Is it time to reassess the very concept of money?

[Sue Pertwee-Tyr]

Ive just been listening to Why Minsky Matters with Steve Keen and others. Minsky seems to think that ever more complex mathematical models are part of the problem in that they try to create stability, whereas stability itself is destabilising.

What good are these technical models when they failed to predict 2008 and have presided over austerity, privatisation and public spending cuts?

John Hicks, the inventor of one of the most famous models, said his own model was a “gadget” and needs replacing.

Surely the point of a model is to reflect reality, not to create stability? And in a highly dynamic context, like a global economy, stability is clearly a meaningless concept. Better to have effective means of recognising and correcting for instability. We don't have self-driving cars, but the driver isn't constantly making wild inputs to the controls (except in 1950s Hollywood).

 

[ks.234]

I don't know the answer to this. To my mind, models are inescapable - anyone who thinks about economics develops some theory of how it works; some use mathematics to set out this theory and some do it via concepts or words. Each approach carries a different kind of risk of being wrong. I'm just surprised that the mathematically-inclined at the BoE are not endlessly tinkering, striving for ever more complex mathematical models with more and more variables, in the vain hope of approaching reality.

The more models I look at, and it takes times because I don’t do numbers, they all start with an assumption or an ‘if’. Most of the more modern ones seem to start with the assumption that markets tend towards equilibrium and the job of banks and policy makers is to facilitate that ‘natural’ trend. When these models have failed then modellers come up with ever more complex models.

What if the central assumption is wrong? What if it is the engineered periods of stability that are actually causes overconfidence and consequence instability and periodic crisis?

 

[stevec67]

The more models I look at, and it takes times because I don’t do numbers, they all start with an assumption or an ‘if’. Most of the more modern ones seem to start with the assumption that markets tend towards equilibrium and the job of banks and policy makers is to facilitate that ‘natural’ trend. When these models have failed then modellers come up with ever more complex models.

What if the central assumption is wrong? What if it is the engineered periods of stability that are actually causes overconfidence and consequence instability and periodic crisis?

Well, that's the nature of models. I'm a chemist by training, and chemistry runs on models. Electrons have orbitals and energy levels. Except that they don't, what they have is probability. Electron orbitals include the nucleus of the atom, they have to, but they can't be detected there, so the fix is that they are only there on an extremely improbable basis (thank you Douglas Adams). The same goes for concepts of pressure and all else.

Any model has its exceptions. The only way to cope with this is to accept their limitations, and like analogies not to stretch them too far. Or come up with another model. Which science does occasionally do.

 

[ks.234]

Well, that's the nature of models. I'm a chemist by training, and chemistry runs on models. Electrons have orbitals and energy levels. Except that they don't, what they have is probability. Electron orbitals include the nucleus of the atom, they have to, but they can't be detected there, so the fix is that they are only there on an extremely improbable basis (thank you Douglas Adams). The same goes for concepts of pressure and all else.

Any model has its exceptions. The only way to cope with this is to accept their limitations, and like analogies not to stretch them too far. Or come up with another model. Which science does occasionally do.

Minsky isn’t talking about all models, just those used in economics. If you put too much load in the wrong place on a bridge for example, the models will predict that the bridge will fall down and invariably it does. But there the “if” is based on observation where as economic models are based on an assumption. Minsky is saying that the assumption is not only wrong, but is actually causing the bridge to fall down. The movement of particles at a sub atomic level are, as you say, probabilities, by from those observations we can build computers that work, whereas our economy, for the majority of people at least, is not working, its collapse a few years ago was not predicted by the models and the increased austerity and privatisation ever since, also the consequence of modelling, has failed to produce something that works.

Ever more complex revisions of the model are designed to protect the model, not the bridge.

Minsky says that our economic models are built on the assumption that markets, if left alone naturally tend towards equilibrium. Minsky says that such an assumption is not only wrong, but is the problem. He describes a situation where as an economy is stabilised after a recession then we enter a speculation stage where rather than making “safe“ loans where the borrower can cover both the principle and the interest, the banking system issues riskier loans whereby only the interest is paid and the principle is re-financed (interest only mortgages being an every day example)

As confidence in rising asset prices continues we enter the Ponzi stage where more and more speculation happens until the bubble bursts and investors can neither afford the principle nor the interest.

