Economic Letter

During most of the 1990s, the United States experienced exceptionally good times, and the Federal Reserve received some of the credit for the booming economy and low inflation.

In the past few years, there have been several developments in the field of modeling the credit risk in banks’ commercial loan portfolios. Credit risk is essentially the possibility that a bank’s loan portfolio will lose value if its borrowers become unable to pay back their debts.

In January 2001, the non-partisan U.S. Congressional Budget Office (2001a) issued updated federal budget projections for fiscal years 2002 through 2011. According to the CBO’s baseline projections, the federal government will accumulate $5.6 trillion in total surpluses over the coming decade.

New financial instruments, new information technologies, and a new regulatory environment have blurred the distinctions between commercial banks and nonbank financial intermediaries in the U.S. in recent years. Furthermore, just as many nonbank financial institutions have increased their use of securitization, commercial banks also have shifted their emphasis from on-balance sheet to off-balance sheet activities (Boyd and Gertler 1994).

After the 1997 balance of payments problems and currency crises that hit Korea, Indonesia, Thailand, and other countries, the stabilization programs supported by the International Monetary Fund (IMF) came under critical fire. At issue was the cost of these programs in terms of forgone output and employment in the countries that adopted them. Stiglitz (2000), for example, argued that “…the IMF’s economic ‘remedies’ often make things worse—turning slowdowns into recessions and recessions into depressions.” Similar statements by other leading economists have been commonplace.

The causes of the currency crises in emerging markets during the late 1990s have been the subject of much debate—especially considering that, before the crises, many of the Asian countries involved tended to have balanced budgets and generally sound macroeconomic performance. Some observers argue that the generally favorable macroeconomic conditions indicate that the crises were not caused by incompatibility between fiscal and monetary policies and exchange rate pegs, but rather by the unexpected and self-fulfilling panics of foreign investors.

In January of 2001, overseas financial markets saw the re-emergence of the “Japan premium,” a term used to describe the extra interest charged on offshore loans to Japanese banks relative to similarly risky banks from other developed countries. So far, the magnitude of the Japan premium has been small, never exceeding 0.05% and 0.07%, depending on the bank examined.

How quickly does the Fed adjust monetary policy in response to developments in the economy? A common view among economists is that the Fed changes the short-term policy interest rate at a very sluggish pace over several quarters.