Summary of Articles in Business Economics, April 2009

By Robert Crow
Editor, Business Economics

“A Two-Headed Dragon for Monetary Policy”

James Bullard
The current financial crisis has been the key global economic event since it unfolded in earnest in early August 2007. The Federal Reserve has taken aggressive actions—both conventional and unconventional—to counteract the economic and financial fallout. This paper emphasizes a “two-headed dragon”—two opposite medium-term risks that the Federal Reserve now faces as it continues to confront financial market turmoil and recession.  One is a Japanese-style deflation trap and the other is a breakout of inflation like that seen during the 1970s. An explicit inflation target would help mitigate these very real risks.

“The Need to Return to a Monetary Framework”

John B. Taylor
This paper examines the 100-fold increase in reserve balances at the Federal Reserve during 2008. By looking at the balance sheet of the Fed and factors influencing the supply and demand for reserves, the paper shows that the increase was due to large purchases of securities and loans to certain sectors and institutions. Such actions constitute a combination of monetary policy and industrial policy, or a “mondustrial” policy. This characterization raises questions about the future of the Fed and suggests the need to return to a monetary framework that controls the money supply while the interest rate is zero and establishes rules for setting the interest rate.

“The Value of Private Businesses in the United States”

Patrick L. Anderson
The vast majority of businesses in the United States are privately held, and approximately 99 percent meet a common government definition of "small." However, surprisingly little is known about the market values of these firms. This paper estimates the market value of privately held firms in the United States from sources on earnings, assets, and reported market value of multiple forms of business entities, including corporations, partnerships, LLCs, and sole proprietorships. It finds that privately held U.S. firms had earnings that exceeded those of publicly held firms in two recent years by a significant margin. Moreover, the market value of these firms exceeded that of publicly traded firms. It is likely that a better understanding of the importance of privately held firms has important policy implications.

“A New Metric to Gauge Household Economic Stress: Improving on the Misery Index”

Robert A. Dye and Chad Sutherland
This paper presents an improvement on the Misery Index that quantifies the economic stress that households are feeling today. Since much economic stress stems from the decline in household wealth that has come as a result of falling house prices, this paper adds a measure of house price change to the Misery Index to the traditional components: the rate of change in the consumer price index and the unemployment rate. The authors show that this intuitive and simple index is useful in analyzing mortgage delinquencies both nationally and regionally.

“Is China’s Exchange Rate Policy a Form of Trade Protection?”

Anthony J. Makin
This paper examines how China’s heavily managed exchange rate contributes to its huge trade surplus with its major trading partners, most notably the United States.  Based on the distinction between economies’ aggregate output and expenditure and on the premise that exchange rates are shared variables between any pair of countries, it develops a straightforward framework that shows how exchange rate management by China’s central bank affects China’s fast growing output, expenditure, employment and trade balance, while simultaneously influencing these aggregates in its slower growing industrialized trading partners.  This framework reveals that under conditions of limited private capital mobility, an inflexible yuan yields higher short-run output gains for China at trading partners’ expense through a form of “exchange rate protection.” At the same time, exchange rate misalignment limits China’s consumption and hence its living standards.  A misaligned currency is also shown to bias international saving and investment flows and is central to any explanation of global imbalances.     

Forum on Emerging Issues

Kevin M. Zhao, Charles L. Baum, and William F. Ford, “The CEO Share of Earnings:
A New Approach to Evaluating Executive Compensation”

Focus on Statistics

Robert P. Parker, “Updated Economic Statistics in 2009”

Focus on Industries and Markets

Michael A. Deneen and   Andrew C. Gross, “World Mining Machinery”

In Memoriam: Edmund A. Mennis

Find the April issue of Business Economics online.