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July 1999

Research
U P D AT E
f r o m t h e F e d e r a l R e s e r v e B a n k o f N e w Yo r k
RESEARCH AND MARKET ANALYSIS GROUP

w w w. n y. f r b. o r g / r m a g h o m e

Payments Services Make a Surprisingly Large
Contribution to Bank Balance Sheets
Many people believe that banks’ main activities are lending and deposit taking and that
other types of services produce marginal
amounts of income. But that perception is not
true, according to a study of the twenty-five
largest bank holding companies in the United
States. Indeed, an often overlooked area of
banking—payments services—generates a
major share of total bank revenues.
In “Banks’ Payments-Driven Revenues”
(Economic Policy Review, vol. 5, no. 2), author
Lawrence J. Radecki analyzes the importance
of fee income to the top twenty-five U.S. bank
holding companies. Using data from the companies’ annual reports and Federal Reserve
System regulatory reports, he builds estimates
for three categories of payments-driven revenue: deposit accounts, credit cards, and securities handling and other processing services.
All told, he finds that payments services
were responsible for as much as two-fifths of
the total combined operating revenue of
about $140 billion earned by the twenty-five

largest bank holding companies in 1996.
Among the categories, deposit accounts yielded
the bulk of the revenues (roughly $40 billion),
followed by credit card services (as much as
$11.8 billion). Securities handling and other
processing services generated about $6.5 billion.
“The very substantial amount of revenue
derived from payments services indicates that
the production and distribution of these services constitute one of the main business activities of commercial banks,” Radecki concludes.

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Ne w Research: Apr il–June 1999

Stocks Still Lag Far behind Housing as a Share
of Most Households’ Portfolios
The rapid growth of the stock market has
encouraged the belief that corporate equities
are becoming a key asset for most American
families. A recent study in Current Issues in
Economics and Finance (vol. 5, no. 5, “Are
Stocks Overtaking Real Estate in Household
Portfolios?”) suggests, however, that only the
wealthiest 10 percent of the population hold
significant amounts of corporate equity.
According to authors Joseph Tracy, Henry
Schneider, and Sewin Chan, the large majority
of American households continue to invest
primarily in real estate. “The importance of
housing varies over the life cycle of the individual, but real estate remains the cornerstone of
most household asset portfolios,” they note.
Their findings counter the view of household wealth provided by the aggregate data
in the Federal Reserve’s Flow of Funds
Accounts. This source shows that equities in
1998 constituted a larger share of total household assets than did real estate.

Noting that the flow of funds figures are
computed in a way that gives additional
weight to the equity shares of wealthy households, the authors turn to an alternative source
of data on household wealth, the Federal
Reserve’s Survey of Consumer Finances. Using
the information on individual households
reported in the 1995 survey, Tracy, Schneider,
and Chan are able to evaluate the asset portfolio of a typical household. They find that
this typical household has almost two-thirds
of its assets in real estate and no portion in
corporate equity.
The study attributes the typical household’s
high real estate share to the current system of
housing finance, which effectively rules out
any limited investment in housing. The lack of
alternative financing options means that
households are compelled to commit a disproportionate amount of their funds to the purchase of a house, leaving little capital for other
kinds of investment.

Publications and Papers
The Research and Market Analysis Group produces a wide range of publications:
• The Economic Policy Review—a policy-oriented research journal focusing
on macroeconomic, banking, and financial market topics.
• Current Issues in Economics and Finance—a newsletter-style publication offering
concise and timely analyses of economic and financial topics.
• Second District Highlights—a regional supplement to Current Issues covering financial
and economic developments in the Federal Reserve System’s Second District.
• Staff Reports—technical papers presenting research findings, designed to stimulate
discussion and elicit comments. These papers are intended for publication in leading
economic and finance journals. Staff Reports are available only in electronic form.
• Publications & Other Research—a brochure spotlighting the Group’s research output.

