Economic Letter

The 1997 Nobel Prize in economics was awarded to Robert C. Merton and Myron S. Scholes. Merton and Scholes and the late Fischer Black are widely credited with developing the tools necessary to price options. This achievement not only has opened new doors for academic research, but also has been widely embraced by practitioners in the financial industry.

One of the hallmarks of economic analysis is the recognition that choice involves trade-offs. Whether it’s a consumer deciding if the roominess of a sports utility vehicle is worth the lower gas mileage, or a firm deciding whether lower wages of an overseas production facility compensate for the lower worker productivity, or Congress deciding whether a new expenditure program justifies the higher taxes needed to finance it, trade-offs must be faced.

The 1997 accounting year of the federal government ended last September 30, recording a budget deficit of $22 billion–not quite 0.3% of national product. President Clinton will submit a balanced budget for fiscal 1999. For all intents and purposes, the budget is in balance.

Trends shaping the banking industry over the past several years continued in full force in the 12th District in 1997. These include changes in market structure, continued alteration of the mix of products and services that banks offer, and innovations in delivery channels.

On July 2, 1997, the Thai baht fell 17% against the U.S. dollar, ending a 13-year period in which the baht closely shadowed the U.S. currency. The devaluation was not entirely a surprise. In fact, it followed months of repeated speculative attacks, during which the Bank of Thailand spent billions of dollars defending its currency.

The enormous volume of trading in foreign exchange (FX) markets–almost 100 times the volume on the New York Stock Exchange–has been a puzzle. Economists have turned to a variety of approaches to solve the puzzle–the goods market approach, the asset market approach, and the microstructure approach.

The economies of East Asia have been buffeted in recent months by bouts of speculative currency attacks, stock and real estate price declines, and banking problems. Media attention has focused on Thailand, Indonesia, Korea, Malaysia, and, most recently, Hong Kong.

In recent years, a debate has re-emerged about whether the Federal Reserve should pay attention to the “NAIRU” in conducting monetary policy. NAIRU is an acronym for “non-accelerating-inflation rate of unemployment” (a closely related concept is the “natural rate of unemployment”).

Since early 1996, the U.S. economy has produced a combination of very low unemployment and stable or declining inflation. Many analysts and pundits regard this performance as surprising, because similar sustained low unemployment rates have been associated in the past with rising inflation.