Knowledge that Transforms

We study trading dynamics in an asset market where the quality of assets is private information and finding a counterparty takes time. When trading ceases in equilibrium as a response to an adverse shock to asset quality, a government can resurrect trading by buying up lemons which involves a financial loss. The optimal policy is centred around an announcement effect where trading starts already before the intervention for two reasons. First, delaying the intervention allows selling pressure to build up thereby improving the average quality of assets for sale. Secondly, intervening at a higher price increases the return from buying an asset of unknown quality. It is optimal to intervene immediately at the lowest price when the market is sufficiently important. For less important markets, when the shock to quality and search frictions are small, it is optimal to rely on the announcement effect. Here delaying the intervention and fostering the effect by intervening at the highest price tend to be complements.

While vertical integration is traditionally seen as a solution to the hold-up problem, this article highlights instead that it can generate hold-up problems—for rivals. We consider a successive duopoly where downstream firms invest and then secure support from an upstream supplier. We first show that vertical integration generates ex ante incentives to create hold-up problems: an integrated supplier is willing to pre-commit itself to appropriating or dissipating part of its customer's profits, to expose the independent rival to being held-up by the other supplier, and discourage in this way the rival's investment. We then show that, even in the absence of any pre-commitment, vertical integration also creates hold-up problems ex post when degrading the quality of the support provided to one downstream firm benefits its rival. We also provide illustrations in terms of standard industrial organization models and of antitrust cases, and discuss the robustness of the insights.

We show that state non-separable preferences à la Epstein–Zin–Weil (EZW) provide a tractable and flexible framework to study the economics of health and longevity. This utility representation: (1) admits a preference for timing of resolution of uncertainty regarding mortality risks; (2) links the marginal valuation of survival to the level of survival; (3) can preserve homotheticity even for low degrees of intertemporal substitution without generating implausible predictions regarding the value of life; and (4) adds needed flexibility to account for the empirical evidence on the value of life. We illustrate the implications of EZW preferences for the economic value of observed differences in life expectancy across countries and over time, and for the value of life over the life cycle.

In elections with three or more candidates, coordination among like-minded voters is an important problem. We analyse the trade-off between coordination and learning about candidate quality under different temporal election systems in the context of the U.S. presidential primary system. In our model, candidates with different policy positions and qualities compete for the nomination, and voters are uncertain about the candidates' valence. This setup generates two effects: vote splitting ( i.e . several candidates in the same policy position compete for the same voter pool) and voter learning (as the results in earlier elections help voters to update their beliefs on candidate quality). Sequential voting minimizes vote splitting in late districts, but voters may coordinate on a low-quality candidate. Using the parameter estimates obtained from all the Democratic and Republican presidential primaries during 2000–12, we conduct policy experiments such as replacing the current system with a simultaneous system, adopting the reform proposal of the National Association of Secretaries of State, or imposing party rules that lead to candidate withdrawal when prespecified conditions are met.

We develop a dynamic general equilibrium model in which the policy rate signals the central bank’s view about macroeconomic developments to price setters. The model is estimated with likelihood methods on a U.S. data set that includes the Survey of Professional Forecasters as a measure of price setters’ inflation expectations. This model improves upon existing perfect information models in explaining why, in the data, inflation expectations respond with delays to monetary impulses and remain disanchored for years. In the 1970s, U.S. monetary policy is found to signal-persistent inflationary shocks, explaining why inflation and inflation expectations were so persistently heightened. The signalling effects of monetary policy also explain why inflation expectations adjusted more sluggishly than inflation after the robust monetary tightening of the 1980s.

In markets with quality unobservable to buyers, third-party certification is often the only instrument to increase transparency. While both sellers and buyers have a demand for certification, its role differs fundamentally: sellers use it for signalling, buyers use it for inspection. Seller-induced certification leads to more transparency, because it is informative—even if unused. By contrast, buyer-induced certification incentivizes certifiers to limit transparency, as this raises demand for inspection. Whenever transparency is socially beneficial, seller certification is preferable. It also yields certifiers larger profits, so that regulating the mode of certification is redundant.

In U.S. data 1981–2012, unsecured firm credit moves procyclically and tends to lead GDP, while secured firm credit is acyclical; similarly, shocks to unsecured firm credit explain a far larger fraction of output fluctuations than shocks to secured credit. In this article, we develop a tractable dynamic general equilibrium model in which unsecured firm credit arises from self-enforcing borrowing constraints, preventing an efficient capital allocation among heterogeneous firms. Unsecured credit rests on the value that borrowers attach to a good credit reputation which is a forward-looking variable. We argue that self-fulfilling beliefs over future credit conditions naturally generate endogenously persistent business-cycle dynamics. A dynamic complementarity between current and future borrowing limits permits uncorrelated sunspot shocks to unsecured debt to trigger persistent aggregate fluctuations in both secured and unsecured debt, factor productivity, and output. We show that these sunspot shocks are quantitatively important, accounting for around half of output volatility.

We build a heterogeneous agents life cycle model that captures a large number of salient features of individual male labour supply over the life cycle, by education, both along the intensive and extensive margins. The model provides an aggregation theory of individual labour supply, firmly grounded on individual-level micro-evidence, and is used to study the aggregate labour supply responses to changes in the economic environment. We find that the aggregate labour supply elasticity to a transitory wage shock is 1.75, with the extensive margin accounting for 62% of the response. Furthermore, we find that the aggregate labour supply elasticity to a permanent-compensated wage change is 0.44.

We study how the marginal welfare gain from increasing the unemployment insurance (UI) benefit level varies over the business cycle. We do this by estimating how the moral hazard cost and the consumption smoothing benefit of UI vary with labour market conditions, which we identify using variation in the interaction of UI benefit levels with the unemployment rate within U.S. states over time. We find that the moral hazard cost is procyclical, greater when the unemployment rate is relatively low. By contrast, we do not find evidence that the consumption smoothing benefit varies with the unemployment rate. We use these empirical results to estimate the marginal welfare gain, and we find that it is modest on average, but varies positively with the unemployment rate.

This article derives novel testable implications of referral-based job search networks in which employees provide employers with information about potential new hires that they otherwise would not have. Using comprehensive matched employer–employee data covering the entire workforce in one large metropolitan labour market combined with unique survey data linked to administrative records, we provide evidence that workers earn higher wages and are less inclined to leave their firms if they have obtained their job through a referral. These effects are particularly strong at the beginning of the employment relationship and decline with tenure in the firm, suggesting that firms and workers learn about workers' productivity over time. Overall, our findings imply that job search networks help to reduce informational deficiencies in the labour market and lead to productivity gains for workers and firms.