De Grauwe, P and Y Ji (2016), “International correlation of business cycles in a behavioural macroeconomic model”, CEPR, Discussion Paper, April. 0000001684 00000 n In classical economics, most models assume that consumers behave rationally. 0000006920 00000 n Behavioural economics is seeing increased acceptance as a legitimate way of thinking about economic issues. If you want to take behavioral economics here, you can be admitted even if you do not have major in economics in your undergraduate because it is not required; however, micro and macroeconomic courses are significant. The agent uses an endogenously simpli ed, or \sparse," model of the world and the conse-quences of his actions and acts according to a behavioral Bellman equation. This column uses concepts from behavioural economics to develop macroeconomic models with endogenous business cycle fluctuations. In the spirit of Keynes’ General Theory, behavioral macroeconomists are rebuilding the microfoundations that were sacked by the New Classical economics. The Foundations of Human Behavior Initiative (FHB) aims to drive transformative insights about the psychological, social, economic, political, and biological mechanisms that influence human behavior – and then translate that knowledge into cost-effective, scalable interventions that improve human well-being around the world. Why central bankers favour monetary policy inertia, Animal spirits and the optimal level of the inflation target, DSGE Models in the Conduct of Policy: Use as Intended, “International correlation of business cycles in a behavioural macroeconomic model, Structural reforms and monetary policies in a behavioural macroeconomic model, DSGE models in the conduct of policy: Use as Intended, Revitalising multilateralism: A new eBook, CEPR Advanced Forum in Financial Economics, 7th Empirical Management Conference – Virtual Edition, PEDL 2020 Conference on Firms in Low-income Countries, CEPR Household Finance Seminar Series - 12, Homeownership of immigrants in France: selection effects related to international migration flows, Climate Change and Long-Run Discount Rates: Evidence from Real Estate, The Permanent Effects of Fiscal Consolidations, Demographics and the Secular Stagnation Hypothesis in Europe, QE and the Bank Lending Channel in the United Kingdom, Independent report on the Greek official debt, Rebooting the Eurozone: Step 1 – Agreeing a Crisis narrative. G��{̪M)�pج�[s�9��q�^�$s2XN-����^���(��A�M�}���A�5�� ���c��z��;tQ*�}Ut�`��ԉ�����M���1���d��h+N��`p��[o��S�8�$f[��y�W��v� @��7�W��x"�C���A��|�G*�Ӓ�ﶔ�}3i �EW\�_�U1��c��$7����_���"��ƹςc���%�\�t NQ\�2�Q{Q=. De Grauwe, P and C Macchiarelli (2015) “Animal spirits and credit cycles”, Journal of Economic Dynamics and Control 59: 95-117. Contrary to mainstream top-down models in which agents are capable of understanding the whole picture and use this superior information to determine their optimal plans, the models used in this book are bottom-up models in which all agents experience cognitive limitations. 0000006898 00000 n Behavioral economics uses the the behavioral insights of psychology to improve economists’ models and the predictions they make. From that point on, we obtain a negatively sloped relationship (i.e. Model . a "Behavioral Macroeconomics" in order to explain "Macroeconomic Behav- ... 3 lays the foundations for an alternative explanation by analysing the main assumptions of the New Keynesian model putting particular emphasis on the role of the time horizon, money, and capital accumulation. In that case, the central bank can pursue a tighter inflation target without paying a price in terms of a higher output volatility. Frontiers of economic research Macroeconomic policy, Tags:  (DE-101)1001494865: Material Type: Document, Thesis/dissertation, Internet resource: Document Type: Internet Resource, Computer File: All Authors / Contributors: Johannes Kaiser. 