the central
bank’s actions; that, in turn, would spur
demands for greater transparency and closer
congressional scrutiny.
Testifying before the Congress’ Joint Economic Committee last May, former Federal
Reserve Chairman Paul Volcker remarked that
broadening the Federal Reserve’s authorities
beyond the supervision of commercial banks
and their bank holding companies would be
“a way of destroying the Federal Reserve in the
long run because it does need independence.”
Volcker further wondered whether “such a
large responsibility [should] be vested in a
single organization, and should that organization reasonably be in the Federal Reserve
without risking dilution of its independence
and central bank monetary responsibilities?”2
Volcker’s query broaches yet another
challenge facing the Federal Reserve, that of
balancing its re-interpreted role in the financial arena with its monetary responsibility.
Monetary policy instruments—the interest
rate, reserve requirements, short-term liquidity facilities and the discount window—can
potentially affect both price and financial
system stability, yet in opposite directions.
Whereas tight monetary policy may combat
inflationary pressure, it may also reduce the
availability of credit and may jeopardize borrowers’ creditworthiness, thus, potentially
weakening the credit market. Hence, in the
short run, there may be tradeoffs between
achieving the goal of price stability and
maintaining a healthy credit market. Having
played the role of banking supervisor since its
establishment in 1913, the Federal Reserve is
no stranger to this tradeoff.

ENDNOTES
1
2

See the Treasury Department.
See Volcker.

R EFE R ENCES
Bernanke, Ben S. “Reducing Systemic Risk.”
Presented at the Federal Reserve Bank of
Kansas City’s annual economic symposium
in Jackson Hole, Wyo., Aug. 22, 2008. See
www.federalreserve.gov/newsevents/speech/
bernanke20080822a.htm
Treasury Department blueprint for a modernized financial regulatory structure (March
2008) can be found at www.ustreas.gov/press/
releases/reports/Blueprint.pdf.
Volcker, Paul A. Testimony before the Joint
Economic Committee, May 14, 2008. See
jec.senate.gov/index.cfm?FuseAction=Files.
View&FileStore_id=3b13d743-490b-4c41ba36-8d86688d93a6.

Further Thoughts

If the Federal Reserve is given a systemwide role in financial regulation, the many
challenges it might present to the central
bank would call for reassessment of its different functions and objectives and for careful
planning. Sound conceptual and structural
regulatory foundations, successful implementation of a financial stability mandate
and continuous adaptation to the everchanging financial environment would pave
the way to a safer economic future.

Sharon Blei is an economist at the Federal Reserve
Bank of St. Louis.
The Regional Economist | www.stlouisfed.org 15

C o mm u n i t y

P r o f i l e

El Dorado Hopes “the Promise”
Brings Back the Golden Days
Photo of oil pump by Susan C. Thomson. Photos of graduates and deming from The Diamond Agency.

By Susan C. Thomson

E

l Dorado, Ark., and the area around it
are naturally rich in pine forests, salt
water and oil. Now, the town is seeking to
capitalize on a new resource—education. In
January 2007, Murphy Oil Corp., the community’s signature employer, announced that
it was setting aside $50 million to endow the
El Dorado Promise, a program that offers
grants to graduates of El Dorado High School
so that they can attend college.
“That started the ball rolling,” Mayor
Mike Dumas says. “That changed the whole
attitude of the community.”
He and other leaders in El Dorado (rhymes
with “tornado”) credit the Promise for
energizing townspeople to approve later
that year a one-cent sales tax for economic
development and the town’s first school tax
increase in 31 years.
They voted “yes” though times were hard
for many. The local unemployment rate was
hovering about two points above the national
average. Luther Lewis, chief executive at the
Medical Center of South Arkansas, says bad

16 The Regional Economist | January 2009

debt was rising at the hospital and more
patients were qualifying for Medicaid.
The town’s once-bedrock manufacturing
industry was eroding and taking its toll. In
2003, lighting manufacturer Prescolite Inc.
pulled out of El Dorado, moving the work of
its 270 employees to Mexico. Two years later,
Cooper-Standard Automotive closed its local
vehicle-parts plant and consolidated production in Auburn, Ind., eliminating another
400 jobs.
Don Wales, chief executive of the El Dorado
Chamber of Commerce, says it had long
been obvious that outsized employee fringe
benefits made the Cooper-Standard plant
uncompetitive. He puts the town’s Pilgrim’s
Pride chicken-processing plant in that
same precarious category, given its history
of labor-management and productivity
problems.
As chicken processing evolved into a big
business, that plant grew accordingly—into
a linchpin of the local economy. Now, it too
is threatened. Late last summer—as part

El Dorado by the numbers
Population
City of El Dorado.......................................... 19,891 *
Union County............................................... 43,230 *
Labor Force
City................................................................. 8,714 **
County.......................................................... 19,365 **
Unemployment Rate
City........................................................7.1 percent **
County...................................................5.7 percent **
Per Capita Income
County........................................................ $35,339 ***
* U.S. Bureau of the Census, estimate 2007
** HAVER/BLS, October 2008
*** BEA/HAVER, 2006

Top Five Employers
Pilgrim’s Pride Corp. . .......................................... 1,000 *
Medical Center of South Arkansas.......................... 650 **
Lion Oil Co............................................................... 600 **
Chemtura................................................................ 500 **
Murphy Oil Corp. .................................................... 445 **
* Estimated by the El Dorado Chamber of Commerce,
October 2008
** Self-reported, October 2008

Left: Graduates from El Dorado High School show off their “Promise” scholarship papers last May. They were congratulated by
Claiborne Deming, president of Murphy Oil Corp., which made those scholarships possible through its El Dorado Promise program.
The oil pump, a freshly painted relic of the boom days, produces about a barrel a day from an old well alongside Highway 82.
Right: Twenty years ago, downtown was boarded up. Today, thanks in large part to oil entrepreneur Richard Mason and his
wife, Vertis, downtown is a picture postcard version of what it looked like when El Dorado was nicknamed “Boomtown” in the
early part of the 20th century.

