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Person

Edward S. Prescott

Senior Economic and Policy Advisor
Areas of Expertise contract theory, financial intermediation, financial history, and organizational theory
Department Research
Education
  • BA,
  • Economics,
  • Swarthmore College,
  • 1988
  • PhD,
  • Economics,
  • University of Chicago,
  • 1995

Edward “Ned” S. Prescott is a senior economic and policy advisor in the Research Department of the Federal Reserve Bank of Cleveland. His research focuses on banking, financial intermediation, and contract theory. His research has appeared in the Journal of Political Economy, the Review of Economic Studies, the Review of Financial Studies, and other publications. Recently, he has worked on the lack of new bank entry and how that has contributed to the decline in the number of banks.

Before joining the Bank in 2015, Dr. Prescott was an economist and vice president at the Federal Reserve Bank of Richmond. In 2004, he was a visiting scholar at CEMFI. He has also taught at the University of Virginia. Presently, he serves as an associate editor for Economic Theory and the Journal of Financial Services Research.

Dr. Prescott obtained his BA in economics from Swarthmore College and his PhD in economics from University of Chicago.

Featured Publications

  • “Origins of Too-Big-to-Fail Policy in the United States.” With George C. Nurisso, Financial History Review, vol. 27 (2020), pp 1-15.

  • “Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation.” With Douglas D. Davis, Oleg Korenok, and John P. Lightle, Journal of Monetary Economics, vol. 115 (2020), pp 113-126.

  • “Market-Based Corrective Actions.” With Philip Bond and Itay Goldstein. Review of Financial Studies, 2010, 23: 781–820.

  • “Private Information and Intertemporal Job Assignments.” With Robert M. Townsend. Review of Economic Studies, 2006, 73: 531–548.

  • “Firms as Clubs in Walrasian Markets with Private Information.” With Robert M. Townsend. Journal of Political Economy, 2006, 114: 644–671.

    • Working Papers

      • Working Paper
        Federal Reserve Structure and the Production of Monetary Policy Ideas
        Michael D. Bordo Edward S. Prescott
        11.20.2023 | WP 23-29
        We evaluate the decentralized structure of the Federal Reserve System as a mechanism for generating and processing new ideas on monetary policy over the 1960 - 2000 period. We document the introduction of monetarism, rational expectations, credibility, transparency, and other monetary policy ideas by Reserve Banks into the Federal Reserve System. We argue that the Reserve Banks were willing to support and develop new ideas due to internal reforms to the FOMC that Chairman William McChesney Martin implemented in the 1950s and the increased ties with academia that developed in this period. Furthermore, the Reserve Banks were able to succeed at this because of their private-public governance structure. We illustrate this with a time-consistency model in which a decentralized organization is better at producing new ideas than a centralized one. We argue that this role of the Reserve Banks is an important benefit of the Federal Reserve’s decentralized structure by allowing for more competition in formulating ideas and by reducing groupthink.

        Topics: Monetary policy, Inflation
      • Working Paper
        Federal Reserve Structure and Economic Ideas
        Michael D. Bordo Edward S. Prescott
        03.28.2022 | WP 22-08
        This essay was written in memory of Marvin Goodfriend for a Federal Reserve Bank of Richmond book called Essays in Honor of Marvin Goodfriend: Economist and Central Banker. We discuss his Carnegie-Rochester conference paper titled "The Role of a Regional Bank in a System of Central Banks." In that paper, Marvin argued that the Federal Reserve's decentralized structure allowed for competing ideas about monetary and banking policy to develop with the central bank. In our essay, we describe how Marvin demonstrated this argument during his long career at the Federal Reserve Bank of Richmond. We also describe the institutional developments that led to this competition, including reforms that Chairman William McChesney Martin made to the operation of the Federal Open Market Committee in the 1950s and the introduction of monetary policy ideas such as monetarism and rational expectations by the Reserve Banks.

        Topics: Monetary policy
      • Working Paper
        Banker Compensation, Relative Performance, and Bank Risk
        Edward S. Prescott Arantxa Jarque
        11.05.2019 | WP 19-20
        A multi-agent, moral-hazard model of a bank operating under deposit insurance and limited liability is used to analyze the connection between compensation of bank employees (below CEO) and bank risk. Limited liability with deposit insurance is a force that distorts effort down. However, the need to increase compensation to risk-averse employees in order to compensate them for extra bank risk is a force that reduces this effect. Optimal contracts use relative performance and are implementable as a wage with bonuses tied to individual and firm performance. The connection between pay for performance and bank risk depends on correlation of returns. If employee returns are uncorrelated, the form of pay is irrelevant for risk. If returns are perfectly correlated, a low wage can indicate risk. Connections to compensation regulation and characteristics of organizations are discussed.

