Knowledge that Transforms

Employment relationships typically involve the division of surplus. Surplus can be the result of a good match, a monopoly rent, or a quasirent that arises because of a specific investment. The division of this surplus is of economic interest as it is a determinant of turnover, investment, and wages. Gary S. Becker (1962) argued, in the context of specific human-capital investments, that the incumbent employee and firm will share the surplus. This notion was formalized in a prototypical model of surplus sharing as first proposed by Masanori Hashimoto (1981). The model has been studied extensively, among others by H. Lorne Carmichael (1983), Robert E. Hall and Edward P. Lazear (1984), and Donald O. Parsons (1986), while Elizabeth Becker and Cotton M. Lindsay (1994) provide an empirical application. The key feature of the model is the existence of transaction costs. Both the employee and the firm have (ex ante uncertain) private information on which they cannot write a contingent contract. This makes that they write a nonrenegotiable contract that specifies a fixed wage. After this, the firm learns the value of the employee’s marginal product whereas the employee learns the value of his outside option. Both parties then decide unilaterally whether to separate or not and inefficient separations may occur. The wage is set in such a way as to maximize the expected total surplus. The present analysis will consider the role of uncertainty in this model. This has not been done before in a rigorous way. Hashimoto considered only degenerate cases. His analysis suggests that the wage will be low when the uncertainty of the market conditions is small, and high when the uncertainty of the conditions inside the firm is small. Parsons (1986) makes a claim that this is actually the case without deriving the result. This paper shows that the comparative statics are ambiguous and may well be the opposite of those suggested by Hashimoto and claimed by Parsons. It also provides the intuition that is behind this result, namely that uncertainty not only influences turnover but also the option value of the match and its opportunity cost. Section I, briefly summarizes Hashimoto’s model and shows that without further assumptions the comparative statics are ambiguous. Section II derives an explicit solution of the wage. Section III briefly considers alternative wage-setting schemes and Section IV concludes.

Propensity-score matching is a nonexperimental method for estimating the average effect of social programs (see William Cochran, 1968; Paul Rosenbaum and Donald Rubin, 1983; James Heckman et al., 1998b). The method compares average outcomes of participants and nonparticipants, conditioning on the propensityscore value. The average comparison measures the average impact of a program. This methodology has received much attention recently in econometrics (see Heckman et al., 1996, 1997, 1998a, b; Jinyong Hahn, 1998; Rajeev Dehejia and Sadek Wahba, 1999; Jeffrey Smith and Petra Todd, 2000; Keisuke Hirano et al., 2000). The underlying identification requirement of the matching methodology is that the program choice is independent of outcomes conditional on a certain set of observables. While intuitively attractive in that the method replicates features of randomized experiments within observational data, the identification requirement excludes a possibility that the program-choice decision could be correlated with the outcomes given the set of observables (see Heckman et al., 1997, 1998b). Unobservables that are correlated both with an outcome and the program choice are not allowed. There are some efforts to estimate more general models using nonparametric methods (see Whitney Newey and James Powell, 1989; Heckman, 1997; Alberto Abadie, 2000; Serge Darolles et al., 2000; Matali Das, 2000; JeanPierre Florens, 2000; Ichimura and Taber, 2000). One such effort is the use of the instrumental-variable methods. Heckman (1997) has shown that the set of assumptions to justify instrumental-variable methods are very restrictive from the perspective of behavioral models of program participation. We show that his conditions justifying instrumental-variable methods actually justify the matching method as a special case.1 This observation ties the limitations of the matching method in line with those of instrumental-variable methods and also is useful in constructing specification tests for matching methods when valid instrumental variables are available. This is analogous to testing the validity of the identification conditions for ordinary least-squares (OLS) estimators when there are overidentifying instrumental variables. We then present two different propensityscore methods that are based on instrumental variables. Both methods include standard propensity-score matching as special cases. They help reduce the dimension of the conditioning variables without invoking functional-form assumptions in the same way that the standard propensity-score matching helps reduce the dimension of the conditioning variables. We show how to use these ideas to construct estimators that can be easily implemented.

