Regional Economist - January 2009

8/9/2019 Regional Economist - January 2009

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Defcits, Debt and Looming Disaster

The Federal reserve Bank oF sT. louis

Reform of Entitlement ProgramsMay Be the Only Hope

The RegionalEconomist

A Quarterly Reviewof Business andEconomic Conditions

Vol. 17, No. 1 January 2009

A WinningCombination?Economics and Sports

El Dorado PromiseFree College EducationRejuvenates Arkansas Town


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3 P r e s i d e n T s M e s s a g e

10 Economic TheoryMeets SportsBy Kristie M. Engemannand Michael T. Owyang

In a change of pace, some econo-mists have turned their attentionto sports, studying such topicsas racism in t he NBA, coachesmaximization of their chancesof winning, and the direction inwhich soccer players and goaliesshould move during penalty kicks.

14 The Federal Reserveas a Super RegulatorBy Sharon K. Blei

If the Fed is g ranted broaderregulatory authority, it mightface new challenges in executingits traditional responsibilitiesand in preserving its indepen-dence against political pressure.

16 c o M M u n i Ty P r o F i l e

El Dorado, Ark.By Susan C. Thomson

An oil companys promise tosend local high school studentsto college has sparked a come-back of sorts in thi s predomi-nantly blue-collar town. Theso-called El Dorado Promise

has not only attracted new resi-dents and businesses to town,but it has inspired residents totax t hemselves more to boosteconomic development andimprove the schools.

19 n a Ti o n a l o v e r v i e w

Man the Li eboats!By Kevin L. Kliesen

Theres no doubt now that theeconomy has hit rocky waters.The only question is whetherthe recession will be as severeas those seen in 1973-75 and1981-82 or not much worse thanthose in 1990-91 and 2001.

20 d i s T r i c T o v e r v i e w

Little Rock Stands OutBy Subhayu Bandyopadhyay,Rubn Hernndez-Murillo,Craig P. Aubuchon andChristopher J. Martinek

Of the four major cities in t heEighth Federal Reserve District,only Little Rock showed growthin jobs in the year ending inOctober. Louisv ille, Memphisand St. Louis all lost jobsandat a greater rate than did thecountry as a whole.

22 econoMya T a g l a n c e

22 r e a d e r e x c h a n g e

c o n T e n T s

Defcits, Debt and Looming DisasterBy Michael Pakko

With government de cits and debt at record highs,the long-term scal outlook for the U.S. requiresserious attention. The x will most likely have to

include fundamental reforms of entitlement programs.

4

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The RegionalEconomist

JA AR 2009 | vol. 17, no. 1

2 The Regional Economist | January 2009


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Jim Bullard , P t ceoF r B f st. l

Because our central bank has relied on thefederal funds rate target for so long toguide the economy, many people think thatthe target rate is the only tool at the Fedsdisposal. As we are seeing in the current

nancial crisis, the Fed has other options.Most visible so far have been the lendingprograms that have been created in the past year, along with established programs thathave been modi ed.

Among the tools the Fed can use is the dis-count window, which has been around sincethe Fed was established in 1913. The windowwas the primary instrument for centralbanking operations for decades, just as openmarket operations (the buying and selling of U.S. Treasury and federal agency securitiesto achieve a desired quantity of reserves or

the fed funds rate target) have dominated inmodern times. Traditionally, the discountwindow has offered overnight lending forgenerally sound depository institutions torelieve short-term liquidity problems. Dis-count window loans must be fully secured.

Except in unusual circumstances, depos-itory institutions rarely tapped into thediscount window for fear they would bestigmatized as weak. But that attitudechanged beginning last year as nancialmarket turmoil intensi ed. The Fed not-

so-subtly reminded depository institutionsabout the availability of the window, cut thewindows interest rate (the discount or pri-mary credit rate) and increased loan periodsto a maximum of 90 days. The line at thewindow was soon long. Primary creditlending exceeded $90 billion in November.

In December 2007, the Fed launchedthe Term Auction Facility to help meetdepository institutions need for liquidity.This facility auctions term funds against

collateral. Starting a bit more than a yearago, auctions have been held several timesa month, with available amounts rangingfrom $20 billion to many multiples of that.Borrowing via the TAF has been substan-tial, reaching a level of $384.6 billionin November.

Last March, the Fed began two lendingprograms for primary dealers, those banksand securities broker-dealers with whomthe Fed trades U.S. government securitiesto carry out open market operations. TheTerm Securities Lending Facility (TSLF)

provides secured loans to primary dealers ona 28-day term. The Primary Dealer CreditFacility (PDCF) provides overnight loans.Among the collateral that the Fed accepts forthese loans are mortgage-backed securities.Both facilities lend at an interest rate equalto the New York Feds discount rate.

This past fall, the Fed introduced anotherset of lending programs. The Asset-Backed

Commercial Paper (ABCP) Money MarketMutual Fund Liquidity Facility (sometimesshortened to AMLF) extends collateralizedloans (from the Boston Fed) to nance pur-chases of ABCP in an attempt to encouragesecondary markets to lend long-term. A fewweeks later, the Commercial Paper Fund-ing Facility (CPFF) was introduced to helpalleviate a shortage of term funding in the

commercial paper market. With nancingfrom the New York Fed, a special purposevehicle (SPV) was set up to buy three-monthunsecured and asset-backed paper.

This list is not exhaustive, and the Fed may devise other lending facilities in an attemptto mitigate the effects of nancial marketturmoil. But it is important to emphasizethat all of the facilities mentioned aboveare separate from the well-publicized loansdrawn up just for AIG, Bear Stearns andCitigroup. These rms received special and

immediate handling because of fears thattheir collapse could have a systemic effect.In all, the Fed has made more than

$2 trillion in loans so far during this crisis.No doubt, this is a staggering amount, butall of it is collateralized or secured. Thelender of last resort function of the centralbank is an important one during a nancialcrisis, and the Fed has been extraordinarily active during the current episode in ful llingthis function.

The Fed as Lender o Last Resort

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For the scal year 2008, the federal gov-ernments de cit totaled $455 billion,the largest ever for a single year. In the naldays of the scal year, which ended Sept. 30,the total federal debt rose above $10 trillionfor the rst time. Forecasts for 2009 antici-pate an even larger de cit. 1 As a new presi-

dent and Congress take of ce, governmentde cits and the public debt will undoubt-edly be a factor in economic policy discus-sions, especially in light of ongoing nancialuncertainty and economic weakness.

From an economic perspective, the size of the de cit and debt per seare not necessar-ily as important as the underlying policiesof spending and taxation. By their very nature, de cits re ect an imbalance betweenexpenditures and receipts. Such imbalances

By Michael Pakko

Defcits, Debtand Looming

Disaster

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squeezed in to accommodate



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need not be a concern and might, in fact, bedesirable under some circumstances. Andwhile rising government debt is often associ-ated with direct economic costs, includinghigher interest rates and lower rates of pri-vate investment, evidence on the signi canceof these effects is mixed.

Nevertheless, when de cits are part of afundamental structural imbalance in thelong term, they signal a need for seriousattention and reform. In a long-run scalanalysis of U.S. federal government pro-grams, this is demonstrably the case.

Government Accounting

The top panel of Figure 1 shows twomeasures of the federal de cit. The blueline is the of cial measure reported by the

government$455 billion for scal 2008.The red line tracks the change in the totaloutstanding national debt from year to year.By this measure, the de cit exceeded $1 tril-lion in 2008. 2 Note that the reported uni edbudget showed a surplus in 1998 through2001; however, the change in the national

debt has recorded red ink in every scal yearsince 1969. The difference between thesetwo measures primarily re ects the treat-ment of the Social Security trust funds. 3

By conventional accounting standards,the de cit is equal to the dif ference betweentotal government spending and total revenuesreceived, over a particular period of time. Thedebt equals the sum of previously accumulatedde cits (or surpluses), plus interest accrued.When it comes to government, however, the

accounting is slightly more complicated.The spending and taxing policies of the

federal government are classi ed into on-budget and off-budget categories. Thoseactivities that are considered off-budgetinclude the Postal Service fund and, moreimportant, Social Security. The of cially

reported de cit is a uni ed budget, whichincludes the revenues and expendituresof these off-budget activities. Because theSocial Security trust funds are currently running large surpluses, their inclusion hasthe effect of lowering the reported de cit.For example, in 2008 the on-budget de citwas $638 billion, while the off-budget sur-plus was $183 billion (due primarily to theSocial Security trust fund). As a result, theuni ed budget de cit was $455 billion.

New York City is seen Oct. 9 with a makeshift 1 in the dollar sign box. The 1 had to be

deral governments mushrooming debt, which topped $10 trillion at the end of the scal year.