        Topics: Bank policy and regulation
      • Working Paper
        Federal Reserve Structure, Economic Ideas, and Monetary and Financial Policy
        Michael D. Bordo Edward S. Prescott
        06.21.2019 | WP 19-13
        The decentralized structure of the Federal Reserve System is evaluated as a mechanism for generating and processing new ideas on monetary and financial policy. The role of the Reserve Banks starting in the 1960s is emphasized. The introduction of monetarism in the 1960s, rational expectations in the 1970s, credibility in the 1980s, transparency, and other monetary policy ideas by Reserve Banks into the Federal Reserve System is documented. Contributions by Reserve Banks to policy on bank structure, bank regulation, and lender of last resort are also discussed. We argue that the Reserve Banks were willing to support and develop new ideas due to internal reforms to the FOMC that Chairman William McChesney Martin implemented in the 1950s. Furthermore, the Reserve Banks were able to succeed at this because of their private-public governance structure, a structure set up in 1913 for a highly decentralized Federal Reserve System, but which survived the centralization of the System in the Banking Act of 1935. We argue that this role of the Reserve Banks is an important benefit of the Federal Reserve’s decentralized structure and contributes to better policy by allowing for more competition in ideas and reducing groupthink.

        Topics: Monetary policy, Financial policy and implementation
      • Working Paper
        Macroprudential Policy: Results from a Tabletop Exercise
        Denise Duffy Joseph G. Haubrich Anna Kovner Alex Musatov Edward S. Prescott Richard J. Rosen Thomas D. Tallarini Jr. Alexandros P. Vardoulakis Emily Yang Andrei Zlate
        05.21.2019 | WP 19-11
        This paper presents a tabletop exercise designed to analyze macroprudential policy. Several senior Federal Reserve officials were presented with a hypothetical economy as of 2020: Q2 in which commercial real estate and nonfinancial debt valuations were very high. After analyzing the economy and discussing the use of monetary and macroprudential policy tools, participants were then presented with a hypothetical negative shock to commercial real estate valuations that occurred in the second half of 2020. Participants then discussed the use of the tools during an incipient downturn. Some of the findings of the exercise were that during an asset boom, there were limits to the effectiveness of US macroprudential tools in controlling narrow risks and that changes to the fed funds rate may not always simultaneously meet macroeconomic and financial stability goals. Some other findings were that during a downturn, it would be desirable to use high-frequency indicators for deciding when to release the countercyclical capital buffer (CCyB) and that tensions exist between microprudential and macroprudential goals when using the CCyB and the stress test.

        Topics: Financial stability
      • Working Paper
        Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation
        Douglas Davis Oleg Korenok John Lightle Edward S. Prescott
        07.31.2018 | WP 18-10
        We develop a stylized interbank market environment and use it to evaluate with experimental methods the effects of liquidity requirements. Baseline and liquidity-regulated regimes are analyzed in a simple shock environment, which features a single idiosyncratic shock, and in a compound shock environment, in which the idiosyncratic shock is followed by a randomly occurring second-stage shock. Interbank trading of the illiquid asset follows each shock. In the simple shock environment, we find that liquidity regulations reduce the incidence of bankruptcies, but at a large loss of investment efficiency. In the compound shock environment, liquidity regulations not only impose a loss of investment efficiency but also fail to reduce bankruptcies.

        Topics: Econometrics modeling and forecasting
      • Working Paper
        Comparison of Small Bank Failures and FDIC Losses in the 1986–92 and 2007–13 Banking Crises
        Edward S. Prescott Eliana Balla Laurel C. Mazur John R. Walter
        11.13.2017 | WP 17-19
        Failure rates of small commercial banks during the banking crisis of the late 1980s were about 7.6%, which is significantly higher than the 5.7% failure rate during the recent crisis. The higher rate is surprising because small banks had significantly increased their commercial real estate (CRE) lending by the second crisis, which is riskier than other types of lending, and economic shocks were more severe in the recent crisis. We compare failure rates in the two periods using a statistical model that allows us to decompose the effect of changes in bank characteristics and economic shocks on failure rates. We find that the severe economic shocks of the recent crisis had a larger impact on high bank failure rates than bank characteristics. Increases in risk from CRE lending were offset by higher capital levels and other changes in bank characteristics. The failure rate would have been much lower in the later crisis if banks were subject to the less severe economic shocks of the earlier crisis. To the extent that higher capital levels were due to Basel I and the prompt corrective action (PCA) provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991, we find that these reforms were beneficial. We also compare Federal Deposit Insurance Corporation (FDIC) losses on failed banks between the two periods. Here, despite the PCA reforms, losses on failed banks were higher in the recent crisis than in the earlier one. These differences are not accounted for by changes in CRE concentrations or the relative size of economic shocks. On this dimension, the reforms of the early 1990s did not seem to help. Finally, we find that a discretionary accounting variable, interest accrued but not yet received, is predictive of both failure and higher FDIC losses in both crises.

