Can You Predict Inflation? Inflation, Economies & Mark-0 Agent-Based Models!
“Big lessons to learn”
Post-COVID US inflation reached 4.8% in 2021 and peaked at 9.1% in June 2022.
Competing narratives emerged to explain the mechanisms driving this inflationary surge. Which initially predicted to be only “temporary”!
In fact, every month after the start of the inflation rally, Central Banks’ workhorse models stubbornly predicted that inflation would fall. However, only to become proven wrong the month after.
Policymakers have been blindsided by inadequate models, and the Bank of England recently admitting it had “big lessons to learn” from failure to forecast inflation using existing models.
Our new paper, Post-COVID Inflation & the Monetary Policy Dilemma: An Agent-Based Scenario Analysis
2306.01284.pdf (arxiv.org)
explores the influence of fiscal and monetary policies on inflationary dynamics within a complex macroeconomic environment, described using the well studied Mark-0 Agent-Based Model. ABM are scenario-generators in which a large number of agents interact based on a set of behavioral rules.
These models allow us to study (possibly) out-of-equilibrium systems with interesting emergent macroeconomic dynamics. The philosophy behind the model is to generate qualitatively plausible scenarios, i.e. being “roughly right” and not “precisely wrong”, as #Keynes famously quipped.
In fact, the Mark-0 model predicted, as early as June 2020, that the post-COVID recovery could be more sluggish than expected and lead to a period of sustained inflation.
Our new analysis contributes to the debate on the appropriate policy responses to post-COVID inflation by providing a flexible framework to assess different policy options in the context of various inflation drivers, including demand-pull, cost-push, and profit-driven inflation. Furthermore, our framework can accommodate varying behavioral effects within a complex economy, including (crucially) agents’ trust in the Central Bank and the corresponding anchoring of inflation expectations. Our main conclusions are
(i) the economic recovery, especially in absence of mitigating policies, can be much more sluggish than expected — or even fall into deep recessions beyond dangerous tipping points;
(ii) the policy response must navigate a narrow path, facing the trade-off between high inflation (with the risk of a runaway scenario) and high unemployment (with the risk of an economic collapse);
(iii) the success of monetary policy in curbing inflation is primarily due to expectation anchoring, rather than to direct impact of interest rate hikes;
(iv) the two most sensitive model parameters are those describing the bargaining power of workers and the market power of firms.
Our primary objective is to provide a dashboard for decision makers to help them apprehend different possible outcomes and anticipate unintended consequences and potential counter-intuitive impacts of their policies.
Lastly, we hope that Mark-0 can be usefully added to the policymakers toolbox and help them navigate a radically complex world.
Professor Jean-Philippe Bouchaud, Académie des Sciences of the Institut de France Member
Can You Predict Inflation? Inflation, Economies & Mark-0 Agent-Based Models!