of a drastic overhaul that was prompted by
spiking feed and fuel costs, an oversupply of
processed chickens and mounting corporate
red ink—Pilgrim’s Pride cut its El Dorado
work force by 700.
With a payroll of 1,000 left, Pilgrim’s Pride
remains the largest local employer. But for
how long? A spokesman declined to elaborate on the company’s notice last spring that
it was considering the plant for possible shutdown. Last month, the company filed for
protection from its creditors under Chapter
11 of the U.S. Bankruptcy Code.
Fortunately, the natural-resource industries remain, of necessity, rooted in place.
The forests feed a lumber industry that began
just after the Civil War. After decades of
industry consolidation, Deltic Timber Corp.
and Anthony Forest Products Co., the largest
surviving companies, are bucking a slowdown caused by the steep drop-off in U.S.
home building. Aubra Anthony Jr., president
of his family’s company, takes the long view.
Timber will come back, he says, “because of
its increasing value not only for traditional
building products and fiber for paper but
also for the emerging biofuels industry and
cellulosic ethanol.”
El Dorado, just 14 miles north of the Louisiana border, lies over one of two commercially viable salt water reserves in the world,
the Dead Sea being the other. Chemtura,
the largest of three chemical plants in town,
pumps that water, or brine, from the ground
and uses the bromine it extracts from it to
make products such as fire retardants and
chemicals for use in oil drilling, water treatment and agriculture.
Plans are afoot for the leftover brine.
Texas-based Tetra Technologies Inc. has broken ground nearby for a $110 million plant
that is expected to employ about 80 people
when in full production at the end of this
year. It will buy brine from Chemtura and
process it into calcium chloride, whose uses
include controlling pressure in oil and gas
drilling, curing cement, processing food and
melting ice and snow.

No commodity, though, has so driven and
defined the town over the years as oil. Its discovery in the area in 1921 set off an explosion
in population and wealth that lasted through
that decade and earned El Dorado its enduring nickname—Boomtown.
A rough version of the original boomtown survives in a downtown that was
largely boarded up 20 years ago.
It is now a picture-postcard
vision of rehabbed storefronts
and old-time kiosks, clocks,
streetlights and telephone
booths. Oil entrepreneur
Richard Mason and his wife,
Vertis, spearheaded the transformation by investing their own
money. Other investors followed,
as did Main Street El Dorado, an
organization that raises money for
improvements downtown and that
stages events there. The Downtown
Business Association is also a big
promoter these days.
Recently, oil has been enjoying
what Rodney Landes, president of
El Dorado’s First Financial Bank,
describes as a “mini-boom.” As
world oil prices soared in 2008,
small operators found profits in
reworking old fields for deeply
embedded oil. In doing so, they
put hundreds to work and provided “a significant boost” to
the local economy, he says.
Most of the local oil—along
with offshore and foreign crude
—passes through the Lion Oil
Co. refinery. An El Dorado
fixture since the go-go 1920s,
it turns out gasoline that is sold
in Arkansas and 14 other states.
The company has invested several million dollars to double
its capacity over the past 20
years and plans to expand it
again this year, Vice President Steven M. Cousins says.

photos by susan C. thomson

The Regional Economist | www.stlouisfed.org 17

photo by the diamond agency

photo by susan C. thomson

Above: At Anthony Forest Products, Jeazon Fuentes
uses a hoist to move laminated beams that have
been wrapped for shipping.
Right: The Lion Oil Co. refinery processes local oil,
as well as offshore oil and foreign crude. The site
will be expanded again this year.

The school district, which
had been losing between
80 and 100 students a year
for the 20 years before
the Promise, is already
crediting it for an uptick
in enrollment—149 more
students in 2007 and
50 more in 2008.

18 The Regional Economist | January 2009

By far, the community’s biggest name in
oil is Murphy. By virtue of its $25 billion in
annual revenue, Fortune magazine ranked the
company the nation’s 134th largest in 2008.
Murphy Oil sells gasoline at Wal-Marts in 20
states and explores for oil and gas all over the
world, though nowhere near El Dorado. Yet,
loyal to its beginning in the region a century
ago, the company maintains its headquarters here and is treasured as the city’s largest
white-collar employer.
Claiborne P. Deming, who retired as Murphy’s president last month, says the Promise
was motivated by the company’s desire “to
give kids an opportunity to go away and
take advantage of their ability.” As a plus,
he adds, the company saw it as a potential
lure to professionals, who are sometimes
difficult for employers to attract to small,
rural Southern towns.
Depending on how long they’ve been
attending El Dorado public schools, graduates
are promised up to the highest tuition at an
Arkansas public university—$3,252 a semester this year. They can spend the money at any
two- or four-year, public or private, in-state
or out-of-state college or university.
The offer was an instant hit. Of the high
school’s 271 graduates that first year, 224, or
83 percent, went to college, compared with
the usual 60 percent. Results were similar in
2008. James Fouse, the school district official
who directs the Promise, says it has expanded
the college options of many students.
For others, it has provided their only opportunity. Senior Paul Lowery, for instance, is
the oldest of three siblings. He always wanted
to go to college but wasn’t always sure he’d be
able to—until the Promise. “I can go now,”
he beams. This fall, he expects to enroll at the
University of Arkansas.

