Discovery and Diffusion of Knowledge in an Endogenous Social Network

We explore the evolution of the structure and performance of a social network in a population of individuals who search for local optima in diverse and dynamic task environments. Individuals choose whether to innovate or imitate and, in the latter case, from whom to learn. The probabilities of these possible actions respond to an individual's past experiences using reinforcement learning. Among some of our more interesting findings is that a population's performance is not monotonically increasing in either the reliability of the communication network or the productivity of innovation.

Post-Cartel Pricing during Litigation

Standard methods in the U.S. for calculating antitrust damages in price-fixing cases is shown to create a strategic incentive for firms to price above the non-collusive price after the cartel has dissolved. This results in an overestimate of the but for price and an underestimate of the level of damages. The extent of this upward bias in the but for price is greater, the longer the cartel was in place and the more concentrated is the industry.

Cartel Pricing Dynamics in the Presence of an Antitrust Authority

Price-fixing is characterized when firms are concerned about creating suspicions that a cartel has formed. Antitrust laws have a complex effect on pricing as they interact with the conditions determining the internal stability of the cartel. Dynamics are driven by two forces - the sensitivity of detection to price movements causes a cartel to gradually raise price while the sensitivity of penalties to the price level induces the cartel to lower price over time in order to maintain the stability of the cartel. While antitrust laws can lower collusive prices, they can also raise them by making it easier for firms to collude.

The Negative Income Tax and the Evolution of U.S. Welfare Policy

The negative income tax proposed by Milton Friedman represents one of the fundamental ideas of modern welfare policy. However, the academic literature has raised two difficulties with it, one challenging its purported work incentives and the other suggesting the possible superiority of work requirements. In addition, work requirement approaches have gained ground in actual U.S. welfare policy over the last 30 years and the number of different programs has proliferated, another development counter to the negative income tax. On the other hand, the Earned Income Tax Credit has produced a negative-income-tax-like program on a vast scale.

Supply Shocks and the Persistence of Inflation

This paper examines the long-run effects of supply shocks (such as oil shocks) on inflation in the United States. The persistence of supply shocks in U.S. inflation fell considerably during the period of Volcker's disinflation (1979-1982). My empirical results suggest that the difference between the pre-Volcker and post-Volcker periods is attributable to the change in the behavior of inflation expectations-agents expected shocks to persist in the pre-Volcker period, but not in the post-Volcker period. I construct a simple model of how different monetary policies lead to different persistence equilibria.

Exact Arbitrage and Portfolio Analysis in Large Asset Markets

We provide a detailed portfolio analysis for a financial market with an atomless continuum of assets. In the context of an exact arbitrage pricing theory (EAPT), we go beyond the characterization of the existence of important portfolios (normalized riskless, mean, cost, factor and mean-variance efficient portfolios) to furnish exact portfolio compositions in terms of explicit portfolio weights. Such an analysis has not been furnished before in the context of the asymptotic arbitrage pricing theory (APT). We also characterize conditions under which a mean-variance efficient portfolio is a benchmark portfolio used in the EAPT to proxy essential risk. We illustrate our results with several examples of specific financial markets.

Exact Arbitrage, Well-Diversified Portfolios and Asset Pricing in Large Markets

For market with an atomless continuum of assets, we formulate the intuitive idea of a "well-diversified" portfolio, and present a notion of "exact arbitrage", strictly weaker than the more conventional notion of "asymptotic arbitrage", and necessary and sufficient for the validity of an APT pricing formula. One formula involves "essential" risk based on a specific index portfolio constructed from factors and factor loadings that are endogenously extracted to satisfy an optimality property involving a finite number of factors. We illustrate how our results can be translated to markets with a large but finite number of assets.

Short-run Money Demand

This paper estimates a long-run demand function for M1, using U.S. data for 1959-1993. The paper interprets deviations from this long-run relation with Goldfeld=s partial adjustment model. A key innovation is the choice of the interest rate in the money demand function. Most previous work uses a short-term market rate, but this paper uses the average return on "near monies" -- close substitutes for M1 such as savings accounts and money market mutual funds. This approach yields a predicted path of M1 velocity that closely matches the data. The volatility of velocity after 1980 is explained by volatility in the returns on near monies.

Testing for Indeterminacy: An Application to U.S. Monetary Policy

This paper considers a prototypical monetary business cycle model for the U.S. economy, in which the equilibrium is undetermined if monetary policy is ‘inactive’. In previous multivariate studies it has been common practice to restrict parameter estimates to values for which the equilibrium is unique. We show how the likelihood-based estimation of dynamic stochastic general equilibrium models can be extended to allow for indeterminacies and sunspot fluctuations. We propose a posterior odds test for the hypothesis that the data are best explained by parameters that imply determinacy. Our empirical results show that the Volcker-Greenspan policy regime is consistent with determinacy, whereas the pre-Volcker regime is not. We find that before 1979 non-fundamental sunspot shocks may have contributed significantly to inflation and interest rate volatility, but essentially did not affect output fluctuations.