www.ny.frb.org/rmaghome

Measurement Problems Fail to Explain Why Recent
Growth Rates Have Not Matched Earlier Rates
Despite posting their strongest performance
in many years, recent measures of real output
(GDP) and productivity growth have fallen
short of their 1960-73 averages. Specifically,
although the recent trend in productivity
growth points to an improved economy,
the post-1996 average growth rate of almost
2 percent is still well below
The post-1996 average productivity the nearly 3 percent average that prevailed between
growth rate of almost 2 percent 1960 and 1973.
Why, then, has current
growth not matched the
rates of the past? In “The
average of nearly 3 percent. Impact of Reduced Inflation
Estimates on Real Output
and Productivity Growth,” author Charles
Steindel examines whether the answer lies in
problems associated with the measurement of
the rates (Current Issues in Economics and
Finance, vol. 5, no. 9).

is well below the 1960-73

Steindel suggests that one can question the
accuracy of the growth rates because the datagathering systems often use survey samples
that are small and somewhat out of date. He
adds that an overstatement of inflation may
be compounding the difficulties, because an
increase in reported inflation decreases the
rates of real GDP and productivity growth.
Such an overstatement may be especially
important in certain hard-to-measure services,
such as medical care and financial services.
These services are inherently hard to price,
and their nature has changed dramatically
with the introduction of new technologies.

The author shows that hard-to-measure
services have indeed accounted for a greater
share of GDP over the years, and that inflation
has been higher in these services than in other
sectors of the economy. Furthermore, reduced
estimates of the rate of inflation in hard-tomeasure services do raise recent GDP and
productivity growth rates.
Nevertheless, Steindel finds that these rates
would still have been lower in recent years
than in the 1960-73 period—even if an especially strong upward bias in service-sector
inflation estimates had begun after 1973.
Accordingly, he concludes that “it is difficult to
attribute the inability of recent output and
productivity growth rates to regain their 196073 pace solely to the inexact pricing of hardto-measure services.”

Staff Reports Available
Only in Electronic Form
Earlier this year, the Research and
Market Analysis Group announced the
full electronic presentation of its Staff
Reports series.
With this announcement, we ceased
distributing hard copies of individual
papers in the series and directed all readers to our Internet site. From the site,
readers can download the latest papers
and many earlier issues in Adobe Acrobat
format.
www.ny.frb.org/rmaghome

Federal Reser ve Bank of Ne w York

New Titles in the Staff Reports Series
The following new Staff Reports are available
electronically at the Research and Market
Analysis Group’s web site.
www.ny.frb.org/rmaghome

Microeconomics
Importing Equality? The Effects of Increased
Competition on the Gender Wage Gap,
by Sandra E. Black and Elizabeth Brainerd
(Number 74)

Consumption, Aggregate Wealth, and
Expected Stock Returns, by Martin Lettau
and Sydney Ludvigson (Number 77)

How does increased product market competition
affect the ability of firms to discriminate? Black and
Brainerd find that increased competition resulting from
globalization has forced companies to reduce costly
discrimination against women.

Ludvigson and Lettau review the role of detrended
wealth in predicting stock returns. They find that trend
deviations in wealth are strong predictors of real stock
returns and excess returns over a Treasury bill rate.

Sunk Costs, Contestability, and the Latent
Contract Market, by Chris Stefanadis
(Number 75)

Explaining Inequality the World Round:
Cohort Size, Kuznets Curves, and Openness,
by Matthew Higgins and Jeffrey G. Williamson
(Number 79)

The idea that an industry with sunk costs may be
contestable even in the absence of long-term contracts
has received little attention in formal economic theory
yet remains popular among monopolists facing
antitrust suits. Stefanadis employs an infinitely repeated
game to formally illustrate the argument.

Macroeconomics and Growth

Higgins and Williamson decompose the sources of
inequality among countries into three central parts: the
demographic or cohort size effect, the so-called Kuznets
Curve or demand effects, and the commitment to globalization or policy effects. Their analysis suggests that
cohort size is the most important force in determining
inequality.

