American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Symposia How Debt Markets Have Malfunctioned in the Crisis ArvindKrishnamurthyNorthwestern U 3 28 The financial crisis that began in 2007 is especially a crisis in debt markets. A full understanding of what happened in the financial crisis requires investigation into the plumbing of debt markets. During a financial crisis, when funds often cannot be raised easily or quickly, the fundamental values for certain assets can become separated for a time from market prices, with consequences that can echo into the real economy. This article will explain in concrete ways how debt markets can malfunction, with deleterious consequences for the real economy. After a quick overview of debt markets, I discuss three areas that are crucial in all debt markets decisions: risk capital and risk aversion; repo financing and haircuts; and counterparty risk. In each of these areas, feedback effects can arise so that less liquidity and a higher cost for finance can reinforce each other in a contagious spiral. I will document the remarkable rise in the premium that investors placed on liquidity during the crisis. Next, I will show how these issues caused debt markets to break down; indeed, fundamental values and market values seemed to diverge across several markets and products that were far removed from the "toxic" subprime mortgage assets at the root of the crisis. Finally, I will discuss briefly four steps that the Federal Reserve took to ease the crisis and how each was geared to a specific systemic fault that arose during the crisis. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.3 10.1257/jep.24.1.3 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Symposia When Safe Proved Risky: Commercial Paper during the Financial Crisis of 2007-2009 MarcinKacperczykNYU PhilippSchnablNYU 29 50 Commercial paper is a short-term debt instrument issued by large corporations. The commercial paper market has long been viewed as a bastion of high liquidity and low risk. But twice during the financial crisis of 2007-2009, the commercial paper market nearly dried up and ceased being perceived as a safe haven. Major interventions by the Federal Reserve, including large outright purchases of commercial paper, were eventually used to support both issuers of and investors in commercial paper. We will offer an analysis of the commercial paper market during the financial crisis. First, we describe the institutional background of the commercial paper market. Second, we analyze the supply and demand sides of the market. Third, we examine the most important developments during the crisis of 2007-2009. Last, we discuss three explanations of the decline in the commercial paper market: substitution to alternative sources of financing by commercial paper issuers, adverse selection, and institutional constraints among money market funds. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.29 10.1257/jep.24.1.29 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Symposia The Failure Mechanics of Dealer Banks DarrellDuffieStanford U 51 72 During the recent financial crisis, major dealer banks -- that is, banks that intermediate markets for securities and derivatives -- suffered from new forms of bank runs. The most vivid examples are the 2008 failures of Bear Stearns and Lehman Brothers. Dealer banks are often parts of large complex financial organizations whose failures can damage the economy significantly. As a result, they are sometimes considered "too big to fail." The mechanics by which dealer banks can fail and the policies available to treat the systemic risk of their failures differ markedly from the case of conventional commercial bank runs. These failure mechanics are the focus of this article. This is not a review of the financial crisis of 2007-2009. Systemic risk is considered only in passing. Both the financial crisis and the systemic importance of large dealer banks are nevertheless obvious and important motivations. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.51 10.1257/jep.24.1.51 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Symposia Credit Default Swaps and the Credit Crisis Rene M.StulzOH State U 73 92 Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counterparty risk and that they facilitate speculation involving negative views of a firm's financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and to quantify the social gains and costs of derivatives in general and credit default swaps in particular. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.73 10.1257/jep.24.1.73 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Symposia Did Fair-Value Accounting Contribute to the Financial Crisis? ChristianLauxVienna U Economics and Business ChristianLeuzU Chicago 93 118 The recent financial crisis has led to a major debate about fair-value accounting. Many critics have argued that fair-value accounting, often also called mark-to-market accounting, has significantly contributed to the financial crisis or, at least, exacerbated its severity. In this paper, we assess these arguments and examine the role of fair-value accounting in the financial crisis using descriptive data and empirical evidence. Based on our analysis, it is unlikely that fair-value accounting added to the severity of the 2008 financial crisis in a major way. While there may have been downward spirals or asset-fire sales in certain markets, we find little evidence that these effects are the result of fair-value accounting. We also find little support for claims that fair-value accounting leads to excessive write-downs of banks' assets. If anything, empirical evidence to date points in the opposite direction, that is, toward the overvaluation of bank assets during the crisis. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.93 10.1257/jep.24.1.93 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Symposia Mental Retirement SusannRohwedderRAND Center for the Study of Aging, Santa Monica, CA and NETSPAR, Tilburg Robert J.WillisU MI 119 38 Early retirement appears to have a significant negative impact on the cognitive ability of people in their early 60s that is both quantitatively important and causal. We obtain this finding using cross-nationally comparable survey data from the United States, England, and Europe that allow us to relate cognition and labor force status. We argue that the effect is causal by making use of a substantial body of research showing that variation in pension, tax, and disability policies explain most variation across countries in average retirement rates. (In an informal manner, we are arguing that public policies that affect the age of retirement may be used as instrumental variables to generate cross-country variation in retirement behavior in order to identify the causal effect of retirement on cognition.) http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.119 10.1257/jep.24.1.119 http://www.aeaweb.org/jep/app/2401_Rohwedder_Willis_appendix.pdf American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Symposia How Longer Work Lives Ease the Crunch of Population Aging NicoleMaestasRAND Corporation, Santa Monica, CA JulieZissimopoulosRAND Corporation, Santa Monica, CA 139 60 Population aging is not a looming crisis of the future -- it is already here. Economic challenges arise when the increase in people surviving to old age and the decline in the number of young people alive to support them cause the growth in society's consumption needs to outpace growth in its productive capacity. The ultimate impact of population aging on our standard of living in the future depends a great deal on how long people choose to work before they retire from the labor force. Here, there is reason for optimism. A constellation of forces, some just now gaining momentum, has raised labor force participation at older ages at just the time it is needed. We examine the most important factors behind the increase in labor force participation realized to date: the shift in the skill composition of the workforce, and technological change. We argue that forces such as changes in the structure of employer-provided pensions and Social Security are likely to propel future increases in labor force participation at older ages. The labor market is accommodating older workers to some degree, and older men and women are themselves adapting on a number of fronts, which could substantially lessen the economic impact of population aging. Age-related health declines and the reluctance of employers to hire and retain older workers present challenges, but the outlook for future gains in labor force participation at older ages is promising. