Showing papers in "Quarterly Journal of Economics in 2002"
TL;DR: In this article, the authors argue that the reversal in relative incomes of colonized countries during the past 500 years resulted from societies with good institutions taking advantage of the opportunity to industrialize.
Abstract: Among countries colonized by European powers during the past 500 years, those that were relatively rich in 1500 are now relatively poor. We document this reversal using data on urbanization patterns and population density, which, we argue, proxy for economic prosperity. This reversal weighs against a view that links economic development to geographic factors. Instead, we argue that the reversal ree ects changes in the institutions resulting from European colonialism. The European intervention appears to have created an “ institutional reversal” among these societies, meaning that Europeans were more likely to introduce institutions encouraging investment in regions that were previously poor. This institutional reversal accounts for the reversal in relative incomes. We provide further support for this view by documenting that the reversal in relative incomes took place during the late eighteenth and early nineteenth centuries, and resulted from societies with good institutions taking advantage of the opportunity to industrialize.
3,035 citations
TL;DR: This paper found that subjects are more concerned with increasing social welfare, sacrificing to increase the payoffs for all recipients, especially low-payoff recipients, than with reducing differences in payoffs.
Abstract: Departures from self-interest in economic experiments have recently inspired models of “social preferences” We design a range of simple experimental games that test these theories more directly than existing experiments Our experiments show that subjects are more concerned with increasing social welfare—sacrificing to increase the payoffs for all recipients, especially low-payoff recipients—than with reducing differences in payoffs (as supposed in recent models) Subjects are also motivated by reciprocity: They withdraw willingness to sacrifice to achieve a fair outcome when others are themselves unwilling to sacrifice, and sometimes punish unfair behavior
2,984 citations
TL;DR: In this article, the authors investigate the hypothesis that the combination of three related innovations (i.e., information technology, complementary workplace reorganization, and new products and services) constitute a significant skill-biased technical change affecting labor demand in the United States.
Abstract: We investigate the hypothesis that the combination of three related innovations—1) information technology (IT), 2) complementary workplace reorganization, and 3) new products and services—constitute a significant skill-biased technical change affecting labor demand in the United States. Using detailed firm-level data, we find evidence of complementarities among all three of these innovations in factor demand and productivity regressions. In addition, firms that adopt these innovations tend to use more skilled labor. The effects of IT on labor demand are greater when IT is combined with the particular organizational investments we identify, highlighting the importance of IT-enabled organizational change.
2,333 citations
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TL;DR: The authors analyzed the behavior of exchange rates, reserves, monetary aggregates, interest rates, and commodity prices across 154 exchange rate arrangements to assess whether official labels provide an adequate representation of actual country practice.
Abstract: In recent years, many countries have suffered severe financial crises, producing a staggering toll on their economies, particularly in emerging markets. One view blames fixed exchange rates“soft pegs”--for these meltdowns. Adherents to that view advise countries to allow their currency to float. We analyze the behavior of exchange rates, reserves, the monetary aggregates, interest rates, and commodity prices across 154 exchange rate arrangements to assess whether “official labels” provide an adequate representation of actual country practice. We find that, countries that say they allow their exchange rate to float mostly do not--there seems to be an epidemic case of “fear of floating.” Since countries that are classified as having a free or a managed float mostly resemble noncredible pegs--the so-called “demise of fixed exchange rates” is a myth--the fear of floating is pervasive, even among some of the developed countries. We present an analytical framework that helps to understand why there is fear of floating.
2,189 citations
TL;DR: In this paper, the authors characterize the dynamic effects of shocks in government spending and taxes on U.S. activity in the postwar period by using a mixed structural VAR/event study approach.
