Economic Review
Second Quarter 2004 

Exploring the Macro-Prudential Aspects of Financial Sector Supervision
By Thomas M. Hoenig

In a speech given at the Bank of International Settlements in Basil, Switzerland, in April, President Hoenig discussed how financial supervisors and monetary policymakers can contribute to a stable financial system that fully supports sustainable economic growth.

Several financial crises in the United States over recent years have also coincided with and been influenced by a period of rapid and path-breaking changes in our financial markets. These changes in our financial structure in turn are altering the nature of the financial crises we experience. Increasingly, crises originate in capital markets and are characterized by asset-price volatility and disruptions in market liquidity.

Mr. Hoenig reviewed the major changes evident in the U.S. financial sector and some of the supervisory steps already taken to address recent crises within the changing financial system. He also discussed the appropriate role for macro-prudential supervision and what could reasonably be accomplished under this framework, including shifting more attention to capital markets and the need to prevent costly financial crises there.

An Evaluation of the Decline in Goods Inflation
By Todd E. Clark

Over the past decade, the worldwide average for inflation has plummeted from 30 percent to 4 percent. For many countries, especially those starting out with high inflation rates, falling inflation has been desirable. But the experiences of other countries have raised the question of whether inflation can be too low. In some economies, inflation has dipped to levels that risk disruption of the normal functioning of the economy.

In the United States, many commentaries on the potential for deflation have noted the sharp contrast between goods and services prices. Excluding food and energy, goods prices as measured by the chain price index for personal consumption expenditures (PCE) dropped 2¼ percent in 2003. Yet nonenergy services prices rose nearly 2½ percent last year. Moreover, goods inflation has fallen sharply over the past decade or so, while services inflation has declined only modestly. In 1993, PCE inflation was about ¾ percent for goods and 3¼ percent for services.

Clark assesses whether the decline in consumer goods inflation relative to services should be cause for concern in the United States. His analysis focuses on three interrelated questions about the decline in goods inflation relative to services: Was it unusual? What caused it? And is it likely to continue? He concludes that the fall in goods inflation relative to services over the past decade is most likely a temporary phenomenon due to dollar appreciation and, to a lesser extent, increased global competition.

What Impact Will E-Commerce Have on the U.S. Economy?
By Jonathan L. Willis

In recent years, e-commerce has emerged as the fastest growing sector of the U.S. marketplace. Despite the contraction in the high-tech industry during the recent recession, firms have continued to enter and expand their presence in e-commerce, and consumers have increased the number of purchases made online. E-commerce currently represents a very small share of overall commerce, but it is expected to continue to expand rapidly in coming years. As e-commerce grows, so will its impact on the overall economy.

The primary route by which e-commerce will affect the economy at large is through its impact on productivity and inflation. Businesses and consumers that use e-commerce benefit from a reduction in costs in terms of the time and effort required to search for goods and services and to complete transactions. This reduction in costs results in higher productivity. An even larger increase in economy-wide productivity levels may result from productivity gains by firms not engaged in e-commerce as they respond to this new source of competition. Continued expansion of e-commerce may also lead to downward pressure on inflation through greater competition, cost savings, and changes in price-setting behavior of sellers.

Willis examines the economic factors that have contributed to the rapid growth of e-commerce and assesses how the future growth of e-commerce may affect the overall economy. He concludes that if e-commerce continues to grow rapidly, it could lead to an increase in productivity growth and downward inflationary pressures that persist for several years.

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