Economic Review
Second Quarter 2007 

Risk Management and Nonbank Participation in the U.S. Retail Payments System - (PDF 161K)
By Richard J. Sullivan

The retail payments system in the United States has changed significantly in recent years. Advances in technology have caused a greater reliance on electronic payment networks. And the industrial structure of the payment services industry has evolved, as more and more nonbanks deliver payment products to end users and supply back-end processing. In general, these changes have made the payments system more efficient and given more choices to consumers and more payment options to merchants and businesses.

At the same time, however, the rapid pace of change has introduced new risks to the payments system. First, as more and more banks market payment services to nonbanks and outsource payments processing, the differences in information possessed by payments participants can magnify difficulties in managing risk. Second, electronic payments have a significantly different risk profile than paper checks. Third, greater complexity of the payments network potentially reduces incentives to manage risk and may cause difficulties in coordinating risk mitigation.

Sullivan lays the groundwork for a dialogue on policy to control risk in the U.S. retail payments system. He concludes that a thorough review of supervisory authority relevant to retail payments would be valuable. In particular, the original authority to supervise nonbank payment processors was established over 40 years ago, when the primary reason for establishing that authority was the use of computer technology applied to bank accounting systems. Is that authority adequate given the revolutionary changes in the payments technology seen over the last four decades?
 

A Guide to Aggregate House Price Measures - (PDF 167K)
By Jordan Rappaport

In recent years, the United States, like many other industrialized nations, has experienced wide swings in the growth rate of housing prices. To understand the behavior of housing prices and their influence on the economy, it is crucial to have an accurate measure of aggregate housing prices. In practice, however, it is difficult to develop such a measure. Analysts rely on three approaches to measure the aggregate price of housing. The first methodology simply averages all observed prices. The second looks at repeat sales of the same property. The third treats a house as a bundle of attributes, each with its own price that changes over time.

Rappaport provides an overview of the three methodologies for pricing housing and a detailed guide to the major house price indexes used by housing analysts. The analysis suggests there is no one “best” measure of housing prices. Each of the three methodologies has conceptual advantages and disadvantages, and the empirical house price indexes have practical advantages and disadvantages as well. Which is best depends on the question being addressed.

The Role of Small and Large Businesses in Economic Development - (PDF 116K)
By Kelly Edmiston

Increasingly, economic development experts are abandoning traditional approaches to economic development that rely on recruiting large enterprises with tax breaks, financial incentives, and other inducements. Instead, they are relying on building businesses from the ground up and supporting the growth of existing enterprises. This approach has two complementary features. The first is to develop and support entrepreneurs and small businesses. The second is to expand and improve infrastructure and to develop or recruit a highly skilled and educated workforce. Both efforts depend in large part on improving the quality of life in the community and creating an attractive business climate.

Edmiston explores whether promoting entrepreneurship and small businesses makes sense as an economic development strategy. He concludes that it probably does, but with some caveats. Small businesses are potent job creators, but so are large businesses. The attribution of the bulk of net job creation to small businesses arises largely from relatively large job losses at large firms, not to especially robust job creation by small firms. More important, data show that, on average, large businesses offer better jobs than small businesses, both in terms of compensation and stability. Further, there is little convincing evidence to suggest that small businesses have an edge over larger businesses in innovation. More research is needed to properly evaluate the case for a small business strategy, and indeed, to determine whether or not public engagement in economic development itself is a cost-effective and worthwhile pursuit.

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