Research Database

The best-known example of a privately created and well-functioning interbank payments system is the Suffolk Banking System. Operating in New England between 1825 and 1858, it was the first regionwide net-clearing system for bank notes in the United States. Some historians portray the System as being owned and managed by a coalition of large Boston banks in order to achieve a public purpose. They argue that while the System was not particularly profitable, it maintained par circulation of bank notes throughout the region. We reconsider this history and find the public-purpose view of the Suffolk Banking System to be specious. The System was owned and operated solely by the Suffolk Bank. It was operated not to promote a common currency or any other public purpose, but to serve the private interests of the Suffolk Bank’s shareholders, which it did quite successfully.

We study bilateral exchange, both direct trade and indirect trade that happens through chains of intermediaries or middlemen. We develop a model of this activity and present applications. This illustrates how, and how many, intermediaries get involved, and how the terms of trade are determined. Bargaining with intermediaries depends on how they bargain with downstream intermediaries, leading to interesting holdup problems. We discuss the roles of buyers and sellers in bilateral exchange, and how to interpret prices. We develop a particular bargaining solution and relate it to other solutions. We also illustrate how bubbles can emerge in the value of inventories.

Negotiations to restructure sovereign debt are time consuming, taking almost a decade on average to resolve. In this paper, we analyze a class of widely used complete information models of delays in sovereign debt restructuring and show that, despite superficial similarities, there are major differences across models in the driving force for equilibrium delay, the circumstances in which delay occurs, and the efficiency of the debt restructuring process. We focus on three key assumptions. First, if delay has a permanent effect on economic activity in the defaulting country, equilibrium delay often occurs; this delay can sometimes be socially efficient. Second, prohibiting debt issuance as part of a settlement makes delay less likely to occur in equilibrium. Third, when debt issuance is not fully state contingent, delay can arise because of the risk that the sovereign will default on any debt issued as part of the settlement.

Given a common technology for replicating blueprints, high-quality blueprints will be replicated more quickly than low-quality blueprints. If quality begets quality, and firms are identified with collections of blueprints derived from the same initial blueprint, then, along a balanced growth path, Gibrat’s Law holds for every type of firm. A firm size distribution with the thick right tail observed in the data can then arise only when the number of blueprints in the economy grows over time, or else firms cannot grow at a positive rate on average. But when calibrated to match the observed firm entry rate and the right tail of the size distribution, this model implies that the median age among firms with more than 10,000 employees is about 750 years. The problem is Gibrat’s Law. If the relative quality of a firm’s blueprints depreciates as the firm ages, then the firm’s growth rate slows down over time. By allowing for rapid and noisy initial growth, this version of the model can explain high observed entry rates, a thick-tailed size distribution, and the relatively young age of large U.S. corporations.

This paper shows that bank runs can be modeled as an equilibrium phenomenon. We demonstrate that some aspects of the intuitive “story” that bank runs start with fears of insolvency of banks can be rigorously modeled. If individuals observe long “lines” at the bank, they correctly infer that there is a possibility that the bank is about to fail and precipitate a bank run. However, bank runs occur even when no one has any adverse information. Extra market constraints such as suspension of convertibility can prevent bank runs and result in superior allocations.

Prior to the Civil War there were three major differences among states in how U.S. banks were regulated: (1) Whether they were established by charter or under free-banking laws. (2) Whether they were permitted to branch. (3) Whether the state established a state-owned bank. I use a census of the state banks that existed in the United States prior to the Civil War that I recently constructed to determine how these differences in state regulation affected the banking outcomes in these states. Specifically, I determine differences in banks per capita by state over time; bank longevities (survival rates) by state, size, and type of organization; and bank failure probabilities also by state, size, and type of organization. In addition, I estimate the losses experienced by note holders and determine whether there were systematic differences in these depending on whether or not a bank was organized under a free banking law.

We estimate the factors determining specialization of crop choice at the level of individual fields, distinguishing between the role of natural advantage (soil characteristics) and economies of density (scale economies achieved when farmers plant neighboring fields with the same crop). Using rich geographic data from North Dakota, including new data on crop choice collected by satellite, we estimate the analog of a social interactions econometric model for the planting decisions on neighboring fields. We find that planting decisions on a field are heavily dependent on the soil characteristics of the neighboring fields. Through this relationship, we back out the structural parameters of economies of density. Setting an Ellison-Glaeser dartboard level of specialization as a benchmark, we find that of the actual level of specialization achieved beyond this benchmark, approximately two-thirds can be attributed to natural advantage and one-third to density economies.

