Knowledge that Transforms

We use data from the Panel Study of Income Dynamics to investigate how households' portfolio allocations change in response to wealth fluctuations. Persistent habits, consumption commitments, and subsistence levels can generate time-varying risk aversion with the consequence that when the level of liquid wealth changes, the proportion a household invests in risky assets should also change in the same direction. In contrast, our analysis shows that the share of liquid assets that households invest in risky assets is not affected by wealth changes. Instead, one of the major drivers of household portfolio allocation seems to be inertia: households rebalance only very slowly following inflows and outflows or capital gains and losses.

Why Don’t People Insure Late-Life Consumption? A Framing Explanation of the Under-Annuitization Puzzle by Jeffrey R. Brown, Jeffrey R. Kling, Sendhil Mullainathan and Marian V. Wrobel. Published in volume 98, issue 2, pages 304-09 of American Economic Review, May 2008

The theory of mechanism design can be thought of as the “engineering” side of economic theory. Much theoretical work, of course, focuses on existing economic institutions. The theorist wants to explain or forecast the economic or social outcomes that these institutions generate. But in mechanism design theory the direction of inquiry is reversed. We begin by identifying our desired outcome or social goal. We then ask whether or not an appropriate institution (mechanism) could be designed to attain that goal. If the answer is yes, then we want to know what form that mechanism might take. In this paper, I offer a brief introduction to the part of mechanism design called implementation theory, which, given a social goal, characterizes when we can design a mechanism whose predicted outcomes (i.e., the set of equilibrium outcomes) coincide with the desirable outcomes, according to that goal. I try to keep technicalities to a minimum, and usually confine them to footnotes.

The European Economic and Monetary Union (EMU) has created a new economic area, larger and closer with respect to the rest of the world. Area-specifi cs hocks are thus more important in EMU than country-specific shocks used to be in the previous states, e.g. in Germany. It is thus not surprising that the models used to determine optimal monetary policy in the Euro area (for instance Smets and Wouters, 2004, ) assume that this works essentially as a closed economy, hit by domestic shocks– i.e. the same assumption made in standard models of U.S. monetary policy (see e.g. Christiano et al., 1999 ), where all shocks are domestic with the only possible exception of energy price shocks. This paper studies monetary policy in the Euro area looking at the variable most directly related to current and expected monetary policy, the yield on long term government bonds. We explore how the behaviour of European long-term rates has been affected by EMU and whether the response of long-term rates to monetary policy has got any closer to that consistent with a closed economy. We find that the level of long-term rates in Europe is almost entirely explained by U.S. shocks and by the systematic response of U.S. and European variables to these shocks. The systematic component of European monetary policy responds to U.S. variables more than it does to local variables. This was true for the Bundesbank before EMU and remains true for the ECB since the start of EMU. We also find that unpredictable fluctuations in long-term rates are driven by shocks to term premia,.not to monetary policy. This means that the ECB can affect long rates only through the systematic component of its monetary policy–which, as we have seen, mostly responds to U.S. variables. Monetary policy ”shocks” induced by the ECB have virtually no effect on long rates. Claiming that monetary policy in the Euro area can be determined as if the region were a closed economy is thus not consistent with the empirical evidence on

Does the Secondary Life Insurance Market Threaten Dynamic Insurance? by Glenn Daily, Igal Hendel and Alessandro Lizzeri. Published in volume 98, issue 2, pages 151-56 of American Economic Review, May 2008

The introduction of the precious metals for the purposes of money may with truth be considered as one of the most important steps towards the improvement of commerce, and the arts of civilised life; but it is no less true that, with the advancement of knowledge and science, we discover that it would be another improvement to banish them again from the employment to which, during a less enlightened period, they had been so advantageously applied. —David Ricardo (1816)

This paper provides the first real-world evidence of Giffen behavior, i.e., upward sloping demand. Subsidizing the prices of dietary staples for extremely poor households in two provinces of China, we find strong evidence of Giffen behavior for rice in Hunan, and weaker evidence for wheat in Gansu. The data provide new insight into the consumption behavior of the poor, who act as though maximizing utility subject to subsistence concerns. We find that their elasticity of demand depends significantly, and nonlinearly, on the severity of their poverty. Understanding this heterogeneity is important for the effective design of welfare programs for the poor.