Abstract: This paper characterizes the dynamic effects of shocks in government spending and taxes on U. S. activity in the postwar period. It does so by using a mixed structural VAR/event study approach. Identiecation is achieved by using institutional information about the tax and transfer systems to identify the automatic response of taxes and spending to activity, and, by implication, to infer escal shocks. The results consistently show positive government spending shocks as having a positive effect on output, and positive tax shocks as having a negative effect. One result has a distinctly nonstandard eavor: both increases in taxes and increases in government spending have a strong negative effect on investment spending. The predominant, Keynesian, view of the effects of escal policy that was embedded in the large-scale macroeconometric models of the seventies and eighties has come under attack. Theoretically, in the neoclassical approach that has developed in the last twenty years, government spending can have drastically different effects than in Keynesian models, particularly on private consumption. Empirically, the response of the economy to several episodes of escal retrenchment in the last efteen years has been at odds with conventional Keynesian wisdom: on several occasions, private consumption and GDP increased signiecantly while government spending was severely cut. Finally, the evidence from large-scale econometric models has been largely dismissed on the grounds that, because of their Keynesian structure, these models assume rather than document a positive effect of escal expansions on output.
1,916 citations
TL;DR: The authors examined a model of dynamic price adjustment based on the assumption that information disseminates slowly throughout the population, and found that the change in ine ation is positively correlated with the level of economic activity.
Abstract: This paper examines a model of dynamic price adjustment based on the assumption that information disseminates slowly throughout the population. Compared with the commonly used sticky-price model, this sticky-information model displays three related properties that are more consistent with accepted views about the effects of monetary policy. First, disine ations are always contractionary (although announced disine ations are less contractionary than surprise ones). Second, monetary policy shocks have their maximum impact on ine ation with a substantial delay. Third, the change in ine ation is positively correlated with the level of economic activity. The dynamic effects of aggregate demand on output and ine ation remain a theoretical puzzle for macroeconomists. In recent years, much of the literature on this topic has used a model of time-contingent price adjustment. This model, often called “ the new Keynesian Phillips curve,” builds on the work of Taylor [1980], Rotemberg [1982], and Calvo [1983]. As the recent survey by Clarida, Gali, and Gertler [1999] illustrates, this model is widely used in theoretical analysis of monetary policy. McCallum [1997] has called it “ the closest thing there is to a standard specie cation.” Yet there is growing awareness that this model is hard to square with the facts. Ball [1994a] shows that the model yields the surprising result that announced, credible disine ations cause booms rather than recessions. Fuhrer and Moore [1995] argue that it cannot explain why ine ation is so persistent. Mankiw [2001] notes that it has trouble explaining why shocks to monetary policy have a delayed and gradual effect on ine ation. These problems appear to arise from the same source: although the price level is sticky in this model, the ine ation rate can change quickly. By contrast, empirical analyses of the ine ation process (e.g., Gordon [1997]) typically give a large role to “ ine ation inertia.”
1,655 citations
TL;DR: In this article, the authors bring these concerns into the realm of economic analysis, and show that this has important implications for how agents process information and make decisions, and that the tools of economic modelling can help shed light on a number of apparently irrational behaviours documented by psychologists.
Abstract: The maintenance and enhancement of self-esteem has always been identified as a fundamental human impulse. Philosophers, writers, educators and of course psychologists have all emphasized the crucial role played by self-image in motivation, affect and social interactions. The aim of this chapter is to bring these concerns into the realm of economic analysis, and show that this has important implications for how agents process information and make decisions. Conversely, the tools of economic modelling can help shed light on a number of apparently irrational behaviours documented by psychologists.
1,378 citations
TL;DR: In this article, the authors develop repeated-game models showing why and how relational contracts within firms (vertical integration) differ from those between (nonintegration) and show that integration affects the parties' temptations to renege on a given relational contract, and hence affects the best relational contract the parties can sustain.
Abstract: Relational contracts—informal agreements sustained by the value of future relationships—are prevalent within and between firms. We develop repeated-game models showing why and how relational contracts within firms (vertical integration) differ from those between (nonintegration). We show that integration affects the parties' temptations to renege on a given relational contract, and hence affects the best relational contract the parties can sustain. In this sense, the integration decision can be an instrument in the service of the parties' relationship. Our approach also has implications for joint ventures, alliances, and networks, and for the role of management within and between firms.
