The accuracy of central bank modelling

Posted | 08/04/2015 / Views | 2646
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The Australian economist and author Steve Keen shared in a recent interview some insights about the validity of central bank economic modelling. According to Steve, there are obvious reasons why central bank intervention has resulted in record levels of debt, increased wealth gaps and inflated equity prices rather than genuine prosperity. 

Steve suggests that central banks prefer to model capitalism “without consideration of banks, debt or money” and references a recent Bank of England quarterly publication regarding loanable funds as an example. He illustrates that when an individual borrows money from another individual, the lender must reduce their spending to account for the money that has been loaned out. There is a decrease in demand by the lender and an increase in demand by the borrower. Anyone who has ever entered into a private loan arrangement can easily relate to this roughly zero-sum scenario. On the macro level however, when a commercial bank loans money it records the loan as an asset and offsets this against the money it deposits into the borrowers account. When this money is then spent, there is a net increase in demand from the creation of the debt and this discrepancy is not adequately considered in central bank modelling.

Steve also highlights problems with models that are based upon the exploitation of free energy. Such modelling is predicated on growth being the result of capital and labour alone. According to US Congressional Budget Office projections for example, the United States is predicted to experience a generally smooth 3.3% GDP growth for the next 100 years. This model results in a US GDP in current dollar terms that is larger than the GDP of the entire world today by the year 2076. Given where we are with respect to oil, water, land and other finite resources, the concept of United States consumption alone matching today’s level of global consumption by 2076 seems counterintuitive to say the least.

Given the hype around yesterday’s RBA decision to keep interest rates on hold, it is an opportune time to be reminded that central bank actions are only as good as the data models that they use. As such, it is prudent to be objective about the level of faith placed in such entities and as always, strive to balance your wealth.