The nature of the business cycle, particularly in the United States, has changed dramatically over the past several decades. In the 1970s and early 1980s, the U.S. economy often whipsawed up and down. Since then, real economic activity stabilized considerably, entering a period economists call the ?Great Moderation.? With the ups and downs of the economy becoming less dramatic, it has become harder to determine in real-time when the economy dips into recession.

Economists have a variety of methods to determine when the economy is entering a recession. These methods range from directly analyzing a broad spectrum of data to the formal use of recession prediction models. The National Bureau of Economic Research (NBER) uses the first approach, relying on several data series to make a determination of when the economy enters or exits a recession. Their decisions are intended to be accurate, not timely. More formal recession prediction models are designed to send a timely signal, but often do not take account of how the Great Moderation has altered the business cycle.

Davig uses a framework that efficiently uses a large set of data in a ?business cycle tracking? model. The model accounts for shifts in overall economic volatility ? to capture the Great Moderation ? and sends a signal when the economy is shifting between periods of low and high economic activity. The model can be used in different ways to extract a signal regarding whether the economy is likely heading for an NBER recession.

The Federal Reserve's Role in Retail Payments: Adapting to a New Environment (PDF 199K)
By Stuart E. Weiner

The U.S. retail payments system is in the midst of a transformation. The shift from paper to electronics, the emergence of new instruments and payments channels, the rise in nonbank participation, the change in risk profiles?all are elements of this new landscape. The Federal Reserve takes as one of its mandates fostering a payments system that is safe, efficient, and accessible. How does the Federal Reserve fulfill this mandate in this new environment?

Since its beginning, the Federal Reserve has played a crucial role in the U.S. retail payments system. From time to time, that role has been reevaluated The current environment suggests the time may be right for another examination. Other central banks are facing similar issues.

Weiner reexamines the Federal Reserve?s role in retail payments in light of the evolving payments system. The Federal Reserve will likely continue to play an important role in retail payments. However, given the evolution of the payments system, the role the Federal Reserve plays and the rationale for this role may be different than they have been in the past.

The Affordability of Homeownership to Middle-Income Americans (PDF 569K)
By Jordan Rappaport

From 1971 through mid-2007, the nominal national sales price of housing grew almost eightfold. Controlling for inflation, this represented a near doubling in the relative price of housing. The retrenchment in prices that began in 2007 has so far remained small compared to the earlier increase.

As house prices climbed, many people complained that housing had become unaffordable to middle-income Americans. As early as 1998, newspapers warned that homeownership was becoming a heavy financial burden. As sales price rises accelerated in 2003 and crested in 2006, homeownership was increasingly portrayed as the ?unattainable? American dream.

Notwithstanding such concerns, homeownership actually rose strongly beginning in the mid-1990s and in 2004 attained its highest level ever. The more recent surge in foreclosures suggests many households indeed purchased homes they could not afford. Still, this does not necessarily imply that housing in general has become unaffordable to middle-income households. Instead, it may be that many defaults resulted from specific households purchasing specific houses whose location, size, and other attributes made their sales price too high relative to the purchasers? financial resources.

Rappaport seeks to answer the question of whether homeownership has indeed become less affordable to middle-income Americans. He also discusses some reasons why perceptions of affordability may have decreased.

Can Markets Improve Water Allocation in Rural America? (PDF 521K)
By Jason Henderson and Maria Akers

Water, one of the most fundamental resources for economic activity, covers about three-fourths of the earth?s surface--but only 2.5 percent of that amount is considered fresh water. While freshwater supplies in the United States are relatively abundant, increasing demand and drought, especially in the Great Plains, have left some states wondering whether there is enough fresh water to go around.

The drive for greater efficiency in the use of water has led to the emergence of water markets. These markets allow for the equitable transfer of water rights from lower-value agricultural uses to higher-value uses, such as for emerging industries and growing municipalities. Many rural communities, though, view water markets as a threat to their economic foundation and future growth.

Henderson and Akers examine how water markets affect both water right holders and their rural communities. They conclude that other mechanisms, in combination with water markets, may be needed to improve the efficiency of water allocation and compensate rural communities for lost economic activity.