april 2010 regional economist - federal reserve bank of st. louis

8/9/2019 April 2010 Regional Economist - Federal Reserve Bank of St. Louis

http://slidepdf.com/reader/full/april-2010-regional-economist-federal-reserve-bank-of-st-louis 1/24

A Quarterly Reviewo Business and Economic Conditions

Vl. 18, N. 2

April 2010

The Federal reserve Bank oF sT. louis

C e n T r a l t a m e r i C a ’ s e C o n o m yTm

Cllase in Tradearis,QuotasandtheLikeAren’toBlameTisime

Incme DifferenCountries’BarrierstoBusinessakeoll



c o n t e n t s

Recer Is Liel T Be Prlnged, PainflBy Bill Emmons

It’stimetopaythepiperorourreewheelingspending

othepastdecade.Althoughsomescenariosorthe

utureeconomyprovidereasontohope,therecovery

islikelytobeslowandvolatile.

4

The Regional Economist i pblihd

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Economist l h wrir a

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Director of Research

chriphr J. Wallr

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Deputy Director of Research

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Editor

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The Regional

EconomistAPRIL 2010 | VoL. 18, no. 2

cover: © MaksiM striganov/shutterstock

3 P R e s I D e n t ’ s M e s s A g e

10 The Trade Collapse:

Lining Up the Suspects

By Silvio Contessi and

Hoda El-Ghazaly

Don’tblametraderestrictions

thistime.Instead,thethree

culpritsarethecreditcrunch,

the“compositionaleect”and

thetrendawayrommakingan

entireproductinonecountry.

12 Disparate Living StandardsAren’t Easily Explained

By Riccardo DiCecio

Dierencesinphysicalandhuman

capitaldon’tullyexplainthe

staggeringdierencesinliving

standardsaroundtheglobe.

Tehighcostostartinganew

businessandthedicultiesin

obtainingnancinginsome

countriesalsoarekeyactors.

14 c o M M unI t Y P R o F I L e

Clmbs, Miss.

By Susan C. Tomson

Columbusandsurrounding

LowndesCountyhaveseena

positiveturnaboutintheir

economythisdecade,thanksin

largeparttotheennesseeValley

Authority’smegasitesprogram.

Itsparkedanewwaveoindustrial

developmentaroundtheairport,

creatingseveralthousandjobs.

17 nAt I o nAL o V e R V I e WAnther Jbless

Recer

By Kevin L. Kliesen

Mostorecastersexpectthatthe

unemploymentratewilldecline

slowly,eventhoughtheeconomy

ispickingupandinationis

expectedtobesubduedthisyear.

Onthebrightside,productivity

hasgoneup,whichisgoodinthe

longrunorlivingstandards.

18 D I s t R I c t o V e R V I e W

Nt-S-Bad News

n Hsing

By Craig P. Aubuchon and

Subhayu Bandyopadhyay

HousepricesintheDistrictel

byonly0.4percentintheourt

quarter,aslowerrateodecline

thanhasbeenthepatterno

late.Asawhole,theDistrict’s

housingmarketishealthier

thanthenation’s.

20 econo MY At A gLA nc

2 1 Why HARM the Subprim

Borrower?

By Rajdeep Sengupta and

Yu Man am

Hybridadjustableratemortgag

(HARM)weredesignedtobe

renancedbythe“resetdate,”

whentheinterestratewould

jump.Tesemortgagesworkeoutwellormanypeoplewho

werecreditrisks—butonly

aslongashousingprices

continuedtorise.

22 R e A De R e x c HA nge

2 The Reginal Ecnmist | April 2010



James Bllard, Prid ad ceo

Fdral Rrv Bak s. Li

The Fed: A Central Ban with a Reginal Strctre

P R e s I D e n t ’ s M e s s A g e

Urbanvs.rural.EastCoastvs.theresto

thecountry.Bigbankersandbigbusi-

nessvs.everyoneelse.Morevs.lessgovern-

mentcontrol.

Familiarasthesecontroversiesmayseem,

theyaren’treerencestothebattlesotoday

buttotheorcesthatwereatplayacentury

agointheyearsimmediatelyprecedingthe

oundingotheFederalReserveSystem.BythetimetheBankingPanico1907

struck,thecountryhadbeenwithoutacen-

tralbankor70years.Tersttwocentral

banks(theFirstandSecondBanksothe

UnitedStates,1791-1811and1817-1837)

wereeachshutdownafertwodecades,in

partbecausemostothecountrywashostile

towardacentralizationandconcentration

obankingpower.Butaferasuccession

obankruns,creditshortagesandnan-

cialcrises,bytheearly20thcenturymost

peoplerecognizedthatanoverhaulothebankingandmonetarysystemwasneeded.

WallStreetbankerswantedamoreecient

system—aprivatecentralbankthatthey

controlled.Toseoutsidethepowercenters

oNewYorkandWashingtonwanteda

structurethatwouldmeettheneedso

allregionsothecountry;manyothese

peopleeltthatbankers—especiallybigcity

bankers—servedprimarilythewealthy.

Tisgroupalsowantedatleastsomepublic

oversightinthesystem.

Teneedorreormwasbasic:Tesup-pliesocurrencyandbankloanswereinex-

ible,tiedmoretothenation’sgoldreserves

andsupplyogovernmentdebtthantothe

needsobusinessandagriculture.Tis

“inelasticcurrency”ledtohighinterestrates

andtightcreditwhendemandormoneywas

highandcouldn’tbemet—orexample,at

harvesttime.Althoughbanksheldreserves

inabout50cities,thelargestvolumewaskept

inNewYork.Hence,sharpincreasesinthe

demandormoneyaroundthecountrycre-

atedmajorliquidityproblemsorbanksin

NewYork,atthenation’snancialcenter.

Financialcrisesprovokedsuspensiono

paymentsandsignicantrecessions.

Inthewakeothe1907Panicandresult-

ingrecession,CongresssetuptheNational

MonetaryCommissiontostudycentral

banksandbankinginothercountriesandproposeastructureortheUnitedStates.

Treeyearslater,thecommissionpresented

theAldrichPlan,namedoritschairman,

Sen.NelsonAldrich,R-R.I.Temostpower-

ulsenatorohisday,hewasviewedasa

stand-inorthebankingandbusinesselite

otheEast.Hisplancalledoronecentral

institutionwithbranchesacrossthecoun-

try.Controlwouldrestwithaboarddomi-

natedbybankers.UnliketheFirstBank

andSecondBankotheUnitedStates,the

governmentwouldhavenonancialstakeinthisproposedstructure.

Aldrich’stimingcouldn’thavebeenworse.

HispartyhadjustlostcontroloCongress,

thankstothegrowingpopularityothePro-

gressivemovement.Likethepopulistsothe

previouscentury,theprogressiveswerewary

otheconcentrationoeconomicandpoliti-

calpower.Teyoughtthemonopolization

okeyindustries,whichusuallywasassisted

bypowerulbankers.Althoughprogressives

supportedbankingreorm,theyadvocated

somecontrolsbythegovernmenttoprotectsocietyatlarge,andtheyinsistedonastruc-

turethatallowedthevaryingcreditneedso

thedierentpartsothecountrytobemet.

TeelectionoDemocratWoodrowWil-

sontothepresidencyin1912killedAldrich’s

plan.Wilsonopposedthecreationoa

centralbankandhadrailedinhiscampaign

against“themoneymonopoly.”Wilson’s

adviserspresentedanalternativeplan:about

20private,locallycontrolledregionalreserve

banks.Teywouldnotonlyholdthereserves

otheirmemberbankssothatthemoneywas

closeathandwhenneededlocally,butwould

meetmemberbanks’othercurrencyand

creditneeds.Eventually,theplanalsocalledorthereservebankstosupervisethose

memberbanks,issuecurrencyagainstcom-

mercialassetsandgold,andperormother

centralbankingunctions.Wilsonapproved

otheplanbut,reectingtheprogressives’

desireorsomegovernmentoversight,pro-

posedacentralboardogovernmentappoin-

teesinWashingtontocontrolandcoordinate

theworkotheregionalbanks.(Atitsincep-

tion,thisboardwasrelativelyweak—andcer-

tainlynotaspowerulasitexiststoday.)Ina

nodtobankers,WilsonproposedtheFederalAdvisoryCouncil;eachregionalbankwould

electonebankertoserveonthiscounciland

meetoccasionallywiththecentralboard.

Toughwranglingcontinuedoverthe

numberoregionalreservebanks(thenal

numberwas12)andtheirlocations,Wilson’s

planwas,orthemostpart,whatwaspassed

byCongressin1913.Althoughthestructure

tookmanyturnsinsubsequentyears,the

FederalReserveSystemwasborn—andstill

stands—asacentralbankwithadecentral-

izedstructure,onewithregionalrepresenta-tion,butpublicoversight—aclassicexample

ochecksandbalancesinU.S.democracy.

The Reginal Ecnmist | www.stlisfed.rg 3



F u t u R e e c o n o M Y


Ecnmic HangerRecovery Is Likely o Be Prolonged, Painul

By Bill Emmons



heglobalnancialcrisisandtheGreatRecessiono2008-09markedtheendoadecadethat

seemedtoogoodtobetrueormanyAmericans. AferescapingtheAsiannancialcrisiso1997-98relativelyunscathed,the

U.S.economyexperiencedhistoricboomsinstockmarkets,housingmarkets

andcreditmarkets.Hugeincreasesinhouseholds’wealthandborrowing,inturn,supportedrobustconsumer-spendinggrowthandhousinginvestment

despitemoderategrowthoincomeormost.obesure,manyAmericanswere

excludedromthegoodtimes,butmanybroad-basedmeasuresoeconomic

welare—suchastheunemploymentrate,consumer-spendinggrowth,access

tocreditandthehomeownershiprate—rivaledorattainedtheirbestlevelsever.

Tis“dreamworld”orisingwealthandmaterialwell-beingbecameanight-

marein2008.Tevalueostocks,nonederalbondsandhousesplunged;credit

becameunavailabletomany,whilemortgageoreclosuressoared;andtheglobal

economysankintoadeeprecession.Meanwhile,mostoanenormousincrease

inhouseholddebtaccumulatedduringtheree-spendingdecaderemainedinplace,andgovernmentborrowingexploded.

Weretherecentnancialcrisisandtheensuingsevererecessionmerely

“badluck”thatwemighthaveavoidediwehad,orexample,crackeddown

onsubprimemortgagelendingmuchearlier?Orwastheburstingostock-

market,housingandcreditbubblesinevitable,soonerorlater?Teanswersto

thesequestionsareimportantorgaugingtheutureotheU.S.economy.Iwe

simplyweresidetrackedbythenancialcrisisandrecession,thenwecanexpect

eventuallytoresumemanyothetrendsandeaturesothepre-2007economy.

I,ontheotherhand,the1998-2007decadeitselwasananomaly,thecrisis

may,inact,signalanecessarytransition—albeitapainulone—toalessree-

spendingbutmoresustainabletrajectoryortheU.S.economy.

Tisarticleisdividedintotwomainparts.Tersttakesalookbackatthe

decadeprecedingthenancialcrisistounderstandwhythedownturnwasso

severe.Inretrospect,itappearsthatsomesorto“coursecorrection”wasinevi-

table.TeU.S.economyhadbecomedangerouslydependentonconsumerbor-

rowingandspending,which,inturn,dependedtoalargedegreeonrapidlyrising

houseprices.Atthesametime,manyothercountrieshaddevelopedtheirown

dependenceonexportingtotheUnitedStates.okeepexportgrowthhigh,

thesenationsincreasinglyreliedonatypeovendornancing—thatis,theylentusthemoneytobuytheirexports.Tenancialcrisismarkedtheendothis

uneasyequilibrium.Whenhousepricesstoppedrising,millionsoAmerican

householdsnolongercouldsupportthedebttheyhadtakenonthatallowed

themtospendmorethantheirincomesonhousing,servicesanddurablegoods—

alargeportionowhichcameromoverseas.Tesecondpartothearticle

looksorward.Whileit’salwaysdiculttoorecasttheuture,threepossible

scenariosortheeconomyareexamined.Nothingabouttheutureeconomyis

certain,butwearelikelytoaceaprolongedandpainulperiodoadjustment.

