We evaluate reforms to the U.S. tax system in a life cycle set-up with heterogeneous married and single households and with an operative extensive margin in labour supply. We restrict our model with observations on gender and skill premia, labour-force participation of married females across skill groups, children, and the structure of marital sorting. We concentrate on two revenue-neutral tax reforms: a proportional income tax and a reform in which married individuals file taxes separately (separate filing). Our findings indicate that tax reforms are accompanied by large increases in labour supply that differ across demographic groups, with the bulk of the increase coming from married females. Under a proportional income tax reform, married females account for more than 50% of the changes in hours across steady states, while under separate filing reform, married females account for all the change in hours.
I allow trading horizon heterogeneity across groups in a standard differential information model of a financial market. This approach can explain the well-established phenomenon that, after a public announcement, trading volume increases, more private information is incorporated into prices and volatility increases. In such environments, public information has the important secondary role of helping agents learn about the information of other agents. Therefore, whenever the correlation between the private information of different groups is sufficiently low, a public announcement increases disagreement among short-horizon traders regarding the expected selling price even as it decreases disagreement about the fundamental value of the asset. Additional testable implications are also suggested.
A search-theoretic model of the retail market for illegal drugs is developed. Trade occurs in bilateral, potentially long-lived matches between sellers and buyers. Buyers incur search costs when experimenting with a new seller. Moral hazard is present because buyers learn purity only after a trade is made. This model is consistent with some new stylized facts about the drugs market, and it is informative for policy design. The effectiveness of different enforcement strategies is evaluated, including some novel ones that leverage the moral hazard present in the market.
This paper studies the long-run properties of intertemporal distortions in a broad class of second-best economies. Our unified framework encompasses and extends many well-known models, such as variants of the Ramsey taxation model with aggregate or idiosyncratic risk, and economies with incentive compatibility constraints due to limited commitment, political economy, self-enforcement or private information, or combinations of these. We identify a sufficient condition that rules out permanent intertemporal distortions: if there exists an allocation that satisfies all constraints and eventually converges to the limiting first-best allocation, then intertemporal distortions are temporary in the second best. This result uncovers a common optimality principle linking the intertemporal allocation of resources with the ability to front-load distortions for this broad class of environments. A series of applications illustrates the significance of these findings.
We study stationary discretionary equilibria in dynamic linear-quadratic rational expectations models. Past papers have assumed that this is uniquely determined; we show that such models can have multiple equilibria in some situations. We demonstrate the existence of multiple discretionary equilibria using a number of examples of increasing complexity and discuss their potential to explain interesting economic phenomena. We investigate the general properties of discretionary equilibria and discuss the design implications for the numerical algorithms needed to find them.
A buyer suggests prices to N sellers in a time period and buys from the seller who accepts the bid first. The number of bidding rounds is determined by how frequently the buyer can make an offer. We show that with no limit on the frequency and without discounting, the price path is either kept flat initially with large jumps at the end or increasing steadily over time. Which class of path occurs in equilibrium depends on the buyer's trade-off between committing to a price ceiling versus finely screening the sellers' costs. With discounting, limiting the number of rounds mitigates the delay caused by the reluctance to raise bids in the first class of equilibrium and therefore can benefit the buyer. This result suggests why, in reality, bargaining parties often take measures to make their offers rigid and consequently force themselves to make fewer offers.
We study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. We derive the utility-based welfare loss function taking into account the effects of positive steady-state inflation and solve for the optimal level of inflation in the model. For plausible calibrations with costly but infrequent episodes at the zero lower bound, the optimal inflation rate is low, typically <2% even after considering a variety of extensions, including optimal stabilization policy, price indexation, endogenous and state-dependent price stickiness, capital formation, model uncertainty, and downward nominal wage rigidities. On the normative side, price-level targeting delivers large welfare gains and a very low optimal inflation rate consistent with price stability. These results suggest that raising the inflation target is too blunt an instrument to efficiently reduce the severe costs of zero bound episodes.
We estimate the effects of interstate highways on the growth of U.S. cities between 1983 and 2003. We find that a 10% increase in a city's initial stock of highways causes about a 1.5% increase in its employment over this 20 year period. To estimate a structural model of urban growth and transportation, we rely on an instrumental variables estimation that uses a 1947 plan of the interstate highway system, an 1898 map of railroads, and maps of the early explorations of the U.S. as instruments for 1983 highways.
Consumers respond positively to products tied to charity, particularly from sellers that are relatively new and hence have limited alternative means of assuring quality. We establish this result using data from a diverse group of eBay sellers who “experiment” with charity by varying the presence of a donation in a set of otherwise matched product listings. Most of charity's benefits accrue to sellers without extensive eBay histories. Consistent with charity serving as a quality signal, we find fewer customer complaints among charity-intensive sellers.
This paper studies the self-sufficiency project (SSP), a controlled randomized experiment concerning welfare, by estimating a model of endogenous skill accumulation, multidimensional job opportunities, and time-varying opportunity costs of labour market time. Methods for estimating dynamic programming models with unobserved heterogeneity are extended to account for unexpected policy interventions and endogenous sample selection and initial conditions. Parameters are identified and consistently estimated by imposing optimal responses to the exact form of the SSP earnings supplement and the experimental program, which induces exogenous variation between treatment groups and within groups as treatment progresses. The estimated model tracks primary outcomes well in and out of sample, except for underestimating trends in the sample of new welfare applicants. Predictions from counterfactual experiments run counter to non-structural results reported elsewhere, and they suggest that details of the SSP's design are critical for interpretation of results. The separate SSP Plus treatment may have longer lasting and more generalized impacts than the in-sample impacts suggest.
We study the interactions among geographical mobility, unemployment, and home-ownership in an economy with heterogeneous locations, endogenous construction, and search frictions in the markets for both labour and housing. The decision of home-owners to accept job offers from other cities depends on how quickly they can sell their houses (i.e. the houses' liquidity), which in turn depends on local labour market conditions. Consequently, home-owners accept job offers from other cities at a lower rate than do renters, generating a link between home-ownership and unemployment both at the city level and in the aggregate. When calibrated to match aggregate U.S. statistics on mobility, housing, and labour flows, the model predicts that the effect of home-ownership on aggregate unemployment is small. When unemployment is high, however, changes in the rate of home-ownership can have economically significant effects.
This paper develops new recursive, set based methods for studying repeated games with private monitoring. For any finite-state strategy profile, we find necessary and sufficient conditions for whether there exists a distribution over initial states such that the strategy, together with this distribution, form a correlated sequential equilibrium (CSE). Also, for any given correlation device for determining initial states (including degenerate cases where players' initial states are common knowledge), we provide necessary and sufficient conditions for the correlation device and strategy to be a CSE, or in the case of a degenerate correlation device, for the strategy to be a sequential equilibrium. We also consider several applications. In these, we show that the methods are computationally feasible, and how to construct and verify equilibria in a secret price-setting game.
This article studies different methods of assigning a good to budget-constrained agents. Schemes that assign the good randomly and allow resale may outperform the competitive market in terms of Utilitarian efficiency. The socially optimal mechanism involves random assignment at a discount—an in-kind subsidy—and a cash incentive to discourage low-valuation individuals from claiming the good.
This article develops an elementary theory of global supply chains. We consider a world economy with an arbitrary number of countries, one factor of production, a continuum of intermediate goods and one final good. Production of the final good is sequential and subject to mistakes. In the unique free trade equilibrium, countries with lower probabilities of making mistakes at all stages specialize in later stages of production. Using this simple theoretical framework, we offer a first look at how vertical specialization shapes the interdependence of nations.
This paper analyses the effect immigration has on the wages of native workers. Unlike most previous work, we estimate wage effects along the distribution of native wages. We derive a flexible empirical strategy that does not rely on pre-allocating immigrants to particular skill groups. In our empirical analysis, we demonstrate that immigrants downgrade considerably upon arrival. As for the effects on native wages, we find a pattern of effects whereby immigration depresses wages below the 20th percentile of the wage distribution but leads to slight wage increases in the upper part of the wage distribution. This pattern mirrors the evidence on the location of immigrants in the wage distribution. We suggest that possible explanations for the overall slightly positive effect on native wages, besides standard immigration surplus arguments, could involve deviations of immigrant remuneration from contribution to production either because of initial mismatch or immigrant downgrading.
The inertia of the local currency prices of traded goods in the face of exchange rate changes is a well-documented phenomenon in International Economics. This paper develops a structural model to identify the sources of this local currency price stability and applies it to micro-data from the beer market. The empirical procedure exploits manufacturers' and retailers' first-order conditions in conjunction with detailed information on the frequency of price adjustments following exchange rate changes to quantify the relative importance of local non-traded cost components, markup adjustment by manufacturers and retailers, and nominal price rigidities in the incomplete transmission of such changes to prices. We find that, on average, approximately 60% of the incomplete exchange rate pass-through is due to local non-traded costs; 8% to markup adjustment; 30% to the existence of own brand price adjustment costs; and 1% to the indirect/strategic effect of such costs, though these results vary considerably across individual brands according to their market shares.
We use variation in the degree of development of local credit markets and matched employer–employee data to assess the role of the firm as an internal credit market. We find that firms operating in less financially developed markets offer lower entry wages but faster wage growth than firms in more financially developed markets. This helps firms finance their operations by implicitly raising funds from workers. We control for local market fixed effects and only exploit time variation in the degree of local financial development induced by an exogenous liberalization, so that the effect we find is unlikely to reflect unobserved local factors that systematically affect wage–tenure profiles. We estimate that the amount of credit generated by implicit lending within the firm is economically important and can be as large as 30 percent of the bank lending. Consistent with credit market imperfections opening up trade opportunities within the firm, we find that the internal rate of return of implicit loans lies between the rate at which workers savings are remunerated in the market and the rate that firms pay on their loans from banks.
A growing consensus in New Keynesian macroeconomics is that nominal cost rigidities, rather than countercyclical markups, account for the bulk of the real effects of monetary policy shocks. We revisit these conclusions using theory and data on inventories. We study an economy with nominal rigidities in which goods are storable. Our theory predicts that if costs of production are sticky and markups do not vary much in response to, say, expansionary monetary policy, firms react by excessively accumulating inventories in anticipation of future cost increases. In contrast, if the data inventories are fairly constant over the cycle and in response to changes in monetary policy. We show that costs must increase and markups must decline sufficiently in times of a monetary expansion in order to reduce firm's incentive to hold inventories and thus bring the model's inventory predictions in line with the data. Versions of the model consistent with the dynamics of inventories in the data imply that countercyclical markups account for a sizable fraction of the response of real variables to monetary shocks.
This article investigates how precisely short-term, job search-oriented training programs as opposed to long-term, human capital intensive training programs work. We evaluate and compare their effects on time until job entry, stability of employment, and earnings. Further, we examine the heterogeneity of treatment effects according to the timing of training during unemployment as well as across different subgroups of participants. We find that participating in short-term training reduces the remaining time in unemployment and moderately increases job stability. Long-term training programs initially prolong the remaining time in unemployment, but once the scheduled program end is reached participants exit to employment at a much faster rate than without training. In addition, they benefit from substantially more stable employment spells and higher earnings. Overall, long-term training programs are well effective in supporting the occupational advancement of very heterogeneous groups of participants, including those with generally weak labor market prospects. However, from a fiscal perspective only the low-cost short-term training schemes are cost efficient in the short run.
Missing values are endemic in the data sets available to econometricians. This paper suggests a semiparametrically efficient likelihood-based approach to deal with general non-ignorable missing data problems for discrete choice models. Our concern is when the dependent variable and/or covariates are unobserved for some sampling units. A supplementary random sample of observations on all covariates may be available. The key insight of this paper is the recognition of non-response as a modification of choice-based (CB) samples. Semiparametrically efficient generalized method of moments (GMM) estimation appropriate for CB samples is then adapted for the non-response framework considered in this paper. Simulation results for various GMM estimators proposed here are very encouraging.
This paper studies the maximum level of cooperation that can be sustained in perfect Bayesian equilibrium in repeated games with network monitoring, where players observe each other's actions either perfectly or not at all. The foundational result is that the maximum level of cooperation can be robustly sustained in grim trigger strategies. If players are equally well monitored, comparative statics on the maximum level of cooperation are highly tractable and depend on the monitoring technology only through a simple statistic, its effective contagiousness. Typically, cooperation in the provision of pure public goods is greater in larger groups, while cooperation in the provision of divisible public goods is greater in smaller groups, and making monitoring less uncertain in the second-order stochastic dominance sense increases cooperation. For fixed monitoring networks, a new notion of network centrality is developed, which determines which players cooperate more in a given network, as well as which networks support greater cooperation.
This article investigates collective denial and willful blindness in groups, organizations, and markets. Agents with anticipatory preferences, linked through an interaction structure, choose how to interpret and recall public signals about future prospects. Wishful thinking (denial of bad news) is shown to be contagious when it is harmful to others, and self-limiting when it is beneficial. Similarly, with Kreps–Porteus preferences, willful blindness (information avoidance) spreads when it increases the risks borne by others. This general mechanism can generate multiple social cognitions of reality, and in hierarchies it implies that realism and delusion will trickle down from the leaders. The welfare analysis differentiates group morale from groupthink and identifies a fundamental tension in organizations' attitudes towards dissent. Contagious exuberance can also seize asset markets, generating investment frenzies and crashes.
The evolution of the U.S. economy over the past 55 years is examined through the lens of a micro-founded model that allows for changes in the behaviour of the Federal Reserve and in the volatility of structural shocks. Agents are aware of the possibility of regime changes and their beliefs matter for the law of motion underlying the macroeconomy. Monetary policy is identified by repeated fluctuations between a Hawk and a Dove regime, with the latter prevailing in the 1970s and during the recent crisis. To explore the role of agents' beliefs I introduce a new class of counterfactual simulations: beliefs counterfactuals. If, in the 1970s, agents had anticipated the appointment of an extremely conservative Chairman, inflation would have been lower and the inflation-output trade-off more favourable. The large drop in inflation and output at the end of 2008 would have been mitigated if agents had expected the Federal Reserve to be exceptionally active in the near future.
We explore which financial constraints matter most in the choice of becoming an entrepreneur. We consider a randomly assigned welfare programme in rural Mexico and show that cash transfers significantly increase entry into entrepreneurship. We then exploit cross-household variation in the timing of these transfers and find that current occupational choices are significantly more responsive to the transfers expected for the future than to those currently received. Guided by a simple occupational choice model, we argue that the programme has promoted entrepreneurship by enhancing willingness to bear risk as opposed to simply relaxing current liquidity constraints.
We develop a numerical procedure that facilitates efficient likelihood evaluation in applications involving non-linear and non-Gaussian state-space models. The procedure employs continuous approximations of filtering densities, and delivers unconditionally optimal global approximations of targeted integrands to achieve likelihood approximation. Optimized approximations of targeted integrands are constructed via efficient importance sampling. Resulting likelihood approximations are continuous functions of model parameters, greatly enhancing parameter estimation. We illustrate our procedure in applications to dynamic stochastic general equilibrium models.
In an economy with distortionary taxes on labour, can subsidies on day care, financed by increased taxes, raise welfare by encouraging women with small children to work? We show, within a stylized life-cycle framework, that the Ramsey optimal policy consists in equalizing consumption/leisure wedges over the life cycle. A simple way to implement this is to make day care expenses tax deductible. Modifying and calibrating our model to fit some key facts about labour supply in Germany, we find that the reform that maximizes a distribution-neutral social welfare function involves subsidizing day care at a rate of 50% and leads to a near doubling of labour supply for mothers with small children. The overall welfare gain from this reform corresponds to a 0.4 percent increase in consumption.
Despite clear evidence of correlations between financial and medical statuses and decisions, most models treat financial and health-related choices separately. This article bridges this gap by proposing a tractable dynamic framework for the joint determination of optimal consumption, portfolio holdings, health investment, and health insurance. We solve for the optimal rules in closed form and capitalize on this tractability to gain a better understanding of the conditions under which separation between financial and health-related decisions is sensible, and of the pathways through which wealth and health determine allocations, welfare and other variables of interest such as expected longevity or the value of health. Furthermore we show that the model is consistent with the observed patterns of individual allocations and provide realistic estimates of the parameters that confirm the relevance of all the main characteristics of the model.
Financial market imperfections severely restrict international trade flows because exporters require external capital. This article identifies and quantifies the three mechanisms through which credit constraints affect trade: the selection of heterogeneous firms into domestic production, the selection of domestic manufacturers into exporting, and the level of firm exports. I incorporate financial frictions into a heterogeneous-firm model and apply it to aggregate trade data for a large panel of countries. I establish causality by exploiting the variation in financial development across countries and the variation in financial vulnerability across sectors. About 20%–25% of the impact of credit constraints on trade is driven by reductions in total output. Of the additional, trade-specific effect, one-third reflects limited firm entry into exporting, while two-thirds are due to contractions in exporters' sales. Financially developed economies export more in financially vulnerable sectors because they enter more markets, ship more products to each destination, and sell more of each product. These results have important policy implications for less developed nations that rely on exports for economic growth but suffer from weak financial institutions.
I extend the Epstein–Zin-lognormal consumption-based asset-pricing model to allow for general i.i.d. consumption growth. Information about the higher moments—equivalently, cumulants—of consumption growth is encoded in the cumulant-generating function. I use the framework to analyse economies with rare disasters, and argue that the importance of such disasters is a double-edged sword: parameters that govern the frequency and sizes of rare disasters are critically important for asset pricing, but extremely hard to calibrate. I show how to sidestep this issue by using observable asset prices to make inferences without having to estimate higher moments of the underlying consumption process. Extensions of the model allow consumption to diverge from dividends, and for non-i.i.d. consumption growth.
How did Europe escape the “Iron Law of Wages?” We construct a simple Malthusian model with two sectors and multiple steady states, and use it to explain why European per capita incomes and urbanization rates increased during the period 1350–1700. Productivity growth can only explain a small fraction of the rise in output per capita. Population dynamics—changes of the birth and death schedules—were far more important determinants of steady states. We show how a major shock to population can trigger a transition to a new steady state with higher per-capita income. The Black Death was such a shock, raising wages substantially. Because of Engel's Law, demand for urban products increased, and urban centers grew in size. European cities were unhealthy, and rising urbanization pushed up aggregate death rates. This effect was reinforced by diseases spread through war, financed by higher tax revenues. In addition, rising trade also spread diseases. In this way higher wages themselves reduced population pressure. We show in a calibration exercise that our model can account for the sustained rise in European urbanization as well as permanently higher per capita incomes in 1700, without technological change. Wars contributed importantly to the “Rise of Europe”, even if they had negative short-run effects. We thus trace Europe's precocious rise to economic riches to interactions of the plague shock with the belligerent political environment and the nature of cities.
Voters often dismantle constitutional checks and balances on the executive. If such checks and balances limit presidential abuses of power and rents, why do voters support their removal? We argue that by reducing politician rents, checks and balances also make it cheaper to bribe or influence politicians through non-electoral means. In weakly institutionalized polities where such non-electoral influences, particularly by the better organized elite, are a major concern, voters may prefer a political system without checks and balances as a way of insulating politicians from these influences. When they do so, they are effectively accepting a certain amount of politician (presidential) rents in return for redistribution. We show that checks and balances are less likely to emerge when the elite is better organized and is more likely to be able to influence or bribe politicians, and when inequality and potential taxes are high (which makes redistribution more valuable to the majority). We also provide case study evidence from Bolivia, Ecuador, and Venezuela consistent with the model.
Credence goods are characterized by informational asymmetries between sellers and consumers that invite fraudulent behaviour by sellers. This article presents a natural field experiment on taxi rides in Athens, Greece, set up to measure different types of fraud and to examine the influence of passengers' presumed information and income on the extent of fraud. We find that passengers with inferior information about optimal routes are taken on significantly longer detours, while lack of information on the local tariff system increases the likelihood of manipulated bills by about fifteen percentage points. Passengers' perceived income seems to have no effect on fraud.
We propose exact simulation-based procedures for: (i) testing mean-variance efficiency when the zero-beta rate is unknown; (ii) building confidence intervals for the zero-beta rate. On observing that this parameter may be weakly identified, we propose likelihood-ratio-type tests as well as Fieller-type procedures based on a Hotelling-HAC statistic, which are robust to weak identification and allow for non-Gaussian distributions including parametric GARCH structures. The Fieller-Hotelling-HAC procedure also accounts (asymptotically) for general forms of heteroskedasticity and autocorrelation. We propose confidence sets for the zero-beta rate based on “inverting” exact tests for this parameter; for both procedures proposed, these sets can be interpreted as multivariate extensions of the classic Fieller method for inference on ratios. The exact distribution of likelihood-ratio-type statistics for testing efficiency is studied under both the null and the alternative hypotheses. The relevant nuisance parameter structure is established and finite-sample bound procedures are proposed, which extend and improve available Gaussian-specific bounds. Finite-sample distributional invariance results are also demonstrated analytically for the HAC statistic proposed by MacKinlay and Richardson (1991). We study invariance to portfolio repacking for the tests and confidence sets proposed. The statistical properties of the proposed methods are analysed through a Monte Carlo study and compared with alternative available methods. Empirical results on NYSE returns show that exact confidence sets are very different from asymptotic ones, and allowing for non-Gaussian distributions affects inference results. Simulation and empirical evidence suggests that likelihood-ratio-type statistics—with p-values corrected using the Maximized Monte Carlo test method—are generally preferable to their multivariate Fieller-Hotelling-HAC counterparts from the viewpoints of size control and power.
Evidence from both psychology and economics indicates that individuals give statements that appear to overestimate their ability compared to that of others. We test three theories that predict such relative overconfidence. The first theory argues that overconfidence can be generated by Bayesian updating from a common prior and truthful statements if individuals do not know their true type. The second theory suggests that self-image concerns asymmetrically affect the choice to receive new information about one's abilities, and this asymmetry can produce overconfidence. The third theory is that overconfidence is induced by the desire to send positive signals to others about one's own skill; this suggests either a bias in judgement, strategic lying, or both. We formulate this theory precisely. Using a large data set of relative ability judgements about two cognitive tests, we reject the restrictions imposed by the Bayesian model and also reject a key prediction of the self-image models that individuals with optimistic beliefs will be less likely to search for further information about their skill because this information might shatter their self-image. We provide evidence that personality traits strongly affect relative ability judgements in a pattern that is consistent with the third theory of social signalling. Our results together suggest that overconfidence in statements is more likely to be induced by social concerns than by either of the other two factors.
We introduce a simple method for constructing a scoring rule to elicit an agent's belief about a random variable that is incentive compatible irrespective of her risk-preference. The agent receives a fixed prize when her prediction error, defined by a loss function specified in the incentive scheme, is smaller than an independently generated random number and earns a smaller prize otherwise. Adjusting the loss function according to the belief elicitation objective, the scoring rule can be used in a rich assortment of situations. Moreover, the scoring rule can be incentive compatible even when the agent is not an expected utility maximizer. Results from our probability elicitation experiments show that subjects' predictions are closer to the true probability under this scoring rule compared to the quadratic scoring rule.
This article studies efficient allocations in a dynamic private information economy with a continuum of idiosyncratic shocks that are persistent. I develop a first-order approach for this environment and show that the problem has a simple recursive structure that relies on only a small number of state variables, making the problem tractable. I find sufficient conditions that guarantee that the first-order approach is valid. To illustrate the first-order approach I numerically compute the efficient allocations in a Mirrleesean economy with productivity shocks that follow a random walk and verify the validity of the first-order approach. I show that persistent shocks create a new trade-off where the social planner decreases the informational rent of the agent today at the cost of providing higher insurance in the future.
Are macro-economists mistaken in ignoring bargaining between spouses? This article argues that models of intra-household allocation could be useful for understanding aggregate labour supply trends in the U.S. since the 1970s. A simple calculation suggests that the standard model without bargaining predicts a 19% decline in married-male labour supply in response to the narrowing of the gender gap in wages since the 1970s. However married-men's paid labour remained stationary over the period from the mid 1970s to the recession of 2001. This article develops and calibrates to U.S. time-use survey data a model of marital bargaining in which time allocations are determined jointly with equilibrium marriage and divorce rates. The results suggest that bargaining effects raised married-men's labour supply by about 2.1 weekly hours over the period, and reduced that of married women by 2.7 hours. Bargaining therefore has a relatively small impact on aggregate labour supply, but is critical for trends in female labour supply. Also, the narrowing of the gender wage gap is found to account for a weekly 1.5 hour increase in aggregate labour supply.
In this article, I develop and estimate a model of on-the-job search in which risk averse workers choose search effort and can borrow or save using a single risk free asset. I derive the implications for optimal savings behaviour in this environment and relate this to the frictions that characterize the endogenous earnings process implied by on-the-job search. Savings behaviour depends in a very intuitive way on the rate at which offers are received, the rate at which jobs are destroyed, and a worker's current rank in the wage distribution. The implication is that workers, who are identical in terms of preferences and opportunities, have substantially different savings behaviour depending on their history and current position in the wage distribution. The mechanism that generates the substantial differences in savings behaviour in the model is the dynamic of the “wage ladder” resulting from the search process. There is an important asymmetry between the incremental wage increases generated by on-the-job search (climbing the ladder) and the drop in income associated with job loss (falling off the ladder). The behaviour of workers in low paying jobs is primarily governed by the expectation of wage growth, while the behaviour of workers near the top of the distribution is driven by the possibility of job loss. The distributions of earnings, wealth, and consumption implied by the model (suitably aggregated) align reasonably well with the data, with the notable exception of implying substantially less concentration of wealth among the richest one percent of the population.
We construct a theory of persistent civil conflicts, where persistence is driven by the endogenous dynamics of inter-ethnic trust and trade. In times of peace, agents belonging to two groups are randomly matched to trade bilaterally. Trade hinges on trust and cooperation. The onset of conflict signals that the aggressor has a low propensity to cooperate, harming future trust and trade. Agents observe the history of conflicts and update their beliefs over time. The theory predicts that civil wars are persistent. Moreover, even accidental conflicts that do not reflect economic fundamentals erode trust, and can plunge a society into a vicious cycle of recurrent conflicts (a war trap). The incidence of conflict can be reduced by policies abating cultural barriers, fostering inter-ethnic trade and human capital, and shifting beliefs. Coercive peace policies, such as peacekeeping forces or externally imposed regime changes, have no enduring effects.
In the 2001 U.S. Survey of Consumer Finances, 27% of households report simultaneously revolving significant credit card debt and holding sizeable amounts of low-return liquid assets; this is known as the “credit card debt puzzle”. In this article, I quantitatively evaluate the role of liquidity demand in accounting for this puzzle: households that accumulate credit card debt may not pay it off using their money in the bank, because they anticipate needing that money in situations where credit cards cannot be used. I characterize the puzzle in survey data, and calibrate a dynamic stochastic heterogeneous-agent model of household portfolio choice, where consumer credit and liquidity coexist as means of consumption and saving, where households consume a cash good and a credit good, and where cash consumption is subject to uncertainty. The model accounts for between 44% and 56% of the households in the data who hold consumer debt and liquidity simultaneously, and for 100% of the liquidity held by a median such household. Under reasonable calibration alternatives, the model can capture the entire puzzle group size as well. One-half of money demand in the model is precautionary.
This article estimates people's taste for living with own-ethnic-group neighbours using variation from a natural experiment in Singapore: ethnic housing quotas. I develop a location choice model that informs the use of policy variation from the quotas to address endogeneity issues well known in the social interactions literature. I assembled a dataset on neighbourhood-level ethnic proportions by matching more than 500,000 names in the phonebook to ethnicities. I find that all groups want to live with some own-ethnic-group neighbours but they also exhibit inverted U-shaped preferences so that once a neighbourhood has enough own ethnic neighbours, they would rather add a new neighbour from other groups. Welfare simulations show that about 30% of the neighbourhoods are within one standard deviation of the first-best allocation of ethnic groups.
Sacrifice is widely believed to enhance cooperation in churches, communes, gangs, clans, military units, and many other groups. We find that sacrifice can also work in the lab, apart from special ideologies, identities, or interactions. Our subjects play a modified VCM game—one in which they can voluntarily join groups that provide reduced rates of return on private investment. This leads to both endogenous sorting (because free-riders tend to reject the reduced-rate option) and substitution (because reduced private productivity favours increased club involvement). Seemingly unproductive costs thus serve to screen out free-riders, attract conditional cooperators, boost club production, and increase member welfare. The sacrifice mechanism is simple and particularly useful where monitoring difficulties impede punishment, exclusion, fees, and other more standard solutions.
Does internet use trigger sex crime? We use unique Norwegian data on crime and internet adoption to shed light on this question. A public program with limited funding rolled out broadband access points in 2000–2008, and provides plausibly exogenous variation in internet use. Our instrumental variables estimates show that internet use is associated with a substantial increase in both reports, charges and convictions of rape and other sex crimes. We present a conceptual framework that highlights three mechanisms for how internet use may affect reported sex crime, namely a reporting effect, a matching effect on potential offenders and victims, and a direct effect on sex crime propensity. To investigate the importance of these mechanisms, we use data on individual reporting behaviour, police investigations, and criminal charges and convictions. None of the analyses we perform suggest that the positive relationship between internet use and sex crime is driven by changes in reporting behaviour. Our findings suggest that the direct effect on sex crime propensity is positive and non-negligible, possibly as a result of increased consumption of pornography.
How much income would a woman living alone require to attain the same standard of living that she would have if she were married? What percentage of a married couple's expenditures are controlled by the husband? How much money does a couple save on consumption goods by living together versus living apart? We propose and estimate a collective model of household behaviour that permits identification and estimation of concepts such as these. We model households in terms of the utility functions of its members, a bargaining or social welfare function, and a consumption technology function. We demonstrate generic non-parametric identification of the model, and hence of a version of adult equivalence scales that we call “indifference scales”, as well as consumption economies of scale, the household's resource sharing rule or members' bargaining power, and other related concepts.
We introduce the financial economics of market microstructure to the financial econometrics of asset return volatility estimation. In particular, we derive the cross-correlation function between latent returns and market microstructure noise in several leading microstructure environments. We propose and illustrate several corresponding theory-inspired volatility estimators, which we apply to stock and oil prices. Our analysis and results are useful for assessing the validity of the frequently assumed independence of latent price and microstructure noise, for explaining observed cross-correlation patterns, for predicting as-yet undiscovered patterns, and most importantly, for promoting improved microstructure-based volatility empirics and improved empirical microstructure studies. Simultaneously and conversely, our analysis is far from the last word on the subject, as it is based on stylized benchmark models; it comes with a “call to action” for development and use of richer microstructure models in volatility estimation and beyond.
We develop a model of endogenous productivity change to examine the impact of the investment in knowledge on the productivity of firms. Our dynamic investment model extends the tradition of the knowledge capital model of Griliches (1979) that has remained a cornerstone of the productivity literature. Rather than constructing a stock of knowledge capital from a firm's observed R&D expenditures, we consider productivity to be unobservable to the econometrician. Our approach accounts for uncertainty, non-linearity, and heterogeneity across firms in the link between R&D and productivity. We also derive a novel estimator for production functions in this setting. Using an unbalanced panel of more than 1800 Spanish manufacturing firms in nine industries during the 1990s, we provide evidence of non-linearities as well as economically significant uncertainties in the R&D process. R&D expenditures play a key role in determining the differences in productivity across firms and the evolution of firm-level productivity over time.
How do income shocks affect armed conflict? Theory suggests two opposite effects. If labour is used to appropriate resources violently, higher wages may lower conflict by reducing labour supplied to appropriation. This is the opportunity cost effect. Alternatively, a rise in contestable income may increase violence by raising gains from appropriation. This is the rapacity effect. Our article exploits exogenous price shocks in international commodity markets and a rich dataset on civil war in Colombia to assess how different income shocks affect conflict. We examine changes in the price of agricultural goods (which are labour intensive) as well as natural resources (which are not). We focus on Colombia's two largest exports, coffee and oil. We find that a sharp fall in coffee prices during the 1990s lowered wages and increased violence differentially in municipalities cultivating more coffee. This is consistent with the coffee shock inducing an opportunity cost effect. In contrast, a rise in oil prices increased both municipal revenue and violence differentially in the oil region. This is consistent with the oil shock inducing a rapacity effect. We also show that this pattern holds in six other agricultural and natural resource sectors, providing evidence that price shocks affect conflict in different directions depending on the type of the commodity.
This article presents a model of information manipulation and political regime change. There is a regime that can be overthrown but only if enough citizens participate in an uprising. Citizens are imperfectly informed about the regime's ability to resist an uprising and the regime can engage in propaganda that, taken at face-value, makes the regime seem stronger than it truly is. This coordination game with endogenous information manipulation has a unique equilibrium and the article gives a complete analytic characterization of the equilibrium's comparative statics. Holding fixed the number of signals available to citizens, if the per-unit signal precision is sufficiently high then the regime is harder to overthrow. In contrast, if the number of signals increases, so that both total signal precision and the regime's costs of manipulation rise together, then the regime is easier to overthrow unless there are strong economies of scale in information control.
Microfinance clients were randomly assigned to repayment groups that met either weekly or monthly during their first loan cycle, and then graduated to identical meeting frequency for their second loan. Long-run survey data and a follow-up public goods experiment reveal that clients initially assigned to weekly groups interact more often and exhibit a higher willingness to pool risk with group members from their first loan cycle nearly 2 years after the experiment. They were also three times less likely to default on their second loan. Evidence from an additional treatment arm shows that, holding meeting frequency fixed, the pattern is insensitive to repayment frequency during the first loan cycle. Taken together, these findings constitute the first experimental evidence on the economic returns to social interaction, and provide an alternative explanation for the success of the group lending model in reducing default risk.
The textbook neoclassical growth model predicts that countries with faster productivity growth should invest more and attract more foreign capital. We show that the allocation of capital flows across developing countries is the opposite of this prediction: capital does not flow more to countries that invest and grow more. We call this puzzle the “allocation puzzle”. Using a wedge analysis, we find that the pattern of capital flows is driven by national saving: the allocation puzzle is a saving puzzle. Further disaggregation of capital flows reveals that the allocation puzzle is also related to the pattern of accumulation of international reserves. The solution to the “allocation puzzle”, thus, lies at the nexus between growth, saving, and international reserve accumulation. We conclude with a discussion of some possible avenues for research.
We study equilibrium wage and employment dynamics in a class of popular search models with wage posting, in the presence of aggregate productivity shocks. Firms offer and commit to (Markov) contracts, which specify a wage contingent on all payoff-relevant states, but must pay equally all of their workers, who have limited commitment and are free to quit at any time. We find sufficient conditions for the existence and uniqueness of a stochastic search equilibrium in such contracts, which is Rank Preserving [RP]: larger and more productive firms offer more generous contracts to their workers in all states of the world. On the RP equilibrium path, turnover is always efficient as workers always move from less to more productive firms. The resulting stochastic dynamics of firm size provide an intuitive explanation for the empirical finding that large employers have more cyclical job creation (Moscarini and Postel-Vinay, 2012). Finally, computation of RP equilibrium contracts is tractable.
In this article, we analyse the firm's choice between serving a foreign market through exports or through foreign affiliate sales in an environment characterized by country-specific shocks to the cost of production. Our model predicts that country pairs with less-correlated output fluctuations trade more, relative to affiliate sales, whereas countries with more-volatile fluctuations are served relatively more by exporters than by foreign affiliates selling abroad. Using detailed data on trade and affiliate sales, we find empirical support for our model's predictions.
I study elections between citizen-candidates who cannot make binding policy commitments before taking office, but who are accountable to voters due to the possibility of re-election. In each period a representative voter chooses among heterogeneous candidates with known policy preferences. The elected candidate chooses the policy to implement, and how much rent-seeking to engage in, when in office. As the voter decides both which candidate to elect and, subsequently, whether the candidate is retained, this framework integrates elements of electoral competition and electoral accountability. I show that, in the best stationary equilibrium, when utility functions are concave over policy, non-median candidates are elected over candidates with policy preferences more closely aligned with the voter. In this equilibrium, there are two candidates who are elected at some history, and the policies these candidates implement in office do not converge. This divergence incentivizes candidates to engage in less rent-seeking, increasing voter welfare.
This article considers a two-sided search market where firms and workers are paired to bargain over a unit surplus. The matching market serves as an endogenous outside option for the agents. The market includes inflexible commitment types who demand a constant portion of any match surplus. The frequency of such types is determined in equilibrium.An equilibrium where there are significant delays in reaching an agreement and where negotiations occasionally break down on the equilibrium path is constructed. Such an equilibrium exists and commitment types affect bargaining dynamics even if the equilibrium frequency of such types is negligible. If the inflows of firms and workers into the market are symmetric, then bargaining involves two-sided reputation building and reputation concerns lead to delays and inefficiency. Access to the market exacerbates bargaining inefficiencies caused by inflexible types. If the inflows of workers and firms are sufficiently asymmetric, then bargaining involves one-sided reputation and commitment types determine the terms of trade.
This article provides evidence that involuntary unemployment, and the segmentation of labour markets into firms offering “good” and “bad” jobs, may both arise as a consequence of contractual incompleteness. We provide a simple model that illustrates how unemployment and market segmentation may jointly emerge as part of a market equilibrium in environments where work effort is not third-party verifiable. Using experimental labour markets that differ only in the verifiability of effort, we demonstrate empirically that contractual incompleteness can cause unemployment and segmentation. Our data are also consistent with the key channels through which the model explains the emergence of both phenomena.
This article provides evidence that schools can influence parents' involvement in education, and this has causal effects on pupils' behaviour. Furthermore, it shows how the impact of more involved parents on their children is amplified at the class level by peer group interaction. We build on a large-scale controlled experiment run in a French deprived educational district, where parents of middle-school children were invited to participate in a simple program of parent–school meetings on how to get better involved in their children's education. At the end of the school year, we find that treated families have increased their school-and home-based involvement activities. In turn, pupils of treatment classes have developed more positive behaviour and attitudes in school, notably in terms of truancy and disciplinary sanctions (with effects-size around 15% of a standard deviation). However, test scores did not improve under the intervention. Our results suggest that parents are an input for schooling policies and it is possible to influence important aspects of the schooling process at low cost.
Rent-sharing by workers can reduce the incentives for investment if some of the returns to sunk capital are captured in higher wages. We propose a simple measure of this “holdup” effect based on the size of the wage offset for firm-specific capital accumulation. Using Social Security earnings records for workers in the Veneto region of Italy linked to detailed financial data for their employers, we find strong evidence of rent-sharing, with an elasticity of wages with respect to potential rents per worker of around 4%, arising mainly at larger firms with higher price-cost margins. On the other hand, we find little evidence that bargaining lowers the return on investment. Instead, firm-level bargaining appears to split the rents after deducting the full cost of capital.
We report laboratory experiments that use new, visually oriented software to explore the dynamics of 3×3 games with intransitive best responses. Each moment, each player is matched against the entire population, here 8 human subjects. A “heat map” offers instantaneous feedback on current profit opportunities. In the continuous slow adjustment treatment, we see distinct cycles in the population mix. The cycle amplitude, frequency and direction are consistent with the standard learning models. Cycles are more erratic and higher frequency in the instantaneous adjustment treatment. Control treatments (using simultaneous matching in discrete time) replicate previous results that exhibit weak or no cycles. Average play is approximated fairly well by Nash equilibrium, and an alternative point prediction, “TASP” (Time Average of the Shapley Polygon), captures some regularities that Nash equilibrium misses.
The growth in labour market participation among women with young children has raised concerns about its implications for child cognitive development. We estimate a model of the cognitive development process of children nested within an otherwise standard model of household behaviour. The household makes labour supply decisions and provides time and money inputs into the child quality production process during the development period. Our empirical results indicate that both parents' time inputs are important for the cognitive development of their children, particularly when the child is young. Money expenditures are less productive in terms of producing child quality. Comparative statics exercises demonstrate that cash transfers to households with children have small impacts on child quality due to the relatively low impact of money investments on child outcomes and the fact that a significant fraction of the transfer is spent on other household consumption and the leisure of the parents.
This article studies empirically the links between international trade and labour income risk faced by manufacturing sector workers in the U.S. We use longitudinal data on workers to estimate time-varying individual income risk at the industry level. We then combine our estimates of persistent labour income risk with measures of exposure to international trade to analyse the relationship between trade and labour income risk. We also study risk estimates from various subsamples of workers, such as those who switched to a different manufacturing industry (or out of the manufacturing sector altogether). Finally, we use these estimates to conduct a welfare analysis evaluating the benefits or costs of trade through the income risk channel. We find import penetration to have a statistically significant association with labour income risk in the U.S. Our welfare calculations suggest that these effects are economically significant.
Job protection and cash benefits are key elements of parental leave (PL) systems. We study how these two policy instruments affect return-to-work and medium-run labour market outcomes of mothers of newborn children. Analysing a series of major PL policy changes in Austria, we find that longer cash benefits lead to a significant delay in return-to-work, particularly so in the period that is job-protected. Prolonged parental leave absence induced by these policy changes does not appear to hurt mothers' labour market outcomes in the medium run. We build a non-stationary model of job search after childbirth to isolate the role of the two policy instruments. The model matches return-to-work and return to same employer profiles under the various factual policy configurations. Counterfactual policy simulations indicate that a system that combines cash with protection dominates other systems in generating time for care immediately after birth while maintaining mothers' medium-run labour market attachment.
We estimate an equilibrium model of ticket resale in which consumers' and brokers' decisions in the primary market reflect rational expectations about the resale market. Estimation is based on a unique dataset that merges transaction details from both the primary and secondary markets for tickets to major rock concerts. In our model, the presence of a resale market permits tickets to be traded from low-value to high-value consumers, but it also stimulates costly efforts by consumers and brokers to obtain underpriced tickets in the primary market. We estimate that observed levels of resale increase allocative efficiency by 5% on average, but that a third of this increase is offset by increases in costly rent-seeking in the primary market and transaction costs in the resale market.
Entrusting the power to punish to a central authority is a hallmark of civilization, yet informal or horizontal sanctions have attracted more attention of late. We study experimentally a collective action dilemma and test whether subjects choose a formal sanction scheme that costs less than the surplus it makes possible, as predicted by standard economic theory, or instead opt for the use of informal sanctions (IS) or no sanctions. Our subjects choose, and succeed in using, IS surprisingly often, their voting decisions being responsive to the cost of formal sanctions. Adoption by voting enhances the efficiency of both IS and non-deterrent formal sanctions. Results are qualitatively confirmed under several permutations of the experimental design.
We study the prevalence of the higher order risk attitudes of prudence and temperance in an experiment with a large demographically representative sample of participants. Under expected utility, prudence and temperance are defined by a convex first, and concave second, derivative of the utility function, and have direct implications for saving behaviour and portfolio choice. In the experiment, participants make pairwise choices that distinguish prudent from imprudent, and temperate from intemperate, behaviour. We correlate individuals' risk aversion, prudence, and temperance levels to their demographic profiles and their financial decisions outside the experiment. We observe that the majority of individuals' decisions are consistent with risk aversion, prudence, and temperance. Prudence is positively correlated with saving, as predicted by precautionary saving theory. Temperance is negatively correlated with the riskiness of portfolio choices.
This article studies optimal monetary policy when decision-makers in firms choose how much attention they devote to aggregate conditions. When the amount of attention that decision-makers in firms devote to aggregate conditions is exogenous, complete price stabilization is optimal only in response to shocks that cause efficient fluctuations under perfect information. When decision-makers in firms choose how much attention they devote to aggregate conditions, complete price stabilization is optimal also in response to shocks that cause inefficient fluctuations under perfect information. Hence, recognizing that decision-makers in firms can choose how much attention they devote to aggregate conditions has major implications for optimal policy.
Do labour markets discriminate against workers with particular ethnic-sounding names? We use non-random sorting into inter-ethnic marriage and salient differences between Sephardic and Ashkenazi surnames to evaluate the causal impact of Sephardic affiliation on wages. Using the 1995 Israeli Census, we estimate the effect of a Sephardic sounding surname on wages. We first compare the wages of Israeli Jewish males born to Sephardic fathers and Ashkenazi mothers (SA), who are more likely to carry a Sephardic surname, with the wages of Israeli Jewish males born to Ashkenazi fathers and Sephardic mothers (AS). We find that Israeli labour markets discriminate based on perceived ethnicity: SA workers earn significantly less than their AS counterparts. We then exploit the custom of women to adopt their husbands' surnames to disentangle actual ethnicity from the ethnicity perceived by the market. Consistent with ethnic discrimination based on surnames, we find that it is father-in-law's ethnicity—rather than father's ethnicity—that shapes female wage rates. Finally, we find that labour markets discriminate based on surname only when those names provide additional information about ethnicity. When ethnicity can be discerned from skin tone, surnames do not provide additional explanatory power with respect to wages.
Taking advantage of unique longitudinal data, we provide the first characterization of what college students believe at the time of entrance about their final major, relate these beliefs to actual major outcomes, and provide an understanding of why students hold the initial beliefs about majors that they do. The data collection and analysis are based directly on a conceptual model in which a student's final major is best viewed as the end result of a learning process. We find that students enter school quite optimistic about obtaining a science degree, but that relatively few students end up graduating with a science degree. The substantial overoptimism about completing a degree in science can be attributed largely to students beginning school with misperceptions about their ability to perform well academically in science.
We investigate whether two players in a long-run relationship can maintain cooperation when the details of the underlying game are unknown. Specifically, we consider a new class of repeated games with private monitoring, where an unobservable state of the world influences the payoff functions and/or the monitoring structure. Each player privately learns the state over time but cannot observe what the opponent learned. We show that there are robust equilibria in which players eventually obtain payoffs as if the true state were common knowledge and players played a “belief-free” equilibrium. We also provide explicit equilibrium constructions in various economic examples.
When an individual performs several tasks simultaneously, processing resources must be allocated to different brain systems to produce energy for neurons to fire. Following the evidence from neuroscience, we model the brain as an organization in which a coordinator allocates limited resources to the brain systems responsible for the different tasks. Systems are privately informed about the amount of resources necessary to perform their task and compete to obtain the resources. The coordinator arbitrates the demands while satisfying the resource constraint. We show that the optimal mechanism is to impose to each system with privately known needs a cap in resources that depends negatively on the amount of resources requested by the other system. This allocation can be implemented using a biologically plausible mechanism. Finally, we provide some implications of our theory: (i) performance can be flawless for sufficiently simple tasks, (ii) the dynamic allocation rule exhibits inertia (current allocations are increasing in past needs), and (iii) different cognitive tasks are performed by different systems only if the tasks are sufficiently important.
Heavier vehicles are safer for their own occupants but more hazardous for other vehicles. Simple theory thus suggests that an unregulated vehicle fleet is inefficiently heavy. Using three separate identification strategies we show that, controlling for own-vehicle weight, being hit by a vehicle that is 1000 pounds heavier generates a 40–50% increase in fatality risk. These results imply a total accident-related externality that exceeds the estimated social cost of US carbon emissions and is equivalent to a gas tax of $0.97 per gallon ($136 billion annually). We consider two policies for internalizing this external cost, a weight-varying mileage tax and a gas tax, and find that they are similar for most vehicles. The findings suggest that European gas taxes may be much closer to optimal levels than the US gas tax.
This article uses variation in access to a targeted lending program to estimate whether firms are credit constrained. While both constrained and unconstrained firms may be willing to absorb all the directed credit that they can get (because it may be cheaper than other sources of credit), constrained firms will use it to expand production, while unconstrained firms will primarily use it as a substitute for other borrowing. We apply these observations to firms in India that became eligible for directed credit as a result of a policy change in 1998, and lost eligibility as a result of the reversal of this reform in 2000, and to smaller firms that were already eligible for the preferential credit before 1998 and remained eligible in 2000. Comparing the trends in the sales and the profits of these two groups of firms, we show that there is no evidence that directed credit is being used as a substitute for other forms of credit. Instead, the credit was used to finance more production–there was a large acceleration in the rate of growth of sales and profits for these firms in 1998, and a corresponding decline in 2000. There was no change in trends around either date for the small firms. We conclude that many of the firms must have been severely credit constrained, and that the marginal rate of return to capital was very high for these firms.
We propose robust methods for inference about the effect of a treatment variable on a scalar outcome in the presence of very many regressors in a model with possibly non-Gaussian and heteroscedastic disturbances. We allow for the number of regressors to be larger than the sample size. To make informative inference feasible, we require the model to be approximately sparse; that is, we require that the effect of confounding factors can be controlled for up to a small approximation error by including a relatively small number of variables whose identities are unknown. The latter condition makes it possible to estimate the treatment effect by selecting approximately the right set of regressors. We develop a novel estimation and uniformly valid inference method for the treatment effect in this setting, called the “post-double-selection” method. The main attractive feature of our method is that it allows for imperfect selection of the controls and provides confidence intervals that are valid uniformly across a large class of models. In contrast, standard post-model selection estimators fail to provide uniform inference even in simple cases with a small, fixed number of controls. Thus, our method resolves the problem of uniform inference after model selection for a large, interesting class of models. We also present a generalization of our method to a fully heterogeneous model with a binary treatment variable. We illustrate the use of the developed methods with numerical simulations and an application that considers the effect of abortion on crime rates.
The mechanism by which aggregate supply creates the income that generates its matching demand (called Say's Law), may not work in a general equilibrium with decentralized markets and savings in bonds or money. Full employment is an equilibrium, but convergence to that state is slow. A self-fulfilling precautionary motive to accumulate bonds (with a zero aggregate supply) can set the economy on an equilibrium path with a fast convergence towards a steady state with unemployment that may be an absorbing state from which no equilibrium path emerges to restore full employment.
We estimate the effect of interstate highways on the level and composition of trade for US cities. Highways within cities have a large effect on the weight of city exports with an elasticity of approximately 0.5. We find little effect of highways on the total value of exports. Consistent with this, we find that cities with more highways specialize in sectors producing heavy goods.
We show that even when the exchange rate cannot be devalued, a small set of conventional fiscal instruments can robustly replicate the real allocations attained under a nominal exchange rate devaluation in a dynamic New Keynesian open economy environment. We perform the analysis under alternative pricing assumptions—producer or local currency pricing, along with nominal wage stickiness; under arbitrary degrees of asset market completeness and for general stochastic sequences of devaluations. There are two types of fiscal policies equivalent to an exchange rate devaluation—one, a uniform increase in import tariff and export subsidy, and two, a value-added tax increase and a uniform payroll tax reduction. When the devaluations are anticipated, these policies need to be supplemented with a consumption tax reduction and an income tax increase. These policies are revenue neutral. In certain cases equivalence requires, in addition, a partial default on foreign bond holders. We discuss the issues of implementation of these policies, in particular, under the circumstances of a currency union.
We use micro data on Irish producer prices to provide clean evidence on pricing-to-market across a broad range of manufacturing sectors. We have monthly observations on prices charged by the same plant for the same product to buyers in Ireland and the UK, two markets segmented by variable exchange rates. Assuming that relative marginal cost is constant across markets within a plant and a product, this allows us to observe the behaviour of the markup in the UK market relative to the home market. To identify pricing-to-market that goes beyond what is mechanically due to price stickiness, we condition on episodes where prices change. When prices are invoiced in local currency, conditional on prices changing, the ratio of the markup in the foreign market to the markup in the home market increases one-for-one with depreciations of home against foreign currency and decreases one-for-one with appreciations of home against foreign currency, a very particular form of pricing-to-market.
Wage inequality has been significantly higher in the U.S. than in continental European countries (CEU) since the 1970s. Moreover, this inequality gap has further widened during this period as the U.S. has experienced a large increase in wage inequality, whereas the CEU has seen only modest changes. This article studies the role of labour income tax policies for understanding these facts, focusing on male workers. We construct a life cycle model in which individuals decide each period whether to go to school, work, or stay non-employed. Individuals can accumulate human capital either in school or while working. Wage inequality arises from differences across individuals in their ability to learn new skills as well as from idiosyncratic shocks. Progressive taxation compresses the (after-tax) wage structure, thereby distorting the incentives to accumulate human capital, in turn reducing the cross-sectional dispersion of (before-tax) wages. Consistent with the model, we empirically document that countries with more progressive labour income tax schedules have (i) significantly lower before-tax wage inequality at different points in time and (ii) experienced a smaller rise in wage inequality since the early 1980s. We then study the calibrated model and find that these policies can account for half of the difference between the U.S. and the CEU in overall wage inequality and 84% of the difference in inequality at the upper end (log 90–50 differential). In a two-country comparison between the U.S. and Germany, the combination of skill-biased technical change and changing progressivity of tax schedules explains all the difference between the evolution of inequality in these two countries since the early 1980s.
We use the revealed preference method to derive a model of individual decision making when the endowment of an agent provides a reference point that may influence her choices. This model generalizes the classical rational choice model, which views choice as a consequence of “utility maximization”. Instead, our model sees choice as arising from “psychologically constrained utility maximization”, where the constraints are induced by one's initial endowment. In particular, this model produces status quo bias as a natural consequence (but not necessarily the endowment effect). A range of economic applications identify the predictive and explanatory strength of the model. In particular, we demonstrate that the status quo bias phenomenon reduces the size of the substitution effect in problems of consumption choice.
This article studies optimal Ramsey taxation when risk sharing in private insurance markets is imperfect due to limited enforcement. In a limited commitment economy, there are externalities associated with capital and labour because individuals do not take into account that their labour and saving decisions affect aggregate labour and capital supply and wages, and thus the value of autarky. Therefore, a Ramsey government has an additional goal, which is to internalize these externalities of labour and capital to improve risk sharing, in addition to its usual goal—minimizing distortions in financing government expenditures. These two goals drive capital and labour taxes in opposite directions. It is shown that the steady-state optimal capital income taxes are levied only to remove the negative externality of the capital, whereas optimal labour income taxes are set to meet the budgetary needs of the government in the long run, despite the presence of positive externalities of labour.
Many structural economics models are semiparametric ones in which the unknown nuisance functions are identified via non-parametric conditional moment restrictions with possibly non-nested or overlapping conditioning sets, and the finite dimensional parameters of interest are over-identified via unconditional moment restrictions involving the nuisance functions. In this article we characterize the semiparametric efficiency bound for this class of models. We show that semiparametric two-step optimally weighted GMM estimators achieve the efficiency bound, where the nuisance functions could be estimated via any consistent non-parametric methods in the first step. Regardless of whether the efficiency bound has a closed form expression or not, we provide easy-to-compute sieve-based optimal weight matrices that lead to asymptotically efficient two-step GMM estimators.
We develop a decentralized Bayesian model of college admissions with two ranked colleges, heterogeneous students, and two realistic match frictions: students find it costly to apply to college, and college evaluations of their applications are uncertain. Students thus face a portfolio choice problem in their application decision, while colleges choose admissions standards that act like market-clearing prices. Enrollment at each college is affected by the standards at the other college through student portfolio reallocation. In equilibrium, student-college sorting may fail: weaker students sometimes apply more aggressively, and the weaker college might impose higher standards. Applying our framework, we analyse affirmative action, showing how it induces minority applicants to construct their application portfolios as if they were majority students of higher caliber.
This article investigates the welfare implications of the rapid innovation in central processing units (CPUs), and asks whether it results in inefficient elimination of basic personal computer (PC) products. I analyse a game in which firms make multiple discrete product choices, and tackle challenges such as partial identification and sample selection. Estimation results demonstrate that the demand for PCs is highly segmented, and that fixed costs consume a substantial portion of the per-unit producer profit. The estimated model implies that Intel's introduction of its Pentium M chip contributed significantly to the growth of the mobile PC segment and to consumer welfare. The lion's share of the benefits to consumers was enjoyed by the 20% least price-sensitive consumers. I also find that the Pentium M crowded out the Pentium III and Pentium 4 technologies, and that the benefits to consumers from keeping those older products on the shelf would have been comparable to the added fixed costs. While total welfare cannot be increased by keeping older technologies on the shelf, such a policy would have allowed the benefits from innovation to “trickle down” to price-sensitive households, improving their access to mobile computing.
Large-scale transport infrastructure investments connect both large metropolitan centres of production as well as small peripheral regions. Are the resulting trade cost reductions a force for the diffusion of industrial and total economic activity to peripheral regions, or do they reinforce the concentration of production in space? This article exploits China's National Trunk Highway System as a large-scale natural experiment to contribute to our understanding of this question. The network was designed to connect provincial capitals and cities with an urban population above 500,000. As a side effect, a large number of small peripheral counties were connected to large metropolitan agglomerations. To address non-random route placements on the way between targeted city nodes, I propose an instrumental variable strategy based on the construction of least cost path spanning tree networks. The estimation results suggest that network connections have led to a reduction in GDP growth among non-targeted peripheral counties. This effect appears to be driven by a significant reduction in industrial output growth. Additional results present evidence in support of a trade-based channel in the light of falling trade costs between peripheral and metropolitan regions.
We introduce the concept of a universal social ordering, defined on the set of pairs of an allocation and a preference profile of any finite population. It is meant to unify evaluations and comparisons of welfare (living standards) for individuals and populations of possibly different sizes and preferences. It can be used for policy evaluation, international comparisons, growth assessment, and inequality measurement. It even makes it possible to evaluate policy options that affect the size of the population or the preferences of its members. We study how to extend the theory of social choice in order to select such orderings on a rigorous axiomatic basis. We provide foundations for leximin as well as additively separable criteria. Key ingredients in this analysis are fairness principles in social aggregation, attitudes with respect to population size, and the bases of interpersonal comparisons. We discuss how this sheds light on recent developments in the empirical literature on international comparisons.
Firms spend substantial resources on marketing and selling. Interpreting this as evidence of frictions in product markets, which require firms to spend resources on customer acquisition, this article develops a search theoretic model of firm dynamics in frictional product markets. Introducing search frictions generates long-term customer relationships, rendering the customer base a state variable for firms, which is sluggish to adjust. This affects: the level and volatility of firm investment, profits, value, sales and markups, the timing of firm responses to shocks, and the relationship between investment and Tobin's q. We document support for these predictions in firm-level data from Compustat, using cross-industry variation in selling expenses to quantify differences in the degree of friction across markets.
This article develops a dynamic asset pricing model with persistent heterogeneous beliefs. The model features competitive traders who receive idiosyncratic signals about an underlying fundamentals process. We adapt Futia's (1981) frequency domain methods to derive conditions on the fundamentals that guarantee non-invertibility of the mapping between observed market data and the underlying shocks to agents' information sets. When these conditions are satisfied, agents remain asymmetrically informed in equilibrium and must ‘forecast the forecasts of others’. An econometrician, who incorrectly imposes a homogeneous beliefs equilibrium, will find that the asset price displays violations of variance bounds, predictability of excess returns, and rejections of cross-equation restrictions.
The conditions under which young workers find their first real post-graduation jobs are important for their future careers and insufficiently documented given their potential importance for young workers welfare. To study these conditions, and in particular the role played by social ties, we use a Swedish population-wide linked employer–employee data set of graduates from all levels of schooling that includes detailed information on family ties, neighbourhoods, schools, class composition, and parents' and children's employers over a period covering years with both high and low unemployment, together with measures of firm performance. We find that strong social ties (parents) are an important determinant for where young workers find their first job. The effects are larger if the graduate's position is “weak” (low education, bad grades), during high unemployment years, and when information on potential openings are likely to be scarce. On the hiring side, by contrast, the effects are larger if the parent's position is “strong” (long tenure, high wage) and if the parent's plant is more productive. The youths appear to benefit from the use of strong social ties through faster access to jobs and by better labour market outcomes as measured a few years after entry. In particular, workers finding their entry jobs through strong social ties are considerably more likely to remain in this job, while experiencing better wage growth than other entrants in the same plant. Firms also appear to benefit from these wage costs (relative to comparable entrants) starting at a lower base. They also benefit on the parents' side; parents' wage growth drops dramatically exactly at the entry of one of their children in the plant, although this is a moment when firm profits tend to be growing. Indeed, the firm-side benefits appear large enough for (at least small) firms to increase job creation at the entry level in years when a child of one of their employees graduates.
Deadlines and late penalties are widely used to incentivize effort. Tighter deadlines and higher penalties induce higher effort, but increase the agent's risk. We model how these contract terms affect the work rate and time-to-completion in a procurement setting, characterizing the efficient contract design. Using new micro-level data on Minnesota highway construction contracts that includes day-by-day information on work plans, hours worked and delays, we find evidence of ex post moral hazard: contractors adjust their effort level during the course of the contract in response to unanticipated productivity shocks, in a way that is consistent with our theoretical predictions. We next build an econometric model that endogenizes the completion time as a function of the contract terms and the productivity shocks, and simulate how commuter welfare and contractor costs vary across different terms and shocks. Accounting for the traffic delays caused by construction, switching to a more efficient contract design would increase welfare by 22.5% of the contract value while increasing the standard deviation of contractor costs—a measure of risk—by less than 1% of the contract value.
We introduce an approach for semiparametric inference in dynamic binary choice models that does not impose distributional assumptions on the state variables unobserved by the econometrician. The proposed framework combines Bayesian inference with partial identification results. The method is applicable to models with finite space of observed states. We demonstrate the method on Rust's model of bus engine replacement. The estimation experiments show that the parametric assumptions about the distribution of the unobserved states can have a considerable effect on the estimates of per-period payoffs. At the same time, the effect of these assumptions on counterfactual conditional choice probabilities can be small for most of the observed states.
While employed, workers learn their comparative advantage and eventually choose occupations that best match their abilities. This learning process is consistent with a number of key facts about occupational mobility, such as the offsetting worker flows across occupations, the non-random patterns of occupational transitions, and the decline of occupational switching with age. We illustrate how search frictions delay learning and lead to mismatch, thereby reducing worker productivity. Moreover, we explore how different workers perform in different occupations. Are the best workers in one occupation also the best workers in another occupation (one-dimensional model of ability)? Or are some workers good at one occupation and other workers good at a different one (comparative advantage model)? The calibration favours the model of comparative advantage, as opposed to the widely used one-dimensional ability model. We use the calibrated model to investigate how the level of unemployment benefits affects worker productivity.
This article studies optimal linear and non-linear redistributive income taxation when there is adverse selection in the labour market. Unlike in standard taxation models, firms do not know workers' abilities, and competitively screen them through non-linear compensation contracts, unobservable to the government, in a Miyazaki–Wilson–Spence equilibrium. Adverse selection leads to different optimal tax formulas than in the standard Mirrlees (1971) model because of the use of work hours as a screening tool by firms, which for higher talent workers results in a “rat race”, and for lower talent workers in informational rents and cross-subsidies. The most surprising result is that, if the government has sufficiently strong redistributive goals, welfare is higher when there is adverse selection than when there is not. Policies that endogenously affect adverse selection are discussed. The model has practical implications for the interpretation, estimation, and use of taxable income elasticities, which are central to optimal tax design.
I study how the misallocation of new technology to individuals, who have low ex post returns to its use, affects learning and adoption behaviour. I focus on anti-malarial treatment, which is frequently over-prescribed in many low-income country contexts where diagnostic tests are inaccessible. I show that misdiagnosis reduces average therapeutic effectiveness, because only a fraction of adopters actually have malaria, and slows the rate of social learning due to increased noise. I use data on adoption choices, the timing and duration of fever episodes, and individual blood slide confirmations of malarial status from a pilot study for a new malaria therapy in Tanzania to show that individuals whose reference groups experienced fewer misdiagnoses exhibited stronger learning effects and were more likely to adopt.
Auctions often involve the sale of many related goods: Treasury, spectrum, and electricity auctions are examples. In multi-unit auctions, bids for marginal units may affect payments for inframarginal units, giving rise to “demand reduction” and furthermore to incentives for shading bids differently across units. We establish that such differential bid shading results generically in ex post inefficient allocations in the uniform-price and pay-as-bid auctions. We also show that, in general, the efficiency and revenue rankings of the two formats are ambiguous. However, in settings with symmetric bidders, the pay-as-bid auction often outperforms. In particular, with diminishing marginal utility, symmetric information and linearity, it yields greater expected revenues. We explain the rankings through multi-unit effects, which have no counterparts in auctions with unit demands. We attribute the new incentives separately to multi-unit (but constant) marginal utility and to diminishing marginal utility. We also provide comparisons with the Vickrey auction.
Information collection and processing in financial institutions is challenging. This can delay the observation by traders of the exact capital charges and constraints of their institution. During this delay, traders face preference uncertainty. In this context, we study optimal trading strategies and equilibrium prices in a continuous centralized market. We focus on liquidity shocks, during which preference uncertainty is likely to matter most. Preference uncertainty generates allocative inefficiency, but need not reduce prices. Progressively learning about preferences generate round–trip trades, which increase volume relative to the frictionless market. In a cross section of liquidity shocks, the initial price drop is positively correlated with total trading volume. Across traders, the number of round–trips is negatively correlated with trading profits and average inventory.
We study information acquisition in a flexible framework with strategic complementarity or substitutability in actions and a rich set of externalities that are responsible for possible wedges between the equilibrium and the efficient acquisition of information. First, we relate the (in)efficiency in the acquisition of information to the (in)efficiency in the use of information and explain why efficiency in the use is no guarantee of efficiency in the acquisition. Next, we show how the acquisition of private information affects the social value of public information (i.e. the comparative statics of equilibrium welfare with respect to the quality of public information). Finally, we illustrate the implications of the results in a monetary economy with price rigidities and dispersed information about productivity shocks.
We compare two large-scale policy interventions aimed at reducing crime: subsidizing high school completion and increasing the length of prison sentences. To this purpose we use a life-cycle model with endogenous education and crime choices. We apply the model to property crime and calibrate it to U.S. data. We find that targeting crime reductions through increases in high school graduation rates entails large efficiency and welfare gains. These gains are absent if the same crime reduction is achieved by increasing the length of sentences. We also find that general equilibrium effects explain roughly one half of the reduction in crime from subsidizing high school.
Connections between individuals facilitate the exchange of goods, resources, and information and create benefits. These connections may be exploited by adversaries to spread their attacks as well. What is the optimal way to design and defend networks in the face of attacks? We develop a model with a Designer and an Adversary. The Designer moves first and chooses a network and an allocation of defence resources across nodes. The Adversary then allocates attack resources on nodes; if an attack succeeds then the Adversary decides on how successful resources should navigate the network. We obtain two principal results. One, we show that in a wide variety of circumstances a star network with all defence resources allocated to the central node is optimal for the Designer. Two, we identify conditions on the technology of conflict, network value function, and the resource configuration for which networks with multiple hubs/components are optimal.
We show that sellers may earn a reputation for their “ability” to deliver high-quality goods on average by honestly announcing the realized quality of items for sale every period. As the expected revenue stream from continuing with honest communication increases with their ability, high-ability sellers remain honest while low-ability sellers find it too costly and sometimes lie about quality for short-term gain. Thus, cheap-talk communication facilitates the market's learning of a seller's ability and strengthens reputation effects. We study this new reputation mechanism and the induced market dynamics, first when sellers cannot restart with a new identity and second when they can. We extend the analysis to various other situations such as voluntary refund and moral hazard.
Pay distributions fan out with experience. The leading explanations for this pattern are that over time, either employers learn about worker productivity but productivity remains fixed or workers' productivities themselves evolve heterogeneously. We propose a dynamic specification that nests both employer learning and dynamic productivity heterogeneity. We estimate this model on a 20-year panel of pay and performance measures from a single, large firm. The advantage of these data is that they provide us with repeat measures of productivity, some of which have not yet been observed by the firm when it sets wages. We use our estimates to investigate how learning and dynamic productivity heterogeneity jointly contribute to the increase in pay dispersion with age. We find that both mechanisms are important for understanding wage dynamics. The dispersion of pay increases with experience primarily because productivity differences increase. Imperfect learning, however, means that wages differ significantly from individual productivity all along the life cycle because firms continuously struggle to learn about a moving target in worker productivity. Our estimates allow us to calculate the degree to which imperfect learning introduces a wedge between the private and social incentives to invest in human capital. We find that these disincentives exist throughout the life cycle but increase rapidly after about 15 years of experience. Thus, in contrast to the existing literature on employer learning, we find that imperfect learning might have especially large effects on investments among older workers.
This article discusses identification in continuous triangular systems without restrictions on heterogeneity or functional form. We do not assume separability of structural functions, restrictions on the dimensionality of unobservables, or monotonicity in unobservables. We do maintain monotonicity of the first stage relationship in the instrument and consider the case of real-valued treatment. Under these conditions alone, and given rich enough support of the data, potential outcome distributions, the average structural function, and quantile structural functions are point identified. If the support of the continuous instrument is not large enough, potential outcome distributions are partially identified. If the instrument is discrete, identification fails completely. If treatment is multi-dimensional, additional exclusion restrictions yield identification.The set-up discussed in this article covers important cases not covered by existing approaches such as conditional moment restrictions (cf. Newey and Powell, 2003) and control variables (cf. Imbens and Newey, 2009). It covers, in particular, random coefficient models, as well as systems of structural equations.
