Working Paper Abstracts – 1979

Working Paper Abstracts – 1979

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Traditionally, monetary theory assumes money bears zero interest. More recently, it has been recognized that banks implicitly pay interest through providing free services. In this paper, the implicit interest rate is estimated from two different sources. Implicit interest appears to be about one-half of what a competitive rate would be in the absence of the prohibition against explicit interest.

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The effect of firms’ accounting techniques on firms’ equilibrium values is the general topic considered here. The specific technique examined is the inventory-costing method — e.g., LIFO or FIFO — adopted for tax reporting. The connection between firms’ selections of accounting techniques and the characteristics of firms’ production-investment decisions is emphasized. Our framework provides a basis for getting theoretical insights into firms’ selection of techniques, for explaining some available empirical results heretofore regarded as somewhat mysterious, and for improving the experimental designs used for work on accounting techniques’ effects. Our results indicate that the optimality of an inventory method is inextricably bound to the characteristics of firms’ production-investment decisions and that all value-maximizing firms pursuing the same type of decisions will opt for the same inventory method. Of course, the same method will be optimal for different types of decisions if the number of methods is less than the number of decision types. In spite of its alleged favorable tax effects under inflation, LIFO is not always the optimal method under inflationary conditions. Moreover, LIFO may be the optimal method even when the expected value of tax deductions under LIFO is less than the expected value of tax deductions under FIFO. Finally, the oft-inferred association between risk changes and changes in inventory methods is not due to a quirk of available sample evidence. It is precisely what one should expect.


The vigor of an economy has frequently been linked to the level of new investment. Compared to most other developed countries, the level of new investment in the UK has been relatively low and the performance of the economy on various dimensions has also been relatively poor. One possible reason for such a low level of investment is that the financial markets are not working properly, and thereby, the amount of capital available for new investment is curtailed. The purpose of this chapter is to examine the financial markets in the UK with particular emphasis on the provisions of investment capital.

The chapter begins with a comparison of the investment levels among different developed countries and then moves on to an overall description of the roles played by different participants in the market in the provision and use of investment funds. Following this more general material will be a detailed analysis of the participants in the financial markets with comparisons to the U.S. where appropriate. Particular attention will be paid to the venture capital markets and to the growing institutionalization of the equity markets. The chapter will conclude with a brief summary of the major conclusions.


This paper explores the role of uncertain price level movements in determining the opportunity cost of holding both fiat and commodity moneys. It is shown that a monetary medium whose opportunity cost fluctuates countercyclically to real asset values lowers interest rates for bonds denominated in that medium and hence lowers the cost to the economy of using that money. Empirical evidence in recent years indicates that fluctuations in gold have been decidedly countercyclical while those of U.S. fiat money have been procyclical. The paper also explains the role of uncertain inflation in generating a demand for nominally denominated contracts. Such demands may arise if capital markets are incomplete or non-diversifiable human wealth is a significant portion of an individual’s assets.


This paper examines the impact of bank portfolio behavior when banks are subject to capital regulation. It employs comparative static analysis of bank portfolio risk when regulators increase the minimum level of required capital relative to assets. The results show, under plausible assumptions that in increase in the required capital-asset ratio can lead to a higher portfolio risk and to a higher probability of failure. For the system as a whole, the results of a higher required capital-asset ratio in terms of the average probability o failure is ambiguous, while the intra-industry variance of probability of failure unambiguously increases. This result leads us to question the viability of regulating commercial banks in terms of a capital requirement. Thus, serious consideration should be given to the discontinuance of regulation of bank capital via ratio constraints and allowing the financial markets to control the risk behavior of bank management. Alternatively, such regulation should be imposed on a much more selective basis.

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In order to compare asset classification data generated by FDIC and state examiners, safety and soundness examination data were compared for 96 California insured nonmember banks that had been examined independently by the state and FDIC within seven months of one another. Two major conclusions emerge. First, regression analysis indicated that examination conclusions can be replicated accurately across individuals and agencies. (This does not imply that examiners generate new or economically valuable information, though replicability is a necessary condition for that conclusion.) Second, it is shown how FDIC might utilize state examination reports to determine which bank’s safety and soundness examinations can be waived without compromising its supervisory responsibilities. Significant supervisory resources could be saved or re-allocated if FDIC were to accept selected state examination reports in lieu of its own.


In multi-period insurance contract, the premiums that the insured must pay increase whenever he files a claim. Hence in this case the buyer of insurance faces a problem which does not exist in one period contracts. Namely: he must decide for which damages he should file a claim and for which he should not, bearing in mind that whenever he makes a claim, his future rates will rise. We show that the results of Arrow [1963], [1974] and Mossin [1968] are valid for this case too. That is: optimal multi-period insurance contracts must provide the insured full insurance above a strictly positive deductible.