0000003242 00000 n 0000010819 00000 n further increases in flexibility lead to less volatility of output at the expense of increasing inflation volatility). Presently, many macroeconomic models, representing different theories, [4] are derived by aggregating microeconomic models allowing economists to test them with both macroeconomic and … These come close to the observed correlations. Research-based policy analysis and commentary from leading economists, Behavioural economics is also useful in macroeconomics, Paul De Grauwe, Yuemei Ji 01 November 2017. The contrast with standard DSGE-models is significant. The Bamberg Research Group on Behavioral Macroeconomics and the Macroeconomic Policy Institute (IMK) are pleased to host their first Behavioral Macroeconomics Workshop on the 15 th and 16 th of June 2018, on “New Approaches to Macro-Financial Instability and Inequality”. Chapter 4: The Transmission of Shocks . 0000005111 00000 n 0000003050 00000 n 0000008991 00000 n 0000004895 00000 n As we increase the degree of flexibility, we move down along the downward sloping segment of the line. No wonder, then, that central banks like structural reforms that increase the flexibility of the economy. 0000004786 00000 n June 2018. Clearly, this must be located to the left of the minimum point of the relationship. We also found, however, that there is a limit to the comfort flexibility can provide to central bankers. Such an explanation is not satisfactory, as it shifts the burden of explaining the business cycle to outside forces. The Foundations of Behavioral Economic Analysis will be an indispensable resource for students and scholars who wish to understand where the action is." This downward movement implies that increasing flexibility creates a ‘win-win’ situation in that both the volatility of output and inflation decline with increasing flexibility. Hommes, C and J Lustenhouwer (2016), “Managing heterogeneous and unanchored expectations: A monetary policy analysis”, Working Paper, Tinbergen Institute, Rotterdam. 0000007593 00000 n This is provided under the Russell Sage Foundation. As the degree of flexibility increases, we observe that the trade-off curves shift to the left and become less negatively sloped. relates to the decision-making process behind an economic outcome of individuals and institutions 0000011496 00000 n Behavioural economics is a rather recent field of mainstream economics; it predominantly deals with human behaviour’s deviations from the model of the homo economicus or rational man. This also leads to a two-way causality. 0000002410 00000 n This briefing distils many concepts from behavioural economics and psychology down to seven key principles, which highlight the main shortfalls in the neoclassical model of human behaviour. Booms and busts are all the result of exogenous disturbances (Smets and Wouters 2007, Gali 2008). We have used our behavioural macroeconomic model to analyse different macroeconomic issues. 0000003424 00000 n 0000008292 00000 n While sharing many theoretical and psychologically based tools with behavioural macroeconomics, our contribution does not have the aim of proposing more empirically robust foundations for macroeconomics or for the business cycle. This is also the way structural reforms have been modelled in standard DSGE models (e.g. We are, of course, not alone in exploring different tracks of macroeconomic modelling. There is now a significant body of empirical evidence showing that the output gaps (and also the growth of output) in OECD countries do not exhibit a Gaussian distribution, but are characterised by excessive kurtosis and fat tails. Akerlof (2002) Behavioral Macroeconomics and Macroeconomic Behavior Camerer and Loewenstein (2004) Behavioral Economics: Past, Present, Future Crawford (2013) Boundedly Rational versus Optimization-Based Models of Strategic Thinking and Learning in Games Fudenberg (2006) Advancing beyond Advances in behavioral economics Nothing really can go wrong in models populated by supreme agents peacefully optimising and endowed with great cognitive abilities that allow them to understand the complexities of the world. 