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Economic Review

Economic Review
C O N T E N T S
Fourth Quarter 2003/Volume 88, Number 4

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.

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PRESIDENT
JACK GUYNN

SENIOR VICE PRESIDENT AND
DIRECTOR OF RESEARCH

ROBERT A. EISENBEIS

RESEARCH DEPARTMENT
THOMAS J. CUNNINGHAM
Vice President and
Associate Director of Research

GERALD P. DWYER JR.
Vice President, Financial

ELLIS W. TALLMAN
Vice President, Macropolicy

JOHN C. ROBERTSON
Assistant Vice President, Regional

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BOBBIE H. MCCRACKIN
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Editor

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Designers

ALISON BOUNDS
Marketing and Circulation

CHARLOTTE WESSELS
Administrative Assistance

The Economic Review of the Federal Reserve Bank of Atlanta, published quarterly, presents analysis of economic and financial topics relevant to Federal Reserve policy. In a format accessible to the nonspecialist, the publication reflects the work of the Research Department. It is edited, designed, produced, and distributed through the Public Affairs Department.

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ISSN 0732-1813

Business Method Patents and Financial Services
Clifford S. Stanford
The Atlanta Fed’s 2003 Financial Markets Conference focused on the emergence and legitimization of “business method” patents in the United States and how this development affects financial services innovation and the future of financial services firms. This article provides an overview of the conference papers and discussions. Two of these papers are featured in this issue of the Economic Review.

The Uninvited Guest: Patents on Wall Street
Robert P. Merges

For at least the past twenty-five years, financial services industries have been creating innovative products and services without the help of patents. The 1998 State Street Bank case changed all this, making patents freely available in these industries. Will patents help or hurt financial services innovation in the long run? This article sheds some light on this issue.

Before the advent of patents, several “appropriability” mechanisms protected financial services innovation: “first mover” advantages, complementary or “cospecific” assets, and trade secrecy. Evidence suggests that, in the immediate post-patent era, financial firms’ first order of business was to protect these traditional appropriability practices. This attitude explains the early push to secure a “prior use rights” defense to protect established firms against patent claims by upstart outsiders. From a historical perspective, this reaction to the “patent threat” tracks that of other industries: in particular, nineteenth-century railroads and the software industry of the 1980s.

In the end, the author argues, patents are not likely to cause any real and lasting problems. Although patents may increase the costs of interchanging innovative ideas, they may bring some unintended benefits as well—by fostering spin-offs and facilitating entry by start-ups, for example. Like random shocks in the natural world, the new patent regime provides a shakeup that could bring some good but unpredictable consequences.


The International Law of Business Method Patents
John M. Conley

Before the landmark State Street case in 1998, the courts and the U.S. Patent and Trademark Office (USPTO) had often denied patents to inventions that were no more than methods of doing business. But State Street swept away three decades of complex, inconsistent case law, firmly establishing the patentability of business methods and computer software.

This article reviews the current state of U.S. and international patent law with respect to business methods. After outlining the basic U.S. and international requirements for patentability, the author describes the evolution and current state of both American law and international law, particularly in the European Union, various European countries, and Japan.

After reviewing a number of case histories, the author argues that the differences between U.S. and international law that appear so striking in theory are probably less profound in practice. While the American patent system has seemingly become more lenient in granting business method patents, the USPTO has taken steps to scrutinize such patents more rigorously on certain grounds. In contrast, Europe and Japan, which have apparently more rigorous business method patent standards than the United States does, may in practice be somewhat more liberal than their policies would indicate.

Eventually, the author predicts, U.S. and international business method patent standards will converge, with the United States being more permissive in theory but more demanding in practice and Europe and Japan displaying the opposite tendency.


Take Your Model Bowling: Forecasting with General Equilibrium Models
Marco Del Negro and Frank Schorfheide

During the past two decades, dynamic stochastic general equilibrium (DSGE) models have taken center stage in academic macroeconomics. Nonetheless, these models are still rarely used in policy-making and forecasting.

This article describes the workings of the DSGE-VAR, a procedure that combines DSGE models and vector autoregressions (VARs). The procedure uses DSGE models as priors to restrict the VAR’s parameters. Since the VAR’s parameters are imprecisely estimated unless a very long time series of data is available, using DSGE priors can improve the VAR’s forecasting performance. Moreover, the Lucas critique implies that DSGE priors can be particularly useful when forecasting the impact of policy changes.

The authors assess DSGE-VAR’s forecasting performance in terms of three variables that most interest monetary policymakers: real output growth, inflation, and the federal funds rate. Their results show that the DSGE-VAR forecast is superior to that of unrestricted VARs and comparable to that of VARs with Minnesota priors.

The article also discusses how DSGE-VAR can be used to identify the fundamental shocks that hit the economy and to forecast the impact of changes in the policy rule followed by the monetary authorities.

Perhaps in the not-too-distant future, practitioners and policymakers will be able to use a full-fledged DSGE model for both forecasting and policy assessment. In the meantime, the authors argue, DSGE-VAR may provide a viable alternative to the models currently used.