Part I: The Past

A Decade of Credit-Fueled Growth

in Household Spending

U.S.householdspendinggrewconsider-

ablyasterduringthe1997-2007decade

thanpersonalincome.Figure1showsthat

per-personexpendituresongoodsandservicesgrewabout29percentinination-

adjustedtermsbetween1997and2007,

whileper-personafer-taxincomegrew

onlyabout25percent.Per-personination-

adjustedgrossdomesticproduct(GDP)

grewonlyabout22percent.1

Teresultospendinggrowthexceed-

ingincomegrowthisaallingsavingrate,

whetheroranindividualamilyororthe

nationasawhole.Figure2showsthatthe

U.S.householdsavingrateellromabout

5percentduring1997-98(alreadyahistori-callylowlevel)toabout2percentduring

Part II: The Future

The Uncertain Outlook

Giventhelargeroleohouseholdspend-

ingongoods,servicesandhousinginthe

Americanand,indeed,theglobaleconomy

duringrecentyears,newlyrugalconsum-ersarelikelytokeepeconomicgrowthrates

subduedorsometime.InviewoAmeri-

canhouseholds’historicallyhighdebtbur-

denandthepotentialornegativeeedback

eectsonincomegrowthitsel,aprotracted

years-longperiodopainuladjustment

appearslikely.

Isthereanyescaperomthisscenario

ogrowth-inhibitinghouseholddeleverag-

ing?Perhaps,butitwillrequiresignicant

changesinconsumerbehaviorandnationa

economicpolicies.Inbroadoutline,Amer-icanconsumersmustdurablyraisetheir

savingratesandtheederalgovernment

mustcomemuchclosertobalancingits

budgetonaconsistentbasisevenintheace

oloomingdecitsounprecedentedsize.

Othercountriesmuststimulatedomestic

spendingandreducetheirlargetradesur-

pluses,whichresultinlargecapitalexports

totheUnitedStatesandothercountries.

continued on Page 6

continued on Page 8

illustration by nigel buchanan The Reginal Ecnmist | www.stlisfed.rg 5




2005-07.TegurealsoshowsthattheU.S.

householdborrowingrate—denedasthe

annualincreaseintheamountohousehold

debtoutstandingasapercentodisposable

income—wasveryhighduringthedecade.

Teperiod1997-2007,thus,wasadecade

orisinghouseholddebt.Figure3showsthe

increaseinhouseholdindebtednessafer

1997relativetotheincreaseinhousehold

income.Ination-adjustedper-person

debtincreasedmorethan80percent

between1997and2007,thelargestincrease

overa10-yearspansincethe1960s.Te

lion’sshareohouseholdborrowingduring

thedecadewassecuredagainstowner-

occupiedhousing—thatis,intheormo

mortgagedebt.Teamountoination-adjustedmortgagedebtoutstandingper

personnearlydoubledbetween1997

and2007,whilethevalueohousehold

realestategrewabitlessthan90percent

through2007.

Aggressivemortgageborrowingmight

haveseemedlikeagoodideaaslongas

housingandotherassetvalueswererising.

Nowthathousingvalueshavedeclined

sharplyinmanypartsothecountry,the

inherentriskoleveragehasbeenexposed.

Debtmagniesboththegainsandlossesontheassetbeingnanced.Te65percent

oU.S.home-owninghouseholdsthat

haveanymortgagedebttogetherappear

tohavelostvirtuallyallotheirhomeown-

ers’equitybetweenearly2006andearly

2009,almost$6trillion(Figure4).Com-

poundedbyrisingunemployment,theloss

ohomeowners’equityhasbeenamajor

actordrivingmortgage-oreclosurerates

tohistorichighs. 2

A Growing but Unbalanced

U.S. Economy

AlthoughoverallU.S.economicgrowth

duringthedecadethrough2007averaged

about3percentannually,justasithaddur-

ingtheprevious10years,thecomposition

andnancingoU.S.growthwerequitedi-

erentacrossthetwodecades.Teeconomy

afer1997becamedominatedbyconsumer

andgovernmentspendingattheexpense

obusinessinvestmentandexports,while

continued rom Page 5

Part I: The Pastthedomesticinvestmentthattookplace

wasskewedtowardresidentialbuildingand

increasinglyreliedonundsprovidedby

oreigninvestorsintheU.S.

Te Composition of U.S. GDP Growth

Whileconsumerspendingaccounted

orabout65percentoeconomicgrowthduringthe1988-1997decade,itconsti-

tuted82.5percentogrowthduringthe

1998-2007decade(able1).Government

spendingongoodsandservicescontributed

aurther14percenttoeconomicgrowth

duringthelaterdecade,comparedwith

only7percentduringtheearlierdecade.

Tus,consumerandgovernmentspending

togetheraccountedor72percentoGDP

growthduringthe1988-97decade,but

96percentduringthe1998-2007decade.

ComparedwiththelongerU.S.post-WorldWarIIhistory,thecompositiono

GDPgrowthduring1998-2007alsowas

unusual.Consumerandgovernment

spendingtogetherconstitutedabout81

percentoGDPgrowthduringthe1950-87

period,whilebusinessinvestmentand

netexportstogetheraccountedorabout

11percent.Tecorrespondinggureso

96and3percent,respectively,orthe1998-

2007periodbetrayasignicantshif

towardconsumerandgovernmentspend-

ingattheexpenseobusinessinvestment

andnetexports.

Te Financing of U.S. Investment

Anotherwaytolookattheeconomyis

toseehowitsinvestmentisnanced.Any

nationhastwosourcesoundsorinvest-

ment—domesticsavingandborrowing

romabroad.Becausethehouseholdsector

issuchalargepartotheU.S.economy,it

shouldcomeasnosurprisethatthedeclining

householdsavingrateduringthe1997-2007

decadewasechoedbyashiftowardoreignborrowingbythenationasawhole.As

showninable1,theU.S.tradedecit

increasedsharplyafer1997.Tisimplies,as

amatteroaccounting,thattheU.S.greatly

increaseditsborrowingromoreigners.

U.S.netborrowingromabroadexceeded

4percentoGDPeachyearrom2000

through2008(withtheexceptiono2001,at

3.9percent),alevelnotpreviouslyexceeded

sincetheearlypartothe20thcentury.

97 98 99 00 01 02 03 04 05 06 07 08 09 10

130

125

120

115

110

105

100

Consumption Expenditures

Disposable Income

Gross Domestic Product

INFLAT ION-ADJUSTED, PER PERSON

FIGURE 1

FIGURE 2

Spending Outpaces Income

Borrowing and Saving

NOTE: The average value of each series during 1997 is set equalto 100. Data are annual through 2009.

SOURCE: Bureau of Economic Analysis

NOTE: Data are annual through 2009.

SOURCES: Federal Reserve Board and Bureau of Economic Analysis

60 65 70

YEAR

YEAR

75 80 85 90 95 00 05 10

14

12

10

8

6

4

2

0

–2

Household Borrowing RateIncrease in household debt as percent of disposablepersonal income

Household Saving Rate

Household saving as percent of disposable personal income

I N

D

E X

L

E V E L

P E R

C

E N

T



FIGURE 3

FIGURE 4

Debt and Income

Mortgage Debt and Homeowners’ Equity

NOTE: Data are annual through 2009.

SOURCES: Federal Reserve Board and Bureau of Economic Analys

NOTE: Data are quarterly through Q4.2009.

SOURCES: Federal Reserve Board and author’s estimates.

97 98 99 00 01 02

YEAR

YEAR

03 04 05 06 07 08

200

190

180

170

160

150

140

130

120

110

100

Household Debt

Disposable Income

IN F L A T IO N -A D JU ST E D , P E R P E R S O N

Average level in 1997 equals 100.

97 98 99 00 01 02 03 04 05 06 07 08 09 1

12000

10000

8000

6000

4000

2000

0

Value of Mortgage Debt Outstanding

Estimated Value in Mortgaged Households’

Real Estate Holdings

B I L L I O N S

O F

D O L L A R S

I N D E X

L E V E L


Is Unbalanced Growth Better than No Growth at All?

Whilethetrendsjustdescribedwere

visibleatthetime,manycommentators

dismissedthemasharmlessor,indeed,

benecialaspectsoanincreasinglyglobal-

izedworldeconomy.Teirargumentwas

seductivelysimple:Justasindividualsandnationsspecializeinactivitiestheydobest

andtradewithotherstoincreasethewelare

oall,perhapstheglobalizationogoods,

servicesandcapitalmarketswouldallowthe

UnitedStatestoconcentrateonwhatitdid

bestandthentradewithothersthatspecial-

izeddierently.

Teobviousawinthisargumentisthat

whattheU.S.appearedtodobestonalarge

scale—consumerspending,homebuilding,

borrowingandtheprovisionosophisti-

catednancialservices,suchasmortgagesecuritization—didnotresultinastable,

letalonebalanced,internationaltradeposi-

tionorastablesavingrate.Inact,theU.S.

tradedecit—moreprecisely,thecurrent-

accountdecit—doubledasapercento

GDPbetween1997and1999,thennearly

doubledagainby2006.Hadthistrend

continued,nancingourburgeoningtrade

decitwouldhavebecomeincreasingly

dicult.Atthesametime,thehousehold

(andnational)savingratewasallingper-

sistently—whichitcouldnotdoorever.Itnowappearsthat,by1997or1998atthe

latest,theU.S.economyhadembarkedona

pathounbalancedgrowth.Soonerorlater,

amajorcoursecorrectionwasinevitable.

Asitturnedout,someotherebalancing

hadbegunbeorethenancialcrisisand

recessionhit.Inparticular,houseprices

stoppedrisinginabout2006.Increasing

numbersohouseholdsdeaultedontheir

unsupportabledebts,aatemerelypostponed

byrisinghousepricesduringthepreceding

years.Asmortgagedeaultsandmarket-

valuelossesonmortgage-backedsecurities

rippledthroughthenancialsystem,the

economyitselbegantoslowsharply.Te

severenancialandeconomicshockso

2008and2009weretheultimateresultand

haveacceleratedthereversalothetrendsin

placeoradecade.

Global Imbalances—Part of the

Solution or the Problem?

JustastheU.S.economyevolvedinan

unbalancedandhistoricallyunusualway

afertheAsiancrisiso1997-98,unusual

internationaldevelopmentsweretaking

place.AverageratesoU.S.andworld

economicgrowthwerehealthyduringthe

1997-2007decade,butindividualecono-

miesdivergedmarkedlyinhowtheygrew.Consumerspending,housinginvestment

andgovernmentspendingtookonincreas-

ingimportanceintheUnitedStatesandin

someotherhigh-incomecountrieslikethe

UnitedKingdom,whilebusinessinvestment

andexportslagged.Atthesametime,many

othercountries—includingbothhigh-

incomeanddevelopingcountries—were

virtualmirrorimagesotheU.S.,increas-

ingbusinessinvestmentandexportsaster

thanconsumerorgovernmentspending.

TeU.S.personalandnationalsavingratesdeclinedtohistoriclows,whilethese“mir-

ror-image”countriesexperiencedsharply

highersavingrates.

osecureamoreevenpatternoinvest-

mentaroundtheworld,thecountrieswitha

surplusosavingstogetherlenthundredso

billionsodollarseachyeartothecountries

generatinginsucientdomesticsavingsto

unddesiredinvestment.Byaccounting

necessity,thesegrowinginternational

c o M p o s i t i o n o u . s . g D p g r o w t h

a

gDp

(% m

)

c -

m

xd (pce;

% gDp )

c

m

d (g; %

gDp )

sm -

pce d

g (% gDp

)

c

-

m (i; %

gDp )

c

x (nX;

% gDp

sm -

i d nX (%

gDp )

1950-1987 3.72 63.4 18.8 81.2 13.0 –2.1 10.9

1988-1997 3.05 64.9 7.4 72.3 20.1 3.3 23.4

1998-2007 3.02 82.5 13.9 96.4 18.1 –15.5 2.6

source: b em a

Table 1




capitalowswereassociatedwithoset-

tingimbalancesinthetradeaccountso

therespectivecountries.

Countriesintherstgroupincurred

increasingdecitsontheirinternational

currentaccounts,whilecountriesinthe

secondgroupaccumulatedlargesurpluses.

Tedecitcountries—includingtheU.S.,

theU.K.,Spainandaewothers—hadin

commonrelativelysophisticatednan-

cialsystemsandrelaxedattitudestoward

borrowing.Surpluscountries—including

China,anumberootheremerging-market

countries,Japan,Germanyandseveral

oil-exportingcountries—typicallyhad

lesswell-developednancialsectorsand

alessborrower-riendlyclimate.Some

surpluscountriesalsoappearedtoollow

an“export-ledgrowthstrategy,”dened

bytheInternationalMonetaryFund

(IMF)toincludeanundervaluedexchangeratetogetherwithmeasurestocompress

domesticspending.3Teresultothese

policieswastoincreasethecountry’strade

surplusand,atthesametime,increaseits

nancial-accountdecit(lendingabroad).

