Knowledge that Transforms

We investigate the effect of electoral rules and forms of government on fiscal policy outcomes in a large sample of democracies. We rely on different estimation methods to address prospective problems of statistical inference, due to nonrandom selection of these constitutional rules. The findings are consistent with our theoretical priors: presidential regimes induce smaller governments than parliamentary democracies, while majoritarian elections lead to smaller governments and smaller welfare programs than proportional elections.

Hospital Transaction Prices and Managed-Care Discounting for Selected Medical Technologies by Avi Dor, Michael Grossman and Siran M. Koroukian. Published in volume 94, issue 2, pages 352-356 of American Economic Review, May 2004

Rational agents with differing priors tend to be overoptimistic about their chances of success. In particular, an agent who tries to choose the action that is most likely to succeed, is more likely to choose an action of which he overestimated, rather than underestimated, the likelihood of success. After studying the comparative statics of this mechanism, I show that it also causes agents to attribute failure to exogenous factors but success to their own choice of action, to disproportionately believe that they will outperform others, to overestimate the precision of their estimates, and to overestimate their control over the outcome.

This paper presents a case study of a well-informed investor in the South Sea bubble. We argue that Hoare's Bank, a fledgling West End London bank, knew that a bubble was in progress and nonetheless invested in the stock: it was profitable to “ride the bubble.” Using a unique dataset on daily trades, we show that this sophisticated investor was not constrained by such institutional factors as restrictions on short sales or agency problems. Instead, this study demonstrates that predictable investor sentiment can prevent attacks on a bubble; rational investors may attack only when some coordinating event promotes joint action.

The cyclical behavior of real wages has evolved from mildly countercyclical during the interwar period to modestly procyclical in the postwar era. This paper presents a general-equilibrium business-cycle model that helps explain the evolution. In the model, changes in the real wage cyclicality arise from interactions between nominal wage and price rigidities and an evolving input-output structure.

Using the December 1998 and August 2000 CPS Computer and Internet Supplements matched with subsequent CPS files, we ask which types of unemployed workers looked for work on line and whether Internet searchers became reemployed more quickly. In our data, Internet searchers have observed characteristics that are typically associated with shorter unemployment spells, and do spend less time unemployed. This unemployment differential is however eliminated and in some cases reversed when we hold observable characteristics constant. We conclude that either Internet job search is ineffective in reducing unemployment durations, or Internet job searchers are negatively selected on unobservables.

Robert E. Lucas, Jr. argued that the welfare gains from reducing aggregate consumption volatility are negligible. Subsequent work that revisited his calculation continued to find small welfare benefits, further reinforcing the perception that business cycles do not matter. This paper argues instead that fluctuations can affect welfare, by affecting the growth rate of consumption. I show that fluctuations can reduce growth starting from a given initial consumption, which can imply substantial welfare effects as Lucas himself observed. Empirical evidence suggests the welfare effects are likely to be substantial, about two orders of magnitude greater than Lucas' original estimates.