P by Ma a



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A similar dichotomy applies to the mea-surement of the national debt: Total publicdebt stood at $10 trillion at the end of scal2008, but debt held by the public was$5.8 trillion. The difference is attribut-able to $4.2 trillion held in governmenttrust funds and other intragovernmentalaccounts, of which $2.4 trillion was heldby the Social Security trust funds.

As long as the balances in the Social Secu-

rity trust funds are increasing, the on-budgetde cit is partly offset by off-budget surpluses.When Social Security bene t payments beginexceeding revenueswhich latest estimatessuggest will begin in 2017the off-budgetcomponents will add to the overall uni edbudget shortfall. (It will be interesting to see if the federal government continues to report theuni ed budget gures when this is the case.)

When the trust funds begin to be drawndown, the government will be faced with the

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need to borrow from the public in orderto pay the obligations of the debt currently held in the trust funds. This will result inan increase in the debt held by the public,with no change in the total outstandingdebt. In this sense, the total debt mightbetter represent the long-term obligationsof current government programs. In fact,as will be discussed later, a proper account-ing of the long-term obligations of federalentitlement programs is far greater thanthe value of government IOUs in the SocialSecurity trust funds.

Relative Size Matters

Although both the de cit and debtfor scal 2008 were the largest on recordin dollar terms, putting these gures inproper perspective is important: A moreappropriate evaluation compares thede cit and the debt with national income.In the same sense that the manageability of a households debt depends on income(the ability of the household to make pay-ments), evaluating the size of the govern-ments debt should be gauged against thesize of the national economy.

When expressed as a percent of GDP, asshown in the lower panel of Figure 1, recentde cits have not been exceptionally large.In fact, of cial de cits in the mid-1980swere nearly twice as large as the 3.2 percent

of GDP recorded for 2008. Even using thealternative measure, last years change inthe national debt amounted to 7.6 percentof GDPonly slightly greater than the7.3 percent of GDP registered in 1986. 4

Similarly, the $10 trillion national debtrepresents 69.5 percent of GDPonly slightly higher than the previous peak of 67.3 percent of GDP that was reached in1996. Netting out intragovernmentalholdings, debt held by the public in 2008represented 40.3 percent of GDP, well

below a previous peak of 49.4 percentin 1993.5

U.S. government debt is also not par-ticularly large compared with that of other countries. In 2007, Frances govern-ment debt amounted to approximately 70 percent of GDP, Italys debt-to-GDPratio was nearly 120 percent and Japanswas over 170 percent.

Put in perspective, current de -cits and debt levels are high, but not

The unifed budget de cit/surplus gures represent the consolid ted on- udget nd off- udget l nces sof ci ll reported. he ch nge in feder l de t is the ch nge in gross feder l de t from one e r to the next(with sign reversed).



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unprecedented. Should this red ink be acause for concern?

Economic Impact o Defcits

In principle, de cits can serve a useful roleby providing the ability to smooth the pathof distortionary taxes over time, particularly over the business cycle. Longer-term de citscan be justi able if they nance long-termexpenditures (as with an individual who

nances the purchase of a home) or if they are expected to pay off in higher nationalincome in the future (as an investment). Ina growing economy, even a permanently

increasing de cit (if it is not increasing toofast) is sustainable in the long run.

It is often argued that government

de cits, particularly longer-term de cits,impose a direct economic cost. A con-ventional Keynesian analysis of this effectbegins from the fundamental nationalincome accounting relationship that totaldomestic investment is equal to nationalsavings, which includes the total of saving(or dissaving) by consumers, business andgovernment. When the government runsa de cit, the borrowing needed to nancethe shortfall diverts the private savings

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The Regional Economist | www.stlouis ed.org


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that would otherwise ow into investment.One of the expected manifestations of thiscrowding out effect is that governmentde cits, by increasing the competition for

loanable funds, put upward pressure oninterest rates.This need not be the case, however. A

theoretical construct that often serves as abaseline for evaluating the effect of de citsis known as Ricardian equivalence. Ina closed economy with rational, forward-looking consumers, Ricardian equivalencesuggests that de cits may have no effect atall. For instance, suppose the governmentwere to implement a lump-sum tax cut,

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These p ojectionsuse Medic re nd oci l ecurit d t from their respective trustees reports. Medic id isssumed to grow t the s me r te s Medic re. Discretion r spending from the w r is ph sed out fter 2010,

with rem ining discretion r spending ssumed to exp nd t the s me r te s GDP. he d t do not ccount forn spending expected to e ssoci ted with the mergenc conomic t iliz tion act of 2008.

nancing the resulting budget shortfallby borrowing from the public, with theresulting debt to be repaid in the futurewith a tax increase. Rational consumerswould be expected to increase their sav-ings in anticipation of higher future taxes,which would be needed to pay off thedebt. The increase in government dissav-ing would be met by an increase in privatesector saving, leaving overall nationalsavings unchanged. With no change inthe balance between national savings andinvestment demand, there would be noupward pressure on interest rates.

The conditions under which Ricardianequivalence holdseven from a theoreti-cal perspectiveare quite restrictive; so,it is unlikely to be a literal descriptionof the impact of de cit nancing on theeconomy. Nevertheless, it serves as abaseline for evaluating the relevance of crowding out effects that might be presentif, for example, consumers are myopicabout their own future tax burden or failto consider the welfare of future genera-tions, or if credit-market imperfectionsprevent them from responding optimally to government de cits.

In this regard, the economic relevanceof crowding outand its consequenteffect on interest ratesis an empiricalmatter. As the de cit has increased in

both size and public prominence overthe past quarter-century, there has beena deluge of research on the subject. Onereview of the literature in 2004 by Wil-liam Gale and Peter Orszag reported on atotal of 66 previous analyses of the topic.Of these, 33 found signi cant effects of budget de cits, while 33 found insigni -cant or mixed effects. Gale and Orszagwent on to conduct their own analysis,

nding signi cant non-Ricardian effects:They suggest that a de cit increase

amounting to 1 percent of GDP lowersnational savings by 0.5 to 0.8 percent andthat expected future de cits raise long-term interest rates by 25 to 35 basis points.

These ndings have been controversial,however. In fact, another paper circulat-ing at the same time by Eric Engen andGlenn Hubbard suggested that the debt,rather than the de cit, was the appropri-ate measure to consider. They found thata 1 percent increase in the debt-to-GDP



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d

1 In its Mid-Session Review in July 2008, theOf ce of Management and Budget projecteda de cit of $482 billion for scal year 2009,which ends Sept. 30, 2009. Implementationof the Emergency Economic Stabilization Actis likely to add an additional several hundredbillion dollars to t he Treasurys upcomingborrowing needs.

2 The change in national debt for 2008 includes$300 billion in t he new Supplementary Financing Program Account. Through thisprogram, the Treasury issues additional debt,depositing the proceeds into its account withthe Federal Reserve. Because the Treasury records this as an increase in cash on-hand,it should more accurately be subtracted fromthe total change in debt. With this adjust-ment, the change in the national debt for 2008would be just over $700 bill ion.

3 There are two Social Security trust funds,Old Age and Survivor In surance (OASI) andDisability Insurance (DI). At the end of scal year 2008, they stood at $2.15 trillion and$216 billion, respectively.

4 Adjusting for the $300 billion described inendnote 2, the increase in the national debtfor 2008 was 5.4 percent of GDP.

5 After adjusting for the $300 bill ion held inthe Supplementary Financing ProgramAccount, the total federal debt represented68.2 percent of GDP, while debt held by thepublic amounted to 38.7 percent.

6 See Social Security Administration. 7 Treasury Department, 2007 Financial Report

of the United States Government. 8 See Kotlikoff (2006 and 2008). 9 See Morrison and Labonte.

R R

Engen, Eric M.; and Hubbard, R. Glenn. Fed-eral Government Debt and Interest Rates, inMark Gertler and Kenneth Rogoff, eds., NBER Macroeconomics Annual 2004, pp. 83-160.Cambridge, Mass: MIT Press.

Gale, William G.; and Orszag, Peter R. BudgetDe cits, National Saving, and Interest Rates,Brookings Papers on Economic Activity,2004,No. 2, pp. 101-210.

Government Accountability Of ce, The Federal Governments Financial Health: A CitizensGuide to the 2007 Financial Report of theUnited States Government, 2008. See www.gao.gov/ nancial/citizensguide2008.pdf.

Kotlikoff, Laurence J. Is the United StatesBankrupt? Federal Reserve Bank of St. LouisReview,Vol. 88, No. 4, July/August 2006,pp. 235-49.

