Working Papers

Authors: Mark Armstrong,John Vickers

Oct 2014

We provide a simple necessary and sufficient condition for when a multiproduct demand system can be generated from a discrete choice model with unit demands.

JEL Codes: D01, D11

Keywords: Discrete choice, unit demand, multiproduct demand functions

Reference: 729

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Authors: Andrew Martinez

Oct 2014

This paper compares annual one-year-ahead and five-year-ahead forecasts from government agencies for the U.S. gross federal debt and deficit from 1984 to 2013.  Other studies have compared two of these agencies' forecasts, but not for debt.  The current paper finds that the forecast from the Analysis of the President's Budget performs best across both horizons but does not encompass the other forecasts.  Instead, each of the forecasts lacks information included by the other agencies and therefore a combination of all three outperforms any forecast individually.

JEL Codes: C53, H68

Keywords: Evaluating Forecasts, Government Forecasting, Macroeconomic Forecasts, Forecast Encompassing, Deficit

Reference: 727

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Authors: Alexander James

Oct 2014

A surprising feature of resource-rich economies is slow growth. It is often argued that natural-resource production impedes development by creating market or institutional failures. This paper establishes an alternative explanationa slow-growing resource sector.  A declining resource sector is disproportionately reflected in resource-dependent countries. Additionally, there is little evidence that resource dependence impedes growth in non-resource sectors. More generally, this paper illustrates the importance of considering industry composition in cross-country growth regressions.

JEL Codes: Q2; Q3; O1

Keywords: Resource Dependence; Economic Growth; Resource Curse

Reference: 147

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Authors: H Peyton Young

Oct 2014

Social norms are patterns of behavior that are self-enforcing at the group level: everyone wants to conform when they expect everyone else to conform.  There are multiple mechanisms that sustain social norms, including a desire to coordinate, fear of being sanctioned, signaling membership in the group, or simply following the lead of others.  This article shows how stochastic evolutionary game theory can be used to study the dynamics of norms.  We illustrate with a variety of examples drawn from economics, sociology, demography, and political science.  These include bargaining norms, norms governing the terms of contracts, norms of retirement, duelling, footbinding, medical treatment, and the use of contraceptives.  These cases highlight the challenges of applying the theory to empirical cases.  They also show that the modern theory of norm dynamics yields insights and predictions that go beyond conventional equilibrium analysis.

JEL Codes: C73, A120, O10

Keywords: evolutionary game theory, equilibrium selection, stochastic stability

Reference: 726

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Authors: Ansgar Walther

Sep 2014

Banks create excessive systemic risk through leverage and maturity mismatch, as financial constraints introduce welfare-reducing pecuniary externalities.  Macroprudential regulators can achieve efficiency with simple linear constraints on banks' balance sheets, which require less information than Pigouvian taxes.  These can be implemented using the Liquidity Coverage and Net Stable Funding ratios of Basel III.  When bank failures are socially costly, microprudential regulation of leverage is also required.  Optimally, macroprudential policy reacts to changes in systematic risk and credit conditions over the business cycle, while microprudential policy reacts to both systematic and idiosyncratic risk.

JEL Codes: G18, G21, G28, E44

Keywords: Systemic risk, leverage, maturity mismatch, macroprudential regulation, liquidiity, capital requirements, fire sales

Reference: 725

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Authors: James Forder

Sep 2014

There is a widely believed but entirely mythical story to the effect that the discovery of 'the Phillips curve' was, in the 1960s and perhaps later, an inspiration to inflationist policy.  The point that this is a myth is argued in Forder, Macroeconomics and the Phillips curve myth, OUP 2014.  One aspect of the explanation of how that myth came to be widely believed is considered in this paper.  It is noted that the expression 'Phillips curve' was applied in a number of quite distinct and inconsistent ways, and as a result there was, by about 1980, an enormous confusion as to what that label meant.  This confusion, as well as the multiplicity of possible meanings, it is suggested, made the acceptance of the myth much easier, and is therefore part, although only part, of the story of its acceptance.

