Knowledge that Transforms

Gary Fethke and Andrew Policano's book Public No More: A New Path to Excellence for America's Public Universities paints a picture of a future for public research universities that is very different than what many people will want to see. Their message is that the financial and governance models under which public universities have operated have broken down and that new models are required. While I do not always agree with their prescriptions, I argue that private research universities face many of the same issues as their public counterparts and that this book deserves to be widely read by all people concerned with the future of American higher education. (JEL H75, I22, I23, I28)

Most macroeconomic models for monetary policy analysis are approximated around a zero inflation steady state, but most central banks target an inflation rate of about 2 percent. Many economists have recently proposed even higher inflation targets to reduce the incidence of the zero lower bound constraint on monetary policy. In this survey, we show that the conduct of monetary policy should be analyzed by appropriately accounting for the positive trend inflation targeted by policymakers. We first review empirical research on the evolution and dynamics of U.S. trend inflation and some proposed new measures to assess the volatility and persistence of trend-based inflation gaps. We then construct a Generalized New Keynesian model that accounts for a positive trend inflation. In this model, an increase in trend inflation is associated with a more volatile and unstable economy and tends to destabilize inflation expectations. This analysis offers a note of caution regarding recent proposals to address the existing zero lower bound problem by raising the long-run inflation target. (JEL E12, E31, E32, E52, E58)

In an important new book, Anat Admati and Martin Hellwig raise broad critical questions about bank regulation. These questions are reviewed and discussed here, with a focus on how the problems of maintaining a stable financial system depend on fundamental problems of information and incentives in financial intermediation. It is argued that financial regulatory reforms can be reliably effective only when their basic principles are understood by informed citizens, and that Admati and Hellwig's book is a major contribution toward this goal, as it clearly lays out the essential case for requiring banks to have more equity. (JEL G01, G21, G28, G32, L51, M48)

This essay reviews Kenneth I. Wolpin's (2013) monograph The Limits of Inference without Theory, which arose from lectures he presented at the Cowles Foundation in 2010 in honor of Tjalling Koopmans. While I readily agree with Wolpin's basic premise that empirical work that eschews the role of economic theory faces unnecessary self-imposed limits relative to empirical work that embraces and tries to test and improve economic theory, it is important to be aware that the use of economic theory is not a panacea. I point out that there are also serious limits to inference with theory: 1) there may be no truly “structural” (policy invariant) parameters, a key assumption underpinning the structural econometric approach that Wolpin and the Cowles Foundation have championed; 2) there is a curse of dimensionality that makes it very difficult for us to elucidate the detailed implications of economic theories, which is necessary to empirically implement and test these theories; 3) there is an identification problem that makes it impossible to decide between competing theories without imposing ad hoc auxiliary assumptions (such as parametric functional form assumptions); and 4) there is a problem of multiplicity and indeterminacy of equilibria that limits the predictive empirical content of many economic theories. I conclude that though these are very challenging problems, I agree with Wolpin and the Cowles Foundation that economists have far more to gain by trying to incorporate economic theory into empirical work and test and improve our theories than by rejecting theory and presuming that all interesting economic issues can be answered by well-designed controlled, randomized experiments and assuming that difficult questions of causality and evaluation of alternative hypothetical policies can be resolved by simply allowing the “data to speak for itself.” (JEL B41, C18)

In his recent Mass Flourishings, Edmund Phelps makes a strong and eloquent plea for a more dynamic economy, which he sees not only as a key for economic performance, but also as necessary for what he calls “the good life.” This review essay evaluates those claims in the light of economic history. (JEL E02, N00, O10, O30, P16)

Capital in the Twenty-First Century by Thomas Piketty provides a unified theory of the functioning of the capitalist economy by linking theories of economic growth and functional and personal income distributions. It argues, based on the long-run historical data series, that the forces of economic divergence (including rising income inequality) tend to dominate in capitalism. It regards the twentieth century as an exception to this rule and proposes policies that would make capitalism sustainable in the twenty-first century. (JEL D31, D33, E25, N10, N30, P16)

Is there a way to understand why some global environmental externalities are addressed effectively, whereas others are not? The transaction costs of defining the property rights to mitigation benefits and costs is a useful framework for such analysis. This approach views international cooperation as a contractual process among country leaders to assign those property rights. Leaders cooperate when it serves domestic interests to do so. The demand for property rights comes from those who value and stand to gain from multilateral action. Property rights are supplied by international agreements that specify resource access and use, assign costs and benefits including outlining the size and duration of compensating transfer payments, and determining who will pay and who will receive them. Four factors raise the transaction costs of assigning property rights: (i) scientific uncertainty regarding mitigation benefits and costs; (ii) varying preferences and perceptions across heterogeneous populations; (iii) asymmetric information; and (iv) the extent of compliance and new entry. These factors are used to examine the role of transaction costs in the establishment and allocation of property rights to provide globally valued national parks, implement the Convention on the International Trade in Endangered Species of Wild Fauna and Flora, execute the Montreal Protocol to manage emissions that damage the stratospheric ozone layer, set limits on harvest of highly-migratory ocean fish stocks, and control greenhouse gas emissions. ( JEL D23, P14, Q22, Q51, Q54, Q58)

China's long-term economic dynamics pose a formidable challenge to economic historians. The Qing Empire (1644–1911), the world's largest national economy before 1800, experienced a tripling of population during the seventeenth and eighteenth centuries with no signs of diminishing per capita income. While the timing remains in dispute, a vast gap emerged between newly rich industrial nations and China's lagging economy in the wake of the Industrial Revolution. Only with an unprecedented growth spurt beginning in the late 1970s did this great divergence separating China from the global leaders substantially diminish, allowing China to regain its former standing among the world's largest economies. This essay develops an integrated framework for understanding that entire history, including both the divergence and the recent convergent trend. We explain how deeply embedded political and economic institutions that contributed to a long process of extensive growth before 1800 subsequently prevented China from capturing the benefits associated with the Industrial Revolution. During the twentieth century, the gradual erosion of these historic constraints and of new obstacles erected by socialist planning eventually opened the door to China's current boom. Our analysis links China's recent development to important elements of its past, while using recent success to provide fresh perspectives on the critical obstacles undermining earlier modernization efforts, and their eventual removal. (JEL N15, N45, O11, O47, P21, P24, P26)

There is a widespread belief that changes in expectations may be an important independent driver of economic fluctuations. The news view of business cycles offers a formalization of this perspective. In this paper we discuss mechanisms by which changes in agents' information, due to the arrival of news, can cause business cycle fluctuations driven by expectational change, and we review the empirical evidence aimed at evaluating their relevance. In particular, we highlight how the literature on news and business cycles offers a coherent way of thinking about aggregate fluctuations, while at the same time we emphasize the many challenges that must be addressed before a proper assessment of the role of news in business cycles can be established. (JEL D83, D84, E13, E32, O33)