Deming says the Promise has given
El Dorado “a nice sense of pulling together
and moving forward.” Landes envisions it
as “a tie breaker” that can work in the city’s
favor in attracting new business.
Don Hale, president of the advertising
agency that promotes El Dorado tourism,
predicts the Promise will succeed in attracting both new businesses and residents.
The school district, which had been losing
between 80 and 100 students a year for the
20 years before the Promise, is already crediting it for an uptick in enrollment—149 more
students in 2007 and 50 more in 2008.
Soon, El Dorado taxpayers will start
seeing physical evidence of their Promiseinspired largesse.
The new sales tax, which went into effect
July 1, 2007, is expected to generate $32-$34
million before expiring in 2015. Some of
the money is earmarked to develop a total
of 1,800 undeveloped acres in two locations
for prospective new businesses and to turn
the 116,000-square-foot building Prescolite
abandoned into a small-business development center.
With the biggest piece of the proceeds—
about $17-$18 million—the city plans to
build a conference center. At 51,000 square
feet, it will be the largest meeting space in
southern Arkansas and a magnet for out-oftown, as well as local, groups, Dumas says.
The additional school tax money will
finance a $45 million high school to replace
the current one, built in the late 1960s.
Groundbreakings for both the new conference center and the new high school are
scheduled for this spring.

Susan C. Thomson is a freelance writer.

n a t i o n a l

o v e r v i e w

Man the Lifeboats!
By Kevin L. Kliesen

L

ast year was an historic year for the
U.S. economy. To begin with, crude
oil, gasoline and commodity prices rose
to record-high levels, causing inflation
to accelerate rapidly. Over the first seven
months of 2008, inflation was running at
about a 6.25 percent annual rate. These
higher prices reduced the purchasing power
of households and narrowed profit margins
of many firms, causing a drag on consumption and business fixed investment.
Since August 2008, oil prices have plunged
and the near-term inflation outlook has
improved considerably. In fact, the CPI
declined at about an 8.25 percent annual
rate between July and November. This
development has led some economists to
speculate about the possibility of deflation,
which is defined as a falling aggregate price
level (GDP price index). Thus far, however,
most economists view the decline in the
CPI as a reflection of (i) falling energy and
commodity prices and (ii) the sharp slowing
in actual and projected domestic and global
economic growth. Most economists do not
expect a fall in the GDP price index this year.
Falling prices of equities and houses were
two developments in 2008 that reduced the
wealth of the nation’s households and created
enormous uncertainty about the strength of
the economy heading into 2009. The S&P
500 was down by nearly 50 percent at one
point in 2008, while house prices had fallen
nationally by about 13 percent from September 2007 to September 2008.
Financial stresses and their associated
fallout took a toll on key industries last
year. The housing industry faced its worst
economic conditions since the 1981-82
recession; the downturn that began in early
2006 showed few signs of bottoming. The

demise of
nontraditional
mortgage financing was a key factor behind
the sharp decline in home sales, which
caused a surge in the number of unsold
homes, thus putting downward pressure
on house prices. Likewise, automotive
manufacturers were also hit especially hard.
In November, the CEOs of Chrysler, Ford
and General Motors, faced with plummeting
sales and bloated inventories, appealed to the
U.S. Congress for government-backed loans.
On their balance sheets, a large number
of banks and other financial institutions
held securities whose underlying value
was tied to houses purchased with these
nontraditional mortgages. As house prices
fell, defaults and foreclosures rose, and the
value of these assets declined. In response,
a large number of U.S. financial institutions
either failed, were taken over or received
considerable financial assistance from the
Federal Reserve or the U.S. Treasury last
year. The much broader market for credit
derivatives, which many firms and investors
use to hedge against financial default, also
contributed to the turmoil.
In response to these developments,
the Federal Reserve adopted a two-track
strategy. First, the Federal Open Market
Committee reduced its federal funds target
rate, down to 1 percent by Oct. 29 and then
to a range of 0 to 0.25 percent on Dec. 16.
Second, the Federal Reserve implemented
several new lending facilities designed to
offset the reduction in credit availability
faced by many financial and nonfinancial
firms. The result was the largest year-toyear percentage increases in the nation’s
stock of high-powered money (monetary
base) ever seen. Policymakers are confident

that this enormous injection will eventually
spur increased lending and a rebound in
economic growth.
Through it all, the nation’s economy
managed to grow at a moderate pace over
the first half of 2008 (about 1.75 percent)—
even though the National Bureau of Economic Research determined that the U.S.
economy entered into a recession in December 2007. The United States also benefited
from a strong world economy in recent years
that was a boon for U.S. exporters. By late
summer, though, it was clear that both the
U.S. and most of the world’s largest economies were either in a recession or were sliding into one. In the third quarter of 2008,
the U.S. economy contracted at a 0.5 percent
annual rate, and most forecasters expect an
even larger decline in the fourth quarter.
The consensus of most forecasters is that
the U.S. economy will continue to contract
over the first half of 2009, with only modest
growth in the third and fourth quarters.
By the fourth quarter of 2009, the unemployment rate is projected to average about
8 percent. It is possible that this recession
will be somewhat deeper and longer than
the fairly mild recessions experienced in
1990-91 and 2001. It is too early to tell if the
recession will be as severe as those seen in
1973-75 and 1981-82.
Kevin L. Kliesen is an economist at the Federal
Reserve Bank of St. Louis. Douglas C. Smith
provided research assistance. For more on
Kliesen’s work, see http://research.stlouisfed.org/
econ/kliesen/index.html.
The Regional Economist | www.stlouisfed.org 19

d i s t r i c t

o v e r v i e w

ILLINOIS

INDIANA

St. Louis
Louisville

MISSOURI

KENTUCKY

ARKANSAS

Employment Growth Mixed
Across Eighth District

Memphis

Little Rock
MISSISSIPPI

By Craig P. Aubuchon, Subhayu Bandyopadhyay,
Rubén Hernández-Murillo and Christopher J. Martinek

