Knowledge that Transforms

Much of what has been written about the process of economic development has concentrated on macroeconomic factors that affect the growth process, such as the community’s savings rate, its ability to attract foreign investment, and the composition and quality of its factor-endowment base. Less formally dealt with, but nonetheless often cited as important in the development process, is the nature of government regulations and the type of institutions that are reflective of the community’s own cultural inheritance…

The Importance of Noncognitive Skills: Lessons from the GED Testing Program by James J. Heckman and Yona Rubinstein. Published in volume 91, issue 2, pages 145-149 of American Economic Review, May 2001

Prior to the Tax Reform Act of 1986 (TRA 86), interest paid on all types of household debt was deductible from income before the payment of taxes. In 1986, Congress changed the law to phase out the deductibility of interest over a five-year period.' Congress believed deductibility of interest an incentive to invest in durables rather than assets which produce taxable income and, therefore, an incentive to consume rather than save.... By phasing out the present deductibility of personal Congress intended to eliminate from the prior tax law a significant disincentive to (Joint Committee on Taxation [JCT], 1987 p. 263). The other goal of the provision was to raise $9.6 billion per year in tax revenue by 1991. Because Congress determined that encouraging home ownership is an important policy goal, achieved in part by providing a deduction for residential mortgage interest, it chose to retain the residential mortgage interest deduction (JCT, 1987 pp. 263-64). Thus, mortgage interest was fully deductible for interest paid on debt secured by a taxpayer's first or second residence up to his basis in the residence. The Omnibus Budget Reconciliation Act of 1987 (OBRA 87) changed the law so that interest paid was fully deductible on up to $1 million in acquisition debt and $100,000 in home equity debt.2 Debt is categorized as acquisition debt if it is used for the purchase or improvement of a home; home equity debt includes all other debt secured by a home. By keeping the mortgage interest deduction, Congress may have provided a loophole that some taxpayers could exploit. There was no restriction on the use of home equity debt, and taxpayers who owned homes could borrow against their home equity to pay for the same purchases they had previously funded with loans. Homeowners were given an incentive to shuffle their portfolios away from debt into mortgage debt. The widespread introduction of home equity lines of credit in the mid-1980's, which may have been spurred in part by the change in tax law, provided an inexpensive and flexible method for households to make this shift.3 Measuring the extent of portfolio shuffling is important for understanding whether households view mortgage and debt as close substitutes. Clearly the substitution of mortgage debt for debt undermines the goals of Congress to boost saving and increase revenue. Moreover, homeowners already have substantial tax preferences through the lack of taxes on the imputed income from housing and the preferential tax treatment of capital gains on their principal residence. The ability to use deductible mortgage debt to finance purchases provides homeowners another tax advantage relative to renters. Figure 1 plots the percentage change in * Putnam Investments, One Post Office Square, Bos on, MA 02109 (e-mail: [email protected]). This paper was completed while I was on the staff of the Board of Governors of the Federal Reserve System. Financial support from the Stanford Institute for Economic Policy Research and the Lynde and Harry Bradley Foundation is gratefully acknowledged. I would like to thank John Shoven, Orazio Attanasio, John Pencavel, Tim Bresnahan, Anne Royalty, Doug Bernheim, Al Teplin, Craig Furfine, Martha StarrMcCluer, Raphael Bostic, Len Burman, Julia Coronado, two anonymous referees, seminar participants, and the Financial Institutions Research Review Group for helpful comments. The views expressed in this paper are those of the author and do not necessarily reflect the views of Putnam Investments or the Federal Reserve Board or its staff. 1 In this paper, consumer interest refers to interest paid on loans that are not secured by a residence. 2 Under TRA 86, interest paid on qualified educational and medical debt secured by a home was also deductible, even if this debt exceeded the household's basis. This provision was not renewed in OBRA 87. Under OBRA 87, home equity debt also could not exceed the difference between the fair market value of the home and the amount of acquisition debt, even if this difference was less than $100,000. 3 Of course, homeowners can also increase their mortgage debt by taking out a traditional home equity loan, by taking cash out when refinancing their mortgage, or by taking out a larger mortgage when they Durchase a home.

Monetary Instability, the Predictability of Prices, and the Allocation of Investment: An Empirical Investigation Using U.K. Panel Data by Paul Beaudry, Mustafa Caglayan and Fabio Schiantarelli. Published in volume 91, issue 3, pages 648-662 of American Economic Review, June 2001

Growth economists have spent more than forty years slowing chipping away at the Solow residual, largely by attributing increasingly larger chunks of it to investment in human capital. A few years ago we were reasonably certain that this was the way to go. But an increasing number of studies seem to be telling us that the effect of schooling variables on productivity vanishes when we turn to what seem to be the appropriate econometric techniques for the purpose of estimating growth equations. Should we take these results at face value? Before we do so and abandon the only workable models we have, it seems sensible to search for ways to reconcile recent empirical findings with some kind of plausible theory. In this paper we argue that we can make a fair amount of progress in this direction by combining two ingredients: better data on human capital, and a further extension of the human capital-augmented neoclassical model that allows for cross-country productivity differentials and for technological diffusion.

Between 1973 and 1978, the Indonesian government engaged in one of the largest school construction programs on record. Combining differences across regions in the number of schools constructed with differences across cohorts induced by the timing of the program suggests that each primary school constructed per 1,000 children led to an average increase of 0.12 to 0.19 years of education, as well as a 1.5 to 2.7 percent increase in wages. This implies estimates of economic returns to education ranging from 6.8 to 10.6 percent.

The fiscal theory of price determination suggests that if primary surpluses evolve independently of government debt, the equilibrium price level “jumps” to assure fiscal solvency. In this non-Ricardian regime, fiscal policy—not monetary policy—provides the nominal anchor. Alternatively, in a Ricardian regime, primary surpluses are expected to respond to debt in a way that assures fiscal solvency, and the price level is determined in conventional ways. This paper argues that Ricardian regimes are as theoretically plausible as non-Ricardian regimes, and provide a more plausible interpretation of certain aspects of the postwar U.S. data than do non-Ricardian regimes.

A Test of Game-Theoretic and Behavioral Models of Play in Exchange and Insurance Environments by Cary A. Deck. Published in volume 91, issue 5, pages 1546-1555 of American Economic Review, December 2001

International Trade and Business Cycles: Is Vertical Specialization the Missing Link? by M. Ayhan Kose and Kei-Mu Yi. Published in volume 91, issue 2, pages 371-375 of American Economic Review, May 2001

This paper focuses on pure redistribution among two regional governments. We abstract from mobility of tax bases and externalities in public goods not because they are unimportant, but because they are already well understood. Under conditions of full information, unlimited commitment capacity, and no spillover effects across regions, optimal redistribution is lump sum But these ideal circumstances are seldom met. One of the central results of the paper is that, to cope with asymmetric information, optimal regional redistribution must distort the tax rate chosen by the poor region away from the second best.