We study the effects of fiscal policy interventions in a liquidity trap in a model with nominal rigidities and an interest rate rule. In a liquidity trap caused by a self-fulfilling state of low confidence, higher government spending has deflationary effects that reduce the spending multiplier when the zero lower bound is binding. Instead, cuts in marginal labour tax rates are inflationary and become more expansionary when the zero lower bound is binding. These findings contradict a popular view, based on a liquidity trap caused by a fundamental shock such as a taste shock, that higher government spending is inflationary and can therefore be associated with large multipliers at the zero lower bound, while lower marginal tax rates are deflationary and therefore counterproductive.
We provide a solution to the informed-principal problem in the independent private values setting with monetary transfers. The principal's private information creates signaling considerations that may distort the implemented allocation. We show that there is no distortion: all principal types implement an allocation that is optimal for the principal ex ante, before he/she learns his/her type. As an application, we consider settings with linear utility. For bilateral exchange in which the principal is one of the traders, the solution is a combination of a participation fee, a buy-out option for the principal, and a resale stage with posted prices.
I extend multi-unit auction estimation techniques to a setting in which firms can express cost complementarities over time. In the context of electricity markets, I show how the auction structure and bidding data can be used to estimate these complementarities, which in these markets arise due to startup costs. I find that startup costs are substantial and that taking them into account helps better explain firm bidding strategies and production patterns. As in other dynamic settings, I find that startup costs limit the ability of firms to change production over time, exacerbating fluctuations in market prices. These fluctuations can induce estimates of market power that ignore dynamic costs to overstate markup volatility, with predicted markups that can be even negative in periods of low demand. I show how accounting for startup costs can provide a natural correction for these markup biases.
We build into a Ricardian model sectoral linkages, trade in intermediate goods, and sectoral heterogeneity in production to quantify the trade and welfare effects from tariff changes. We also propose a new method to estimate sectoral trade elasticities consistent with any trade model that delivers a multiplicative gravity equation. We apply our model and use our estimated elasticities to identify the impact of NAFTA's tariff reductions. We find that Mexico's welfare increases by 1.31%, U.S.'s welfare increases by 0.08%, and Canada's welfare declines by 0.06%. We find that intra-bloc trade increases by 118% for Mexico, 11% for Canada, and 41% for the U.S. We show that welfare effects from tariff reductions are reduced when the structure of production does not take into account intermediate goods or input–output linkages. Our results highlight the importance of sectoral heterogeneity, intermediate goods, and sectoral linkages for the quantification of the welfare gains from tariffs reductions.
This paper studies adaptive learning with multiple models. An agent operating in a self-referential environment is aware of potential model misspecification, and tries to detect it, in real-time, using an econometric specification test. If the current model passes the test, it is used to construct an optimal policy. If it fails the test, a new model is selected. As the rate of coefficient updating decreases, one model becomes dominant, and is used “almost always”. Dominant models can be characterized using the tools of large deviations theory. The analysis is used to address two questions posed by Sargent's Phillips Curve model.
We study patterns of foreign direct investment (FDI) in a multi-country world economy. We develop a model featuring non-homothetic preferences for quality and monopolistic competition in which specialization is purely demand-driven and the decision to serve foreign countries via exports or FDI depends on a proximity-concentration trade-off. We characterize the joint patterns of trade and FDI when countries differ in income distribution and size and show that FDI is more likely to occur between countries with similar per capita income levels. The model predicts a Linder Hypothesis for horizontal FDI, which is consistent with some patterns we find using establishment-level data on multinational activity.
An important line of research using laboratory experiments has provided a new potential reason for gender imbalances in labour markets: men are more competitively inclined than women. Whether, and to what extent, gender differences in attitudes toward competition lead to differences in naturally occurring labour markets remains an open question. To examine this, we run a natural field experiment on job-entry decisions where we randomize almost 9000 job-seekers into different compensation regimes. By varying the role that individual competition plays in setting the wage and the gender composition, we examine whether a competitive compensation regime, by itself, can cause differential job entry. The data highlight the power of the compensation regime in that women disproportionately shy away from competitive work settings. Yet, there are important factors that attenuate the gender differences, including whether the job is performed in teams, whether the position has overt gender associations, and the age of the job-seekers. We also find that the effect is most pronounced in labour markets with attractive alternative employment options. Furthermore, our results suggest that preferences over uncertainty can be just as important as preferences over competition per se in driving job-entry choices.
This article studies belief heterogeneity in a benchmark competitive asset market: a market for Arrow–Debreu securities. We show that differences in agents' beliefs lead to a systematic pricing pattern, the favourite–longshot bias (FLB): securities with a low-pay-out probability are overpriced, whereas securities with high probability pay-out are underpriced. We apply demand estimation techniques to betting market data, and find that the observed FLB is explained by a two-type population consisting of canonical traders, who hold virtually correct beliefs and are the majority type in the population (70%); and noise traders exhibiting significant belief dispersion. Furthermore, exploiting variation in public information across markets in our data set, we show that our belief heterogeneity model empirically outperforms existing preference-based explanations of the FLB.
I study a dynamic problem in which a group of agents collaborate over time to complete a project. The project progresses at a rate that depends on the agents' efforts, and it generates a pay-off upon completion. I show that agents work harder the closer the project is to completion, and members of a larger team work harder than members of a smaller team—both individually and on aggregate—if and only if the project is sufficiently far from completion. I apply these results to determine the optimal size of a self-organized partnership, and to study the manager's problem who recruits agents to carry out a project, and must determine the team size and its members' incentive contracts. The main results are: (i) that the optimal symmetric contract compensates the agents only upon completing the project; and (ii) the optimal team size decreases in the expected length of the project.
For many goods and services such as electricity, health care, cellular phone service, debit-card transactions, or those sold with loyalty discounts, the price of the next unit of service depends on past usage. As a result, consumers who are inattentive to their past usage but are aware of contract terms may remain uncertain about the price of the next unit. I develop a model of inattentive consumption, derive equilibrium pricing when consumers are inattentive, and evaluate bill-shock regulation requiring firms to disclose information that substitutes for attention. When inattentive consumers are sophisticated but heterogeneous in their expected demand, bill-shock regulation reduces social welfare in fairly-competitive markets, which may be the effect of the Federal Communication Commission's recent bill-shock agreement. If some consumers are attentive while others naively fail to anticipate their own inattention, however, then bill-shock regulation increases social welfare and can benefit consumers. Hence, requiring zero-balance alerts in addition to the Federal Reserve's new opt-in rule for debit-card overdraft protection may benefit consumers.
This article uses detailed barcode data on purchase transactions by households in 49 U.S. cities to calculate the first theoretically founded urban price index. In doing so, we overcome a large number of problems that have plagued spatial price index measurement. We identify two important sources of bias. Heterogeneity bias arises from comparing different goods in different locations, and variety bias arises from not correcting for the fact that some goods are unavailable in some locations. Eliminating heterogeneity bias causes 97% of the variance in the price level of food products across cities to disappear relative to a conventional index. Eliminating both biases reverses the common finding that prices tend to be higher in larger cities. Instead, we find that price level for food products falls with city size.
We estimate the elasticity of exports to credit using matched customs and firm-level bank credit data from Peru. To account for non-credit determinants of exports, we compare changes in exports of the same product and to the same destination by firms borrowing from banks differentially affected by capital-flow reversals during the 2008 financial crisis. We find that credit shocks affect the intensive margin of exports, but have no significant impact on entry or exit of firms to new product and destination markets. Our results suggest that credit shortages reduce exports through raising the variable cost of production, rather than the cost of financing sunk entry investments.
We study the pricing behaviour of a multiproduct firm, when consumers must pay a search cost to learn its prices. Equilibrium prices are high, because consumers understand that visiting a store exposes them to a hold-up problem. However, a firm with more products charges lower prices, because it attracts consumers who are more price sensitive. Similarly, when a firm advertises a low price on one product, consumers rationally expect it to charge somewhat lower prices on its other products as well. We therefore find that having a large product range, and advertising a low price on one product, are substitute ways of building a “low-price image”. Finally, we show that in a competitive setting each product has a high regular price, with firms occasionally giving random discounts that are positively correlated across products.
We study the evolution of a social norm of “cooperation” in a dynamic environment. Each agent lives for two periods and interacts with agents from the previous and next generations via a coordination game. Social norms emerge as patterns of behaviour that are stable in part due to agents' interpretations of private information about the past, influenced by occasional commonly observed past behaviours. For sufficiently backward-looking societies, history completely drives equilibrium play, leading to a social norm of high or low cooperation. In more forward-looking societies, there is a pattern of “reversion” whereby play starting with high (low) cooperation reverts towards lower (higher) cooperation. The impact of history can be countered by occasional “prominent” agents, whose actions are visible by all future agents and who can leverage their greater visibility to influence expectations of future agents and overturn social norms of low cooperation.
We analyse the causal impact of competition on managerial quality and hospital performance. To address the endogeneity of market structure we analyse the English public hospital sector where entry and exit are controlled by the central government. Because closing hospitals in areas where the governing party is expecting a tight election race (“marginals”) is rare due to the fear of electoral defeat, we can use political marginality as an instrumental variable for the number of hospitals in a geographical area. We find that higher competition results in higher management quality, measured using a new survey tool, and improved hospital performance. Adding a rival hospital increases management quality by 0.4 standard deviations and increases survival rates from emergency heart attacks by 9.7%. We confirm the robustness of our IV strategy to “hidden policies” that could be used in marginal districts to improve hospital management and to changes in capacity that may follow from hospital closure.
We investigate global factors associated with bank capital flows. We formulate a model of the international banking system where global banks interact with local banks. The solution highlights the bank leverage cycle as the determinant of the transmission of financial conditions across borders through banking sector capital flows. A distinctive prediction of the model is that local currency appreciation is associated with higher leverage of the banking sector, thereby providing a conceptual bridge between exchange rates and financial stability. In a panel study of 46 countries, we find support for the key predictions of our model.
Marriage institutions have changed over time, evolving from polygyny to monogamy, and then to serial monogamy (as defined by divorce and remarriage). We propose a unified theory of such institutional changes, where the dynamics of income distribution are the driving force. We characterize the marriage-market equilibrium in each of the three alternative regimes, and determine which one emerges as a political equilibrium, depending on the state of the economy. In a two-class society, a rise in the share of rich males drives the change from polygyny to monogamy. The introduction of serial monogamy follows from a further rise in the proportion of either rich females or rich males. Monogamy eases the transition to serial monogamy, since it promotes social mobility.
We conduct a series of laboratory experiments to understand what role commitment and reputation play in bargaining. The experiments implement the Abreu and Gul (2000) bargaining model that demonstrates how introducing behavioral types, which are obstinate in their demands, creates incentives for all players to build reputations for being hard bargainers. The data are qualitatively consistent with the theory, as subjects mimic induced types. Furthermore, we find evidence for the presence of complementary types, whose initial demands acquiesce to induced behavioural demands. However, there are quantitative deviations from the theory: subjects make aggressive demands too often and participate in longer conflicts before reaching agreements. Overall, the results suggest that the Abreu and Gul (2000) model can be used to gain insights to bargaining behavior, particularly in environments where the process underlying obstinate play is well established.
We study contractual arrangements that support an efficient use of time in a knowledge-intensive economy in which agents endogenously specialize in either production or consulting. The resulting market for advice is plagued by informational problems, since both the difficulty of the questions posed to consultants and the knowledge of those consultants are hard to assess. We show that spot contracting is not efficient because lemons (in this case, self-employed producers with intermediate knowledge) cannot be appropriately excluded from the market. However, an ex ante, firm-like contractual arrangement uniquely delivers the first best. This arrangement involves hierarchies in which consultants are full residual claimants of output and compensate producers via incentive contracts. This simple characterization of the optimal ex ante arrangement suggests a rationale for the organization of firms and the structure of compensation in knowledge-intensive sectors. Our findings correspond empirically to observed arrangements inside professional service firms and between venture capitalists and entrepreneurs.
Using administrative panel data on the entire Danish population we document a new set of facts characterizing occupational mobility. For most occupations, mobility is U-shaped and directional: not only low but also high wage earners within an occupation have a particularly large probability of leaving their occupation, and the low (high) earners tend to switch to new occupations with lower (higher) average wages. Exceptions to this pattern of two-sided selection are occupations with steeply rising (declining) productivity, where mainly the lower (higher) paid workers within this occupation tend to leave. The facts conflict with several existing theories that are used to account for endogeneity in occupational choice, but it is shown analytically that the patterns are explained consistently within a theory of vertical sorting under absolute advantage that includes learning about workers' abilities.
We propose a new methodology for measuring intergenerational mobility in economic well-being. Our method is based on the joint distribution of surnames and economic outcomes. It circumvents the need for intergenerational panel data, a long-standing stumbling block for understanding mobility. It does so by using cross-sectional data alongside a calibrated structural model to recover the traditional intergenerational elasticity measures. Our main idea is simple. If “inheritance” is important for economic outcomes, then rare surnames should predict economic outcomes in the cross-section. This is because rare surnames are indicative of familial linkages. If the number of rare surnames is small this approach will not work. However, rare surnames are abundant in the highly skewed nature of surname distributions from most Western societies. We develop a model that articulates this idea and shows that the more important is inheritance, the more informative will be surnames. This result is robust to a variety of different assumptions about fertility and mating. We apply our method using the 2001 census from Catalonia, a large region of Spain. We use educational attainment as a proxy for overall economic well-being. A calibration exercise results in an estimate of the intergenerational correlation of educational attainment of 0.60. We also find evidence suggesting that mobility has decreased among the different generations of the 20th century. A complementary analysis based on sibling correlations confirms our results and provides a robustness check on our method. Our model and our data allow us to examine one possible explanation for the observed decrease in mobility. We find that the degree of assortative mating has increased over time. Overall, we argue that our method has promise because it can tap the vast mines of census data that are available in a heretofore unexploited manner.
We introduce ex post participation constraints in the standard sequential screening model. This captures the presence of consumer withdrawal rights as, for instance, mandated by European Union regulation of “distance sales contracts”. With such additional constraints, the optimal contract is static and, unlike with only ex ante participation constraints, does not elicit the agent's information sequentially. This holds whenever differences in ex ante and ex post outside options are below a positive upper bound. Welfare effects of mandatory withdrawal rights are ambiguous. Since it is insufficient in our setting to consider only local incentive constraints, we develop a novel technique to identify the relevant global constraints.
This article studies the determinants of college major choice using an experimentally generated panel of beliefs, obtained by providing students with information on the true population distribution of various major-specific characteristics. Students logically revise their beliefs in response to the information, and their subjective beliefs about future major choice are associated with beliefs about their own earnings and ability. We estimate a rich model of college major choice using the panel of beliefs data. While expected earnings and perceived ability are a significant determinant of major choice, heterogeneous tastes are the dominant factor in the choice of major. Analyses that ignore the correlation in tastes with earnings expectations inflate the role of earnings in college major choices. We conclude by computing the welfare gains from the information experiment and find positive average welfare gains.
Committee voting has mostly been investigated from the perspective of the standard Baron–Ferejohn model of bargaining over the division of a pie, in which bargaining ends as soon as the committee reaches an agreement. In standing committees, however, existing agreements can be amended. This article studies an extension of the Baron–Ferejohn framework to a model with an evolving default that reflects this important feature of policymaking in standing committees: In each of an infinite number of periods, the ongoing default can be amended to a new policy (which is, in turn, the default for the next period). The model provides a number of quite different predictions. (i) From a positive perspective, the key distinction turns on whether the quota is less than unanimity. In that case, patient enough players waste substantial shares of the pie each period and the size principle fails in some pure strategy Markov perfect equilibria. In contrast, the unique Markov perfect equilibrium payoffs in a unanimity committee coincide with those in the corresponding Baron–Ferejohn framework. (ii) If players have heterogeneous discount factors then a large class of subgame perfect equilibria (including all Markov perfect equilibria) are inefficient.
I study a general class of noisy rational expectations models that nests the standard Grossman and Stiglitz (1980) and Hellwig (1980) models, but relaxes the usual assumption of joint normality of asset pay-offs and supply, and allows for more general signal structures. I provide a constructive proof of existence of equilibrium, characterize the price function, and provide sufficient conditions for uniqueness within the class of equilibria with continuous price functions, which are met by both the Grossman and Stiglitz (1980) models and the Hellwig (1980) models with a continuum of investors. My solution approach does not rely on the typical “conjecture and verify” method, and I exhibit a number of non-normal examples in which asset prices can be characterized explicitly and in a closed form. The results presented here open up a broad class of models for applied work. To illustrate the usefulness of generalizing the standard model, I show that in settings with non-normally distributed pay-offs, shocks to fundamentals may be amplified purely due to learning effects, price drifts can arise naturally, and the disagreement–return relation depends in a novel way on return skewness.
Maximum-likelihood estimation of nonlinear models with fixed effects is subject to the incidental-parameter problem. This typically implies that point estimates suffer from large bias and confidence intervals have poor coverage. This article presents a jackknife method to reduce this bias and to obtain confidence intervals that are correctly centred under rectangular-array asymptotics. The method is explicitly designed to handle dynamics in the data, and yields estimators that are straightforward to implement and can be readily applied to a range of models and estimands. We provide distribution theory for estimators of model parameters and average effects, present validity tests for the jackknife, and consider extensions to higher-order bias correction and to two-step estimation problems. An empirical illustration relating to female labour-force participation is also provided.
We argue that one major cause of the U.S. post-war baby boom was the rise in female labour supply during World War II. We develop a quantitative dynamic general equilibrium model with endogenous fertility and female labour force participation decisions. We use the model to assess the impact of the war on female labour supply and fertility in the decades following the war. For the war generation of women, the high demand for female labour brought about by mobilization leads to an increase in labour supply that persists after the war. As a result, younger women who reach adulthood in the 1950s face increased labour market competition, which impels them to exit the labour market and start having children earlier. The effect is amplified by the rise in taxes necessary to pay down wartime government debt. In our calibrated model, the war generates a substantial baby boom followed by a baby bust.
This article analyses the identification and empirical content of the pure moral hazard (PMH) and the hybrid moral hazard (HMH) principal–agent models. The PMH model has hidden actions, while the HMH model has hidden information in addition to hidden actions. In both models, agents are risk averse and principals are risk neutral. The article derives the equilibrium restrictions from the optimal contract and uses the restrictions to show that the models have empirical content. For any given risk-aversion parameter, the models' other parameters are non-parametrically point identified. The risk-aversion parameter—and hence the model—are, however, only partially identified. Management's ability to manipulate accounting reports arises endogenously within HMH models, but not in all versions of PMH models. We use our framework to investigate whether shareholders contract with management recognizing that accounting reports are susceptible to manipulation and, therefore, endogenous to the incentives offered to management. The data reject all models in which accounting reports are verifiable. Furthermore, the version of the PMH in which accounting reports can be manipulated is rejected if expected compensation is restricted to be positive.
By the 1970s, quid pro quo policy, which requires multinational firms to transfer technology in return for market access, had become a common practice in many developing countries. While many countries have subsequently liberalized quid pro quo requirements, China continues to follow the policy. In this article, we incorporate quid pro quo policy into a multicountry dynamic general equilibrium model, using microevidence from Chinese patents to motivate key assumptions about the terms of the technology transfer deals and macroevidence on China's inward foreign direct investment (FDI) to estimate key model parameters. We then use the model to quantify the impact of China's quid pro quo policy and show that it has had a significant impact on global innovation and welfare.
Episodes of large capital inflows in small open economies are often associated with a shift of resources from the tradable to the non-tradable sector and sometimes lead to balance-of-payments crises. This article builds a two-sector dynamic model to study the evolution of the sectoral structure and its impact on financial fragility. The model embeds a static mechanism of balance-of-payments crisis which produces multiple equilibria within a single time period when the non-tradable sector is large enough compared to the tradable sector. The article studies the dynamics induced by an increase in financial openness. It shows that the relative size of the non-tradable sector overshoots, which makes the economy more likely to be financially fragile during the transitory dynamics. Using an extended version of the model, the article conducts a quantitative analysis and shows that this mechanism accounts well for several episodes of large capital inflows that led to financial crises.
Many countries use college-major-specific admissions policies that require a student to choose a college-major pair jointly. Given the potential of student-major mismatches, we explore the equilibrium effects of postponing student choice of major. We develop a sorting equilibrium model under the college-major-specific admissions regime, allowing for match uncertainty and peer effects. We estimate the model using Chilean data. We introduce the counterfactual regime as a Stackelberg game in which a social planner chooses college-specific admissions policies and students make enrolment decisions, learn about their fits to various majors before choosing one. Our estimates indicate that switching from the baseline to the counterfactual regime leads to a 1% increase in average student welfare and that it is more likely to benefit female, low-income and/or low-ability students.
We conducted an experiment with 182 inmates from a maximum security prison to analyze the impact of criminal identity salience on cheating. The results show that inmates cheat more when we exogenously render their criminal identity more salient. This effect is specific to individuals who have a criminal identity, because an additional placebo experiment shows that regular citizens do not become more dishonest in response to crime-related reminders. Moreover, our experimental measure of cheating correlates with inmates' offences against in-prison regulation. Together, these findings suggest that criminal identity salience plays a crucial role in rule violating behaviour.
Despite the popularity of prediction, markets among economists, businesses, and policymakers have been slow to adopt them in decision-making. Most studies of prediction markets outside the lab are from public markets with large trading populations. Corporate prediction markets face additional issues, such as thinness, weak incentives, limited entry, and the potential for traders with biases or ulterior motives—raising questions about how well these markets will perform. We examine data from prediction markets run by Google, Ford Motor Company, and an anonymous basic materials conglomerate (Firm X). Despite theoretically adverse conditions, we find these markets are relatively efficient, and improve upon the forecasts of experts at all three firms by as much as a 25% reduction in mean-squared error. The most notable inefficiency is an optimism bias in the markets at Google. The inefficiencies that do exist generally become smaller over time. More experienced traders and those with higher past performance trade against the identified inefficiencies, suggesting that the markets' efficiency improves because traders gain experience and less skilled traders exit the market.
This note shows how to apply the procedure of  Kim et al . (1998)  to the estimation of VAR, DSGE, factor, and unobserved components models with stochastic volatility. In particular, it revisits the estimation algorithm of the time-varying VAR model of Primiceri (2005) . The main difference of the new algorithm is the ordering of the various MCMC steps, with each individual step remaining the same.
We study the relationship between the political connections of Chinese firms and workplace fatalities. In our preferred specification, we find that the worker death rate for connected companies is two to three times that of unconnected firms (depending on the sample employed), a pattern that holds for within-firm estimations. The connections–mortality relationship is attenuated in provinces where safety regulators' promotion is contingent on meeting safety targets. In the absence of fatalities, connected firms receive fewer reports of major violations for safety compliance, whereas in years of fatal accidents the rate of reported violations is identical. Moreover, fatal accidents produce negative returns at connected companies and are associated with the subsequent departure of well-connected executives. These results provide suggestive evidence that connections enable firms to avoid (potentially costly) compliance measures, rather than using connections to avoid regulatory response after accidents occur. Our findings emphasize the social costs of political connections, and suggest that appropriate regulatory incentives may be useful in mitigating these costs.
We study the effects of securitization on interbank lending competition. An applicant's observable features are seen by a remote bank, while her true credit quality is known only to a local bank. Without securitization, the remote bank does not compete because of a winner's curse. With securitization, in contrast, ignorance is bliss: the less a bank knows about its loans, the less of a lemons problem it faces in selling them. This enables the remote bank to compete successfully in the lending market. Consistent with the empirical evidence, remote and securitized loans default more than observationally equivalent local and unsecuritized loans, respectively.
Powerful, centralized states controlling a large share of national income only begin to appear in Europe after 1500. We build a model that explains their emergence in response to the increasing importance of money for military success. When fiscal resources are not crucial for winning wars, the threat of external conflict stifles state-building. As finance becomes critical, internally cohesive states invest in state capacity while divided states rationally drop out of the competition, causing divergence. We emphasize the role of the “Military Revolution”, a sequence of technological innovations that transformed armed conflict. Using data from 374 battles, we investigate empirically both the importance of money for military success and patterns of state-building in early modern Europe. The evidence is consistent with the predictions of our model.
We examine the asset pricing implications of a neoclassical model of repeated investment and disinvestment. Prior research has emphasized a negative relation between productivity and equity risk that results from operating leverage when capital adjustment is costly. In general, however, expansion and contraction options affect risk in the opposite direction: they lower equity risk as profitability declines. The general prediction is a non-monotonic overlay of opposing real option and operating leverage effects. For parameters chosen to match empirical firm characteristics, the predicted non-monotonicities are quantitatively important, and are detectable in the data. The calibrated model implies that real option effects dominate operating leverage effects, and the average firm is best described by an increasing risk profile, a conclusion supported by conditional beta estimates. The baseline calibration helps explain the profitability premium in the cross-section, but makes the value puzzle worse. Panels with heterogeneous firms can deliver simultaneous profitability and value effects that match empirical levels.
This article applies mechanism design to the study of international conflict resolution. Standard mechanisms in which an arbitrator can enforce her decisions are usually not feasible because disputants are sovereign entities. Nevertheless, we find that this limitation is inconsequential. Despite only being capable of making unenforceable recommendations, mediators can be equally effective as arbitrators. By using recommendation strategies that do not reveal that one player is weak to a strong opponent, a mediator can effectively circumvent the unenforceability constraint. This is because these strategies make the strong player agree to recommendations that yield the same payoff as arbitration in expectation. This result relies on the capability of mediators to collect confidential information from the disputants, before making their recommendations. Simple protocols of unmediated communication cannot achieve the same level of ex ante welfare, as they preclude confidentiality.
We develop a dynamic stochastic general equilibrium (DSGE) model with rational inattention and compare its predictions to data. Households and decision-makers in firms have limited attention and optimally allocate their attention. Rational inattention is the only source of slow adjustment. The model matches the empirical impulse responses to monetary policy shocks and aggregate technology shocks. At the same time, profit losses and utility losses from inattention are very small. Furthermore, it matters whether one uses this model or a conventional DSGE model for policy analysis.
This article analyses costly information acquisition in asset markets with Knightian uncertainty about the asset fundamentals. In these markets, acquiring information not only reduces the expected variability of the fundamentals for a given distribution ( i.e . risk). It also mitigates the uncertainty about the true distribution of the fundamentals. Agents who lack knowledge of this distribution cannot correctly interpret the information other investors impound into the price. We show that, due to uncertainty aversion, the incentives to reduce uncertainty by acquiring information increase as more investors acquire information. When uncertainty is high enough, information acquisition decisions become strategic complements and lead to multiple equilibria. Swift changes in information demand can drive large price swings even after small changes in Knightian uncertainty.
This article studies the causes of China's Great Famine, during which 16.5 to 45 million individuals perished in rural areas. We document that average rural food retention during the famine was too high to generate a severe famine without rural inequality in food availability; that there was significant variance in famine mortality rates across rural regions; and that rural mortality rates were positively correlated with per capita food production, a surprising pattern that is unique to the famine years. We provide evidence that an inflexible and progressive government procurement policy (where procurement could not adjust to contemporaneous production and larger shares of expected production were procured from more productive regions) was necessary for generating this pattern and that this policy was a quantitatively important contributor to overall famine mortality.
I study the positive relationship between prices of tradable goods and per capita income. I develop a highly tractable general equilibrium model of international trade with heterogeneous firms and non-homothetic consumer preferences that positively links prices of tradables to consumer income. Guided by the model's testable prediction, I estimate the elasticity of price with respect to per capita income from a unique data set that I construct, which features prices of 245 identical goods sold in 29 European, Asian, and North American markets via the Internet by Spain's second largest apparel manufacturer—Mango. I find that doubling a destination's per capita income results in an 18% increase in the price of identical items sold there. Per capita income differences account for a third, whereas shipping cost differences can explain up to a third of the cross-country price variations of identical items purchased via the Internet by consumers who do not take advantage of quantity discounts. The price elasticity estimates compare favourably to estimates that I obtain from a standard data set that features prices across retail locations around the world, suggesting that variable mark-ups play a key role in accounting for observed cross-country differences in prices of tradables.
We study sales techniques which discourage consumer search by making it harder or more expensive to return to buy after a search for alternatives. It is unilaterally profitable for a seller to deter search under mild conditions, but sellers can suffer when all do so. When a seller cannot commit to its policy, it exploits the inference that those consumers who try to buy later have no good alternative, and in many cases the outcome is as if the seller must make an exploding offer. Search deterrence results in sub-optimal matching of products to consumers and often raises the price consumers pay.
This article theoretically and empirically analyses behaviour in penny auctions, a relatively new auction mechanism. As in the US dollars or war-of-attrition, players in penny auctions commit higher non-refundable costs as the auction continues and only win if all other players stop bidding. I first show that, in any equilibria that does not end immediately, players bid probabilistically such that the expected profit from every bid is zero. Then, using two large data sets covering 166,000 auctions, I calculate that average profit margins actually exceed 50%. To explain this deviation, I incorporate a sunk-cost fallacy into the theoretical model to generate a set of predictions about hazard rates and player behaviour, which I confirm empirically. While players do (slowly) learn to correct this bias and there are few obvious barriers to competition, activity in the market is rising and concentration remains relatively high.
We examine the impact of Chinese import competition on broad measures of technical change—patenting, IT, and TFP—using new panel data across twelve European countries from 1996 to 2007. In particular, we establish that the absolute volume of innovation increases within the firms most affected by Chinese imports in their output markets. We correct for endogeneity using the removal of product-specific quotas following China's entry into the World Trade Organization in 2001. Chinese import competition led to increased technical change within firms and reallocated employment between firms towards more technologically advanced firms. These within and between effects were about equal in magnitude, and account for 14% of European technology upgrading over 2000–7 (and even more when we allow for offshoring to China). Rising Chinese import competition also led to falls in employment and the share of unskilled workers. In contrast to low-wage nations like China, developed countries had no significant effect on innovation.
We use probabilistic expectations data elicited from survey respondents in rural Malawi to investigate how risky sexual behaviour may be influenced by individuals' expectations about survival, and future HIV status, which in turn depend on the perceived impact of HIV/AIDS on survival, expectations about own and partner's current HIV status, and expectations about HIV transmission rates. Subjective expectations, in particular about mortality risk but not the risk of living with HIV, play an important role in determining the decision to have multiple sexual partners. Using our estimated parameters, we simulate the impact of various policies that would influence expectations. An information campaign on mortality risk would decrease risky sexual behaviour on average, whereas an information campaign on HIV transmission risks, which tend to be overestimated by respondents, would actually increase risky behaviour. Also, the expansion of anti-retroviral therapy (ART) treatments to all individuals infected with HIV would increase risky sexual behaviour for a quarter of the HIV-negative individuals or those who have not been tested because they are aware that ART increases life expectancy, and thus reduces the cost of becoming HIV positive.
The increase in the information that firms can collect or purchase about network effects across consumers motivates two important questions: how does a firm's pricing strategy react to detailed information on network effects? Are the availability and use of such information beneficial or detrimental to consumer surplus? We develop a model in which a monopoly sells a network good and price discriminates based on information about consumers' influence and consumers' susceptibility to influence. The monopoly optimally offers consumers price discounts for their influence and charges price premia for their susceptibility; the price premia and the price discounts are simple functions of the pattern of network effects. We determine under which conditions, relative to uniform price, consumer surplus increases, and we characterize the value of information on network effects for the monopoly.
This article studies optimal patents with respect to the timing of innovation disclosure. In a simple model, we identify forces that lead firms to either suboptimally patent too early or too late in equilibrium, and we determine conditions so that stronger patents induce earlier or later equilibrium disclosure. Then, by solving an infinite multistage patent game with a more explicit structure, we describe innovation growth, and derive detailed predictions that can be used for policy experiments. As an application, we calibrate our multistage game using summary statistics from the seeds breeding industry. We find that weaker patent rights may result in welfare gains of 46% relative to the status quo. The gains are achieved because weaker patents reduce competition, thus leading firms to postpone patenting.
This article measures the economic impacts of social pressure to share income with kin and neighbours in rural Kenyan villages. We conduct a lab experiment in which we randomly vary the observability of investment returns to test whether subjects reduce their income in order to keep it hidden. We find that women adopt an investment strategy that conceals the size of their initial endowment in the experiment, though that strategy reduces their expected earnings. This effect is largest among women with relatives attending the experiment. Parameter estimates suggest that women anticipate that observable income will be “taxed” at a rate above 4%; this effective tax rate nearly doubles when kin can observe income directly. At the village level, we find an association between the willingness to forgo expected return to keep income hidden in the laboratory experiment and worse economic outcomes outside the laboratory.
In this article, I quantify the extent to which lobbying expenditures by firms affect policy enactment. To achieve this end, I construct a novel dataset containing all federal energy legislation and lobbying activities by the energy sector during the 110th Congress. I then develop and estimate a game-theoretic model where heterogeneous players choose lobbying expenditures to affect the probability that a policy is enacted. I find that the effect of lobbying expenditures on a policy's equilibrium enactment probability to be statistically significant but very small. Nonetheless, the average returns from lobbying expenditures are estimated to be over 130%.
We develop an asymptotic theory for static discrete-action games with a large number of players, and propose a novel inference approach based on stochastic expansions around the limit of the finite-player game. Our analysis focuses on anonymous games in which payoffs are a function of the agent's own action and the empirical distribution of her opponents' play. We establish a law of large numbers and central limit theorem which can be used to establish consistency of point or set estimators and asymptotic validity for inference on structural parameters as the number of players increases. The proposed methods as well as the limit theory are conditional on the realized equilibrium in the observed sample and therefore do not require any assumptions regarding selection among multiple equilibria.
This article studies a market game under uncertainty in which agents may submit multiple limit and market orders. When agents know their preferences at all states, the competitive equilibrium can be supported as a Nash equilibrium of the market game, that is, agents behave as if they were price takers. Therefore, if the associated competitive economy has a fully revealing rational expectations equilibrium, then so does the market game. This resolves the puzzle that agents behave as if prices were given, even though prices aggregate private information, at least for this “private values” case. Necessary conditions for Nash equilibrium show that the resulting allocation cannot deviate too far from a competitive equilibrium. When agents do not know their preferences at some states, though, a characterization result shows that the Nash equilibria of the market game tend to be far from competitive.
Using micro-data from 48 developing countries, this article studies changes in cross-sectional patterns of fertility and child investment over the demographic transition. Before 1960, children from larger families obtained more education, in large part because they had richer and more educated parents. By century's end, these patterns had reversed. Consequently, fertility differentials by income and education historically raised the average education of the next generation, but they now reduce it. Relative to the level of average education, the positive effect of differential fertility in the past exceeded its negative effect in the present. While the reversal of differential fertility is unrelated to changes in GDP per capita, women's work, sectoral composition, or health, roughly half is attributable to rising aggregate education in the parents' generation. The data are consistent with a model in which fertility has a hump-shaped relationship with parental skill, due to a corner solution in which low-skill parents forgo investment in their children. As the returns to child investment rise, the peak of the relationship shifts to the left, reversing the associations under study.
This article studies an economy with both centralized and decentralized monetary exchanges under search frictions. A degenerate asset distribution is featured under a broad class of preferences including, for example, constant return to scale, constant elasticity of substitution, CARA and others from a range of macroeconomic literatures. Some novel applications impossible under quasi-linear preferences, for example endogenous growth, are illustrated under this class of preferences. This article finds that the welfare cost and growth loss of inflation can be much higher in these applications than previous estimates.
We study models where prices respond slowly to shocks because firms are rationally inattentive. Producers must pay a cost to observe the determinants of the current profit maximizing price, and hence observe them infrequently. To generate large real effects of monetary shocks in such a model the time between observations must be long and/or highly volatile. Previous work on rational inattentiveness has allowed for observation intervals that are either constant-but-long ( e.g . Caballero, 1989 or Reis, 2006 ) or volatile-but-short ( e.g . Reis's, 2006 example where observation costs are negligible), but not both. In these models, the real effects of monetary policy are small for realistic values of the duration between observations. We show that non-negligible observation costs produce both of these effects: intervals between observations are infrequent and volatile. This generates large real effects of monetary policy for realistic values of the average time between observations.
In this article, we examine the effect of “choice fatigue” on decision making. We exploit a natural experiment in which voters face the same contest at different ballot positions due to differences in the number of local issues on their ballot. Facing more decisions before a given contest significantly increases the tendency to abstain or rely on decision shortcuts, such as voting for the status quo or the first-listed candidate. We estimate that, without choice fatigue, abstentions would decrease by 8%, and 6% of the propositions in our data set would have passed rather than failed.
We present a model of market competition in which consumers' attention is drawn to the products' most salient attributes. Firms compete for consumer attention via their choices of quality and price. Strategic positioning of a product affects how all other products are perceived. With this attention externality, depending on the cost of producing quality some markets exhibit “commoditized” price salient equilibria, while others exhibit “de-commoditized” quality salient equilibria. When the costs of quality change, innovation can lead to radical shifts in markets, as in the case of decommoditization of the coffee market by Starbucks. In the context of financial innovation, the model generates the phenomenon of “reaching for yield”.
This article derives novel testable implications of referral-based job search networks in which employees provide employers with information about potential new hires that they otherwise would not have. Using comprehensive matched employer–employee data covering the entire workforce in one large metropolitan labour market combined with unique survey data linked to administrative records, we provide evidence that workers earn higher wages and are less inclined to leave their firms if they have obtained their job through a referral. These effects are particularly strong at the beginning of the employment relationship and decline with tenure in the firm, suggesting that firms and workers learn about workers' productivity over time. Overall, our findings imply that job search networks help to reduce informational deficiencies in the labour market and lead to productivity gains for workers and firms.
Decisions involving charitable giving often occur under the shadow of risk. A common finding is that potential donors give less when there is greater risk that their donation will have less impact. While this behaviour could be fully rationalized by standard economic models, this article shows that an additional mechanism is relevant: the use of risk as an excuse not to give. In a laboratory study, participants evaluate risky payoffs for themselves and risky payoffs for a charity. When their decisions do not involve tradeoffs between money for themselves and the charity, they respond very similarly to self risk and charity risk. By contrast, when their decisions force tradeoffs between money for themselves and the charity, participants act more averse to charity risk and less averse to self risk. These altered responses to risk bias participants towards choosing payoffs for themselves more often, consistent with excuse-driven responses to risk. Additional results support the existence of excuse-driven types.
This article presents a dynamic general equilibrium model to investigate how different contracting modes based on formal and relational enforcements emerge endogenously and are linked dynamically with the process of economic development. Formal contracts are enforced by third-party institutions (courts), whereas relational contracts are self-enforcing agreements without third-party involvement. The novel feature of our model is that it demonstrates the co-evolution of these different enforcement modes and market equilibrium conditions, all of which are jointly determined. We then characterize the equilibrium paths of such dynamic processes and show the time structure of relational contracting in the process of development. In particular, we show that relational contracting fosters the emergence of a market-based economy in the growth phase of development; however, its role declines as the economy enters a mature phase.
We define a class of dynamic Markovian games, directional dynamic games (DDG), where directionality is represented by a strategy-independent partial order on the state space. We show that many games are DDGs, yet none of the existing algorithms are guaranteed to find any Markov perfect equilibrium (MPE) of these games, much less all of them. We propose a fast and robust generalization of backward induction we call state recursion that operates on a decomposition of the overall DDG into a finite number of more tractable stage games , which can be solved recursively. We provide conditions under which state recursion finds at least one MPE of the overall DDG and introduce a recursive lexicographic search (RLS) algorithm that systematically and efficiently uses state recursion to find all MPE of the overall game in a finite number of steps. We apply RLS to find all MPE of a dynamic model of Bertrand price competition with cost-reducing investments which we show is a DDG. We provide an exact non-iterative algorithm that finds all MPE of every stage game, and prove there can be only 1, 3, or 5 of them. Using the stage games as building blocks, RLS rapidly finds and enumerates all MPE of the overall game. RLS finds a unique MPE for an alternating move version of the leapfrogging game when technology improves with probability 1, but in other cases, and in any simultaneous move version of the game, it finds a huge multiplicity of MPE that explode exponentially as the number of possible cost states increases.
Should policy makers be prevented from bailing out investors in the event of a crisis? I study this question in a model of financial intermediation with limited commitment. When a crisis occurs, the policy maker will respond with fiscal transfers that partially cover intermediaries' losses. The anticipation of this bailout distorts ex ante incentives, leading intermediaries to become excessively illiquid and increasing financial fragility. Prohibiting bailouts is not necessarily desirable, however: while it induces intermediaries to become more liquid, it may nevertheless lower welfare and leave the economy more susceptible to a crisis. A policy of taxing short-term liabilities, in contrast, can both improve the allocation of resources and promote financial stability.
Coordination problems resembling weakest-link games with multiple Pareto ranked equilibria are ubiquitous in the economy and society. This makes it important to understand if and when agents are able to coordinate efficiently. Existing research on weakest-link games shows an overwhelming inability of people to coordinate on efficient equilibria, especially in larger groups. We show experimentally that freedom of neighbourhood choice overcomes the problem and leads to fully efficient coordination. This implies substantial welfare effects with achieved welfare being about 50% higher in games with neighbourhood choice than without it. We identify exclusion of low effort providers who in response start providing high effort as the simple but effective mechanism enforcing efficient coordination. A variety of other treatments show that the efficiency result as well as the identified mechanism are robust to changes in the information condition, payoff specification, and a substantial increase in group size. Moreover, we find that neighbourhood choice boosts efficiency even when exclusion does not materially affect the excluded agent. Our results are widely applicable on the societal and organizational level, e.g . containment of diseases, fight against terrorism, and co-authorship networks.
We link daily air pollution exposure to measures of contemporaneous health for communities surrounding the twelve largest airports in California. These airports are some of the largest sources of air pollution in the US, and they experience large changes in daily air pollution emissions depending on the amount of time planes spend idling on the tarmac. Excess airplane idling, measured as residual daily taxi time, is due to network delays originating in the Eastern US. This idiosyncratic variation in daily airplane taxi time significantly impacts the health of local residents, largely driven by increased levels of carbon monoxide (CO) exposure. We use this variation in daily airport congestion to estimate the population dose-response of health outcomes to daily CO exposure, examining hospitalization rates for asthma, respiratory, and heart-related emergency room admissions. A one standard deviation increase in daily pollution levels leads to an additional $540 thousand in hospitalization costs for respiratory and heart-related admissions for the 6 million individuals living within 10 km (6.2 miles) of the airports in California. These health effects occur at levels of CO exposure far below existing Environmental Protection Agency mandates, and our results suggest there may be sizable morbidity benefits from lowering the existing CO standard.
Online markets for remote labour services allow workers and firms to contract with each other directly. Despite this, intermediaries—called outsourcing agencies—have emerged in these markets. This article shows that agencies signal to employers that inexperienced workers are high quality. Workers affiliated with an agency have substantially higher job-finding probabilities and wages at the beginning of their careers compared to similar workers without an agency affiliation. This advantage declines after high-quality non-affiliated workers receive good public feedback scores. The results indicate that intermediaries have arisen endogenously to permit a more efficient allocation of workers to jobs.
A number of theories in organizational economics and industrial organization suggest that vertical integration, while costly, increases productivity. It follows from firms' maximizing behaviour that higher prices in the product market ought to induce more integration. Trade policy provides a source of exogenous price variation to assess this prediction: higher tariffs should lead to higher prices and, therefore, to more integration. We construct firm-level vertical integration indices for a large set of countries and industries and exploit variation in applied most-favoured-nation tariffs to examine the impact of tariffs on firm boundaries. The empirical results provide strong support for the view that higher output prices generate more vertical integration. Our estimates of the average price elasticity of vertical integration are in the range 0.4–2.
This article develops a dynamic model of retail competition and uses it to study the impact of the expansion of a new national competitor on the structure of urban markets. In order to accommodate substantial heterogeneity (both observed and unobserved) across agents and markets, the article first develops a general framework for estimating and solving dynamic discrete choice models in continuous time that is computationally light and readily applicable to dynamic games. In the proposed framework, players face a standard dynamic discrete choice problem at decision times that occur stochastically. The resulting stochastic-sequential structure naturally admits the use of conditional choice probability methods for estimation and makes it possible to compute counterfactual simulations for relatively high-dimensional games. The model and method are applied to the retail grocery industry, into which Walmart began rapidly expanding in the early 1990s, eventually attaining a dominant position. We find that Walmart's expansion into groceries came mostly at the expense of the large incumbent supermarket chains, rather than the single-store outlets that bore the brunt of its earlier conquest of the broader general merchandise sector. Instead, we find that independent grocers actually thrive when Walmart enters, leading to an overall reduction in market concentration. These competitive effects are strongest in larger markets and those into which Walmart expanded most rapidly, suggesting a diminishing role of scale and a greater emphasis on differentiation in this previously mature industry.
Voters commonly face a choice between competent candidates and those with policy preferences similar to their own. This article explores how electoral rules, such as district magnitude, mediate this trade-off and affect the composition of representative bodies and the quality of policy outcomes. We show formally that anticipation of bargaining over policy causes voters in elections with multiple single-member districts to prefer candidates with polarized policy positions over more competent candidates. Results from a unique field experiment in Afghanistan are consistent with these predictions. Specifically, representatives selected by elections with a single multi-member district are better educated and exhibit less extreme policy preferences.
We study trading dynamics in an asset market where the quality of assets is private information and finding a counterparty takes time. When trading ceases in equilibrium as a response to an adverse shock to asset quality, a government can resurrect trading by buying up lemons which involves a financial loss. The optimal policy is centred around an announcement effect where trading starts already before the intervention for two reasons. First, delaying the intervention allows selling pressure to build up thereby improving the average quality of assets for sale. Secondly, intervening at a higher price increases the return from buying an asset of unknown quality. It is optimal to intervene immediately at the lowest price when the market is sufficiently important. For less important markets, when the shock to quality and search frictions are small, it is optimal to rely on the announcement effect. Here delaying the intervention and fostering the effect by intervening at the highest price tend to be complements.
We build a heterogeneous agents life cycle model that captures a large number of salient features of individual male labour supply over the life cycle, by education, both along the intensive and extensive margins. The model provides an aggregation theory of individual labour supply, firmly grounded on individual-level micro-evidence, and is used to study the aggregate labour supply responses to changes in the economic environment. We find that the aggregate labour supply elasticity to a transitory wage shock is 1.75, with the extensive margin accounting for 62% of the response. Furthermore, we find that the aggregate labour supply elasticity to a permanent-compensated wage change is 0.44.
This paper studies a model of long-term contracting for experimentation. We consider a principal–agent relationship with adverse selection on the agent’s ability, dynamic moral hazard, and private learning about project quality. We find that each of these elements plays an essential role in structuring dynamic incentives, and it is only their interaction that generally precludes efficiency. Our model permits an explicit characterization of optimal contracts.
We study how the marginal welfare gain from increasing the unemployment insurance (UI) benefit level varies over the business cycle. We do this by estimating how the moral hazard cost and the consumption smoothing benefit of UI vary with labour market conditions, which we identify using variation in the interaction of UI benefit levels with the unemployment rate within U.S. states over time. We find that the moral hazard cost is procyclical, greater when the unemployment rate is relatively low. By contrast, we do not find evidence that the consumption smoothing benefit varies with the unemployment rate. We use these empirical results to estimate the marginal welfare gain, and we find that it is modest on average, but varies positively with the unemployment rate.
Prices tend to remain constant for a period of time and then jump. In the
                    literature, this “rigidity” is usually interpreted to reflect a cost of
                    adjusting prices. This article shows that price rigidity can alternatively
                    reflect optimal price setting when there are no adjustment costs, namely, if the
                    seller is rationally inattentive. The model generates non-trivial pricing
                    patterns that are consistent with the data and that are hard to explain with the
                    traditional adjustment-cost model. In particular, prices are adjusted frequently
                    but move back and forth between a few given values, hazard functions are
                    downward sloping, and responses to persistent shocks are sluggish. These results
                    are obtained in a model that implements rational inattention without simplifying
                    assumptions on the functional forms of the processed signals.
Exclusive dealing contracts between manufacturers and retailers force new entrants to set up their own costly dealer networks to enter the market. We ask whether such contracts may act as an entry barrier, and provide an empirical analysis of the European car market. We first estimate a demand model with product and spatial differentiation, and quantify consumers' valuations for dealer proximity and dealer exclusivity. We then perform policy counterfactuals to assess the profit incentives and possible entry-deterring effects of exclusive dealing. We find that there are no unilateral incentives to maintain exclusive dealing, but there is a collective incentive for the industry as a whole. Furthermore, a ban on exclusive dealing would raise the smaller entrants' market share. But more importantly, consumers would gain, not so much because of increased price competition, but rather because of the increased spatial availability, which compensates for the demand inefficiency from a loss of dealer exclusivity.
This article shows that equilibrium unemployment dynamics can significantly increase the efficacy of fiscal policy. In response to a shock that brings the economy into a liquidity trap, an expansion in government spending increases output and causes a fall in the unemployment rate. Since movements in unemployment are persistent, the effects of current spending prevail into the future, leading to an enduring rise in income. As an enduring rise in income boosts private demand, an increase in government spending sets in motion a virtuous employment-spending spiral with large effects on macroeconomic aggregates.
We develop a framework for optimal taxation when agents can earn their income both in traditional activities, where private and social products coincide, and in rent-seeking activities, where private returns exceed social returns either because they involve the capture of pre-existing rents or because they reduce the returns to traditional work. We characterize Pareto optimal income taxes that do not condition on how much of an individual's income is earned in each of the two activities. These optimal taxes feature an externality-corrective term, the magnitude of which depends both on the Pigouvian correction that would obtain if rent-seeking incomes could be perfectly targeted and on the relative impact of rent-seeking externalities on the private returns to traditional and to rent-seeking activities. If rent-seeking externalities primarily affect other rent-seekers, for example, the optimal correction lies strictly below the Pigouvian correction. A calibrated model indicates that the gap between the Pigouvian and optimal correction can be quantitatively important. Our results thus point to a hefty informational requirement for correcting rent-seeking externalities through the income tax code.
This article investigates the role of intercity transport costs in determining the income of sub-Saharan African cities. In particular, focusing on fifteen countries whose largest city is a port, I find that an oil price increase of the magnitude experienced between 2002 and 2008 induces the income of cities near that port to increase by 7% relative to otherwise identical cities 500 km farther away. Combined with external estimates, this implies an elasticity of city economic activity with respect to transport costs of −0.28 at 500 km from the port. Moreover, the effect differs by the surface of roads between cities. Cities connected to the port by paved roads are chiefly affected by transport costs to the port, while cities connected to the port by unpaved roads are more affected by connections to secondary centres.
We introduce a model of strategic thinking in games of initial response. Unlike standard models of strategic thinking, in this framework the player's “depth of reasoning” is endogenously determined, and it can be disentangled from his beliefs over his opponent's cognitive bound. In our approach, individuals act as if they follow a cost–benefit analysis. The depth of reasoning is a function of the player's cognitive abilities and his payoffs. The costs are exogenous and represent the game-theoretical sophistication of the player; the benefit instead is related to the game payoffs. Behaviour is in turn determined by the individual's depth of reasoning and his beliefs about the reasoning process of the opponent. Thus, in our framework, payoffs not only affect individual choices in the traditional sense, but they also shape the cognitive process itself. Our model delivers testable implications on players' chosen actions as incentives and opponents change. We then test the model's predictions with an experiment. We administer different treatments that vary beliefs over payoffs and opponents, as well as beliefs over opponents' beliefs. The results of this experiment, which are not accounted for by current models of reasoning in games, strongly support our theory. We also show that the predictions of our model are highly consistent, both qualitatively and quantitatively, with well-known unresolved empirical puzzles. Our approach therefore serves as a novel, unifying framework of strategic thinking that allows for predictions across games.
The latitude gradient in comparative development is a striking fact: as one moves away from the equator, economic activity rises. While this regularity is well known, it is not well understood. Perhaps the strongest correlate of (absolute) latitude is the intensity of ultraviolet radiation (UV-R), which epidemiological research has shown to be a cause of a wide range of diseases. We establish that UV-R is strongly and negatively correlated with economic activity, both across and within countries. We propose and test a mechanism that links UV-R to current income differences via the impact of disease ecology on the timing of the take-off to sustained growth.
In U.S. data 1981–2012, unsecured firm credit moves procyclically and tends to lead GDP, while secured firm credit is acyclical; similarly, shocks to unsecured firm credit explain a far larger fraction of output fluctuations than shocks to secured credit. In this article, we develop a tractable dynamic general equilibrium model in which unsecured firm credit arises from self-enforcing borrowing constraints, preventing an efficient capital allocation among heterogeneous firms. Unsecured credit rests on the value that borrowers attach to a good credit reputation which is a forward-looking variable. We argue that self-fulfilling beliefs over future credit conditions naturally generate endogenously persistent business-cycle dynamics. A dynamic complementarity between current and future borrowing limits permits uncorrelated sunspot shocks to unsecured debt to trigger persistent aggregate fluctuations in both secured and unsecured debt, factor productivity, and output. We show that these sunspot shocks are quantitatively important, accounting for around half of output volatility.
We study torture as a mechanism for extracting information from a suspect who may or may not be informed. We show that a standard rationale for torture generates two commitment problems. First, the principal would benefit from a commitment to torture a suspect he knows to be innocent. Secondly, the principal would benefit from a commitment to limit the amount of torture faced by the guilty. We analyse a dynamic model of torture in which the credibility of these threats and promises is endogenous. We show that these commitment problems dramatically reduce the value of torture and can even render it completely ineffective. We use our model to address questions such as the effect of enhanced interrogation techniques, rights against indefinite detention, and delegation of torture to specialists.
We study the relation between mechanism design and voting in public good provision. If incentive mechanisms must satisfy conditions of robust coalition-proofness as well as robust incentive compatibility, the participants' contributions to public good provision can only depend on the level of the public good that is provided and that level can only depend on the population shares of people favouring one level over another. For a public good that comes as a single indivisible unit the outcome depends on whether or not the share of votes in favour of provision exceeds a specified threshold. With more provision levels for the public good, more complicated mechanisms can be used but they still involve the counting of votes rather than any measurement of the participants' willingness to pay. The article thus provides a foundation for the use of voting mechanisms.
We propose a dynamic framework to study the value of medical innovation in the context of infectious disease. We apply our framework to evaluate an HIV treatment breakthrough known as HAART. The model captures how, in lowering both the expected cost and likelihood of HIV infection, HAART reduced the implicit price of risky sex. Forward-looking agents responded by optimally shifting their behaviour. The model also imposes equilibrium constraints, explicitly capturing how optimal shifts in behaviour affect equilibrium choices by changing both infection probabilities and the ease of finding partners willing to engage in risky sex. Using the estimated model, we conduct counterfactual simulations to compute the value of HAART from the perspective of uninfected agents. This includes the option value of the innovation along with value accruing from changes in sex behaviour in response to HAART introduction. We also calculate the added value of a fully functional vaccine from the perspective of both infected and uninfected agents, where infected agents benefit from a vaccine due to resulting shifts in market equilibrium.
In large-scale panel data models with latent factors the number of factors and their loadings may change over time. Treating the break date as unknown, this article proposes an adaptive group-LASSO estimator that consistently determines the numbers of pre- and post-break factors and the stability of factor loadings if the number of factors is constant. We develop a cross-validation procedure to fine-tune the data-dependent LASSO penalties and show that after the number of factors has been determined, a conventional least-squares approach can be used to estimate the break date consistently. The method performs well in Monte Carlo simulations. In an empirical application, we study the change in factor loadings and the emergence of new factors in a panel of U.S. macroeconomic and financial time series during the Great Recession.
In elections with three or more candidates, coordination among like-minded voters is an important problem. We analyse the trade-off between coordination and learning about candidate quality under different temporal election systems in the context of the U.S. presidential primary system. In our model, candidates with different policy positions and qualities compete for the nomination, and voters are uncertain about the candidates' valence. This setup generates two effects: vote splitting ( i.e . several candidates in the same policy position compete for the same voter pool) and voter learning (as the results in earlier elections help voters to update their beliefs on candidate quality). Sequential voting minimizes vote splitting in late districts, but voters may coordinate on a low-quality candidate. Using the parameter estimates obtained from all the Democratic and Republican presidential primaries during 2000–12, we conduct policy experiments such as replacing the current system with a simultaneous system, adopting the reform proposal of the National Association of Secretaries of State, or imposing party rules that lead to candidate withdrawal when prespecified conditions are met.
How do successive, forward-looking agents experiment with interdependent and endogenous technologies? In this article, trying a radically new technology not only is informative of the value of similar technologies, but also reduces the cost of experimenting with them, in effect expanding the space of affordable technologies. Successful radical experimentation has mixed effects: it improves the immediate outlook for further experimentation but decreases the value and the marginal value of experimentation in a longer term, resulting in less ambitious “incremental” experimentation and in a reduced size of radical experimentation. Incremental experimentation lowers the option value of similar technologies, which may spur a new wave of radical experimentation. However, experimentation eventually stagnates for all parameters of the model.
We provide an experimental and theoretical evaluation of a cost-reducing innovation in the delivery of “self-help group” microfinance services, in which privatized agents earn payments through membership fees for providing services. Under the status quo, agents are paid by an outside donor and offer members free services. In our multi-country randomized control trial, we evaluate the change in this incentive scheme on agent behaviour and performance, and on overall village-level outcomes. We find that privatized agents start groups, attract members, mobilize savings, and intermediate loans at similar levels after a year but at much lower costs to the NGO. At the village level, we find higher levels of borrowing, business-related savings, and investment in business. Examining mechanisms, we find that self-help groups serve more business-oriented clientele when facilitated by agents who face strong financial incentives.
We provide the first direct empirical support for the importance of signalling in monetary policy by testing two key predictions from a novel structural model. First, all policymaker types should become less tough on inflation over time and secondly, types that weigh output more should have a more pronounced shift. Voting data from the Bank of England's Monetary Policy Committee strongly support both predictions. Counterfactual results indicate signalling has a substantial impact on interest rates over the business cycle, and improves the committee designer's welfare. Implications for committee design include allowing regular member turnover and transparency regarding publishing individual votes.
Financial innovations are a common explanation for the rise in credit card debt and bankruptcies. To evaluate this story, we develop a simple model that incorporates two key frictions: asymmetric information about borrowers' risk of default and a fixed cost of developing each contract lenders offer. Innovations that ameliorate asymmetric information or reduce this fixed cost have large extensive margin effects via the entry of new lending contracts targeted at riskier borrowers. This results in more defaults and borrowing, and increased dispersion of interest rates. Using the Survey of Consumer Finances and Federal Reserve Board interest rate data, we find evidence supporting these predictions. Specifically, the dispersion of credit card interest rates nearly tripled while the “new” cardholders of the late 1980s and 1990s had riskier observable characteristics than existing cardholders. Our calculations suggest that these new cardholders accounted for over 20% of the rise in bank credit card debt and delinquencies between 1989 and 1998.
Long-run forecasts of economic variables play an important role in policy, planning, and portfolio decisions. We consider forecasts of the long-horizon average of a scalar variable, typically the growth rate of an economic variable. The main contribution is the construction of prediction sets with asymptotic coverage over a wide range of data generating processes, allowing for stochastically trending mean growth, slow mean reversion, and other types of long-run dependencies. We illustrate the method by computing prediction sets for 10- to 75-year average growth rates of U.S. real per capita GDP and consumption, productivity, price level, stock prices, and population.
This article develops an empirical framework for analysing the timing of international treaties. A treaty is modelled as a dynamic game among governments that decide on participation in every period. The net benefit of treaty membership increases over time. Spillovers among members and non-members accelerate or delay treaty formation by transforming participation into a strategic complement or substitute, respectively. The predictions of the model inform the estimation of the structural parameters, based on a cross section of treaty ratification dates. With this approach, I estimate the sign and magnitude of strategic interaction in the ratification of the Montreal Protocol, in the formation of Europe's preferential trade agreements, and in the growth of Germany's network of bilateral investment treaties. Through a series of counterfactual experiments, I explore different mechanisms that give rise to strategic interaction in the formation of these treaties.
Many health care treatments are not urgent and may be delayed if patients so choose. Because insurance coverage is typically determined by the treatment date, individuals may have incentives to strategically delay treatments to minimize out-of-pocket costs. The strategic delay of treatment—a particular form of moral hazard—can be an important source of subsequent adverse selection, in which ex ante identical individuals select insurance coverage based on their differing accumulation of previously delayed treatments. This article investigates these forces empirically in the context of the missing market for dental insurance. Using rich claim-level data, my analysis reveals that approximately 40% of individuals strategically delay dental treatments when incentivized to do so, and this flexibility in delaying treatment can explain why the market for dental insurance has largely unraveled. More generally, the counterfactual analysis suggests features such as open enrolment periods and contracting on pre-existing conditions may be helpful tools in overcoming adverse selection in insurance contexts where the timing of uncertainty is not contractible.
Using a new narrative measure of fiscal policy shocks for the U.K., we show that households with mortgage debt exhibit large and significant consumption responses to tax changes. Homeowners without a mortgage, in contrast, do not adjust their expenditure, with responses not statistically different from zero at all horizons. We compare our findings to the predictions of traditional and newer theories of liquidity constraints, providing a novel interpretation for the aggregate effects of tax changes on the macroeconomy.
In many markets, goods flow from initial producers to final customers travelling through many layers of intermediaries and information is asymmetric. We study a dynamic model of bargaining in networks that captures these features. We show that the equilibrium price demanded over time is non-monotonic, but the sequence of transaction prices declines over time, with the possible exception of the last period. The price dynamic is, therefore, reminiscent of fire-sales and hot-potato trading. Traders who intermediate the object arise endogenously and make a positive profit. The profit-earning intermediaries are not necessarily traders with many connections; for the case of multilayer networks, they belong to the path that reaches the maximum number of potential buyers using the minimal number of intermediaries. This is not necessarily the path of the network that maximizes the probability of consumption by traders who value the most the object (i.e. welfare).
Individual earnings are higher in bigger cities.We consider three reasons: spatial sorting of initially more productive workers, static advantages from workers' current location, and learning by working in bigger cities. Using rich administrative data for Spain, we find that workers in bigger cities do not have higher initial unobserved ability as reflected in fixed effects. Instead, they obtain an immediate static premium and accumulate more valuable experience. The additional value of experience in bigger cities persists after leaving and is stronger for those with higher initial ability. This explains both the higher mean and greater dispersion of earnings in bigger cities.
Why do people vote? We design a field experiment to estimate a model of voting “because others will ask”. The expectation of being asked motivates turnout if individuals derive pride from telling others that they voted, or feel shame from admitting that they did not vote, provided that lying is costly. In a door-to-door survey about election turnout, we experimentally vary (1) the informational content and use of a flyer pre-announcing the survey, (2) the duration and payment for the survey, and (3) the incentives to lie about past voting. The experimental results indicate significant social image concerns. For the 2010 Congressional election, we estimate a value of voting “to tell others” of about $\$$15, contributing 2 percentage points to turnout. Finally, we evaluate a get-out-the-vote intervention in which we tell potential voters that we will ask if they voted.
We study a principal–agent setting in which both sides learn about future profitability from output, and the project can be abandoned/terminated if profitability is too low. With learning, shirking by the agent both reduces output and lowers the principal’s estimate of future profitability. The agent can exploit this belief discrepancy and earn information rents, reducing his incentives to exert effort. The optimal contract controls information rents to improve incentives by distorting the termination decision. Our results capture the transition from a young, financially constrained firm to a mature firm that pays dividends. For young firms, poor performance permanently raises the termination threshold, as doing so lowers information rents. Mature firms pay smoothed dividends and have a fixed termination threshold. Dividend smoothing occurs because earnings surprises are used to adjust financial slack in line with profitability. When profitability only reflects the agent’s private ability, a simple equity contract is optimal.
This article explores the sale of an object to an ambiguity averse buyer. We show that the seller can increase his profit by using an ambiguous mechanism. That is, the seller can benefit from hiding certain features of the mechanism that he has committed to from the agent. We then characterize the profit maximizing mechanisms for the seller and characterize the conditions under which the seller can gain by employing an ambiguous mechanism. Finally, we propose a class of ambiguous mechanisms that are easy to implement and perform better than the best non-ambiguous mechanism.
We explore subjective performance reviews in long-term employment relationships. We show that firms benefit from separating the task of evaluating the worker from the task of paying him. The separation allows the reviewer to better manage the review process, and can, therefore, reward the worker for his good performance with not only a good review contemporaneously, but also a promise of better review in the future. Such reviews spread the reward for the worker’s good performance across time and lower the firm’s maximal temptation to renege on the reward. The manner in which information is managed exhibits patterns consistent with a number of well-documented biases in performance reviews.
We study symmetric information games where a number of senders choose what information to communicate. We show that the impact of competition on information revelation is ambiguous in general. We identify a condition on the information environment (i.e. the set of signals available to each sender) that is necessary and sufficient for equilibrium outcomes to be no less informative than the collusive outcome, regardless of preferences. The same condition also provides an easy way to characterize the equilibrium set and governs whether introducing additional senders or decreasing the alignment of senders' preferences necessarily increases the amount of information revealed.
We analyse conditions facilitating profitable deception in a simple model of a competitive retail market. Firms selling homogenous products set anticipated prices that consumers understand and additional prices that naive consumers ignore unless revealed to them by a firm, where we assume that there is a binding floor on the anticipated prices. Our main results establish that “bad” products (those with lower social surplus than an alternative) tend to be more reliably profitable than “good” products. Specifically, (1) in a market with a single socially valuable product and sufficiently many firms, a deceptive equilibrium—in which firms hide additional prices—does not exist and firms make zero profits. But perversely, (2) if the product is socially wasteful, then a profitable deceptive equilibrium always exists. Furthermore, (3) in a market with multiple products, since a superior product both diverts sophisticated consumers and renders an inferior product socially wasteful in comparison, it guarantees that firms can profitably sell the inferior product by deceiving consumers. We apply our framework to the mutual fund and credit card markets, arguing that it explains a number of empirical findings regarding these industries.
While neoclassical theory emphasizes the impact of trade on wage inequality between occupations and sectors, more recent theories of firm heterogeneity point to the impact of trade on wage dispersion within occupations and sectors. Using linked employer–employee data for Brazil, we show that much of overall wage inequality arises within sector–occupations and for workers with similar observable characteristics; this within component is driven by wage dispersion between firms; and wage dispersion between firms is related to firm employment size and trade participation. We then extend the heterogenous-firm model of trade and inequality from Helpman et al. (2010) and estimate it with Brazilian data. We show that the estimated model provides a close approximation to the observed distribution of wages and employment. We use the estimated model to undertake counterfactuals, in which we find sizable effects of trade on wage inequality.
This article analyses the existence and the effects of bubbles in an endogenous growth model with financial frictions and heterogeneous investments. Bubbles are likely to emerge when the degree of pledgeability is in the middle range, implying that improving the financial market might increase the potential for asset bubbles. Moreover, when the degree of pledgeability is relatively low, bubbles boost long-run growth; when it is relatively high, bubbles lower growth. Furthermore, we examine the effects of a bubble burst, and show that the effects depend on the degree of pledgeability, that is, the quality of the financial system. Finally, we conduct a full welfare analysis of asset bubbles.
We study the manipulability of stable matching mechanisms. To quantify incentives to manipulate stable mechanisms, we consider markets with random cardinal utilities, which induce ordinal preferences over match partners. We show that most agents in large matching markets are close to being indifferent of overall stable matchings. In one-to-one matching, the utility gain by manipulating a stable mechanism does not exceed the gap between utilities from the best and worst stable partners. Thus, most agents in a large market would not have significant incentives to manipulate stable mechanisms. The incentive compatibility extends to many-to-one matching when agents employ truncation strategies and capacity manipulations in a Gale—Shapley mechanism.
Decentralization can improve service delivery, but it can also generate externalities across jurisdictional boundaries. We examine the nature and size of water pollution externalities as rivers flow across jurisdictions. Panel data on water pollution in Brazilian rivers coupled with county splits that change the locations of borders allow us to identify the spatial patterns of pollution as rivers approach and cross borders, controlling for fixed effects and trends specific to each location. The theory of externalities predicts that pollution should increase at an increasing rate as the river approaches the downstream exit border, that there should be a structural break in the slope of the pollution function at the border, and that a larger number of managing jurisdictions should exacerbate pollution externalities. We find support for all four predictions in the data. Satellite data on growth in night-time lights along rivers show that local authorities allow more settlements to develop close to rivers in the downstream portions of counties, which is the likely underlying mechanism. The border effects on pollution are not as pronounced when the cost of inter-jurisdictional coordination is lower.
We consider learning and signalling in a dynamic Cournot oligopoly where firms have private information about their production costs and only observe the market price, which is subject to unobservable demand shocks. An equilibrium is Markov if play depends on the history only through the firms’ beliefs about costs and calendar time. We characterize symmetric linear Markov equilibria as solutions to a boundary value problem. In every such equilibrium, given a long enough horizon, play converges to the static complete information outcome for the realized costs, but each firm only learns its competitors’ average cost. The weights assigned to costs and beliefs under the equilibrium strategies are non-monotone over time. We explain this by decomposing incentives into signalling and learning, and discuss implications for prices, quantities, and welfare.
