From that point on, we obtain a negatively sloped relationship (i.e. Chapter 3: A Behavioral Macroeconomic Model . Akerlof, G and R Shiller (2009) Animal spirits: How human psychology drives the economy and why it matters for global capitalism, Princeton University Press. We would always make optimal decisions. Farmer, R E A (2006), “Animal Spirits”, Palgrave Dictionary of Economics. In order to understand this, start from point A. In general, in more flexible economies central banks do not face the same kind of uncomfortable trade-offs as in rigid economies. 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. Such an explanation is not satisfactory, as it shifts the burden of explaining the business cycle to outside forces. Why do people buy the stuff they buy? 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 This may lead to the conclusion that flexibility is always welfare improving – but that is not the case. %PDF-1.3 %���� 0000010819 00000 n Only exogenous disturbances can get these agents off the rail, forcing them to re-optimise. 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. … Therefore, these reforms can be seen as shifting the supply curve to the right, increasing the production potential of countries. 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The horizontal axis shows the standard deviations of output; the vertical axis the standard deviations of inflation. 0000006898 00000 n Beyond the minimum point further increases in flexibility lead to lower output volatility at the expense of higher inflation volatility. Frontiers of economic research Macroeconomic policy, Tags:  �3ȥ�(������g��a��g�� trailer << /Size 146 /Info 80 0 R /Encrypt 90 0 R /Root 89 0 R /Prev 132734 /ID[<14875a215ee4a1d953d2e7d450e9e6ea><14875a215ee4a1d953d2e7d450e9e6ea>] >> startxref 0 %%EOF 89 0 obj << /Type /Catalog /Pages 82 0 R /OpenAction 91 0 R /PageMode /UseOutlines /Outlines 93 0 R /FICL:Enfocus 85 0 R /PageLabels 79 0 R >> endobj 90 0 obj << /Filter /Standard /R 2 /O (����� �}�v���*�pp\n'����]�) /U (A��1\(�G~i�$I���^� \\L[f��Y�) /P -12 /V 1 >> endobj 91 0 obj << /S /GoTo /D [ 92 0 R /FitBH -32768 ] >> endobj 144 0 obj << /S 393 /O 509 /L 525 /Filter /FlateDecode /Length 145 0 R >> stream Booms and busts are all the result of exogenous disturbances (Smets and Wouters 2007, Gali 2008). Model . 0000009013 00000 n 0000004416 00000 n 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). Date: 15.-16. We obtain a non-linear relationship. We have chosen to do so by assuming that agents experience cognitive limitations preventing them from having rational expectations. relates to the decision-making process behind an economic outcome of individuals and institutions Where the optimum flexibility will be reached then depends on the preferences about inflation versus output volatility. 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. One issue is the high synchronisation of national business cycles in the industrialised world. 0000014164 00000 n The Foundations of Behavioral Economic Analysis will be an indispensable resource for students and scholars who wish to understand where the action is." 1.2 Behaviour. 0000003135 00000 n We extended our behavioural model to two countries and found that the model is capable of generating a strong international transmission of animal spirits, which in turn leads to a strong correlation of business cycles. In this case, the trade-off is negatively sloped. There is a growing number of researchers developing ‘agent-based’ models and ‘behavioural’ macroeconomic models (Alfarano et al. 0000001525 00000 n Behavioral Foundations for Keynesian Macroeconomics: The Consumption Function Fabio D’Orlando and Eleonora Sanfilippo∗ Preliminary Draft Abstract This paper aims to discuss: (i) the presence of behavioral assumptions in Keynes’s General Theory; and (ii) the possibility of grounding a Keynesian-type consumption function The foundation’s Behavioral Economics program supports research that uses insights and methods from psychology, economics, sociology, political science and other social sciences to examine and improve social and living conditions in the United States. This is much less the case in mainstream macroeconomics, however. 0000002648 00000 n This is not so when the economy is too rigid. 0000002948 00000 n De Grauwe, P and Y Ji (2017a) “Inflation targets and the zero lower bound in a behavioural macroeconomic model", Economica, forthcoming. It instead has the more modest goal of proposing an empirically sound way of measuring the well-being losses stemming from macroeconomic … 0000004034 00000 n 0000009699 00000 n There are many ways in which one can depart from mainstream macroeconomic models. Colander, D, P Howitt, A Kirman, A Leijonhufvud and P Mehrling (2008), "Beyond DSGE models: Toward an empirically based macroeconomics", American Economic Review 98(2): 236-40. business cycle fluctuations, DSGE models, behavioural macroeconomics, heuristics, adaptive learning, agent-based models, output gap, inflation, animal spirits. 0000008991 00000 n In that case, the central bank can pursue a tighter inflation target without paying a price in terms of a higher output volatility. 0000004546 00000 n 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. 0000004895 00000 n Farmer, R, J Doyne and D Foley (2009), “The economy needs agent-based modelling”, Nature 460: 685-686. Hommes, C and J Lustenhouwer (2016), “Managing heterogeneous and unanchored expectations: A monetary policy analysis”, Working Paper, Tinbergen Institute, Rotterdam. For values of b2 exceeding 0.5, these trade-offs become positively sloped – that is, when c1 (the inflation parameter in the Taylor rule) increases, both inflation and output volatility decline. As a result, one can argue that standard DSGE models do not have an endogenous business cycle theory. Homo economicus continues to reign supreme in dynamic stochastic general equilibrium (DSGE) models. 