S

ince 2001, the composition of jobs in the
United States and the Eighth District
has shifted. As employment in serviceproviding industries has grown, the number
of manufacturing jobs has decreased. In
October 2001, goods-producing industries
accounted for 17.8 percent of the U.S. labor
force. By October 2008, this figure was
only 15.5 percent. Across the four largest
Eighth District cities, this trend is also true;
the share of goods-producing industries
decreased from 17.1 percent to 14.8 percent
over the same period. The District cities
that have performed well in service-providing industries have also experienced the
strongest overall job growth.

leisure/hospitality service sectors all helped
lift Little Rock above the national average.
Memphis, which had the highest share of
service-sector jobs in the Eighth District,
posted the lowest year-over-year growth rate,
primarily because of job losses in the transportation and trucking industry, which make
up 27 percent of the Memphis economy.
For the Eighth District as a whole, the
education sector performed the best,
although still behind the U.S. as a whole.
Manufacturing and financial services
experienced the largest year-over-year
declines in job growth, with every District
MSA reporting negative growth.
Little Rock Zone

Eighth District Overview

From October 2007 to October 2008, Little
Rock was the only large metropolitan statistical area (MSA) within the Eighth District to
post a positive year-over-year rate of growth
in employment. At a growth rate of 0.03 percent, Little Rock was also the only large MSA
in the District to outperform the U.S., which
experienced job losses of 0.8 percent. Louisville (–1.3), St. Louis (–0.9) and Memphis
(–1.7) all posted lower year-over-year growth
rates than the U.S. as a whole.
St. Louis and Louisville both have a higher
proportion of goods-producing jobs than
the U.S. and experienced large job losses in
the manufacturing sector. Little Rock and
Memphis have a higher proportion of jobs in
the service sector than the U.S. Strong job
growth in the education, information and
20 The Regional Economist | January 2009

Little Rock has posted a positive year-overyear growth rate each year since 2003; this
growth rate has been above the U.S. yearover-year growth rate since 2006. Underlying
Little Rock’s employment growth have been
job gains in several service industries.
From October 2007 to October 2008, Little
Rock experienced positive job growth in
leisure/hospitality services (3.4), information
services (1.0), resources/mining/construction (3.0), education (1.7) and government
(1.1). Little Rock was also the only branch
city in the Eighth District to experience job
growth in the resources/mining/construction and leisure/hospitality sectors.
As a state capital, Little Rock employs
almost one-fifth (19.8 percent) of its labor
force in the government sector, higher than
the U.S. (16.4 percent) and higher than

TENNESSEE

The Eighth Federal Reserve District
is composed of four zones, each of
which is centered around one of
the four main cities: Little Rock,
Louisville, Memphis and St. Louis.

the rest of the Eighth District (13 percent).
Year-over-year growth of 1.1 percent in the
government sector helped to offset job losses
in the manufacturing, trade/transportation
and financial-services sectors.
Within the Little Rock Zone, the Texarkana, Ark., area (2.1 percent) and Fayetteville-Springdale-Rogers, Ark., area (0.8
percent) both posted positive year-overyear growth. Growth in Fort Smith, Ark.,
declined by 0.1.
Louisville Zone

The Louisville metro area employs 17
percent of its work force in goods-producing
industries, the highest proportion of the
four branch metro areas in the District. The
Louisville area experienced a 1.3 percent
decline in year-over-year growth through
October 2008, largely due to a 6.7 percent
drop in manufacturing. Within that sector,
durable goods and transportation equipment
experienced sharp job losses. Jobs in the
durable-goods manufacturing sector were
down 10 percent since October 2007; jobs in
the transportation-equipment manufacturing sector were down 29.5 percent over the
same period.
Louisville also experienced higher job
losses than the U.S. as a whole in information services (–2.0 percent), financial
services (–2.3 percent), business services
(–2.3 percent) and leisure/hospitality services (–3.5 percent).
Smaller metro areas in the Louisville
Zone that also had a decline in employment

Employment Growth
OCTOBER 2007 TO OCTOBER 2008—PERCENT CHANGE
4.0
3.0
2.0
1.0
0.0
–1.0
–2.0
–3.0
–4.0
–5.0
–6.0
–7.0

Little Rock
Louisville
Memphis
St. Louis
U.S.

Total
Nonfarm

Resources,
Mining and
Construction

0.03
–1.27
–1.65
–0.86
–0.78

3.02
–3.35
–5.25
–0.60
–5.20

Trade,
Transportation
Manufacturing and Utilities
–3.64
–6.74
–1.50
–4.25
–3.75

included Clarksville, Tenn. (–1.1 percent);
Evansville, Ind. (–0.4 percent); and Bowling
Green, Ky. (–0.4 percent).
Memphis Zone

Memphis experienced the largest yearover-year decline in nonfarm employment
among branch cities, losing 1.7 percent of
its jobs since October 2007. Memphis lost
jobs in nearly every employment sector,
but a third of the losses were concentrated
in the trade/transportation/utilities sector,
which lost 3,600 jobs since the previous year.
Memphis also had significant job losses in
the construction (–5.3 percent), business
services (–3.1 percent) and financial services
(–3.9 percent) sectors. Job growth remained
unchanged for information services (0.04
percent) and education (0.02 percent).
Jackson, Miss., a smaller MSA in the Memphis Zone, experienced a zero percent change
in year-over-year employment.
St. Louis Zone

The St. Louis Zone mirrors the U.S. in
its proportion of goods-producing jobs
and service-sector jobs, with 15.6 and 84.4
percent, respectively. St. Louis experienced
similar year-over-year growth rates as the
U.S. for total employment and in several sectors. Nonfarm payroll employment declined
by 0.9 percent from October 2007 to October
2008, slightly below the U.S. experience.

