2017 Prize: Helène Rey, winner; Fabio Maccheroni, Massimo Marinacci and Aldo Rustichini, nominees
The 2017 Maurice Allais Economics Prize award ceremony took place on 19th May at the MINES ParisTech “Grande Ecole”. The Prize was awarded to Hélène Rey, Professor at the London Business School, for her work entitled “Dilemma not Trilemma : The Global Financial Cycle and Monetary Policy Independence” published in the Proceedings of the 2013 Economic Policy Symposium of Jackson Hole by the Federal Reserve Bank of Kansas City. The Jury also insisted on paying homage to the nominees Fabio Maccheroni and Massimo Marinacci, Professors at the Università Bocconi (Milano) and Aldo Rustichini, Professor at the University of Minnesota, for their article titled “Ambiguity Aversion, Robustness, and the Variational Representation of Preferences”, published in Econometrica (2006) .
The 2017 laureate: Hélène Rey, Professor at the London Business School
Hélène Rey is a graduate from ENSAE and Stanford University, and a PhD laureate from both the London School of Economics and the École des Hautes Études en Sciences Sociales. She taught at Princeton University and now holds the Lord Bagri Chair of the London Business School.
The French economist obtained a number of scientific prizes including two prizes rewarding young European economists: the 2006 Bernácer Prize and the 2013 Yrjö Jahnsson Prize, which she shared with Thomas Piketty. She is also a member of France’s Haut conseil de stabilité financière and Commission économique de la Nation.
Hélène Rey is known internationally for her work in the field of monetary macroeconomics. Her research on exchange rates and capital flows aims in particular at identifying the determinants and consequences of crises and financial imbalances.
The 2017 Maurice Allais Economics Prize was awarded for Hélène Rey’s article entitled “Dilemma not Trilemma : The Global Financial Cycle and Monetary Policy Independence” which was published by the Federal Reserve Bank of Kansas City in the Proceedings of the 2013 Economic Policy Symposium of Jackson Hole.
In this contribution, Hélène Rey questions the validity in today’s world of the famous Robert Mundell “impossible trinity”, also called “trilemma”. Mundell’s argument stemmed from the Mundell-Fleming theoretical model, an application of elementary Keynesian analysis in the context of an open economy, dating back from the 1960s. According to this “trilemma”, it is only possible to have two of these three things at once: (a) fixed exchange rates; (b) the freedom to set interest rates in the economy, which is a sign of an autonomous monetary policy; and (c) free movement of capital, notably “hot money” and short term capital. This theoretical result provided one of the founding principles of international economics courses that have been taught to generations of students until the mid-2000.
At first glance, the current state of the world economy seems to follow the principle of the “trilemma”, with the current exchange rate regime being dominated by floating rates -and not fixed rates; capital flows being free; and central banks being able to conduct monetary policy in a sovereign way. The goal of Hélène Rey’s article was to demonstrate that the reality lies elsewhere, because the “trilemma” does not hold anymore. The approach followed by Hélène Rey in this important document can be summarised in three points:
- First, an analysis of interdependencies of capital flows, fluctuation of credit and stocks prices between the 7 main geographical zones of the world (North America, Latin America, Central and Eastern Europe, Western Europe, emerging Asian countries, Asia and Africa) leads Hélène Rey to demonstrate the existence of a “global financial cycle” over the period 1990-2013. This cycle takes the form of a global cycle of confidence, negatively correlated with uncertainty on global markets. The global financial cycle of capital flows can influence monetary policies carried out in countries across the various regions of the world.
- In a second step, Hélène Rey shows that the global cycle depends on the monetary policy of the United States (the monetary policy of the Fed consisting in fixing short term interest rates). As a consequence, countries in other parts of the world cannot carry out monetary policies independently, but are instead de facto constrained, at least partially, by the US monetary policy. This is happening even when the economic conditions observed in other regions of the world may not necessarily coincide with the global financial cycle. This lack of independence may generate very important costs for these countries in terms of economic imbalance and inefficiency. Hélène Rey considers that this can be the source of periods of excessive credit growth, and financial bubbles.
