A Nobel Prize for Empirical Macroeconomics: Assessing the Contributions of Thomas Sargent and Christopher Sims

This paper provides an assessment of the contributions of the 2011 Nobel Prize winners, Thomas Sargent and Christopher Sims. They received the prize ‘for their empirical research on cause and effect in the macroeconomy’. The paper illustrates that Sargent entertained different interpretations of rational expectations during distinct phases of his research. And it shows that Sims shifted the focus from theoretical identification restrictions to identifying the main characteristics of the time series data, a shift of focus from theory to time series.     

The dynamics of risk-sensitive allocations

This paper describes Pareto optimal allocations when agents have risk-sensitive preferences as formulated by Hansen and Sargent (IEEE Trans. Automat. Control 40(5) (1995) 968-971). Necessary and sufficient conditions are given for the existence and stability of steady states at which Pareto weights are time-invariant. When all agents are risk-sensitive with the same power reward function there is a unique interior steady state which is stable when the power is positive and unstable when the power is negative. When there is at least one agent with time-additive preferences eventually all risk-sensitive agents have zero Pareto weights.     

ON DETAIL‐FREE MECHANISM DESIGN AND RATIONALITY*

Mechanism design theory has been criticized, because mechanisms depend on the detail of specification and agents’ behaviour relies on strong rationality assumptions. Hence the study of “detail‐free” mechanism design with weak rationality is important as a practical theory. This paper emphasizes that, even if we confine our attention to detail‐free mechanisms with weak rationality, there exists plenty of scope for the development of new and significant ideas. I describe my recent work along these lines, and argue that stochastic decisions work in large double auction environments, and that moral preferences improve the implementability of social choice functions.     

Dynamic variational preferences

We introduce and axiomatize dynamic variational preferences, the dynamic version of the variational preferences we axiomatized in [F. Maccheroni, M. Marinacci, A. Rustichini, Ambiguity aversion, robustness, and the variational representation of preferences, Mimeo, 2004], which generalize the multiple priors preferences of Gilboa and Schmeidler [Maxmin expected utility with a non-unique prior, J. Math. Econ. 18 (1989) 141-153], and include the Multiplier Preferences inspired by robust control and first used in macroeconomics by Hansen and Sargent (see [L.P. Hansen, T.J. Sargent, Robust control and model uncertainty, Amer. Econ. Rev. 91 (2001) 60-66]), as well as the classic Mean Variance Preferences of Markovitz and Tobin. We provide a condition that makes dynamic variational preferences time consistent, and their representation recursive. This gives them the analytical tractability needed in macroeconomic and financial applications. A corollary of our results is that Multiplier Preferences are time consistent, but Mean Variance Preferences are not.     

Tooke's approach to explaining prices

This paper examines the method of analysis and theoretical approach Thomas Tooke (1774–1858) employed in his empirical study of English prices. It is shown that Tooke adopted the “long period method” formulated by Adam Smith to analyse a capitalist society. It is shown that like most nineteenth-century classical economists, Tooke adopted a modified version of Adam Smith's “adding-up” approach to normal prices and distribution which incoporated Ricardo's theory of rent. The paper shows that based on this approach, Tooke explained short-run fluctuations in prices be reference to factors that disrupted the adjustment of supply to the “effectual” demand for commodities.     

Price Level Determinacy under a Pure Interest Rate Peg

In this article we reexamine a famous result by T. J. Sargent and N. Wallace (1975, Journal of Political Economy83, 241–254) according to which a “pure interest rate peg” leads to nominal price indeterminacy. We use P. Weil's (1991, International Economic Review32, 37–53) generalization of the Sidrauski–Brock model, where arrival of new “generations” of infinitely lived agents is allowed, and we obtain the following results: (i) Nominal indeterminacy holds in the traditional Sidrauski–Brock framework; (ii) This nominal indeterminacy disappears as soon as new generations arrive in time, via some rigorous version of Patinkin's “real balance effect”; (iii) A multiplicity of solutions may still remain, but full determinacy occurs in some cases, depending notably on fiscal policy or the distribution of endowments in time. Journal of Economic Literature Classification Numbers: E4, E5     

Guy Routh's Heterodox Critique of Economic Methodology

Guy Routh was an outstandingly incisive and severe critic of mainstream economic theory's abstraction, class bias, and empirical irrelevance. Routh's The Origin of Economic Ideas (1975 1989), with such chapter titles as “The Preposterous Origins” and “From Propaganda to Dogma”, was described by Robert Heilbroner as “irreverent, original, controversial, and delightful” while J. K. Galbraith expressed his “utmost enjoyment” and “utmost approval” of the book. Routh's trenchant critique of mainstream theorizing and his vision of an empirically-grounded alternative have been largely forgotten since his death in 1993, but deserve the attention of heterodox and especially of institutionalist and social economists.     

