Knowledge that Transforms

Capital-Markets Crises and Economic Collapse in Emerging Markets: An Informational-Frictions Approach by Guillermo A. Calvo and Enrique G. Mendoza. Published in volume 90, issue 2, pages 59-64 of American Economic Review, May 2000

Saving and growth are strongly positively correlated across countries. Recent empirical evidence suggests that this correlation holds largely because high growth leads to high saving, not the other way around. This evidence is difficult to reconcile with standard growth models, since forward-looking consumers with standard utility should save less in a fast-growing economy because they know they will be richer in the future than they are today. We show that if utility depends partly on how consumption compares to a “habit stock” determined by past consumption, an otherwise-standard growth model can imply that increases in growth can cause increased saving.

The integrated equilibrium is a paradigm that has played a central role in the field of international trade. The concept originated with Paul A. Samuelson (1949), was further developed by Avinash K. Dixit and Victor F. Norman (1980), and placed at the heart of international analysis by Elhanan Helpman and Paul R. Krugman (1985). The central idea is that a world with imperfect mobility of productive factors across regions or countries may replicate the essential equilibrium of a fully integrated economy, provided that goods are perfectly mobile. The concept of the integrated equilibrium has proved to be exceptionally tractable and useful for analytic developments, as for example in the work of Gene M. Grossman and Helpman (1992). We have found using elements of integrated equilibrium analysis useful in our own work (e.g., Davis et al., 1997). The central figures in developing the theory of trade and growth within the integrated equilibrium framework have been quite aware of its limitations. Helpman and Krugman (1985) include a section on the cases in which factor-price equalization (FPE) breaks down. Grossman and Helpman (1992) make the distinction between national and international spillovers a key element of their theory of trade and growth. Moreover, the starting point of Krugman’s work in the past decade on economic geography has been precisely to deny that the world operates as if it were an integrated economy. This notwithstanding, we believe that the grip of integrated equilibrium analysis on the way that the economics profession conceives of world trade patterns remains very powerful and in important ways distorts one’s view of trade relations, particularly among the relatively rich countries of the OECD. We do not propose to banish integrated equilibrium analysis. We believe that it is useful in the proper context. However, we do propose that it is important to have a fuller appreciation of the limits of such analysis from an empirical standpoint and thus to have a richer view of the determinants of world trade patterns.

Money, Sticky Wages, and the Great Depression by Michael D. Bordo, Christopher J. Erceg and Charles L. Evans. Published in volume 90, issue 5, pages 1447-1463 of American Economic Review, December 2000

In our 1990 paper, we showed that managers concerned with their reputations might choose to mimic the behavior of other managers and ignore their own information. We presented a model in which “smart” managers receive correlated, informative signals, whereas “dumb” managers receive independent, uninformative signals. Managers have an incentive to follow the herd to indicate to the labor market that they have received the same signal as others, and hence are likely to be smart. This model of reputational herding has subsequently found empirical support in a number of recent papers, including Judith A. Chevalier and Glenn D. Ellison’s (1999) study of mutual fund managers and Harrison G. Hong et al.’s (2000) study of equity analysts. We argued in our 1990 paper that reputational herding “requires smart managers’ prediction errors to be at least partially correlated with each other” (page 468). In their Comment, Marco Ottaviani and Peter Sorensen (hereafter, OS) take issue with this claim. They write: “correlation is not necessary for herding, other than in degenerate cases.” It turns out that the apparent disagreement hinges on how strict a definition of herding one adopts. In particular, we had defined a herding equilibrium as one in which agent B always ignores his own information and follows agent A. (See, e.g., our Propositions 1 and 2.) In contrast, OS say that there is herding when agent B sometimes ignores his own information and follows agent A. The OS conclusion is clearly correct given their weaker definition of herding. At the same time, however, it also seems that for the stricter definition that we adopted in our original paper, correlated errors on the part of smart managers are indeed necessary for a herding outcome—even when one considers the expanded parameter space that OS do. We will try to give some intuition for why the different definitions of herding lead to different conclusions about the necessity of correlated prediction errors. Along the way, we hope to convince the reader that our stricter definition is more appropriate for isolating the economic effects at work in the reputational herding model. An example is helpful in illustrating what is going on. Consider a simple case where the parameter values are as follows: p 5 3⁄4; q 5 1⁄4; z 5 1⁄2, and u 5 1⁄2. In our 1990 paper, we also imposed the constraint that z 5 ap 1 (1 2 a)q, which further implies that a 5 1⁄2. The heart of the OS Comment is the idea that this constraint should be disposed of—i.e., we should look at other values of a. Without loss of generality, we will consider values of a above 1⁄2, and distinguish two cases.

Economic Growth and the Elasticity of Substitution: Two Theorems and Some Suggestions by Rainer Klump and Olivier de La Grandville. Published in volume 90, issue 1, pages 282-291 of American Economic Review, March 2000

Because government intervention transfers resources from one party to another, it creates room for corruption. As corruption often undermines the purpose of the intervention, governments will try to prevent it. They may create rents for bureaucrats, induce a misallocation of resources, and increase the size of the bureaucracy. Since preventing all corruption is excessively costly, second-best intervention may involve a certain fraction of bureaucrats accepting bribes. When corruption is harder to prevent, there may be both more bureaucrats and higher public-sector wages. Also, the optimal degree of government intervention may be nonmonotonic in the level of income.

To test a model of contagion—where individuals hear some bad news and communicate it to their acquaintances, who then pass it on, leading to a market panic—requires a knowledge of the information networks of participants, something hitherto unavailable. For two panics in the 1850's this paper examines the behavior of Irish depositors in a New York bank. As recent immigrants, their social network was determined largely by their place of origin in Ireland, and where they lived in New York. During both panics this social network turns out to be the prime determinant of behavior.

Most OECD economies, including that of Canada, experienced a slowdown in economic growth from the 1961–1973 period to the 1973– 1988 period, and to the 1988–1995 period. Consequently, progress in the standard of living, as measured by GDP per capita, also slowed down in most OECD countries over the three subperiods. This paper analyses the sources of output growth in 122 industries and in the private business sector to gain an additional perspective on the slowdown of the Canadian economy. We adopt the constant-quality indexes of capital and labor inputs introduced by Dale W. Jorgenson and Zvi Griliches (1967) and later used extensively in Jorgenson et al. (1987), Jorgenson (1995a, b), and Jorgenson and Eric Yip (2000) to identify the sources of growth. These measures allow us to take into account the changing composition of the labor force and the capital stock. At the industry level, we adjust for capital quality by aggregating the capital stock across five asset types by means of the rental prices of capital rather than the asset prices of capital. The use of rental prices allows us to incorporate differences in depreciation rates and tax treatment across different asset types for each industry. At the same time, we combine hours worked by each type of worker using the share of labor compensation to reflect labor quality. At the aggregate level, we apply the same framework by aggregating the capital stock across different asset types and hours worked across different types of workers. A number of studies have compared Canada’s economic growth performance with that of its competitors using this framework (Chrysostom Dougherty, 1991; Dougherty and Jorgenson, 1997; Jorgenson and Yip, 2000). However, this is the first attempt at using this framework to assess Canada’s economic performance at the industry level.