Teemergenceolargeglobalimbalances

duringthedecadeafertheAsiancrisishas

beenstudiedingreatdetail,whiletheir

interpretationremainsopentodebate.4

TeIMFandotheranalystshaveout-

linedanumberoscenariosortheworld

economyduringthenextewyears.5Te

possibilitiesrangeromverygood—an

internationallycoordinatedrestructuring

okeyeconomies—toverybad—aretreat

intoshort-sighted,protectionistpolicies

leadingtoarenewedglobaleconomic

slump.Whichoutcomeultimatelyoccurs

dependsonhowprivateandpublicactorsbehaveduringthenextew,criticalmonths

andyears.Herearethreebroadscenarios,

togetherwiththepolicyactionsthatwould

makethempossible.

Scenario 1: Global Cooperation o

Rebalance World Output and Demand

Temostoptimisticscenarioentails

wide-spread,simultaneouseortsbythe

leadersandordinarycitizensomany

countriestoreocustheireconomieson

sustainabledomesticproductionandcon-

sumption.Inthiscontext,sustainability

reerstopatternsowork,investmentand

spendingthatdonotrelyonpersistent,large

internationaltransersoeconomicand

nancialresources.Drawingananalogyto

anindividualhousehold,thebasicideais

that“proigate”consumersshouldplanto

spendwithintheirmeanswithoutrequent

recoursetoborrowing,while“miserly”

householdsshouldavoidaccumulating

excessivesavingsthatarelenttoothers.At

thenationallevel,itimpliesthatinterna-

tionaltradeandnancialbalancesshould

notbearromzeroineitherdirectionover

longperiodsotime.

Unortunately,theU.S.hasincurredvery

largetradedecitsandcorrespondingnan-

cialsurpluses(capitalimports)ordecades.

Moreover,theimbalancesgrewsharplyduringthe1997-2007decade.Tispattern

oincreasinglyunsustainableeconomic

growthwasanimportantcontributortothe

globaleconomicandnancialcrisisthat

occurredbecause,ultimately,millionso

Americanhouseholdsbuckledunderexces-

siveburdensounsupporteddebtwhen

housepricesdeclined.

AtthesametimethatmanyAmerican

householdswerediggingthemselvesdeeper

intodebt,therewereosettingimbalances

buildingupinothercountries.Giventheinterdependentnatureointernationaltrade

andcapitalows,itclearlywouldbebesti

coordinatedbehaviorandpolicychanges

couldbeundertakeninmanyorallothe

aectedcountries.

Abenignglobalrebalancingwouldsee

decitcountries,suchastheUnitedStates,

increasesavingbyhouseholdsandtheed-

eralgovernment,whileincreasingbusiness

investmentandexports.Atthesametime,

surpluscountriessuchasChinawouldexpand

socialsaetynets(todecreasehouseholds’needtosave),improvecorporategovernanc

(todecreasehoardingocashandwasteul

overinvestment),andencourageconsumer

spendingandimports.Othergroupsosur-

pluscountriesalsocouldcontributemean-

ingullytoglobalrebalancing.Forexample,

oil-exportingcountriescoulddelinkoil

pricesromthedollar,andtheagingecono-

miesoEuropeandJapancouldtakeactions

toraisetheirdomesticgrowthpotential.6

continued rom Page 5Part II: The Future

th pibilii ra rm

vry d—a iraially

rdiad rrri

ky mi— vry

bad—a rra i hr-

ihd, prii plii

ladi a rwd lbal

mi lmp.




decitsandnear-zeroshort-terminterest

rates—whichprobablykepttheglobal

economyoutoadepression—arereversed

abruptlyandiprivate-sectorspending

slowsunexpectedly,economiesaroundthe

worldcouldallbackintoaslumpasbadas

orworsethanthedownturnexperienced

during2008and2009.Underthesecircum-

stancesoa“double-dip”globalrecession,

renewedpolicyinterventionsmightneedto

beevenmoredrasticthanduringtherst

downturn.Furtherlong-lastingeconomic

damageintheormolong-termunemploy-

mentandnancialdeaultswouldoccur.

Conclusion

Paying the Piper

Withthebenetohindsight,onecan

sayweshouldhaveseenthenancialcrisiscoming.Althoughsomeanalystspointed

tounbalancedU.S.economicgrowthand

growingglobalnancialimbalances,ew

anticipatedhowrapid,severeandglobalthe

downturnwouldturnouttobe.

Americansalmostcertainlywillsave

more,spendincloserproportiontotheir

incomeandincreasetheirborrowingmore

slowly,ordecreaseitoutrightinthecoming

years.Saiddierently,aprotractedperiod

ohousehold“deleveraging”appearslikely.

Tiswilltranslateintorelativelyslowconsumerspendingandoveralleconomic

growthunlessothersourcesodemand

materialize.Ieconomicgrowthremains

weak,itwillmeanthathousepricesremain

subdued,mortgagedeaultsremainhigh

duetorequentinstancesonegativehome-

owners’equityandtheaverageAmerican

household’snancialsituationimproves

onlyslowly.

Onebitterlessonwehavelearnedisthat

unbalancedgrowth,whetherinonecountry

oraroundtheworld,bringsrisksinitswake.

Unlessweareabletorebalanceourown

economyand,incooperationwithother

majorcountries,dothesameattheglobal

level,wearelikelytoacealongperiodo

slowandvolatileeconomicrecovery.

Bill Emmons is an economist at the Federal Reserve Bank o St. Louis. For more on hiswork, see http://www.stlouised.org/banking/ pd/SPA/Emmons_vitae.pd

Tisbenign-rebalancingscenarioprobably

wouldbeassociatedwithweakercurrency

valuesindecitcountriesandstronger

currenciesinsurpluscountries.Orderly

exchange-ratechangescanmoderatethe

domesticadjustmentsneededinwagesand

pricestosupportchangingtradepatterns.

Scenario 2: Lack of Coordinated Policy

Adjustments—Global Imbalances Return

Less-benignoutcomesarepossible,o

course.Continuedrelianceonexport-led

growthstrategiesinmajoremergingmar-

ketsandsomelarge,advancedcountries

couldrustrateattemptsbytheU.S.toshif

itseconomyawayromexcessiveconsumer

andgovernmentborrowingandspending

andtowardbusinessinvestmentandexports.

Conversely,ourtradingpartnerscouldtake

positivestepsthatourownindierenceorpolicygridlocknegated.

SupposetheU.S.unilaterallymadea

numberopoliticallydicultpolicychoices

thatwouldsupporteconomicrestructur-

ingandglobalrebalancing.Tesemight

includereducingtaxincentivesthatavor

excessivehousinginvestment,mortgage

borrowingandhealth-careexpenditures,

aswellasimplementingabroad-based

consumptiontaxdesignedtoencourage

savingoverconsumerspending.Butiour

tradingpartnersdidnotsimultaneously

increasetheirwillingnessandabilitytobuy

ourexports,theresultcouldbedisastrous.

AveryweakU.S.economycouldbecrippled

byanevenmoredepressedhousingmarket

andashrinkinghealth-caresector,while

exportsectorsshowednegligibleimprove-

mentovertheirgrowthbaselines.Te

politicalresponselikelywouldbetoreverse

thereormsandexpandbailouteorts.A

returntolowhouseholdandnationalsav-

ing,unbalanceddomesticgrowthandglobal

imbalancesprobablywouldollow.

Scenario 3: No Policy Adjustments and

Premature Withdrawal of Macroeconomic

Support—Global Slump Returns

Athirdpossibilityisthatnoprogress

towardeconomicrestructuringoanykind

ismade,whilepolicymakersintheUnited

Statesandelsewheremisjudgethestrength

oeconomicrecovery.Igovernment

policiesthathaveresultedinlargebudget

E N D N O E S

1 DataromBureauoEconomicAnalysis.An

importantreasonwhyhouseholdafer-tax

incomegrewasterthanGDPwasthattax

rateswerereducedintheearly2000s.Tus,

partothegrowthindisposablehousehold

incomeduringthedecaderepresenteda

redistributiononationalincome,rather

thangenuineincreasesinoutput.2 SeeEmmons.Teaggregatevalueohome-

owners’equityconcealsawidevarietyo

individualsituations.Manyhomeowners

withmortgagedebthavepositiveequity,while

manyothershavenegativeequity.Itisthose

withnegativeequitywhoareatgreatestrisk

odeault.3 SeeBlanchardandMilesi-Ferretti.4 SeeBernankeandBlanchardand

Milesi-Ferretti.5 SeeBlanchardandMilesi-Ferretti.6 Delinkingoilpricesromthedollarmight

divertsomecapitalexportsromoilexport-

ing-nationsintonon-U.S.markets,resulting

inlessupwardpressureonthedollar.Mean-

while,deregulatinglabormarketsandservice

sectorsintheagingnationsoEuropeand

Japancouldraisedomesticgrowthpotential

andreducetradesurpluses.

R E F E R E N C E S

Bernanke.BenS.“TeGlobalSavingGlut

andtheCurrentAccountDecit.”Homer

JonesLectureattheFederalReserveBank

oSt.Louis,April14,2005.Seewww.

ederalreserve.gov/boarddocs/speech-

es/2005/20050414/deault.htm

Blanchard,Olivier;andMilesi-Ferretti,Gian-

Maria.“GlobalImbalances:InMidstream?”

IMFStaPositionNote,Dec.22,2009,

SPN/09/29.

Bucks,BrianK.;Kennickell,ArthurB.;Mach,

raciL.;andMoore,KevinB.“Changesin

U.S.FamilyFinancesFrom2004to2007:

EvidenceFromtheSurveyoConsumer

Finances.”Federal Reserve Bulletin,February

2009,Vol.95,No.1,pp.A1-A55.

Emmons,WilliamR.“Housing’sGreatFall:

PuttingHouseholdBalanceSheetsogether

Again.”FederalReserveBankoSt.Louis’

Te Regional Economist ,October2009,Vol.17

No.4,pp.14-15.



longwiththespreadothenancial

crisisthatbeganin2007,theworld

experiencedthelargestrecessionsincethe

GreatDepression.AccordingtotheInter-

nationalMonetaryFund,worldGDPellby

0.8percentin2009,whileadvancedecono-

miesexperiencedacontractiono3.2per-

cent,thelargestdeclineinthepast50years.Exportsromtheadvancedeconomiesell

evenmore,byastaggering12.3percent,about

ourtimesasmuchasthedropinGDPand

approximatelyasmuchasexportstothe

advancedeconomies.

TegureshowstherateogrowthoU.S.

GDP,importsandexports,aswellasapattern

thatwascommontomanyothercountries

duringthecrisis:Teimportsandexportso

advanced,emerginganddevelopingecono-

miesellbysimilarpercentages,rangingrom

aminimumo11.7percenttoamaximumo13.5percent.Similarly,thereboundoU.S.

tradeowsthatappearsinthegureatthe

endo2009wasobservedinothercountries.

Telarger-than-expecteddropintrade

haspuzzledeconomistsandcommentators

throughoutthecurrentrecession.Anumber

otradescholarsarelookingintopotential

culprits.

Tesuspectthatcanbeeasilydiscardedis

traderestrictions.Unlikeduringotherreces-

sionsandtheGreatDepression,countries

havenotusedtrademeasures—suchastaris,quotasoranti-dumpingmeasures—during

thisrecessiontorestrictimports.Onereason

istheWorldradeOrganizationorbidsthese

measures;anotherreasoniswenowunder-

standthattraderestrictionsworsenedthe

GreatDepression.

Teremainingcausesortheplummetin

exportsaremorediculttodiscard:thecol-

lapseotradenance,theincreaseinvertical

specializationandthecompositionotrade

ows.raditionaltextbookanalysisotrade

dynamicsduringrecessionsattributes

tradedeclinetolowerdemandornalgood

importsinthecountryexperiencingacon-

traction.However,thechangesintheway

tradeisnancedandorganized,alongwith

abetterunderstandingotheinternational

economy,inducedeconomiststoocusonthethreeelementswediscusshere.

First Suspect: Finance

Variousstudieshavedocumentedthe

importanceonanceorinternationaltrade

transactions,asnancialinstitutionsarekey

suppliersoservicessuchastheevaluationo

counterpartydeaultriskandtheprovision

opaymentinsuranceandguaranteesto

exporters.EconomistMarcAuboinesti-

matedthatabout90percentointernational

tradetransactionsrelyononeormoranotherotradenance.