JEL Codes: B22, B29

Keywords: Phillips curve, expectations, Phillips curve myth

Reference: 724

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Authors: James Forder

Sep 2014

Friedman (1968) - his famous Presidential Address to the American Economic Association - contains an elementary error right at the heart of what is usually supposed to be the paper's crucial argument.  That is the argument to the effect that during an inflation, changing expectations shift in Phillips curve.  It is suggested that the fact of this mistake, and of its having gone all-but unnoticed are points of historical interest.  Further reflections, drawing on the arguments of Forder (2014) Macroeconomics and the Phillips curve myth, are suggested.

JEL Codes: B22, E31

Keywords: Phillips, Friedman, Expectations

Reference: 723

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Authors: Pawel Dziewulski,John Quah

Sep 2014

Suppose we observe a finite number of input decisions made by a firm, as well as the prices at which those inputs were acquired.  What conditions on the set of observations are necessary and sufficient for it to be consistent with a firm choosing inputs to maximize profit, subject to a production function exhibiting production complementarities?  In this paper, we develop an axiomatic characterisation of this hypothesis and also develop a test that can be easily applied to finite data sets.

JEL Codes: D21, D24

Keywords: profit maximisation, production complementarities, supermodular production, modern manufacturing, cyclical monotonicity, quasilinear preferences

Reference: 722

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Authors: John Knight, Ramani Gunatilaka

Aug 2014

The paper contrasts early theories of the utility function (starting with Bentham and elaborated by Jevons) with the modern theory (laid down by Fisher and Samuelson).  The former include in the utility function not only the sensation of current events but also the memory of past events and the anticipation of future events.  The alternative hypotheses are tested by introducing both past and expected future income into the estimated subjective well-being function, using an appropriate data set for China.  The tests favour the early theories.  Implications are drawn.

JEL Codes: B13, B21, D60

Keywords: Anticipation, China, Discounted utility, Memory, Subjective well-being, Utility function

Reference: 721

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Authors: Lucas Bretschger, Christos Karydas

Aug 2014

We study the effects of greenhouse gas emissions on optimum growth and climate policy by using an endogenous growth model with polluting non-renewable resources. Climate change harms the capital stock. Our main contribution is to introduce and extensively explore the naturally determined time lag between greenhouse gas emission and the damages due to climate change, which proves to be crucial for the transition of the economy towards its steady state. The social optimum and the optimal abatement policies are fully characterized. The inclusion of a green technology delays optimal resource extraction. The optimal tax rate on emissions is proportional to output. Poor understanding of the emissions diffusion process leads to suboptimal carbon taxes and suboptimal growth and resource extraction.

JEL Codes: Q54, O11, Q52, Q32

Keywords: Non-Renewable Resource Dynamics; Pollution Di usion Lag; Optimum Growth; Clean Energy; Climate Policy

Reference: 144

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Authors: Antoine Bommier, Lucas Bretschger, Francois Le Grand

Aug 2014

The paper proves the existence of equilibrium in nonrenewable resource markets when extraction costs are non-convex and resource storage is possible.  Inventories atten the consumption path and eliminate price jumps at the end of the extraction period. Market equilibrium becomes then possible, contradicting previous claims from Eswaran, Lewis and Heaps (1983). We distinguish between two types of solutions, one with immediate and one with delayed build-up of inventories. For both cases we do not only characterize potential optimal paths but also show that equilibria actually exist under fairly general conditions. It is found that optimum resource extraction involves increasing quantities over a period of time. What is generally interpreted as an indicator of increasing resource abundance is thus perfectly compatible with constant resource stocks.