This article estimates peer effects originating from the ability composition of tutorial groups for undergraduate students in economics. We manipulated the composition of groups to achieve a wide range of support, and assigned students—conditional on their prior ability—randomly to these groups. The data support a specification in which the impact of group composition on achievement is captured by the mean and standard deviation of peers’ prior ability, their interaction, and interactions with students’ own prior ability. When we assess the aggregate implications of these peer effects regressions for group assignment, we find that low- and medium-ability students gain on an average 0.19 SD units of achievement by switching from ability mixing to three-way tracking. Their dropout rate is reduced by 12 percentage points (relative to a mean of 0.6). High-ability students are unaffected. Analysis of survey data indicates that in tracked groups, low-ability students have more positive interactions with other students, and are more involved. We find no evidence that teachers adjust their teaching to the composition of groups.
All individuals face some risk of ending up old, sick, alone, and poor. Is there a role for social insurance for these risks and, if so, what is a good programme? A large literature has analysed the costs and benefits of pay-as-you-go public pensions and found that the costs exceed the benefits. This article, instead, considers means-tested social insurance (MTSI) programmes for retirees such as Medicaid and Supplemental Security Income. We find that the welfare gains from these programmes are large. Moreover, the current scale of MTSI in the U.S. is too small in the following sense. If we condition on the current Social Security programme, increasing the scale of MTSI by 1/3 benefits both the poor and the affluent when a payroll tax is used to fund the increase.
This article studies the structural transformation of Russia in 1885–1940 from an agrarian to an industrial economy through the lens of a two-sector neoclassical growth model. We construct a data set that covers Tsarist Russia during 1885–1913 and Soviet Union during 1928–1940. We develop a methodology that allows us to identify the types of frictions and economic mechanisms that had the largest quantitative impact on Russian economic development. We find that entry barriers and monopoly power in the non-agricultural sector were the most important reason for Tsarist Russia’s failure to industrialize before World War I. Soviet industrial transformation after 1928 was achieved primarily by reducing such frictions, albeit coinciding with a significantly lower performance of productivity in both agricultural and non-agricultural sectors. We find no evidence that Tsarist agricultural institutions were a significant barrier to labour reallocation to manufacturing, or that “Big Push” mechanisms were a major driver of Soviet growth.
This article provides direct empirical evidence on the relationship between technology and firms’ global sourcing strategies. Using new data on U.S. firms’ decisions to contract for manufacturing services from domestic or foreign suppliers, I show that a firm’s adoption of communication technology between 2002 and 2007 is associated with a 3.1 point increase in its probability of fragmentation. The effect of firm technology also differs significantly across industries; in 2007, it is 20% higher, relative to the mean, in industries with production specifications that are easier to codify in an electronic format. These patterns suggest that technology lowers coordination costs, though its effect is disproportionately higher for domestic rather than foreign sourcing. The larger impact on domestic fragmentation highlights its importance as an alternative to offshoring, and can be explained by complementarities between technology and worker skill. High technology firms and industries are more likely to source from high human capital countries, and the differential impact of technology across industries is strongly increasing in country human capital.
We derive the incentive compatible and ex-ante welfare maximizing (⁠|$i.e.$| utilitarian) mechanism for settings with an arbitrary number of agents and alternatives where the privately informed agents have single-crossing and single-peaked preferences. The optimal outcome can be implemented by modifying a sequential voting scheme that is used in many legislatures and committees. The modification uses a flexible majority threshold for each of several alternatives, and allows us to replicate, via a single sequential procedure, the entire class of anonymous, unanimous, and dominant strategy incentive compatible mechanisms. Our analysis relies on elegant characterizations of this class of mechanisms for single-peaked and single-crossing preferences.
This article studies multidimensional matching between workers and jobs. Workers differ in manual and cognitive skills and sort into jobs that demand different combinations of these two skills. To study this multidimensional sorting problem, I develop a theoretical framework that generalizes the unidimensional notion of assortative matching and sufficient conditions on the technology under which sorting obtains. I derive the equilibrium in closed form and use this explicit solution to study biased technological change. The main finding is that an increase in worker-job complementarities in cognitive relative to manual inputs leads to more pronounced sorting and wage inequality across cognitive relative to manual skills. This can trigger wage polarization and boost aggregate wage inequality. I then estimate the model for the U.S. and identify sizable technology shifts: during the last two decades, worker-job complementarities in cognitive inputs strongly increased, whereas complementarities in manual inputs decreased. In addition to this bias in complementarities, there has been a cognitive skill-bias in production. Counterfactual exercises suggest that these technology shifts (as opposed to changes in skill supply and demand) can account for observed changes in worker-job sorting, wage polarization and a significant part of the increase in U.S. wage dispersion.
Principals often operate on misspecified models of their agents’ preferences. When preferences are such that non-local incentive constraints may bind in the optimum, even slight misspecification of the preferences can lead to large and non-vanishing losses. Instead, we propose a two-step scheme whereby the principal: (1) identifies the model-optimal menu; and (2) modifies prices by offering to share with the agent a fixed proportion of the profit she would receive if an item were sold at the model-optimal price. We show that her loss is bounded and vanishes smoothly as the model converges to the truth. Finally, two-step mechanisms without a sharing rule like (2) will not yield a valid approximation.
We develop a theory of contracts with limited enforcement in the context of a dynamic relationship. The seller is privately informed on his persistent cost, while the buyer remains uninformed. Public enforcement relies on remedies for breaches. Private enforcement comes from terminating the relationship. We first characterize enforcement constraints under asymmetric information. Those constraints ensure that parties never breach contracts. In particular, a high-cost seller may be tempted to trade high volumes at high prices at the beginning of the relationship before breaching the contract later on. Such “take-the-money-and-run” strategy becomes less attractive as time passes. It can thus be prevented by backloading payments and increasing volumes over a transitory phase. In a mature phase, enforcement constraints are slack and the optimal contract, although keeping memory of the shadow cost of enforcement constraints binding earlier on, looks stationary. Second-best distortions depend on a modified virtual cost that encapsulates this shadow cost of enforcement.
We develop a dynamic general equilibrium model in which the policy rate signals the central bank’s view about macroeconomic developments to price setters. The model is estimated with likelihood methods on a U.S. data set that includes the Survey of Professional Forecasters as a measure of price setters’ inflation expectations. This model improves upon existing perfect information models in explaining why, in the data, inflation expectations respond with delays to monetary impulses and remain disanchored for years. In the 1970s, U.S. monetary policy is found to signal-persistent inflationary shocks, explaining why inflation and inflation expectations were so persistently heightened. The signalling effects of monetary policy also explain why inflation expectations adjusted more sluggishly than inflation after the robust monetary tightening of the 1980s.
This study incorporates a recent preference specification of expectations-based loss aversion, which has been applied broadly in microeconomics, into a classic macro model to offer a unified explanation for three empirical observations about life-cycle consumption. First, loss aversion explains excess smoothness and sensitivity—that is, the empirical observation that consumption responds to income shocks with a lag. Intuitively, such lagged responses allow the agent to delay painful losses in consumption until his expectations have adjusted. Secondly, the preferences generate a hump-shaped consumption profile. Early in life, consumption is low due to a first-order precautionary-savings motive. However, as uncertainty resolves over time, this motive is dominated by time-inconsistent overconsumption that eventually leads to declining consumption towards the end of life. Thirdly, consumption drops at retirement. Prior to retirement, the agent wants to overconsume his uncertain income before his expectations catch up. Post-retirement, however, income is no longer uncertain, and overconsumption is associated with a sure loss in future consumption. As an empirical contribution, I structurally estimate the preference parameters using life-cycle consumption data. My estimates match those obtained in experiments and other micro studies, and generate the degree of excess smoothness observed in macro consumption data.
This article performs a welfare analysis of markets with private information in which agents condition on prices in the rational expectations tradition. Price-contingent strategies introduce two externalities in the use of private information: a pecuniary externality and a learning externality. The pecuniary externality induces agents to put too much weight on private information and in the standard case, when the allocation role of the price prevails over its informational role, overwhelms the learning externality which impinges in the opposite way. The price may be very informative but at the cost of an excessive dispersion of the actions of agents. The welfare loss at the market solution may be increasing in the precision of private information. The analysis provides insights into optimal business cycle policy and a rationale for a Tobin-like tax for financial transactions.
We propose and analyse a general model of priority races. Researchers privately have breakthroughs and decide how long to let their ideas mature before disclosing them, thereby establishing priority. Two-researcher, symmetric priority races have a unique equilibrium that can be characterized by a differential equation. We study how the shapes of the breakthrough distribution and of the returns to maturation affect maturation delays and research quality, both in dynamic and comparative statics analyses. Making researchers better at discovering new ideas or at developing them has contrasted effects on research quality. Being closer to the technological frontier enhances the value of maturation for researchers, which mitigates the negative impact on research quality of the race for priority. Finally, when researchers differ in their abilities to do creative work or in the technologies they use to develop their ideas, more efficient researchers always let their ideas mature more than their less efficient opponents. Our theoretical results shed light on academic competition, patent races, and innovation quality.
Do tax cuts and spending increases stimulate output? Studies that identify fiscal shocks using structural vector autoregressions (SVAR) have reached different conclusions. In this article, we show analytically that this lack of consensus reflects different assumptions on the fiscal rules that—by relating tax and spending policies to macroeconomic conditions—determine the identification of fiscal shocks and the associated fiscal multipliers. We then propose a new identification strategy based on a proxy SVAR that uses non-fiscal instruments to directly estimate the parameters of the fiscal rules. We find that spending increases stimulate output more than tax cuts..
Searching for partners involves informational persistence that reduces future traders’ matching probability. In this article, traders who are no longer available but who left tracks on the market are called phantoms. We examine a dynamic matching market in which phantoms are a by-product of search activity, no coordination frictions are assumed, and non-phantom traders may lose time trying to match with phantoms. The resulting aggregate matching technology features increasing returns to scale in the short run, but has constant returns to scale in the long run. We embed a generalized version of this matching function in the canonical continuous-time equilibrium search unemployment model. Long-run constant returns to scale imply there is a unique steady state, whereas short-run increasing returns generate excess volatility in the short run and endogenous fluctuations based on self-fulfilling prophecies.
We show that healthcare providers face a tradeoff between increasing the number of patients they treat and improving their quality of care. To measure the magnitude of this quality-quantity tradeoff, we estimate a model of dialysis provision that explicitly incorporates a centre’s unobservable and endogenous choice of treatment quality while allowing for unobserved differences in productivity across centres. We find that a centre that reduces its quality standards such that its expected rate of septic infections increases by 1 percentage point can increase its patient load by 1.6%, holding productivity, capital, and labour fixed; this corresponds to an elasticity of quantity with respect to quality of |$-$|0.2. Notably, our approach provides estimates of productivity that control for differences in quality, whereas traditional methods would misattribute lower-quality care to greater productivity.
In this article we introduce a new computationally tractable framework for Ericson and Pakes-style dynamic oligopoly models that overcomes the computational complexity involved in computing Markov perfect equilibrium (MPE). First, we define a new equilibrium concept that we call moment-based Markov equilibrium (MME), in which firms keep track of their own state, the detailed state of dominant firms, and few moments of the distribution of fringe firms’ states. Second, we provide guidelines to use MME in applied work and illustrate with an application how it can endogenize the market structure in a dynamic industry model even with hundreds of firms. Third, we develop a series of results that provide support for using MME as an approximation. We present numerical experiments showing that MME approximates MPE for important classes of models. Then, we introduce novel unilateral deviation error bounds that can be used to test the accuracy of MME as an approximation in large-scale settings. Overall, our new framework opens the door to study new issues in industry dynamics.
I provide an analysis of vertical relations in markets with imperfect competition at both layers of the supply chain and where exchange is intermediated either with wholesale prices or revenue-sharing contracts. Revenue-sharing is extremely attractive to firms that are able to set the revenue shares but often makes the firms that set retail prices worse off. This is so whether revenue-sharing lowers or raises industry profits. These results are strengthened when a market moves from “the wholesale model” of sales to “the agency model” of sales, which results in retailers setting revenue shares and suppliers setting retail prices. I also show that retail price-parity restrictions raise industry prices. These results provide a potential explanation for why many online retailers have adopted the agency model and retail price-parity clauses.
Affluent households can respond to taxation with means that are not economically viable for the rest of the population, such as sophisticated tax plans and international tax arbitrage. This article studies an economy in which an inequality-averse social planner faces agents who have access to a tax-avoidance technology with subadditive costs, and who can shape the risk profile of their income as they see fit. Subadditive avoidance costs imply that optimal taxation cannot be progressive at the top. This in turn may trigger excessive risk-taking. When the avoidance technology consists in costly migration between two countries that compete fiscally, we show that an endogenous increase in inequality due to risk-taking makes progressive taxation more fragile, which vindicates in turn risk-taking and can lead to equilibria with regressive tax rates at the top, and high migrations of wealth towards the smaller country.
This paper investigates how legal cannabis access affects student performance. Identification comes from an exceptional policy introduced in the city of Maastricht in the Netherlands that discriminated access via licensed cannabis shops based on an individual’s nationality. We apply a difference-in-difference approach using administrative panel data on course grades of local students enrolled at Maastricht University before and during the partial cannabis prohibition. We find that the academic performance of students who are no longer legally permitted to buy cannabis substantially increases. Grade improvements are driven by younger students and the effects are stronger for women and low performers. In line with how cannabis consumption affects cognitive functioning, we find that performance gains are larger for courses that require more numerical/mathematical skills. Our investigation of underlying channels using course evaluations suggests that performance gains are driven by an improved understanding of the material rather than changes in students’ study effort.
This article studies the non-parametric identification and estimation of voters’ preferences when voters are ideological. We establish that voter preference distributions and other parameters of interest can be identified from aggregate electoral data. We also show that these objects can be consistently estimated and illustrate our analysis by performing an actual estimation using data from the 1999 European Parliament elections.
We study optimal taxation of bequests and inter vivos transfers in a model where altruistic parents and their offspring disagree on intertemporal trade-offs. We show that the laissez-faire equilibrium is Pareto inefficient, and whenever offspring are impatient from their parents’ perspective, optimal policy involves a positive tax on parental transfers. Cautioned by the technical complications present in this class of models, our normative prescriptions do not rely on the assumption of differentiability of the agents’ policy functions.
This article presents a framework for analysing global identification in log linearized Dynamic Stochastic General Equilibrium (DSGE) models that encompasses both determinacy and indeterminacy. First, it considers a frequency domain expression for the Kullback–Leibler distance between two DSGE models and shows that global identification fails if and only if the minimized distance equals 0. This result has three features: (1) it can be applied across DSGE models with different structures; (2) it permits checking whether a subset of frequencies can deliver identification; (3) it delivers parameter values that yield observational equivalence if there is identification failure. Next, the article proposes a measure for the empirical closeness between two DSGE models for a further understanding of the strength of identification. The measure gauges the feasibility of distinguishing one model from another based on a finite number of observations generated by the two models. It is shown to represent the highest possible power under Gaussianity when considering local alternatives. The above theory is illustrated using two small-scale and one medium-scale DSGE models. The results document that certain parameters can be identified under indeterminacy but not determinacy, that different monetary policy rules can be (nearly) observationally equivalent, and that identification properties can differ substantially between small and medium-scale models. For implementation, two procedures are developed and made available, both of which can be used to obtain and thus to cross validate the findings reported in the empirical applications. Although the article focuses on DSGE models, the results are also applicable to other vector linear processes with well-defined spectra, such as the (factor-augmented) vector autoregression.
We experimentally analyse distributional preferences when a decider chooses the provision of a good that benefits herself or a receiver, and creates costs for a group of payers. The treatment variation is the number of payers. We observe that subjects provide the good even if there are many payers so that the costs of provision exceed the benefits by far. This result holds regardless of whether the provision increases the decider’s payoff or not. Intriguingly, it is not only selfish or maximin types who provide the good. Rather, we show that a substantial fraction of subjects are “insensitive to group size”: they reveal to care about the payoff of all parties, but attach the same weight to small and large groups so that they ignore large provision costs that are dispersed among many payers. Our results have important consequences for the approval of policies with concentrated benefits and large, dispersed cost, as well as the analysis of ethical behaviour, medical decision-making, and charity donations.
A hyperbolic discounting model of labour supply and welfare participation with heterogeneous time preference parameters is estimated. Exclusion restrictions are constructed from variations in behaviour induced by time limits in a welfare reform experiment. We find that most individuals are time-inconsistent, and they exhibit varying degrees of present bias and perception of the commitment problem. Introducing a welfare component to the tax system can make individuals worse off by aggravating the commitment problem. Certain dynamic policy interventions carry sizeable commitment-related work incentives; for instance, a dynamic sanction triggered by past employment can be preferred by some individuals as a commitment device.
Previous research has established that the predictions of game theory are quite sensitive to the assumptions made about the players’ beliefs. We evaluate the severity of this robustness problem by characterizing conditions on the primitives of the model—the players’ beliefs and higher-order beliefs about the payoff-relevant parameters—for the behaviour of a given Harsanyi type to be approximated by the behaviour of (a sequence of) perturbed types. This amounts to providing belief-based characterizations of the strategic topologies of Dekel et al. (2006). We apply our characterizations to a variety of questions concerning robustness to perturbations of higher-order beliefs, including genericity of types that are consistent with a common prior, and we investigate the connections between our notions of robustness and the notion of common |$p$|-belief of Monderer and Samet (1989).
We show that state non-separable preferences à la Epstein–Zin–Weil (EZW) provide a tractable and flexible framework to study the economics of health and longevity. This utility representation: (1) admits a preference for timing of resolution of uncertainty regarding mortality risks; (2) links the marginal valuation of survival to the level of survival; (3) can preserve homotheticity even for low degrees of intertemporal substitution without generating implausible predictions regarding the value of life; and (4) adds needed flexibility to account for the empirical evidence on the value of life. We illustrate the implications of EZW preferences for the economic value of observed differences in life expectancy across countries and over time, and for the value of life over the life cycle.
Media outlets are increasingly owned by conglomerates, inducing a conflict of interest: a media outlet can bias its coverage to benefit companies in the same group. We test for bias by examining movie reviews in media outlets owned by News Corp, such as the Wall Street Journal, and Time Warner, such as Time. We find higher ratings for 20th Century Fox movies in News Corp. outlets compared to movies by other studios. To disentangle bias from correlation of taste, we introduce and validate a novel matching procedure using individual movie ratings from online platforms. Using this procedure, we find no evidence of bias in News Corp. nor Time Warner outlets. We reject even small effects, such as bias of one extra star (out of four) every thirteen movies. We test for differential bias when the return to bias is plausibly higher, examine bias by media outlet and by journalist, as well as editorial bias. We also consider bias by omission—whether media outlets are more likely to review highly-rated movies by affiliated studios—and conflict of interest within a movie aggregator. In none of these dimensions do we find evidence of bias. We relate to previous work and discuss three explanations for the lack of bias in our setting: high values of media reputation, organizational features in a conglomerate, and low returns to bias.
A growing literature suggests that high-income countries export high-quality goods. Two hypotheses may explain such specialization, with different implications for welfare, inequality, and trade policy. Fajgelbaum et al. formalize the Linder hypothesis that home demand determines the pattern of specialization and, therefore, predict that high-income locations export high-quality products. The factor-proportions model also predicts that skill-abundant, high-income locations export skill-intensive, high-quality products. Prior empirical evidence does not separate these explanations. I develop a model that nests both hypotheses and employ microdata on U.S. manufacturing plants’ shipments and factor inputs to quantify the two mechanisms’ roles in quality specialization across U.S. cities. Home-market demand explains as much of the relationship between income and quality as differences in factor usage.
When designing data collection, crucial questions arise regarding how much data to collect and how much effort to expend to enhance the quality of the collected data. To make choice of sample design a coherent subject of study, it is desirable to specify an explicit decision problem. We use the Wald framework of statistical decision theory to study allocation of a budget between two or more sampling processes. These processes all draw random samples from a population of interest and aim to collect data that are informative about the sample realizations of an outcome. They differ in the cost of data collection and the quality of the data obtained. One may incur lower cost per sample member but yield lower data quality than another. Increasing the allocation of budget to a low-cost process yields more data, while increasing the allocation to a high-cost process yields better data. We initially view the concept of “better data” abstractly and then fix attention on two important cases. In both cases, a high-cost sampling process accurately measures the outcome of each sample member. The cases differ in the data yielded by a low-cost process. In one, the low-cost process has non-response and in the other it provides a low-resolution interval measure of each sample member’s outcome. In these settings, we study minimax-regret sample design for prediction of a real-valued outcome under square loss; that is, design which minimizes maximum mean square error. The analysis imposes no assumptions that restrict the unobserved outcomes. Hence, the decision maker must cope with both the statistical imprecision of finite samples and the partial identification of the true state of nature.
This article studies the impact of increasing trading frequency in financial markets on allocative efficiency. We build and solve a dynamic model of sequential double auctions in which traders trade strategically with demand schedules. Trading needs are generated by time-varying private information about the asset value and private values for owning the asset, as well as quadratic inventory costs. We characterize a linear equilibrium with stationary strategies and its efficiency properties in closed form. Frequent trading (more double auctions per unit of time) allows more immediate asset reallocation after new information arrives, at the cost of a lower volume of beneficial trades in each double auction. Under stated conditions, the trading frequency that maximizes allocative efficiency coincides with the information arrival frequency for scheduled information releases, but can far exceed the information arrival frequency if new information arrives stochastically. A simple calibration of the model suggests that a moderate market slowdown to the level of seconds or minutes per double auction can improve allocative efficiency for assets with relatively narrow investor participation and relatively infrequent news, such as small- and micro-cap stocks.
Public regulation is increasingly facing competition from “private politics” in the form of activism and corporate self-regulation. However, its effectiveness, welfare consequences, and interaction with public regulation are poorly understood. This article presents a unified dynamic framework for studying the interaction between public regulation, self-regulation, and boycotts. We show that the possibility of self-regulation saves on administrative costs, but also leads to delays. Without an active regulator, firms self-regulate to preempt or end a boycott and private politics is beneficial for activists but harmful for firms. With an active regulator, in contrast, firms self-regulate to preempt public regulation and private politics is harmful for activists but beneficial for firms. Our analysis generates a rich set of testable predictions that are consistent with the rise of private politics over time and the fact that there is more self-regulation and activism in the U.S., while public regulation continues to be more common in Europe.
We study the optimal use of disclosure and fiscal backstops during financial crises. Providing information can reduce adverse selection in credit markets, but negative disclosures can also trigger inefficient bank runs. In our model, governments are thus forced to choose between runs and lemons. A fiscal backstop mitigates the cost of runs and allows a government to pursue a high disclosure strategy. Our model explains why governments with strong fiscal positions are more likely to run informative stress tests, and, paradoxically, how they can end up spending less than governments that are more fiscally constrained.
This article provides a flexible model of resource extraction, such as deforestation, and derives the optimal conservation contract. When property rights are “strong” and districts are in charge of extracting their own resources to get revenues, conservation in one district benefits the others since the reduced supply raises the sales price. A central authority would internalize this positive externality and thus conserve more. When property rights are instead weak and extraction is illegal or costly control, conservation in one district increases the price and thus the profit from illegally depleting the resource in the other districts. The externality from conservation is then negative, and centralization would lead to less conservation. We also derive the optimal conservation contract, and we explain when the principal, who values conservation, benefits from contracting with the districts directly even when contracting with a central authority would have led to more conservation, and vice versa.
We develop a theoretical model with labour market frictions, incomplete financial markets, and with households which have two members. Households face unemployment risks, but their members adjust their labour supplies to insure against unemployment. We use the model to explain the cyclical properties of aggregate employment and participation. As in the U.S. data, the model predicts that the participation rate (the fraction of individuals that want jobs) is not strongly correlated with aggregate economic activity. This property is in sharp contrast to the strongly procyclical participation predicted by both neoclassical models and models with search frictions, when we assume bachelor households or households with infinitely many members (complete markets). In the two-member household model and in the data, primary earners are always in the labour force, secondary earners have a mildly countercyclical participation rate, and a mildly procyclical employment rate. Their behaviour insures the household against unemployment risks.
We study effort and risk-taking behaviour in an economy with a continuum of principal–agent pairs where each agent exerts costly hidden effort. Principals write contracts based on both absolute and relative performance evaluations (APE and RPE, respectively) to make individually optimal risk–return trade-offs but do not take into account their impact on endogenously determined aggregate variables. This results in contractual externalities when these aggregate variables are used as benchmarks in contracts. Contractual externalities have welfare changing effects when principals put too much weight on APE or RPE due to information frictions. Relative to the second best, if the expected productivity is high, risk-averse principals over-incentivize their own agents, triggering a rat race in effort exertion, resulting in over-investment in effort and excessive exposure to industry risks. The opposite occurs when the expected productivity is low, inducing pro-cyclical investment and risk-taking behaviours.
I present a behavioural model of a “data analyst” who extrapolates a fully specified probability distribution over observable variables from a collection of statistical data sets that cover partially overlapping sets of variables. The analyst employs an iterative extrapolation procedure, whose individual rounds are akin to the stochastic regression method of imputing missing data. Users of the procedure’s output fail to distinguish between raw and imputed data, and it functions as their practical belief. I characterize the ways in which this belief distorts the correlation structure of the underlying data generating process—focusing on cases in which the distortion can be described as the imposition of a causal model (represented by a directed acyclic graph over observable variables) on the true distribution.
In markets with quality unobservable to buyers, third-party certification is often the only instrument to increase transparency. While both sellers and buyers have a demand for certification, its role differs fundamentally: sellers use it for signalling, buyers use it for inspection. Seller-induced certification leads to more transparency, because it is informative—even if unused. By contrast, buyer-induced certification incentivizes certifiers to limit transparency, as this raises demand for inspection. Whenever transparency is socially beneficial, seller certification is preferable. It also yields certifiers larger profits, so that regulating the mode of certification is redundant.
This article studies the pruned state-space system for higher-order perturbation approximations to dynamic stochastic general equilibrium (DSGE) models. We show the stability of the pruned approximation up to third order and provide closed-form expressions for first and second unconditional moments and impulse response functions. Our results introduce generalized method of moments (GMM) estimation and impulse-response matching for DSGE models approximated up to third order and provide a foundation for indirect inference and simulated method of moments (SMM). As an application,we consider a New Keynesian model with Epstein–Zin preferences and two novel feedback effects from long-term bonds to the real economy, allowing us to match the level and variability of the |$10$|-year term premium in the U.S. with a low relative risk aversion of |$5$|⁠.
We compute a sunspot equilibrium in an estimated small-scale New Keynesian model with a zero lower bound (ZLB) constraint on nominal interest rates and a full set of stochastic fundamental shocks. In this equilibrium, a sunspot shock can move the economy from a regime in which inflation is close to the central bank’s target to a regime in which the central bank misses its target, inflation rates are negative, and interest rates are close to zero with high probability. A non-linear filter is used to examine whether the U.S. in the aftermath of the Great Recession and Japan in the late 1990s transitioned to a deflation regime. The results are somewhat sensitive to the model specification, but on balance, the answer is affirmative for Japan and negative for the U.S.
Recessions often happen after periods of rapid accumulation of houses, consumer durables and business capital. This observation has led some economists, most notably Friedrich Hayek, to conclude that recessions often reflect periods of needed liquidation resulting from past over-investment. According to the main proponents of this view, government spending or any other form of aggregate demand policy should not be used to mitigate such a liquidation process, as doing so would simply result in a needed adjustment being postponed. In contrast, ever since the work of Keynes, many economists have viewed recessions as periods of deficient demand that should be countered by activist fiscal policy. In this paper we reexamine the liquidation perspective of recessions in a setup where prices are flexible but where not all trades are coordinated by centralized markets. The model illustrates why liquidations likely cause recessions characterized by deficient aggregate demand and accordingly suggests that Keynes’ and Hayek’s views of recessions may be closely linked. In our framework, interventions aimed at stimulating aggregate demand face a trade-off whereby current stimulus postpones the adjustment process and therefore prolongs the recessions, but where some stimulative policies may nevertheless remain desirable.
We investigate housing market responses to transaction taxes using administrative data on all property transactions in the U.K. from 2004 to 2012 combined with quasi-experimental variation from tax notches and tax stimulus. We present two main findings. First, transaction taxes are highly distortionary across a range of margins, causing large distortions to the price, volume, and timing of property transactions. Secondly, temporary transaction tax cuts are an enormously effective form of fiscal stimulus. A temporary elimination of a 1% transaction tax increased housing market activity by 20% in the short run (due to both timing and extensive responses) and less than half of the stimulus effect was reversed after the tax was reintroduced (due to re-timing). Because of the complementarities between moving house and consumer spending, these stimulus effects translate into extra spending per dollar of tax cut equal to about 1. We interpret our empirical findings in the context of a housing model with downpayment constraints in which leverage amplifies the effects of transaction taxes.
We analyse a consumption-saving problem in which time-inconsistent preferences generate demand for commitment, but uncertainty about future consumption needs generates demand for flexibility. We characterize in a standard contracting framework the circumstances under which this combination is possible, in the sense that a commitment contract exists that implements the desired state-contingent consumption plan, thus offering both commitment and flexibility. The key condition that we identify is a preference reversal condition: high desired consumption today should be associated with low marginal utility at future dates. Moreover, there are conditions under which preference reversal naturally arises. The key insight of our article is that time-inconsistent preferences not only generate commitment problems, but also allow their possible solution, since the preferences of later selves can be exploited to punish overconsumption by earlier selves.
I study a class of continuous-time games of learning and imperfect monitoring. A long-run player and a market share a common prior about the initial value of a Gaussian hidden state, and learn about its subsequent values by observing a noisy public signal. The long-run player can nevertheless control the evolution of this signal, and thus affect the market’s belief. The public signal has an additive structure, and noise is Brownian. I derive conditions for an ordinary differential equation to characterize equilibrium behavior in which the long-run player’s actions depend on the history of the game only through the market’s correct belief. Using these conditions, I demonstrate the existence of pure-strategy equilibria in Markov strategies for settings in which the long-run player’s flow utility is nonlinear. The central finding is a learning-driven ratchet principle affecting incentives. I illustrate the economic implications of this principle in applications to monetary policy, earnings management, and career concerns.
This article characterizes the efficiency properties of competitive economies with financial constraints, in which phenomena such as fire sales and financial amplification may arise. We show that financial constraints lead to two distinct types of pecuniary externalities: distributive externalities that arise from incomplete insurance markets and collateral externalities that arise from price-dependent financial constraints. For both types of externalities, we identify three sufficient statistics that determine optimal taxes on financing and investment decisions to implement constrained efficient allocations. We also show that fire sales and financial amplification are neither necessary nor sufficient to generate inefficient pecuniary externalities. We demonstrate how to employ our framework in a number of applications. Whereas collateral externalities generally lead to over-borrowing, the distortions from distributive externalities may easily flip sign, leading to either under- or over-borrowing. Both types of externalities may lead to under- or over-investment.
There are growing calls to restrict advertising of junk foods. Whether such a move will improve diet quality will depend on how advertising shifts consumer demands and how firms respond. We study an important and typical junk food market—the potato chips market. We exploit consumer level exposure to adverts to estimate demand, allowing advertising to potentially shift the weight consumers place on product healthiness, tilt demand curves, have dynamic effects and spillover effects across brands. We simulate the impact of a ban and show that the potential health benefits are partially offset by firms lowering prices and by consumer switching to other junk foods.
Assessing the importance of uninsurable wage risk for individual financial choices faces two challenges. First, the identification of the marginal effect requires a measure of at least one component of risk that cannot be diversified or avoided. Moreover, measures of uninsurable wage risk must vary over time to eliminate unobserved heterogeneity. Secondly, evaluating the economic significance of risk requires knowledge of the size of all the wage risk actually faced. Existing estimates are problematic because measures of wage risk fail to satisfy the “non-avoidability” requirement. This creates a downward bias, which is at the root of the small estimated effect of wage risk on portfolio choices. To tackle this problem we match panel data of workers and firms and use the variability in the profitability of the firm that is passed over to workers to obtain a measure of uninsurable risk. Using this measure to instrument total variability in individual earnings, we find that the marginal effect of uninsurable wage risk is much larger than estimates that ignore endogeneity. We bound the economic impact of risk and find that its overall effect is contained, not because its marginal effect is small but because its size is small. And the size of uninsurable wage risk is small because firms provide substantial wage insurance.
We incorporate consumption indivisibilities into the Krugman (1980) model and show that an importer's per capita income becomes a primary determinant of “export zeros”. Households in the rich North (poor South) are willing to pay high (low) prices for consumer goods; hence, unconstrained monopoly pricing generates arbitrage opportunities for internationally traded products. Export zeros arise because some northern firms abstain from exporting to the South, to avoid international arbitrage. Rich countries benefit from a trade liberalization, while poor countries lose. These results hold also under more general preferences with both extensive and intensive consumption margins. We show that a standard calibrated trade model (that ignores arbitrage) generates predictions on relative prices that violate no-arbitrage constraints in many bilateral trade relations. This suggests that international arbitrage is potentially important.
We develop a framework to study optimal sector-specific taxation, where each agent chooses an occupation by comparing her skill differential with the tax burden differential across sectors. Because skills are not perfectly transferable, the Diamond–Mirrlees theorem (according to which the second-best entails production efficiency) fails: social welfare can be increased by inducing some agents to join the sector in which their productivity is not the highest. At the optimum, income taxes balance the marginal losses from inter-sector migration with the marginal gains from tailoring tax schedules to the distribution of productivities in each sector (“tagging”). A calibrated model indicates that sector-specific taxation generates substantive welfare gains when skill transferability decreases with income, as it enables the government to increase average taxes on high earners with large wage premia.
For many applications of signalling, senders rather than nature choose unobserved features such as their private choices of quality, capacity, investment, contract, or price, along with other actions that are (partially) observed by receivers. Despite the large number of different applications, these games have not been studied in any systematic way. We identify and study a general class of such games, which we call “endogenous signalling games”. These games normally suffer from a plethora of equilibria. To focus on reasonable equilibria, we propose to solve such games by requiring that the solution be invariant to a particular reordering of the senders’ moves. For a class of single-sender monotone endogenous signalling games, we show that the sender’s private choice can still have some commitment value even though it is not observed and that the sender’s signals must be exaggerated in equilibrium. Applications to loss-leader pricing, costly announcements, limit pricing, advertising, corporate financing, and private contracting are given.
Distributional comparative statics is the study of how individual decisions and equilibrium outcomes vary with changes in the distribution of economic parameters (income, wealth, productivity, information, etc.). This article develops new tools to address such issues and illustrates their usefulness in applications. The central development is a condition called quasi-concave differences, which implies concavity of the policy function in optimization problems without imposing differentiability or quasi-concavity conditions. The general take-away is that many distributional questions in economics which cannot be solved by direct calculations or the implicit function theorem, can be addressed easily with this article’s methods. Several applications demonstrate this: the article shows how increased uncertainty affects the set of equilibria in Bayesian games; it shows how increased dispersion of productivities affects output in the model of Melitz (2003); and it generalizes Carroll and Kimball (1996)’s result on concave consumption functions to the Aiyagari (1994) setting with borrowing constraints.
We describe a symmetric continuous-time model of trading among relatively overconfident, oligopolistic informed traders with exponential utility. Traders agree to disagree about the precisions of their continuous flows of Gaussian private information. The price depends on a trader’s inventory (permanent price impact) and the derivative of a trader’s inventory (temporary price impact). More disagreement makes the market more liquid; without enough disagreement, there is no trade. Target inventories mean-revert at the same rate as private signals. Actual inventories smoothly adjust towards target inventories at an endogenous rate which increases with disagreement. Faster-than-equilibrium trading generates “flash crashes” by increasing temporary price impact. A “Keynesian beauty contest” dampens price fluctuations.
We present theory and evidence highlighting the role of natural amenities in neighbourhood dynamics, suburbanization, and variation across cities in the persistence of the spatial distribution of income. Our model generates three predictions that we confirm using a novel database of consistent-boundary neighbourhoods in U.S. metropolitan areas, 1880–2010, and spatial data for natural features such as coastlines and hills. First, persistent natural amenities anchor neighbourhoods to high incomes over time. Secondly, naturally heterogeneous cities exhibit persistent spatial distributions of income. Thirdly, downtown neighbourhoods in coastal cities were less susceptible to the widespread decentralization of income in the mid-twentieth century and experienced an increase in income more quickly after 1980.
Do natural resources benefit producer economies, or is there a “Natural Resource Curse”, perhaps as the crowd-out of manufacturing productivity spillovers reduces long-term growth? We combine new data on oil and gas endowments with Census of Manufactures microdata to estimate how oil and gas booms affect local economies in the U.S. Local wages rise during oil and gas booms, but manufacturing is not crowded out—in fact, the sector grows overall, driven by upstream and locally-traded subsectors. Tradable manufacturing subsectors do contract during resource booms, but their productivity is unaffected, so there is no evidence of foregone local learning-by-doing effects. Over the full 1969–2014 sample, a county with one standard deviation additional oil and gas endowment averaged about 1% higher real wages. Overall, the results provide evidence against a Natural Resource Curse within the U.S.
Kernel-based estimators such as local polynomial estimators in regression discontinuity designs are often evaluated at multiple bandwidths as a form of sensitivity analysis. However, if in the reported results, a researcher selects the bandwidth based on this analysis, the associated confidence intervals (CIs) may not have correct coverage, even if the estimator is unbiased. This article proposes a simple adjustment that gives correct coverage in such situations: replace the normal quantile with a critical value that depends only on the kernel and ratio of the maximum and minimum bandwidths the researcher has entertained. We tabulate these critical values and quantify the loss in coverage for conventional CIs. For a range of relevant cases, a conventional 95% CI has coverage between 70% and 90%, and our adjustment amounts to replacing the conventional critical value 1.96 with a number between 2.2 and 2.8. Our results also apply to other settings involving trimmed data, such as trimming to ensure overlap in treatment effect estimation. We illustrate our approach with three empirical applications.
We propose a dynamic non-cooperative framework for long-term-care (LTC) decisions of families and use it to evaluate LTC policy options for the U.S. We first document the importance of informal caregiving and economic determinants of care arrangements. We then build a heterogeneous-agents model with imperfectly-altruistic overlapping generations to account for the patterns we find. A key innovation is the availability of informal care (IC), which is determined through intra-family bargaining. This opens up a new margin in response to policy and allows for informal insurance through home-production of care. Our calibrated model captures the observed care arrangements well. We study the implications of non-means-tested IC and formal care (FC) subsidies as well as changes to means-tested Medicaid. We find that IC responds strongly to these policies. An IC subsidy substantially reduces reliance on Medicaid, while the reduction of tax revenues due to lower labour supply by caregivers is modest. There are large welfare gains from a combination of IC and FC subsidies, even when combined with a reduction of the Medicaid program.
This article estimates a business cycle model with endogenous financial asset supply and ambiguity averse investors. Firms’ shareholders choose not only production and investment, but also capital structure and payout policy subject to financial frictions. An increase in uncertainty about profits lowers stock prices and leads firms to substitute away from debt as well as reduce shareholder payout. This mechanism parsimoniously accounts for the postwar comovement in investment, stock prices, leverage, and payout, at both business cycle and medium term cycle frequencies. Ambiguity aversion permits a Markov-switching VAR representation of the model, while preserving the effect of uncertainty shocks on the time variation in the equity premium.
Police agencies devote vast resources to minimizing the time that it takes them to attend the scene of a crime. Despite this, the long-standing consensus is that police response time has no meaningful effect on the likelihood of catching offenders. We revisit this question using a uniquely rich dataset from the Greater Manchester Police. To identify causal effects, we use a novel strategy that exploits discontinuities in distance to the response station across locations next to each other, but on different sides of division boundaries. Contrary to previous evidence, we find large and strongly significant effects: in our preferred estimate, a 10% increase in response time leads to a 4.7 percentage points decrease in the likelihood of clearing the crime. We find stronger effects for thefts than for violent offences, although the effects are large for every type of crime. We find suggestive evidence in support of two mechanisms: the likelihood of an immediate arrest and the likelihood that a suspect will be named by a victim or witness both increase as response time becomes faster. We argue that, under conservative assumptions, hiring an additional response officer would generate a benefit, in terms of future crime prevented, equivalent to 170% of her payroll cost.
Most of the political economy literature blames inefficient policies on institutions or politicians’ motives to supply bad policy, but voters may themselves be partially responsible by demanding bad policy. In this article, we posit that voters may systematically err when assessing potential changes in policy by underappreciating how new policies lead to new equilibrium behaviour. This biases voters towards policy changes that create direct benefits—welfare would rise if behaviour were held constant—even if those reforms ultimately reduce welfare because people adjust behaviour. Conversely, voters are biased against policies that impose direct costs even if they induce larger indirect benefits. Using a lab experiment, we find that a majority of subjects vote against policies that, while inflicting direct costs, would help them to overcome social dilemmas and thereby increase welfare. Subjects also support policies that, while producing direct benefits, create social dilemmas and ultimately hurt welfare. Both mistakes arise because subjects fail to fully anticipate the equilibrium effects of new policies. More precisely, we establish that subjects systematically underappreciate the extent to which policy changes will affect the behaviour of other people, and that these mistaken beliefs exert a causal effect on the demand for bad policy.
Difference-in-differences (DID) is a method to evaluate the effect of a treatment. In its basic version, a “control group” is untreated at two dates, whereas a “treatment group” becomes fully treated at the second date. However, in many applications of the DID method, the treatment rate only increases more in the treatment group. In such fuzzy designs, a popular estimator of the treatment effect is the DID of the outcome divided by the DID of the treatment. We show that this ratio identifies a local average treatment effect only if the effect of the treatment is stable over time, and if the effect of the treatment is the same in the treatment and in the control group. We then propose two alternative estimands that do not rely on any assumption on treatment effects, and that can be used when the treatment rate does not change over time in the control group. We prove that the corresponding estimators are asymptotically normal. Finally, we use our results to reassess the returns to schooling in Indonesia.
This article provides a model-based empirical strategy to, (1) detect the presence and gauge the magnitude of government subsidies and (2) quantify their impact on production reallocation across countries, industry prices, costs and consumer surplus. I construct and estimate an industry model that allows for dynamic agents in both demand and supply and apply my strategy to world shipbuilding, a classic target of industrial policy. I find strong evidence consistent with China having intervened and reducing shipyard costs by |$13$|–|$20\%$|⁠, corresponding to |$1.5$| to |$4.5$| billion US dollars, between 2006 and 2012. The subsidies led to substantial reallocation of ship production across the world, with Japan, in particular, losing significant market share. They also misaligned costs and production, while leading to minor surplus gains for shippers.
We introduce learning into an otherwise standard two-sided search-and-bargaining market. There is uncertainty about the price distribution due to uncertainty about an underlying exogenous state of relative demand: in the high state, buyers are on the long side; otherwise, they are on the short side. In equilibrium, prices are on average higher in the high state. Individual agents learn about the distribution while searching. Agents typically start out by experimenting with a tough bargaining position—buyers may initially insist on a low price and sellers on a high price. After successive failures to trade, agents become increasingly pessimistic about the market conditions and soften their bargaining stance. When frictions are small, equilibrium transaction prices are approximately market clearing, despite aggregate demand being unknown. Thus, the search-and-bargaining procedure enables price discovery in a decentralized market.
This article considers a classical linear simultaneous equations model with random coefficients on the endogenous variables. Simultaneous equations models are used to study social interactions, strategic interactions between firms, and market equilibrium. Random coefficient models allow for heterogeneous marginal effects. I show that random coefficient seemingly unrelated regression models with common regressors are not point identified, which implies random coefficient simultaneous equations models are not point identified. Important features of these models, however, can be identified. For two-equation systems, I give two sets of sufficient conditions for point identification of the coefficients’ marginal distributions conditional on exogenous covariates. The first allows for small support continuous instruments under tail restrictions on the distributions of unobservables which are necessary for point identification. The second requires full support instruments, but allows for nearly arbitrary distributions of unobservables. I discuss how to generalize these results to many equation systems, where I focus on linear-in-means models with heterogeneous endogenous social interaction effects. I give sufficient conditions for point identification of the distributions of these endogenous social effects. I propose a consistent nonparametric kernel estimator for these distributions based on the identification arguments. I apply my results to the Add Health data to analyse peer effects in education.
This article studies the impact of distortions in the access to international capital markets on competition and productivity. I show that a reduction in these distortions leads to an increase in aggregate productivity through two different channels. First, firms that were previously credit constrained respond to better financing terms by increasing their investment in technology, a reallocation effect. Secondly, non-constrained firms also expand their investment in technology because of increased competition, a pro-competitive effect. I provide evidence for these two channels using firm-level census data from the deregulation of international financial flows in Hungary.
I develop a directed search model to study the recruitment decisions of firms competing for workers who ex post differ in two dimensions: (1) their match productivity and (2) their probability of accepting a job offer, endogenously determined by their choice of application portfolio. To attract these workers, firms post a recruiting intensity and a hiring standard, in addition to terms of trade. A higher recruiting intensity is costly, but allows the firm to select more applicants for an interview, which reveals their productivity. The hiring standard solves the tradeoff between immediate hiring and waiting for a potentially better match in the future. I characterize equilibrium and find that various outcomes, including uniqueness of equilibrium and the cyclicality of recruiting intensity, crucially depend on firms’ recruiting cost and workers’ search cost. Calibration of the model to the U.S. labour market indicates a continuum of equilibria. Given selection of a particular equilibrium, hiring standards are countercyclical while recruiting intensity is procyclical. The calibrated model creates more amplification than a standard model without intensive margins and gives rise to procyclical match efficiency when viewed through the lens of a Cobb–Douglas matching function.
We extend the model of risk sharing with limited commitment by introducing both a public and a private (unobservable and/or non-contractible) storage technology. Positive public storage relaxes future participation constraints, hence it can improve risk sharing, contrary to the case where hidden income or effort is the deep friction. The characteristics of constrained-efficient allocations crucially depend on the storage technology’s return. At the steady state, if the return on storage is (i) moderately high, both assets and the consumption distribution may remain time-varying; (ii) sufficiently high, assets converge almost surely to a constant and the consumption distribution is time-invariant; (iii) equal to agents’ discount rate, perfect risk sharing is self-enforcing. Agents never have an incentive to use their private storage technology, |$i.e.$| Euler inequalities are always satisfied, at the constrained-efficient allocation of our model, while this is not the case without optimal public asset accumulation. Finally, we find that, in contrast with the limited-commitment model without storage, past income affects consumption growth negatively both in our model with storage and in data from Indian villages.
We provide a Keynesian growth theory in which pessimistic expectations can lead to very persistent, or even permanent, slumps characterized by high unemployment and weak growth. We refer to these episodes as stagnation traps, because they consist in the joint occurrence of a liquidity and a growth trap. In a stagnation trap, the central bank is unable to restore full employment because weak growth depresses aggregate demand and pushes the policy rate against the zero lower bound, while growth is weak because low aggregate demand results in low profits, limiting firms’ investment in innovation. Aggressive policies aiming at restoring growth, such as subsidies to investment, can successfully lead the economy out of a stagnation trap by generating a regime shift in agents’ growth expectations.
Recent empirical work shows large consumption responses to house price movements. This is at odds with a prominent theoretical view which, using the logic of the permanent income hypothesis, argues that consumption responses should be small. We show that, in contrast to this view, workhorse models of consumption with incomplete markets calibrated to rich cross-sectional micro facts actually predict large consumption responses, in line with the data. To explain this result, we show that consumption responses to permanent house price shocks can be approximated by a simple and robust rule-of-thumb formula: the marginal propensity to consume out of temporary income times the value of housing. In our model, consumption responses depend on a number of factors such as the level and distribution of debt, the size and history of house price shocks, and the level of credit supply. Each of these effects is naturally explained with our simple formula.
We document contemporaneous differences in the aggregate labour supply of married couples across seventeen European countries and the U.S. Based on a model of joint household decision making, we quantify the contribution of international differences in non-linear labour income taxes and consumption taxes to the international differences in hours worked in the data. Through the lens of the model, taxes, together with wages and the educational composition, account for a significant part of the small differences in married men’s and the large differences in married women’s hours worked in the data. Taking the full non-linearities of labour income tax codes, including the tax treatment of married couples, into account is crucial for generating the low cross-country correlation between married men’s and women’s hours worked in the data, and for explaining the variation of married women’s hours worked across European countries.
In the regression discontinuity design (RDD), it is common practice to assess the credibility of the design by testing whether the means of baseline covariates do not change at the cut-off (or threshold) of the running variable. This practice is partly motivated by the stronger implication derived by Lee (2008), who showed that under certain conditions the distribution of baseline covariates in the RDD must be continuous at the cut-off. We propose a permutation test based on the so-called induced ordered statistics for the null hypothesis of continuity of the distribution of baseline covariates at the cut-off; and introduce a novel asymptotic framework to analyse its properties. The asymptotic framework is intended to approximate a small sample phenomenon: even though the total number |$n$| of observations may be large, the number of effective observations local to the cut-off is often small. Thus, while traditional asymptotics in RDD require a growing number of observations local to the cut-off as |$n\to \infty$|⁠, our framework keeps the number |$q$| of observations local to the cut-off fixed as |$n\to \infty$|⁠. The new test is easy to implement, asymptotically valid under weak conditions, exhibits finite sample validity under stronger conditions than those needed for its asymptotic validity, and has favourable power properties relative to tests based on means. In a simulation study, we find that the new test controls size remarkably well across designs. We then use our test to evaluate the plausibility of the design in Lee (2008), a well-known application of the RDD to study incumbency advantage.
We find that daily air pollution levels have a significant effect on the decision to purchase or cancel health insurance in a manner inconsistent with rational choice theory. A one standard deviation increase in daily air pollution leads to a 7.2% increase in the number of insurance contracts sold that day. Conditional on purchase, a one standard deviation decrease in air pollution during the cooling-off (i.e. cost-free cancellation) period relative to the order-date level increases the return probability by 4.0%. We explore a range of potential mechanism and find the most support for projection bias and salience.
This article studies the transmission of financial shocks in a model where corporate credit is intermediated via both banks and bond markets. In choosing between bank and bond financing, firms trade-off the greater flexibility of banks in case of financial distress against the lower marginal costs of large bond issuances. I find that, in response to a contraction in bank credit supply, aggregate bond issuance in the corporate sector increases, but not enough to avoid a decline in aggregate borrowing and investment. Keeping leverage constant while retiring bank debt would expose firms to a higher risk of financial distress; they offset this by reducing total borrowing. A calibration of the model to the Great Recession indicates that this precautionary mechanism can account for one-third of the total decline in investment by firms with access to bond markets.
Most governments in the world, including the U.S., prohibit sex work. Given these types of laws rarely change and are fairly uniform across regions, our knowledge about the impact of decriminalizing sex work is largely conjectural. We exploit the fact that a Rhode Island District Court judge unexpectedly decriminalized indoor sex work to provide causal estimates of the impact of decriminalization on the composition of the sex market, reported rape offences, and sexually transmitted infections. While decriminalization increases the size of the indoor sex market, reported rape offences fall by 30% and female gonorrhoea incidence declines by over 40%.
We propose a stylized dynamic model to understand the role of social networks in the phenomenon we call “globalization”. In a nutshell, this term refers to the process by which even agents who are geographically far apart come to interact, thus being able to overcome what would otherwise be a fast saturation of local opportunities. A key feature of our model is that the social network is the main channel through which agents exploit new opportunities. Therefore, only if the social network becomes global (heuristically, it “reaches far in few steps”) can global interaction be steadily sustained. An important insight derived from the model is that, for the social network to turn global, the long-range links required (bridges) cannot endogenously arise unless the matching mechanism displays significant local structure (cohesion). This sheds novel light on the dichotomy between bridging and cohesion that has long played a prominent role in the socio-economic literature. Our analysis also relates the process of globalization to other features of the environment such as the quality of institutions or the arrival rate of fresh ideas. The model is partially studied analytically for a limit scenario with a continuum population and is fully solved numerically for finite-population contexts.
We study asset prices and portfolio choice with overlapping generations, where the young disregard history to learn from own experience. Disregarding history implies less precise estimates of output growth, which in equilibrium leads the young to increase their investment in risky assets after positive returns, that is, they act as trend chasers. In equilibrium, the risk premium decreases after a positive shock and, therefore, trend chasing young agents lose wealth relative to old agents who behave as contrarians. Consistent with findings from survey data, the average belief about the risk premium in the economy relates negatively to future excess returns and is smoother than the true risk premium.
The recent unravelling of the Eurozone’s financial integration raised concerns about feedback loops between sovereign and banking insolvency. This article provides a theory of the feedback loop that allows for both domestic bailouts of the banking system and sovereign debt forgiveness by international creditors or solidarity by other countries. Our theory has important implications for the re-nationalization of sovereign debt, macroprudential regulation, and the rationale for banking unions.
This article studies non-parametric panel data models with multidimensional, unobserved individual effects when the number of time periods is fixed. I focus on models where the unobservables have a factor structure and enter an unknown structural function non-additively. The setup allows the individual effects to impact outcomes differently in different time periods and it allows for heterogeneous marginal effects. I provide sufficient conditions for point identification of all parameters of the model. Furthermore, I present a non-parametric sieve maximum likelihood estimator as well as flexible semiparametric and parametric estimators. Monte Carlo experiments demonstrate that the estimators perform well in finite samples. Finally, in an empirical application, I use these estimators to investigate the relationship between teaching practice and student achievement. The results differ considerably from those obtained with commonly used panel data methods.
Recent literature analysing wage effects of immigration assumes labour supply is fixed across education-experience cells. This article departs from this assumption estimating a labour market equilibrium dynamic discrete choice model on U.S. micro-data for 1967–2007. Individuals adjust to immigration by changing education, participation, and/or occupation. Adjustments are heterogeneous: 4.2–26.2% of prime-aged native males change their careers; of them, some switch to white-collar careers and increase education by about three years; others reduce labour market attachment and reduce education also by about three years. These adjustments mitigate initial effects on wages and inequality. Natives that are more similar to immigrants are the most affected on impact, but also have a larger margin to adjust and differentiate. Adjustments also produce a self-selection bias in the estimation of wage effects at the lower tail of the distribution, which the model corrects.
We explore costly deliberation by two differentially informed and possibly biased jurors: A hawk Lones and a dove Moritz alternately insist on a verdict until one concedes. Debate assumes one of two genres, depending on bias: A juror, say Lones, is intransigent if he wishes to prevail and reach a conviction for any type of Moritz next to concede. In contrast, Lones is ambivalent if he wants the strongest conceding types of Moritz to push for acquittal. Both jurors are ambivalent with small bias or high delay costs. As Lones grows more hawkish, he argues more forcefully for convictions, mitigating wrongful acquittals. If dovish Moritz is intransigent, then he softens (strategic substitutes), leading to more wrongful convictions. Ambivalent debate is new, and yields a novel dynamic benefit of increased polarization. For if Moritz is ambivalent, then he toughens (strategic complements), and so, surprisingly, a more hawkish Lones leads to fewer wrongful acquittals and convictions. So more polarized but balanced debate can improve communication, unlike in static cheap talk. We also show that patient and not too biased jurors vote against their posteriors near the end of the debate, optimally playing devil’s advocate. We shed light on the adversarial legal system, peremptory challenges, and cloture rules.
This article shows how input heterogeneity triggers productivity spillovers at the workplace. In an egg production plant in rural Peru, workers produce output combining effort with inputs of heterogeneous quality. Exploiting variation in the productivity of inputs assigned to workers, we find evidence of a negative causal effect of an increase in coworkers’ daily output on own output and its quality. We show theoretically and suggest empirically that the effect captures free riding among workers, which originates from the way the management informs its dismissal decisions. Our study and results show that input heterogeneity and information on input quality contribute to determine the shape of incentives and have implications for human resource management, production management, and the interaction between the two. Counterfactual analyses show that processing information on inputs or changing their allocation among workers can generate significant productivity gains.
We study a unique field experiment in India in which 1.5 million stock investors face lotteries for the random allocation of shares. We find that the winners of these randomly assigned initial public offering (IPO) lottery shares are significantly more likely to hold them than lottery losers 1, 6, and even 24 months after the random allocation. This finding strongly evokes laboratory findings of an “endowment effect” for risky gambles, and persists in samples of highly active investors, suggesting along with additional evidence that this behaviour is not driven by inertia alone. The effect decreases as experience in the IPO market increases, but remains even for very experienced investors. Leading theories of the endowment effect based on reference-dependent preferences are unable to fully explain these and other findings in the data.
We provide new empirical evidence for the way in which financial markets process information. Our results rely critically on high-frequency intraday price and volume data for the S&P 500 equity portfolio and U.S. Treasury bonds, along with new econometric techniques, for making inference on the relationship between trading intensity and spot volatility around public news announcements. Consistent with the predictions derived from a theoretical model in which investors agree to disagree, our estimates for the intraday volume-volatility elasticity around important news announcements are systematically below unity. Our elasticity estimates also decrease significantly with measures of disagreements in beliefs, economic uncertainty, and textual-based sentiment, further highlighting the key role played by differences-of-opinion.
We develop a model of crime in which the number of police, the crime rate, the arrest rate, the employment rate, and the wage rate are joint outcomes of a subgame perfect Nash equilibrium. The local government chooses the size of its police force and citizens choose among work, home, and crime alternatives. We estimate the model using metropolitan statistical area (MSA)-level data. We use the estimated model to examine the effects on crime of targeted federal transfers to local governments to increase police. We find that knowledge about unobserved MSA-specific attributes is critical for the optimal allocation of police across MSA’s.
Sender, who is either good or bad, wishes to look good at an exogenous deadline. Sender privately observes if and when she can release a public flow of information about her private type. Releasing information earlier exposes to greater scrutiny, but signals credibility. In equilibrium bad Sender releases information later than good Sender. We find empirical support for the dynamic predictions of our model using data on the timing of U.S. presidential scandals and U.S. initial public offerings. In the context of elections, our results suggest that October Surprises are driven by the strategic behaviour of bad Sender.
Between 2007 and 2013, U.S. households experienced a large and persistent decline in net worth. The objective of this article is to study the business cycle implications of such a decline. We first develop a tractable monetary model in which households face idiosyncratic unemployment risk that they can partially self-insure using savings. A low level of liquid household wealth opens the door to self-fulfilling fluctuations: if wealth-poor households expect high unemployment, they have a strong precautionary incentive to cut spending, which can make the expectation of high unemployment a reality. Monetary policy, because of the zero lower bound, cannot rule out such expectations-driven recessions. In contrast, when wealth is sufficiently high, an aggressive monetary policy can keep the economy at full employment. Finally, we document that during the U.S. Great Recession wealth-poor households increased saving more sharply than richer households, pointing towards the importance of the precautionary channel over this period.
I show that, in a benchmark model, debt securities minimize the welfare losses associated with the moral hazards of excessive risk-taking and lax effort. For any security design, the variance of the security payoff is a statistic that summarizes these welfare losses. Debt securities have the least variance, among all limited liability securities with the same expected value. In other models, mixtures of debt and equity are exactly optimal, and pure debt securities are approximately optimal. I study both static and dynamic security design problems, and show that these two types of problems are equivalent. I use moral hazard in mortgage lending as a recurring example, but my results apply to other corporate finance and principal-agent problems.
We study environments in which agents are randomly matched to play a Prisoner’s Dilemma, and each player observes a few of the partner’s past actions against previous opponents. We depart from the existing related literature by allowing a small fraction of the population to be commitment types. The presence of committed agents destabilizes previously proposed mechanisms for sustaining cooperation. We present a novel intuitive combination of strategies that sustains cooperation in various environments. Moreover, we show that under an additional assumption of stationarity, this combination of strategies is essentially the unique mechanism to support full cooperation, and it is robust to various perturbations. Finally, we extend the results to a setup in which agents also observe actions played by past opponents against the current partner, and we characterize which observation structure is optimal for sustaining cooperation.
I study the implications of recursive utility, a popular preference specification in macro-finance, for the design of optimal fiscal policy. Standard Ramsey tax-smoothing prescriptions are substantially altered. The planner over-insures by taxing less in bad times and more in good times, mitigating the effects of shocks. At the intertemporal margin, there is a novel incentive for introducing distortions that can lead to an ex-ante capital subsidy. Overall, optimal policy calls for a much stronger use of debt returns as a fiscal absorber, leading to the conclusion that actual fiscal policy is even worse than we thought.
We present a dynamic model of trading under adverse selection in which a seller sequentially meets buyers, each of whom receives a noisy signal about the quality of the seller’s asset and offers a price. We fully characterize the equilibrium trading dynamics and show that buyers’ beliefs about the quality of the asset can either increase or decrease over time, depending on the initial level. This result demonstrates how the introduction of private buyer signals enriches the set of trading patterns that can be accommodated within the framework of dynamic adverse selection, thereby broadening its applicability. We also examine the economic effects of search frictions and the informativeness of buyers’ signals in our model and discuss the robustness of our main insights in multiple directions.
In this article, I study how relative wages and border enforcement affect immigration from Mexico to the U.S. To do this, I develop a discrete choice dynamic programming model where people choose from a set of locations in both the U.S. and Mexico, while accounting for the location of one’s spouse when making decisions. I estimate the model using data on individual immigration decisions from the Mexican Migration Project. Counterfactuals show that a 10% increase in Mexican wages reduces migration rates and durations, overall decreasing the number of years spent in the U.S. by about 5%. A 50% increase in enforcement reduces migration rates and increases durations of stay in the U.S., and the overall effect is a 7% decrease in the number of years spent in the U.S.
Economists often favour market-based mechanisms over non-market based mechanisms to allocate scarce public resources on grounds of economic efficiency and revenue generation. When the usage of the resources in question generates type-dependent negative externalities, the welfare comparison can become ambiguous. Both types of allocation mechanisms are being implemented in China's major cities to distribute limited vehicle licences as a measure to combat worsening traffic congestion and air pollution. While Beijing employs non-transferable lotteries, Shanghai uses an auction system. This article empirically quantifies the welfare consequences of the two mechanisms by taking into account both allocation efficiency and automobile externalities post-allocation. Our analysis shows that different allocation mechanisms lead to dramatic differences in social welfare. Although Beijing's lottery system has a large advantage in reducing automobile externalities over auction, the advantage is offset by the significant allocative cost from misallocation. The lottery system in Beijing resulted in a social welfare loss of 30 billion Yuan (nearly $5 billion) in 2012 alone. A uniform-price auction would have generated nearly 20 billion Yuan to Beijing municipal government, more than covering all its subsidies to the local public transit system.
In this article, we use micro data on both trade and production for a sample of large Chinese manufacturing firms in the footwear industry from 2002 to 2006 to estimate an empirical model of export demand, pricing, and market participation by destination market. We use the model to construct indexes of firm-level demand, marginal cost, and fixed cost. The empirical results indicate substantial firm heterogeneity in all three dimension with demand being the most dispersed. The firm-specific demand and marginal cost components account for over 30% of market share variation, 40% of sales variation, and over 50% of price variation among exporters. The fixed cost index is the primary factor explaining differences in the pattern of destination markets across firms. The estimates are used to analyse the supply reallocation following the removal of the quota on Chinese footwear exports to the EU. This led to a rapid restructuring of export supply sources on both the intensive and extensive margins in favour of firms with high demand and low fixed costs indexes, with marginal cost differences not being important.
This article shows that accounting for variation in mistakes can be crucial for welfare analysis. Focusing on consumer under-reaction to not-fully-salient sales taxes, we show theoretically that the efficiency costs of taxation are amplified by differences in under-reaction across individuals and across tax rates. To empirically assess the importance of these issues, we implement an online shopping experiment in which 2,998 consumers purchase common household products, facing tax rates that vary in size and salience. We replicate prior findings that, on average, consumers under-react to non-salient sales taxes—consumers in our study react to existing sales taxes as if they were only 25% of their size. However, we find significant individual differences in this under-reaction, and accounting for this heterogeneity increases the efficiency cost of taxation estimates by at least 200%. Tripling existing sales tax rates nearly doubles consumers’ attention to taxes, and accounting for this endogeneity increases efficiency cost estimates by 336%. Our results provide new insights into the mechanisms and determinants of boundedly rational processing of not-fully-salient incentives, and our general approach provides a framework for robust behavioural welfare analysis.
In this article, we use cross-state panel and cross-U.S. commuting-zone data to look at the relationship between innovation, top income inequality and social mobility. We find positive correlations between measures of innovation and top income inequality. We also show that the correlations between innovation and broad measures of inequality are not significant. Next, using instrumental variable analysis, we argue that these correlations at least partly reflect a causality from innovation to top income shares. Finally, we show that innovation, particularly by new entrants, is positively associated with social mobility, but less so in local areas with more intense lobbying activities.
We study the gains from trade liberalization in models with monopolistic competition, firm-level heterogeneity, and variable markups. For a large class of demand functions used in the international macro and trade literature, we derive a parsimonious generalization of the welfare formula in Arkolakis et al. (2012). We then use both estimates from micro-level trade data and evidence regarding firm-level pass-through to quantify the implications of this new formula. Within the class of models that we consider, our main finding is that gains from trade liberalization predicted by models with variable markups are equal to, at best, and slightly lower than, at worst, those predicted by models with constant markups. In this sense, pro-competitive effects of trade are elusive.
We propose a criterion of approximate incentive compatibility, strategy-proofness in the large (SP-L), and argue that it is a useful second-best to exact strategy-proofness (SP) for market design. Conceptually, SP-L requires that an agent who regards a mechanism’s “prices” as exogenous to her report—be they traditional prices as in an auction mechanism, or price-like statistics in an assignment or matching mechanism—has a dominant strategy to report truthfully. Mathematically, SP-L weakens SP in two ways: (1) truth-telling is required to be approximately optimal (within epsilon in a large enough market) rather than exactly optimal, and (2) incentive compatibility is evaluated ex interim, with respect to all full-support i.i.d. probability distributions of play, rather than ex post with respect to all possible realizations of play. This places SP-L in between the traditional notion of approximate SP, which evaluates incentives to manipulate ex post and as a result is too strong to obtain our main results in support of SP-L, and the traditional notion of approximate Bayes-Nash incentive compatibility, which, like SP-L, evaluates incentives to manipulate ex interim, but which imposes common knowledge and strategic sophistication assumptions that are often viewed as unrealistic.
We quantify the impact of scientific grant funding at the National Institutes of Health (NIH) on patenting by pharmaceutical and biotechnology firms. Our article makes two contributions. First, we use newly constructed bibliometric data to develop a method for flexibly linking specific grant expenditures to private-sector innovations. Second, we take advantage of idiosyncratic rigidities in the rules governing NIH peer review to generate exogenous variation in funding across research areas. Our results show that NIH funding spurs the development of private-sector patents: a $10 million boost in NIH funding leads to a net increase of 2.7 patents. Though valuing patents is difficult, we report a range of estimates for the private value of these patents using different approaches.
We estimate an equilibrium on-the-job search model with endogenous search intensity. Workers differ by skill, firms by productivity. Workers respond to mismatch by intensive search, and sorting may result from complementarities in the match-level production function. The model is estimated on Danish-matched employer–employee data. Firms are ranked through revealed preference by the fraction of hires that is poached from other firms: the poaching rank. Identification is obtained by firm rank conditional mobility and wage patterns. Wage variation is decomposed into four sources: sorting (40%), worker heterogeneity (32%), firm heterogeneity (18%), and frictional competition (10%). A social planner can improve output net of search cost by 1.5% relative to the decentralized solution.
In late 2003, Norway passed a law mandating 40% representation of each gender on the board of public limited liability companies. The primary objective of this reform was to increase the representation of women in top positions in the corporate sector and decrease the gender disparity in earnings within that sector. We document that the women appointed to these boards post-reform were observably more qualified than their female predecessors along many dimensions, and that the gender gap in earnings within boards fell substantially. However, we see no robust evidence that the reform benefited the larger set of women employed in the companies subject to the quota. Moreover, the reform had no clear impact on highly qualified women whose qualifications mirror those of board members but who were not appointed to boards. Finally, we find mixed support for the view that the reform affected the decisions of young women. While the reform was not accompanied by any change in female enrollment in business education programmes, we do see some improvements in labour market outcomes for young women with graduate business degrees in their early career stages; however, we observe similar improvements for young women with graduate science degrees, suggesting this may not be due to the reform. Overall, seven years after the board quota policy fully came into effect, we conclude that it had very little discernible impact on women in business beyond its direct effect on the women who made it into boardrooms.
This article examines the effect of cash versus in-kind transfers on local prices. Both types of transfers increase the demand for normal goods; in-kind transfers also increase supply in recipient communities, which could lead to lower prices than under cash transfers. We test and confirm this prediction using a programme in Mexico that randomly assigned villages to receive boxes of food (trucked into the village), equivalently-valued cash transfers, or no transfers. We find that prices are significantly lower under in-kind transfers compared to cash transfers; relative to the control group, in-kind transfers cause a 4% fall in prices while cash transfers cause a positive but negligible increase in prices. In the more economically developed villages in the sample, households’ purchasing power is only modestly affected by these price effects. In the less developed villages, the price effects are much larger in magnitude, which we show is due to these villages being less tied to the outside economy and having less competition among local suppliers.