1,311 citations
TL;DR: In this article, the authors proposed a general methodology to measure the extent of tunneling activities in Indian business groups, based on isolating and then testing the distinctive implications of the tunneling hypothesis for the propagation of earnings shocks across e rms within a group.
Abstract: Owners of business groups are often accused of expropriating minority shareholders by tunneling resources from e rms where they have low cash e ow rights to e rms where they have high cash e ow rights. In this paper we propose a general methodology to measure the extent of tunneling activities. The methodology rests on isolating and then testing the distinctive implications of the tunneling hypothesis for the propagation of earnings shocks across e rms within a group. When we apply our methodology to data on Indian business groups, we e nd a signie cant amount of tunneling, much of it occurring via nonoperating components of proe t. I. INTRODUCTION Weak corporate law and lax enforcement mechanisms raise fears of expropriation for minority shareholders around the world. These fears seem especially warranted in the presence of business groups, a common organizational form in many developed and developing countries. In a business group, a single shareholder (or a family) completely controls several independently traded e rms and yet has signie cant cash e ow rights in only a few of them. 1 This discrepancy in cash e ow rights between the different e rms he controls creates strong incentives to expropriate. The controlling shareholder will want to transfer, or tunnel, proe ts across e rms, moving them from e rms where he has
1,276 citations
TL;DR: In this article, the authors developed a model based on the solution of political agency problems to find the determinants of government responsiveness to its citizens. But the model was not tested on panel data from India and the results showed that public food distribution and calamity relief expenditure are greater, controlling for shocks.
Abstract: The determinants of government responsiveness to its citizens is a key issue in political economy. Here we develop a model based on the solution of political agency problems. Having a more informed an politically active electorate strengthens incentives for governments to be responsive. This suggests that there is a role both for democratic institutions and the mass media in ensuring that the preferences of citizens are reflected in policy. The ideas behind the model are tested on panel data from India. We show that public food distribution and calamity relief expenditure are greater, controlling for shocks, where governments face greater electoral accountability and where newspaper circulation is highest.
1,130 citations
TL;DR: In this paper, the authors use data from over 200 countries and dependencies to quantify the implications of common currencies for trade and income and find that every one percent increase in a country's overall trade (relative to GDP) raises income per capita by at least one third of a percent, which supports the hypothesis that important beneficial effects of currency unions come through the promotion of trade.
Abstract: To quantify the implications of common currencies for trade and income, we use data for over 200 countries and dependencies In our two-stage approach, estimates at the first stage suggest that belonging to a currency union/board triples trade with other currency union members Moreover, there is no evidence of trade-diversion Our estimates at the second stage suggest that every one percent increase in a country’s overall trade (relative to GDP) raises income per capita by at least one third of a percent We combine the two estimates to quantify the effect of common currencies on output Our results support the hypothesis that important beneficial effects of currency unions come through the promotion of trade
TL;DR: This article found that students who attended more selective colleges do not earn more than other students who were accepted and rejected by comparable schools but attended less selective colleges, and that the average tuition charged by the school is significantly related to the students' subsequent earnings.
Abstract: There are many estimates of the effect of college quality on students' subsequent earnings. One difficulty interpreting past estimates, however, is that elite colleges admit students, in part, based on characteristics that are related to their earnings capacity. Since some of these characteristics are unobserved by researchers who later estimate wage equations, it is difficult to parse out the effect of attending a selective college from the students' pre-college characteristics. This paper uses information on the set of colleges at which students were accepted and rejected to remove the effect of unobserved characteristics that influence college admission. Specifically, we match students in the newly colleted College and Beyond (C&B) Data Set who were admitted to and rejected from a similar set of institutions, and estimate fixed effects models. As another approach to adjust for selection bias, we control for the average SAT score of the schools to which students applied using both the C&B and National Longitudinal Survey of the High School Class of 1972. We find that students who attended more selective colleges do not earn more than other students who were accepted and rejected by comparable schools but attended less selective colleges. However, the average tuition charged by the school is significantly related to the students' subsequent earnings. Indeed, we find a substantial internal rate of return from attending a more costly college. Lastly, the payoff to attending an elite college appears to be greater for students from more disadvantaged family backgrounds.
