Knowledge that Transforms

Financial crises are often preceded by peri ods of credit expansion during which firms and households become increasingly vulnerable to a reversal in economic conditions. When eco nomic conditions actually worsen, financing constraints become tighter, causing a deeper contraction of economic activity. These events have led to policy proposals for preventing excessive borrowing during “normal times.” If rational agents evaluate financing decisions from a privately optimal standpoint, why would the debt level not be socially efficient? The theoretical literature has offered an answer to this question based on a pecuniary externality that arises due to the presence of financial frictions: private agents tend to under value net worth during a period of financial distress because they fail to internalize the fact that additional net worth would have positive spillovers on other agents’ balance sheets. 1 As a result, private agents borrow excessively. The quantitative implications of these “credit exter nalities,” however, remain largely unknown. In particular, these key questions have not been addressed:

Asset price movements in many cases seem de-linked from aggregate economic fundamentals. Forexample, RaviBansal andIvanShaliastovich (2008a) show that frequent large moves in asset prices, i.e. jumps, on average are not correlated with movements in macro-variables (see Table 1 below). Motivated by this, we present a general equilibrium model in which variation in investor confidence about expected growth determines risk premia and hence asset prices. This confidence risk channel can account for (i) the lack of connection between large asset-price moves and macro-variables such as consumption, (ii)large declinesinassetprices, thatis, the left tail of the return distribution, and (iii) observed predictability of equity returns and consumption growth by the price to dividend ratio. In essence, we present a model in which behaviorally motivated shifts in expectations play an important role for the asset prices. Our economy set-up follows a standard longrun risks specification of Ravi Bansal and Amir Yaron (2004), and features Gaussian consumption growth process with time-varying expected growth and volatility; there are no large moves orjumpsintheunderlyingconsumptionanddividenddynamics. Expectedgrowth isnotdirectly observable, and investors learn about it using the cross-section of signals. The time-varying cross-sectional varianceof thesignals determines the quality of the information, and therefore the confidence that investors place in their growth forecast. In the long-run risks framework, the fluctuations in confidence risk determines risk premia and asset prices. We model investors as being recency-biased in their expectation formation, that is, they overweigh recent observations as in Werner De Bondt and Richard Thaler (1990). This is important, as in the standard Kalman-Filter based expectation formation, periods of low information quality get down-weighted, which diminishes the role of the confidence risk channel.

This paper presents a general analysis of the effects of monopolistic third-degree price discrimination on welfare and output when all markets are served. Sufficient conditions—involving straightforward comparisons of the curvatures of the direct and inverse demand functions in the different markets—are presented for discrimination to have negative or positive effects on social welfare and output.

Optimal Auction Design and Equilibrium Selection in Sponsored Search Auctions by Benjamin Edelman and Michael Schwarz. Published in volume 100, issue 2, pages 597-602 of American Economic Review, May 2010

Aggregate economies of scale are the engine of growth in models with quasi-endogenous research: larger populations are linked to a higher stock of non-rival ideas (see Jones, 1995; Kortum, 1997; Eaton and Kortum, 2001). Thus, growth rates of per capita real output are proportional to population growth rates, gy = ε · gL, where the parameter ɛ is the efficiency-size elasticity.

This paper examines the frequency, pervasiveness, and determinants of product switching by US manufacturing firms. We find that one-half of firms alter their mix of five-digit SIC products every five years, that product switching is correlated with both firm- and firm-product attributes, and that product adding and dropping induce large changes in firm scope. The behavior we observe is consistent with a natural generalization of existing theories of industry dynamics that incorporates endogenous product selection within firms. Our findings suggest that product switching contributes to a reallocation of resources within firms toward their most efficient use.

This is a submitted manuscript of an article published by the American Economic Association in the American Economic Review.

In 2002, I estimate that US artists, studios and publishers produced artistic originals worth $65.1 billion. By category, production was $9.8 billion in theatrical movies, $7.6 billion in original songs and recordings, $7.1 billion in original books, $35.6 billion in long-lived television programs and $5 billion in miscellaneous artwork. My research on television programs and miscellaneous artwork is still incomplete, so those numbers could change significantly in the final paper. The cost of producing this $65.1 billion in original artwork could be treated either as a current expense (method 1) or a capital investment (method 2). Under method 1, artistic production costs are treated as intermediate inputs in the same way as advertising costs, manufacturing costs and shipping costs. Final revenue from sales or rentals to households of reproductions of artistic originals is all that matters for measuring gross domestic product (GDP). This is the method BEA currently uses for artistic originals. On the other hand, under method 2, artistic production costs are treated as private investment and added to the pre-existing capital stock of artistic originals to get the total capital stock of artwork. This capital stock of copyrighted artwork then earns money

Integration of global financial markets was supposed to lead to greater financial stability, as risks were spread around the world. The finan cial crisis has thrown doubt on this conclusion. A failure in one part of the global economic system caused a global “meltdown.” The recent crisis has shown that in the absence of appro priate government intervention, privately profit able transactions may lead to systemic risk. This paper provides a general analytic framework within which we can analyze the optimal degree (and form) of financial integration. Within this general framework, full integration is not in general optimal. Indeed, faced with a choice between two polar regimes, full integration or autarky, in the simplified model autarky may be superior.