Jeffrey M. Lacker

Optimal Contracts under Costly State Falsification

We examine an exchange economy with two agents: one risk neutral with a certain endowment and a second risk averse with a random endowment. The realization of the endowment is public but can be falsified by the second agent at a cost. For a broad class of falsification cost functions the optimal no-falsification contract is noncontingent on a left-hand interval and strictly increasing with a slope strictly less than one on a right-hand interval. Under a mild further restriction, optimal no-falsification contracts are, in addition, piece-wise linear. Optimal contracts may in general require falsifying the state, but for a set of the highest endowment realizations there is no falsification. We find simple conditions under which the optimal contract is a no-falsification contract. The model has applications that include financial, insurance, and employment contracts and tax policy.

Money and credit as means of payment

Abstract A stochastic economic environment is presented in which the mix of cash and resource-costly credit used as means of payment is endogenous. For reasonable values of the credit cost parameter, velocity can be quite variable and sensitive to the nominal interest rate. Those parameter values also generate larger welfare costs of inflation than have been found previously and a sizable impact of inflation on real interest rates.

Collateralized Debt as the Optimal Contract

In a simple risk-sharing environment with ex post private information, conditions are found under which a collateralized debt contract is the optimal allocation. The critical condition for optimality is that the borrower values the collateral good more highly than does the lender; otherwise the optimal contract does not resemble debt. Limited collateral can give rise to an endogenous borrowing constraint, driving a further wedge between the intertemporal marginal rates of substitution of the borrower and the lender. I argue that perhaps all debt contracts are implicitly collateralized.

Limited Commitment and Central Bank Lending

Central bank or International Monetary Fund lending should be regarded as a line of credit, analogous to private line-of-credit products. Contractual provisions in private line-of-credit arrangements are designed to control managerial moral hazard and provide a means for profit-maximizing lenders to credibly commit to withdraw credit and induce closure when appropriate. The contractual mechanisms utilized by private line-of-credit providers are not effective for a central bank whose primary mission—to maintain financial system stability—can override its obligation to protect public funds and undercut its ability to limit its lending reach. We consider in some detail five broad approaches to a central bank’s commitment problem: good offices only, collateralization and early intervention, constructive ambiguity, extending supervisory and regulatory reach, and reputation building. Our analysis suggests that the first four institutional approaches cannot be counted on to overcome the fundamental forces inducing a central bank to lend. We argue that the only practical way for a central bank to credibly limit lending is for it to build up over time a reputation for restraint.

Clearing, settlement and monetary policy

This paper develops a general equilibrium model of the clearing and settlement of private payment instruments. Spatial separation, heterogeneous preference shocks and limited communication provide a role for private credit as a means of payment. Although this method could be applied to various settlement arrangements, the use of central bank deposit liabilities in settlement is studied here. Various tools of payment system policy, such as intraday overdraft limits and fees, collateral requirements, reserve requirements, and interest on reserves, are examined.

Stored value cards: costly private substitutes for government currency

A model in which both currency and stored value cards are used to make payments is presented. I compare steady-state equilibria with and without stored value cards. Stored value cards are beneficial because they help alleviate the deadweight loss due to inflation. When the nominal interest rate is greater than the governments resource cost of providing currency, the alternative means of payment may have larger real resource costs than the currency it replaces. Stored value results in either a net increase or a net decrease in economic welfare depending upon whether average costs are below or above a certain cut-off. Quantitative restrictions on stored value can be socially beneficial because they reduce the amount of resources absorbed by the most costly stored value applications.

Payment economics: studying the mechanics of exchange

Abstract The five papers that follow this essay were presented at the Federal Reserve Bank of Richmonds Conference on Payment Economics held October 23–24, 2000, in Williamsburg, Virginia. The conference was motivated by the convergence of lines of research in monetary and banking theory that are focused on the institutional arrangements that facilitate exchange. At the same time, central bank policymakers concerned about the efficiency implications of their involvement in and regulation of clearing and settlement arrangements increasingly seek an economic understanding of these activities. It appears that a distinct and coherent field of inquiry is emerging, focused on the mechanics of exchange. This field, which we call payment economics, studies both the instruments agents use to make payments and the central role of bank intermediation in facilitating the use of private liabilities in exchange.

Coalition-Proof Allocations in Adverse-Selection Economies

We reexamine the canonical adverse selection insurance economy first studied by Rothschild and Stiglitz [1976]. We define blocking in a way that takes private information into account and define a coalition-proof correspondence as a mapping from coalitions to allocations with the property that allocations are in the correspondence, if and only if, they are not blocked by any other allocations in the correspondence for any subcoalition. We prove that the Miyazaki allocation—the Pareto-optimal allocation (possibly cross-subsidized) most preferred by low-risk agents—is coalition-proof.

Incentive compatible financial contracts, asset prices, and the value of control

Abstract We examine a general equilibrium model of asset prices in the presence of a simple informational imperfection. Assets are productive only when combined with managerial services. A manager “controls” an asset; he can conceal some of the output at a cost. This limits the extent to which managers can shed risk by issuing claims. Incentive compatibility drives a wedge, the “value of control”, between physical and financial asset values. Equilibrium allocations can be supported by alternative specifications of the right to “name the next manager”. If this right is assigned to holders of claims, then financial asset prices exhibit “excess volatility.”

Inside money and real output: A reinterpretation

Abstract The interpretation of correlations between inside money innovations and real output is examined. Such correlations could reflect a “real business cycle” in which money responds to new information concerning future real disturbances, but the same correlations could arise from the anticipated real effects of future monetary policy actions. Correlations between inside money and real output are thus equally consistent with the hypothesis that business cycle fluctuations are caused by monetary policy. Correlations between inside money and outside money might allow us to reject the monetary interpretation, but if policy happens to be correlated with real sector disturbances in a particular way, the two hypotheses are observationally equivalent. Monthly postwar U.S. data is consistent with either hypothesis: Inside money innovations could represent anticipated policy shocks. Alternatively, inside money innovations could represent real shocks if policy is correlated with real shocks in a particular way.