______. Is the U.S. Going Broke? Forbes,Sept. 29, 2008, pp. 34-35.

Morrison, Wayne M.; and Labonte, Marc. ChinasHoldings of U.S. Securities: Implications forthe U.S. Economy, Congressional ResearchService, Order Code RL34314; May 19, 2008.See www.fas.org/sgp/crs/row/RL34314.pdf.

Of ce of Management and Budget. Mid-SessionReview, Budget of the U.S. Government, Fiscal Year 2009, July 2008. See www.whitehouse.gov/omb/budget/fy2009/pdf/09msr.pdf.

Social Security Administration. The 2008 AnnualReport of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, March 2008.See www.ssa.gov/OACT/pubs.html.

ratio led to an increase in interest rates of only four to ve basis points.

Recent experience has renewed skepticismabout the effect of government de cits oninterest rates. As the U.S. government de -cit and debt have risen sharply over the pastfew years, long-term interest rates remainedabnormally low relative to short-term rates.One factor that has evidently contributed tothis phenomenonnot explicitly consid-ered under the conventional Keynesian viewor in the Ricardian-equivalence analysisis the effect of savings coming into thiscountry from abroad. The increasingdemand for borrowing by the U.S. Treasury in recent years has been met with a substan-tial foreign in ow. (See sidebar on Page 7.)Even if U.S. residents are non-Ricardian intheir behavior, the demand for U.S. Trea-sury securities by foreigners is likely to havemitigated upward pressure on interest ratesthat might otherwise have been observed.

A Demographic Time Bomb

While the immediate impacts of govern-ment de cits and debt are a matter of somecontroversy, most economists agree thatthe long-term scal outlook for the U.S.requires serious attention. The retirementof the Baby Boom generation and a slow-ing rate of growth in the labor force willcreate a demographic time bomb in which

entitlement growth threatens to swampavailable resources.

As mentioned earlier, the Social Security trust funds are projected to begin runningdown in 2017. By 2041, they are expectedto be depleted. 6 One way of measuringthe long-run shortfall is to estimate thepresent value of unfunded obligations, thatis, to estimate how much money would beneeded, in todays dollars, to pay for futurepromises in excess of expected tax revenues.In the case of Social Security, the U.S. Trea-

sury estimates that paying promised bene tsthrough the year 2081 would require $6.8trillion, in addition to taxes collected undercurrent law. 7

The situation is even more dire when weconsider health-care costs. The unfundedobligations of Medicare parts A and Bamount to a present value of $25.7 trillion.Medicare Part D (prescription drug cover-age) adds another $8.4 trillion. All told, theshortfall for government social insurance

programs comes to a present value of $40.9tril lion. This is the governments of cialestimatesome private sector economistssuggest that the total burden is even greater.Economist Lawrence Kotlikoff has recently estimated the total unfunded liabilities of current federal programs at $70 trillion. 8

Figure 2 displays recent forecasts fromthe Government Accountability Of ce,illustrating the budget implications of thesetrends. The upper panel shows accelerat-ing de cits over the next seven decades.Assuming revenues held constant at thehistorical average of 18 percent, these projections show the de cit rising to over40 percent of GDP by 2080. The lowerpanel of Figure 2 shows the implicationsfor the federal debt: an exponential rate of increase that reaches over 600 percent of GDP by 2080. This would far exceed any level of government borrowing in history.

These projections are unlikely to actually occur. The trends are unsusta inable. Longbefore reaching such unprecedented levelof borrowing, there would surely be a crisisof con dence among U.S. creditors, bothdomestic and foreign.

Current measures of the federal de citand the national debt, as dismal as they might appear, fail to re ect full conse-quences of current-law scal policy. Theunfunded future liabilities of government

entitlement programs imply rising de citsand a ballooning public debt far larger thantodays shortfalls. And debates about theimmediate economic impact of govern-ment de cits on private savings and interestrates, while of academic interest, fail toaddress the full importance of these long-run consequences. Fundamental reform of entitlement programs is critical for puttingU.S. scal policy on a long-run sustainablepath.

Michael Pakko is an economist at the Federal Reserve Bank of St. Louis. For more on his work,see http://research.stlouisfed.org/econ/pakko/ index.html. Luke Shimek provided researchassistance.



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A Winning ombination?conomic heory Meets ports

By Kristie M. Engemann and Michael T. Owyang

r e s e a r c h

Unlike researchers in the natural sci-ences, economists often lack the ability to conduct laboratory or controlled experi-ments to test theories or make inference.In recent years, economists have begun tostudy natural experimentsnaturally occurring events that provide a researcherwith a basis to analyze outcomes within aclearly de ned setting. One such arti ciallaboratory that economists have discoveredis sports. Economists have used data fromsports to examine such diverse issues as(1) risk behavior, (2) market ef ciency,(3) market power and (4) discrimination.

Risk Behavior: Does MaximizationPredict Coaches Decisions?

A basic assumption in economic models isthat, in competitive markets, rms maximize

pro ts. In the sports world, such maximiza-

tion might be seen as a coach maximizing his

teams chance of winning. Economist DavidRomer tested whether coaches make the opti-mal choice in a fourth-down situation in theNational Football League (NFL). He arguedthat this analysis should be similar to the

rm maximization model because winningis highly valued, coaches have pressure to windue to the competitive nature of the job andteams can learn from past experiences.

Romer studied all of the regular-seasonNFL games during the 1998, 1999 and 2000

seasons, but used only the rst quarter of the games in his analysis; later in the game,teams may change their strategy basedon the score. Therefore, the rst quartershould yield the best insight as to whetherteams maximize their chances of winning.Romer analyzed the expected payoff fromgoing for a rst down on the fourth downat every point on the eld versus kickingthe ball (punting or a eld goal attempt).His analysis compared the expected valuesof the outcome of a play, as well as theexpected value of leaving the opponentwith the ball at that spot on the eld.

After taking all results into account, heestimated that teams are better off goingfor a rst down than punting if they havefewer than four yards to go in their half of the eld; if they have fewer than 6.5 yards

to go on the other teams 45-yard line; and

if they have fewer than 9.8 yards to go on

the other teams 33-yard line, at which pointteams are within typical eld-goal range.After the other teams 21-yard line, the valueof going for it frequently outweighs theexpected value of kicking a eld goal, and atthe 5-yard line, the team is always better off going for the rst down or touchdown.

How did Romers predictions comparewith actual plays in the NFL games? Insituations where teams were expected tobe better off kicking the ball on fourth

down, they went for a rst down less than1 percent of the time. However, when teamswere expected to be better off going fora rst down, they kicked the ball almost90 percent of the time. Romer estimatedthat if a team optimized in these situationsthroughout the whole game, it would winone more game every three seasons.

Romer surmised that coaches previousexperiences might cause more conserva-tive decisions than one would predict usingstandard assumptions about optimizingbehavior. Alternatively, a coachs objectivemight be more complicated than simply choosing plays that would result in thehighest expected outcome. For instance,he might view activities that decrease thechance of winning (e.g., a failed rst-downattempt) more negatively than he views a

successful activity positively, which couldstem from fan or owner preferences.

Risk Behavior: Does Game TheoryPredict Player Behavior?

What happens when only two players areinvolved rather than entire teams? Econo-mists Pierre-Andr Chiappori, Steven Levittand Timothy Groseclose tested whetherkickers and goalies used mixed strategies(i.e., chose strategies at random) to optimizetheir chances of being successful during

penalty kicks in soccer. Even though socceris a team sport, the penalty kicks involve just those two players and thus allow fora test of economic game theory. For eachpenalty kick, the kicker should maximize hischance of scoring, while the goalie shouldmaximize his chance of preventing a score.

The authors studied all penalty kicks overa two-year period in the elite French leagueand over a three-year period in the elite Ital-ian league. For each penalty kick, they had

i t t t m p t t b b tt ff t b f t , t t f t

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the names of the kicker and the goalie, thedirection the kicker kicked (right, left or cen-ter) and which foot he used, and the direc-tion the goalie jumped (right, left or center).Due to the high speed of the ball, each playermust decide which direction to kick/jumpbefore the other player makes a move.

The authors contended that a goaliesstrategy should depend on the kickerspast kicks, but a kickers strategy should beindependent of the goalie. In the authorssample, when both players chose the kickersnatural side (which is the left side in mostcases because the kickers usually kickwith their right foot), the kicker scored 64percent of the time, and when both chosethe kickers non-natural side, the kickerscored about 44 percent of the time. Whenthe goalie jumped to the wrong side, thekicker scored 94 percent of the time when he

kicked to his natural side and 89 percent of the time when he kicked to his non-naturalside. Obvious from these data is that kick-ers are substantially more successful whenkicking to their natural side.

