Adaptive Business Cycles

The most interesting features of evolutionary games, besides the ability to select among multiple Nash equilibria, are their dynamic properties. These dynamic properties are best displayed in a stochastic setting. In the usual deterministic setting, dynamics disappear in the long run (or they are stable orbits that repeat themselves). Studying evolutionary dynamics in a stochastic setting has a potential economic application: the modeling of business cycles. This paper is organized in the following way. Part 1 summarizes the standard economic analysis of business cycles. Part 2 presents a brief review of the adaptive business cycle literature. Part 3 brie‡y discusses Minksy’s theory of …nancial instability, that we try to model in what follows. In parts 4 to 8 we study a formal evolutionary model of liquidity management. Part 8 illustrates some simulations of the model obtained under alternative calibrations and concludes. In the appendix we further discuss the standard economic approach to modeling business cycles. We also discuss alternative strategies to model business cycles using evolutionary game theory.