In 1974 an article appeared in Science magazine with the dry-sounding title “Judgment Under Uncertainty: Heuristics and Biases” by a pair of psychologists who were not well known outside their discipline of decision theory. In it Amos Tversky and Daniel Kahneman introduced the world to Prospect Theory, which mapped out how humans actually behave when faced with decisions about gains and losses, in contrast to how economists assumed that people behave. Prospect Theory turned Economics on its head by demonstrating through a series of ingenious experiments that people are much more concerned with losses than they are with gains, and that framing a choice from one perspective or the other will result in decisions that are exactly the opposite of each other, even if the outcomes are monetarily the same. Prospect Theory led cognitive psychology in a new direction that began to uncover other human biases in thinking that are probably not learned but are part of our brain’s wiring.

Thinking fast and slow.

Será que a desigualdade de rendimentos aumentou durante os últimos tempos? Quem ganhou e quem perdeu neste processo? Este processo afectou todos os países da OCDE uniformemente? Em que medida é que maiores desigualdades de rendimentos são a consequência de maiores diferenças nos rendimentos dos trabalhadores e até que ponto são afectados por outros factores? Finalmente, como é que a redistribuição governamental através do sistema de benefícios fiscais afecta estas tendências?

Book Review: OECD, Growing Unequal? Income Distribution and Poverty in OECD Countries:

Maybe Greenberg hadn’t come across Fault Lines: How Hidden Fractures Still Threaten the World Economy. Raghuram G. Rajan, a professor at the University of Chicago and former chief economist at the International Monetary Fund, proves the exception to Greenberg’s rule of unsatisfactory endings. Where others have delved into the personalities and perverse systems that led to the financial crisis and then summed up with a half­baked list of policy ideas, Rajan puts a premium on policy. In fact, nearly half of Fault Lines is dedicated to policy choices that Rajan believes are not only realistically achievable but likely to be quite effective. He makes a good case.

Fault Lines How Hidden Fractures Still Threaten The World Economy

Much research in the last two decades has demonstrated that human responses deviate from the performance deemed normative according to various models of decision making and rational judgment (e.g., the basic axioms of utility theory). This gap between the normative and the descriptive can be interpreted as indicating systematic irrationalities in human cognition. However, four alternative interpretations preserve the assumption that human behavior and cognition is largely rational. These posit that the gap is due to (1) performance errors, (2) computational limitations, (3) the wrong norm being applied by the experimenter, and (4) a different construal of the task by the subject. In the debates about the viability of these alternative explanations, attention has been focused too narrowly on the model response. In a series of experiments involving most of the classic tasks in the heuristics and biases literature, we have examined the implications of individual differences in performance for each of the four explanations of the normative/descriptive gap. Performance errors are a minor factor in the gap; computational limitations underlie non-normative responding on several tasks, particularly those that involve some type of cognitive decontextualization. Unexpected patterns of covariance can suggest when the wrong norm is being applied to a task or when an alternative construal of the task should be considered appropriate.

Individual differences in reasoning: Implications for the rationality debate?-Open Peer Commentary-Differences, games, and pluralism

?Por que sucede la crisis economica de 2008? ?fue provocada por los Estados Unidos como una estrategia expansionista o una simple falla del sistema capitalista? En perspectiva, el mundo de las relaciones productivas impacta sobre el social y viceversa. No es extrano observar el interes de las ciencias sociales por el estudio del riesgo en los ultimos anos. Para los especialistas, el riesgo se corresponde con la probabilidad de sufrir algun dano a futuro...