We study a model of a small open economy that specializes in the production of commodities and that exhibits frictions in the setting of both prices and wages. We study the optimal response of monetary and exchange rate policy following a positive (negative) shock to the price of the exportable that generates an appreciation (depreciation) of the local currency. According to the calibrated version of the model, deviations from full price stability can generate welfare gains that are equivalent to almost 0.5% of lifetime consumption, as long as there is a significant degree of rigidity in nominal wages. On the other hand, if the rigidity is concentrated in prices, the welfare gains can be at most 0.1% of lifetime consumption. We also show that a rule - formally defined in the paper - that resembles a "dirty floating" regime can approximate the optimal policy remarkably well.

This paper develops a model of vintage human capital in which each technology requires vintage specific skills. We examine the properties of a stationary equilibrium for our economy. The stationary equilibrium is characterized by an endogenous distribution of skilled workers across vintages. The distribution is shown to be single peaked and, under general conditions, there is a lag between the time when a technology appears and the peak of it's usage, a phenomenon known as diffusion. An increase in the rate of exogenous technological change shifts the distribution of human capital to more recent vintages thereby increasing the diffusion rate.

We study the optimal accumulation of international reserves in a quantitative model of sovereign default with long-term debt and a risk-free asset. Keeping higher levels of reserves provides a hedge against rollover risk, but this is costly because using reserves to pay down debt allows the government to reduce sovereign spreads. Our model, parameterized to mimic salient features of a typical emerging economy, can account for a significant fraction of the holdings of international reserves, and the larger accumulation of both debt and reserves in periods of low spreads and high income. We also show that income windfalls, improved policy frameworks, larger contingent liabilities, and an increase in the importance of rollover risk imply increases in the optimal holdings of reserves that are consistent with the upward trend in reserves in emerging economies. It is essential for our results that debt maturity exceeds one period.

In this paper I develop continuous-time methods for solving dynamic principal-agent problems in which the agent’s privately observed productivity shocks are persistent over time. I characterize the optimal contract as the solution to a system of ordinary differential equations, and show that, under this contract, the agent’s utility converges to its lower bound—immiseration occurs. I also show that, unlike in environments with i.i.d. shocks, the principal would like to renegotiate with the agent when the agent’s productivity is low—it is not renegotiation-proof. I apply the theoretical methods I have developed and numerically solve this (Mirrleesian) dynamic taxation model. I find that it is optimal to allow a wedge between the marginal rate of transformation and individuals’ marginal rate of substitution between consumption and leisure. This wedge is significantly higher than what is found in the i.i.d. case. Thus, using the i.i.d. assumption is not a good approximation quantitatively when there is persistence in productivity shocks.

This paper reexamines the conventional wisdom that commercial banking is an industry in severe decline. We find that a careful reading of the evidence does not justify this conclusion. It is true that on-balance sheet assets held by commercial banks have declined as a share of total intermediary assets. But this measure overstates any drop in banking, for three reasons. First, it ignores the rapid growth in commercial banks' off-balance sheet activities. Second, it fails to take account of the substantial growth in off-shore C&I lending by foreign banks. Third, it ignores the fact that over the last several decades financial intermediation has grown rapidly relative to the rest of the economy. We find that after adjusting the measure of bank assets to account for these considerations there is no clear evidence of secular decline. To corroborate these findings, we also construct an alternative measure of the importance of banking, using data from the National Income Accounts. Again, we find no clear evidence of a sustained declined. At most the industry may have suffered a slight loss of market share over the last decade. But as we discuss, this loss may reflect a transitory response to a series of adverse shocks and the phasing in of new regulatory requirements, rather than the beginning of a permanent decline.

This article is largely a description of the earnings, income, and wealth distributions in the United States in 2013 as measured by the Survey of Consumer Finances (SCF). We describe facts that lie at the joint distribution of the three variables. We look at inequality in relation to age, education, employer status, and marital status. We discuss the evolution of our results over the past 25 years (1989 - 2013), emphasizing the role played by the Great Recession. We pay special attention to the degree of income and wealth concentration at the top and discuss what the use of the SCF data can contribute to the ongoing debate on this topic. Finally, we look at which income sources and asset classes contribute most to income and wealth concentration.

An important contention of Proposition 13's proponents was that a tax reduction would boost economic activity. It is too early to ascertain whether or not this has happened in California. This study addresses the issue in a more general context by attempting to answer the question: Do state and local taxes affect economic growth? Economic theory tells us that a change in the level of state and local taxes might affect economic growth in a number of ways, but the direction of the net result is not obvious. The methodology used here is multiple regression analysis across states. The major contribution of this study is the use of other variables besides taxes to explain growth in personal income, reducing possible biases in the results of previous work in this area. The results of this study indicate that state and local taxes may be a significant deterrent to growth in personal income.

