Economic Implications of Model Uncertainty
Sunday, Jan. 7, 2018 10:15 AM - 12:15 PM
- Chair: Stephen Morris, Princeton University
The Tail that Wags the Economy: Beliefs and Persistent Stagnation
AbstractThe Great Recession was a deep downturn with long-lasting eects on credit markets, labor markets and output. While narratives about what caused the recession abound, the persistence of GDP below its pre-crisis trend is puzzling. We propose a simple persistence mechanism that can be easily quantified and combined with existing models, even complex ones. Our solution rests on the premise that no one knows the true distribution of shocks to the economy. If agents use observed macro data to estimate this distribution non-parametrically, then transitory events, especially extreme events, generate persistent changes in beliefs and thus in macro outcomes. We apply our tool to an existing model, designed to explain the onset of the great recession, and find that adding belief updating endogenously generates the persistence of the downward shift in US output, colloquially known as "secular stagnation."
Games of Incomplete Information Played by Statisticians
AbstractThe common prior assumption is a convenient restriction on beliefs in games of incomplete information, but conflicts with evidence that players publicly disagree in many economic environments. This paper proposes a foundation for heterogeneous beliefs in games, in which disagreement arises not from different information, but from different interpretations of common information. A key assumption imposes that while players may interpret data in different ways,
they have common certainty in the predictions induced by a class of interpretations.
The main results characterize which rationalizable actions and Nash equilibria can be predicted when agents observe a finite quantity of data, and how much data is needed to predict different solutions. This quantity, which I refer to as the robustness of the solution, is shown to depend crucially on the degree of strictness of the solution and the "complexity" of inference from data.
Crises: Equilibrium Shifts and Large Shocks
AbstractA coordination game with incomplete information is played through time. In each period, payoffs depend on a fundamental state and an additional idiosyncratic shock. Fundamentals evolve according to a random walk where the changes in fundamentals (namely common shocks) have a fat-tailed distribution. We show that majority play shifts either if fundamentals reach a critical threshold or if there are large common shocks, even before the threshold is reached. The fat-tails assumption matters because it implies that large shocks make players more unsure about whether their payoffs are higher than others. This feature is necessary for large shocks to matter.
- D8 - Information, Knowledge, and Uncertainty
- E3 - Prices, Business Fluctuations, and Cycles