Tereore,theconjectureisthatthecredit

crunchmayhavecausedthelargedecline

inworldtradebyreducingrms’accessto

nance.AstudybyeconomistsMaryAmiti

andDavidWeinsteinhasshownthatasimilar

mechanismwasatworkduringtheJapanese

crisisothelate1990sandearly2000s.Tey

oundthatlackonancingaccountedor

nearlyone-thirdotheplungeinJapanese

exportsduringthe1990s.

Freshevidenceorthecurrentrecessionishardtocomebyandtodateexistsonlyor

exportstotheU.S.EconomistsDavinChor

andKalinaManovaoundthatcountrieswith

tightercreditavailabilityduringthecrisis

exportedlesstotheU.S.Moreover,exportsto

theU.S.contractedmoreinsectorsthatother

researchhasshowntobemoreheavilydepen-

dentonextensiveexternalnancing.Tis

earlyevidencesuggeststhatthetradenance

nexusseemstobeoneotheexplanations

othetradecontractionduringthecurrent

crisis,atleastortheU.S.

Second Suspect: Vertical Fragmentatio

Tesecondsuspectisverticalragmenta-

tion,aormointernationaltradethathas

beengrowingexponentiallywiththespread

oglobalizationinthepast20years.Wenormallythinkointernationaltradeasbein

dominatedbynalgoods,thosethatdonot

needurtherprocessing.Onthecontrary,

thedatashowthatinternationaltradein

industrializedcountriesisdominatedby

capitalgoods(suchasmachinery)andother

typesointermediategoods(suchassteel)

thatarenormallyusedortheproductiono

consumergoods.InthecaseotheU.S.,thes

intermediategoodsaccountornearlythree-

ourthsototalimportsandexports.

Asmassivereightershaveminimizedthecostotransport,internationalsharingopro

ductionhasincreased.Goodsareincreasingl

manuacturedinstagesindierentcountries

Beoreaproductiscompletedandshippedto

itsnaldestination,itscomponentshaveofen

crossedbordersseveraltimes.

ConsidertheexampleotheiPhone.Its

CPUandvideoprocessingaremadeinSin-

gapore.Itsdigitalcamera,circuitboardsan

metalcasingsaremadeinaiwan.Itstouch-

screencontrollersaremadeintheU.S.From

thesecountries,allcomponentsarethenshippedandassembledinShenzhen,China,

beorebeingdeliveredtonalconsumersin

variouscountries.CompleteiPhonesarrive

toAmericanconsumersaferthephones’

componentshavecrossedatleastourbor-

ders,includingtheU.S.bordertwice.

Ithedemandornalgoodsdeclines,the

rsteectisthatthedemandorintermedi-

ategoodssuersineachothecountries

inwhichproductiontakesplace.Atthe

g L o B A L e c o n o M Y

Te rade Collapse:Lining Up the Suspects

By Silvio Contessi and Hoda El-Ghazaly

© kevin leMing/corbi




sametime,internationaltradealsoappears

tosuermorethanGDPbecauseateach

bordercrossingtheullvalueothepartly

assembledgoodisrecordedastrade,while

GDPmeasuresonlyvalueadded.Inorderto

understandthedierence,considerasimple

goodlikeapencil,madeotwocomponents,

woodandgraphite,assembledusinglabor.

Whenthepencilisproducedentirelyinthe

U.S.,itscontributiontoU.S.GDPisthenal

pricetoconsumers(say$1)netothecost

oitscomponents(80cents);thereore,20

centsovaluehasbeenadded.Whenthe

pencilisonlyassembledintheU.S.butits

componentsareimportedromCanada,

orexample,anddemandorpencilsinthe

U.S.allsbyoneunit,U.S.GDPallsby20

cents,butU.S.importsromCanadaallby

80cents,ourtimesasmuch!Tishappens

becauseGDPisavalue-addedmeasurewhile

tradeisagrossmeasure.EconomistCarolineFreundestimatesthat

whenworldincomeincreasesby1percent

thesedays,tradeincreases,onaverage,by3.5

percent.Inthe1960s,theimpactoanequiva-

lentchangeinincomeontradewasonly2

percent.Tisislikelyrelatedtotheincrease

inverticalspecialization.Variousother

economistshaveprovidedevidencethatthe

recentdeclineintradeisstrongerinsectors

thatmakeintenseuseointermediateinputs.

Third Suspect: Compositional EffectDuringrecessions,consumersandrms

demandewergoods;however,thedeclinein

demandislessthanequalacrossallindus-

triesbecausesomesectorsaremoreimpacted

thanothers.Whenhouseholdsandrms

adjusttheirspendingdownward,thedemand

orbothdomesticandimportedgoodsalls.

Now,iinternationaltradeisconcentrated

inthesectorsthataremostimpactedbythe

negativeeconomicshock,thenoveralltrade

shouldexperienceagreaterallthanGDP.

Forexample,considerthecaseinwhichover-allU.S.GDPdeclinesby2percent,butthe

agriculturalcomponentoGDPallsby,say,

7percent.Itradeisparticularlyconcentrated

inagriculture,thenwewouldobserveadrop

intradelargerthanthedropinoverallGDP.

Tecompositionothedeclineindemand

mayaectthemagnitudeothedeclinein

tradesimplybecausetheremaybemoretrade

inthesectorsthatwerehitthehardest.Econ-

omistsAndreiLevchenko,LoganLewisand

Lindaesarshowthatthisisexactlywhat

happenedtotheU.S.duringthecurrent

recession;thelargestdeclinesintradeare

recordedorthosesectorsthathadthelarg-

estdropsinoutput(industrialsuppliesand

materials,computers,peripheralsandparts,

automotivevehicles,enginesandparts).Tis

mayalsoexplainwhyinternationaltradeinservicesotherthannance,transportand

tourismellbymuchlessthanoveralltrade,

astheservicecomponentoGDPellmuch

lessthanoverallGDPduringthecrisis.

A One-Time Thing?

Teinternationaleconomyoperatesasa

networkinwhichthelinebetweenproducer

andconsumercontinuestozig-zagandblur.

Insuchaworld,itiskeytorecognizethose

actorsthathavethemostinuenceoninter-

nationaltrade.Economistshaveidentiedthreemainsuspectsastheleadingcauseso

decliningtradevolumesduringthecurrent

recessionand,byliningupthesuspects,they

havebeenabletoanalyzethecauses’indivi-

dualcontributionstothetradecollapse,at

leastortheU.S.Asnewdataromthecur-

rentcrisisbecomeavailable,othercountries

willbestudiedinordertohelpusunderstand

whetherthelargedropintradeisspecic

tothisrecessionorwilllikelyreappearin

uturerecessions.Inthemeantime,most

projectionsorthisyearindicatearecoveryinworldGDP(3.9percentintheWorld

EconomicOutlookotheInternational

MonetaryFund)andinworldtrade(arobust

5.8percentincrease).

Silvio Contessi is an economist and HodaEl-Ghazaly is a research associate at theFederal Reserve Bank o St. Louis. For more onContessi’s work, see http://research.stlouised.org/econ/contessi

R E F E R E N C E S

Auboin,Marc.“BoostingradeFinancein

DevelopingCountries:WhatLinkwiththe

WO?”WorkingPaperERSD-2007-04,

WorldradeOrganization,November2007.

Amiti,Mary;andWeinstein,David.“Exports

andFinancialShocks.”WorkingPaper15556,

NationalBureauoEconomicResearch,December2009.

Borchert,Ingo;andMattoo,Aaditya.“Te

Crisis-ResilienceoServicesrade.”Working

Paper4917,theWorldBank,April2009.

Chor,Davin;andManova,Kalina.“OtheCli

andBack:CreditConditionsandInterna-

tionalradeduringtheGlobalFinancial

Crisis.”StanordUniversityManuscript,

December2009.

Coughlin,Cletus.“Worldrade:Piratedby

theDownturn.”FederalReserveBanko

St.LouisInternational Economic rends,

August2009.

Economist, Te.“TeCollapseoManuactur-

ing.”Feb.21-27,2009,p.9.

Freund,Caroline.“DemystiyingtheCollapse

inrade.”VoxEU.org,July3,2009.Seewww.voxeu.org/index.php?q=node/3731

Levchenko,Andrei;Lewis,Logan;andesar,

Linda.“TeCollapseoU.S.rade:InSearch

otheSmokingGun.”VoxEU.org ,Novem-

ber27,2009.Seewww.voxeu.org/index.

php?q=node/4280

WorldradeOrganization.“WOSees9%

GlobalradeDeclinein2009asRecession

Strikes.”(PressreleaseromMarch24,2009.)

Seewww.wto.org/english/news_e/pres09_

e/pr554_e.htm

Yi,Kei-Mu.“TeCollapseoGlobalrade:Te

RoleoVerticalSpecialisation,”inRichard

BaldwinandSimonEvenett,eds., Te Col-

lapse o Global rade, Murky Protectionism,

and the Crisis: Recommendations or the

G20. Pp.45-48.Ane-bookromVoxEU.org,March2009.Seewww.voxeu.org/reports/

Murky_Protectionism.pd


10

5

0

–5

–10

–15

–20

U.S. Exports

U.S. Imports

U.S. GDP

PERCENT CHANGE YEAR-TO-YEAR

source: a’ d d m u.s. c b d b em a.

Growth Rates



Comparedwithincomeinequalityin

theUnitedStates,dierencesinliving

standardsworldwidearestaggering.In

2000,realgrossstateproduct(GSP)per

workerorConnecticutwasapproximately

$92,000;thisisalmost90percentlarger

thaninMississippi,wherethetotalwas

nearly$49,000.1Incontrast,whilerealgrossdomesticproduct(GDP)perworker

totaledalmost$1,000inBurundiin2000,

itexceeded$100,000inLuxembourg.2How

suchlargedierencesinGDPperworker

canpersistinanincreasinglyglobalworld

isoneothekeyquestionsineconomics.

Someactorsbehindthepersistentdispar-

ityinincomeperworkerareobvious.Tere

arelargedierencesacrosscountriesinthe

amount(andquality)oactoriesandequip-

mentavailableorproduction(thatis,physical

capital)andinworkers’stockoknowledgeandability(thatis,humancapital).Physical

andhumancapital,however,donotcom-

pletelydetermineoutputperworker.Inact,

largeportionsothedierencesinincomeper

workerbetweennationscannotbeexplained

bytheaccumulationoeitherkindocapital

alone.Forinstance,outputperworkerin

MexicoisseventimesthatoChinaeven

thoughconcentrationsophysicalandhuman

capitalarequitesimilar. 3Incomedierences

thatcannotbeexplainedbydierencesin

physicalandhumancapitalareattributedtototal actor productivity(FP).

Explaining Productivity

Productivityplaysanimportantrolein

determiningoutput.First,increasesin

productivitystimulateoutputorxed

levelsoinputsbyallowingormoree-

cientuseoresources.Moreover,thereis

astrongrelationshipbetweenproductivity

andhumanandphysicalcapital.Higher

By Riccardo DiCecio

p R o D u C T I V I T y

cme Differences arnd GlbeG Bend

phsical, Hman Caital

productivityleadstomoreinvestment,

urtherincreasingoutput.Becauseothe

keyroleoproductivityindetermining

output,understandingwhyproductivity

diersacrosscountriesisimportantor

understandingglobalincome-per-worker

disparities.

Temostproductivenationssharechar-acteristicssuchasstrongpropertyrights,

governmenttransparency,limitedcorrup-

tionandlimitedbarrierstoentry.Tese

ormsosocial inrastructureensurethat

privateinvestmentandinnovationare

properlyrewardedandthatproductive

inputsareeectivelyused.

Teeectobarrierstoentryonpro-

ductivityhasreceivedmuchattentionin

theeconomicsliterature.Easeoentryor

newbusinessosterscompetitionand,thus,

encouragesproductivity.Whereitiseasierornewbusinessestodevelop,established

rmsmustconstantlyconsiderthethreat

onewcompetition,whichincreasespro-

ductivity.Furthermore,itiscrucialthat

capitalandlaborareallocatedtotheirmost

productiveuse.Forexample,a2009study

ndsthatreallocatingproductiveactors

(capitalandlabor)acrossrmssuchthat

theirmarginalproducts 4equalthoseinthe

UnitedStateswouldleadtoFPgainso

40-60percentinIndiaand30-50percentin

Chinainthemanuacturingsector.5

Recentresearchhasocusedonthe

causesomisallocationoproductiveac-

torsacrossrms/sectorsandonthecauses

odistortionsinindustrystructure.wo

causes—nancialconstraintsandthecosts

associatedwithregulationcompliance—are

discussedintheollowingsections.While

earlierstudiesusedstatisticaltechniquesto

analyzethedeterminantsoFP,themore

recentstudiessummarizedbelowrelyon

detailedeconomicmodelsorms’entry,

operationandexitdecisions.

