When the economy is like a pack of wild horses

25 October, 2012 at 18:54 | Posted in Economics | 2 Comments

Andrew Haldane is England’s Executive Director for Financial Stability. Olaf Storbeck recently inteviewed him about the crisis of contemporary economics and the way forward.

I am just trying to make sense of the real world. The workhorse model we used in economics is no longer working properly. Hence we are compelled to think innovatively, to seek insights from disciplines beyond our own. We are looking for systems behaviour that matches what we can see happening in the real world. In some ways we are just borrowing ideas from other disciplines.

What are the issues of contemporary macroeconomics?

With the benefit of hindsight, we built an edifice, a set of models, that were quite peculiar in the assumptions they made . For example, we drifted away from the notion of having a multiplicity of equilibria. We also forgot that we could even get stuck in the wrong equilibrium, which is one way of making sense of where we are today. We drifted away from the notion that systems could become dynamically unstable when stretched or stressed too much. It is hard to think of a system outside of economics, whether from the natural world or from social sciences, that doesn’t have a multiplicity of equilibria and doesn’t behave peculiarly when stretched or stressed and can which be destabilising. However, in modern macro, the notion of equilibrium was a singular stationary, stabilising concept.

Can you give a concrete example, please?

Back in the 20s, when macro was beginning to find its feet, Knut Wicksell used the metaphor, when explaining economic systems, of the rocking horse. Imagine you are hitting a rocking horse with a stick: The horse moves according to a pretty regular pattern. That metaphor is a fairly accurate summary of how we approached economic modelling theoretically and empirically for a century.

If the economy doesn’t resemble a rocking horse, what’s a more appropriate description?

Instead of beating a rocking horse, imagine hitting a pack of wild horses with a stick. What happens next? Well, the truth is: you don’t know. One possibility is nothing happens at all. Maybe the horse you beat runs off in one direction. Most likely, however, the horse runs off scared and panics all the other horses who then also charge off in a direction that is impossible to predict ex ante.

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2 Comments »

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  1. For Pete’s sake! Where have these people been since the time of John Law? At least once on fiat currency regimes (~80 years now?) it should be as clear as a bell that we don’t NEED financial stability. The entire premise of fiat currency is to let currency supply float as an automatic stabilizer so that the issuing nation can achieve stable pursuit of an unpredictable survival (aka, adaptation) path. There is no such thing as stability in evolution. Time to start over, and send most of our voters back to revised grammar schools?

    The earth isn’t flat, and we have too many people expert in irrelevant paradigms.

  2. This is the perfect introduction for my eBook:
    The Nature of the Beast: how economists mistook wild horses for a rocking chair.
    http://betternature.wordpress.com/my-books/nature-of-the-beast/

    I’m a physicist (geophysicist) who has pursued this line of thought for some time – to a broad framework within which all the important questions can be sensibly explored. Instead of most of the important questions being excluded by a priori assumptions.

    The system is not necessarily chaotic, it can be “complex”, with reasonably predictable character, like living things. You get instability and complexity from economies of scale and from fractional reserves, as well as from people’s herd behaviour and other sources.


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