ETH Zürich Invitation for The Turning Point Macro-Econophysics of 30, November 2010 Macroeconomics? Hiroshi Yoshikawa University of Tokyo

“Macroeconomics was born as a distinct field The 2008-09 Financial Crisis in the 1940‟s, as a part of the intellectual (2005=100) 130 response to the Great Depression. The term

120 then referred to the body of knowledge and Exports expertise that economic disaster. My thesis 110 in this lecture is that macroeconomics in this

100 original sense has succeeded: Its central Industrial Production problem of depression prevention has been 90 solved, for all practical purposes, and has in 80 fact been solved for many decades. ” 70 Robert Lucas, Nobel Laureate

60 2006 2007 2008 2009 Presidential Address to the 2003 American Economic Association Source: METI, Cabinet Office Neoclassical Economics “ Most macroeconomics of the past 30 years was spectacularly Price Mechanism useless at best, and positively or Markets harmful at worst.” Paul Krugman、June 2009 Pareto Efficiency at Lionel Robbins Lectures in London School of Economics Adam Smith (1776) Invisible Hand

“The most interesting recent developments The Adjustment of Price in macroeconomic theory seem to me describable as the reincorporation of Equates aggregative problems such as inflation and the business cycle within the general Demand for and Supply of Apples framework of „microeconomic‟ theory. If Price of Apple these developments succeed, the term „macroeconomic‟ will simply disappear from S use and the modifier „micro‟ will become superfluous.” P* Robert Lucas (1987) D Quantity of Apples

Q* Behind Demand and Supply Curves …. Equilibrium As a Point

The Marginal Utilities of All the Consumers (j=1,…,J) out of Consuming Apples are Equal to the Price. Equilibrium U j (C j ) P As a Distribution C j

And … the Marginal Products of All the Producers (k=1,…,K) to Produce Apples are Equal to the Price. To Analyze Equilibrium as a Distribution, F j (L j ) P We Need Resort to L j the Methods of Statistical Physics. Equilibrium As a Point Are Thus, Economics must be Economic Behavior based on and Microeconomic Analysis Motion of “Particle” of Purposeful Fundamentally Different? Economic Behavior

Most Economists This Leads Us Think to the Analysis They are based on Fundamentally Different. the Representative Agent. Welfare Calculation Financial Markets by Robert Lucas (1987) Traditional Finance

Based on the Representative Consumer Efficient Market Theory

If business cycles of the magnitude experienced since WW II were eliminated completely, this would Econophysics raise the level of utility by only $8.50 per person! Financial Bubbles

Macroeconomics Consumption-Based Capital Asset Pricing Model

u"(C)C C 1 C r Financial u'(C) C (C) C Real Economy Markets where 1 u"(C)C 0 (C) u'(C) Real Economy

Analysis of Network Keynesian Neoclassical Comprising Economics Economics Many Heterogeneous Agents

Unemployment Full Employment

Microeconomic Foundations for Keynesian Economics What Matters Is Not Microeconomic Foundation for Employment or Unemployment Keynesian Economics 0 or 1 But Many Levels of Productivity namely Distribution of Productivity

The Principle of Statistical Physics

Boltzmann or Exponential Distribution in stationary state Yoshikawa, H. (2003) “The Role of Demand in Macroeconomics,” Japanese Economic Review, Vol.54, No.1, 1-27. Gibbs Distribution

Distribution Changes as Aggregate Demand Changes

Source : Aoki M. and H. Yoshikawa, (2007) Reconstructing Macroeconomics: A Perspective from Statistical Physics and Combinatorial Stochastic Processes, Cambridge University Press What We Found is the Power Law The Nature of Micro Shocks In Standard Models, “Micro Shocks” are Assumed to Wash Out

We Can Understand “Macro” by the Average

Source : Aoyama H, H. Yoshikawa, H. Iyetomi, and Y. Fujiwara (2010) “Productivity Dispersion : Facts, Theory, and Implications”, Journal Self-Averaging of Economic Interaction and Coordination, Vol.5

The Nature of Micro Shocks Self-Averaging n

X n xk Self-Averaging k 1

Variance ( X n） CV ( X n ) Mean( X n )

E( X E( X )) 2 n Non Self-Averaging n n E( X n ) CV ( X n ) 1 E( X n ) (E( X n ) See : Sornette, D (2000), Critical Phenomena P((1 )E(X ) X (1 )E(X )) 1 in Natural Sciences, Springer. n n n for any 0 n A Simple Growth Model 2 Parameter Poisson / Dirichlet

n1 n2  nk n Distribution

K n Y y ni n i p ( 0, 0 1) i i n ni y i ( 0, 1) k n k n p 1 i n ja (n) j i n n j

n Non Self-Averaging K n a j (n) j We Cannot Understand “Macro” by the Average ni exp( ni ln ) 1 ln( )ni Standard Microeconomic Foundations Based on yi ln( )ni Representative Agent n Do not Make sense Y K ja (n) See : Aoki M. and H. Yoshikawa, (2010) "Non-Self-Averaging in Macroeconomic Models: n n j A Criticism of Modern Micro-founded Macroeconomics", Center for International j Research on the Japanese Economy Discussion Paper, CIRJE-F-761. Tree Structure Transition Rates in Markov Model

(a) Three-level Tree (b) One-level Tree

2 3 4 1 1 2 3 Source : Aoki M. and H. Yoshikawa, (2010) "Non-Self-Averaging in Macroeconomic Models: A Criticism of Modern Micro- founded Macroeconomics", Center for International Research on the Japanese Economy Discussion Paper, CIRJE-F-761.

Progress of Macroeconophysics Requires Close Collaboration of Economists and Physicists