Starting a New Business:

Financial Constraints

Apoorlydevelopednancialsectormay

hinderthecreationonewbusinessesin

somenations.Inthedevelopedworld,

creditisapartoeverydaylie.Newbusi-

nessownersgainuseoequipmentandoor

spacethattheycannotaordwithcash

becausebanksreasonablyassumethatpeo-

plearewillingandabletopayodebt.Else-

where,however,micronanceloanstotaling

merehundredsodollarsareviewedasrare

andexcitingbusinessopportunities.

A2009studypresentsamodelwhere

borrowingconstraintsdistortthenumber

orms,theallocationoentrepreneurial

talentandtheallocationocapitalacrossrms.6Teabilitytopayorxedoperat-

ingcostsdependsonanindividual’swealth

andnotonherentrepreneurialability:

alented-but-poorindividualsareine-

cientlyexcludedromstartingabusiness.

Consistentwiththedata,themodelpredicts

thathighxedcostsresultinsectorswith

ewerentrepreneurs(andestablishments)

thandesired.Moreover,theestablishments

tendtobelargerthantheoptimalestablish-

mentsize.Asaresult,theleastnancially

developedcountrieshaveFPthatismorethan40percentlowerthanintheUnited

States.Dierencesinnancialdevelopment

canexplain80percentothedierencesin

incomepercapitabetweenMexicoandthe

UnitedStates.

Starting a New Business:

Regulations and Entry Costs

Somebarrierstoentryarethedirect

resultogovernmentpolicy.Fromnation

© saM Dcruz/shutterstock© ak photo/shutterstock




ENDNOES

1 Teseguresarecalculatedbydividingthe

2000realGSP(BureauoEconomicAnalysis)

bythelabororce(BureauoLaborStatistics). 2 SeeHeston,SummersandAten.Tegures

reportedarerealGDPperworker(ininterna-

tionaldollars,1996constantprices). 3 SeeHallandJones. 4 Temarginalproductoaproductiveactor

istheextraquantityooutputobtainedby

usingoneextraunitothatactorwhilekeep-

ingtheotherproductiveactorsconstant. 5 SeeHsiehandKlenow. 6 SeeBuera,KaboskiandShin. 7 SeeBarseghyan. 8 SeeBarseghyanandDiCecio. 9 SeeLaPortaandShleier.

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Hall,RobertE.;andJones,CharlesI.“Why

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UnocialEconomyandEconomicDevelop-

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Activity,Fall2008,pp.275-352.

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obstaclesentrepreneursmustendurebeore

startinganewbusiness.TeWorldBank’s

Doing Businesssurveyndsithardestto

establishanewbusinessinGuinea-Bissau,

whereentrepreneursace16procedures,

213daysowaitingandeestotaling323

percentoincomepercapita.Incontrast,

NewZealand’sentrepreneurscanopenshop

afercompletingoneprocedure,waiting

onedayandpayingeestotalinglessthan

1percentoincomepercapita.Policyin

theUnitedStatesisalsoairlyencouraging.

Newbusinessescanbeginaferanaverage

osixprocedures,asix-daywaitandpay-

ingeeslessthan1percentoincomeper

capita.Althoughsomebarrierstoentrywill

bepresenteverywhere,regulatorybarriers

specicallydierbetweennationsandplay

Alhh hih ry dira h rai liima

bi, hy ra h rai illiima —

ha i, bi ald rm pbli ahrii avid

payi a ad mplyi wih rlai.

animportantroleindeterminingnations’

productivityandoutput.

Oneconvenientmeasureoentrybarriers

isthelegaleesassociatedwithstartinga

newbusiness.Teinuenceotheseentrycosts,measuredasapercentoGDPper

capita,hasbeenproventobesubstantialin

theliterature.Arecentstudyndsthatan

80percent(opercapitaGDP)increasein

theseentrycostscausesa22percentreduc-

tioninFPanda29percentreductionin

GDPperworker.7

Currentresearchndsurthersupport

ortheimportanceoentrybarriers,by

ocusingonabroadermeasureoentry

costswhichincludesnonregulatorycosts—

orexample,sunkinvestment,technologyacquisitionandadvertising.8Ahigherentry

costimpliesthatewerentrantsarewill-

ingtopayit,scaringawayentrepreneurs

whocouldpotentiallybehighlyproductive.

What’slefisapooloproducerssulliedby

low-productivityrms.Asaresult,rms’

averageproductivityandFParelow.

Tetotaleectoentrybarriersonpro-

ductivityisproound.Forexample,FP

declinesby0.14percentoreach1percent

increaseinentrycosts.Tisrelationship—

alongwiththelargevariationinentry

costs—leadstolargedierencesineconomic

outcomesacrosscountries.Inthemodel

createdbythisauthorandelloweconomist

LevonBarseghyan,FPis35percenthigher

andoutputperworkeris57percenthigher,

onaverage,incountrieswithlowentrycosts

thanincountrieswithhighentrycosts.

Althoughhighentrycostsdiscourage

thecreationolegitimatebusinesses,they

encouragethecreationoillegitimate

ones—thatis,businessesconcealedrom

publicauthoritiestoavoidpayingtaxesand

complyingwithregulations.Tecreation

oaseparate“shadoweconomy”provides

somerelietoentrepreneurs,butithurts

thenationasawhole.Firmsintheinor-

malsectoraresmallerandlessproductive

thansmalllegallyoperatingrms. 9By

discouragingnewlegitimatebusinesses

andencouragingalargershadoweconomy,

highregulatorybarrierstoentryleadtoan

economypopulatedbyaewinecientlylargelegalrmsandmanyineciently

smallrmsintheinormaleconomy.

Riccardo DiCecio is an economist at the Federal Reserve Bank o St. Louis. See http://research.stlouised.org/econ/dicecio/index.html or moreon his work.




Columbus,Miss.,anchoronortheast-

ernMississippi’s“goldentriangle”

area,hasalwaysturnedheads,ionlyor

itsdozensowell-keptantebellumand

Victorianhomes.Now,thecity’sonce

rundowndowntownalsocatcheseyes,

whatwithitscolorullyreurbished

acadesonnewshops,restaurantsandupper-levelapartments.Smallwonder,

then,thatColumbusearnedaPreserve

Americaawardromtheederalgov-

ernmentin2005andaplaceonthe

NationalrustorHistoricPreserva-

tion’sannualDozenDistinctiveDesti-

nationslistin2008.

Meantime,surroundingLowndes

Countyasawholehasbeengrabbing

attentionoradierentkindorenais-

sance—industrialandgrand-scale.Te

By Susan C. Tomson

c o M M u n I t Y P R o F I L e

Spr BigTrnarndr MiiippiRi

MEGASITES

Th Rssn-ownd Svrst pnt

tva-

d m x .

b d ,

m 3.4 m

d . t

x ;

,

d .

large photo by susan c. thoMson

inset photo © 2006 by severstal north aMerica, inc.

all rights reserveD.




Columbus-LowndesDevelopmentLink,

acombinationchamberocommerceand

economicdevelopmentagency,calculates

thatthecountyhasgained$3.5billioninnew

businessinvestmentand3,734newjobssince

2003.Mostothishashappenedaroundthe

GoldenriangleRegionalAirport,itsname

takenromthewayColumbusandnearby

StarkvilleandWestPointhavetogether

denedthemselvesordecades.

“Temainthingthathappenedthat

changedthiscommunitywasmegasites,”

saysJoeMaxHiggins,theLink’shard-

driving,plain-speakingchieexecutive.

TeennesseeValleyAuthoritycoined

thetermin2004orsitesintheVAregion

thatcouldbedeemedworthyolarge-scale

development—1,000acresinsize,environ-

mentallyclean,andaccessibletotranspor-

tationandutilities,amongothercriteria.

Higginsandhisstahoppedontheopportunity,hurryingtogetheranappli-

cation—aoot-highstackopapers—ora

1,400-acreplotasidetheairport.Itbecame

oneothersttwocertiedbytheVA’s

independentmegasiteconsultant.Five

monthslater,anewsteel-makingventure

spokeorit.

Ataproposed1.2millionsquareeet

andaninitialinvestmento$625million,

theSeverCorrplant,ajointU.S.-Russian

startup,wasthelargestindustrialproject

underconstructioninthenationatthetime,accordingtotheMississippiDevelopment

Authority.LowndesCountyandthestate

oMississippiwenttogether—andtogreat

lengths—tosecureit.

Fromthestate,thecompanygota$25

milliongrantand$10millionloanorinra-

structureplusabunchotaxcreditsand

breaksonsalestaxesandotherstatetaxes.

Tecountycontributedtheland,a$5mil-

lioninrastructuregrantandacutoabout

40percentonrealestatetaxes.ogether,the

incentiveswereworthabout$100million.Oeighteventualmegasites,Lowndes

Countywontwo,thesecondconsisting

o1,800acresontheairport’sotherside.

Paccar,oBellevue,Wash.,askedora

pieceoit,proposinga$400million,

420,000-square-ootplanttomakediesel

enginesorthecompany’sKenworthand

Peterbilttrucks.Onceagain,thecounty

andstateteamedtocobbletogetherapack-

ageoloans,grantsandtaxavors,witha

totalvaluethistimeo$40million.

SeverCorr,whichchangeditsnameto

SeverstalaferitsRussianpartnerbecame

soleowner,beganproductionin2007and

isnowdoublingitscapacityto3.4million

tonsorolledsteelayearinanalconstruc-

tionphase.Whentheprojectiscompleted

attheendotheyear,thecompanyprojects

itwillhave650employees—50morethanit

promisedthestateinreturnoritsconces-

sions—andatotalstart-to-nishinvestment

o$1.4billionintheplant.

Paccar,aferayear’sdelayduetothe

recession,isgearinguptoopenlaterthis

yearwith250employeesandacommitment

tothestateor250moreby2013.

SeverstalandPaccarhaveonlybeenthe

biggestdealsamongmanythattogether

havetransormedLowndesCountyinto

whatAllegraBrighamdescribesasthe

economic“hubcountyortheregion.”Brighamisthechieexecutiveothe

Lowndes-based4-CountyElectricPower

Association,whichactuallyservesallor

partsoeightcounties.Shesaysallothe

countieshave“tremendouslybeneted”

romthenewindustryLowndeshas

succeededinlanding.

Itaddsuptoastunningturnaroundora

cityandcountythatHigginssaystriedbut

ailedtoattractanysignicantnewemploy-

ersortheprevious20years.Allthattime,

theareawashemorrhagingjobs—mostothemlow-pay—asanumberomanuactur-

ersclosedshopormovedaway,saysHarry

Sanders,memberandormerpresidento

theLowndesCountyBoardoSupervisors

andalielongColumbusresident.

Tenewjobs,bycontrast,requiremore

skillsandpayaboveaverage,Higginssays.

AsistypicaloMississippi,allthejobsare

nonunion.

While“localpeoplemovingup”have

takenmostothenewslots,somehavebeen

lledby“anumberonewpeopleromallovertheplace,”saysJimMcAlexander,

presidentoCadenceBankinColumbus.

Someothenewcomershaveboughtand

restoredhistorichomes,producinga“great

economicimpactonthetown,”saysBrenda

Caradine,whomovedtoColumbus15years

ago,boughtoneothosehistorichomesand

turneditintoabedandbreakast.

Shealsoorganizedthecity’sannualen-

nesseeWilliamsribute,aweekormoreo

Lwndes Cnt, Miss.,

by h mbr

platin .................. ..................... .................. 59,284

Labr Frce ................... ..................... ............... 25,844

unemlment Rate ................................11.6 ercent

per Caita persnal Incme.................. .......... $29,124

* u.S. Brea f the Censs, estimate Jl 1, 2008

** HAVER (BLS), December 2009

*** BEA/HAVER, 2007

ToP EMPLoyERS

Clmbs Air Frce Base ................... ................. 3,075

Batist Memrial Hsital .................. ................. 1,095

Lwndes Cnt pblic Schls .................. .......... 815

Clmbs Mnicial Schl District ................... ... 663

Severstal ..................... ..................... .................... ... 550

Weerhaeser ................... .................... ................. 550

SouRCES: Self-rerted

† Incldes art-time

*

**

**

***

†

†

†

lectures,parties,housetoursandproes-sionalperormancesthattaketheircue

romtheplaywright’sbirthinColumbus

in1911.TeColumbusConventionand

VisitorsBureauhasrestoredthe1875,two-

storyhousewherehewasbornandlived

untilhewasnearly4andmadeitthetown’s

welcomecenter.

