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Economists Discover The Poor Behave Differently From The Rich

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http://www.businessweek.com/articles/2013-11-07/economists-discover-the-poor-behave-differently-from-the-rich#r=rss

In a speech in Frankfurt in October, Peter Praet, a member of the executive board of the European Central Bank, told a conference of economists something curiously obvious. “Individual households are heterogeneous in many respects,” he said. “It is important to measure and analyze this heterogeneity because it can have important implications for aggregate figures.” People are different, he meant, and we need to understand how to understand the economy.

Praet had to state the obvious because until this year economists, in particular those who make forecasts, put their faith in models that ignored those differences. Those that the ECB and the International Monetary Fund used to predict the future relied on a “representative agent,” a single imaginary person who stands in for everyone.

The problem was that these models failed to predict the consequences of the austerity programs that several European countries adopted in 2010. It turned out that actual people didn’t behave like the imaginary proxy. Economists are learning that the poor and the wealthy respond differently to austerity and stimulus. This could present challenges to politicians. If people behave differently, then policy might have to treat them differently.

..

The representative-agent models used by central banks and the IMF came out of a movement among economists in the 1970s and ’80s who assumed that people were rational and planned for the future. For example, Olivier Blanchard, now chief economist of the IMF, wrote in 1990 that when a government tightens its belt to reduce deficits, households might start spending, relieved that the problem is being handled and there won’t be an even bigger readjustment in the future.

If models could assume that everyone was the same rational person, there was no need for data on how people act. And conveniently, relying on a single person made the math behind the modeling easier.

Per Krusell, who now teaches at Stockholm University, was a brand-new Ph.D. in the early 1990s when he began work on a macroeconomic model that assumed more than one agent recognizing that people are different. He and Tony Smith, another new Ph.D., had a hunch that with enough computing power they could build a multiple-agent model. “If we had presented those ideas to our senior colleagues, they would have said, ‘No, go try something else,’ ” says Krusell. The resulting model won positions for Krusell at Princeton and Smith at Yale.

Still, their paper languished for more than a decade, basic research without a practical application. “We had a model that had something to say about propensities to save being different,” says Krusell. “Now the question [was], ‘How big are the differences?’ ”

Well anything for an easier life.....

The primary function of the ideas was to ensure the models worked. That they did, unfortunately reality is more complex. Shocking news that economists have just discovered people are different...

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Rubbish.

The poor (and middle classes now) don't plan for the future because they can't, and are increasingly incentivised not to. It's economically rational behaviour.

And what about the rich? Planned ahead by putting it all in housing did you?

These 'investors' who'd be bankrupt now if it weren't for the kindly assistance of their government. That doesn't seem very rational does it?

As for approximate models, have you ever looked at a map? Totally unrealistic. Far too small for a start, and the colours are all wrong...

Edited by (Blizzard)

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Rubbish.

The poor (and middle classes now) don't plan for the future because they can't, and are increasingly incentivised not to. It's economically rational behaviour.

And what about the rich? Planned ahead by putting it all in housing did you?

These 'investors' who'd be bankrupt now if it weren't for the kindly assistance of their government.

As for approximate models, have you ever looked at a map? Totally unrealistic. Far too small for a start, and the colours are all wrong...

People may not plan for the future much, many dont even have a budget, even an approximate one...they rely on the balance at the bank to see what they can buy today..

However, people who dont have much will grasp at freebies tossed to them....so they get a job, and a bankers mate offers them the chance to buy a house with a tiny mortgage they CAN afford...no thought needed as to how it is going to pan out...the slick glossy will tell them how it will pan out..nothing but good...sign here.

If anyone is in any doubt that this is how the collapse occured, just google NINJA loans..

The whole premise of these "instruments" was based on the lack of thought a person would give to a gift....and the people taking the credit?...the Government looking for a vote.

They KNOW how people think....our government even denied the existence of subprime....they didnt let any banks actually fail without massive subsidy to investors, and they still think that lending money to each other to increase "the economy" is the holy grayel they seek.

Austerity?...never happened.

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Rubbish.

