We study the effects of differences in local financial development within an integrated financial market. We construct a new indicator of financial development by estimating a regional effect on the probability that, ceteris paribus, a household is shut off from the credit market. By using this indicator, we find that financial development enhances the probability an individual starts his own business, favors entry of new firms, increases competition, and promotes growth. As predicted by theory, these effects are weaker for larger firms, which can more easily raise funds outside of the local area. These effects are present even when we instrument our indicator with the structure of the local banking markets in 1936, which, because of regulatory reasons, affected the supply of credit in the following 50 years. Overall, the results suggest local financial development is an important determinant of the economic success of an area even in an environment where there are no frictions to capital movements.

A discretionary policy-maker responds to the state of the economy each period. Private agents' current behavior determines the future state based on expectations of future policy. Discretionary policy thus can lead to dynamic complementarity between private agents and a policy-maker, which in turn can generate multiple equilibria. Working in a simple new Keynesian model with two-period staggered pricing—in which equilibrium is unique under commitment—we illustrate this interaction: if firms expect a high future money supply, (i) they will set a high current price; and (ii) the future monetary authority will accommodate with a higher money supply, so as not to distort relative prices. We show that there are two point-in-time equilibria under discretion, and we construct a related stochastic sunspot equilibrium.

Does investor protection foster economic growth? To assess the widely held affirmative view, we introduce investor protection into a standard overlapping generations model of capital accumulation. Better investor protection implies better risk sharing. Because of entrepreneurs' risk aversion, this results in a larger demand for capital. This is the demand effect. A second effect (the supply effect) follows from general equilibrium restrictions. Better protection (i.e., higher demand) increases the interest rate and lowers the income of entrepreneurs, decreasing current savings and next period's supply of capital. The supply effect is stronger the tighter are the restrictions on capital flows. Our model thus predicts that the (positive) effect of investor protection on growth is stronger for countries with lower restrictions. Cross-country data provide support for this prediction, as does the detailed examination of the growth experiences of South Korea and India.

We investigate the regulation of labor markets through employment, collective relations, and social security laws in 85 countries. We find that the political power of the left is associated with more stringent labor regulations and more generous social security systems, and that socialist, French, and Scandinavian legal origin countries have sharply higher levels of labor regulation than do common law countries. However, the effects of legal origins are larger, and explain more of the variation in regulations, than those of politics. Heavier regulation of labor is associated with lower labor force participation and higher unemployment, especially of the young. These results are most naturally consistent with legal theories, according to which countries have pervasive regulatory styles inherited from the transplantation of legal systems.