C.V. Starr Research by Topic

C.V. Starr researchers are continually investigating the pressing economic issues of the day using the tools of rigorous empirical and theoretical economic science. Here you will find a large number of academic studies undertaken by C.V. Starr Center research staff, organized by topic. page 1 | page 2 | page 3 Energy Economics | Markets and the Welfare | Financial Crises and Macro-Finance Policy | Institutions and Economic Performance | Wealth distribution, Inequality and Redistributive Policies | Banking Systems, Risk and Financial Markets | Polarization and Conflict | Health and Healthcare | Education and Education Policy | Monetary Policy and Prices | Modern Fiscal Policy | The Economics of Development | Labor Force Dynamics and Household Economics | Unemployment and the Labor Market | Experimental Methods and the Economics of Social Psychology | Housing and the Financial Crisis | International Capital Flows, International Prices, and Trade | Stock Markets and Asset Pricing | Economics of Fluctuations and Dynamics | Migration | Misallocation

Energy Economics

'The Welfare Effects of Nudges: a Case Study of Energy Use Social Comparisons,' Allcott, H. (with J.B. Kessler), 2015.

"Nudge"-style interventions are typically evaluated on the basis of their effects on behavior, not social welfare. We use a field experiment to measure the welfare effects of one especially policy-relevant intervention, home energy conservation reports. We measure consumer welfare by sending introductory reports and using an incentive-compatible multiple price list to determine willingness-to-pay to continue the program. We combine this with estimates of implementation costs and externality reductions to carry out a comprehensive welfare evaluation. We find that this nudge increases social welfare, although traditional program evaluation approaches overstate welfare gains by a factor of five. To exploit significant individual-level heterogeneity in welfare gains, we develop a simple machine learning algorithm to optimally target the nudge; this would more than double the welfare gains. Our results highlight that nudges, even those that are highly effective at changing behavior, need to be evaluated based on their welfare implications.

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'Real-Time Pricing and Electricity Market Design,' Allcott, H., 2013.

This paper considers two related distortions in electricity markets: the lack of real-time retail pricing and the suppression of peak wholesale prices due to Installed Capacity requirements. I lay out a framework for understanding these problems using a two-stage entry model in which producers with multiple technologies set capacity and then sell electricity into wholesale markets as demand varies over time. The model is calibrated to supply and demand conditions in the PJM electricity market. I estimate that moving from 10 percent of consumers on real-time pricing to 20 percent would increase welfare in PJM by $120 million per year. However, the welfare gains from clearer signals of scarcity prices under an Energy Only market design are more than twice as large. Furthermore, equilibrium peak prices in the Energy Only design drop to reasonable levels once a moderate share of retail consumers are on real-time pricing.

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Markets and the Welfare

'The Welfare Effects of Nudges: a Case Study of Energy Use Social Comparisons,' Allcott, H. (with J.B. Kessler), 2015.

"Nudge"-style interventions are typically evaluated on the basis of their effects on behavior, not social welfare. We use a field experiment to measure the welfare effects of one especially policy-relevant intervention, home energy conservation reports. We measure consumer welfare by sending introductory reports and using an incentive-compatible multiple price list to determine willingness-to-pay to continue the program. We combine this with estimates of implementation costs and externality reductions to carry out a comprehensive welfare evaluation. We find that this nudge increases social welfare, although traditional program evaluation approaches overstate welfare gains by a factor of five. To exploit significant individual-level heterogeneity in welfare gains, we develop a simple machine learning algorithm to optimally target the nudge; this would more than double the welfare gains. Our results highlight that nudges, even those that are highly effective at changing behavior, need to be evaluated based on their welfare implications.

download full paper
'Real-Time Pricing and Electricity Market Design,' Allcott, H., 2013.

This paper considers two related distortions in electricity markets: the lack of real-time retail pricing and the suppression of peak wholesale prices due to Installed Capacity requirements. I lay out a framework for understanding these problems using a two-stage entry model in which producers with multiple technologies set capacity and then sell electricity into wholesale markets as demand varies over time. The model is calibrated to supply and demand conditions in the PJM electricity market. I estimate that moving from 10 percent of consumers on real-time pricing to 20 percent would increase welfare in PJM by $120 million per year. However, the welfare gains from clearer signals of scarcity prices under an Energy Only market design are more than twice as large. Furthermore, equilibrium peak prices in the Energy Only design drop to reasonable levels once a moderate share of retail consumers are on real-time pricing.

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'Adverse Selection and Self-fulfilling Business Cycles,' Benhabib, J. (with F. Dong and P. Wang), 2014.

We develop a macroeconomic model with adverse selection. A continuum of households purchase goods from a continuum of anonymous producers. The quality of products can only be learned after trade. Adverse selection arises as low-quality goods deliver higher profits for producers but are less desirable for households. Higher aggregate demand induces more high-quality goods, raises average quality, and drives up household demand. We show that this demand externality can generate multiple equilibria or indeterminacy even when the steady state equilibrium is unique, making self-fulfilling expectation driven business cycles possible. Indeterminacy arising from adverse selection in credit markets is also constructed.

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'Advertising, Capitalism, and Mass Consumption,' Benhabib, J. and A. Bisin, 2002.

