Simulation technology could help prevent future financial crises

How will economic policies adapt in 2020 when a quarter of the EU population is over 65? Can economics better predict how banks will react to credit crunches in the future, and what their impact will be on the wider economy? How will the economy work when dwindling natural resources make it harder to satisfy our energy needs? The European Commission today unveiled breakthrough research that could help economists answer questions like these by using economic simulation software. Produced by an EU-backed research project worth €2.5 million that came to a successful end today, the software applies simulation technology also used for computer generated images (CGI) in movies. It predicts the interaction between large populations of different economic actors, like households and companies, banks and borrowers or employers and job-seekers, who trade, and compete like real people. By giving each simulated agent individual and realistic behaviour and interactions that show how markets will evolve, these massive scale simulations can better test new policies tackling future societal challenges.

"This first class European research can help us make the move from the economics of pen and paper to the economics of super-computers," said Viviane Reding, EU Commissioner for Information Society and Media. " The results of this research project, will complement traditional economic statistics and assumptions about how economic actors react by enabling better testing of a policy's effects on people, while still on the drawing board. I expect government researchers and national research institutes will act quickly to put this tool at the disposal of decision- makers as soon as possible."

This simulation technology developed by EU-backed research uses computer-based experiments to focus on the relationship between large populations of different economic actors across many interconnected markets. It is the first time this technology is applied on such a big scale using high-powered computing. Each simulated household (or business, or bank) will make different decisions in reaction to various monetary, fiscal or pro-innovation policies including, for example, whether to remain in a job or seek a new one, how much of a wage is saved, spent or invested. This means that the impact of one policy in one market at one point in time is no longer assessed in isolation from other factors.

Traditional economics failed to predict the scale of the knock-on effect of the credit crunch on the world economy. The new software shows how banks react in different ways by looking at a wide range of factors like how much reserves they must keep compared to investments, their savers' consumption/investment and saving patterns, and psychological factors like confidence in the market. It can then give policymakers – who want to know how fiscal and monetary reforms will affect banks and customers – a better warning of the scale of a financial crisis' impact on the real economy. The software can also simulate the same scenario with an older demographic to help plan for an older Europe, or with limited energy supplies.

Designed to run on supercomputers that allow simulation to be carried out on a massive scale but accessible to any connected desktop PC, the software can be used by economists and policymakers with no knowledge of computer programming. By connecting hundreds of thousands of small simulated actions and reactions across the economy, the software can give policymakers better and bigger pictures of their policy impact on people's life and work.

The three-year project was carried out by economists and computer scientists from eight universities (in Italy, France, Germany, Turkey and the UK), brought together by the EU and financed from the European Commission's technology research budget.