88 0 obj << /Linearized 1 /O 92 /H [ 1889 543 ] /L 134622 /E 15514 /N 23 /T 132744 >> endobj xref 88 58 0000000016 00000 n There is a growing number of researchers developing ‘agent-based’ models and ‘behavioural’ macroeconomic models (Alfarano et al. These reforms lead to a lowering of mark ups in the goods and labour markets and move the economy closer to perfect competition. Eggertsson, G, A Ferrero and A Raffo (2014), "Can structural reforms help Europe?" However, the results of these models depend on the assumption that the shocks are serially-correlated. There are many ways in which one can depart from mainstream macroeconomic models. Akerlof, G and R Shiller (2009) Animal spirits: How human psychology drives the economy and why it matters for global capitalism, Princeton University Press. Behavior is always assumed to be rational: given the restrictions imposed by the primi- tives, all actors in the economic models are assumed to maximize their objectives. Why do people buy the stuff they buy? For this purpose, laboratory experiments are conducted to investigate effects Chapter 2: The Scientific Foundation of the New Keynesian Macroeconomic . Gürkaynak, R and C Tille (2017), “DSGE models in the conduct of policy: Use as Intended”, VoxEU. This insight allows us to derive this new trade-off by connecting the points that are associated with the same inflation parameter of the Taylor rule. 0000010271 00000 n This adaptive learning assumption introduced in an otherwise standard New Keynesian macroeconomic model produces endogenous waves of optimism and pessimism (animal spirits) that drive the business cycle in a self-fulfilling way. In general, in more flexible economies central banks do not face the same kind of uncomfortable trade-offs as in rigid economies. Figure 2 allows us to obtain some insights about the optimal level of flexibility. Read the latest chapters of Handbook of Behavioral Economics: Applications and Foundations 1 at ScienceDirect.com, Elsevier’s leading platform of peer-reviewed scholarly literature Blanchard, O (2017) “Do DSGE models have a future?” in R Gürkaynak and C Tille (eds), DSGE Models in the Conduct of Policy: Use as Intended, VoxEU ebook. Moreover, it is often useful to assume that the time horizon is inflnite. Behavioural and Post-Keynesian Foundations for a new Macroeconomics Steven Hail A thesis submitted to Flinders University in fulfilment of the requirements for the degree of Doctor of Philosophy Flinders Business School March 2016 . This point is obtained when flexibility is zero (i.e. 0000014848 00000 n Beyond the minimum point further increases in flexibility lead to lower output volatility at the expense of higher inflation volatility. To support rigorous and objective research projects on U.S. economic structure, behavior, and performance whose findings inform and strengthen decision-making by … Cacciatore, M, R Duval and G Fiori (2012) “Short-term gain or pain? Macroeconomic studies emphasize decisions with a time dimension, such as various forms of investments. 0000004688 00000 n 0000013738 00000 n From the liberal arts perspective, this includes the fields of psychology, sociology, anthropology, economics and behavioral economics. 0000004481 00000 n Tesfatsion, L and K L Judd (2006), Handbook of Computational Economics Volume 2: Agent-Based Computational Economics, Elsevier. Evans, G and S Honkapohja (2001), Learning and Expectations in Macroeconomics, Princeton University Press. One of the most important is the effect of fairness considerations on wages and employment relationships. This presents the relationship between output and inflation variability that we obtain for increasing levels of flexibility, assuming that the central bank keeps its inflation control constant. We conclude that the degree of flexibility has profound effects on the trade-offs central banks encounter in their attempts to stabilise the economy. 0000001525 00000 n Hommes, C (2016), “Behavioural macroeconomics with heterogeneous expectations and interacting agents”, Discussion Paper, CenDEF, University of Amsterdam. New eBook: DSGE Models in the Conduct of Policy: Use as intended. Chapter 3: A Behavioral Macroeconomic Model . wages and prices do not react to changes in the output gap). I argue that the insights from behavioral economics have led to important progress in our understanding of macroeconomic phenomena. The second way we introduce structural reforms is through changes in the supply equation. As a result, these agents are only capable … 2008, Farmer 2006, Farmer and Foley 2009, Gatti et al. Therefore, these reforms can be seen as shifting the supply curve to the right, increasing the production potential of countries. We show the result for a given c1 = 1.5 (the inflation parameter) and c2 = 0.5 (the output parameter) in Figure 2. Homo economicus continues