Fault Lines, how hidden fractures still threaten the World Economy

Our paper contributes to the literature on the causes of the 2007–2008 financial crisis in the United States. By means of an agent-based model, we replicate an artificial credit-network economy in order to assess the impact of growing income inequality in the presence of peer effects and home equity borrowing. We show that the resulting debt-financed consumption boom jeopardises the stability of the economic system, thus paving the way for a financial crisis. Our model includes a behavioural rule for consumption based on expenditure cascades, a hierarchical structure of household finance, an articulated credit market with collateralised consumption loans and mortgages and a simple housing market. Results show that the model is able to capture the economic and social pressure of inequality on low and middle income households that pushes them to increase their consumption via home equity extraction. Rising non-performing loans lead to higher bad debt on the banks’ balance sheets and, consequently, to the emergence of a crisis as an endogenous dynamic.

https://www.boeckler.de/pdf/v_2014_10_30_cardaci.pdf

Inequality, household debt and financial instability: An agent-based perspective

Impact of rainfall pattern on cereal market and food security in Sudan: Stochastic approach and CGE model

By means of a macroeconomic model with an agent-based house- hold sector and a stock-flow consistent structure, we analyse the impact of rising income inequality on the likelihood of a crisis for different institutional settings. In particular, we study how economic crises emerge in the presence of different credit conditions and policy reactions to rising income disparities. Our simulations show the relevance of the degree of financialisation of an economy. In fact, when inequality grows, a Scylla and Charybdis kind of dilemma seems to arise: on the one hand, low credit availability implies a drop in aggregate demand and output; on the other hand, relaxed credit constraints and a higher willingness to lend result in greater financial instability and a debt-driven boom and bust cycle. We also point out that policy reactions play a key role: a real structural reform that tackles inequality, by means of a more progressive tax system, actually compensates for the rise in income disparities thereby stabilising the economy. Results also show that this is a better solution compared to a stronger fiscal policy reaction, which, instead, only leads to a larger duration of the boom and bust cycle.

Inequality, Financialisation and Economic Crises: An Agent-Based Macro Model

In this paper the authors extend the macroeconomic agent-based model described in Delli Gatti, D., Desiderio, S., Gaffeo, E., Cirillo, P. and Gallegati, M. (Macroeconomics from the bottom-up, 2011) with the inclusion of a bank-bank network that mimics real-world dynamics of interbank markets. They also introduce a public sector and other modifications in order to carry out different policy experiments. More specifically, they test the implementation of a monetary policy by means of a standard Taylor rule, an unconventional monetary policy (i.e. helicopter drop) and a set of macroprudential regulations. The authors explore the properties of the model for such different scenarios. The results shed some light on the effectiveness of monetary and macroprudential policies in an economy with an interbank market during times of crises.

https://www.econstor.eu/bitstream/10419/169125/1/898567319.pdf

Policy experiments in an agent-based model with credit networks

We develop a macroeconomic model with an agent-based household sector and a stock-flow consistent structure, in order to analyse the impact of rising income inequality on the likelihood of a debt crisis for diff erent institutional settings. In particular, we study how economic crises emerge in the presence of di fferent credit conditions and policy reactions to rising income disparities. Our simulations show the relevance of the degree of financialisation of an economy. In fact, when inequality grows, a Scylla and Charybdis kind of dilemma seems to arise: on the one hand, low credit availability implies a drop in aggregate demand and output; on the other hand, a higher willingness to lend and lower perceptions of system risk result in greater instability and a debt-driven boom and bust cycle. The model allows us to replicate the credit-led consumption booms that paved the way for both the crisis of 1929 and the recent financial crisis. In addition, our paper yields a new insight on the appropriate policy reaction: tackling inequality by means of a more progressive tax system compensates for the rise in income disparities thereby stabilising the economy. This is a better solution compared to a more proactive fiscal policy which, instead, only leads to a larger duration of the boom and bust cycle.

https://sep.luiss.it/sites/sep.luiss.it/files/WPSEP%2002-16%20Cardaci%20Saraceno.pdf

Alberto Cardaci

Papers

Inequality, household debt and financial instability: An agent-based perspective

Impact of rainfall pattern on cereal market and food security in Sudan: Stochastic approach and CGE model

Inequality, Financialisation and Economic Crises: An Agent-Based Macro Model

Policy experiments in an agent-based model with credit networks

Inequality, Financialisation and Credit Booms: a Model of Two Crises