Information
Services

Financial
Services

Professional
and Business
Services

Education
and Health

Leisure and
Hospitality

Government

Other
Services

1.05
–1.97
0.04
–1.67
–1.52

–2.95
–2.30
–3.87
–0.81
–1.53

–0.36
–2.29
–3.14
–1.43
–1.66

1.70
1.46
0.02
1.38
2.77

3.39
–3.47
–2.05
–0.76
–0.01

1.14
2.65
–0.25
–1.17
1.05

1.42
–0.72
2.90
–0.48
0.60

–2.40
0.18
–2.03
–0.37
–1.63

Job losses were similar to national losses in
manufacturing (–4.3 percent), information
services (–1.7 percent), financial services
(–0.8 percent) and business services (–1.4
percent). St. Louis employment benefited
from 1.4 percent growth in education services. Education was the only sector in
St. Louis to add jobs since October 2007.
In contrast to the U.S. economy, St. Louis
lost jobs in the government services sector.
Within the St. Louis Zone, the smaller
MSAs of Columbia, Mo., and Springfield,
Mo., had job growth of 0.1 and 0.3 percent,
respectively. Job growth declined by 0.2
percent in Jefferson City, Mo.
Conclusion

Between January and October 2008, the
U.S. shed nearly 1 percent of total nonfarm
jobs. Goods-producing industries such as
manufacturing were the hardest hit. Both
Louisville and St. Louis, with relatively large
proportions of their work forces involved
in manufacturing, had significant losses.
In contrast, regions with the strongestperforming service industries fared the best.
Indeed, Little Rock was the only zone that
had positive year-over-year growth through
October 2008.
One apparent trend is that declining economic activity has reversed previous gains in
service-sector employment that once covered
job losses in the manufacturing sector. For

instance, the large share of transportation jobs in Memphis has reduced overall
employment in the local economy because
there are fewer goods to move. Employment
in financial services has declined in all four
branch cities of the Eighth District. Excluding Little Rock, the professional and business,
and leisure/hospitality services sectors have
gotten smaller in each branch city.

Subhayu Bandyopadhyay and Rubén Hernández-Murillo are economists at the Federal
Reserve Bank of St. Louis. For more on their
work, see http://research.stlouisfed.org/econ/
bandyopadhyay/index.html and http://research.
stlouisfed.org/econ/hernandez/index.html.
Craig P. Aubuchon and Christopher J. Martinek
are research associates at the Bank.

The Regional Economist | www.stlouisfed.org 21

e c o n o m y

a t

a

R e a d e r

g l a n c e

Eleven more charts are available on the web version of this issue. Among the topics they cover are agriculture, commercial
banking, housing permits, income and jobs. Much of the data is specific to the Eighth District. To go directly to these charts,
use this URL: www.stlouisfed.org/publications/re/2009/a/pdf/1-09-data.pdf.

8
7
6
5
4
3
2
1
0
–1
–2

C O N S U M ER P RI C E I N D EX

PERCENT

PERCENT

REA L G D P G ROWTH

03

04

05

06

07

08

6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5

NOTE: Each bar is a one-quarter growth rate (annualized);
the red line is the 10-year growth rate.

All Items Less Food and Energy

CPI–All Items

e x c h a n g e

Letters to the editor

The following are excerpts from letters
about October’s article titled “U.S. Income
Inequality: It’s Not So Bad.” To read the
letters in their entirety, along with complete responses by the article’s author,
St. Louis Fed economist Thomas A. Garrett,
go to www.stlouisfed.org/publications/re.

Dear Editor:
The article first provides some evidence
03

04

05

06

07

November

that a wider measure would show less

08

inequality, then argues that inequality is

NOTE: Percent change from a year earlier.

useful and necessary for a vibrant economy.
The first ignores many other ways in which

I N F L ATIO N - I N D EXE D TREAS U RY YIE L D S P REA D S

RATES ON FEDERAL FUNDS FUTURES ON SELECTED DATES

3

2.5

measures, and the second is wrong, and

2

2.0

which inequality causes trouble.

1.5

income families are less likely to have

10-Year

20-Year

PERCENT

5-Year

0
–1

8/5/08

9/16/08

10/29/08

12/16/08

1.0

for their income and suffer greater insecurity,
total inequality of well-being is still larger.

Dec. 12

05

06

07

health insurance, more likely to live in dangerous neighborhoods, work longer hours

0.5

–2
–3

in addition there are many other ways in
If you include the fact that the lowest-

1
PERCENT

inequality is actually greater than our

0.0

08

Dec. 08 Jan. 09 Feb. 09 Mar. 09 Apr. 09 May 09

NOTE: Weekly data.

CONTRACT MONTHS

But there are other and serious bad
effects of economic inequality: It leads to
political corruption and to crimes of the
poor, like prostitution and drug running.

I N TEREST RATES

7.0

6

It violates a basic assumption behind the

6.5

5

talism, i.e., that market demand and prices

6.0

4
PERCENT

PERCENT

C I V I L IA N U N E M P L OY M E N T RATE

5.5
5.0

are good guides for what to produce and
how to produce it. Does anyone believe

3

that our allocation of resources to infant

10-Year Treasury

health and to cosmetic surgery is justifiable?

2
Fed Funds Target

4.5
4.0

theoretical justification for free market capi-

Even worse, inequality leaves the masses

1
1-Year Treasury

November
03

04

05

06

07

0

08

03

04

05

06

07

November

08

without adequate income to provide full
employment and the few affluent without
real investment opportunities; so, the afflu-

NOTE: Beginning in January 2003, household data reflect revised
population controls used in the Current Population Survey.

ent and corporations bid up the prices of
stocks and other existing assets.

