Economic Review
Third Quarter 2001 

Why Do Central Banks Monitor So Many Inflation Indicators?
By Sharon Kozicki 

Monetary policy is typically undertaken with an eye to achieving a select few objectives in the long run. The Federal Reserve conducts monetary policy to promote two long-run goals: price stability and sustainable economic growth. In many other countries, central banks have a single long-run goal defined in terms of an inflation target. Yet while central banks have narrowly defined long-run goals, most monitor a wide range of economic indicators. 

Why do central banks collect and analyze so many indicators? Kozicki presents multicountry empirical evidence to assess whether any single indicator reliably predicts inflation. If such an indicator exists, it would need to perform adequately under a wide variety of economic conditions and changing economic structures, because no country faces an unchanging economic environment. One way to test for such robust performance is to examine the value of indicators across a variety of countries experiencing different economic conditions, financial structures, policy shifts, and so forth. 

Kozicki first discusses why several widely used indicators might predict inflation. She explains how the predictive performance of these indicators can be compared and reports empirical results for 11 developed economies, including the United States. She concludes that while monitoring the change in GDP growth is useful on average across countries, no single economic indicator is always reliable. This evidence supports an approach to policymaking that involves monitoring a wide range of economic indicators. 

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Is State Fiscal Policy Asymmetric Over the Business Cycle?
By Bent E. Sorensen and Oved Yosha 

A number of stabilizers are thought to mute the business cycle. One key stabilizer is federal fiscal policy. The federal budget surplus tends to rise during economic booms and fall in downturns, helping to stabilize consumers’ disposable income and thereby mitigate economic fluctuations. During booms, for example, the budget surplus typically rises because tax revenues rise more than expenditures.

Another stabilizer that has traditionally received less attention is state fiscal policy. Like the federal budget surplus, state government surpluses tend to rise during economic expansions and decline during downturns. Moreover, like the federal budget, state budgets represent large shares of the economy. The stabilizing influence of state fiscal policy, however, may differ across business cycle expansions and downturns – making state fiscal policy asymmetric. For example, state budgets could be more effective at mitigating economic slumps than at muting booms if taxes fall more sharply during a slump than they rise in an expansion of equal magnitude. Asymmetry in fiscal policy could be caused by a number of factors, such as balanced budget rules, which are constitutionally imposed restrictions on a state government’s ability to incur debt.

Sorensen and Yosha examine the business cycle behavior of state fiscal policy to determine whether policy is asymmetric and, if so, to identify the causes. They conclude that state revenue and expenditure display significant asymmetry over the business cycle, with nearly offsetting effects on the budget surplus. As a result, state fiscal policy tends to mute economic booms to roughly the same degree it mitigates slowdowns. The asymmetries in revenue and expenditure appear to be associated with balanced budget rules, although their fundamental causes cannot be clearly identified.

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Exploring Policy Options for a New Rural America--A Conference Summary
By Mark Drabenstott and Katharine H. Sheaff 

The United States needs a new rural policy. That was the conclusion of ten policy experts and 250 rural leaders from throughout the nation who met in Kansas City for the Center for the Study of Rural America’s second annual conference on rural policy matters, Exploring Policy Options for a New Rural America. The conference examined a menu of promising policy options and also considered ways to combine these options into a more coherent overall approach to the challenges facing rural communities.

Drabenstott and Sheaff highlight the issues raised at the conference. Participants agreed that new rural policy will be needed to help local communities seize the economic opportunities ahead. Fostering more entrepreneurs and tapping digital technology will be critical ingredients of a new policy approach. Participants also agreed that capital—especially equity capital—will be an important part of the mix. Cooperation among firms and communities was a major theme in discussing ways to reinvigorate traditional rural industries, whether helping manufacturing clusters to form, encouraging new alliances in a more product-oriented agriculture, or helping rural places make more of their scenic amenities.

Perhaps the most challenging discussion at the conference centered on building a new overall framework for rural policy and a new slate of policy options. The United Kingdom and Italy provided interesting new experiments in rural policy. Yet participants concluded that moving the United States from a longstanding reliance on supporting one sector to a broader focus on rural policy will not be easy. No matter how difficult, though, participants agreed that the transition was one worth making.

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