BRAVE NEW WORLD OR DÉJÀ VU?
BRAVE NEW WORLD OR DÉJÀ VU?
In the past several weeks Bridge News has presented two views on the current state of our economy and whether it is the same as it has always been or is somehow different. David H. Resler of Nomura Securities, in his opinion piece of July 14, argued that the current economy more closely resembles that of neo-Classical economic theory than the neo-Keynesian framework we have used for several decades. He feels neo-Classical economic theory will now be more useful in examining the economy and of greater predictive value than the neo-Keynesian model. Federal Reserve Board Chairman Alan Greenspan, in his testimony before Congress, stated that it was too soon to know whether or not the U.S. economy has entered a different economic era. One where the old strictures and rules might no longer be relevant and which allows the U.S. economy to grow faster with less risk of inflation. He stated the Fed is still examining the issue, but it is clear from the recent behavior of the Fed that they are seriously considering that such may be the case.
Theirs is an attempt to define a structure; a new world-view that can explain the current state of affairs and that can be utilized in an analytical framework because the current models do not appear to be working. Given their position this is understandable – the future of Nomura’s position rides on Resler’s shoulders and, literally, the future of the world’s economy rests on Greenspan’s. Each needs to develop an understandable model of the economy that is useful for prediction and, by extension, decision-making.
The question arises, “Are they following a prudent course or are they falling short of what is needed to understand the current economy?” Are they unnecessarily limiting their outlook and straightjacketing their policy responses? The problem with their thinking is that neo-Classical, neo-Keynesian, or any other theoretical constructs are more descriptive than prescriptive. They are more capable of telling us where we are than of how we can get to where we want to go. They can tell us how to maintain the status quo, but not how to create a more desired outcome.
Both Resler and Greenspan appear to be looking at the trees and missing the forest. The question is not whether things are different, of course they are, but what does it mean to say they are different? Are there different sets of economic laws that govern our economy at different times or do just the circumstances change? The laws of economics, like those of physics, are immutable. The Law of Supply and Demand today follows the same principles it did since time immemorial. Economic laws do not change from one era to another, but remain timeless. What do change are the relationships among the various components that make up an economy and thus its outcome. Understanding these changing relationships is crucial to developing an accurate picture of how a complex system operates. A metaphor might be useful as an explanation.
Imagine our solar system, where the movements and locations of the various heavenly bodies are determined by the laws of planetary movement, gravity, and other physics principles. In the absence of an event that disrupts the system, it will remain essentially in stasis. Now imagine that Jupiter breaks into 15 different pieces that are scattered throughout the solar system by the force of its disintegration. Depending on the ripple effects of the changes induced, the solar system may change only slightly or be radically transformed. What changed were the relationships among the system components. Each now has a different constellation of forces affecting it, but the immutable laws of physics govern the reactions. The laws governing the system have not changed, but the system surely has. Whatever the outcome, it will be determined by physical law and not the actions of the components. The laws of physics allow us to understand the changes and to predict future events.
It appears that our economy is in a similar state of flux following the monumental changes in the world in the last decade. The world has gone from a Cold War with the globe divided into blocs of self-contained economies to one where the barriers have largely disappeared. The ongoing technological and informational revolutions are also changing fundamental relationships. What has not changed are the economic laws underlying the international economy. The changes observed are the result of the changing relationships among the nations of the world, the means of production, and the access to information. The outcome is shaped by the changing relationships, but determined by the laws of economics. The changes are ongoing and far-reaching and it is by no means certain that we have seen the final shape our international economy will take. In fact, it is more likely that we will see major changes continue for a long time to come.
And, since the relationships between components change through interaction, answers found today may be incorrect tomorrow. Why is M2 no longer a useful policy tool? Is full employment 6%, 5.5%, or some other number? The answer depends on what other things are happening. China’s opening to the world has added a billion new workers to the international labor force and India may soon add its near billion. That has helped hold down potential wage growth, lowering the full-employment level, but what happens when one billion Chinese decide to become mass consumers? What happens to the rosy inflation outlook then? In such a situation we must reexamine all of the “truths” which we have established on the economy to see if they still hold. The difficulty lies in the fact that many have not yet grasped just how much change has occurred as these relationships shift and how necessary it has become to reevaluate their analytical constructs. The changes have not yet been included in their world-view and thus their outlook remains incomplete at best and seriously skewed at worst.
Because the international economy is in such a state of flux, it makes the attempt by Resler and Greenspan to pigeonhole the economy all the more Sysiphean. What they are attempting to do is necessary for their purposes and responsibilities, but if it does not remain a dynamic process, over time their theoretical constructs will be too restrictive and lead to incorrect decisions. They will end up constantly making ad hoc adjustments to their models or searching for new ones to account for the continuing changes. Far more than in times past, what is needed now is a flexible approach and a willingness to realize the economy is changing – yet staying the same.
