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Complex Systems Seminar

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Amrit Krishnan

on 17 December 2014

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Transcript of Complex Systems Seminar

Current economic theory and its fallacies
Proposed framework
Interesting examples
Concluding remarks
Complexity economics is not a theory, it is an evolution of methods of science to analyze the dynamics of economies.
Flow of presentation
A thought experiment to start with
Economic theory, equilibrium, markets
Neo-classical economics
Financial crisis-2008
Who is responsible?

Current economic theory and its fallacies
Use complexity science-includes agent based models, game theory and cellular automaton. Study the outcomes qualitatively together and separately
Try and fit mathematical structure around it if possible
Pay close attention to prediction of transition behavior, critical points
Proposed framework
1. Bilateral trade in small-world networks
2. Macroeconomic auction simulator
Interesting examples
Rethinking economics using complexity theory
A thought experiment
Shopkeeper's boy breaks window
Gets it fixed
Is it really helpful for the economy?
Economic activities might mean growth, but not necessarily an improvement of the quality of life for everyone.
Economic theory-101
Economics is the social science that studies economic activity to gain an understanding of the processes that govern the production, distribution and consumption of goods and services in an economy.
Assume processes and flow of money to be in equilibrium (supply and demand)
Keynesian economics-short run, long run
Selfish or greedy behavior of individuals yields a result that is beneficial to society – a modern, widespread, but inaccurate reformulation of the principle of the “invisible hand”.
Game Theory
Strategies of evolution
Co-operation in the long run
Less realistic with complete assumption of rationality

Complexity is the study of phenomena that emerge from the interaction of low level building blocks
One constructs simulations, reproduces emergent phenomena, and then seeks to quantify their regularities and discover more elegant mathematics to characterize them.
Equilibrium? Look closely
Chaotic dynamics or cascade effects
It is important to recognize that, under conditions of delayed adaptation, an unstable, non-equilibrium system behavior may result even if each system component displays a stable dynamics.
Power law statistics in financial markets indicate there may be transition and critical behavior
Financial crisis-2008
Responsibility kept changing hands
Collateralized debt obligation and leverage
Equilibrium misunderstood
Who is responsible?
Rationality is a dangerous assumption
Co-operation isn't always guaranteed
Emergent behavior lurking in the shadows
The most robust regression models such as Dynamic Stochastic General Equilibrium (DSGE) model that seeks to characterize an economy derived from economic first principles could fail.
Concluding remarks
1. Agent-based simulations have a great potential to help formulate monetary policy
2. Game-theory and econometrics are branches of the complexity economics tree
3. Classical equilibria notion needs to be re-formulated
1. Herbert Gintis- A review of The Economy as a Complex Adaptive System by Eric D. Beinhocker.

2. J. Doyne Farmer, Economics needs to treat the economy as a complex system

3. Dirk Helbing, Rethinking Economics Using Complexity Theory
Mary and Gary are counterfeiters. One day, they make a perfect copy of a 100kr bill. They use it to pay their gardener. The gardener uses the 100kr to buy pizza. The pizza maker uses the 100kr to rent video tapes. The 100kr bill keeps circulating in the economy, and no one ever discovers that it is counterfeit. Who was harmed by Mary and Gary counterfeiting a 100kr bill?

Here is the hook, where is the worm?
Solution: The government--and its citizens--lose. The Federal Reserve Board usually increases the money supply by buying government securities--the stuff that the treasury issues to finance budget deficits. This process is called monetizing the deficit. Most of the new money that's created eventually assumes the form of demand deposits (a.k.a. checking accounts), but some of it is in the form of vault cash and currency in circulation. By issuing their own 100kr bill, the counterfeiters prevented the Riksbank from taking a piece of paper that only cost them about 2½kr to produce and exchanging it for 100kr worth of government securities.
Agent-based models
Use a computer to simulate decisions of
heterogeneous individual agents
households, firms, banks, government, ...
ground with behavioral knowledge
Can include: Real estate, capital markets, taxes, foreign exchange, liquidity, stock market, ...
Can ground with micro-data. Potentially allows rich calibration and validation.
An example where power-law statistics observed
Goals for agent-based modelling
Quantitative scenario analysis- generate crises we haven’t seen yet
Reproduce current crisis
Propagation of sector-specific shocks
Robustness testing
Policy testing
Efficacy of tax policy
Efficacy of monetary policy
Efficacy of different approaches to economic
Participatory simulation (joystick for decision makers)
Post mortem analysis
Early warning indicators
And also......
Inadequate funding
Econometric models: 30,000 person-years?
DSGE models: 20,000 person-years?
Agent-based models: 500 person-years?
Full transcript