Economic Review
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| How Useful Are Leading Indicators of Inflation? By C. Alan Garner Many economists expect inflation to rise in 1995. These expectations are based on various approaches to forecasting inflation. One approach is based on the standard economic theory that inflation rises when slack is eliminated from the economy and production exceeds capacity constraints. According to this view, measures of economic slack such as unemployment and capacity utilization provide useful information about the inflation outlook. But the relationship between slack and inflation is complicated and subject to variable lags. Uncomfortable with this complex relationship, some analysts rely on alternative approaches to forecasting inflation. One approach is based on "leading indicators" of inflation. The leading indicators typically incorporate information on selected prices to augment or replace information on economic slack. The prices selected are usually key commodity prices that fluctuate more or less continuously in response to changing economic conditions. Prominent leading indicators of inflation include the price of gold, broader indexes of commodity prices, and composite indicators that combine several economic series believed to predict the inflation rate. Garner examines five widely watched leading indicators and concludes that the composite indicators have given the most useful early warning signals of inflation turning points, but none of the indicators has recently been successful in predicting inflation magnitudes. Back to top Economic Review home Challenges to the Natural Rate
Framework By most estimates, the U.S. unemployment rate is currently below its "natural rate." The implication is the economy is operating at an unsustainably high level of resource utilization. Capacity levels are being strained, tending to put upward pressure on wages and prices. In anticipation of these rising inflationary pressures, the Federal Reserve has firmed monetary policy several times over the past year. A majority of mainstream economists appear comfortable with the natural rate framework, in part because it has tracked inflation successfully over the past 35 years. Despite its excellent record, however, the natural rate framework has not been without critics. In the past year, nonbelievers have advanced a number of arguments for why mounting inflationary pressures should not be a concern at this time. These arguments have focused on the heightened globalization of the marketplace, the weak bargaining position of the labor force, widespread productivity gains, and the absence to date of an unambiguous rise in inflation. In this article, adapted from presentations made to the National Economists Club and the Congressional Budget Office in February 1995, Weiner considers the arguments against the natural rate framework. He offers some counterarguments and concludes that concerns about future inflationary pressures are well founded. Back to top Economic Review home Recent Evidence on the Muted
Inventory Cycle Inventories play an important role in business cycles. Inventory build-ups add momentum to the economy during expansions, while inventory liquidations sap economic strength during recessions. In addition, because inventory fluctuations are notoriously difficult to predict, they present considerable uncertainty in assessing the economic outlook. The role of inventories in shaping the current outlook for the U.S. economy is particularly uncertain. In the early 1990s, inventory swings appeared less pronounced than usual, leading some analysts to conclude the business cycle might now be more muted. New inventory control practices, they believed, were permanently diminishing the role of inventories in the business cycle. Yet, recent strong inventory restocking suggests this conclusion might be premature. Inventories may be just as important in the business cycle today as in the past. Filardo examines recent inventory data to assess whether the role of inventories in the business cycle has changed. He finds little evidence to suggest inventories are playing a reduced role in the business cycle, and therefore rejects the view that a change in inventory behavior has muted the business cycle. Back to top Economic Review home Multi-Office Bank Lending to
Small Businesses: Some New Evidence In a long-awaited move, Congress enacted legislation last fall authorizing full interstate banking. While most states had already acted to allow some form of entry by outside holding companies, the new law was expected to hasten the spread of large multi-office banking organizations. Most analysts believe the change will benefit the public by increasing competition, improving services to depositors, and reducing banks' vulnerability to local downturns. Concern has been voiced, however, that the benefits of multi-office banking may be achieved at the expense of small businesses. Some analysts worry that large multi-office banks will be less able or less willing to lend to small businesses than the smaller banks they replace. Keeton investigates the relationship between multi-office banking and small business lending using new information on small business loans in Tenth District states. Data for mid-1994 support the view that further growth in multi-office banking may impose short-run costs on some small businesses. He cautions, though, against concluding that multi-office banking should be curtailed. Instead, regulators should continue to ensure that local banking markets remain competitive, so other banks can step in and fill any gaps in the legitimate credit needs of small businesses. Back to top Economic Review home Bank Lending and Monetary
Policy: Evidence on a Credit Channel While there is widespread agreement that banks play a key part in the transmission of monetary policy actions to the economy, debate continues on whether bank lending plays a special part in the monetary transmission mechanism. If a special lending or credit channel exists, changes in the willingness and ability of banks to extend credit may have implications for the economy. Moreover, ongoing changes in the role of banks in financial markets may affect the credit channel and so alter the monetary transmission mechanism. Recent research on a bank credit channel has focused on two questions. Are certain borrowers so dependent on bank lending that any change in banks' willingness to lend has an immediate effect on investment and spending decisions? And, do monetary policy changes directly constrain bank lending? Both conditions are necessary for bank lending to play a special role in the monetary transmission mechanism. Morris and Sellon provide insight into the second question--whether bank lending is constrained by monetary policy. The authors analyze how banks adjust the amount and terms of business lending when monetary policy is tightened. The analysis differs from previous research by using a more precise measure of monetary policy actions, which allows a more accurate identification of episodes of monetary tightening. The authors suggest that bank business lending is not constrained by restrictive monetary policy. Thus, Morris and Sellon conclude, monetary policy does not operate through a special credit channel. |