We identified a Postmodernist Critique of the organization of society which suggests that the interaction of monopoly power and advertising creates negative welfare effects for consumers. In particular, advertising takes the form of the "manipulation of preferences,' leads consumers to "work and spend cycles" and subjects them to the "commodification of leisure." We studied the interaction of monopoly power and advertising in a simple general equilibrium model, constructed to satisfy the basic postulates of this Critique (especially in terms of the effects of advertising on consumers’ preferences) and we identified specifications and parameter configurations of our model that give rise to equilibria which could support the Postmodernist Critique. Our analysis may provide a framework for the empirical analysis of the relevance of the Critique. In particular, it may be important to assess more precisely the relevance of the component of advertising that is stressed in the Critique, that of the "manipulation of preferences" relative to its informational component. The empirical relevance of the distortion caused by advertising relative to the many distortions and frictions present in the U.S. economy (from incompleteness of financial markets and borrowing constraints, to asymmetric information and distortionary taxation schemes) also remains to be established.

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'A Case for Incomplete Markets,' Cogley, T. and T. Sargent (with L.E. Blume, D.A. Easley, and V. Tsyrennikov), 2015.

We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which variousrestrictions on financial markets are desirable according to our welfare criterion.

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'The Long and the Short of It: Sovereign Debt Crises and Debt Maturity,' Fernandez, R. (with A. Martin), 2015.

We present a simple model of sovereign debt crises in which a country chooses its optimal mix of short and long-term debt contracts subject to standard contracting frictions: the country cannot commit to repay its debts nor to a specific path of future debt issues, and contracts cannot be made state contingent. We show that in order to satisfy incentive compatibility the country must issue short-term debt, which exposes it to roll-over crises and inefficient repayments. We examine two policies -- restructuring and reprofiling -- and show that both improve ex ante welfare if structured correctly. We show that how debt payments in times of crises is distributed across creditors in immaterial. What matters instead is how the surplus generated by restructuring is divided between the country and its creditors.

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'Frictions in a Competitive, Regulated Market: Evidence from Taxis,' Fréchette, G.R. and A. Lizzeri (with T. Salz), 2015.

This paper presents a dynamic general equilibrium model of a taxi market. The model is estimated using data from New York City yellow cabs. Two salient features by which most taxi markets deviate from the efficient market ideal is the need of both market sides to physically search for trading partners in the product market as well as prevalent regulatory limitations on entry in the capital market. To assess the relevance of these features we use the model to simulate the effect of changes in entry and an alternative search technology. The results are contrasted with a policy that improves the intensive margin of medallion utilization through a transfer of medallions to more efficient ownership. We use the geographical features of New York City to back out unobserved demand through a matching simulation.

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'Middlemen in Limit-Order Markets,' Jovanovic, B. (with A.J. Menkveld), 2015.

A limit order market enables an early seller to trade with a late buyer by leaving a price quote. Information arrival in the interim period creates adverse selection risk for the seller and therefore hampers trade. Entry of high-frequency traders (HFTs) might restore trade as their machines can refresh quotes quickly on (hard) information. Empirically, HFT entry reduced adverse selection by 23% and increased trade by 17%. Model calibration shows that one percentage point more of the gains from trade were realized. Finally, we show that a well-designed double auction raises this to ten percentage points.

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'Trading on Sunspots,' Jovanovic, B. (with V. Tsyrennikov), 2015.

In a model with multiple Pareto-ranked equilibria we endogenize the equilibrium selection probabilities by adding trade in assets that pay based on the realization of a sunspot. Asset trading imposes restrictions on the equilibrium set in a way that raises welfare. When the probability of a low-output outcome is high enough, the coordination game becomes more like a prisoner’s dilemma in which the high-output equilibrium disappears because of the asset positions that agents trade towards induce some agents not to invest. We derive an upper bound on the probabilities of the low-output equilibrium that we interpret as a disaster. We derive asset pricing implications including the disaster premium, and we study the effect on stock prices of news shocks to beliefs.

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'Foreign Ownership of U.S. Safe Assets: Good or Bad?' Ludvigson, S.C. (with J. Favilukis and S. Van Nieuwerburgh), 2016.

The last 20 years have been marked by a sharp rise in international demand for U.S. reserve assets, or safe stores-of-value. What are the welfare consequences to U.S. households of these trends, or of a reversal? In a lifecycle model with aggregate and idiosyncratic risks, the young and oldest households may benefit substantially from such capital inflows, but middle-aged savers may suffer from greater exposure to systematic risk in equity and housing markets. Under the veil of ignorance, a newborn in the lowest wealth quantile is willing to forego 3% of lifetime consumption to avoid a large capital outflow.

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'The Welfare Effects of Intertemporal Price Discrimination: An Empirical Analysis of Airline Pricing in U.S. Monopoly Markets,' Lazarev, J., 2013.