JEL Codes: Q30, C62, D92, D41

Keywords: Exhaustible resources, nonconvex extraction cost, equilibrium existence, resource storage

Reference: 146

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Authors: Lucas Betschger, Alexandra Vinogradova

Aug 2014

Climate physics predicts that the intensity of natural disasters will increase in the future due to climate change. One of the biggest challenges for economic modeling is the inherent uncertainty of climate events, which crucially affects consumption, investment, and abatement decisions. We present a stochastic model of a growing economy where natural disasters are multiple and random, with damages driven by the economy's polluting activity. We provide a closed-form solution and show that the optimal path is characterized by a constant growth rate of consumption and the capital stock until a shock arrives, triggering a downward jump in both variables. Optimum mitigation policy consists of spending a constant fraction of output on emissions abatement. This fraction is an increasing function of the arrival rate, polluting intensity of output, and the damage intensity of emissions. A sharp response of the optimum growth rate and the abatement share to changes in the arrival rate and the damage intensity justifes more stringent climate policies as compared to the expectation-based scenario. We subsequently extend the baseline model by adding climate-induced fluctuations around the growth trend and stock-pollution effects, demonstrating robustness of our results. In a quantitative assessment of our model we show that the optimal abatement expenditure at the global level may represent 0.9% of output, which is equivalent to a tax of $71 per ton carbon.

JEL Codes: O10, Q52, Q54

Keywords: Climate policy, uncertainty, natural disasters, endogenous growth

Reference: 145

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Authors: Selma Telalagic

Aug 2014

This paper provides a causal reason for failure in productive efficiency in the household and explains why some households may be less efficient than others.  In the theoretical model, spouses make labour allocation decisions in each period to generate income, facing a threat of divorce in the next period.  This threat of divorce encourages spouses to invest in their outside options.  If decision-making is noncooperative, asymmetric outside options lead to lower productivity.  Using exogenous variation in inheritance rules in Malawi as a measure of outside options, the empirical results show that matrilineal households (where women have access to land) have 10% higher consumption than patrilineal households (where women have no access to land).  These resuls are robust to a wide variety of specifications and are corroborated by an analysis of labour allocation and income.  The results suggest that variation in spouses' outside options can help explain variation in household productivity.

JEL Codes: D12, D13, J12, J16

Keywords: Productive efficiency, Households, Land rights, Matriliny, Malawi

Reference: 720

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Authors: Donna Harris, Benedikt Herrmann, Andreas Kontoleon, Jonathan Newtonor

Aug 2014

This paper examines the relationship between norm enforcement and in-group favouritism behaviour.  Using a new two-stage allocation experiment with punishments, we investigate whether in-group favouritism is considered as a social norm in itself or as a violation of a different norm, such as egalitarian norm.  We find that which norm of behaviour is enforced depends on who the punisher is.  If the punishers belong to the in-group, in-group favouritism is considered a norm and it does not get punished.  If the punishers belong to the out-group, in-group favouritism is frequently punished.  If the punishers belong to no group and merely observe in-group favouritism (the third-party), they do not seem to care sufficiently to be willing to punish this behavour.  Our results shed a new light on the effectiveness of altruistic norm enforcement when group identities are taken into account and help to explain why in-group favouritism is widespread across societies.

JEL Codes: C92, D70, D73

Keywords: In-group Favouritism, Group Identity, Social Norms, In-group Punishment, Out-group Punishment, Third-party Punishment

Reference: 719

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Authors: Ferdinand Rauch, Matthias Beestermoller

Aug 2014

We show that the countries of the former Austro-Hungarian monarchy trade significantly more with one another in the aftermath of the collapse of the Iron Curtain than predicted by a standard gravity model.  This trade surplus declines linearly and monotonically over time.  We argue that these findings suggest that decaying cultural forces explain a significant part of trading capital.  We document the rate of decay of these cultural forces.

JEL Codes: F14, F15, N33, N34, N94

Keywords: Trade, Gravity, Culture, Borders, Habsburg Empire, Persistence

Reference: 718

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Authors: Ferdinand Rauch

Jul 2014

Gravity equations in trade imply that trade flows are proportional to the size of a country and inversely proportional to distance.  This paper develops an analogy of these observations with gravity in physics, and provides geometric intuition for a large class of mathematical processes in two dimensional space for which these relationships would be expected.  It then gives examples of trade processes that conform to gravity, including foraging patterns of various animal species.

