Is There a Theory of Everything for Monetary and Fiscal Policy?

Preliminary Steps Toward a Universal Economic Dynamics for Monetary and Fiscal Policy

New research by Yaneer Bar-Yam at the New England Complex Systems Institute (NECSI) provides a momentous first step toward a non-partisan understanding of monetary and fiscal policy dynamics.

According to Bar-Yam, the economy is a Complex Adaptive System (CAS). One hallmark characteristic of CAS is regime shift (Vance, 2017). These are large, abrupt changes in the structure and function of tightly coupled systems that persist for relatively long periods of time (fisheries collapse in much the same way that the Earth’s magnetic poles reverse).

Economies undergo regime shifts all the time, such as during currency and sovereign debt crises, stock market crashes, and between periods of stagflation and, well, “Japan”. Therefore, good economic policy really ought to be sensitive to the mutually reinforced processes and feedbacks that generate such shifts. Practically, and somewhat counterintuitively, this means that the validity of supply-side Reaganomics is not mutually exclusive to the validity of New Keynesian fiscal and monetary policy. The only question is when to apply which tool. In order to decide, we must ask ourselves: which regime are we in?

According to the present paper, economic growth will be much better optimized, and people much happier, if fiscal policy were designed to balance flows to capital and labor, instead of one or the other. The authors conclude that too much money is currently flowing to the saving/investment loop of the feedback cycle, and that in the absence of additional monetary policy, which is restricted by a zero lower bound in short-term interest rates, solutions can be found in wealth redistribution, increases to the minimum wage, and public spending on education, jobs training and healthcare.

Estimates of borrowing and total savings (or debt) for Labor and Capital. A transition from capital borrowing to labor borrowing and capital savings in 1980 is evident. Image: Complex Systems Institute/Yaneer Bar-Yam

Although Reagonomics worked for a time to curb the very serious problem of high inflation, it eventually resulted in rampant income inequality, stagnant wages and declining growth. Given that supply-side economics eventually causes deflation — savings do not “trickle down” forever — fiscal flows to the savings/investment loop of the feedback cycle should eventually be curtailed; tax-cuts to median earners and small business owners, as well as investment in public infrastructure should then follow in order to increase wages.

It would very convenient if economic policymakers could tune this feedback loop like a dial. However, political neutrality in economics is much more difficult to achieve in practice than in theory, since contemporary political parties tend to lean decidedly in one ideological direction or the other. This introduces an additional feedback loop that may be much harder to manage over time. So how do we determine where the imbalance lies, and when to intervene? The present paper and future works in this program will attempt to address that very question.

ArXiv Paper

Yaneer Bar-Yam, Jean Langlois-Meurinne, Mari Kawakatsu, Rodolfo Garcia, Preliminary steps toward a universal economic dynamics for monetary and fiscal policy, arXiv:1710.06285 (October 10, 2017).

NECSI Summary

New England Complex Systems Institute. 2017. Preliminary Steps Toward a Universal Economic Dynamics for Monetary and Fiscal Policy.

HumanCurrent Podcast

HumanCurrent. (2017). 067 — The Path to Economic Growth According to Complexity Science.

Motherboard Article

Motherboard. (2017). Math Suggests Inequality Can Be Fixed With Wealth Redistribution, Not Tax Cuts.

Related Article: Regime Shifts in Complex Systems

Vance, Leisha, et al. (2017). Toward a leading indicator of catastrophic shifts in complex systems: Assessing changing conditions in nation states. Received 25 May 2017, Revised 19 October 2017, Accepted 21 November 2017, Available online 28 December 2017.