Bank of england knowledge

1. Knowledge
in/of
Economics:
the
need
for
a
new
(monetary)economics
Bank
of
England-­‐17th
February
2015
Lex
Hoogduin
University
of
Groningen
and
Duisenberg
School
of
Finance1

2. IntroducMon
(1)
• Financial
crisis
as
wake-­‐up
call
for
monetary
theory,
finance
and
macroeconomics
• Not
because
Mming
could
not
be
predicted
• Analysing,
describing
financial
(in)stability
difficult
in
a
framework
where
money
&
finance
have
no
proper
foundaMon/place

3. IntroducMon
(2)
• Against
the
background
of
the
Great
Financial
Expansion
(GFE)
of
past
4-­‐5
decades
• GFE
has
probably
fundamentally
changed
the
way
modern
economies
work
• Cannot
be
understood
without
understanding
money
and
finance

4. IntroducMon
(3)
• Cannot
in
a
framework
in
which
money
and
finance
are
a
sideshow/inessenMal
• Problem
in
mainstream
is
with
2
core
assumpMons
related
to
the
knowledge
of
economic
agents
(and
then
also
related
to
economic
theory
itself)
• 1.
Uncertainty
about
the
future
• 2.
Dispersion
of
knowledge
across
the
financial
system;complexity
of
the
financial
system

5. IntroducMon
(4)
• Taking
into
account
uncertainty
and
complexity
implies
a
different
paradigm
for
(monetary)
economics
• Different
methodology
• Different
pretence
of
what
economic
theory
can
achieve

6. IntroducMon
(5)
• A
different
concept
of
economic/financial
policy
and
what
it
can
achieve
• Own
language
and
concepts
• This
other
paradigm
need
not
to
be
built
up
from
scratch

7. IntroducMon
(6)
• It
can
build
on
three
building
blocks
that
are
already
there:
• 1.
The
original
work
of
Keynes
and
post-­‐Keynesians
focusing
on
uncertainty
• 2.
The
work
of
the
(neo-­‐)
Austrians
and
Hayek
in
parMcular
on
dispersed
knowledge,
markets
and
(spontaneous)
order
• 3.
Tools
from
“modern”
complexity
theory,
as
developed
from
the
1980s
with
Santa
Fe
as
starMng
point

8. Agenda
• 1.
Lack
of
knowledge
about
the
future
(uncertainty)
• 2.
Dispersion
of
knowledge
• 3.
Broad
outline
of
the
alternaMve
paradigm
• 4.
Examples
of
applicaMons
(banking
supervision,
data
strategy,
secular
stagnaMon?,
norms
in
economic
policy………)

9. Lack
of
knowledge
(1)
• Based
on
Keynes
(1921)
and
Knight
(1921)
• DisMncMon
between
risk
and
uncertainty
• Risk:
all
possible
outcomes
of
a
decision
or
acMon
can
be
known

10. Lack
of
knowledge
(2)
• Probability
calculus
is
applicable
• Economic
decision
making
can
be
modeled
as
a
computable
opMmising
problem
• According
to
Keynes
assumed
by
Classical
Theory
and
in
the
prevailing
mainstream

11. Lack
of
knowledge
(3)
• However,
logically
it
is
impossible
to
list
all
potenMal
events
in
the
future
that
may
affect
today’s
decisions
• People
cannot
know
now
what
will
be
discovered
in
the
future
• The
future
is
not
prestatable
(cf.
Kauffman)
• The
future
phase
space
is
undetermined
now

12. Lack
of
knowledge
(4)
• ParMcularly
relevant
for
taking
long-­‐term
decisions
• Economic
agents
cannot
and
do
not
make
decisions
fully
raMonally
as
their
decisions
are
modeled
in
mainstream
monetary
economics
• Concept
of
intertemporal
equilibrium
of
mainstream
(Arrow-­‐Debreu)
is
irrelevant
in
the
world
as
it
is

13. Lack
of
knowledge
(5)
• Economic
calculus
under
risk
should
be
replaced
by
a
theory
of
decision
making
under
uncertainty
• In
the
General
Theory
in
parMcular
Keynes
has
provided
elements
for
such
a
theory
• Keynes
has
clearly
linked
the
existence
of
uncertainty
and
the
role
of
money
and
finance

14. Dispersion
of
knowledge
(1)
• Back
to
the
1930s,
to
Hayek
in
parMcular
• His
arMcles
Economics
and
knowledge
and
the
use
of
knowledge
in
society
• In
1928
Hayek
had
elaborated
his
own
version
of
intertemporal
equilibrium,
building
on
Walras

15. Dispersion
of
knowledge
(2)
• The
socialist
calculaMon
debate
put
him
on
another
track
• Lange
argued
that
central
planning
was
efficient
and
that
it
was
possible
to
calculate
a
general
equilibrium
rather
than
leaving
it
to
markets
• Hayek
came
to
realise
that
no
economic
agent
(including
a
central
planner)
in
a
decentralised
economy
can
or
does
possess
all
the
informaMon
(data)
that
are
assumed
to
be
known
in
calculaMng
general
equilibrium