The utility of homeownership as a household wealth-building vehicle has long been recognized. In recent years, homeownership has been promoted as an important strategy for improving the financial situation of lowand moderateincome households. However, this strategy does not come without its risks, as homeownership exposes households to potential troubles along multiple dimensions. This paper highlights the conditions under which a homeownership strategy is likely to be effective. A key contribution is its significant focus on the risks of homeownership, which are assessed by studying the distribution of foreclosure across neighborhoods. According to the Current Population Survey (CPS), between 1994 and 2006, homeownership rates among households in the first and second income quartiles increased by 11.1 and 12.9 percent, respectively. This exceeded the 10.3 percent increase observed for the general population and was due in part to several factors. First, income, education, and wealth for lowand moderate-income households all increased significantly over this period (Arthur B. Kennickell 2006), which increased the accesAssets And Credit Among Low-inCome HouseHoLds †

For over three centuries and across the globe, lottery-linked savings (LLS) programs have offered individuals the opportunity to save, and in lieu of paying traditional interest, have given savers periodic chances to win money or prizes. Despite their long history, LLS programs are relatively unstudied by scholars. In this paper, I detail an LLS program that the UK government has offered continuously since 1956, the UK Premium Bond (PB) program. PBs guarantee holders risk-free return of nominal principal. In aggregate, they pay a market-related return, distributed to holders each month by a lottery like mechanism. Premium bonds are popular savings vehicles in the UK. Over £31.1 billion of PBs were outstanding as of March 2006, and public reports suggest that they were held by between 22 percent and 40 percent of UK citizens. The 60.2 million residents of the UK had £517 invested in PBs per capita. If held in the banking sector, PB holdings would have accounted for 3.9 percent of household sterling deposits in UK financial institutions. LLS programs, such as PBs, are fascinating not just because of their size, but because of their appeal to nonsavers, especially low-income families. Mauro Guillen and Adrian Tschoegl (2002, reviewing LLS programs in Latin America, concluded: “The bankers we spoke with believe that [LLS] are especially successful with low income depositors, and in cases where there are lots of people outside the banking system.” In South Africa, a new LLS program raised over 1.2 billion rand and enrolled 750,000 participants across a wide spectrum of the economy in two years. In the United Kingdom, while PBs are held by about the same fraction of the population holding stocks, PBs have a stronger appeal to lower-income British households. PBs are held by a larger fraction of British households than are stocks and shares for all households, except those earning over £52,000 annually (Department for Work and Pensions 2007). Are PB holders saving, gambling, or engaging in both activities? This question is not just academic, because national laws and regulations in many countries bar private LLS programs on the basis that they are prohibited gambling activities. For example, in South Africa, the government has tried to shut down the popular LLS program mentioned above; in the United States, these programs would violate state lottery laws and federal banking regulations. In this paper, I analyze the time series of net sales of the PB program and conclude that the program appears to be a hybrid of gambling and savings, but with a clear savings element.

There is considerable evidence that producer-level churning contributes substantially to aggregate (industry) productivity growth, as more productive businesses displace less productive ones. However, this research has been limited by the fact that producer-level prices are typically unobserved; thus within-industry price differences are embodied in productivity measures. If prices reflect idiosyncratic demand or market power shifts, high "productivity" businesses may not be particularly efficient, and the literature's findings might be better interpreted as evidence of entering businesses displacing less profitable, but not necessarily less productive, exiting businesses. In this paper, we investigate the nature of selection and productivity growth using data from industries where we observe producer-level quantities and prices separately. We show there are important differences between revenue and physical productivity. A key dissimilarity is that physical productivity is inversely correlated with plant-level prices while revenue productivity is positively correlated with prices. This implies that previous work linking (revenue-based) productivity to survival has confounded the separate and opposing effects of technical efficiency and demand on survival, understating the true impacts of both. We further show that young producers charge lower prices than incumbents, and as such the literature understates the productivity advantage of new producers and the contribution of entry to aggregate productivity growth.