TL;DR: In this article, the authors developed an equilibrium model of industrial structure in which the organization of e rms is endogenous, and they studied the determinants of the equilibrium mode of organization when inputs are fully or partially specialized.
Abstract: We develop an equilibrium model of industrial structure in which the organization of e rms is endogenous. Differentiated consumer products can be produced either by vertically integrated e rms or by pairs of specialized companies. Production of each variety of consumer good requires a specialized component. Vertically integrated e rms can manufacture the components they need, but they face a relatively high cost of governance. Specialized e rms can produce at lower cost, but search for partners is costly, and input suppliers face a potential holdup problem. We study the determinants of the equilibrium mode of organization when inputs are fully or partially specialized. I. INTRODUCTION
TL;DR: The authors developed an evolutionary growth theory that captures the interplay between the evolution of mankind and economic growth since the emergence of the human species, which encompasses the observed evolution of population, technology and income per capita in the long transition from an epoch of Malthusian stagnation to sustained economic growth.
Abstract: This research develops an evolutionary growth theory that captures the interplay between the evolution of mankind and economic growth since the emergence of the human species. This unified theory encompasses the observed evolution of population, technology and income per capita in the long transition from an epoch of Malthusian stagnation to sustained economic growth. The theory suggests that prolonged economic stagnation prior to the transition to sustained growth stimulated natural selection that shaped the evolution of the human species, whereas the evolution of the human species was the origin of the take-off from an epoch of stagnation to sustained growth.
TL;DR: In this paper, the authors assume that a person exaggerates the likelihood that a short sequence of i.i.d. signals resembles the long run rate at which those signals are generated, and they predict that people may pay for financial advice from experts whose expertise is entirely illusory.
Abstract: Many people believe in the Law of Small Numbers, exaggerating the degree to which a small sample resembles the population from which it is drawn. To model this, I assume that a person exaggerates the likelihood that a short sequence of i.i.d. signals resembles the long-run rate at which those signals are generated. Such a person believes in the gambler's fallacy , thinking early draws of one signal increase the odds of next drawing other signals. When uncertain about the rate, the person over-infers from short sequences of signals, and is prone to think the rate is more extreme than it is. When the person makes inferences about the frequency at which rates are generated by different sources -- such as the distribution of talent among financial analysts -- based on few observations from each source, he tends to exaggerate how much variance there is in the rates. Hence, the model predicts that people may pay for financial advice from experts whose expertise is entirely illusory. Other economic applications are discussed.
TL;DR: In this paper, the authors analyzed how people respond to changes in credit supply and found that increases in credit limits generate an immediate and significant rise in debt, counter to the Permanent Income Hypothesis.
Abstract: This paper utilizes a unique new dataset of credit card accounts to analyze how people respond to changes in credit supply. The data consist of a panel of thousands of individual credit card accounts from several different card issuers, with associated credit bureau data. We estimate both marginal propensities to consume (MPCs) out of liquidity and interest-rate elasticities. We also evaluate the ability of different models of consumption to rationalize our results, distinguishing the Permanent-Income Hypothesis (PIH), liquidity constraints, precautionary saving, and behavioral models. We find that increases in credit limits generate an immediate and significant rise in debt, counter to the PIH. The average 'MPC out of liquidity' (dDebt/dLimit) ranges between 10%-14%. The MPC is much larger for people starting near their limits, consistent with binding liquidity constraints. However, the MPC is significant even for people starting well below their limit. We show this response is consistent with buffer-stock models of precautionary saving. Nonetheless there are other results that conventional models cannot easily explain, e.g. why so many people are borrowing on their credit cards, and simultaneously holding low yielding assets. Unlike most other studies, we also find strong effects from changes in account-specific interest rates. The long-run elasticity of debt to the interest rate is approximately -1.3. Less than half of this elasticity represents balance-shifting across cards, with most reflecting net changes in total borrowing. The elasticity is larger for decreases in interest rates than for increases, which can explain the widespread use of temporary promotional rates. The elasticity is smaller for people starting near their credit limits, again consistent with liquidity constraints.
