Towards a dynamic disequilibrium theory with randomness

Abstract

The 2008 Global Financial Crisis, and the myriad other crises confronting economies around the world, exposed the inadequacies of the Dynamic Stochastic General Equilibrium models. These models not only hadn’t predicted the crisis, its occurrence was completely outside of their framework. The framework assumes there are no macroeconomic inconsistencies—all plans are realized, all budget constraints honoured. But after each instance in which that assumption is proved wrong, say in a crisis, the DSGE models assume that kind of event won’t happen again. By contrast, our framework explains why these inconsistencies arise and investigates the consequences, shows how large changes in the aggregate demand could trigger inconsistencies, explains the origins of such changes, and explains why decentralized market forces may be disequilibrating. We identify the crucial departures from the Arrow–Debreu assumptions underlying our results. We analyse the policy implications of this alternative theory, which typically are distinctly different from those of the standard model.

Bounded strategic reasoning explains crisis emergence in multi-agent market games

“…The previous section showed the average convergence towards the desired resource capacity c . Here, we consider the endogenous emergence of crises, or self-induced shocks [ 52 ], as a result of endogenous changes in agent beliefs [ 53 ]. Following [ 52 ], we consider crises to occur when the resulting attendance change is at least three standard deviations from the average historical attendance change, and refer to these as 3 + σ events.…”

“…changes in agent beliefs [53]. Following [52], we consider crises to occur when the resulting attendance change is at least three standard deviations greater than 3σ from the average historical attendance change, and refer to these as 3 + σ events.…”

What Problem Is Post-Crisis QE Trying to Solve?

“…However, this paper too is discussing the issue within the context of a narrowly considered banking system without looking at new business models and the increasingly blurred line between banks and shadow banks. In another theoretical paper Guzman and Stiglitz (2020) suggest a better way to understand deep downturns like the 2008 financial crisis is to think of the economy experiencing a constant evolution, marked by uncertainty and learning in the face of macroeconomic inconsistencies-processes which may be disequilibrating. This is certainly the way the present authors think about re-regulation, bank business model shifts and QE policies (See Guzman and Stiglitz 2020).…”