Non-self-averaging in macroeconomic models: a criticism of modern micro-founded macroeconomics

When the coefficient of variation, namely the ratio of the standard deviation over the mean approaches zero as the number of economic agents becomes large, a system is called self-averaging. Otherwise, it is non-self-averaging. Most economic models take it for granted that the economic system is self-averaging. However, they are based on the extremely unrealistic assumption that all the economic agents face the same probability distribution, and that micro shocks are independent. Once these unrealistic assumptions are dropped, non-self-averaging behavior naturally emerges. Using a simple stochastic growth model, this paper demonstrates that the coefficient of variation of aggregate output or GDP does not go to zero even if the number of sectors or economic agents goes to infinity. Non-self-averaging phenomena imply that even if the number of economic agents is large, dispersion could remain significant, and we cannot legitimately focus solely on the means of aggregate variables. This, in turn, means that the standard microeconomic foundations based on representative agents have little value for they are meant to provide us with accurate dynamics of the means of aggregate variables. Contrary to the main stream view, micro-founded macroeconomics such as a dynamic general equilibrium model does not provide solid micro foundations.     

ECONOMIC FLUCTUATIONS WITH INTERACTIVE AGENTS: DYNAMIC AND STOCHASTIC EXTERNALITIES*

This paper proposes a general modelling framework for macroeconomic dynamic behaviour of a large collection of interacting agents, and illustrates the procedure for a simple case of agents having the same binary decision set. Evolution over time of the fractions of agents using the same technology is modelled as a birth-and-death stochastic process with endogenized transition rates, and its master equation (Chapman-Kolmogorov backward equation) is expanded into power series in the total number of agents in the model. The first term of the expansion is the aggregate (macroeconomic) dynamic model. Stochastic dynamics of the proportions of agents using the same technology can exhibit multiple equilibria; this paper discusses an example with one locally unstable and two locally stable equilibria, with some simulation computer runs. There are two results of broad implication. One is the demonstration that stochastic dynamics allocates positive probabilities to all locally stable equilibria. Stochastic dynamics thus stands in sharp contrast to deterministic dynamics. In the latter, history (initial conditions) and expectations (often exogenously introduced discontinuous changes in trajectories) uniquely select the basin of attraction in which trajectories are eventually located. The second is the illustration of the usefulness of jump Markov processes in general, and birth-and-death processes in particular in economic modelling. Among several results specific to these processes, we show that the mean first passage time from one locally stable equilibrium to another is proportional to the exponential function of the height of the potential barrier separating the two basins of attraction of these two locally stable equilibria.     

Misadjustment to anticipated shocks: an example of exchange-rate response

A simple model for a small open economy is used to illustrate a distinction between over(under)shooting and what is labeled as misadjusting responses of the exchange rate in this paper. If the relative price elasticity of the aggregate demand, d, is greater than 1, then the exchange rate misadjusts when the time interval between the date when the exchange is anticipated for the first time to the realization of the change is longer than a certain minimum, called the minimum lead time. If d is less than 1, then the exchange rate overshoots with sufficiently long lead time when a shift up of real output is anticipated.     

House prices, consumption, and monetary policy: a financial accelerator approach

We consider a general equilibrium model with frictions in credit markets used by households. In our economy, houses provide housing services to consumers and serve as collateral to lower borrowing cost. We show that this amplifies and propagates the effect of monetary policy shocks on housing investment, house prices and consumption. We also consider the effect of a structural change in credit markets that lowers the transaction costs of additional borrowing against housing equity. We show that such a change would increase the effect of monetary policy shocks on consumption, but would decrease the effect on house prices and housing investment.     

On decentralized stabilization policies and dynamic assignment problems

The paper formulates the assignment problem in a dynamic setting where both the system and the instrument generation are dynamically modeled, taking explicit account of finite adjustment speeds. The decentralized stabilization problem for this dynamic model is then formulated, and several special cases are solved. An example of a two-country model is presented in which target variables of the two governments overlap. The root-locus analysis method is used to solve the stabilization problem for this example. The paper concludes with a brief discussion of comparative advantage in dynamic setting.     

Promoting access to intellectual property: patent pools, copyright collectives, and clearinghouses

This paper reviews and compares patent pools, intellectual property (IP) clearinghouses, and copyright collectives as systems for promoting efficient access to licensable IP in a 'market for technology'. These systems promote downstream use of innovations by economizing on search and transaction costs in licensing, as well as potentially mitigating the conditions that lead to the 'tragedy of the anti-commons' and other coordination problems in multilateral licensing. We compare and classify different systems in terms of their features, review some existing systems, and discuss their economic characteristics.     

INEFFICIENT INFORMATION AGGREGATION AS A SOURCE OF ASSET PRICE BUBBLES

This paper presents a new theory of bubbles, or discrepancies between the market clearing price and the fundamental value of an asset. In our setting, Bayesian traders, oriented towards long-term gains, receive private information ('news') and also make inferences from noisy price signals. Price exhibits higher variance than fundamental value (the latter defined as fully-aggregated expected value) especially when news is informative but infrequent. The corresponding bubbles are self-limiting but may exhibit momentum and overshooting. A parametric example, involving the exponential/gamma conjugate families, is provided.
We don't have any penetrating explanations of yesterday's stock market, but we certainly believe that stocks do not fall 86½ points for nothing.
The general case for a drop in the market after its recent record highs is clear enough. The Fed…,… the tax bill.
None of this, though, was any different on Thursday than it was with the market at its peak six sessions ago. News…and rumors yesterday…were certainly negative but scarcely dramatic.
Some market pros believe this kind of a drop is merely the market catching up with what it already knew. We doubt it. Our hunch is that something changed between Wednesday and Thursday, and that eventually we'll learn what it was ( Wall Street Journal Editorial, Friday, September 12, 1986).     

Bankruptcy filings before and after implementation of the bankruptcy reform law

After the effective date of the Bankruptcy Reform Act (1979), bankruptcy filings rose sharply in most states. The increase can be ascribed partially to the fact that unemployment rose and working hours declined from 1978 to 1980. In addition, state laws on garnishment had a greater effect on bankruptcy filings in 1980 than in 1978. Nonetheless, a significant increase in filing rates from 1978 to 1980 could not be accounted for by changes in state laws or employment conditions. The evidence is consistent with the hypothesis that the Act, per se, contributed to the increase in bankruptcy filings.