Economic Letter

While China’s economic reforms have engendered much success since they were undertaken in the late 1970s—real GDP growth has averaged roughly 10% per year over the period—the development of its financial system arguably lags behind. Very high investment (over 40% of GDP) has fueled much of the recent growth, but, as some claim, it also has generated excess capacity in the economy, a sign of inefficient allocation of capital.

Each year, the President of the San Francisco Fed joins the Federal Reserve Board Governor responsible for liaison with Asia on a “fact-finding” trip to the region. These trips advance the Bank’s broad objectives of serving as a repository of expertise on economic, banking, and financial issues relating to the Pacific Basin and of building ties with policymakers and economic officials there.

This Economic Letter summarizes the papers presented at the conference “Financial Innovations and the Real Economy” held at the Federal Reserve Bank of San Francisco by the Bank’s Center for the Study of Innovation and Productivity on November 16–17, 2006.

This Economic Letter summarizes the papers presented at the annual Pacific Basin Conference held at the Federal Reserve Bank of San Francisco on June 16-17, 2006, under the sponsorship of the Bank’s Center for Pacific Basin Studies. The papers are listed at the end and are available online.

In the latest episode of monetary tightening in the United States, the Federal Open Market Committee (FOMC), which sets U.S. monetary policy, raised the target level of its key policy interest rate, the federal funds rate, from 1% in June 2004 to 5-1/4% in June 2006. This gradual increase was accomplished via a sequence of 17 consecutive 25-basis-point increases at successive FOMC meetings.

Over the past several years, movements in asset prices have substantially raised household wealth. For the U.S. and many other industrialized countries, the most recent boost has come more from the appreciation of house prices than financial assets.

Commercial real estate (CRE), such as office towers, shopping centers, and apartment buildings, makes up approximately one-third of the total value of U.S. real estate. Not surprisingly, CRE-related loans account for a significant portion of total bank lending—about 22% as of 2005.

As 2006 draws to a close, one economic development that stands out over the year is the slowdown in the housing sector. In particular, the slowdown raises concerns about the perceived shift households have made toward “alternative” mortgage products, which may leave them more exposed to negative effects from higher interest rates and falling house prices.

The December 12, 2006, statement of the Federal Open Market Committee (FOMC) said, “Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures.” The link between “inflation pressures” and the “level of resource utilization” is formalized by the Phillips curve, which says that short-term movements in inflation and unemployment (a measure of labor resource utilization) tend to go in opposite directions.

Historically, small businesses have tended to turn to local lenders for credit. In recent years, however, technological advances in processing information and assessing credit risk have raised the potential for loosening the geographic ties between small business borrowers and lenders. This Economic Letter discusses factors affecting the geographic scope of markets for small business credit and uses data available for the San Francisco Bay Area to examine the extent to which small businesses rely on local lenders, how this reliance has changed over time, and the implications of any changes for the Federal Reserve’s bank merger policy.