This paper studies how a firm's ability to price discriminate over time affects production, product quality, and product allocation among consumers. The theoretical model has forward-looking heterogeneous consumers who face a monopoly firm. The firm can affect the quality and quantity of the goods sold each period. I show that in the model the welfare effects of intertemporal price discrimination are ambiguous. I use this model to study the time paths of prices for airline tickets offered on monopoly routes in the U.S. Using estimates of the model's demand and cost parameters, I compare the welfare travelers receive under the current system to several alternative systems, including one in which free resale of airline tickets is allowed. I find that free resale of airline tickets would increase the average price of tickets bought by leisure travelers by 54% and decrease the number of tickets they buy by 10%. Their consumer surplus would decrease by only 16% due to a more efficient allocation of seats and the opportunity to sell a ticket on a secondary market.

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'Simulating the Dynamic Effects of Horizontal Mergers: U.S. Airlines,' Lazarev, J. (with L. Benkard and A. Bodoh-Creed), 2010.

We propose a new method for studying the medium and long run dynamic effects of horizontal mergers. Our method builds on the two-step estimator of Bajari, Benkard, and Levin (2007). Policy functions are estimated on historical pre-merger data, and then future industry outcomes are simulated both with and without the proposed merger. In our airline entry model, an airline’s entry/exit decisions are made jointly across route segments, and depend on features of its own route network as well as the networks of the other airlines. We also allow for city-specific profitability shocks that affect all route segments out of a given city, as well as segment-specific shocks. Using data for 2003-2008, we apply our model to three recently proposed airline mergers. We find that a merger between two major hub carriers leads to increased entry by the other hub carriers, and can lead to substantial increased entry by low cost carriers, both effects offsetting some of the initial concentrating effects of the merger. Our model also suggests that a merger between two hub carriers can in certain cases lead to dismantling of a hub.

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'Getting More from Less: Understanding Airline Pricing,' Lazarev, J., 2012.

Motivated by pricing practices in the airline industry, the paper studies the incentives of players to publicly and independently limit the sets of actions they can play later in a game. I find that to benefit from self-restraint, players have to exclude all actions that create temptations to deviate and keep some actions that can deter deviations of others. I develop a set of conditions under which these strategies form a subgame perfect equilibrium and show that in a Bertrand oligopoly, firms can mutually gain from self-restraint, while in a Cournot oligopoly they cannot.

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'Matching and Chatting: An Experimental Study of the Impact of Network Communication on School-Matching Mechanisms,' Schotter, A. (with T. Ding), 2015.

While, in theory, the school matching problem is a static non-cooperative one shot game, in reality the “matching game” is played by parents who choose their strategies after consulting or chatting with other parents in their social networks. In this paper we compare the performance of the Boston and the Gale-Shapley mechanisms in the presence of chatting through social networks. Our results indicate that allowing subjects to chat has an important impact on the likelihood that subjects change their strategies and also on the welfare and stability of the outcomes determined by the mechanism.

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Financial Crises and Macro-Finance Policy

'Rollover Risk and Market Freezes,' Gale, D. (with V.V. Acharya and T. Yorulmazer), 2011.

The debt capacity of an asset is the maximum amount that can be borrowed using the asset as collateral. We model a sudden collapse in the debt capacity of good collateral. We assume short-term debt that must be frequently rolled over, a small transaction cost of selling collateral in the event of default, and a small probability of meeting a buy-to-hold investor. We then show that a small change in the asset’s fundamental value can be associated with a catastrophic drop in the debt capacity, the kind of market freeze observed during the crisis of 2007 to 2008.

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'Household Leverage and the Recession,' Midrigan, V. (with T. Philippon), 2011.

A salient feature of the recent recession is that regions that have experienced the largest changes in household leverage have also experienced the largest declines in output and employment. We study a cash-in-advance economy in which home equity borrowing, alongside public money, is used to conduct transactions. Declines in home prices tighten the cash-in-advance constraint, triggering recessions. We parameterize the model to match the key cross-sectional features of the data. The model implies that real activity is very sensitive to liquidity shocks, but not to credit shocks, and that monetary policy can significantly reduce the severity of credit-driven recessions.

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'Delta-Method Inference for a Class of Set-Identified SVARS,' Montiel Olea, J.L. (with B. Gafarov and M. Meier), 2016.

This paper studies Structural Vector Autoregressions that impose equality and/or inequality restrictions to set-identify a single shock (e.g., a monetary shock). We make three contributions to the literature. (i) We present an algorithm to compute—for each horizon, each variable, a fixed vector of reduced-form parameters, and a given collection of equality and/or inequality restrictions—the largest and smallest value of the coefficients of the structural impulse-response function. (ii) We provide conditions under which the largest and smallest value of the structural parameters are directionally differentiable functions of the reduced-form parameters. (iii) We propose a computationally convenient delta-method confidence interval for the set-identified coefficients of the structural impulse-response function. We present sufficient conditions to guarantee the pointwise consistency in level of the suggested inference approach. To illustrate our results, we use a monetary Structural Vector Autoregression estimated with monthly U.S. data. We set-identify an unconventional monetary policy shock that decreases the two-year government bond rate upon impact, but has no effect over the nominal federal funds rate. We impose two additional sign restrictions on the contemporaneous responses of inflation and output. We use our confidence bands to assess the effects of the announcement of the second part of the so-called Quantitative Easing program in August 2010.

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'Stress Tests and Bank Portfolio Choice,' Williams, B., 2015.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.

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Institutions and Economic Performance

'Reestablishing the Income-Democracy Nexus,' Benhabib, J. (with A. Corvalan and M. Spiegel), 2011.