U . S . A G RI C U LT U RA L TRA D E

FAR M I N G C ASH RE C EI P TS

75
Trade Balance

170
BILLIONS OF DOLLARS180

60
BILLIONS OF DOLLARS

James N. Morgan, emeritus professor of economics and research scientist, Institute for Social
Research, University of Michigan; fellow of the
American Statistical Association; member of the
National Academy of Sciences

180
Imports

Exports

45
30
15

160
150
140

Crops

Livestock

130

Dear Mr. Morgan:

120

Your letter confuses income inequal-

110

ity and poverty. The social ills that you

100
0

October

03

04

05

06

07

NOTE: Data are aggregated over the past 12 months.
22 The Regional Economist | January 2009

08

90

August

03

04

05

06

07

NOTE: Data are aggregated over the past 12 months.

08

describe, such as crime, lack of health
insurance, drug abuse, etc., are a result of
poverty and not income inequality. Those

at the lowest end of the income distribution will still suffer negative
consequences regardless of how rich others are. Consider the following example: Suppose an economy has 10 people each making
$10,000. All 10 people are below the poverty level, and income
inequality is zero. Now suppose one of these 10 people finds $1 million in a trash can. Income inequality now increases dramatically, but
the well-being of the nine people still making $10,000 a year has not

Fed Flash Poll Results

Whenever a new issue of The Regional Economist is published, a new poll is
posted on the Bank’s home page, www.stlouisfed.org. The poll question is
always pegged to an article in that quarter’s issue. Here are the results of the
poll that went with the October issue. The question stemmed from the article
“U.S. Income Inequality: It’s Not So Bad.”

worsened. The point here is that the well-being of the nine people

13%

now-wealthier individual.

	Remain silent.

27%

Tom Garrett
Dear Editor:

What would you do about the growing
income gap in the united states?

8%

is a function of their poverty-level income and not the income of the

39%
13%

You state that “Wealthy people are not wealthy because they

	Invest more in education and job training to lift the income
of poor people at the expense of those with higher incomes.

have more money; it is because they have greater productivity.”
In what way do wealthy people have “greater productivity”—is

Argue that income inequality has benefits and shows that
our economy is working.
Cut tax breaks, subsidies and the like for those on both
sides of the gap to allow the natural state of income
inequality to surface.

229 responses as of 12/3/2008

Pass legislation to bring us closer to equal distribution
of income.

this capital productivity you are talking about or productivity of
their labor?
Your overall philosophy appears to be that “income inequality
is the byproduct of a well-functioning capitalist economy”—
presumably even a democratic capitalist economy. If this is the
case, why would the grass roots of any country, whether ours or
in emerging economies, favor such an economic system, especially
now in the face of the meltdown of the “capitalist economy,”
which needed to be bailed out by the taxpayers of the country?
John J. Pimenta of Wheaton, Ill.

This issue’s poll question:

What would you do to trim the debt and deficit?
1.
2.
3.
4.
5.

Raise taxes to pay for current government programs.
Cut government spending across the board.
Do nothing. Allow deficit spending to continue.
Reform Social Security and Medicare, focusing on revenue increases.
Reform Social Security and Medicare, focusing on benefit reductions.
To vote, got to www.stlouisfed.org.  Anyone can vote, but please do so only once.
(This is not a scientific poll.)

Dear Mr. Pimenta:
Here I am relating income to marginal productivity, that is, the
value of one’s labor. Income is positively correlated with the value
of labor. Think of a major league baseball player versus a janitor.
The former is highly skilled and generates large revenues (through
ticket sales, etc.). Not everyone can be a major league ballplayer.
On the other hand, janitorial work is low-skilled labor that most
people could perform.
I would argue that any economic system should be evaluated on
its long-run performance, rather than any short-run performance.
Certainly, capitalism is not perfect, but it is that very system that
has propelled this country to the greatest economic power on the
planet. Even the poorest folks in the United States have a standard
of living that is much higher than poor people in other countries.
Furthermore, there are numerous factors that have played a role
in the current crisis, many of which are not related to our specific
economic system.
Tom Garrett

Community Development Conference Is Set
The second biennial Exploring Innovation conference sponsored by the
Federal Reserve Bank of St. Louis will take place April 22-24 in St. Louis.
The conference brings together people from all over the country who are
involved in community development, including bankers, researchers,
developers of affordable housing and representatives of nonprofit
organizations and of government agencies.
The theme of the 2009 conference will be “Innovation in Changing
Times,” a reflection of the current financial crisis. This conference will
focus on resiliency, sustainability and innovative programs that can
improve an organization’s performance so that it can still have a positive
impact on its community, even in the face of tough economic conditions.
Registration begins this month. For more information, see www.exploringinnovation.org.
Working with the Fed to plan this event are CFED (Corporation for
Enterprise Development), Enterprise Community Partners, NeighborWorks America, Opportunity Finance Network and Social Compact.

Dear Editor:
Tom Garrett has overturned countless studies and updates of
income inequality assessments in one efficient stroke of careful
analysis of the data and analytical flaws in prior approaches. He
also highlights the role of official data sources in spreading the
interpretive problems with misguided reporting routines.

www.exploringinnovation.org

John Shelnutt, an economist in Little Rock, Ark.
The Regional Economist | www.stlouisfed.org 23

R e a d e r

e x c h a n g e

ask AN economist

n e x t
economic efficiency of a nation, such openness

Globalization …
of a Financial Crisis

may hurt some groups within an economy. In

Subhayu Bandyopadhyay’s
research interests are
international trade,
development economics
and public economics.
The native of India has lived
in the United States since
1987 and is now a U.S. citizen.
He is an avid cricket fan,
having played the baseball-like
game in his youth. He likes to
travel and meet people of
different cultures.

particular, there is a lot of concern that immigration may hurt native U.S. labor. To the extent that