The resurgence of the American economy since 1995 has outrun all but the most optimistic expectations. Economic forecasting models have been seriously off track and growth projections have been revised to reflect a more sanguine outlook only recently. It is not surprising that the unusual combination of more rapid growth and slower inflation in the 1990's has touched off a strenuous debate among economists about whether improvements in America's economic performance can be sustained. The starting point for the economic debate is the thesis that the 1990's are a mirror image of the 1970's, when an unfavorable series of supply shocks led to stagflation -- slower growth and higher inflation. In this view, the development of information technology (IT) is one of a series of positive, but temporary, shocks. The competing perspective is that IT has produced a fundamental change in the U.S. economy, leading to a permanent improvement in growth prospects.

This paper examines the risk aspects of an investment-based defined contribution Social Security plan. We focus on the risk after the plan is fully phased in. Individuals deposit a fraction of wages to a Personal Retirement Account (PRA), invest these funds in a 60:40 equity-debt mix, and in a similarly invested annuity at age 67. The value of the assets follows a random walk with mean and variance of a 60:40 equity-debt portfolio over the period 1946-95, a mean log return of 5.5 percent (net of administrative costs of 0.4 percent) and a standard deviation of 12.5 percent. We study he stochastic distributions of this process by doing 10, 000 simulations of the 80-year experience of the cohort that reached age 21 in 1998. The resulting annuities are compared to the future defined benefits specified in current law (the benchmark' benefits). With no uncertainty, a 5.5 percent log return would permit the benchmark benefits to be purchased with PRA deposits of 3.1 percent of payroll, only one-sixth of the pay-as-you-go tax needed for the benchmark benefits. Saving a higher share of wages provides a cushion' that protects the individual from the risk of an unacceptably low level of benefits. For example, PRA deposits of 6 percent of wages reduces the probability that the benefits are less than the benchmark to 0.17 and the probability that they are less than 61 percent of the benchmark to 0.05. PRA deposits of 9 percent of wages (half of the tax rate required in a pay-as-you-go system) would substantially reduce these risks. This pure investment-based plan is an extreme case. The investment risk can be reduced further by using a mixed system that combines pay-as-you-go and investment-based components or that makes intergenerational transfers conditional on the performance of stock and bond prices.

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This paper describes links between the max-min expected utility theory of Gilboa and Schmeidler (1989) and the applications of robust control theory proposed by Anderson, Hansen and Sargent (2000) and Dupuis, James and Petersen (1998).

This thesis contains four chapters, each of which examines different aspects of the uncertainty facing monetary policymakers.''Monetary policy and market interest rates'' investigates how interest rates set on financial markets respond to policy actions taken by the monetary authorities. The reaction of market rates is shown to depend crucially on market participants' interpretation of the factors underlying the policy move. These theoretical predictions find support in an empirical analysis of the U.S. financial markets.''Predicting monetary policy using federal funds futures prices'' examines how prices of federal funds futures contracts can be used to predict policy moves by the Federal Reserve. Although the futures prices exhibit systematic variation across trading days and calendar months, they are shown to be fairly successful in predicting the federal funds rate target that will prevailafter the next meeting of the Federal Open Market Committee from 1994 to 1998.''Monetary policy with uncertain parameters'' examines the effects of parameter uncertainty on the optimal monetary policy strategy. Under certain parameter configurations, increasing uncertainty is shown to lead to more aggressive policy, in contrast to the accepted wisdom.''Should central banks be more aggressive?'' examines why a certain class of monetary policy models leads to more aggressive policy prescriptions than what is observed in reality. These counterfactual results are shown to be due to model restrictions rather than central banks being too cautious in their policy behavior. An unrestricted model, taking the dynamics of the economy and multiplicative parameter uncertainty into account, leads to optimal policy prescriptions which are very close to observed Federal Reserve behavior.

Suppose that agents share risks in competitive markets. We show that better information makes everyone worse off if the economy has a representative agent—that is, the economy's demand for state-contingent consumption equals the demand of a hypothetical agent who owns all the economy's wealth. The representative agent, moreover, is normatively unrepresentative: although each agent dislikes information, the “representative” agent is indifferent. Although we emphasize pure exchange, our results imply that a representative-agent model might seriously misstate the welfare effects of improved information in an economy with production and risk sharing, even if it performs well otherwise. (JEL D8)

Preferences over Inflation and Unemployment: Evidence from Surveys of Happiness by Rafael Di Tella, Robert J. MacCulloch and Andrew J. Oswald. Published in volume 91, issue 1, pages 335-341 of American Economic Review, March 2001