That is what will probably happen to Y if X changes. This can be contrasted to unconditional forecasting.
Such a forecast says what value Y will be, depending on the forecasts of all X variables which can influence Y Simon Wren-Lewis The two views discussed in this section are not completely binary. They can be seen to lie on a spectrum from modest to optimistic. It can be said that, by recognizing the world as a complex system, complexity economists are more modest than on average their mainstream counterparts. As mentioned above, complexity economists generally observe emergent patterns and then develop models which explain the mechanisms that drive them.
This interaction between observations and theory is not linear as the development of new models might lead to the discovery of novel patterns which in turn might inspire new models. The methods which complexity economists use to communicate their theories and pattern observations in scientific journals are very diverse but generally quite formalistic. To formally document patterns, complexity economists use a wide variety of empirical methods. Empirical research has been an important, if somewhat disjointed, part of the complexity research program Durlauf A great body of literature has been developed on the documentation these patterns, also known as stylized facts.
These stylized facts have been collected using a wide variety of methods. To formalize theories which explain these patterns, complexity economists again use a wide variety of mathematical modelling techniques. Some of the most popular modelling techniques are network modelling Caldarelli et al.
These types of models are popular because they are able to capture out-of-equilibrium behavior. The choice of which modelling method is appropriate depends on the patterns the researchers wants to explain. In general, the method which best describes patterns will be preferred. If models have the same explanatory power the simplest Sun et al. For example, to explain key stylized facts observed in financial markets, such as stationary returns, excess kurtosis and volatility persistence Cont , Franke and Westerhoff present a simple dynamical systems model with bounded rational investors who switch between trend-following and fundamentalist strategies depending on which strategy is more profitable at that point in time.
Its non-equilibrium dynamics allows it to improve on the standard consumption based asset pricing models which are at odds with these basic facts Adam et al. That being said, Chiarella et al. Complexity economists seek to better understand the patterns which characterize our complex economic system.
- The Ecology of Learning: Sustainability, Lifelong Learning and Everyday Life.
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Sometimes, this translates to a desire to improve it by intervening in it. This speaks to the left, and can be linked to the optimistic group mentioned in the epistemology section. On the other hand, it sometimes translates to a realization that the economy is too complex of a system for any planning to work. On the contrary, it can easily backfire. This speaks to the right, and can be linked to the modest group mentioned earlier.
That being said, complexity economists today are very diverse and cannot be easily linked to any particular ideology, not even those which I grouped in the optimistic or modest groups earlier. As a new school of thought, prominent complexity economists are mostly trying to convince economist to expand their analysis beyond a rational expectations, representative agent, and equilibrium focus.
That being said, there are some interesting debates among complexity economists. These include: 1 the difference from mainstream economics, 2 the role and limits of mathematical models, 3 the appropriate amount of model complexity, 4 the use of model description protocols, and 5 on how to validate models. The next section will briefly highlight these debates. First, there is disagreement among complexity economists about the relationship of complexity economics to mainstream economics.
One side basically states that complexity economics is a completely new field, almost a polar opposite of mainstream economics, e. Arthur , Farmer and Foley The other side sees complexity economics more as an adjunct to conventional economics that adds something about pattern formation Durlauf A second debate concerns the importance of formalizing theories using mathematical models in complexity economics.
Durlauf discusses this debate in detail. Between those complexity economists who make formal mathematical models, there is a debate on how complex these models should be. Generally, modelers balance between two rules Sun et al. According to the first rule a model should be kept as simple as possible. The second rule argues that the model should be detailed enough to model the richness of target systems. That being said, while complexity models can model highly complicated cognitive agents Sun , complexity economists generally recognize that real human beings are far more complicated than their models allow.
Another debate was inspired by the frustrations with difficulties in describing and replicating agent-based models. Confronted with the lack of a protocol for agent-based modelling descriptions, Grimm et al. Finally, as a relatively new tool, there is still no consensus on how agent-based models should be validated Fagiolo et al. It is generally agreed that as validation, ABMs should at least be able to replicate some key stylized facts.
Preferably, they should be able to replicate multiple of these key patterns at the same time Grimm et al. Yet, Guerini and Moneta note that models which incorporate different causal structures may replicate the same stylized facts.
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They therefore propose a method to focus only on representing causal structures among aggregate variables of the ABM and test whether they significantly differ from the causal structures that can be found in the real world. Another approach to choosing the right model in this case is picking the one which is also consistent with lower level micro stylized facts Grimm et al.
Viewing the economy as a complex system, complexity economics is methodologically focused. This makes it compatible with most other non-mainstream schools of economic thought, especially Austrian, behavioral, ecological, evolutionary, institutional, and post-Keynesian economics. It is not unheard of that complexity economists use cognitive rules from behavioral, neo-classical and post-Keynesian economics in an evolutionary framework.
As complexity economics was inspired by the broader complexity science movement, it also draws inspiration from other disciplines such as biology, ecology, physics, and mathematics. From the perspective of complexity economics, behavioral, ecological, evolutionary, and institutional economics focus on specific aspects of complex adaptive systems. Evolutionary economists study the selection mechanisms that give rise to both behavior and institutions. Finally, ecological economists study the sustainability of the complex system and its relationship with other non-economic complex systems. Austrian and post-Keynesian economics differ from these in their broader assumptions about the economic system.
