Simple Monetary Rules under Fiscal Dominance

This paper asks whether interest rate rules that respond aggressively to inflation, following the Taylor principle, are feasible in countries that suffer from fiscal dominance. We find that if interest rates are allowed to also respond to government debt, they can produce unique equilibria. But such equilibria are associated with extremely volatile inflation. The resulting frequent violations of the zero lower bound make such rules infeasible. Even within the set of feasible rules the welfare optimizing response to inflation is highly negative. The welfare gain from responding to government debt is minimal compared to the gain from eliminating fiscal dominance.     

Oil Currency and the Dollar Standard: A Simple Analytical Model of an International Trade Currency

The U.S. dollar is the central reference currency for international trade pricing and the main invoicing currency for primary commodities. This paper links these two observations within a stylized theoretical framework, and shows how to obtain a quantitative estimate of the gain to the U.S. economy when the dollar is a reference currency. With dollar invoicing of primary commodities, U.S. firms bear less exchange rate risk than foreign firms. This asymmetry leads to a dollar standard in international goods pricing. We then derive a simple analytical formula to calculate the gains and find that they are extremely small.     

Capital Market Regimes and Bank Structure in Europe

We hypothesize that fundamental features that distinguish European capital markets have predictably influenced emerging national differences in bank capitalization and loan growth. Using bank‐level data from 13 European countries, 1998 to 2004, we find evidence of positive effects of “equity‐friendly” market features on bank capitalization and positive effects of both “equity‐friendly” and “credit‐friendly” market features on loan growth. The findings are strongest in small banks and in banks with cooperative charters. Our results suggest that ongoing and prospective integration of European banking markets is mitigated by relatively static features of the equity and credit markets on which banks rely.     

Implicit Employment Contracts: The Limits of Management Reputation for Promoting Firm Productivity

Implicit employment contracts are a common way to motivate firm productivity but also require that employees trust management to be fair when allocating postproduction firm resources between employees and owners. We use an experiment to study the problem of motivating firm productivity, which depends on levels of owner investment and employee productive effort, when managers have an incentive to favor the owner's interests over those of the employee. Drawing on research in psychology and behavioral economics, we argue that reputation concerns can more effectively promote firm productivity when manager compensation is relatively insensitive to how much the owner is allocated after production occurs. Consistent with our predictions, we find that reputation concerns lead to greater firm productivity and higher payoffs for all firm members, but only when manager pay is relatively insensitive to the owner's ex post allocation. In addition to offering testable empirical implications, our theory and results are important because they can help explain why executive compensation is, in practice, surprisingly insensitive to owner returns.     

From Research to Policy: Lessons from Individual Development Accounts

There goes in the world a notion that the scholar should be a recluse, a valetudinarian…. As far as this is true of the studious classes, it is not just and wise. Action is with the scholar subordinate, but it is essential…. Without it, thought can never ripen into truth… (Ralph Waldo Emerson).     

Book Reviews

Companion to Contemporary Economic Thought by DAVID GREENAWAY, MICHAEL BLEANEY and IAN M.T. STEWART (eds.), (London, New York: Routledge, 1991, pp xii and 858, ISBN 0 415 02612 1. International Adjustment and Financing. the Lessons of 1985–1991 by C. FRED BERGSTEN, (ed.), (Washington: Institute for International Economics, 1992), pp xiii and 335, US $34.95 hardback, US $24.95 softback, ISBN 0 88132 142 7 and 0 88132 112 5. Financial Instability and the International Debt Problem by GEORGE MCKENZIE and STEPHEN THOMAS (Basingstoke: Macmillan, 1992), pp ix and 211, $40 hardback, ISBN 0 333 46419 2. Down in The Dumps, Administration of the Unfair Trade Laws by RICHARD BOLTUCK and ROBERT E. LIT AN (eds.), (Washington, DC: The Brookings Institution, 1991). pp xii and 350, US $34.95 hardback, US $15.94 softback, ISBN 0 8157 1020 8, 0 8157 1019 4. Industrial Reform in Socialist Countries, From Restructuring to Revolution by IAN JEFFRIES (Aldershot: Edward Elgar Publishing Ltd., 1992), pp x and 294, $45.00 hardback, ISBN 1 85278 380 X.     

Consumer Perceptions of Health Claims in Advertisements and on Food Labels

It has been hypothesized that consumers are more skeptical of health claims made in food ads than of health claims made on food labels. Therefore, the current research explores consumers' skepticism of health claims when the source of such claims is identified as a food ad or a food label. The study also examines whether consumers' beliefs are affected by nutrition information on food labels and whether health claims that have been challenged by the Federal Trade Commission (FTC) and by consumer groups are more likely to affect consumers' beliefs than are unchallenged health claims. The findings have implications for understanding the role of education in reducing consumer misperceptions of health claims.     

Why Are Buyouts Levered? The Financial Structure of Private Equity Funds

Private equity funds are important to the economy, yet there is little analysis explaining their financial structure. In our model the financial structure minimizes agency conflicts between fund managers and investors. Relative to financing each deal separately, raising a fund where the manager receives a fraction of aggregate excess returns reduces incentives to make bad investments. Efficiency is further improved by requiring funds to also use deal-by-deal debt financing, which becomes unavailable in states where internal discipline fails. Private equity investment becomes highly sensitive to aggregate credit conditions and investments in bad states outperform investments in good states.