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Prevent financial depression through narratives

Prevent financial depression through narratives
14 Apr. 2020

Prévenir-les-dépressions-financières-grâce-à-la-narrationBy enlarging the scope of usual economical models to integrate interacations between households, retroactive loops and the notion of confidence, Federico Morelli, Marco Tarzia, Jean-Philippe Bouchaud and Michael Benzaquen, professor at the École polytechnique and holder of the chair « Econophysics & Complex Systems » were able to account for the irregularities observed during the 2008 financial crisis. Their work was published on the 10th of April in the scientific journal Proceedings of the National Academy of Sciences (PNAS).

As of today, the usual dynamic stochastic general equilibrium model is still being used as a reference in monetary policy decision taking. With the generalisation of the behaviour of a single representative household at its core, this model was unable to simulate or cope with the 2008 crisis.

By integrating the influence that each household has on the others and taking inspiration from physics methodologies, the researchers suggest a more realistic model. With adequate parameters, it can simulate strong fluctuations caused by minor variations of economic conditions that are amplified by interactions. Furthermore, these retroactive loops between households show scenarios with very varied consequences, highlighting the impossibility to evaluate extreme risks with certainty.

Thus, the households’ confidence role as a primordial lever on consumption emerges. This study showcases the possibility to integrate narratives in monetary policies, in order to restore confidence before its collapse, preventing large scale crisis. This new model may be used at a later point in time to understand the ongoing financial crisis caused by the Covid-19.

The research chair « Econophysics & Complex Systems » ambitions to develop tools to understand the dynamics of economic systems, while also going beyond the very theoretical scope of the usual models. Coordinated by Michael Benzaquen, researcher at the CNRS and associate professor at the École Polytechnique of the Institut Polytechnique de Paris, this chair uses an analytical approach derived from statistical physics models to study aggregated behaviours with interactions, heterogeneities and feedback loops. Since 2018, this research is supported by the support of Jean-Philippe Bouchaud, president of Capital fund Management, one of the France’s largest hedge funds. CFM provides both infrastructure and data to enrich the models developed by Pr Benzaquen’s team.

*LadHyX, a joint research unit (UMR) of the CNRS – École polytechnique