Tuesday, November 6, 2012

Negative Feedback loops


We're looking at Nate Silver's The Signal and the Noise: Why So Many Predictions Fail-but Some Don't, starting here.

Here's another stray reference in the book which reminded me of something else. Silver talks about Larry Summers and feedback loops in the economy.

Usually, in Summers’s view, negative feedbacks predominate in the American economy, behaving as a sort of thermostat that prevents it from going into recession or becoming overheated. Summers thinks one of the most important feedbacks is between what he calls fear and greed.

Summers is a brilliant if famously obnoxious economist, of course, with a lot of practical experience of economic crises in several administrations. Isn't it surprising how little attention there has been to the homeostatic mechanisms in the American economy apart from the price system? A capitalist economy does have some inherent resilience and stability, for all its volatility. But we don't have much real knowledge about confidence and expectations ( for all the attention in economics to rational expectations.)

Another feedback loop is displacement of demand. Recessions produce pent-up demand for houses or cars or consumer durables. Less buying now typically means, other things equal, more buying tomorrow. Choice across time matters. (One of my larger themes, however, is preferences and tastes may not be stable as before, as abundance means many basic needs are satisfied.)

The best account I've seen from this dynamic perspective is Jane Jacob's dialogue about dynamic stability, which we looked at here. Surely someone within the economics profession is doing some systematic work in this vein. Or perhaps not, as it is so heterodox. If someone knows of any such good work, please comment.

In college, one sure way to throw something at an economics problem was to contrast comparative statics with a dynamic view of the economy. But much of the bedrock of economics is still single-country comparative statics, perhaps, for the daring, with some hysteresis - path-dependence - thrown in.

When people try to do dynamics , it necessarily relies much more on assumptions about behavior and psychology. Take, for example, the controversies over CBO dynamic forecasts of tax revenue. Republicans tend to want to see more behavioral changes and higher revenue for a given tax cut because do dynamic effects. Democrats do not.

The upshot is we would do much better thinking about the economy in dynamic terms, with close attention to feedback loops. But we mostly don't.

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