Knowledge that Transforms

Sample selection models provide an important way of accounting for economic decisions that combine discrete and continuous choices and of correcting for nonrandom sampling. Nonparametric estimators for these models are developed in this paper. These can be used for estimating shapes and important economic quantities, as in standard nonparametric regression. Endogeneity of regressors of interest is allowed for. Series estimators for these models are developed, which are useful for imposing additivity restrictions that arise from selection corrections. Convergence rates and asymptotic normality results are derived. An application to returns to schooling among Australian young females is given.

This paper examines the profitability of three types of integration in a cooperative game solved by a random-order value (e.g. the Shapley value). Collusion between players i and j is a contract merging their resources in the hands of one of them, say i. This contract can be represented as a combination of exclusion, which lets i exclude j’s resource but not use it himself, and inclusion, which lets i use j’s resource but not exclude j from it. This representation yields a third-difference condition on the characteristic function that determines the profitability of collusion, generalizing existing results for specific games. Namely, collusion is profitable [unprofitable] when the complementarity of the colluding players is reduced [increased] by other players.

This paper considers the desirability of the observed tendency of central banks to adjust interest rates only gradually in response to changes in economic conditions. It shows, in the context of a simple model of optimizing private-sector behaviour, that assignment of an interest-rate smoothing objective to the central bank may be desirable, even when reduction of the magnitude of interest-rate changes is not a social objective in itself. This is because a response of policy to “irrelevant” lagged variables may be desirable owing to the way it steers private-sector expectations of future policy.

We characterize competitive equilibria with perfect foresight in a deterministic, three-period pure-exchange overlapping generations economy with perfect information and no commitment to loan contracts. Commitment is replaced by an enforcement mechanism that excludes defaulters from asset markets for one period. For hump-shaped endowment profiles, young individuals face endogenous debt constraints that ration current consumption. Changes in current and future yields affect these constraints, inducing an additional income effect on rationed household demand that makes current and future consumption complements. This mechanism can lead to multiple steady states, persistent indeterminacy and regime switching. We show that sensitivity to shocks and complex dynamic behaviour are consistent with endogenous debt limits but not with exogenous liquidity constraints.

When human capital accumulation generates pecuniary externalities across professions, and capital markets are imperfect, persistent inequality in utility and consumption is inevitable in any steady state. This is true irrespective of the degree of divisibility in investments. However, divisibility (or fineness of occupational structure) has implications for both the multiplicity and Pareto-efficiency of steady states. Indivisibilities generate a continuum of inefficient and efficient steady states with varying per capita income. On the other hand, perfect divisibility typically implies the existence of a unique steady state distribution which is Pareto-efficient.

We consider a dynamic general equilibrium asset pricing model with heterogeneous agents and asymmetric information. We show how agents' different methods of gathering information affect their chances of survival in the market depending upon the nature of the information and the level of noise in the economy.

We consider the impact of reputation on the survival of a monopolist selling single units in discrete time periods, whose quality is learned slowly. If the seller learns her own quality at the same rate as customers, a sufficiently bad run of luck could induce her to stop selling. When she knows her quality, a good seller never stops selling though at low reputations a bad seller does with some probability. Furthermore, a seller with positive, though imperfect, information sells for the same number of periods whether her information is private or public. We further consider the robustness of the central result when the seller's opportunities for strategic behaviour are limited. Copyright The Review of Economic Studies Limited, 2003.

Optimal monetary policy maximizes the welfare of a representative agent, given frictions in the economic environment. Constructing a model with two sets of frictions—costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods—we find optimal monetary policy is governed by two familiar principles. First, the average level of the nominal interest rate should be sufficiently low, as suggested by Milton Friedman, that there should be deflation on average. Yet, the Keynesian frictions imply that the optimal nominal interest rate is positive. Second, as various shocks occur to the real and monetary sectors, the price level should be largely stabilized, as suggested by Irving Fisher, albeit around a deflationary trend path. Since expected inflation is roughly constant through time, the nominal interest rate must therefore vary with the Fisherian determinants of the real interest rate. Although the monetary authority has substantial leverage over real activity in our model economy, it chooses real allocations that closely resemble those which would occur if prices were flexible. In our benchmark model, there is some tendency for the monetary authority to smooth nominal and real interest rates. Copyright 2003, Wiley-Blackwell.

For a nonexcludable public good with benefit and cost functions independent of the number of participants, this paper studies second-best allocations under Bayesian interim incentive compatibility and interim individual rationality. As the number of participants becomes large, second-best provision levels converge in distribution to first-best levels if the latter are bounded. Second-best provision levels become large in absolute terms but small relative to first-best levels if benefit and cost functions are isoelastic. In contrast, for an excludable public good, the ratio of second-best to first-best levels is bounded away from zero. Copyright The Review of Economic Studies Limited, 2003.

We study informal insurance within communities, explicitly recognizing the possibility that subgroups of individuals may destabilize insurance arrangements among the larger group. We therefore consider self-enforcing risk-sharing agreements that are robust not only to single-person deviations but also to potential deviations by subgroups. However, such deviations must be credible, in the sense that the subgroup must pass exactly the same test that we apply to the entire group; it must itself employ some self-enforcing risk-sharing agreement. We observe that the stability of subgroups is inimical to the stability of the group as a whole. Two surprising consequences of this analysis are that stable groups have (uniformly) bounded size, a result in sharp contrast to the individual-deviation problem, and that the degree of risk-sharing in a community is generally non-monotonic in the level of uncertainty or need for insurance in the community.