Recent financial market turmoil
did not affect just the United States,
but spread to become a global crisis.
In the April issue of The Regional
Economist, read about the impact
on other countries around the
world and find out about some
of the policy responses that
they implemented.

the skill level of the immigrant is a close substitute
for that of the native worker, this seems plausible.
However, at least three points are worth noting in
this context. First, unskilled immigrants may do
jobs that unskilled natives may not want to do; so,
natives may not compete with immigrants for the
same type of jobs. Second, skilled immigrants may
complement and enhance the productivity of the
unskilled natives, much like machines enhance the

Should we be concerned about the
economic impact of immigration
on native U.S. labor?

i s s u e

productivity of labor. Finally, to the extent that the
employers of the immigrants benefit, they are able
to invest in their businesses to raise employment
opportunities for all.
A recent paper by Gianmarco I.P. Ottaviano and
Giovanni Peri focuses on these issues.1 The authors

Immigration is the use of imported labor

found that immigration during the 1990-2006

as a factor of production. While international

period had a small negative effect (negative 0.7

trade in goods and services ships goods across

percent) on wages of native workers with no high

international borders, immigration allows labor

school degree. In the longer run, this effect was

to be imported. In principle, international trade

actually a positive 0.3 percent for the same

can perform the same function as immigration

group. Average wages also showed a similar

because nations that have cheap labor can

pattern in the researchers’ analysis.

make goods that are intensive in labor and export

We know from Depression-era history that

not necessarily provide opportunities to others.

them to labor-scarce nations. This should help

greater protectionism in the face of an economic

Rather, the law of unintended consequences can

alleviate the labor scarcity problem for richer

downturn is likely to only accentuate the problem

lead to outcomes that are detrimental to all.

nations, while reducing the labor glut in the

of high unemployment. It is generally recognized

poorer ones, benefiting both. In practice,

that the Smoot-Hawley Tariff Act in 1930 —along

however, barriers to trade, as well as the fact

with retaliatory tariffs imposed by other coun-

that services are often not easily traded, may

tries—exacerbated the onset of the worldwide

require nations to allow immigration.

Great Depression.

While movement of labor, capital and goods

Times of economic slowdown might increase

across international borders is generally con-

pressures to “protect” jobs, but ill-conceived plans

sidered a good thing in the context of overall

to limit employment opportunities for some does

1

	Ottaviano, Gianmarco I.P.; and Giovanni Peri.
“Immigration and National Wages: Clarifying the
Theory and the Empirics.” National Bureau of
Economic Research Working Paper No. 14188,
July 2008. See www.nber.org/papers/w14188.
Submit your question in a letter to the editor.
(See Page 2.) One question will be answered
by the appropriate economist in each issue.

PRSRT STD
Federal Reserve Bank of St. Louis
P.O. Box 442
St. Louis, Mo 63166

US POSTAGE
PAID

ST LOUIS MO
PERMIT NO 444

economy at a

The Regional

glance

Economist

January 2009

8
7
6
5
4
3
2
1
0
–1
–2

03

04

05

06

07

08

6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5

November

03

2.5

2

2.0
20-Year

PERCENT

PERCENT

1
0
–1

07

08

1.5
8/5/08

9/16/08

10/29/08

12/16/08

1.0

Dec. 12

05

06

07

0.0

08

Dec. 08 Jan. 09 Feb. 09 Mar. 09 Apr. 09 May 09
CONTRACT MONTHS

NOTE: Weekly data.

C I V I L I A N U N E M P L O Y M E N T R AT E

I N T E R E S T R AT E S

7.0

6

6.5

5

6.0

4
PERCENT

PERCENT

06

0.5

–2

5.5

3
10-Year Treasury

5.0

2

4.5

1

4.0

05

RATES ON FEDERAL FUNDS FUTURES ON SELECTED DATES

3

10-Year

04

NOTE: Percent change from a year earlier.

I N F L AT I O N - I N D E X E D T R E A S U RY Y I E L D S P R E A D S

5-Year

All Items Less Food and Energy

CPI–All Items

NOTE: Each bar is a one-quarter growth rate (annualized);
the red line is the 10-year growth rate.

–3

VOL. 17, NO. 1

CONSUMER PRICE INDEX

PERCENT

PERCENT

REAL GDP GROWTH

|

Fed Funds Target
1-Year Treasury

November
03

04

05

06

07

0

08

03

04

05

November

06

07

08

06

07

08

NOTE: Beginning in January 2003, household data reflect revised
population controls used in the Current Population Survey.

U . S . A G R I C U LT U R A L T R A D E

FA R M I N G C A S H R E C E I P T S

75

180
Imports

Exports

Trade Balance

170
BILLIONS OF DOLLARS180

BILLIONS OF DOLLARS

60
45
30
15

160
150
140

Crops

Livestock

130
120
110
100

0

October

03

04

05

06

07

NOTE: Data are aggregated over the past 12 months.

08

90

August

03

04

05

NOTE: Data are aggregated over the past 12 months.

