The U.S. economy is currently experiencing a period of significant financial stress. This stress has contributed to the downturn in the economy by boosting the cost of credit and making businesses, households, and financial institutions highly cautious. To alleviate the financial stress and counteract its effects on the economy, the Federal Reserve has reduced the federal funds rate target substantially and undertaken unprecedented actions to support the functioning of financial markets. There will come a point, however, when the Federal Reserve needs to remove liquidity from the economy and unwind special lending programs to ensure a return to sustainable growth with low inflation.

In past recoveries, the decision when to tighten policy was based mainly on the strength of business and consumer spending and the degree of upward pressure on prices and wages. An additional element in the current exit strategy will be determining if financial stress is no longer high enough to endanger economic recovery. As financial conditions begin to improve, the various measures of financial stress that the Federal Reserve monitors may give mixed signals. In this situation, policymakers would greatly benefit from having a single, comprehensive index of financial stress. Such an index could also prove valuable further down the road, when the Federal Reserve might again need to decide whether financial stress was serious enough to warrant special attention.

Hakkio and Keeton present a new index of financial stress--the Kansas City Financial Stress Index (KCFSI). They explain how the components of the KCFSI capture key aspects of financial stress and show that high values of the KCFSI have tended to coincide with known periods of financial stress. They also show that the KCFSI provides valuable information about future economic growth.

Characteristics of High Foreclosure Neighborhoods in the Tenth District (PDF 1.06 mb)

By Kelly D. Edmiston

The foreclosure crisis that began in earnest in 2006 continues to shrink the once valuable assets of homeowners, communities, and investors. In the last three years, more than three million households have lost their homes, and as many as 5 million more could lose their homes in the next three years.

A striking feature of the crisis is the variation in its severity across both time and space. Initially, the foreclosure crisis hit low-income neighborhoods disproportionately. Foreclosures remain concentrated in these neighborhoods. But in recent months, the foreclosure epidemic has spread more deeply into higher-income neighborhoods. What accounts for the evolving pattern of foreclosure rates across neighborhoods, and where might concentrations of foreclosures occur in the future?

Edmiston analyzes the seven states of the Tenth Federal Reserve District to help shed light on the foreclosure rate pattern and to explore where foreclosure trends are likely to head. His analysis confirms that foreclosure rates have been high in low-income neighborhoods--but only to the extent that subprime mortgages penetrated those neighborhoods. He also finds that the foreclosure crisis is seeping into higher-income neighborhoods--due primarily to unfavorable conditions in local economies and residential real estate markets.

Do State Corporate Income Taxes Reduce Wages? (PDF 918K)

By R. Alison Felix

Amid falling revenues and impending budget shortfalls, state policymakers must find ways to increase revenue, cut spending, or both. At the same time, they must develop policies that attract or keep businesses and jobs. Some policymakers may consider raising corporate tax rates because it avoids directly taxing workers who are already suffering the effects of this recession. But as states reevaluate their current tax policy, it is important to consider the effects of each tax component. One important question is: Who will bear the burden of the taxes?

State corporate income taxes are complex, and thus the answer to this question is far from obvious. Many believe that the state corporate tax structure is highly progressive because the corporate capital taxed is owned disproportionately by wealthy individuals. In today's economy, however, the burden of the corporate tax may have shifted to consumers or labor, resulting in a less progressive tax structure.

Research has shown that in some cases labor bears a substantial weight of the corporate tax. While this burden has fluctuated over time, the relationship between corporate taxes and wages has been consistently negative. In other words, higher corporate taxes are typically associated with lower wages.

Felix examines the impact of state corporate taxes on wages. She shows that corporate taxes reduce wages and that the magnitude of the negative relationship between the taxes and wages has increased over the past 30 years. She also finds that state corporate taxes have a larger negative effect on more highly educated workers.

Recession and Recovery Across the Nation: Lessons from History (PDF 753K)

By Chad R. Wilkerson

The U.S. economy officially fell into recession in December 2007, but the timing of the downturn varied widely across regions of the country. In some regions, employment began to erode much earlier in 2007, while in other regions economic activity stayed strong well into the second half of 2008. Do regions typically vary this much in the timing and circumstances of their recessions? If so, perhaps past experience can also shed light on whether some regions can be expected to rebound earlier or stronger than others from this recession.

To explore these possibilities, Wilkerson looks at job growth trends across the 12 districts of the Federal Reserve System in recent business cycles. He finds that the timing and depth of regional recessions typically vary widely, with several districts regularly outperforming others. The same generally holds true for the timing and strength of economic recoveries and expansions across the country. Some of these differences can be explained by the unique industrial structures of the districts, but other factors also play a role.