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Dave Wrixon
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Bridge Engineer / Domain Speculator 50 years of age. UK Citizen. Deep amateur interest in Economics.
  • Why It All Went Wrong! – And How We Stop It Happening Again! 0 comments
    Jun 27, 2009 6:18 PM

     

    On reflection, it seems I may have got the Cart a Little before the Horse with my last Post. 

    I have started to address the role of statistics in the management of the economy without a sensible overview. I shall now attempt to correct that omission.

    Economies are often compared with cars, and various motoring analogies are used to describe their behaviour. The underlying implications are that economies are systems that can be controlled in much the same way as a well designed engineering system. Similar comparisons can be made with the Human Body, but as any doctor will tell you the system they are trying to manage is infinitely more complicated and the options open to them are in many ways much more limited. A car for example can be completely dismantled and have some parts re-engineered before being totally reassembled. These options do not exist for the Human Body, even if we had the necessary technology, as it results in death which is not considered an acceptable outcome. Similarly, we cannot just let an economy stop as the consequences would be too grave. We are also really only dealing with a sub-system of the global economy over which nobody has effective political jurisdiction, so total control is not possible.

    Whilst, it is assumed that economies can be managed in a similar way to the output of a car engine, and indeed there have been encouraging short to medium term successes, a definitive solution has proven elusive. To discuss why this has proven to be the case, I should like to take the analogy of an aeroplane flight, which again is not perfect for the obvious reason that planes don’t stay in the air indefinitely.

    The first thing that one would probably notice is in an aeroplane cockpit is that there is a hell of lot of instrumentation panels. That is because in order to get the required outcomes from a complex piece of engineering in an infinitely variable and often hostile environment, an enormous number of timely and measured adjustments need to be made. For the purposes of this discussion, let us assume that the objective is to get from A to B within the restrictions of the flight schedule, meeting all the necessary safety criteria and with the maximum possible fuel efficiency. I hope that is not too naïve of me, as I am not a pilot.

    One of the first things we need to consider is the relative performances of the aircraft whilst under manual and automatic control. Clearly if the plane is flying by computer control then decision making process is automated and considering the large amount of testing of the systems during pre-production, very objective. However, there is always the possibility that something unforeseen might happen that bamboozles the logic circuits of the aircraft and for which intervention by an experience pilot using his intuition might be a better outcome. Much depends on the competence and integrity of the pilot as to whether a better outcome in adverse situations might be expected.

    When it comes to economies they have traditionally been overseen by politicians that have their own agendas and just cannot resists meddling with the controls, even though conventional wisdom suggests their input can only result in disaster. For this reason in recent years things have been often been delegated to central banks and more specifically to their monetary oversight committees. This has been desirable as the politicians have tended to behave like barn storming adventure seekers, whose actions might be compared with a pilot that hammers the engines all the way so that he can get to the destination as he want to go out on the beer with his mates, or perhaps one that diverts to another destination under a false pretext, so that he can spend an extra night with his mistress. The central bank committees can sometimes behave like professional pilots and sometimes like auto pilots. I think a lot of people would tend to agree that the Bank of England has tended to behave like a skilled and experienced navigator whilst the ECB has largely been on auto pilot even when the exceptional circumstances have given rise to an erratic bumpy ride. Things the other side of the Atlantic have tended to fall into the barn storming adventurer category.

    It would therefore seem that ideally, the aircraft should be flown on autopilot, but we need very reliable instrumentation and infallible logic circuits to make things robust and reliable. In other words, to manage or economy properly we need to have a clear understanding of cause and effect, and we must be able to accurately measure the critical economic parameters before putting them into robust economic models to determine how the controls we have over the economy can best regulated. It is also imperative that where human intervention is allowed to take place, this must be done in by experienced real world economists who are not subject to the pressures of political or commercial allegiances and are of the highest integrity. There must also be clear and established criteria for such intervention and a suitable system of checks and balances. In America particularly, this means much greater independence of the Central Bank.

    Even then they need to have the best instrumentation available to base their objective decision making on. Of course with the economy, it is clear that Air Speed is the most critical parameter of all. Due to recent events, this is now at the top of the list of priorities for Airbus Engineers and also due to recent events it should be at the top of the priorities for the US Government, although it is no doubt at this very moment being subjugated by politicians with their own agendas. Yes, ladies and gentlemen, to put it in a nut shell, if we cannot measure inflation in the most appropriate manner to enable proper adjustment of the few crude controls we have available over the economy then we are screwed. It is often argued that inflation is nothing to do with price increases in the economy, and this is true as a theoretical level, but what we need to be able to measure is what is happening where it matters. It can be seen from recent experience that the money supply can be expanded without it having much of an impact on the real economy. We, by contrast, need to accurately quantify the parameters which have a direct impact on real-time business decision making, so that we can adjust the inputs that regulate these parameters. Above all we need a meaningful and accurate measure of inflation and reverting momentarily to a motoring analogy, we need it were the rubber hits the road.

    However, we measure inflation this then a suitable response must be made. There are two theoretical options. Once is through Monetary Policy and the other is through Fiscal Policy, although these are not as independent as people might think. Fiscal policy is very much the remit of politicians that in a democracy must exercise control of the government’s budgets. The aggregate result is also an aggregation of a lot of diverse policy decision, each of which is highly political in nature. The role of the executive government, at the risk of sounding crassly naïve, is to a great extent to co-ordinate policy to meet aggregate fiscal targets. Settle down. This is not a laughing matter.

    Through Monetary policy by contrast is possible to control the excesses of not only the Consumer, but Government as well as business. Yes, it has to be accepted that the Government must be subservient to Economists. This may seem undemocratic, but it is not. Ultimately, we are all slaves to market constraints. We need skilled professional pilots with their hand on the Joy Stick free from outside interference to lead us to safety in times of peril. This is no job for those Barn Storming Adventurers. If this was a fire fight, you would not see politicians trying to lead the troops into battle. Here where the stakes are even higher, it is important that they do not take charge. Just as you do not need to be a populist to be an economist, you certainly don’t have to be an economist to be politician.

    It must also be realised that has there are other tools than interest rates. AS Bernanke has recently made it clear, it is also possible to directly regulate the amount of money in the economy, even if his methods are not the best. By having regulated reserve ratios and by adjusting those reserve ratios China has demonstrated that not just the supply of money, but the availability of debt can be controlled not only by interest rate policy but effectively by quota. This method has been used primarily in response to asset price inflation, and it has proven effective. Yes, China regulates the Real Estate prices and Stock Markets not just through interest rates but directly through the supply of credit.

     

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