The authors showed that, over theirsample of 459 penalty kicks, the playersused mixed strategies that one would expectin order to maximize behavior. Indeed, akicker went to the center more often thanthe goalie did (17 percent versus 2 percent),and a kicker went to his natural side less

often than the goalie did (45 percent versus57 percent). Both players were more likely to go to the kickers natural side than hisnon-natural side, and the case where they simultaneously went to the kickers naturalside was the most common (25 percent),followed by the goalie jumping to thekickers natural side but the kicker goingto the opposite (21 percent).

Based on all of these results, Chiappori,Levitt and Groseclose could not rule outthat soccer players successfully optimize

their behavior during penalty kicks.Do Markets Work?

Many aspects of the sports labor mar-ket have been analyzed. The competitiveenvironment of sports provides a settingin which one would expect merit-basedoutcomes to prevail.

Along this line, researchers Edward Fee,Charles Hadlock and Joshua Pierce studiedpromotions among coaches in the NFL.

The authors assessed whether promotionswithin teams were based on differentcriteria than promotions from outside.The researchers focused on promotions of offensive and defensive coordinators (level 2coaches) to head coaches (level 1 coaches).

Examining data for NFL coaches from1970 to 2001, the authors used a teamswinning percentage as a measure of teamperformance. The authors used pointsscored for offensive coordinators andpoints allowed for defensive coor-dinators as a measure of individualperformance. In assessing promo-tions of level 2 coaches to headcoach on another team, thehiring decision depended onindividual performance ratherthan team performance. Incontrast, both team perfor-mance and individual perfor-mance mattered for promotionto head coach on the same team. A strongteam performance actually decreased thelikelihood of such a promotion, mostly because teams with winning records wereless likely to replace their head coach. Aftercontrolling for the team, the highest indi-vidual performers were more likely to bepromoted. However, the two effects essen-tially canceled each other out, leaving virtu-ally no effect of individual performance on

internal promotions.Fee, Hadlock and Pierce likened this

situation to top management at rms. 1 For senior management excluding CEOs,strong performers are more likely to obtainthe position of CEO at a different rmrather than their own rm due to slotconstraints. The authors ndings do notsupport the theory that internal promotionsserve as incentives for the best performers,at least not for top-level positions.

Market Power and the Labor Market

A sports league can be viewed as a mon-opsonythere is one buyer but many sellersof a product (players services, in this case).A sports league, such as Major League Base-ball (MLB), has market power because itcan pay players less than their contributionto the team generates in revenue. However,the league cannot exercise as much marketpower for players who are eligible for salary arbitration or free agency. 2



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To study the effect of free agency andsalary arbitration on salary and contractlength, economist Lawrence Kahn looked atall players from 1987 to 1990. He obtaineddata on each players salary, contract, totalcompensation, performance statistics andlocal demographics (e.g., population andper capita income of the teams metropoli-tan statistical area) and performed separateanalyses on nonpitchers and pitchers. Com-pared to players with less than three years of service, free agents earned about ve timesmore each year and players with ve years

of service earned between ve and six timesmore each year during this time period.

The table shows the results of Kahnsanalysis after controlling for performancestatistics, years of experience, etc. The toppanel shows that players with arbitrationand free agency earned higher annual sala-ries than players with fewer than three yearsof service. A notable exception is whitepitchers who were free agentsthey earnedroughly the same amount as those withfewer than three years of service. However,

free agents were the only group with consis-tently longer contract length, which wouldaffect total compensation (bottom panel)perhaps more than annual salary alone.

Kahn argued that his results are in linewith free agents willingness to accepta lower annual salary for the insurancethat comes with longer contracts. He alsoargued that the signi cant effect of freeagency on contract length shows that teamsare will ing to sign longer contracts only at

C M P a N G U P P L a y L a N y a V C

Nonpitche s Pitche s

Whites Nonwhites Whites Nonwhites

Annual compensation (% di e ence)

Pl ers with:

3 or 4 e rs of service 36 43 36 28

5 e rs of service 48 44 28 53

ree genc 44 35 4 31

Total compensation (% di e ence)

Pl ers with:

3 or 4 e rs of service 36 36 34 27

5 e rs of service 62 56 54 76

ree genc 68 59 51 66

U C : K hn (1993).

A AL A D TOTAL COMPE SATIO DIFFERE CES FOR MLB GRO PS the possibility of losing a player, thus avoid-ing a bidding war with other teams.

Discrimination in Pay

Many economists have studied discrimi-nation in the labor market, including thesports labor market. Researchers Kahnand Peter Sherer examined pay differen-tials between white and black players inthe National Basketball Association (NBA)during the 1985-86 season. In 1985-86,about 75 percent of players were black, and,on average, black players earned almost 3percent more than white players. In fact,the only three players during that seasonwho earned more than $2 million wereblack (Magic Johnson, Moses Malone andKareem Abdul-Jabbar). Also, white playerstended to play in cities with lower popula-tion, a higher white share of populationand higher home-game attendance.

Kahn and Sherer reached a differentconclusion regarding pay differentialsafter controlling for players performancestatistics (e.g., points, minutes per gameand number of seasons played), team char-acteristics (winning percentage and homeattendance) and some local demographics(total population and the percentage black,and per capita income). White playersearned about 20 percent more than blackplayers, all else equal, in the mid-1980s.

In addition, the authors found that a whiteplayer with the same performance levelas a black player would bring in a total of 8,000 to 13,000 more fans at home games,which they estimated was an extra $80,000to $130,000 in revenue. The authorsargued that their results re ect customerdiscrimination (rather than employer orco-worker discrimination) because fansappeared to be willing to pay a premiumto watch white players.

Economist Barton Hamilton studied

whether this white premium contin-ued into the 1990s by examining salariesduring the 1994-95 NBA season. For thisseason, the average black player earnedabout 17 percent more than the averagewhite player, and nine of the 10 highest-paid players were black. Like Kahn andSherer, Hamilton controlled for playersperformance, team characteristics andlocal demographics to determine the trueimpact of race on a players salary. Unlike



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d

1 However, head coaches have a higher averagturnover rate (22 percent) than CEOs(10 percent).

2 In the MLB, players are not eligible for freeagency, which allows them to negotiate acontract with multiple teams, until they havsix years of major league service. Players wthree, four or ve years of major league ser-vice are eligible for salary arbitration. Undesalary arbitration, the player and the teameach submit a nal offer, and an arbitratormust choose one of them. See Kahn (1993).

3 One conclusion that Price and Wolfersdrew is that a potential bias by the refereesfor their own race exists. They argued thatbecause NBA referees are heavily scrutinizeafter each of their games, it is most likely anunconscious bias.

R R

Chiappori, Pierre-Andr; Levitt, Steven; andGroseclose, Timothy. Testing Mixed-Strat-egy Equilibria W hen Players Are Heteroge-neous: The Case of Penalty Kicks in Soccer. American Economic Review, September 200Vol. 92, No. 4, pp. 1138-51.

Fee, C. Edward; Hadlock, Charles J.; and PiercJoshua R. Promotions in the Internal andExternal Labor Market: Evidence fromProfessional Football Coaching Ca reers. Journal of Business, March 2006, Vol. 79,No. 2, pp. 821-50.

Hamilton, Barton Hughes. Racial Discrimination and Professional Basketball Salaries inthe 1990s. Applied Economics,March 1997Vol. 29, No. 3, pp. 287-96.

Kahn, Lawrence M. Free Agency, Long-termContracts and Compensation in MajorLeague Baseball: Esti mates from Panel DatReview of Economics and Statistics, Februar1993, Vol. 75, No. 1, pp. 157-64.

Kahn, Lawrence M.; and Sherer, Peter D. RacDifferences in Professional Basketball PlayCompensation. Journal of Labor EconomJanuary 1988, Vol. 6, No. 1, pp. 40-61.

Price, Joseph; and Wolfers, Justin. Racial Discrimination among NBA Referees. NationBureau of Economic Research Working PapeNo. 13206, June 2007.

Romer, David. Do Firms Maximize ? Evidenfrom Professional Football. Journal of Pocal Economy, April 2006, Vol. 114, No. 2,pp. 340-65.

the previous authors, he found no signi -cant pay differential between the averagewhite and black player. However, among thestars and the superstars (i.e., those playersin the top 25 percent and top 10 percentof the salary distribution, respectively),whites earned about 18 percent morethan blacks. Because the stars arethe most visible players on a team,Hamilton argued that this pay differ-ential continued to re ect customerdiscrimination.

Discrimination in Play

Economists Joseph Price and JustinWolfers performed a different evalua-tion of discrimination in the NBA. They estimated the amount of racial bias fromreferees when calling fouls on players of the opposite race, which can in uence theon-court performance of the players. They examined every NBA game from the 1991-92 to the 2003-04 seasons and obtainedstatistics for each player and the race of the(randomly assigned) three referees for every game. The economists were able to com-pare the number of personal fouls a playerreceived depending on the racial composi-tion of the of ciating crew.

