Knowledge that Transforms

Price and Quality of Desktop and Mobile Personal Computers: A Quarter-Century Historical Overview by Ernst R. Berndt and Neal J. Rappaport. Published in volume 91, issue 2, pages 268-273 of American Economic Review, May 2001

Reconciling Conflicting Evidence on the Performance of Propensity-Score Matching Methods by Jeffrey A. Smith and Petra E. Todd. Published in volume 91, issue 2, pages 112-118 of American Economic Review, May 2001

Committees improve decisions by pooling members' independent information, but promote manipulation, obfuscation, and exaggeration of private information when members have conflicting preferences. Committee decision procedures transform continuous data into ordered ranks through voting. This coarsens the transmission of information, but controls strategic manipulations and allows some degree of information sharing. Each member becomes more cautious in casting the crucial vote than when he alone makes the decision based on own information. Increased quality of one member's information results in his casting the crucial vote more often. Committees make better decisions for members than does delegation. (JEL D71, D82, C72)

The Market Evaluation of Criminality: Evidence from the Auction of British Convict Labor in America, 1767-1775 by Farley Grubb. Published in volume 91, issue 1, pages 295-304 of American Economic Review, March 2001

By incorporating the probability distribution directly into the analysis, this paper proposes a new theoretical approach to resolving the perennial dilemma of being uncertain about what discount rate to use in cost-benefit analysis. A numerical example is constructed from the results of a survey based on the opinions of 2,160 economists. The main finding is that even if every individual believes in a constant discount rate, the wide spread of opinion on what it should be makes the effective social discount rate decline significantly over time. Implications and ramifications of this proposed “gamma-discounting” approach are discussed. (JEL H43)

Much of the existing theory of incentives describes a static relationship that lasts for just one transaction. This static assumption is not only unrealistic, but the resulting predictions appear to be at odds with many work organizations. The current paper introduces possible long-term interaction among agents, and studies how the design of explicit incentives and work organizations can exploit, and interact with, the implicit incentives generated by the repeated interaction of the agents. The optimal incentive scheme is shown to display observed features of the increasingly popular “teams,” such as the use of low-powered, group incentives. (JEL D23, J33, J41, L23)

Abstract: The two key questions which motivate our work are: do bubbles exist (in the sense that stock market prices do not always correspond to the present value of expected future profitability) and, if bubbles exist, do they have an effect on business fixed investment? The case of Japan is particularly interesting because of the dramatic movements in the Japanese stock market and the wide perception that these were associated with a bubble. We use a variety of techniques to analyze these questions. Fist, we examine financing and investment patterns to gauge firms' reactions to the 1980s stock market run-up. Second, we test subsets of the orthogonality conditions associated with the empirical first-order conditions for fixed investment. Third, we use a linear projection to decompose stock market prices into fundamental and bubble components, allowing us to carry out parametric estimates of the effect of the bubble component on fixed investment. The data strongly suggest that there was a bubble that had an economically important statistically significant effect on business fixed investment in Japan.;

In recent decades, asset booms and busts have been important factors in macroeconomic fluctuations in both industrial and developing countries. In light of this experience, how, if at all, should central bankers respond to asset price volatility? We have addressed this issue in previous work (Bernanke and Gertler, 1999). The context of our earlier study was the relatively new, but increasingly popular, monetary-policy framework known as inflation-targeting (see e.g., Bernanke and Frederic Mishkin, 1997). In an inflation-targeting framework, publicly announced medium-term inflation targets provide a nominal anchor for monetary policy, while allowing the central bank some flexibility to help stabilize the real economy in the short run. The inflation-targeting approach gives a specific answer to the question of how central bankers should respond to asset prices: Changes in asset prices should affect monetary policy only to the extent that they affect the central bank’s forecast of inflation. To a first approximation, once the predictive content of asset prices for inflation has been accounted for, there should be no additional response of monetary policy to assetprice fluctuations. In use now for about a decade, inflationtargeting has generally performed well in practice. However, so far this approach has not often been stress-tested by large swings in asset prices. Our earlier research employed simulations of a small, calibrated macroeconomic model to examine how an inflation-targeting policy (defined as one in which the central bank’s instrument interest rate responds primarily to changes in expected inflation) might fare in the face of a boom-and-bust cycle in asset prices. We found that an aggressive inflationtargeting policy rule (in our simulations, one in which the coefficient relating the instrument interest rate to expected inflation is 2.0) substantially stabilizes both output and inflation in scenarios in which a bubble in stock prices develops and then collapses, as well as in scenarios in which technology shocks drive stock prices. Intuitively, inflation-targeting central banks automatically accommodate productivity gains that lift stock prices, while offsetting purely speculative increases or decreases in stock values whose primary effects are through aggregate demand. Conditional on a strong policy response to expected inflation, we found little if any additional gains from allowing an independent response of central-bank policy to the level of asset prices. In our view, there are good reasons, outside of our formal model, to worry about attempts by central banks to influence asset prices, including the fact that (as history has shown) the effects of such attempts on market psychology are dangerously unpredictable. Hence, we concluded that inflationtargeting central banks need not respond to asset prices, except insofar as they affect the inflation forecast. In the spirit of recent work on robust control, the exercises in our earlier paper analyzed the performance of policy rules in worst-case † Discussants: Robert Shiller, Yale University; Glenn Rudebusch, Federal Reserve Bank of San Francisco; Kenneth Rogoff, Harvard University.

The Legacy of U.S. Educational Leadership: Notes on Distribution and Economic Growth in the 20th Century by Claudia Goldin and Lawrence F. Katz. Published in volume 91, issue 2, pages 18-23 of American Economic Review, May 2001

Are firms that engage in trade more vulnerable to exchange rate risk? In this paper we examine the relationship between exchange rate movements, firm value and trade. Our empirical work tests whether exchange rate exposure can be explained by variables that proxy for the level of international activity, firm size, industry affiliation and country affiliation. The results suggest that while a significant fraction of firms in these countries is exposed to exchange rate movements, there is little evidence of a systematic link between exposure and trade. Indeed, what little evidence there is of a link suggests that firms that engage in greater trade exhibit lower degrees of exposure. This may reflect the fact that those firms most engaged in trade are also the most aware of exchange rate risk, and therefore are the most likely to hedge their exposure.