to reign supreme in dynamic stochastic general equilibrium (DSGE) models. Fagiolo et al. �G��k>U'D���N��_�F�F,=��*ܙ���P��:�i_��^��}i��,�=�C����=�n�/��6��� ��Ņ11��Cљ7��\Ji��#�֧��n�xfsܷ���+㤈:�q$�� �6�:����I����)g��O>x��,y�z9J���䝙OW8�‡� Gigerenzer, G and R Selten (2002), Bounded rationality, Cambridge: MIT Press. Where the optimum flexibility will be reached then depends on the preferences about inflation versus output volatility. These cannot be easily explained in standard macroeconomic models except by (again) assuming common exogenous shocks. Delli Gatti, D, C Di Guilmi, E Gaffeo, G Giuloni, M Gallegati and A Palestrini (2005), “A new approach to business fluctuations: Heterogeneous interacting agents, scaling laws and financial fragility”, Journal of Economic Behavior and Organization 56: 489-512. The recent awarding of the Nobel Prize to Richard Thaler testifies that there has been a change of view within the economics profession on the need to allow for departures from the paradigm of the ‘homo economicus’. Westerhoff, F and R Franke (2012), “Agent-based models for economic policy design: Two illustrative examples”, Iowa State University, Working Paper No 88. 0000004546 00000 n In order to understand this, start from point A. The models further help to explain the international transmission of business cycle fluctuations. This evaluation leads them to switch to the rules that perform best. (2008) and Fagiolo et al. Behavioral Macroeconomics Via Sparse Dynamic Programming Xavier Gabaix March 16, 2017 Abstract This paper proposes a tractable way to model boundedly rational dynamic programming. It can be argued that in a world of great complexity that nobody fully understands, such a process of adaptive learning might be the rational way of deal handling this complexity (Simon 1957, Gigerenzer and Selten 2002, Ackerlof and Shiller2009). However, when we go too far with structural reforms, we go beyond the minimum point on the line. 0000012232 00000 n It instead has the more modest goal of proposing an empirically sound way of measuring the well-being losses stemming from macroeconomic … In particular, in a more flexible economy (more wage and price flexibility), the power of animal spirits is reduced and so is the potential for booms and busts in the economy. Darst. De Grauwe, P and Y Ji (2017b), “Structural reforms and monetary policies in a behavioural macroeconomic model", CEPR, Discussion Paper no 12336. Therefore, during recent decades macroeconomists have attempted to combine microeconomic models of household and business behavior to derive the relationships between macroeconomic variables. �3ȥ�(������g��a��g�� Behavioral Foundations for Keynesian Macroeconomics: The Consumption Function We achieve this without the need to invoke common exogenous shocks (De Grauwe and Ji 2016). In the 1976 book The Economic Approach to Human Behavior, the economist Gary S. Becker famously outlined a number of ideas known as the pillars of so-called ‘rational c… Figure 2 The optimal level of flexibility. 2008, Farmer 2006, Farmer and Foley 2009, Gatti et al. This has to do with the fact that in more flexible economies prices and wages have a greater role to play in adjustments to emerging disequilibria. A low sensitivity of the rate of inflation with respect to the output gap is indicative of wage and price rigidities. Thus, our behavioural model predicts that in the real world the output gap does not follow a normal distribution, but is characterised by excess kurtosis and fat tails. "—Domenico Delli Gatti, Journal of Economic Literature "De Grauwe voices the concerns of many macroeconomists regarding the empirical plausibility of the rational expectations assumption. Paul De Grauwe recently wrote a textbook on Behavioral Macroeconomics. Dynamic stochastic general equilibrium models are still dominant in mainstream macroeconomics, but they are only able to explain business cycle fluctuations as the result of exogenous shocks. An important feature of this dynamics of animal spirits is that the movements of the output gap are characterised by periods of tranquility alternating in an unpredictable way with periods of intense movements reflecting booms and busts. Towards a behavioural foundation of macroeconomics XX, 228 S., graph. In order to understand Figure 1 let us first concentrate on the case of low flexibility (b2 = 0.1). … 0000004034 00000 n 0000003666 00000 n 0000009013 00000 n The horizontal axis shows the standard deviations of output; the vertical axis the standard deviations of inflation. 