Economists' political bias and model choice

One can count on Gilles Saint-Paul for innovative research topics. During his career, he has addressed and impressive array of topics that range far beyond Economics strictu sensu. For this reason, I have reported several times about his latest research.

His latest opus is an introspection in our profession and how our political biases influence our modelling choices. He claims that an economist with conservative inclinations will favor a model with smaller fiscal multipliers. While the ethical thing to do would be to be driven by empirical evidence, this may just be a subconscious choice. But at least economists strive to be logically consistent, and if one choose a large multiplier, then then must also claim that demand shocks are substantial, as models with large multipliers rely on this. Looking at evidence from the Survey of Professional Forecasters, Saint-Paul finds that forecasters who believe that expansions are more inflationary also adhere to the belief that public expenses are less expansionary.

Saint-Paul goes further, though. His claim is that we live in a self-confirming equilibrium. We devise theories to understand our surrounding and take decisions, and those decisions then shape the economic environment. Theories can thus survive even if they deviate from the true structure as long as the decisions make it conform. This is a statement about a lack of uniqueness of the path to the rational expectations equilibrium. In a sense, this is not too disturbing, as long as decisions are still optimal and outcomes do not differ too much from the rational expectations first best. And if this true, we will never know what the rational expectations first best is. Of broader implications would be if the political agenda of an economist would lead an economy on an different path, on a different self-confirming equilibrium. Is this why Europe and the United States are different? Were Keynes and von Hayek that influential?

Near rational agents and house price booms

House price run-ups, especially when they appear excessive, are difficult to explain. It is it even more difficult to explain how they are not coordinated across countries in a globalized world. Indeed, right now house prices are severely depressed in the United States, while you can have strong suspicions of bubbles in China, Norway and Switzerland. Bubbles are substantial deviations from fundamentals that could be due to some deviations from rationality or herd behavior, or both. But "rationalizing" this is a major challenge because of the apparent randomness of the occurrence of such house price booms.

Klaus Adam, Pei Kuang and Albert Marcet think they have a way to explain this using the concept of internally rationally agent. Such a agent, like the economist, does not know the true process of prices but tries to infer it from past observation using Bayes' rule. The belief about prices then becomes part of the state space and leads to some sort of path dependence. With shocks that are not perfectly correlated, it is then possible for different countries to experience different paths for house prices.

Emotions in economic interactions

How do you get people to cooperate. By increasing utility, of course, but that is difficult to measure, obviously, and there may some components beyond rationality in emotional contexts. However, we have some interesting ways to get some neurological hints about positive and negative emotions by measuring the conductance of skin. This may help to explain why people are sometimes willing to hurt themselves in order to punish others.

Mateus Joffily, David Masclet, Charles Noussair and Marie-Claire Villeval conduct an experiment where cooperation, free-riding and punishment can happen. They measure skin conductance to reveal the intensity of emotions and let players reveal whether their emotions are positive or negative. Cooperation and punishment of free-riding elicit positive emotions, the latter indicating that emotions can override self-interest. That is also because punishment relieves some of the negative emotions from observing free-riding. And one does not like being punished, which lends one to cooperate more in the future. Finally, people like being in a set-up where sanctions are possible, in particular because it allows a virtuous circle of emotions that reinforce each other and lead to more cooperation.