JEL Codes: F00

Keywords: Foraging, Gravity, International Trade

Reference: 716

Individual View

Authors: Mark Armstrong

Jul 2014

This paper surveys models of markets in which some consumers are "savvy" while others are not.  We discuss when the presence of savvy consumers improves the deals available to non-savvy consumers in the market (the case of search externalities), and when the non-savvy fund generous deals for savvy consumers (ripoff externalities).  We also discuss when the two groups of consumers have aligned or divergent views about market interventions.  The analysis covers two overlapping families of models: those which examine markets with price/quality dispersion, and those which exhibit forms of consumer hold-up.

JEL Codes: D03, D18, D43, D83

Keywords: Consumer protection, consumer search, price dispersion, hold-up, add-on pricing

Reference: 715

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Authors: Kevin Hjortshøj O'Rourke, Roberto Bonfatti

Jul 2014

Existing theories of pre-emptive war typically predict that the leading country may choose to launch a war on a follower who is catching up, since the follower cannot credibly commit to not use their increased power in the future.  But it was Japan who launched a war against the West in 1941, not the West that pre-emptively attacked Japan.  Similarly, many have argued that trade makes war less likely, yet World War I erupted at a time of unprecedented globalization.  This paper develops a theoretical model of the relationship between trade and war which can help to explain both these observations.  Dependence on strategic imports can lead follower nations to launch pre-emptive wars when they are potentially subject to blockade.

Reference: 132

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Authors: Clare Leaver, Paul Segal

Jul 2014

This paper investigates recent advances in our understanding of the global distribution of income, and produces the first estimates of global inequality that take into account data on the incomes of the top one percent within countries.  We discuss conceptual and methodological issues - including alternative definitions of the global distribution, the use of household surveys and national accounts data, the use of purchasing power parity exchange rates, and the incorporation of recently available data on top incomes from income tax records.  We also review recent attempts to estimate the global distribution of income.  Our own estimates combine household survey data with top income data, and we analyze various aspects of this disribution, including its within- and between-country components, and changes in relative versus absolute global inequality.  Finally, we examine global poverty, which is identified through the lower end of the global distribution.

This paper appears in (Eds.) A. B. Atkinson and F. Bourguignon, Handbook of Income Distribution, Volume 2A, Elsevier, Amsterdam, 2015.

JEL Codes: D63, E01, I32

Keywords: global inequality, purchasing power parity exchange rates, household surveys, national accounts, top incomes, global poverty

Reference: 714

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Authors: Lucas Bretschger, Lin Zhang

Jul 2014

There is widespread concern that an international agreement on stringent climate policies will not be reached because it would imply too high costs for fast growing economies like China. To quantify these costs we develop a general equilibrium model with fully endogenous growth. The framework includes disaggregated industrial and energy sectors, endogenous innovation, and sector-speci c investments. We find that the implementation of Chinese government carbon policies until 2020 causes a welfare reduction of 0.3 percent. For the long run up to 2050 we show that welfare costs of internationally coordinated emission reduction targets lie between 3 and 8 percent. Assuming faster energy technology development, stronger induced innovation, and rising energy prices in the reference case reduces welfare losses signi cantly. We argue that increased urbanization raises the costs of carbon policies due to altered consumption patterns.

JEL Codes: Q54, O41, O53, C68

Keywords: Carbon policy; China; Endogenous growth; Induced innovation; Urbanization

Reference: 143

Individual View

Authors: Martina Kirchberger

Jul 2014

Children are increasingly treated as active members in the household.  However, their preferences over consumption and leisure are rarely modelled.  This paper considers heterogeneity in siblings' preferences over leisure and consumption and builds a theoretical and empirical model for children's time and consumption allocations in a household.  We test the predictions of the model with unique data from Ethiopia, India, Peru and Vietnam which contain detailed information on time use and allocations of assignable goods for sibling pairs.  We find that conditioning on observable variables, the residuals of these simultaneous decisions are significantly negatively correlated.  This suggests that differences in siblings' relative time and consumption allocations are driven by their relative preferences over leisure and consumption rather than differences in parents' relative altruism.  Families seem to function as market economies in which children trade off leisure and consumption, select their optimal bundle, and are rewarded by their parents accordingly.

