Monday, 21 September 2009

Cognitive/behavioural links and macroeconomic models

Everyone is looking for new macroeconomic models these days. Paul Krugman's recent article has been a prompt for a reopening of intense discussion on the matter.

It seems that there are two major classes of proposal emerging: those based on cognitive/behavioural insights, and those which incorporate financial firms as part of the model instead of just assuming they transparently pass demand and money around the economy.

Financial models include "New Models for a New Challenge", Cecchetti, Disyatat and Kohler's proposal (via Mark Thoma - though a number of the comments on his posting point back towards the behavioural option). Another is Kobayashi's, which I may have mentioned before.

I've explored the behavioural models more in past columns but I hadn't noticed this conference in Australia which looks to have had some interesting presentations. Krugman hints at behavioural explanations in his commentary but has not yet suggested a model incorporating them. George Akerlof's Nobel price acceptance speech in 2001 introduced some ideas from behavioural research into macroeconomics but his recent book, "Animal Spirits", co-authored with Robert Shiller, has, disappointingly, not moved the discussion forward much. Arnold Kling has some useful comments here. I'm still waiting for a model that will provide a convincing behavioural explanation of major macroeconomic phenomena.

Some people such as Rob Killick have a different objection to the behavioural models - not an economic but a political one. He complains that the idea of cognitive biases puts the blame on people for the crisis and lets "the system" off the hook. I think this very much depends on how the insights are used - my advice would be that behavioural insights should absolutely be used to change the system, not to excuse it.

Some such as Paul Mason believe there will be no revolution - his language is reminiscent of some of the heterodox economics arguments from these guys (who also discuss Krugman's article here).

Outside of the quest for new models, there are interesting discussions going on about the existing models. Scott Sumner's ideas are interesting and a more immediately relevant (but more technical) aspect of Krugman's article is the discussion of Say's Law and Keynesianism, on which I'll have more to write soon.

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