Tetown’s70-year-oldannualspring

“pilgrimage”—twoweeksohomeand

gardentours,concerts,carriageridesand

photo by susan c. thoMson




historicre-enactments—isthecenterpiece

othebureau’syear-roundmenuocultural,

historicalandrecreationaloerings.

Teindustrialboomhasbeenaplusor

tourism,resultingin“morepeoplegoingto

events,morepeopleabletovisitourattrac-

tions,”saysJamessismanakis,thebureau’s

chieexecutive.Forallthenewindustry,theColumbus/

Lowndeseconomystillrestsonsomeold

reliables.PapermakerWeyerhaeuser,a

countypresenceor30years,operatestwo

plants,onemakingpulp,theotherturn-

ingitintoanabsorbentusedindiapersand

emininehygieneproducts.

BaptistMemorialHospital,ormerly

LowndesCountyHospital,notonlygener-

atesjobs,butthecounty’sprotonitssale

in2003reedupundsoreconomicdevel-

opment,Sanderssays.Butthearea’sNo.1economicenginehas

longbeen,andremains,theColumbusAir

ForceBase,apilot-trainingacilitysince

WorldWarII.Itspayrollisbyarthelargest

around,andabout55percentoitsemployees

arecivilians,hiredlocally.Addingtogether

itspayroll,itsannualexpendituresandthe

estimatedvalueothejobsitcreatesindi-

rectly,thebasehascalculateditsannualeco-

nomicimpactonColumbusat$321million.

“Andit’saconstant,”saysSanders.“Tey

don’thavelayos.”Aneconomiccushioninbadtimespast,thebasehasalsoproveda

catalystorthebettertimesnowollowing.

Tebasegured“inthedynamics”in

2002whenAmericanEurocopter,asubsid-

iaryoaFrench-Germanhelicoptermaker,

choseLowndesCountyoritsrstU.S.

plant,saysEarlWalker,itsgeneralmanager.

Amongthearea’sattractions,companyo-

cialsatthetimealsomentionedMississippi

StateUniversityandtheregionalairport.

WithdailypassengerightstoAtlanta

andMemphis,theairportisalreadyMissis-

sippi’sthirdbusiest.Its6,500-ootrunway

isbeinglengthenedto8,000eettoaccom-

modatelargerplanesandhasroomtogrow

to10,000eet,whiletheairportitselhas

spaceorasecondrunway.

Teuniversity,innext-doorOktibbehaCounty,isknownoritspremieraerospace

engineeringprogramsandaightresearch

labthathelpedgivebirthtoStarkAerospace

andtheMississippioperationsoAurora

FlightSciencesCorp.,basedinManassas,Va.

Tecompaniestookupresidencenearthe

airportin2007and2006,respectively,Stark

tomakeandAuroratodevelopunmanned

aircraf,commonlycalleddrones.

Teairport,theuniversity,Eurocopter,

StarkandAurorahavetogetherprovidedthe

areawithacritical—andmarketable—massoight-relatedassets.

Seekingtocapitalizeonthem,theLink

latelastyearannounceditsmostambitious

industrialdevelopmentyet.TeGolden

riangleGlobalIndustrialAerospacePark

consistso2,500acresborderingthesecond

megasiteandoersthepotentialo12to13

millionsquareeetobuildablespace.

“Itwillbecreatedalongthesamelinesas

themegasites,althoughnomorecertica-

tionsareavailable,”Higginssays.Onlytwo

othersitesintheentireSoutheasternU.S.willoeranycompetition,headds.

McAlexandersees“tremendouspotential”

inadevelopmenttargeting“oneotheast-

estgrowingindustriesintheuture.”And

itscreationistimely,hesays,positioning

Columbus/LowndesCountytobe“arahead

othegame”whentheeconomytakeso.

Susan C. Tomson i s a reelancer.

photo by chris jenkin

photo by susan c. thoMson

photo by u.s. air orce base, coluMbus, Miss.

Th Coms ar Forc bs ( )

; , c-130j.

Th Godn Trng Rgon arport ( ) -

dd d dm. t Wyrhsr

(m) m d, f,

d d d.




n A t I o n A L o V e R V I e W

By Kevin L. Kliesen

Signs Point toward Another Jobless Recovery

heU.S.economynished2009onahigh

note,asrealGDPadvancedatabouta

6percentannualrateoverthelastthree

monthsotheyear.Tiswasasharpcontrast

totheyear’sdismalstart,whentheeconomy

wasstrugglinginthethroesoadeepreces-

sion.ypically,deeprecessionstendtobe

ollowedbyexceptionallyrapidgrowth

(6percentormore),whichleadstosharp

declinesintheunemploymentratebutalsoto

worriesaboutrisingination.However,most

orecastersexpectonlymodestgrowththisyearandaslowdeclineintheunemployment

rate.Onabrighternote,mostorecasters

andFederalReservepolicymakersgenerally

expectinationtoremainsubduedin2010.

Modest Recovery Seems Likely

AlthoughtheNationalBureauoEconomic

Research(NBER)BusinessCycleDating

Committeehasyettomakeadetermination,

manyeconomistsbelievethattherecession

endedinthesummero2009.ypically,the

reboundineconomicactivitythatollowsrecessionsstemsromrisingrealincomes

andimprovingnancialmarketconditions.

Astheeconomyimproves,ofenbecauseo

areboundininterest-sensitiveconsumer

expendituresandthesaleonewlybuilt

houses,businessesbeginorderingnewgoods

rommanuacturersandincreasetheirexpen-

dituresonnewequipmentandstructures.

Sincedouble-diprecessionsareextremely

rare,thereboundinactivityisalsoasignal

tormstoexpandtheirpayrolls.Tisis

traditionallywhytheNBERlooksatnonarmpayrollemploymenttohelpthecommittee

datebusinesscycleturningpoints.

Troughthersttwomonthso2010,

thedataonproduction,incomesand

expendituressuggestedthattheeconomy

wascontinuingtoexpand.Importantly,

consumerexpendituresappearedtobe

growingmodestly,andbusinesscapital

spendingbeganturningupward.Inpar-

ticular,manuacturingactivityappearedto

beadvancingbriskly.Partomanuac-

turing’sstrengthwasduetoahealthy

reboundinexports,whichwaslargely

areectionotheglobaleconomic

recovery.Althoughthereweresigns

ostabilizationinthehousingsec-

tor,thelevelohomeoreclosures

andtheinventoryopreviously

soldhomesonthemarketremained

quitehigh.Anothersourceocon-

cernwasthecommercialrealestate

(CRE)sector,whichsawsharplylowerlevelsoconstructionandallingrentsand,

accordingly,risingloandeaults.Problems

intheCREsectorhamperedsmall-and

medium-sizebanks,whichappeartohave

moreexposuretononperormingCREloans

thanlargerbanksdo.

Overall,theSurveyoProessionalFore-

casters(SPF)expectsthatrealGDPwill

increaseby3percentthisyearandnextyear,

andthatination,asmeasuredbytheCPI,

willaverageabout1.75percentthisyearand

about2percentnext.Byandlarge,orecast-ersexpectthattheFederalReservewillexit

romitsaccommodativepolicyinamanner

thatneitherexacerbatesinationexpecta-

tionsnorprematurelyweakenstherecovery.

Are Jobless Recoveries the New Norm?

Economistshavebeencloselywatching

thecontoursothisrecoverytoseeithe

patternojobgrowth—orlack,thereo—is

similartothosethatollowedtheprevious

tworecessions.Recallthatlabormarketsdid

notimproveuntilwellafertheserecessionsended.Forexample,the2001recessionwas

deemedtohaveendedinNovember2001,but

theunemploymentratedidnotpeakuntil

June2003andpayrollemploymentdidnot

reachitstroughuntilAugust2003.

Althoughthecurrentrecoveryisinits

earlystages,itnonethelessappearsthata

similarlabormarketpatternisdeveloping.

DespiterisingrealGDPinthethirdand

ourthquarterso2009,rmscontinuedto

shedjobsoverthesecondhalo2009and

thersttwomonthso2010.Although

theSPFexpectsjobgainstoaverageabout

100,000permonthoverthelastnine

monthso2010,theseincreasesmightbe

muchlessinotorthehiringassociated

withthe2010decennialcensus.

Whileperhapsdisconcertingtothepublic

andeconomicpolicymakers,thelackojob

growthintheaceorisingrealincomesandastereconomicgrowthreectscontinued

stronggainsinlaborproductivity.In2009,

productivityrose5.8percent—thelargest

annualincreasesince1965.omostecono-

mists,strongproductivitybodeswellorthe

economyoverthelongrun.Indeed,rising

livingstandardsdependonlittleelse.Inthe

shortrun,particularlyintheearlystageso

therecovery,rmsusetheirexistinglabor

orceandcapitalstocktoulllordersand

expandproduction.Eventually,though,the

extremelyrapidrateoproductivitygrowthincreasesthegrowthoincomeandconsumer

spending.Astheeconomystrengthens,rms

onceagainbegintohire,orcingtheunem-

ploymentratedowntoitsnaturalrate.

Kevin L. Kliesen is an economist at the Federal Reserve Bank o St. Louis. See http://research.stlouised.org/econ/kliesen or more on his work.Douglas C. Smith provided research assistance.

bruce [email protected] The Reginal Ecnmist | www.stlisfed.rg 17



D I s t R I c t o V e R V I e W

Decline in Hse Prices Slws Dwn;District Still Faring Better than Natin

The Eighth Federl Reerve Ditric

is composed o our zones, each o

which is centered around one o

the our main cities: Little Rock,

Louisville, Memphis and St. Louis.

MISSOURI

ILLINOIS

ARKANSASTENNESSEE

KENTUCKY

MISSISSIPPI

INDIANA

Memphis

Little Rock

Louisville

St. Louis

By Craig P. Aubuchon and Subhayu Bandyopadhyay

continued on Page 20


I

ntheourthquartero2009,EighthDistricthouseprices,asmeasuredbytheFederalHousingFinanceAgency(FHFA),ellbyonly0.4percentromthepreviousquarter,amuchslowerrate

thanthe1.7percentdeclinebetweenthesecondandthirdquarters.However,comparedwithpricesromayearearlier,thedeclinewas2.3percent,thelargestyear-over-yeardeclinesincethecollapseothehousingbubbleinlate2007.

Despitetheactthatthesedeclineswere

thelargestothecurrentepisode,theDis-

tricthousingmarketasawholecontinued

tooutperormthatothenation.Aggre-

gatehousepricesintheDistrictdidnot

increaseasmuchasthenation’sduringthe

boom,andthesubsequentdeclinehasbeen

milder.TeDistrictalsoreacheditshousepricepeaknearlyayearaferthenationand

maintainedpricesnearthepeakoranother

year.Tispatternheldorthemajorityo

majorMetropolitanStatisticalAreas(MSAs)

withintheDistrict;theyexperiencedan

averagedeclinerompeakolessthan3per-

cent.Incontrast,someothelargestMSAs

inthecountryexperiencedpricedeclines

greaterthan30percentthroughtheourth

quartero2009.

Eighth District Outperforms the Nation

Figure1showsthegrowthinhouseprices

orthenationandtheDistrictsince2000. 1

TeFHFAindextrackstherepeatsaleso

homesthatarenancedwithconorming

mortgagesromFannieMaeorFreddieMac. 2

Bythismeasure,housepricesortheUnited

Statespeakedinthesecondquartero2007,

with70percentgrowthsince2000.Since

then,thelargesttwopricedeclineshavecome

inthethirdquartero2008and2009,andby

theourthquartero2009,priceswereonly

50percenthigherthantheywerein2000.

Incontrast,theaggregatepricesor

theDistrictdidnotreachapeakuntilthe

rstquartero2008atarelativevaluation

muchlowerthanthatotheUnitedStates

asawhole.Equallynotable,Districthouse

pricesdeclinedbyamuchsmallerpercent-ageromtheirpeak.Indeed,intherst

quartero2009,housepricesdeclinedby

lessthanahalpercent.Itwasonlyinthe

lasttwoquarterso2009thathouseprices

begantomovelower,albeitataratethat

wasslowerthanthatorthenationasa

whole.Itisnosurprise,then,thatsince

therstquartero2008,thelargemajority

oDistrictMSAsperormedbetterthan

thenationasawholewithregardtoprice

changesonayearlylevel.Teprimary

exceptionwasFayetteville,Ark.,whichsawsimilarpricedeclinesasthenationoverthis

timeperiodbutexceededtheU.S.decline

onseveraloccasions.

