Money & Banking News
September 2007
Click on these links to read some recent readings related to the textbook Money and Banking: A Policy-Oriented Approach by Dean Croushore.
In this issue:
1. What We Do and Don’t Know about the Term Premium
2. What’s Really Happening in Housing Markets?
3. Comparing the Prime and Subprime Mortgage Markets
4. Are Global Prices Converging or Diverging?
What We Do and Don’t Know about the Term Premium
In Chapter 5, the term premium is defined and its properties are discussed. The textbook notes that it is difficult to measure the term premium, in part because it varies over time. In this article, Eric Swanson describes economists’ attempts to measure the term premium. Economists think that much of the movements in long-term interest rates in recent years should be attributable to movements in the term premium, but they also note that the measures of the term premium differ widely, depending on which method is used to measure it.
Federal Reserve Bank of San Francisco, FRBSF Economic Letter, Number 2007-21, July 20, 2007.
What’s Really Happening in Housing Markets?
Residential investment is a major component of GDP, as we discuss in Chapter 12. Since 2001, construction of new homes has led residential investment to grow very rapidly, which has been a source of strength for the U.S. economy. Now, with trouble in mortgage markets, the decline in residential investment is slowing the economy down. To understand what is causing this distress in housing markets, Morris A. Davis, François Ortalo-Magné, and Peter Rupert look in more detail at housing prices and land prices, as well as mortgage markets. The main problem faced in housing markets is the drying-up of credit for mortgages, which is likely to lead to further declines in home prices.
Federal Reserve Bank of Cleveland, Economic Commentary, July 2007.
Comparing the Prime and Subprime Mortgage Markets
A key problem in mortgage markets in 2007 has been an increase in default rates. This has led to a drying up of credit for mortgage loans, thus reducing residential investment, which is a key component of GDP, as we discuss in Chapter 12. But unlike other times in our history, when default rates on mortgages rose because of a recession, the 2007 episode is unusual in that there has been no increase in defaults on most mortgages, only on subprime mortgages. This article by Sumit Agarwal and Calvin T. Ho describes the differences between prime and subprime mortgages, looks at the data on defaults on such loans, and describes what financial institutions are doing to prevent such problems in the future.
Federal Reserve Bank of Chicago, Chicago Fed Letter, Number 241, August 2007.
Are Global Prices Converging or Diverging?
In discussing the interdependence among nations in Chapter 14, the textbook discusses various theories about the relationships between prices in different countries. As the world’s economies expand their trade with each other, it is logical to think that prices of goods in different countries will get closer to each other. The data described in this article by Reuven Glick show that such convergence of prices did indeed occur from 1990 to 1997. However, from 1997 to 2005, that trend was reversed, and prices in different countries began to diverge. The most likely source of the divergence is the increase in oil prices and thus transportation costs, which prevent goods from being shipped as cheaply as they could be in earlier periods.
Federal Reserve Bank of San Francisco, FRBSF Economic Letter, Number 2007-24, August 10, 2007.