International
Purchasing Power Parity: Three Stakes
through the Heart of the Unit Root Null,
by Matthew Higgins and Egon Zakrajšek
(Number 80)

Using three new tests, Higgins and Zakrajšek find
overwhelming evidence in favor of real exchange rate
stationarity during the post–Bretton Woods era among
developed economies and among a larger group of
“open” economies.
International Trade and Factor Mobility: An
Empirical Investigation, by Linda S. Goldberg
and Michael W. Klein (Number 81)

Does foreign direct investment serve as a complement to or a substitute for trade? The authors’ investigation shows that U.S. foreign direct investment in Latin
America has led to both increases and decreases in trade
among countries and across manufacturing industries.

Banking and Finance
The Term Structure of Announcement Effects,
by Michael J. Fleming and Eli M. Remolona
(Number 76)

How do U.S. Treasury yields of different maturities
respond to macroeconomic announcements? Fleming
and Remolona find that the announcements evoke
the sharpest reactions from the intermediate-term
maturities. The authors also find that different types
of announcements generate different patterns of
announcement effects.
Are There “Bank Effects” in Borrowers’ Costs
of Funds? Evidence from a Matched Sample
of Borrowers and Banks, by R. Glenn Hubbard,
Kenneth N. Kuttner, and Darius N. Palia
(Number 78)

The authors use a large, matched sample of individual loans, borrowers, and banks to measure the effects
of banks’ financial conditions on loan interest rates
while controlling for firm characteristics. They find that
the cost of borrowing from low-capital banks tends to
be higher than the cost of borrowing from well-capitalized banks, and that the difference is more pronounced
for smaller firms.

Papers Presented by Economists in the Research
and Market Analysis Group
Martin Lettau and Sydney Ludvigson.
“Consumption, Aggregate Wealth, and
Expected Stock Returns.” National Bureau of
Economic Research Asset Pricing Meeting,
Cambridge, Massachusetts, May 13.
Lettau and Ludvigson show that a wide
class of optimal models of consumer behavior
implies that the log consumption to aggregate
wealth ratio forecasts the return on aggregate
wealth, or the market portfolio. Although
human wealth is not observable, they argue
that its important predictive components can
be captured by labor income. Thus, movements
in nonhuman wealth that produce a deviation
from its shared trend with consumption and
labor income drive changes in the ratio. Lettau
and Ludvigson find that these deviations are
strong predictors of real stock returns and
excess returns over a Treasury bill rate.
Donald P. Morgan. “Judging the Risk of Banks:
Why Can’t Bond Raters Agree?” Seminar sponsored by the Bank of England, London,
England, June 4.
Is bank risk hard to observe from the outside, as bank supervisors presume, or have
banks become opaque because they are protected from market discipline? Morgan argues
that banks are in fact opaque, and that the
opaqueness is inherent to the business. The
mostly financial assets of banks have risks that
are harder to measure (such as loans) and/or
easier to change (such as trading assets) than
the more fixed assets of nonfinancial firms.
Morgan finds that rating agencies disagree
more over banks with more loans and trading
assets relative to securities. Since banks on the

whole have very few fixed assets, he concludes
that banks are regulated and protected because
they are opaque.
Carol Rapaport. “Medicare and Inequalities in
Health Outcomes: The Case of Breast Cancer,”
with Sandra L. Decker. International Health
Economics Association Conference, Rotterdam,
the Netherlands, June 9.
Rapaport and Decker evaluate whether
expanding Medicare to cover women aged
fifty-five to sixty-four will improve various
breast cancer outcomes in these individuals.
Among their findings, they determine that
expanding Medicare does not improve the
probability that a black woman will have her
cancer diagnosed sooner. However, if she is
diagnosed early, the price effects of insurance
will improve her chances of survival.
Kevin J. Stiroh. “Do Computers Make Output
Harder to Measure?” with Robert H. McGuckin.
Conference titled “Intangibles: Management,
Measurement, and Organization,” sponsored
by New York University’s Stern School of
Business, New York City, May 27.
Stiroh and McGuckin explore the possibility
that information technology is generating output that is increasingly hard to measure in
nonmanufacturing industries, a factor that
contributes to the divergence in industry productivity growth rates. Stiroh and McGuckin’s
results suggest that these escalating measurement problems are understating aggregate
productivity growth in the 1990s, and that
these problems play an important role in
understanding recent industry-level productivity trends.

