Winter term 2005/2006
Institute of Economic Policy I

Holger Gerhardt
E-mail: gerhardt@wiwi.hu-berlin.de, office hours: Tuesday, 2:15 - 3:45 p.m.

Schedule | Course information | Topics covered | Lecture notes and students' presentations | Seminar papers | Assigned readings

Schedule

Friday, 4 - 7 p.m., room 11.32, Alex 5;
Block seminar on Fri./Sat./Sun., January 20/21/22, 2006

"LS" means "Lehrstunde", i.e. 45 minutes:

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Course information

The number of participants is restricted to 30; in order to apply for participation please send an e-mail to gerhardt@wiwi.hu-berlin.de.

3 SWS; diploma studies VWL, fields "Economic Theory" or "Economic Policy";
MEMS: 6 SP, module "Psychological Foundations of Dynamic Macroeconomics".

Students can take this course in the fifth semester or higher. It is recommended, however, to have taken "Konjunktur- und Wachstumspolitik" or "Konjunktur- und Beschäftigungstheorie" or "Introduction to Advanced Macroeconomic Analysis", respectively, before attending this seminar.

The final grade will be based on: Active participation and presentation (1/3); seminar paper (2/3), due March 31st, 2006.

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The class starts by reviewing the rationality concept commonly employed in economic models ("full rationality") and its implications for the motion of variables of macroeconomic interest - e.g., inflation, the smoothness of consumption or the structure and volume of trading on financial markets. The existence of deviations between the predictions of theoretic models and actual data is then investigated.

After that "full rationality" is contrasted with approaches viewing human beings as "boundedly rational"; psychological and neurological findings on human decision making are presented (based on Camerer et al., 2005). Models applying these findings to macroeconomic analysis are introduced, with an emphasis on models that assume agents to have only limited abilities in gathering and processing data, leading to "rational inattention", the use of heuristics ("rules of thumb", "mental accounting"), "learning", "epidemiological expectations", "robust control" and the like. The findings by Lettau & Uhlig (1999), Maćkowiak & Wiederholt (2005) and Van Nieuwerburgh & Veldkamp (2005) are discussed in detail.

During the seminar sessions the focus is on the functioning of asset markets, since these play an important role in market economies and many models of boundedly rational agents exist in this area. The class analyses to what extent departures from "full rationality" have noticeable effects on real variables, whether these departures could be exploited by other market participants and whether this might recommend regulation of markets. Topics for seminar papers, however, are not restricted to asset markets: papers can also deal with the role of bounded rationality in other fields of macroeconomic research.

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• Week 1 (October 21, 2005): Slides
• Week 2 (October 28, 2005): Slides
• Weeks 3 and 4 (November 4 and 11, 2005): Handout on consumption-based asset pricing
• Weeks 5 and 6 (November 18 and 25, 2005): Handout on the "volatility puzzle", the "equity premium puzzle" and the "risk-free rate puzzle"
• Week 7 (December 2, 2005): Handout on "rational inattention"
• Block seminar (January 20 - 22, 2006) - students' presentations:
  • Saving behaviour and bounded rationality - presented by Dennis Badenhop
  • Macroeconomic expectations - presented by Havva Canibek
  • Hansen and Sargent (2001): "Robust Control and Model Uncertainty" - presented by Marc Vahlert
  • Money illusion - presented by Florian Zinsmeister
  • Mankiw and Reis (2002): "Sticky Information versus Sticky Prices" - presented by Lin Lin
  • Ball et al. (2005): "Monetary Policy for Inattentive Economies" - presented by Juliane Begenau and Björn Ohl
  • Lux (1995): "Herd Behaviour, Bubbles and Crashes" - presented by Gleb Korolkov and Aleksandrs Vatagins
  • Van Nieuwerburgh and Veldkamp (2005): "Information Acquisition and Portfolio Under-Diversification" - presented by Alejandro Lara Gügel
  • Van Nieuwerburgh and Veldkamp (2005): "Information Immobility and the Home Bias Puzzle" - presented by Ilja Nothnagel
  • Sheshinski (2002): "Bounded Rationality and Socially Optimal Limits on Choice in a Self-Selection Model" - presented by Iulia Mihailescu
• Week 13 (January 27, 2006): Slides on Arthur et al. (1996): "Asset Pricing under Endogenous Expectations in an Artificial Asset Market"
• Week 14 (February 3, 2006): Handout on Lettau and Uhlig (1999): "Rules of Thumb versus Dynamic Programming"

