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Economic Review

Economic Review
C O N T E N T S
January/February 1995, Volume 80, Number 1

Some Lessons from Basic Finance for Effective Socially Responsible Investing
Larry D. Wall

Given the vast sums of money that mutual and pension fund managers invest, an important question is how they should go about deciding which assets, especially which stocks, they should purchase. One school of thought argues that investment policies should reflect some set of social values. This study examines three questions about the financial implications of effective socially responsible investing in common stocks--that is, socially responsible investment intended to change firms' behavior.

The first question concerns what socially responsible investors can do to effectively influence firms' investment policies. The second question is, under what conditions, if any, will the securities markets permit effective socially responsible investment? Third, what impact will socially responsible investment have on the performance of portfolios that follow it?

The analysis has two implications for fund managers and investors who want to change firms' behavior. The first is that the investment strategy should focus on buying shares of small socially responsive firms. The second is that investors who owned targeted socially responsible stocks before socially responsible investment began will realize above-market rates of return in the short run; however, once socially responsible investors stop bidding up the price, investors will receive reduced returns.

Inflation and Inflation Forecasting: An Introduction
Ellis W. Tallman

Although current inflation rates are relatively benign, the costs of unexpected inflation, even at low rates, remain substantial for individual firms and consumers. Many types of planning decisions, such as businesses' and governments' plans for expected expenses and revenues, hinge on inflation forecasts.

This article provides an overview of the effects of inflation and the significance of inflation forecasting. The author first considers how forecasting models are specifically designed to fill the needs of particular users. The analysis examines two statistical models--the Phillips curve and money demand/monetarist models--that employ standard economic theory to suggest variables that help predict inflation. Forecasts from a simple, but widely used, version of each model are then compared with simple time series models that include only past data on inflation. This comparison using standard accuracy criteria shows that the economic models did not perform much better than the simplest time series forecasting model. The author concludes that future research should focus on estimating dynamic models that are by design more structural and that may help uncover the sources of inflation.

Review Essay--An Economist's Perspective on History:
Institutions Institutional Change and Economic Performance

Andrew C. Krikelas

Douglass North earned a share of the 1993 Nobel prize for economics for two decades of research that culminated in the development of an innovative framework for analyzing economic history. This review essay discusses the book that most comprehensively presents North's paradigm, which characterizes history as the record of an evolving game in which institutions, organizations, and individuals function as the rules, teams, and players. Through examples, the reviewer illustrates how North's game theoretic paradigm can serve not only as a tool for analyzing historical events but also as a methodological bridge between the diverse branches of the social sciences and humanities.

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