Inflation, Prices, and Information in Competitive Search

We study the effects of inflation in a competitive search model where each buyer's utility is private information, and where money is essential in facilitating trade. The equilibrium is efficient at the Friedman rule, but inflation creates an inefficiency in the terms of trade. Buyers experience a preference shock after they are matched with a seller, and thus they have a precautionary motive for holding money. Sellers, who compete to attract buyers, post non-linear price schedules to screen out different types of buyers. As inflation rises, sellers post relatively flat price schedules which reduce the need for buyers to hold precautionary balances. These price schedules induce buyers with a low desire to consume to purchase inefficiently high quantities because of the low marginal cost of purchasing goods. In contrast, buyers with a high desire to consume purchase inefficiently low quantities as they face binding liquidity constraints. The reduction of precautionary balances as inflation rises allows the model to fit historical US data on velocity and interest rates.inflation; precautionary money demand; competitive search; private information.

INFLATION, PRICES, AND INFORMATION IN COMPETITIVE SEARCH

Inflation, as a tax on money, induces buyers to reduce their money balances. Sellers are aware of this, so to attract costumers, they post price offers that reduce the need for buyers to carry precautionary money balances. We study this effect of inflation in a competitive search environment where buyers experience preference shocks after they are matched with a seller. With full information, equilibrium price offers consist of a flat fee which is independent of the quantities purchased. With private information of buyers' preferences, equilibrium price offers are restricted by incentive compatibility constraints. As a result, the price schedule that maps quantities purchased onto payments must be increasing. As inflation rises, these price schedules become relatively flat, so the marginal cost of purchasing goods is low. Consequently, buyers that are not liquidity constrained (with a low desire to consume) purchase inefficiently large quantities. Meanwhile, buyers with a high desire to consume typically purchase inefficiently low quantities because, as their money balances fall, they become liquidity constrained. This is in contrast with the full information benchmark where inflation reduces the quantities purchased by all buyers.

Inflation, Prices, and Information in Competitive Search

We study the effects of inflation in a competitive search model where each buyer’s utility is private information, and money is essential. The equilibrium is efficient at the Friedman rule, but inflation creates an inefficiency in the terms of trade. Buyers experience a preference shock after they are matched with a seller, and thus they have a precautionary motive for holding money. Sellers, who compete to attract buyers, post non-linear price schedules. As inflation rises, sellers post relatively flat price schedules, which reduce the need for precautionary balances. These price schedules induce buyers with a low desire to consume to purchase inefficiently high quantities because of the low marginal cost of purchasing goods. In contrast, buyers with a high desire to consume purchase inefficiently low quantities as they face binding liquidity constraints. The model fits historical US data on velocity and interest rates.Publicad

Trading for the Future: Signaling in Permit Markets

Permits markets are celebrated as a policy instrument since they allow (i) firms to equalize marginal costs through trade and (ii) the regulator to distribute the burden in a politically desirable way. These two concerns, however, may conflict in a dynamic setting. Anticipating the regulator's future desire to give more permits to firms that appear to need them, firms purchase permits to signal their need. This raises the price above marginal costs and the market becomes inefficient. If the social cost of pollution is high and the government intervenes frequently in the market, the distortions are greater than the gains from trade and non-tradable permits are better. The analysis helps to understand permit markets and how they should be designed.Tradable permits; time inconsistency; the ratchet effect; rent-seeking; plan vs. market

Incentives, Reputation and the Allocation of Authority

We address the question how much authority a principal should delegate to a manager with conflicting interests and uncertain ability in a context in which the manager has both compensationbased and reputational incentives. The optimal level of authority balances the value of the manager’s decision-making expertise against the cost of ensuring that the manager uses his discretion productively. Reputational incentives reduce the necessary monetary incentives to discourage purely opportunistic behavior, but may cause the manager to pursue conservative courses of action to preserve his reputation. This undermines the benefits of delegating control, leading to decreased managerial authority and stronger monetary incentives. When the principal can commit to long-term contracts, she eliminates this conservative bias by rewarding a successful manager with greater future compensation and authority than would be optimal in a static setting. Early in the relationship the principal may delegate additional authority in order to screen for managers of high ability

Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking

Both investors and borrowers are concerned about liquidity. Investors desire liquidity because they are uncertain about when they will want to eliminate their holding of a financial asset. Borrowers are concerned about liquidity because they are uncertain about their ability to continue to attract or retain funding. Because borrowers typically cannot repay investors on demand, investors will require a premium or significant control rights when they lend to borrowers directly, as compensation for the illiquidity investors will be subject to. We argue that banks can resolve these liquidity problems that arise in direct lending. Banks enable depositors to withdraw at low cost, as well as buffer firms from the liquidity needs of their investors. We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions. Far from being an aberration to be regulated away, the funding of illiquid loans by a bank with volatile demand deposits is rationalized in the context of the functions it performs. This model can be used to investigate important issues such as narrow banking and bank capital requirements.

Incentives, Reputation and the Allocation of Authority

We address the question how much authority a principal should delegate to a manager with conflicting interests and uncertain ability in a context in which the manager has both compensation-based and reputational incentives. The optimal level of authority balances the value of the manager's decision-making expertise against the cost of ensuring that the manager uses his discretion productively. Reputational incentives reduce the necessary monetary incentives to discourage purely opportunistic behavior, but may cause the manager to pursue conservative courses of action to preserve his reputation. This undermines the benefits of delegating control, leading to decreased managerial authority and stronger monetary incentives. When the principal can commit to long-term contracts, she eliminates this conservative bias by rewarding a successful manager with greater future compensation and authority than would be optimal in a static setting. Early in the relationship the principal may delegate additional authority in order to screen for managers of high ability.agency problems, delegation, compensation contracts, job design, career concerns, managerial conservatism

A field experiment on crowdfunding for a club good

While increasingly popular in many domains crowdfunding remains largely un-derresearched and little is known about the best way to encourage participation. In a field experiment we vary suggested amounts and test different wordings for a campaign to finance a club good - an institute's summer party with free food, drinks, and music. We find that higher suggestions shift the median and the mode of gifts from €5 to €10 at a similar response rate. We also find evidence in favor of a "donation" frame that generates higher income than a "contribution" frame

Optimal Corporate Governance Structures

This paper explores how motivating an incumbent CEO to make investments that improve the effectiveness of the firm organization under his management interacts with the replacement policy of the board of directors. We characterize the optimal compensation package (including severance pay) under governance structures that differ in the power that the incumbent CEO has on the board of directors. We explain why yielding the incumbent CEO some control of the board (entrenchment) can be desirable and offer predictions on when this arrangement is optimal. We also examine the correlation between the elements of his compensation package and the structure of the board.