Jonathan A. Parker
Accelerator or Brake? Cash for Clunkers, Household Liquidity, and Aggregate Demand by Daniel Green, Brian Melzer, Jonathan A. Parker and Arcenis Rojas
We estimate the importance of household liquidity for the effect of the Car Allowance Rebate System (CARS) on vehicle transactions. We measure the average program impact by comparing households with “clunkers” eligible for CARS to households with similar vehicles that are ineligible. The liquidity provided by CARS contributed to its larger than anticipated take-up. Clunkers with existing loans, which required immediate repayment upon trade-in, were tradedin at much lower rates, an effect consistent with liquidity constraints and distinguishable from that of other debt, household income, and the size of the program subsidy. Household debt capacity did not measurably constrain participation.
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We Put Financial Advisers to the Test–and They Failed by Antoinette Schoar — The Wall Street Journal
October 27, 2016
Professor Antoinette Schoar discusses her recent study with Sendhil Mullainathan (Harvard University) and Markus Noeth (Hamburg University), in which they sent out “mystery shoppers” to solicit retirement savings advice from financial advisers in the greater Boston area. They find that financial advisers are apparently willing to make their clients worse off for their own financial gain. However, they also find that advisers with a fiduciary responsibility give better, less biased advice — an important implication for the Department of Labor’s upcoming fiduciary rule.
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How to improve productivity? Make sure it’s shared broadly by Simon Johnson — The Washington Post
October 27, 2016
In this opinion piece, Professor Simon Johnson shares ideas about what the next president’s administration can do to improve productivity growth. Johnson identifies improving human capital and expanding access to new innovations as keys to enhancing productivity across all segments of society.
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Nobel Laureate Merton Says Buffett’s Financial WMDs Help Society by Tom Redmond and Shigeki Nozawa — Bloomberg
October 26, 2016
In a recent interview in Kyoto, Japan, GCFP co-director and Nobel laureate Robert Merton discussed the benefits of financial innovation over the past few decades. In clear contrast to former Federal Reserve Chairman Paul Volcker, who famously said that the last financial innovation useful to society was the ATM, he addresses how newer instruments such as options and swaps have added value to society. Merton won the 1997 Nobel Prize in economics for his work on pricing options.
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A Tale of Six Cities: Underfunded Retiree Health Care by Robert Pozen and Joshua Rauh
The growing costs of health care benefits for retired public employees—known as OPEB (other post-employment benefits)—pose a serious challenge to many city governments. In this paper, we analyze the retiree health care systems of six American cities: Boston, Minneapolis, Pittsburgh, San Francisco, San Antonia, and Tampa, Florida. Without major reforms, most of these cities will have to devote a much larger share of tax revenues to OPEB benefits and consequently less to essential functions like schools and police. We outline a broad variety of reasonable measures that cities could adopt to materially reduce their long-term OPEB liabilities.
Buying cures versus renting health: Financing health care with consumer loans by Vahid Montazerhodjat, David M. Weinstock and Andrew W. Lo
Transformative therapies have the capacity to cure patients of serious diseases, but steep up-front price tags often pushes them toward more affordable drugs that mitigate rather than cure. This paper proposes a practical way to increase drug affordability through health care loans – the equivalent of mortgages for large health care expenses. In addition to enhancing affordability for consumers, such loans would also incentivize the development of transformative therapies rather than those that offer small incremental advances.
