Highlights 2018

WP 18/08

In “Self-assessed cognitive ability and financial wealth: Are people aware of their cognitive decline?” Franco Peracchi, with Fabrizio Mazzonna, investigate whether people correctly perceive their own cognitive decline and the potential financial consequences of misperception. Using data from the Health and Retirement Survey, a rich and large representative longitudinal dataset on American people aged 50 or older, the authors show that older people tend to underestimate their own cognitive decline. To evaluate people awareness of their cognitive capabilities the authors analyze the difference between self-rating of changes in memory across waves and the actual change in memory measured using a two word list recall test. They find that respondents unaware of their own cognitive decline are more likely to experience larger losses in their financial wealth compared to respondents who are aware of the decline in their memory performance and to all other respondents who did not experience a similar experience. Finally, they analyze different potential explanations for the patterns of wealth changes observed among respondents who are unaware of their cognitive decline and find support for the view that financial losses reflect bad financial decisions, rather than rational disinvestment strategies.

WP 18/07

In “Investment in Financial Information and Portfolio Performance” Luigi Guiso, with Tullio Jappelli, addresses two crucial issues: how much financial information should investors collect? What is the effect of information on portfolio performance? These questions are at the heart of the current debate on the determinants of wealth inequality that emphasizes the importance of heterogeneity in return to wealth. In models with rational investors the value of financial information is correctly perceived and investment information is therefore associated with higher expected portfolio returns and higher Sharpe ratio. The authors test this implication using two unique surveys of customers of a leading Italian bank with portfolio data and measures of financial information. They find that the investment in information is positively associated with returns to financial wealth but is negatively correlated to the Sharpe ratio. They claim that this result can be rationalized if one allows investors to be overconfident about the quality of their information, while retaining expected utility maximization. In fact, they show that, for a moderate amount of overconfidence, the correlation between the amount of information and the Sharpe ratio is actually negative, which is consistent with the empirical findings.

WP 18/06

In “Global Crises and Populism: the Role of Eurozone Institutions” Luigi Guiso, with Helios Herrera, Massimo Morelli and Tommaso Sonno, show that populist parties are likely to gain consensus when mainstream parties and status quo institutions fail to manage the shocks faced by their economies. Institutional constraints, which limit the possible counter-cyclical actions in the face of shocks, induce frustration among voters who turn to populist movements.Based on this logic the authors explain the different support of populist parties among European countries in response to the shock of globalization and to the 2008-2011 financial and sovereign debt crisis. They predict a greater success of populist parties in response to these shocks in Euro zone countries, and their empirical analysis confirms this prediction. This is consistent with voters' frustration for the greater inability of the Euro zone governments to react to difficult-to-manage globalization shocks and financial crises. This evidence suggests that a slow, staged process of political unification can expose the EU to a risk of political backlash if hard to manage shocks hit the economies during the integration process.

WP 18/05

In "The IT Revolution and Southern Europe's Two Lost Decades" Fabiano Schivardi, with Tom Schmitz, observes that since the mid-Nineties productivity growth in Southern Europe has been much lower than in other developed countries. The authors claim that this negative performance has been partly caused by the interaction between IT revolution and inefficient management practices in place at Southern European firms. To quantify this effect they calibrate a multi-country general equilibrium model with heterogeneous firms and workers using firm-level evidence. In their model, management practices and IT adoption interact in three ways: inefficient management limits Southern firms' productivity gains from IT adoption; IT increases the aggregate relevance of management, making its inefficiencies more crucial; IT-driven wage increases in other countries stimulate high-skilled workers' emigration from Southern countries. The authors show that inefficient management can account for 28% of Italy's, 39% of Spain's and 67% of Portugal's lower productivity growth compared to Germany between 1995 to 2008. They also show that policies that target the symptom (low IT adoption), such as IT subsidies, can actually worsen the outcome, as they do not tackle the deep cause of the malaise, that is, inefficient management practices.

WP 18/04

In “Fiscal Rules as Bargaining Chips” Facundo Piguillem, with Alessandro Riboni, observe that in recent years fiscal rules have been adopted by more and more countries. Since most fiscal rules can be overridden by consensus, their effectiveness is widely debated. The authors show that the possibility of overriding does not make fiscal rules ineffectual: as they determine the outside option in case of disagreement, the opposition uses fiscal rules as “bargaining chips”. Then the party in power offers spending concessions to the opposition to avoid the application of the fiscal rule. This political bargain has two main implications. Firstly, the accumulation of debt becomes more costly because the opposition will only agree to bypassing the fiscal rule in exchange for more spending on the public goods they prefer. Secondly, the expectation of future compromise increases the benefit of transferring resources to the future. All in all, the paper shows that the incentives for inefficient debt accumulation are reduced, leading to a favorable assessment of fiscal rules. Finally, the authors compute the optimal fiscal rule for different degrees of political polarization. They find that when spending is discretionary and polarization is high a government shutdown provision may be optimal. However, making spending completely mandatory eliminates the over-accumulation of debt, for any degree of polarization.

WP 18/03

In “War of the Waves: Radio and Resistance During World War II”, Stefano Gagliarducci, with Massimiliano Onorato, Francesco Sobbrio and Guido Tabellini, analyze the role of the media in the context of the Nazi-fascist occupation of Italy between 1943 and 1945, and of the related civil war between fascist and partisan forces. In particular, the paper studies the effects of the BBC counter-propaganda (Radio Londra) on the intensity of the partisan and civilian resistance. To this aim it exploits exogenous time and geographic variation in the BBC signal strength across Italian municipalities to predict the number of episodes of violence perpetrated by the Nazi-fascists in response to partisan or civilian resistance. The main result is that a 10% increase in the BBC signal strength increases the number of episodes of Nazi-fascist violence by more than 2.5 times, relative to the monthly average.

WP 18/02

In “Comments on “Unobservable Selection and Coefficient Stability: Theory and Evidence” and “Poorly Measured Confounders are More Useful on the Left Than on the Right””, Franco Peracchi, with Giuseppe De Luca and Jan R. Magnus, establish a linkage between the approaches proposed by Oster (2017) and Pei, Pischke and Schwandt (2017) which contribute to the development of inferential procedures for causal effects in the challenging and empirically relevant situation where the unknown data-generation process is not included in the set of models considered by the investigator. The authors show that the general misspecification framework recently proposed by De Luca, Magnus and Peracchi (2018) is particularly suited to analyze and understand the implications of the restrictions imposed by the two approaches.

WP 18/01

In “Temporary Price Changes, Inflation Regimes and the Propagation of Monetary Shocks”, Francesco Lippi, with Fernando Alvarez, analyze the implications of a sticky price model where firms choose a price plan, namely a set of two prices for their product. While changing the plan entails a “menu cost”, either price in the plan can be charged at any point in time. This generates a persistent reference price level and many short-lived deviations from it, as seen in many datasets. Interestingly, modeling temporary price changes substantially alters the real effect of monetary policy. In the continuous time model, the real effect of monetary shocks is inversely proportional to the number of plan changes, but independent of the number of price changes. Thus a very modest response of the aggregate price level can coexist with a very large number of price changes. The paper also presents evidence consistent with the model implications using CPI data for Argentina across a wide range of inflation rates.