A number of recent empirical studies have cast doubt on the "modernization theory" of democratization, which posits that increases in income are conducive to increases in democracy levels. This doubt stems mainly from the fact that while a strong positive correlation exists between income and democracy levels, the relationship disappears when one controls for country fixed effects. This raises the possibility that the correlation in the data reflects a third causal characteristic, such as institutional quality. In this paper, we reexamine the robustness of the income-democracy relationship. We extend the research on this topic in two dimensions: first, we make use of newer income data, which allows for the construction of larger samples with more within-country observations. Second, we concentrate on panel estimation methods that explicitly allow for the fact that the primary measures of democracy are censored with substantial mass at the boundaries, or binary censored variables. Our results show that when one uses both the new income data available and a properly non linear estimator, a statistically significant positive income-democracy relationship is robust to the inclusion of country fixed effects.

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'On the Joint Evolution of Culture and Institutions,' Bisin, A. (with T. Verdier), 2015.

What accounts for economic growth and prosperity? What stands at their origin? Recent literature typically searches for single univariate causal explanations: institutions, culture, human capital, geography. In this paper we provide instead a first theoretical modeling of the interaction between different possible explanations for growth and prosperity (in particular, between culture and institutions) and their effects on economic activity. Depending on the economic environment, culture and institutions might complement each other, giving rise to a multiplier effect, or on the contrary they can act as substitutes, contrasting each other and limiting their combined ability to spur economic activity. By means of examples we show how the dynamics display non-ergodic behavior, cycles, and other interestingly complex phenomena.

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'The European Origins of Economic Development,' Easterly, W. (with R. Levine), 2016.

Although a large literature argues that European settlement outside of Europe during colonization had an enduring effect on economic development, researchers have been unable to assess these predictions directly because of an absence of data on colonial European settlement. We construct a new database on the European share of the population during colonization and examine its association with economic development today. We find a strong, positive relation between current income per capita and colonial European settlement that is robust to controlling for the current proportion of the population of European descent, as well as many other country characteristics. The results suggest that any adverse effects of extractive institutions associated with small European settlements were, even at low levels of colonial European settlement, more than offset by other things that Europeans brought, such as human capital and technology.

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'The Political Economy of Debt and Entitlements,' Lizzeri, A. (with L. Bouton and N. Persico), 2016.

This paper presents a dynamic political-economic model of government obligations. The focus is on the interplay between debt and entitlements. In our model both are tools for temporarily powerful groups to extract resources from groups that will be powerful in the future. Debt transfers resources across periods; entitlements directly target the future allocation of resources. We prove four main results. First, debt and entitlement are (imperfect) substitutes in the sense that constraining debt increases entitlements (and vice versa). Second, if debt is unconstrained, it is beneficial to limit entitlements but not to eliminate them. Third, debt and entitlements respond in opposite ways to political instability, and, in contrast with prior literature, political instability may even reduce debt when entitlements are endogenous. Finally, we identify two possible explanations for the joint growth of debt and entitlements.

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'Price Setting Under Uncertainty About Inflation,' Perez, D. (with A. Drenik), 2016.

When setting prices firms use idiosyncratic information about the demand for their products as well as public information about the aggregate macroeconomic state. This paper provides an empirical assessment of the effects of the availability of public information about inflation on price setting. We exploit an event in which economic agents lost access to information about the inflation rate: starting in 2007 the Argentinean government began to misreport the national inflation rate. Our difference-in-difference analysis reveals that this policy led to an increase in the coefficient of variation of prices of 18% with respect to its mean. This effect is analyzed in the context of a general equilibrium model in which agents make use of publicly available information about the inflation rate to set prices. We quantify the model and use it to further explore the effects of higher uncertainty about inflation on the effectiveness of monetary policy and aggregate welfare. We find that monetary policy becomes more effective in a context of higher uncertainty about inflation and that not reporting accurate measures of the CPI entails significant welfare losses.

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'Stress Tests and Bank Portfolio Choice,' Williams, B., 2015.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.

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Wealth distribution, Inequality and Redistributive Policies

'Skewed Wealth Distributions: Theory and Empirics,' Benhabib, J. and A. Bisin, 2016.

Invariably across a cross-section of countries and time periods, wealth distributions are skewed to the right displaying thick upper tails, that is, large and slowly declining top wealth shares. In this survey we categorize the theoretical studies on the distribution of wealth in terms of the underlying economic mechanism generating skewness and thick tails. Further, we show how these mechanisms can be micro-founded by the consumption-saving decisions of rational agents in specific economic and demographic environments. Finally we map the large empirical work on the wealth distribution to its theoretical underpinning.

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'Wealth Distribution and Social Mobility in the US: A Quantitative Approach,' Benhabib, J., A. Bisin, and M. Luo, 2015.

This paper attempts to quantitatively identify the factors that drive wealth dynamics in the U.S. and are consistent with its observed skewed cross-sectional distribution and social mobility. We concentrate on three critical factors: a skewed and persistent distribution of earnings, differential saving and bequest rates across wealth levels, and capital income risk. All of these factors are necessary for matching both distribution and mobility, with a distinct role in inducing wealth accumulation near the borrowing constraints, contributing to the thick top tail of wealth, and affecting upward and/or downward social mobility.