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.139 10.1257/jep.24.1.139 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Symposia What the Stock Market Decline Means for the Financial Security and Retirement Choices of the Near-Retirement Population Alan L.GustmanDartmouth College Thomas L.SteinmeierTX Tech U NahidTabatabaiDartmouth College 161 82 This paper investigates the effect of the current recession on the retirement age population. Data from the Health and Retirement Study suggest that those approaching retirement age (early boomers ages 53 to 58 in 2006) have only 15.2 percent of their wealth in stocks, held directly or in defined contribution plans or IRAs. Their vulnerability to a stock market decline is limited by the high value of their Social Security wealth, which represents over a quarter of the total household wealth of the early boomers. In addition, their defined contribution plans remain immature, so their defined benefit plans represent sixty five percent of their pension wealth. Simulations with a structural retirement model suggest the stock market decline will lead the early boomers to postpone their retirement by only 1.5 months on average. Health and Retirement Study data also show that those approaching retirement are not likely to be greatly or immediately affected by the decline in housing prices. We end with a discussion of important difficulties facing those who would use labor market policies to increase the employment of older workers. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.161 10.1257/jep.24.1.161 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Articles Economic Theory and the World of Practice: A Celebration of the (S, s) Model AndrewCaplinNYU JohnLeahyNYU 183 202 It was the question of how best to balance the costs of ordering and of running out of stock against the costs of holding excess inventory that inspired Kenneth Arrow, Theodore Harris, and Jacob Marschak to introduce the (S, s) model in 1951. In this celebratory article, we show how this model not only answered important practical questions, but also opened the door to a quite startling range of important and challenging follow-up questions, many of great practical importance and analytic depth. The (S, s) model has become one of the touchstone models of economics, opening new vistas of applied economic theory to all who internalize its structure. Today it is universally applied to solve questions faced in inventory control. The core model elements, uncertainty and fixed costs of adjustment, are ubiquitous, which has resulted in its becoming the general purpose economic model of discrete adjustment. The (S, s) model has also become a profound source of inspiration for macroeconomists seeking to understand the role that discrete microeconomic adjustments play in macroeconomic fluctuations. Looking forward, we foresee rapid growth in the use of (S, s) modeling to aid households making complex and costly financial decisions, such as when and how to terminate a mortgage. In the projected era of "household operations research," new modeling challenges will arise due to enriched feedback from the world of practice. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.183 10.1257/jep.24.1.183 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Articles Why Do Management Practices Differ across Firms and Countries? NicholasBloomStanford U and Center for Economic Performance, London School of Economics JohnVan ReenenCenter for Economic Performance, London School of Economics 203 24 Economists have long puzzled over the astounding differences in productivity between firms and countries. In this paper, we present evidence on a possible explanation for persistent differences in productivity at the firm and the national level -- namely, that such differences largely reflect variations in management practices. We have, over the last decade, undertaken a large survey research program to systematically measure management practices across firms, industries, and countries. Our survey approach focuses on aspects of management like systematic performance monitoring, setting appropriate targets, and providing incentives for good performance. We explain how we measure management; identify some basic patterns in our data; then turn to the question of why management practices vary so much across firms and nations. What we find is a combination of imperfectly competitive markets, family ownership of firms, regulations restricting management practices, and informational barriers allow bad management to persist. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.203 10.1257/jep.24.1.203 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Features Retrospectives: Engel Curves AndreasChaiMax Planck Institute of Economics, Jena AlessioMonetaMax Planck Institute of Economics, Jena 225 40 Engel curves describe how household expenditure on particular goods or services depends on household income. German statistician Ernst Engel (1821-1896) was the first to investigate this relationship systematically in an article published about 150 years ago. The best-known single result from the article is "Engel's law," which states that the poorer a family is, the larger the budget share it spends on nourishment. We revisit Engel's article, including its context and the mechanics of the argument. Because the article was completed a few decades before linear regression techniques were established and income effects were incorporated into standard consumer theory, Engel was forced to develop his own approach to analyzing household expenditure patterns. We find his work contains some interesting features in juxtaposition to both the modern and classical literature. For example, Engel's way of estimating the expenditure-income relationship resembles a data-fitting technique called the "regressogram" that is nonparametric -- in that no functional form is specified before the estimation. Moreover, Engel introduced a way of categorizing household expenditures in which expenditures on commodities that served the same purpose by satisfying the same underlying "want" were grouped together. This procedure enabled Engel to discuss the welfare implications of his results in terms of the Smithian notion that individual welfare is related to the satisfaction of wants. At the same time, he avoided making a priori assumptions about which specific goods were necessities, assumptions which were made by many classical economists like Adam Smith. Finally, we offer a few thoughts about some modern literature that builds on Engel's research. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.225 10.1257/jep.24.1.225 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Features Recommendations for Further Reading TimothyTaylorMacalester College 241 48 http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.241 10.1257/jep.24.1.241 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Journal Article Front Matter i vi http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.i 10.1257/jep.24.1.i American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 1 Winter 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=1 Features Notes 249 250 http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.1.249 10.1257/jep.24.1.249