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Economic Review

Economic Review
C O N T E N T S
First Quarter 1997/Volume 82, Number 1

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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Is Low Unemployment Inflationary? Taking Note of the Deposit Insurance Fund: A Plan for the FDIC to Issue Capital Notes
Roberto Chang 4 Larry D. Wall 14

Many discussions about current macroeconomic events are based on the premise that inflation must accelerate after unemployment falls below a certain value. That value, called the nonaccelerating inflation rate of unemployment, or NAIRU, is believed to be around 6 percent, suggesting that recent unemployment rates are too low for stable inflation. But in fact inflation has been low and stable for several years.

This article argues that the concept of the NAIRU is of very limited use for predicting inflation, understanding its causes, or forming policy. Such is the implication of empirical evidence showing that the NAIRU is highly variable and that its location cannot be estimated with sufficient precision to know whether unemployment is above or below it. In addition, contemporary economic theory implies that a fall in unemployment may or may not be associated with higher inflation, depending on the fundamental causes of unemployment movements. Those fundamental causes can be identified, but then a comparison between observed unemployment and the NAIRU provides no additional useful information about future changes in inflation.

In the United States the risk that a financial breakdown could lead to a taxpayer bailout of the deposit insurance fund has been cited to justify current regulatory controls on what activities may be affiliated with banks. Despite some regulatory changes in the 1990s to protect taxpayers from future debacles, however, widespread failures could still expose taxpayers to losses.

This article proposes a new way to monitor the deposit insurance fund by having the FDIC issue capital notes. Because the interest paid on the notes would be suspended if the fund required a loan from the Treasury or eliminated if taxpayer funds were contributed to offset deposit insurance losses, noteholders would have more incentive to clearly signal the condition of the insurance fund. This signal would help regulators, taxpayers, and their congressional representatives monitor the health of the fund and would change the incentive structure facing FDIC directors. The cost of the notes would be minimal in part because the proceeds would be used to reduce banks' existing deposit insurance obligations.

What's Really New about the New Forms of Retail Payment? The Buck Stops Where? The Role of Limited Liability in Economics
William Roberds 32 Thomas H. Noe and
Stephen D. Smith
46

Rapid developments in technology have brought about new methods of retail payment—such as remote banking, electronic cash, and debit, stored-value, and smart cards—that were unavailable a decade ago. Some observers believe that these alternative payment methods will differ from traditional methods not only in a technological but also in an economic sense and will alter how consumers and businesses interact.

This article examines the question of whether, from the standpoint of economic theory, there is or will likely be anything new about these new forms of payment. The author describes some of the conflicts of interest that confront all types of payment systems in market economies. He then considers why traditional forms of payment, such as checks and banknotes, represent reasonable solutions to these conflicts of interest and outlines some shortcomings of the traditional forms. The article also analyzes the economic characteristics of the new forms of payment and explains why they differ little and in some cases not at all from more traditional forms. Finally, the author concludes that the same policy issues that apply to the creation of checkable deposits and to the issue of banknotes should apply to the creation of the new forms of liabilities.

Over the last few centuries laws have increasingly protected individuals and corporations from liability resulting from bad economic outcomes. This evolution in liability provisions, by many accounts, has significantly influenced both the level and distribution of contemporary economic output as well as the allocation of financial resources in today's financial markets.

Through a review of an extensive and growing literature, the authors of this article consider how limited liability affects investment, labor, and financing decisions made by individuals and corporations as well as government policies intended to promote economic growth or redistribute wealth. The authors first examine conflicts that may arise in labor markets because of certain rights held by providers of human capital or because some assumptions about personal limited liability may not be compatible with sustained production. The discussion then considers how liability rules influence the incentives of debtors, creditors, and managers. Finally, the authors look at the role of limited liability in the relationship between government and private institutions as it relates to economic growth and the provision of liquidity to the banking system.

By providing an explanation of incentive structures under alternative liability regimes, this article should help policymakers better understand the possibly unintended effects of certain policies and programs.