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Journal articles and research papers on which your seminar paper can be based as well as the requirements that your seminar paper has to fulfil to earn a good grade can be found in a PDF file.

Concerning the style of your writing and of your seminar presentations, I recommend to read two extremely helpful - and entertaining - documents on the web:

• Writing Tips for Ph.D. Students by John H. Cochrane of the University of Chicago - while intended to help writing concise research papers, they also offer much advice that is useful when writing seminar papers and preparing seminar presentations.
• Ten Rules for Mathematical Writing - lecture slides by Dimitri P. Bertsekas of the MIT. Please take his advice seriously! An example from his slides: "Mathspeak should be 'readable'. Bad: Let k > 0 be an integer. Good: Let k be a positive integer. Or: Consider an integer k > 0."

You can download a LaTeX/BibTeX master document for writing your seminar papers as a ZIP file. And you can view the resulting PDF file.

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Week 1 (Oct. 21)

In preparation of the first seminar session, please read the following survey:

John Conlisk (1996): "Why Bounded Rationality?", Journal of Economic Literature 34(2), pp. 669 - 700. PDF downloadable from JSTOR*.

Supplementary literature:

Gerd Gigerenzer and Reinhard Selten (2001): "Rethinking Rationality", in Bounded Rationality. The Adaptive Toolbox. Gerd Gigerenzer and Reinhard Selten, eds. Cambridge, Massachusetts: MIT Press, pp. 1 - 12.

Barton L. Lipman (1995): "Information Processing and Bounded Rationality: A Survey", Canadian Journal of Economics 28(1), pp. 41 - 67. PDF downloadable from JSTOR*.

Ariel Rubinstein (1998): Modeling Bounded Rationality. Cambridge, Massachusetts: MIT Press, chapter 1, pp. 7 - 24. The entire book can be downloaded for free as a PDF file from Ariel Rubinstein's webpage.

 
Week 2 (Oct. 28)

In preparation of the second session, please read the following survey:

Colin Camerer, George Loewenstein and Drazen Prelec (2005): "Neuroeconomics: How Neuroscience Can Inform Economics", Journal of Economic Literature 43(1), pp. 9 - 64. PDF downloadable [4.5 MByte] from Colin Camerer's web page.

Faruk Gul and Wolfgang Pesendorfer of Princeton University have written a reply to Camerer et al. (2005). Gul and Pesendorfer claim that the "neuroeconomic" criticism of "standard economics" misses the point, because "standard economics" has never attempted to answer the questions that neuroeconomics asks:

Faruk Gul and Wolfgang Pesendorfer (2005): "The Case for Mindless Economics", unpublished manuscript, Princeton University. PDF downloadable from Faruk Gul's web page.
See also the discussions of this article on "The Fly Bottle" and on "EconLog", each including a short contribution by Colin Camerer.

Supplementary literature:

The web page of the conference "How Humans Behave: Implications for Economics and Economic Policy", held at the Federal Reserve Bank of Boston in June 2003, provides an interesting conference overview [PDF, 950 KB] as well as links to the papers presented at the conference.

 
Week 3 (Nov. 4)

In preparation of the third session, please read the following article:

Axel Leijonhufvud (1993): "Towards a Not-Too-Rational Macroeconomics", Southern Economic Journal 60(1), pp. 1 - 13.

Supplementary literature:

Alan P. Kirman (1992): "Whom or What Does the Representative Individual Represent?", Journal of Economic Perspectives 6(2), pp. 117 - 136. PDF downloadable from JSTOR*.