In the past several weeks Bridge News has presented two views on the current state of our economy and whether it is the same as it has always been or is somehow different. David H. Resler of Nomura Securities, in his opinion piece of July 14, argued that the current economy more closely resembles that of neo-Classical economic theory than the neo-Keynesian framework we have used for several decades. He feels neo-Classical economic theory will now be more useful in examining the economy and of greater predictive value than the neo-Keynesian model. Federal Reserve Board Chairman Alan Greenspan, in his testimony before Congress, stated that it was too soon to know whether or not the U.S. economy has entered a different economic era. One where the old strictures and rules might no longer be relevant and which allows the U.S. economy to grow faster with less risk of inflation. He stated the Fed is still examining the issue, but it is clear from the recent behavior of the Fed that they are seriously considering that such may be the case.
Theirs is an attempt to define a structure; a new world-view that can explain the current state of affairs and that can be utilized in an analytical framework because the current models do not appear to be working. Given their position this is understandable – the future of Nomura’s position rides on Resler’s shoulders and, literally, the future of the world’s economy rests on Greenspan’s. Each needs to develop an understandable model of the economy that is useful for prediction and, by extension, decision-making.
The question arises, “Are they following a prudent course or are they falling short of what is needed to understand the current economy?” Are they unnecessarily limiting their outlook and straightjacketing their policy responses? The problem with their thinking is that neo-Classical, neo-Keynesian, or any other theoretical constructs are more descriptive than prescriptive. They are more capable of telling us where we are than of how we can get to where we want to go. They can tell us how to maintain the status quo, but not how to create a more desired outcome.
Both Resler and Greenspan appear to be looking at the trees and missing the forest. The question is not whether things are different, of course they are, but what does it mean to say they are different? Are there different sets of economic laws that govern our economy at different times or do just the circumstances change? The laws of economics, like those of physics, are immutable. The Law of Supply and Demand today follows the same principles it did since time immemorial. Economic laws do not change from one era to another, but remain timeless. What do change are the relationships among the various components that make up an economy and thus its outcome. Understanding these changing relationships is crucial to developing an accurate picture of how a complex system operates. A metaphor might be useful as an explanation.
Imagine our solar system, where the movements and locations of the various heavenly bodies are determined by the laws of planetary movement, gravity, and other physics principles. In the absence of an event that disrupts the system, it will remain essentially in stasis. Now imagine that Jupiter breaks into 15 different pieces that are scattered throughout the solar system by the force of its disintegration. Depending on the ripple effects of the changes induced, the solar system may change only slightly or be radically transformed. What changed were the relationships among the system components. Each now has a different constellation of forces affecting it, but the immutable laws of physics govern the reactions. The laws governing the system have not changed, but the system surely has. Whatever the outcome, it will be determined by physical law and not the actions of the components. The laws of physics allow us to understand the changes and to predict future events.
It appears that our economy is in a similar state of flux following the monumental changes in the world in the last decade. The world has gone from a Cold War with the globe divided into blocs of self-contained economies to one where the barriers have largely disappeared. The ongoing technological and informational revolutions are also changing fundamental relationships. What has not changed are the economic laws underlying the international economy. The changes observed are the result of the changing relationships among the nations of the world, the means of production, and the access to information. The outcome is shaped by the changing relationships, but determined by the laws of economics. The changes are ongoing and far-reaching and it is by no means certain that we have seen the final shape our international economy will take. In fact, it is more likely that we will see major changes continue for a long time to come.
And, since the relationships between components change through interaction, answers found today may be incorrect tomorrow. Why is M2 no longer a useful policy tool? Is full employment 6%, 5.5%, or some other number? The answer depends on what other things are happening. China’s opening to the world has added a billion new workers to the international labor force and India may soon add its near billion. That has helped hold down potential wage growth, lowering the full-employment level, but what happens when one billion Chinese decide to become mass consumers? What happens to the rosy inflation outlook then? In such a situation we must reexamine all of the “truths” which we have established on the economy to see if they still hold. The difficulty lies in the fact that many have not yet grasped just how much change has occurred as these relationships shift and how necessary it has become to reevaluate their analytical constructs. The changes have not yet been included in their world-view and thus their outlook remains incomplete at best and seriously skewed at worst.
Because the international economy is in such a state of flux, it makes the attempt by Resler and Greenspan to pigeonhole the economy all the more Sysiphean. What they are attempting to do is necessary for their purposes and responsibilities, but if it does not remain a dynamic process, over time their theoretical constructs will be too restrictive and lead to incorrect decisions. They will end up constantly making ad hoc adjustments to their models or searching for new ones to account for the continuing changes. Far more than in times past, what is needed now is a flexible approach and a willingness to realize the economy is changing – yet staying the same.
posted by BNitemoves at 4:22 PM
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