This paper integrates and extends some recent computational advances in Bayesian inference with the objective of more fully realizing the Bayesian promise of coherent inference and model comparison in economics. It combines Markov chain Monte Carlo and independence Monte Carlo with importance sampling to provide an efficient and generic method for updating posterior distributions. It exploits the multiplicative decomposition of marginalized likelihood into predictive factors, to compute posterior odds ratios efficiently and with minimal further investment in software. It argues for the use of predictive odds ratios in model comparison in economics. Finally, it suggests procedures for public reporting that will enable remote clients to conveniently modify priors, form posterior expectations of their own functions of interest, and update the posterior distribution with new observations. A series of examples explores the practicality and efficiency of these methods.

U.S. government concerns about great disparities in housing conditions are at least 100 years old. For the first 50 years of this period, U.S. housing crises were widely considered to stem from the failure of the construction industry to adopt new technology -- in particular, factory production methods. The introduction of these methods in many industries had already greatly narrowed the quality of goods consumed by low- and high-income Americans. It was widely known why the industry failed to adopt these methods: Monopolies in traditional construction blocked and sabotaged them. Very little has changed in the last 50 years. The industry still fails to adopt factory methods, with monopolies, like HUD and NAHB, blocking attempts to adopt them. As a result, the productivity record of the construction industry has been horrendous. One thing has changed. Today there is very little discussion of factory-built housing; of the very few that recognize the industry's failure to adopt factory methods, there is no realization that monopolies are blocking the methods. That these monopolies, in particular, HUD and NAHB, can cause so much hardship in our country, and through misinformation and deceit cover it up, seems almost beyond belief. But, unfortunately, it's a history that is not uncommon. There are many other industries where monopolies have inflicted great harm on Americans, like the tobacco industry, yet through misinformation and deceit cover up the great harm.

The Covid-19 crisis has exposed the vast inequalities that exist within the US economy. As the virus has spread silently, it has laid bare other crises that face our nation---especially the economic vulnerabilities of the country's poor and marginalized. Many of these vulnerabilities can, in fact, be traced back to a single cause that itself has spread silently, but over the last several decades, not months: Monopolies. That monopolies are "silent spreaders of poverty and economic inequality" was well known to economic and legal scholars of the 1930s and 1940s. Wendell Berge, who was Assistant Attorney General for Antitrust in the 1940s, wrote: "Monopoly conditions have often grown up almost unnoticed by the public until one day it is suddenly realized that an industry is no longer competitive but is governed by an economic oligarchy." The harm caused by these monopolies that have mostly avoided detection often exist in markets with small firms, low concentration levels, and small price-cost margins, as in residential construction, or wreak their harm in public institutions, where prices and concentration have no meaning. While there has been a very welcome resurgence in the concern about monopolies in the last decade or so, this has primarily involved vast corporations, and often about their threat to democratic institutions. Though greatly welcomed, we should not let apprehension with these larger companies distract us from the many hidden monopolies that have silently spread harm to the poor for the last 100 years -- not just the last 10 or so. We should stand on the shoulders of giants that taught us this about monopolies, not only Berge, but Thurman Arnold, Henry Simons, and others.

In this paper we consider a particular international economic policy regime: the laissez-faire regime, the distinguishing features of which are unrestricted portfolio choice and floating exchange rates. And as we show, that regime, although favored by many economists, is not economically feasible. It does not have a determinate equilibrium. That is an implication of an over-lapping-generations model. But as we argue in the paper, that is no reason for doubting the indeterminacy of the laissez-faire regime equilibrium.

We prove the existence of a competitive equilibrium in an overlapping generations model in which each generation has a preference ordering over its own and its descendents’ consumptions. The model is one of pure exchange with many goods in each period and two period lived generations. The bequest from one generation to the next is required to be non-negative and is endogenous. In equilibrium, some sequences of agents of successive generations may be continually “linked” by positive bequests and act as infinitely lived agents. Other sequences of agents may not be so linked and therefore behave as sequences of finite lived agents. We give three examples which illustrate the following points: (i) multiple equilibria may exist some of which resemble those of standard overlapping generations models, whereas in others some sequences of agents behave as if infinitely lived, (ii) multiple steady states of the above two types may exist in which the latter are unstable and the former are stable, and (iii) if agents have preferences given by discounted sums of utilities with different discount rates, then not all sequences of generations can be continually linked and hence behave as infinitely lived agents.