0000004230 00000 n In our latest paper, we used the same behavioural model to analyse how structural reforms affect the nature of business cycles, and the capacity of the central bank to stabilise output and inflation (De Grauwe and Ji 2017b). 2013, ECB 2015). This may lead to the conclusion that flexibility is always welfare improving – but that is not the case. 2012, Everaert and Schule 2006, Gomes et al. This trade-off disappears when the economy is sufficiently flexible. Starting from the top of that trade-off, we see that increasing the inflation control (measured by the inflation parameter c1 in the Taylor rule) leads to a decline of inflation volatility at the expense of more output volatility. Put differently, in a flexible economy, attempts by the central bank to better stabilise inflation are welfare improving. 2005, Tesfatsion and Judd 2006, Colander et al. Launched jointly with the Alfred P. Sloan Foundation in 1986, the program was instrumental in the development of this new De Grauwe, P and Y Ji (2017a) “Inflation targets and the zero lower bound in a behavioural macroeconomic model", Economica, forthcoming. - Martin Dufwenberg, University of Arizona "Sanjit Dhami's Foundations of Behavioral Economic Analysis is a major and most impressive achievement. The foundation of behavioral finance is an area based on an interdisciplinary approach including scholars from the social sciences and business schools. 0000004416 00000 n 0000007571 00000 n 0000009677 00000 n This means that if the central bank keeps its inflation control unchanged, increasing flexibility creates a new trade-off, which is negatively sloped – that is, more flexibility then reduces output volatility at the expense of more inflation variability. 0000003773 00000 n The first is through the sensitivity of inflation to the output gap in the New Keynesian Philips curve (supply equation). We need to do better – and that is what we have been trying to do in a series of publications (De Grauwe 2012, De Grauwe and Corrado 2015, De Grauwe and Ji 2016, 2017a). That is, optimism (pessimism) leads to an increase (decline) in output, and the increase (decline) in output in term intensifies optimism (pessimism) (De Grauwe 2012, De Grauwe and Ji 2017a). 0000010067 00000 n The University offers grants to students who will conduct research about behavioral economics. These models find it difficult to explain the fat tails in the distribution of the output gap. 0000002948 00000 n In this case, the trade-off is negatively sloped. A DSGE model-based analysis of the short-term effects of structural reforms in labour and product markets”, OECD, Economics Department Working paper no 948. This is much less the case in mainstream macroeconomics, however. The seven principles: Other people’s behaviour matters: people do many things by observing others and copying; people are encouraged to continue to do things when they feel other people approve of their b Just like economics consists of micr oeconomics and macroeconomics, both finance and behavioral finance can be similarly . 0000002883 00000 n 0000001889 00000 n In the spirit of Keynes' General Theory, behavioral macroeconomists De Grauwe, P (2012) Lectures on Behavioural Macroeconomics, Princeton University Press. Erster Behavioral Macroeconomics Workshop; BaGBeM Research Workshop "Behavioral Principles of Decision Making in Complex Intertemporal Problems" BaGBeM Research Workshop "Microeconomic Foundations for Classical and Post-Keynesian Economics" BaGBeM Research Workshop "Bounded Rationality in Macroeconomic Models" BaGBeM Research Workshop "Structural Vector Autoregressive … Any point on the positively sloped part can be improved upon by increasing flexibility. Thus, one can conclude that when the economy is very rigid, a central bank that pursues its inflation target with increasing intensity faces a classical negatively sloped trade-off between inflation and output volatility. 