Bounded Rationality Models & The Credit Environment

Here is solid introduction to Bounded Rationality models-what they are, how they work, and their makeup. Also, the article highlights the potential use of bounded rationality models for policy making . Click Here To Skip The Introduction & Learn About Bounded Rationality & The Current Crisis

Background On Bounded Rationality (Via Economist View)

Different models of bounded rationality vary basic assumptions of the rational agent model in different ways. Some of those assumptions are:
- Utility is discounted over time in a consistent way- People have access to all relevant information

- All relevant information is expressed through market prices

- People can instantly weigh up the change in utility given by any buying or selling decision

- People act to maximise their utility

Therefore, the typical way to create a bounded rationality model is to relax one or more of these criteria.

Article Introduction (Via Economist View)

The discussion below looks at how governments ought to respond to the current problems in the economy if a key assumption of economic models, rationality, is dropped and replaced with an assumption that agents have bounded rationality:

Article Excerpts (Via Economist View)

“Whichever model of behaviour is assumed, policymakers should ask what the models indicate for macroeconomic policy. This question has been considered in a conference on “behavioural macroeconomics” at the Boston Federal Reserve in 2007.[2] No doubt the old solutions will work, given enough time. But today, with a much better understanding of economic behaviour, we could design more sophisticated solutions which would work faster.”

“A clear example comes from the concept of anchoring. Anchoring creates a tendency to fixate on one option too long when we might profitably switch to another – it limits the effects of all kinds of quantitative changes in policy.”

“The paradoxical conclusion is that it may not matter what new institutions or new rules are designed – as long as something is done. Any new framework gives agents a reason to abandon their anchor to fear; and gives them a chance to reattach themselves to hope. This – the converse of Keynes’ paradox of thrift – is what will ultimately rescue the world economy.”

Click Here To Learn About Bounded Rationality & The Current Crisis