U.S. CROP AND LIVESTOCK PRICES / INDEX 1990-92=100
195
Crops

Livestock

175
155
135
115
95
75

November

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

commercial bank performance ratios
U . S . B an k s by A sset S i z e / third Q U A R T E R 2 0 0 8
All

$100 million­$300 million

Less than
$300 million

$300 million$1 billion

Less than
$1 billion

$1 billion$15 billion

Less than
$15 billion

More than
$15 billion

Return on Average Assets*

0.44

0.65

0.60

0.46

0.53

0.38

0.45

0.44

Net Interest Margin*

3.31

3.93

3.96

3.86

3.91

3.87

3.89

3.13

Nonperforming Loan Ratio

2.26

1.88

1.82

2.22

2.03

2.31

2.18

2.30

Loan Loss Reserve Ratio

2.00

1.32

1.33

1.41

1.37

1.61

1.50

2.19

R E T U R N O N AV E R A G E A S S E T S *
0.52

NET INTEREST MARGIN*

0.98
1.11
0.68
0.54

–0.29

.25

.50

1.14

.75

1.00

1.25 1.50

PERCENT

2.0

2.5

1.07

3.5

4.0

4.5

2.08

Illinois

1.27
1.21

Indiana

1.38
1.22
1.18
1.17
1.27
1.20

Missouri
3.70

1.00 1.50 2.00 2.50 3.00 3.50 4.00

1.39

Tennessee
PERCENT

1.65

1.40
1.40

Mississippi

Third Quarter 2008

3.0

1.25

Kentucky

1.47

.50

1.5

Arkansas

1.30
1.12

.00

1.0

Eighth District

2.00

0.89

3.88

3.25
3.25

L O A N L O S S R E S E RV E R AT I O

1.27
1.09

0.59

3.59

Tennessee

1.69

0.97

3.95
4.10

Mississippi
Missouri

1.05

2.03

1.39

3.89
3.86

Kentucky

N O N P E R F O R M I N G L O A N R AT I O
1.11

3.84
3.63

Indiana

1.01

0.49

–.50 –.25 .00

3.65
3.54

Illinois

0.94
1.07

0.40

3.98
4.08

Arkansas

1.00

0.91

3.70
3.78

Eighth District

0.95

1.61
2.75

0.99

.00

.50

1.00

1.50

2.00

2.50

Third Quarter 2007

NOTE: Data include only that portion of the state within Eighth District boundaries.
SOURCE: FFIEC Reports of Condition and Income for all Insured U.S. Commercial Banks
* Annualized data

For additional banking and regional data, visit our web site at:
www.reserach.stlouis.org/fred/data/regional.html.

3.00

regional economic indicators
nonfarm employment growth * / third Q U A R T E R 2 0 0 8
year-over-year percent changE
United
States

Eighth
District †

Arkansas

–0.3%

–0.3%

8.3

Construction

Illinois

Indiana

0.3%

–0.1%

–0.7%

0.3%

0.1%

4.7

–0.7

–0.9

1.7

3.1

–15.7

#NA

–5.9

–2.0%

–0.2

–3.7

–1.5

–0.9

–0.1

–1.2

#NA

Manufacturing

–3.0

–2.8%

–3.0

–0.9

–4.1

–3.0

–3.6

–4.0

–2.5

Trade/Transportation/Utilities

–1.1

0.3%

–0.1

0.4

–0.7

1.7

0.1

0.7

–0.1

Information

–1.5

–0.9%

1.0

–1.5

0.3

–1.4

–1.5

–0.9

–1.1

Financial Activities

–1.3

–1.2%

0.7

–1.5

0.2

–0.4

–0.5

–2.5

–1.9

Professional & Business Services

–0.7

–0.1%

2.1

0.8

–1.2

–0.6

1.0

–0.4

–2.0

Educational & Health Services

3.2

1.3%

2.0

1.3

0.7

–0.3

1.7

1.8

1.8

Leisure & Hospitality

0.9

–0.4%

1.5

–0.4

0.9

0.3

–1.4

–1.1

–1.8

Other Services

0.6

–0.6%

1.0

–1.2

0.4

–0.6

1.0

–1.2

–0.4

Government

1.4

0.6%

0.5

–0.1

1.2

3.0

0.1

0.4

0.3

Total Nonagricultural
Natural Resources/Mining

Kentucky

Mississippi

Missouri

Tennessee

–0.4%

–0.5%

–0.6%

* NOTE: Nonfarm payroll employment series have been converted from the 1987 Standard Classification (SIC) system
basis to a 2002 North American Industry Classification (NAICS) basis.
†

E ighth District growth rates are calculated from the sums of the seven states. For Natural Resources/Mining and Construction categories, the data exclude
Tennessee (for which data on these individual sectors is no longer available).

U nemployment R ates

adjusted gross casino revenue*
II/2008

III/2007

United States

6.0%

5.3%

4.7%

Arkansas

4.7

4.9

5.5

Illinois

7.1

6.2

5.2

Indiana

6.3

5.3

4.5

Kentucky

6.9

6.0

5.5

Mississippi

7.8

6.6

6.3

Missouri
Tennessee

6.5

5.6

5.2

6.9

6.1

4.7

900
800
MILLIONS OF DOLLARS

III/2008

700
600
500
400
300
Mississippi

200

2000Q3

2001Q3

2002Q3

2003Q3

Indiana

Illinois

2004Q3

2005Q3

Missouri
2006Q3

2007Q3 2008Q3

* NOTE: Adjusted gross revenue = total wagers minus players’ winnings. Native
American casino revenue (Mississippi only) is not included in 2007 Q3 dollars.
Recession bars are determined by the National Bureau of Economic Research.
SOURCE: State gambling commissions.

H ousing permits / thir D quarter

REAL PERSONAL INCOME* / second QUARTER

year-over-year percent change in year-to-date levels

year-over-year percent change

–32.7
–24.6
–19.4
–21.9
–46.1

7.8

–40
2008

–20

1.9

Tennessee
0

20

2007

All data are seasonally adjusted unless otherwise noted.

40

PERCENT

3.1

1.8

Missouri
–19.1

1.9

1.7

Mississippi

–34.7
–31.6

4.4

1.3

Kentucky

–5.3

–35.5

–60

1.0

Indiana

–13.7

3.8

1.5

Illinois

–26.3

3.5
2.6

Arkansas

–28.5
–31.2

–39.9

1.5

United States

–2

–1
2008

0

1

2

4.5
2.5
2.5

3

4

2007

*NOTE: Real personal income is personal income divided by the PCE
chained price index.

5