Understanding the Behavioral Forces at Work in Shaping the Macroeconomy

Understanding the Behavioral Forces at Work in Shaping the Macroeconomy

As a specialist in macroeconomics and econometrics — the application of mathematics and statistical methods to economic data — NYU Abu Dhabi Assistant Professor of Economics Chetan Dave enjoys the precision of his discipline. "It is precise about assumptions and their implications, and about what it can and cannot do," he said. "It's a practical study of a very complicated, possibly dismal, constrained reality."

Be that as it may, Dave continues his attempt to make discoveries within the boundaries of that constraint. As he explained, "Modern economics cleanly delineates tools and methods, and the topics to which it applies those tools and methods. If one is well trained in the tools, then anything that qualifies as human decision-making under constraints is up for grabs to be analyzed by an economist. It's why economics is a pre-eminent social science discipline — because it is precise when it can be, precisely tells you when it cannot and requires more study, and gives practical solutions to surprisingly complex problems."

A history enthusiast interested in the economic aspects of the rise and fall of civilizations around the world, Dave enjoys studying national-level factors that help economies grow or shrink, as well as factors that motivate learning in order to improve economic outcomes. "All of this constitutes the substance of what research macroeconomists are often interested in," he said. "The tools we use are interesting in their own right, and while I have an independent research interest in developing those tools, they only illuminate the path to the answers."

In addition to several journal article revisions, Dave is working on papers that deal primarily with various aspects of learning in economics — more specifically, modeling aspects of economic theories of learning in macroeconomic models, and, on the side, modeling the behavioral bases of normative economics. His research is almost entirely empirical and includes one main field and two secondary fields within economics: structural macroeconometrics, an area that focuses on the empirical evaluation of macroeconomic models of economic growth and business cycle activity; behavioral and experimental economics, the incorporation of ideas and theories from psychology into formal economic modeling, particularly in the empirical evaluation of experimental data; and applied econometrics, in which Dave uses models, data, and econometric analyses to answer a variety of research questions across the social sciences. In short, he is interested in the sophisticated use of economic models and data to answer questions, and, he said, "developing a deeper understanding of economic and other behavioral forces at work in shaping the macroeconomy."

Concerning structural macroeconometrics, one paper, "Lattice Filtering and Rational Inattention," attempts to develop the notion of lattice-adaptive learning. "In such a model, the idea is that a policymaker learns about the state of the economy adaptively using a very particular filter, known in engineering as a lattice filter," Dave explained. "The advantages of this filter are several, and so it makes for a good assumption when modeling learning. But the key advantage is that the speed and perhaps the information capacity of the filter can, in a sense, be controlled. This is of interest to me, a I would like to bridge two ways of thinking about information processing by a policymaker."

Economics is a pre-eminent social science discipline — because it is precise when it can be, precisely tells you when it cannot and requires more study, and gives practical solutions to surprisingly complex problems.

Chetan Dave, NYUAD assistant professor of Economics

According to Dave, for a macroeconomist, increasingly accurate descriptions of individual decision-making enable models to better describe aggregate data. As such, better macroeconomic models can be formulated if care is taken to base the model
on microfoundations that reflect consistency with microeconomic theory and how people really behave. These microfoundations can be built using discoveries in the field of psychology and economics. For instance, macroeconomists often assume that expectations can be characterized by costless signal extraction and the implementation of Bayes' Law — which expresses how a subjective degree of belief should rationally change to account for evidence — and so are always correct on average. However, Dave explained, "Previous work in psychology has identified biases in how individuals form expectations, so that they deviate from some of the classical assumptions that economists make. These important insights have to be investigated in economic contexts."

Consequently, in "Confirmation Bias and Strategic Signal Extraction," Dave — along with co-author Gary Charness of the University of California Santa Barbara — investigates whether strategic pressures to update beliefs correctly (as per Bayes' Law) can mitigate a bias known as confirmation bias, that is, an individual's tendency to seek, interpret, and
use evidence in a manner that is biased toward confirming existing beliefs or hypotheses. "I examine whether individuals exhibit confirmation bias in environments where information is costless, like those assumed in some macroeconomic models," said Dave. "We implement a unique experimental design and find evidence that they do, but, over time, the bias can be mitigated by strategic pressures to update beliefs — even inadvertently — in a manner more consistent with Bayes' Law."

A third paper, "Time is (Not) Money?" co-authored with Enrique Fatas of the University of East Anglia, seeks to determine whether response times from stimuli are a useful statistic to measure particularly defined cognitive activity in economics experiments. Very rarely used in economics, Dave and Fatas are using time responses to explore deliberation processes, "but with homogeneous environments and experimental economics methodologies," Dave explained. They are exploring how deliberation processes are altered by game features such as complexity and whether games are of the "social" versus market interactions variety. "I must admit I am having a lot of fun with the econometrics of the data," said Dave.

These are but three of the various projects Dave currently has under way. In addition, within the area of macroeconomics, he continues to work on three additional projects. The first involves theories of large deviations in economic aggregates with NYU New York Professor of Economics Jess Benhabib. The second project, with NYUNY Professor of Economics John Leahy, is focused on evaluating the informational content of professional forecasts of macroeconomic variables when they are included in macroeconometric frameworks. Finally, in collaboration with a colleague at the Paris School of Economics, Dave is developing encompassing methods of distinguishing between endogenous versus exogenous sources of cyclic variations in real GDP.

Outside of the publishing arena, Dave is the faculty advisor for the NYUAD Economics and Finance Club, and conducts experiments at the University's Social Science Experimental Laboratory, an interdisciplinary center where experimental work in the social sciences combines economic theory, political science, and sociology. There, he runs incentivized decision-making experiments with human subjects in order to test theoretical predictions and the properties of proposed or existing models of economic, political, or social institutions. "This allows an economist to cleanly identify the effect of incentives on observed behavior," he explained.

With the goal of contributing to the development of better modeling of policy choices in the macroeconomic realm, Dave hopes to contribute to economics — albeit on the more microeconomic side — research in cognitive psychology to build better descriptive models of the reasons why individuals make the choices they do in economic settings. As Dave said, "Economics is to an extent the careful study of common sense in the process of resource allocation, and since common sense is often quite uncommon, the study and practice of economics tends to be critically central to the development of humankind."