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- Structural Changes in the Financial Markets:
Economic and Policy Significance
By Henry Kaufman In a speech delivered this spring to the Board
of Directors of the Federal Reserve Bank of Kansas City and to the CS First Boston
Corporation Global Banking Conference in New York City, Henry Kaufman predicted that the
latest swings in bond and stock prices are likely to be merely a prologue to much greater
volatility in the years ahead. This potential for financial trauma is a by-product of
radical changes in the structure of financial institutions and markets that over time are
leaving the system without an adequate institutional buffer and, therefore, more
susceptible to sharp oscillations in the flows of investment credit.
Kaufman stressed that while new financial excesses cannot be totally
prevented, proper action can mitigate their adverse consequences to some extent. To
accomplish that, however, we must be willing to acknowledge the risks that lie ahead, to
take them into account in the formulation of monetary policy, and to make some fundamental
changes in the structure of official oversight and regulation of financial institutions
and markets.
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Should We Throw Sand in the
Gears of Financial Markets?
By Craig S. Hakkio
The volatility of financial markets in recent years has led to increased
concern. As trading of financial assets on organized exchanges and over-the-counter
markets has grown, events such as the 1987 stock market crash and the 1992 Exchange Rate
Mechanism crisis in Europe have raised fundamental questions about the role these markets
play in the economy. In particular, there is concern that much of the increased trading of
financial assets is of a short-term, speculative nature that adds little value to the
intermediation process and in the extreme case may distort the efficient functioning of
financial markets.
This view has led some economists to advocate a securities transaction
tax. Such a tax, it is argued, when applied to a broad range of financial transactions,
would raise the cost of short-term speculative trading, reduce financial market
volatility, and improve the efficiency of financial markets. This type of tax might also
raise substantial revenue that could help reduce the federal budget deficit. The revenue
potential has not gone unnoticed i n Washington, where recent budget proposals by bot h
the Bush and Clinton administrations have included an STT.
Hakkio explores the pros and cons of a securities transaction tax. He
concludes that the proponents have overstated the likely benefits of a securities
transaction tax and underestimated the potential costs.
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Will the Shift to Stocks and
Bonds by Households Be Destabilizing?
By Donald P. Morgan
In the last decade, households have tended to shift out of bank deposits
and money market funds and into stocks and bonds. Some analysts and journalists worry that
the shift could be destabilizing to the economy and financial markets. Consumption
spending, it is argued, might fluctuate more because households have invested in riskier
stocks and bonds. Financial markets also could be more volatile because households might
behave as short-sighted novices who will sell assets in panic at the first dip in the
market. In addition, the pension and mutual funds through which households invest tend to
trade more actively than households. The increasing role of such heavy traders, it is
feared, might increase financial market volatility.
Morgan argues that these concerns, though understandable, are
exaggerated. Households appear to be saving for retirement and are therefore likely to
ride out short-term bumps in the market. Moreover, the market role of institutional
investors has been trending up for 30 years without any accompanying trend in volatility.
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Causes of the Recent Increase
in Bank Security Holdings
By William R. Keeton
While bank security holdings have increased sharply in recent years, there is widespread
disagreement about the significance of the increase. Some analysts argue that the increase
is not a cause for concern because it results from temporary factors such as the business
cycle. Others argue that the increase represents a permanent shift in bank portfolio
preferences from loans to securities, which could cause banks to look more like mutual
funds. If the latter view is true, small firms that rely on banks for credit may be unable
to fund new investment. Moreover, monetary policy may be less able to influence total
spending in the economy by affecting bank lending.
Keeton seeks to determine how much of the surge in bank security holdings can be explained
by temporary factors. He discusses possible explanations for the recent increase in bank
security holdings and presents empirical evidence based on the aggregate behavior of bank
portfolios over the previous 30 years. He concludes that more than half the increase in
security holdings cannot be explained by temporary factors, suggesting that bank portfolio
preferences may have permanently changed.
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A New Agricultural
Policy for a New World Market
By Alan Barkema and Mark Drabenstott
A new farm bill will be enacted in 1995, and the debate over it has
already begun. With farm bills being renewed just once every five years, the 1995 bill
provides a propitious opportunity to re-evaluate the current bill in light of fundamental
changes to the marketplace since the adoption of the 1990 bill. One of the most important
changes since then has been in the world food market. Selling successfully in world
markets is vital to U.S. agriculture because it produces far more food than domestic
consumers require. Thus, while the upcoming farm bill will spawn debate on many issues,
few will be more important than reconciling U.S. agricultural policy with a new world food
market.
Recent developments in the world food market reflect basic changes in
two key market features. The market for finished food products is much stronger than for
bulk commodities. And the food market has been growing more rapidly in Asia and North
America than in Europe. If these trends persist, will current farm policy be in step with
the world food market of the future? Barkema and Drabenstott examine the factors likely to
shape the world market and conclude that agricultural policy must be overhauled if U.S.
agriculture is to excel in tomorrow's marketplace.
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