Monthly Archives: December 2010

Networks and Macroeconomics

No other field challenges your beliefs like macroeconomics. It will just not allow you to rest unless you decide to give up and fall into the trap of what Ricardo Cabellaro calls ‘the pretense of knowledge’. In a very convincingly argued case against the pitfalls of reading too much into the precision and addictiveness of the Dynamic Stochastic General Equilibrium Modelling framework, he introduces us to some interesting, alternative ways of looking at the macroeconomy.

These models try to capture the nature of economic complexity that is easily eschewed by the DSGE framework in favor of precision and neat quantitative results. According to Caballero, “ the nodes of such economic models are special for they contain agents with frontal lobes who can both strategize and panic”. Networks are important and such agents introduce much of unpredictability in the linkages.

Do agents always understand the complete networks and linkages? Apparently not. In fact  “the importance of this lack of understanding is at its most extreme level during financial crises when seemingly irrelevant and distant linkages are perceived to be relevant”.  Novelty and uncertainty play an important role in determining the size of reaction as well.

He also introduces us to literature that deals with developing a policy framework which is robust to small mistakes from the policy maker. Hansen and Sargent’s extremely readable “Robustness” is an important contribution to this literature.

I don’t really have the expertise to comment on what this means for the fate of the whole DSGE world and whether grad students can get away with not learning it. However, I am definitely convinced that the research cited by Cabellaro certainly offers a fresh perspective of linking individual behavior to macro behavior. Randomly browsing the net for his cited references, I came across a course on networks offered by Daron Acemoglu of MIT. The introduction in his course syllabus is worth reproducing here:

Networks are ubiquitous in our modern society. The World Wide Web that links us to and enables information flows with the rest of the world is the most visible example. But it is only one of many networks within which we are situated. Our social life is organized around networks of friends and colleagues. These networks determine our information, influence our opinions, and shape our political attitudes. They also link us, often through important but weak ties, to everybody else in the United States and in the world. Economic and financial markets also look much more like networks than anonymous marketplaces. Firms interact with the same suppliers and customers and use web-like supply chains. Financial linkages, both among banks and between consumers, companies and banks, also form a network over which funds flow and risks are shared. Systemic risk in financial markets often results from the counterparty risks created within this financial network. Food chains, interacting biological systems and the spread and containment of epidemics are some of the other natural and social phenomena that exhibit a marked networked structure.

So, while working on the dissertation, when I was just starting to think that I finally might have made it at least somewhat near the frontier, here comes a group of very intelligent economists pushing it even further!

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Filed under current economic issues, macroeconomics, Macroeconomics and the crisis, social perspectives