Admission Impossible? Self Interest and Affrmative Action

This paper explains people’s preferences for ethnic and racial diversity in higher education through a model based on self interest. Although all citizens from the majority group value diversity and their own education in the same way, their preferences for the level of diversity as well as the means of achieving it depend on their competitive positions in university admissions. High-income majority citizens, who tend to have better academic qualifications than lower-income majority candidates, prefer more diversity, which they want to achieve through affirmative action by displacing marginal majority candidates for marginal minority candidates. Lower-income majority candidates prefer less diversity, which they want to achieve through admissions rules that partially ignore academic qualifications. Data from a CBS/NYT opinion poll confirm these predictions. Our model suggests why recently several American universities have replaced race-conscious admissions policies with race-blind policies that de-emphasize standardized tests, with little to no effect on diversity. Income inequality and competitive admissions both make banning affrmative action more likely.

Intergenerational Risk Sharing in the Spirit of Arrow, Debreu, and Rawls, with Applications to Social Security Design

This paper examines the optimal allocation of risk in an overlapping-generations economy. It compares the allocation of risk the economy reaches naturally to the allocation that would be reached if generations behind a Rawlsian 'veil of ignorance' could share risk with one another through complete Arrow-Debreu contingent-claims markets. The paper then examines how the government might implement optimal intergenerational risk sharing with a social security system. One conclusion is that the system must either hold equity claims to capital or negatively index benefits to equity returns.

Macroeconomic Expectations of Households and Professional Forecasters

Economists have long emphasized the importance of expectations in determining macroeconomic outcomes. Yet there has been almost no recent effort to model actual empirical expectations data; instead, macroeconomists usually simply assume that expectations are "rational". This paper shows that while empirical household expectations are not rational in the usual sense, expectational dynamics are well captured by a model in which households' views derive from news reports of the views of professional forecasters, which in turn may be rational. The model's estimates imply that people only occasionally pay attention to news reports; this inattention generates "stickyness" in aggregate expectations, with important macroeconomic consequences.

Externalities of Non-Cooperative Tax Policy in the Globally Integrated Market

This paper investigates efficiency losses caused by independent tax systems, and proposes ways of remedying this coordination failure. Whereas the harmful effects of tariff competition have been thoroughly explored in the trade policy literature, little is known about the externalities that result from jurisdictional corporate tax policies on the trade of multinational companies. I show that cooperative tax policy with self-interested governments has the potential for increasing not only the levels of tax revenues and corporate profits but also the volume of trade through a more efficient allocation of tax burden.

Learning, Hypothesis Testing, and Nash Equilibrium

Although there exist learning processes for which the empirical distribution of play comes close to Nash equilibrium, it is an open question whether the players themselves can learn to play equilibrium strategies without assuming that they have prior knowledge of their opponents' strategies and/or payoffs. We exhibit a large class of statistical hypotheses testing procedures that solve this problem. Consider a finite stage game G that is repeated infinitely often. At each time, the players have hypotheses about their opponents' repeated game strategies. They frequently test their hypotheses against the opponents' recent actions. When a hypotheses fails test, a new one is adopted. Play is almost rational in the sense that, at each point of time, the players' strategies are є -best replies to their beliefs. We show that, at least 1 - є of the time t these hypotheses testing strategies constitute an є-equilibrium of the repeated game from t on; in fact the strategies are close to being subgame perfect for long stretches of time. Further, all players for whom prediction matters, i.e. whose best responses depend on the opponents' behavior, learn to predict within є.

Inventories, Employment and Hours

The purpose of this paper is to develop a model that integrates inventory and labor decisions. We extend a model of inventory behavior to include a detailed specification of the role of labor input in the production process and of the costs associated with it. In particular, we distinguish between employment, hours and effort per worker, and allow for adjustment costs associated with employment changes. We assume that the requirement function for effective hours has a general trans-logarithmic form, and derive an estimable system of Euler equations for inventories and employment with implied cross-equation restrictions. The econometric results shed light on several important topics, including the shape of the marginal cost of output and the role of labor hoarding as an explanation of procyclical productivity and the persistence of inventory stocks. Moreover, they raise questions about the adequacy of commonly used specifications such as Cobb-Douglas approximations to the production process and the definition of labor input as the product of employment and effective hours worked per worker.

Greenspan and the Greenbook

A vast literature has emerged using Taylor rules to analyze monetary policy. Although very attractive both theoretically and empirically, such rules imply a mechanical response by the policy variable to fundamental ones. This study looks for empirical evidence of a more sophisticated monetary policy, one which takes into account expected future developments. An important piece of information I use is the Greenbook forecast series, which are calculated by the Federal Reserve Board's Research Department prior to the Board meetings. Using Greenbook forecasts allows calculation of future inflation shocks as expected by the Fed. These shocks are significant in the estimated Taylor rule, confirming that policymaking is forward-looking. In addition, using Greenbook forecasts allows one to obtain better real time estimates of the potential output, and thus to obtain a more precise characterization of monetary policy.

Why Does it Matter that Beliefs and Valuations be Correctly Represented?

This paper contains an analysis of a simple principal-agent problem illustrating possible problems that may arise when the prinicpal ascribes to the agent subjective probabilities and utilities that are implied by the subjective expected utility model but do not represent the agent’s beliefs and valuations. In particular, it is possible that an incentive contract designed by the principal induces the agent to choose an action that is not in the principal’s best interest.