Knowledge that Transforms

We report 28 new experiment sessions consisting of up to three experience levels to examine the robustness of learning and “error” elimination among participants in a laboratory asset market and its effect on price bubbles. Our answer to the title question is: “yes.” We impose a large increase in liquidity and dividend uncertainty to shock the environment of experienced subjects who have converged to equilibrium, and this treatment rekindles a bubble. However, in replications of that same challenging environment across three experience levels, we discover that the environment yields a rare residual tendency to bubble even in the third experience session. Therefore, a caveat must be placed on the effect of twice-experienced subjects in asset markets: in order for price bubbles to be extinguished, the environment in which the participants engage in exchange must be stationary and bounded by a range of parameters. Experience, including possible “error” elimination, is not robust to major new environment changes in determining the characteristics of a price bubble. (JEL C91, D83)

Economics began with Xenophon’s Oeconomicus (c 360 BCE), in which Socrates interviews a model citizen who has two primary concerns. He goes out to his farm in the country to monitor and motivate his workers there. Then he goes back to the city, where his participation in various political institutions is essential for maintaining his rights to own this farm. Such concerns about agents’ incentives and political institutions are also central in economic theory today. But they were not always. Two centuries ago, economics developed as an analytical social science by focusing on produc tion and allocation of material goods, developing methodologies of national-income accounting and price theory. Questions about resource allocation seemed particularly amenable to math ematical analysis, because flows of goods and money are measurable and should satisfy flowbalance equations and no -arbitrage conditions. From this perspective, the classical economic problem was that people’s ability to satisfy their desires is constrained by limited resources. The classical economic result was that unrestricted free trade can achieve allocative efficiency, in the sense that reallocating the available resources cannot improve everyone’s welfare. A shift of focus from allocation of resources back to analysis of incentives began from the time of Augustin Cournot (1838), when economic theorists began to analyze optimal decisions of rational individuals as a tool for understanding supply and demand in price theory (see Jurg

Purely forward-looking versions of the New Keynesian Phillips curve (NKPC) generate too little inflation persistence. Some authors add ad hoc backward-looking terms to address this shortcoming. We hypothesize that inflation persistence results mainly from variation in the long-run trend component of inflation, which we attribute to shifts in monetary policy. We derive a version of the NKPC that incorporates a time-varying inflation trend and examine whether it explains the dynamics of inflation. When drift in trend inflation is taken into account, a purely forward-looking version of the model fits the data well, and there is no need for backward-looking components. (JEL E12, E31, E52)

In this paper, we describe a set of trade-offs that policymakers face with respect to fluctua? tions at different frequencies. A complete treat? ment is given in Brock, Durlauf, and Rondina (2008). The presence of frequency-specific effects of policy choices has generally not been a focus of macroeconomic policy analysis, important exceptions include Alexei Onatski and Noah M. Williams (2003). Our analysis dif? fers from previous studies in that our objective is to understand to what extent a policymaker is forced, when choosing a feedback rule to sta? bilize the economy, to exacerbate volatility at some frequencies in order to reduce them at oth? ers, or whether it is possible to reduce volatil? ity at all frequencies. These trade-offs, known as design limits in the control theory literature, are important in understanding what stabiliza? tion policies do, and also possess implications for policy design in the presence of policymaker ignorance.

Currently, a growing literature is emerging on estimating the impact of exogenous shocks using the difference-in-difference (DD) tech? nique. Essentially, this technique compares the impact of an unexpected event in a particu? lar locale (called the treatment/experimental group) to a location or set of locations (called a control group) similar to the experimental group in all respects except for the shock itself. One challenge many DD studies face is how to choose the control group, and there is now a growing literature on this (Joshua A. Angrist and Alan B. Krueger 1999; Jeffrey D. Kubik and John R. Moran 2003; and Alberto Abadie, Alexis Diamond, and Jens Hainmueller 2007). Another challenge is whether one can general? ize one's results based on a single experimental group, as is typical for most DD analysis. This paper adopts a generalized-difference-in-dif ference (GDD) technique outlined in Ariel R. Belasen and Solomon W. Polachek (forthcom? ing) to examine the impact of hurricanes on the labor market. This technique incorporates many experimental as well as many control groups, and as such this approach addresses a number of shortcomings in current DD analyses. We find that earnings of the average worker in a Florida county rise over 4 percent within the first quarter of being hit by a major Category Four or Five hur? ricane relative to counties not hit, and rise about Wa percent for workers in Florida counties hit by less major Category One to Three hurricanes. Concomitantly, employment falls between Wi and 5 percent depending on hurricane strength. On the other hand, the effects of hurricanes on neighboring counties have the opposite effects, moving earnings down between 3 and 4 percent in the quarter the hurricane struck. To better examine the specific shocks, we also observe sectoral employment shifts. Finally, we conduct a time-series analysis and find that, over time, there is somewhat of a cobweb, with earnings and employment rising and falling each quarter over a two-year time period.