The poor (and middle classes now) don't plan for the future because they can't, and are increasingly incentivised not to. It's economically rational behaviour.

And what about the rich? Planned ahead by putting it all in housing did you?

These 'investors' who'd be bankrupt now if it weren't for the kindly assistance of their government. That doesn't seem very rational does it?

As for approximate models, have you ever looked at a map? Totally unrealistic. Far too small for a start, and the colours are all wrong...

These is no one single explanation for peoples behaviours.

There are certain people who are aggressive savers not matter what, and some who are aggressive spenders…the rest in-between. Its only whats rational to the individual that matters, and your life experience effects that to some degree…

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Economists are learning that the poor and the wealthy respond differently to austerity and stimulus.

That'll be because the money is being given to the wealthy and taken from the poor. Of course they then respond differently.

"Economists" :rolleyes: - a term under false pretence.

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For example, Olivier Blanchard, now chief economist of the IMF, wrote in 1990 that when a government tightens its belt to reduce deficits, households might start spending, relieved that the problem is being handled and there won’t be an even bigger readjustment in the future.

Pity the fool.

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Well anything for an easier life.....

The primary function of the ideas was to ensure the models worked. That they did, unfortunately reality is more complex. Shocking news that economists have just discovered people are different...

OMG..

For example, Olivier Blanchard, now chief economist of the IMF, wrote in 1990 that when a government tightens its belt to reduce deficits, households might start spending, relieved that the problem is being handled and there won’t be an even bigger readjustment in the future.

This is Ricardian Equivilence... a theory noted for having essentially zero empirical backing but being useful to argue for austerity and the slashing of welfare programs. See also : The Laffer Curve, Trickle-Down, etc..

The rational-agent models give answers that are politically convenient. There is a wealth of research in fields like psychology that could be used to construct more realistic agents - including agents that changed over time or changed their behavior with personal circumstances - but I suspect that those models would not give the desired answers..

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For example, Olivier Blanchard, now chief economist of the IMF, wrote in 1990 that when a government tightens its belt to reduce deficits, households might start spending, relieved that the problem is being handled and there won’t be an even bigger readjustment in the future.

I love the idea that Mr and Mrs Prole would quickly google the latest budget deficit statistics before deciding whether or not to get the kitchen redone.

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OMG..

For example, Olivier Blanchard, now chief economist of the IMF, wrote in 1990 that when a government tightens its belt to reduce deficits, households might start spending, relieved that the problem is being handled and there won’t be an even bigger readjustment in the future.

This is Ricardian Equivilence... a theory noted for having essentially zero empirical backing but being useful to argue for austerity and the slashing of welfare programs. See also : The Laffer Curve, Trickle-Down, etc..

The rational-agent models give answers that are politically convenient. There is a wealth of research in fields like psychology that could be used to construct more realistic agents - including agents that changed over time or changed their behavior with personal circumstances - but I suspect that those models would not give the desired answers..

Is there an economic model basic upon the proverb of 'give them an inch and they'll take a mile' because top to bottom its like groundhog day.

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Still, their paper languished for more than a decade, basic research without a practical application. “We had a model that had something to say about propensities to save being different,” says Krusell. “Now the question [was], ‘How big are the differences?’ ”

There wasn’t much reason to find out. Representative-agent models had fairly accurate predictive power until the financial crisis and its aftermath.

They claim that now but it's a fair bet that if you looked back in time you would find it never predicted anything and every significant change in trend and every crisis was unexpected.

Edited by billybong

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I love the idea that Mr and Mrs Prole would quickly google the latest budget deficit statistics before deciding whether or not to get the kitchen redone.

To be absolutely fair, it seems that when the idea was first floated (1820), tentatively, the number of taxpayers was small and often composed of people careful to preserve the family wealth down generations, so it was not as far fetched then as it is now.

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They claim that bow but it's a fair bet that if you looked back in time you would find it never predicted anything and every significant change in trend and every crisis was unexpected.

The model of the Earth being an oblate sphere worked really well for the sailors right up to the moment they sailed off the edge of the world..

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