Knowledge that Transforms

We construct a dynamic theory of sovereign debt and structural reforms with limited enforcement and moral hazard. A sovereign country in recession wishes to smooth consumption. It can also undertake costly reforms to speed up recovery. The sovereign can renege on contracts by suffering a stochastic cost. The constrained optimal allocation (COA) prescribes imperfect insurance with non-monotonic dynamics for consumption and effort. The COA is decentralized by a competitive equilibrium with markets for renegotiable GDP-linked one-period debt. The equilibrium features debt overhang: reform effort decreases in a high debt range. We also consider environments with less complete markets. (JEL D82, E21, E23, E32, F34, H63)

We show that kidney exchange markets suffer from market failures whose remedy could increase transplants by 30 to 63 percent. First, we document that the market is fragmented and inefficient; most transplants are arranged by hospitals instead of national platforms. Second, we propose a model to show two sources of inefficiency: hospitals only partly internalize their patients’ benefits from exchange, and current platforms suboptimally reward hospitals for submitting patients and donors. Third, we calibrate a production function and show that individual hospitals operate below efficient scale. Eliminating this inefficiency requires either a mandate or a combination of new mechanisms and reimbursement reforms. (JEL D24, D47, I11)

Using de-identified bank account data, we show that spending drops sharply at the large and predictable decrease in income arising from the exhaustion of unemployment insurance (UI) benefits. We use the high-frequency response to a predictable income decline as a new test to distinguish between alternative consumption models. The sensitivity of spending to income we document is inconsistent with rational models of liquidity-constrained households, but is consistent with behavioral models with present-biased or myopic households. Depressed spending after exhaustion also implies that the consumption-smoothing gains from extending UI benefits are four times larger than from raising UI benefit levels. (JEL D14, D91, E21, E24, E70, J65)

We propose an approach to measuring the misallocation of production in a market that compares actual industry cost curves to undistorted (counterfactual ) supply curves. As compared to traditional, TFPR-based, misallocation measures, this approach leverages cost data, such that results are readily mapped to welfare metrics. As an application, we analyze global crude oil extraction and quantify the extent of misallocation therein, together with the proportion attributable to market power. From 1970 to 2014, we find substantial misallocation, in the order of US$744 billion, 14.1 percent to 21.9 percent of which is attributable to market power. (JEL D24, F23, L13, L71, Q35)

For exiting products, statistical agencies often impute inflation from surviving products. This understates growth if creatively-destroyed products improve more than surviving ones. If so, then the market share of surviving products should systematically shrink. Using entering and exiting establishments to proxy for creative destruction, we estimate missing growth in US Census data on non-farm businesses from 1983 to 2013. We find missing growth (i) equaled about one-half a percentage point per year; (ii) arose mostly from hotels and restaurants rather than manufacturing; and (iii) did not accelerate much after 2005, and therefore does not explain the sharp slowdown in growth since then. (JEL E23, E31, L14, L15, O30, O41)

This paper uses administrative data to analyze a large employer-borne payroll tax rate cut for young workers in Sweden. We find no effect on net-of-tax wages of young treated workers relative to slightly older untreated workers, and a 2–3 percentage point increase in youth employment. Firms employing many young workers receive a larger tax windfall and expand right after the reform: employment, capital, sales, and profits increase. These effects appear stronger in credit-constrained firms. Youth-intensive firms also increase the wages of all their workers collectively, young as well as old, consistent with rent sharing of the tax windfall. (JEL H25, H32, J13, J23, J31, M51)

We use machine learning to uncover regularities in the initial play of matrix games. We first train a prediction algorithm on data from past experiments. Examining the games where our algorithm predicts correctly, but existing economic models don’t, leads us to add a parameter to the best performing model that improves predictive accuracy. We then observe play in a collection of new “ algorithmically generated” games, and learn that we can obtain even better predictions with a hybrid model that uses a decision tree to decide game-by-game which of two economic models to use for prediction. (JEL C70, C91)

Leading empiricists and theorists of cities have recently argued that the generation and exchange of ideas must play a more central role in the analysis of cities. This paper develops the first system of cities model with costly idea exchange as the agglomeration force. The model replicates a broad set of established facts about the cross section of cities. It provides the first spatial equilibrium theory of why skill premia are higher in larger cities and how variation in these premia emerges from symmetric fundamentals. (JEL J24, J31, O31, R12, R23)

We revisit Galí’s (2014 ) analysis by extending his model to incorporate persistent bubble shocks. We find that, under adaptive learning, a stable bubbly steady state and the associated sunspot solutions under optimal monetary policy are not E-stable. When deriving the unique forward-looking minimum stable variable (MSV ) solution around an unstable bubbly steady state, we obtain results that are consistent with the conventional views: leaning against the wind policy reduces bubble volatility and is optimal. Such a steady state and the associated MSV solution are E-stable. (JEL E13, E32, E44, E52, G12)

Bureaucracies often post staff to better or worse locations, ostensibly to provide incentives. Yet we know little about whether this works, with heterogeneity in preferences over postings impacting effectiveness. We propose a performance-ranked serial dictatorship mechanism, whereby bureaucrats sequentially choose desired locations in order of performance. We evaluate this using a two-year field experiment with 525 property tax inspectors in Pakistan. The mechanism increases annual tax revenue growth by 30–41 percent. Inspectors whom our model predicts face high equilibrium incentives under the scheme indeed increase performance more. Our results highlight the potential of periodic merit-based postings in enhancing bureaucratic performance. (JEL C93, D73, H71, H83, J45, M54, O17)