Summary of Articles in Business Economics, April 2008

By Robert Crow
Editor, Business Economics

“A Behavioral Life-Cycle Approach to Understanding the Wealth Effect”

Diane K. Schooley and Debra Drecnik Worden
The somewhat surprising strength in consumer spending in recent years has focused renewed attention on the much-debated wealth effect, the notion that when individuals feel wealthier, they consume more.  This study utilizes survey data to examine the wealth effect within the context of the behavioral life-cycle model of savings.  While households are likely to spend more as their assets increase, this effect is dampened by the portion of assets held in home equity.  This unexpected finding is due to homeowners responding to the perceived wealth gain from increased home values by cashing out their equity.  Moreover, households that have a full-time income earner, are homeowners, have more education, have a younger household head, or expect economic growth, are more likely to report a wealth effect.  Households that utilize savings “rules of thumb” are less likely to report a wealth effect.  These results can be used to improve the wealth effect specification in consumer demand models and assist firms to target consumer markets.

“The Depoliticization of Monetary Policy”

Jerry H. Tempelman
In the past thirty years, it has been claimed that Republicans tend to favor relatively restrictive monetary policy while Democrats favor relatively accommodative monetary policy. Another claim is that, regardless of which political party is in power, monetary policy tends to be relatively restrictive during the first two years of an administration and relatively accommodative during its final two years.  This paper does not find empirical evidence supporting either claim over the past quarter century (1982–2006). The depoliticization of monetary policy decisions probably reflects, among other factors, both the post-1970s new-Keynesian consensus in macroeconomic theory and the realization of political independence of the Federal Reserve System during the Volcker-Greenspan years.

“The Puzzle of Manufacturing Sector Investment”

Donald A. Norman
Investment in the manufacturing sector has lagged behind the rise in profits, cash flow, overall manufacturing activity, and other drivers of investment since 2002.  After reviewing several benchmarks that illustrate the lag in investment, various explanations as to why investment lagged are discussed.  These explanations include a lack of “animal spirits”; a capacity overhang from the late 1990s; rising structural costs; increased investment of U.S. firms overseas; the desire on the part of companies to improve their balance sheets and liquidity; and—significantly—increased spending on intangible investments (R&D, advertising, process improvements like “lean” manufacturing, employee training, and those IT expenditures that are expensed).  Regardless of whether fixed investment continues to lag profits, whether this lag will have negative impact on productivity or implies a diminished role for manufacturing depends on the reasons for the change.  If, reduced capital expenditures reflect a shift toward intangible investment, productivity growth need not be diminished and the role of manufacturing need not diminish. 

 “The Great Inflation:  Inflation, Inflationary Expectations, and the Phillips Cycle 1960-2002”

Thomas W. Synnott, 3rd,
Given the ongoing concern with controlling inflation, what can be learned from the “Great Inflation” of 1966-1983?  Improvements of monetary policy were largely responsible for taming the Great Inflation, but new threats—including the dimming of memory—are current challenges to preventing its recurrence.

“The Effects of Education on the Natural Rate of Unemployment”

Albert E. DePrince, Jr., and Pamela D. Morris
Macroeconomic policy depends to a major extent on policymakers’ perception of the unemployment rate that can be achieved without triggering inflation.  This study develops a “natural” unemployment rate that is based upon educational attainment. Behind this natural rate are labor force participation rates that vary positively with educational attainment, observed unemployment rates that are inversely related to educational attainment, and deviations of the observed unemployment rate from this hypothesized natural rate that are related to several expectation-based variables, such as the slope of the yield curve, consumer sentiment, and asset prices. 

“Fiscal Realities for the State and Local Governments”

Roger E. Brinner, Joyce Brinner, Matt Eckhouse, and Megan Leahey
The U.S. economic slump of 2008, as is usual for all economic slumps, has taken a dramatic toll on state and local government revenues and budget surpluses.  Even though this result is predictable, states in particular have been even less well prepared than normal.  This paper quantifies the highly regular, cyclical revenue patterns that emerge when actual revenues are abstracted from legislated changes.  Identifying these patterns should assist policy formulation today—as states consider higher tax rates or borrowing—by promoting an understanding of what is temporary and what is permanent in the current revenue weakness.  Moreover, if these lessons are learned, future revenue forecasting and budget planning at the state and local levels should be materially enhanced.  The paper also examines the true sources of the exceptional expenditure growth that precluded the normal buildup of a solid surplus during the economic boom of 2003-2007.  The principal culprit is shown to be state and local government pay inflation that has far exceeded private sector norms for the past three years.

Focus On Statistics
“Regulatory Rules and Estimating Economic Growth: Two Perspectives on Expensing Employee Stock Options”

Cynthia A. Glassman and David N. Beede
Approaching the issues from different angles, the authors look closely at how nonsurvey data sources are affected by changes in regulatory rules, and, in turn, how that link impacts statistics on employee stock options, an important component of national income.

Focus On Industries and Markets
“The Global Market for Buses, 2000-2010”

Lance A. Ealey and Andrew C. Gross
Using the perspective of global demand for autobuses, the authors describe manufacturing trends and other factors that affect this industry, including foreign trade and the development of alternative fuels.

Find the April issue of Business Economics at:http://nabe.com/publib/be/0802/index.html