Knowledge that Transforms

Martin Feldstein:1 Chairman Alan Greenspan's remarks today give us an opportunity to understand his thinking about monetary policy and about the Federal Reserve's actions during the past 15 years. It was a period of substantial accomplishment that no doubt reflects in considerable measure the views of the Chairman himself. The Fed's primary goal, price stability, has been achieved, with inflation down from 4 percent at the end of the 1980's to about 1.5 percent now. The 2-percentage-point difference between the interest rate on conventional Treasury bonds and on inflation-indexed bonds (TIPS) shows that financial markets expect inflation will remain at about 2 percent for at least the next decade.

In the now-classical real options theory, the price of an underlying asset is modeled as a geometric Brownian motion, and optimal exercise strategies are described by simple explicit formulas. This paper extends the classical theory to allow any geometric Lévy process to model prices. Such processes may account for fat tails and skewness of probability distributions of commodity prices. The optimal exercise strategies are specified in the paper in terms of statistics of record-setting low or high prices. The formulas derived extend those observed in the Gaussian case, but the form of the result is novel even for that case.

This paper studies the matching of opportunities with talent when costly diagnosis confers an informational advantage to the agent undertaking it. When this agent is underqualified, adverse selection prevents efficient referrals through fixed-price contracts. Spot-market contracts that rely on income sharing can match opportunities with talent but induce a team-production problem which, if severe enough, can prevent the referral of valuable opportunities. Partnership contracts, in which agents agree in advance to the allocation of opportunities and of the revenues they generate, support referrals where the market cannot, but often at the expense of distortions on those opportunities that are not referred.

Opportunism in Multilateral Vertical Contracting: Nondiscrimination, Exclusivity, and Uniformity: Reply by R. Preston McAfee and Marius Schwartz. Published in volume 94, issue 3, pages 802-803 of American Economic Review, June 2004

Examining the Role of Social Isolation on Stated Preferences by John A. List, Robert P. Berrens, Alok K. Bohara and Joe Kerkvliet. Published in volume 94, issue 3, pages 741-752 of American Economic Review, June 2004

In Burnside and Dollar (2000) we used standard regression techniques from the growth literature to measure the effect of foreign aid on growth. The main finding in our paper was that the effect of foreign aid on growth depended on the macroeconomic policies of recipient countries. In this issue, William Easterly et al. (2004), challenge the robustness of our result to new data. Before commenting on their findings it is useful to review the basis of our original findings. Our paper focused on three versions of a panel growth regression, estimated using data for 51 countries, and six four-year periods, from 1970 to 1993. These regressions may be summarized as:

Optimal incentive mechanisms may require that agents are rewarded differentially even when they are completely identical and are induced to act the same. We demonstrate this point by means of a simple incentive model where agents’ decisions about effort exertion is mapped into a probability that the project will succeed. We give necessary and sufficient conditions for optimal incentive mechanisms to be discriminatory. We also show that full discrimination across all agents is required if and only if the technology has increasing return to scale. In the non-symmetric framework we show that negligible differences in agents’ attributes may result in major differences in rewards in the unique optimal mechanism.(This abstract was borrowed from another version of this item.)

This paper argues that campaign finance policy, in the form of contribution limits and matching public financing, can be Pareto improving even under very optimistic assumptions concerning the role of campaign advertising and the rationality of voters. The optimistic assumptions are that candidates use campaign contributions to convey truthful information to voters about their qualifications for office and that voters update their beliefs rationally on the basis of the information they have seen.The argument also assumes that campaign contributions are provided by interest groups and that candidates can offer to provide policy favors to attract higher contributions.

Independent courts render current policy more durable (by raising the cost of future policy changes) but may also engage in policy-making of their own. This paper asks: Is there an optimal level of judicial independence from the perspective of incumbent officials in the other branches? To answer that question, the paper develops a model of strategic institutional choice, and tests it on the judicial institutions of the American states. Consistent with the model's predictions, the most independenceenhancing institutions are found where political competition between rival parties is tightest and differences between party platforms are largest.