Economic Letter

This Letter reviews four papers on the relationship between inflation and economic activity that were presented at a recent macroeconomics workshop organized by the Federal Reserve Bank of San Francisco and the Stanford Institute of Economic Policy Research. The papers focused on the Phillips curve, named for A.W. Phillips (1958); he showed that a plot of (wage) inflation against unemployment for the U.K. produced a downward-sloping curve, indicating that higher unemployment was accompanied by lower inflation.

There is a one- to two-year delay between when the Federal Reserve changes monetary policy and the resulting effects on real output, unemployment, and inflation, so policymakers must be forward-looking and preemptive in order to effectively stabilize the economy and control inflation (Rudebusch 1995). Macroeconomic forecasts are thus a crucial element for the conduct of monetary policy, and good forecasts help ensure good policy.

Bank supervisory agencies, such as the Federal Reserve, need timely and reliable information about banks’ financial conditions in order to conduct effective supervision. On-site examinations of banks are an important source of such information: they not only permit supervisors to confirm the accuracy of regulatory reports that the banks themselves file, but they also allow supervisors to gather additional, confidential information on banks’ financial conditions.

Since 1990, there have been four increases in the minimum wage under two modifications to the Fair Labor Standards Act. The first modification resulted in increases of 45 cents in 1990 and 1991, raising the federal minimum wage from $3.35 to $4.25.

The monthly consumer price index (CPI) is the most oft-cited measure of inflation and one of the most important and closely watched statistics in the U.S. economy. It is an indicator of how well the Federal Reserve is doing in achieving and maintaining low inflation, and it also is used to determine cost-of-living adjustments for many government programs, collective bargaining contracts, and individual income tax brackets.

The Federal Reserve has seen its legislative mandate for monetary policy change several times since its founding in 1913, when macroeconomic policy as such was not clearly understood. The most recent revisions were in 1977 and 1978, and they require the Fed to promote both price stability and full employment.

The recent trend of bank consolidation in California has once again focused attention on how regulators analyze the competitive effects of mergers. Traditionally, the Federal Reserve has defined banking markets to be local in scope.

The East Asian economic slowdown has reduced employment growth throughout California, but some regions have been affected more than others. In the San Francisco Bay Area, strong trade ties to East Asia combined with a slowdown in the area’s prominent high-tech manufacturing sector have pushed employment growth below the state’s employment growth rate for the first time in three years.

U.S. monetary policy affects all kinds of economic and financial decisions people make in this country–whether to get a loan to buy a new house or car or to start up a company, whether to expand a business by investing in a new plant or equipment, and whether to put savings in a bank, in bonds, or in the stock market, for example. Furthermore, because the U.S. is the largest economy in the world, its monetary policy also has significant economic and financial effects on other countries.

Describing the reasons for the policy actions of the Federal Reserve has long been a popular topic for economists, economic journalists, investors, and others. In particular, there is keen interest in what economists call the Fed’s implied “reaction function,” which models how the Fed sets monetary policy in response to conditions in the economy.