EconSouth (Third Quarter 2007)

Research Notes and News

Research Notes and News highlights recently published research as well as other news from the Federal Reserve Bank of Atlanta.

Identifying financial market frictions
Defined simply as anything that interferes with trade, financial market frictions can exist even in efficient markets. Understanding financial market frictions is important, according to a recent article, because such frictions generate real costs to investors, because they generate business opportunities, and because they change over time.

Financial market frictions depend in part on market structure. Market structure tends to evolve over time, as trading volume increases, from low fixed costs and high marginal costs to high fixed costs and low marginal costs. To help identify the best means of reducing market frictions' costs, authors Ramon DeGennaro and Cesare Robotti classify and discuss five primary categories of frictions: transactions costs, taxes and regulations, asset indivisibility, nontraded assets, and agency and information problems.

Looking for evidence of how frictions influence market participants' behavior, the authors not only review the economic literature but also conduct an empirical exercise to illustrate and quantify frictions' impact on investors' risk-return trade-off. Their results show that market frictions impose utility costs on investors by making preferable investment portfolios unattainable. Their findings and other academic studies also suggest that investors who ignore market frictions compound the harm done by the frictions themselves.
Economic Review
Third Quarter 2007

Creating a single Southeastern economic indicator
Although each of the six Southeastern U.S. states within the Sixth Federal Reserve District has unique economic characteristics, these states' business cycles also tend to move together. Currently, no single economic indicator exists for the region's economy.

In a recent article, Pedro Silos and Diego Vilán outline and estimate a model of the Sixth Federal Reserve District economy that provides a single economic indicator. The model assumes that the region's economic activity—measured by a large set of time series of employment, construction, earnings, and sales tax revenues—is driven by an unobserved common factor. The model incorporates disaggregated information for each state into a large model to derive a common component.

Understanding the dynamics behind this common factor will help academics, policymakers, and businesspeople better diagnose and forecast the region's economic condition. Having a single economic indicator for the region will also allow for simpler and faster interpretation of various (sometimes contradictory) economic signals and make comparisons with the nation's and other regions' economies easier.

Comparing their latent common factor model with the current practice of averaging individual states' coincident indicators, the authors find that their indicator provides a more reasonable assessment of the impact of large idiosyncratic shocks, such as Hurricane Katrina, than the weighted-average estimates.
Economic Review
Third Quarter 2007

Lockhart says Southeast mirrors nation
Addressing the Southern Governors Association in Biloxi, Miss., on Aug. 25, Atlanta Fed President Dennis Lockhart said that the Southeast's economy is a microcosm of the United States as a whole, mainly in that both are resilient and diverse. Lockhart stressed the importance of education and retraining to make workers resilient to competitive pressures in the global economy.

Underlying the region's ability to withstand economic shifts are workers with skills that are transferable from one industry to another, Lockhart said. A skilled and flexible workforce has helped the region adapt as some industries have shrunk. While the Southeast and the country have lost jobs in manufacturing industries such as textiles, apparel, and furniture making, for example, some of these losses are being offset by growth in higher-wage manufacturing. "For instance, a highly efficient vehicle assembly and parts manufacturing industry has taken root in our region," he remarked. He said the district had 119,000 auto-assembly industry jobs in 2006, a 13 percent increase since 2001.

Another economic strength in the region has been growth in service industries such as health care, education, tourism, and other professions. Lockhart also pointed out that almost 700,000 jobs in the Southeast are at nonbank, foreign-owned businesses.

The rapid pace of economic change is challenging to workers who must adapt and to policymakers who seek to bring jobs to their states. Consequently, an important policy question is how "states encourage development of workers with high aptitude and, therefore, help provide a highly adaptable workforce," Lockhart said.

"Those involved in promoting economic development at the state level should apply policies aimed at achieving a resilient workforce characterized by well-developed vocational aptitudes built on foundation skills, especially a capacity to learn new things throughout a career," he said.
Text of speech
August 2007