Monday, January 08, 2018

Economics Which Models Itself After 19th Century Physics Is Overdue For An Update

aeon |  The price theory assumes that there exist fixed and independent curves that describe supply and demand, but the reality is that these forces are coupled and in flux – and the idea that they lead to a stable and optimal equilibrium seems more than a little wobbly.

Even stranger, though, is that in answering these basic questions money hardly seems to be mentioned – despite the fact that one would think money is at the heart of the subject. (Isn’t economics about money? Aren’t prices set by using money?) If you look at those textbooks, you will find that, while money is used as a metric, and there is some discussion of basic monetary plumbing, money is not considered an important subject in itself. And both money and the role of the financial sector are usually completely missing from economic models, nor do they get paid lip service. One reason central banks couldn’t predict the banking crisis was because their models didn’t include banks.

Economists, it seems, think about money less than most people do: as Mervyn King, the former governor of the Bank of England, observed in 2001: ‘Most economists hold conversations in which the word “money” hardly appears at all.’ For example, the key question of money-creation by private banks, according to the German economist Richard Werner, has been ‘a virtual taboo for the thousands of researchers of the world’s central banks during the past half century’. And then there is the mass of complex financial derivatives, whose nominal value was estimated in 2010 at $1.2 quadrillion, but which is nowhere to be found in conventional models, even though it was at the root of the crisis.

To sum up, the key tenets of mainstream or neoclassical economics – including such things as ‘utility’ or ‘demand curves’ or ‘rational economic man’ – are just made-up inventions, no more real than the crystalline spheres that Medieval astronomers thought suspended the planets. But real things like money are to a remarkable extent ignored.

In physics, the quantum revolution was born when physicists found that at the subatomic level energy was always exchanged in terms of discrete parcels, which they called quanta, from the Latin for ‘how much’. Perhaps we need to follow the quantum lead, and look at transactions between people. In economics, the equivalent would be exchanges of money – like when you go into a shop, point at something, and ask: How much? Or, if you’re in Italy, Quanto?, which makes the connection a little clearer.