Knowledge that Transforms

We use a model of boundedly rational learning to account for the observations of recurrent hyperinflations in the 1980’s. In a standard monetary model we replace the assumption of full rational expectations by a formal definition of quasi-rational learning. The model under learning matches some crucial stylized facts observed during the recurrent hyperinflations experienced by several countries in the 1980’s remarkably well. We argue that, despite being a small departure from rational expectations, quasi-rational learning does not preclude falsifiability of the model, it does not violate reasonable rationality requirements, and it can be used for policy evaluation.

We develop a new theoretical link between inequality and growth. In our model, fertility and education decisions are interdependent. Poor parents decide to have many children and invest little in education. A mean-preserving spread in the income distribution increases the fertility differential between the rich and the poor, which implies that more weight gets placed on families who provide little education. Consequently, an increase in inequality lowers average education and, therefore, growth. We find that this fertility-differential effect accounts for most of the empirical relationship between inequality and growth.

Using a comprehensive data set of Portuguese manufacturing firms, we show that the firm size distribution is significantly right-skewed, evolving over time toward a lognormal distribution. We also show that selection accounts for very little of this evolution. Instead, we propose a simple theory based on financing constraints. A calibrated version of our model does a good job at explaining the evolution of the firm size distribution.

We assemble bank-level and other data for Fed member banks to model determinants of bank failure. Fundamentals explain bank failure risk well. The first two Friedman-Schwartz crises are not associated with positive unexplained residual failure risk, or increased importance of bank illiquidity for forecasting failure. The third Friedman-Schwartz crisis is more ambiguous, but increased residual failure risk is small in the aggregate. The final crisis (early 1933) saw a large unexplained increase in bank failure risk. Local contagion and illiquidity may have played a role in pre-1933 bank failures, even though those effects were not large in their aggregate impact.

Of the ten million children in the United States who lacked health insurance in 1996, an estimated 4.7 million were eligible for Medicaid but not enrolled (Thomas Selden et al., 1998). In response, federal and state governments have recently devoted up to $500 million annually to the development of outreach campaigns to increase take-up among those eligible. However, little is known about the reasons families fail to enroll, how to increase enrollment, or whether outreach can work. There is also no evidence that early enrollment in Medicaid improves outcomes. Children in need of hospitalization who are eligible for Medicaid but not enrolled are typically enrolled in Medicaid at the point of hospitalization. In addition, estimation of the impact of early enrollment in Medicaid on health-care utilization and child health is hindered by the endogeneity of the enrollment decision: children in greater need of medical care are more likely to enroll. Thus, straightforward estimation of the impact of Medicaid enrollment on child health will underestimate the effect of Medicaid enrollment on health. I examine both the causes and consequences of low take-up in Medicaid using data on Medicaid enrollment in California from 1996 to 2000 and the timing and placement of communitybased application assistants that were part of an outreach campaign launched in mid-1998. I � nd the most profound effects of outreach on those with the highest costs of enrolling: Hispanic and Asian children, who have greater language and immigration concerns than other families. Access to bilingual application assistants increases new monthly Medicaid enrollment among Hispanics by 4.6 percent and among Asian children by 6 percent on average relative to other children in the same neighborhood.

Economists have long observed that crowding out of government grants to private charities is incomplete. The accepted belief is that givers treat the grants as imperfect substitutes for private giving. We theoretically and empirically investigate a second reason: the strategic response of a charity will be to reduce fund-raising efforts after receiving a grant. Employing panel data from arts and social service organizations, we find that government grants cause significant reductions in fund-raising. This adds a new dimension to the policy discussions—analysts should account for the behavioral responses of the charity, as well as the donors, to government grants.

The ultimatum game, by its all-or-nothing nature, makes it difficult to discern what kind of preferences may be generating choices. We explore a game that convexifies the decisions, allowing us a better look at the indifference curves of bargainers while maintaining the subgame-perfect equilibrium. We conclude that bargainers' preferences are convex and regular but not always monotonic. Money-maximization is the sole concern for about half of the subjects, while the other half reveal a preference for fairness. We also found, unexpectedly, the importance of risk aversion among money-maximizing proposers, which in turn generates significant bargaining power for fair-minded responders.

Data from recent years indicate that employers are especially unlikely to cut the nominal wage rate paid for a job. Adjustments to real or relative wages that require absolute cuts in money wages are very rare, relative to the frequency one might expect to observe based on distributions of wage changes that do not require money wage cuts (Erica L. Groshen and Mark E. Schweitzer, 1995, 1997; David E. Lebow et al., 1999). A worker who remains with the same employer from one year to the next is accordingly unlikely to report an absolute reduction in the nominal wage he receives (David Card and Dean Hyslop, 1997; Shulamit Kahn, 1997; Joseph G. Altonji and Paul J. Devereux, 1999). The existence and causes of “downward nominal wage rigidity” have implications for macroeconomic outcomes and for practical issues in monetary policy. Presumably, efficient operation of labor markets requires many downward adjustments of relative wages, and occasional decreases in the overall wage level relative to product prices. If the average rate of wage inflation were close to zero, some of these relative or real wage adjustments would be blocked by a floor under current levels of nominal wage rates. George A. Akerlof et al. (1996) assert that downward nominal wage rigidity reflects fundamental preferences of workers, and argue that it implies a central bank should target a rate of price inflation greater than zero because “a target of zero inflation will impose permanent real costs on the economy” (p. 2). The notion that downward nominal wage rigidity is a fundamental constraint, so that inflation serves to “grease the wheels of the labor market,” is controversial even among those who accept the possibility of nominal rigidities in general. It has been argued that downward nominal wage rigidity, as distinct from such phenomena as “menu costs” [which would discourage adjustment of a wage in either direction (David Romer, 1993)], may be an artifact of an inflationary monetary regime, and would disappear in the absence of persistent inflation. “Nominal wage reductions would no longer be seen as unusual if the average nominal wage was not growing. Workers would not see them as unfair, and firms would not shy away from imposing them” (Robert J. Gordon, 1996, p. 62; see also N. Gregory Mankiw, 1996; William Poole, 1998; William B. English, 2000). To see whether downward nominal wage rigidity would exist in a noninflationary regime, it may be useful to examine data from times and places where there was no persistent wage inflation. For the United States, at least, that excludes data from years since the Second World War: throughout the postwar period, price inflation or real wage growth has been sufficient to keep average wage inflation above zero. Before the Second World War, on the other hand, long-run trend rates of price inflation were often close to zero or negative (Robert B. Barsky, 1987). If wage inflation was correspondingly low, U.S. historical data may offer tests of the proposition that downward nominal wage rigidity exists even in noninflationary