Taxes,Tuition Fees,and Education for Pleasure

The fact that education provides both a productive and a consumptive (nonproductive) return has important and, in some cases, dramatic implications for optimal taxes and tuition fees. Using a simple model, we show that when the consumption share in education is endogenous and tuition fees are unconstrained, the optimal tax/fee system involves regressive income taxes and high tuition fees. A progressive labor income tax system may, on the other hand, be a second‐best response to politically constrained, low tuition fees. Finally, the existence of individuals with different abilities will also move the optimal income tax system toward progressivity.     

Is the Real Interest Rate Stable?

Univariate time-series models for consumption, nominal interest rates, and prices each appear to have a single unit root before 1979. If nominal interest rates have a unit root but inflation and inflation forecast errors do not, then ex ante real interest rates have a unit root and are therefore nonstationary. This deduction does not depend on the properties of the unobservable ex post observed real return, which combines the ex ante real interest rate and inflation-forecasting errors. The unit-root characteristic of real interest rates is puzzling from at least two perspectives: many models imply that the growth rate of consumption and the real interest rate should have similar time-series characteristics; also, nominal returns for other assets (e.g., stocks and bonds) appear to have different times-series properties from those of treasury bills.     

Monetary Policy and Financial Stability: Cross‐Country Evidence

We explain the heterogeneous response of central banks to financial stability risks based on a financial stability orientation (FSO) index, which reflects statutory, regulatory, and discretionary components of central banks' monetary policy frameworks. Our baseline results from a cross‐country panel of modified Taylor rules suggest that central banks with a high FSO increase their policy rates in response to elevated financial stability risks by 0.27 percentage points more than central banks with a low orientation. Back‐of‐the‐envelope calculations suggest that this policy rate differential translates into a reduced crisis probability but also into considerably lower inflation and output growth rates.     

Explaining Forward Exchange Bias…Intraday

Intraday interest rates are zero. Consequently, a foreign exchange dealer can short a vulnerable currency in the morning, close this position in the afternoon, and never face an interest cost. This tactic might seem especially attractive in times of fixed-rate crisis, since it suggests an immunity to the central bank's interest rate defense. In equilibrium, however, buyers of the vulnerable currency must be compensated on average with an intraday capital gain as long as no devaluation occurs. That is, currencies under attack should typically appreciate intraday. Using data on intraday exchange rate changes within the European Monetary System, we find this prediction is borne out.     

book reviews

WOMEN FOR HIRE, A STUDY OF THE FEMALE OFFICE WORKER London School of Economics and Political Science A HANDBOOK OF INDUSTRIAL RELATIONS PRACTICE Personnel Director British Aluminium VOTES, VIRTUES AND VICES: TRADE UNION POWER THE TROJAN HORSE: UNION POWER IN BRITISH POLITICS School of Industrial & Business Studies University of Warwick WHITE COLLAR UNIONISM: THE REBELLIOUS SALARIAT Manchester Business School THE INTERNATIONAL YEARBOOK OF ORGANIZATION STUDIES Centre for European Industrial Studies University of Bath     

DISTRIBUTIONAL IMPACTS OF GREENHOUSE GAS EMISSIONS TRADING: ALTERNATIVE ALLOCATION AND RECYCLING STRATEGIES IN CALIFORNIA

Cap and trade remains attractive to many state governments because it provides a much‐needed source of additional revenue when greenhouse gas emission allowances are auctioned to the highest bidder. We analyze the income distribution impacts of the California Global Warming Solutions Act under alternative policy designs. These include the free allocation of emission allowances versus recycling of auction revenues through proportional income tax relief and a per capita dividend. The analysis is undertaken under conditions where significant economic gains, rather than losses, are projected for the policy, and in the context of the new electricity pricing regulatory environment in which passing along the opportunity costs of using free allowances may not be approved. We adapt and enhance the Regional Economic Models, Inc. Policy Insight Plus Model and apply it for the first time to estimate the income distribution impacts of cap and trade. The analysis illustrates the importance of considering macroeconomic impacts and identifies important efficiency‐equity tradeoffs. The method and results are generalizable to the dozens of states and regions still formulating or revising climate action plans in the United States and to many regions and nations around the world. (JEL D31, R11, Q54)     

Determinants of Cross‐Border Mergers and Acquisitions

The vast majority of cross‐border mergers involve private firms outside of the United States. We analyze a sample of 56,978 cross‐border mergers between 1990 and 2007. We find that geography, the quality of accounting disclosure, and bilateral trade increase the likelihood of mergers between two countries. Valuation appears to play a role in motivating mergers: firms in countries whose stock market has increased in value, whose currency has recently appreciated, and that have a relatively high market‐to‐book value tend to be purchasers, while firms from weaker‐performing economies tend to be targets.     

An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs

The presence of any friction in financial markets qualitatively changes the nature of the optimization problem faced by an investor. It requires one to either act or do nothing, an issue which, of course, does not arise in frictionless situations. The investor considered here accumulates wealth without consuming until some terminal point in time when he consumes all. His objective is to maximize the expected utility derived from that terminal consumption. We postpone the terminal point far into the future to obtain a stationary portfolio rule. The portfolio policy is in the form of two control barriers between which portfolio proportions are allowed to fluctuate. We show how to calculate them.     

The Incredible HOLC? Mortgage Relief during the Great Depression

This paper examines the relief provided by the Home Owners’ Loan Corporation (HOLC), a New Deal program that purchased and refinanced over 1 million distressed residential mortgages. I document that the HOLC paid relatively high prices for its mortgages, most likely in an effort to encourage lender participation and stimulate the housing market. The consequence was that lenders were able to remove poorly performing assets from their balance sheets at attractive prices. While this meant the HOLC’s ability to seek principal reductions was somewhat limited, borrowers still received significant relief through the terms of the HOLC’s more modern and forgiving mortgage contracts.