In this article, I show that the key aspects of sovereign debt crises can be rationalized as part of the efficient risk-sharing arrangement between a sovereign borrower and foreign lenders in a production economy with informational and commitment frictions. The constrained efficient allocation involves ex post inefficient outcomes that resemble sovereign default episodes in the data and can be implemented with non-contingent defaultable bonds and active maturity management. Defaults and periods of temporary exclusion from international credit markets happen along the equilibrium path and are essential to supporting the efficient allocation. Furthermore, during debt crises, the maturity composition of debt shifts towards short-term debt and the term premium inverts as in the data.
Many information structures generate correlated rather than mutually independent signals, the news media being a prime example. This article provides experimental evidence that many people neglect the resulting double-counting problem in the updating process. In consequence, beliefs are too sensitive to the ubiquitous “telling and re-telling of stories” and exhibit excessive swings. We identify substantial and systematic heterogeneity in the presence of the bias and investigate the underlying mechanisms. The evidence points to the paramount importance of complexity in combination with people’s problems in identifying and thinking through the correlation. Even though most participants in principle have the computational skills that are necessary to develop rational beliefs, many approach the problem in a wrong way when the environment is moderately complex. Thus, experimentally nudging people’s focus towards the correlation and the underlying independent signals has large effects on beliefs.
We study state taxes as a potential source of spatial misallocation in the U.S.. We build a spatial general equilibrium framework that incorporates salient features of the U.S. state tax system, and use changes in state tax rates between 1980 and 2010 to estimate the model parameters that determine how worker and firm location respond to changes in state taxes. We find that heterogeneity in state tax rates leads to aggregate welfare losses. In terms of consumption equivalent units, harmonizing state taxes increases worker welfare by 0.6% if government spending is held constant, and by 1.2% if government spending responds endogenously. Harmonization of state taxes within Census regions achieves most of these gains. We also use our model to study the general equilibrium effects of recently implemented and proposed tax reforms.
This article studies an asymptotic framework for conducting inference on parameters of the form |$\phi(\theta_0)$|⁠, where |$\phi$| is a known directionally differentiable function and |$\theta_0$| is estimated by |$\hat \theta_n$|⁠. In these settings, the asymptotic distribution of the plug-in estimator |$\phi(\hat \theta_n)$| can be derived employing existing extensions to the Delta method. We show, however, that (full) differentiability of |$\phi$| is a necessary and sufficient condition for bootstrap consistency whenever the limiting distribution of |$\hat \theta_n$| is Gaussian. An alternative resampling scheme is proposed that remains consistent when the bootstrap fails, and is shown to provide local size control under restrictions on the directional derivative of |$\phi$|⁠. These results enable us to reduce potentially challenging statistical problems to simple analytical calculations—a feature we illustrate by developing a test of whether an identified parameter belongs to a convex set. We highlight the empirical relevance of our results by conducting inference on the qualitative features of trends in (residual) wage inequality in the U.S.
We propose a dynamic theory of financial intermediaries that are better able to collateralize claims than households, that is, have a collateralization advantage. Intermediaries require capital as they have to finance the additional amount that they can lend out of their own net worth. The net worth of financial intermediaries and the corporate sector are both state variables affecting the spread between intermediated and direct finance and the dynamics of real economic activity, such as investment, and financing. The accumulation of net worth of intermediaries is slow relative to that of the corporate sector. The model is consistent with key stylized facts about macroeconomic downturns associated with a credit crunch, namely, their severity, their protractedness, and the fact that the severity of the credit crunch itself affects the severity and persistence of downturns. The model captures the tentative and halting nature of recoveries from crises.
We develop a model explaining how criminal organizations strategically use pre-electoral violence as a way of influencing electoral results and politicians’ behaviour. We then characterize the incentives to use such violence under different levels of electoral competition and different electoral rules. Our theory is consistent with the empirical evidence within Sicily and across Italian regions. Specifically, the presence of organized crime is associated with abnormal spikes in violence against politicians before elections—particularly when the electoral outcome is more uncertain—which in turn reduces voting for parties opposed by criminal organizations. Using a very large data set of parliamentary debates, we also show that violence by the Sicilian Mafia reduces anti-Mafia efforts by members of parliament appointed in Sicily, particularly from the parties that traditionally oppose the Mafia.
The rules and procedures of legislatures often provide legislators with information bearing on the identities of upcoming proposers. For a broad class of legislative bargaining games, we establish that Markovian equilibria necessarily deliver all economic surplus to the first proposer whenever the information structure permits the legislators to rule out some minimum number of proposers one round in advance. This result holds regardless of the recognition process and even if players vary in patience and risk aversion. It raises the possibility that procedures adopted in the interest of transparency may contribute to the imbalance of political power.
Large multi-product firms dominate international trade flows. Using novel linked production and export data at the firm-product level, we find that the overwhelming majority of manufacturing firms export products that they do not produce. Three quarters of the exported products and 30% of export value from Belgian manufacturers are in goods that are not produced by the firm, so-called Carry-Along Trade (CAT). The number of CAT products is strongly increasing in firm productivity while the number of produced products that are exported is weakly increasing in firm productivity. We propose a general model of production and sourcing at multi-product firms and explore new demand- and supply-side modelling features capable of generating predictions consistent with the empirical findings. Export price data and company interviews offer suggestive evidence for the presence of demand-scope complementarities.
We study two wage bargaining games between a firm and multiple workers. We revisit the bargaining game proposed by Stole and Zwiebel. We show that, in the unique Subgame Perfect Equilibrium, the gains from trade captured by workers who bargain earlier with the firm are larger than those captured by workers who bargain later, as well as larger than those captured by the firm. The resulting equilibrium payoffs are different from those reported in Stole and Zwiebel as they are not the Shapley values. We propose a novel bargaining game, the Rolodex game, which follows a simple and realistic protocol. In the unique no-delay Subgame Perfect Equilibrium of this game, the payoffs to the firm and to the workers are their Shapley values.
This article analyses the effectiveness of hiring credits. Using comprehensive administrative data, we show that the French hiring credit, implemented during the Great Recession, had significant positive employment effects and no effects on wages. Relying on the quasi-experimental variation in labour cost triggered by the hiring credit, we estimate a structural search and matching model. Simulations of counterfactual policies show that the effectiveness of the hiring credit relied to a large extent on three features: it was non-anticipated, temporary and targeted at jobs with rigid wages. We estimate that the cost per job created by permanent hiring credits, either countercyclical or time-invariant, in an environment with flexible wages would have been much higher.
We implement a dynamic asset pricing experiment in the spirit of Lucas (1978) with storable assets and non-storable cash. In the first treatment, we impose diminishing marginal returns to cash to incentivize consumption smoothing across periods. We find that subjects use the asset to smooth consumption, although the asset trades at a discount relative to the risk-neutral fundamental price. This under-pricing is a departure from the asset price “bubbles” observed in the large experimental asset pricing literature originating with Smith et al. (1988) and can be rationalized by considering subjects’ risk aversion with respect to uncertain money earnings. In a second treatment, with no induced motivation for trade à la the Smith et al. design, we find that the asset trades at a premium relative to its expected value and that shareholdings are highly concentrated. Elimination of asset price uncertainty in additional experimental treatments serves to reinforce the same observations, and suggests that speculative behaviour explains the departure of prices from fundamental value in the absence of a consumption-smoothing motive for asset trades.
Many decisions are made in environments where outcomes are determined by the realization of multiple random events. A decision maker may be uncertain how these events are related. We identify and experimentally substantiate behaviour that intuitively reflects a lack of confidence in their joint distribution. Our findings suggest a dimension of ambiguity which is different from that in the classical distinction between risk and “Knightian uncertainty”.
We study complexity in the market for securitized products, a market at the heart of the financial crisis of 2007–9. The complexity of these products rose substantially in the years preceding the financial crisis. We find that securities in more complex deals default more and have lower realized returns. The worse performance is economically meaningful: a one standard deviation increase in complexity represents an 18% increase in default on AAA securities. However, yields of more complex securities are not higher indicating that investors did not perceive them as riskier. Our results are consistent with complexity obfuscating security quality.
We document the short- and long-run effects of male-biased sex ratios. We exploit a natural historical experiment where large numbers of male convicts and far fewer female convicts were sent to Australia in the 18th and 19th centuries. In areas with more male-biased sex ratios, women were historically more likely to get married and less likely to work outside the home. In these areas today, both men and women continue to have more conservative attitudes towards women working, and women work fewer hours outside the home. While these women enjoy more leisure, they are also less likely to work in high-ranking occupations. We demonstrate that the consequences of uneven sex ratios on cultural attitudes, labour supply decisions, and occupational choices can persist in the long run, well after sex ratios are back to the natural rate. We document the roles of vertical cultural transmission and marriage homogamy in sustaining this cultural persistence.
Why do office-motivated politicians sometimes espouse views that are non-congruent with their electorate’s? Can non-congruent statements convey any information about what a politician will do if elected, and if so, why would voters elect a politician who makes such statements? Furthermore, can electoral campaigns also directly affect an elected official’s behaviour? We develop a model of credible “cheap talk”—costless and non-binding communication—in elections. The foundation is an endogenous voter preference for a politician who is known to be non-congruent over one whose congruence is sufficiently uncertain. This preference arises because uncertainty about an elected official’s policy preferences generates policymaking distortions due to reputation/career concerns. We show that cheap talk can alter the electorate’s beliefs about a politician’s policy preferences and thereby affect the elected official’s behaviour. Informative cheap talk can increase or decrease voter welfare, with a greater scope for welfare benefits when reputation concerns are more important.
I present a theory of harmful addiction in which “giving in” to an unwanted urge (⁠|$i.e.$| consumption) delays the recurrence of urges in the short-run, but increases their long-run frequency. The theory offers new predictions as to how the frequency, levels, cue-dependence, and temporal consistency of consumption evolve during habituation, while uniquely capturing near-term substitution in demand across time. New welfare implications for restrictions on consumption and on marketing are also addressed.
We provide a general theoretical characterization of how firms’ technology choice on a technology frontier determines the long-run elasticity of substitution between capital and labour. We show that the shape of the frontier determines factor shares and the elasticity of substitution between capital and labour. If there are adjustment costs to technology choice, the short- and long-run elasticities differ, with the long-run always higher. If the technology frontier is log-linear, the production function becomes Cobb–Douglas in the long run but, consistent with empirical evidence, short-run dynamics are characterized by gross complementarity. The approach is easily implementable and yields a powerful way to introduce CES-type production functions in macroeconomic models. We provide an illustration within an estimated dynamic general equilibrium model and show that the use of our production technology provides a good match for the short- and medium-run behaviour of the U.S. labour share.
We measure the impact of direct-to-consumer television advertising (DTCA) by drug manufacturers. Our identification strategy exploits shocks to local advertising markets generated by the political advertising cycle and a regulatory intervention affecting a single product. We find evidence of significant business stealing effects among branded, advertised drugs. In addition, we show positive spillovers from drug advertisements to non-advertised competitors in the same class. We decompose the effect and show it is primarily due to new customers. Finally, we provide evidence that DTCA is cost-effective from a societal standpoint in our setting.
This article illustrates and characterizes how adaptive learning can lead to recurrent large fluctuations. Learning models have typically focused on the convergence of beliefs towards an equilibrium. However in stochastic environments, there may be rare but recurrent episodes where shocks cause beliefs to escape from the equilibrium, generating large movements in observed outcomes. I characterize the escape dynamics by drawing on the theory of large deviations, developing new results which make this theory directly applicable in a class of learning models. The likelihood, frequency, and most likely direction of escapes are all characterized by a deterministic control problem. I illustrate my results with two simple examples.
This article provides a model of social learning where the order in which actions are taken is determined by an |$m$|-dimensional integer lattice rather than along a line as in the herding model. The observation structure is determined by a random network. Every agent links to each of his preceding lattice neighbours independently with probability |$p$|⁠, and observes the actions of all agents that are reachable via a directed path in the realized social network. For |$m\geq 2$|⁠, we show that as |$p<1$| goes to one, (1) so does the asymptotic proportion of agents who take the optimal action, (2) this holds for any informative signal distribution, and (3) bounded signal distributions might achieve higher expected welfare than unbounded signal distributions. In contrast, if signals are bounded and |$p=1$|⁠, all agents select the suboptimal action with positive probability.
We experimentally investigate the time-inconsistent taste for immediate gratification and future-preference misprediction. Across 7 weeks, 100 participants choose the number of unpleasant transcription tasks given various wages to complete immediately and at different future dates. Participants preferred 10–12% fewer tasks in the present compared to any future date, leading to an estimated |$\beta $| of |$0.83$|⁠. Comparing predictions with actual immediate-work choices provides evidence against substantial sophistication, with estimates implying that participants understand no more than 24% of their present bias. Finally, we find evidence of “projection bias”: participants wished to complete 4–12% fewer tasks when decisions were elicited right after completing tasks rather than before.
Low adoption of agricultural technologies holds large productivity consequences for developing countries. Many countries hire agricultural extension agents to communicate with farmers about new technologies, even though a large academic literature has established that information from social networks is a key determinant of product adoption. We incorporate social learning in extension policy using a large-scale field experiment in which we communicate to farmers using different members of social networks. We show that communicator own adoption and effort are susceptible to small performance incentives, and the social identity of the communicator influences others’ learning and adoption. Farmers appear most convinced by communicators who share a group identity with them, or who face comparable agricultural conditions. Exploring the incentives for injection points in social networks to experiment with and communicate about new technologies can take the influential social learning literature in a more policy-relevant direction.
We examine how trust is sustained in large societies with random matching, when records of past transgressions are retained for a finite length of time. To incentivize trustworthiness, defaulters should be punished by temporary exclusion. However, it is profitable to trust defaulters who are on the verge of rehabilitation. With perfect bounded information, defaulter exclusion unravels and trust cannot be sustained, in any purifiable equilibrium. A coarse information structure, that pools recent defaulters with those nearing rehabilitation, endogenously generates adverse selection, sustaining punishments. Equilibria where defaulters are trusted with positive probability improve efficiency, by raising the proportion of likely re-offenders in the pool of defaulters.
This article develops a method to estimate and simulate the adoption of a network good. I estimate demand for mobile phones as a function of individuals’ social networks, coverage, and prices, using transaction data from nearly the entire network of Rwandan mobile phone subscribers at the time, over 4.5 years. I estimate the utility of adopting a phone based on its eventual usage: subscribers pay on the margin, so calls reveal the value of communicating with each contact. I use this structural model to simulate the effects of two policies. A requirement to serve rural areas lowered operator profits but increased net social welfare. Developing countries heavily tax mobile phones, but standard metrics that neglect network effects grossly understate the true welfare cost in a growing network, which is up to 3.12 times the revenue raised. Shifting from handset to usage taxes would have increased the surplus of poorer users by at least 26%.
We unite two basic approaches to modelling limited attention in choice by showing that the rational inattention model implies the formation of consideration sets—only a subset of the available alternatives will be considered for choice. We provide necessary and sufficient conditions for rationally inattentive behaviour which allow the identification of consideration sets. In simple settings, chosen options are those that are best on a stand-alone basis. In richer settings, the consideration set can only be identified holistically. In addition to payoffs, prior beliefs impact consideration sets. Linear inequalities identify all priors consistent with each possible consideration set.
We study the implications of including many covariates in a first-step estimate entering a two-step estimation procedure. We find that a first-order bias emerges when the number of included covariates is “large” relative to the square-root of sample size, rendering standard inference procedures invalid. We show that the jackknife is able to estimate this “many covariates” bias consistently, thereby delivering a new automatic bias-corrected two-step point estimator. The jackknife also consistently estimates the standard error of the original two-step point estimator. For inference, we develop a valid post-bias-correction bootstrap approximation that accounts for the additional variability introduced by the jackknife bias-correction. We find that the jackknife bias-corrected point estimator and the bootstrap post-bias-correction inference perform excellent in simulations, offering important improvements over conventional two-step point estimators and inference procedures, which are not robust to including many covariates. We apply our results to an array of distinct treatment effect, policy evaluation, and other applied microeconomics settings. In particular, we discuss production function and marginal treatment effect estimation in detail.
This article quantitatively evaluates the trade-off between the provision of health-related social insurance and the incentives to maintain good health through costly investments. To do so, we construct and estimate a dynamic model of health investments and health insurance in which the cross-sectional health distribution evolves endogenously and is shaped by labour market and health insurance policies. A no wage discrimination law in the labour market limits the extent to which wages can depend on the health status of a worker, and a no prior conditions law outlaws higher insurance premia for individuals with worse health status. In the model, the static gains from better insurance against poor health induced by these policies are traded off against their adverse dynamic incentive effects on household efforts to lead a healthy life. In our quantitative analysis, we find that it is optimal to insure 80% of labour market-related income risk (70% if a no prior conditions law is also present). Providing full insurance is strongly suboptimal, however, since at high levels of consumption insurance, the negative dynamic incentive effects on health effort and thus the population health distribution in the long run start to dominate the short-run consumption insurance gains.
Historically, European Jews have specialized in financial services while being the victims of antisemitism. We find that the present-day demand for finance is lower in German counties where historical antisemitism was higher, compared to otherwise similar counties. Households in counties with high historical antisemitism have similar saving rates but invest less in stocks, hold lower saving deposits, and are less likely to get a mortgage to finance homeownership after controlling for wealth and a rich set of current and historical covariates. Present-day antisemitism and supply-side forces do not fully explain the results. Households in counties where historical antisemitism was higher distrust the financial sector more—a potential cultural externality of historical antisemitism that reduces wealth accumulation in the long run.
Non-equilibrium models of choice (e.g. level-|$k$| reasoning) have significantly different, sometimes more accurate, predictions in games than does Nash equilibrium. When it comes to the maximal set of functions that are implementable in mechanism design, however, they turn out to have similar implications. Focusing on single-valued rules, we discuss the role and implications of different behavioural anchors (arbitrary level-0 play), and prove a level-|$k$| revelation principle. If a function is level-|$k$| implementable given any level-0 play, it must obey a slight weakening of standard strict incentive constraints. Further, the same condition is also sufficient for level-|$k$| implementability, although the role of specific level-0 anchors is more controversial for the sufficiency argument. Nonetheless, our results provide tight characterizations of level-|$k$| implementable functions under a variety of level-0 play, including truthful, uniform, and atomless anchors.
To what extent does crime follow the pattern of potential gains to illegal activity? This article presents evidence on how criminals respond to this key incentive by reporting crime–price elasticities estimated from a comprehensive crime dataset containing detailed information on stolen items for London between 2002 and 2012. Evidence of significant positive crime–price elasticities are shown, for a panel of 44 consumer goods and for commodity related goods (jewellery, fuel, and metal crimes). The reported evidence indicates that potential gains are a major empirical driver of criminal activity and a crucial part of the economic model of crime. The changing structure of goods prices helps to explain over 10–15% of the observed fall in property crime across all goods categories, and the majority of the sharp increases in the commodity related goods observed between 2002 and 2012.
We conduct an empirical analysis of consumer preferences and search costs on an Internet platform. Using data from a major French platform (PriceMinister), we show descriptive evidence of substantial price dispersion among adverts for the same product, of consumers often not choosing the cheapest advert and sometimes choosing an advert dominated in price and non-price characteristics by another available advert. We consider a sequential search model where consumers sample adverts in an endogenous order based on their preferences and search costs. We show that the optimal search-and-purchase strategy can be characterized by a set of inequalities which can feasibly be tested on transaction and advert data. This allows us to estimate, for each transaction, a set of preference and search cost parameter values, thus allowing for flexible consumer heterogeneity in preferences and search costs. The estimated model can then describe a wide range of consumer search and purchase behaviours. We find that the model can explain almost all transactions in the data and requires non-zero preferences and search costs for at least 50% and 22% (respectively) of observations. We also find evidence of heterogeneous and sometimes substantial search costs.
This article proposes a theory of optimal public expenditure when unemployment is inefficient. The theory is based on a matching model. Optimal public expenditure deviates from the Samuelson rule to reduce the unemployment gap (the difference between current and efficient unemployment rates). Such optimal “stimulus spending” is described by a formula expressed with three sufficient statistics: the unemployment gap, the unemployment multiplier (the decrease in unemployment achieved by increasing public expenditure), and the elasticity of substitution between public and private consumption. When unemployment is inefficiently high and the multiplier is positive, the formula yields the following results. (1) Optimal stimulus spending is positive and increasing in the unemployment gap. (2) Optimal stimulus spending is zero for a zero multiplier, increasing in the multiplier for small multipliers, largest for a moderate multiplier, and decreasing in the multiplier beyond that. (3) Optimal stimulus spending is zero if extra public goods have no value, it becomes larger as the elasticity of substitution increases, and it completely fills the unemployment gap if extra public goods are as valuable as extra private goods.
This article proposes a strategic framework to account for fertility choices in polygamous households. It uses unique data on fertility histories of a representative sample of co-wives in Senegal to estimate a duration model of birth intervals with individual baseline hazards. Exploiting entries and exits of co-wives as well as gender of births, empirical tests show that children are strategic complements. One wife raises her fertility in response to an increase by the other wife, because children are the best claim to resources controlled by the husband. This result is the first quantitative evidence that the competition between co-wives drives fertility upwards. It suggests that polygamy undermines the fertility transition in Sub-Saharan Africa by incentivizing women to want many children. This article is also one of the few attempts to open the black box of non-nuclear families, placing strategic interactions at the heart of household decision-making.
Home price expectations are believed to play an important role in housing dynamics, yet we have limited understanding of how they are formed and how they affect behaviour. Using a unique “information experiment” embedded in an online survey, this article investigates how consumers’ home price expectations respond to past home price growth, and how they impact investment decisions. After eliciting respondents’ priors about past and future local home price changes, we present a random subset of them with factual information about past (one- or five-year) changes, and then re-elicit expectations. This unique “panel” data allows us to identify causal effects of the information, and provides insights on the expectation formation process. We find that, on average, year-ahead home price expectations are revised in a way consistent with short-term momentum in home price growth, though respondents tend to underpredict the strength of momentum. Revisions of longer-term expectations show that respondents do not expect the empirically-occurring mean reversion in home price growth. These patterns are in line with recent behavioural models of housing cycles. Finally, we show that home price expectations causally affect investment decisions in a portfolio choice experiment embedded in the survey.
We develop and evaluate experimentally a novel tool that redesigns the job search process by providing tailored advice at low cost. We invited jobseekers to our computer facilities for twelve consecutive weekly sessions to search for real jobs on our web interface. For one-half, instead of relying on their own search criteria, we use readily available labour market data to display relevant alternative occupations and associated jobs. The data indicate that this broadens the set of jobs they consider and increases their job interviews especially for participants who otherwise search narrowly and have been unemployed for a few months.
We use 130 years of data on historical migrations to the U.S. to show a causal effect of the ancestry composition of U.S. counties on foreign direct investment (FDI) sent and received by local firms. To isolate the causal effect of ancestry on FDI, we build a simple reduced-form model of migrations: Migrations from a foreign country to a U.S. county at a given time depend on (1) a push factor, causing emigration from that foreign country to the entire U.S., and (2) a pull factor, causing immigration from all origins into that U.S. county. The interaction between time-series variation in origin-specific push factors and destination-specific pull factors generates quasi-random variation in the allocation of migrants across U.S. counties. We find that doubling the number of residents with ancestry from a given foreign country relative to the mean increases the probability that at least one local firm engages in FDI with that country by 4 percentage points. We present evidence that this effect is primarily driven by a reduction in information frictions, and not by better contract enforcement, taste similarities, or a convergence in factor endowments.
We model and test two school-based peer cultures: one that stigmatizes effort and one that rewards ability. The model shows that either may reduce participation in educational activities when peers can observe participation and performance. We design a field experiment that allows us to test for, and differentiate between, these two concerns. We find that peer pressure reduces takeup of an SAT prep package virtually identically across two very different high school settings. However, the effects arise from very distinct mechanisms: a desire to hide effort in one setting and a desire to hide low ability in the other.
The standard revenue-maximizing auction discriminates against a priori stronger bidders so as to reduce their information rents. We show that such discrimination is no longer optimal when the auction’s winner may resell to another bidder, and the auctioneer has non-Bayesian uncertainty about such resale opportunities. We identify a “worst-case” resale scenario, in which bidders’ values become publicly known after the auction and losing bidders compete Bertrand-style to buy the object from the winner. With this form of resale, misallocation no longer reduces the information rents of the high-value bidder, as he could still secure the same rents by buying the object in resale. Under regularity assumptions, we show that revenue is maximized by a version of the Vickrey auction with bidder-specific reserve prices, first proposed by Ausubel and Cramton (2004). The proof of optimality involves constructing Lagrange multipliers on a double continuum of binding non-local incentive constraints.
We develop a new methodology to estimate the elasticity of urban costs with respect to city population using French house and land price data. After handling a number of estimation concerns, we find that the elasticity of urban costs increases with city population with an estimate of about 0.03 for an urban area with 100,000 inhabitants to 0.08 for an urban area of the size of Paris. Our approach also yields a number of intermediate outputs of independent interest such as the share of housing in expenditure, the elasticity of unit house and land prices with respect to city population, and within-city distance gradients for house and land prices.
We study the interplay between informational frictions and second-degree price discrimination. Our theory recognizes that consumers differ in their tastes for quality as well as in the information they possess about available offers, which leads to dispersion over price–quality menus in equilibrium. While firms are ex ante identical, we show that their menus are ordered so that more generous menus leave more surplus to consumers of all valuations. We explore the cross-section of equilibrium menus and variations in market conditions to generate empirical predictions on prices, qualities, and markups across firms, and within a firm’s product line. For instance, more competition may raise prices for low-quality goods; yet, consumers are better off, as the qualities they receive also increase. The predictions of our model illuminate empirical findings in many markets, such as those for cell phone plans, yellow-pages advertising, cable TV, and air travel.
This article models a frictional labour market where employers endogenously discriminate against the long-term unemployed. The estimated model replicates recent experimental evidence which documents that interview invitations for observationally equivalent workers fall sharply as unemployment duration progresses. We use the model to quantitatively assess the consequences of such employer behaviour for job finding rates and long-term unemployment and find only modest effects given the large decline in callbacks. Interviews lost to duration impact individual job finding rates solely if they would have led to jobs. We show that such instances are rare when firms discriminate in anticipation of an ultimately unsuccessful application. Discrimination in callbacks is thus largely a response to dynamic selection, with limited consequences for structural duration dependence and long-term unemployment.
We study platform markets in which the information about users’ preferences is dispersed. First, we show how the dispersion of information introduces idiosyncratic uncertainty about participation decisions and how the latter shapes the elasticity of the demands and the equilibrium prices. We then study the effects on profits, consumer surplus, and welfare of platform design, blogs, forums, conferences, advertising campaigns, post-launch disclosures, and other information management policies affecting the agents’ ability to predict participation decisions on the other side of the market.
We use randomized interest rates, offered across eighty geographically distinct regions for twenty-nine months by Mexico’s largest microlender, to sketch the adjustment from a price change to a new equilibrium. Demand is elastic, and more so over the longer run; e.g. the dollars-borrowed elasticity increases from |$-$|1.1 in Year one to |$-$|2.9 in Year three. Credit bureau data do not show evidence of crowd-out, although this and other null results are imprecisely estimated. The lender’s profits increase, albeit noisily, starting in Year two. But competitors do not respond by reducing rates. These findings, together with other results, suggest that informational frictions are important, and that cutting rates furthered Compartamos Banco’s “double bottom line” of improving social welfare subject to a profitability constraint.
I study optimal design of a dynamic capital allocation process in an organization in which the division manager with empire-building preferences privately observes the arrival and properties of investment projects, and headquarters can audit projects at a cost. Under certain conditions, a budgeting mechanism with threshold separation of financing is optimal. Headquarters: (1) allocate a spending account to the manager and replenish it over time; (2) set a threshold, such that projects below it are financed from the account, while projects above are financed fully by headquarters upon an audit. Further analysis studies when co-financing of projects is optimal and how the size of the account depends on past performance of projects.
The majority of innovations are developed by multi-sector firms. The knowledge needed to invent new products is more easily adapted from some sectors than from others. We study this network of knowledge linkages between sectors and its impact on firm innovation and aggregate growth. We first document a set of sectoral-level and firm-level observations on knowledge applicability and firms’ multi-sector patenting behaviour. We then develop a general equilibrium model of firm innovation in which inter-sectoral knowledge linkages determine the set of sectors a firm chooses to innovate in and how much R&D to invest in each sector. It captures how firms evolve in the technology space, accounts for cross-sector differences in R&D intensity, and describes an aggregate model of technological change. The model matches new observations as demonstrated by simulation. It also yields new insights regarding the mechanism through which sectoral fixed costs of R&D affect growth.
This article considers the problem of testing many moment inequalities where the number of moment inequalities, denoted by |$p$|⁠, is possibly much larger than the sample size |$n$|⁠. There is a variety of economic applications where solving this problem allows to carry out inference on causal and structural parameters; a notable example is the market structure model of Ciliberto and Tamer (2009) where |$p=2^{m+1}$| with |$m$| being the number of firms that could possibly enter the market. We consider the test statistic given by the maximum of |$p$| Studentized (or |$t$|-type) inequality-specific statistics, and analyse various ways to compute critical values for the test statistic. Specifically, we consider critical values based upon (1) the union bound combined with a moderate deviation inequality for self-normalized sums, (2) the multiplier and empirical bootstraps, and (3) two-step and three-step variants of (1) and (2) by incorporating the selection of uninformative inequalities that are far from being binding and a novel selection of weakly informative inequalities that are potentially binding but do not provide first-order information. We prove validity of these methods, showing that under mild conditions, they lead to tests with the error in size decreasing polynomially in |$n$| while allowing for |$p$| being much larger than |$n$|⁠; indeed |$p$| can be of order |$\exp (n^{c})$| for some |$c > 0$|⁠. Importantly, all these results hold without any restriction on the correlation structure between |$p$| Studentized statistics, and also hold uniformly with respect to suitably large classes of underlying distributions. Moreover, in the online supplement, we show validity of a test based on the block multiplier bootstrap in the case of dependent data under some general mixing conditions.
A series of discontinuities in the allocation mechanism of federal transfers to municipal governments in Brazil allow us to identify the causal effect of public spending on local labour markets, using a “fuzzy” Regression Discontinuity Design (RDD). Our estimates imply a cost per job of about 8,000 US dollars per year and a local income multiplier around two. The effect comes mostly from employment in services and is more pronounced among less financially developed municipalities.
Dynastic models common in macroeconomics use a single parameter to control the willingness of individuals to substitute consumption both intertemporally, or across periods, and intergenerationally, or across parents and their children. This article defines the concept of elasticity of intergenerational substitution (EGS), and extends a standard dynastic model in order to disentangle the EGS from the EIS, or elasticity of intertemporal substitution. A calibrated version of the model lends strong support to the notion that the EGS is significantly larger than one. In contrast, estimates of the EIS suggests that it is at most one. What disciplines the identification is the need to match empirically plausible fertility rates for the U.S. We illustrate the potential role of the EGS in macroeconomics.
In markets where sellers are able to price discriminate, individuals pay different prices that may be unobserved by the econometrician. This article considers the structural estimation of a demand and supply model of differentiated products with such price discrimination and limited information on prices taking the form of, e.g., observing list prices from catalogues or average prices. Within this framework, identification is achieved not only with usual moment conditions on the demand side, but also through supply-side restrictions. The model can be estimated by GMM using a nested fixed point algorithm that extends the usual contraction mapping algorithm to our setting. We apply our methodology to estimate the demand and supply in the French new automobile market. Our results suggest that discounting arising from price discrimination is important. The average discount is estimated to be 9.6%, with large variation depending on buyers’ characteristics and cars’ specifications. Our results are consistent with other evidence on transaction prices in France.
To estimate the causal effect of refugee migration on voting outcomes in parliamentary and municipal elections in Denmark, our study is the first that addresses the key problem of immigrant sorting by exploiting a policy that assigned refugee immigrants to municipalities on a quasi-random basis. We find that in all but the most  urban municipalities, allocation of larger refugee shares between electoral cycles leads to an increase in the vote share for right-leaning parties with an anti-immigration agenda, and we show large differences in voters’ responses to refugee allocation according to pre-policy municipal characteristics. However, in the largest and urban municipalities, refugee allocation has—if anything—the opposite effect on vote shares for anti-immigration parties. This coincides with a sharp divide in attitudes to refugees between urban and rural populations, which may be partly explained by distinctive interactions between natives and those with different background in cities and rural areas. Refugee allocation also has a large impact on the anti-immigration parties’ choice of where to stand for municipal election, and we provide some evidence that it influences voter turnout.
We empirically study the effects of broadband internet diffusion on local election outcomes and on local government policies using rich data from the U.K. Our analysis shows that the internet has displaced other media with greater news content (i.e. radio and newspapers), thereby decreasing voter turnout, most notably among less-educated and younger individuals. In turn, we find suggestive evidence that local government expenditures and taxes are lower in areas with greater broadband diffusion, particularly expenditures targeted at less-educated voters. Our findings are consistent with the idea that voters’ information plays a key role in determining electoral participation, government policies, and government size.
When judging the value of a good, people may be overly influenced by the state in which they previously consumed it. For example, someone who tries out a new restaurant while very hungry may subsequently rate it as high quality, even if the food is mediocre. We produce a simple framework for this form of attribution bias that embeds a standard model of decision making as a special case. We test for attribution bias across two consumer decisions. First, we conduct an experiment in which we randomly manipulate the thirst of participants prior to consuming a new drink. Second, using data from thousands of amusement park visitors, we explore how pleasant weather during their most recent trip affects their stated and actual likelihood of returning. In both of these domains, we find evidence that people misattribute the influence of a temporary state to a stable quality of the consumption good. We provide evidence against several alternative accounts for our findings and discuss the broader implications of attribution bias in economic decision making.
We study the impact of the integration of women in U.S. policing between the late 1970s and early 1990s on violent crime reporting and domestic violence (DV). Along these two key dimensions, we find that female officers improved police quality. Crime victimization data reveal that as female representation increases among officers in an area, violent crimes against women in that area, and especially DV, are reported to the police at significantly higher rates. There are no such effects for violent crimes against men or from increases in the female share of civilian police employees. Furthermore, increases in female officer shares are followed by significant declines in rates of intimate partner homicide and non-fatal domestic abuse. These effects are all consistent between fixed effects models with controls for economic and policy variables and models that focus exclusively on increases in female police employment driven by externally imposed affirmative action plans following litigation for employment discrimination.
We introduce a dynamic noisy rational expectations model in which information diffuses through a general network of agents. In equilibrium, agents who are more closely connected have more similar period-by-period trades, and an agent’s profitability is determined by a centrality measure that is related to Katz centrality. Volatility after an information shock is more persistent in less central networks, and volatility and trading volume are also influenced by the network’s asymmetry and irregularity. Using account-level data of all portfolio holdings and trades on the Helsinki Stock Exchange between 1997 and 2003, we find support for the aggregate predictions, altogether suggesting that the market’s network structure is important for these dynamics.
Panel and experimental data are used to analyse the economic outcomes in the extended warranty market. We establish that the strong demand and high profits in this market are driven by consumers distorting the failure probability of the insured product, rather than standard risk aversion or sellers’ market power. Providing information to consumers about failure probabilities significantly reduces their willingness to pay for warranties, indicating the important role of information, or lack of, in driving consumers’ purchase behaviour. Such information provision is shown to be more effective in enhancing consumer welfare than additional market competition.
We propose non-parametric definitions of absolute and comparative naivete. These definitions leverage ex ante choice of menu to identify predictions of future behaviour and ex post (random) choices from menus to identify actual behaviour. The main advantage of our definitions is their independence from any assumed functional form for the utility function representing behaviour. An individual is sophisticated if she is indifferent ex ante between retaining the option to choose from a menu ex post or committing to her actual distribution of choices from that menu. She is naive if she prefers the flexibility in the menu, reflecting a mistaken belief that she will act more virtuously than she actually will. We propose two definitions of comparative naivete and explore the restrictions implied by our definitions for several prominent models of time inconsistency.
How strong are strategic complementarities in price setting across firms? In this article, we provide a direct empirical estimate of firms’ price responses to changes in competitor prices. We develop a general theoretical framework and an empirical identification strategy, taking advantage of a new micro-level dataset for the Belgian manufacturing sector. We find strong evidence of strategic complementarities, with a typical firm adjusting its price with an elasticity of 0.4 in response to its competitors’ price changes and with an elasticity of 0.6 in response to its own cost shocks. Furthermore, we find evidence of substantial heterogeneity in these elasticities across firms. Small firms exhibit no strategic complementarities in price setting and complete cost pass-through. In contrast, large firms exhibit strong strategic complementarities, responding to both competitor price changes and their own cost shocks with roughly equal elasticities of around 0.5. We show that this pattern of heterogeneity in markup variability across firms is important for explaining the aggregate markup response to international shocks and the observed low exchange rate pass-through into domestic prices.
We study the relationship between homebuyers’ beliefs about future house price changes and their mortgage leverage choices. Whether more pessimistic homebuyers choose higher or lower leverage depends on their willingness and ability to reduce the size of their housing market investments. When households primarily maximize the levered return of their property investments, more pessimistic homebuyers reduce their leverage to purchase smaller houses. On the other hand, when considerations such as family size pin down the desired property size, pessimistic homebuyers reduce their financial exposure to the housing market by making smaller downpayments to buy similarly-sized homes. To determine which scenario better describes the data, we investigate the cross-sectional relationship between house price beliefs and mortgage leverage choices in the U.S. housing market. We use plausibly exogenous variation in house price beliefs to show that more pessimistic homebuyers make smaller downpayments and choose higher leverage, in particular in states where default costs are relatively low, as well as during periods when house prices are expected to fall on average. Our results highlight the important role of heterogeneous beliefs in explaining households’ financial decisions.
Can we identify highly central individuals in a network without collecting network data, simply by asking community members? Can seeding information via such nominated individuals lead to significantly wider diffusion than via randomly chosen people, or even respected ones? In two separate large field experiments in India, we answer both questions in the affirmative. In particular, in 521 villages in Haryana, we provided information on monthly immunization camps to either randomly selected individuals (in some villages) or to individuals nominated by villagers as people who would be good at transmitting information (in other villages). We find that the number of children vaccinated every month is 22% higher in villages in which nominees received the information. We show that people’s knowledge of who are highly central individuals and good seeds can be explained by a model in which community members simply track how often they hear gossip about others. Indeed, we find in a third data set that nominated seeds are central in a network sense, and are not just those with many friends or in powerful positions.
The world’s poor are seeing a rapid expansion in access to formal savings accounts. What is the source of savings when households are connected to a formal account? We combine a high-frequency panel survey spanning two and a half years with an experiment in which a Sri Lankan bank used mobile Point-of-Service (POS) terminals to collect deposits directly from households each week. We find that the headwaters of formal savings lie in sacrificed leisure time: households work more, and improved savings options generate an increase in labour effort in both self-employment and in the wage market. The results suggest that the labour allocation channel is an important mechanism linking savings opportunities to income.
We consider a game between a principal, an agent, and a monitor in which the principal would like to rely on messages by the monitor (the potential whistleblower) to target intervention against a misbehaving agent. The difficulty is that the agent can credibly threaten to retaliate against the monitor in the event of an intervention. In this setting, intervention policies that are responsive to the monitor’s message provide informative signals to the agent, which can be used to target threats efficiently. Principals that are too responsive to information shut down communication channels. Successful intervention policies must therefore garble the information provided by monitors and cannot be fully responsive. We show that policy evaluation on the basis of non-verifiable whistleblower messages is feasible under arbitrary incomplete information provided policy design takes into account that messages are endogenous.
Standard optimal Debt Management (DM) models prescribe a dominant role for long bonds and advocate against issuing short bonds. They require very large positions in order to complete markets and assume each period that governments repurchase all outstanding bonds and reissue (r/r) new ones. These features of DM are inconsistent with U.S. data. We introduce incomplete markets via small transaction costs which serves to make optimal DM more closely resemble the data : r/r are negligible, short bond issuance substantial and persistent and short and long bonds positively co-vary. Intuitively, long bonds help smooth taxes over states and short bonds over time. Solving incomplete market models with multiple assets is challenging so a further contribution of this article is introducing a novel computational method to find global solutions.
Unemployed households’ access to unsecured revolving credit more than tripled over the last three decades. This article analyses how both cyclical fluctuations and trend increases in credit access impact the business cycle. The main quantitative result is that credit expansions and contractions have contributed to moderately deeper and more protracted recessions over the last 40 years. As more individuals obtained credit from 1977 to 2010, cyclical credit fluctuations affected a larger share of the population and became more important determinants of employment dynamics. Even though business cycles are more volatile, newborns strictly prefer to live in the economy with growing, but fluctuating, access to credit markets.
Individuals are constantly processing external information and translating it into actions. This draws on limited resources of attention and requires economizing on attention devoted to signals related to economic behaviour. A natural measure of such costs is based on Shannon’s “channel capacity”. Modelling economic agents as constrained by Shannon capacity as they process freely available information turns out to imply that discretely distributed actions, and thus actions that persist across repetitions of the same decision problem, are very likely to emerge in settings that without information costs would imply continuously distributed behaviour. We show how these results apply to the behaviour of an investor choosing portfolio allocations, as well as to some mathematically simpler “tracking” problems that illustrate the mechanism. Trying to use costs of adjustment to explain “stickiness” of actions when interpreting the behaviour in our economic examples would lead to mistaken conclusions.
Exporting firms often enter foreign markets that are similar to their previous export destinations. We develop a dynamic model in which a firm’s exports in a market may depend on how similar the market is to the firm’s home country (gravity) and to its previous export destinations (extended gravity). Given the large number of export paths from which forward-looking firms may choose, we use a moment inequality approach to estimate our model. Our estimates indicate that sharing similarities with a prior export destination in terms of geographic location, language, and income per capita jointly reduces the cost of foreign market entry by 69–90%. Reductions due to geographic location (25–38%) and language (29–36%) have the largest effect. Extended gravity thus has a large impact on export entry costs.
Deforestation is a matter of pressing global concern, yet surprisingly little is known about the relative efficacy of various policies designed to combat it. This article sets out a framework for measuring the cost effectiveness of alternative policies—both command-and-control and incentive-based—in the Brazilian Amazon. First, I estimate the demand for deforestation on private properties, exploiting regional variation in transportation costs as a means to recover farmers’ responses to permanent policies. Here, rescaling transportation costs using local yields allows me to express changes in farmers’ valuations in dollars per hectare. I then use the estimated demand to infer farmers’ willingness to deforest under different counterfactual policies, such as payments to avoid deforestation and taxes on land use, along with the corresponding potential farmers’ lost surpluses. The results indicate that payment programmes and land use taxes on agricultural land can be highly effective in preserving the rainforest and also be substantially less expensive than command-and-control policies (approximately 8 times less costly). A carbon tax equal to the social cost of carbon could virtually eliminate all agricultural land in the Amazon, given the low agricultural returns there.
How should carbon be taxed as a part of fiscal policy? The literature on optimal carbon pricing often abstracts from other taxes. However, when governments raise revenues with distortionary taxes, carbon levies have fiscal impacts. While they raise revenues directly, they may shrink the bases of other taxes (e.g. by decreasing employment). This article theoretically characterizes and then quantifies optimal carbon taxes in a dynamic general equilibrium climate–economy model with distortionary fiscal policy. First, this article establishes a novel theoretical relationship between the optimal taxation of carbon and of capital income. This link arises because carbon emissions destroy natural capital: they accumulate in the atmosphere and decrease future output. Consequently, this article shows how the standard logic against capital income taxes extends to distortions on environmental capital investments. Second, this article characterizes optimal climate policy in sub-optimal fiscal settings where income taxes are constrained to remain at their observed levels. Third, this article presents a detailed calibration that builds on the seminal DICE approach but adds features essential for a setting with distortionary taxes, such as a differentiation between climate change production impacts (e.g. on agriculture) and direct utility impacts (e.g. on biodiversity existence value). The central quantitative finding is that optimal carbon tax schedules are 8–24% lower when there are distortionary taxes, compared to the setting with lump-sum taxes considered in the literature.
We provide evidence on the relationship between aggregate uncertainty and the macroeconomy. Identifying uncertainty shocks using methods from the news shocks literature, the analysis finds that innovations in realized stock market volatility are robustly followed by contractions, while shocks to forward-looking uncertainty have no significant effect on the economy. Moreover, investors have historically paid large premia to hedge shocks to realized but not implied volatility. A model in which fundamental shocks are skewed left can match those facts. Aggregate volatility matters, but it is the realization of volatility, rather than uncertainty about the future, that has been associated with declines.
We present a tractable heterogeneous-agent version of the New Keynesian model that allows us to study the interaction between inequality and monetary policy. Though formulated as a precautionary-saving model à la Huggett–Aiyagari, its reduced form is a two-agent model with a highly concentrated wealth distribution. When prices are sticky and wages flexible, as in the textbook representative-agent model, monetary policy affects the distribution of consumption, but has no effect on output as workers choose not to change their hours worked in response to wage movements. This highlights a transmission mechanism of the textbook model that we find implausible: in response to a monetary stimulus, the representative worker’s labor supply is greatly affected by the profits she receives. First, the lower profits induced by higher wages raise labor supply through a wealth effect and, secondly, the mere presence of profits reduces the negative income effect of a wage rise. When wages are rigid, in contrast, our model exhibits plausible responses of output and hours worked to monetary policy shocks.
Using household survey data for the U.S. and the U.K., we show that the aggregate response of consumption to interest rate changes is driven by households with a mortgage. Outright home-owners do not adjust expenditure at all while renters change their spending but by less than mortgagors. Income rises for all households as interest rate cuts directly affect firm investment and household consumption, boosting aggregate demand. A crucial difference between the housing tenure groups is the composition of their balance sheets: mortgagors hold sizable illiquid assets but little liquid wealth. Our results reveal that general equilibrium effects on household income coupled with balance-sheet-driven heterogeneity in the marginal propensity to consume play a key role in the transmission of monetary policy.
In this article we study consumption network effects. Does the consumption of our peers affect our own consumption? How large is such effect? What are the economic mechanisms behind it? We use administrative panel data on Danish households to construct a measure of consumption based on tax records on income and assets. We combine tax record data with matched employer–employee data to identify peer groups based on workplace, which gives us a much tighter and credible definition of networks than used in previous literature. We use the non-overlapping network structure of one’s peers group, as well as firm-level shocks, to build valid instruments for peer consumption. We estimate non-negligible and statistically significant network effects, capable of generating sizable multiplier effect at the macro-level. We also investigate what mechanisms generate such effects, distinguishing between intertemporal and intratemporal consumption effects as well as a more traditional risk sharing view.
Colonial powers typically organized economic activity in the colonies to maximize their economic returns. While the literature has emphasized long-run negative economic impacts via institutional quality, the changes in economic organization implemented to spur production historically could also directly influence economic organization in the long-run, exerting countervailing effects. We examine these in the context of the Dutch Cultivation System, the integrated industrial and agricultural system for producing sugar that formed the core of the Dutch colonial enterprise in 19th century Java. We show that areas close to where the Dutch established sugar factories in the mid-19th century are today more industrialized, have better infrastructure, are more educated, and are richer than nearby counterfactual locations that would have been similarly suitable for colonial sugar factories. We also show, using a spatial regression discontinuity design on the catchment areas around each factory, that villages forced to grow sugar cane have more village-owned land and also have more schools and substantially higher education levels, both historically and today. The results suggest that the economic structures implemented by colonizers to facilitate production can continue to promote economic activity in the long run, and we discuss the contexts where such effects are most likely to be important.
Do forced assimilation policies always succeed in integrating immigrant groups? This article examines how a specific assimilation policy—language restrictions in elementary school—affects integration and identification with the host country later in life. After World War I, several U.S. states barred the German language from their schools. Affected individuals were less likely to volunteer in World War II and more likely to marry within their ethnic group and to choose decidedly German names for their offspring. Rather than facilitating the assimilation of immigrant children, the policy instigated a backlash, heightening the sense of cultural identity among the minority.
Using detailed panel data from the Pale of Settlement area between 1800 and 1927, we document that anti-Jewish pogroms—mob violence against the Jewish minority—broke out when economic shocks coincided with political turmoil. When this happened, pogroms primarily occurred in places where Jews dominated middleman occupations, i.e., moneylending and grain trading. This evidence is inconsistent with the scapegoating hypothesis, according to which Jews were blamed for all misfortunes of the majority. Instead, the evidence is consistent with the politico-economic mechanism, in which Jewish middlemen served as providers of insurance against economic shocks to peasants and urban grain buyers in a relationship based on repeated interactions. When economic shocks occurred in times of political stability, rolling over or forgiving debts was an equilibrium outcome because both sides valued their future relationship. In contrast, during political turmoil, debtors could not commit to paying in the future, and consequently, moneylenders and grain traders had to demand immediate (re)payment. This led to ethnic violence, in which the break in the relationship between the majority and Jewish middlemen was the igniting factor.
We examine empirically the generalizability of internally valid micro-estimates of causal effects in a fixed population over time when that population is subject to aggregate shocks. Using panel data, we show that the returns to investments in agriculture in India and Ghana, small and medium non-farm enterprises in Sri Lanka, and schooling in Indonesia fluctuate significantly across time periods. We show how the returns to these investments interact with specific, measurable, and economically relevant aggregate shocks, focusing on rainfall and price fluctuations. We also obtain lower-bound estimates of confidence intervals of the returns based on estimates of the parameters of the distributions of rainfall shocks in our two agricultural samples. We find that even these lower-bound confidence intervals are substantially wider than those based solely on sampling error that are commonly provided in studies, most of which are based on single-year samples. We also find that cross-sectional variation in rainfall cannot be confidently used to replicate within-population rainfall variability. Based on our findings, we discuss methods for incorporating information on external shocks into evaluations of the returns to policy.
We study the effects of European immigration to the U.S. during the Age of Mass Migration (1850–1920) on economic prosperity. Exploiting cross-county variation in immigration that arises from the interaction of fluctuations in aggregate immigrant flows and of the gradual expansion of the railway network, we find that counties with more historical immigration have higher income, less poverty, less unemployment, higher rates of urbanization, and greater educational attainment today. The long-run effects seem to capture the persistence of short-run benefits, including greater industrialization, increased agricultural productivity, and more innovation.
The muted volatility of inflation during the Great Recession and its aftermath has refocused attention on the constraints that firms face when adjusting prices. Using new empirical and theoretical results, I argue that each firm’s choice of how much information to acquire to set prices plays a central role in determining the patterns of pricing at the product level and the degree of aggregate price rigidity in response to shocks. In support of the information channel, I present product-level evidence that firms price goods using coarse pricing policies that are updated infrequently and consist of a small menu of prices. Firms are heterogeneous in the complexity and duration of their pricing policies, and this heterogeneity is reflected in differential responses to the Great Recession cycle, with firms exhibiting more complex policies responding more aggressively. I develop a theory of information-constrained price setting that generates coarse pricing endogenously, and quantitatively matches the discreteness, duration, and volatility of policies in the data. The information friction dampens the responsiveness of prices to shocks, and, coupled with heightened volatility, induces firms to keep prices relatively high, to protect against losses in an uncertain environment.
In this article, I jointly investigate the political and the economic effects of immigration, and study the causes of anti-immigrant sentiments. I exploit exogenous variation in European immigration to U.S. cities between 1910 and 1930 induced by World War I and the Immigration Acts of the 1920s, and instrument immigrants’ location decision relying on pre-existing settlement patterns. I find that immigration triggered hostile political reactions, such as the election of more conservative legislators, higher support for anti-immigration legislation, and lower redistribution. Exploring the causes of natives’ backlash, I document that immigration increased natives’ employment, spurred industrial production, and did not generate losses even among natives working in highly exposed sectors. These findings suggest that opposition to immigration was unlikely to have economic roots. Instead, I provide evidence that natives’ political discontent was increasing in the cultural differences between immigrants and natives. Results in this article indicate that, even when diversity is economically beneficial, it may nonetheless be socially hard to manage.
This article studies a security design problem featuring flexible information acquisition. To raise liquidity, a seller issues a security backed by her asset in place at the price she proposes to a buyer. Before deciding whether to accept the offer, the buyer can acquire costly information about the underlying asset. This case differs from the existing literature on security design, in that the buyer has the full flexibility of choosing not only the amount of resources to spend in information acquisition, but also how to allocate them, depending on the shape of the security. Debt is shown to be the unique optimal security for the seller, as its payoff is the least sensitive to the value of its underlying asset. This minimizes the buyer’s incentive to acquire information and mitigates the resulting adverse selection. I do not assume monotonicity of the feasible securities nor impose various distributional assumptions on information structures. Instead, I identify conditions for general information costs that support the results.
We document that the spread of the Mafia in Sicily at the end of the 19th century was in part caused by the rise of socialist Peasant Fasci organizations. In an environment with weak state presence, this socialist threat triggered landowners, estate managers, and local politicians to turn to the Mafia to resist and combat peasant demands. We show that the location of the Peasant Fasci is significantly affected by a severe drought in 1893, and using information on rainfall, we estimate the impact of the Peasant Fasci on the location of the Mafia in 1900. We provide extensive evidence that rainfall before and after this critical period has no effect on the spread of the Mafia or various economic and political outcomes. In the second part of the article, we use this source of variation in the strength of the Mafia in 1900 to estimate its medium-term and long-term effects. We find significant and quantitatively large negative impacts of the Mafia on literacy and various public goods in the 1910s and 20s. We also show a sizable impact of the Mafia on political competition, which could be one of the channels via which it affected local economic outcomes. We document negative effects of the Mafia on longer-term outcomes (in the 1960s, 70s, and 80s) as well, but these are in general weaker and often only marginally significant. One exception is its persistent and strong impact on political competition.
This article deals with the identification and estimation of dynamic games when players’ beliefs about other players’ actions are biased, that is, beliefs do not represent the probability distribution of the actual behaviour of other players conditional on the information available. First, we show that an exclusion restriction, typically used to identify empirical games, provides testable non-parametric restrictions of the null hypothesis of equilibrium beliefs in dynamic games with either finite or infinite horizon. We use this result to construct a simple Likelihood Ratio test of equilibrium beliefs. Second, we prove that this exclusion restriction, together with consistent estimates of beliefs at two points in the support of the variable involved in the exclusion restriction, is sufficient for non-parametric point-identification of players’ belief functions as well as useful functions of payoffs. Third, we propose a simple two-step estimation method. We illustrate our model and methods using both Monte Carlo experiments and an empirical application of a dynamic game of store location by retail chains. The key conditions for the identification of beliefs and payoffs in our application are the following: (1) the previous year’s network of stores of the competitor does not have a direct effect on the profit of a firm, but the firm’s own network of stores at previous year does affect its profit because the existence of sunk entry costs and economies of density in these costs; and (2) firms’ beliefs are unbiased in those markets that are close, in a geographic sense, to the opponent’s network of stores, though beliefs are unrestricted, and potentially biased, for unexplored markets which are farther away from the competitors’ network. Our estimates show significant evidence of biased beliefs. Furthermore, imposing the restriction of unbiased beliefs generates a substantial attenuation bias in the estimate of competition effects.
Bureaucracies are configured differently to private sector and political organizations. Across a wide range of civil services entry is competitive, promotion is constrained by seniority, jobs are for life, and retirement occurs at a fixed age. This implies that older entering officers, who are less likely to attain the glittering prize of reaching the top of the bureaucracy before they retire, may be less motivated to exert effort. Using a nationwide stakeholder survey and rich administrative data on elite civil servants in India, we provide evidence that: (i) officers who cannot reach the senior-most positions before they retire are perceived to be less effective and are more likely to be suspended and (ii) this effect is weakened by a reform that extends the retirement age. Together, these results suggest that the career incentive of reaching the top of a public organization is a powerful determinant of bureaucrat performance.
Using a novel source of quasi-experimental variation in interest rates, we develop a new approach to estimating the Elasticity of Intertemporal Substitution (EIS). In the U.K., the mortgage interest rate features discrete jumps—notches—at thresholds for the loan-to-value (LTV) ratio. These notches generate large bunching below the critical LTV thresholds and missing mass above them. We develop a dynamic model that links these empirical moments to the underlying structural EIS. The average EIS is small, around 0.1, and quite homogeneous in the population. This finding is robust to structural assumptions and can allow for uncertainty, a wide range of risk preferences, portfolio reallocation, liquidity constraints, present bias, and optimization frictions. Our findings have implications for the numerous calibration studies that rely on larger values of the EIS.
We analyse dynamic general equilibrium models with more-or-less directed search by informed buyers and random search by uninformed buyers. This nests existing specifications and generates new insights. A quantitative application concerns the welfare cost of inflation, which is known to be quite high with pure random search and low with pure directed search. Our calibration implies the impact of inflation is fairly low, in part because, in addition to the usual costs, it provides benefits by more heavily taxing high-price sellers that inefficiently profit from exploiting the uninformed. Other applications analyse analytically and numerically changes in credit conditions and information.
This article investigates how the success of a management practice depends on the underlying values articulated by the management. A large U.S. transportation company is in the process of fitting its trucks with an electronic on-board recorder (EOBR) to provide drivers with information on their driving performance. The company also has commenced a multi-year initiative to remake its internal operations, the first phase of which focuses exclusively on changing values toward a greater emphasis on teamwork and empowerment. In this setting, a natural question is whether the optimal managerial practice consists of: (1) letting each driver know his or her individual performance only; or also (2) providing drivers with information about their performance with respect to other drivers. Using the EOBR-provided driver performance data, we randomize these practices across sites. The main result of our experiment is that (2) leads to better performance than (1) in a particular site if and only if the site has not yet received the values intervention, and worse performance if it has. The result is consistent with the presence of a conflict between competition-based managerial practices and a shift to a cooperation-based value system. More broadly, it highlights the role of intangible factors in determining the optimal set of managerial practices.
We study the implications of aggregating consumers’ purchase histories into scores that proxy for unobserved willingness to pay. A long-lived consumer interacts with a sequence of firms. Each firm relies on the consumer’s current score–a linear aggregate of noisy purchase signals—to learn about her preferences and to set prices. If the consumer is strategic, she reduces her demand to manipulate her score, which reduces the average equilibrium price. Firms in turn prefer scores that overweigh past signals relative to applying Bayes’ rule with disaggregated data, as this mitigates the ratchet effect and maximizes the firms’ ability to price discriminate. Consumers with high average willingness to pay benefit from data collection, because the gains from low average prices dominate the losses from price discrimination. Finally, hidden scores—those only observed by the firms—reduce demand sensitivity, increase average prices, and reduce consumer surplus, sometimes below the naive-consumer level.
We use administrative data from the Internal Revenue Service to examine long-term impacts of childhood Medicaid eligibility expansions on outcomes in adulthood at each age from 19 to 28. Greater Medicaid eligibility increases college enrolment and decreases fertility, especially through age 21. Starting at age 23, females have higher contemporaneous wage income, although male increases are imprecise. Together, both genders have lower mortality. These adults collect less from the earned income tax credit and pay more in taxes. Cumulatively from ages 19 to 28, at a 3% discount rate, the federal government recoups 58 cents of each dollar of its “investment” in childhood Medicaid.
The standard Medicare Part D drug insurance contract is non-linear—with reduced subsidies in a coverage gap—resulting in a dynamic purchase problem. We consider enrolees who arrived near the gap early in the year and show that they should expect to enter the gap with high probability, implying that, under a benchmark model with neoclassical preferences, the gap should impact them very little. We find that these enrolees have flat spending in a period before the doughnut hole and a large spending drop in the gap, providing evidence against the benchmark model. We structurally estimate behavioural dynamic drug purchase models and find that a price salience model where enrolees do not incorporate future prices into their decision-making at all fits the data best. For a nationally representative sample, full price salience would decrease enrolee spending by 31%. Entirely eliminating the gap would increase insurer spending 27%, compared to 7% for generic-drug-only gap coverage.
This article studies the optimal determination of bankruptcy exemptions for risk averse borrowers who use unsecured contracts but have the possibility of defaulting. In a large class of economies, knowledge of four variables is sufficient to determine whether a bankruptcy exemption level is optimal or should be increased or decreased. These variables are 1. the composition of households’ liabilities, 2. the sensitivity of the credit supply schedule to exemption changes, 3. the probability of filing for bankruptcy with non-exempt assets, and 4. the value given by households to a marginal dollar in different states, which can be mapped to changes in households’ consumption. I recover empirical estimates of the sufficient statistics using U.S. data over the period 2008–16 and find that increasing exemption levels improves overall welfare, although there is substantial variation in estimated welfare gains across U.S. states and income quintiles.
This article studies how credit markets respond to policy constraints on household leverage. Exploiting a sharp policy-induced discontinuity in the cost of originating certain high-leverage mortgages, we study how the Dodd–Frank “Ability-to-Repay” rule affected the price and availability of credit in the U.S. mortgage market. Our estimates show that the policy had only moderate effects on prices, increasing interest rates on affected loans by 10–15 basis points. The effect on quantities, however, was significantly larger; we estimate that the policy eliminated 15% of the affected market completely and reduced leverage for another 20% of remaining borrowers. This reduction in quantities is much greater than would be implied by plausible demand elasticities and indicates that lenders responded to the policy not only by raising prices but also by exiting the regulated portion of the market. Heterogeneity in the quantity response across lenders suggests that agency costs may have been one particularly important market friction contributing to the large overall effect as the fall in lending was substantially larger among lenders relying on third-parties to originate loans. Finally, while the policy succeeded in reducing leverage, our estimates suggest this effect would have only slightly reduced aggregate default rates during the housing crisis.
What are the origins and consequences of the state as a provider of public goods? We study public goods provision established through new laws in German cities during the 1500s. Cities that adopted the laws subsequently began to differentially produce and attract human capital and to grow faster. Legal change occurred where ideological competition introduced by the Protestant Reformation interacted with local politics. We study plagues that shifted local politics in a narrow period as sources of exogenous variation in public goods institutions, and find support for a causal interpretation of the relationship between legal change, human capital, and growth.
Financial regulation is harmonized across countries even though countries vary in their ability to bail-out their banking sector in the event of a crisis. This article addresses the question of whether countries with different fiscal capacity should optimally have different bank regulation, implemented—among other tools—through capital requirements—a question so far ignored by the theoretical banking literature. I show that countries with larger fiscal capacity should have lower ex ante minimum bank capital requirements, in an environment with endogenously incomplete markets and overinvestment due to “Too-Big-To-Fail” moral hazard and pecuniary externalities. I also show that, in addition to a minimum bank capital requirement, regulators in countries with strong “Too-Big-To-Fail” moral hazard should impose a limit on the liabilities pledged by financial institutions in a crisis state. This implies limits on put options/credit default swap contracts. Finally, I argue that the type of regulatory instrument used is crucial as to whether larger fiscal capacity implies more- or less-stringent bank regulation.
Advances in medical technology have made kidney transplants over the blood group barrier feasible. This article investigates how such technology should be implemented when designing pairwise kidney exchange programs. The possibility to receive a kidney transplant from a blood group incompatible donor motivates an extension of the preference domain, allowing patients to distinguish between compatible donors and half-compatible donors (i.e. blood group incompatible donors that only become compatible after undergoing an immunosuppressive treatment). It is demonstrated that the number of transplants can be substantially increased by providing an incentive for patients with half-compatible donors to participate in kidney exchange programs. The results also suggest that the technology is beneficial for patient groups that are traditionally disadvantaged in kidney exchange programs (e.g. blood group O patients). The positive effect of allowing transplants over the blood group barrier is larger than the corresponding effects of including altruistic patient–donor pairs or of allowing three-way exchanges in addition to pairwise exchanges.
International financial integration helps to diversify risk but also may spread crises across countries. We provide a quantitative analysis of this trade-off in a two-country general equilibrium model with collateral-constrained borrowing using a global solution method. Borrowing constraints bind occasionally, depending upon the state of the economy and levels of inherited debt. We examine different degrees of international financial integration, moving from financial autarky, to bond and equity market integration. Financial integration leads to a significant increase in global leverage, substantially escalates the probability of crises for any one country, and dramatically increases the degree of “contagion” across countries. Outside of crises, the impact of financial integration on macroeconomic aggregates is relatively small. But the impact of a crisis with integrated international financial markets is much less severe than that under financial market autarky. Thus, a trade-off emerges between the probability of crises and the severity of crises. Using a large cross-country database of financial crises in developing and developed economies over a forty-year period, we find evidence in support of the model.
Theories of multilateral bargaining and coalition formation applied to legislatures predict that parties’ seat shares determine their bargaining power. We present findings that are difficult to reconcile with this prediction, but consistent with a norm prescribing that “the most voted party should form the government”. We first present case studies from several countries and regression discontinuity design-based evidence from twenty-eight national European parliaments. We then focus on 2,898 Spanish municipal elections in which two parties tie in the number of seats. We find that the party with slightly more general election votes is substantially more likely to appoint the mayor. Since tied parties should (on average) have equal bargaining power, this identifies the effect of being labeled the most voted. This effect is comparable to that of obtaining an additional seat, and is also present when a right-wing party is the most voted and the second and third most voted parties are allied left-wing parties who can form a combined majority. A model where elections both aggregate information and discipline incumbents can rationalize our results and yields additional predictions we take to the data, such as voters punishing second most voted parties that appoint mayors.
We study a two-country setting in which leveraged investors generate fire-sale externalities, leading to financial crises and contagion. Governments can affect the incidence of financial crisis and the degree of contagion by injecting public liquidity and, additionally, by segmenting the countries’ liquidity markets. We show that segmentation allows a country to avoid contagion and fend off mild financial crises caused by a small shock to its liquidity demand, at the cost of exposing it to more severe financial crises caused by a large shock. We derive a “pecking order” result, whereby segmentation is a second-best measure that coordinated governments should use only when tax capacity constrains them from injecting liquidity. Even when segmentation is welfare-enhancing, it should be applied to public liquidity alone, never restricting the free flow of private liquidity across countries. Uncoordinated governments tend to use segmentation excessively.
This article uses a structural model to show that foreclosures played a crucial role in exacerbating the recent housing bust and to analyse foreclosure mitigation policy. We consider a dynamic search model in which foreclosures freeze the market for non-foreclosures and reduce price and sales volume by eroding lender equity, destroying the credit of potential buyers, and making buyers more selective. These effects cause price-default spirals that amplify an initial shock and help the model fit both national and cross-sectional moments better than a model without foreclosure. When calibrated to the recent bust, the model reveals that the amplification generated by foreclosures is significant: ruined credit and choosey buyers account for 25.4% of the total decline in non-distressed prices and lender losses account for an additional 22.6%. For policy, we find that principal reduction is less cost-effective than lender equity injections or introducing a single seller that holds foreclosures off the market until demand rebounds. We also show that policies that slow down the pace of foreclosures can be counterproductive.
Aggregate shocks affect most households’ and firms’ decisions. Using three stylized models, we show that inference based on cross-sectional data alone generally fails to correctly account for decision making of rational agents facing aggregate uncertainty. We propose an econometric framework that overcomes these problems by explicitly parameterizing the agents’ decision problem relative to aggregate shocks. Our framework and examples illustrate that the cross-sectional and time-series aspects of the model are often interdependent. Therefore, estimation of model parameters in the presence of aggregate shocks requires the combined use of cross-sectional and time-series data. We provide easy-to-use formulas for test statistics and confidence intervals that account for the interaction between the cross-sectional and time-series variation. Lastly, we perform Monte Carlo simulations that highlight the properties of the proposed method and the risks of not properly accounting for the presence of aggregate shocks.
Using a broad set of national industry trade shocks, I employ a novel approach to estimate agglomeration effects by exploiting within industry variation in indirect exposure to the other local industries’ (national) trade shocks across local labour markets. This variation stems from differences in local industry composition and allows to test for the existence of heterogeneous agglomeration effects across industries. I find considerable employment spillovers from other  tradable industries’ trade shocks and even stronger effects within the same broad sector. Spillovers are larger for industries employing similar workers and are triggered predominantly by shocks to high-technology industries.
We extend Duffie et al.’s (2005) search-theoretic model of over-the-counter (OTC) asset markets, allowing for a decentralized inter-dealer market with arbitrary heterogeneity in dealers’ valuations (or, equivalently, inventory costs). We develop a solution technique that makes the model fully tractable and allows us to derive, in closed form, theoretical formulas for key statistics analysed in empirical studies of the intermediation process in OTC markets. A calibration to the market for municipal bonds allows us to quantify important unobservable characteristics of this market, including the severity of search and bargaining frictions and the nature of heterogeneity across dealers. We use our calibrated model to study the effect of these market characteristics on total welfare and the distribution of gains from trade across customers and dealers.
How should macroprudential policy be designed when policymakers also have access to liquidity provision tools to manage crises? We show in a tractable model of systemic banking risk that there are three factors at play: first, ex post liquidity provision mitigates financial crises, and this reduces the need for macroprudential policy. In the extreme, if liquidity provision is untargeted and costless or if it completely forestalls crises by credible out-of-equilibrium lending-of-last-resort, there is no role left for macroprudential regulation. Second, however, macroprudential policy needs to consider the ex ante incentive effects of targeted liquidity provision. Third, if shadow banking reduces the effectiveness of macroprudential instruments, it is optimal to commit to less generous liquidity provision as a second-best substitute for macroprudential policy.