Leigh Tesfatsion (2004): "Introduction to Rational Expectations", lecture notes, Iowa State University, Ames. PDF downloadable without restrictions.

Richard H. Thaler (2000): "From Homo Economicus to Homo Sapiens", Journal of Economic Perspectives 14(1), pp. 133 - 141. PDF downloadable from JSTOR*.

 
Week 4 (Nov. 11)

In preparation of the fourth session, please read sections 1 - 4 of the following book chapter:

Nicholas Barberis and Richard H. Thaler (2003): "A Survey of Behavioral Finance", chapter 18 of: George M. Constantinides, Milton Harris and René Stulz (eds.): Handbook of the Economics of Finance, pp. 1053 - 1123. Elsevier Science, North Holland: Amsterdam. PDF downloadable from Nicholas Barberis's web page.

 
Week 5 (Nov. 18)

In preparation of the fifth session, please read sections 5 - 9 of

Barberis and Thaler (2003).

 
Weeks 6 and 7 (Nov. 25 and Dec. 2)

There is no assigned reading; however, you are invited to have already a look at the paper that we will cover in sessions 6 and 7:

Bartosz Maćkowiak and Mirko Wiederholt (2006): "Optimal Sticky Prices under Rational Inattention", unpublished manuscript, Humboldt-Universität zu Berlin. PDF downloadable from Mirko Wiederholt's web page.

The seminal articles on "rational inattention" are:

Christopher A. Sims (1998): "Stickiness", Carnegie-Rochester Conference Series on Public Policy 49, pp. 317 - 356. PDF downloadable from ScienceDirect*.

Christopher A. Sims (2003): "Implications of Rational Inattention", Journal of Monetary Economics 50(3), pp. 665 - 690. PDF downloadable from ScienceDirect*.

A critical assessment of recent research papers that apply the idea of rational inattention in the areas of price setting and investor behaviour as well as suggestions for future research are contained in

Christopher A. Sims (2005): "Rational Inattention: A Research Agenda", manuscript, presented at the 7th Deutsche Bundesbank Spring Conference in Berlin. PDF downloadable from Christopher Sims's web page.

 
Week 13 (Jan. 27)

There is no assigned reading; however, you are invited to have already a look at the paper that we will cover in this week's session:

W. Brian Arthur, John H. Holland, Blake LeBaron, Richard G. Palmer and Paul Tayler (1996): "Asset Pricing Under Endogenous Expectations in an Artificial Asset Market", in: W. Brian Arthur, Steven N. Durlauf and David Lane (eds.): The Economy as an Evolving Complex System II, Addison-Wesley: Reading. PostScript file downloadable from the Santa Fe Institute's website.

Supplementary literature:

Blake LeBaron (2000): "Agent-Based Computational Finance: Suggested Readings and Early Research", Journal of Economic Dynamics and Control 24(5 - 7), pp. 679 - 702.

 
Week 14 (Feb. 3)

There is no assigned reading; however, you are invited to have already a look at the paper that we will cover in this week's session:

Martin Lettau and Harald Uhlig (1999): "Rules of Thumb versus Dynamic Programming", American Economic Review 89(1), pp. 148 - 174. PDF downloadable from JSTOR*.

 
Week 15 (Feb. 10)

In this week's session we will have a final discussion which sums up and concludes the seminar. The aim is to get the big picture: "What have we learned and to what end?" - borrowed from the title of an important survey on monetary policy ... ;-)

I would like you to prepare the discussion a little: Please have a look again at the article(s) that you presented during the block seminar (and possibly at related literature). Write down (at least) three points that you liked and three points that you disliked about the respective article(s). In addition, please choose one article out of all articles covered in the seminar - i.e., that we read together, that I presented or that you presented during the block seminar - and write down such a "pro/con" list also for this article.

I think this exercise and the final discussion can help you a lot in preparing the discussion sections of your seminar papers!

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* You can access JSTOR and ScienceDirect from any computer that is part of Humboldt University's network - i.e., when using one of the PC pools, when using the campus WLAN, when being dialled in from home, or when working at one of the university's offices.