Private takings

This paper considers the implications associated with a recent Supreme Court ruling that can be interpreted as supporting the use of eminent domain in transferring the property rights of one private agent—a landowner—to another private agent—a developer. Compared to voluntary exchange, when property rights are transferred via eminent domain, landowners’ investments in their properties become more inefficient and, as a result, any benefit associated with mitigating the holdout problem between landowners and the developer is reduced. Social welfare can only increase if the holdout problem is significant; otherwise, social welfare will fall when property rights are transferred via eminent domain.Eminent domain

Optimal deposit contracts: do-it-yourself bank-run prevention for banks

The need for federal deposit insurance is often based on the claim that it prevents bank runs and makes the banking system more stable. But research shows that banks could prevent bank runs by constructing their deposit contracts appropriately, and, in the absence of deposit insurance, they would do so in their own self interest. Federal deposit insurance may be useful as insurance per se—protecting depositors against unforeseen accidents—but it should not be considered necessary for banking system stability.Deposit insurance ; Financial crises ; Bank failures

How well does the federal funds futures rate predict the future federal funds rate?

Contrary to popular belief, federal funds futures rates do not tell us precisely where the market thinks federal funds rates will be in the future. On average, futures rates overpredict future fed funds rates, and, depending on whether fed funds rates are falling or rising, the futures rate may consistently overestimate or underestimate the future fed funds rates. To obtain a reliable estimate of the future fed funds rate, one must adjust the fed funds futures rate appropriately to account for the bias and past movements of the fed funds rate.Federal funds rate

Clearing over-the-counter derivatives

Prior to the financial crisis of 2008, the over-the-counter derivatives market was not required to “clear” transactions. This changed with the signing of the new financial reform legislation, the Dodd–Frank Act on July 21, 2010. Going forward, most OTC derivatives will be cleared through a particular set of institutional arrangements: a regulated clearinghouse. This article provides an overview of how clearing works, the potential benefits of central clearing for OTC derivatives, and the optimal clearing structure.Derivative securities ; Financial crises ; Risk management

Life cycle wage and job changes

Evidence from the Panel Study of Income Dynamics shows that while the majority of job changers who state they were not fired or laid off choose jobs with wages that are higher than their previous jobs, a substantial proportion of these job changers choose jobs that have lower wages. A model is constructed that is consistent with workers choosing a career path that entails a job change to either a higher paying or lower paying job. In the model, a job consists of a tied wage and amenity package. Due to compensating wage differentials, higher wages are paid where other job amenities are unattractive. Given this, a worker chooses a career path that leads to a job change where the wage in the new job may be higher or lower than in the previous job, with the actual choice being determined by the rate of time preference.Wages ; Employment (Economic theory)

How amenities affect job and wage choices over the life cycle

The current wage at a job may not fully reflect the "value" of that job. For example, a job with a low starting wage may be preferred to one with a high starting wage if the growth rate of wages is higher in the former than in the latter. In fact, differences in wage growth can potentially explain why a worker might want to quit a high-paying job for one with a lower starting wage. Job amenities are another important factor that not only influences the value of a job but also provides an independent rationale for why workers change jobs. Including a job's amenities as part of its "value" can also generate a move from high-paying to low-paying jobs (or vice versa) as part of an optimal consumption plan over the life cycle. Both the direction of movement and the timing of a job change depend critically on the relationship between a worker's rate of time preference and the market interest rate.Job satisfaction ; Wages ; Employment (Economic theory)

A Theory of Money and Banking

We construct a simple environment that combines a limited communication friction and a limited information friction in order to generate a role for money and intermediation. We ask whether there is any reason to expect the emergence of a banking sector (i.e., institutions that combine the business of money creation with the business of intermediation). In our model the unique equilibrium is characterized, in part, by the existence of an agent that: (1) creates money (a debt instrument that circulates as a means of payment); (2) lends it out (swapping it for less liquid forms of debt); (3) is responsible for monitoring those agents in control of the capital backing the illiquid debt; and (4) collects on money loans as they come due. Furthermore, the bank money in our model is a debt instrument that embeds within it important stipulations that are found in actual private money instruments. Thus, our model goes some way in addressing the questions of why private money takes the form that it does, as well as why private money is typically supplied by banks.Money, Banking

A beautiful theory

It wasn’t A Beautiful Mind—the book or the movie—that made John Forbes Nash, Jr., famous. It was his work in game theory, a theory that models strategic interactions between people as games. Before Nash, the only games theorists could get a handle on were artificial ones with no real-world applications. Nash’s insights enabled economists to expand the use of game theory to interesting practical problems.Game theory

Arbitrage: the key to pricing options

Arbitrage has become associated in popular attitudes with the most ruthless and profit-driven of human impulses, but the opposite reputation might be more well-deserved. The ability to arbitrage is essential for the efficient operation of markets. An interesting application of the principle of arbitrage arose when it provided the breakthrough insight in economists’ solution to a formerly intractable problem: how to properly price the emergent financial instruments known as options.Arbitrage ; Options (Finance)

Moral hazard in the Diamond-Dybvig model of banking

We modify the Diamond-Dybvig model studied in Green and Lin to incorporate a self-interested banker who has a private record-keeping technology. A public record-keeping device does not exist. We find that there is a trade-off between sophisticated contracts that possess relatively good risk-sharing properties but allocate resources inefficiently for incentive reasons, and simple contracts that possess relatively poor risk-sharing properties but economize on the inefficient use of resources. While this trade-off depends on model parameters, we find that simple contracts prevail under a wide range of empirically plausible parameter values. Although moral hazard in banking may simplify the optimal structure of deposit liabilities, this simple structure does not enhance the prospect of bank runs.Contracts ; Financial crises ; Banks and banking