We develop a field experiment that assesses whether advertising can serve as a signal that enhances consumers’ evaluations of advertised goods. We implement the experiment on a mobile search platform that provides listings and reviews for an archetypal experience good, restaurants. In collaboration with the platform, we randomize about 200,000 users in 13 Asian cities into exposure of ads for about 600+ local restaurants. Within the exposure group, we randomly vary the disclosure to the consumer of whether a restaurant’s listing is a paid-ad. This enables isolating the effect on outcomes of a user knowing that a listing is sponsored—a pure signalling effect. We find that this disclosure increases calls to the restaurant by 77%, holding fixed all other attributes of the ad. The disclosure effect is higher when the consumer uses the platform away from his typical city of search, when the uncertainty about restaurant quality is larger, and for restaurants that have received fewer ratings in the past. On the supply side, newer, higher rated and more popular restaurants are found to advertise more on the platform; and ratings of those that advertised during the experiment are found to be higher two years later. Taken together, we interpret these results as consistent with a signalling equilibrium in which ads serve as implicit signals that enhance the appeal of the advertised restaurants to consumers. Both consumers and advertisers seem to benefit from the signalling. Consumers shift choices towards restaurants that are better rated (at baseline) in the disclosure group compared to the no disclosure group, and advertisers gain from the improved outcomes induced by disclosure.
Medical innovations during the 1940s quickly resulted in significant health improvements around the world. Countries with initially higher mortality from infectious diseases experienced larger increases in life expectancy, population, and subsequent social conflict. This cross-country result is robust across alternative measures of conflict and is not driven by differential trends between countries with varying baseline characteristics. A similar effect is also present within Mexico. Initial suitability conditions for malaria varied across municipalities, and anti-malaria campaigns had differential effects on population growth and social conflict. Both across countries and within Mexico, increased conflict over scarce resources predominates and this effect is more pronounced during times of economic hardship (specifically, in countries with a poor growth record and in drought-stricken areas in Mexico). At least during this time period, a larger increase in population made social conflict more likely.
We study the problem of a monetary authority pursuing an exchange rate policy that is inconsistent with interest rate parity because of a binding zero lower bound constraint. The resulting violation in interest rate parity generates an inflow of capital that the monetary authority needs to absorb by accumulating foreign reserves. We show that these interventions by the monetary authority are costly, and we derive a simple measure of these costs: they are proportional to deviations from the covered interest parity (CIP) condition and the amount of accumulated foreign reserves. Our framework can account for the recent experiences of “safe-haven” currencies and the sign of their observed deviations from CIP.
Local air pollution has led authorities in many cities around the world to impose limits on car use by means of driving restrictions or license-plate bans. By placing uniform restrictions on all cars, many of these programs have created incentives for drivers to buy additional, more polluting cars. We study vintage-specific restrictions, which place heavy limits on older, polluting vehicles and no limits on newer, cleaner ones. We use a novel model of the car market and results from Santiago’s 1992 program, the earliest program to use vintage-specific restrictions, to show that such restrictions should be designed to work exclusively through the extensive margin (type of car driven), never through the intensive margin (number of miles driven). If so, vintage restrictions can yield important welfare gains by moving the fleet composition toward cleaner cars, comparing well to alternative instruments such as scrappage subsidies and pollution-based registration fees.
We develop a quantitative theory of repeated political transitions driven by revolts and reforms. In the model, the beliefs of disenfranchised citizens play a key role in determining revolutionary pressure, which in interaction with preemptive reforms determine regime dynamics. We study the quantitative implications of the model by fitting it to data on the universe of political regimes existing between 1946 and 2010. The estimated model generates a process of political transitions that looks remarkably close to the data, replicating the empirical shape of transition hazards, the frequency of revolts relative to reforms, the distribution of newly established regime types after revolts and reforms, and the unconditional distribution over regime types.
We study the role of housing wealth in financing retirement consumption. In our model retirees: 1. derive utility benefits from remaining in their home (aging in place); and 2. choose in each period whether to maintain their house. The evidence that we present shows that these features are important in explaining the saving decisions of the elderly. The costs and the maintenance requirement of reverse mortgages (RMs) reduce (or eliminate) the benefits of the loans for retirees who wish to do less maintenance. We evaluate the impact of different loan features on retirees’ utility, cash-flows to lenders, and to the government agency that provides mortgage insurance. We show that combining RMs with insurance against a forced home sale (e.g. due to a move to a nursing home) is Pareto improving and can lead to increased demand for the loans due to product complementarities.
We revisit the issue of the high cyclicality of wages of new hires. We show that after controlling for composition effects likely involving procyclical upgrading of job match quality, the wages of new hires are no more cyclical than those of existing workers. The key implication is that the sluggish behaviour of wages for existing workers is a better guide to the cyclicality of the marginal cost of labour than is the high measured cyclicality of new hires wages unadjusted for composition effects. Key to our identification is distinguishing between new hires from unemployment versus those who are job changers. We argue that to a reasonable approximation, the wages of the former provide a composition-free estimate of the wage flexibility, while the same is not true for the latter. We then develop a quantitative general equilibrium model with sticky wages via staggered contracting, on-the-job search, and heterogeneous match quality, and show that it can account for both the panel data evidence and aggregate evidence on labour market volatility.
The basic assumption of a structural vector autoregressive moving average (SVARMA) model is that it is driven by a white noise whose components are uncorrelated or independent and can be interpreted as economic shocks, called “structural” shocks. When the errors are Gaussian, independence is equivalent to non-correlation and these models face two identification issues. The first identification problem is “static” and is due to the fact that there is an infinite number of linear transformations of a given random vector making its components uncorrelated. The second identification problem is “dynamic” and is a consequence of the fact that, even if a SVARMA admits a non-invertible moving average (MA) matrix polynomial, it may feature the same second-order dynamic properties as a VARMA process in which the MA matrix polynomials are invertible (the fundamental representation). The aim of this article is to explain that these difficulties are mainly due to the Gaussian assumption, and that both identification challenges are solved in a non-Gaussian framework if the structural shocks are assumed to be instantaneously and serially independent. We develop new parametric and semi-parametric estimation methods that accommodate non-fundamentalness in the MA dynamics. The functioning and performances of these methods are illustrated by applications conducted on both simulated and real data.
We conduct field experiments to investigate dynamic inconsistency and commitment demand in food choice. In two home grocery delivery programs, we document substantial dynamic inconsistency between advance and immediate choices. When given the option to commit to their advance choices, around half of subjects take it up. Commitment demand is negatively correlated with dynamic inconsistency, suggesting those with larger self-control problems are less likely to be aware thereof. We evaluate the welfare consequences of dynamic inconsistency and commitment policies with utility measures based on advance, immediate, and unambiguous choices. Simply offering commitment has limited welfare (and behavioural) consequences under all measures.
In this article, I directly test the hypothesis that interactions between inventors of different firms drive knowledge spillovers. I construct a network of publicly traded companies in which each link is a function of the relative proportion of two firms’ inventors who have former patent collaborators in both organizations. I use this measure to weigh the impact of R&D performed by each firm on the productivity and innovation outcomes of its network linkages. An empirical concern is that the resulting estimates may reflect unobserved, simultaneous determinants of firm performance, network connections, and external R&D. I address this problem with an innovative IV strategy, motivated by a game-theoretic model of firm interaction. I instrument the R&D of one firm’s connections with that of other firms that are sufficiently distant in network space. With the resulting spillover estimates, I calculate that among firms connected to the network the marginal social return of R&D amounts to approximately 112% of the marginal private return.
I empirically measure the welfare gains from optimal incentive regulation in the context of electric utilities facing both emissions and rate of return regulation (RORR). I provide evidence that RORR induces lower fuel efficiency, leading to greater coal consumption and higher emissions abatement costs. Replacing RORR with the optimal mechanism of Laffont and Tirole (1986) yields annual welfare gains of $686 million or a 11% reduction in electricity prices. I construct a much simpler two-contract menu that can achieve more than 65% of these welfare gains.
The fact that money, banking, and financial markets interact in important ways seems self-evident. The theoretical nature of this interaction, however, has not been fully explored. To this end, we integrate the Diamond (1997, Journal of Political Economy105, 928–956) model of banking and financial markets with the Lagos and Wright (2005, Journal of Political Economy113, 463–484) dynamic model of monetary exchange—a union that bears a framework in which fractional reserve banks emerge in equilibrium, where bank assets are funded with liabilities made demandable in government money, where the terms of bank deposit contracts are affected by the liquidity insurance available in financial markets, where banks are subject to runs, and where a central bank has a meaningful role to play, both in terms of inflation policy and as a lender of last resort. Among other things, the model provides a rationale for nominal deposit contracts combined with a central bank lender-of-last-resort facility to promote efficient liquidity insurance and a panic-free banking system.
This article examines the economic impact of a tuberculosis control program launched in Norway in 1948. In the 1940s, Norway had one of the highest tuberculosis infection rates in Europe, affecting about 85% of the inhabitants. To lower the disease burden, the Norwegian government launched a large-scale tuberculosis testing and vaccination campaign that substantially reduced tuberculosis infection rates among children. We find that cohorts in school during and after the campaign in municipalities with high tuberculosis prevalence gained more in terms of education, earnings, longevity, and height following this public health intervention. Furthermore, the gains from the disease control program are not limited to the initially treated cohorts but also affect their children. The results also suggest that individuals from a low socioeconomic background benefited more from the intervention and we present new evidence that a narrowing of the gap in childhood health can lead to a reduction in socioeconomic inequalities in adulthood.
News production requires investment, and competitors’ ability to appropriate a story may reduce a media’s incentives to provide original content. Yet, there is little legal protection of intellectual property rights in online news production, which raises the issue of the extent of copying online and the incentives to provide original content. In this article, we build a unique dataset combining all the online content produced by French news media during the year 2013 with new micro audience data. We develop a topic detection algorithm that identifies each news event, trace the timeline of each story, and study news propagation. We provide new evidence on online news production. First, we document high reactivity of online media: one quarter of the news stories are reproduced online in under 4 min. We show that this is accompanied by substantial copying, both at the extensive and at the intensive margins, which may constitute a severe threat to the commercial viability of the news media. Next, we estimate the returns to originality in online news production. Using article-level variations and media-level daily audience combined with article-level social media statistics, we find that original content producers tend to receive more viewers, thereby mitigating the newsgathering incentive problem raised by copying.
We show that a change in organizational structure from partnerships to public companies—which weakens contractual commitment—can lead to higher investment in high return-and-risk activities, higher productivity (value added per employee) and greater income dispersion (inequality). These predictions are consistent with the observed evolution of the financial sector where the switch from partnerships to public companies has been especially important in the decades that preceded the 21st Century financial crisis.
We study how the diffusion of being pivotal affects immoral outcomes. In our main experiment, subjects decide about agreeing to kill mice and receiving money versus objecting to the killing and foregoing the monetary amount. In a baseline condition, subjects decide individually about the life of one mouse. In the main treatment, subjects are organized into groups of eight and decide simultaneously. Eight mice are killed if at least one subject opts for killing. The fraction of subjects agreeing to kill is significantly higher in the main condition compared with the baseline condition. In a second experiment, we run the same baseline and main conditions but use a charity context and additionally study sequential decision-making. We replicate our finding from the mouse paradigm. We further show that the observed effects increase with experience, i.e., when we repeat the experiment for a second time. For both experiments, we elicit beliefs about being pivotal, which we validate in a treatment with non-involved observers. We show that beliefs are a main driver of our results.
Markets have an exposure problem when getting to the optimal allocation requires a sequence of transactions which if started but not completed leaves at least one trader with losses. We use laboratory experiments to evaluate the effect of the exposure problem on alternative market mechanisms. The continuous double auction performs poorly: efficiency is only 20% when exposure is high and 55% when it is low. A package market effectively eliminates the exposure problem: in low and high-exposure treatments efficiency is 82% and 89%, respectively. Building on stability notions from matching theory we introduce the concept of mechanism stability. A model of trade that combines mechanism stability with noisy best responses and imperfect foresight explains the difference in market performance. Finally, decentralized bargaining with contingent contracts performs well with perfect information and communication but not in the more realistic case when traders’ preferences are privately known.
I propose a novel general equilibrium framework to quantify the impact of law enforcement on the internal organization of firms and thereby on aggregate outcomes. The model features an agency problem between the firm and its middle managers. Imperfect law enforcement allows middle managers to divert revenue from firms, which reduces delegation and constrains firm size. I use French matched employer–employee data for evidence of the model’s pattern of managerial wages. Relative to the French benchmark economy, reducing law enforcement to its minimum value decreases GDP (equivalently, total factor productivity; TFP) by 23% and triples the self-employment rate. Consistent with the model, I document cross-country empirical evidence of a positive correlation between law enforcement indicators and the aggregate share of managerial workers. Mapped across the world, the model explains 3–6% of the ratio in GDP per worker between the poorest and richest quintile of countries, and 6–11% of their TFP ratio.
What are the macroeconomic effects of transfers to households with children? How do alternative policies fare in welfare terms? We answer these questions in an equilibrium life-cycle model with household labour supply decisions, skill losses of females associated to non-participation, and heterogeneity in terms of fertility, childcare expenditures, and access to informal care. Calibrating our model to the U.S. economy, we first provide a roadmap for policy evaluation by contrasting transfers that are conditional on market work (childcare subsidies and childcare credits) with those that are not (child credits), when both types can be means tested or universal. We then evaluate expansions of current arrangements for the U.S. and find that expansions of conditional transfers have substantial positive effects on female labour supply, that are largest at the bottom of the skill distribution. Expanding childcare credits leads to long-run increases in the participation of married females of 10.6%, while an equivalent expansion of child credits leads to the opposite (⁠|$-$|2.4%). Expanding existing programs generates substantial welfare gains for newborn households, which are largest for less-skilled households. Expanding childcare credits leads to the largest welfare gains for newborns and achieves majority support.
This article examines the dynamic effects of a teachers’ pay for performance experiment on long-term outcomes at adulthood. The program led to a gradual increase in university education of the treated high school students, reaching an increase of 0.25 years of schooling by age 28–30. The effects on employment and earnings were initially negative, coinciding with a higher rate of enrolment in university, but became positive and significant with time. These gains are largely mediated by the positive effect of the program on several high school outcomes, including quantitative and qualitative gains in the high-stakes matriculation exams.
We study the effects of monetary announcements when agents face Knightian uncertainty about the commitment capacity of the monetary authority. Households are ambiguity averse and differentially exposed to inflation due to differences in wealth. In response to the announcement of a future monetary loosening, only wealthy households (creditors) act as if the announcement will be fully implemented, due to the potential wealth losses from future inflation. As a result the economy responds as if aggregate net wealth falls, which attenuates the effects of the announcement. Redistributing from super-wealthy to middle-wealthy households makes the announcement more expansionary, in the extreme as expansionary as under a fully credible announcement.
What mental models do individuals use to approximate their tax schedule? Using incentivized forecasts of the U.S. Federal income tax schedule, we estimate the prevalence of the “schmeduling” heuristics for constructing mental representations of nonlinear incentive schemes. We find evidence of widespread reliance on the “ironing” heuristic, which linearizes the tax schedule using one’s average tax rate. In our preferred specification, 43% of the population irons. We find no evidence of reliance on the “spotlighting” heuristic, which linearizes the tax schedule using one’s marginal tax rate. We show that the presence of ironing rationalizes a number of empirical patterns in individuals’ perceptions of tax liability across the income distribution. Furthermore, while our empirical framework accommodates a rich class of other misperceptions, we find that a simple model including only ironers and correct forecasters accurately predicts average underestimation of marginal tax rates. We replicate our finding of prevalent ironing, and a lack of other systematic misperceptions, in a controlled experiment that studies real-stakes decisions across exogenously varied tax schedules. To illustrate the policy relevance of the ironing heuristic, we show that it augments the benefits of progressive taxation in a standard model of earnings choice. We quantify these benefits in a calibrated model of the U.S. tax system.
The traditional approach to obtain valid confidence intervals for non-parametric quantities is to select a smoothing parameter such that the bias of the estimator is negligible relative to its standard deviation. While this approach is apparently simple, it has two drawbacks: first, the question of optimal bandwidth selection is no longer well-defined, as it is not clear what ratio of bias to standard deviation should be considered negligible. Second, since the bandwidth choice necessarily deviates from the optimal (mean squares-minimizing) bandwidth, such a confidence interval is very inefficient. To address these issues, we construct valid confidence intervals that account for the presence of a non-negligible bias and thus make it possible to perform inference with optimal mean squared error minimizing bandwidths. The key difficulty in achieving this involves finding a strict, yet feasible, bound on the bias of a non-parametric estimator. It is well-known that it is not possible to consistently estimate the pointwise bias of an optimal non-parametric estimator (for otherwise, one could subtract it and obtain a faster convergence rate violating Stone’s bounds on the optimal convergence rates). Nevertheless, we find that, under minimal primitive assumptions, it is possible to consistently estimate an upper bound on the magnitude of the bias, which is sufficient to deliver a valid confidence interval whose length decreases at the optimal rate and which does not contradict Stone’s results.
We generalize the scope of random allocation mechanisms, in which the mechanism first identifies a feasible “expected allocation” and then implements it by randomizing over nearby feasible integer allocations. The previous literature has shown that the cases in which this is possible are sharply limited. We show that if some of the feasibility constraints can be treated as goals rather than hard constraints, then, subject to weak conditions that we identify, any expected allocation that satisfies all the constraints and goals can be implemented by randomizing among nearby integer allocations that satisfy all the hard constraints exactly and the goals approximately. By defining ex post utilities as goals, we are able to improve the ex post properties of several classic assignment mechanisms, such as the random serial dictatorship. We use the same approach to prove the existence of |$\epsilon$|-competitive equilibrium in large markets with indivisible items and feasibility constraints.
We estimate production functions for cognition and health for children aged 1–12 in India, based on the Young Lives Survey. India has over 70 million children aged 0–5 who are at risk of developmental deficits. The inputs into the production functions include parental background, prior child cognition and health, and child investments, which are taken as endogenous. Estimation is based on a nonlinear factor model, based on multiple measurements for both inputs and child outcomes. Our results show an important effect of early health on child cognitive development, which then becomes persistent. Parental investments affect cognitive development at all ages, but more so for younger children. Investments also have an impact on health at early ages only.
While potentially more productive, more complex tasks generate larger agency rents. Agents therefore prefer to acquire complex skills, to earn large rents. In our overlapping generations model, their ability to do so is kept in check by competition with predecessors. Old agents, however, are imperfect substitutes for young ones, because the latter are easier to incentivize, thanks to longer horizons. This reduces competition between generations, enabling young managers to go for larger complexity than their predecessors. Consequently, equilibrium complexity and rents gradually increase beyond what is optimal for the principal and for society.
This article presents a dynamic political-economic model of total government obligations. Its focus is on the interplay between debt and entitlements. In our model, both are tools by which temporarily powerful groups can extract resources from groups that will be powerful in the future: debt transfers resources across periods; entitlements directly target the future allocation of resources. We prove the following results. First, the presence of endogenous entitlements dampens the incentives of politically powerful groups to accumulate debt, but it leads to an increase in total government obligations. Second, fiscal rules can have perverse effects: if entitlements are unconstrained, and there are capital market frictions, debt limits lead to an increase in total government obligations and to worse outcomes for all groups. Analogous results hold for entitlement limits. Third, our model sheds some lights on the influence of capital market frictions on the incentives of governments to adopt fiscal rules, and implement entitlement programs. Finally, we identify preference polarization as a possible explanation for the joint growth of debt and entitlements.
The large regional variation in minimum wage levels during the period 2002–8 in China implies that Chinese manufacturing firms experienced competitive shocks as a function of firm location and their low-wage employment share. We find that minimum wage hikes accelerate the input substitution from labour to capital, reduce employment growth and accelerate total factor productivity growth—particularly among the less productive firms under private Chinese or foreign ownership, but not among state-owned enterprises. The heterogeneous firm response to labour cost shocks can be explained by differences in management practices and suggests that management quality and competitive pressure are complementary.
How far should an industry be allowed to consolidate when competition and innovation are endogenous? We develop a stochastically alternating-move game of dynamic oligopoly and estimate it using data from the hard disk drive industry, in which a dozen global players consolidated into only three in the last 20 years. We find plateau-shaped equilibrium relationships between competition and innovation, with heterogeneity across time and productivity. Our counterfactual simulations suggest the current rule-of-thumb policy, which stops mergers when three or fewer firms exist, strikes approximately the right balance between pro-competitive effects and value-destruction side effects in this dynamic welfare trade-off.
We surveyed a large sample of Swedish lottery players about their psychological well-being 5–22 years after a major lottery event and analysed the data following pre-registered procedures. Relative to matched controls, large-prize winners experience sustained increases in overall life satisfaction that persist for over a decade and show no evidence of dissipating over time. The estimated treatment effects on happiness and mental health are significantly smaller. Follow-up analyses of domain-specific aspects of life satisfaction implicate financial life satisfaction as an important mediator for the long-run increase in overall life satisfaction.
An increasing number of police departments use information technology (IT) to optimize patrolling strategies, yet little is known about its effectiveness in preventing crime. Based on quasi-random access to “predictive policing,” this study shows that IT improves police productivity as measured by crime clearance rates. Thanks to detailed information on individual incidents and offender-level identifiers it also shows that criminals strategies are predictable. Moreover, the introduction of predictive policing coincides with a large negative trend-discontinuity in crime rates. The benefit–cost ratio of this IT innovation appears to be large.
U.S. monetary policy shocks induce comovements in the international financial variables that characterize the “Global Financial Cycle.” A single global factor that explains an important share of the variation of risky asset prices around the world decreases significantly after a U.S. monetary tightening. Monetary contractions in the US lead to significant deleveraging of global financial intermediaries, a decline in the provision of domestic credit globally, strong retrenchments of international credit flows, and tightening of foreign financial conditions. Countries with floating exchange rate regimes are subject to similar financial spillovers.
This article establishes a new fact about educational production: ordinal academic rank during primary school has lasting impacts on secondary school achievement that are independent of underlying ability. Using data on the universe of English school students, we exploit naturally occurring differences in achievement distributions across primary school classes to estimate the impact of class rank. We find large effects on test scores, confidence, and subject choice during secondary school, even though these students have a new set of peers and teachers who are unaware of the students’ prior ranking in primary school. The effects are especially pronounced for boys, contributing to an observed gender gap in the number of Maths courses chosen at the end of secondary school. Using a basic model of student effort allocation across subjects, we distinguish between learning and non-cognitive skills mechanisms, finding support for the latter.
Insurance benefit design has important implications for consumer welfare. In this article, we model insurer behaviour in the Medicare prescription drug coverage market and show that strategic private insurer incentives impose a fiscal externality on the traditional Medicare program. We document that plans covering medical expenses have more generous drug coverage than plans that are only responsible for prescription drug spending, which translates into higher drug utilization by enrolees. The effect is driven by drugs that reduce medical expenditure and treat chronic conditions. Our equilibrium model of benefit design endogenizes plan characteristics and accounts for asymmetric information; the model estimates confirm that differential incentives to internalize medical care offsets can explain disparities across plans. Counterfactuals show that strategic insurer incentives are as important as asymmetric information in determining benefit design.
This article develops a search theory of labour unions in which the possibility of unionization distorts the behaviour of non-union firms. In the model, unions arise endogenously through a majority election within firms. As union wages are set through a collective bargaining process, unionization compresses wages and lowers profits. To prevent unionization, non-union firms over-hire high-skill workers— who vote against the union— and under-hire low-skill workers— who vote in its favour. As a consequence of this distortion in hiring, firms that are threatened by unionization hire fewer workers, produce less and pay a more concentrated distribution of wages. In the calibrated economy, the threat of unionization has a significant negative impact on aggregate output, but it also reduces wage inequality.
This article introduces a general equilibrium model of endogenous technical change through basic and applied research. Basic research differs from applied research in the nature and the magnitude of the generated spillovers. We propose a novel way of empirically identifying these spillovers and embed them in a framework with private firms and a public research sector. After characterizing the equilibrium, we estimate our model using micro-level data on research expenditures by French firms. Our key finding is that uniform research subsidies can accentuate the dynamic misallocation in the economy by oversubsidizing applied research. Policies geared towards public basic research and its interaction with the private sector are significantly welfare-improving.
We model a decentralized, dynamic auction market platform in which a continuum of buyers and sellers participate in simultaneous, single-unit auctions each period. Our model accounts for the endogenous entry of agents and the impact of intertemporal optimization on bids. We estimate the structural primitives of our model using Kindle sales on eBay. We find that just over one-third of Kindle auctions on eBay result in an inefficient allocation with deadweight loss amounting to 14% of total possible market surplus. We also find that partial centralization—for example, running half as many 2-unit, uniform-price auctions each day—would eliminate a large fraction of the inefficiency, but yield lower seller revenues. Our results also highlight the importance of understanding platform composition effects—selection of agents into the market—in assessing the implications of market redesign. We also prove that the equilibrium of our model with a continuum of buyers and sellers is an approximate equilibrium of the analogous model with a finite number of agents.
What is the aggregate and distributional impact of microfinance? To answer this question, we develop a quantitative macroeconomic framework of entrepreneurship and financial frictions in which microfinance is modelled as guaranteed small-size loans. We discipline and validate our model using recent empirical evaluations of small-scale microfinance programs. We find that the long-run general equilibrium impact is substantially different from the short-run effect. In the short-run partial equilibrium, output and capital increase with microfinance but total factor productivity (TFP) falls. In the long run, when general equilibrium effects are considered, as should be for economy-wide microfinance interventions, scaling up microfinance has only a small impact on per-capita income, because an increase in TFP is offset by lower capital accumulation. However, the vast majority of the population benefits from microfinance directly and indirectly. The welfare gains are larger for the poor and the marginal entrepreneurs, although higher interest rates in general equilibrium tilt the gains toward the rich.
Fixed differences loom smaller when compared to large differences. We propose a model of relative thinking where a person weighs a given change along a consumption dimension by less when it is compared to bigger changes along that dimension. In deterministic settings, the model predicts context effects such as the attraction effect but predicts meaningful bounds on such effects driven by the intrinsic utility for the choices. In risky environments, a person is less likely to sacrifice utility on one dimension to gain utility on another that is made riskier. For example, a person is less likely to exert effort for a fixed monetary return if there is greater overall income uncertainty. We design and run experiments to test basic model predictions and find support for these predictions.
This article studies how the monetary policy regime affects the relative importance of nominal exchange rates and inflation rates in shaping the response of real exchange rates to shocks. We document two facts about inflation-targeting countries. First, the current real exchange rate predicts future changes in the nominal exchange rate. Second, the real exchange rate is a poor predictor of future inflation rates. We estimate a medium-size, open-economy DSGE model that accounts quantitatively for these facts as well as other empirical properties of real and nominal exchange rates. The key estimated shocks that drive the dynamics of exchange rates and their covariance with inflation are disturbances to the foreign demand for dollar-denominated bonds.
In this paper, we use two comprehensive micro-data sets to study how the distribution of mortgage debt evolved during the 2000s housing boom. We show that the allocation of mortgage debt across the income distribution remained stable, as did the allocation of real estate assets. Any theory of the boom must replicate these facts, and a general equilibrium model shows that doing so requires two elements: (1) an exogenous shock that increases expected house price growth or, alternatively, reduces interest rates and (2) financial markets that endogenously relax borrowing constraints in response to the shock. Empirically, the endogenous relaxation of constraints was largely accomplished with subprime lending, which allowed the mortgage debt of low-income households to increase at the same rate as that of high-income households.
What is the relationship between bank capital, the risk of a financial crisis, and its severity? This article introduces the first comprehensive analysis of the long-run evolution of the capital structure of modern banking using newly constructed data for banks’ balance sheets in 17 countries since 1870. In addition to establishing stylized facts on the changing funding mix of banks, we study the nexus between capital structure and financial instability. We find no association between higher capital and lower risk of banking crisis. However, economies with better capitalized banking systems recover faster from financial crises as credit begins to flow back more readily.
We identify a new mechanism through which cultural diversity affects economic outcomes, based on a model of culture as shared cognition. Under this view, cultural diversity matters because it increases strategic uncertainty. The model can help better understand a variety of disparate evidence, including why homogeneous societies can be more conformist, why diverse societies may get stuck in a low-trust trap, why companies with a strong culture may fail to adopt superior work practices, and why autocratic rulers in diverse societies may overinvest in state capacity.
Little is known about whether people make good choices when facing important decisions. This article reports on a large-scale randomized field experiment in which research subjects having difficulty making a decision flipped a coin to help determine their choice. For important decisions (e.g. quitting a job or ending a relationship), individuals who are told by the coin toss to make a change are more likely to make a change, more satisfied with their decisions, and happier six months later than those whose coin toss instructed maintaining the status quo. This finding suggests that people may be excessively cautious when facing life-changing choices.
This article studies the impact of immigration on wages, internal migration, and welfare. Using U.S. Census data, I estimate a spatial equilibrium model where labour differs by skill level, gender, and nativity. Workers are heterogeneous in city preferences. Cities vary in productivity levels, housing prices, and amenities. I use the estimated model to assess the distributional consequences of several immigration policies. The results show that a skill selective immigration policy leads to welfare gains for low skill workers, but welfare losses for high skill workers. The negative impacts are more substantial among the incumbent high skill immigrants. Internal migration mitigates the initial negative impacts, particularity in cities where housing supplies are inelastic. However, the negative wage impacts on some workers intensify. This is because an out-migration of workers of a given type may raise the local wages for workers of that type, while reducing the local wages of workers with complementary characteristics. Overall, there are substantial variations in the welfare effects of immigration across and within cities. Further, I use the model to assess the welfare effects of the border wall between Mexico and the U.S. The results show that the potential benefits are significantly smaller than the proposed cost of construction.
This article studies the introduction of an EU-wide emission standard on the automobile market. Using panel data from 1998 to 2011, I find that firms decreased emission ratings by 14%. Firms use technology adoption and gaming of emission tests to decrease emissions, rather than shifting the sales mix or downsizing. I find that the standard missed its emission target, and from estimating a structural model, I find that the standard was not welfare improving. The political environment in the EU shaped the design and weak enforcement and resulted in firms’ choices for abatement by technology adoption and gaming.
Can attitudes towards minorities, an important cultural trait, be changed? We show that the presence of African American soldiers in the UK during World War II reduced anti-minority prejudice, a result of the positive interactions which took place between soldiers and the local population. The change has been persistent: in locations in which more African American soldiers were posted there are fewer members of and voters for the UK’s leading far-right party, less implicit bias against blacks and fewer individuals professing racial prejudice, all measured around 2010. Our results point towards intergenerational transmission from parents to children as the most likely explanation.
Communication is integral to organizations and yet field evidence on the relation between communication and worker productivity remains scarce. We argue that a core role of communication is to transmit information that helps co-workers do their job better. We build a simple model in which workers choose the amount of communication by trading off this benefit against the time cost incurred by the sender, and use it to derive a set of empirical predictions. We then exploit a natural experiment in an organization where problems arrive and must be sequentially dealt with by two workers. For exogenous reasons, the first worker can sometimes communicate face-to-face with their colleague. Consistently with the predictions of our model, we find that: (1) the second worker works faster (at the cost of the first worker having less time to deal with incoming problems) when face-to-face communication is possible, (2) this effect is stronger when the second worker is busier and for homogenous and closely located teams, and (3) the (career) incentives of workers determine how much they communicate with their colleagues. We also find that workers partially internalise social outcomes in their communication decisions. Our findings illustrate how workers in teams adjust the amount of mutual communication to its costs and benefits.
In dynamic games, players may observe a deviation from a pre-play, possibly incomplete, non-binding agreement before the game is over. The attempt to rationalize the deviation may lead players to revise their beliefs about the deviator’s behaviour in the continuation of the game. This instance of forward induction reasoning is based on interactive beliefs about not just rationality, but also the compliance with the agreement itself. I study the effects of such rationalization on the self-enforceability of the agreement. Accordingly, outcomes of the game are deemed implementable by some agreement or not. Conclusions depart substantially from what the traditional equilibrium refinements suggest. A non-subgame perfect equilibrium outcome may be induced by a self-enforcing agreement, while a subgame perfect equilibrium outcome may not. The incompleteness of the agreement can be crucial to implement an outcome.
We examine how many and what kind of firms ultimately rely on foreign inputs, sell to foreign markets, and are affected by trade shocks. To capture that firms can trade indirectly by buying from or selling to domestic firms that import or export, we use Belgian data with information on both domestic firm-to-firm sales and foreign trade transactions. We find that most firms use a lot of foreign inputs, but only a small number of firms show that dependence through direct imports. While direct exporters are rare, a majority of firms are indirectly exporting. In most firms, however, indirect export is quantitatively modest, and sales at home are the key source of revenue. We show that what matters for the transmission of foreign demand shocks to a firm’s revenue is how much the firm ultimately sells to foreign markets, not whether these sales are from direct or indirect export.
We provide new time-varying estimates of the housing wealth effect back to the 1980s. We use three identification strategies: ordinary least squares with a rich set of controls, the Saiz housing supply elasticity instrument, and a new instrument that exploits systematic differences in city-level exposure to regional house price cycles. All three identification strategies indicate that housing wealth elasticities were if anything slightly smaller in the 2000s than in earlier time periods. This implies that the important role housing played in the boom and bust of the 2000s was due to larger price movements rather than an increase in the sensitivity of consumption to house prices. Full-sample estimates based on our new instrument are smaller than recent estimates, though they remain economically important. We find no significant evidence of a boom–bust asymmetry in the housing wealth elasticity. We show that these empirical results are consistent with the behaviour of the housing wealth elasticity in a standard life-cycle model with borrowing constraints, uninsurable income risk, illiquid housing, and long-term mortgages. In our model, the housing wealth elasticity is relatively insensitive to changes in the distribution of  loan-to-value (LTV) for two reasons: first, low-leverage homeowners account for a substantial and stable part of the aggregate housing wealth elasticity; second, a rightward shift in the LTV distribution increases not only the number of highly sensitive constrained agents but also the number of underwater agents whose consumption is insensitive to house prices.
We identify a competition-policy-based argument for regulating the secondary features of complex or complexly priced products when consumers have limited attention. Limited attention implies that consumers can only “study” a small number of complex products in full, while—by failing to check secondary features—they can superficially “browse” more. Interventions limiting ex post consumer harm through safety regulations, caps on certain fees, or other methods induce consumers to do more or more meaningful browsing, enhancing competition. We show that for a pro-competitive effect to obtain, the regulation must apply to the secondary features, and not to the total price or value of the product. As an auxiliary positive prediction, we establish that because low-value consumers are often more likely to study—and therefore less likely to browse—than high-value consumers, the average price consumers pay can be increasing in the share of low-value consumers. We discuss applications of our insights to health-insurance choice, the European Union’s principle on unfair contract terms, food safety in developing countries, and the shopping behaviour of (and prices paid by) low-income and high-income consumers.
This article shows that the intensity of violence in Rwanda’s recent past can be traced back to the initial establishment of its pre-colonial state. Villages that were brought under centralized rule one century earlier experienced a doubling of violence during the state-organized 1994 genocide. Instrumental variable estimates exploiting differences in the proximity to Nyanza—an early capital—suggest that these effects are causal. Before the genocide, when the state faced rebel attacks, with longer state presence, violence is lower. Using data from several sources, including a lab-in-the-field experiment across an abandoned historical boundary, I show that the effect of the historical state is primarily sustained by culturally transmitted norms of obedience. The persistent effect of the pre-colonial state interacts with government policy: where the state developed earlier, there is more violence when the Rwandan government mobilized for mass killing and less violence when the government pursued peace.
We study the Markov perfect equilibrium in a dynamic game where agents have non-constant time preference, decentralized households determine aggregate savings, and a planner chooses climate policy. The article is the first to solve this problem with general discounting and general functional forms. With time-inconsistent preferences, a commitment device that allows a planner to choose climate policy for multiple periods is potentially very valuable. Nevertheless, our quantitative results show that while a permanent commitment device would be very valuable, the ability to commit policy for “only” 100 years adds less than 2% to the value of climate policy without commitment. We solve a log-linear version of the model analytically, generating a formula for the optimal carbon tax that includes the formula in Golosov et al. (2014, Econometrica, 82, 41–88) as a special case. More importantly, we develop new algorithms to solve the general game numerically. Convex damages lead to strategic interactions across generations of planners that lower the optimal carbon tax by 45% relative to the scenario without strategic interactions.
We study competitive equilibria in a signalling economy with heterogeneously informed buyers. In terms of the classic Spence (1973, The Quarterly Journal of Economics, 87, 355—374) model of job market signalling, firms have access to direct but imperfect information about worker types, in addition to observing their education. Firms can be ranked according to the quality of their information, i.e., their expertise.  In equilibrium, some high-type workers forgo signalling and are hired by better informed firms, which make positive profits. Workers’ education decisions and firms’ use of their expertise are strategic complements, allowing for multiple equilibria that can be Pareto ranked. We characterize wage dispersion and the extent of signalling as a function of the distribution of expertise among firms.  Our model can also be applied to a variety of other signalling problems, including securitization, corporate financial structure, insurance markets, or dividend policy.
This study empirically quantifies the efficiency of a real-world bargaining game with two-sided incomplete information. Myerson and Satterthwaite (1983) and Williams (1987) derived the theoretical ex-ante efficient frontier for bilateral trade under two-sided uncertainty and demonstrated that it falls short of ex-post efficiency, but little is known about how well bargaining performs in practice. Using about 265,000 sequences of a game of alternating-offer bargaining following an ascending auction in the wholesale used-car industry, this study estimates (or bounds) distributions of buyer and seller values and evaluates where realized bargaining outcomes lie relative to efficient outcomes. Results demonstrate that the ex-ante and ex-post efficient outcomes are close to one another, but that the real bargaining falls short of both, suggesting that the bargaining is indeed inefficient but that this inefficiency is not solely due to the information constraints highlighted in Myerson and Satterthwaite (1983). Quantitatively, findings indicate that over one-half of failed negotiations are cases where gains from trade exist, leading an efficiency loss of 12–23% of the available gains from trade.
Markov regime-switching models are very common in economics and finance. Despite persisting interest in them, the asymptotic distributions of likelihood ratio-based tests for detecting regime switching remain unknown. This study examines such tests and establishes their asymptotic distributions in the context of nonlinear models, allowing multiple parameters to be affected by regime switching. The analysis addresses three difficulties: (i) some nuisance parameters are unidentified under the null hypothesis, (ii) the null hypothesis yields a local optimum, and (iii) the conditional regime probabilities follow stochastic processes that can only be represented recursively. Addressing these issues permits substantial power gains in empirically relevant settings. This study also presents the following results: (1) a characterization of the conditional regime probabilities and their derivatives with respect to the model’s parameters, (2) a high-order approximation to the log-likelihood ratio, (3) a refinement of the asymptotic distribution, and (4) a unified algorithm to simulate the critical values. For models that are linear under the null hypothesis, the elements needed for the algorithm can all be computed analytically. Furthermore, the above results explain why some bootstrap procedures can be inconsistent, and why standard information criteria can be sensitive to the hypothesis and the model structure. When applied to US quarterly real gross domestic product (GDP) growth rate data, the methods detect relatively strong evidence favouring the regime-switching specification. Lastly, we apply the methods in the context of dynamic stochastic equilibrium models and obtain similar results as the GDP case.
This article establishes the existence of multiple equilibria in infinite-horizon open economy models in which the value of tradable and non-tradable endowments serves as collateral. In this environment, the economy displays self-fulfilling financial crises in which pessimistic views about the value of collateral induce agents to deleverage. Under plausible calibrations, there exist equilibria with underborrowing. This result stands in contrast to the overborrowing result stressed in the related literature. Underborrowing emerges in the present context because in economies that are prone to self-fulfilling financial crises, individual agents engage in excessive precautionary savings as a way to self-insure.
Does the pattern of social connections between individuals matter for macroeconomic outcomes? If so, where do differences in these patterns come from and how large are their effects? Using network analysis tools, we explore how different social network structures affect technology diffusion and thereby a country’s rate of growth. The correlation between high-diffusion networks and income is strongly positive. But when we use a model to isolate the effect of a change in social networks on growth, the effect can be positive, negative, or zero. The reason is that networks diffuse both ideas and disease. Low-diffusion networks have evolved in countries where disease is prevalent because limited connectivity protects residents from epidemics. But a low-diffusion network in a low-disease environment compromises the diffusion of good ideas. In general, social networks have evolved to fit their economic and epidemiological environment. Trying to change networks in one country to mimic those in a higher-income country may well be counterproductive.
We characterize trade policies that result from political competition when assessments of well-being include both material and psychosocial components. The material component reflects, as usual, satisfaction from consumption. Borrowing from social identity theory, we take the psychosocial component as combining the pride and self-esteem an individual draws from the status of groups with which she identifies and a dissonance cost she bears from identifying with those that are different from herself. In this framework, changes in social identification patterns that may result, for example, from increased income inequality or heightened class or ethnic tensions, lead to pronounced changes in trade policy. We analyse the nature of these policy changes.
We model the building of a city, estimate parameters of the model, and calculate welfare losses from institutional frictions encountered in changing land-use. We distinguish formal and slum construction technologies; in contrast to slums, formal structures can be built tall, are durable, and non-malleable. As the city grows areas are initially developed informally, then formally, and then redeveloped periodically. Slums are modelled as a technology choice; however, institutional frictions in land markets may hinder their conversion to formal usage that requires secure property rights. Using unique data on Nairobi for 2003 and 2015, we develop a novel set of facts that support assumptions of the model, estimate all parameters of the model, and calculate welfare losses of conversion frictions. We track the dynamic evolution of the city and compare it with model predictions. In the core city formal sector, about a third of buildings were torn down over 12 years and replaced by buildings on average three times higher. For slums in older areas near the centre, even after buying out slumlords, overcoming institutional frictions would yield gains amounting to about |${\$}$|18,000 per slum household, thirty times typical annual slum rent payments.
The willingness to pay for insurance captures the value of insurance against only the risk that remains when choices are observed. This article develops tools to measure the ex ante expected utility impact of insurance subsidies and mandates when choices are observed after some insurable information is revealed. The approach retains the transparency of using reduced-form willingness to pay and cost curves, but it adds one additional sufficient statistic: the percentage difference in marginal utilities between insured and uninsured. I provide an approach to estimate this additional statistic that uses only the reduced-form willingness to pay curve, combined with a measure of risk aversion. I compare the approach to structural approaches that require fully specifying the choice environment and information sets of individuals. I apply the approach using existing willingness to pay and cost curve estimates from the low-income health insurance exchange in Massachusetts. Ex ante optimal insurance prices are roughly 30% lower than prices that maximize observed market surplus. While mandates reduce market surplus, the results suggest they would actually increase ex ante expected utility.
We introduce a robust approach to study dynamic monopoly pricing of a durable good in the face of buyer learning. A buyer receives information about her willingness-to-pay for the seller’s product over time, and decides when to make a one-time purchase. The seller does not know how the buyer learns but commits to a pricing strategy to maximize profits against the worst-case information arrival process. We show that a constant price path delivers the robustly optimal profit, with profit and price both lower than under known values. Thus, under the robust objective, intertemporal incentives do not arise at the optimum, despite the possibility for information arrival to influence the timing of purchases. We delineate whether constant prices remain optimal (or not) when the seller seeks robustness against a subset of information arrival processes. As part of the analysis, we develop new techniques to study dynamic Bayesian persuasion.
This article characterizes optimal compensation contracts in principal-agent settings in which the consequences of the agent’s action are only observed over time. The optimal timing of pay trades off the costs of deferred compensation arising from the agent’s relative impatience and potential consumption smoothing needs against the benefit of exploiting additional informative signals. By capturing this information benefit of deferral in terms of the likelihood ratio dynamics, our characterization covers general signal processes in a unified setting. With bilateral risk neutrality and agent limited liability, optimal contracts are high-powered and stipulate at most two payout dates. If the agent is additionally risk-averse, payouts are contingent on performance exceeding a hurdle that is increasing over time. We obtain clear-cut predictions on how the duration of optimal compensation depends on the nature of information arrival as well as agent characteristics and derive implications for the maturity structure of securities in financial contracting settings.
We show that helping young job seekers signal their skills to employers generates large and persistent improvements in their labour market outcomes. We do this by comparing an intervention that improves the ability to signal skills (the “job application workshop”) to a transport subsidy treatment designed to reduce the cost of job search. In the short run, both interventions have large positive effects on the probability of finding a formal job. The workshop also increases the probability of having a stable job with an open-ended contract. Four years later, the workshop significantly increases earnings, job satisfaction, and employment duration, but the effects of the transport subsidy have dissipated. Gains are concentrated on individuals who generally have worse labour market outcomes. Overall, our findings highlight that young people possess valuable skills that are unobservable to employers. Making these skills observable generates earnings gains that are far greater than the cost of the intervention.
This article investigates the effects of development projects on economic networks. To this end, we study the impact that a randomly allocated Community-Driven Development program in The Gambia has on economic interactions within rural villages. The program provides an exogenous source of variation to village-level stocks of productive capital and to village-wide collective activities. Based on detailed data on economic and social networks, we find a significant reduction of transfers in these networks in treatment villages. Guided by a theoretical framework, we investigate several possible mechanisms and find evidence that is consistent with two channels. First, the evidence points to modest wealth effects and a village-level transformation process towards a more formal economy. Second, we also find evidence that is consistent with elite capture, favouritism, and unequally distributed benefits leading to reductions in social capital and thus economic transactions. Overall, our findings suggest changes in networks as an avenue through which development interventions may have unintended consequences.
Motivated by wide cross-sectional variations in intensity of care that are unrelated to quality of care, researchers and policymakers commonly claim that healthcare providers waste considerable resources, engaging in so-called “flat-of-the-curve” medicine. A key yet elusive prediction of this hypothesis is that providers ought to be able to cut back on care without sacrificing quality. This article examines the effects of a particular form of provider cutbacks—those generated by physicians working in high-pressure peer group environments. Using expansive, time-stamped discharge data from 137 hospital-based emergency departments, I document that physicians systematically alter their pace and intensity of care across frequently shuffled peer groups. Peer groups that induce a physician to work faster also induce her to order fewer tests and spend less money. Contrary to the flat-of-the-curve hypothesis, these cutbacks lead to large reductions in quality of care. This evidence, paired with the fact that slower physicians do not produce better average outcomes, suggests that cross-physician differences in resource utilization reflect substantial differences in physician productivity within a hospital.
What is the role of monetary policy in a bubbly world? To address this question, we study an economy in which financial frictions limit the supply of assets. The ensuing scarcity generates a demand for “unbacked” assets, i.e., assets that are backed only by the expectation of their future value. We consider two types of unbacked assets: bubbles, which are created by the private sector, and money, which is created by the central bank. Bubbles and money share many features, but they also differ in two crucial respects. First, while the rents from the creation of bubbles accrue to entrepreneurs and foster investment, the rents from money creation accrue to the central bank. Second, while bubbles are driven by market psychology, and can rise and fall according to the whims of the market, money is under the control of the central bank. We characterize the optimal monetary policy and show that, through its ability to supply assets, monetary policy plays a key role in the bubbly world. The model sheds light on the recent expansion of central bank liabilities in response to the bursting of bubbles.
We characterize when a stable and strategy-proof mechanism is guaranteed to exist in the setting of many-to-one matching with contracts. We introduce three novel conditions—observable substitutability, observable size monotonicity, and non-manipulability via contractual terms—and show that when these conditions are satisfied, the cumulative offer mechanism is the unique mechanism that is stable and strategy-proof (for workers). Moreover, we show that our three conditions are, in a sense, necessary: if the choice function of some firm fails any of our three conditions, we can construct unit-demand choice functions for the other firms such that no stable and strategy-proof mechanism exists. Thus, our results provide a rationale for the ubiquity of cumulative offer mechanisms in practice.
The communication revelation principle (RP) of mechanism design states that any outcome that can be implemented using any communication system can also be implemented by an incentive-compatible direct mechanism. In multistage games, we show that in general the communication RP fails for the solution concept of sequential equilibrium (SE). However, it holds in important classes of games, including single-agent games, games with pure adverse selection, games with pure moral hazard, and a class of social learning games. For general multistage games, we establish that an outcome is implementable in SE if and only if it is implementable in a canonical Nash equilibrium in which players never take codominated actions. We also prove that the communication RP holds for the more permissive solution concept of conditional probability perfect Bayesian equilibrium.
We examine a determinant of cultural persistence that has emerged from a class of models in evolutionary anthropology: the similarity of the environment across generations. Within these models, when the environment is more stable across generations, the traits that have evolved up to the previous generation are more likely to be suitable for the current generation. In equilibrium, a greater value is placed on tradition and there is greater cultural persistence. We test this hypothesis by measuring the variability of climatic measures across 20-year generations from 500 to 1900. Employing a variety of tests that use different samples and empirical strategies, we find that populations with ancestors who lived in environments with more cross-generational instability place less importance on maintaining tradition today and exhibit less cultural persistence.
This article develops a tractable theoretical framework for the Top Trading Cycles (TTC) mechanism for school choice that allows quantifying welfare and optimizing policy decisions. We compute welfare for TTC and Deferred Acceptance (DA) under different priority structures and find that the choice of priorities can have larger welfare implications than the choice of mechanism. We solve for the welfare-maximizing distributions of school quality for parametrized economies and find that optimal investment decisions can be very different under TTC and DA. Our framework relies on a novel characterization of the TTC assignment in terms of a cutoff for each pair of schools. These cutoffs parallel prices in competitive equilibrium, with students’ priorities serving the role of endowments. We show that these cutoffs can be computed directly from the distribution of preferences and priorities in a continuum model and derive closed-form solutions and comparative statics for parameterized settings. The TTC cutoffs not only clarify the role of priorities in determining the TTC assignment but also demonstrate that TTC is more complicated than DA.
This article investigates stable and efficient networks in the context of risk sharing, when it is costly to establish and maintain relationships that facilitate risk sharing. We find a novel trade-off between efficiency and equality: the most stable efficient networks also generate the most inequality. We then suppose that individuals can be split into groups, assuming that incomes across groups are less correlated than within a group but relationships across groups are more costly to form. The tension between efficiency and equality extends to these correlated income structures. More-central agents have stronger incentives to form across-group links, reaffirming the efficiency benefits of having highly central agents. Our results are robust to many extensions. In general, endogenously formed networks in the risk-sharing context tend to exhibit highly asymmetric structures, which can lead to stark inequalities in consumption levels.
We explain how the common practice of size-discovery trade detracts from overall financial market efficiency. At each of a series of size-discovery sessions, traders report their desired trades, generating allocations of the asset and cash that rely on the most recent exchange price. Traders can thus mitigate exchange price impacts by waiting for size-discovery sessions. This waiting causes socially costly delays in the rebalancing of asset positions across traders. As the frequency of size-discovery sessions is increased, exchange market depth is further lowered by the traders’ reduced incentive to bid aggressively on the exchange, further delaying the rebalancing of positions, and more than offsetting the gains from trade that occur at each of the size-discovery sessions.
We formalize the idea that house price changes may drive rational waves of optimism and pessimism in the economy. In our model, a house price increase caused by aggregate disturbances may be misinterpreted as a sign of higher local permanent income, leading households to demand more consumption and housing. Higher demand reinforces the initial price increase in an amplification loop that drives comovement in output, labour, residential investment, land prices, and house prices even in response to aggregate supply shocks. The qualitative implications of our otherwise frictionless model are consistent with observed business cycles and it can explain the economic impact of apparently autonomous changes in sentiment without resorting to non-fundamental shocks or nominal rigidity.
We use survey questions about spending in hypothetical scenarios to investigate features of propensities to consume that are useful for distinguishing between consumption theories. We find that (1) responses to unanticipated gains are vastly heterogeneous (either zero or substantially positive); (2) responses increase in the size of the gain, driven by the extensive margin of spending adjustments; (3) responses to losses are much larger and more widespread than responses to gains; and (4) even those with large responses to gains do not respond to news about future gains. These four findings suggest that limited access to disposable resources, and frictions in adjusting consumption, are important determinants of consumption behaviour. We also find that (5) households do not respond to the offer of a one-year interest-free loan, suggesting that this is not a consequence of short-term credit constraints; and (6) people do cut spending in response to news about future losses, suggesting that neither is this a consequence of myopia. A calibrated precautionary savings model with utility costs of changing consumption, and a sufficient fraction of low-wealth households, can account for these features of propensities to consume on both the extensive and intensive margins.
This article develops a search and matching model of mergers and acquisitions (M&A) and uses it to evaluate the implications of merger activity for aggregate economic outcomes. The theory is consistent with a rich set of facts on U.S. M&A, including sorting among merging firms, a substantial merger premium and serial acquisition. It provides a sharp link between these facts and the nature of merger gains. At the micro-level, both complementarities between merging firms and productivity improvements of target firms are important in generating gains. At the macro-level, the model suggests a significant beneficial impact of M&A on aggregate outcomes—the contribution to steady state output is 14|$\%$| and 4|$\%$| for consumption—which occurs through the reallocation of resources across firms and equilibrium effects on firm selection and new entrepreneurship. Nevertheless, the economy is not efficient, suggesting a scope for policy improvements—a simple flat tax on M&A can raise steady state consumption as much as 2|$\%$| relative to the laissez-faire equilibrium. In short, the boundaries of the firm can matter for macroeconomic outcomes.
This article examines the impact of a property rights reform in rural China that allowed farmers to lease out their land. We find the reform led to increases in land rental activity in rural households. Our results indicate that the formalization of leasing rights resulted in a redistribution of land toward more-productive farmers. Consequently, output and aggregate productivity increased by 8|$\%$| and 10|$\%$|⁠, respectively. We also find that the reform increased the responsiveness of land allocation across crops to changes in crop prices.
We examine intergenerational mobility in the very long run, across generations that are six centuries apart. We exploit a unique dataset containing detailed information at the individual level for all people living in the Italian city of Florence in 1427. These individuals have been associated, using their surnames, with their pseudo-descendants living in Florence in 2011. We find that long-run earnings elasticity is about 0.04; we also find an even stronger role for real wealth inheritance and evidence of persistence in belonging to certain elite occupations. Our results are confirmed when we account for the quality of the pseudo-links and when we address the potential selectivity bias behind the matching process. Finally, we frame our results within the existing evidence and argue that the quasi-immobility of preindustrial society and the existence of multigenerational effects might explain the long-lasting effects of ancestors’ socioeconomic status.
Performance evaluation (“rating”) systems not only provide information to users but also motivate the rated worker. This article solves for the optimal (effort-maximizing) rating within the standard career concerns framework. We prove that this rating is a linear function of past observations. The rating, however, is not a Markov process, but rather the sum of two Markov processes. We show how it combines information of different types and vintages. An increase in effort may adversely affect some (but not all) future ratings.
In most of the developed world, skilled women marry at a lower rate than less skilled ones. We document heterogeneity across countries in how the marriage gap between skilled and unskilled women has evolved over time. As labour market opportunities for women have improved, the marriage gap has been growing in some countries but shrinking in others. We discuss the comparative statics of a theoretical model in which the (negative) social attitudes toward working women might contribute to the relatively lower marriage rate of skilled women and might also induce a non-monotonic relationship between their labour market prospects and their marriage outcomes. The model delivers predictions about how the skilled–unskilled marriage gap should react to changes in labour market opportunities across economies with more or less conservative attitudes toward working women. We verify the key predictions of this model in a panel of 26 developed countries, as well as in a panel of U.S. states.
Observed choices between risky lotteries are difficult to reconcile with expected utility maximization, both because subjects appear to be too risk averse with regard to small gambles for this to be explained by diminishing marginal utility of wealth, as stressed by Rabin (2000), and because subjects’ responses involve a random element. We propose a unified explanation for both anomalies, similar to the explanation given for related phenomena in the case of perceptual judgments: they result from judgments based on imprecise (and noisy) mental representations of the decision situation. In this model, risk aversion results from a sort of perceptual bias—but one that represents an optimal decision rule, given the limitations of the mental representation of the situation. We propose a quantitative model of the noisy mental representation of simple lotteries, based on other evidence regarding numerical cognition, and test its ability to explain the choice frequencies that we observe in a laboratory experiment.
An agent may privately learn which aspects of his job are more important by shirking on some of them, and use that information to shirk more effectively in the future. In a model of long-term employment relationship, we characterize the optimal relational contract in the presence of such learning-by-shirking and highlight how the performance measurement system can be managed to sharpen incentives. Two related policies are studied: intermittent replacement of existing measures, and adoption of new ones. In spite of the learning-by-shirking effect, the optimal contract is stationary, and may involve stochastic replacement/adoption policies that dilute the agent’s information rents from learning how to game the system.
A long-standing question about consumer behaviour is whether individuals’ observed purchase decisions satisfy the revealed preference (RP) axioms of the utility maximization theory (UMT). Researchers using survey or experimental panel data sets on prices and consumption to answer this question face the well-known problem of measurement error. We show that ignoring measurement error in the RP approach may lead to overrejection of the UMT. To solve this problem, we propose a new statistical RP framework for consumption panel data sets that allows for testing the UMT in the presence of measurement error. Our test is applicable to all consumer models that can be characterized by their first-order conditions. Our approach is non-parametric, allows for unrestricted heterogeneity in preferences and requires only a centring condition on measurement error. We develop two applications that provide new evidence about the UMT. First, we find support in a survey data set for the dynamic and time-consistent UMT in single-individual households, in the presence of nonclassical measurement error in consumption. In the second application, we cannot reject the static UMT in a widely used experimental data set in which measurement error in prices is assumed to be the result of price misperception due to the experimental design. The first finding stands in contrast to the conclusions drawn from the deterministic RP test of Browning (1989, International Economic Review, 979–992). The second finding reverses the conclusions drawn from the deterministic RP test of Afriat (1967, International Economic Review, 8, 6–77) and Varian (1982, Econometrica, 945–973).
Strategies of players in a population are updated according to the behavioural rules of agents, where each agent is a player or a coalition of players. It is known that classic results on the stochastic stability of conventions are due to an asymmetry property of the strategy updating process. We show that asymmetry can be defined at the level of the behavioural rule and that asymmetric rules can be mixed and matched whilst retaining asymmetry of the aggregate process. Specifically, we show robustness of asymmetry to heterogeneity within an agent (Alice follows different rules at different times); heterogeneity between agents (Alice and Bob follow different rules); and heterogeneity in the timing of strategy updating. These results greatly expand and convexify the domain of behavioural rules for which results on the stochastic stability of conventions are known.
Asymmetric information in the marriage market may cause adverse selection and delay marriage if partner quality is revealed over time. Sexual safety is an important but hidden partner attribute, especially in areas where HIV is endemic. A model of positive assortative matching with both observable (attractiveness) and hidden (sexual safety) attributes predicts that removing the asymmetric information about sexual safety accelerates marriage and pregnancy for safe respondents, and more so if they are also attractive. Frequent HIV testing may enable safe people to signal and screen. Consistent with these predictions, we show that a high-frequency, “opt-out” HIV testing intervention changed beliefs about partner’s safety and accelerated marriage and pregnancy, increasing the probabilities of marriage and pregnancy by 26 and 27|$\%$| for baseline-unmarried women over 28 months. Estimates are larger for safe and attractive respondents. Conversely, a single-test intervention lacks these effects, consistent with other HIV testing evaluations in the literature. Our findings suggest that an endogenous response to HIV risk may explain why the HIV/AIDS epidemic has coincided with systematic marriage and pregnancy delays.
Procuring an innovation involves motivating a research effort to generate a new idea and then implementing that idea efficiently. If research efforts are unverifiable and implementation costs are private information, a trade-off arises between the two objectives. The optimal mechanism resolves the trade-off via two instruments: a cash prize and a follow-on contract. It primarily uses the latter, by favouring the innovator at the implementation stage when the value of the innovation is above a certain threshold and handicapping the innovator when the value of the innovation is below that threshold. A cash prize is employed as a supplementary incentive only when the value of innovation is sufficiently high. These features are consistent with current practices in the procurement of innovation and the management of unsolicited proposals.
We introduce a new model of repeated games in large populations with random matching, overlapping generations, and limited records of past play. We prove that steady-state equilibria exist under general conditions on records. When the updating of a player’s record can depend on the actions of both players in a match, any strictly individually rational action can be supported in a steady-state equilibrium. When record updates can depend only on a player’s own actions, fewer actions can be supported. Here, we focus on the prisoner’s dilemma and restrict attention to strict equilibria that are coordination-proof, meaning that matched partners never play a Pareto-dominated Nash equilibrium in the one-shot game induced by their records and expected continuation payoffs. Such equilibria can support full cooperation if the stage game is either “strictly supermodular and mild” or “strongly supermodular,” and otherwise permit no cooperation at all. The presence of “supercooperator” records, where a player cooperates against any opponent, is crucial for supporting any cooperation when the stage game is “severe.”
The growth of the “gig” economy generates worker flexibility that, some have speculated, will favour women. We explore this by examining labour supply choices and earnings among more than a million rideshare drivers on Uber in the U.S. We document a roughly 7% gender earnings gap amongst drivers. We show that this gap can be entirely attributed to three factors: experience on the platform (learning-by-doing), preferences and constraints over where to work (driven largely by where drivers live and, to a lesser extent, safety), and preferences for driving speed. We do not find that men and women are differentially affected by a taste for specific hours, a return to within-week work intensity, or customer discrimination. Our results suggest that, in a “gig” economy setting with no gender discrimination and highly flexible labour markets, women’s relatively high opportunity cost of non-paid-work time and gender-based differences in preferences and constraints can sustain a gender pay gap.
In this article, we ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. Using Compustat data, we first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, we then estimate parameters of a general equilibrium firm dynamics model with endogenous entry and exit to include both bankruptcy options. Finally, we evaluate a bankruptcy policy change similar to one recommended by the American Bankruptcy Institute that amounts to a “fresh start” for bankrupt firms. We find that changes to the law can have sizable consequences for borrowing costs and capital structure which via selection affects productivity, as well as long run welfare.
I consider the aggregate impact of low intermediate input intensity in the agricultural sector of developing countries. In a dynamic general equilibrium model with idiosyncratic shocks, incomplete markets, and subsistence requirements, farmers in developing countries use fewer intermediate inputs because it limits their exposure to uninsurable shocks. The calibrated model implies that Indian agricultural productivity would increase by 16% if markets were complete, driven by quantitatively important increases in both the average real intermediate share and measured TFP through lower misallocation. I then extend the results to consider the importance of risk in other contexts. First, the introduction of insurance decreases cross-country differences in agricultural labour productivity by 14%. Second, scaling the introduction of improved seeds to decrease downside risk reduces inequality by reallocating resources from rich to poor farmers via equilibrium effects. This reallocation substantially increases aggregate productivity relative to what would be expected from extrapolating the partial equilibrium impact.
In this article, we quantify the effects of nurses on health care delivery and patient health in the context of an unintended and policy-induced nurse shortage. Our empirical strategy takes advantage of a parental-leave program in Denmark, which offered any parent the opportunity to take up to one year’s absence per child aged 0–8. Combining the policy variation with administrative employer–employee match data, we document substantial program take-up among nurses, who could not be replaced on net despite public education and immigration expansion efforts to mitigate the employment effects. We find that the parental leave program reduced hospital and nursing home nurse employment by 15% and 10%, respectively. Using detailed patient health records, we find detrimental effects on hospital-care delivery as indicated by a large increase in 30-day readmission rates among acute myocardial infarction patients. We find no evidence for an increase in hospital mortality. In nursing homes, we estimate a large increase in mortality.
Unlike in standard models, decision makers often narrowly bracket and make each decision in isolation. I develop a new approach, which I term narrow thinking, to systematically model narrow bracketing. The definition of narrow thinking is that different decisions are based on different, non-nested, information. As a result, the narrow thinker makes each decision with imperfect knowledge of other decisions and faces difficulties coordinating her multiple decisions. The narrow thinker effectively cares less about her other decisions when making each decision. The main application of narrow thinking is to provide a smooth model of mental accounting without requiring the decision maker to have explicit budgets. My approach generates unique predictions about how the degree of mental accounting depends on expenditure shares and cognitive limitations. It also illustrates how narrow bracketing and mental accounting can be explained by the same underlying friction.
Should the generosity of unemployment benefits and the progressivity of income taxes depend on the presence of business cycles? This paper proposes a tractable model where there is a role for social insurance against uninsurable shocks to income and unemployment, as well as business cycles that are inefficient due to the presence of matching frictions and nominal rigidities. We derive an augmented Baily–Chetty formula showing that the optimal generosity of the social insurance system depends on a macroeconomic stabilization term. This term pushes for an increase in generosity when the level of economic activity is more responsive to social programmes in recessions than in booms. A calibration to the US economy shows that taking concerns for macroeconomic stabilization into account substantially raises the optimal unemployment insurance replacement rate but has a negligible impact on the optimal progressivity of the income tax. More generally, the role of social insurance programmes as automatic stabilizers affects their optimal design.
We study production in advance in a setting where firms first source inventories that remain unobservable to rivals, and then simultaneously set prices. In the unique equilibrium, each firm occasionally holds a sale relative to its reference price, resulting in firms sometimes being left with unsold inventory. In the limit as inventory costs become fully recoverable, the equilibrium converges to an equilibrium of the game where firms only choose prices and produce to order—the associated Bertrand game (examples of which include fully asymmetric clearinghouse models). Thus, away from that limit, our work generalizes Bertrand-type equilibria to production in advance, and challenges the commonly held view associating production in advance with Cournot outcomes. The analysis involves, as an intermediate step, mapping the price-inventory game into an asymmetric all-pay contest with outside options and non-monotonic winning and losing functions. We apply our framework to public policy towards information sharing, mergers, cartels, and taxation.
Most fiscal rules can be overridden by consensus. We show that this does not make them ineffectual. Since fiscal rules determine the outside option in case of disagreement, the opposition uses them as “bargaining chips” to obtain spending concessions. We show that under some conditions this political bargain mitigates the debt-accumulation problem. We analyse various rules and find that when political polarization is high, harsh fiscal rules (e.g. government shutdown) maximize the opposition’s bargaining power and lead to lower debt accumulation. When polarization is low, less strict fiscal limits (e.g. balanced-budget rule) are preferable. Moreover, we find that the optimal fiscal rules could arise in equilibrium by negotiation. Finally, by insuring against power fluctuations, negotiable rules yield higher welfare than hard ones.
We exploit recent molecular genetics evidence on the genetic basis of arsenic excretion and unique information on family links among respondents living in different environments from a large panel survey to uncover the hidden costs of arsenic poisoning in Bangladesh. We provide for the first time estimates of the effects of the ingestion and retention of inorganic arsenic on direct measures of cognitive and physical capabilities as well as on the schooling attainment, occupational structure, entrepreneurship, and incomes of the rural Bangladesh population. We also provide new estimates of the effects of the consumption of foods grown and cooked in arsenic-contaminated water on individual arsenic concentrations. The estimates are based on arsenic biomarkers obtained from a sample of members of rural households in Bangladesh who are participants in a long-term panel survey following respondents and their coresident household members over a period of 26 years.
In the standard herding model, privately informed individuals sequentially see prior actions and then act. An identical action herd eventually starts and public beliefs tend to “cascade sets” where social learning stops. What behaviour is socially efficient when actions ignore informational externalities? We characterize the outcome that maximizes the discounted sum of utilities. Our four key findings are: (1) cascade sets shrink but do not vanish, and herding should occur but less readily as greater weight is attached to posterity. (2) An optimal mechanism rewards individuals mimicked by their successor. (3) Cascades cannot start after period one under a signal log-concavity condition. (4) Given this condition, efficient behaviour is contrarian, leaning against the myopically more popular actions in every period. We make two technical contributions: as value functions with learning are not smooth, we use monotone comparative statics under uncertainty to deduce optimal dynamic behaviour. We also adapt dynamic pivot mechanisms to Bayesian learning.
Bloom et al. (2016) find that Chinese import competition induced a rise in patenting, IT adoption, and total factor productivity (TFP) by up to 30% of the total increase in Europe in the late 1990s and early 2000s. We uncover several coding errors in an important robustness check of their patent results. When corrected, we find no statistically significant relationship between Chinese competition and patents. Other specifications in the original paper use a problematic |$ \log(1+\rm patents) $| transformation. This normalization induces bias given low average patent counts for firms in China-competing sectors and rapidly declining patents across the sample.
This article explores the consequences of extremely low real interest rates in a world with integrated but heterogeneous capital markets, nominal rigidities, and an effective lower bound [a zero lower bound (ZLB) for simplicity]. We establish four main results: (1) At the ZLB, creditor countries export their recession abroad, which we illustrate with a new Metzler diagram in quantities; (2) Beggar-thy-neighbour currency and trade wars provide stimulus to the undertaking country at the expense of other countries; (3) (Safe) public debt issuances and increases in government spending anywhere are expansionary everywhere; and (4) When there is a scarcity of safe assets, net issuers of these assets import the recession from abroad.