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China’s economic policymakers have to learn to let go if they want to establish credibility by Yasheng Huang
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Jerome and Dorothy Lemelson Professor of Management and Global Economics at MIT
The spillovers, interactions, and (un)intended consequences of monetary and regulatory policies by Kristin Forbes, Dennis Reinhardt and Tomasz Wieladek
Have bank regulatory policies and unconventional monetary policies — and any possible interactions — been a factor behind the recent ‘deglobalisation’ in cross-border bank lending? To test this hypothesis, we use bank-level data from the United Kingdom — a country at the heart of the global financial system. Our results suggest that increases in microprudential capital requirements tend to reduce international bank lending and some forms of unconventional monetary policy can amplify this effect. Specifically, the United Kingdom’s Funding for Lending Scheme (FLS) significantly amplified the effects of increased capital requirements on external lending. Quantitative easing may also have had an amplification effect, but these estimates are usually insignificant and smaller in magnitude. We find that this interaction between microprudential regulations and the FLS can explain roughly 30% of the contraction in aggregate UK cross-border bank lending between mid-2012 and end-2013, corresponding to around 10% of the contraction globally. This suggests that unconventional monetary policy designed to support domestic lending can have the unintended consequence of reducing foreign lending
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The Value of Connections in Turbulent Times: Evidence from the United States by Daron Acemoglu, Simon Johnson, Amir Kermani, James Kwak, and Todd Mitton
The announcement of Timothy Geithner as nominee for Treasury Secretary in November 2008 produced a cumulative abnormal return for financial firms with which he had a prior connection. This return was about 6% after the first full day of trading and about 12% after ten trading days. There were subsequently abnormal negative returns for connected firms when news broke that Geithner’s confirmation might be derailed by tax issues. Personal connections to top executive branch officials can matter greatly even in a country with strong overall institutions, at least during a time of acute financial crisis and heightened policy discretion.
Ending “Too Big to Fail”: Government Promises vs. Investor Perceptions by Todd A. Gormley, Simon Johnson, Changyong Rhee
Can a government credibly promise not to bailout firms whose failure would have major negative systemic consequences? Our analysis of Korea’s 1997-99 crisis, suggests an answer: No. Despite a general “no bailout” policy during the crisis, the largest Korean corporate groups (chaebol) – facing severe financial and governance problems – could still borrow heavily from households through issuing bonds at prices implying very low expected default risk. The evidence suggests “too big to fail” beliefs were not eliminated by government promises, presumably because investors believed that this policy was not time consistent. Subsequent government handling of potential and actual defaults by Daewoo and Hyundai confirmed the market view that creditors would be protected.
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Revenue and Incentive Effects of Basis Step-Up at Death: Lessons from the 2010 “Voluntary” Estate Tax Regime by Robert Gordon, David Joulfaian, and James Poterba
The effective tax burden on the returns from long-term investments held by many highnet-worth households in the United States is determined in significant part by the interaction between the income tax treatment of capital gains and the estate tax, in particular the tax provision that allows basis step-up for assets that are passed to beneficiaries at death.
What Determines End-of-Life Assets? A Retrospective View by James Poterba Steven Venti and David A. Wise
We consider assets when individuals were last observed prior to death in the Health and Retirement Study (HRS) and trace assets backwards to the age when these individuals were first observed. For most individuals, assets in the last year observed (LYO) were very similar to assets in the first year observed (FYO). In particular, most of those who were last observed with very low asset levels also had low assets when first observed. We also estimate the relationship between an individual’s asset change between the first and last date of observation, that individual’s education and health status when first observed, and that individual’s within-sample changes in health and family composition. We obtain estimates for HRS respondents who were 51 to 61 in 1992 and for AHEAD respondents who were age 70 and over in 1993.
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Stressed, Not Frozen: The Federal Funds Market in the Financial Crisis by Gara Afonso, Anna Kovner, and Antoinette Schoar
We examine the importance of liquidity hoarding and counterparty risk in the U.S. overnight interbank market during the financial crisis of 2008. Our findings suggest that counterparty risk plays a larger role than does liquidity hoarding: in the two days after Lehman Brothers’ bankruptcy, loan terms become more sensitive to borrower characteristics. In particular, whereas poorly performing large banks see an increase in spreads of 24 basis points, while borrowing 1% less, on average. Worse performing banks do not hoard liquidity. While the interbank market does not freeze entirely, it does not seem to expand to meet latent demand.
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Public pension accounting rules and economic outcomes by James Naughton, Reining Petacchi, and Joseph Weber
We find a negative association between a state׳s fiscal condition and the use of discretion in applying Governmental Accounting Standards Board (GASB) rules to understate pension funding gaps. We also find that the use of discretion is negatively associated with states’ decisions to increase taxes and cut spending. In addition, we find that the funding gap understatement is positively associated with higher future labor costs. Importantly, this association is primarily attributable to the GASB methodology, which systematically understates the funding gap. This suggests that the GASB approach is associated with policy choices that have the potential to exacerbate fiscal stress.
