The Marriage of Psychology with Multiple Equilibria in Economics

This is the first of a new weekly blog series, Monday’s Macro Memo with Roger Farmer, which will discuss a wide range of economic issues of the day. The blog will appear on both the NIESR site and on Roger Farmer’s Economic Window and in the first few weeks, I will be posting a series of videos, recorded at a conference held at the Bank England  on July 3rd and 4th of 2017.  The conference was titled "Applications of Behavioural Economics and Multiple Equilibrium Models to Macroeconomic Policy" and the photograph below is of the presenters, discussants and some of the attendees.

Participants at the Conference

Participants at the Conference

I had been planning, for some time, to run a conference on the topic of multiple equilibria sponsored by Warwick University. Andy Haldane and Sujit Kapadia had been talking with Alan Taylor of U.C. Davis about organizing a conference on the topic of behavioural economics. After talking with Andy, Sujit and Alan, we decided it would be ideal to combine our plans into a single conference that would highlight the promise of studying the marriage of psychology with multiple equilibria in economics. The video, linked below, explains why this is a fruitful idea. 

For more than thirty years, I have advanced a research agenda which  promotes the idea that psychology, aka beliefs, matters for economics. Beliefs are central to determining economic outcomes and should be treated as a new fundamental. My own research and the research of my graduate students, Konstantin Platonov and Giovanni Nicolò, also featured at the conference, studies models of multiple equilibria. But these models are incomplete. When an economic model has multiple possible outcomes, the social scientist who constructed the model has not finished her job. She must explain what feature of the social world selects which of the many possible equilibrium outcomes will prevail. That’s where psychology enters the picture.  Economists talk of animal spirits as a factor that helps to determine the unemployment rate and the inflation rate in the real world. Psychology tells us where animal spirits come from and how they are determined.

There is increasing interest in the way that stories influence the real economy. This was the topic of Robert Shiller's 2017 Presidential address to the American Economic Association. Stories have no role to play in conventional economic models because Robert Lucas, writing in 1972, persuaded the profession that the expectations of market participants are determined by economic fundamentals. That idea makes sense in economic models where there is a unique equilibrium. It makes little or no sense in models like the ones I promoted in my 1993 book, the Macroeconomics of Self-Fulfilling Prophecies,  where there are multiple equilibria. The papers presented at the Bank of England conference are about the tensions between these two sets of ideas.

In addition to the introductory video, linked above, we also recorded videos from many of the conference presenters and discussants. I will be releasing these videos in a series of posts in the coming weeks and I will discuss the research associated with the accompanying topic. You can find links to the original papers on the conference website linked here. Stay tuned.