Behavioral and Experimental Macroeconomics and Policy Analysis: A Complex Systems Approach

Abstract

This survey discusses behavioral and experimental macroeconomics, emphasizing a complex systems perspective. The economy consists of boundedly rational heterogeneous agents who do not fully understand their complex environment and use simple decision heuristics. Central to our survey is the question of under which conditions a complex macro-system of interacting agents may or may not coordinate on the rational equilibrium outcome. A general finding is that under positive expectations feedback (strategic complementarity)—where optimistic (pessimistic) expectations can cause a boom (bust)—coordination failures are quite common. The economy is then rather unstable, and persistent aggregate fluctuations arise strongly amplified by coordination on trend-following behavior leading to (almost-)self-fulfilling equilibria. Heterogeneous expectations and heuristics switching models match this observed micro and macro behavior surprisingly well. We also discuss policy implications of this coordination failure on the perfectly rational aggregate outcome and how policy can help to manage the self-organization process of a complex economic system. (JEL C63, C90, D91, E12, E71, G12)

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“…To describe the interactions between heterogeneous investors, most researchers compared the heterogeneous agents' model (HAM) with adaptive belief, introduced in 1997 and applied to financial markets. In the last two decades, broad behavioural literature on heterogeneous agents' models (HAMs) with boundedly rational agents with heterogeneous expectations has developed; (Hommes, 2021). Before the crisis, Central Banks and other policy institutions extensively utilised the essential class of macro models: the Dynamic Stochastic General Equilibrium (DSGE) models (Hommes, 2021).…”

“…In the last two decades, broad behavioural literature on heterogeneous agents' models (HAMs) with boundedly rational agents with heterogeneous expectations has developed; (Hommes, 2021). Before the crisis, Central Banks and other policy institutions extensively utilised the essential class of macro models: the Dynamic Stochastic General Equilibrium (DSGE) models (Hommes, 2021). However, the DSGE models have been questioned (Stiglitz, 2018).…”

“…However, the DSGE models have been questioned (Stiglitz, 2018). After the outbreak of the financial-economic crisis, a serious debate among macroeconomists about the future of macroeconomic theory has arisen (Hommes, 2021). There have also been more extreme recommendations for transforming macro through a paradigm change to adopting an interdisciplinary complex systems approach, behavioural agent-based models, and simulation (rather than analytical tools) (Battiston et al, 2016); (Dawid & Gatti, 2018); (Bookstaber & Kirman, 2018); (Haldane & Turrell, 2019); (Hommes, 2021).…”

Bounded rationality in Keynesian beauty contests: a lesson for central bankers?

“…Laboratory studies have become an increasingly popular methodology to address questions related to macroeconomics (for surveys, seeHommes, 2013;Amano et al, 2014;Duffy, 2014;Cornand and Heinemann, 2019;Hommes, 2020).…”

“…For other surveys covering the topic strategic substitutes vs. complements, see, e.g.,Camerer and Fehr (2006);Hommes (2013Hommes ( , 2020.…”