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Economic Review

Economic Review
September/October 1995, Volume 80, Number 5

Is a Weak Dollar Inflationary?
Roberto Chang

Since the early seventies, the U.S. dollar has been allowed to float freely, and its exchange rates have become extremely volatile and difficult to explain, let alone to predict. The dollar's erratic behavior has stimulated a lively debate in academic and policy circles over what the government's response should be. One of the major questions that must be answered before a response can be contemplated is whether dollar exchange rate changes influence U.S. inflation.

This article examines the empirical relationship between dollar movements and inflation in the United States. Historical evidence suggests that a falling dollar causes inflation to increase but by a very small amount, and the author discusses why the inflationary effects of a weak dollar are so small. One possible answer is that when the dollar depreciates, sellers of traded goods may choose not to increase prices in response but to reduce their profit margins instead.

Financial Crises and the Payments System: Lessons from the National Banking Era
William Roberds

Since the Great Depression, the Fed has historically intervened during potential financial crises to ensure that financial market participants were provided with the liquidity necessary to complete their transactions. In recent years, this part of the Fed's role in the payments system has come under increased scrutiny as advances in computer and communications technology have led to increases in the liquidity of many types of financial claims and to the creation of new financial markets and new forms of payment. Recent years have also seen passage of legislation designed to more precisely limit the scope and administration of the Fed's safety net as it applies to individual banks.

This article examines the current debate over the Fed's payments safety net role in light of the historical experience of the National Banking Era (1864-1914). Though somewhat remote from modern experience, this period is highly relevant for the study of financial crises and payment system disruptions, offering a number of lessons for the effective provision of liquidity during crises. The most evident and least controversial lesson from the National Banking Era experience is that in crisis situations, timing is critical.

Policy Essay--Risk-Based Bank Capital: Issues and Solutions
Robert R. Bliss

Market risk has become an integral consideration in bank business. Derivatives are increasingly used as a means of risk management, and bank involvement in derivatives trading represents a new, different, and very important line of business. Existing regulations for the determination of bank capital, based on the quality of assets held, are not appropriate for trading portfolio assets where exposure to market risk factors is of primary importance.

This essay discusses three major proposals for dealing with market risk in determining banks' risk-based capital. The standard and internal model approaches are concerned with regulating the models used internally by banks for risk assessment and management. The third alternative, called the precommitment approach, emphasizes incentives and goals while leaving modeling issues entirely to banks. The author argues that, properly implemented, the precommitment approach is best suited to attaining regulatory goals.

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