About one-third of the referees duringthis time period were black, and black play-ers accounted for over 80 percent of total

minutes played. At rst glance, the datashowed that black players had more playingtime and fewer fouls per 48 minutes played(the foul rate) than white players. More-over, players had slightly lower foul rateswhen the of ciating crew was of the samerace, on average. A more in-depth analysiswith controls for various characteristics(e.g., player position, height, weight, all-starstatus) showed that the foul rate for blackplayers increased by about 4 percent whenall three referees were white rather than

black. As a consequence, playing time andpoints scored decreased slightly. Overall,the authors found that 62 percent of theblack referees appeared to have a pro-blackbias (by calling fewer fouls on black play-ers), while 78 percent of the white refereesappeared to have a pro-white bias (by call-ing more fouls on black players).

With these impacts on individual players,the authors tested the effect that this appar-ent referee bias had on the most important

outcome: winning. During the sampleperiod, the margin of victory was one pointin 4 percent of the games; thus, the seem-ingly small referee bias could have a largeeffect on the overall outcome. Indeed, Priceand Wolfers argued that changing the racialcomposition of the referees to match thatof the players on the team would lead to anincrease in winning percentage for the teamwith more time played by black players from48.6 percent to 50.5 percent. 3

ot Just Fun and Games

Because economists do not generally have the opportunity to conduct laboratory experiments, sports provide an excellentopportunity to test theories, ranging fromthe existence of discrimination in the labormarket to whether rms or individualsoptimize their behavior to achieve a certaingoal. With the high level of data availability that sports provides, undoubtedly there willbe more natural experiments to analyze.

Kristie Engemann is a research analyst, and Michael Owyang is an economist, both at theFederal Reserve Bank of St. Louis. For more onOwyangs work, see http://research.stlouisfed.org/econ/owyang/index.html.



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Drawing upon long-dormant emergency powers as lender of last resort, the Fed-eral Reserve has taken unprecedented steps toshore up the nancial system. If, as a result of these precedents, the Federal Reserves role asa regulator is expanded, the central bank willprobably face new challenges in executing itstraditional responsibilities and preserving itsindependence against political pressure. Thus,changes in the role of the Federal Reserveshould be carefully considered, bearing inmind the importance of its role in monetary policy and the payment systemand theimportance of protecting these functions frompolitical and nancial pressures.

The Fed Responds to Crisis

The challenges presented by the subprime

meltdown and the subsequent strain in globalnancial markets have dramatically reshaped

the nancial landscape in the U.S. Sincethe onset of the crisis in August 2007, thecountry has witnessed a series of prominentbank failures: Countrywide, IndyMac andWashington Mutual (by far the largest com-mercial bank failure in American history);the demise of Americas ve major investmentbanks; the bailout of mega-insurer AmericanInternational Group (AIG); and the decline of mortgage titans Fannie Mae and Freddie Mac.

Faced with these extraordinary developments,the Federal Reserveto which all eyes wereturned for rescuetook upon itself the mis-sion of managing and containing the crisis.

Assuming responsibility not only for thosebanks under its supervision, but for the

nancial system as a whole, the central bankdrew upon long-dormant emergency powersand took bold steps: It enhanced nancialinstitutions access to liquidity by deployingan array of new short-term liquidity facilities;

expanded reciprocal currency arrangementswith foreign central banks; engineered andbacked JP Morgans takeover of ailing invest-ment bank Bear Stearns; agreed to lend toFannie Mae and Freddie Mac; provided anemergency credit line to AIG; and workedout with the U.S. Treasury an ambitious$700 billion emergency rescue package forthe American nancial services industry.

Thus, the Federal Reserve, establishednearly a century ago as lender of last resortto tackle nancial panics, emerged in a new,broader guisethat of the nations nancialsystem savior.

A Systemwide Regulator?

Why has the Federal Reserve assumedthis extended role? The reasons appear tobe multiple. First, the Federal Reserve is thelender of last resort and has a monopoly overthe supply of liquidity to the nancial system.This role provides the central bank with boththe tools and the expertise for managing andcontaining systemic disruptions. Second, theFederal Reserve plays a key role in providingpayment services and overseeing the paymentsystem, the integrity of which is essential to

nancial stability. The Federal Reserve alsoenjoys an unmatched reputation for technicalskill and nonpartisanship, the ability to wield

moral suasion and a unique primus interpares ( rst among equals) status amongfederal regulators, placing it in the primeposition for leading national rescue efforts.In the global arena, its close relationship withforeign central banks and its high interna-tional acclaim enable the Federal Reserve tocoordinate multinational endeavors to shoreup crumbling nancial markets. Faced withthe dramatic developments in the nancialsystem, the Federal Reserve answered a call

no other federal agency was better-suitedor willingto answer.

To date, regulators of nancial institutionsin the U.S. have been mandated to focus onthe prudential issues, namely, business con-duct and nancial conditions of individualinstitutions. The recent nancial shakeoutvividly demonstrates the need for a system-wide, macro-prudential approach to nan-cial regulation. Unlike micro-prudentialregulation, which focuses on the nancialcondition of single institutions, the system-wide approachs eld of vision is the nancialsystem as a whole, focusing on commonexposures, linkages and interdependenciesamong nancial institutions.

It has been suggested that a systemwideregulator, entrusted with the responsibility for

maintaining nancial system stability, shouldbe able to either collect or access the informa-tion required for the evaluation of the systemicrisks associated with certain industry-widepractices, common exposures or default by a nancial institution, and should be ableto wield both the authority and the tools tointervene when needed. In the eyes of many,the Federal Reserve is the natural candidatefor the role. A blueprint for regulatory overhaul released by the U.S. Department of the Treasury last March (the Paulson plan)

recommends mandating the Federal Reserveas market stability regulator. 1

Whether formalized or not, the FederalReserves extended role in nancial oversight,alongside its long-existing roles in maintain-ing price stability and promoting economicperformance, raises important challenges.One such challenge is the potential con-

ict between micro- and macro-prudentialregulatory objectives. Micro-prudentialregulation is pro-cyclical by natureboth

c e n T r a l B a n k

By Sharon K. Blei



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d

1 See the Treasury Department.2 See Volcker.

R R

Bernanke, Ben S. Reducing Systemic Risk.Presented at the Federal Reserve Bank of Kansas Citys annual economic symposiumin Jackson Hole, Wyo., Aug. 22, 2008. Seewww.federalreserve.gov/newsevents/speech/bernanke20080822a.htm

Treasury Department blueprint for a modern-ized nancial regulatory structure (March2008) can be found at www.ustreas.gov/press/releases/reports/Blueprint.pdf.

Volcker, Paul A. Testimony before the JointEconomic Committee, May 14, 2008. See jec.senate.gov/index.cfm?FuseAction=Files.View&FileStore_id=3b13d743-490b-4c41-ba36-8d86688d93a6.

because capital requirements and account-ing rules enhance the pro-cyclicality already inherent in credit markets and also becauseprudential regulators tend to be stricter intimes of economic weakness and laxer dur-ing expansion. The systemwide approachto regulation, on the other hand, aims tostabilize systemic shocks to nancial marketsand is, therefore, counter-cyclical by de ni-tion. Regulatory measures that are desirablefrom a micro-prudential point of view may seem, therefore, detrimental from a systemicstandpoint. (For example, taking correctiveaction against a nancial institution might bewell-justi ed as far as prudential regulationgoes, yet undesirable from a system-wide per-spective, since doing so may further deterio-rate that institutions nancial condition andincrease the risk it poses to the system.)

Acquiring the information essential to

executing the role of systemwide regulatornamely, real-time data about a vast array of nancial institutions, their nancialcondition, structure and the contractuallinkages between thempresents additionalchallenges. First, there are the technical dif-

culties and non-negligible costs associatedwith collecting and processing such complexdataboth to supervisors and institutions.Then, theres the need for close collaborationwith other regulators (public, private andeven foreign), who may not be willing

to cooperate.

Whither Independence?

Another major concern is that broaderresponsibilities over the nancial systemmight subject the Federal Reserve to excessivepolitical pressure and, thereby, compromiseits independence in the conduct of monetary policy. Independence against narrow politi-cal and commercial pressures, that is, beingrelatively immune to the danger of captivityby interested parties, is crucial to the Federal

Reserves monetary policy role. Politicianshave always sought in uence on the FederalReserve, especially at t imes of economicturmoil; they have pressured it to favor certainsectors or industries or to lower interest rates.