16. Dispersion
of
knowledge
(3)
• In
the
market
system
somehow
this
widely
dispersed
informaMon
and
knowledge
is
used
• Equilibrium
system
is
just
a
logical
system;
it
shows
that
a
set
of
prices
exist
such
that
the
plans
of
all
economic
agents
are
consistent
and
can
be
executed
unchanged
• Does
not
say
if
and
how
that
will
happen

17. Dispersion
of
knowledge
(4)
• Equilibrium
system
has
no
empirical
content
• Hayek
iniMally
argues
that
such
empirical
content
can
only
come
from
understanding
how
people
acquire
knowledge
and
change
expectaMons
on
that
basis
• Very
similar
to
what
is
now
being
done
in
non-­‐
equilibrium
economics/complexity
economics
• See
for
example
work
of
Hommes
on
heterogenous
expectaMons

18. Dispersion
of
knowledge
(5)
• Hayek
has
lek
that
path
• Note
also
that
earlier
alempts
along
those
lines
have
failed
• Swedish
school
in
1930s
• Hicks
in
Value
and
Capital
(1936)
• Disequilibrium
economics
in
the
1970s
(Malinvaud,
Dreze,
Benassy)

19. Dispersion
of
knowledge
(6)
• Hayek
became
convinced
that
a
theory
of
learning
and
expectaMon
formaMon
is
beyond
reach
• Becomes
more
fascinated
by
how
economic
agents
can
decide
having
only
very
limited
and
local
knowledge
• And
that
sMll
a
rather
structured
overall
outcome
of
the
economic
process
emerges

20. Dispersion
of
knowledge
(7)
• Leads
him
to
focus
on
the
rule
of
prices
and
of
a
common
set
of
rules
in
a
broad
sense
(also
law,
ethics,
insMtuMons)
• Role
of
money
and
finance
analysed
from
that
perspecMve
• Similar
to
the
framework
that
Keynes
used

21. Dispersion
of
knowledge
(8)
• Economy
and
financial
system
are
complex,
in
the
sense
that
not
all
informaMon
and
knowledge
that
is
present
in
the
system
can
be
known
at
one
point
• How
can
a
complex
system
nevertheless
have
structure?
• Leads
us
to
outline
of
alternaMve
paradigm

22. AlternaMve
paradigm
(1)
• Abandon
the
equilibrium
and
non-­‐equilibrium
noMon
• Replace
it
by
the
concept
of
order
in
the
complex
economy
• Order:
the
set
of
palerns
of
economic
outcomes
that
may
result
from
interacMng
economic
agents
acMng
purposefully
under
uncertainty
in
a
situaMon
of
scarcity
on
the
basis
of
a
common
set
of
rules
in
a
broad
sense

23. AlternaMve
paradigm
(2)
• Correct
expectaMons
or
fully
coordinated
plans
no
requirement
for
order
• Order
is
likely
to
evolve
• Example:
CompeMMve
order
• Palerns:
drive
to
efficiency,
law
of
one
price,
drive
to
innovate
and
increase
producMvity

24. AlternaMve
paradigm
(3)
• Detailed
predicMon
and
control
impossible
• Different
view
of
the
future:
imaginable,
but
not
predictable
(exogenous
expectaMons)
• Future
is
not
waiMng
to
be
discovered,
but
emerges
from
the
interacMons
of
economic
agents
• To
a
certain
extent
spontaneously;self-­‐organisaMon

25. AlternaMve
paradigm
(4)
• Economic
policy
cannot
be
aimed
at
achieving
precise
results,
but
is
about
creaMng
the
right
condiMons/rules
of
the
game
for
certain
palerns
to
arise
or
not
to
arise
• RelaMon
to
Hayek
(1974):
pretence
of
knowledge
• Basis
for
analysing
the
role
of
money
and
finance
in
the
economic/financial
order
• Differences
between
Keynes
&
Hayek
can
be
analysed
in
this
framework
and
are
probably
rooted
in
a
different
role
of
money
and
finance
in
the
market
order

26. AlternaMve
paradigm
(5)
• Some
of
the
tools
of
“modern”
complexity
theory
provide
a
language
to
describe
an
evolving
economic
order
and
palerns
within
that
order
• EvoluMonary
dynamics,
non-­‐linear
dynamics
• Other
tools
may
provide
an
heurisMc
for
generaMng
theories:
e.g.
agent
based
modeling

27. AlternaMve
paradigm
(6)
• In
decision
making
under
uncertainty,
the
macro
picture
emerges
from
micro
behaviour
and
interacMon
• The
whole
is
more
than
the
aggregate
of
its
parts
• But
in
that
theory
micro
decisions
can
only
be
made
in
a
framework
of
common
knowledge

28. AlternaMve
paradigm
(7)
• Micro
behaviour
has
a
macro
foundaMon
• AlternaMve
paradigm
unifies
economic
theory

29. Examples
• Banking
supervision
• Data
collecMon
strategy
• Role
of
norms
in
economic
policy
• The
plausibility
of
secular
stagnaMon
• Financial
fragility
in
comparison
with
systemic
risk