In the example of a pressurised system Minsky would say that Banks are not passive actors or occasional regulators, but are acting as pumps, causing speculation and investment bubbles.

The modelling is causing the bridge to fall down. The modelling might then rebuild the bridge with a few tweaks to redistribute the load, but that produces a misplaced confidence to increase the load until the bridge collapses again, then develop another more complex model, and so on and so on.

The podcast is worth a listen, even if you don’t agree with economists like Steve Keen and the various bankers in it.

 

[stevec67]

Minsky isn’t talking about all models, just those used in economics. If you put too much load in the wrong place on a bridge for example, the models will predict that the bridge will fall down and invariably it does. But there the “if” is based on observation where as economic models are based on an assumption. Minsky is saying that the assumption is not only wrong, but is actually causing the bridge to fall down. The movement of particles at a sub atomic level are, as you say, probabilities, by from those observations we can build computers that work, whereas our economy, for the majority of people at least, is not working, its collapse a few years ago was not predicted by the models and the increased austerity and privatisation ever since, also the consequence of modelling, has failed to produce something that works.

Ever more complex revisions of the model are designed to protect the model, not the bridge.

Minsky says that our economic models are built on the assumption that markets, if left alone naturally tend towards equilibrium. Minsky says that such an assumption is not only wrong, but is the problem. He describes a situation where as an economy is stabilised after a recession then we enter a speculation stage where rather than making “safe“ loans where the borrower can cover both the principle and the interest, the banking system issues riskier loans whereby only the interest is paid and the principle is re-financed (interest only mortgages being an every day example)

As confidence in rising asset prices continues we enter the Ponzi stage where more and more speculation happens until the bubble bursts and investors can neither afford the principle nor the interest.

In the example of a pressurised system Minsky would say that Banks are not passive actors or occasional regulators, but are acting as pumps, causing speculation and investment bubbles.

The modelling is causing the bridge to fall down. The modelling might then rebuild the bridge with a few tweaks to redistribute the load, but that produces a misplaced confidence to increase the load until the bridge collapses again, then develop another more complex model, and so on and so on.

The podcast is worth a listen, even if you don’t agree with economists like Steve Keen and the various bankers in it.

I will have a go at the podcast. In terms of models, as I said earlier: "Any model has its exceptions. The only way to cope with this is to accept their limitations, and like analogies not to stretch them too far". You talked about bridge building, which ought to be a pretty straightforward and well understood discipline. Do lots of hard sums, get the same result. But at Verranzano Narrows they did all the sums for what should have been a successful bridge and failed to factor in resonant frequency calculations, and we all know the disastrous consequences. The Shard, in London, has a problem with resonant air in the lift shaft. The lift moans and groans and sings. They didn't put it in the model. The Dalek, in Leeds, has a problem where wind from a certain direction will blow trucks over, and this has tragically killed someone. Again, not in the model. They have now built screens to direct air flow. Unknown unknowns weren't closed out and they bit them. I'm no economist but I suspect that all the models have large numbers of confounding factors or unknown unknowns. They also depend on human behaviour, which is always flawed and unpredictable. I suspect that the degree of noise in the various factors is enough to tip the model one way or another, giving an unreliable result. I suspect that if you were to conduct a sensitivity analysis on these models you would get quite a spread of results. Rather like asking an engineer to calculate what happens in a road collision, it's theoretically possible but there is so much chaos and "if this then that, but if that then this" that the range of possible outcomes is divergent rather than convergent.

 

[ks.234]

I will have a go at the podcast. In terms of models, as I said earlier: "Any model has its exceptions. The only way to cope with this is to accept their limitations, and like analogies not to stretch them too far". You talked about bridge building, which ought to be a pretty straightforward and well understood discipline. Do lots of hard sums, get the same result. But at Verranzano Narrows they did all the sums for what should have been a successful bridge and failed to factor in resonant frequency calculations, and we all know the disastrous consequences. The Shard, in London, has a problem with resonant air in the lift shaft. The lift moans and groans and sings. They didn't put it in the model. The Dalek, in Leeds, has a problem where wind from a certain direction will blow trucks over, and this has tragically killed someone. Again, not in the model. They have now built screens to direct air flow. Unknown unknowns weren't closed out and they bit them. I'm no economist but I suspect that all the models have large numbers of confounding factors or unknown unknowns. They also depend on human behaviour, which is always flawed and unpredictable. I suspect that the degree of noise in the various factors is enough to tip the model one way or another, giving an unreliable result. I suspect that if you were to conduct a sensitivity analysis on these models you would get quite a spread of results. Rather like asking an engineer to calculate what happens in a road collision, it's theoretically possible but there is so much chaos and "if this then that, but if that then this" that the range of possible outcomes is divergent rather than convergent.