Federal Reser ve Bank of Ne w York

Cédric Tille and Paolo Pesenti. “Competitive
Devaluations: A Welfare-Based Approach,”
with Giancarlo Corsetti and Nouriel Roubini.
Seminar sponsored by INSEAD, Fontainebleau,
France, April 16.
The authors describe a three-country, centerperiphery model that examines the mechanism
by which exchange rate shocks are transmitted
across countries. They provide a choice-theoretic

framework for the policy analysis and empirical assessment of competitive devaluations,
and show that the optimality of undertaking a
competitive devaluation depends on the trade
pattern. The authors conclude that there can be
an incentive to devalue when the two periphery
countries’ exports compete in the center market;
however, the incentive is reduced in the presence
of a direct trade link between the countries.

Recently Published
Sandra E. Black. 1999.“Do Better Schools Matter? Parental Valuation of Elementary Education.”
Quarterly Journal of Economics 114, no. 2 (May): 577-600.
Linda S. Goldberg. 1999.“Investment, Pass-Through, and Exchange Rates: A Cross-Country
Comparison,” with José Campa. International Economic Review 40, no. 2 (May): 287-314.
Linda S. Goldberg and Joseph Tracy. 1999.“Exchange Rates and Employment Instability:
Evidence from Matched CPS Data,” with Stephanie Aaronson. American Economic Review,
Papers and Proceedings 89, no. 2 (May): 204-10.
Linda S. Goldberg and Joseph Tracy. 1999.“Exchange Rates and Local Labor Markets.”
NBER Working Paper no. 6985.
James Harrigan. 1999.“Estimation of Cross-Country Differences in Industry Production
Functions.” Journal of International Economics 47, no. 2 (April): 267-93.
Paolo Pesenti. 1999.“Paper Tigers? A Model of the Asian Crisis,” with Giancarlo Corsetti
and Nouriel Roubini. European Economic Review 43, no. 7: 1211-36.
Asani Sarkar. 1999.“Market Liquidity and Trader Welfare in Multiple Dealer Markets: Evidence
from Dual Trading Restrictions,” with Peter Locke and Lifan Wu. Journal of Financial
and Quantitative Analysis 34, no. 1: 57-88.
Kevin J. Stiroh. 1999.“Information Technology and Growth,” with Dale W. Jorgenson.
American Economic Review, Papers and Proceedings 89, no. 2 (May): 109-15.
Kevin J. Stiroh. 1999.“Measuring Input Substitution in Thrifts: Morishima,Allen-Uzawa, and
Cross-Price Elasticities.” Journal of Economics and Business 51, no. 2 (March-April): 145-57.

Kei-Mu Yi. “The Nature and Growth of Vertical
Specialization in World Trade,” with David
Hummels and Jun Ishii. Seminar sponsored by
Brandeis University’s Graduate School of
International Economics and Finance,
Waltham, Massachusetts, May 4.
The authors describe vertical specialization,
a process that occurs when a country uses
imported intermediate parts to create a good it
later exports—that is, the country links sequentially with other countries to produce a final

good. This process has become an increasingly
important part of international trade. Yi,
Hummels, and Ishii find that vertical specialization has grown by roughly 40 percent over the
past twenty-five years, and that the process now
accounts for approximately 30 percent of international exports.
Individual copies of these papers can be
obtained by e-mailing the Research and
Market
Analysis
Group
authors
at
firstname.lastname@ny.frb.org.

