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Current economic situation
Posted by Lees N. Stuntz on 1/5/2009
Dear List,
This is a posting by Tom Fiddaman on the SD list. He is addressing the current economic situation with an emphasis on the human element. It follows a discussion that circulated a bit earlier on our list, and is a good addition for anyone who is discussing the current situation with their students.
Happy New Year!
Lees
Posted by Tom Fiddaman
John Voyer correctly notes that positive feedbacks in the economy are not news.
The multiplier-accelerator and other theories have been around for a long time.
Where Powers really goes astray is with the notion that we can build a model,
reach consensus, and solve the problem technocratically. The system is too
complex for that. If you read the blogs of academic economists, you'll find
dozens of theories about the financial crisis, and little formal basis to
distinguish among them. By "formal" I really mean "model," and models have not
been visible in the discussion, at least to me.
The nugget of wisdom in Powers' message is that positive feedback can work both
ways, and that efforts to maximize a system's growth rate can have destabilizing
side effects. Like the electric power system, the economy works best when it's
on, and is difficult to restart if inadvertently switched off. Optimizing for
robustness might be a better option. Ironically, there's little evidence that
efforts to increase the growth rate actually do anything - per capita GDP growth
has been nearly constant in advanced economies since the industrial revolution.
To some extent, it might be possible to remove positive feedbacks, as Powers
proposes. One might, for example, reconsider the implications of money creation
through lending. I doubt that it's possible or desirable to eliminate all
positive loops though - after all, if you eliminate capital accumulation, growth
stops. The focus of most macroeconomic policy though is creation of
countercyclic
negative feedbacks. It's not clear that those policies are well understood (see
Forrester thesis below), or that they work in extreme conditions (as we're
seeing
now).
However, I think it's wrong to blame the rules and place faith in the invisible
hand. Mark-to-market, for example, might have contributed to the problem by
creating one of Powers' positive loops (falling prices force asset liquidation
to
meet capital requirements, driving prices further down). However, in a world
where undistorted signals were sufficient for stability, investors would have
seen that coming and priced assets accordingly, and the crisis would never have
occurred. The worst of the subprime lending was in the private sector; it wasn't
the GSEs who were driving ARMs, low-documentation loans, and other junk.
The real problem is not Fed policy or FNMA, it's that people got excited about
rising asset prices and forgot to think about fundamental value and risk. As a
result they took on too much leverage and too many non-transparent instruments.
There were bubbles long before there were regulators.
The real challenge here, I think, is that a lot of the perverse positive loops
are in people's heads. Education helps, but people forget, so it's an ongoing
process. Forgetting is amplified by evolutionary effects. It's hard to
distinguish between a robust strategy and risky speculation. Given the
difficulty
with attribution, it's quite likely that selection pressure will favor managers
who generate short term returns, and thus good times will gradually drive out
good sense. To some extent this is the problem of evil, and we will never fix
it,
but we do need to make some headway on such problems, otherwise the financial
crisis will be merely the first of a number of global catastrophes.
If you want a good example of SD work in this space, take a look at Nathan
Forrester's thesis.
http://dspace.mit.edu/handle/1721.1/15739
At least take a look at the introduction (pgs 7-18) and conclusions (215-217).
You can download the model from my site here
http://metasd.com/models/index.html#Business
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