Knowledge that Transforms

This paper proposes a formulation of consumer sovereignty, for use in normative economics, which does not presuppose individuals' preferences to be coherent. The fundamental intuition, that opportunity and responsibility have moral value, is formalized as an “opportunity criterion” for assessing resource allocation systems. A model of an exchange economy is presented in which rational arbitrageurs compete to make profits by trading with nonrational consumers. In equilibrium, this economy satisfies the opportunity criterion. One interpretation of this result is that, in a competitive environment, the overall effects of money pumps are benign, even if individuals' preferences are unstable or incoherent.

Since the emergence of early endogenous growth models (Larry E. Jones and Rodolfo E. Manuelli, 1990; Sergio Rebelo, 1991), a large body of work has studied the growth effects of tax reform. While virtually all of this literature has confined itself to the analysis of flat-rate taxes, tax codes are generally progressive. This paper, therefore, explores the effects of progressive taxes in conventional growth models with heterogenous households. In such frameworks, the tax code helps to determine simultaneously the pre-tax income distribution and the rate of technical progress. We present three main findings. First, we show that when variations in tax codes stem from differences in progressivity, shares of tax revenue in GDP or income may constitute poor proxies for average marginal tax rates. In particular, we find that the decrease in progressivity associated with the Tax Reform Act of 1986 (TRA-86) lowered the U.S. average marginal tax rate by 0.06 to 0.37 percentage points depending on the model used. At the same time, however, the endogenous adjustment in the distribution of income produced by this progressivity change contributed to raising the tax share of income by approximately 0.8 percentage points. Because marginal tax rates are not easily observable, empirical work often has to make use of tax shares in income as an alternative. To the degree that lower marginal rates entail less tax distortion, our study suggests that relying on tax shares may cause less progressive tax codes to be incorrectly perceived as more distortional. Second, we find that the progressivity decrease implied by TRA-86 helped raise U.S. per capita GDP growth by 0.12 to 0.34 percentage points. Given the prominence of TRA-86 compared with other U.S. tax reforms over the past four decades, these growth effects, while not negligible (as in Robert E. Lucas, 1990), shed doubt on the potential for tax policy to alter significantly prospects for U.S. long-run growth. Finally, consistent with previous work, our analysis suggests that the progressivity change associated with TRA-86 had a significant effect on income inequality, resulting in a 20to 24percent increase in the Gini coefficient of income. We carry out our analysis using two prototypical endogenous growth models augmented to include a nondegenerate distribution of income. These models, one first formulated by Robert J. Barro (1990) and the other by Rebelo (1991), account for two polar extremes regarding the use of tax proceeds. On the one hand, in Rebelo’s two-sector framework, tax revenue is spent in a way that affects neither the marginal utility of private consumption nor the production possibilities of the private sector. On the other hand, in the environment envisioned by Barro (1990), all tax revenue serves to finance public services that enhance private production. Interestingly, the results we have just described emerge irrespective of the framework under consideration.

Integrated Longitudinal Employer-Employee Data for the United States by John J. Abowd, John Haltiwanger and Julia Lane. Published in volume 94, issue 2, pages 224-229 of American Economic Review, May 2004

Real Exchange Rate Fluctuations and the Dynamics of Retail Trade Industries on the U. S.-Canada Border by Jeffrey R. Campbell and Beverly Lapham. Published in volume 94, issue 4, pages 1194-1206 of American Economic Review, September 2004

To have one central bank governor address you today may be regarded as a misfortune, but to invite two looks like carelessness! It is a great honour to be invited by this year’s President-Elect, Marty Feldstein, to deliver the Ely lecture. Marty has been my teacher, mentor, colleague and friend for over thirty years, and I never cease to be amazed by the energy and imagination which he devotes to the study of economic problems. I got to know Marty during my time as a Kennedy Scholar at Harvard in 1971. The Kennedy Scholarships form one part of Britain's national memorial to President Kennedy. The other part is an acre of land, now American territory, at Runnymede. At the ceremony to open the Runnymede memorial in 1965, Prime Minister Harold Wilson remarked about President Kennedy that "his eyes were on the horizon, but his feet were on the ground”. Almost thirty years earlier Richard T. Ely published his autobiography entitled "Ground under Our Feet". Whereas I found the experience of coming from Europe to the United States intellectually liberating and exhilarating, a hundred years earlier Ely found academic freedom by making the reverse journey. As

This paper presents the tale of a replication experiment. The main characters are operating systems, Hessians, scaling, double-peaked likelihoods, and the limits of PC computing. Some of these characters, especially the Hessians, looked scary at first, but turned out to be sheep in wolves’ clothing. In other words, the story has a happy ending. To appreciate the twists and turns, we go back and start at the beginning. Once upon a time, indeed, in the June 2003 issue of the AER, B. D. McCullough and H. D. Vinod (2003; “MV” hereafter) set out to test the AER replication policy. While many AER authors were invited to participate in this replication event, few answered the call. We did. MV singled out our cooperation and honoring of the AER replication policy. MV replicated the results in our 1999 AER paper (Shachar and Nalebuff, 1999). You might have expected that we would be happy. But we were not. MV were concerned not only with replication but also with reliability of nonlinear estimation procedures. Specifically, they were concerned that nonlinear solvers can produce inaccurate answers. They believe that this is a systemic problem with empirical research in economics. Thus, they proposed a four-step method to verify the solution from a nonlinear solver. Using data from our paper to illustrate their point they conclude (referring to our 1999 article as “SN”):

This paper considers the problem of how to construct and reconcile price indexes across space and time. A general taxonomy of panel price index methods, containing four broad classes, is proposed, along with five criteria for discriminating between them. Methods from each of the four classes are then used to compute spatial and temporal price indexes for the 15 countries of the European Union (EU) over the period 1995–2000. Using these panel price indexes, I test whether or not price levels and relative prices converged across the EU over this period.

The Canada-U.S. Free Trade Agreement provides a unique window onto the effects of a reciprocal trade agreement on an industrialized economy (Canada). For industries that experienced the deepest Canadian tariff cuts, the contraction of low-productivity plants reduced employment by 12 percent while raising industry-level labor productivity by 15 percent. For industries that experienced the largest U.S. tariff cuts, plant-level labor productivity soared by 14 percent. These results highlight the conflict between those who bore the short-run adjustment costs (displaced workers and struggling plants) and those who are garnering the long-run gains (consumers and efficient plants).

Taken from page 76 -- "The specter of a “liquidity trap,” originally proposed as a theoretical possibility by John Maynard Keynes (1936) but long considered to be of doubtful practical relevance, has recently created alarm among the world’s central banks. In Japan, the overnight rate has been essentially at zero for most of the time since February 1999, making further interest-rate cuts impossible. Yet until well into 2003, growth remained anemic while prices continued to fall, suggesting a need for further monetary stimulus. Since March 2001, the Bank of Japan has supplemented its “zero-interest-rate policy” with a policy of “quantitative easing,” under which additional bank reserves are supplied beyond those needed to keep overnight interest rates at zero. Yet an increase in base money of more than 50 percent failed to halt the deflation, suggesting a liquidity trap. More recently, other central banks, including the Fed, have come close enough to the zero bound to worry about how they would deal with a similar predicament. Here we first discuss whether monetary policy should actually become ineffective when the zero bound on interest rates is reached. We argue that open-market operations, even of “unconventional” types, will be ineffective if they do not change expectations about the future conduct of policy; in this sense, a liquidity trap is possible. Nonetheless, a credible commitment regarding future policy can largely mitigate the distortions created by the zero bound. We fully characterize the optimal commitment in a simple example."