Traditional banking is built on four pillars: small and medium enterprise lending, insured deposit taking, access to lender of last resort (LOLR), and prudential supervision. This article unveils the logic of the quadrilogy by showing that it emerges naturally as an equilibrium outcome in a game between banks and the government. A key insight is that regulation and public insurance services (LOLR, deposit insurance) are complementary. The model also shows how prudential regulation must adjust to the emergence of shadow banking and rationalizes structural remedies to counter bogus liquidity hoarding and financial contagion: ring-fencing between regulated and shadow banking and the sharing of liquidity in centralized platforms.
In order to share risk, protection buyers trade derivatives with protection sellers. Protection sellers’ actions affect the riskiness of their assets, which can create counterparty risk. Because these actions are unobservable, moral hazard limits risk sharing. To mitigate this problem, privately optimal derivative contracts involve variation margins. When margins are called, protection sellers must liquidate some assets, depressing asset prices. This tightens the incentive constraints of other protection sellers and reduces their ability to provide insurance. Despite this fire-sale externality, equilibrium is information-constrained efficient. Investors, who benefit from buying assets at fire-sale prices, optimally supply insurance against the risk of fire sales.
This article provides a revealed preference characterisation of quasi-hyperbolic discounting which is designed to be applied to readily available expenditure surveys. We describe necessary and sufficient conditions for the leading forms of the model and also study the consequences of the restrictions on preferences popularly used in empirical lifecycle consumption models. Using data from a household consumption panel dataset, we explore the prevalence of time-inconsistent behaviour. The quasi-hyperbolic model provides a significantly more successful account of behaviour than the alternatives considered. We estimate the joint distribution of time preferences and the distribution of discount functions at various time horizons.
This article documents that parents accumulate savings to insure their children against income risk. I refer to this behaviour as dynastic precautionary saving. Using a sample of matched parent–child pairs from the Panel Study of Income Dynamics, I test for dynastic precautionary savings by examining the response of parental consumption to the child’s permanent income uncertainty. I exploit variation in permanent income risk across age and industry–occupation groups to confirm that, all else equal, higher uncertainty in the child’s permanent income depresses parental consumption, indicating a precautionary saving motive across generations.
We derive a fully non-linear optimal income tax schedule in the presence of private insurance. We fill the gap in the literature by studying the optimal tax formula with a comprehensive structure of the private markets—including incomplete markets models—both theoretically and quantitatively. As in the standard taxation literature without private insurance, the optimal tax formula can still be expressed in terms of standard sufficient statistics. With private insurance, however, the formula involves additional terms that reflect how the private market interacts with public insurance. For example, the optimal tax formula should also consider asset distribution and pecuniary externalities as well as the welfare effects of borrowing constraints.
This article tests for bias in consumer lending using administrative data from a high-cost lender in the U.K. We motivate our analysis using a new principal-agent model of bias where loan examiners are incentivized to maximize a short-term outcome, not long-term profits, leading to bias against illiquid applicants at the margin of loan decisions. We identify the profitability of marginal applicants using the quasi-random assignment of loan examiners, finding significant bias against immigrant and older applicants when using the firm’s preferred measure of long-run profits but not when using the short-run measure used to evaluate examiner performance. In this case, market incentives based on characteristics that vary across groups lead to inefficient group-based bias.
This article studies the optimal design of rules in a dynamic model when there is a time inconsistency problem and uncertainty about whether the policy maker can commit to follow the rule ex post. The policy maker can either be a commitment type, which can always commit to follow rules, or an optimizing type, which sequentially decides whether to follow rules or not. This type is unobservable to private agents, who learn about it through the actions of the policy maker. Higher beliefs that the policy maker is the commitment type (i.e. the policy maker’s reputation) help promote good behaviour by private agents. We show that in a large class of economies, preserving uncertainty about the policy maker’s type is preferable from an ex ante perspective. If the initial reputation is not too high, the optimal rule is the strictest one that is incentive compatible for the optimizing type. We show that reputational considerations imply that the optimal rule is more lenient than the one that would arise in a static environment. Moreover, opaque rules are preferable to transparent ones if reputation is high enough.
We study a real small open economy with two key ingredients (1) partial segmentation of home and foreign bond markets and (2) a pecuniary externality that makes the real exchange rate excessively volatile in response to capital flows. Partial segmentation implies that, by intervening in the bond markets, the central bank can affect the exchange rate and the spread between home- and foreign-bond yields. Such interventions allow the central bank to address the pecuniary externality, but they are also costly, as foreigners make carry trade profits. We analytically characterize the optimal intervention policy that solves this trade-off: (1) the optimal policy leans against the wind, stabilizing the exchange rate; (2) it involves smooth spreads but allows exchange rates to jump; (3) it partly relies on “forward guidance,” with non-zero interventions even after the shock has subsided; (4) it requires credibility, in that central banks do not intervene without commitment. Finally, we shed light on the global consequences of widespread interventions, using a multi-country extension of our model. We find that, left to themselves, countries over-accumulate reserves, reducing welfare and leading to inefficiently low world interest rates.
We study default effects in the context of a residential electricity-pricing program. In the large-scale randomized controlled trial we analyse, one treatment group was given the option to opt-in to time-varying pricing while another was defaulted into the program but allowed to opt-out. We provide dramatic evidence of a default effect on program participation, consistent with previous research. A novel feature of our study is that we also observe how the default manipulation impacts customers’ subsequent electricity consumption. Passive consumers who did not opt-out but would not have opted in—comprising more than 70|$\%$| of the sample—nonetheless reduce consumption in response to higher prices. Observing of this follow-on behaviour enables us to assess competing explanations for the default effect. We draw conclusions about the likely welfare effects of defaulting customers onto time-varying pricing.
This article studies equilibrium dynamics in consumer durable goods markets after aggregate credit shocks. We introduce two novel features into a general-equilibrium model of durable consumption with heterogeneous households facing idiosyncratic income risk and borrowing constraints: (1) indivisible durable goods are vertically differentiated in their quality and (2) trade on secondary markets at market-clearing prices, with households endogenously choosing when to trade or scrap their durables. The model highlights a new transmission mechanism for macroeconomic shocks and successfully matches several empirical patterns that we document using data on U.S. car markets around the Great Recession. After a tightening of the borrowing limit, debt-constrained households postpone the decision to scrap and upgrade their low-quality cars, which depresses mid-quality car prices. In turn, this effect reduces wealthy households’ incentives to replace their mid-quality cars with high-quality ones, thereby decreasing new-car sales. We further use our framework to evaluate targeted fiscal stimulus policies such as the Car Allowance Rebate System in 2009 (“Cash for Clunkers”).
We develop a search model of informal labour markets with realistic labour regulations, including minimum wage, and heterogeneous workers and firms. Smaller firms and lower wages in the informal sector emerge endogenously as firms and workers decide whether to comply with regulations. Because skilled and unskilled workers are imperfect substitutes in production, the model uniquely captures the informality consequences of shocks that affect returns to skill, such as rising educational levels. The model also reproduces empirical patterns incompatible with other frameworks: the presence of skilled and unskilled workers in the formal and informal sectors, the rising share of skilled workers by firm size, and formal and firm-size wage premiums that vary by skill level. We estimate the model using 2003 data from Brazil and show that it successfully predicts labour market changes observed between 2003 and 2012. Under a range of different assumptions, changes in workforce composition appear as the main drivers of the reduction in informality over this period. Policy simulations using the estimated model suggest that progressive payroll taxes are a cost-effective way to reduce informality.
Bitcoin provides its users with transaction-processing services which are similar to those of traditional payment systems. This article models the novel economic structure implied by Bitcoin’s innovative decentralized design, which allows the payment system to be reliably operated by unrelated parties called miners. We find that this decentralized design protects users from monopoly pricing. Competition among service providers within the platform and free entry imply no entity can profitably affect the level of fees paid by users. Instead, a market for transaction-processing determines the fees users pay to gain priority and avoid transaction-processing delays. The article (i) derives closed-form formulas of the fees and waiting times and studies their properties, (ii) compares pricing under the Bitcoin Payment System to that under a traditional payment system operated by a profit-maximizing firm, and (iii) suggests protocol design modifications to enhance the platform’s efficiency. The Appendix describes and explains the main attributes of Bitcoin and the underlying blockchain technology.
Due to the absence of unemployment insurance (UI) choices, the traditional approach to estimating the value of UI is to infer it from the observed consumption response to job loss under some assumption on risk preferences. Exploiting the rich data and unique policy context in Sweden, we propose two alternative approaches that relax this assumption and we implement all three methods on the same sample of workers. The first approach considers the difference in marginal propensity to consume (MPC) when unemployed versus employed, which allows to identify the difference in prices to smooth consumption in the respective states. The second approach exploits UI choices embedded in the Swedish UI system in a Revealed Preference approach. While the drop in consumption expenditures is relatively small (⁠|$\sim$|13%), we find that the MPC is around 25% higher when unemployed than employed, translating into a marginal value of transfers that is at least |$60$|% higher when unemployed than employed. This high value of UI is confirmed by our RP estimates and indicates substantial risk aversion given the relatively small drop in consumption expenditures.
I propose to identify an SVAR, up to shock ordering, using the autocovariance structure of the squared innovations implied by an arbitrary stochastic process for the shock variances. These higher moments are available without parametric assumptions on the variance process. In contrast, previous approaches exploiting heteroskedasticity rely on the path of innovation covariances, which can only be recovered from the data under specific parametric assumptions on the variance process. The conditions for identification are testable. I compare the identification scheme to existing approaches in simulations and provide guidance for estimation and inference. I use the methodology to estimate fiscal multipliers peaking at 0.86 for tax cuts and 0.75 for government spending. I find that tax shocks explain more variation in output at longer horizons. The empirical implications of my estimates are more consistent with theory and the narrative record than those based on some leading approaches.
We argue theoretically and document empirically that aging leads to greater (industrial) automation, because it creates a shortage of middle-aged workers specializing in manual production tasks. We show that demographic change is associated with greater adoption of robots and other automation technologies across countries and with more robotics-related activities across U.S. commuting zones. We also document more automation innovation in countries undergoing faster aging. Our directed technological change model predicts that the response of automation technologies to aging should be more pronounced in industries that rely more on middle-aged workers and those that present greater opportunities for automation and that productivity should improve and the labor share should decline relatively in industries that are more amenable to automation. The evidence supports all four of these predictions.
We recast the Aiyagari–Bewley–Huggett model of income and wealth distribution in continuous time. This workhorse model—as well as heterogeneous agent models more generally—then boils down to a system of partial differential equations, a fact we take advantage of to make two types of contributions. First, a number of new theoretical results: (1) an analytic characterization of the consumption and saving behaviour of the poor, particularly their marginal propensities to consume; (2) a closed-form solution for the wealth distribution in a special case with two income types; (3) a proof that there is a unique stationary equilibrium if the intertemporal elasticity of substitution is weakly greater than one. Second, we develop a simple, efficient and portable algorithm for numerically solving for equilibria in a wide class of heterogeneous agent models, including—but not limited to—the Aiyagari–Bewley–Huggett model.
This article argues that an important, yet overlooked, determinant of the government spending multiplier is the direction of the fiscal intervention. Regardless of whether we identify government spending shocks from (1) a narrative approach or (2) a timing restriction, we find that the contractionary multiplier—the multiplier associated with a negative shock to government spending—is above 1 and largest in times of economic slack. In contrast, the expansionary multiplier—the multiplier associated with a positive shock—is substantially below 1 regardless of the state of the cycle. These results help understand seemingly conflicting results in the literature. A simple theoretical model with incomplete financial markets and downward nominal wage rigidities can rationalize our findings.
Unemployment insurance (UI) programs traditionally take the form of a single insurance contract offered to job seekers. In this work, we show that offering a menu of contracts can be welfare improving in the presence of adverse selection and moral hazard. When insurance contracts are composed of (1) a UI payment and (2) a severance payment paid at the onset of unemployment, offering contracts with different ratios of UI benefits to severance payment is optimal under the equivalent of a single-crossing condition: job seekers in higher need of unemployment insurance should be less prone to moral hazard. In that setting, a menu allows the planner to attract job seekers with a high need for insurance in a contract with generous UI benefits, and to attract job seekers most prone to moral hazard in a separate contract with a large severance payment but little unemployment insurance. We propose a simple sufficient statistics approach to test the single-crossing condition in the data.
The proportion of U.K. people with university degrees tripled between 1993 and 2015. However, over the same period the time trend in the college wage premium has been extraordinarily flat. We show that these patterns cannot be explained by composition changes. Instead, we present a model in which firms choose between centralized and decentralized organizational forms and demonstrate that it can explain the main patterns. We also show the model has implications that differentiate it from both the exogenous skill-biased technological change model and the endogenous invention model, and that U.K. data fit with those implications. The result is a consistent picture of the transformation of the U.K. labour market in the last two decades.
Many studies use shift-share (or “Bartik”) instruments, which average a set of shocks with exposure share weights. We provide a new econometric framework for shift-share instrumental variable (SSIV) regressions in which identification follows from the quasi-random assignment of shocks, while exposure shares are allowed to be endogenous. The framework is motivated by an equivalence result: the orthogonality between a shift-share instrument and an unobserved residual can be represented as the orthogonality between the underlying shocks and a shock-level unobservable. SSIV regression coefficients can similarly be obtained from an equivalent shock-level regression, motivating shock-level conditions for their consistency. We discuss and illustrate several practical insights of this framework in the setting of Autor et al. (2013), estimating the effect of Chinese import competition on manufacturing employment across U.S. commuting zones.
Time series methods for identifying structural economic disturbances often require disturbances to satisfy technical conditions that can be inconsistent with economic theory. We propose replacing these conditions with a less restrictive condition called recoverability, which only requires that the disturbances can be inferred from the observable variables. As an application, we show how shifting attention to recoverability makes it possible to construct new identifying restrictions for technological and expectational disturbances. In a vector autoregressive example using post-war U.S. data, these restrictions imply that independent disturbances to expectations about future technology are a major driver of business cycles.
Using a quantitative model that features technical progress in automation and endogenous skill choice, we show that, given the current U.S. tax system, a sustained fall in automation costs can lead to a massive rise in income inequality. We characterize the optimal tax system in this model. We find that it is optimal to tax robots while the current generations of routine workers, who can no longer move to non-routine occupations, are active in the labour force. Once these workers retire, optimal robot taxes are zero.
We study rules based on instruments versus targets. Our application is a New Keynesian economy where the central bank has non-contractible information about aggregate demand shocks and cannot commit to policy. Incentives are provided to the central bank via punishment which is socially costly. Instrument-based rules condition incentives on the central bank’s observable choice of policy, whereas target-based rules condition incentives on the outcomes of policy, such as inflation, which depend on both the policy choice and realized shocks. We show that the optimal rule within each class takes a threshold form, imposing the worst punishment upon violation. Target-based rules dominate instrument-based rules if and only if the central bank’s information is sufficiently precise, and they are relatively more attractive the less severe the central bank’s commitment problem. The optimal unconstrained rule relaxes the instrument threshold whenever the target threshold is satisfied.
Differences in management quality are an important contributor to productivity differences across countries. A key question is how to best improve poor management in developing countries. We test two different approaches to improving management in Colombian auto parts firms. The first uses intensive and expensive one-on-one consulting, while the second draws on agricultural extension approaches to provide consulting to small groups of firms at approximately one-third the cost of the individual approach. Both approaches lead to improvements in management practices of a similar magnitude (8–10 percentage points). The group-based intervention leads to significant increases in firm sales, profits, and labour productivity, while the impacts on firm performance are smaller in magnitude and less robust from the individual consulting. The results point to the potential of group-based approaches as a pathway to scaling up management improvements.
We study a coordination game among agents in a network. The agents choose whether to take action (e.g. adopting a new technology) in an uncertain environment that yields increasing value in the actions of neighbours. We develop an algorithm that fully partitions the network into communities (coordination sets) within which agents have the same propensity to adopt. Our main finding is that a novel measure of network connectedness, which we term “social connectedness,” determines the propensity to adopt for each agent. Social connectedness captures both the number of links each agent has within her community (interconnectedness) as well as the number of links she has with members of other communities who have a higher propensity to adopt (embeddedness). There is a single coordination set if and only if the network is balanced—that is, the average degree of each subnetwork is no larger than the average degree of the network. Finally, we demonstrate that contagion is localized within coordination sets, such that a shock to an agent uniformly affects this agent and all members of her coordination set but has no impact on the other agents in the network.
This article generalizes central results from the theory of (endogenously) directed technical change to settings where technology does not take a labour-augmenting form and with arbitrarily many levels of skill. Building on simple notions of complementarity, the results remain intuitive despite their generality. The developed theory allows to study the endogenous determination of labour-replacing, that is, automation technology through the lens of directed technical change theory. In an assignment model with a continuum of differentially skilled workers and capital, where capital perfectly substitutes for labour in the production of tasks, any increase in the relative supply of skilled workers stimulates investment into improving the productivity of capital, potentially leading skill premia to increase in relative skill supply. Relatedly, trade with a skill-scarce country discourages improvements in capital productivity, potentially reversing the standard Heckscher–Ohlin effects.
We document that an experimental intervention offering transport subsidies for poor rural households to migrate seasonally in Bangladesh improved risk sharing. A theoretical model of endogenous migration and risk sharing shows that the effect of subsidizing migration depends on the underlying economic environment. If migration is risky, a temporary subsidy can induce an improvement in risk sharing and enable profitable migration. We estimate the model and find that the migration experiment increased welfare by 12.9%. Counterfactual analysis suggests that a permanent, rather than temporary, decline in migration costs in the same environment would result in a reduction in risk sharing.
This article develops a heterogeneous firm-dynamics model to jointly study firms’ currency debt composition and investment choices. In our model, foreign currency borrowing arises from a dynamic trade-off between exposure to currency risk and growth. The model endogenously generates selection of productive firms into foreign currency borrowing. Among them, firms with high marginal product of capital use foreign loans more intensively. We assess econometrically the model’s predicted pattern of foreign currency borrowing using firm-level census data from the deregulation of these loans in Hungary, calibrate the model, and quantify the aggregate impact of this financing. Our counterfactual exercises show that understanding the characteristics of firms borrowing in foreign currency is critical to assess the aggregate consequences of this financing.
We develop a new theory of information production during credit booms. Entrepreneurs need credit to undertake investment projects, some of which enable them to divert resources. Lenders can protect themselves from such diversion in two ways: collateralization, and costly screening that generates durable information about projects. In equilibrium, the collateralization-screening mix depends on the value of aggregate collateral. High collateral values make it possible to reallocate resources towards productive projects, but they also crowd out screening. This has important dynamic implications. During credit booms driven by high collateral values (e.g. real estate booms), economic activity expands but the economy’s stock of information on existing projects gets depleted. As a result, collateral-driven booms end in deep crises and slow recoveries: when booms end, investment is constrained both by the lack of collateral and by the lack of information on existing projects, which takes time to rebuild. We provide empirical support for the mechanism using US firm-level data.
This article analyses the dynamic spatial equilibrium of taxicabs and shows how common taxi regulations lead to substantial inefficiencies as a result of search frictions and mis-allocation. To analyse the role of regulation on frictions and efficiency, I pose a dynamic model of spatial search and matching between taxis and passengers. Using a comprehensive dataset of New York City yellow medallion taxis, I use this model to compute the equilibrium spatial distribution of vacant taxis and estimate intraday demand given price and medallion regulations. My estimates show that the weekday New York market achieves about $\$$5.7 million in daily welfare or about $\$$27 per trip, but an additional 53 thousand customers fail to find cabs due to search frictions. Counterfactual analysis shows that implementing simple tariff pricing changes can enhance allocative efficiency and expand the market, offering daily consumer surplus gains of up to $\$$227 thousand and up to 49 thousand additional daily taxi-passenger matches, a similar magnitude to the gain in matches generated by adopting a perfect static matching technology.
Using a broad panel of advanced economies, we document that increases in GDP per capita are associated with a systematic shift in the composition of value added to sectors that are intensive in high-skill labour, a process we label as skill-biased structural change. It follows that further development in these economies leads to an increase in the relative demand for skilled labour. We develop a quantitative two-sector model of this process as a laboratory to assess the sources of the rise of the skill premium in the U.S. and a set of ten other advanced economies, over the period 1977 to 2005. For the U.S., we find that the sector-specific skill neutral component of technical change accounts for 18–24% of the overall increase of the skill premium due to technical change, and that the mechanism through which this component of technical change affects the skill premium is via skill-biased structural change.
We develop a model where risk-averse workers can costly invest in their skills before matching with heterogenous firms. At the investment stage, workers face multiple sources of risk. They are uncertain about how skilled they will turn out and also about their income shock realizations at the time of employment. We analyse the equilibria of two versions of the model that depend on when uncertainty resolves, which determines the available risk-sharing possibilities between workers and firms. We provide a thorough analysis of equilibrium comparative statics regarding changes in risk, worker and firm heterogeneity, and technology. We derive conditions on the match output function and risk attitudes under which these shifts lead to more investment and show how this affects matching and wages. To illustrate the applied relevance of our theory, we provide a stylized quantitative assessment of the model and analyse the sources (risk, heterogeneity, or technology) of rising U.S. wage inequality. We find that changes in risk were the most important driver behind the surge in inequality, followed by technological change. We show that these conclusions are significantly altered if one neglects the key feature of our model, which is that educational investment is endogenous.
We study the effects of parameter uncertainty prompted by structural breaks. In our model, agents respond differently to uncertainty prompted by regime shifts in shock processes than they react to comparable perceived increases in shock volatility. The magnitude of the response to an increase in uncertainty about TFP associated with a structural break is greater than that of a response to a comparable perceived rise in volatility. This is because lifetime utility varies more when shocks shift beliefs and perceived wealth.
We estimate the causal real economic effects of a randomized anti-corruption crackdown on local governments in Brazil using rich micro-data on corruption and firms. After anti-corruption audits, municipalities experience an increase in the number of firms concentrated in sectors most dependent on government relationships and public procurement. Through the estimation of geographic spillovers and additional tests, we show that audits operate via both a direct detection effect as well as through indirect deterrence channels. Politically connected firms suffer after the audits. Our estimates indicate the anti-corruption program generates significant local multipliers which are consistent with the presence of a large corruption tax on government-dependent firms.
This article studies the transmission of the Global Financial Cycle (GFC) to domestic credit market conditions in a large emerging market, Turkey, over 2003–13. We use administrative data covering the universe of corporate credit transactions matched to bank balance sheets to document four facts: (1) an easing in global financial conditions leads to lower borrowing costs and an increase in local lending; (2) domestic banks more exposed to international capital markets transmit the GFC locally; (3) the fall in local currency borrowing costs is larger than foreign currency borrowing costs due to the co-movement of the uncovered interest rate parity (UIP) premium with the GFC over time; (4) data on posted collateral for new loan issuances show that collateral constraints do not relax during the boom phase of the GFC.
We show that the creation of the first integrated multi-modal pan-European transport network during Roman times influences economic integration over two millennia. Drawing on spatially highly disaggregated data on excavated Roman ceramics, we document that contemporary interregional trade was influenced by connectivity within the network. Today, these connectivity differentials continue to influence integration as approximated by cross-regional firm investment behaviour. Continuity is partly explained by selective infrastructure routing and cultural integration due to bilateral convergence in preferences and values. We show that our results are Roman-connectivity specific and do not reflect pre-existing patterns of exchange using pre-Roman trade data.
How does the arrival of a new minority group affect the social acceptance and outcomes of existing minorities? We study this question in the context of the First Great Migration. Between 1915 and 1930, 1.5 million African Americans moved from the U.S. South to Northern urban centres, which were home to millions of European immigrants arrived in previous decades. We formalize and empirically test the hypothesis that the inflows of Black Americans changed perceptions of outgroup distance among native-born whites, reducing the barriers to the social integration of European immigrants. Predicting Black in-migration with a version of the shift-share instrument, we find that immigrants living in areas that received more Black migrants experienced higher assimilation along a range of outcomes, such as naturalization rates and intermarriages with native-born spouses. Evidence from the historical press and patterns of heterogeneity across immigrant nationalities provide additional support to the role of shifting perceptions of the white majority.
This article proposes a test for the conditional superior predictive ability (CSPA) of a family of forecasting methods with respect to a benchmark. The test is functional in nature: under the null hypothesis, the benchmark’s conditional expected loss is no more than those of the competitors, uniformly across all conditioning states. By inverting the CSPA tests for a set of benchmarks, we obtain confidence sets for the uniformly most superior method. The econometric inference pertains to testing conditional moment inequalities for time series data with general serial dependence, and we justify its asymptotic validity using a uniform non-parametric inference method based on a new strong approximation theory for mixingales. The usefulness of the method is demonstrated in empirical applications on volatility and inflation forecasting.
We study the long-term impact of a policy-driven change in childhood nutrition. For this purpose, we evaluate a program that rolled out nutritious school lunches free of charge to all pupils in Swedish primary schools between 1959 and 1969. We estimate the impact of the program on children’s economic, educational, and health outcomes throughout life. Our results show that the school lunch program generated substantial long-term benefits, where pupils exposed to the program during their entire primary school period have 3% higher lifetime income. The effect was greater for pupils that were exposed at earlier ages and for pupils from poor households, suggesting that the program reduced socioeconomic inequalities in adulthood. Exposure to the program also had substantial effects on educational attainment and health, which can explain a large part of the effect of the program on lifetime income.
About half of the change in U.S. non-durable consumption expenditure is due to changes in the products entering households’ consumption basket (the extensive margin). Changes in the basket are driven by fluctuations in the rate at which households add products; removals fluctuate little. These patterns reflect that, in response to income increases, households adopt consumer products already available in the market. Household adoption amplifies the effects of fiscal transfers on consumption by more than 30%. Cyclical household adoption of products also implies that inflation measures based on a representative household consuming all varieties available in the market underestimate true household-level inflation by as much as 1% per year over the Great Recession in the consumption categories covered by our data.
We study a class of permutation tests of the randomness of a collection of Bernoulli sequences and their application to analyses of the human tendency to perceive streaks of consecutive successes as overly representative of positive dependence—the hot hand fallacy. In particular, we study permutation tests of the null hypothesis of randomness (i.e. that trials are i.i.d.) based on test statistics that compare the proportion of successes that directly follow |$k$| consecutive successes with either the overall proportion of successes or the proportion of successes that directly follow |$k$| consecutive failures. We characterize the asymptotic distributions of these test statistics and their permutation distributions under randomness, under a set of general stationary processes, and under a class of Markov chain alternatives, which allow us to derive their local asymptotic power. The results are applied to evaluate the empirical support for the hot hand fallacy provided by four controlled basketball shooting experiments. We establish that substantially larger data sets are required to derive an informative measurement of the deviation from randomness in basketball shooting. In one experiment, for which we were able to obtain data, multiple testing procedures reveal that one shooter exhibits a shooting pattern significantly inconsistent with randomness—supplying strong evidence that basketball shooting is not random for all shooters all of the time. However, we find that the evidence against randomness in this experiment is limited to this shooter. Our results provide a mathematical and statistical foundation for the design and validation of experiments that directly compare deviations from randomness with human beliefs about deviations from randomness and thereby constitute a direct test of the hot hand fallacy.
Allocating resources without monetary payments is expected to yield inefficient allocations. Theory suggests that introducing rationing when resources are allocated repeatedly over time can mitigate this issue, while the magnitude of the resulting efficiency gains is an empirical question in most settings. We study a dynamic assignment mechanism used by the Michigan Department of Natural Resources to allocate bear hunting licenses and find that it yields a more efficient allocation than static mechanisms, allocating participants to types of resources for which they have a higher value without crowding out participants with a high overall value for hunting. Our empirical analysis also highlights the importance of heterogeneity across participants and across allocated resources for determining the efficiency of a dynamic allocation mechanism.
It is often argued that people might take on too much high-cost debt because they are present focused and/or over-optimistic about how soon they will repay. We measure borrowers’ present focus and over-optimism using an experiment with a large payday lender. Although the most inexperienced quartile of borrowers under-estimate their likelihood of future borrowing, the more experienced three quartiles predict correctly on average. This finding contrasts sharply with priors we elicited from 103 payday lending and behavioural economics experts, who believed that the average borrower would be highly overoptimistic about getting out of debt. Borrowers are willing to pay a significant premium for an experimental incentive to avoid future borrowing, which we show implies that they perceive themselves to be time inconsistent. We use borrowers’ predicted behaviour and valuation of the experimental incentive to estimate a model of present focus and naivete. We then use the model to study common payday lending regulations. In our model, banning payday loans reduces welfare relative to existing regulation, while limits on repeat borrowing might increase welfare by inducing faster repayment that is more consistent with long-run preferences.
We revisit the question of why shifts in aggregate demand drive business cycles. Our theory combines intertemporal substitution in production with rational confusion, or bounded rationality, in consumption and investment. The first element allows aggregate supply to respond to shifts in aggregate demand without nominal rigidity. The second introduces a “confidence multiplier,” that is, a positive feedback loop between real economic activity, consumer expectations of permanent income, and investor expectations of returns. This mechanism amplifies the business-cycle fluctuations triggered by demand shocks (but not necessarily those triggered by supply shocks); it helps investment to comove with consumption; and it allows front-loaded fiscal stimuli to crowd in private spending.
We study the severity of liquidity constraints in the U.S. housing market using a life-cycle model with uninsurable idiosyncratic risks in which houses are illiquid, but agents can extract home equity by refinancing their mortgages. The model implies that four-fifths of homeowners are liquidity constrained and willing to pay an average of 13 cents to extract an additional dollar of liquidity from their home. Most homeowners value liquidity for precautionary reasons, anticipating the possibility of income declines and the need to make mortgage payments. The model reproduces well the observed response of consumption to tax rebates and mortgage relief programs and predicts large welfare gains from policies aimed at providing temporary liquidity relief to homeowners.
This article explores a natural connection between fiscal multipliers and foreign holdings of public debt. Although fiscal expansions can raise domestic economic activity through various channels, they can also have crowding-out effects if the resources used to acquire public debt reduce domestic consumption and investment. These crowding-out effects are likely to be weaker when governments have access to foreign savings when selling their debt, leading to larger fiscal multipliers. We test this hypothesis for the U.S. in the post-war period and for a panel of 17 advanced economies from the 1980s to the present. To do so, we assemble a novel database of public debt holdings by domestic and foreign creditors for these countries. We combine these data with standard measures of fiscal policy shocks and show that, indeed, the size of fiscal multipliers is increasing in the share of public debt held by foreigners. In particular, the fiscal multiplier is smaller than one when the foreign share is low, such as in the U.S. in the 1950s and 1960s and Japan today, and larger than one when the foreign share is high, such as in the U.S. and several European countries today.
This article investigates whether offers of commitment contracts, in the form of self-imposed choice-set restrictions and penalties with no financial upside, are well-targeted tools for addressing self-control problems. In an experiment on gym attendance (N|$=1{,}248$|⁠), we examine take-up of commitment contracts and also introduce a separate elicitation task to identify actual and perceived time inconsistency. There is high take-up of commitment contracts for greater gym attendance, resulting in significant increases in exercise. However, this take-up is influenced both by noisy valuation and incorrect beliefs about one’s time inconsistency. Approximately half of the people who take up commitment contracts for higher gym attendance also take up commitment contracts for lower gym attendance. There is little association between commitment contract take-up and reduced-form and structural estimates of actual or perceived time inconsistency. A novel information treatment providing an exogenous shock to awareness of time inconsistency reduces demand for commitment contracts. Structural estimates of a model of quasi-hyperbolic discounting and gym attendance imply that offering our commitment contracts lowers consumer surplus and is less socially efficient than utilizing linear exercise subsidies that achieve the same average change in behaviour.
In many centralized matching markets, agents’ property rights over objects are derived from a coarse transformation of an underlying score. Prominent examples include the distance-based system employed by Boston Public Schools, where students who lived within a certain radius of each school were prioritized over all others, and the income-based system used in New York public housing allocation, where eligibility is determined by a sharp income cutoff. Motivated by this, we study how to optimally coarsen an underlying score. Our main result is that, for any continuous objective function and under stable matching mechanisms, the optimal design can be attained by splitting agents into at most three indifference classes for each object. We provide insights into this design problem in three applications: distance-based scores in Boston Public Schools, test-based scores for Chicago exam schools, and income-based scores in New York public housing allocation.
Banks in low-income countries face severe liquidity risk due to volatile deposits, which destabilize their funding, and dysfunctional liquidity markets, which induce expensive interbank and central bank lending. Such liquidity risk dissuades the transformation of short-term deposits into long-term loans and deters long-term investment. To validate this mechanism, we exploit a Sharia-compliant levy in Pakistan, which generates unintended and quasi-experimental variation in liquidity risk, with data from the credit registry and firm imports. We find that banks with a stronger exposure to liquidity risk lower their supply of long-term finance, which reduces the long-term investment of connected firms.
Many intertemporal trade-offs are unbalanced: while the advantages of options are concentrated in a few periods, the disadvantages are dispersed over numerous periods. We provide novel experimental evidence for “concentration bias,” the tendency to overweight advantages that are concentrated in time. Subjects commit to too much overtime work that is dispersed over multiple days in exchange for a bonus that is concentrated in time: concentration bias increases subjects’ willingness to work by 22.4% beyond what standard discounting models could account for. In additional conditions and a complementary experiment involving monetary payments, we study the mechanisms behind concentration bias and demonstrate the robustness of our findings.
We develop a simple flexible-price model of business cycles driven by spikes in risk premiums. Aggregate shocks increase firms’ uninsurable idiosyncratic risk and raise risk premiums. We show that risk shocks can create quantitatively plausible recessions, with contractions in employment, consumption, and investment. Business cycles are inefficient—output, employment, and consumption fall too much during recessions, compared to the constrained-efficient allocation. Optimal policy involves stimulating employment and consumption during recessions.
We devise a tractable model of firm dynamics with on-the-job search. The model admits analytical solutions for equilibrium outcomes, including quit, layoff, hiring, and vacancy-filling rates, as well as the distributions of job values, a fundamental challenge posed by the environment. Optimal labor demand takes a novel form whereby hiring firms allow their marginal product to diffuse over an interval. The evolution of the marginal product over this interval endogenously exhibits gradual mean reversion, evoking a notion of imperfect labor market competition. This in turn contributes to dispersion in marginal products, giving rise to endogenous misallocation. Quantitatively, the model provides a parsimonious reconciliation of leading estimates of rent sharing, the negative association between wages and quits, the link between job and worker flows, and the cyclicality of labor market quantities and prices.
A growing literature has documented the role of firm heterogeneity within sectors for nominal income inequality. This article explores the implications for household price indices across the income distribution. Using detailed matched U.S. home and store scanner microdata, we present evidence that rich and poor households source their consumption differently across the firm size distribution within disaggregated product groups. We use the data to examine alternative explanations, propose a tractable quantitative model with two-sided heterogeneity that rationalizes the observed moments, and calibrate it to explore general equilibrium counterfactuals. We find that larger, more productive firms sort into catering to the taste of richer households, and that this gives rise to asymmetric effects on household price indices. We quantify these effects in the context of policy counterfactuals that affect the distribution of disposable incomes on the demand side or profits across firms on the supply side.
Do mergers help or hinder collusion? This article studies the stability of the vitamin cartels in the 1990s and presents a repeated-games approach to quantify “coordinated effects” of a merger. We use data and direct evidence from American courts and European agencies to show the collusive incentive of the short-lived vitamin C cartel was likely to be negative when it actually collapsed in 1995, whereas the incentives of the long-lived cartels (vitamins A and E, and beta carotene) were unambiguously positive until the prosecution in 1999. Simulations suggest some mergers could have prolonged the vitamin C cartel, but others could have further destabilized it, because both the direction and magnitude of coordinated effects depend not only on the number of firms but also on their cost asymmetry.
Government procurement contracts rarely have many bids, often only one. Motivated by the institutional features of federal procurement, this article develops a principal-agent model where a buyer seeks sellers at a cost and negotiates contract terms with them. The model is identified and estimated with data on IT and telecommunications contracts. We find the benefits of drawing additional sellers are significantly reduced because the procurement agency can extract informational rents from sellers. Another factor explaining the small number of bids is that sellers are relatively homogeneous, conditional on observed project attributes. Administrative hurdles and corruption appear to play very limited roles.
We exploit a volcanic “experiment” to study the costs and benefits of geographic mobility. In our experiment, a third of the houses in a town were covered by lava. People living in these houses were much more likely to move away permanently. For the dependents in a household (children), our estimates suggest that being induced to move by the “lava shock” dramatically raised lifetime earnings and education. While large, these estimates come with a substantial amount of statistical uncertainty. The benefits of moving were very unequally distributed across generations: the household heads (parents) were made slightly worse off by the shock. These results suggest large barriers to moving for the children, which imply that labour does not flow to locations where it earns the highest returns. The large gains from moving for the young are surprising in light of the fact that the town affected by our volcanic experiment was (and is) a relatively high income town. We interpret our findings as evidence of the importance of comparative advantage: the gains to moving may be very large for those badly matched to the location they happened to be born in, even if differences in average income are small.
The discovery of massive deposits of precious metals in America during the early modern period caused an exogenous monetary injection to Europe’s money supply. I use this episode to identify the causal effects of money. Using a panel of six European countries, I find that monetary expansions had a material impact on real economic activity. The magnitudes are substantial and persist for a long time: an exogenous 10% increase in the production of precious metals in America measured relative to the European stock leads to a front-loaded response of output and, to a lesser extent, inflation. There was a positive hump-shaped response of real GDP, with a cumulative increase up to 0.9% six to nine years later. The evidence suggests that this is because prices responded to monetary injections with considerable lags.
We quantify the role of geography and land quality for agricultural productivity differences across countries using high-resolution micro-geography data and a spatial accounting framework. The rich spatial data provide for each cell of land covering the entire globe, the potential yield for 18 crops, which measures the maximum attainable crop output given soil quality, climate conditions, terrain topography, and a given level of cultivation inputs. While there is considerable heterogeneity in land quality across space, even within narrow geographic regions, we find that low agricultural land productivity is not due to unfavourable geographic endowments. If countries produced current crops in each cell according to potential yields, the rich-poor agricultural yield gap would virtually disappear, from 214% to 5%. We also find evidence of additional aggregate productivity gains attainable through spatial reallocation and changes in crop production.
Theory predicts that central-bank lending programs put ceilings on private domestic lending rates, reduce ex post financing risk, and encourage ex ante investment. This article shows that with global banks and integrated financial markets, but domestic central banks, then lending of last resort can be achieved using swap lines. Through them, a source central bank provides source-currency credit to recipient-country banks using the recipient central bank as the monitor and as the bearer of the credit risk. In theory, the swap lines should put a ceiling on deviations from covered interest parity, lower average ex post bank borrowing costs, and increase ex ante inflows from recipient-country banks into privately issued assets denominated in the source-country’s currency. Empirically, these three predictions are tested using variation in the terms of the swap line over time, variation in the central banks that have access to the swap line, variation in the days of the week in which the swap line is open, variation in the exposure of different securities to foreign investment, and variation in banks’ exposure to dollar funding risk. The evidence suggests that the international lender of last resort is very effective.
We present a model of endogenous network formation to recover unobserved social networks using only observable outcomes. We propose a novel equilibrium concept that allows for a sharp characterization of equilibrium behaviour and that yields a unique prediction under testable conditions. While the equilibrium is characterized by a large number of non-linear equations, we show that it can be efficiently employed to recover the networks by an appropriately designed approximate Bayesian computation method. We apply the model to recover the network of social links between lawmakers in the U.S. Congress using data from the 109th to 113th legislatures. We show that social connections are important for legislators’ productivities, and we identify some of the key determinants of network centralities in the U.S. Congress.
How does the shadow banking system respond to changes in capital regulation of commercial banks? We propose a quantitative general equilibrium model with regulated and unregulated banks to study the unintended consequences of regulation. Tighter capital requirements for regulated banks cause higher convenience yield on debt of all banks, leading to higher shadow bank leverage and a larger shadow banking sector. At the same time, tighter regulation eliminates the subsidies to commercial banks from deposit insurance, reducing the competitive pressures on shadow banks to take risks. The net effect is a safer financial system with more shadow banking. Calibrating the model to data on financial institutions in the US, the optimal capital requirement is around 16|$\%$|⁠.
We study the co-evolution of religion, science, and politics. We first uncover, in international and U.S. data, a robust negative relationship between religiosity and patents per capita. The model then combines: (1) scientific discoveries that raise productivity but sometimes erode religious beliefs; (2) a government that allows innovations to diffuse, or blocks them; (3) religious institutions that can invest in doctrinal reform. Three long-term outcomes emerge. The “Western-European Secularization” regime has declining religiosity, unimpeded science, and high taxes and transfers. The “Theocratic” regime involves knowledge stagnation, unquestioned dogma, and high religious-public-goods spending. The “American” regime combines scientific progress and stable religiosity through doctrinal adaptations, with low taxes and some fiscal-legal advantages for religious activities. Rising income inequality can, however, empower a Religious-Right alliance that starts blocking belief-eroding ideas.
We construct and calibrate a monetary model of corporate finance with endogenous formation of lending relationships. The equilibrium features money demands by firms that depend on their access to credit and a pecking order of financing means. We describe the mechanism through which monetary policy affects the creation of relationships and firms’ incentives to use internal or external finance. We study optimal monetary policy following an unanticipated destruction of relationships under different commitment assumptions. The Ramsey solution uses forward guidance to expedite creation of new relationships by committing to raise the user cost of cash gradually above its long-run value. Absent commitment, the user cost is kept low, delaying recovery.
We propose a model in which the emergence of a single dominant currency is driven by the need to finance international trade. The model generates multiple stable steady states, each characterized by a different dominant asset, consistent with the historical durability of real-world currency regimes. The persistence of regimes is caused by a positive interaction between the returns to saving in an asset and the use of that asset for financing trade. A calibrated version of the model shows that the welfare gains of dominance are substantial, but accrue primarily during the transition to dominance. We perform several counterfactual experiments to assess potential threats to the dollar’s continued dominance.
Since the creation of the euro, capital flows among member countries have been large and volatile. Motivated by this fact, I provide a theory connecting the exchange rate regime to financial integration. The key feature of the model is that monetary policy affects the value of collateral that creditors seize upon default. Under flexible exchange rates, national governments can expropriate foreign creditors by depreciating the exchange rate, which induces investors to impose tight constraints on international borrowing. Creating a monetary union, by eliminating this source of currency risk, increases financial integration among member countries. This process, however, does not necessarily lead to higher welfare. The reason is that a high degree of capital mobility can generate multiple equilibria, with bad equilibria characterized by inefficient capital flights. Capital controls or fiscal transfers can eliminate bad equilibria, but their implementation requires international cooperation.
This article considers a class of experimentation games with Lévy bandits encompassing those of Bolton and Harris (1999, Econometrica, 67, 349–374) and Keller, Rady, and Cripps (2005, Econometrica, 73, 39–68). Its main result is that efficient (perfect Bayesian) equilibria exist whenever players’ payoffs have a diffusion component. Hence, the trade-offs emphasized in the literature do not rely on the intrinsic nature of bandit models but on the commonly adopted solution concept (Markov perfect equilibrium). This is not an artefact of continuous time: we prove that efficient equilibria arise as limits of equilibria in the discrete-time game. Furthermore, it suffices to relax the solution concept to strongly symmetric equilibrium.
Informal care provided by adult children substitutes for formal long-term care services. However, information about children is not used in pricing long-term care insurance which pays only for formal care. I start by providing descriptive evidence that private information about children’s informal care likelihood results in adverse selection: the market attracts a disproportionate number of individuals who face higher formal care utilization risk due to a lower probability of receiving care from their children. To quantify the welfare consequence of adverse selection, I develop and estimate a dynamic intergenerational model featuring long-term care insurance, savings, informal care provision, and employment choices. Based on the estimated equilibrium insurance market framework, I show that using information about children in pricing insurance contracts reduces adverse selection and results in the average welfare gain of $6,200 per family. Using the non-cooperative feature of the model, I also quantify to what extent parents forgo long-term care insurance to avoid diminishing children’s informal care incentive.
We develop a model of fragile self-esteem—self-esteem that is vulnerable to objectively unjustified swings—and study its implications for choices that depend on, or are aimed at enhancing or protecting, one’s self-view. In our framework, a person’s self-esteem is determined by sampling his memories of ego-relevant outcomes in a fashion that in turn depends on how he feels about himself, potentially creating multiple fragile “self-esteem personal equilibria.” Self-esteem is especially likely to be fragile, as well as unrealistic in either the positive or the negative direction, if being successful is important to the agent. A person with a low self-view might exert less effort when success is more important. An individual with a high self-view, in contrast, might distort his choices to prevent a collapse in self-esteem, with the distortion being greater if his true ability is lower. We discuss the implications of our results for mental well-being, education, job search, workaholism, and aggression.
This article shows that entrepreneurial human capital is a key driver of firm dynamics using administrative panel data on the universe of firms and workers in Portugal. Firms started by more educated entrepreneurs are larger at entry and exhibit higher life cycle growth. Consistent with an effect on growth, the thickness of the right tail of the size distribution increases with entrepreneur schooling. The evidence points to several underlying mechanisms, with technology adoption playing the most important part. I develop and estimate a model of firm dynamics that can parsimoniously account for these findings and use it to draw aggregate implications. Accounting for the effect of entrepreneurial human capital on firm dynamics can substantially increase aggregate returns to schooling and the fraction of cross-country income differences explained by human and physical capital.
Critics claim that patent screening is ineffective, granting low-quality patents that impose unnecessary social costs. We develop an integrated framework, involving patent office examination, fees, and endogenous validity challenges in the courts, to study patent screening both theoretically and quantitatively. In our model, some inventions require the patent incentive while others do not, and asymmetric information creates a need for screening. We show that the endogeneity of challenges implies that courts, even if perfect, cannot solve the screening problem. Simulations of the model, calibrated on U.S. data, indicate that screening is highly imperfect, with almost half of all patents issued on inventions that do not require the patent incentive. While we find that the current patent system generates positive social value, intensifying examination would yield large welfare gains. The social value of the patent system would also be larger if complemented by antitrust limits on licensing.
This article develops a quantitative open economy framework with dynamics, firm heterogeneity and financial frictions to study the impact of corporate tax reforms targeted at multinationals. The model quantifies their impact on firm selection, production and welfare. Firms draw idiosyncratic shocks, invest in capital, choose optimal financing and select endogenously into selling abroad, through exporting or FDI. I apply this framework to the removal of the U.S. repatriation tax as in the Tax Cuts and Jobs Act. The reform’s impact trades-off two selection effects—more offshoring versus greater U.S. business dynamism. The reform leads to higher U.S. welfare at little cost to the Treasury. A series of exercises illustrate that the novel features of this framework have significant quantitative implications. The reform gives starkly different cross-sectional predictions and lower welfare gains when financial frictions are removed and it is welfare reducing in a static counterpart of the model.
We show that the folk theorem holds generically for the repeated two-player game with private monitoring if the support of each player’s signal distribution is sufficiently large. Neither cheap talk communication nor public randomization is necessary.
Using newly collected data on death rates and aerial victories of more than 5,000 German fighter pilots during World War II, we examine the effects of public recognition on performance and risk-taking. When a particular pilot is honoured publicly, both the victory rate and the death rate of his former peers increase. Fellow pilots react more if they come from the same region of Germany, or if they worked closely with him. Our results suggest that personal rivalry can be a prime motivating force, and that non-financial rewards can lead to a crowd-in of both effort and risk-taking via social connections.
This article investigates how incentives and behavioural policy interventions affect individuals’ allocation of scarce cognitive resources. Based on experimental evidence, we demonstrate that incentives systematically influence individuals’ allocation of cognitive resources, and their propensity to actively engage with a decision or to stay passive. Policies that steer individuals’ attention to a specific decision lead to more active decision-making and better choices in the targeted choice domain, but induce negative cognitive spillovers on the quality of choices in other domains. In our setting, these two countervailing effects offset each other, such that the overall payoff consequences of the interventions are essentially zero. We further document that cognitive spillovers are especially pronounced for complex choices and for subgroups of the population with a smaller stock of cognitive resources. We discuss implications for the design and evaluation of behavioural policy interventions.
This article considers the effect of contracting limitations in risk-sharing networks, arising for example from observability, verifiability, complexity, or cultural constraints. We derive necessary and sufficient conditions for Pareto efficiency under these constraints in a general setting, and we provide an explicit characterization of Pareto efficient bilateral transfer profiles under CARA utility and normally distributed endowments. Our model predicts that network centrality is positively correlated with consumption volatility, as more central agents become quasi-insurance providers to more peripheral agents. The proposed framework has important implications for the empirical specification of risk-sharing tests, allowing for local risk-sharing groups that overlap within the village network.
We build a theory of financial intermediation based on the premise that some investors are better able to figure out the trade motives of their counterparties in bilateral meetings—screening experts. We solve for the equilibrium market structure and study how information asymmetries stemming from heterogeneity in screening expertise shape up the core–periphery trade structure. In particular, the core of the market is populated by screening experts: they have the largest share of trade volume, they are actively engaged in middleman activity, and trade with the most counterparties. Using transaction-level micro-data and information disclosure requirements, we provide extensive evidence consistent only with our theory of financial intermediation.
We study a noisy rational expectations equilibrium in a multi-asset economy populated by informed and uninformed investors and noise traders. The assets can include state contingent claims such as Arrow–Debreu securities, assets with only positive payoffs, options or other derivative securities. The probabilities of states depend on an aggregate shock, which is observed only by the informed investor. We derive a three-factor CAPM with asymmetric information, establish conditions under which asset prices reveal information about the shock, and show that information asymmetry amplifies the effects of payoff skewness on asset returns. We also find that volatility derivatives make incomplete markets effectively complete, and their prices quantify market illiquidity and shadow value of information to uninformed investors.
We study the interaction between the currency choice of private domestic contracts and optimal monetary policy. The optimal currency choice depends on the price risk of each currency, as well as on the covariance of its price and the relative consumption needs of the agents signing the contract. When a larger share of contracts is denominated in local currency, the government can use inflation more effectively to either redistribute resources or reduce default costs, which makes local currency more attractive for private contracts. When governments lack commitment, competitive equilibria can be constrained inefficient, thus providing a reason to regulate the currency choice of private contracts. We show that both the equilibrium use of local currency and the implications for regulation depend on the level of domestic policy risk. Our model can explain the wide use of the US dollar in international trade contracts and the observed hysteresis in dollarization.
We use a revealed-preference approach to estimate investor expectations of stock market returns. Using data on demand for index funds that follow the S&P 500, we develop and estimate a model of investor choice to flexibly recover the time-varying distribution of expected future returns across investors. Our analysis is facilitated by the prevalence of leveraged funds that track the same underlying asset: by choosing between higher and lower leverage, investors trade off higher return against less risk. Our estimates indicate that investor expectations are heterogeneous, extrapolative, and persistent. Following a downturn, investors become more pessimistic on average, but there is also an increase in disagreement among participating investors due to the presence of contrarian investors.
We investigate a model of one-to-one matching with transferable utility and general unobserved heterogeneity. Under a separability assumption that generalizes Choo and Siow (2006, Journal of Political Economy, 114, 175–201), we first show that the equilibrium matching maximizes a social gain function that trades off exploiting complementarities in observable characteristics and matching on unobserved characteristics. We use this result to derive simple closed-form formulae that identify the joint matching surplus and the equilibrium utilities of all participants, given any known distribution of unobserved heterogeneity. We provide efficient algorithms to compute the stable matching and to estimate parametric versions of the model. Finally, we revisit Choo and Siow’s empirical application to illustrate the potential of our more general approach.
We develop a concept of weak identification in linear instrumental variable models in which the number of instruments can grow at the same rate or slower than the sample size. We propose a jackknifed version of the classical weak identification-robust Anderson–Rubin (AR) test statistic. Large-sample inference based on the jackknifed AR is valid under heteroscedasticity and weak identification. The feasible version of this statistic uses a novel variance estimator. The test has uniformly correct size and good power properties. We also develop a pre-test for weak identification that is related to the size property of a Wald test based on the Jackknife Instrumental Variable Estimator. This new pre-test is valid under heteroscedasticity and with many instruments.
We study how strategic interaction and cooperation are affected by the heterogeneity of cognitive skills of groups of players, over consecutive plays of repeated games with randomly matched opponents using Prisoner’s Dilemma as stage game. We observe overall higher cooperation rates and average final payoffs in integrated treatment groups—where subjects of different IQ levels interact together—than in separated treatment groups. Lower IQ subjects are better off and higher IQ subjects are worse off in integrated groups than in separated groups. Higher IQ subjects adopt harsher strategies when they are pooled with lower IQ subjects than when they play separately. We demonstrate that this outcome should be expected in learning and evolutionary models where higher intelligence subjects exhibit lower frequency of errors in the implementation of strategies. Estimations of errors and strategies in our experimental data are consistent with the model’s assumptions and predictions.
This article studies the relationship between patience and comparative development through a combination of reduced-form analyses and model estimations. Based on a globally representative dataset on time preference in 76 countries, we document two sets of stylized facts. First, patience is strongly correlated with per capita income and the accumulation of physical capital, human capital, and productivity. These correlations hold across countries, sub-national regions, and individuals. Second, the magnitude of the patience elasticity strongly increases in the level of aggregation. To provide an interpretive lens for these patterns, we analyse an overlapping generations model in which savings and education decisions are endogenous to patience, aggregate production is characterized by capital-skill complementarities, and productivity implicitly depends on patience through a human capital externality. In our model estimations, general equilibrium effects alone account for a non-trivial share of the observed amplification effects, and an extension to human capital externalities can quantitatively match the empirical evidence.
This article develops and estimates a dynamic model where individuals differ in ability and location preference to evaluate the mechanisms that affect the evolution of immigrants’ careers in conjunction with their re-migration plans. Our analysis highlights a novel form of selective return migration where those who plan to stay longer invest more into skill acquisition, with important implications for the assessment of immigrants’ career paths and the estimation of their earnings profiles. Our study also explains the willingness of immigrants to accept jobs at wages that seem unacceptable to natives. Finally, our model provides important insight for the design of migration policies, showing that policies that initially restrict residence or condition residence on achievement shape not only immigrants’ career profiles through their impact on human capital investment but also determine the selection of arrivals and leavers.
In 2008, Volkswagen introduced a new generation of “Clean Diesel” cars and heavily marketed them to environmentally conscious US consumers. Unknown to the public, these cars were anything but clean, emitting pollutants up to 150 times the level of comparable gas-fuelled cars. We study the rollout of these emissions-cheating diesel cars across the United States from 2008 to 2015 as a natural experiment to examine the impact of moderate levels of car pollution on infant and child health in the general population. Using the universe of vehicle registrations, we find that an additional cheating diesel car per 1,000 cars increases |$\mathrm{PM_{2.5}}$|⁠, |$\mathrm{PM_{10}}$|⁠, and ozone by 2, 2.2, and 1.3|$\%$|⁠, respectively, while the low birth weight rate and infant mortality rate increase by 1.9 and 1.7|$\%$|⁠, respectively. Similar impacts are found for acute asthma attacks in children. These health impacts occur at all pollution levels and across the socioeconomic spectrum.
Each year in the US, hundreds of billions of dollars are spent on transportation infrastructure and billions of hours are lost in traffic. We develop a quantitative general equilibrium spatial framework featuring endogenous transportation costs and traffic congestion and apply it to evaluate the welfare impact of transportation infrastructure improvements. Our approach yields analytical expressions for transportation costs between any two locations, the traffic along each link of the transportation network, and the equilibrium distribution of economic activity across the economy, each as a function of the underlying quality of infrastructure and the strength of traffic congestion. We characterize the properties of such an equilibrium and show how the framework can be combined with traffic data to evaluate the impact of improving any segment of the infrastructure network. Applying our framework to both the US highway network and the Seattle road network, we find highly variable returns to investment across different links in the respective transportation networks, highlighting the importance of well-targeted infrastructure investment.
We study people’s subjective models of the macroeconomy and shed light on their attentional foundations. To do so, we measure beliefs about the effects of macroeconomic shocks on unemployment and inflation, providing respondents with identical information about the parameters of the shocks and previous realizations of macroeconomic variables. Within samples of 6,500 US households and 1,500 experts, beliefs are widely dispersed, even about the directional effects of shocks, and there are large differences in average beliefs between households and experts. Part of this disagreement seems to arise because respondents think of different propagation channels of the shocks, in particular demand- vs. supply-side mechanisms. We provide evidence on the role of associative memory in driving heterogeneity in thoughts and forecasts: contextual cues and prior experiences shape which propagation channels individuals retrieve and thereby which forecasts they make. Our findings offer a new perspective on the widely documented disagreement in macroeconomic expectations.
This article documents a new set of stylized facts on how pricing moments depend on product age and emphasizes how this heterogeneity is crucial for the amplification of nominal shocks to the real economy. Exploiting information from a unique panel containing billions of transactions in the US consumer goods sector, we show that our empirical findings are consistent with a narrative in which firms face demand uncertainty and learn through prices. Such a mechanism of active learning from prices can strongly influence an economy’s aggregate price level and can thus be important for assessing the degree of monetary non-neutrality. To quantify this, we build a general equilibrium menu cost model with active learning and exogenous entry that features heterogeneity in pricing moments over the life cycle of products. Under this setup, firms engage in active learning to deal with uncertainty on their demand curves. Firms choose prices not only to maximize static profits but also to create signals to obtain valuable information on their demand. In the calibrated version of our model, the cumulative real effects of a nominal shock are approximately three times as large compared to a standard price-setting model. The main intuition behind this result is that active learning weakens the selection effect. Price changes are mainly determined by forces of active learning and, hence, become more orthogonal to aggregate shocks, which reduces the aggregate price flexibility of the economy.
We investigate the allegation that legacy US airlines communicated via earnings calls to coordinate with other legacy airlines in offering fewer seats on competitive routes. To this end, we first use text analytics to build a novel dataset on communication among airlines about their capacity choices. Estimates from our preferred specification show that the number of offered seats is 2|$\%$| lower when all legacy airlines in a market discuss the concept of “capacity discipline.” We verify that this reduction materializes only when legacy airlines communicate concurrently, and that it cannot be explained by other possibilities, including that airlines are simply announcing to investors their unilateral plans to reduce capacity, and then following through on those announcements.
The problem of demand inversion—a crucial step in the estimation of random utility discrete-choice models—is equivalent to the determination of stable outcomes in two-sided matching models. This equivalence applies to random utility models that are not necessarily additive, smooth, nor even invertible. Based on this equivalence, algorithms for the determination of stable matchings provide effective computational methods for estimating these models. For non-invertible models, the identified set of utility vectors is a lattice, and the matching algorithms recover sharp upper and lower bounds on the utilities. Our matching approach facilitates estimation of models that were previously difficult to estimate, such as the pure characteristics model. An empirical application to voting data from the 1999 European Parliament elections illustrates the good performance of our matching-based demand inversion algorithms in practice.
China’s economic model involves regular and intensive government interventions in financial markets, while Western policymakers often refrain from substantial interventions outside crisis periods. We develop a theoretical framework to rationalize the approaches of both China and the West to managing the financial system as being optimal given the differences in their respective economies. In this framework, a government leans against trading of noise traders but at the expense of introducing policy noise to the market. Our welfare analysis shows that under certain underlying economic conditions, the optimal government policy induces a government-centric equilibrium, in which government intervention is so intensive that all investors choose to acquire private information about policy noise rather than fundamentals. This policy regime characterizes China’s approach with financial stability prioritized over other policy objectives.
To assign teachers to schools, a modified version of the well-known deferred acceptance mechanism has been proposed in the literature and is used in practice. We show that this mechanism fails to be fair and efficient for both teachers and schools. We identify a class of strategy-proof mechanisms that cannot be improved upon in terms of both efficiency and fairness. Using a rich dataset on teachers’ applications in France, we estimate teachers preferences and perform a counterfactual analysis. The results show that these mechanisms perform much better than the modified version of deferred acceptance. For instance, the number of teachers moving from their positions more than triples under our mechanism.
Should regulators encourage the migration of trade from over-the-counter (OTC) to centralized markets? To address this question, we study a model in which banks make costly decisions to participate in an OTC market, a centralized market, or both markets at the same time. Banks differ in their ability to take large positions, what we call their trading capacity. In equilibrium, intermediate-capacity banks find it optimal to participate in the centralized market. In contrast, low- and high-capacity banks find it optimal to participate in the OTC market, due to an endogenous complementarity. Namely, low-capacity banks receive worse terms of trade than in the centralized market but better risk sharing, thanks to the intermediation services offered by high-capacity banks. High-capacity banks receive worse risk sharing than in the centralized market, but profit from the provision of intermediation services to low-capacity banks. While the social optimum has qualitatively similar participation patterns, it prescribes that more customers migrate to the centralized market, and that more dealers enter the OTC market.
An increasing number of households installing solar panels and consuming the energy thus produced raises two challenges for regulators: network financing and vertical equity. We propose alternative tariff and subsidy designs for policymakers to incentivize solar panel adoptions and guarantee that network costs are recovered, while trading off efficiency, equity, and welfare motives. We estimate a structural model of energy demand and solar panel adoption, using a unique matched dataset on energy consumption, prices, income, wealth, solar panel installations, and building characteristics for 165,000 households in Switzerland from 2008 to 2014. Our counterfactuals recommend the optimal solar panel installation cost subsidies and two-part energy tariffs to achieve a solar energy target. We show that, relative to installation cost subsidies, relying on marginal prices to incentivize solar panel adoptions is more cost efficient and progressive across the income distribution, but generates a larger aggregate welfare loss.
Can we reduce the damage from climate change by investing in seawalls, stilts, or other forms of adaptation? Focusing on the case of severe storms in the US, I develop a macro heterogeneous-agent model to quantify the interactions between adaptation, federal disaster policy, and climate change. The model departs from the standard climate damage function and incorporates the damage from storms as the realization of idiosyncratic shocks. Using the calibrated model, I infer that adaptation capital comprises approximately 1|$\%$| of the US capital stock. I find that while the moral hazard effects from disaster aid reduce adaptation in the US economy, federal subsidies for investment in adaptation more than correct for the moral hazard. I introduce climate change into the model as a permanent increase in either or both the severity or probability of storms. Adaptation reduces the damage from this climate change by approximately one-third. Finally, I show that modelling the idiosyncratic risk component of climate damage has quantitatively important implications for adaptation and for the welfare cost of climate change.
Empirical evidence on distributional preferences shows that people do not judge inequality as problematic per se but that they take into account the fairness or unfairness of the outcome. This article conceptualizes a view of unfair inequality and introduces a new measure of inequality based on two widely held fairness principles: equality of opportunity and freedom from poverty. It develops a method for decomposing inequality and its trends into an unfair and a fair component. We provide two empirical applications of our measure. First, we analyse the development of inequality in the US from 1969 to 2014 from a fairness perspective. Second, we conduct a corresponding international comparison between the US and 31 European countries in 2010. Our results document that unfair inequality matches the well-documented inequality growth in the US since 1980. This trend is driven by decreases in social mobility, i.e., increasing importance of parental education and occupation for the income of their children. Among the 32 countries of our international comparison, the land of opportunity ranks among the most unfair societies in 2010.
Facing the same labour demand shock through imports from China, we show that men and women make different labour market and family adjustments that result in significant long-run gender inequality. The gender gap is driven by the female biological clock. Using population registers and matched employer-employee data from Denmark, we document that especially women in their late 30s, towards the end of their biological clock, decide to have a baby as the shock causes displacement. High-earning women in leadership positions and women who need to acquire new human capital are central because their new employment would require particularly high investments that are incompatible with having a newborn in the short time remaining on the biological clock. While children penalize women in the labour market, we show that due to the biological clock an otherwise gender-neutral shock leads to a gender gap in the labour market.
Since the collapse of the Bretton Woods monetary system, the monies of the developed world have been unbacked by any formal promise of convertibility. Yet, inflation has typically undershot, not overshot, central bank targets over the past couple decades. The low, while generally positive, inflation rate has (more arguably) been associated with low output and low growth. In this article, I consider these observations through the lens of a class of representative agent rational expectations models with nominal (price-setting) frictions and the possibility of firm entry/exit. I show that for any level of nominal frictions (no matter how small) and for any monetary policy rule that satisfies a set of weak restrictions, there is a large set of equilibria that exhibit permanently low inflation, low output, and low nominal interest rates. These equilibria can only exhibit positive long-run inflation if growth is low and the specification of nominal frictions (i.e. the Phillips curve) takes an unconventional but nonetheless empirically plausible form.
Does immigration change support for redistribution? We design and conduct large-scale surveys and experiments in six countries to investigate how people perceive immigrants and how these perceptions influence their support for redistribution. We find striking misperceptions about the number and characteristics of immigrants. In all countries, respondents greatly overestimate the total number of immigrants, think immigrants are culturally and religiously more distant from them, and economically weaker—less educated, more unemployed, and more reliant on and favoured by government transfers—than they actually are. In the experimental part of our article, we show that simply making respondents think about immigration before asking questions about redistribution makes them support less redistribution, including actual donations to charities. The perception that immigrants are economically weaker and more likely to take advantage of the welfare system is strongly correlated with lower support for redistribution, much more so than the perceived cultural distance or the perceived share of immigrants. These findings are confirmed by further experimental evidence. Information about the true shares and origins of immigrants does not change support for redistribution. An anecdote about a “hard-working” immigrant has somewhat stronger effects but is unable to counteract the negative priming effect of making people think about immigration. Our results further suggest that narratives shape people’s views on immigration more deeply than hard facts.
We derive bounds on the causal effect of belief-dependent preferences (reciprocity and guilt aversion) on choices in sequential two-player games without data on the (higher-order) beliefs of players. We show how informative bounds can be derived by exploiting a specific invariance property common to those preferences. We illustrate our approach by analysing data from an experiment conducted in Denmark. Our approach produces tight bounds on the causal effect of reciprocity in the games we consider. These bounds suggest there exists significant reciprocity in our population—a result also substantiated by the participants’ answers to a post-experimental questionnaire. On the other hand, our approach yields high implausible estimates of guilt aversion—participants would be willing, in some games, to pay at least three Danish crowns (DKK) to avoid letting others down by one DKK. We contrast our estimated bounds with point estimates obtained using data on stated higher-order beliefs, keeping all other aspects of the model unchanged. We find that point estimates fall within our estimated bounds, suggesting that elicited higher-order belief data in our experiment is weakly (if at all) affected by various reporting biases.
To explore whether schools’ causal impacts on test scores measure their overall impact on students, we exploit plausibly exogenous school assignments and data from Trinidad and Tobago to estimate the causal impacts of individual schools on several outcomes. Schools’ impacts on high-stakes tests are weakly related to impacts on important outcomes such as arrests, dropout, teen motherhood, and formal labour market participation. To examine if parents’ school preferences are related to these causal impacts, we link them to parents’ ranked lists of schools and employ discrete-choice models to infer preferences for schools. Parents choose schools that improve high-stakes tests even conditional on peer quality and average outcomes. Parents also choose schools that reduce criminality and teen motherhood and increase labour market participation. School choices among parents of low-achieving students are relatively more strongly related to schools’ impacts on non-test-score outcomes, while the opposite is true for parents of high-achieving students. These results suggest that evaluations based solely on test scores may be misleading about the benefits of school choice (particularly for low-achieving students), and education interventions more broadly.
In the US, both taxes and old-age social security benefits depend on one’s marital status and tend to reduce the labour supply of the secondary earner. To what extent are these provisions holding back the female labour supply? We estimate a rich dynamic life-cycle model of labour supply and savings for couples and singles using the Method of Simulated Moments for the 1945 and 1955 birth cohorts. Our model matches well the life-cycle profiles of labour market participation, hours, and savings for married and single people, and generates plausible elasticities of labour supply. It implies that eliminating these marriage-related provisions would drastically increase the participation of married women over their entire life cycle, reduce the participation of married men after age 60, and increase savings. If the resulting government surplus were used to lower income taxation, there would be large welfare gains for the vast majority of the population. These results hold for both cohorts, including the later one, which has participation similar to that of more recent generations.
We use new, comprehensive micro data on oil fields to build and estimate a structural model of the oil industry embedded in a general equilibrium model of the world economy. In the model, firms that belong to Organization of the Petroleum Exporting Countries (OPEC) act as a cartel. The remaining firms are a competitive fringe. We use the model to study the macroeconomic impact of the advent of fracking. Fracking weakens the OPEC cartel, leading to a large long-run decline in oil prices. Fracking also reduces the volatility of oil prices in the long run because fracking firms can respond more quickly to changes in oil demand.
Between 1940 and 1970, more than 4 million African Americans moved from the South to the North of the US, during the Second Great Migration. This same period witnessed the struggle and eventual success of the civil rights movement in ending institutionalized racial discrimination. This article shows that the Great Migration and support for civil rights are causally linked. Predicting Black inflows with a shift-share instrument, we find that the Great Migration raised support for the Democratic Party, increased Congress members’ propensity to promote civil rights legislation, and encouraged pro-civil rights activism outside the US South. We provide different pieces of evidence that support for civil rights was not confined to the Black electorate but was also shared by segments of the white population.