Agreed, but the central point is that while mathematical models might pertain to science, the economy is not, as much as economists would like to think otherwise, a science.

Also worth noting that the original model that needed to be modified was still based on available and observable empirical evidence whereas the economy is still modelled on a presumption, based on human behaviour in a ‘natural’ system governed by an ‘invisible hand’, not modern science.

 

[Mick P]

Agreed, but the central point is that while mathematical models might pertain to science, the economy is not, as much as economists would like to think otherwise, a science.

Also worth noting that the original model that needed to be modified was still based on available and observable empirical evidence whereas the economy is still modelled on a presumption, based on human behaviour in a ‘natural’ system governed by an ‘invisible hand’, not modern science.

I once attended a seminar in London and the guest speaker was Norman Lamont, the then current Chancellor of the Exchequer. He was in a filthy mood because he was trying to curb credit and somehow one of his staff in No11 had received a mail shot inviting him to apply for a credit card with a limit of £100k. He had a bit of a rant about direct mail houses sending out inappropriate mail. He gave me a dirty look when he saw my name badge with the Post Office logo on it, so I thought it best not to indulge in chit chat with him over the buffet.

One of his biggest moans was that all senior politicians have advisors to give them the pros and cons on ways of manipulating the economy. He quipped that if you had a dozen trusted economist in a room, you would receive a dozen variations of advice and of course each one deemed themselves right and the other 11 completely wrong.

The moral is - trust ye not economist for they be an untrustworthy bunch of spivs.

 

[Seeker_UK]

“All models are wrong, but some are useful” – George Box

All models are wrong - Wikipedia

en.wikipedia.org

 

[ks.234]

I once attended a seminar in London and the guest speaker was Norman Lamont, the then current Chancellor of the Exchequer. He was in a filthy mood because he was trying to curb credit and somehow one of his staff in No11 had received a mail shot inviting him to apply for a credit card with a limit of £100k. He had a bit of a rant about direct mail houses sending out inappropriate mail. He gave me a dirty look when he saw my name badge with the Post Office logo on it, so I thought it best not to indulge in chit chat with him over the buffet.

One of his biggest moans was that all senior politicians have advisors to give them the pros and cons on ways of manipulating the economy. He quipped that if you had a dozen trusted economist in a room, you would receive a dozen variations of advice and of course each one deemed themselves right and the other 11 completely wrong.

The moral is - trust ye not economist for they be an untrustworthy bunch of spivs.

Yes, especially to the last two sentences, which I’ll come back to.

First of all, as much as it pains me to say this, Lamont was correct. As much as the National Debt is waved at us like a red rag in a bull ring, it is private debt that has caused our great and not so great economic crashes. Maybe Lamont had read his Minsky on the causes of financial instability?!?

I agree entirely that if you had a dozen trusted economist in a room, you would receive a dozen variations of advice, but I believe it depends on what you ask for. If you want to cut spending you will find a dozen economic models to tell you that spending money will cause economic bad things to happen, so there is no alternative. If you want to create spending for a decent NHS, you can find any number of models to demonstrate that such spending stimulates economic activity, reduces inequality and improves physical and mental health.

We have models that are based on the ideas of the free market and rational expectations geared towards profits as a measure of GDP. But we could look to models that are geared towards the Health of human beings, of communities, and of the Planet we live on.

One such model is Doughnut Economics.

Here* is a podcast from Radio Paradise, it explores an idea like Doughnut economics and plays tracks of vaguely relevant music in between the talking. All in nice sq. Interesting.

Beware Economists bearing Models

* http://radio2050.com/

A thought provoking, action inspiring show here to lift spirits, ignite imaginations, and remind us that there's hope even in the most dire situations.

 

[Sue Pertwee-Tyr]

I suspect that economists, like accountants, are predisposed to giving the answer the client is paying for.