The Exchange Rate and its Fundamentals in a Complex World

We develop a nonlinear exchange rate model with heterogeneous agents. Some agents adopt a “fundamentalist” forecasting rule, while others use a “chartist” forecasting rule. We show that the model is capable of explaining the empirical puzzles relating to exchange rate movements. In particular, the model explains the “exchange rate determination” and PPP puzzles, the excess volatility, and fat tails in exchange rate returns.     

Author׳s gender affects rating of academic articles: Evidence from an incentivized,deception-free laboratory experiment

Even though women׳s position in academia has changed dramatically over the last few decades, there is still some evidence that when it comes to evaluation of scientific achievements, gender may play a significant role. Gender bias is particularly likely to take the form of statistical discrimination. In this study we sought to verify the hypothesis that researcher׳s gender affects evaluation of his or her work, especially in a field where women only represent a minority. Towards this end we asked a sample of subjects, mostly economics majors, to evaluate a paper written by mixed-gender couples, indicating that it was (co-)authored by a “female economist”, “male economist”, “young female economist” or “young male economist” or giving no information about the author at all. While age factor played no role, female authors appeared to be seen as less competent than males, in that subjects (being incentivized to give their best judgment) less often believed that their papers have been published. This effect did not interact strongly with the gender of the subject.     

The randomness of rational expectations: a perspective on Sargent's early incentives *

This paper searches for the story Thomas Sargent is likely to have told when he was trying to use rational expectations economics in the late-1960s and early 1970s. An argument will be made for his interest in achieving what he would regard as conceptual integrity of the determinism in neoclassical economic theory and the randomness in econometrics. This involves providing a narrative of how he came to the idea of rational expectations and what he had to relinquish to be able to put his initial interpretation of the concept to use.     

INCOMPLETE INFORMATION GAMES WITH MULTIPLE PRIORS*

We present a model of incomplete information games, where each player is endowed with a set of priors. Upon arrival of private information, it is assumed that each player “updates” his set of priors to a set of posterior beliefs, and then evaluates his actions by the most pessimistic posterior beliefs. So each player's preferences may exhibit aversion to ambiguity or uncertainty. We define a couple of equilibrium concepts, establish existence results for them, and demonstrate by examples how players’ views on uncertainty about the environment affect the strategic outcomes.     

Nonlinear adjustment in US bond yields: An empirical model with conditional heteroskedasticity

Starting from the work by Campbell and Shiller (Campbell, J.Y. and Shiller, R.J. (1987). Cointegration and tests of present value models. Journal of Political Economy, 95(5):1062–1088.), empirical analysis of interest rates has been conducted in the framework of cointegration. However, parts of this approach have been questioned recently, as the adjustment mechanism may not follow a simple linear rule; another line of criticism points out that stationarity of the spreads is difficult to maintain empirically.     

Institutionalism,Planning, and the Current Crisis

This article originated in a shock of recognition. In the second volume of his discourse on “Civilization and Capitalism,” Fernand Braudel muses on the “eclecticism” of “the most advanced kind of capitalism”: “As if the characteristic advantage of standing at the commanding heights of the economy … consisted precisely of not having to confine oneself to a single choice, of being able, as today’s businessmen would put it, to keep one’s options open.”¹ My colleagues and I work as venture capitalists and as investment bankers of a specialized kind, engaged in raising capital to support the growth of technologybased companies and in realizing liquidity for their founding investors—often ourselves—by managing public offerings of their shares or by merging them into much larger companies. A primary virtue of our practice is the opportunity to choose with broad discretion where to commit our own and our clients’ capital across what Braudel calls “the differential geography ofprofit.”²     

An empirical investigation of the effect of borrowing constraints on Spanish consumption

Abstract. This work analyses the relevance of borrowing constraints on the intertemporal behaviour of Spanish non-durable consumption. We estimate Euler equations with cohort data extracted from the “Encuesta Continua de Presupuestos Familiares” (ECPF) for the period 1985–1993. The results are robust to the use of different estimators to eliminate fixed individual effects, to different specifications of the model, to the effect of uncertainty and to the presence of habits in consumption. Our results allow us to conclude that non-durable consumption of a considerable fraction of the Spanish population is affected by borrowing constraints. At the same time, and in accordance with similar results for other countries, we confirm that borrowing constraints are especially important for the young. The author acknowledges the grant received from the Conselleria de Cultura, Educación y Ciencia de la Generalitat Valènciana, as part of its grant's programme for stays in foreign universities and the financial support by DGICYT grants SEC99-0820 and SEC 2002-00667. The author also acknowledges the hospitality of the Department of Economics at University College London (UCL) and of the Departamento de Análisis Económico de la Universidad Nacional de Educación a Distancia. This work has been presented in the XXV Simposio de Análisis Económico, held in Bellaterra (Spain) in December 2000. Finally, the author acknowledges comments by J. E. Boscá and two anonymous referees that have contributed to improving the final version of the paper.     

