INTRODUCTION TO MACRO-ECONOMIC DESIGN

Please remember that these web pages are under a constant state of amendment and revision. They are going to be the main chapters of my book on Macro-economic Design and Management. To assist readers with keeping abreast of the changes, new editing on all pages is always reported on the LATEST UPDATES page unless they are small changes.

This page is a new draft for what may become the main script which is called MONEY ISLAND and which can currently be found on the page entitled PRINCIPLES. That page is also being edited and the story will get more detailed and told in a new way in the next draft.

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INTRODUCTION TO MACRO-ECONOMIC DESIGN
And Management

The design of an economy, like the design of anything, makes a difference to how it responds to various things that cross its path both internally and externally. It can be a stable design or an unstable design. It can make the passengers comfortable, or sick. It can be well managed or badly managed. It can collide with other economies or it can live harmoniously with them, each economy benefiting from the interactions with others.

INTRODUCTION
As a past student of management control systems and as a onetime owner of my own financial advice and investment management company, Ingram Investment Services Ltd, previously Anglia Insurance Brokers, I have spent most of a lifetime reading about macro-economics and the efforts being made to understand and improve the performance of economies. My self-education in these matters was assisted by hundreds of discussions with leading economists and others in the financial services arena, in the UK, and since then around the world. This learning curve now spans at least four decades, from 1970 till today in 2015 as an active participant, as well as earlier observations since around the mid 1950’s as I observed the behaviour of the stock market as a shareholder and saw my father’s anger at what policy-makers were doing in those days. I feel that it is time to bring to the world the new perspectives that the classic and well proven discipline of engineering systems design and management can bring to the subject of macro-economic design and management. This subject has fascinated me since I studied it as a student engineer in the 1960's and it has given me a very specific way of observing the design and the management of the world's economies which I now need to share. Looking through this lens, what I see is very different and it is better at predicting policy outcomes than what I read and hear from the mainstream economists, although very gradually I can see new areas of research being announced that encroach on my work. Others have also noticed.

WHAT IS SO WRONG WITH ECONOMIES TODAY?
Besides not allowing prices to adjust properly, or even at all in some cases, (fixed interest bonds), as the economics text books rightly say, prices should adjust in order to keep a near balance. There are a few other basic principles which, according to my observations, are consistently not being followed. The result of not following those basic principles are easy for an engineer to predict (lots of financial instability), and as I have found, both the effects and the causes are easy to observe in practice. I have found that the origins of financial and economic instability are right there in the text books, and in your face.

That being the case, why is it that these problems remain hidden in plain sight? The world of macro-economics as taught today is quite different in its approach. Students are taught that the economies of nations are unstable by nature. That can only be true if the pricing mechanisms are not in place or if there is some incorrect management issue. Economists tend to put the blame on people-behaviour and insufficient data with which to conduct monetary policy. If the pricing mechanisms were acting as they should, there should not be much need for a lot of data. Any excess stimulus should get automatically re-balanced and the stimulus itself should be well balanced. The unbalanced stimulus, or shall we say, intervention of Quantitative Easing, QE, of printing money by the trillion was a response to an already out-of-balance situation which should not have occurred in the first place. True, the situation was markedly worsened by poor regulations and irresponsible behaviour in the banking sector, but it was not true that this was at the root of the problem. If it had been at the root of the problem the QE intervention should have been enough. But it was not enough - far from it. Interest rates are still far too low years later. The American, Japanese, and European economies and any other economies with a significant property finance and bond finance sector find themselves in a trap caused by poor automated pricing dynamics in those financial debt sectors combined with very low inflation rates and associated low rates of interest.

One only has to read right through my Home Page or the LOW INFLATION TRAP page to see how that works.

Over the decades I have seen economists create all kinds of monetary theories and postulates which seem to work well only in certain conditions. Mostly it has been said, they explain the past without forecasting the future. The same conditions rarely repeat. Why is that? It is because there are so many inbuilt sources of instability, the effects of which reach out like ripples in a pond, and they can have long lasting effects that also affect pretty much everything else. If there was just one such problem creating one set of ripples, it might be easily recognized for what it is. But in fact I have identified several of these. They all chime in at different times, and one triggers the other, like clocks ringing the hour but none of them keeping anything like good time. To make things worse, all kinds of devices have been invented to either manage the instabilities, reduce the related risk, or to exploit those instabilities for the benefit of the few at the expense of the many. 

The confusion of policy-makers is another unpredictable factor for anyone trying to decide what financial position to take in order to be safe. One never knows what they will do next. They do not even do what they say they will as anyone observing the Federal Reserve Bank bulletins will know. The composition and mechanisms in the makeup of the world's economies is always changing. But most of those new instruments and inventions that get created are just a response to the other instabilities which are already in place. I was recently asked what should be done about that. To this I replied that I am busy laying down a set of principles to follow, which if followed, would give the world’s economies the basic framework needed to create financial and economic stability. Therefore the way to deal with all of these innovations is to see how they affect that stability. If they comply with the principles they can be helpful. If they do not, they should be brought to the attention of the regulators.

