March/April 2013

Cato Papers on Public Policy: Second Annual Volume

In an era of sound bites and microblogs, in-depth scholarly analysis is more critical than ever.

This January marked the release of the second installment of Cato Papers on Public Policy, an annual volume of innovative, original articles on critical economic policy issues. The overarching goal of the publication is to provide imaginative new analysis from nationally recognized experts across different fields. “In a nutshell, the papers aim to produce research that employs modern economic methodology but that is firmly focused on what policies are beneficial for the economy and society,” writes Jeffrey Miron, director of undergraduate economics studies at Harvard University, a Cato senior fellow, and editor of the Papers. The second volume spans a wide range of issues.

The gold standard was a key factor behind the Great Depression, but why did it produce such an intense worldwide deflation and associated economic contraction?

The conventional account of the onset of the Depression usually begins with the tightening of U.S. monetary policy in 1928. However, according to Douglas A. Irwin, professor of economics at Dartmouth College, the rapid accumulation and effective neutralization of gold reserves by France is frequently overlooked. “The impact of the gold accumulation by each of the two countries was almost equally significant in producing deflationary pressure from 1929 to 1931,” he writes. In tracing these forces, Irwin helps show how the international monetary system produced such a monumental economic catastrophe.

During the recent financial crisis, the Term Auction Facility (TAF) program was one of the main tools used by the U.S. fiscal authorities to intervene in the interbank money markets. According to the U.S. Federal Reserve, the purpose of the TAF was to inject funds through a broader range of counter parties and against a broader range of collateral than open market operations.

In short, it was implemented to ease the liquidity problems plaguing banks at the time. Using TAF micro-level loan data, Efraim Benmelech, associate professor of finance at Northwestern University, finds that foreign banks accounted for about 60 percent of TAF lending. His analysis illustrates the major role that foreign — in particular, European — banks currently play in the U.S. financial system. “The main reason for the large number of loans made to foreign banks was the currency mismatch in European banks’ balance sheets,” Benmelech concludes.

CEOs are routinely perceived to be overpaid, and corporate boards of directors are perceived to provide poor or limited oversight of CEOs. Yet Steven N. Kaplan, professor of entrepreneurship and finance at the University of Chicago, finds that the evidence is somewhat different from the perceptions. While average CEO pay increased substantially through the 1990s, it has declined since then.

“CEO pay levels relative to other highly paid groups today are comparable to their average levels in the early 1990s,” he writes. In addition, CEOs on average are paid for performance and penalized for poor results, given that there is “a large fraction of stock options and restricted stock in the typical CEO pay package.” Finally, boards do monitor CEOs, and that monitoring appears to have increased over time. “CEO tenures in the 2000s are lower than in the 1980s and 1990s” and furthermore, that turnover “is tied to poor stock performance.”

In short, the perception that executive pay is high and the current lackluster economy are two of the factors creating political pressure to reward people at the top with less.

From 1920 through 1970, the rate of incarceration in the United States was roughly constant, hovering around 100 per 100,000. Today, the rate is five times that level. According to the most recent data, the United States accounts for about 5 percent of the global population, yet it puts away 23 percent of prisoners worldwide. By comparing crime and incarceration rates over time for the United States, Canada, and England and Wales, Justin McCrary of the University of California, Berkeley, and Sarath Sanga of Yale Law School find that shifts in U.S. punishment policy led to the increase. Moreover, they conclude that “the large shifts in U.S. punishment policy do not seem to have caused commensurately large improvements in public safety.” On the contrary, an increase today in the sentence length confronting a potential offender will not have a positive influence on the probability that a non-incarcerated criminal will commit an offense.

This installment of Cato Papers on Public Policy marks the second volume of the Institute’s most recent collection of timely, in-depth research publications.