- As a result, one now has to choose between properly independent and effective monetary policies, and full freedom of capital flows. This is true even as exchange rates are floating, which clearly goes against the principles of the “trilemma” that should therefore be replaced by a “dilemma”: one has to choose between the effective autonomy of monetary policy and the free movement of short term capital whatever the exchange rate regime in place.
How to choose? Hélène Rey argues that, in contradiction with the findings of orthodox growth models, empirical studies do not provide evidence of positive effects of free movement of capital but quite to the opposite, the fact that capital can move freely disrupts both monetary policies and financial markets. Hélène Rey concludes that it is preferable to regulate short term capital flows in order to give back greater autonomy to monetary policy.
This argument had already been formulated by economists in the late 1940’s (Ragnar Nurkse, International Currency Experience, 1947) who drew lessons from the severe imbalances of the 1930s. This had been understood by economists, including the most liberal, until it was -unfortunately- forgotten towards the turn of the 1980s’ with the Reagan revolution. This effort to bring back such an argument today, in a different context and using different types of analysis, has major implications for monetary policy nowadays and in the future. It bears many similarities with the approach followed by Maurice Allais throughout his career as a researcher, as testified by a number of his publications.
The 2017 nominees: Fabio Maccheroni and Massimo Marinacci, Professors at the Università Bocconi (Milano), and Aldo Rustichini, Professor at the University of Minnesota
Three italian economists: Fabio Maccheroni, Professor at the Department of decision sciences of the Università Bocconi (Milano); Massimo Marinacci, Professor and AXA-Bocconi Chair at the Department of decision sciences of the Università Bocconi (Milano); and Aldo Rustichini, Professor at the Department of Economics of the University of Minnesota have been nominated by the Jury for their article entitled “Ambiguity Aversion, Robustness, and the Variational Representation of Preferences”, published in 2006 in Econometrica.
Some preliminary explanations are necessary to give a sense to their contribution.
In the theory of rational expectations inherited from the 1960s, economic agents are certain to have the right model, which is the same for all. This means that they can predict the next economic equilibrium in a non-ambiguous way. This hypothesis appeared less and less satisfying in a world characterised by greater turbulence, but also by greater doubt -or epistemic uncertainty- over possible futures as well as over the very specifications of models used both mentally and physically by economic agents. Models trying to capture ambiguity itself have flourished, some directly related to future events (multiple probabilities a priori), and others on the conviction to have the right model that would allow to predict the distribution of probabilities to be affected to future states of the economic system (epistemic ambiguity). Maurice Allais was quite sceptic about the theory of rational expectations. He considered it simply as a convenient way of avoiding difficulties related to the extension to dynamic or inter-temporal cases of the general equilibrium economic model. Yet, according to him, this hypothesis was not realistic. The growing success of behavioural economics and finance has recently highlighted this weak link with empirical facts. The three authors nominated for the Maurice Allais Prize explicitly link their article with this school of thought.
Moreover, most of us have traditionally considered ambiguity as something to be avoided. But some will try to avoid it at all cost, while others will do so less ardently. Some may even find it not so undesirable… Just as we have been accepting for a long time now the notion of risk aversion or risk-seeking when describing individuals’ behaviour, we have had to admit that some people show an aversion to ambiguity, while others may actually seek such ambiguity. Yet the formal definition of the corresponding parameter has been the focus of attention from a large part of economic research since the early 2000. A narrow or a broader definition of this parameter can be used.
According to the broader definition, an individual is averse to ambiguity as long as he or she deviates from behavioural patterns that are characteristic of expected utility. The idea stems straight from the famous Allais Paradox published in the early 1950s. According to this paradox, even when probabilities are well known (risky situation in strict terms), the “expected utility” rule supposedly followed of economic agents turns out not to accurately describe those behaviours. One has to take into consideration the way probabilities can have a psychological influence on individuals’ behaviours, a “rank-dependent” model of which Maurice Allais already had a fairly precise idea in 1952 and which he elaborated in response to the Paradox and other empirical findings in 1986 -a text that only few economists know about. The obvious consequence to this is that an ambiguous knowledge of probabilities reinforces the aforementioned psychological transformation. The broader definition of aversion to ambiguity has thus been developed according to this observation.