TL;DR: In this article, optimal income transfers for low incomes are analyzed along the intensive margin (intensity of work on the job) and along the extensive margin (participation into the labor force).
Abstract: This paper analyzes optimal income transfers for low incomes. Labor supply responses are modeled along the intensive margin (intensity of work on the job) and along the extensive margin (participation into the labor force). When behavioral responses are concentrated along the intensive margin, the optimal transfer program is a classical Negative Income Tax program with a substantial guaranteed income support and a large phasing-out tax rate. However, when behavioral responses are concentrated along the extensive margin, the optimal transfer program is similar to the Earned Income Tax Credit with negative marginal tax rates at low income levels and a small guaranteed income. Carefully calibrated numerical simulations are provided.
TL;DR: In this paper, the effects of electoral institutions on the size and composition of public expenditure in OECD and Latin American countries were studied, where voters anticipating government policymaking under different electoral systems have an incentive to elect representatives more prone to transfer (public good) spending in proportional (majoritarian) systems.
Abstract: We study the effects of electoral institutions on the size and composition of public expenditure in OECD and Latin American countries. We emphasize the distinction between purchases of goods and services, which are easier to target geographically, and transfers, which are easier to target across social groups. We present a theoretical model in which voters anticipating government policymaking under different electoral systems have an incentive to elect representatives more prone to transfer (public good) spending in proportional (majoritarian) systems. The model also predicts higher total primary spending in proportional (majoritarian) systems when the share of transfer spending is high (low). After dee ning rigorous measures of proportionality to be used in the empirical investigation, we e nd considerable support for our predictions.
TL;DR: In this article, the exact procedures used by litigants and courts to evict a tenant for non-payment of rent and to collect a bounced check were measured and described by Lex Mundi member law firms in 109 countries.
Abstract: In cooperation with Lex Mundi member law firms in 109 countries, we measure and describe the exact procedures used by litigants and courts to evict a tenant for non-payment of rent and to collect a bounced check. We use these data to construct an index of procedural formalism of dispute resolution for each country. We find that such formalism is systematically greater in civil than in common law countries. Moreover, procedural formalism is associated with higher expected duration of judicial proceedings, more corruption, less consistency, less honesty, less fairness in judicial decisions, and inferior access to justice. These results suggest that legal transplantation may have led to an inefficiently high level of procedural formalism, particularly in developing countries.
TL;DR: In this article, the authors argue that unless risk aversion is very high, lack of coordination in rule setting is a second-order problem compared to the overall gains from monetary policy stabilization.
Abstract: Author(s): Obstfeld, Maurice; Rogoff, Kenneth | Abstract: It is well known that if international linkages are relatively small, the potential gains to international monetary policy coordination are typically quite limited. But what if goods and financial markets are tightly linked? Is it then problematic if countries unilaterally design their institutions for monetary stabilization? Are the stabilization gains from having separate currencies largely squandered in the absence of effective international monetary coordination? We argue that under plausible assumptions the answer is no. Unless risk aversion is very high, lack of coordination in rule setting is a second-order problem compared to the overall gains from monetary policy stabilization.
TL;DR: This article found a strong positive correlation between state divorce prevalence and the political gender gap in the United States and found that women are less likely to support the Democratic party following marriage. But they did not find that women were more likely to vote for the Republican Party after divorce.
Abstract: The last three decades have witnessed the rise of a pohtical gender gap in the United States wherein more women than men favor the Democratic party. We trace this development to the decline in marriage, which we posit has made men richer and women poorer. Data for the United States support this argument. First, there is a strong positive correlation between state divorce prevalence and the political gender gap—higher divorce prevalence reduces support for the Democrats among men but not women. Second, longitudinal data show that following marriage (divorce), women are less (more) likely to support the Democratic party.