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'Age, Luck and Inheritance,' Benhabib, J. (with S. Zhu), 2009.

We introduce the investment risk into a heterogeneous agents model and present a mechanism to analytically generate a double Pareto distribution of wealth. We replicate the distribution of the U.S. wealth and especially the three prominent features: a high Gini coefficient, skewness to the right, and Pareto tails. We disentangle the contribution of inheritance, age and stochastic rates of capital return to wealth inequality, in particular to the Gini coefficient. Finally, we investigate the effects of the fiscal and redistributive policies on wealth inequality and social welfare.

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'The Distribution of Wealth and Redistributive Policies,' Benhabib, J. and A. Bisin, 2006.

We study the dynamics of the distribution of wealth in an Overlapping Generation economy with bequest and various forms of redistributive taxation. We characterize the transitional dynamics of the wealth distribution as well as the stationary distribution. We show that the stationary wealth distribution is a Pareto distribution whose statistical properties depend on fiscal policies. It can therefore be characterized by a single parameter (if population is constant), which is univocally related to the Gini coefficient of the distribution of wealth. We study analytically the dependence of the distribution of wealth, of wealth inequality in particular, on various redistributive fiscal policy instruments like capital income taxes, estate taxes, and the form and extent of welfare subsidies. Wealth is less concentrated (the Gini coefficient is lower) for both higher capital income taxes and estate taxes, but the marginal effect of capital income taxes is much stronger than the effect of estate taxes. Finally, we characterize optimal redistributive taxes with respect to a utilitarian social welfare measure. Social welfare is maximized short of minimal wealth inequality and with zero estate taxes.

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'Monetary Policy According to HANK,' Violante, G.L. (with G. Kaplan and B. Moll), 2016.

We revisit the transmission mechanism of monetary policy for household consumption in a Heterogeneous Agent New Keynesian (HANK) model. The model yields empirically realistic distributions of household wealth and marginal propensities to consume because of two key features: multiple assets with different degrees of liquidity and an idiosyncratic income process with leptokurtic income changes. In this environment, the indirect effects of an unexpected cut in interest rates, which operate through a general equilibrium increase in labor demand, far outweigh direct effects such as intertemporal substitution. This finding is in stark contrast to small- and medium-scale Representative Agent New Keynesian (RANK) economies, where intertemporal substitution drives virtually all of the transmission from interest rates to consumption.

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'Optimal Tax Progressivity: An Analytical Framework,' Violante, G.L. (with J. Heathcote and K. Storesletten), 2016.

What shapes the optimal degree of progressivity of the tax and transfer system? On the one hand, a progressive tax system can counteract inequality in initial conditions and substitute for imperfect private insurance against idiosyncratic earnings risk. At the same time, progressivity reduces incentives to work and to invest in skills, effects that are especially costly when the government must finance public expenditure. We develop a tractable equilibrium model that features all of these trade-offs. The analytical expressions we derive for social welfare deliver a transparent understanding of how preference, technology, and market structure parameters influence the optimal degree of progressivity. A calibration for the U.S. economy indicates that endogenous skill investment, flexible labor supply, and the desire to finance valued government purchases play quantitatively similar roles in limiting optimal progressivity.

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Banking Systems, Risk and Financial Markets

'Windfall Gains and Stock Market Participation,' Cesarini, D. (with J.S Briggs, E. Lindqvist, and R. Östling), 2015.

We estimate the causal effect of wealth on stock market participation using administrative data on Swedish lottery players. A $150,000 windfall gain increases stock ownership probability among pre-lottery non-participants by 12 percentage points, while pre-lottery stock holders are unaffected. The effect is immediate, seemingly permanent and heterogeneous in intuitive ways. Standard lifecycle models predict wealth effects far too large to match our causal estimates under common calibrations. Additional analyses suggest a limited role for explanations such as procrastination or real-estate investment. Overall, results suggest that “nonstandard” beliefs or preferences contribute to the nonparticipation of households across many demographic groups.

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'Sovereign Debt, Domestic Banks, and the Provision of Public Liquidity,' Perez, D., 2015.

This paper explores two mechanisms through which a sovereign default can disrupt the domestic economy via its banking system. First, a default creates a negative balance sheet effect on banks, which prevents the flow of resources to productive investments. Second, default undermines internal liquidity as banks replace government securities with less productive investments. A quantitative analysis of the model shows that these mechanisms generate a deep and persistent fall in output post-default, which accounts for the government’s commitment necessary to explain observed levels of external public debt. The model is used to study policies that address the government’s lack of commitment.

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'Sovereign Debt Maturity Structure Under Asymmetric Information,' Perez, D., 2015.

This paper studies the optimal choice of sovereign debt maturity when investors are unaware of the government’s willingness to repay. Under a pooling equilibrium there is a wedge between the borrower’s true default risk and the default risk priced in debt, and the size of this wedge differs with the maturity of debt. Long-term debt becomes less attractive for safe borrowers since it pools more default risk that is not inherent to them. In response, safe borrowers issue low levels of debt with a shorter maturity profile -relative to the optimal choice under perfect information and risky borrowers mimic the behavior of safe borrowers to preclude the market from identifying their type. In times of financial distress, spreads increase and the default risk wedge of long-term debt relative to short-term debt increases which makes borrowers shorten their debt maturity. Data on bond issuances for a panel of countries show that, consistent with the model, maturities co-vary negatively with spreads and that this co-movement is stronger in those situations in which informational asymmetries are larger.