Comparing the Rise and the Fall

among Eighth District MSAs

Figure2tellsasomewhatsurprisingstory

ortheDistrict.Teregionswiththelargest

housepriceincreaseswerenotnecessarily

theregionswiththelargestdeclines.Indeed,

thoseregionswithstrongpopulationgrowth

oremploymentgrowthmightexpectnatural

increasesinhouseprices,inlinewithun-

damentalvaluations.Otherregionsexpe-

riencedlargepricedeclines,despitebelow

averageincreasesinpricessince2000.

FortSmith,Ark.,experiencedthelargest

increaseinhousepricesbetweentheourthquartero2008andtheourthquartero

2009(whichwasthepeakortheFortSmith

area.JeersonCity,Mo.,wastheonlyother

DistrictMSAtoexperienceapeakinthe

ourthquarter).Duringthatperiod,prices

increased1.8percent;asshowninFigure2,

pricesrose45percentsince2000,slightly

abovetheDistrictaverageo40percent.

Withoutadeclineinhouseprices,theFort

Smithmetroareaeasilyoutperormedthe

districtaverageoa3percentdeclinerom

thepeaktotheourthquartero2009.OtherMSAsthataredbetterthantheDistrict

averageintermsogrowthtopeak(rom

Q1.2000)anddeclinesincepeak(toQ4.2009)

includeLittleRock,Ark.,(43percent

increase,1.3percentdecline)andPineBlu,

Ark.,(46.8and–1.3percent,respectively).

Conversely,Fayetteville,Ark.,experi-

encedthelargestdeclineinhouseprices



E N D N O E S

1 TeEighthDistricthousingpriceindexis

calculatedastheaverageothe18MSAsthat

reporthousepricedata,weightedbypopula-

tionineachMSA.Te18MSAsare:Fayette-

ville,Ark.;FortSmith,Ark.;HotSprings,

Ark.;Jonesboro,Ark.;LittleRock,Ark.;Pine

Blu,Ark.;exarkana,Ark.;Evansville,Ind.;

BowlingGreen,Ky.;Elizabethtown,Ky.;Lou-

isville,Ky.;Owensboro,Ky.;Columbia,Mo.;

JeersonCity,Mo.;St.Louis,Mo.;Springeld

Mo.;Jackson,enn.;andMemphis,enn. 2 Incontrast,theS&P/Case-Shillerindex

trackshomesthatarealsonancedusing

largerormoreunconventionalmortgages.

Furthermore,theS&P/Case-Shillerindexis

valueweighted,sothatmoreexpensivehomes

inuencetheindexmoreheavily;theFHFA

indexisunitweighted,sothatregionswith

morehousingunitsaremoreinuentialinthe

index.Foramoredetaileddescription,see

AubuchonandWheelock. 3 Te10-CityCompositeindexisconsidereda

snapshotoU.S.houseprices,particularlyin

largerregions.TeComposite10indexwas

usedasabaselineintheSupervisoryCapital

AssessmentProgram(bankstresstests)con-

ductedbytheFederalReserveinearly2009.

R E F E R E N C E

Aubuchon,CraigP.;andWheelock,DavidC.

“HowMuchHaveU.S.HousePricesFallen?”

FederalReserveBankoSt.Louis’ National

Economic rends,August2008,p.1.See

http://research.stlouised.org/publications/

net/past/2008/


source: d h a

B o s t o n

C h i c a g o

D e n v e r

L a s V e g a s

L o s A n g e l e s

M i a m i

N e w

Y o r k

S a n D i e g o

S a n F r a n c i s c o

W a s h i n g t o n ,

D . C .

L i t t l e R o c k

L o u i s v i l l e

S t . L o u i s

M e m p h i s

200

150

100

50

0

–50

–100

Percent Change Q1.2000 to Peak

Percent Change Peak to Q4.2009

PERCENT CHANGE Q1.2000 TO PEAK; PERCENT DECLINE PEAK TO Q4.2009

P E R C E N

T

FiGuRe 3

Q 1 . 2

0 0 0

Q 1 . 2

0 0 1

Q 1 . 2

0 0 2

Q 1 . 2

0 0 3

Q 1 . 2

0 0 4

Q 1 . 2

0 0 5

Q 1 .

2 0 0 6

Q 1 . 2

0 0 7

Q 1 . 2

0 0 8

Q 1 . 2

0 0 9

180

170

160

150

140

130

120

110

100

Eighth District U.S.

Q1 .2000=100

FiGuRe 1

FHFA House Price Index

source: d h a

F a y e t t e v i l

l e

F o r t S m t h

H o t S p r i n g

s

J o n e s b o r o

L i t t l e R o c k

P i n e B l u

f f

T e x a r k a n

a

E v a n s v i l

l e

B o w l i n g G r e e

n

E l i z a b e t h t o w

n

L o u i s v i l

l e

O w e n s b o r o

C o l u m b i a

J e f f e r s o n C i

t y

S t . L o u

i s

S p r i n g f i e l d

J a c k s o

n

M e m p h

i s

70

60

50

40

30

20

10

0

–10

–20

Percent Change Q1.2000 to Peak

Percent Change Peak to Q4.2009

PERCENT CHANGE Q1.2000 TO PEAK; PERCENT DECLINE PEAK TO Q4.2009

P E R C E N T

FiGuRe 2

source: d h a



e c o n o M Y A t A g L A n c e

Eleven more charts are available on the web version o this issue. Among the areas they cover are agriculture, commercial

banking, housing permits, income and jobs. Much o the data is specic to the Eighth District. To go directly to these charts,

use this URL: www.stlouised.org/publications/re/2010/b/pd/04-10data.pd

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

04 05 06 07 08 09

75

60

45

30

15

0

NOTE: Data are aggregated over the past 12 months.

Exports

Imports

DecemberTrade Balance

B I L L I O N S

O F

D O L L A R S

04 05 0906 07 08

190

170

150

130

110

90

NOTE: Data are aggregated over the past 12 months.

November

Crops Livestock

B I L L I O N S

O F

D O L L A R S

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

05 06 07 08 09 10

11

10

9

8

7

6

5

4

P E R C E N T

February

05 06 07 08 09 10

6

5

4

3

2

1

0

10-Year Treasury

Fed Funds Target

February1-Year Treasury

P E R C E N T

NOTE: On Dec. 16, 2008, the FOMC set a target range for

the federal funds rate of 0 to 0.25 percent. The observations

plotted since then are the midpoint of the range (0.125 percent).

I N F L A T I O N - I N D E X E D T R E A S U R Y Y I E L D S P R E A D S RAT ES ON FE DE RA L F UN DS FU TU RE S O N S EL EC TE D D AT ES

3.0

2.5

2.0

1.5

1.0

0.5

0.0

–0.5

–1.0

–1.5

–2.0

–2.5

–3.0

NOTE: Weekly data.

5-Year 10-Year 20-Year

P E R C E N T

March 12, 2010

06 07 08 09 10 Mar. 10 Apr. 10 May 10 June 10 July 10 Aug. 10

.42

.32

.22

.12

CONTRACT MONTHS

P E R C E N T

11/04/09

12/16/09

01/27/10

03/16/10

R E A L G D P G R O W T H C O N S U M E R P R I C E I N D E X

04 05 06 07 08 09

8

6

4

2

0

–2

–4

–6

–8

NOTE: Each bar is a one-quarter growth rate (annualized);

the red line is the 10-year growth rate.

P E R C E N T

05 06 07 08 09 10

6

5

4

3

2

1

0

–1

–2

–3 P E R C E N T

C H A N G E

F R O M

A

Y E

A R

E A R L I E R

February

CPI–All Items

All Items Less Food and Energy

romthepeak,at10.1percent.Tisprice

declinewasonparwithmajormetropolitan

areaslikeWashington,D.C.,(9.1percent),

NewYork(12.1percent),Boston(13.1per-

cent)andChicago(14.1percent).Within

theDistrict,Fayettevillealsoexperienced

thesecond-largestpriceincrease,onearly57percentbetweentherstquartero2000

andthelocalpeakinthesecondquartero

2007.Othercitiesthatexceededtheaverage

priceincreaseandexperiencedgreaterthan

averagepricedeclineswereSt.Louis(51.4

and–5.3percent);exarkana,Ark.,(46and

–4.2percent);HotSprings,Ark.,(65.5and

–4.9percent)andElizabethtown,Ky.,(49.3

and–3.2percent).

Incontrast,onlyMemphis,enn.,lagged

theDistrictaverageintermsohouseprice

growthandexceededtheDistrictaverageorpricedeclines.Withpriceappreciation

oonly27.7percent,Memphiswasthefh-

slowestgrowingMSAintheDistrict;how-

ever,therelativepricedeclineo5percent

wasthesecond-largestdecline,behindonly

thatoFayetteville.

District Relative to Top 10 Metro Areas

Figure3presentstheFHFAdataorthe

ourlargestDistrictMSAsalongsidethe

10MSAsthatdenetheS&P/Case-Shiller

10-CityCompositeHPI.3

Inthisview,theDistrictMSAs’priceincreasesand

decreasesbetween2000and2009seemto

matchonlythoseoDenver.Furthermore,

thiscomparisonrevealsthatthedierences

inperormanceamongtheDistrictMSAs

paledincomparisontothedierencesin

perormanceamongthese10largenon-

DistrictMSAs.Overall,theMSAsothe

Districtexhibitedlowerpriceuctuations

comparedwithseveralnon-DistrictMSAs.

Tisexperiencesuggeststhatwhenconsid-

eringtheperormanceoEighthDistrict

houseprices,itisimportanttoconsidernot

justthedierencesbetweenDistrictMSAs,

butalsoconsidertheperormanceasjudged

againstthenationasawhole.

Subhayu Bandyopadhyay is an economist and Craig P. Aubuchon is a senior research associ-ate at the Federal Reserve Bank o St. Louis.See http://research.stlouised.org/econ/bandyopadhyay/ or more on Bandyopadhyay’s work.

continued rom Page 18




hehybridadjustableratemortgage

orhybridARM(prophetically,the

acronymisHARM)wasthemostcommon

subprimemortgageproduct.Hybrid-ARM

productswerespecializedproductsthat

includedaninitialperiodoverwhichthe

repaymentscheduleonthemortgageresem-

bledthatoaxedratemortgage(FRM)andasubsequentperiodoverwhichthepayment

scheduleresembledanARM.1Tetempo-

raryintroductoryteaserratewaskeptlower,

arguably,tomaketheproductattractiveto

thesubprimeborrower.Tedateatwhich

thepaymentsresetintoanindexedrate(or

example,LIBORplus6percent)wastypi-

callytwoorthreeyearsafertheclosingdate

onthemortgage.2Whatwastherationale

behindsuchauniquedesignonsubprime

products?Didthisuniquedesignhavea

roletoplayinthesubsequentcollapseothismarket?

Why Hybrid ARM?

First,subprimeborrowersweretypically

thosewhohadimpairedorincomplete

credithistories.Becauseotheirhigherrisk

odeault,subprimeborrowerswerecharged

higherinterestratesthanconventionalor

primeborrowersonallkindsoloans.For

example,theinterestratesonsubprimeauto

loanswereabout25-30percentonaverage,

studieshaveshown.3

Itheinterestrateonsubprimemortgageshadbeensettoprice

theriskaswasdoneonsubprimeautoloans,

itwasunlikelythatthemortgagescould

havebeenaordedbysubprimeborrowers.

Tisisbecausemortgageobligationsare

signicantlyhigherthanpaymentson

otherormsoconsumerdebt,including

autoloans.Tehybrid-ARMproductwas

conceivedtoenablesubprimeborrowersto

obtainmortgagesataordablerates.4

Itwasbelievedthatthiscouldbeachieved

throughtheappreciationinhouseprices.

EconomistGaryGortonarguedinapaper

in2008thatthemortgagedesignsoughtto

benetromhousepriceappreciationover

shorthorizons.Allelseequal,borrowers

couldbuildupequityintheirhomesina

periodorisinghousepricesand,intheeyesothelender,becomelessoariskon

subsequentmortgages.Tisallowedthem

torenanceatalowerrate(onthesubse-

quentmortgage),whichalsoreducedtheir

likelihoododeault.Inessence,houseprice

appreciationwascriticaltotheviabilityothe

hybrid-ARMdesign.Tereore,thehybrid

ARMproductallowedpaymentsattheteaser

rateessentiallytohelptheborrowerbuild

upequity,butoncetheloanresetintothe

indexedrate,paymentobligationsincreased.