TL;DR: Investigation of individual motives to participate in rotating savings and credit associations in Kenya suggests that most roscas are predominantly composed of women, particularly those living in a couple and earning an independent income.
Abstract: This paper investigates individual motives to participate in rotating savings and credit associations (roscas).Detailed evidence from roscas in a Kenyan slum (Nairobi) suggests that most roscas are predominantly composed of women, particularly those living in a couple and earning an independent income. To explain this phenomenon, we propose an argument based on conflictual interactions within the household.Participation in a rosca is a strategy a wife employs to protect her savings against claims by her husband for immediate consumption.The empirical implications of the model are then tested using the data collected in Kenya.
TL;DR: The authors analyzes monotone comparative statics predictions in several classes of stochastic optimization problems and analyzes the necessary and sufficient conditions for comparative static predictions to hold based on primitive functions, that is, utility functions and probability distributions.
Abstract: This paper analyzes monotone comparative statics predictions in several classes of stochastic optimization problems. The main results characterize necessary and sufficient conditions for comparative statics predictions to hold based on properties of primitive functions, that is, utility functions and probability distributions. The results apply when the primitives satisfy one of the following two properties: (i) a single-crossing property, which arises in applications such as portfolio investment problems and auctions, or (ii) log-supermodularity, which arises in the analysis of demand functions, affiliated random variables, stochastic orders, and orders over risk aversion.
TL;DR: In this paper, the authors studied the historical mean and standard deviation of the return on equities and bonds and on the equilibrium demand for these securities in a stationary, overlapping-generations economy in which consumers are subject to a borrowing constraint.
Abstract: Ongoing questions on the historical mean and standard deviation of the return on equities and bonds and on the equilibrium demand for these securities are addressed in the context of a stationary, overlapping-generations economy in which consumers are subject to a borrowing constraint. The key feature captured by the OLG economy is that the bulk of the future income of the young consumers is derived from their wages forthcoming in their middle age, while the bulk of the future income of the middle-aged consumers is derived from their savings in equity and bonds. The young would like to borrow and invest in equity but the borrowing constraint prevents them from doing so. The middle-aged choose to
TL;DR: The authors used variation in immigrant flows as a natural experiment to study the effect of sex ratios on the children and grandchildren of immigrants, and found that high sex ratios had a large positive effect on the likelihood of female marriage, and a large negative effect on female labor force participation.
Abstract: Sex ratios, i.e., relative numbers of men and women, can affect marriage prospects, labor force participation, and other social and economic variables. But the observed association between sex ratios and social and economic conditions may be confounded by omitted variables and reverse causality. This paper uses variation in immigrant flows as a natural experiment to study the effect of sex ratios on the children and grandchildren of immigrants. The flow of immigrants affected the second generation marriage market because second generation marriages were mostly endogamous, i.e., to members of the same ethnic group. The empirical results suggest that high sex ratios had a large positive effect on the likelihood of female marriage, and a large negative effect on female labor force participation. Perhaps surprisingly, the marriage rates of second generation men appear to be a slightly increasing function of immigrant sex ratios. Higher sex ratios also appear to have raised male earnings and the incomes of parents with young children. The empirical results are broadly consistent with theories where higher sex ratios increase female bargaining power in the marriage market.
TL;DR: In this article, the authors investigated the role of product market and entry regulation in low employment growth in many European countries and found that stronger deterrence of entry by the boards increased retailer concentration and slowed down employment growth.
Abstract: Are product market and entry regulation key sources of low employment growth in many European countries? We investigate this question in the context of the French retail trade industry. Since 1974, approval by regional zoning boards has been required for the creation or extension of any large retain store in France. We exploit a unique database that provides time- and region-specific variation in boards' approval decisions. We show that stronger deterrence of entry by the boards increased retailer concentration and slowed down employment growth in France.
TL;DR: In this paper, the authors show that even in the absence of diminishing returns in production and techno-logical spillovers, international trade leads to a stable world income distribution, and that countries accumulating faster experience a worsening in their terms of trade.