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'Sets of Models and Prices of Uncertainty,' Sargent, T. (with L.P. Hansen), 2015.

A decision maker constructs a convex set of nonnegative martingales to use as likelihood ratios that represent parametric alternatives to a baseline model and also nonparametric models statistically close to both the baseline model and the parametric alternatives. Max-min expected utility over that set gives rise to equilibrium prices of model uncertainty expressed as worst-case distortions to drifts in a representative investor’s baseline model. We offer quantitative illustrations for baseline models of consumption dynamics that display long-run risk. We describe a set of parametric alternatives that generates countercyclical prices of uncertainty.

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'A Case for Incomplete Markets,' Cogley, T. and T. Sargent (with L.E. Blume, D.A. Easley, and V. Tsyrennikov), 2015.

We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which variousrestrictions on financial markets are desirable according to our welfare criterion.

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'Long Swings in Currency Markets: Imperfect Knowledge and I(2) Trends,' Frydman, R. (with M.D. Goldberg, S. Johansen, and K. Juselius), 2012.

Using multivariate unit-root tests, the paper finds that real and nominal exchange rates are more persistent than univariate unit-root studies suggest. It shows that an imperfect knowledge economics model of currency swings and risk is able to account for this greater persistence, even though it recognizes that market participants revise their forecasting strategies in non-routine ways, and thus, does not impose a fixed probability distribution on how these strategies unfold over time. The model provides the micro-foundations for a persistent segmented trends process, thereby explaining the tendency for asset prices to move in one direction for long stretches of time. The paper shows that if one were prepared to assume away the importance of non-routine revisions of forecasting strategies and impose a Markov chain on such change, the Engel and Hamilton (1990) segmented-trends model of long swings would result.

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'Liquidity Hoarding,' Gale, D. (with T. Yorulmazer), 2011.

Banks hold liquid and illiquid assets. An illiquid bank that receives a liquidity shock sells assets to liquid banks in exchange for cash. We characterize the constrained efficient allocation as the solution to a planner’s problem and show that the market equilibrium is constrained inefficient, with too little liquidity and inefficient hoarding. Our model features a precautionary as well as a speculative motive for hoarding liquidity, but the inefficiency of liquidity provision can be traced to the incompleteness of markets (due to private information) and the increased price volatility that results from trading assets for cash.

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'Money, Financial Stability and Efficiency,' Gale, D. (with F. Allen and E. Carletti), 2011.

Most analyses of banking crises assume that banks use real contracts. However, in practice contracts are nominal and this is what is assumed here. We consider a standard banking model with aggregate return risk, aggregate liquidity risk and idiosyncratic liquidity shocks. We show that, with non-contingent nominal deposit contracts, the first-best efficient allocation can be achieved in a decentralized banking system. What is required is that the central bank accommodates the demands of the private sector for fiat money. Variations in the price level allow full sharing of aggregate risks. An interbank market allows the sharing of idiosyncratic liquidity risk. In contrast, idiosyncratic (bank-specific) return risks cannot be shared using monetary policy alone; real transfers are needed.

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'Rollover Risk and Market Freezes,' Gale, D. (with V.V. Acharya and T. Yorulmazer), 2011.

The debt capacity of an asset is the maximum amount that can be borrowed using the asset as collateral. We model a sudden collapse in the debt capacity of good collateral. We assume short-term debt that must be frequently rolled over, a small transaction cost of selling collateral in the event of default, and a small probability of meeting a buy-to-hold investor. We then show that a small change in the asset’s fundamental value can be associated with a catastrophic drop in the debt capacity, the kind of market freeze observed during the crisis of 2007 to 2008.

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'An Empirical Study of Trade Dynamics in the Fed Funds Market,' Lagos, R. (with G. Afonso), 2014.

We use minute-by-minute daily transaction-level payments data to document the cross-sectional and time-series behavior of the estimated prices and quantities negotiated by commercial banks in the fed funds market. We study the frequency and volume of trade, the size distribution of loans, the distribution of bilateral fed funds rates, and the intraday dynamics of the reserve balances held by commercial banks. We find evidence of the importance of the liquidity provision achieved by commercial banks that act as de facto intermediaries of fed funds.

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'Monetary Exchange in Over-the-Counter Markets: A Theory of Speculative Bubbles, the Fed Model, and Self-fulfilling Liquidity Crises,' Lagos, R. (with S. Zhang), 2015.

We develop a model of monetary exchange in over-the-counter markets to study the effects of monetary policy on asset prices and standard measures of financial liquidity, such as bid-ask spreads, trade volume, and the incentives of dealers to supply immediacy, both by participating in the market-making activity and by holding asset inventories on their own account. The theory predicts that asset prices carry a speculative premium that reflects the asset’s marketability and depends on monetary policy as well as the microstructure of the market where it is traded. These liquidity considerations imply a positive correlation between the real yield on stocks and the nominal yield on Treasury bonds—an empirical observation long regarded anomalous. The theory also exhibits rational expectations equilibria with recurring belief driven events that resemble liquidity crises, i.e., times of sharp persistent declines in asset prices, trade volume, and dealer participation in market-making activity, accompanied by large increases in spreads and abnormally long trading delays.