JEL Codes: D1, J1, J2

Keywords: Intra-household allocation, children

Reference: 713

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Authors: Eric B. Schneider

Jun 2014

Abstract:

This paper is the first to use the individual level, longitudinal catch-up growth of boys and girls in a historical population to measure their relative deprivation. The data is drawn from two government schools, the Marcella Street Home (MSH) in Boston, MA (1889-1898) and the Ashford School of the West London School District (1908- 1917). The paper provides an extensive discussion of the two schools including the characteristics of the children, their representativeness, selection bias and the conditions in each school. It also provides a methodological introduction to measuring children’s longitudinal catch-up growth. After analysing the catch-up growth of boys and girls in the schools, it finds that there were no substantial differences between the catch-up growth by gender. Thus, these data suggest that there were not major health disparities between boys and girls in late nineteenth century America and early twentieth century Britain.

Keywords: Children

Reference: 131

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Authors: David Gill,Victoria Prowse

Jun 2014

In this paper we investigate how cognitive ability and character skills influence behavior, success and the evolution of play towards Nash equilibrium in repeated strategic interactions.  We study behavior in a p-beauty contest experiment and find striking differences according to cognitive ability: more cognitively able subjects choose numbers closer to equilibrium, converge more frequently to equilibrium play and earn more even as behavior approaches the equilibrium prediction.  To understand better how subjects with different cognitive abilities learn differently, we estimate a structural model of learning based on level-k reasoning.  We find a systematic positive relationship between cognitive ability and levels; furthermore, the average level of more cognitively able subjects responds positively to the cognitive ability of their opponents, while the average level of less cognitively able subjects does not respond.  Finally, we compare the influence of cognitive ability to that of character skills, and find that both cognition and personality affect behavior and learning.  More agreeable and emotionally stable subjects perform better and learn faster, although the effect of cognitive ability on behavior is stronger than that of character skills.

JEL Codes: C92, C73, D83

Keywords: Cognitive ability, character skills, personality traits, level-k, bounded rationality, learning, convergence, non-equilbrium behavior, beauty contest, repeated games, structural modeling, theory of mind, intelligence, IQ, cognition, Raven test

Reference: 712

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Authors: Sujoy Mukerji, Peter Klibanoff, Kyoungwon Seo

Jun 2014

We axiomatize preferences that can be represented by a monotonic aggregation of subjective expected utilities generated by a utility function and some set of i.i.d. probability measures over a product state space, S1. For such preferences, we define relevant measures, show that they are treated as if they were the only marginals possibly governing the state space and connect them with the measures appearing in the aforementioned representation. These results allow us to interpret relevant measures as reflecting part of perceived ambiguity, meaning subjective uncertainty about probabilities over states. Under mild conditions, we show that increases or decreases in ambiguity aversion cannot affect the relevant measures. This property, necessary for the conclusion that these measures reflect only perceived ambiguity, distinguishes the set of relevant measures from the leading alternative in the literature. We apply our findings to a number of well-known models of ambiguity-sensitive preferences. For each model, we identify the set of relevant measures and the implications of comparative ambiguity aversion.

JEL Codes: D01, D80, D81, D83

Keywords: Symmetry, beliefs, ambiguity, ambiguity aversion, sets of probabilities

Reference: 711

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Authors: Kevin Sheppard, Wen Xu

May 2014

 We propose a new class of multivariate volatility models utilizing realized measures of asset volatility and covolatility extracted from high-frequency data. Dimension reduction for estimation of large covariance matrices is achieved by imposing a factor structure with time-varying conditional factor loadings. Statistical properties of the model, including conditions that ensure covariance stationary or returns, are established. The model is applied to modeling the conditional covariance data of large U.S. financial institutions during the financial crisis, where empirical results show that the new model has both superior in- and out-of-sample properties. We show that the superior performance applies to a wide range of quantities of interest, including volatilities, covolatilities, betas and scenario-based risk measures, where the model's performance is particularly strong at short forecast horizons.

 

JEL Codes: C32, C53, C58, G17, G21

Keywords: Conditional Beta, Conditional Covariance, Forecasting, HEAVY, Marginal Expected Shortfall, Realized Covariance, Realized Kernel, Systematic Risk

Reference: 710

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