What else is lurking in darker corners of the world economy?

Crisis Economists' models failed to pick up on small events in dim corners of the economy which caused spiralling problems elsewhere.
 
In the early days of cartography (circa 1500), the problem of depicting the unknown on maps was addressed by leaving the space blank, except for the warning "hic sunt dracones": here be dragons.
 
Olivier Blanchard, the IMF's economic counsellor and director of research, has come up with the contemporary economic equivalent in the IMF's quarterly publication, with an article entitled "Where Danger Lurks". The risks are in what he calls the dark corners.
 
It's an important and distinctly scary account of why he believes the global financial crisis caught most macro-economists by surprise with its arrival, magnitude and duration.
 
Blanchard argues the macro-economists – those operating in the critical areas of monetary and fiscal policy formulation – had developed economic models based on benign but erroneous assumptions about the role of fluctuations in output and employment.
 
The techniques incorporated in these models were best suited to a world view in which economic fluctuations occurred but were regular and essentially self-correcting. The term "business cycle", with its implied predictability, displaced fluctuations.
 
Blanchard writes: "The problem is that we came to believe that this was indeed the way the world worked. These techniques (incorporated in the models), made sense only under a vision in which economic fluctuations were regular enough so that, by looking at the past, people and firms (and the econometricians who apply statistics to economics) could understand their nature and form expectations of the future, and simple enough so that small shocks had small effects and a shock twice as big as another had twice the effect on economic activity.
 
Read the complete the article what's in the global economy's dark corners? (subscription required)

 

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Max Walsh

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Max Walsh was for many years one of Australia’s top economic and political commentators, highly regarded as a journalist, author and broadcaster. Throughout his career, Max was involved in all dimensions of the media industry, which has encompassed positions with two of Australia’s largest publishing companies and television networks.

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