Posted by: Michael Mandel on July 23
This may be too wonky, but here goes…
Remember that earlier this year I was rereading Taleb’s The Black Swan. I drew some conclusions about technology and financial regulation. First, Taleb helped me understand what it means for technological change to be fundamentally unpredictable. Second, I got new insight into the best way to do financial and economic regulation.
even though the underlying rules for a system are simple, and even though the system is started from simple underlying conditions, the behavior that the system shows can nevertheless be highly complex.
How does this apply to today’s economy? From my perspective, Wolfram shows that a set of simple rules can produce both ‘near-random’ behavior and ‘near-regular’ behavior, depending on the initial conditions and how long the system has been running. Near-regular behavior means that there is some predictability about what’s going to happen next—-the world feels sane and understandable. Near-random behavior means that the near-term future becomes effectively unpredictable—-there are no short-cuts, no rules of thumb about what is going to happen next. The ground feels unsafe.
In ordinary times, the economy and financial markets operate as if the world was near-regular—predictable and understandable, to some degree. Last fall, however, we suddenly fell into a zone of near-randomness, that we are still digging ourselves out from.
Why did this happen? One insight from reading Wolfram: Without changing the underlying rules, it’s possible for a system to evolve from near-regularity to near-randomness, without much warning. Or, it can go from near-randomness into a zone of near-regularity.
I think that we can be safe in assuming that most people and businesses prefer to operate in an economic environment which is ‘near-regular’. That is, where there is some degree of predictability about the future. On the other hand, few people feel comfortable living in a world which is ‘near-random’.
That suggests the role of regulation is to keep the economy and financial markets operating within a near-regular region. If we start drifting into a near-random region, financial and economy regulators have to be able to take action in order to steer back into the near-regular region again.
So what can the regulators do? First, they can simplify the rules of the game so much that the economy and the financial markets become predictable. That might mean moving to a system of ‘simple banks’ which can only take deposits and make straightforward loans.
The other alternative is to find a good regulatory strategy by trial and error. Following Wolfram’s insights, we have to actually run the economy and the financial markets under that regulatory system to see if it produces the desired results. There are no short-cuts—unless we are prepared to greatly simplify the financial system.
Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.