International trade has grown like a giant mushroom in recent years. It has completely transformed the dynamics of the world’s economies but little has been done to find a way of eliminating the source of the imbalances from that source. I am not saying that the impact of competitive labour from the developing nations on the developed nations should be curbed, as it takes jobs to the developing nations and from the developed ones, although moderation in all things can be helpful. What I am saying is that the price of currencies is acting in more than one field at the same time. Trade is one field which it is supposed to operate in. International capital flows is the other field which should have its own stabiliser, kept separate from the pricing of currencies. To say the least, to upset what is now about half of the prices that are used for world economic output in this way, is not helpful. To have about a third of economic output put out of balance through the wrong pricing of debt and the associated extremely unstable dynamics of that is, on its own, a sufficient problem to draw the attention of  this essay from the respected Project Syndicate website, which finds that five years after a property boom and bust, economic output remains 9% below the norm. To have a monetary policy that targets prices instead of demand does not help. Prices re-balance if the demand is out of sync. It does not work easily the other way around: if you distort the price you create the imbalances that you are trying to avoid. If you have a policy instrument with which to manage the level of demand then it should be a precise instrument. What have we got instead? Demand from the economy has a momentum of its own which is called the ‘herd instinct’. If fed by a loose and remote monetary policy instrument that targets the price of money (interest rates) instead of the amount of credit available to lend, it automatically overshoots the target. Worse still, it creates a huge overhang afterwards because the level of demand in the economy is credit driven. Too much debt to repay debilitates / obstructs a fast economic recovery.  Clearly we have the wrong financial and management framework on many fronts. I have followed a process of looking for alternatives which can free up pricing responses and which take out over-responses from the pricing of long term debt repayment levels and bond values. I have been addressing the international currency pricing and international capital flows problem by providing just one role for the price of currencies, not two. I have sought to find a better framework and a more precise instrument for use in monetary policy. What I think I can now safely envisage is an economy which is largely self-adjusting and which does not need millions of data bits in order to make a good monetary policy decision.

Sometimes, when people look at the new financial contracts which I have described, they ask if these will be more competitive and easier to manage and less capital intensive. Of course they are, and it does not take a lot of thinking to demonstrate that. If these contracts and regulations are not causing problems for others anymore then they are not causing problems for themselves either. The good news then is that if the regulations and taxes that are getting in the way were to be removed, free competition between the old and the new contracts on offer will see an eventual end to the old ones which cause damage.

The answer lies in the design of the financial framework to free up the pricing responses and to provide a much more precise monetary instrument. What I have written above more or less covers the issues, but just for the sake of greater completeness, here are some good questions:  "Why is it that the price of the currency of nations is interfering with the balance of trade instead of balancing it? Why are international capital flows altering interest rates in other nations when we know that the interest rate which is right for one country is not necessarily right for any other nation? Why should interest rates be moved off centre by the rates of interest in other countries? How much of the transaction money in circulation should be credit based and how much of it should be printed? The answer to that question makes a difference." These are a few of the main questions that will be addressed in this paper backed by references to other published papers of mine as well as those from other people, as appropriate.

Because of their training, in which economists are taught that instability is inevitable, it is only in very recent years that they have understood that there are more fundamental forces at work behind the scenes and that they need to start getting a grip on those issues. Only now are they beginning to listen to what I have been saying for the past two decades or more. 

Rather than piling one new data set upon another and one new policy instrument upon another, it is better that the world should go back to the text books and apply the basic principles. That is as I see it. The engineering, medical, and social text books, all say that if, in a complex system, any one part is not working 'by the book' then problems appear all over the system. This makes a lot of sense. In fact as a young investigative engineer in the 1960’s I was told to check that everything was being done as per the instructions before running around looking for other explanations. In Macro-economics, most of the causes of problems can be traced to wrong pricing, captured pricing, over-geared pricing dynamics, double action pricing, and the management of pricing instead of demand. You can choose: address all the symptoms at great cost and without learning anything about the origins of the problems, or identify the source of the problems and put an end to the sources of the problems. Why not add this well understood teaching to the macro-economics text books?

MONEY ISLAND
What follows is a 'fairy tale' about an island and how its economy and its financial framework and its management systems developed. It is does not follow the real history of how things developed. That gets too complicated and it leads to a lot of controversy because there have always been too many wrong things going on at the same time. The story of Money Island is told in a way that introduces these wrong things one at a time and by either avoiding each mistake or correcting it, 'Money Island' gets to have a modern economy which is about as financially stable as any economy can ever be. Later, a revolution takes place and each of these essential stability features is dismantled until the island's economy resembles the one with which we are all familiar today - unstable and confused. This story follows well known principles in identifying the problems and in seeking to avoid the obvious mistakes which the writer has seen and learned about over a lifetime of watching what goes on in the real world from a systems design and management viewpoint...

...to be continued. 

The current MONEY ISLAND outline can be found on the page entitled PRINCIPLES.

It has some defects and will be re-written as soon as I have done it. It is a long script and it is important to take things in a good and clear order.


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