Knowledge that Transforms

We propose a theoretical framework for assessing whether a forecast model estimated over one period can provide good forecasts over a subsequent period. We formalize this idea by defining a forecast breakdown as a situation in which the out-of-sample performance of the model, judged by some loss function, is significantly worse than its in-sample performance. Our framework, which is valid under general conditions, can be used not only to detect past forecast breakdowns but also to predict future ones. We show that main causes of forecast breakdowns are instabilities in the data-generating process and relate the properties of our forecast breakdown test to those of structural break tests. The empirical application finds evidence of a forecast breakdown in the Phillips' curve forecasts of U.S. inflation, and links it to inflation volatility and to changes in the monetary policy reaction function of the Fed.

We consider situations in which every agent would like to take an action that is coordinated with those of others, as well as close to a common state of nature, with the ideal proximity to that state varying across agents. Before this coordination game is played, agents decide to whom they reveal their private information about the state. The information transmission occurring in the cheap-talk communication stage is characterized by a strategic communication network whose links represent truthful information transmission. In equilibrium, whether communication takes place between two agents depends not only on the conflict of interest between these agents, but also on the number and preferences of the other agents with whom they communicate. In particular, communication to a large group of recipients may be feasible even though communication to a small subset of that group may not be. We show that agents who are more central in terms of preference tend to communicate more and to have a greater impact on decisions.

In this paper, we establish sharp bounds on the joint distribution of potential outcomes and the distribution of treatment effects in parametric switching regime models with normal mean-variance mixture errors and in the semi-parametric switching regime models of Heckman (1990). Our results for parametric switching regime models with normal mean-variance mixture errors extend some existing results for the Gaussian switching regime model and our results for semi-parametric switching regime models supplement the point identification results of Heckman (1990). Compared with the corresponding sharp bounds when selection is random, we observe that self-selection tightens the bounds on the joint distribution of the potential outcomes and the distribution of treatment effects. These bounds depend on the identified model parameters only and can be easily estimated once the identified model parameters are estimated. The important issue of inference is briefly discussed.

This paper introduces a model of preferences, in which, given beliefs about uncertain outcomes, an individual evaluates an action by a quantile of the induced distribution. The choice rule of Quantile Maximization unifies maxmin and maxmax as maximizing the lowest and the highest quantiles of beliefs distributions, respectively, and offers a family of less extreme preferences. Taking preferences over acts as a primitive, we axiomatize Quantile Maximization in a Savage setting. Our axiomatization also provides a novel derivation of subjective beliefs, which demonstrates that neither the monotonicity nor the continuity conditions assumed in the literature are essential for probabilistic sophistication. We characterize preferences of quantile maximizers towards downside risk. We discuss how the distinct properties of the model, robustness and ordinality, can be useful in studying choice behaviour for categorical variables and in economic policy design. We also offer applications to poll design and insurance problems.

We explore how optimal information choices change the predictions of strategic models. When a large number of agents play a game with strategic complementarity, information choices exhibit complementarity as well: if an agent wants to do what others do, they want to know what others know. This makes heterogeneous beliefs difficult to sustain and may generate multiple equilibria. In models with substitutability, agents prefer to differentiate their information choices. We use these theoretical results to examine the role of information choice in recent price-setting models and to propose modelling techniques that ensure equilibrium uniqueness.

An IV approach, using as instruments non-linear transformations of the lagged levels, is explored to test for unit roots in panels with general dependency and heterogeneity across cross-sectional units. We allow not only for the cross-sectional dependencies of innovations, but also for the presence of co-integration across cross-sectional levels. Unbalanced panels and panels with differing individual short-run dynamics and cross-sectionally related dynamics are also permitted. We also more carefully formulate the unit root hypotheses in panels. In particular, using order statistics, we make it possible to test for and against the presence of unit roots in some of the individual units for a given panel. The individual IV t-ratios, which are the bases of our tests, are asymptotically and normally distributed and cross-sectionally independent. Therefore, the critical values of the order statistics as well as the usual average statistic can be easily obtained from simple elementary probability computations. We show via a set of simulations that our tests work well, whereas other existing tests fail to perform properly. As an illustration, we apply our tests to the panels of real exchange rates, and find no evidence for the purchasing power parity hypothesis, which is in sharp contrast with the previous studies.

We study a labor market equilibrium model in which firms sign optimal long-term contracts with workers. Firms that are financially constrained offer an increasing wage profile: They pay lower wages today in exchange of higher wages once they become unconstrained and operate at a larger scale. In equilibrium, constrained firms are on average smaller and pay lower wages. In this way the model generates a positive relation between firm size and wages. Using data from the National Longitudinal Survey of Youth (NLSY) we show that the key dynamic properties of the model are supported by the data.

Why don't all countries converge rapidly to the use of most efficient or best practice technologies? Micro level studies suggest managerial skills play a key role in the adoption of modern technologies. In this paper we model the interactive process between on-the-job managerial skill acquisition and the adoption of modern technology. We use the model to illustrate why some countries develop managerial skills quickly and adopt best practice technologies, while others stay backwards. The model also explains why managers will not migrate from rich countries to poor countries, as would be needed to generate convergence. Finally we show why standard growth accounting exercises will incorrectly attribute a large proportion of managerial skills' contribution to total factor productivity and we quantify the importance of this bias.

Poor countries have lower PPP-adjusted investment rates and face higher relative prices of investment goods. It has been suggested that this happens either because these countries have a relatively lower TFP in industries producing capital goods or because they are subject to greater investment distortions. This paper provides a micro-foundation for the cross-country dispersion in investment distortions. We first document that firms producing capital goods face a higher level of idiosyncratic risk than their counterparts producing consumption goods. In a model of capital accumulation where the protection of investors' rights is incomplete, this difference in risk induces a wedge between the returns on investment in the two sectors. The wedge is bigger, the poorer the investor protection. In turn, this implies that countries endowed with weaker institutions face higher relative prices of investment goods, invest a lower fraction of their income, and end up being poorer. We find that our mechanism may be quantitatively important.

A social choice function is robustly implementable if there is a mechanism under which the process of iteratively eliminating strictly dominated messages lead to outcomes that agree with the social choice function for all beliefs at every type profile. In an interdependent-value environment with single-crossing preferences, we identify a contraction property on the preferences which together with strict ex post incentive compatibility is sufficient to guarantee robust implementation in the direct mechanism. Strict ex post incentive compatibility and the contraction property are also necessary for robust implementation in any mechanism, including indirect ones. The contraction property requires that the interdependence is not too high. In a linear signal model, the contraction property is equivalent to an interdependence matrix having all eigenvalues smaller than one.