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Systemic Risk and Stability in Financial Networks by Daron Acemoglu, Asuman Ozdaglar, and Alireza Tahbaz-Salehi
American Economic Review 2015
This paper argues that the extent of financial contagion exhibits a form of phase transition: as long as the magnitude of negative shocks affecting financial institutions are sufficiently small, a more densely connected financial network (corresponding to a more diversified pattern of interbank liabilities) enhances financial stability. However, beyond a certain point, dense interconnections serve as a mechanism for the propagation of shocks, leading to a more fragile financial system. Our results thus highlight that the same factors that contribute to resilience under certain conditions may function as significant sources of systemic risk under others.
Microeconomic Origins of Macroeconomic Tail Risks by Daron Acemoglu, Asuman Ozdaglar, Alireza Tahbaz-Salehi
We document that even though the normal distribution provides a good approximation to GDP fluctuations, it severely underpredicts “macroeconomic tail risks,” that is, the frequency of large economic downturns. Using a multi-sector general equilibrium model, we show that the interplay of idiosyncratic microeconomic shocks and sectoral heterogeneity results in systematic departures in the likelihood of large economic downturns relative to what is implied by the normal distribution. Notably, we also show that such departures can happen while GDP is approximately normally distributed away from the tails, highlighting the qualitatively different behavior of large economic downturns from small or moderate fluctuations. We further demonstrate the special role that input-output linkages play in generating “tail comovements,” whereby large recessions involve not only significant GDP contractions, but also large simultaneous declines across a wide range of sectors.
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Six Randomized Evaluations of Microcredit: Introduction and Further Steps by Abhijit Banerjee, Dean Karlan, and Jonathan Zinman
Causal evidence on microcredit impacts informs theory, practice, and debates about its effectiveness as a development tool. The six randomized evaluations in this volume use a variety of sampling, data collection, experimental design, and econometric strategies to identify causal effects of expanded access to microcredit on borrowers and/or communities. These methods are deployed across an impressive range of locations — six countries on four continents, urban and rural areas — borrower characteristics, loan characteristics, and lender characteristics. Summarizing and interpreting results across studies, we note a consistent pattern of modestly positive, but not transformative, effects. We also discuss directions for future research.
Do Firms Want to Borrow More? Testing Credit Constraints Using a Directed Lending Program by Abhijit Banerjee and Esther Duflo
This paper uses variation in access to a targeted lending program to estimate whether firms are credit constrained. The basic idea is that while both constrained and unconstrained firms may be willing to absorb all the directed credit that they can get (because it may be cheaper than other sources of credit), constrained firms will use it to expand production, while unconstrained firms will primarily use it as a substitute for other borrowing. We apply these observations to firms in India that became eligible for directed credit as a result of a policy change in 1998, and lost eligibility as a result of the reversal of this reform in 2000. Using firms that were already getting this kind of credit before 1998, and retained eligibility in 2000 to control for time trends, we show that there is no evidence that directed credit is being used as a substitute for other forms of credit. Instead the credit was used to finance more production–there was a large acceleration in the rate of growth of sales and profits for these firms. We conclude that many of the firms must have been severely credit constrained, and that the marginal rate of return to capital was very high for these firms.
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Ricardo Cabellero & Alp Simsek
Fire Sales in a Model of Complexity by Ricardo Cabellero and Alp Simsek
We present a model of financial crises that stem from endogenous complexity. We conceptualize complexity as banks’ uncertainty about the financial network of cross exposures. As conditions deteriorate, cross exposures generate the possibility of a domino effect of bankruptcies. As this happens, banks face an increasingly complex environment since they need to understand a greater fraction of the financial network to assess their own financial health. Complexity dramatically amplifies banks’ perceived counterparty risk, and makes relatively healthy banks reluctant to buy risky assets. The model also features a novel complexity externality.