Economic Letter

There is a well-worn story that illustrates how economists view financial markets (and, perhaps, the rest of the world). An economist and a non-economist are walking down the street. The non-economist spots a $20 bill on the sidewalk and starts to reach for it.

In most countries’ experience, the course of financial liberalization—much like the course of true love in Shakespeare—”never did run smooth.” The process of reforming an economy from one where the government takes the lead in allocating financial and real resources to one where market forces determine economic outcomes can involve choices and consequences that are painful and costly.

At the beginning of the 1990s, policy doctors were almost unanimous in advocating a strong dose of capital and financial market liberation for developing countries as a way to improve their prospects for economic growth. The expectation was that such liberalization would make foreign saving available to local entrepreneurs, who would invest it in building the businesses, homes, and other infrastructure of their countries’ economies.

Several recent developments have raised concerns about a productivity slowdown in the U.S. that could slow economic growth and boost inflation. For example, after soaring at the astounding rate of nearly 4-1/2% in 2002, 2003, and the first half of 2004, nonfarm labor productivity growth slowed to around 1-3/4% in the third quarter of last year and to only 3/4% in the fourth quarter.

The last decade has witnessed a series of major macroeconomic crises in emerging market economies. Typically these crises have been characterized by the sudden stop of capital inflows, the collapse of fixed exchange rate regimes, falls in asset prices, and sharp declines in output.

The job vacancy rate, which represents employers’ unmet labor demand, is an important indicator of the short-term outlook for hiring and job creation. Because there is no continuous aggregate vacancy series in the United States, analysts and observers interested in labor demand and hiring activity have relied on the Conference Board’s “Help-Wanted Advertising Index” to measure changes in job vacancies over time.

Many economists argue that a flexible exchange rate regime is preferable to a fixed exchange rate regime because it helps to insulate the domestic economy from adverse external shocks. For example, when export demand declines, a depreciation makes domestic goods more competitive abroad, stimulates an offsetting expansion in demand, and dampens the contraction in domestic economic activity.

In the years following the Asian financial crisis of 1997-1998, the governments of South Korea and Thailand each have sought to generate economic recovery by expanding domestic credit. The rapid credit expansion in both countries has created concerns about the extent to which their economies can channel these funds efficiently and sustain economic growth.