This document contains detailed algebra for the proofs of propositions 1 and 2.

We analyze optimal policy in a simple small open economy model with price setting frictions. In particular, we study the optimal response of the nominal exchange rate following a terms of trade shock. We depart from the New Keynesian literature in that we explicitly model interna-tionally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification not only is in line with the long-standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent small open economy New Keynesian literature, our model is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although we show there are preferences for which price stability is optimal even without flexible fiscal instruments, our model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model we propose is a useful framework in which to study fear of floating.

This paper considers a view commonly associated with the "quantity theory of money": that banks should face 100 percent reserve requirements. It argues first that the objectives of the quantity theorists' proposals were more than merely price level stability, and that in fact, price level stability was at most a secondary objective of their proposals. Second, it argues that these theorists had a world with distortions in mind with respect to their proposals. These are present in a special setting examined that (a) supports the imposition of 100 percent reserve requirements (on the basis of an unconstrained Pareto criterion), and (b) supports the view that these restrictions stabilize the price level and make its movements more "predictable."

Before the establishment of federal deposit insurance, the U.S. experienced periodic banking panics, during which banks suspended specie payments and reduced lending. There was often a corresponding economic slowdown. The Panic of 1837 is considered one of the worst banking panics, and it coincided with a slowdown that lasted for almost five years. The economic disruption was not uniform across the country, however. The slowdown in New England was substantially less severe than elsewhere. Here we suggest that the Suffolk Bank, a private bank, was one reason for New England’s relative success. We argue that the Suffolk Bank’s provision of note-clearing and lender of last resort services (via the Suffolk Banking System) lessened the effects of the Panic of 1837 in New England relative to the rest of the country, where no bank provided such services.

The classical and early neoclassical economists knew that the essential function of money was its role as a medium of exchange. Recently, this idea has been formalized using search-theoretic noncooperative equilibrium models of the exchange process. The goal of this paper is to use a simple model of this class to analyze four substantive issues in monetary economics: the interaction between specialization and exchange, dual fiat currency regimes, the welfare improving role of money, and the susceptibility of monetary economies to extrinsic uncertainty.

The neoclassical growth model is extended to include costly intermediated borrowing and lending between households. This is an important extension as substantial resources are used in intermediating the large amount of borrowing and lending between households. In 2007, in the United States, the amount intermediated was 1.7 times GNP, and the resources used in this intermediation amounted to at least 3.4 percent of GNP. The theory implies that financial intermediation services are an intermediate good and that the spread between borrowing and lending rates measures the efficiency of the financial sector.

The distinguishing feature of natural-catastrophe risk is claimed to be aggregate risk. Because such risk is encompassed in the general competitive model, it seems to pose no new theoretical challenge. However, that model has markets contingent on exogenous events, while the actual economy seems to be developing mainly markets contingent on the level of total damage. In the context of a model with aggregate risk and endogenous total damage, a notion of competitive markets contingent on total damage is formulated. That notion implies that such markets achieve the same (efficient) risk sharing as markets contingent on exogenous events.

A paradigm is presented where both the extent of financial intermediation and the rate of economic growth are endogenously determined. Financial intermediation promotes growth because it allows a higher rate of return to be earned on capital, and growth in turn provides the means to implement costly financial structures. Thus, financial intermediation and economic growth are inextricably linked in accord with the Goldsmith-McKinnon-Shaw view on economic development. The model also generates a development cycle reminiscent of the Kuznets hypothesis. In particular, in the transition from a primitive slow-growing economy to a developed fast-growing one, a nation passes through a stage where the distribution of wealth across the rich and poor widens.

This paper establishes the stylized fact that medieval debasements were accompanied by unusually large minting volumes and revenues. This fact is a puzzle under the commonly held view that metallic coins are commodity money and exchange by weight. An existing explanation is that debased coins were used to reduce the real burden of nominally denominated debts. This explanation is logically flawed: nothing prevents agents from renegotiating contracts and avoid incurring minting costs. The paper also establishes other facts about monetary mutations, which altogether pose a challenge to monetary economics.

A model of a labor market is developed in which agents possess private information about their own productivities. This has the property that firms may use unemployment to create appropriate self-selection incentives. When this is the case, existence of an equilibrium may require that employment be stochastic. This is true even though all uncertainty is necessarily resolved prior to hiring. Even when existence is not at issue, it may be privately as well as socially desirable to randomize employment prospects. Finally, it is argued that this "adverse selection" approach is consistent with traditional "Keynesian" approaches to macroeconomics, but avoids some of the arbitrary features of several "Keynesian models."