Like all human beings, we enjoy the ups and downs of a roller coaster but not necessarily everywhere else in life. We typically dislike fluctuations in our economic and social conditions.
A lot of our actions are designed to limit abrupt changes in our living conditions: we eat three times a day rather than once; we use central heating in the winter and air conditioning in the summer; we save for our old age; we subscribe for insurance and vote for unemployment benefits etc.
If an individual, call them Robinson, were stranded on an island, it is unlikely they would take decisions which would endogenously induce boom and bust cycles. The only reason there would be boom-bust cycles on a self-sufficient island is if nature imposed busts through droughts and other extrinsic shocks such as sunspots.
However, economies as collections of many people and institutions experience booms and busts, expansions and recessions, periods of exuberance and periods of despair. How can we reconcile our individual quest for stability with the apparent inherent instability of socio-economic systems? Why do our individual decisions aiming at stability translate into unstable macroeconomic outcomes?
Our project funded by Rebuilding Macroeconomics examines why then do reasonable individual decisions, in aggregate, produce economy wide outcomes that have characteristics that are distinct from the intention of individual behavior. The idea that aggregate outcomes have properties very different from individual level decisions is referred to in the system theory literature as emergent phenomena.
Emergent structures can be found in many natural phenomena: hurricanes emerge from mutual positive feedback between wind, humidity, evaporation of warm surface waters and Coriolis effects. Swarm behaviour of marching locusts, schooling fish and flocking birds are famous natural life examples of emergent phenomena.
There has been little effort in economics at understanding emergent phenomena in a systematic way. The existence of a two-way feedback between microstructure and macrostructure has been recognised for a very long time, from the invisible hand of Adam Smith to the work of Hayek and Schelling. There are many examples where aggregate outcomes may display instability when individual level decisions are aimed at favouring stability, but it is unclear what are the key forces driving such phenomena.
Although we have a lot to learn from those natural emergent phenomena, studying economic emergent phenomena is somewhat different than in other fields for two reasons. First, the decisions units are not simply governed by habit or genes. Economic decision makers are constantly trying to understand the system in which they live and try to take purposeful decisions accordingly.
Second, these agents are often forward looking, taking decisions that reflect how they think their environment may evolve over time. Both these characteristics give constraints on behaviour that are generally not present in the main body studying emergent phenomena.
Understanding emergent phenomena in a systematic way is crucial if we want to stabilise the economy and produce better macroeconomic outcomes. Only a systemic understanding of what may cause instability will allow us to specify well-targeted policies.
In our systematic study of emergent phenomena under the Instability Hub, emergent behaviour could take different forms such as hysteresis, limit cycles or chaos. This will give us a way to better to direct our empirical exploration as to both find what type of instability may be most prevalent at the macroeconomic level, and what type of microeconomic phenomena may best explains it.
Click here to see the progress of this research project.
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15 January 2019