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Dynamics of Understanding the World

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  • Bartosz Mackowiak

    (European Central Bank)

Abstract

Why was everyone (the private sector, policymakers, academics) so unprepared for the recent financial crisis? To address this question, we study a model in which agents decide how carefully to think through different scenarios. We find that agents think through more carefully scenarios that appear more likely to them, they know less about, and are easier to think through. Furthermore, if actions are strategic complements, agents think through scenarios that others are thinking through. We first solve a two-period economy. We then study an infinite-horizon economy where agents update their beliefs about the likelihood of different scenarios based on noisy observations about the current state of the economy.

Suggested Citation

  • Bartosz Mackowiak, 2011. "Dynamics of Understanding the World," 2011 Meeting Papers 1240, Society for Economic Dynamics.
    • Handle: RePEc:red:sed011:1240
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