Robust control and model misspecification

A decision maker fears that data are generated by a statistical perturbation of an approximating model that is either a controlled diffusion or a controlled measure over continuous functions of time. A perturbation is constrained in terms of its relative entropy. Several different two-player zero-sum games that yield robust decision rules are related to one another, to the max-min expected utility theory of Gilboa and Schmeidler [Maxmin expected utility with non-unique prior, J. Math. Econ. 18 (1989) 141-153], and to the recursive risk-sensitivity criterion described in discrete time by Hansen and Sargent [Discounted linear exponential quadratic Gaussian control, IEEE Trans. Automat. Control 40 (5) (1995) 968-971]. To represent perturbed models, we use martingales on the probability space associated with the approximating model. Alternative sequential and nonsequential versions of robust control theory imply identical robust decision rules that are dynamically consistent in a useful sense.     

Recursive robust estimation and control without commitment

In a Markov decision problem with hidden state variables, a posterior distribution serves as a state variable and Bayes’ law under an approximating model gives its law of motion. A decision maker expresses fear that his model is misspecified by surrounding it with a set of alternatives that are nearby when measured by their expected log likelihood ratios (entropies). Martingales represent alternative models. A decision maker constructs a sequence of robust decision rules by pretending that a sequence of minimizing players choose increments to martingales and distortions to the prior over the hidden state. A risk sensitivity operator induces robustness to perturbations of the approximating model conditioned on the hidden state. Another risk sensitivity operator induces robustness to the prior distribution over the hidden state. We use these operators to extend the approach of Hansen and Sargent [Discounted linear exponential quadratic Gaussian control, IEEE Trans. Automat. Control 40(5) (1995) 968-971] to problems that contain hidden states.     

GLOBALIZATION: CONTENTS AND DISCONTENTS

William Shakespeare's Tragedy of King Richard III, written approximately in 1592, is the story of evil acts by the detested and misshapen hunchback, Richard, who plots to sow discontent among his brother, the King, and others, and has his brother murdered along with other wicked deeds in order to gain the throne. It opens with the line, “Now is the winter of our discontent” (p. 111, ed. Wright 1936). “The Winter of Our Discontent” is also the title of John Steinbeck's (1961) novel of a man who trades his moral convictions to reclaim lost family wealth. “Globalization and Its Discontents” is the title of Joseph Stiglitz's (2002) book that critiques rigid adherence by major economic institutions—such as the International Monetary Fund—to economic orthodoxy in the promotion of globalization. (JEL F6, D72, D3, O23, O24, L17, K33)     

Nominal bargaining power, selection protocol, and discounting in legislative bargaining

The comparative static predictions of the Baron and Ferejohn [Baron, D.P., and Ferejohn, J.A., (1989). Bargaining in legislatures, American Political Science Review 83 (4), 1181-1206] model better organize behavior in legislative bargaining experiments than Gamson's Law. Regressions similar to those employed in field data produce results seemingly in support of Gamson's Law (even when using data generated by simulating agents who behave according to the Baron-Ferejohn model), but this is determined by the selection protocol which recognizes voting blocks in proportion to the number of votes controlled. Proposer power is not nearly as strong as predicted in the closed rule Baron and Ferejohn model, as coalition partners refuse to take the small shares given by the continuation value of the game. Discounting pushes behavior in the direction predicted by Baron and Ferejohn but has a much smaller effect than predicted.     

The Relationship between Anthropology and Economics

This article provides an institutional perspective on a recent effort by the author to develop a comprehensive empirical model of the “high-tech” sector of the Texas economy.¹ The model is unique in that it incorporates institutional phenomena into econometric analysis. This approach has been suggested by the author in previous work.²     

Adam Smith's “tolerable administration of justice” and the Wealth of Nations

Adam Smith argues that a country’s income depends on its labor productivity, which in turn hinges on the division of labor. But why are some countries able to take advantage of the division of labor and become rich, while others fail to do so and remain poor? Smith describes how the security of property rights, through a “tolerable administration of justice,” allows investment and exchange to take place, bringing about economic progress. Recent empirical work on economic development has supported Smith’s emphasis on a country’s political “institutions,” particularly the judiciary, in determining its national income.