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Economic Review

Economic Review
C O N T E N T S
Third Quarter 1997, Volume 82, Number 3

Economic Review articles are posted on the Web as they become available. Page numbers in the PDF file posted here may not reflect the page numbers of the printed version.

Bank Deposits and Credit As Sources of Systemic Risk Decision Time for European Monetary Union
Robert A. Eisenbeis 4 Joseph A. Whitt Jr. 20

There is little agreement on even the rudimentary definitions of a financial crisis, the sequence of events constituting a crisis, or the causes of these events. This article investigates the various theories of financial panics and crises with particular emphasis on the links between credit and deposits.

The survey suggests that panics are not perfectly predictable, as some theories may suggest, but neither are they random events. Information asymmetries about banks ability to liquefy deposits were apparently a major contributing factor to banking panics in the past. In addition, financial crises do not seem to have been primary causal agents of recessions. The analysis also suggests that government policies can affect the likelihood of a financial crisis as well as play a role in its solution. The article raises a cautionary note that the dynamics of crises may differ significantly going forward given recent, rapidly developing changes in the U.S. and world financial system.

If the plans of European governments for economic and monetary union by the end of the decade are realized, a new common currency called the euro will be in use in at least a few western European countries within five years. Even earlier, starting in 1999, a new European Central Bank is slated to take control of monetary policy in the initial member countries.

This article examines the economic and political factors that will determine whether monetary union proceeds on schedule and, if so, which countries are likely to be initial members. There is little chance that most of the countries will comply with a strict reading of the convergence criteria for membership, but evidence from the financial markets suggests that by early 1997 market participants were leaning toward the belief that the political impetus in favor of a broad union might prevail over strict enforcement of the criteria in the end, resulting in a monetary union that would encompass a substantial portion of western Europe.

The Role of Currency Derivatives in Internationally Diversified Portfolios Common Trends and Cycles and the Structure of Florida's Economy
Peter A. Abken and Milind M. Shrikhande 34 Edgar Parker 60

Diversification is widely practiced by investors seeking to reduce risk. In recent years investors have been turning to foreign markets to obtain even greater scope for diversification than domestic markets offer. With the internationalization of security portfolios, however, also comes an additional risk—foreign exchange risk.
The use of currency derivatives in internationally diversified portfolios can help mitigate foreign exchange risk. This article investigates the impact of currency hedging on these portfolios, in particular index portfolios of stocks and bonds from markets in seven industrialized countries. The author finds that the apparent risk-reducing benefits of currency hedging of equity portfolios in the early 1980s did not continue into subsequent periods. In contrast, foreign long-term bond portfolios consistently exhibited dramatically lower variability of hedged returns compared with unhedged returns. The case for (or against) currency hedging is not decisive, though, because the lower variability of hedged returns historically is associated with lower returns. The decision to hedge depends on the investor's preference for risk and return.

Florida, like the rest of the nation, has undergone many economic changes in recent decades, including the decline of the manufacturing base and the growth of international trade. In Florida tourism s growing importance has also figured significantly. In addition to changes at the state level, Florida's cities have become less similar over time.

The author of this article uses multiple cointegration and common cycles analysis to study the interrelationships of labor markets in six Florida MSAs over the past quarter-century. He finds a long-run comovement in these labor markets but also that earlier, close relationships have changed as the economic structures of the MSAs have evolved.

This analysis helps underline the increasing diversity of influences on the growth trends of Florida MSAs. It also suggests that these MSAs react differently to short-run shocks. Both of these dynamics are important in gauging the differing effects of policy or economic shocks on the state in parts and as a whole.