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'Turnover Liquidity and the Transmission of Monetary Policy,' Lagos, R. (with S. Zhang), 2016.

We provide empirical evidence of a novel liquidity-based transmission mechanism through which monetary policy influences asset markets, develop a model of this mechanism, and assess the ability of the quantitative theory to match the evidence.

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'A Markov Switching cay,' Ludvigson, S.C. (with F. Bianchi and M. Lettau), 2015.

This paper presents evidence of infrequent shifts, or “breaks,” in the mean of the consumption-wealth variable cay(t). Conventional estimates of cay(t), which presume a constant mean, display increasing persistence over the sample. We introduce a Markov-switching version of cay(t) that adjusts for infrequent shifts in its mean. The Markov-switching cay(t) is less persistent and has superior forecasting power for excess stock market returns compared to the conventional estimate.

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'Capital Share Risk and Shareholder Heterogeneity in U.S. Stock Pricing,' Ludvigson, S.C. and S. Ma (with M. Lettau), 2016.

Value and momentum strategies earn persistently large return premia yet are negatively correlated. Why? We find that the negative correlation is largely attributable to opposite signed exposure of value and momentum to long-horizon growth in the capital share of income, which explains up to 85% of the variation in returns on size-book/market portfolios and up to 95% of momentum returns, while outperforming popular return-based factor models. Opposite signed exposure of value and momentum to capital share risk coincides with opposite signed exposure to the income shares of stockholders in the top 10 versus bottom 90 percent of the stock-wealth distribution.

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'Foreign Ownership of U.S. Safe Assets: Good or Bad?' Ludvigson, S.C. (with J. Favilukis and S. Van Nieuwerburgh), 2016.

The last 20 years have been marked by a sharp rise in international demand for U.S. reserve assets, or safe stores-of-value. What are the welfare consequences to U.S. households of these trends, or of a reversal? In a lifecycle model with aggregate and idiosyncratic risks, the young and oldest households may benefit substantially from such capital inflows, but middle-aged savers may suffer from greater exposure to systematic risk in equity and housing markets. Under the veil of ignorance, a newborn in the lowest wealth quantile is willing to forego 3% of lifetime consumption to avoid a large capital outflow.

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'Liquidity Constraints in the U.S. Housing Market,' Midrigan, V. (with D. Gorea), 2015.

We study the severity of liquidity constraints in the U.S. Housing market using a heterogeneous-agent model in which houses are illiquid but agents have the option to refinance their long-term mortgages. We parameterize the model to match the distribution of individual-level holdings of housing, mortgage debt and liquid assets, as well as the amount of housing turnover and mortgage refinancing in the 2001 data. Our model implies sizable welfare losses from liquidity constraints: one-third of homeowners are willing to give up in excess of 5% of every dollar transferred from home equity to a liquid account. Interestingly, we find that liquidity constraints are more severe during a boom rather than a bust in house prices, and are more severe for retirees despite their lower marginal propensities to consume out of liquidity injections. The wave of mortgage refinancing observed in the data accounts for about one-third of the rise and fall in household spending during the 2001-2011 period.

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'Information and Enforcement in Informal Credit Markets,' Ray, D. (with P. Ghosh), 2001.

We study the problem of loan enforcement in an informal credit market with limited information flow. Specifically, credit histories of borrowers are not available, raising the possibility of endemic default. We show that if there is some minimum proportion of "natural defaulters" in the population, then there exists an equilibrium characterized by certain simple behavior rules for lenders and borrowers. The equilibrium is unique if certain restrictions are placed on strategies. This equilibrium takes the form that lenders must advance a "small" amount of credit (possibly at a high interest rate) to first-time borrowers. Credit limits are relaxed and the relationship is continued, conditional on repayment. We call this phenomenon micro-rationing. We then introduce the possibility of macro-rationing: the temporary exclusion of some borrowers from any source of credit. We show that in this case, (i) our "simple" equilibrium always exists regardless of the proportion of natural defaulters; though (ii) micro-rationing is always present in equilibrium, while (iii) macro-rationing arises if and only if the proportion of natural defaulters lies below a certain threshold. Finally, we show that if lenders have the option of privately collecting information on the credit histories of new clients, multiple equilibria in information collection could arise. Consequently, it is possible to interpret limited client information in informal credit markets as coordination failure among moneylenders.

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'Stress Tests and Bank Portfolio Choice,' Williams, B., 2015.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.

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Polarization and Conflict

'Groups in Conflict: Size Matters, But Not in the Way You Think,' Ray, D. (with L. Mayoral), 2016.

This paper studies costly conflict over private and public goods. Oil is an example of the former, political power an example of the latter. Groups involved in conflict are likely to be small when the prize is private, and large when the prize is public. We examine these implications empirically by constructing a global dataset at the ethnic group level and studying conflict along ethnic lines. Our theoretical predictions find significant confirmation in an empirical setting.

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'Conflict and Development,' Ray, D. (with J. Esteban), 2016.