Still these are often compatible with complexity economics. Early on, Austrian economists viewed the economy as a complex adaptive system. The staple post-Keynesian modelling technique of stock-flow consistent modelling Godley and Lavoie can be seen as dynamical systems mathematics applied to monetary macroeconomics. Increasingly this technique is being combined with agent-based modelling; see for example Seppecher , Riccetti et al. Complexity economics was partially developed to contrast the prevailing neo-classical economics paradigm.
It is primarily different from mainstream economists in its ontology and methodology. In thinking about the economy, the ontology, mainstream economists and have come to rely heavily on the concept of equilibrium. The main difference between complexity economics and the mainstream is the focus on equilibria—static patterns that call for no further behavioral adjustments.
Complexity economics portrays the economy not as deterministic, predictable, and mechanistic, but as process dependent, organic, and always evolving Arthur From the perspective of complexity economics, equilibrium economics is a special case of non-equilibrium and hence complexity economics Arthur Or, as Durlauf , p. Furthermore, complexity economists have been vocal critics of the mainstream rational expectations hypothesis Muth which assumes that economic agents know the model of the economy and on average take its predictions as valid.
Complexity economists believe this is so unrealistic that it potentially invalidates mainstream model outcomes. In some cases, expectations are self-referential: economic outcomes depend on the expectations of agents today. For example if agents want to determine whether or not to go out to a bar. Their decision to go depends on their expectations about how crowded the bar is. If they expect it to be crowded they will stay home and vice versa. Agents learn about the actual crowdedness of the bar the day after — even if they stayed home.
In this case, no equilibrium of bar attendance will ever emerge. Instead, it will fluctuate because of the negative relationship between expectations and attendance. Not only does assuming equilibrium not hold in this case, it would fail to predict the fluctuating bar attendance. Given this difference in ontological focus on equilibrium, it is not surprising that, complexity economists tend to use non-equilibrium modelling methods.
Furthermore, the methodological approach of complexity economists in more inductive. Formal models are almost always made to explain a set of observed phenomena or stylized facts, which can then in turn be used to inspire further empirical work. While shifting, this is still not always the case in mainstream economics Rodrik Most publications are in specialized journals such as:.
Occasionally, some complexity economists find their way to popular mainstream journals such as: The American Economic Review Arthur , Colander et al. Finally, some complexity economists published in top general journals such as Science Battiston et al. There are several think tanks and university departments which are specialized in complexity economics.
University departments which are actively involved in economic complexity include:. Adam, K. Stock market volatility and learning. The Journal of Finance, 71 1 , pp. Angrist, J. Undergraduate econometrics instruction: through our classes, darkly. Journal of Economic Perspectives, 31 2 , Arthur, W. Competing technologies, increasing returns, and lock-in by historical events. The economic journal, 99 , Inductive reasoning and bounded rationality.
The American economic review, 84 2 , Complexity and the economy.
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Science, , Out-of-equilibrium economics and agent-based modeling. Handbook of computational economics, 2, History of Economic Ideas, 18 2 , Armstrong, Angus Why Rebuild Macroeconomics? Axelrod, R. The complexity of cooperation: Agent-based models of competition and collaboration. Princeton University Press. Battiston, S. Complexity theory and financial regulation. Bischi, G. J Evol Econ Bosker, M. Journal of Urban Economics, 61 1 , Brock, W. A rational route to randomness. Econometrica: Journal of the Econometric Society, Caiani, A. Agent based-stock flow consistent macroeconomics: Towards a benchmark model.
Journal of Economic Dynamics and Control, 69, pp. Caldarelli, G. Emergence of complexity in financial networks. In Complex Networks pp. Springer, Berlin, Heidelberg. Chiarella, C. The impact of heterogeneous trading rules on the limit order book and order flows. Journal of Economic Dynamics and Control, 33 3 , Colander, D. Beyond DSGE models: toward an empirically based macroeconomics.
The American Economic Review, 98 2 , Commendatore P. In: Commendatore P. Springer Proceedings in Complexity. Springer, Cham. Cont, R. Dopfer, K. Durlauf, S. Complexity and empirical economics. The Economic Journal, Edmonds, B. Springer Berlin Heidelberg. Epstein, J. Generative social science: Studies in agent-based computational modeling. Fagiolo, G. A critical guide to empirical validation of agent-based models in economics: Methodologies, procedures, and open problems.
Computational Economics, 30 3 , Farmer, J. The economy needs agent-based modelling. Nature, , The virtues and vices of equilibrium and the future of financial economics. Complexity, 14 3 , Gabaix, X. Power laws in economics and finance.
Gallegati, M. Introduction to agent-based economics.
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Palgrave Macmillan, New York. Godley, W, and Lavoie, M Monetary economics: an integrated approach to credit, money, income, production and wealth. The complementary relationship between institutional and complexity economics: The example of deep mechanismic explanations. Journal of Economic Issues, 51 2 , How to relate models to reality? An epistemological framework for the validation and verification of computational models No. Grimm, V. Pattern-oriented modeling of agent-based complex systems: lessons from ecology.
The ODD protocol: a review and first update. Ecological modelling, 23 , Guerini, M. In: Journal of Economic Dynamics and Control. Haldane, A. An interdisciplinary model for macroeconomics. Oxford Review of Economic Policy, 34 , Hayek, F. The theory of complex phenomena. The critical approach to science and philosophy, Heise, A. Whither economic complexity?.
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