Abstract: We show that even in the absence of diminishing returns in production and techno-logical spillovers, international trade leads to a stable world income distribution. This is because specialization and trade introduce de facto diminishing returns: countries that accumulate capital faster than average experience declining export prices, depressing the rate of return to capital and discouraging further accumulation. Because of constant re-turns to capital accumulation from a global perspective time-series behavior of the world economy is similar to that of existing endogenous growth models, with the world growth rate determined by policies, savings and technologies. Because of diminishing returns to capital accumulation at the country level, the cross-sectional behavior of the world economy is similar to that of existing exogenous growth models: cross-country variation in economic policies, savings and technology translate into cross-country variation in incomes, and country dynamics exhibit conditional convergence as in the Solow-Ramsey model. The dispersion of the world income distribution is determined by the forces that shape the strength of the terms of trade effects the degree of openness to international trade and the extent of specialization. Finally, we provide evidence that countries accumulating faster experience a worsening in their terms of trade. Our estimates imply that, all else equal, a 1 percentage point faster growth is associated with approximately a 0.7 percentage point decline in the terms of trade.
TL;DR: In this article, a model of memory grounded in psychological and biological research was developed to investigate the impact of limited memory on human behavior, and the resulting model predicts both over-and underreaction but provides enough structure to predict when each effect dominates.
Abstract: In order to investigate the impact of limited memory on human behavior, I develop a model of memory grounded in psychological and biological research. I assume that people take their memories as accurate and use them to make inferences. The resulting model predicts both over- and underreaction but provides enough structure to predict when each effect dominates. I then use this framework to study the consumption decision. The results match empirical work on consumption predictability as well as differences in the marginal propensity to consume from different income streams. Most importantly, because it ties the extent of bias to a measurable aspect of the stochastic process being forecasted, the model makes testable empirical predictions.
TL;DR: In this article, a framework based on endogenous noise trading is proposed to reduce the volatility of the exchange rate without any sacrifice in terms of monetary autonomy, and empirical evidence supports the existence of a non-fundamental channel in the link between exchange rate regimes and exchange rate volatility.
Abstract: Policy-makers often justify their choice of fixed exchange rate regimes as a shelter against nonfundamental influences in the foreign exchange market. This paper proposes a framework, based on endogenous noise trading, which makes sense of the policy-makers' view. We show that as a result of multiple equilibria, the model violates Mundell's "Incompatible Trinity:" under some conditions, it is possible to reduce the volatility of the exchange rate without any sacrifice in terms of monetary autonomy. We provide empirical evidence supportive of the existence of a nonfundamental channel in the link between exchange rate regimes and exchange rate volatility. If … markets come to believe exchange rate stability is not itself a significant policy objective, we should not be surprised that snowballing cumulative movements can develop that appear widely out of keeping with current balance-of-payments prospects or domestic price movements. At that point, freely floating exchange rates, instead of delivering on the promise of money autonomy for domestic monetary or other policies, can greatly complicate domestic economic management [Paul Volcker 1978–79, p. 9].
TL;DR: The authors provides a quantitative theory for the recent rise in residual wage inequality consistent with the empirical observation that a sizable part of this increase has a transitory nature, a feature that eludes standard models based on ex ante heterogeneity in ability.
Abstract: This paper provides a quantitative theory for the recent rise in residual wage inequality consistent with the empirical observation that a sizable part of this increase has a transitory nature, a feature that eludes standard models based on ex ante heterogeneity in ability. An acceleration in the rate of quality improvement of equipment, like the one observed from the early 1970s, increases the productivity/quality differentials across machines (jobs). In a frictional labor market, this force translates into higher wage dispersion even among ex ante equal workers. With vintage-human capital, the acceleration reduces workers' capacity to transfer skills from old to new machines, generating a rise in the cross-sectional variance of skills, and therefore of wages. Through calibration, the paper shows that this mechanism can account for 30 percent of the surge in residual inequality in the U. S. economy (or for most of its transitory component). Two key implications of the theory—faster within-job wage growth and larger wage losses upon displacement—find empirical support in the data.