American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Journal Article Front Matter i ii http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.i 10.1257/jep.25.1.i American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Symposia A Macroprudential Approach to Financial Regulation Samuel G.HansonHarvard U Anil K.KashyapU Chicago Jeremy C.SteinHarvard U 3 28 Many observers have argued that the regulatory framework in place prior to the global financial crisis was deficient because it was largely "microprudential" in nature. A microprudential approach is one in which regulation is partial equilibrium in its conception and aimed at preventing the costly failure of individual financial institutions. By contrast, a "macroprudential" approach recognizes the importance of general equilibrium effects, and seeks to safeguard the financial system as a whole. In the aftermath of the crisis, there seems to be agreement among both academics and policymakers that financial regulation needs to move in a macroprudential direction. In this paper, we offer a detailed vision for how a macroprudential regime might be designed. Our prescriptions follow from a specific theory of how modern financial crises unfold and why both an unregulated financial system, as well as one based on capital rules that only apply to traditional banks, is likely to be fragile. We begin by identifying the key market failures at work: why individual financial firms, acting in their own interests, deviate from what a social planner would have them do. Next, we discuss a number of concrete steps to remedy these market failures. We conclude the paper by comparing our proposals to recent regulatory reforms in the United States and to proposed global banking reforms. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.3 10.1257/jep.25.1.3 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Symposia Fire Sales in Finance and Macroeconomics AndreiShleiferHarvard U RobertVishnyU Chicago 29 48 Analysts of the recent financial crisis often refer to the role of asset "fire sales" in depleting the balance sheets of financial institutions and aggravating the fragility of the financial system. The term "fire sale" has been around since the nineteenth century to describe firms selling smoke-damaged merchandise at cut-rate prices in the aftermath of a fire. But what are fire sales in broad financial markets with hundreds of participants? As we suggested in a 1992 paper, a fire sale is essentially a forced sale of an asset at a dislocated price. The asset sale is forced in the sense that the seller cannot pay creditors without selling assets. The price is dislocated because the highest potential bidders are typically involved in a similar activity as the seller, and are therefore themselves indebted and cannot borrow more to buy the asset. Indeed, rather than bidding for the asset, they might be selling similar assets themselves. Assets are then bought by nonspecialists who, knowing that they have less expertise with the assets in question, are only willing to buy at valuations that are much lower. In this paper, we selectively review some of the research on fire sales, emphasizing both concepts and supporting evidence. We begin by describing our 1992 model of fire sales and the related findings in empirical corporate finance. We then show that models of fire sales can account for several related phenomena during the recent financial crisis, including the contraction of the banking system and the failures of arbitrage in financial markets exemplified by historically unprecedented differences in prices of very similar securities. We then link fire sales to macroeconomics by discussing how such dislocations of security prices and the reduction in balance sheets of banks can reduce investment and output. Finally, we consider how the concept of fire sales can help us think about government interventions in financial markets, including the evidently successful Federal Reserve interventions in 2009. Fire sales are surely not the whole story of the financial crisis, but they are a phenomenon that binds together many elements of the crisis. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.29 10.1257/jep.25.1.29 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Symposia Over the Cliff: From the Subprime to the Global Financial Crisis Frederic S.MishkinColumbia U 49 70 The financial crisis of 2007 to 2009 can be divided into two distinct phases. The first and more limited phase from August 2007 to August 2008 stemmed from losses in one relatively small segment of the U.S. financial system—namely, subprime residential mortgages. Despite this disruption to financial markets, real GDP in the United States continued to rise into the second quarter of 2008, and forecasters were predicting only a mild recession. In mid-September 2008, however, the financial crisis entered a far more virulent phase. In rapid succession, the investment bank Lehman Brothers entered bankruptcy on September 15, 2008; the insurance firm AIG collapsed on September 16, 2008; there was a run on the Reserve Primary Fund money market fund on the same day; and the highly publicized struggle to pass the Troubled Asset Relief Program (TARP) began. How did something that appeared in mid-2008 to be a significant but fairly mild financial disruption transform into a full-fledged global financial crisis? What caused this transformation? Did the government responses to the global financial crisis help avoid a worldwide depression? What challenges do these government interventions raise for the world financial system and the economy going forward? http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.49 10.1257/jep.25.1.49 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Symposia A Year of Living Dangerously: The Management of the Financial Crisis in 2008 VincentReinhartAmerican Enterprise Institute, Washington, DC 71 90 There are many reasons to regret the decision of U.S. financial authorities to insert the government into the resolution of the investment bank Bear Stearns in March 2008. The Federal Reserve's use of its discount window built up false hope of future rescues. Paying off the uninsured creditors of Bear Stearns overcompensated them at the time and invited speculative attacks on the equity of similarly situated firms. I will argue that the market seizure after Lehman Brothers' decision to seek the protection of bankruptcy was an echo of the prior official decision to protect Bear Stearns. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.71 10.1257/jep.25.1.71 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Symposia Consumer Financial Protection John Y.CampbellHarvard U Howell E.JacksonHarvard U Brigitte C.MadrianHarvard U PeterTufanoHarvard U 91 114 The recent financial crisis has led many to question how well businesses deliver services and how well regulatory institutions address problems in consumer financial markets. This paper discusses consumer financial regulation, emphasizing the full range of arguments for regulation that derive from market failure and from limited consumer rationality in financial decision making. We present three case studies—of mortgage markets, payday lending, and financing retirement consumption—to illustrate the need for, and limits of, regulation. We argue that if regulation is to be beneficial, it must be tailored to specific problems and must be accompanied by research to measure the effectiveness of regulatory interventions. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.91 10.1257/jep.25.1.91 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Articles Selection in Insurance Markets: Theory and Empirics in Pictures LiranEinavStanford U AmyFinkelsteinMIT 115 38 Government intervention in insurance markets is ubiquitous and the theoretical basis for such intervention, based on classic work from the 1970s, has been the problem of adverse selection. Over the last decade, empirical work on selection in insurance markets has gained considerable momentum. This research finds that adverse selection exists in some insurance markets but not in others. And it has uncovered examples of markets that exhibit "advantageous selection"—a phenomenon not considered by the original theory, and one that has different consequences for equilibrium insurance allocation and optimal public policy than the classical case of adverse selection. Advantageous selection arises when the individuals who are willing to pay the most for insurance are those who are the most risk averse (and so have the lowest expected cost). Indeed, it is natural to think that in many instances individuals who value insurance more may also take action to lower their expected costs: drive more carefully, invest in preventive health care, and so on. Researchers have taken steps toward estimating the welfare consequences of detected selection and of potential public policy interventions. In this essay, we present a graphical framework for analyzing both theoretical and empirical work on selection in insurance markets. This graphical approach provides both a useful and intuitive depiction of the basic theory of selection and its implications for welfare and public policy, as well as a lens through which one can understand the ideas and limitations of existing empirical work on this topic. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.115 10.1257/jep.25.1.115 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Articles Who Pays for Obesity? JayBhattacharyaStanford U NeerajSoodU Southern CA 139 58 Adult obesity is a growing problem. From 1962 to 2006, obesity prevalence nearly tripled to 35.1 percent of adults. The rising prevalence of obesity is not limited to a particular socioeconomic group and is not unique to the United States. Should this widespread obesity epidemic be a cause for alarm? From a personal health perspective, the answer is an emphatic "yes." But when it comes to justifications of public policy for reducing obesity, the analysis becomes more complex. A common starting point is the assertion that those who are obese impose higher health costs on the rest of the population—a statement which is then taken to justify public policy interventions. But the question of who pays for obesity is an empirical one, and it involves analysis of how obese people fare in labor markets and health insurance markets. We will argue that the existing literature on these topics suggests that obese people on average do bear the costs and benefits of their eating and exercise habits. We begin by estimating the lifetime costs of obesity. We then discuss the extent to which private health insurance pools together obese and thin, whether health insurance causes obesity, and whether being fat might actually cause positive externalities for those who are not obese. If public policy to reduce obesity is not justified on the grounds of external costs imposed on others, then the remaining potential justification would need to be on the basis of helping people to address problems of ignorance or self-control that lead to obesity. In the conclusion, we offer a few thoughts about some complexities of such a justification. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.139 10.1257/jep.25.1.139 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Articles Priceless: The Nonpecuniary Benefits of Schooling PhilipOreopoulosU Toronto and Canadian Institute for Advanced Research, Toronto Kjell G.SalvanesNorwegian School of Economics and Business Administration and Center for the Economics of Education, London School of Economics 159 84 Increasing wealth provides key motivation for students to forgo earnings and struggle through exams. But, as we argue in this paper, schooling generates many experiences and affects many dimensions of skill that, in turn, affect central aspects of individuals' lives. Schooling not only affects income, but also the degree to which one enjoys work, as well as one's likelihood of being unemployed. It leads individuals to make better decisions about health, marriage, and parenting. It also improves patience, making individuals more goal-oriented and less likely to engage in risky behavior. Schooling improves trust and social interaction, and may offer substantial consumption value to some students. We discuss various mechanisms to explain how these relationships may occur independent of wealth effects and present evidence that nonpecuniary returns to schooling are at least as large as pecuniary ones. Ironically, one explanation why some early school leavers miss out on these high returns is that they lack the very same decision-making skills that more schooling would help improve. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.159 10.1257/jep.25.1.159 http://www.aeaweb.org/jep/app/2501_oreopoulos_app.pdf American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Articles Lessons from the Kibbutz on the Equality-Incentives Trade-Off RanAbramitzkyStanford U 185 208 The first kibbutz was established southwest of the Sea of Galilee in 1910, but the vast majority of kibbutzim were established in the 1930s and 1940s, shortly before the creation of the state of Israel in 1948. Founders aimed to create a "new human being" who cared about the group more than about himself, a homo sociologicus who would challenge the selfish homo economicus. This idealistic view can explain many of the key features of kibbutzim: equal sharing in the distribution of income; no private property; a noncash economy; communal dining halls where members ate their meals together; high provision of local public goods for use by kibbutz members; separate communal residences for children outside their parents homes, which were supposed to free women from their traditional role in society and allow them to be treated equally with men; collective education to instill socialist and Zionist values; communal production, whereby kibbutz members worked inside their kibbutzim in agriculture or in one of the kibbutz plants; and no use of hired labor from outside kibbutzim—because hiring labor was considered "exploitation" under the reigning socialist ideology. To an economist, steeped in thinking about incentives that self-interested individuals face, there are three reasons why an equal-sharing arrangement of this sort seems unlikely to last. First, high-ability members have an incentive to exit equal sharing arrangements to earn a wage premium—so-called "brain drain." Second, low-ability individuals have an incentive to enter equal-sharing arrangements so that they can be subsidized by more-able individuals—so-called adverse selection. Third, in context of equal sharing, shirking and free-riding are likely to be prevalent. However, kibbutzim have survived successfully for the past century and currently consist of 120,000 members living in 268 kibbutzim. In a number of ways, the kibbutzim offer an exceptional environment to examine the potential trade-off between equality and incentives. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.185 10.1257/jep.25.1.185 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Articles Behavior under Extreme Conditions: The Titanic Disaster Bruno S.FreyU Zurich and U Warwick David A.SavageQueensland U Technology BennoTorglerQueensland U Technology and CREMA, Basel 209 22 During the night of April 14, 1912, the RMS Titanic collided with an iceberg on her maiden voyage. Two hours and 40 minutes later she sank, resulting in the loss of 1,501 lives—more than two-thirds of her 2,207 passengers and crew. This remains one of the deadliest peacetime maritime disasters in history and by far the most famous. For social scientists, evidence about how people behaved as the Titanic sunk offers a quasi-natural field experiment to explore behavior under extreme conditions of life and death. A common assumption is that in such situations, self-interested reactions will predominate and social cohesion is expected to disappear. However, empirical evidence on the extent to which people in the throes of a disaster react with self-regarding or with other-regarding behavior is scanty. The sinking of the Titanic posed a life-or-death situation for its passengers. The Titanic carried only 20 lifeboats, which could accommodate about half the people aboard, and deck officers exacerbated the shortage by launching lifeboats that were partially empty. Failure to secure a seat in a lifeboat virtually guaranteed death. We have collected individual-level data on the passengers and crew on the Titanic, which allow us to analyze some specific questions: Did physical strength (being male and in prime age) or social status (being a first- or second-class passenger) raise the survival chance? Was it favorable for survival to travel alone or in company? Does one's role or function (being a crew member or a passenger) affect the probability of survival? Do social norms, such as "Women and children first!" have any effect? Does nationality affect the chance of survival? We also explore whether the time from impact to sinking might matter by comparing the sinking of the Titanic over nearly three hours to the sinking of the Lusitania in 1915, which took only 18 minutes from when the torpedo hit the ship. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.209 10.1257/jep.25.1.209 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Features Retrospectives: The Phillips Curve: A Rushed Job? A. G.SleemanWestern WA U 223 38 Half a century ago, Economica published what its webpage claims is "the most heavily cited macroeconomics title of the 20th century"—the paper by A. W. H. "Bill" Phillips (1958) that introduced the Phillips curve. Based on admittedly circumstantial evidence, I will argue that Bill Phillips was not satisfied with the paper and had not intended to publish it in 1958. I believe that Phillips was persuaded to allow his paper to be published in 1958 by James Meade. After a brief overview of Phillips' early life and career, I attempt to show why Phillips was probably unhappy with the paper that introduced the curve that came to be identified with his name and how, nevertheless, it came to be published. http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.223 10.1257/jep.25.1.223 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Features Recommendations for Further Reading TimothyTaylorMacalester College 239 46 http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.239 10.1257/jep.25.1.239 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 25 1 Winter 2011 http://www.aeaweb.org/issue.php?journal=JEP&volume=25&issue=1 Features Notes 247 248 http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.247 10.1257/jep.25.1.247