Bridging agent-based and dynamic-stochastic-general-equilibrium modelling approaches for building policy-focused macrofinancial models

This work package takes up where WP1 and WP2 leave off: Namely to embed micro-behavioural realism in economic decision making into policy-focused macro-financial models. Agent-based models have become increasingly used across a range of disciplines, to study the aggregate outcomes resulting from the dynamic interaction of boundedly rational agents. It is rather well understood that in agent-based models even small shocks may lead to pronounced boom and bust phases. The consortium’s objective in taking up this class of models is to embed he insights into micro-behavioural realism in economic decision making gained in WP1 and 2 into these models, and merge them with the parsimonious structure of DSGE models that has proved useful in matching macro-financial models with the data and in studying policy design and evaluation. Financial markets have a special role in merging agent-based and DSGE models, as financial markets often operate at high frequencies, requiring financial investors to make decisions within very limited periods of time, and rendering non-homo-oeconomicus type decisions yet more prevalent in these markets. The models to be developed in this work package will therefore pay close attention to the integration of financial markets, taking up insights from the research carried out in WP3, WP4 and WP5, and use the resultant rich structures to re-examine monetary and macroprudential policy rules that have found support in pure DSGE models.

Key Objectives

(O.7.1) Integrate micro-behavioural realism into DSGE-type, policy-focused macroeconomic models, exploring the role of different forms of capturing micro-behavioural realism in economic decision making, but commonly stressing the role of heterogeneous expectations, learning and herding in times of booms and busts.

(O.7.2) Explore within the resultant hybrid agent-based-DSGE models the role of financial markets for the possible emergence of expectations-driven asset price bubbles.

(O.7.3) Study how highly volatile, partially unstable dynamics in financial markets influence and interact with the dynamics of the real part of the economy.

(O.7.4) Characterize the scope for economic policy in this class of macro-financial models, including (but not limited to) studying the performance of monetary policy rules taking into account asset prices and examining macro-prudential policies aimed at strengthening financial market resilience.

Main participants