Abstract

Standard macroeconomic models assume that households are rational in the sense that they are perfect utility maximizers, and explain economic dynamics in terms of shocks that drive the economy away from equilibrium. Here we present a conceptual alternative based on a heterogenous agent model in which households follow a simple behavioral rule. We build on the standard Ramsey-Cass-Koopmans model, and let individual households set their savings rate using a myopic ‘imitate-the-best’ heuristic. From time to time each household updates its savings rate by copying its neighbor with the highest consumption. We find that if the updating time is short, the economy is stuck in a poverty trap, but for longer updating times economic output approaches its optimal value, and we observe a critical transition to an economy with irregular endogenous oscillations in economic output, resembling a business cycle. In this regime households divide into two groups: Poor households with low savings rates and rich households with high savings rates. Thus inequality and economic dynamics both occur spontaneously as a consequence of imperfect household decision making. It supports an alternative program of research that substitutes utility maximization for behaviorally grounded decision making.

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