Knowing and Making

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 ...

Eric Falkenstein has an interesting post  which highlights some of the problems in the study of behavioural economics (in this case, behavioural finance). I have to agree with his premise, though my conclusions are a bit different. I've just reread some of Nudge  and am partway through Animal Spirits . Both books cheerlead for the behavioural cause - though in each case, one author - Thaler and Shiller respectively - seem to be much more closely associated with it than the other - Sunstein and Akerlof. However both books exemplify the problem that Falkenstein identifies. The field is full of effects without explanations. You can easily list a whole string of cognitive biases which can be easily demonstrated - I show the effect directly to audiences in presentations, by running a price anchoring experiment. But the behaviourists rarely seem to propose a good underlying model of how these effects arise. Having just completed another book, The Making of an Economics, Redux , I can see...