Tiswasdonetoreducethelenders’exposuretoahigh-riskborroweroveralonghorizon

andessentiallyorcearenancingothe

mortgage.Teborrowerwaspreventedrom

renancingearlybyincludingapenaltyor

prepaymentonthemortgage.

Inarecentpaper,economistsGeetesh

BhardwajandRajdeepSenguptapointto

somelesserknownactsaboutsubprime

mortgagesingeneral.5First,over70percent

osubprimeoriginationsoreachyear

(2000-2007)wereoriginatedasrenances.

Second,asignicantmajorityotheseoriginationswerehybrid-ARMproducts

designedtoresetintoaullyindexedrate

afertwoorthreeyears.Signicantly,this

resetwasdesignedtobeastepup(but

hardlyeverastep down),soastoincrease

thepaymentburdenandessentiallyorcea

renancingotheloan.Tird,contraryto

conventionalwisdom,teaserratesonhybrid

ARMswerenotlowandnotsignicantly

dierentromthoseonclosingrateson

subprimeFRMs.Fourth,mostsubprime

originationsincludedprepaymentpenal-

tieswiththeprepaymenttermexpiringno

soonerthantheresetdateontheARM.

Tismeantthatorhybrid-ARMproducts,

thecontractensuredthatthepenaltywould

beineectatleastaslongastheborrower

wasrequiredtopaytheteaserrate.Inshort,themortgagewasdesignedtoensurethat

subprimeborrowerscontinuedtomake

monthlypaymentsattheclosingratesbeor

theycouldrenanceintoanothermortgage.

Repayment Behavior

on Subprime Mortgages

Intermsoactualrepaymentbehavior,

themostimportantaspectosubprimeloan

perormancewasthehighratesoearly

prepaymentsontheloan.Aloanissaidto

beprepaidwhenitiseitherrenancedintoanothermortgageorthepropertyissoldo.

Tisishardlysurprisingbecauserenancing

wasanintegralpartothemortgagedesign.

Anoteworthyobservationhereisthatlow

interestrateswerenotalwaysthemotiva-

tionbehindprepayments(renances)inthe

subprimemarket.Tenotableexamples

herewerehybrid-ARMproductsoriginated

in2003,ayearohistoricallylowinterest

rates.Interestingly,inalltheyearsthese

productswereinexistence,subprimeorigi-

nationsrom2003showedthelowestdeaulrates.However,theprincipalreasonorthe

remarkableperormanceo2003origina-

tionswashighandearlyrenances.6Indeed,

almost83percentohybrid-ARMsubprime

productsoriginatedin2003wererenanced

bytheendo2006.Tecorrespondingper-

centageorFRMswas63percent.Signi-

cantly,theactthatmortgagesoriginated

s u B P R I M e M o R t g A g e s

Why HARM the Subprime Borrower?By Rajdeep Sengupta and Yu Man Tam

continued on Page 22

© illustration works/corbi




ENDNOES

1 DuringthexedlegothehybridARM,the

mortgageepaysalowerintroductoryclosing

ratecalledtheteaserrate.Teteaserrate

remainsineectuntiltheresetdate,afer

whichtherepaymentscheduleonthehybrid

ARMresemblesanARM.Teresetdate,

marketindexrateusedandthemarginare

decidedattheclosingdate.2 Tesemortgagesarealsocalledthe2/28

(two-yearteaserrateollowedbya28-year

ARM)anda3/27(three-yearteaserrate

ollowedbya27-yearARM)respectively.3 SeeAdams,EinavandLevin.4 SeeGorton.5 SeeBhardwajandSengupta.6 SeeBhardwajandSengupta.

REFERENCES

Adams,William;Einav,Liran;andLevin,

Jonathan.“LiquidityConstraintsand

ImperectInormationinSubprimeLend-

ing.” American Economic Review ,2009,

Vol.99,No.1,pp.49-84.

Bhardwaj,Geetesh;andSengupta,Rajdeep.

“DidPrepaymentsSustaintheSubprime

Market?”WorkingPapers2008-039,

FederalReserveBankoSt.Louis,2008.

Gorton,Gary.“TePanico2007.”National

BureauoEconomicResearchWorking

Paper14358,2008.

duringthelow-interest-rateenvironment

around2003-2004andrenancedina

high-rateenvironmentinsubsequentyears

indicatesthatlowerrateswerehardlythe

motivationbehindsubprimerenances.

Whilewedon’tknoworsurewhatthe

motivationwas,themostplausibleexplana-tionwouldbetoextracthomeequity.

Why Did the Subprime Market Collapse?

Teimportantthingtorememberisthat

aborroweronthebrinkodeaulthasan

exitoption:prepaythemortgageeitherby

renancingorsellingtheproperty.Interest-

ingly,BhardwajandSenguptaoundthat

thetotalproportionoloansthateither

wentintodeaultorwereprepaidremained

unchangedacrossallvintages.Moreimpor-

tant,therewasasignicantlyhighincidenceoearlyprepaymentsonsubprimeorigina-

tionsoearliervintages.However,thiswas

ollowedbyasharpdropinprepaymentrates

afer2006,suggestingthatewerborrowers

couldusetheprepaymentexitoption.

Whydidprepaymentsdeclineororigi-

nationsolatervintages?Hereinlaythe

importanceothesubprimemortgage

design.Prepayments(eitherintheormo

renancesoranoutrightsaleotheprop-

erty)werecriticaltothesustainabilityo

subprimemortgages.Inaregimeorisinghouseprices,borrowerscouldavoiddeault

byprepayingtheirloans(eitherthrougha

renanceorapropertysale).Moreover,i

thehousepriceappreciationwassuciently

large,aborrowercouldrecoverthecosts

orenancingandevenchoosetoextract

equity.However,thisoptionwasnolonger

availablewhenpricesdidnotappreciate.

Consequently,borrowerdeaultsbeganto

increasesharplyin2006,whenhouseprices

ceasedtoappreciate.

Rajdeep Sengupta is an economist and Yu Manam is a senior research associate at the Federal Reserve Bank o St. Louis. See http://research.stlouised.org/econ/sengupta/ or more onSengupta’s work.

This is in response to “Infation May Be the Next

Dragon To Slay,” an article that appeared in the

January 2010 issue o The Regional Economist.

To read more letters, go to http://stlouised.org/

publications/re/letters/index.cm

Feb. 2, 2010

Dear Editor:

I would like to thank the researcher or

clearly explaining the predicament that those in

charge o the Fed will likely to be acing. There

is so much currency in the system, and the

Fed continues to debase the dollar by printing

money by the trillion. Where will it end? Does

the American public realize the government

isn’t a separate entity but an extension o

themselves? YOU the Americans will have to

pay all the trillions in debt that the government

is taking on. And your standard o living, based

on debt and spending, cannot go on orever. It

appears as though the high-octane liestyle is

almost at an end. Unusually, l ound this article

through the St. Louis Fed Reserve web site,

which is interesting in itsel because usually

those who let the cat out o the bag, as it were,

are most likely to conceal it. On the same

page, a poll is being carried out about infation.

Currently, 812 people have taken the poll and

61 percent believe that infation is “dead in the

water.” The dangers o such massive injections

into the currency supply are being aired with

increased vigor by many except the popular

press. Unortunately, the masses will not read

the said article or know how to insulate them-

selves rom the pain associated with high

levels o infation. I hope the problems do

not come to light, but I bought 7 kg o silver

today because l am betting that they do. Does

anyone have a time rame to said infation?

I am guessing 2-3 years, but would welcome

comments. Search or Bob Chapman. Heconstantly talks about said problems.

John Kitcher, English teacher in elementary

school in Seoul, South Korea

Go to http://stlouised.org/ExternalCFForms/

EditorLetterEnt.cm to submit a letter electroni-

cally. You may also submit a letter to the editor

using the e-mail address or street address on

Page 2.

R e A D e R e x c H A n g e

LETTER To THE EDIToRcontinued rom Page 21




FED FLASH PoLL RESuLTS

1,114 REsponsEs as oF 3/9/2010

THIS ISSuE’S PoLL quESTIoN:

Which scenario do you think is most likely or the world economy?

Submit your question in a letter to the editor. (See Page 2.) One

question will be answered by the appropriate economist in each issue.

Cros Grrg m

r d d r b

s. l 2007. h m x

m-m d m

. r, g dd

m m d

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m d d . s ://.d.// m .

ASk AN ECoNoMIST

50

45

4035

30

25

20

15

10

5

0

FEDERAL RESERVE EARNINGS PAID TO THE U.S. TREASURY, IN BILLIONS OF DOLLARS

2005 2006 2007 2008 2009

21.5

29

34.631.7

45

source: d r bd g

How does the Fed make money or the reasury, and are profts audited by Congress or any agency?

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prram h Fd iiiad a a rp h lar ri i h gra

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rd h trary, whih rrd i 2007. Dpi i idpd, h

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dralrrv.v/bardd/rpr/ rad h rp . Ba h

Fd i l-fad, i i bj h rial bdary pr.

When a new issue o The Regional Economist is published, a new poll is

posted on our web site. The poll question is always pegged to an article in

that quarter’s issue. Here are the results o the poll that went with the

January issue. The question stemmed rom the article “Infation May Be

the Next Dragon To Slay.”

WHICH Do you THINk IS THE ToP RISk FoR REIGNITINGINFLATIoN ovER THE NExT SEvERAL yEARS?

There is no infation risk—it’s dead and buried.

The ederal budget decit continues to mushroom.

The Fed waits too long to return the monetary supplyto a pre-crisis level.

Commodity prices balloon again as investors tire olow-yielding Treasury securities and shit their moneyinto higher-yielding commodity contracts and other assets.

There turns out to be less slack (smaller output gap)in the economy than many experts believe.

1. “Big spender” countries (especially U.S.) live within their means, and miserly

countries (especially China) break open the piggy bank.

2. Countries don’t coordinate policies. Trade imbalances return—in spades.

Boom ollowed by bust (again).

3. Economic restructuring stalls. Stimuli end. Private spending slows.

Economies tank.

Ater reading “Economic Hangover: The Recovery Is Likely To Be Prolonged,

Painul,” go to www.stlouised.org/publications/re to vote. (This is not a

scientifc poll.)

FED PRoGRAM To FoCuS oN CoMMuNITy DEvELoPMENT

“eplri Ivai i cmmiy Dvlpm Wk” will b April 19-23.

th pbli i ivid parak i h v h wk, raizd by h

Fdral Rrv Bak s. Li. Prram ar bi plad hrh

h eihh Diri.

th prmir v, “Rrri ad Rli r h Fr,” will ak

pla April 20. I i h fr i a yarl ri pbli pliy dial h

ial lm ra mmiy dvlpm. th prram will b a

h Fd i s. Li ad will b brada via vidr adi a

h Bak’ brah i Lil Rk, Livill ad Mmphi. cfrmd aial

pali ild Rh Mcambrid h Nonproft Quarterly ad Ray Bhara

vi prid ad ir rarh llw a h nw Amria Fdai.

Ad will al har ab h s. Li Fd’ “10,000-Hr chall,” a

ampai ra mmiy dvlpm prial bm

pr i ivai.

ohr aivii ild a April 21 ri h dmary “nw nih-

br,” h grar Livill nprf thly smmi April 22 ad h

s. Li Rial Hi cr April 23.

g www.lid.r/v/01eD r a mpl hdl ad rira-

i irmai.


47% 18%

21%

7%

7%

Fed Earnings



PRSRT STD

US POSTAGE

PAID

ST LOUIS MO

PERMIT NO 444

n e x t I s s u e

The Economic Progress of African-Americans

How signifcant has been the economic progress

o Arican-Americans in the U.S. since 1970?

The common perception is that inequality

between races has decreased. Did these societal

changes translate into economic changes, as well,

or blacks? Did economic well-being o Arican-

American children improve? Read about Ari-

can-American economic progress in urban areas

in the July issue o The Regional Economist .

Tell a friend abt The Regional Economist !

RE is published every January, April, July and October by

the Federal Reserve Bank o St. Louis. To receive your ree

subscription by mail, fl l out this card and send to:

Federal Reserve Bank o St. Louis, Public Aairs Dept.,

Attn: Carol Musser, Box 442, St. Louis, MO, 63166.

You can also read RE online at www.stlouised.org/re.

You’ll also fnd instructions there or signing up to get an

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