Research Group Hosts Conference on Income Inequality
In May, some of the country’s leading
researchers, academics, and policy analysts
met at the Federal Reserve Bank of New York
to discuss the subject of income inequality in
the United States. The conference—“Unequal
Incomes, Unequal Outcomes? Economic
Inequality and Measures of Well-Being”—
drew more than seventy participants and featured remarks by New York Fed President
William J. McDonough and Director of
Research Stephen G. Cecchetti.
Over the past several decades, the United
States has experienced an extraordinary rise
in income inequality accompanied by declining
real incomes among the poor. With this in
mind, the Research Group economists who
organized the conference asked presenters to
focus on the less widely discussed fallout
from income inequality: the impact on broad
measures of economic well-being. In other

words, has there been a similar deterioration
in outcomes—in health, housing, education,
crime, and the provision of local public services—particularly among the poor?
Among their findings, the participants concluded that the well-being of the poor did deteriorate according to some measures, such as
mortality and health. Moreover, the quality of
the housing stock has improved, but housing
has become less affordable for the poor. On a
more positive note, crime victimization rates
have fallen nationwide, and there was little evidence that violent crime has become more concentrated in poor neighborhoods.
The conference proceedings will be published in a special issue of the Economic Policy
Review later this year. For more information on
the conference, please contact James Orr at
james.orr@ny.frb.org.

Federal Reser ve Bank of Ne w York

RESEARCH AND MARKET ANALYSIS GROUP
PUBLICATIONS AND PAPERS: APRIL–JUNE 1999
Economic Policy Review

Staff Reports

Volume 5, Number 2

Available only at www.ny.frb.org/rmaghome.

Recent Banking Sector Reforms in Japan,
by Hiroshi Nakaso

Importing Equality? The Effects of Increased
Competition on the Gender Wage Gap,
by Sandra E. Black and Elizabeth Brainerd
Number 74 (April)

Legal Structure, Financial Structure, and the
Monetary Policy Transmission Mechanism,
by Stephen G. Cecchetti
How Important Is the Stock Market Effect
on Consumption? by Sydney Ludvigson
and Charles Steindel
Banks’ Payments-Driven Revenues,
by Lawrence J. Radecki

Current Issues in Economics
and Finance
Are Stocks Overtaking Real Estate in
Household Portfolios? by Joseph Tracy,
Henry Schneider, and Sewin Chan
Volume 5, Number 5 (April)
Is Upstate New York Showing Signs
of a Turnaround? by Richard Deitz
and Mike De Mott
Volume 5, Number 6 (May)
Second District Highlights
Mercosur: Implications for Growth in
Member Countries, by Michelle Connolly
and Jenessa Gunther
Volume 5, Number 7 (May)
The Future of Financial Intermediation
and Regulation: An Overview,
by Stephen G. Cecchetti
Volume 5, Number 8 (May)

Sunk Costs, Contestability, and the Latent
Contract Market, by Chris Stefanadis
Number 75 (April)
The Term Structure of Announcement
Effects, by Michael J. Fleming
and Eli M. Remolona
Number 76 (May)
Consumption, Aggregate Wealth, and
Expected Stock Returns, by Martin Lettau
and Sydney Ludvigson
Number 77 (June)
Are There “Bank Effects” in Borrowers’ Costs
of Funds? Evidence from a Matched Sample
of Borrowers and Banks, by R. Glenn Hubbard,
Kenneth N. Kuttner, and Darius N. Palia
Number 78 (June)
Explaining Inequality the World Round:
Cohort Size, Kuznets Curves, and Openness,
by Matthew Higgins and Jeffrey G. Williamson
Number 79 (June)
Purchasing Power Parity: Three Stakes
through the Heart of the Unit Root Null,
by Matthew Higgins and Egon ZakrajŠek
Number 80 (June)
International Trade and Factor Mobility: An
Empirical Investigation, by Linda S. Goldberg
and Michael W. Klein
Number 81 (June)

The Impact of Reduced Inflation Estimates
on Real Output and Productivity Growth,
by Charles Steindel
Volume 5, Number 9 (June)
Business-to-Business Electronic Commerce,
by John Wenninger
Volume 5, Number 10 (June)
The views expressed in the publications and papers summarized in Research Update are those of the
authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the
Federal Reserve System.