Knowledge that Transforms

An Ascending Auction for Interdependent Values: Uniqueness and Robustness to Strategic Uncertainty by Dirk Bergemann and Stephen Morris. Published in volume 97, issue 2, pages 125-130 of American Economic Review, May 2007

Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macroeconomic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model, we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the “Great Moderation”?

Neuroeconomic Studies of Impulsivity: Now or Just as Soon as Possible? by Paul William Glimcher, Joseph Kable and Kenway Louie. Published in volume 97, issue 2, pages 142-147 of American Economic Review, May 2007

This paper offers a simple approach to the theory of decentralizing inventory and pricing decisions along a supply chain. We consider an upstream manufacturer selling to two outlets, which compete as differentiated duopolists and face uncertain demand. Demand spillovers between the outlets arise in the event of stockouts. The price mechanism, in which each outlet pays a two-part price and chooses price and inventory, virtually never coordinates incentives efficiently. Contracts that can elicit first-best decisions include resale price floors or buy-back policies (retailer-held options to sell inventory back to the manufacturers).

We develop a structural econometric model to estimate risk preferences from data on deductible choices in auto insurance contracts. We account for adverse selection by modeling unobserved heterogeneity in both risk (claim rate) and risk aversion. We find large and skewed heterogeneity in risk attitudes. In addition, women are more risk averse than men, risk aversion exhibits a U-shape with respect to age, and proxies for income and wealth are positively associated with absolute risk aversion. Finally, unobserved heterogeneity in risk aversion is greater than that of risk, and, as we illustrate, has important implications for insurance pricing.

Systematic asymmetries in exchange behavior have been widely interpreted as support for “endowment effect theory,” an application of prospect theory positing that loss aversion and utility function kinks set by entitlements explain observed asymmetries. We experimentally test an alternative explanation, namely, that asymmetries are explained by classical preference theories finding influence through the experimental procedures typically used. Contrary to the predictions of endowment effect theory, we observe no asymmetries when we modify procedures to remove the influence of classical preference theories. When we return to traditional-type procedures, however, the asymmetries reappear. The results support explanations based in classical preference theories and reject endowment effect theory.

This paper argues that UK WWI fiscal policy followed the ‘English method’identified by Sprague (1917) and his discussants, and revived by the US tofinance the Korean War (see Ohanian 1997). During WWI, UK fiscal policyadopted the “McKenna rule” named for Reginald McKenna, Chancellor ofthe Exchequer (1915-16). McKenna presented his fiscal rule to Parliamentin June 1915. The McKenna rule guided UK fiscal policy for the rest ofWWI and the interwar period. We draw on narrative evidence to show thatmotivation for the McKenna rule came from a desire to treat labour and cap-ital fairly and equitably, not pass WWI costs onto future generations, andcommit to a debt retirement path and higher taxes. However, a permanentincome model suggests the McKenna rule adversely affected the UK becausea higher debt retirement rate produces a lower consumption-output ratio.Data from 1916-37 supports this prediction. ∗ The views in this paper represent those of the authors and are not necessarily those ofthe Federal Reserve Bank of Atlanta, the Federal Reserve System, the Reserve Bankof New Zealand, Norges Bank, or their respective staffs. We thank Ellis Tallman formany useful comments and Kateryna Rakowsky for research assistance. A version ofthis paper is forthcoming in the Papers and Proceedings of the American EconomicReview.

Inexperienced women, along with economics and business majors, are much more susceptible to the winner’s curse, as are subjects with lower SAT/ACT scores. There are strong selection effects in bid function estimates for inexperienced and experienced subjects due to bankruptcies and bidders who have lower earnings returning less frequently as experienced subjects. These selection effects are not identified using standard econometric techniques but are identified through experimental treatment effects. Ignoring these selection effects leads to misleading estimates of learning.

This paper studies the problem of allocating a good between two players in each period of an infinite-horizon game. The players' valuations in each period are private information, and the valuations change over time. We analyze two special cases for the dynamics of valuations: correlated where players' valuations are exogenous but serially correlated; and learning by doing, where a player's past consumption improves his current distribution of valuations, but his valuations are otherwise uncorrelated. We analyze conditions under which there exists an efficient, Bayesian incentive-compatible (BIC), individually rational (IR), budget-balanced (BB) mechanism, when the mechanism designer has commitment power. We consider

In developing countries lacking legal enforcement, villagers may use implicit contracts to minimize crime. I construct a dynamic limited-commitment model, in which a thief cannot commit to forego stealing, but is induced to steal less by the promise of future gifts. Combining survey data on production, theft, gifts, and trust with experiments measuring trustworthiness, I provide supporting evidence. Farmers living near more relatives or with plots that are difficult to steal from give fewer gifts and trust more, and those living near more relatives also experience less theft. Giving increases when trust is lower and the threat of theft is greater.