Creator: Atkeson, Andrew, Hellwig, Christian, and Ordonez, Guillermo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 464 Abstract:
In all markets, firms go through a process of creative destruction: entry, random growth and exit. In many of these markets there are also regulations that restrict entry, possibly distorting this process. We study the public interest rationale for entry taxes in a general equilibrium model with free entry and exit of firms in which firm dynamics are driven by reputation concerns. In our model firms can produce high-quality output by making a costly but efficient initial unobservable investment. If buyers never learn about this investment, an extreme “lemons problem” develops, no firm invests, and the market shuts down. Learning introduces reputation incentives such that a fraction of entrants do invest. We show that, if the market operates with spot prices, entry taxes always enhance the role of reputation to induce investment, improving welfare despite the impact of these taxes on equilibrium prices and total production.
Keyword: Entry and exit, Creative destruction, Firm dynamics, General equilibrium, Regulation, and Reputation Subject (JEL): D21 - Firm Behavior: Theory, L15 - Information and Product Quality; Standardization and Compatibility, L51 - Economics of Regulation, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Ordonez, Guillermo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 431 Abstract:
Concerns about constructing and maintaining good reputations are known to reduce borrowers’ excessive risk-taking. However, I find that the self-discipline induced by these concerns is fragile, and can break down without obvious changes in economic fundamentals. Furthermore, in the aggregate, breakdowns are clustered among borrowers with intermediate and good reputations, which can exacerbate an economy’s weakness and contribute to a broad economic crisis. These results come from an aggregate dynamic global game analysis of reputation formation in credit markets. The selection of a unique equilibrium is accomplished by assuming that borrowers have incomplete information about economic fundamentals.
Keyword: Fragility, Reputation, Risk-taking, and Global games Subject (JEL): E44 - Financial Markets and the Macroeconomy, D82 - Asymmetric and Private Information; Mechanism Design, G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill, and G01 - Financial Crises
Creator: Green, Edward J. and Lin, Ping Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 576 Abstract:
In a finite-trader version of the Diamond-Dybvig (1983) model, the symmetric, ex-ante efficient allocation is implementable by a direct mechanism (i.e., each trader announces the type of his own ex-post preference) in which truthful revelation is the strictly dominant strategy for each trader. When the model is modified by formalizing the sequential-service constraint (cf. Wallace, 1988), the truth-telling equilibrium implements the symmetric, ex-ante efficient allocation with respect to iterated elimination of strictly dominated strategies.
Keyword: Implementation, Financial intermediation, and Bank run Subject (JEL): G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Altug, Sumru Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 366 Keyword: Assymetric information , Lending, Borrowing constraint, Transaction cost, Private information, Market friction, and Idiosyncratic risk Subject (JEL): D82 - Asymmetric and Private Information; Mechanism Design and D52 - Incomplete Markets
Creator: Smith, Bruce D. (Bruce David), 1954-2002 Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 228 Abstract:
"Summary of Recommendations: . . . Repeal present control by the System over interest rates that member banks may pay on time deposits and present prohibition of interest payments by member banks on demand deposits." Milton Friedman (1960, p. 100) "I conclude that the over-all monetary effects of ceiling regulations are small and easy to neutralize by traditional monetary controls. The allocative and distributive effects are, however, unfortunate. The root of the policy was an exaggerated and largely unnecessary concern for the technical solvency of savings and loan associations." James Tobin (1970, p. 5) The regulation of deposit interest rates has received little support from economists. The same is true for the original rationale for such regulation: that bank competition for deposits generates inherent "instability" in the banking system. This paper develops an "adverse selection" model of banking in which this rationale is correct. Moreover, in this model instability in the banking system can arise despite the presence of a "lender of last resort," and despite the absence of any need for "deposit insurance." However, in the world described, the regulation of deposit interest rates is shown to be an appropriate response to "instability" in the banking system. Finally, it is argued that "adverse selection" models of deposit interest rate determination can confront a number of observed phenomena that are not readily explained in other contexts.
Keyword: Risk, Banking panics, Unregulated banks, Banking Act of 1935, Instability, Bank regulation, Banking Act of 1933, and Banking Act Subject (JEL): D82 - Asymmetric and Private Information; Mechanism Design, G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages, G11 - Portfolio Choice; Investment Decisions, and E42 - Monetary Systems; Standards; Regimes; Government and the Monetary System; Payment Systems
Creator: Prescott, Edward C. and Townsend, Robert M., 1948- Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 203 Abstract:
General competitive analysis is extended to cover a dynamic, pure-exchange economy with privately observed shocks to preferences. In the linear, infinite-dimensional space containing lotteries we establish the existence of optima, the existence of competitive equilibria, and that every competitive equilibrium is an optimum. An example illustrates that rationing and securities with contrived risk have an equilibrium interpretation.
Keyword: Lotteries, Competitive equilibria, and Pure exchange Subject (JEL): D82 - Asymmetric and Private Information; Mechanism Design and D51 - Exchange and Production Economies