We propose a simple test for moment inequalities that has exact size in normal models with known variance and has uniformly asymptotically exact size under asymptotic normality. The test compares the quasi-likelihood ratio statistic to a chi-squared critical value, where the degree of freedom is the rank of the inequalities that are active in finite samples. The test requires no simulation and thus is computationally fast and especially suitable for constructing confidence sets for parameters by test inversion. It uses no tuning parameter for moment selection and yet still adapts to the slackness of the moment inequalities. Furthermore, we show how the test can be easily adapted to inference on subvectors in the common empirical setting of conditional moment inequalities with nuisance parameters entering linearly. User-friendly Matlab code to implement the test is provided.
We study a model of innovation with a large number of firms that create new technologies by combining several discrete ideas. These ideas are created via private investment and spread between firms. Firms face a choice between secrecy, which protects existing intellectual property, and openness, which facilitates learning from others. Their decisions determine interaction rates between firms, and these interaction rates enter our model as link probabilities in a learning network. Higher interaction rates impose both positive and negative externalities, as there is more learning but also more competition. We show that the equilibrium learning network is at a critical threshold between sparse and dense networks. At equilibrium, the positive externality from interaction dominates: the innovation rate and welfare would be dramatically higher if the network were denser. So there are large returns to increasing interaction rates above the critical threshold. Nevertheless, several natural types of interventions fail to move the equilibrium away from criticality. One effective policy solution is to introduce informational intermediaries, such as public innovators who do not have incentives to be secretive. These intermediaries can facilitate a high-innovation equilibrium by transmitting ideas from one private firm to another.
We study a model of over-the-counter trading in which ex ante identical traders invest in a contact technology and participate in bilateral trade. We show that a rich market structure emerges both in equilibrium and in an optimal allocation. There is continuous heterogeneity in market access under weak regularity conditions. If the cost per contact is constant, heterogeneity is governed by a power law and there are middlemen, market participants with unboundedly high contact rates who account for a positive fraction of meetings. Externalities lead to overinvestment in equilibrium, and policies that reduce investment in the contact technology can improve welfare. We relate our findings to important features of real-world trading networks.
Housing affordability is the main policy challenge for most large cities in the world. Zoning changes, rent control, housing vouchers, and tax credits are the main levers employed by policymakers. How effective are they at combatting the affordability crisis? We build a dynamic stochastic spatial equilibrium model to evaluate the effect of these policies on the well-being of its citizens. The model endogenizes house prices, rents, construction, labour supply, output, income, and wealth inequality, the location decisions of households within the city as well as inter-city migration. Its main novel features are risk, risk aversion, and incomplete risk-sharing. We calibrate the model to the New York metropolitan statistical area. Housing affordability policies carry substantial insurance value but affect aggregate housing and labour supply and cause misallocation in labour and housing markets. Housing affordability policies that enhance access to this insurance especially for the neediest households create substantial net welfare gains.
We develop a multi-sector gravity model with heterogeneous workers to quantify the aggregate and group-level welfare effects of trade. The model generalizes the specific-factors intuition to a setting with labour reallocation, leads to a parsimonious formula for the group-level welfare effects from trade, and nests the aggregate results in Arkolakis, Costinot and Rodríguez-Clare (2012, “New Trade Models, Same Old Gains?”, American Economic Review, 102, 94–130). We estimate the model using the structural relationship between China-shock driven changes in manufacturing employment and average earnings across US groups defined as commuting zones. We find that the China shock increases average welfare but some groups experience losses as high as four times the average gain. However, adjusting for plausible measures of inequality aversion barely affects the welfare gains. We also develop and estimate an extension of the model that endogenizes labour force participation and unemployment, finding similar welfare effects from the China shock.
Cartels participating in procurement auctions frequently use bid rotation or prioritize incumbents to allocate contracts. However, establishing a link between observed allocation patterns and firm conduct has been difficult: there are cost-based competitive explanations for such patterns. We show that by focusing on auctions in which the winning and losing bids are very close, it is possible to distinguish allocation patterns reflecting cost differences across firms from patterns reflecting non-competitive environments. We apply our tests to two datasets: the sample of Ohio milk auctions studied in Porter and Zona (1999, “Ohio School Milk Markets: An Analysis of Bidding”, RAND Journal of Economics, 30, 263–288), and a sample of municipal procurement auctions from Japan.
We study how introducing a central bank digital currency affects equilibrium allocations and welfare in an environment where both currency and bank deposits are used in exchange. We highlight an important policy tradeoff: while a digital currency tends to improve efficiency in exchange, it may also crowd out bank deposits, raise banks’ funding costs, and decrease investment. We derive conditions under which targeted digital currencies, which compete only with physical currency or only with bank deposits, raise welfare. If such targeted currencies are infeasible, we illustrate the policy tradeoffs that arise when issuing a single, universal digital currency.
Mammography guidelines have weakened in response to evidence that mammograms diagnose breast cancers that would never eventually cause symptoms, a phenomenon called “overdiagnosis.” Given concerns about overdiagnosis, instead of recommending mammograms, US guidelines encourage women aged 40–49 to get them as they see fit. To assess whether these guidelines target women effectively, I propose an approach that examines mammography behaviour within an influential clinical trial that followed participants long enough to find overdiagnosis. I find that women who are more likely to receive mammograms are healthier and have higher socioeconomic status. More importantly, I find that the 20-year level of overdiagnosis is at least 3.5 times higher among women who are most likely to receive mammograms. At least 36|$\%$| of their cancers are overdiagnosed. These findings imply that US guidelines encourage mammograms among healthier women who are more likely to be overdiagnosed by them. Guidelines in other countries do not.
This article aims to measure and understand the role of inheritances in shaping wealth inequality. We use a quasi-experimental design and Swedish administrative data to document that the average heir depletes her inheritance within a decade while the inheritances of wealthy heirs remain intact. These different depletion rates are not due to different consumption or labour supply responses but due to different rates of return on inherited wealth. Upon their receipt, inheritances reduce relative measures of wealth inequality, such as top shares or percentile ratios. Theoretically, this reduction in inequality could be due to either a compressed inheritance distribution or similar chances of having wealthy parents (high intergenerational mobility). Empirically, the first force is more significant in Sweden. Within a decade, however, the effect is reversed: inheritances increase wealth inequality since the different depletion rates widen the inequality in inherited wealth over time. This implies that inheritance taxation can reduce long run wealth inequality only through the taxation of wealthy heirs.
We examine the ability of the government to impact mortgage refinancing activity and spur consumption by focusing on the Home Affordable Refinance Program (HARP) that relaxed housing equity constraints by extending government credit guarantee on insufficiently collateralized refinanced mortgages. Difference-in-difference tests based on program eligibility criteria reveal a significant increase in refinancing activity by HARP. More than three million eligible borrowers with primarily fixed-rate mortgages refinanced under HARP, receiving an average reduction of 1.45|$\%$| in interest rate ($3,000 in annual savings). Durable spending by borrowers increased significantly after refinancing. Regions more exposed to the program saw a relative increase in non-durable and durable consumer spending, a decline in foreclosure rates, and faster recovery in house prices. Competitive frictions in the refinancing market hampered the program’s impact: the take-up rate and annual savings among those who refinanced were reduced by 10–20|$\%$|⁠, with amplified effects for the most indebted borrowers.
Firms have ever-increasing access to consumer data, which they use to personalize their advertising and to price discriminate. This raises privacy concerns. Policymakers have argued in response that consumers should be given control over their data, able to choose what to share and when. Since firms learn about a consumer’s preferences both from what they do and do not disclose, the equilibrium implications of consumer control are unclear. We study whether such measures improve consumer welfare in monopolistic and in competitive markets. We find that consumer control can improve consumer welfare relative to both perfect price discrimination and uniform pricing. First, consumers can use disclosure to amplify competitive forces. Second, consumers can disclose information to induce even a monopolist to lower prices. Whether consumer control improves welfare depends on the disclosure technology and market competitiveness. Simple disclosure technologies suffice in competitive markets. When facing a monopolist, a consumer needs partial disclosure possibilities to obtain any welfare gains.
This article examines the optimal accumulation of capital and the effects of government debt in neoclassical growth models in which firms have market power and therefore charge prices above marginal cost. In this environment, the real interest rate earned by savers is less than the net marginal product of capital. We establish a new method for evaluating dynamic efficiency that can be applied in such economies. A plausible calibration suggests that the wedge between the real interest rate and the marginal product of capital is about 4 percentage points and that the US economy is dynamically efficient. In addition, government Ponzi schemes can have different implications for welfare than they do under competition. Even if the government can sustain a perpetual rollover of debt and accumulating interest, the policy may nonetheless reduce welfare by depressing steady-state capital and aggregate consumption. These findings suggest that even with low interest rates, as have been observed recently, fiscal policymakers should still be concerned about the crowding-out effects of government debt.
This article studies the decentralized adoption of a technology standard when network effects are present. If the new standard is incompatible with the current installed base, adoption may be inefficiently delayed. I quantify the magnitude of “excess inertia” in the switch of the movie distribution and exhibition industries from 35 mm film to digital. I specify and estimate a dynamic game of digital hardware adoption by theatres and digital movies supply by distributors. Counterfactual simulations establish that excess inertia reduces surplus by |$16\%$| relative to the first-best adoption path; network externalities explain |$41\%$| of the surplus loss. Targeted adoption subsidies or a mandate on digital distribution help bridge this welfare gap.
We incorporate the lumpy nature of firm-level investment into the study of how tax policy affects investment behaviour. We show that tax policies can directly impact the lumpiness of investment. Extensive-margin responses to tax policy are key to understanding the effects of different tax reforms and to designing effective stimulus policies. We illustrate these results by studying China’s 2009 VAT reform, which lowered the tax cost of investment and reduced partial irreversibility—the price gap between new and used capital. Using comprehensive tax survey data and a difference-in-differences design, we estimate a 36|$\%$| relative investment increase that is driven by investment spikes. Using a dynamic investment model that fits the reduced-form effects of the reform, we show that policies that directly reduce the likelihood of firm inaction are more effective at stimulating investment.
We study the politicians and voters of the Sweden Democrats, a major populist radical-right party. Based on detailed administrative data, we present the first comprehensive account of which politicians are selected into such a party. Surveys show that politicians and voters of the Sweden Democrats share strong anti-establishment and anti-immigration attitudes that drastically set them apart from Sweden’s other parties. Searching for individual traits that link naturally to these attitudes, we classify the universe of Swedish politicians and voters by social and economic marginalization and exposure to immigration. Politicians from the Sweden Democrats over-represent marginalized groups without strong attachments to the labour market or to traditional nuclear families, which instead are under-represented among politicians in all other parties. Among voters, the Sweden Democrats have higher electoral support in precincts with higher shares of the same marginalized groups. We see the mobilization of the marginalized as an important driver of the party’s success. Finally, we uncover that Sweden-Democrat politicians score lower on a number of valence traits than other-party politicians. In sum, the rise of the Sweden Democrats raised political representation for marginalized groups, but this came at a valence cost.
To determine the welfare implications of price changes in demand data, we introduce a revealed preference relation over prices. We show that the absence of cycles in this relation characterizes a consumer who trades off the utility of consumption against the disutility of expenditure. Our model can be applied whenever a consumer’s demand over a strict subset of all available goods is being analysed; it can also be extended to settings with discrete goods and non-linear prices. To illustrate its use, we apply our model to a single-agent data set and to a data set with repeated cross-sections. We develop a novel test of linear hypotheses on partially identified parameters to estimate the proportion of the population who are revealed better off due to a price change in the latter application. This new technique can be used for non-parametric counterfactual analysis more broadly.
We study optimal fiscal policy in a standard incomplete-markets model with uninsurable idiosyncratic income risk, where a Ramsey planner chooses time-varying paths of proportional capital and labour income taxes, lump-sum transfers (or taxes), and government debt. We find that (1) short-run capital income taxes are effective in providing redistribution since the tax base is relatively unequal and inelastic; (2) an increasing pattern of labour income taxes over time mitigates intertemporal distortions from capital income taxes; (3) the optimal policy increases overall transfers, calibrated initially to the US welfare system, by roughly |$50\%$|⁠; (4) two-thirds of the welfare gains come from redistribution and the remaining third come mostly from insurance; and (5) redistribution also leads to a more efficient allocation of labour via wealth effects on labour supply—lower productivity households can afford to work relatively less.
We present an approach to analyse learning outcomes in a broad class of misspecified environments, spanning both single-agent and social learning. We introduce a novel “prediction accuracy” order over subjective models and observe that this makes it possible to partially restore standard martingale convergence arguments that apply under correctly specified learning. Based on this, we derive general conditions to determine when beliefs in a given environment converge to some long-run belief either locally or globally (i.e. from some or all initial beliefs). We show that these conditions can be applied, first, to unify and generalize various convergence results in previously studied settings. Second, they enable us to analyse environments where learning is “slow”, such as costly information acquisition and sequential social learning. In such environments, we illustrate that even if agents learn the truth when they are correctly specified, vanishingly small amounts of misspecification can generate extreme failures of learning.
We study the interaction between tax advantages for municipal bonds and the market structure of auctions for these bonds. We show that this interaction can limit a bidder’s ability to extract information rents and is a crucial determinant of state and local governments’ borrowing costs. Reduced-form estimates show that increasing the tax advantage by 3 pp lowers mean borrowing costs by 9–10|$\%$|⁠. We estimate a structural auction model to measure markups and to illustrate and quantify how the interaction between tax policy and bidder strategic behaviour determines the impact of tax advantages on municipal borrowing costs. We use the estimated model to evaluate the efficiency of Obama and Trump administration policies that limit the tax advantage for municipal bonds. Because reductions in the tax advantage inflate bidder markups and depress competition, the resulting increase in municipal borrowing costs more than offsets the tax savings to the government. Finally, we use the model to analyse a recent non-tax regulation that affects entry into municipal bond auctions.
Motivated by the prevalence of simultaneous bidding across a wide range of auction markets, we develop and estimate a model of strategic interaction in simultaneous first-price auctions when objects are heterogeneous and bidders have non-additive preferences over combinations. We establish non-parametric identification of primitives in this model under standard exclusion restrictions, providing a basis for both estimation and testing of preferences over combinations. We then apply our model to data on Michigan Department of Transportation (MDOT) highway procurement auctions, quantifying the magnitude of cost synergies and evaluating the performance of the simultaneous first-price mechanism in the MDOT marketplace.
We develop a novel, risk-based theory of the effects of exchange rate stabilization. In our model, the choice of exchange rate regime allows policymakers to make their currency, and by extension, the firms in their country, a safer investment for international investors. Policies that induce a country’s currency to appreciate when the marginal utility of international investors is high lower the required rate of return on the country’s currency and increase the world-market value of domestic firms. Applying this logic to exchange rate stabilizations, we find a small economy stabilizing its bilateral exchange rate relative to a larger economy can increase domestic capital accumulation, domestic wages, and even its share in world wealth. In the absence of policy coordination, small countries optimally choose to stabilize their exchange rates relative to the currency of the largest economy in the world, which endogenously emerges as the world’s “anchor currency”, Larger economies instead optimally choose to float their exchange rates. The model therefore predicts an equilibrium pattern of exchange rate arrangements that is remarkably similar to the one in the data.
We study how an organization should dynamically screen an agent of uncertain loyalty whom it suspects of committing damaging acts of undermining. The organization controls the stakes of the relationship, while the agent strategically times undermining, which can occur repeatedly and is detected only stochastically. The optimal commitment stakes policy exhibits both discreteness and gradualism, with distinct “untrusted” and “trusted” phases featuring gradually rising stakes during the untrusted phase and a discrete gap in stakes between phases. This policy is also the equilibrium outcome when the organization cannot commit, and the agent’s equilibrium undermining policy exhibits variable, non-monotonic intensity.
We incorporate externalities into the stable matching theory of two-sided markets. Extending the classical substitutes condition to markets with externalities, we establish that stable matchings exist when agent choices satisfy substitutability. We show that substitutability is a necessary condition for the existence of a stable matching in a maximal-domain sense and provide a characterization of substitutable choice functions. In addition, we extend the standard insights of matching theory, like the existence of side-optimal stable matchings and the deferred acceptance algorithm, to settings with externalities even though the standard fixed-point techniques do not apply.
Can massive online retailers such as Amazon and Alibaba issue digital tokens that potentially compete with bank debit accounts? There is a long history of trading stamps and loyalty points, but new technologies are poised to sharply raise the significance of redeemable assets as a store of value. Here, we develop a simple stylized model of redeemable tokens that can be used to study sales and pricing strategies for issuing tokens, including ICOs. Our central finding is that platforms can potentially earn higher revenues by making tokens non-tradable unless they can generate a sufficiently high outside-platform convenience yield.
We study the impact of changing choice set size on the quality of choices in health insurance markets. Using novel data on enrolment and medical claims for school district employees in the state of Oregon, we document that the average employee could save $600 by switching to a lower cost plan. Structural modelling reveals large “choice inconsistencies” such as non-equalization of the dollar spent on premiums and out of pocket, and a novel form of “approximate inertia” where enrolees are excessively likely to switch to other plans that are close to the current plan on the plan design spreadsheet. Variation in the number of plan choices across districts and over time shows that enrolees make lower-cost choices when the choice set is smaller. We show that a curated restriction of choice set size improves choices more than the best available information intervention, partly because approximate inertia lowers gains from new information. We explicitly test and reject the assumption that this is because individuals choose worse from larger choice sets, or “choice overload”. Rather, we show that this feature arises from the fact that larger choice sets feature worse choices on average that are not offset by individual re-optimization.
Entrepreneurs and venture capitalists are concerned about investors’ beliefs in asset markets because these beliefs shape the value of a potential IPO and the possibility to expand. Investors’ beliefs, on the other hand, can be influenced by start-up activity insofar as the latter contains valuable information about eventual profitability. This two-way feedback is shown to generate excessive, non-fundamental, waves in start-up activity, IPOs, and asset prices. Policies that “lean against the wind” can improve welfare, without requiring an informational advantage by the government.
We study dynamic matching in exchange markets with easy- and hard-to-match agents. A greedy policy, which attempts to match agents upon arrival, ignores the positive externality that waiting agents provide by facilitating future matchings. We prove that the trade-off between a “thicker” market and faster matching vanishes in large markets; the greedy policy leads to shorter waiting times and more agents matched than any other policy. We empirically confirm these findings in data from the National Kidney Registry. Greedy matching achieves as many transplants as commonly used policies (1.8|$\%$| more than monthly batching) and shorter waiting times (16 days faster than monthly batching).
We introduce a portfolio friction in a two-country DSGE model where investors face a constant probability to make new portfolio decisions. The friction leads to a more gradual portfolio adjustment to shocks and a weaker portfolio response to changes in expected excess returns. We apply the model to monthly data for the US and the rest of the world for equity portfolios. We show that the model is consistent with a broad set of evidence related to portfolios, equity prices, and excess returns for an intermediate level of friction. The evidence includes portfolio inertia, limited sensitivity to expected excess returns, a significant impact of financial shocks, excess return predictability, and asset price momentum and reversal.
We provide two characterizations, one axiomatic and the other neuro-computational, of the dependence of choice probabilities on deadlines, within the widely used softmax representation $$\begin{align*}
p_{t}\left( a,A\right) =\dfrac{e^{\frac{u\left( a\right) }{\lambda\left(
t\right) }+\alpha\left( a\right) }}{\sum_{b\in A}e^{\frac{u\left(
b\right) }{\lambda\left( t\right) }+\alpha\left( b\right) }},
\end{align*}$$where |$p_{t}\left( a,A\right)$| is the probability that alternative |$a$| is selected from the set |$A$| of feasible alternatives if |$t$| is the time available to decide, |$\lambda$| is a time-dependent noise parameter measuring the unit cost of information, |$u$| is a time-independent utility function, and |$\alpha$| is an alternative-specific bias that determines the initial choice probabilities (reflecting prior information and memory anchoring).Our axiomatic analysis provides a behavioural foundation of softmax (also known as Multinomial Logit Model when |$\alpha$| is constant). Our neuro-computational derivation provides a biologically inspired algorithm that may explain the emergence of softmax in choice behaviour. Jointly, the two approaches provide a thorough understanding of softmaximization in terms of internal causes (neuro-physiological mechanisms) and external effects (testable implications).
We quantify intergenerational and assortative processes by comparing different degrees of kinship within the same generation. This “horizontal” approach yields more, and more distant kinship moments than traditional methods, which allows us to account for the transmission of latent advantages in a detailed intergenerational model. Using Swedish registers, we find strong persistence in the latent determinants of status, and a striking degree of sorting—to explain the similarity of distant kins, assortative matching must be much stronger than previously thought. Latent genetic influences explain little of the variance in educational attainment, and sorting occurs primarily in non-genetic factors.
In the US, the federal government grants colleges access to a student’s Free Application for Federal Student Aid (FAFSA) which facilitates substantial price discrimination. This article is the first to estimate the consequences of allowing colleges to use the FAFSA in their pricing decisions. I build and estimate a structural model of college pricing and simulate counterfactuals wherein some or all of the FAFSA information is restricted. I find that if FAFSA information were restricted, 13|$\%$| of students attending elite colleges would be inefficiently priced out of the elite market. Nevertheless, student welfare would rise as colleges charged the majority of students lower prices. Colleges do use the FAFSA to transfer resources from high- to low-income students on average, but this redistribution is highly imprecise: allowing colleges to use the FAFSA harms one-third of low-income students while one in seven high-income students actually benefit.
We present a test of Coasean theories of efficient separations. We study a cohort of jobs from the introduction through the repeal of a large age- and region-specific unemployment benefit extension in Austria. In the treatment group, 18.5|$\%$| fewer jobs survive the program period. According to the Coasean view, the destroyed marginal jobs had low joint surplus. Hence, after the repeal, the treatment survivors should be more resilient than the ineligible control group survivors. Strikingly, the two groups instead exhibit identical post-repeal separation behaviour. We provide, and find suggestive evidence consistent with, an alternative model in which wage rigidity drives the inefficient separation dynamics.
Recent work has demonstrated that existing solutions of the unemployment volatility puzzle are at odds with the procylicality of the opportunity cost of employment, the cyclicality of wages, and the volatility of risk-free rates. We propose a model of business cycles that is immune to these critiques by incorporating two key features. First, we allow for preferences that generate time-varying risk over the business cycle to account for observed fluctuations in asset prices. Second, we introduce human capital acquisition, as is consistent with the evidence on how wages grow with experience in the labor market. Our model reproduces the observed fluctuations in unemployment because hiring a worker is a risky investment with long-duration returns. As in the data, the price of risk in our model sharply increases in recessions. The benefit from hiring new workers therefore greatly declines, leading to a large decrease in job vacancies and an increase in unemployment of the same magnitude as in the data. We show that our results extend to versions of the model that include physical capital, a life cycle for workers, and alternative preference structures common in the asset-pricing literature.
We estimate the dynamic causal effects of consumer sentiment shocks in the US. We identify autonomous changes in survey evidence on consumer confidence using fatalities in mass shootings as an instrument. We find the instrument to be significant for an aggregate index of consumer expectations and also back up the identification scheme with micro evidence that exploits the geographical variation in mass shootings. Sentiment shocks have real macroeconomic effects. A negative sentiment shock is recessionary: It sets off a persistent decline in consumer confidence and induces a contraction in industrial production, private sector consumption and in the labour market, while having less evident nominal effects. Finally, sentiment shocks explain a non-negligible part of the cyclical fluctuations in consumer confidence and real macroeconomic aggregates.
This article develops a discrete choice model of demand with optimal sequential consumer search. Consumers first choose a product to search; then, once they learn the utility they get from the searched product, they choose whether to buy it or to keep searching. We characterize the search problem as a standard discrete choice problem and propose a parametric search cost distribution that generates closed-form expressions for the probability of purchasing a product. We propose a method to estimate the model that supplements aggregate product data with individual-specific data which allows for the separate identification of search costs and preferences. We estimate the model using data from the automobile industry and find that search costs have non-trivial implications for elasticities and markups. We study the effects of exclusive dealing regulation and find that firms benefit at the expense of consumers, who face higher search costs and higher prices than would be the case if multi-brand dealerships were used.
A patient seller interacts with a sequence of myopic consumers. Each period, the seller chooses the quality of his product, and a consumer decides whether to trust the seller after she observes the seller’s actions in the last |$K$| periods (limited memory) and at least one previous consumer’s action (observational learning). However, the consumer cannot observe the seller’s action in the current period. With positive probability, the seller is a commitment type who plays his Stackelberg action in every period. I show that under limited memory and observational learning, consumers are concerned that the seller will not play his Stackelberg action when he has a positive reputation and will play his Stackelberg action after he has lost his reputation. Such a concern leads to equilibria where the seller receives a low payoff from building a reputation. I also show that my reputation failure result hinges on consumers’ observational learning.
We examine how 17 behavioural biases relate to each other, to three standard measures of risk and time preferences, to cognitive skills, personality, and demographics, and to outcomes in household finance, well-being, and health. Most consumers in our nationally representative panel data exhibit multiple biases, with substantial cross-person heterogeneity. Biases are positively correlated within person, especially after adjusting for measurement error. From that correlation structure, we reduce our 20 bias and standard preference measures to four behavioural common factors. Each BCF reflects a group of related biases regarding beliefs, decision quality, discounting, or risk/uncertainty attitudes. The first two BCFs also strongly correlate with each other (positively) and cognitive skills (negatively). The first three BCFs and cognitive skills strongly correlate with various outcomes in the expected directions. Our results support processing-based models where basic limitations in cognition and/or attention produce multiple biases, and they have several other implications for theory and practice.
By exploiting new macroeconomic data known as foreign affiliates statistics, we show that affiliates of foreign multinational firms are an order of magnitude more profitable than local firms in a number of low-tax countries. Leveraging this differential profitability, we estimate that 36|$\%$| of multinational profits are shifted to tax havens globally. US multinationals shift twice as much profit as other multinationals relative to the size of their foreign earnings. We analyse how the location of corporate profits would change if shifted profits were reallocated to their source countries. Domestic profits would increase by about 20|$\%$| in high-tax European Union countries, 10|$\%$| in the US, and 5|$\%$| in developing countries, while they would fall by 55|$\%$| in tax havens. We provide a new international database of GDP, trade balances, and factor shares corrected for profit shifting. In contrast to the picture painted by official statistics, our results suggest that the corporate capital share has increased not only in North America but also in high-tax European countries. Capital is making a comeback globally, but its rise is obscured by the tax avoidance strategies of multinational companies.
Do the long work hours required by many high-paying professions inhibit the entry of women? I investigate this question by studying a 2003 policy that capped the average workweek for medical residents at 80 hours. Using data on the universe of US medical school graduates, I find that when a specialty reduces its weekly hours, more women enter the specialty, whereas there is little change in men’s entry. I provide evidence that the increase in women is due to changes in labour supply, rather than labour demand. At the residency program level, I document that baseline female representation predicts female entry after the reform. A back-of-the-envelope calculation suggests that the reallocation of women among medical specialties due to the hours reduction can close the physician gender wage gap by 11|$\%$|⁠.
Do productivity and managerial quality vary within the firm? If so which managerial traits and practices matter most for team productivity? Combining granular garment production data with survey data on managers across 120 production lines in India, we document substantial productivity dispersion both across teams producing overlapping products and within team over the course of production runs, and structurally link this variation to a comprehensive assessment of supervisor quality. We find that factors related to managerial attention and control are the most important for enabling line productivity, both more impactful than traditionally emphasized dimensions like cognitive skills and tenure. We document that one mechanism by which specific managerial practices contribute to productivity is by way of enabling faster learning-by-doing. In-sample pay patterns suggest potential net gains from screening for or training in less readily measured dimensions of managerial quality, as pass-through of productivity contributions to pay is incomplete.
This article sets out a data-driven approach for targeting environmental policies optimally in order to combat deforestation. We focus on the Amazon, the world’s most extensive rainforest, where Brazil’s federal government issued a “Priority List” of municipalities in 2008—a blacklist to be targeted with more intense environmental monitoring and enforcement. First, we estimate the causal impact of the Priority List on deforestation (along with other relevant treatment effects) using “changes-in-changes” due to Athey and Imbens (2006), finding that it reduced deforestation by 43|$\%$| and cut emissions by almost 50 million tons of carbon. Second, we develop a novel framework for computing targeted optimal blacklists that draws on our treatment effect estimates, assigning municipalities to a counterfactual list that minimizes total deforestation subject to realistic resource constraints. We show that the ex post optimal list would result in carbon emissions over 10|$\%$| lower than the actual list, amounting to savings of more than |$ \$ $|1.2 billion (34|$\%$| of the total value of the Priority List), with emissions over 23|$\%$| lower on average than a randomly selected list. The approach we propose is relevant both for assessing targeted counterfactual policies to reduce deforestation and for quantifying the impacts of policy targeting more generally.
This article develops a model to explore how favour exchange influences wealth dynamics. We identify a key obstacle to wealth accumulation: wealth crowds out favour exchange. Therefore, households must choose between growing their wealth and accessing favour exchange. We show that low-wealth households rely on favour exchange at the cost of having tightly limited long-term wealth. As a result, initial wealth disparities persist and can even grow worse. We then explore how communities and policymakers can overcome this obstacle. Using simulations, we show that community benefits and place-based policies can stimulate both saving and favour exchange, and in some cases, can even transform favour exchange into a force that accelerates wealth accumulation.
The historical transition to a low fertility regime was central for long-run growth, but what caused it? Existing economic explanations largely focus on the economic incentives to limit fertility. This article presents new evidence highlighting the importance of cultural forces as a complementary driver of the fertility transition. We leverage a sharp change in fertility in Britain in 1877 and document large synchronized declines in fertility among culturally British households residing outside of Britain, in Canada, the US, and South Africa, relative to their non-British neighbours. We propose a plausible catalyst for the change: the famous Bradlaugh–Besant trial of 1877.
Developing artificial intelligence (AI) technology requires data. In many domains, government data far exceed in magnitude and scope data collected by the private sector, and AI firms often gain access to such data when providing services to the state. We argue that such access can stimulate commercial AI innovation in part because data and trained algorithms are shareable across government and commercial uses. We gather comprehensive information on firms and public security procurement contracts in China’s facial recognition AI industry. We quantify the data accessible through contracts by measuring public security agencies’ capacity to collect surveillance video. Using a triple-differences strategy, we find that data-rich contracts, compared to data-scarce ones, lead recipient firms to develop significantly and substantially more commercial AI software. Our analysis suggests a contribution of government data to the rise of China’s facial recognition AI firms, and that states’ data collection and provision policies could shape AI innovation.
We present a new class of methods for identification and inference in dynamic models with serially correlated unobservables, which typically imply that state variables are econometrically endogenous. In the context of Industrial Organization, these state variables often reflect econometrically endogenous market structure. We propose the use of Generalized Instrument Variables methods to identify those dynamic policy functions that are consistent with instrumental variable (IV) restrictions. Extending popular “two-step” methods, these policy functions then identify a set of structural parameters that are consistent with the dynamic model, the IV restrictions and the data. We provide computed illustrations to both single-agent and oligopoly examples. We also present a simple empirical analysis that, among other things, supports the counterfactual study of an environmental policy entailing an increase in sunk costs.
This article presents a model of quantitative easing (QE) at the zero lower bound (ZLB) on the short-term nominal interest rate. QE, which reduces the maturity of government debt, is effective at the ZLB because it generates expectations of future monetary expansion in a time-consistent equilibrium. Numerical experiments show that this effect can be substantial.
This article studies career spillovers across workers, which arise in firms with limited promotion opportunities. We exploit a 2011 Italian pension reform that unexpectedly tightened eligibility criteria for the public pension, leading to sudden, substantial, and heterogeneous retirement delays. Using administrative data on Italian private-sector workers, the analysis leverages cross-firm variation to isolate the effect of retirement delays among soon-to-retire workers on the wage growth and promotions of their colleagues. We find evidence of spillover patterns consistent with older workers blocking the careers of their younger colleagues, but only in firms with limited promotion opportunities.
The rise of opinion programs has transformed television news. Because they present anchors’ subjective commentary and analysis, opinion programs often convey conflicting narratives about reality. We experimentally document that people across the ideological spectrum turn to opinion programs over “straight news”, even when provided large incentives to learn objective facts. We then examine the consequences of diverging narratives between opinion programs in a high-stakes setting: the early stages of the COVID-19 pandemic in the US. We find stark differences in the adoption of preventative behaviours among viewers of the two most popular opinion programs, both on the same network, which adopted opposing narratives about the threat posed by the COVID-19 pandemic. We then show that areas with greater relative viewership of the program downplaying the threat experienced a greater number of COVID-19 cases and deaths. Our evidence suggests that opinion programs may distort important beliefs and behaviours.
We study the susceptibility of committee governance (e.g. by boards of directors), modelled as the collective determination of a ranking of a set of alternatives, to manipulation of the order in which pairs of alternatives are voted on—agenda-manipulation. We exhibit an agenda strategy called insertion sort that allows a self-interested committee chair with no knowledge of how votes will be cast to do as well as if she had complete knowledge. Strategies with this “regret-freeness” property are characterized by their efficiency, and by their avoidance of two intuitive errors. What distinguishes regret-free strategies from each other is how they prioritize among alternatives; insertion sort prioritizes lexicographically.
This article studies the optimal design of corporate taxes when firms have private information about future investment opportunities and face financial constraints. A government whose goal is to efficiently raise a given amount of revenue from its corporate sector should attempt to tax unconstrained firms, which value resources inside the firm less than financially constrained firms. We show that a corporate payout tax (a tax on dividends and share repurchases) can both separate constrained and unconstrained firms and raise revenue and is therefore optimal. Our quantitative analysis implies that a revenue-neutral switch from profit taxation to payout taxation would increase the overall value of existing firms and new entrants by |$7\%$|⁠. This switch could be implemented in the current US tax system by making retained earnings fully deductible.
Throughout the Western world, people’s policy views are correlated across domains in a strikingly similar fashion. This article proposes that what partly explains the structure of ideology is moral universalism: the extent to which people exhibit the same level of altruism and trust towards strangers as towards in-group members. In new large-scale multinational surveys, heterogeneity in universalism descriptively explains why some people support redistribution, health care, environmental protection, affirmative action, and foreign aid, while others advocate for spending on the military, law enforcement, and border protection. Universalism is a substantially stronger predictor of policy views and ideological constraints than variables such as income, wealth, education, religiosity, or beliefs about government efficiency. Consistent with the idea that universalism shapes policy views, we further document that the left–right divide on redistribution, environmental protection, or foreign aid strongly attenuates or even reverses when people evaluate less universalist implementations of these policies.
Short-time work (STW) policies provide subsidies for hour reductions to workers in firms experiencing temporary shocks. They are the main policy tool used to support labour hoarding during downturns and were aggressively used during the coronavirus disease 2019 (COVID-19) pandemic. Yet, very little is known about their employment and welfare consequences. This article leverages unique administrative social security data from Italy and quasi-experimental variation in STW policy rules to offer evidence on the effects of STW on firms’ and workers’ outcomes during the Great Recession. Our results show large and significant negative effects of STW treatment on hours, but large and positive effects on headcount employment. We then analyse whether these positive employment effects are welfare enhancing, distinguishing between temporary and more persistent shocks. We first provide evidence that liquidity constraints and rigidities in wages and hours may make labour hoarding inefficiently low without STW. Then, we show that adverse selection of low productivity firms into STW reduces the long-run insurance value of the program and creates significant negative reallocation effects when the shock is persistent.
We propose a method to estimate static discrete games with weak assumptions on
the information available to players. We do not fully specify the information structure of the game but allow instead for all information structures consistent with players knowing their own payoffs. To make this approach tractable, we adopt as a solution concept Bayes correlated equilibrium (BCE). We characterize the sharp identified set under BCE and unrestricted equilibrium selection, and find that in simple games with limited variation in covariates identified sets are informative. In an application, we estimate a model of entry in the Italian supermarket industry and quantify the effect of large malls on local supermarkets. Estimates and predictions differ from those obtained under more restrictive assumptions.
We study a decision-framing design problem: a principal faces an agent with frame-dependent preferences and designs an extensive form with a frame at each stage. This allows the principal to circumvent incentive compatibility constraints by inducing dynamically inconsistent choices of the sophisticated agent. We show that a vector of contracts can be implemented if and only if it can be implemented using a canonical extensive form, which has a simple high–low–high structure using only three stages and the two highest frames, and employs unchosen decoy contracts to deter deviations. We then turn to the study of optimal contracts in the context of the classic monopolistic screening problem and establish the existence of a canonical optimal mechanism, even though our implementability result does not directly apply. In the presence of naive types, the principal can perfectly screen by cognitive type and extract full surplus from naifs.
We study list price competition when firms can individually target consumer discounts (at a cost) afterwards, and we address recent privacy regulation (like the GDPR) allowing consumers to choose whether to opt-in to targeting. Targeted consumers receive poaching and retention discount offers. Equilibrium discount offers are in mixed strategies, but only two firms vie for each contested consumer and final profits on them are Bertrand-like. When targeting is unrestricted, firm list pricing resembles monopoly. For plausible demand conditions and if targeting costs are not too low, firms and consumers are worse off with unrestricted targeting than banning it. However, targeting induces higher (lower) list prices if demand is convex (concave), and either side of the market can benefit if list prices shift enough in its favour. Given the choice, consumers opt in only when expected discounts exceed privacy costs. Under empirically plausible conditions, opt-in choice makes all consumers better off.
How do housing and family shape the savings, spending, and inter-generational transfer behaviour of the elderly? Using the Health and Retirement Study, we document that inter-generational transfers to children are substantially backloaded, that homeowners dis-save much more slowly than renters but often sell their houses when entering a nursing home, and that care by children slows down nursing home entry and is linked to larger bequests, particularly of housing. To rationalise these facts, we develop a dynamic, non-cooperative model of the family with an indivisible housing asset and joint bargaining between elderly parents and their children over the housing and care arrangements of the parents. The model generates realistic savings and care choices and matches the timing of transfers and home liquidations. A key novelty is the housing-as-commitment channel: In the absence of long-run family contracts, housing provides a commitment device for more efficient savings. We find that this channel increases homeownership in old age by one-third and families’ willingness to pay for houses by 5–10%. This mechanism also facilitates informal care, slows down spending, and leads to larger bequests, implications that we support empirically.
We study whether long-term cumulative exposure to airborne small particulate matter (PM2.5) affects the probability that an individual receives a new diagnosis of Alzheimer's disease or related dementias. We track the health, residential location, and PM2.5 exposures of Americans aged sixty-five and above from 2001 through 2013. The expansion of Clean Air Act regulations led to quasi-random variation in individuals’ subsequent exposures to PM2.5. We leverage these regulations to construct instrumental variables for individual-level decadal PM2.5 that we use within flexible probit models that also account for any potential sample selection based on survival. We find that a 1 µg/m3 increase in decadal PM2.5 increases the probability of a new dementia diagnosis by an average of 2.15 percentage points (pp). All else equal, we find larger effects for women, older people, and people with more clinical risk factors for dementia. These effects persist below current regulatory thresholds.
Financial sector wages have increased extraordinarily over the last decades. We address two potential explanations for this increase: (1) rising demand for talent and (2) firms sharing rents with their employees. Matching administrative data of Swedish workers, which include unique measures of individual talent, with financial information on their employers, we find no evidence that talent in finance improved, neither on average nor at the top. The increase in relative finance wages is present across talent and education levels, which together can explain at most 20% of it. In contrast, rising financial sector profits that are shared with employees account for up to half of the relative wage increase. The limited labour supply response may partly be explained by the importance of early-career entry and social connections in finance. Our findings alleviate concerns about “brain drain” into finance but suggest that finance workers have captured rising rents over time.
We use administrative and survey-based micro data to study the relationship between cognitive abilities (IQ), the formation of inflation expectations, and the consumption plans of a representative male population. High-IQ men display 50 |$\%$| lower forecast errors for inflation than other men. High-IQ men, but not others, have consistent inflation expectations and perceptions over time. In terms of choice, only high-IQ men increase their consumption propensity when expecting higher inflation as the consumer Euler equation prescribes. Education levels, income, other expectations, and socio-economic status, although important, do not explain the variation in expectations and choice by IQ. Recent modelling attempts to incorporate boundedly rational agents into macro models do not fully capture all the facts we document. We discuss which dimensions of expectations formation and choice are important for heterogeneous-agents models of household consumption and for the transmission of fiscal and monetary policy.
Agents learn about a changing state using private signals and their neighbours’ past estimates of the state. We present a model in which Bayesian agents in equilibrium use neighbours’ estimates simply by taking weighted sums with time-invariant weights. The dynamics thus parallel those of the tractable DeGroot model of learning in networks, but arise as an equilibrium outcome rather than a behavioural assumption. We examine whether information aggregation is nearly optimal as neighbourhoods grow large. A key condition for this is signal diversity: each individual’s neighbours have private signals that not only contain independent information, but also have sufficiently different distributions. Without signal diversity—e.g. if private signals are i.i.d.—learning is suboptimal in all networks and highly inefficient in some. Turning to social influence, we find it is much more sensitive to one’s signal quality than to one’s number of neighbours, in contrast to standard models with exogenous updating rules.
We obtain optimal dynamic contests for environments where the designer monitors effort through coarse, binary signals—Poisson successes—and aims to elicit maximum effort, ideally in the least amount of time possible, given a fixed prize. The designer has a vast set of contests to choose from, featuring termination and prize-allocation rules together with real-time feedback for the contestants. Every effort-maximizing contest (which also maximizes total expected successes) has a history-dependent termination rule, a feedback policy that keeps agents fully apprised of their own success, and a prize-allocation rule that grants them, in expectation, a time-invariant share of the prize if they succeed. Any contest that achieves this effort in the shortest possible time must in addition be what we call second chance: once a pre-specified number of successes arrive, the contest enters a countdown phase where contestants are given one last chance to succeed.
We find strong empirical evidence that the liquidity yield on government bonds in combination with standard economic fundamentals can well account for nominal exchange rate movements. We find impressive evidence that changes in the liquidity yield are significant in explaining exchange rate changes for all the G10 countries, and we stress that the US dollar is not special in this relationship. We show how these relationships arise out of a canonical two-country New Keynesian model with liquidity returns. Additionally, we find a role for sovereign default risk and currency swap market frictions.
I study unemployment insurance (UI) in general equilibrium with incomplete markets, search frictions, and nominal rigidities. An increase in generosity raises the aggregate demand for consumption if the unemployed have a higher marginal propensity to consume than the employed or if agents precautionary save in light of future income risk. This raises output and employment unless monetary policy raises the nominal interest rate. In an analysis of the U.S. economy over 2008–2014, UI benefit extensions had a contemporaneous output multiplier around 1. The unemployment rate would have been as much as 0.4 pp higher absent these extensions.
We assess the welfare consequences of occupational licensing for workers and consumers. We estimate a model of labour market equilibrium in which licensing restricts labour supply but also affects labour demand via worker quality and selection. On the margin of occupations licensed differently between U.S. states, we find that licensing raises wages and hours but reduces employment. We estimate an average welfare loss of 12% of occupational surplus. Workers and consumers respectively bear 70% and 30% of the incidence. Higher willingness to pay offsets 80% of higher prices for consumers, and higher wages compensate workers for 60% of the cost of mandated investment in occupation-specific human capital. Welfare effects appear more favourable in occupations in which licensing is more common.
We study robust mechanism design in environments in which agents commonly believe that others’ types are identically distributed, but we do not assume that the actual distribution is common knowledge, nor that it is known to the designer. First, we characterize all incentive compatible transfers under these assumptions. Second, we characterize the conditions under which full implementation is possible via direct mechanisms, that only elicit payoff relevant information, and the transfer schemes which achieve it whenever possible. The full implementation results obtain from showing that the problem can be transformed into one of designing a network of strategic externalities, subject to suitable constraints which are dictated by the incentive compatibility requirements.
This paper proposes tools for robust inference in difference-in-differences and event-study designs where the parallel trends assumption may be violated. Instead of requiring that parallel trends holds exactly, we impose restrictions on how different the post-treatment violations of parallel trends can be from the pre-treatment differences in trends (“pre-trends”). The causal parameter of interest is partially identified under these restrictions. We introduce two approaches that guarantee uniformly valid inference under the imposed restrictions, and we derive novel results showing that they have desirable power properties in our context. We illustrate how economic knowledge can inform the restrictions on the possible violations of parallel trends in two economic applications. We also highlight how our approach can be used to conduct sensitivity analyses showing what causal conclusions can be drawn under various restrictions on the possible violations of the parallel trends assumption.
Under the production approach to markup estimation, any flexible input should recover the markup. I test this implication using manufacturing datasets from Chile, Colombia, India, Indonesia, the U.S., and Southern Europe, as well as store-level data from a major U.S. retailer, and overwhelmingly reject that markups estimated using labour and materials have the same distribution. For every dataset, markups estimated using labour are negatively correlated with markups estimated using materials, exhibit greater dispersion, and have opposite time trends. I continue to find stark differences in markups estimated using energy and non-energy raw materials. Non-neutral productivity differences across firms can explain these findings.
Firms arguably price at ninety-nine-ending prices because of left-digit bias—the tendency of consumers to perceive a $4.99 as much lower than a $5.00. Analysis of retail scanner data on 3500 products sold by twenty-five U.S. chains provides robust support for this explanation. I structurally estimate the magnitude of left-digit bias and find that consumers respond to a one-cent increase from a ninety-nine-ending price as if it were more than a twenty-cent increase. Next, I solve a portable model of optimal pricing given left-digit biased demand. I use this model and other pricing procedures to estimate the level of left-digit bias retailers perceive when making their pricing decisions. While all retailers respond to left-digit bias by using ninety-nine-ending prices, their behaviour is consistently at odds with the demand they face. Firms price as if the bias were much smaller than it is, and their pricing is more consistent with heuristics and rule-of-thumb than with optimization given the structure of demand. I calculate that retailers forgo 1–4% of potential gross profits due to this coarse response to left-digit bias.
This paper proposes an adaptive randomisation procedure for two-stage randomised controlled trials. The method uses data from a first-wave experiment in order to determine how to stratify in a second wave of the experiment, where the objective is to minimise the variance of an estimator for the average treatment effect. We consider selection from a class of stratified randomisation procedures which we call stratification trees: these are procedures whose strata can be represented as decision trees, with differing treatment assignment probabilities across strata. By using the first wave to estimate a stratification tree, we simultaneously select which covariates to use for stratification, how to stratify over these covariates, and the assignment probabilities within these strata. Our main result shows that using this randomisation procedure with an appropriate estimator results in an asymptotic variance which is minimal in the class of stratification trees. Moreover, our results are able to accommodate a large class of assignment mechanisms within strata, including stratified block randomisation. In a simulation study, we find that our method, paired with an appropriate cross-validation procedure, can improve on ad-hoc choices of stratification. We conclude by applying our method to the study in Karlan and Wood (2017, Journal of Behavioral and Experimental Economics, vol. 66, 1–8), where we estimate stratification trees using the first wave of their experiment.
Growth has fallen in the U.S. amid a rise in firm concentration. Market share has shifted to low labour share firms, while within-firm labour shares have actually risen. We propose a theory linking these trends in which the driving force is falling overhead costs of spanning multiple products or a rising efficiency advantage of large firms. In response, the most efficient firms (with higher markups) spread into new product lines, thereby increasing concentration and generating a temporary burst of growth. Eventually, due to greater competition from efficient firms, within-firm markups and incentives to innovate fall. Thus our simple model can generate qualitative patterns in line with the observed trends.
We provide a novel explanation for the empirical failure of the capital asset pricing model (CAPM) despite its widespread practical use. In a rational-expectations economy in which information is dispersed, variation in expected returns over time and across investors creates an informational gap between investors and the empiricist. The CAPM holds for investors, but the securities market line appears flat to the empiricist. Variation in expected returns across investors accounts for the larger part of this distortion, which is empirically substantial; it offers a new interpretation of why “betting against beta” (BAB) works: BAB really bets on true beta. The empiricist retrieves a stronger CAPM on days when public information reduces disagreement among investors.
We show that moment inequalities in a wide variety of economic applications have a particular linear conditional structure. We use this structure to construct uniformly valid confidence sets that remain computationally tractable even in settings with nuisance parameters. We first introduce least-favorable critical values which deliver non-conservative tests if all moments are binding. Next, we introduce a novel conditional inference approach which ensures a strong form of insensitivity to slack moments. Our recommended approach is a hybrid technique which combines desirable aspects of the least favorable and conditional methods. The hybrid approach performs well in simulations calibrated to Wollmann (2018, American Economic Review, 108, 1364–1406), with favorable power and computational time comparisons relative to existing alternatives.
We assess the impact of a rapid rise in Japanese import competition on the growth in racial earnings and employment gaps during the 1970s and 80s. Using commuting zone level variation in exposure, we find Japanese competition led to a decrease in manufacturing employment and labour force participation for blacks. This was driven by a shift in demand for skill in manufacturing. The difference in effects between the 10th percentile most and least exposed commuting zone was equivalent to 36–46% of the relative rise in black non-labour force participation, and 78–96% of the relative decline in black median male earnings.
Safe asset shortages can expose an economy to liquidity traps. The nature of these traps is determined by the cyclicality of the bond premium. A counter-cyclical bond premium opens the possibility of expectations-driven liquidity traps in which small issuances of government debt crowd out private debt and reduce output. In contrast, when the bond premium is pro-cyclical and the economy is in a liquidity trap, government debt is expansionary. In the data, we find evidence of a counter-cyclical bond premium. Large interventions can prevent the emergence of self-fulfilling traps, but they require sufficient fiscal capacity. In a quantitative model calibrated to the Great Recession, a promise to increase the government debt-to-GDP ratio by 20 percentage points precludes the possibility of self-fulfilling traps.
We combine matched employer–employee data with firms’ financial records to study a 2001 Italian reform that lifted constraints on the employment of temporary contract workers while maintaining rigid employment protection regulations for employees hired under permanent contracts. Exploiting the staggered implementation of the reform across different collective bargaining agreements, we find that this policy change led to an increase in the share of temporary contracts but failed to raise employment. The reform had both winners and losers. Firms are the main winners as the reform was successful in decreasing labor costs, leading to higher profits. By contrast, young workers are the main losers since their earnings were substantially depressed following the policy change. Rent-sharing estimates show that temporary workers receive only two-thirds of the rents shared by firms with permanent workers, helping explain most of the labor costs and earnings reductions caused by the reform.
This paper documents an externality from the agricultural use of the most widely applied herbicide in the world—glyphosate—on birth outcomes of surrounding populations. We focus on the subclinical effects of water contamination in areas distant from the original locations of application. Our identification relies on: (i) the regulation allowing the introduction of genetically modified seeds in Brazil; (ii) the potential gain in municipality-level productivity from adoption of genetically modified soybean seeds and the strong complementary between these seeds and glyphosate; and (iii) the direction of water flow within water basins. We document a significant deterioration in birth outcomes for populations downstream from locations that are likely to have increased relatively more the use of glyphosate. According to our preferred specification, the average increase in glyphosate use in the sample during 2000–10 period led to an increase of 5% of the average in infant mortality rate.
We use regional variation in the American Recovery and Reinvestment Act (2009–12) to analyse the effect of government spending on consumer spending. Our consumption data come from household-level retail purchases in the Nielsen scanner data and auto purchases from Equifax credit balances. We estimate that a $1 increase in county-level government spending increases local non-durable consumer spending by $0.29 and local auto spending by $0.09. We translate the regional consumption responses to an aggregate fiscal multiplier using a multi-region, new Keynesian model with heterogeneous agents, incomplete markets, and trade linkages. Our model is consistent with the estimated positive local multiplier, a result that distinguishes our incomplete markets model from models with complete markets. At the zero lower bound, the aggregate consumption multiplier is twice as large as the local multiplier because trade linkages propagate the effect of government spending across regions.
This paper studies a competitive model of insurance markets in which consumers are privately informed about their risk and risk preferences. We provide a characterization of the equilibria, which depend non-trivially on consumers’ type distribution, a desirable feature for policy analysis. The use of consumer characteristics for risk classification is modeled as the disclosure of a public informative signal. A novel property of signals, monotonicity, is shown to be necessary and sufficient for their release to be welfare improving for almost all consumer types. We also study the effect of changes to the risk distribution in the population as the result of demographic changes or policy interventions. We show that an increase in the risk distribution, according to the monotone likelihood ratio ordering of distribution, leads to lower utility for almost all consumer types. In contrast, the effect is ambiguous when considering the first-order stochastic dominance ordering.
We link survey data on Danish people’s perceived income positions and fairness views on inequality within various reference groups to administrative records on their reference groups, income histories, and life events. People are, on average, well-informed about the income levels of their reference groups. Yet, lower-ranked respondents in all groups tend to overestimate their own position among others because they believe others’ incomes are lower than they actually are, whereas the opposite holds true for higher-ranked respondents. Misperceptions of positions in reference groups relate to proximity to other individuals, transparency norms, and visible signals of income. People view inequalities within their co-workers and education groups as significantly more unfair than overall inequality, yet underestimate inequality the most exactly within these groups. Views on the fairness of inequalities are strongly correlated with an individual’s current position, move with shocks like unemployment or promotions, and change when experimentally informing people about their actual positions. However, the higher perceived unfairness of income differences within co-workers and education groups stays unchanged. The theoretical framework shows that this can have important implications for redistribution policy.
We study the effects of central bank balance sheet policies—namely, quantitative easing and foreign exchange interventions—in a model where people form expectations through an iterative level-k thinking process. We emphasize two main theoretical results. First, under a broad set of conditions, central bank interventions are effective under level-k thinking, while they are neutral in the rational expectations equilibrium. Second, when preferences exhibit constant relative risk aversion, asset purchases increase aggregate output if they target assets with pro-cyclical returns but reduce it if asset returns are counter-cyclical. Finally, we empirically show that forecast errors about future asset prices are predictable by balance sheet interventions, a property that differentiates our channel from popular alternatives, such as portfolio-balance and signaling channels.
We study the potential for asset collateralization to expand access to credit in rural Kenya. Increasing the share of a loan for a durable agricultural asset that is collateralized by the physical asset itself (from 0 to 96%) while reducing the share backed by financial assets increases loan take-up considerably, with only a very limited impact on repayment behavior and the lender's profitability. A Karlan–Zinman test finds evidence of small and marginally significant selection effects in some specifications but no evidence of moral hazard. We find no evidence that joint versus individual liability affects take-up or repayment. Loans had real impacts on investment, milk sales, and girls’ school enrollment. The lender, a savings and credit cooperative, responded to the study results by offering 80% asset-collateralized loans.
Left-digit bias (or 99-cent pricing) has been discussed extensively in economics, psychology, and marketing. Despite this, we show that the rideshare company, Lyft, was not using a 99-cent pricing strategy prior to our study. Based on observational data from over 600 million Lyft sessions followed by a field experiment conducted with 21 million Lyft passengers, we provide evidence of large discontinuities in demand at dollar values. Approximately half of the downward slope of the demand curve occurs discontinuously as the price of a ride drops below a dollar value (e.g. $14.00 to $13.99). If our short-run estimates persist in the longer run, we calculate that Lyft could increase its profits by roughly $160M per year by employing a left-digit bias pricing strategy. Our results showcase the robustness of an important behavioral bias for a large, modern company and its persistence in a highly competitive market.
I study how geography shaped city formation and aggregate development in the U.S. prior to the Civil War. To guide my analysis, I present a conjecture that cities’ farm hinterlands fostered both city development and aggregate growth: the hinterland hypothesis. The hinterland hypothesis has rich implications on how various elements of U.S. geography—railroads, changes in U.S. political borders, and international trade—affected city formation and U.S. growth. To evaluate the hinterland hypothesis and its implications, I assemble a novel historical dataset on population, trading routes, and agricultural productivity at a high spatial resolution. I combine the data with a dynamic quantitative model of economic geography that yields the hinterland hypothesis as a prediction. I find evidence for the hinterland hypothesis by showing that the model can replicate the key patterns of U.S. urbanization and city formation. Finally, I conduct a series of counterfactuals in the model to quantify the effect of geography on cities and growth, guided by the implications of the hinterland hypothesis. Results indicate that railroads were responsible for 1.8% of urban population in 1860 and for 25% of real GDP growth between 1830 and 1860. The effect of international trade was similar in magnitude, while the effect of political border changes was small during the period.
Borrowers obtain liquidity by issuing securities backed by the current period payoff and resale price of a long-lived collateral asset, and they are privately informed about the payoff distribution. Asset price can be self-fulfilling: a higher asset price lowers adverse selection and allows borrowers to raise greater funding, which makes the asset more valuable, leading to multiple equilibria. Optimal security design eliminates multiple equilibria, improves welfare, and can be implemented as a repo contract. Persistent adverse selection lowers debt funding, generates volatility in asset prices, and exacerbates credit crunches. The theory demonstrates the role of asset-backed securities on stability of market-based financial systems.
Multiproduct firms constitute a considerable share of firms and account for an even greater share of production. Nevertheless, the vast majority of production function estimates are based on the assumption that firms are single-product manufacturers. This assumption is due to a lack of data on how firms allocate their inputs across their various product lines. I provide a strategy for estimating product-specific input allocations and production functions of multiproduct firms involved in monopolistic competition. The strategy is based on using firms’ product prices and output demand in solving for product-level input allocations.
Fears of immigrants as a threat to public health have a long and sordid history. At the turn of the 20th century, when immigrants made up one-third of the population in crowded American cities, contemporaries blamed high urban mortality rates on the newest arrivals. We evaluate how the implementation of country-specific immigration quotas in the 1920s affected urban health. Cities with larger quota-induced reductions in immigration experienced a persistent decline in mortality rates, driven by a reduction in deaths from infectious diseases. The unfavourable living conditions immigrants endured explains the majority of the effect as quotas reduced residential crowding and mortality declines were largest in cities where immigrants resided in more crowded conditions and where public health resources were stretched thinnest.
This paper is concerned with possible model misspecification in moment inequality models. Two issues are addressed. First, standard tests and confidence sets for the true parameter in the moment inequality literature are not robust to model misspecification in the sense that they exhibit spurious precision when the identified set is empty. This paper introduces tests and confidence sets that provide correct asymptotic inference for a pseudo-true parameter in such scenarios, and hence, do not suffer from spurious precision. Second, specification tests have relatively low power against a range of misspecified models. Thus, failure to reject the null of correct specification does not necessarily provide evidence of correct specification. That is, model specification tests are subject to the problem that absence of evidence is not evidence of absence. This paper develops new diagnostics for model misspecification in moment inequality models that do not suffer from this problem.
We study how cross-country macroeconomic spillovers caused by sovereign default affect equilibrium bailouts. Because of portfolio diversification, the default of one country causes a macroeconomic contraction in other countries, which motivates a bailout. But why do creditor countries choose to bailout debtor countries instead of their own private sector? We show that this is because an external bailout could be cheaper than a domestic bailout. We also show that although anticipated bailouts lead to higher borrowing, they can be Pareto improving not only ex post (after a country has defaulted) but also ex ante (before the country chooses its debt).
A large psychology literature argues that, due to selective memory recall, decision-makers’ forecasts of the future are overly influenced by the perceived news. We adopt the diagnostic expectations (DE) paradigm [Bordalo et al. (2018), Journal of Finance, 73, 199–227] to capture this feature of belief formation, develop a method to incorporate DE in business cycle models, and study the implications for aggregate dynamics. First, we address (1) the theoretical challenges associated with modelling the feedback between optimal actions and agents’ DE beliefs and (2) the time-inconsistencies that arise under distant memory (i.e. when news is perceived with respect to a more distant past than just the immediate one). Second, we show that under distant memory the interaction between actions and DE beliefs naturally generates repeated boom–bust cycles in response to a single initial shock. We also propose a portable solution method to study DE in dynamic stochastic general equilibrium models and use it to estimate a quantitative DE New Keynesian model. Both endogenous states and distant memory play a critical role in successfully replicating the boom–bust cycle observed in response to a monetary policy shock.
We design a laboratory experiment to study bargaining behaviour when negotiations involve multiple issues. Parties must discover both trading prices and agreement scopes, giving rise to unexplored information structures and bargaining strategies. We find that bargainers often trade the efficient set of issues despite lacking information about individual aspects. However, beneficial agreements critically hinge on integrated negotiations that allow deals on bundles of issues. Moreover, access to more information boosts agreement rates in small-surplus negotiations but can also backfire as it triggers increased risk-taking and conflicting fairness preferences in large-surplus negotiations. Finally, successful negotiations display a specific bargaining convention that emerges endogenously. It involves alternating offers that meet the other side’s most recent demand halfway.
I develop a directed technical change model of economic growth and energy efficiency in order to study the impact of climate change mitigation policies on energy use. I show that the standard Cobb–Douglas production function used in the environmental macroeconomics literature overstates the reduction in cumulative energy use that can be achieved with a given path of energy taxes. I also show that, in the model, the government combines energy taxes with research and development (R&D) policy that favors output-increasing technology—rather than energy efficiency technology—to maximize welfare subject to a constraint on cumulative energy use. In addition, I study energy use dynamics following sudden improvements in energy efficiency. Exogenous shocks that increase energy efficiency also decrease the incentive for subsequent energy efficiency R&D and increase long-run energy use relative to a world without the original shock. Subsidies for energy efficiency R&D, however, permanently alter R&D incentives and decrease long-run energy use.
This paper examines whether monetary policy pass-through to mortgage interest rates affects household fertility decisions. Our empirical strategy exploits variation in households’ eligibility for a rate adjustment, coupled with the large reductions in the monetary policy rate that occurred during the Great Recession in the U.K. and U.S. We estimate that each one percentage point drop in the policy rate increased birth rates amongst households eligible for a rate adjustment by 3%. Our results provide new evidence on the nature of monetary policy transmission to households and suggest a new mechanism via which mortgage contract structures can affect both aggregate demand and supply.
What determines the distribution of establishments in terms of size and life-cycle growth? How are those determinants related to aggregate productivity? We provide novel answers by developing a framework that uses price and quantity information on establishments’ outputs and inputs to jointly estimate the demand and production parameters, and subsequently, establishments’ quality-adjusted productivity, deriving both micro-level and aggregate implications. We find that the dominant source of variation in establishment size is variation in quality/product appeal but that variation in technical efficiency plays an important supporting role. Multiple factors dampen dispersion in establishment size including dispersion in input (quality-adjusted) prices, markups, and residual wedges. Relatively moderate dampening factors induce large aggregate allocative efficiency losses relative to their absence. We show that joint estimation of the parameters of the demand and production function crucially affects inferences on the determinants of the size distribution of firms and their implications for aggregate productivity.
Private efficiency of wage rigidity has taken centre stage in economics. Measuring its effects has proven elusive for lack of actual wage data. Using a unique confidential labour contract-level dataset matched with firm-level high-frequency asset prices, we find robust evidence that firms’ stock prices and employment fluctuate more in response to monetary policy announcements, the higher the degree of wage rigidity. Hand-collected information on the periods across renegotiations of collective bargaining agreements allow us to construct an accurate and predetermined measure of wage rigidity. We find that the amplification induced by wage rigidity is stronger for firms with high labour intensity, low profitability, and a large share of workers with more rigid contracts.
We study a model of the rise and fall of illiberal democracies. Voters value both liberty and economic security. In times of crisis, voters may prefer to elect an illiberal government that, by violating constitutional constraints, offers greater economic security but less liberty. However, violating these constraints allows the government to manipulate information, in turn reducing electoral accountability. We show how elements of liberal constitutions induce voters to elect illiberal governments that remain in power for inefficiently long—including forever. We derive insights into what makes constitutions stable against the rise of illiberal governments. We extend the model to allow for illiberal governments to overcome checks and balances and become autocracies. We show that stronger checks and balances are a double-edged sword: they slow down autocratization but may make it more likely. We discuss the empirical relevance of our theoretical framework and its connection to real world examples.
In markets for indivisible resources such as workers and objects, subsidy and taxation for an agent may depend on the set of acquired resources and prices. This paper investigates how such transfer policies interfere with the substitutes condition, which is critical for market equilibrium existence and auction mechanism performance among other important issues. For environments where the condition holds in the absence of policy intervention, we investigate which transfer policies preserve the substitutes condition in various economically meaningful settings, establishing a series of characterisation theorems. For environments where the condition may fail without policy intervention, we examine how to use transfer policies to re-establish it, finding exactly when transfer policies based on scales are effective for that purpose. These results serve to inform policymakers, market designers, and market participants of how transfer policies may impact markets, so more informed decisions can be made.
This paper studies commodity taxation in a model featuring heterogeneous consumers, imperfect competition, and tax salience. We derive new formulas for the incidence and marginal excess burden of commodity taxation highlighting interactions between tax salience and market structure. We estimate the necessary inputs to the formulas by using Nielsen Retail Scanner and Consumer Panel data covering grocery stores and households in the U.S. and detailed sales tax data. We estimate a large amount of pass-through of taxes onto consumer prices and find that households respond more to changes in prices than taxes. We also estimate significant heterogeneity in tax salience across households. We calibrate our new formulas using these results and conclude that essentially all of the incidence of sales taxes falls on consumers, and the marginal excess burden of taxation is larger than estimates based on standard formulas that ignore imperfect competition and tax salience.
This paper incorporates diagnostic expectations into a general equilibrium macroeconomic model with a financial intermediary sector. Diagnostic expectations are a forward-looking model of extrapolative expectations that overreact to recent news. Frictions in financial intermediation produce non-linear spikes in risk premia and slumps in investment during periods of financial distress. The interaction of sentiment with financial frictions generates a short-run amplification effect followed by a long-run reversal effect, termed the feedback from behavioural frictions to financial frictions. The model features sentiment-driven financial crises characterized by low pre-crisis risk premia and neglected risk. The conflicting short-run and long-run effect of sentiment produces boom–bust investment cycles. The model also identifies a stabilizing role for diagnostic expectations. Under the baseline calibration, financial crises are less likely to occur when expectations are diagnostic than when they are rational.
It is often desired to rank different populations according to the value of some feature of each population. For example, it may be desired to rank neighbourhoods according to some measure of intergenerational mobility or countries according to some measure of academic achievement. These rankings are invariably computed using estimates rather than the true values of these features. As a result, there may be considerable uncertainty concerning the rank of each population. In this paper, we consider the problem of accounting for such uncertainty by constructing confidence sets for the rank of each population. We consider both the problem of constructing marginal confidence sets for the rank of a particular population as well as simultaneous confidence sets for the ranks of all populations. We show how to construct such confidence sets under weak assumptions. An important feature of all of our constructions is that they remain computationally feasible even when the number of populations is very large. We apply our theoretical results to re-examine the rankings of both neighbourhoods in the U.S. in terms of intergenerational mobility and developed countries in terms of academic achievement. The conclusions about which countries do best and worst at reading, math, and science are fairly robust to accounting for uncertainty. The confidence sets for the ranking of the fifty most populous commuting zones by measures of mobility are also found to be small. These confidence sets, however, become much less informative if one includes all commuting zones, if one considers neighbourhoods at a more granular level (counties, census tracts), or if one uses movers across areas to address concerns about selection.
Using exhaustive administrative data on Italian social security records, we construct measures of local labour market thickness for executives that vary by industry and location. We show that firm performance is strongly and persistently affected by executive death, but only in thin local labour markets. The new executives hired after death events in thin local labour markets have lower education levels and are more likely to be replaced. These predictions are consistent with a simple model of executive search in which market thickness determines the arrival rate of applications for executive positions.
This paper revisits the link between electrification and the rise in female labour force participation (LFP), and presents theoretical and empirical evidence showing that electrification triggered a rise in female LFP by increasing market opportunities for skilled women. I formalize my theory in an overlapping generations model and find that my mechanism explains one quarter of the rise in female LFP during the rollout of electricity in the U.S. (1880–1940), and matches the slow decline in female home production hours during this period. I then present micro-evidence supporting my theory using newly digitized data on the early electrification of the U.S.
Rich behavioural biases, mistakes, and limits on rational decision-making are often thought to make equilibrium analysis much more intractable. We establish that this is not the case in the context of one-sector growth models such as Ramsey–Cass–Koopmans or Bewley–Aiyagari models. We break down the response of the economy to a change in the environment or policy into two parts: the direct response at the given (pre-tax) prices, and the equilibrium response which plays out as prices change. Our main result demonstrates that under weak regularity conditions, regardless of the details of behavioural preferences, mistakes and constraints on decision-making, the long-run equilibrium will involve a greater capital-labour ratio if and only if the direct response (from the corresponding consumption-saving model) involves an increase in aggregate savings. One implication of this result is that, from a qualitative point of view, behavioural biases matter for long-run equilibrium if and only if they change the direction of the direct response. We provide detailed illustrations of how this result can be applied and generate new insights using models of misperceptions, self-control and temptation, and naive and sophisticated quasi-hyperbolic discounting.
