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Uncertainty, Beliefs, and Crises in Macroeconomics

English title Uncertainty, Beliefs, and Crises in Macroeconomics
Applicant Oechslin Manuel
Number 189088
Funding scheme Project funding (Div. I-III)
Research institution Faculty of Economics & Management University of Lucerne
Institution of higher education University of Lucerne - LU
Main discipline Economics
Start/End 01.09.2020 - 31.08.2024
Approved amount 502'568.00
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Keywords (10)

Macroeconomic crises; Belief contest; Macroeconomics; State space; Fundamental uncertainty; Limited time horizon; Macroeconomic regulation and stabilization; Intertemporal preferences; Macroeconomic time series; Subjective beliefs

Lay Summary (German)

Lead
Marktwirtschaften generieren regelmässig Innovationen in der Form neuartiger Geschäftsmodelle und Institutionen. Als Folge ändern sich oft gesamtwirtschaftliche Zusammenhänge in einer Art und Weise, die sich nur unzureichend objektiv, d.h. aufgrund vorhandener Daten und Erfahrungen, abschätzen lässt. Makroökonomische Entwicklungen sind daher durch fundamentale Unsicherheit beeinflusst.
Lay summary
Dieses Projekt soll zum besseren Verständnis der Funktionsweise einer Wirtschaft unter fundamentaler Unsicherheit beitragen. Dabei liegt der Fokus auf den Wechselwirkungen zwischen fundamentaler Unsicherheit und individuellem Verhalten—Wechselwirkungen, welche die Krisenanfälligkeit einer Wirtschaft u.U. stark erhöhen. Wir entwickeln eine Theorie der subjektiven Erwartungsbildung, die dem Handeln der Akteure zugrunde liegt. Zentrales Element dieser Theorie sind ökonomische Anreize, auf die Erwartungsbildung einzuwirken. So möchten z.B. Innovatoren die Erwartungen möglicher Investoren positiv beeinflussen, während die bisherigen Marktführer an skeptischen Erwartungen interessiert sind. Die gewonnenen Erkenntnisse helfen, makroökonomische Krisenpotentiale klarer zu erkennen—und besser zu verstehen, wie diese durch Regulatoren und Zentralbanken vermindert werden können. Die optimalen Massnahmen weichen u.U. stark von jenen in konventionellen Modellen ab.

Die grossen Verwerfungen im Nachgang der Krise von 2008-09 lassen keinen Zweifel an der Wichtigkeit, den Ursachen von Fluktuationen und Krisen auf den Grund zu gehen. Dieses Projekt leistet einen Beitrag hierzu, indem es fundamentale Unsicherheit und subjektive Erwartungen in den makroökonomischen Theorierahmen integriert.
Direct link to Lay Summary Last update: 02.07.2020

Responsible applicant and co-applicants

Employees

Abstract

Existing macroeconomic models assume that agents -- in their roles as consumers, managers, financial market participants, and politicians -- know how the economy "works". This does not preclude the possibility of surprise "shocks"; yet agents are generally assumed to know the true distributions of random variables. While convenient, this is a strong informational assumption, and it is increasingly recognized that it would be desirable to relax it, particularly for the study of economic crises. In this proposal, we suggest to explore a natural way to incorporate fundamental uncertainty, i.e., uncertainty about the distribution of economic fundamentals, into the macroeconomic framework. We develop a modification of the state space of standard macro models that incorporates this type of uncertainty. In such an environment, subjective beliefs play a dominant role for behavior. An important question concerns the emergence of such beliefs. As part of the project, we propose a model of a competitive social belief formation process that incorporates economic incentives, psychological elements relating to narratives, as well as standard Bayesian features. Our proposed framework nests standard models as special cases. Overall, the objectives of our research are to derive:(i) A theoretical framework of a state space under fundamental uncertainty and of a corresponding belief formation process, together with a suitable model of intertemporal preferences (Work Packages 1 to 3);(ii) Analytical and simulation-based results about the properties of economic time series in an environment of fundamental uncertainty and about the possibility of an early "crisis warning system" (Work Package 4);(iii) Insights into what regulation, stabilization and crisis mitigation policies can possibly achieve under fundamental uncertainty (Work Package 5).We expect to find that fundamental uncertainty substantially affects the dynamics of an economy and may give rise to pronounced cyclical patterns in excess of the cyclicality under objective information. We also expect to find important implications for macroeconomic stabilization, regulation, and crisis mitigation. Fundamental uncertainty may significantly change the menu of suitable policy options. Moreover, due to the change in the informational setting, it may require a modification of the concept of "credibility". If we succeed in finding a tractable framework for integrating fundamental uncertainty into macroeconomic analysis, the impact on the field of macroeconomics could be substantial. For conducting this research, we ask for the funding of four PhD projects with a duration of four years each.
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