December 19, 2024

The Hutchins Roundup brings the latest thinking in fiscal and monetary policy to your inbox. Have something you'd like us to include in the next Roundup? Email us and we'll take a look.

This edition was written by Sarah Ahmad, Tristan Loa, Georgia Nabors, and David Wessel.

Societal value of medical innovations exceeds costs

Medical innovations have contributed to rising health care costs, but do they improve welfare? To answer this question, Abe Dunn at the Bureau of Economic Analysis and co-authors leverage the results of 8,000 cost effectiveness studies for medical products across 13 major health conditions. Prices for these treatments increased 75% more than overall prices from 2007 to 2018. But after accounting for quality improvements, the effective price increase ranged from positive 47% to negative 65%—depending on the assumption about the value of a statistical life year—suggesting that official measures of health care inflation are overstated. Some of these treatments have such high prices that consumer welfare is reduced by their introduction, with companies capturing more than 100% of the surplus created in the short run. However, in the long run, consumers benefit when patents expire, and generic versions become available. A back-of-the envelope calculation suggests that welfare gains from innovation (including both gains to consumers and producers) are an order of magnitude higher than the costs of R&D.

Lobbying expenditures increase after mergers

Combining data on mergers and political expenditures between 1999 and 2017, Bo Cowgill and Andrea Prat of Columbia Business School and Tommaso Valletti of Imperial College London find that the average merger is associated with a $70,000 to $180,000 increase in lobbying expenditures within the first six months. This correlation becomes stronger if merging companies are larger and belong to the same industry. The findings support the authors’ theory that lobbying exhibits economies of scale, as increased market concentration through mergers incentivizes firms to lobby for regulations that protect their rents from being dissipated by competition. Mergers also increase the likelihood that a firm will establish a more permanent political operation such as a corporate PAC or an in-house lobbying operation. The authors found no evidence that the rise in political spending after a merger was the result of increased regulatory scrutiny.

Arbitrageurs make the Treasury market more elastic

Kristy Jansen, Wenhao Li, and Lukas Schmid of the University of Southern California find that strong arbitrage increases the capacity of the Treasury market to absorb demand shocks without large changes in yields, leading to an elastic Treasury market. This effect is stronger for shorter-term bonds because arbitrageurs are better able to absorb demand imbalances due to lower risks in the short-term. However, after a monetary policy shock, the shift in investor preference towards short-term bonds forces arbitrageurs to hold more long-term bonds and demand higher risk premia. Lastly, the authors find that quantitative easing (QE) policies typically have limited impact on Treasury yields unless they are perceived as permanent. When QE signals a sustained and credible shift in the Fed’s balance sheet, it reduces yields significantly by alleviating the burden on arbitrageurs to absorb the risks of long-term bonds.

US dollar rising on currency markets

Chart courtesy of MarketWatch

Quote of the week

"Why did inflation rise so rapidly? And how effectively did monetary policy respond? To be prepared for the future, we need to be clear-eyed about what surprised us..." says Tiff Macklem, Governor of the Bank of Canada. 

"First, economic supply matters every bit as much as demand, and we need to understand it better. Monetary policy typically focuses mostly on demand. That’s because interest rates largely affect demand and because supply usually evolves more smoothly and predictably. The pandemic reminded us we cannot take that for granted. Supply disruptions can be sudden, severe and persistent, they can accumulate, and they are more inflationary when demand is strong. We also learned that what matters for inflation is not only the demand-supply balance for the economy as a whole but also across different sectors. The disinflation in weak sectors may be smaller than the inflationary impact of sectors that are overheated. In the future, we need better information and analysis about the supply side of the economy.

Second, we learned that price-setting behavior changes when inflation is high. Typically, businesses are hesitant to raise prices. They worry their price increases will stand out and they’ll lose customers to their competitors. But as the economy came out of the pandemic, supply disruptions and higher commodity prices pushed up costs. And demand was very strong. Businesses had trouble keeping up with orders. With high demand, businesses felt they could pass on more of their cost increases than usual, and more rapidly. What we learned is that, in some contexts, businesses can dramatically change their pricing behavior. Our economic models and forecasts need to reflect this reality.

And finally, we learned—or perhaps relearned—just how much people hate inflation. All of a sudden, people couldn’t afford the things they need to live. And while inflation is low once again, many prices are still a lot higher than they were before the pandemic. So people feel ripped off. And that erodes public trust in our economic system."

About the Hutchins Center on Fiscal and Monetary Policy at Brookings

The mission of the Hutchins Center on Fiscal and Monetary Policy is to improve the quality and efficacy of fiscal and monetary policies and public understanding of them.