We develop a model of inter-temporal and intra-temporal price discrimination by monopoly airlines to study the ability of different discriminatory pricing mechanisms to increase efficiency and the associated distributional implications. To estimate the model, we use unique data from international airline markets with flight-level variation in prices across time, cabins, and markets and information on passengers’ reasons for travel and time of purchase. The current pricing practice yields approximately 77% of the first-best welfare. The source of this inefficiency arises primarily from private information about passenger valuations, not dynamic uncertainty about demand. We also find that if airlines could discriminate between business and leisure passengers, total welfare would improve at the expense of business passenger surplus. Also, replacing the current pricing that involves screening passengers across cabin classes with offering a single cabin class has minimal effect on total welfare.
We study the problem of a seller (e.g. a bank) who is privately informed about the quality of her asset and wants to exploit gains from trade with uninformed buyers (e.g. investors) by issuing securities backed by her asset cash flows. In our setting, buyers post menus of contracts to screen the seller, but the seller cannot commit to trade with only one buyer, i.e. markets are non-exclusive. We show that non-exclusive markets behave very differently from exclusive ones: (1) separating contracts are never part of equilibrium; (2) mispricing of claims faced by the seller is always greater than in exclusive markets; (3) there is always a semi-pooling equilibrium where all sellers issue the same debt contract priced at average-valuation, and sellers of low-quality assets issue remaining cash flows at low-valuation; (4) market liquidity can be higher or lower than in exclusive markets, but (5) the average quality of originated assets is always lower. Our model’s predictions are consistent with empirical evidence on the issuance and pricing of mortgage-backed securities, and we use the theory to evaluate recent reforms aimed at enhancing transparency and exclusivity in markets.
Uncertainty rises in recessions and falls in booms. But what is the causal relationship? We construct cross-country panel data on stock market returns to proxy for first- and second-moment shocks and instrument these with natural disasters, terrorist attacks, and political shocks. Our IV regression results reveal a robust negative short-term impact of second moments (uncertainty) on growth. Employing multiple vector autoregression estimation approaches, relying on a range of identifying assumptions, also reveals a negative impact of uncertainty on growth. Finally, we show that these results are reproducible in a conventional micro–macro business cycle model with time-varying uncertainty.
Many real-life settings of individual choice involve social interactions, causing targeted policies to have spillover effects. This article develops novel empirical tools for analysing demand and welfare effects of policy interventions in binary choice settings with social interactions. Examples include subsidies for health-product adoption and vouchers for attending a high-achieving school. We show that even with fully parametric specifications and unique equilibrium, choice data, that are sufficient for counterfactual demand prediction under interactions, are insufficient for welfare calculations. This is because distinct underlying mechanisms producing the same interaction coefficient can imply different welfare effects and deadweight-loss from a policy intervention. Standard index restrictions imply distribution-free bounds on welfare. We propose ways to identify and consistently estimate the structural parameters and welfare bounds allowing for unobserved group effects that are potentially correlated with observables and are possibly unbounded. We illustrate our results using experimental data on mosquito-net adoption in rural Kenya.
With “2020 hindsight,” the 2000s housing cycle is not a boom–bust but a boom–bust–rebound. Using a spatial equilibrium regression in which house prices are determined by income, amenities, urbanization, and supply, we show that long-run city-level fundamentals predict not only 1997–2019 price and rent growth but also the amplitude of the boom–bust–rebound. This evidence motivates our model of a cycle rooted in fundamentals. Households learn about fundamentals by observing “dividends” but become over-optimistic in the boom due to diagnostic expectations. A bust ensues when beliefs start to correct, exacerbated by a price–foreclosure spiral that drives prices below their long-run level. The rebound follows as prices converge to a path commensurate with higher fundamental growth. The estimated model explains the boom–bust–rebound with a single shock and accounts quantitatively for the dynamics of prices, rents, and foreclosures in cities with the largest cycles. We draw implications for asset cycles more generally.
We develop a dynamic macroeconomic model with heterogeneous financial intermediaries and endogenous entry. Time-varying endogenous macroeconomic risk arises from the risk-shifting behaviour of the cross-section of financial intermediaries. When interest rates are high, a decrease in interest rates stimulates investment and decreases aggregate risk. In contrast, when they are low, further stimulus can increase financial instability while inducing a fall in the risk premium. In this case, there is a trade-off between stimulating the economy and financial stability. This provides a model of the risk-taking channel of monetary policy.
We explore the impact of rising incomes at the top of the distribution on spatial sorting patterns within large U.S. cities. We develop and quantify a spatial model of a city with heterogeneous agents and non-homothetic preferences for neighbourhoods with endogenous amenity quality. As the rich get richer, demand increases for the high-quality amenities available in downtown neighbourhoods. Rising demand drives up house prices and spurs the development of higher quality neighbourhoods downtown. This gentrification of downtowns makes poor incumbents worse off, as they are either displaced to the suburbs or pay higher rents for amenities that they do not value as much. We quantify the corresponding impact on well-being inequality. Through the lens of the quantified model, the change in the income distribution between 1990 and 2014 led to neighbourhood change and spatial resorting within urban areas that increased the welfare of richer households relative to that of poorer households, above and beyond rising nominal income inequality.
Global warming is a worldwide and protracted phenomenon with heterogeneous local economic effects. We propose a dynamic economic assessment model of the world economy with high spatial resolution to assess its consequences. Our model features several forms of adaptation to local temperature changes, including costly trade and migration, local technological innovations, and local natality rates. We quantify the model at a 1∘×1∘ resolution and estimate damage functions that determine the impact of temperature changes on a region’s fundamental productivity and amenities conditional on local temperatures. Welfare losses from global warming are very heterogeneous across locations, with 20% losses in parts of Africa and Latin America but also gains in some northern latitudes. Overall, spatial inequality increases. Uncertainty about average welfare effects is significant but much smaller for relative losses across space. Migration and innovation are shown to be important adaptation mechanisms. We use the model to study the impact of carbon taxes, abatement technologies, and clean energy subsidies. Carbon taxes delay consumption of fossil fuels and help flatten the temperature curve but are much more effective when an abatement technology is forthcoming.
This paper studies the optimal design of a macro-prudential instrument, a loan-to-value (LTV) limit, and its implications for monetary policy in a model with nominal rigidities and financial frictions. The analysis accounts for both an effective lower bound on the nominal interest rate and an upper bound on the ability of LTV limits to stimulate credit demand. The welfare-based loss function features a role for macro-prudential policy to enhance risk-sharing. Optimal LTV limits are strongly countercyclical. In a house price boom-bust episode, the active use of LTV limits alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap.
We study the effect of exposure to immigrants on the educational outcomes of U.S.-born students, using a unique dataset combining population-level birth and school records from Florida. This research question is complicated by the substantial school selection of U.S.-born students, especially among White and comparatively affluent students, in response to the presence of immigrant students in the school. We propose a new identification strategy, comparing sibling outcomes with the inclusion of family fixed effects, to partial out the unobserved non-random selection of native-born families into schools. We find that the presence of immigrant students has a positive effect on the academic achievement of U.S.-born students, especially for students from disadvantaged backgrounds. Moreover, the presence of immigrants does not negatively affect the performance of affluent U.S.-born students, who typically show a higher academic achievement compared to immigrant students. We provide suggestive evidence on potential channels.
Many e-commerce platforms use buyers’ personal data to intermediate their transactions with sellers. How much value do such intermediaries derive from the data record of each single individual? We characterize this value and find that one of its key components is a novel externality between records, which arises when the intermediary pools some records to withhold the information they contain. Our analysis has several implications about compensating individuals for the use of their data, guiding companies’ investments in data acquisition, and more broadly studying the demand side of data markets. Our methods combine modern information design with classic duality theory and apply to a large class of principal-agent problems.
We show that mortgage recourse systems, by discouraging default, magnify the impact of nominal rigidities. They cause deeper and more persistent recessions. This mechanism can account for up to 31% of the recovery gap during the Great Recession between the U.S., mostly a non-recourse economy, and Spain, a recourse economy. General equilibrium effects explain most of the differences between mortgage systems. With recourse, highly indebted homeowners dramatically cut consumption in a crisis, and account for a larger share of the aggregate consumption decline. However, without recourse, mortgages would be more expensive for riskier households, and homeownership rates would be lower.
Reclassification risk is a major concern in health insurance where contracts are typically 1 year in length but health shocks often persist for much longer. While most health systems with private insurers pair short-run contracts with substantial pricing regulations to reduce reclassification risk, long-term contracts with one-sided insurer commitment have significant potential to reduce reclassification risk without the negative side effects of price regulation, such as adverse selection. We theoretically characterize optimal long-term insurance contracts with one-sided commitment, extending the literature in directions necessary for studying health insurance markets. We leverage this characterization to provide a simple algorithm for computing optimal contracts from primitives. We estimate key market fundamentals using data on all under-65 privately insured consumers in Utah. We find that dynamic contracts are very effective at reducing reclassification risk for consumers who arrive at the market in good health, but they are ineffective for consumers who come to the market in bad health, demonstrating that there is a role for the government insurance of pre-market health risks. Individuals with steeply rising income profiles find front-loading costly, and thus relatively prefer ACA-type exchanges. Switching costs enhance, while myopia moderately compromises, the performance of dynamic contracts.
I study, both empirically and theoretically, the economic and financial consequences of corporate lobbying. Firms lobby politicians to increase their share of government contracts, but political competition creates firm-level risk, inflating their cost of capital and reducing their incentive to invest in research and development (R&D). I document an annual 6–8% return premium for stocks of high-lobbying firms, which compensates investors for political risk. An estimated model in which firms can lobby and innovate and investors are risk averse replicates key features of corporate lobbying in the U.S., including the well-established paradox that lobbying contributions are small relative to the policies at stake. The model predicts that if investors ceased seeking compensation for political risk, R&D investment would increase by 6% and the innovation rate by 0.4% points. The risk-premium costs of lobbying are quantitatively and economically important even if the resources “wasted” on lobbying are objectively small.
This paper studies a general model of matching with constraints. Observing that a stable matching typically does not exist, we focus on feasible, individually rational, and fair matchings. We characterize such matchings by fixed points of a certain function. Building on this result, we characterize the class of constraints on individual schools under which there exists a student-optimal fair matching, the matching that is the most preferred by every student among those satisfying the three desirable properties. We study the numerical relevance of our theory using data on government-organized daycare allocation.
The FDIC resolves insolvent banks with scoring auctions. Although the structure of the scoring rule is known to bidders, they are uncertain about how the FDIC trades off different bid components. Scoring-rule uncertainty motivates bidders to submit multiple bids for the same failed bank. To evaluate the effects of uncertainty and multiple bidding for FDIC costs, we develop a methodology for analysing multidimensional bidding when the auctioneer’s scoring weights are unknown to bidders. We estimate private valuations for failed-bank assets during the great financial crisis and compute counterfactuals in the absence of scoring uncertainty. Our findings imply a substantial reduction in FDIC resolution costs of between 29.8% ($8.2 billion) and 44.6% ($12.3 billion). These savings can reduce policy-driven banking-sector distortions, since FDIC resolution costs are covered either through special levies on banks or through loans from the US Treasury. Our analyses also shed new light on optimal bid portfolio choice in combinatorial auctions.
Emerging markets have experienced large human and economic costs from coronavirus disease 2019, and their tight fiscal space has limited the support extended to their citizens. We study the impact of an epidemic on economic and health outcomes by integrating epidemiological dynamics into a sovereign default model. The sovereign’s option to default tightens fiscal space and results in an epidemic with limited mitigation and depressed consumption. A quantitative analysis of our model accounts well for the dynamics of fatalities, social distancing, consumption, sovereign debt, and spreads in Latin America. We find that because of default risk, the welfare cost of the pandemic is about a third higher than it is in a version of the model with perfect financial markets. We study debt relief programs and find a compelling case for their implementation. These programs deliver large social gains, improving health and economic outcomes for the country at no cost to international lenders or financial institutions.
We use novel, large-scale data on 17.5 million Americans to study how a policy-driven increase in economic resources affects children's long-term outcomes. Using the 2000 Census and 2001–13 American Community Survey linked to the Social Security Administration's NUMIDENT, we leverage the county-level rollout of the Food Stamps program between 1961 and 1975. We find that children with access to greater economic resources before age five have better outcomes as adults. The treatment-on-the-treated effects show a 6% of a standard deviation improvement in human capital, 3% of a standard deviation increase in economic self-sufficiency, 8% of a standard deviation increase in the quality of neighbourhood of residence, a 1.2-year increase in life expectancy, and a 0.5 percentage-point decrease in likelihood of being incarcerated. These estimates suggest that Food Stamps’ transfer of resources to families is a highly cost-effective investment in young children, yielding a marginal value of public funds of approximately sixty-two.
We show that the entry of formal financial institutions can have far-reaching and long-lasting impacts on informal lending and social networks more generally. We first study the introduction of microfinance in 75 villages in Karnataka, India, 43 of which were exposed to microfinance. Using difference-in-differences, we show that networks shrank more in exposed villages. Moreover, links between households that were both unlikely to borrow from microfinance were at least as likely to disappear as links involving likely borrowers. We replicate these surprising findings in the context of a randomised controlled trial (RCT) in Hyderabad, where a microfinance institution randomly selected 52 of 104 neighbourhoods to enter first. Four years after all neighbourhoods were treated, households in early-entry neighbourhoods had credit access longer and had larger loans. We again find fewer social relationships between households in these neighbourhoods, even among those ex-ante unlikely to borrow. Because the results suggest global spillovers, atypical in usual models of network formation, we develop a new dynamic model of network formation that emphasizes chance meetings, where efforts to socialize generate a global network-level externality. Finally, we analyse informal borrowing and the sensitivity of consumption to income fluctuations. Households unlikely to take up microcredit suffer the greatest loss of informal borrowing and risk sharing, underscoring the global nature of the externality.
How does an increase in market size, say due to globalization, affect welfare? We study this question using a model with monopolistic competition, heterogeneous markups, and fixed costs. We characterize changes in welfare and decompose changes in allocative efficiency into three different effects: (1) reallocations across firms with heterogeneous price elasticities due to intensifying competition, (2) reallocations due to the exit of marginally profitable firms, and (3) reallocations due to changes in firms’ markups. Whereas the second and third effects have ambiguous implications for welfare, the first effect, which we call the Darwinian effect, always increases welfare regardless of the shape of demand curves. We nonparametrically calibrate demand curves with data from Belgian manufacturing firms and quantify our results. We find that mild increasing returns at the microlevel can catalyze large increasing returns at the macrolevel. Between 70 and 90% of increasing returns to scale come from improvements in how a larger market allocates resources. The lion’s share of these gains are due to the Darwinian effect, which increases the aggregate markup and concentrates sales and employment in high-markup firms. This has implications for policy: an entry subsidy, which harnesses Darwinian reallocations, can improve welfare even when there is more entry than in the first best.
We study how perceptions of corporate responsibility influence policy preferences and the effectiveness of corporate communication when agents have imperfect memory recall. Using a new large-scale survey of U.S. citizens on their support for corporate bailouts, we first establish that the public demands corporations to behave better within society, a sentiment we label “big business discontent.” Using random variation in the order of survey sections and in the exposure to animated videos, we then show that priming respondents to think about corporate responsibility lowers the support for bailouts. This finding suggests that big business discontent influences policy preferences. Furthermore, we find that messages which paint a positive picture of corporate responsibility can “backfire,” as doing so brings attention to an aspect on which the public has negative views. In contrast, reframing corporate bailouts in terms of economic tradeoffs increases support for the policy. We develop a memory-based model of decision-making and communication to rationalize these findings.
If sectoral trade flows obey structural gravity, countries’ bilateral trade imbalances are the result of macro trade imbalances, “triangular trade”, or pairwise asymmetric trade barriers. Using data for 40 major economies and the Rest of the World, we show that large and pervasive asymmetries in trade barriers are required to account for most of the observed variation in bilateral imbalances. A dynamic quantitative trade model suggests that eliminating these asymmetries would significantly reduce bilateral (but not macro) imbalances and have sizeable impacts on welfare. We provide evidence that the asymmetries we measure are in part related to the policy environment: trade inside the European Single Market appears to be subject to more bilaterally symmetric frictions. Extending the same symmetry to all parts of the global economy would give a large boost to the real incomes of several non-E.U. countries.
We propose a theory that analyzes how a workers’ asset holdings affect their job productivity. In a labor market with uninsurable risk, workers choose to direct their job search trading off productivity and wages against unemployment risk. Workers with low asset holdings have a precautionary job search motive, they direct their search to low productivity jobs because those offer a low risk at the cost of low productivity and a low wage. Our main theoretical contribution shows that the presence of consumption smoothing can reconcile the directed search model with negative duration-dependence on wages, a robust empirical regularity that the canonical directed search model cannot rationalize. We calibrate the infinite horizon economy and find this mechanism to be quantitatively important. We evaluate a tax financed unemployment insurance (UI) scheme and analyze how it affects welfare. Aggregate welfare is inverted U-shaped in benefits: the insurance effect UI dominates the incentive effects for low levels of benefits and vice versa for high benefits. In addition, when UI increases, total production falls in the economy while worker productivity increases.
In the late nineteenth century, the North American bison was brought to the brink of extinction in less than two decades. We demonstrate that the loss of the bison had immediate, negative consequences for the Native Americans who relied on them and ultimately resulted in a persistent reversal of fortunes. Once amongst the tallest people in the world, the generations of bison-reliant people born after the slaughter lost their entire height advantage. By the early twentieth century, child mortality was 16 percentage points higher and the probability of reporting an occupation 19 percentage points lower in bison nations compared with nations that were never reliant on the bison. Throughout the latter half of the twentieth century and into the present, income per capita has remained 25% lower, on average, for bison nations. This persistent gap cannot be explained by differences in agricultural productivity, self-governance, or application of the Dawes Act. We provide evidence that this historical shock altered the dynamic path of development for formerly bison-reliant nations. We demonstrate that limited access to credit constrained the ability of bison nations to adjust through re-specialization and migration.
Do firms adjust wages in response to changes in their own demand level or to changes in competitive pressure from rival employers? We study how exporters adjust wages in response to unexpected product demand shocks during the 2008–9 Great Recession. Using rich data on Portuguese firms’ pre-recession export shipments, we measure firm-level shocks to export demand during the Recession. We show that shocks constructed at the firm level are not necessarily firm-specific and can be decomposed into a common component affecting all producers in a product market and an idiosyncratic component affecting individual firms within markets based on the locations of their pre-recession customers. We demonstrate that while both components impact firms’ output and their workers’ wages, the common component spills over from firms to their labour market rivals, whereas the idiosyncratic component does not. We find that 10–15% of firms’ idiosyncratic demand passes through to their employees’ wage growth with no effect on retention rates, implying significant dependence of wages on noncompetitive quasi-rents. Moreover, we find that wages respond primarily to shifts in internal labour demand when labour markets are thin, but they respond more to competition from other employers when labour markets are fluid. These results indicate that employers’ ability to set wages hinges on the underlying competitiveness of the labour market.
Industrialization experiences differ substantially across countries. We use a benchmark model of structural change to shed light on the sources of this heterogeneity and, in particular, the phenomenon of premature deindustrialization. Our analysis leads to three key findings. First, benchmark models of structural change robustly generate hump-shaped patterns for the evolution of the industrial sector. Second, heterogeneous patterns of catch-up in sectoral productivities across countries can generate variation in industrialization experiences similar to those found in the data, including premature deindustrialization. Third, differences in the rate of agricultural productivity growth across economies can account for the majority of the variation in peak industrial employment shares.
In many environments, including credit and online markets, records about participants are collected, published, and erased after some time. We study the effects of erasing past records in a dynamic market where the quality of sellers follows a Markov process, and buyers leave feedback about sellers to an information intermediary. When the average quality of sellers is low, unlimited records lead to a market breakdown in the long run. We consider the information design problem and characterize information policies that can sustain trade and that maximize social welfare. These policies hide some information from the market in order to foster socially desirable experimentation. We show that these outcomes can be implemented by appropriately deleting past records. Crucially, positive and negative records play opposite roles with different intensities and must have different lengths: negative records must be deleted sufficiently late, and positive ones sufficiently early.
This article explores the relationship between the duration of a vacancy and the starting wage of a new job, using linked data on vacancies, the posting establishments, and the workers eventually filling the vacancies. The unique combination of large-scale, administrative worker, establishment, and vacancy data is critical for separating establishment- and job-level determinants of vacancy duration from worker-level heterogeneity. Conditional on observables, we find that vacancy duration is negatively correlated with the starting wage and its establishment component, with precisely estimated elasticities of −0.07 and −0.21⁠, respectively. While the negative relationship is qualitatively consistent with search-theoretic models where firms use the wage as a recruiting device, these elasticities are small, suggesting that firms’ wage policies can account only for a small fraction of the variation in vacancy filling across establishments.
This paper shows that more highly concentrated labour markets experience more positive employment effects of the minimum wage. In the most concentrated labour markets, employment rises following a minimum wage increase. The paper establishes its main findings by studying the effects of local minimum wage increases on a key low-wage retail sector, and using data on labour market concentration that covers the entirety of the U.S. with fine spatial variation at the occupation level. The results carry over to the fast-food sector and the entire low-wage labour market and are robust to using proxies of labour market concentration available for a broader range of industries, such as the number of establishments and population density. A model of oligopsonistic competition can explain these effects: there is more room to increase wages in high-concentration areas where wages tend to be further below marginal productivity. These findings provide evidence supporting monopsonistic wage setting as an explanation for the near-zero minimum wage employment effect documented in prior work.
In disseminating information, policymakers face a choice between broadcasting to everyone and informing a small number of “seeds” who then spread the message. While broadcasting maximises the initial reach of messages, we offer theoretical and experimental evidence that it need not be the best strategy. In a field experiment during the 2016 Indian demonetisation, we delivered policy information, varying three dimensions of the delivery method at the village level: initial reach (broadcasting versus seeding); whether or not we induced common knowledge of who was initially informed; and number of facts delivered. We measured three outcomes: the volume of conversations about demonetisation, knowledge of demonetisation rules, and choice quality in a strongly incentivised policy-dependent decision. On all three outcomes, under common knowledge, seeding dominates broadcasting; moreover, adding common knowledge makes seeding more effective but broadcasting less so. We interpret our results via a model of image concerns deterring engagement in social learning, and we support this interpretation with evidence on differential behaviour across ability categories.
We examine two key channels through which commodity price super-cycles affect the economy: a wealth channel, through which higher commodity prices increase domestic demand, and a cost channel, through which they induce wage increases. By exploiting regional variation in exposure to commodity price shocks and administrative firm-level data from Brazil, we empirically disentangle these transmission channels. We introduce a dynamic model with heterogeneous firms and workers to further quantify the mechanisms and evaluate welfare. A counterfactual economy in which commodity booms are purely endowment shocks experiences only 30% of the intersectoral labour reallocation between tradables and nontradables, and 40% of the within-tradable labour reallocation between domestic and exported production. Finally, the consumption-equivalent welfare gain of a commodity super-cycle is twice as large in the counterfactual economy.
This paper studies two-player games in continuous time with imperfect public monitoring, in which information may arrive both gradually and continuously, governed by a Brownian motion, and abruptly and discontinuously, according to Poisson processes. For this general class of two-player games, we characterize the equilibrium payoff set via a convergent sequence of differential equations. The differential equations characterize the optimal trade-off between value burnt through incentives related to Poisson information and the noisiness of incentives related to Brownian information. In the presence of abrupt information, the boundary of the equilibrium payoff set may not be smooth outside the set of static Nash payoffs. Equilibrium strategies that attain extremal payoff pairs as well as their intertemporal incentives are elicitable from the limiting solution. The characterization is new even when information arrives through Poisson events only.
In the past three decades, governments in emerging markets have accumulated large amounts of international reserves, especially those with fixed exchange rates. This article proposes a theory of reserve accumulation that can account for these facts. Using a model of endogenous sovereign default with nominal rigidities, we argue that the interaction between sovereign risk and aggregate demand amplification generates a macroeconomic-stabilization hedging role for international reserves. We show that issuing debt to purchase reserves during good times allows the government to stabilize aggregate demand when sovereign spreads rise and rolling over the debt becomes more expensive. We provide empirical evidence consistent with the model’s predictions.
The U.K. economy experienced significant macroeconomic adjustments following the 2016 referendum on its withdrawal from the European Union. To understand these adjustments, this paper presents empirical facts using novel U.K. macroeconomic data and estimates a small open economy model with tradable and non-tradable sectors. We demonstrate that the referendum outcome can be interpreted as news about a future decline in productivity growth in the tradable sector. An immediate fall in the relative price of non-tradable goods induces a temporary “sweet spot” for tradable producers. Economic activity in the tradable sector expands in the short run, while the non-tradable sector contracts. Aggregate output, consumption, and investment growth decelerate.
The impact of fiscal policy on economic activity is still a matter of great debate. And, ever since Keynes first commented on it, interwar Britain, 1918–39, has remained a particularly interesting and contentious case—not least because of its high-debt environment and turbulent business cycle. This debate has often focused on the effects of government spending, but little is known about the effects of tax changes. In fact, a number of tax reforms in the period focused on long-term and social objectives, often reflecting the personality of British Chancellors. Based on extensive historiographical research, we apply a narrative approach to the interwar period in Britain and isolate a new series of exogenous tax changes. We find that tax changes have a sizable effect on GDP, with multipliers exceeding 2 within two years. Our estimates provide new evidence on the effects of tax changes, contribute to the historical debate about fiscal policy in the interwar period and are also consistent with the sizable tax multipliers found after World War II.
We investigate the bank lending channel of negative nominal policy rates from an empirical and theoretical perspective. For the empirical results, we rely on Swedish data, including daily bank-level lending rates. We find that retail household deposit rates are subject to a lower bound (DLB). Empirically, once the DLB is met, the pass-through to mortgage lending rates and credit volumes is substantially lower and bank equity values decline in response to further policy rate cuts. We construct a banking sector model and use our estimate of the pass-through of negative policy rates to lending rates as an identified moment to parameterize the model and assess the impact of negative policy rates in general equilibrium. Using the theoretical framework, we derive a sufficient statistic for when negative policy rates are expansionary and when they are not.
We use customs data for Irish firms to show that in successful episodes of export market entry, there are statistically and economically significant post-entry dynamics of quantities, but not of mark-ups. To match these moments, we structurally estimate a model where firms can invest in future customer base through two channels: by selling more today, and by spending on marketing and advertising. Our estimates suggest that customer base is insensitive to lagged sales, so firms have no incentive to engage in dynamic pricing to accumulate customers. Instead, investment in customer base through marketing and advertising explains the dynamics of quantities. The ratio of advertising and marketing expenditures to sales implied by the model is consistent with data from other sources. Our estimated model generates long-run export responses to permanent tariff changes that are bigger than short run responses, as well as responses that are increasing in the expected persistence of tariff shocks, contributing to our understanding of the International Elasticity Puzzle.
We use textual analysis of earnings conference calls held by listed firms around the world to measure the amount of risk managers and investors at each firm associated with each country at each point in time. Flexibly aggregating this firm-country-quarter-level data allows us to systematically identify spikes in perceived country risk (“crises”) and document their source and pattern of transmission to foreign firms. While this pattern usually follows a gravity structure, it often changes dramatically during crises. For example, while crises originating in developed countries propagate disproportionately to foreign financial firms, emerging market crises transmit less financially and more to traditionally exposed countries. We apply our measures to show that elevated perceptions of a country’s riskiness, particularly those of foreign and financial firms, are associated with significant falls in local asset prices, capital outflows, and an increased likelihood of a sudden stop.
We propose that a person’s desire to consume an object or possess an attribute increases in how much others want but cannot have it. We term this motive imitative superiority-seeking and show that it generates preferences for exclusion that help explain a host of market anomalies and make novel predictions in a variety of domains. In bilateral exchange, trade becomes more zero-sum, leading to an endowment effect. People’s value of consuming a good increases in its scarcity, which generates a motive for firms and organizations to engage in exclusionary policies. A monopolist producing at constant marginal cost can increase profits by randomly excluding buyers relative to the standard optimal mechanism of posting a common price. In the context of auctions, a seller can extract greater revenues by randomly barring a subset of consumers from bidding. Moreover, such non-price-based exclusion leads to higher revenues than the classic optimal sales mechanism. A series of experiments provides direct support for these predictions. In basic exchange, a person’s willingness to pay for a good increases as more people are explicitly barred from the opportunity to acquire it. In auctions, randomly excluding people from the opportunity to bid substantially increases bids amongst those who retain this option. Consistent with our predictions, exclusion leads to bigger gains in expected revenue than increasing competition through inclusion. Our model of superiority-seeking generates “Veblen effects,” rationalizes attitudes against redistribution and provides a novel motive for social exclusion and discrimination.
Based on an asset demand system, we develop a framework to quantify the impact of market trends and changes in regulation on asset prices, price informativeness, and the wealth distribution. Our leading applications are the transition from active to passive investment management and climate-induced shifts in asset demand. The transition from active to passive investment management had a large impact on equity prices but a small impact on price informativeness because capital did not flow from more to less informed investors on average. This finding is based on a new measure of investor-level informativeness that identifies which investors are more informed about future profitability. Climate-induced shifts in asset demand have a potentially large impact on equity prices and the wealth distribution, implying capital gains for passive investment advisors, pension funds, insurance companies, and private banking and capital losses for active investment advisors and hedge funds.
This paper analyses a model of strategic exploration in which competing players independently explore a set of alternatives. The model features a multiple-player multiple-armed bandit problem and captures a strategic trade-off between pre-emption—covert exploration of alternatives that the opponent will explore in the future—and prioritization—exploration of the most promising alternatives. Our results explain how the strategic trade-off shapes equilibrium behaviours and outcomes, for example, in technology races between superpowers and R&D competitions between firms. We show that players compete on the same set of alternatives, leading to duplicated exploration from start to finish, and they explore alternatives that are a priori less promising before more promising ones are exhausted. The model also predicts that competition induces players to implement unreliable technologies too early, even though they should wait for the technologies to mature. Coordinated exploration is impossible even if the alternatives are equally promising, but it can emerge in equilibrium following a phase of pre-emptive competition if there is a short deadline. With asymmetric capacities of exploration, the weak player conducts extensive instead of intensive exploration—exploring as many alternatives as the strong player does but never fully exploring any.
This paper analyses how limits to the complexity of statistical models used by market participants can shape asset prices. We consider an economy in which the stochastic process that governs the evolution of economic variables may not have a simple representation, and yet, agents are only capable of entertaining statistical models with a certain level of complexity. As a result, they may end up with a lower-dimensional approximation that does not fully capture the intertemporal complexity of the true data-generating process. We first characterize the implications of the resulting departure from rational expectations and relate the extent of return and forecast-error predictability at various horizons to the complexity of agents’ models and the statistical properties of the underlying process. We then apply our framework to study violations of uncovered interest rate parity in foreign exchange markets. We find that constraints on the complexity of agents’ models can generate return predictability patterns that are simultaneously consistent with the well-known forward discount and predictability reversal puzzles.
Economists have widely endorsed pricing CO2 emissions to internalize climate change-related externalities. Doing so would significantly affect coal, the most carbon-intensive energy source. However, U.S. coal markets exhibit an additional distortion: the railroads that transport coal to power plants can exert market power. This article estimates how coal-by-rail markups respond to changes in coal demand. I identify markups in a major intermediate goods market using both reduced-form and structural methods. I find that rail carriers reduce coal markups when downstream power plant demand changes due to a drop in the price of natural gas (a competing fuel). My results imply that decreases in coal markups have increased recent U.S. climate damages by $11.9 billion, compared to a counterfactual where markups did not change. Incomplete pass-through would likely erode the environmental benefits of an incremental carbon tax, shifting the tax burden towards upstream railroads. Still, a non-trivial tax would likely increase welfare.
We develop a new approach for estimating average treatment effects in observational studies with unobserved group-level heterogeneity. We consider a general model with group-level unconfoundedness and provide conditions under which aggregate balancing statistics—group-level averages of functions of treatments and covariates—are sufficient to eliminate differences between groups. Building on these results, we re-interpret commonly used linear fixed-effect regression estimators by writing them in the Mundlak form as linear regression estimators without fixed effects but including group averages. We use this representation to develop Generalized Mundlak Estimators that capture group differences through group averages of (functions of) the unit-level variables and adjust for these group differences in flexible and robust ways in the spirit of the modern causal literature.
What are the unequal effects of changes in consumer prices on the cost of living? In the context of changes in import prices (driven by, e.g. changes in trade costs or exchange rates), most analyses focus on variation across households in initial expenditure shares on imported goods. However, the unequal welfare effects of non-marginal foreign price changes also depend on differences in how consumers substitute between imported and domestic goods, on which there is scant evidence. Using data from Switzerland surrounding the 2015 appreciation of the Swiss franc, we provide evidence that lower-income households have higher price elasticities. We quantify the contribution of heterogeneous elasticities for the unequal welfare effects of observed price changes between 2014 and 2015 and for counterfactual shocks to the mean and dispersion of import price changes.
Can taxes on consumption redistribute in developing countries? Contrary to consensus, we show that taxing consumption is progressive once we account for informal consumption. Using household expenditure surveys in 32 countries, we proxy for informal consumption using the type of store where purchases occur. We establish that the budget share spent in informal stores steeply declines with income, so that richer households pay a substantially larger share of their income in taxes. Our findings imply that the widespread policy of exempting food from taxation is hard to justify on equity grounds in low-income countries.
A widely held view is that small firms in developing countries are prevented from making profitable investments by lack of access to credit and insurance markets. One solution is to provide repayment flexibility in credit contracts. Repayment flexibility eases both the credit constraint, as it allows for increased spending during the start-up phase, and offers insurance, in case of fluctuations in income. In a field experiment among traditional microfinance clients and larger collateralized borrowers in Bangladesh, we randomly assign the option to delay up to 2 monthly repayments at any point during a 12-month loan cycle. The flexible contract leads to substantial improvements in the traditional microfinance clients’ business outcomes, driven by borrowers in the upper tail of the distribution. In addition, we find a significant impact on socio-economic status, combined with lower default rates. We show theoretically and empirically that these effects are induced by an increase in entrepreneurial risk taking, implying that the primary mechanism is insurance provision. Repayment flexibility also attracts less risk-averse borrowers interested in business expansion. At the same time, the effects for the larger loan are much more modest. Our findings suggest that lack of insurance is an important constraint for small firms but that a simple financial product that increases repayment flexibility can be an effective tool for enabling enterprise growth.
We explore how business groups use internal labour markets (ILMs) in response to changing economic conditions. We show that following the exit of a large industry competitor, group-affiliated firms expand, and gain market share by increasing their reliance on the ILM to ensure swift hiring, especially of technical managers and skilled blue collar workers. The ability to take advantage of this shock to growth opportunities is greater in firms with closer access to their affiliates’ human capital, as geographical proximity facilitates employee relocations across units. Overall, our findings point to the ILM as a prominent mechanism making affiliation with a business group valuable at times of change. For the ILM to perform its role in the face of industry shocks, group sectoral diversification must be combined with geographical proximity between affiliates.
This article shows that individual-level heterogeneity in survival expectations derived from subjective survey information improves the out-of-sample predictions of a dynamic model of retirement and saving. We consider three approaches to modelling survival: life tables, average subjective expectations, and individual-specific estimates based on reported survival probabilities. The models are estimated using Dutch data from the 1990s, a period during which workers could retire from age 59 at no penalty to pension benefits. Actuarial adjustments were introduced in the early 2000s, and we use data from the period 2006–16 to evaluate the accuracy of the counterfactual predictions. While the three models yield different preference estimates, their within-sample fit is similar. Out-of-sample forecasts do differ markedly. The models with homogeneous expectations anticipate a 4- or 5-year increase in the average retirement age in the new regime, compared with an observed increase of 2.6 years. The model with heterogeneous expectations predicts a more realistic increase of 2.7 years. Expectations matter when it comes to counterfactual predictions, even if different combinations of preferences and expectations appear equivalent within a given institutional setting.
We present an experimental framework to study the extent to which failures of contingent thinking explain classic anomalies in a broad class of environments, including overbidding in auctions and the Ellsberg paradox. We study environments in which the subject’s choices affect payoffs only in some states but not in others. We find that anomalies are in large part driven by incongruences between choices in the standard presentation of each problem and a “contingent” presentation, which focuses the subject on the set of states where her actions matter. Additional evidence suggests that this phenomenon is in large part driven by people’s failure to put themselves in states that have not yet happened even though they are made aware that their actions only matter in those states.
How do consumer credit markets affect the allocation of workers to firms, output, and labour productivity? We address this question in two steps. First, we use new micro-data to estimate empirical elasticities of job search patterns to credit. Second, we estimate our novel theory of sorting under risk aversion to match these elasticities, and then we conduct aggregate counterfactuals. Empirically, we show that an increase in credit limits worth 10% of prior annual earnings allows individuals to take 0.33 weeks longer to find a job. Conditional on finding a job, they earn 1.85% more and work at higher paying firms. We also find that young and high-utilization individuals are more responsive to credit. Theoretically, we integrate risk aversion and borrowing into a model with worker and firm heterogeneity. We estimate the model to match our new empirical elasticities, and we then measure how the credit expansion from 1964 to 2004 affected sorting and output. Sorting improves as credit expands since constrained workers—in particular constrained, young, high human capital workers—find more capital-intensive jobs.
We develop a model of the global financial cycle with one key ingredient: the international demand for safe dollar assets. The model matches patterns of dollar borrowing and currency mismatch, the U.S. external balance sheet, exorbitant privilege, spillovers of the U.S. monetary policy to the rest of the world, and the dollar as a global risk factor. In doing so, we lay out a novel transmission mechanism through which the U.S. monetary policy affects the currency market and the global economy. The global financial cycle is a dollar cycle.
We examine path dependency in physician decisions in an emergency department setting, and find that physicians’ treatment decisions for the current and previous patients are positively correlated. We show that the positive autocorrelation is higher when the current patient is of greater medical uncertainty or more similar to the previous patient in terms of observed characteristics and when the physician is less experienced or more fatigued. We then show that these patterns are highly consistent with the memory and attention model, whereby the physician’s current decision is anchored to her previous decision. The results from both reduced-form analyses and structural estimations provide further support for the importance of memory and attention in physician decision-making.
In standard promotion tournaments, contestants are ranked based on their output or productivity. We argue that workers' career progression may also depend on their relative rankings in dimensions a priori unrelated to their job performance, such as visibility or in-person presence. Such implicit tournaments may rationalize a variety of seemingly counterproductive practices in the workplace, including long working hours, low uptake of statutory leave, and presenteeism. We illustrate the significance of implicit tournaments using the case of paternity leave among new fathers, where we exogenously vary a focal worker's ranking within a contest, not via his own leave status but that of his competitors, exploiting a policy reform. We show that the focal worker is put on a better earnings trajectory than otherwise when a larger share of his competitors take leave because of the reform. The focal worker's own absolute leave, however, has no direct effect on his earnings path as long as his own and his competitors' leave statuses are symmetric. With effective coordination, it should thus be possible for all fathers to utilize paternity leave without incurring unwarranted career costs. This has implications for statutory leave policies, flexible work arrangements, and gender equality.
Diagnostic expectations constitute a realistic behavioural model of inference. This paper shows that this approach to expectation formation can be productively integrated into the New Keynesian framework. Diagnostic expectations generate endogenous extrapolation in general equilibrium. We show that diagnostic expectations generate extra amplification in the presence of nominal frictions; a fall in aggregate supply generates a Keynesian recession; fiscal policy is more effective at stimulating the economy. We perform Bayesian estimation of a rich medium-scale model that incorporates consensus forecast data. Our estimate of the diagnosticity parameter is in line with previous studies. Moreover, we find empirical evidence in favour of the diagnostic model. Diagnostic expectations offer new propagation mechanisms to explain fluctuations.
This article studies the effects of higher bank capital requirements. Using new firm-lender matched credit data from South Korea, we document that Basel III coincided with a 25% decline in credit from regulated banks, and an increase of similar magnitude from non-bank (shadow) lenders. We use our data to estimate the effect of capital requirements on bank credit, and the spillover effect of the reform on non-bank lending. We then build a general equilibrium model with heterogeneous banks and firms that replicates these micro estimates. We find that Basel III can account for most of the observed decrease in regulated bank lending and about three quarters of the increase in shadow lending. The latter is driven exclusively by general equilibrium effects of the reform.
We develop a theory of endogenous uncertainty in which the ability of investors to learn about firm-level fundamentals is impaired during financial crises. At the same time, higher uncertainty reinforces financial distress. Through this two-way feedback loop, a temporary financial shock can cause a persistent reduction in risky lending, output, and employment that coincides with increased uncertainty, default rates, credit spreads, and disagreement among forecasters. We embed our mechanism into standard real business cycle and New-Keynesian models and show how it generates endogenous and internally persistent processes for the efficiency and labour wedges.
We develop an economic model of transitions in and out of employment. Heterogeneous workers switch employment status when the net benefit from working, a Brownian motion with drift, hits optimally chosen barriers. This implies that the duration of jobless spells for each worker has an inverse Gaussian distribution. We allow for arbitrary heterogeneity across workers and prove that the distribution of inverse Gaussian distributions is partially identified from the duration of two non-employment spells for each worker. We estimate the model using Austrian social security data and find that dynamic selection is a critical source of duration dependence.
Libor is an estimate of interbank borrowing costs computed daily from rates reported by a fixed panel of banks. Evidence suggests that banks have manipulated Libor in recent years by misreporting their borrowing costs. I estimate a strategic reporting model that identifies banks’ borrowing costs as well as their motives for misreporting. The estimation places a lower bound on the value that Libor would have had if banks had truthfully reported their borrowing costs. The model is identified even when unobserved heterogeneity exists in the form of a common cost component that is known by all banks but unobservable to the econometrician and is allowed to follow a non-stationary process. The only data used for identification are banks’ Libor quotes. Overall, I find that the estimated lower bound for the unmanipulated Libor is always above the published Libor, with an average deviation of 25 basis points at the worst of the financial crisis of 2007–2008. The estimated bound displays a pattern similar to two other measures of interbank borrowing costs that have been used previously to assess the extent of manipulation. The model is also used to determine the extent to which misreporting was motivated by signalling or banks’ net exposure to Libor. The estimation results indicate that sending creditworthiness signals was the main driver of systematic misreporting from 2007 to 2010.
We develop a framework for difference-in-differences designs with staggered treatment adoption and heterogeneous causal effects.  We show that conventional regression-based estimators fail to provide unbiased estimates of relevant estimands absent strong restrictions on treatment-effect homogeneity. We then derive the efficient estimator addressing this challenge, which takes an intuitive “imputation” form when treatment-effect heterogeneity is unrestricted. We characterize the asymptotic behaviour of the estimator, propose tools for inference, and develop tests for identifying assumptions. Our method applies with time-varying controls, in triple-difference designs, and with certain non-binary treatments. We show the practical relevance of our results in a simulation study and an application. Studying the consumption response to tax rebates in the U.S., we find that the notional marginal propensity to consume is between 8 and 11% in the first quarter—about half as large as benchmark estimates used to calibrate macroeconomic models—and predominantly occurs in the first month after the rebate.
This paper develops a method to estimate workers’ outside employment opportunities. We outline a matching model with two-sided heterogeneity, from which we derive a sufficient statistic, the “outside options index” (OOI), for the effect of outside options on earnings, holding worker productivity constant. The OOI uses the cross-sectional concentration of similar workers across job types to quantify workers’ outside options as a function of workers’ commuting costs, preferences, and skills. Using German micro-data, we find that differences in options explain 20% of the gender earnings gap, and that gender gaps in options are mostly due to differences in the implicit costs of commuting and moving.
We develop a new equilibrium model in which households’ labour supply choices form the link between sorting on the marriage market and sorting on the labour market. We first show that in theory, the nature of home production—whether partners’ hours are complements or substitutes—shapes equilibrium labour supply as well as marriage and labour market sorting. We then estimate our model using German data to empirically assess the nature of home production, and find that spouses’ home hours are complements. We investigate to what extent complementarity in home hours drives sorting and inequality. We find that home production complementarity strengthens positive marriage sorting and reduces the gender gap in hours and in labour sorting. This puts significant downward pressure on the gender wage gap and on within-household income inequality, but fuels between-household inequality. Our estimated model sheds new light on the sources of inequality in today’s Germany, and—by identifying important shifts in home production technology toward more complementarity—on the evolution of inequality over time.
We study the impact of widespread adoption of work-from-home (WFH) technology using an equilibrium model where people choose where to live, how to allocate their time between working at home and at the office, and how much space to use in production. Motivated by cross-sectional evidence on WFH, we model WFH as a complement to work at the office. Simulations of the model indicate that the pandemic induced a large change to the relative productivity of WFH that substantially increased home prices and will permanently affect incomes, income inequality, and city structure.
We study information aggregation in a dynamic trading model. We show theoretically that separable securities, introduced by Ostrovsky in the context of Expected Utility, no longer aggregate information if some traders have imprecise beliefs and are ambiguity averse. Moreover, these securities are prone to manipulation as the degree of information aggregation can be influenced by the initial price set by the uninformed market maker. These observations are also confirmed in our laboratory experiment using prediction markets. We define a new class of strongly separable securities, which are robust to the above considerations and show that they characterize information aggregation in both strategic and non-strategic environments. We derive several testable predictions, which we are able to confirm in the laboratory. Finally, we show theoretically that strongly separable securities are both sufficient and necessary for information aggregation but, strikingly, there does not exist a security that is strongly separable for all information structures.
This article introduces a measure of the diffusion of binary outcomes over a large, sparse network, when the diffusion is observed in two time periods. The measure captures the aggregated spillover effect of the state-switches in the initial period on their neighbours’ outcomes in the second period. This article introduces a causal network that captures the causal connections among the cross-sectional units over the two periods. It shows that when the researcher’s observed network contains the causal network as a subgraph, the measure of diffusion is identified as a simple, spatio-temporal dependence measure of observed outcomes. When the observed network does not satisfy this condition, but the spillover effect is non-negative, the spatio-temporal dependence measure serves as a lower bound for diffusion. Using this, a lower confidence bound for diffusion is proposed, and its asymptotic validity is established. The Monte Carlo simulation studies demonstrate the finite sample stability of the inference across a range of network configurations. The article applies the method to data on Indian villages to measure the diffusion of microfinancing decisions over households’ social networks.
We develop a model of size-based market power in a frictional labour market. In the canonical search environment, competition for workers is encoded in outside options. In our granular setting, large employers remove their own job postings from their workers’ outside option. Thus, size gives market power and a more concentrated market structure depresses wages because it reduces competition for workers. We calibrate the model to Austrian data and find that such size-based market power depresses wages by about 2.6% or 1,500 euros annually per worker.
We develop a dynamic model of input–output networks that incorporates adjustment costs of changing inputs. Our closed-form solution for the dynamics of the economy shows that temporary shocks to upstream sectors, whose output travels through long supply chains, have disproportionately significant welfare impact compared to affected sectors’ Domar weights. We conduct a spectral analysis of the U.S. production network and reveal that the welfare impact of temporary sectoral shocks can be represented by a low-dimensional, 3-factor structure.
We study the relationship between credit expansions, macroeconomic fluctuations, and financial crises using a novel database on the sectoral distribution of private credit for 117 countries since 1940. We document that, during credit booms, credit flows disproportionately to the non-tradable sector. Credit expansions to the non-tradable sector, in turn, systematically predict subsequent growth slowdowns and financial crises. In contrast, credit expansions to the tradable sector are associated with sustained output and productivity growth without a higher risk of a financial crisis. To understand these patterns, we show that firms in the non-tradable sector tend to be smaller, more reliant on loans secured by real estate, and more likely to default during crises. Our findings are consistent with models in which credit booms to the non-tradable sector are driven by easy financing conditions and amplified by collateral feedbacks, contributing to increased financial fragility and a boom–bust cycle.
Well-functioning courts are essential for the health of both financial and real economies. Courts function poorly in most lower-income countries, but the root causes of poor performance are not well understood. We use field experiments with ongoing cases to analyse sources of dysfunction in Mexico’s largest labour court. We provide parties with personalized predictions for case outcomes and show that this information nearly doubles settlement rates and reduces average case duration. The experiment generates the first experimental evidence in live court cases that reducing information asymmetries results in a decrease in delay, an outcome predicted by many theories of bargaining. We also find that the information treatment is effective only when the plaintiff is present to receive it directly, suggesting agency issues between plaintiffs and their private lawyers. For most workers, the treatment appears to improve welfare, as measured by discounted payouts and ability to pay bills.
This article studies how firms’ screening incentives in the labour market affect the optimal design of social insurance programs and quantitatively assesses the U.S. disability policies accounting for firms’ screening of the disabled. We develop an equilibrium search model where workers with different productivities have heterogeneous preferences over non-wage benefits and firms cannot offer an employment contract that explicitly depends on worker types. In this environment, firms may use contracts to screen out a certain type of workers, distorting employment rates and contracts in equilibrium. Therefore, the optimal structure of social insurance policies depends on firms’ screening incentives. We extend and structurally estimate this framework to quantitatively understand the inefficiencies arising from firms’ incentives to screen out disabled workers and examine the optimal joint design of disability insurance (DI) and various forms of firm subsidies. We find that hiring subsidies mitigate screening distortions; at the same time, they interact with DI by reducing the labour supply disincentives it generates. The optimal policy structure leads to a considerable welfare gain by simultaneously making firm subsidies and DI benefits more generous.
How should the government respond to automation? We study this question in a heterogeneous agent model that takes worker displacement seriously. We recognize that displaced workers face two frictions in practice: reallocation is slow and borrowing is limited. We analyze a second best problem where the government can tax automation but lacks redistributive tools to fully alleviate borrowing frictions. The equilibrium is (constrained) inefficient and automation is excessive. Firms do not internalize that automation depresses the income of automated workers early on during the transition, precisely when they become borrowing constrained. The government finds it optimal to slow down automation on efficiency grounds, even when it does not value equity. Quantitatively, the optimal speed of automation is considerably lower than at the laissez-faire. The optimal policy improves efficiency and delivers meaningful welfare gains.
How do social networks influence the decision to migrate? Prior work suggests two distinct mechanisms that have historically been difficult to differentiate: as a conduit of information, and as a source of social and economic support. We disentangle these mechanisms using a massive “digital trace” dataset that allows us to observe the migration decisions made by millions of individuals over several years, as well as the complete social network of each person in the months before and after migration. These data allow us to establish a new set of stylized facts about the relationship between social networks and migration. Our main analysis indicates that the average migrant derives more social capital from “interconnected” networks that provide social support than from “extensive” networks that efficiently transmit information.
Public health systems are dominant in much of the world but often face fiscal constraints that lead to rationing of care. As a result, private sector healthcare providers could in theory beneficially supplement public systems, but evaluating the benefits of private alternatives has been challenging. We evaluate a private supplement to the free public health system for one of the world’s deadliest health problems, diabetes. We estimate enormous impacts of the private supplement, increasing the share of those treated who are under control by 69%. This effect arises through both improved treatment compliance and health behavior. We find diabetes complications fall in the short run, and that the net costs of this intervention are one-third of the gross costs. The returns to private care do not appear to reflect more productive delivery but rather more attachment to medical care, offering lessons for improving the public system.
We introduce two data-driven procedures for optimal estimation and inference in nonparametric models using instrumental variables. The first is a data-driven choice of sieve dimension for a popular class of sieve two-stage least-squares estimators. When implemented with this choice, estimators of both the structural function h0 and its derivatives (such as elasticities) converge at the fastest possible (i.e. minimax) rates in sup-norm. The second is for constructing uniform confidence bands (UCBs) for h0 and its derivatives. Our UCBs guarantee coverage over a generic class of data-generating processes and contract at the minimax rate, possibly up to a logarithmic factor. As such, our UCBs are asymptotically more efficient than UCBs based on the usual approach of undersmoothing. As an application, we estimate the elasticity of the intensive margin of firm exports in a monopolistic competition model of international trade. Simulations illustrate the good performance of our procedures in empirically calibrated designs. Our results provide evidence against common parameterizations of the distribution of unobserved firm heterogeneity.
We develop a theory of information spillovers in sovereign bond markets in which investors can learn about default risk before trading in primary and secondary markets. If primary markets are structured as multi-unit discriminatory-price auctions, an endogenous winner’s curse leads to strategic complementarities in information acquisition. Shocks to default risk in one country may trigger crisis episodes with widespread information acquisition, sharp increases in the level and volatility of yields in risky countries, low and stable yields in safe countries, market segmentation, and arbitrage profits between primary and secondary markets. These predictions are consistent with the dynamics of auction informativeness during the Eurozone Sovereign Debt Crisis, which we measure using the reaction of secondary market yields to primary market yields.
We study partially linear models when the outcome of interest and some of the covariates are observed in two different datasets that cannot be linked. This type of data combination problem arises very frequently in empirical microeconomics. Using recent tools from optimal transport theory, we derive a constructive characterization of the sharp identified set. We then build on this result and develop a novel inference method that exploits the specific geometric properties of the identified set. Our method exhibits good performances in finite samples, while remaining very tractable. We apply our approach to study intergenerational income mobility over the period 1850–1930 in the U.S. Our method allows us to relax the exclusion restrictions used in earlier work, while delivering confidence regions that are informative.
How can we motivate good politicians—those that will carry out policy that is responsive to citizens’ preferences—to enter politics? In a field experiment in Pakistan, we vary how political office is portrayed to ordinary citizens. Emphasizing prosocial motives for holding political office instead of personal returns—such as the ability to help others versus enhancing one’s own respect and status—raises the likelihood that individuals run for office and that voters elect them. A year later, the treatment improves the alignment of policy with citizens’ preferences. These effects emerge only when treatments are randomly delivered in a public setting. Taken together, the results demonstrate that how politics is perceived shapes who decides to run for office, who is elected, as well the policies that democracies deliver.
This article provides a general framework to study the role of production networks in international GDP comovement. We first derive an additive decomposition of bilateral GDP comovement into components capturing shock transmission and shock correlation. We quantify this decomposition in a parsimonious multi-country, multi-sector dynamic network propagation model, using data for the G7 countries over the period 1978–2007. Our main finding is that while the network transmission of shocks is quantitatively important, it accounts for a minority of observed comovement under the estimated range of structural elasticities. Contemporaneous responses to correlated shocks in the production network are more successful at generating comovement than intertemporal propagation through capital accumulation. Extensions with multiple shocks, nominal rigidities, and international financial integration leave our main result unchanged. A combination of TFP and labour supply shocks is quantitatively successful at reproducing the observed international business cycle.
We consider the effects of climate change on seasonally migrant populations that herd livestock—i.e. transhumant pastoralists—in Africa. Traditionally, transhumant pastoralists benefit from a cooperative relationship with sedentary agriculturalists whereby arable land is used for crop farming in the wet season and animal grazing in the dry season. Rainfall scarcity can disrupt this arrangement by inducing pastoral groups to migrate to agricultural lands before the harvest, causing conflict to emerge. We examine this hypothesis by combining ethnographic information on the traditional locations of transhumant pastoralists and sedentary agriculturalists with high-resolution data on the location and timing of rainfall and violent conflict events in Africa from 1989 to 2018. We find that reduced rainfall in the territory of transhumant pastoralists leads to conflict in neighbouring areas. Consistent with the proposed mechanism, the conflicts are concentrated in agricultural areas; they occur during the wet season and not the dry season; and they are due to rainfall’s impact on plant biomass growth. Since pastoralists tend to be Muslim and agriculturalists Christian, this mechanism accounts for a sizable proportion of the rapid rise in religious conflict observed in recent decades. Regarding policy responses, we find that development aid projects tend not to mitigate the effects that we document. By contrast, the effects are reduced when transhumant pastoralists have greater power in national government, suggesting that more equal political representation is conducive to peace.
We measure desired labour supply at the extensive (employment) margin in two representative surveys of the U.S. and German populations. We elicit reservation raises: the percent wage change that renders a given individual indifferent between employment and nonemployment. It is equal to her reservation wage divided by her actual, or potential, wage. The reservation raise distribution is the nonparametric aggregate labour supply curve. Locally, the curve exhibits large short-run elasticities above 3, consistent with business cycle evidence. For larger upward shifts, arc elasticities shrink towards 0.5, consistent with quasi-experimental evidence from tax holidays. Existing models fail to match this nonconstant, asymmetric curve.
We study the long-term effects of a randomized intervention targeting children's socio-emotional skills. The classroom-based intervention for primary school children has positive impacts that persist for over a decade. Treated children become more likely to complete academic high school and enrol in university. Two mechanisms drive these results. Treated children show fewer attention deficit/hyperactivity disorder symptoms: they are less impulsive and less disruptive. They also attain higher grades, but they do not score higher on standardized tests. The long-term effects on educational attainment thus appear to be driven by changes in socio-emotional skills rather than cognitive skills.
Hundreds of millions of microenterprises in emerging economies face increased competition from the entry and expansion of large firms that offer similar products. This paper examines the impacts of the opening of chain-run convenience stores on one of the world’s most ubiquitous microenterprises: owner-operated shops. To address endogeneity in time and location of chains’ opening, I pair two-way fixed effects with a novel instrument that shifts the profitability of chains but not of shops at the neighbourhood level. Expanding the number of chain outlets from zero to the neighbourhood average of 6.7 stores reduces the number of shops by 15%, a decline driven not by increased shop exits but by decreased shop entries. Shops retain their sales of fresh products and keep 96% of their customers, but customers visit shops less frequently and spend less on packaged goods. Surviving shops leverage competitive advantages stemming from being owner operated, such as lower agency costs, cultivating relationships with neighbours, and offering customers informal credit. The welfare gains of convenience chains replacing shops increase with household income; the poorest households experience a welfare loss.
Regulations to design private yet publicly sponsored health insurance markets are increasingly adopted in many OECD countries. Here I combine data and economic theory to analyse the interaction between insurers’ competition and the design of premium subsidies in determining equilibrium outcomes. My empirical model includes adverse selection, rich heterogeneity in preferences for vertically and horizontally differentiated plans and accommodates alternative assumptions on pricing conduct. In the context of the Affordable Care Act in the U.S., I estimate the joint distribution of preferences and expected cost using Californian administrative records on 3.4 million plan choices between 2014 and 2017, combined with plan and survey data on medical claims. An empirical horse race between conduct assumptions favours oligopoly pricing over perfect competition. Considering alternative subsidy designs shows that, in equilibrium, shifting subsidy generosity toward the “young invincibles” would lower premiums for all enrolees while increasing enrolment and profits.
Using large-scale survey data covering more than 110 countries and exploiting within-country variation across cohorts and surveys, we show that individuals with longer exposure to democracy display stronger support for democratic institutions, and that this effect is almost entirely driven by exposure to democracies with successful performance in terms of economic growth, control of corruption, peace and political stability, and public goods provision. Across a variety of specifications, estimation methods, and samples, the results are robust, and the timing and nature of the effects are consistent with our interpretation. We also present suggestive evidence that democratic institutions that receive support from their citizens perform better in the face of negative shocks.
How do innovation and education policy affect individual career choices and aggregate productivity? This paper analyses the effect of R&D subsidies and higher education policy on productivity growth through the supply of innovative talent. We put scarce talent, higher education attainment, and career choice at the centre of a new endogenous growth framework with individual-level heterogeneity in talent, financial resources, and preferences. We link the model to micro-level data from Denmark on the backgrounds of who obtains a PhD and becomes an inventor and the outcomes of a set of policy interventions. We find that R&D subsidies can be strengthened when combined with higher education subsidies, which enable talented but poor youth to pursue a career in research. Education and innovation policies not only alleviate different frictions, but also impact innovation at different time horizons. Education policy is more effective in societies with higher income inequality.
Many studies have documented that the sales concentration of U.S. producers has risen in recent decades. In this article, we show that this increase was accompanied by more entry and growth of foreign competitors. Using confidential census data covering the universe of all firm sales in the U.S. manufacturing sector, we find that rising import competition increased concentration among U.S. firms by reallocating sales from smaller to larger U.S. firms and by causing firm exit. However, this increase in production concentration was counteracted by the expansion of foreign firms, which reduced domestic firms’ share of the U.S. market inclusive of foreign firms’ sales. We find that once the sales of foreign exporters are taken into account, U.S. market concentration in manufacturing was stable between 1992 and 2012.
Meritocracies aspire to reward hard work and promise not to judge individuals by the circumstances into which they were born. However, circumstances often shape the choice to work hard. I show that people’s merit judgments are “shallow” and insensitive to this effect. They hold others responsible for their choices, even if these choices have been shaped by unequal circumstances. In an experiment, U.S. participants judge how much money workers deserve for the effort they exert. Unequal circumstances disadvantage some workers and discourage them from working hard. Nonetheless, participants reward the effort of disadvantaged and advantaged workers identically, regardless of the circumstances under which choices are made. For some participants, this reflects their fundamental view regarding fair rewards. For others, the neglect results from the uncertain counterfactual. They understand that circumstances shape choices but do not correct for this because the counterfactual—what would have happened under equal circumstances—remains uncertain.
This study argues that the decline of coercive labour institutions over the course of industrialization was partly driven by complementarity between physical capital and effective labour in manufacturing. Given the difficulty of extracting labour effort in care-intensive industrial tasks through monitoring and punishment, capital-owning elites ultimately chose to emancipate workers to induce their supply of effective labour and, thus, boost the return to physical capital. This hypothesis is empirically examined in the context of serf emancipation in nineteenth-century Prussia. Exploiting variation in proto-industrialization across Prussian counties, the analysis finds that, consistent with the proposed hypothesis, the initial abundance of elite-owned physical capital is associated with a higher pace of serf emancipation and lower redemption payments to manorial lords.
We study demand estimation in a large auction market. In our model, a dynamically evolving population of buyers with unit demand and heterogeneous and privately known preferences for a finite set of differentiated products compete in a sequence of auctions that occur in discrete time. We define an empirically tractable equilibrium concept in which bidders behave as though they are competing with the stationary distribution of opposing bids, characterize bidding strategies, and prove existence of equilibrium. Having developed this demand system, we prove that it is non-parametrically identified from panel data. We extend the model to consider a random coefficients demand system akin to workhorse demand models in industrial organization, and show that this too is non-parametrically identified. We apply the model to estimate demand and show how large sellers can exercise market power by using persistent reserve price policies, which induce higher bids and, therefore, revenues. Our analysis highlights the importance of both dynamic bidding strategies and panel data sample selection issues when analysing these markets.
The gains from monetary policy cooperation depend on real and financial distortions in the economy and evolve dynamically with prevailing economic conditions. We show that, with international trade in assets, these gains are driven by asymmetric cross-border developments in productivity and savings, and can reach multiples of the cost of economic fluctuations. When financial flows are restricted to nonstate-contingent bonds, the gains from cooperation grow with the size of global imbalances, i.e. net-foreign-asset positions.
We study dynamic signalling when the sender does not see the signals that her actions generate. The sender then uses her past play to forecast what a receiver believes, in turn forcing the receiver to forecast the previous forecast, and so forth. We identify a class of linear-quadratic-Gaussian games where this endogenous higher-order uncertainty can be handled. The sender’s second-order belief is key: it is a private state that she controls, and it creates a new channel for information transmission. We examine the role of higher-order uncertainty and this new signalling channel in applications to macroeconomics, reputation, and trading: inflationary biases under discretion can be larger; career-concerned agents may benefit from not knowing their reputations; and informed trades can carry more price impact. We also introduce an existence method for boundary value problems that can be used in other dynamic games.
The extent to which households can self-insure depends on family structure and wage risk. We calibrate a model of couples and singles’ savings and labour supply under two types of wage processes. The first wage process is the canonical—age-independent, linear—one that is typically used to evaluate government insurance provision. The second wage process is a flexible one. We use our model to evaluate the optimal mix of the two most common types of means-tested benefits—IW versus income floor. The canonical wage process underestimates wage persistence for women and thus implies that IW benefits should account for most benefit income. In contrast, the richer wage process that matches the wage data well, implies that the income floor should be the main benefit source, similarly to the system in place in the U.K. This stresses that allowing for rich wage dynamics is important to properly evaluate policy.
We propose a new sequential Efficient Pseudo-Likelihood (k-EPL) estimator for dynamic discrete choice games of incomplete information. k-EPL considers the joint behaviour of multiple players simultaneously, as opposed to individual responses to other agents’ equilibrium play. This, in addition to reframing the problem from conditional choice probability (CCP) space to value function space, yields a computationally tractable, stable, and efficient estimator. We show that each iteration in the k-EPL sequence is consistent and asymptotically efficient, so the first-order asymptotic properties do not vary across iterations. Furthermore, we show the sequence achieves higher-order equivalence to the finite-sample maximum-likelihood estimator with iteration and that the sequence of estimators converges almost surely to the maximum-likelihood estimator at a nearly superlinear rate when the data are generated by any regular Markov perfect equilibrium, including equilibria that lead to inconsistency of other sequential estimators. When utility is linear in parameters, k-EPL iterations are computationally simple, only requiring that the researcher solve linear systems of equations to generate pseudo-regressors which are used in a static logit/probit regression. Monte Carlo simulations demonstrate the theoretical results and show k-EPL’s good performance in finite samples in both small- and large-scale games, even when the game admits spurious equilibria in addition to one that generated the data. We apply the estimator to analyse competition in the U.S. wholesale club industry.
I model and quantify the impact of a new dimension of globalization: offshore R&D. In the model, firms employ researchers across the globe to develop new product blueprints and then engage in offshore production and exporting. Frictions impeding trade and the separation of production from R&D lead to a “market-access” motive for offshore R&D, while cross-country differences in the distributions of firm knowhow and worker ability generate a “talent-acquisition” motive. I discipline the model using empirical facts derived from a new firm-level dataset. Counterfactual experiments show that the two motives can account for a significant portion of the observed offshore R&D. Incorporating offshore R&D amplifies the gains from globalization by a factor of 1.3 and generates new implications for the impacts of traditional forms of global integration, namely trade and multinational production.
Historically, large changes in U.S. government spending induced fiscal efforts that were not all alike, with some using more progressive taxes than others. We develop a heterogeneous-agent New Keynesian model to analyse how the distribution of taxes across households shapes spending multipliers. The model yields empirically realistic distributions in marginal propensities to consume and labour elasticities, which result in lower responsiveness to tax changes for higher-income earners. In turn, multipliers are larger when spending is financed with higher tax progressivity—that is, when the tax burden falls more heavily on higher-income earners. This result is historically material. We estimate that, on average, tax rates increased more for top-income than for bottom-income earners after a spending shock. Thus, the typical U.S. spending shock was financed with higher tax progressivity. We further exploit the historical variation in the financing of spending to estimate progressivity-dependent multipliers, which we find consistent with the model.
This study presents a new economic perspective on state-building based on a case study in the Democratic Republic of the Congo’s hinterland. We explore the implications for the state of considering rebels as stationary bandits. When the state, through a military operation, made it impossible for rebels to levy taxes, it inadvertently encouraged them to plunder the assets of the very citizens they previously preferred to tax. When it negotiated with rebels instead, this effect was absent, but negotiating compromised the state’s legitimacy and prompted the emergence of new rebels. The findings suggest that attempting to increase taxation by a weak state in the hinterland could come at the expense of safety in the medium term and of the integrity of the state in the long term.
We present a novel algorithm called Dynamic Perturbation for solving large-scale macroeconomic models. Our approach involves computing first-order Taylor expansions of the policy functions along the entire equilibrium path. This method applies to a wide range of models and offers significantly higher accuracy than traditional perturbation approaches. Remarkably, even when utilising first-order approximations, our method can effectively handle models with strong nonlinearities and occasionally binding constraints, such as the zero lower bound.
Interviewing is a decisive stage of most processes that match candidates to firms and organizations. This article studies how and why a candidate’s interview outcome depends on the other candidates interviewed by the same evaluator. We use large-scale data from high-stakes admission and hiring processes, where candidates are quasi-randomly assigned to evaluators and time slots. We find that the individual assessment decreases as the quality of other candidates assigned to the same evaluator increases. The influence of the previous candidate stands out, leading to a negative autocorrelation in evaluators’ votes of up to 40% and distorting final admission and hiring decisions. Our findings are in line with a contrast effect model where evaluators form a benchmark through associative recall. We assess potential changes in the design of interview processes to mitigate contrasting against the previous candidate.
This article studies the problem of optimally allocating treatments in the presence of spillover effects, using information from a (quasi-)experiment. I introduce a method that maximizes the sample analogue of average social welfare when spillovers occur. I construct semi-parametric welfare estimators with known and unknown propensity scores and cast the optimization problem into a mixed-integer linear program, which can be solved using off-the-shelf algorithms. I derive a strong set of guarantees on regret, i.e. the difference between the maximum attainable welfare and the welfare evaluated at the estimated policy. The proposed method presents attractive features for applications: (i) it does not require network information of the target population; (ii) it exploits heterogeneity in treatment effects for targeting individuals; (iii) it does not rely on the correct specification of a particular structural model; and (iv) it accommodates constraints on the policy function. An application for targeting information on social networks illustrates the advantages of the method.