An extended role in nancial regulationcould arouse an even greater appetite forin uence among politicians. In addition,such a role entails using taxpayer money and affecting the allocation of credit in theeconomy and, thus, would inevitably lend

scal and political nuances to the centralbanks actions; that, in turn, would spurdemands for greater transparency and closercongressional scrutiny.

Testifying before the Congress Joint Eco-nomic Committee last May, former FederalReserve Chairman Paul Volcker remarked thatbroadening the Federal Reserves authoritiesbeyond the supervision of commercial banksand their bank holding companies would bea way of destroying the Federal Reserve in thelong run because it does need independence.Volcker further wondered whether such alarge responsibility [should] be vested in asingle organization, and should that organi-zation reasonably be in the Federal Reservewithout risking dilution of its independenceand central bank monetary responsibilities? 2

Volckers query broaches yet anotherchallenge facing the Federal Reserve, that of

balancing its re-interpreted role in the nan-cial arena with its monetary responsibility.Monetary policy instrumentsthe interestrate, reserve requirements, short-term liquid-ity facilities and the discount windowcanpotentially affect both price and nancialsystem stability, yet in opposite directions.Whereas tight monetary policy may combatin ationary pressure, it may also reduce theavailability of credit and may jeopardize bor-rowers creditworthiness, thus, potentially weakening the credit market. Hence, in the

short run, there may be tradeoffs betweenachieving the goal of price stability andmaintaining a healthy credit market. Havingplayed the role of banking supervisor since itsestablishment in 1913, the Federal Reserve isno stranger to this tradeoff.

Further Thoughts

If the Federal Reserve is given a system-wide role in nancial regulation, the many challenges it might present to the centralbank would call for reassessment of its differ-

ent functions and objectives and for carefulplanning. Sound conceptual and structuralregulatory foundations, successful imple-mentation of a nancial stability mandateand continuous adaptation to the ever-changing nancial environment would pavethe way to a safer economic future.

Sharon Blei is an economist at the Federal ReserveBank of St. Louis.



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El Dorado, Ark., and the area around it

are naturally rich in pine forests, saltwater and oil. Now, the town is seeking tocapitalize on a new resourceeducation. InJanuary 2007, Murphy Oil Corp., the com-munitys signature employer, announced thatit was setting aside $50 million to endow theEl Dorado Promise, a program that offersgrants to graduates of El Dorado High Schoolso that they can attend college.

That started the ball rolling, MayorMike Dumas says. That changed the wholeattitude of the community.

He and other leaders in El Dorado (rhymeswith tornado) credit the Promise forenergizing townspeople to approve laterthat year a one-cent sales tax for economicdevelopment and the towns rst school taxincrease in 31 years.

They voted yes though times were hardfor many. The local unemployment rate washovering about two points above the nationalaverage. Luther Lewis, chief executive at theMedical Center of South Arkansas, says bad

debt was rising at the hospital and more

patients were qualifying for Medicaid.The towns once-bedrock manufacturing

industry was eroding and taking its toll. In2003, lighting manufacturer Prescolite Inc.pulled out of El Dorado, moving the work of its 270 employees to Mexico. Two years later,Cooper-Standard Automotive closed its localvehicle-parts plant and consolidated produc-tion in Auburn, Ind., eliminating another400 jobs.

Don Wales, chief executive of the El DoradoChamber of Commerce, says it had long

been obvious that outsized employee fringebene ts made the Cooper-Standard plantuncompetitive. He puts the towns PilgrimsPride chicken-processing plant in thatsame precarious category, given its history of labor-management and productivity problems.

As chicken processing evolved into a bigbusiness, that plant grew accordinglyintoa linchpin of the local economy. Now, it toois threatened. Late last summeras part

El Dorado b t mbPOPu AT ON

City of El Dorado ................... ..................... . 19,891

union Co nty...................... .................... ..... 43,230

ABOR FORCECity .................... .................... ..................... ... 8,714

Co nty .................. ..................... .................. 19,365

uNEMP O MENT RATE

City .......................................................7.1 percentCo nty ..................................................5.7 percent

PER CAP TA NCOME

Co nty .................. ..................... ................ $35,339

TOP FI E EMPLO ERS

Pilgrims Pride Corp. ................... ..................... ... 1,000

Medical Center of So th Arkansas. ........................ 650ion Oil Co. .................... ..................... .................... 600

Chemt ra ................... ..................... .................... ... 500

M rphy Oil Corp. ............................... .................... 445

* Estimated by the El Dorado Chamber of Commerce,October 2008

** Self-reported, October 2008

**

**

**

*

*

*

**

**

**

**

By Susan C. Thomson

El Dorado Hopes the Promise B B t g d

c o M M u n i T y P r o F i l e

* u.S. B rea of the Cens s, estimate 2007** HAVER/B S, October 2008

*** BEA/HAVER, 2006

***

P L PUMP by U aN C. M N. P G aDUa aND D

**



17/24

of a drastic overhaul that was prompted by spiking feed and fuel costs, an oversupply of processed chickens and mounting corporatered inkPilgrims Pride cut its El Doradowork force by 700.

With a payroll of 1,000 left, Pilgrims Prideremains the largest local employer. But forhow long? A spokesman declined to elabo-rate on the companys notice last spring thatit was considering the plant for possible shut-down. Last month, the company led forprotection from its creditors under Chapter11 of the U.S. Bankruptcy Code.

Fortunately, the natural-resource indus-tries remain, of necessity, rooted in place.The forests feed a lumber industry that began just after the Civil War. After decades of industry consolidation, Deltic Timber Corp.and Anthony Forest Products Co., the largestsurviving companies, are bucking a slow-down caused by the steep drop-off in U.S.home building. Aubra Anthony Jr., presidentof his familys company, takes the long view.Timber will come back, he says, because of its increasing value not only for traditional

building products and ber for paper butalso for the emerging biofuels industry andcellulosic ethanol.

El Dorado, just 14 miles north of the Loui-siana border, lies over one of two commer-cially viable salt water reserves in the world,the Dead Sea being the other. Chemtura,the largest of three chemical plants in town,pumps that water, or brine, from the groundand uses the bromine it extracts from it tomake products such as re retardants andchemicals for use in oil dri lling, water treat-

ment and agriculture.Plans are afoot for the leftover brine.

Texas-based Tetra Technologies Inc. has bro-ken ground nearby for a $110 million plantthat is expected to employ about 80 peoplewhen in full production at the end of this year. It will buy brine from Chemtura andprocess it into calcium chloride, whose usesinclude controlling pressure in oil and gasdrilling, curing cement, processing food andmelting ice and snow.

No commodity, though, has so driven andde ned the town over the years as oil. Its dis-covery in the area in 1921 set off an explosionin population and wealth that lasted throughthat decade and earned El Dorado its endur-ing nicknameBoomtown.

A rough version of the original boom-town survives in a downtown that waslargely boarded up 20 years ago.It is now a picture-postcardvision of rehabbed storefrontsand old-time kiosks, clocks,streetlights and telephonebooths. Oil entrepreneurRichard Mason and his wife,Vertis, spearheaded the trans-formation by investing their ownmoney. Other investors followed,as did Main Street El Dorado, anorganization that raises money forimprovements downtown and thatstages events there. The DowntownBusiness Association is also a bigpromoter these days.

Recently, oil has been enjoying

what Rodney Landes, president of El Dorados First Financial Bank,describes as a mini-boom. Asworld oil prices soared in 2008,small operators found pro ts inreworking old elds for deeply embedded oil. In doing so, they put hundreds to work and pro-vided a signi cant boost tothe local economy, he says.

Most of the local oilalongwith offshore and foreign crude

passes through the Lion OilCo. re nery. An El Dorado

xture since the go-go 1920s,it turns out gasoline that is soldin Arkansas and 14 other states.The company has invested sev-eral million dollars to doubleits capacity over the past 20 years and plans to expand itagain this year, Vice Presi-dent Steven M. Cousins says.

Le t:Gr du tes from l Dor do igh chool show off their Promise schol rship p pers l st M . he were congr tul ted Cl i orne Deming, president of Murph il Corp., which m de those schol rships possi le through its l Dor do Promise progr m.

he oil pump, freshl p inted relic of the oom d s, produces out rrel d from n old well longside ighw 82.right: went e rs go, downtown w s o rded up. od , th nks in l rge p rt to oil entrepreneur ich rd M son nd hiswife, Vertis, downtown is picture postc rd version of wh t it looked like when l Dor do w s nickn med boomtown in thee rl p rt of the 20th centur .

P by U aN C

The Regional Economist | www .stlouis ed.org 17


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T t t, b b t

80 100 t t f t 20 b ft P m ,

t t f pt m t149 m

t t 2007 50 m 2008.