In this review, we examine the links between economic development and social conflict. By economic development, we refer broadly to aggregate changes in per-capita income and wealth, or in the distribution of that wealth. By social conflict, we refer to within-country unrest, ranging from peaceful demonstrations, processions and strikes to violent riots and civil war. We organize our review by critically examining three common perceptions: that conflict declines with ongoing economic growth; that conflict is principally organized along economic differences rather than similarities; and that conflict, most especially in developing countries, is driven by ethnic motives. “No society is immune from the darkest impulses of man.” Barack Obama, New Delhi, India 27 January 2015.

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Health and Healthcare

'The Empirical Content of Models with Multiple Equilibria in Economies with Social Interactions,' Bisin, A. (with A. Moro and G. Topa), 2011.

We study a general class of models with social interactions that might display multiple equilibria. We propose an estimation procedure for these models and evaluate its efficiency and computational feasibility relative to different approaches taken to the curse of dimensionality implied by the multiplicity. Using data on smoking among teenagers, we implement the proposed estimation procedure to understand how group interactions affect health-related choices. We and that interaction effects are strong both at the school level and at the smaller friends-network level. Multiplicity of equilibria is pervasive at the estimated parameter values, and equilibrium selection accounts for about 15 percent of the observed smoking behavior. Counterfactuals show that student interactions, surprisingly, reduce smoking by approximately 70 percent with respect to the equilibrium smoking that would occur without interactions.

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Education and Education Policy

'Education and Borrowing Constraints: An Analysis of Alternative Allocation Systems,' Fernandez, R., 2008.

This paper compares the allocative properties of markets and exams in an environment in which students differ in wealth and ability and schools differ in quality. In the presence of borrowing constraints, exams are shown to dominate markets in terms of matching efficiency. Whether aggregate consumption is greater under exams than under markets depends on the power of the exam technology; for a sufficiently powerful test, exams dominate markets in terms of aggregate consumption as well. The effects of income taxation are analyzed and the optimal allocation scheme when wealth is observable is derived. The latter consists of allowing markets to set school prices but having the government allocate fellowships based both on financial need and exam score.

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'Learning and Mechanism Design: An Experimental Test of School Matching Mechanisms with Intergenerational Advice,' Schotter, A. (with T. Ding), 2015.

The results of this paper should be taken as a cautionary tale by mechanism designers. While the mechanisms that economists design are typically in the form of static one-shot games, in the real world mechanisms are used repeatedly by generations of agents who engage in the mechanism for a short period of time and then pass on advice to their successors. Hence, behavior evolves via social learning and may diverge dramatically from that envisioned by the designer. We demonstrate that this is true of school matching mechanisms, even those, like the Gale-Shapley Deferred-Acceptance mechanism where truth-telling is a dominant strategy.

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'Matching and Chatting: An Experimental Study of the Impact of Network Communication on School-Matching Mechanisms,' Schotter, A. (with T. Ding), 2015.

While, in theory, the school matching problem is a static non-cooperative one shot game, in reality the “matching game” is played by parents who choose their strategies after consulting or chatting with other parents in their social networks. In this paper we compare the performance of the Boston and the Gale-Shapley mechanisms in the presence of chatting through social networks. Our results indicate that allowing subjects to chat has an important impact on the likelihood that subjects change their strategies and also on the welfare and stability of the outcomes determined by the mechanism.

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'Genes, Education, and Labor Market Outcomes: Evidence from the Health and Retirement Study,' Thom, K. (with N.W. Papageorge), 2016.

Recent advances in behavioral genetics allow us to overcome past limitations on the study of genes and human capital accumulation. We build on this progress to explore the relationship between observed genetic variants, educational attainment, and labor market outcomes in the Health and Retirement Study (HRS). We demonstrate that observed genetic variants, summarized as a genetic score variable, can explain 3.2-6.6 percent of the variation in educational attainment depending on the specification. Incorporating this genetic information into economic analysis using a rich longitudinal data set allows us to better understand the structure of ability endowments, including how they interact with childhood environments to drive a host of labor market outcomes. Understanding these interactions is particularly important for designing appropriate policies to reduce disparities in economic outcomes.

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'Education Policy and Intergenerational Transfers in Equilibrium,' Violante, G.L. (with B. Abbott, G. Gallipoli and C. Meghir), 2016.

This paper examines the equilibrium effects of alternative financial aid policies intended to promote college participation. We build an overlapping generations life-cycle, heterogeneous-agent, incomplete-markets model with education, labor supply, and consumption/saving decisions. Driven by both altruism and paternalism, parents make inter vivos transfers to their children. Both cognitive and non-cognitive skills determine the non-pecuniary cost of schooling. Labor supply during college, government grants and loans, as well as private loans, complement parental resources as means of funding college education. We find that the current financial aid system in the U.S. improves welfare, and removing it would reduce GDP by 4-5 percentage points in the long-run. Further expansions of government-sponsored loan limits or grants would have no salient aggregate effects because of substantial crowding-out: every additional dollar of government grants crowds out 30 cents of parental transfers plus an equivalent amount through a reduction in student’s labor supply. However, a small group of high-ability children from poor families, especially girls, would greatly benefit from more generous federal aid.

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