The more restrictive definition considers that a behaviour can be referred to as aversion to ambiguity only in cases where there has been a violation of the notion of “probabilistic sophistication”, of which the “rank-dependent model” can only offer particular cases.
The existence of these two definitions meant that two separate theoretical lines of thought remained in this quest of a theory not only of risk -the problem had been solved by Maurice Allais for some years, in virtually the same terms as Kahneman and Tversky- but of ambiguity and aversion to ambiguity as briefly described previously.
The economic, mathematical and philosophical remarkable achievement of Fabio Maccheroni, Massimo Marinacci and Aldo Rustichini’s 2006 contribution came from the general theory of aversion to ambiguity that they proposed. This new theory encompassed not only both the aforementioned definitions, but also a third one. In addition, it was possible to apply this new theory to all possible models of ambiguity, whether they considered probabilities related to future events (“multiple priors models”) or epistemic probabilities linked to the belief of having the right model -mental of physics- to predict future economic events (the so called Hans-Sargent ambiguity).
It is thus not surprising that this paper has been recognised a major contribution to the analysis of risk and ambiguity, and that it has been cited many more times than one would expect from such a specialised and advanced theoretical paper (more than 800 citations over 10 years). This paper, which can be seen as the continuation of Maurice Allais renowned contribution, could not have gone unnoticed by the jury, in spite of the many other submissions of very high international level that have been received.
2015 Prize: Xavier Gabaix, winner; Eric Barthalon, nominee
The 2015 Maurice Allais Economics Prize award ceremony took place on 29th May at the MINES ParisTech. The Prize was awarded to Professor Xavier Gabaix for his remarkable work on “limited rationality”. The Jury also insisted on paying homage to the nominee Eric Barthalon for his work Uncertainty, expectations and financial instability – Reviving Allais’s lost theory of psychological time.
The 2015 laureate: Xavier GABAIX, Professor at New York University, singled out by the IMF as one of the top 25 most promising economists
A graduate of the Paris École Normale Supérieure and of Harvard University, Xavier Gabaix is currently Professor at New York University’s Stern School of Business, having previously taught at the Massachussets Institute of Technology. He has already been awarded several scientific prizes for economics.
The 2015 Maurice Allais Prize has been awarded to him for his article entitled “A sparsity-based model of bounded rationality”, published in 2014 in The Quarterly Journal of Economics, which could be called the crowning achievement of his research into the limited attention economy. His model submits that the individual will seek his maximal interest while taking account of only a part of the data which a rational individual (in the strong sense of neo-classical theory) would consider, and it makes it possible to establish the respective degrees of attention at which certain data, but not others, will be taken into account.
A remarkable study of limited rationality, the limits of equilibrium of the markets and consumer protection.
On the theoretical level the fundamental implications of this research concern the determination of individual demands, hence of aggregate demand, and therefore of the economic equilibrium. For example, from the standpoint of neo-classical analysis, if all prices – and in particular the wage rate – are multiplied by a factor k (one example being the passage from the Franc to the Euro) the individual’s supply of labour does not change, neither does his demand for fruit and vegetables or any other product, nor is there any change in the general economic equilibrium. But Xavier Gabaix’s “sparsity-based bounded rationality” modifies these conclusions: wages undoubtedly count as “salient” prices, but the same does not apply to all the other prices. This leads to modifications in the labour supply and in the demands for various other products to which the individual has not devoted the same “degree of attention”, and hence to modifications in the general equilibrium. For Xavier Gabaix the equilibrium of the markets no longer automatically brings about optimal use of resources on the collective level.
Moving on to the more immediately practical consequences, this “sparsity-based bounded rationality” means that public authorities ought to protect the consumer against exploitation by the marketing services of businesses of what might be considered to be the flawed rationality of a large number of consumers.
Moreover Xavier Gabaix’s research also strikes a chord with the preoccupations and some of the conclusions reached by Maurice Allais in works such as his Théorie Générale des Surplus [General Theory of Surpluses] both in terms of monetary behaviour and the equilibria of markets.
