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Why are Economies Unstable? Research Project
An Interactions-based Macroeconomic Model
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Principal Co-Investigator: Maxim Gusev
Maxim Gusev is a lead researcher in advanced quantitative strategies at LGT Capital Partners. Maxim obtained his MS in physics (1993) and PhD in theoretical physics (1995) from Moscow State University and completed his post-doctoral research at Universidad Autónoma de Madrid in 1996. Maxim was a researcher at Moscow State University during 1997-1998.
Principal Co-Investigator: Dimitri Kroujiline
Dimitri Kroujiline is a lead researcher in advanced quantitative strategies at LGT Capital Partners. Dimitri received his MS in physics (1991) from Moscow State University, as well as MS in applied mathematics (1994) and PhD in geophysics (1998) from Harvard University. Dimitri was a post-doctoral fellow at Harvard University during 1998-1999.
Project Summary
The traditional approach in economics and finance does not model the interactions between people. Yet, this approach does not fully explain certain observations, especially those related to emergent phenomena (i.e. moving between expansion and contraction in the economy, and between bull and bear markets in finance). When economic interactions between people are made explicit, an extra level of detail between the micro and macro levels is added. This makes the link between the micro and macro properties nontrivial. Can methods from statistical mechanics and dynamical systems help describe these interactions and give us insights into macroeconomic instability?
Decision making involves both independent thinking and exchange of opinions via interactions with others. By taking into account interaction among agents, we may do a better job at capturing source of instability (see an overview by Lux, 2009). For example, interactions may lead small disturbances to have much larger consequences for the economy. An example of this sort of amplification was of course the sub-prime crisis leading to the Global Financial Crisis.
To investigate this, we aim to derive a tractable interactions-based macroeconomic model from microfoundations to shed light on the sources of instability. This approach will extend the modeling framework, developed for the stock market in Gusev et al. (2015), to the general economy.
Results
Working Paper
A Simple Economic Model with Interactions
Maxim Gusev, Dimitri Kroujiline | June 3, 2020
Abstract:
Macroeconomic models rarely make explicit how agents actually interact. If however interaction is explicitly specified, the link between the micro and macro properties of models becomes much richer, leading in certain cases to the onset of macro-level instability. This working paper incor- porates interactions among agents at a micro level into the basic Solow model to study disequilib- rium behaviors and economic instability on a macro level. In particular, we investigate two limit- ing cases. First, we recover the classic case where the economy converges to the balanced growth path and then grows along it. In the second case, where the interactions-fueled demand dynamics become the main force driving the economy, we obtain business cycles as quasiperiodic endoge- nous fluctuations.