Above:at anthon orest Products, Je zon uentesuses hoist to move l min ted e ms th t h ve

een wr pped for shipping.right: he Lion il Co. re ner processes loc l oil,

s well s offshore oil nd foreign crude. he sitewill e exp nded g in this e r.

By far, the communitys biggest name inoil is Murphy. By virtue of its $25 billion inannual revenue, Fortune magazine ranked thecompany the nations 134th largest in 2008.Murphy Oil sells gasoline at Wal-Marts in 20states and explores for oil and gas all over theworld, though nowhere near El Dorado. Yet,loyal to its beginning in the region a century ago, the company maintains its headquar-ters here and is treasured as the citys largestwhite-collar employer.

Claiborne P. Deming, who retired as Mur-phys president last month, says the Promisewas motivated by the companys desire togive kids an opportunity to go away andtake advantage of their ability. As a plus,he adds, the company saw it as a potentiallure to professionals, who are sometimes

dif cult for employers to attract to small,rural Southern towns.

Depending on how long theyve beenattending El Dorado public schools, graduatesare promised up to the highest tuition at anArkansas public university$3,252 a semes-ter this year. They can spend the money at any two- or four-year, public or private, in-stateor out-of-state college or university.

The offer was an instant hit. Of the highschools 271 graduates that rst year, 224, or83 percent, went to college, compared with

the usual 60 percent. Results were similar in2008. James Fouse, the school district of cialwho directs the Promise, says it has expandedthe college options of many students.

For others, it has provided their only oppor-tunity. Senior Paul Lowery, for instance, isthe oldest of three siblings. He always wantedto go to college but wasnt always sure hed beable tountil the Promise. I can go now,he beams. This fall, he expects to enroll at theUniversity of Arkansas.

Deming says the Promise has givenEl Dorado a nice sense of pulling togetherand moving forward. Landes envisions itas a tie breaker that can work in the citysfavor in attracting new business.

Don Hale, president of the advertisingagency that promotes El Dorado tourism,predicts the Promise will succeed in attract-ing both new businesses and residents.

The school district, which had been losingbetween 80 and 100 students a year for the20 years before the Promise, is already credit-ing it for an uptick in enrollment149 morestudents in 2007 and 50 more in 2008.

Soon, El Dorado taxpayers will startseeing physical evidence of their Promise-inspired largesse.

The new sales tax, which went into effect

July 1, 2007, is expected to generate $32-$34million before expiring in 2015. Some of the money is earmarked to develop a totalof 1,800 undeveloped acres in two locationsfor prospective new businesses and to turnthe 116,000-square-foot building Prescoliteabandoned into a small-business develop-ment center.

With the biggest piece of the proceedsabout $17-$18 millionthe city plans tobuild a conference center. At 51,000 squarefeet, it will be the largest meeting space in

southern Arkansas and a magnet for out-of-town, as well as local, groups, Dumas says.The additional school tax money will

nance a $45 million high school to replacethe current one, built in the late 1960s.

Groundbreakings for both the new confer-ence center and the new high school arescheduled for this spring.

Susan C. Thomson is a freelance writer.

P by U aN C. M N P by



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n a T i o n a l o v e r v i e w

Man the Lifeboats!By Kevin L. Kliesen

that this enormous injection will eventually spur increased lending and a rebound ineconomic growth.

Through it all, the nations economy managed to grow at a moderate pace overthe rst half of 2008 (about 1.75 percent)even though the National Bureau of Eco-nomic Research determined that the U.S.economy entered into a recession in Decem-ber 2007. The United States also bene tedfrom a strong world economy in recent yearsthat was a boon for U.S. exporters. By latesummer, though, it was clear that both theU.S. and most of the worlds largest econo-

mies were either in a recession or were slid-ing into one. In the third quarter of 2008,the U.S. economy contracted at a 0.5 percentannual rate, and most forecasters expect aneven larger decline in the fourth quarter.The consensus of most forecasters is thatthe U.S. economy will continue to contractover the rst half of 2009, with only modestgrowth in the third and fourth quarters.

By the fourth quarter of 2009, the unem-ployment rate is projected to average about8 percent. It is possible that this recession

will be somewhat deeper and longer thanthe fairly mild recessions experienced in1990-91 and 2001. It is too early to tell if therecession will be as severe as those seen in1973-75 and 1981-82.

Last year was an historic year for theU.S. economy. To begin with, crudeoil, gasoline and commodity prices roseto record-high levels, causing in ationto accelerate rapidly. Over the rst sevenmonths of 2008, in ation was running atabout a 6.25 percent annual rate. Thesehigher prices reduced the purchasing powerof households and narrowed pro t marginsof many rms, causing a drag on consump-tion and business xed investment.

Since August 2008, oil prices have plungedand the near-term in ation outlook hasimproved considerably. In fact, the CPIdeclined at about an 8.25 percent annualrate between July and November. Thisdevelopment has led some economists tospeculate about the possibility of de ation,

which is de ned as a falling aggregate pricelevel (GDP price index). Thus far, however,most economists view the decline in theCPI as a re ection of (i) falling energy andcommodity prices and (ii) the sharp slowingin actual and projected domestic and globaleconomic growth. Most economists do notexpect a fall in the GDP price index this year.

Falling prices of equities and houses weretwo developments in 2008 that reduced thewealth of the nations households and createdenormous uncertainty about the strength of

the economy heading into 2009. The S&P500 was down by nearly 50 percent at onepoint in 2008, while house prices had fallennationally by about 13 percent from Septem-ber 2007 to September 2008.

Financial stresses and their associatedfallout took a toll on key industries last year. The housing industry faced its worsteconomic conditions since the 1981-82recession; the downturn that began in early 2006 showed few signs of bottoming. The

demise of nontraditionalmortgage nancing was a key factor behindthe sharp decline in home sales, whichcaused a surge in the number of unsoldhomes, thus putting downward pressureon house prices. Likewise, automotivemanufacturers were also hit especially hard.In November, the CEOs of Chrysler, Fordand General Motors, faced with plummetingsales and bloated inventories, appealed to theU.S. Congress for government-backed loans.

On their balance sheets, a large numberof banks and other nancial institutionsheld securities whose underlying valuewas tied to houses purchased with thesenontraditional mortgages. As house pricesfell, defaults and foreclosures rose, and the

value of these assets declined. In response,a large number of U.S. nancial institutionseither failed, were taken over or receivedconsiderable nancial assistance from theFederal Reserve or the U.S. Treasury last year. The much broader market for creditderivatives, which many rms and investorsuse to hedge against nancial default, alsocontributed to the turmoil.

In response to these developments,the Federal Reserve adopted a two-trackstrategy. First, the Federal Open Market

Committee reduced its federal funds targetrate, down to 1 percent by Oct. 29 and thento a range of 0 to 0.25 percent on Dec. 16.Second, the Federal Reserve implementedseveral new lending facilities designed tooffset the reduction in credit availability faced by many nancial and non nancial

rms. The result was the largest year-to- year percentage increases in the nationsstock of high-powered money (monetary base) ever seen. Policymakers are con dent

Kevin L. Kliesen is an economist at the Federal Reserve Bank of St. Louis. Douglas C. Smith provided research assistance. For more onKliesens work, see http://research.stlouisfed.orecon/kliesen/index.html.



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d i s T r i c T o v e r v i e w

Employment Growth MixedAcross Eighth District

Since 2001, the composition of jobs in theUnited States and the Eighth Districthas shifted. As employment in service-providing industries has grown, the numberof manufacturing jobs has decreased. InOctober 2001, goods-producing industriesaccounted for 17.8 percent of the U.S. laborforce. By October 2008, this gure wasonly 15.5 percent. Across the four largestEighth District cities, this trend is also true;the share of goods-producing industriesdecreased from 17.1 percent to 14.8 percentover the same period. The District citiesthat have performed well in service-provid-ing industries have also experienced thestrongest overall job growth.

Eighth District Overview

From October 2007 to October 2008, LittleRock was the only large metropolitan statisti-cal area (MSA) within the Eighth District topost a positive year-over-year rate of growthin employment. At a growth rate of 0.03 per-cent, Little Rock was also the only large MSAin the District to outperform the U.S., whichexperienced job losses of 0.8 percent. Lou-isville (1.3), St. Louis (0.9) and Memphis(1.7) all posted lower year-over-year growthrates than the U.S. as a whole.

St. Louis and Louisville both have a higherproportion of goods-producing jobs thanthe U.S. and experienced large job losses inthe manufacturing sector. Little Rock andMemphis have a higher proportion of jobs inthe service sector than the U.S. Strong jobgrowth in the education, information and

leisure/hospitality service sectors all helpedlift Little Rock above the national average.Memphis, which had the highest share of service-sector jobs in the Eighth District,posted the lowest year-over-year growth rate,primarily because of job losses in the trans-portation and trucking industry, which makeup 27 percent of the Memphis economy.

