Knowledge that Transforms

Inflation Is Always and Everywhere a Monetary Phenomenon: Richmond vs. Houston in 1864 by Richard C. K. Burdekin and Marc D. Weidenmier. Published in volume 91, issue 5, pages 1621-1630 of American Economic Review, December 2001

How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk: Comment by Dieter Balkenborg. Published in volume 91, issue 3, pages 731-738 of American Economic Review, June 2001

Consider an individual making a portfolio choice at date T involving two assets. The (gross) returns at t per unit invested at t 1 are Yit and Y2t* The individual has observed these returns from t = 0 to t = T. He has also observed the values of the variables Y3t',... YKt, which are thought to be relevant in forecasting future returns. Thus, the information available to him when he makes his portfolio choice is z = {(Yt ... YKt)} t=0. He invests one unit, divided between an amount a in asset 1 and an amount 1 a in asset 2, and he then holds on to the portfolio until date T + H. Let w = {(Yit, Y2t)}T:H+ 1 and let h(w, a) denote the value of the portfolio at t T + H:

Incentive-Enhancing Preferences: Personality, Behavior, and Earnings by Samuel Bowles, Herbert Gintis and Melissa Osborne. Published in volume 91, issue 2, pages 155-158 of American Economic Review, May 2001

The Declining Price Anomaly in Dutch Dutch Rose Auctions by Gerard J. van den Berg, Jan C. van Ours and Menno P. Pradhan. Published in volume 91, issue 4, pages 1055-1062 of American Economic Review, September 2001

Contrary to the standard economic advice, many regulations of financial intermediaries, as well as other regulations such as blue laws, fishing rules, zoning restrictions, or pollution controls, take the form of quantity controls rather than taxes. We argue that costs of enforcement are crucial to understanding these choices. When violations of quantity regulations are cheaper to discover than failures to pay taxes, the former can emerge as the optimal instrument for the government, even when it is less attractive in the absence of enforcement costs. This analysis is especially relevant to situations where private enforcement of regulations is crucial.

We study a dynamic game in which all players initially possess the same information and coordinate on a high level of activity. Eventually, players with a long string of bad experiences become inactive. This prospect can cause a coordination avalanche in which all activity in the population stops. Coordination avalanches are part of Pareto-efficient equilibria; they can occur at any point in the game; their occurrence does not depend on the true state of nature; and allowing players to exchange information may merely hasten their onset. We present applications to search markets, organizational meltdown, and inefficient computer upgrades.

Proponents of the Bayh-Dole Act argue that industrial use of federally funded research would be reduced without university patent licensing. Our survey of U.S. universities supports this view, emphasizing the embryonic state of most technologies licensed and the need for inventor cooperation in commercialization. Thus, for most university inventions, there is a moral-hazard problem with inventor effort. For such inventions, development does not occur unless the inventor's income is tied to the licensee's output by payments such as royalties or equity. Sponsored research from the licensee cannot by itself solve this problem.

Banks perform valuable activities on either side of their balance sheets. On the asset side, they make loans to difficult, illiquid borrowers. On the liability side, they provide liquidity on demand to depositors. But there seems to be a fundamental incompatibility between the two activities: the demands for liquidity by depositors may arrive at an inconvenient time and force the fire-sale liquidation of illiquid assets. Furthermore, because depositors are served in sequence, the prospect of fire sales may precipitate self-fulfilling runs that further jeopardize bank activities. Is this an aberration, stemming from historical accident, and enshrined by deposit insurance? Or is there logic, hitherto unnoticed, for the bank’s choice of activities? Our recent work suggests that the answer to the latter question is yes. In order to describe why a bank’s fragile capital structure allows it to create liquidity and to explain why bank loans are illiquid, we present a simple example based on Diamond and Rajan (2001a).

It appears likely that the number of currencies in the world, having proliferated along with the number of countries over the past 50 years, will decline sharply over the next two decades. The question I plan to pose here is: where, from an economic point of view, should we aim for this process to stop? Should there be a single world currency, as Richard Cooper (1984) boldly envisioned? Should there remain multiple major currencies but with a much stricter arrangement among them for stabilizing exchange rates, as say Ronald McKinnon (1984) or John Williamson (1993) recommended? Building on Maurice Obstfeld and Rogoff (2000b, d), I will argue here that the status quo arrangement among the dollar, yen, and euro (which I take to be benign neglect) is not far from optimal, not only for now but well into the new century. And it would remain a good system even if political obstacles to achieving greater monetary policy coordination (or even a common world currency) could be overcome. Again, this is not a paper on, say, the pros and cons of dollarization for small and medium-sized economies, but rather on arrangements among the core currencies. Any blueprint for the future core of the world currency system involves some crystal-ball gazing. But at the same time, recent research in international macroeconomics offers several important insights that can help inform the discussion.