IPSHITA BAG – OCTOBER 4TH, 2023
Chen Lian is an assistant professor in the Economic department at UC Berkeley. His research focuses on macroeconomics, behavioral economics, and finance. In March 2023, I conducted an email interview with Professor Lian to discuss his background and current research.
Bag: Thank you so much for taking the time to do an interview with me. I would like to start with a couple of questions about your background in economics. What initially got you interested in economics and what keeps you interested in economics to this day? Also, what led you to macroeconomics specifically?
Lian: My interest in economics initially sparked during my childhood in East Asia. I was captivated by the East Asia Economic Growth Miracle and how it transformed the lives of people in the region. This incredible phenomenon led me to explore economics as a subject, and I quickly found myself drawn to macroeconomics specifically. Macroeconomics has not only provided me with insights into the growth miracle but also allowed me to better understand globally significant events that occurred during my lifetime. For example, the 2008 financial crisis and the recent surge in inflation have had profound effects on economies worldwide, and studying macroeconomics has enabled me to examine these events from a broader perspective. This ongoing relevance and the fascinating complexity of macroeconomics continue to keep me deeply engaged with the subject to this day.
Bag: How would you describe behavioral macroeconomics to those who are unfamiliar with it? How is it different, if it is different, from “traditional” macroeconomics?
Lian: Behavioral macroeconomics is an approach that integrates insights from psychology into the study of macroeconomics. It recognizes that human decision-making processes are not always rational, and that factors such as cognitive biases and social influences can impact economic outcomes at the macro level. Unlike traditional macroeconomics, which generally assumes rational and self-interested behavior, behavioral macroeconomics seeks to develop more accurate and nuanced models of the economy by accounting for the complexity and diversity of human behavior. This approach helps us better understand real-world economic phenomena, and can lead to more effective policy recommendations that take into account the true nature of human decision-making.
Bag: Could you briefly describe what your research is about?
Lian: My research primarily focuses on incorporating the insights of behavioral economics into the analysis of monetary and fiscal policy. By acknowledging the influence of psychological factors on economic decision-making, I aim to develop a more comprehensive understanding of how these policies impact the macroeconomy. In addition, I also investigate the role of financial frictions, such as credit constraints and information asymmetries, in shaping macroeconomic outcomes.
Can Deficits Finance Themselves?
Bag: Intuitively, one might believe that the government would be unable to overcome large deficits by expanding the volume of deficits. This would involve issuing more debt to raise money and then giving this to households. But the title of your paper “Can Deficits Finance Themselves?” suggests otherwise.
Could you explain the dichotomy between the pessimism of relying too much on deficits to tackle budgetary problems and your paper’s optimism? How would incurring more deficits boost aggregate demand when debt servicing of deficits would result in higher taxes in the near future?
Lian: You raise a valid point about the potential pitfalls of relying on expanding deficits to address budgetary issues. In practice, it is indeed difficult for governments to overcome large deficits without fiscal adjustments. Our paper, “Can Deficits Finance Themselves?”, has a different goal. We want to “report” on the possibility of full self-financing of deficits within the context of a standard, textbook macroeconomic model. We demonstrate that, within this model, delaying fiscal adjustments can lead to a scenario where deficits appear to finance themselves.
The result suggested by our paper’s title is not meant to imply that expanding deficits is a universally viable solution. Instead, it aims to prompt further investigation into the factors that differentiate the textbook model from reality. By understanding these differences, we can gain valuable insights into the dynamics of fiscal policy and debt management in the actual economy, and potentially develop more nuanced strategies for addressing deficits and their consequences.
A Theory of Narrow Thinking
Bag: In your paper, “A Theory of Narrow Thinking,” you mention that by making each decision with imperfect knowledge of other decisions, a narrow thinker would face difficulty in coordinating her multiple decisions. I have a few questions pertaining to this concept.
Are there any unintended positive consequences for the narrow thinker?
Lian: The concept of a narrow thinker can be viewed as a form of bounded rationality, which acknowledges the limitations of an individual’s cognitive capacity. By capturing the economic agent’s optimal behavior within the constraints of their cognitive resources, the narrow thinker model offers a more realistic representation of human decision-making compared to traditional models that assume perfect rationality. Not fully thinking through the complicated interactions across multiple decisions can actually help the agent economize their cognitive resources.
Bag: How might firms, governments, banks, and other entities respond to narrow thinking from consumers? Do they anticipate that consumers will be narrow thinkers? Do they adjust their own behavior accordingly?
Lian: For example, “bundling” sales by firms, where goods are sold together, can be viewed as a way to help consumers avoid narrow thinking by simplifying their decision-making process.
Bag: Are firms, governments, banks, and other entities prone to narrow thinking themselves, and if so, how might narrow thinking affect them?
Lian: There is substantial evidence suggesting that different departments within these organizations often struggle to fully coordinate. As a result, each department may engage in “narrow thinking” to some extent, neglecting the interactions with other departments.
Bag: How can consumers and other entities limit their tendency to think narrowly?
Lian: They can leverage technology to alleviate cognitive constraints and make better decisions. Utilizing tools that help organize, prioritize, and analyze information can assist in mitigating the effects of narrow thinking and improve overall decision-making processes.
Accommodating Frictions in Coordination
Bag: Your handbook, “Accommodating Frictions in Coordination,” focuses on how information frictions in an economy generate heterogenous expectations and what might happen to agents’ coordination of actions as a result.
Bank runs can happen in a full information economy—even if the bank’s fundamentals are sound. If there is a common expectation that others will withdraw, then it becomes optimal for each depositor to act and withdraw. The question is, what happens to the coordination of such an expectation in the presence of information frictions? Can imperfect information help break the bad coordination that causes bank runs (even with good fundamentals) under complete information? And if so, how?
Lian: Under imperfect information, the occurrence of a bank run becomes more closely linked to the bank’s fundamentals. If the bank’s fundamentals are strong, a bank run is unlikely to happen. On the other hand, if the bank’s fundamentals are weak, a bank run is more likely to occur. In this way, imperfect information can help prevent bank runs in cases where the bank’s fundamentals are sound, as the uncertainty surrounding the actions of others can deter depositors from making potentially unwarranted withdrawals.
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