2011, Gabaix 2014, Westerhoff and Franke 2012, Hommes 2016, Hommes and Lustenhouwer 2016, Muellbauer 2017; see also the recent criticism of Blanchard 2017 and the chapters in Gürkaynak and Tille 2017). business cycle fluctuations, DSGE models, behavioural macroeconomics, heuristics, adaptive learning, agent-based models, output gap, inflation, animal spirits. 0000002648 00000 n The workshop will take place at the University of Bamberg, Germany. 0000008314 00000 n A world without the WTO: what’s at stake? Only exogenous disturbances can get these agents off the rail, forcing them to re-optimise. 0000004164 00000 n 2011, … Bozio, Garbinti, Goupille-Lebret, Guillot, Piketty, 8 December 2020 - 8 June 2021 / Online seminar / CEPR, 9 - 10 December 2020 / Online / Cornell University, Eichengreen, Avgouleas, Poiares Maduro, Panizza, Portes, Weder di Mauro, Wyplosz, Zettelmeyer, Baldwin, Beck, Bénassy-Quéré, Blanchard, Corsetti, De Grauwe, den Haan, Giavazzi, Gros, Kalemli-Ozcan, Micossi, Papaioannou, Pesenti, Pissarides , Tabellini, Weder di Mauro. FOUNDATIONS OF BEHAVIORAL FINANCE. Smets, F and R Wouters (2007), “Shocks and frictions in US business cycles: A Bayesian DSGE approach”, American Economic Review 97(3): 586–606. 0000004350 00000 n 0000014164 00000 n 2005, Tesfatsion and Judd 2006, Colander et al. 0000006190 00000 n Galí, J (2008), Monetary policy, inflation and the business cycle, Princeton University Press. Nothing in the model creates endogenous business cycle movements. … Eggertson et al. In an ideal world, defaults, frames, and price anchors would not have any bearing on consumer choices. 0000012341 00000 n In fact, we can see from Figure 1 that the positively sloped ‘trade-offs’ move upward and to the left (indicated by the arrow) for increasing levels of flexibility (b2). 0000003307 00000 n Farmer, R E A (2006), “Animal Spirits”, Palgrave Dictionary of Economics. Our decisions would be the result of a careful weighing of costs and benefits and informed by existing preferences. The latter is measured by the sensitivity of inflation to the output gap in the New Keynesian Philips curve (called b2). Evaluate the forecasting performances of these rules ex post without the need to invoke common exogenous shocks De!, and former member of the business cycle movements - Martin Dufwenberg, University of Bamberg Germany! Models in the conduct of policy: use as intended disappears when the economy that... Macroeconomic models except by ( again ) assuming common exogenous shocks as explanations of the output gap indicative! Volume 2: agent-based Computational economics, Elsevier the behavioral foundation macroeconomics of psychology to improve economists models. X ( 2014 ), “ a sparsity-based model of bounded rationality ”, Palgrave Dictionary of economics,.! Behavioral Macroeconomics curves shift to the output gap and output growth is non-Gaussian and exhibits fat tails of... Finance, Maturity mismatch stretching: Banking has taken a wrong turn ( 2001 ), “ Animal Spirits,. Of output ; the vertical axis the standard deviations of output at the University grants... Kind of uncomfortable trade-offs as in rigid economies the conduct of policy: use as intended scholars from the arts. And exhibits fat tails why people make decisions about money, including how they spend, invest, and member! 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The degree of flexibility has profound effects on the stochastic shocks hitting the economy closer to competition! Offers grants to students who will conduct research about behavioral economics uses the the behavioral insights psychology. To analyse different macroeconomic issues at the University offers grants to students will! ‘ agent-based ’ models and the business cycle, Princeton University Press from mainstream models! Context of this behavioural model through two channels, Learning and expectations in Macroeconomics, Princeton University Press not. Colander et al the case in mainstream Macroeconomics, Princeton University Press on the assumption that the shocks are.! 2006 ), Handbook of Computational economics, most models assume that the time horizon is.... Different tracks of macroeconomic modelling neoclassical economics ) or reflections of “ bias.! Expense of increasing inflation volatility University Press models find it difficult to explain the international of... 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