        Topics: Bank policy and regulation
      • Working Paper
        Origins of Too-Big-to-Fail Policy
        George C. Nurisso Edward S. Prescott
        05.24.2017 | WP 17-10
        This paper traces the origin of the too-big-to-fail problem in banking to the bailout of the $1.2 billion Bank of the Commonwealth in 1972. It describes this bailout and those of subsequent banks through that of Continental Illinois in 1984. Motivations behind the bailouts are described with a particular emphasis on those provided by Irvine Sprague in his book Bailout. During this period, market concentration due to interstate banking restrictions is a factor in most of the bailouts, and systemic risk concerns were raised to justify the bailouts of surprisingly small banks. Sprague’s descriptions are also used to describe the tradeoffs and the time-consistency problem faced by bank regulators. Finally, most of the bailouts in this period relied on the Federal Deposit Insurance Corporation’s use of the Essentiality Doctrine. A discussion of this doctrine is provided and used to illustrate how legal constraints on regulators may become less constraining over time.

        Topics: Bank policy and regulation

    • Economic Commentaries

    • Federal Reserve Structure and Economic Ideas.” With Michael D. Bordo, In Essays in Honor of Marvin Goodfriend: Economist and Central Banker (Eds. Robert G. King and Alexander L. Wolman). Federal Reserve Bank of Richmond, 2022, pp 105-116.
    • “Liquidity Requirements and the Interbank Loan Market: An Experimental Investigation.” With Douglas D. Davis, Oleg Korenok, and John P. Lightle, Journal of Monetary Economics, vol. 115 (2020), pp 113-126.
    • “Banker Compensation, Relative Performance, and Bank Risk.” With Arantxa Jarque, Journal of the Japanese and International Economies, vol. 56 (2020).
    • “Origins of Too-Big-to-Fail Policy in the United States.” With George C. Nurisso, Financial History Review, vol. 27 (2020), pp 1-15.
    • “A Comparison of Community Bank Failures and FDIC Losses in the 1986-92 and 2007-13 Banking Crises.” With Eliana Balla, Laurel C. Mazur, and John R. Walter, Journal of Banking and Finance, vol. 106 (2019), pp. 1-15.
    • “Introduction to the Special Issue.” With Ana Lozano-Vivas, Journal of Financial Services Research, vol. 55 (2019), pp 111-113.
    • “Incentive Compensation and Bank Risk: Insights from Organizational Economics.”In The Future of Large, Internationally Active Banks (Eds. Asli Demirgüç-Kunt, Douglas D. Evanoff, and George G. Kaufman). World Scientific Publishing Co., Singapore, 2017, pp 399-417.
    • “Fixed Prices and Regulatory Discretion as Triggers for Contingent Capital Conversion: An Experimental Investigation.” With Douglas Davis. International Journal of Central Banking, 2017, 13: 33–71.
    • “An Experimental Analysis of Contingent Capital with Market-Price Triggers.” With Douglas Davis and Oleg Korenok. Journal of Money, Credit, and Banking, 2014, 46: 999–1033.
    • “Market-Based Corrective Actions.” With Philip Bond and Itay Goldstein. Review of Financial Studies, 2010, 23: 781–820.
    • “Firms as Clubs in Walrasian Markets with Private Information.” With Robert M. Townsend. Journal of Political Economy, 2006, 114: 644–671.
    • “State-Contingent Bank Regulation with Unobserved Actions and Unobserved Characteristics.” With David A. Marshall. Journal of Economic Dynamics and Control, 2006, 30: 2015–2049.
    • “Private Information and Intertemporal Job Assignments.” With Robert M. Townsend. Review of Economic Studies, 2006, 73: 531–548.
    • “Computing Solutions to Moral-Hazard Programs Using the Dantzig-Wolfe Decomposition Algorithm.” Journal of Economic Dynamics and Control, 2004, 28: 777–800.
    • “Communication in Models with Private Information: Theory and Computation.” The Geneva Papers on Risk and Insurance Theory, 2003, 28 : 105–130.
    • “Incentives, Communication, and Payment Instruments.” With John A. Weinberg. Journal of Monetary Economics, 2003, vol. 50: 433–454.
    • “Hired Hooves: Transactions in a South Indian Village Factor Market.” With Rolf A.E. Mueller and Daniel A. Sumner. Australian Journal of Agricultural and Resource Economics, 2002, 46: 233–255.
    • “Collective Organizations versus Relative Performance Contracts: Inequality, Risk Sharing, and Moral Hazard.” With Robert M. Townsend. Journal of Economic Theory, 2002, 103: 282–310.
    • “Bank Capital Regulation with and without State-Contingent Penalties.” With David A. Marshall. Carnegie-Rochester Conference Series on Public Policy, 2001, 54: 139–184.

  • Federal Reserve Bank of Richmond, Economic Quarterly

    Federal Reserve Bank of Richmond, Economic Brief

    Editorials and Other Policy Pieces

    • “A Case against Disclosing Camels Ratings.” With Stephen Slivinski. American Banker, 2009 (May 29), 174 (102).
    • “A Snapshot of Mortgage Conditions with an Emphasis on Subprime Mortgage Performance.” With Scott Frame and Andreas Lehnert. Document prepared for Federal Reserve’s Home Mortgage Initiatives, 2008 (August).