These volumes contain the papers of the invited symposium sessions of the Eighth World Congress of the Econometric Society. The meetings were held at the University of Washington, Seattle, in August 2000; we served as Program Co-Chairs. Volume 1 also contains an invited address, the “Seattle Lecture,” given by Eric Maskin. This address was in addition to other named lectures that are typically published in Econometrica. Symposium sessions had discussants, and about half of these wrote up their comments for publication. These remarks are included in the book after the session papers they comment on.

The book chapters explore and interpret recent developments in a variety of areas in economics and econometrics. Although we chose topics and authors to represent the broad interests of members of the Econometric Society, the selected areas were not meant to be exhaustive. We deliberately included some new active areas of research not covered in recent Congresses. For many chapters, we encouraged collaboration among experts in an area. Moreover, some sessions were designed to span the econometrics–theory separation that is sometimes evident in the Econometric Society. We followed the lead of our immediate predecessors, David Kreps and Ken Wallis, by including all of the contributions in a single book edited by the three of us. Because of the number of contributions, we have divided the book into three volumes; the topics are grouped in a manner that seemed appropriate to us.

These volumes contain the papers of the invited symposium sessions of the EighthWorld Congress of the Econometric Society. The meetings were held at the University of Washington, Seattle, in August 2000; we served as Program Co-Chairs. Volume 1 also contains an invited address, the “Seattle Lecture,” givenby Eric Maskin. This address was inadditionto other named lectures that are typically published in Econometrica. Symposium sessions had discussants, and about half of these wrote up their comments for publication. These remarks are included in the book after the session papers they comment on.

The book chapters explore and interpret recent developments in a variety of areas in economics and econometrics. Although we chose topics and authors to represent the broad interests of members of the Econometric Society, the selected areas were not meant to be exhaustive. We deliberately included some new active areas of research not covered in recent Congresses. For many chapters, we encouraged collaboration among experts in an area. Moreover, some sessions were designed to span the econometrics–theory separation that is sometimes evident in the Econometric Society. We followed the lead of our immediate predecessors, David Kreps and Ken Wallis, by including all of the contributions in a single book edited by the three of us. Because of the number of contributions, we have divided the book into three volumes; the topics are grouped in a manner that seemed appropriate to us.

We believe that the EighthWorld Congress of the Econometric Society was very successful, and we hope that these books serve as suitable mementos of that event.

These volumes contain the papers of the invited symposium sessions of the Eighth World Congress of the Econometric Society. The meetings were held at the University of Washington, Seattle, in August 2000; we served as Program Co-Chairs. The book also contains an invited address, the “Seattle Lecture,” given by Eric Maskin. This address was in addition to other named lectures that are typically published in Econometrica. Symposium sessions had discussants, and about half of them wrote up their comments for publication. These remarks are included in the book after the session papers they comment on.

The book chapters explore and interpret recent developments in a variety of areas in economics and econometrics. Although we chose topics and authors to represent the broad interests of members of the Econometric Society, the selected areas were not meant to be exhaustive. We deliberately included some new active areas of research not covered in recent Congresses. For many chapters, we encouraged collaboration among experts in an area. Moreover, some sessions were designed to span the econometrics–theory separation that is sometimes evident in the Econometric Society. We followed the lead of our immediate predecessors, David Kreps and Ken Wallis, by including all of the contributions in a single book edited by the three of us. Because of the number of contributions, we have divided the book into three volumes; the topics are grouped in a manner that seemed appropriate to us.

We believe that the Eighth World Congress of the Econometric Society was very successful, and we hope that these books serve as suitable mementos of that event.

INTRODUCTION

In his essay on economic policy and the political process, Avinash Dixit (1994) quotes Alan Blinder's “Murphy's law of economic policy” (1987, p. 1):

This statement, its second half at least, seems to be especially valid for the economics of transition. Rarely have economic advisers played such a prominent role in policy debates as has been the case since 1990 in central and eastern European economies. Jeffrey Sachs has attracted worldwide attention for his forceful advocacy of the “big bang” approach to transition. These views were endorsed by one part of the profession and criticized vehemently by another, while many others remained skeptical about what economic theory has to say about the transition from socialism to capitalism. No pre-established theory of transition existed before the fall of the Berlin wall. The ratio to theory to policy papers in transition economics has nevertheless been surprisingly low. The theories with which Western advisers were probably best-equipped were those concerning macroeconomic stabilization. However, most economists will agree that stabilization is only one of the dimensions of transition. Other very important aspects relate to the necessary large-scale institutional changes: the creation and development of markets, including financial markets, the institution and enforcement of property rights and other legal and political changes along with enterprise privatization and restructuring.

Introduction

The analysis of banking regulation must start with a careful analysis of the characteristics of banking and of why regulation is needed in that industry. A growing number of economists challenge the traditional view that banking differs from other somewhat competitive industries and needs to be regulated. Meanwhile, practitioners have lost some of their earlier enthusiasm for deregulation. The S&L crisis in the US and the difficulties encountered by a number of other financial institutions have led to stricter regulatory requirements. Furthermore, the 1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA) by and large has removed the regulators' discretionary powers. Europe is also pondering the future of its prudential regulation. The Basle 1988 agreement on the uniformization of capital adequacy requirements has paved the way for a European Monetary Union. In both cases, there is much concern that the requirements do not take sufficient account of bank diversification or of the real riskiness of loans. It is suggested that regulators should use softer information about the quality of loans than the institutional nature of the borrowers. By depriving the requirements of their mechanical aspect, these suggestions raise the issue of who would regulate. Should this close monitoring be performed by a central bank or by private investors (main creditor, multiple creditors, rating agencies)? And should deposit insurance be privately contracted for or should it be publicly provided conditional on the bank having a high credit rating or else some government requirements being met?

This paper studies moral hazard both at the bank level and at the level of its monitors. It sets aside macroeconomic aspects of banking, which we hope to address in future work.