Recent sovereign defaults are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default is more likely in recessions because this is when it is more costly for a risk averse borrower to repay noncontingent debt. The model closely matches business cycles in Argentina predicting high volatility of interest rates, higher volatility of consumption relative to output, and negative correlations of output with interest rates and the trade balance. (JEL E21, E23, E32, E43, F34, O11, O19)

We provide a pricing theory for emerging asset classes, like emerging markets, that are not yet mature enough to be attractive to the general public. We show how leverage cycles can cause contagion, flight to collateral, and issuance rationing in a frequently recurring phase we call the anxious economy. Our model provides an explanation for the volatile access of emerging economies to international financial markets, and for three stylized facts we identify in emerging markets and high yield data since the late 1990s. Our analytical framework is a general equilibrium model with heterogeneous agents, incomplete markets, and endogenous collateral, plus an extension encompassing adverse selection. (JEL D53, G12, G14, G15)

We find that prior to World Trade Organization membership, countries set import tariffs 9 percentage points higher on inelastically supplied imports relative to those supplied elastically. The magnitude of this effect is similar to the size of average tariffs in these countries, and market power explains more of the tariff variation than a commonly used political economy variable. Moreover, US trade restrictions not covered by the WTO are significantly higher on goods where the United States has more market power. We find strong evidence that these importers have market power and use it in setting noncooperative trade policy. (JEL F12, F13)

A consistent finding in the poverty literature is the diminution of the impact of the macroeconomy on official poverty rates in the United States since the early 1980s. Up until then, measures of aggregate economic activity (real GDP growth or the unemployment rate) had a more substantial influence on the poverty rate. Most recently, this fact has been documented by Hilary W. Hoynes, Marianne E. Page, and Ann Huff Stevens (2006, HPS hereafter). Kevin Lang (2007) notes that much has changed since the early 1980s with respect to antipoverty policy and labor market factors that affect poverty status. Important changes include the transition from cash to in-kind transfers, the stagnation in real median earnings, rising earnings inequality, and the increase in female-headed households. Nevertheless, after considering several factors that influence poverty, including wage growth, inequality, and female employment, HPS conclude their analysis of poverty trends with the view that explanation of the change in the response of poverty to macroeconomic indicators remains an open issue. This paper examines whether traction may be gained on this issue by enhancing our understanding of the volatility of poverty rates. Specifically, we examine the volatility of poverty rates over time and across demographic groups. To the extent that poverty rate variability is associated with the risk of poverty incidence, it is shown that certain eras have exposed members of particular demographic groups to more poverty risk than others. Then, we contrast the volatility of poverty rates to that of aggregate economic activity. Margaret M. McConnell and Gabriel Perez-Quiros (2000), among others, present evidence that the volatility of real GDP has been significantly Poverty Volatility and Macroeconomic Quiescence

This paper looks at the predictions of a standard heterogeneous firm model regarding the exports of firms across markets in response to a particular trade policy experiment and compares these predictions to the data. A unique feature of our data is that it has information on the exports of the same firm to different markets which allows us to look for a new set of predictions of such models. We argue that while certain predictions seem consistent with the data, others are not. We then describe the patterns found in the data and argue that firm and market specific demand shocks help explain a number of these anomalies. These parsimoniously capture factors, like business contacts or networks, or even fashion shocks, that make buyers more attracted to one firm rather than another in a particular market.