The 2015 nominee: Eric BARTHALON, virtuoso of the financial market
A graduate of the Paris École Supérieure de Commerce, Eric Barthalon has held senior posts in the banking sector and is currently Chief Economist and Tactical Asset Allocation Manager with Allianz Investment Management SE.
He was nominated by the Maurice Allais Prize Jury for his book Uncertainty, expectations and financial instability – Reviving Allais’s lost theory of psychological time, published in 2014 by the Columbia University Press.
Maurice Allais never tired of calling for economic theory to be measured against empirical observation. So exchanges between practitioners and academics were high on his list of priorities. The work submitted to the Maurice Allais Foundation by Éric Barthalon is exemplary in this respect.
Its author pleads for the rehabilitation of Maurice Allais’s “lost theory of psychological time”. Once again stress is laid on the fact that individuals’ rationality is not so perfect as the neo-classical theory supposes. Hence the “rate of forgetfulness” causes past prices to be partially “forgotten” so that all of them do not have equal weight in influencing the rational calculations of individuals – a basic factor in Maurice Allais’s “HRL” monetary theory.
A wealth of insights into the “exuberance” of the financial markets
Eric Barthalon establishes a link between Maurice Allais’s knowledge of the 1929 crisis and his own experience, as a high-level practitioner, of the crises of 1987, 1998, 2001 and, of course, 2007. Drawing on an original empirical observation – the link between the objectively observable nominal interest rate and the nominal rate of growth subjectively perceived by the market – Eric Barthalon adds a new storey to Maurice Allais’s monetary edifice. His conclusions regarding the fundamental instability due to our system of money creation by the commercial banks is, however, closely akin to the view developed by Maurice Allais in his HRL theory of the demand for money. But Eric Barthalon goes further and in the closing chapters of his book builds bridges, that are both original and promising, with financial modelling.
In the view of Professor Bertrand Munier, Chairman of the Jury, “the Jury’s choices for 2015, both for the winner and the nominee, thus convey a general message: to pay tribute to the evolution of economic analysis into a discipline which, while retaining its specificity intact, basing itself on the rational behaviour of economic agents, draws closer to the individual and collective behaviour patterns observed by all and sundry yet which have hitherto been modelled only by psychologists. This was the import of a great part of the research carried out by Maurice Allais.”
The 2013 Prize : Three winners and two nominees
The 2013 Maurice Allais Economics Prize was awarded jointly to Professor Roger FARMER, Distinguished Professor, University of California and Senior Norman-Houblon Fellow, Bank of England, Mme Carine NOURRY, Professor at the Université of Aix-Marseille, GREQAM, I.U.F and M. Alain VENDITTI, Director of Research at the CNRS, GREQAM-Université d’Aix-Marseille and Adjunct Professor at the EDHEC, for their article ”The Inefficient Markets Hypothesis: Why financial markets do not work well in the real world”, published in 2012 in the NBER Working Papers Series.
The Jury also honoured as nominees Professor Alfred GALICHON, of the Paris Institut d’Etudes Politiques, for his article “Dual theory of choice with multivariate risks” published in 2012 in collaboration with Mr. Mark Henry in the Journal of Economic Theory, and Professor Philippe MONGIN, Director of Research at the CNRS, Professor at the H.E.C., for his study entitled “Duhemian Themes in Expected Utility Theory”, which appeared in 2009 in French Studies in the Philosophy of Science (Boston Studies in the Philosophy of Science, Springer).
All 19 applicants were of an excellent standard requiring the Jury to devote lengthy discussion to detailed evaluation of the analyses presented by the appointed reviewers. Use was made of the voting procedure proposed by Maurice Allais and Bertrand Munier to the CNRS Economics and Management Jurys where they were deliberating.
The most significant of the selection criteria applied by the Jury were: the importance of the contribution made to the advance of knowledge, logical rigour, efforts to compare the theoretical work with observable reality, publication (print or on-line) via a prestigious medium, relation to the method and progress of Maurice Allais’s research, acknowledgement of Maurice Allais and dissemination of his work.