For the Eighth District as a whole, theeducation sector performed the best,although still behind the U.S. as a whole.Manufacturing and nancial servicesexperienced the largest year-over-yeardeclines in job growth, with every DistrictMSA reporting negative growth.

Little Rock Zone

Little Rock has posted a positive year-over- year growth rate each year since 2003; thisgrowth rate has been above the U.S. year-over-year growth rate since 2006. UnderlyingLittle Rocks employment growth have been job gains in several service industries.

From October 2007 to October 2008, LittleRock experienced positive job growth inleisure/hospitality services (3.4), informationservices (1.0), resources/mining/construc-tion (3.0), education (1.7) and government(1.1). Little Rock was also the only branchcity in the Eighth District to experience jobgrowth in the resources/mining/construc-tion and leisure/hospitality sectors.

As a state capital, Little Rock employsalmost one- fth (19.8 percent) of its laborforce in the government sector, higher thanthe U.S. (16.4 percent) and higher than

the rest of the Eighth District (13 percent).Year-over-year growth of 1.1 percent in thegovernment sector helped to offset job lossesin the manufacturing, trade/transportationand nancial-services sectors.

Within the Little Rock Zone, the Texar-kana, Ark., area (2.1 percent) and Fayette-ville-Springdale-Rogers, Ark., area (0.8percent) both posted positive year-over- year growth. Growth in Fort Smith, Ark.,declined by 0.1.

Louisville Zone

The Louisville metro area employs 17percent of its work force in goods-producingindustries, the highest proportion of thefour branch metro areas in the District. TheLouisville area experienced a 1.3 percentdecline in year-over-year growth throughOctober 2008, largely due to a 6.7 percentdrop in manufacturing. Within that sector,durable goods and transportation equipmentexperienced sharp job losses. Jobs in thedurable-goods manufacturing sector weredown 10 percent since October 2007; jobs inthe transportation-equipment manufactur-ing sector were down 29.5 percent over thesame period.

Louisville also experienced higher joblosses than the U.S. as a whole in infor-mation services (2.0 percent), nancialservices (2.3 percent), business services(2.3 percent) and leisure/hospitality ser-vices (3.5 percent).

Smaller metro areas in the LouisvilleZone that also had a decline in employment

The ighth ede al rese ve Distis composed of four zones, e chwhich is centered round one othe four m in cities: Little ockLouisville, Memphis nd t. Lo

MISSOURI

ILLINOIS

ARKANSAS TENNESSEE

KENTUCKY

M I S S I S S I P P I

INDIANA

Memphis

Little Rock

Louisville

St. Louis

By Craig P. Aubuchon, Subhayu Bandyopadhyay,Rubn Hernndez-Murillo and Christopher J. Martinek



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included Clarksville, Tenn. (1.1 percent);Evansville, Ind. (0.4 percent); and BowlingGreen, Ky. (0.4 percent).

Memphis Zone

Memphis experienced the largest year-over-year decline in nonfarm employmentamong branch cities, losing 1.7 percent of its jobs since October 2007. Memphis lost jobs in nearly every employment sector,

but a third of the losses were concentratedin the trade/transportation/utilities sector,which lost 3,600 jobs since the previous year.Memphis also had signi cant job losses inthe construction (5.3 percent), businessservices (3.1 percent) and nancial services(3.9 percent) sectors. Job growth remainedunchanged for information services (0.04percent) and education (0.02 percent).

Jackson, Miss., a smaller MSA in the Mem-phis Zone, experienced a zero percent changein year-over-year employment.

St. Louis Zone

The St. Louis Zone mirrors the U.S. inits proportion of goods-producing jobsand service-sector jobs, with 15.6 and 84.4percent, respectively. St. Louis experiencedsimilar year-over-year growth rates as theU.S. for total employment and in several sec-tors. Nonfarm payroll employment declinedby 0.9 percent from October 2007 to October2008, slightly below the U.S. experience.

Job losses were similar to national losses inmanufacturing (4.3 percent), informationservices (1.7 percent), nancial services(0.8 percent) and business services (1.4percent). St. Louis employment bene tedfrom 1.4 percent growth in education ser-vices. Education was the only sector inSt. Louis to add jobs since October 2007.In contrast to the U.S. economy, St. Louislost jobs in the government services sector.

Within the St. Louis Zone, the smallerMSAs of Columbia, Mo., and Spring eld,Mo., had job growth of 0.1 and 0.3 percent,respectively. Job growth declined by 0.2percent in Jefferson City, Mo.

Conclusion

Between January and October 2008, theU.S. shed nearly 1 percent of total nonfarm jobs. Goods-producing industries such asmanufacturing were the hardest hit. BothLouisville and St. Louis, with relatively large

proportions of their work forces involvedin manufacturing, had signi cant losses.In contrast, regions with the strongest-performing service industries fared the best.Indeed, Little Rock was the only zone thathad positive year-over-year growth throughOctober 2008.

One apparent trend is that declining eco-nomic activity has reversed previous gains inservice-sector employment that once covered job losses in the manufacturing sector. For

instance, the large share of transporta-tion jobs in Memphis has reduced overallemployment in the local economy becausethere are fewer goods to move. Employmentin nancial services has declined in all fourbranch cities of the Eighth District. Exclud-ing Little Rock, the professional and business,and leisure/hospitality services sectors havegotten smaller in each branch city.

Subhayu Bandyopadhyay and Rubn Hernn-dez-Murillo are economists at the Federal Reserve Bank of St. Louis. For more on their work, see http://research.stlouisfed.org/econ/ bandyopadhyay/index.html and http://research.stlouisfed.org/econ/hernandez/index.html.Craig P. Aubuchon and Christopher J. Martinekare research associates at the Bank.

4.0

3.0

2.0

1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Resources, Trade, ProfessionalTotal Mining and Transportation Information Financial and Business Education Leisure and Other

Nonfarm Construction Manufacturing and Utilities Services Services Services and Health Hospitality Government Services

Little Rock 0.03 3.02 3.64 2.40 1.05 2.95 0.36 1.70 3.39 1.14 1.42Louisville 1.27 3.35 6.74 0.18 1.97 2.30 2.29 1.46 3.47 2.65 0.72Memphis 1.65 5.25 1.50 2.03 0.04 3.87 3.14 0.02 2.05 0.25 2.90St. Louis 0.86 0.60 4.25 0.37 1.67 0.81 1.43 1.38 0.76 1.17 0.48U.S. 0.78 5.20 3.75 1.63 1.52 1.53 1.66 2.77 0.01 1.05 0.60

Employment Growth

O C T O B E R 2 0 0 7 T O O C T O B E R 2 0 0 8 P E R C E N T C H A N G E



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THIS ISS ES POLL q ESTIO :

What would you do to trim the debt and de cit? 1. ise t xes to p for current government progr ms.2. Cut government spending cross the o rd.3. Do nothing. allow de cit spending to continue.4. eform oci l ecurit nd Medic re, focusing on revenue incre ses.5. eform oci l ecurit nd Medic re, focusing on ene t reductions.

To vote, got to www.stlouis ed.org. Anyone can vote, but please do so(This is not a scientifc poll.)

henever a new issue ofThe Regional Economist is pu lished, a new poll isposted on the banks home page, www.stlouisfed.org. he poll question isalways pegged to an article in that quarters issue. ere are the results of thepoll that went with the cto er issue. he question stemmed from the articlU. . ncome nequality: ts Not o bad.

remain silent.

A gue that income inequality has benefts and shows thatou economy is wo king.Cut tax b eaks, subsidies and the like o those on bothsides o the gap to allow the natu al state o incomeinequality to su ace.

nvest mo e in education and job t aining to li t the incomeo poo people at the expense o those with highe incomes.

Pass legislation to b ing us close to equal dist ibutiono income.

FED FLASH POLL RES LTS

WHAT WO LD O DO ABO T THE GROWI GI COME GAP I THE ITED STATES?

229 r SP NS S AS 12/3/2008

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24/24

Federal Reserve Bank of St. Louis

P.O. Box 442

St. Louis, Mo 63166

PRSRT STD

US POSTAGE

PAID

ST LOUIS MO

PERMIT NO 444

Submit your question in a letter to the editor.(See Page 2.) One question will be answeredby the appropriate economist in each issue.

AS A ECO OMIST

Subhayu Bandyopadhyaysrese rch interests reintern tion l tr de,development economics

nd pu lic economics.

Regional Economist - January 2009

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