Shortly after the financial crisis of 2008, Queen Elizabeth famously asked the luminaries at the London School of Economics, given the magnitude of this crisis, “Why did nobody see it?”
A few bold economists did see the crisis coming, Professor Steve Keen of Kingston University being one of the most adamant. Keen has staked a position on the edge of mainstream economics with a dynamic economic model that owes more to engineering systems dynamics than it does to the shopworn 19th century equilibrium models of yore.
In a nutshell, Keen’s model which he calls Minsky after American economist Hyman Minsky, models the economic landscape dynamically. In Minsky, equilibria are unstable, and the system constantly readjusts through dynamic feedback loops in a manner that owes more to hydrodynamics than it does to the old supply/demand curve.
The results are striking and illuminating. They allowed Keen to begin sounding the alarm for the debt bubble that crashed with a bang in 2007, as far back as 2005. Unlike traditional economics modeling, Minsky accounts for the growth and function of debt in the economy. His model shows how changing levels of debt impact the entire economy.
In spite of Keen’s accurate prediction of the housing crisis of 2008, many mainstream economists remain doubtful. Paul Krugman, always one to seek the safe harbor of tradition wonders why Keen believes that, “putting banks in the story is essential. Now, I’m all for including the banking sector in stories where it’s relevant; but why is it so crucial to a story about debt and leverage?”
The reason debt and leverage are crucial is that they change the amount of money and demand in the economy. Traditional economics leave debt out of the models entirely. Minsky accounts for debt in a dynamic way and that has profound consequences. It leads to useful information, like foreseeing the crash of 2008.
At this time, Keen’s Minsky Model is able to model a simple “corn economy” of the GDP of an individual nation. In the future Keen plans to build it out so that it can model the dynamic relationships among a number of economies and commodities.
Keen believes this is important because currently our accepted models are inadequate. Most of our models are guided by ideology, and it doesn’t matter if that ideology is left or right, if the models are bad, it is likely to be wrong. And that will lead to policy failures that have real world implications. Keen said, “Economics needs to catch up, because it is contributing to where we are, and that is not a healthy state.”
The United States’ Federal Reserve may be slow to notice, but countries worldwide are beginning to wake up to the possibility that our models may be poor and overtaxed. Keen has had positive discussions with the Bank of England, China, Pakistan, and Czech Republic, among others.
Minsky (downloadable from https://sourceforge.net/projects/minsky/) may be in the early stages of development, but it is a bold move forward from the traditional static equilibrium models. Current models do not account for credit or energy, which are two of the largest and most important sectors of the global economy. New models that can portray dynamic systems and feedback loops are necessary to economic planning. Better models will provide the tools to chart a course out of the current global economic malaise.