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”. Alfarano, S, T Lux and F Wagner (2005), “Estimation of agent-based models: The case of an asymmetric herding model”, Computational Economics 26: 19–49. We are, of course, not alone in exploring different tracks of macroeconomic modelling. Behavioural research explains human behaviour through the lens of social preferences, heuristics and norms, … Figure 2 allows us to obtain some insights about the optimal level of flexibility. The force of this criticism has been reduced by the second reason for incorporating behavioral economics results into macroeconomics: cognitive psychologists and experimental economists have documented a number of systematic deviations between the decisions of human beings and those of the “economic man.” We achieve this without the need to invoke common exogenous shocks (De Grauwe and Ji 2016). Clearly, this must be located to the left of the minimum point of the relationship. In these models, structural reforms in labour markets include relaxing job protection, cuts in unemployment benefits, and so on; in product markets the reforms include reductions in barriers to entry for new firms. 0000012341 00000 n The second way we introduce structural reforms is through changes in the supply equation. Fagiolo et al. 0000010067 00000 n Moreover, it is often useful to assume that the time horizon is inflnite. 2005, Tesfatsion and Judd 2006, Colander et al. 0000011518 00000 n 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). 0000008314 00000 n 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. FOUNDATIONS OF BEHAVIORAL FINANCE. 0000002729 00000 n 9.30 – 10.40 David 1: Welcome, Intro, & Methods in Behavioral Economics 11.00 – 12.10 Matthew 1: Normal-Science Behavioral Economics (& Camp Outline) 2.00 – 3.10 Matthew 2: Belief-Based Preferences & Intro to Prospect Theory 3.30 – 4.40 Matthew 3: Reference Dependence and News Utility The contrast with standard DSGE-models is significant. 0000003968 00000 n These measure the inflation and output volatility choices the central bank faces when it increases its inflation control (measured by the sensitivity of the interest rate to changes in inflation in the Taylor rule). The latter is measured by the sensitivity of inflation to the output gap in the New Keynesian Philips curve (called b2). As a result, these agents are only capable … 0000001684 00000 n Muellbauer, J (2016), “Macroeconomics and consumption”, CEPR Discussion paper 11588; Oxford University, Department of Economics working paper 811. 0000004786 00000 n These cannot be easily explained in standard macroeconomic models except by (again) assuming common exogenous shocks. 0000012232 00000 n Presently, many macroeconomic models, representing different theories, [4] are derived by aggregating microeconomic models allowing economists to test them with both macroeconomic and … Darst. One good example is the recent effort to integrate the financial sector in DSGE models to explain the business cycle. We find that structural reforms that increase the flexibility of wages and prices can have profound effects on the dynamics of the business cycle. 0000003839 00000 n 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. 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 . 0000003600 00000 n The models further help to explain the international transmission of business cycle fluctuations. Therefore, economics is the foundation of behavioral economics. Cacciatore, M, R Duval and G Fiori (2012) “Short-term gain or pain? However, the results of these models depend on the assumption that the shocks are serially-correlated. In the spirit of Keynes’ General Theory, behavioral macroeconomists are rebuilding the microfoundations that were sacked by the New Classical economics. They have to rely on large exogenous shocks as explanations of the boom and bust features of business cycles. 2008, Farmer 2006, Farmer and Foley 2009, Gatti et al. Journal of Monetary Economics 61: 2-22. This evaluation leads them to switch to the rules that perform best. 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… "—Domenico Delli Gatti, Journal of Economic Literature "De Grauwe voices the concerns of many macroeconomists regarding the empirical plausibility of the rational expectations assumption. A low sensitivity of the rate of inflation with respect to the output gap is indicative of wage and price rigidities. 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). One of the most important is the effect of fairness considerations on wages and employment relationships. 0000012210 00000 n 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. 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. Figure 2 The optimal level of flexibility. 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. These deviations from rational calculation are introduced as “non-standard” (the standard being neoclassical economics) or reflections of “bias”. Executive Summary This thesis strives to enrich macroeconomic theories with behavioural components. 0000004688 00000 n 0000004164 00000 n Towards a behavioural foundation of macroeconomics XX, 228 S., graph. 0000008292 00000 n Westerhoff, F and R Franke (2012), “Agent-based models for economic policy design: Two illustrative examples”, Iowa State University, Working Paper No 88. Put differently, as we move down from point A there is an unambiguous increase in welfare. 0000004481 00000 n wages and prices do not react to changes in the output gap). These models then lead to the view that business cycle fluctuations occur as a result of exogenous events (shocks) that force individuals to reconsider their optimal plans. Eggertsson, G, A Ferrero and A Raffo (2014), "Can structural reforms help Europe?" 0000003307 00000 n 0000005390 00000 n We have used our behavioural macroeconomic model to analyse different macroeconomic issues. further increases in flexibility lead to less volatility of output at the expense of increasing inflation volatility). This column uses concepts from behavioural economics to develop macroeconomic models with endogenous business cycle fluctuations. To support rigorous and objective research projects on U.S. economic structure, behavior, and performance whose findings inform and strengthen decision-making by … 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 The workshop will take place at the University of Bamberg, Germany. Behavioral economics uses the the behavioral insights of psychology to improve economists’ models and the predictions they make. 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). 0000002410 00000 n 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. Behavioral Foundations for Keynesian Macroeconomics: The Consumption Function 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. Tesfatsion, L and K L Judd (2006), Handbook of Computational Economics Volume 2: Agent-Based Computational Economics, Elsevier. 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.
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