QUERY Economic System

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Jay Forrester <jforestr@MIT.E
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Posts: 12
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by Jay Forrester <jforestr@MIT.E »

Posted by Jay Forrester <jforestr@MIT.EDU>

This message was in the K-12 discussion exchange, but I am resending
to the system dynamics list because others may be interested.

Jay Forrester
----------------

Begin forwarded message:

First, the current crisis did not start with the burst housing
bubble. It started with the excessive credit that led to the
housing bubble. That excess credit resulted from the Federal
Reserve holding down interest rates to less than the inflation rate
in housing. This negative real interest rate (bank interest minus
inflation in the housing assets) produced a powerful incentive for
investment and speculation in housing. And the action of the
Federal Reserve, with the increase in risk taking by banks, were a
result of pressure from Congress and the public who were all
enjoying the short-term rise in housing prices.

We see here one of the characteristics of a complex social system in
which a policy that is good in the short run is almost always bad in
the long run. Feeding the bubble with easy credit was popular in
the short run but now we have the consequent day of reckoning with
the collapse of the financial system.

There are a number of papers on this matter in the ""System Dynamics
Group Literature Collection"" DVD available at:
http://systemdynamics.org/MITCollectionDVDinfo.htm

Look for the papers on the National Model. The model itself is not
there, it has not yet been released, but there are many interesting
discussions and computer runs on the economic long wave (also known
as the Kondatrieff Wave), which I believe explain the Great
Depression of the 1930s and the economic turmoil at the present
time. Given the extreme degree of government financing that is now
in process, the outcome may this time be different from the 1930s.

Posted by Jay Forrester <jforestr@MIT.EDU>
posting date Wed, 15 Oct 2008 19:09:42 -0400
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<DGPacker@aol.com>
Junior Member
Posts: 2
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by <DGPacker@aol.com> »

Posted by <DGPacker@aol.com>

This important note from Jay Forrester reminds me how much I miss the sd
listserve (luckily it still is there but few use it because, I guess, its demise
was decided and announced and no viable replacement has yet appeared. I feel
out of touch with no way to be brushed, at least, by notes--some great like this
one. For a global society not to have a web of interconnecteness diminishes its
impact. We need to have something now, especially in light of all of the clear
dynamic issues affecting so much of the world that provides opportunity for
capturing appreciation of the systems that are impacting billions.

Dave Packer
Posted by DGPacker@aol.com
posting date Thu, 16 Oct 2008 11:10:35 EDT
_______________________________________________
""Jim Thompson"" <james.thomp
Member
Posts: 21
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by ""Jim Thompson"" <james.thomp »

Posted by ""Jim Thompson"" <james.thompson@strath.ac.uk>

Distilled to its essence Jay Forrester wrote, the current crisis started with
the
Federal Reserve holding down interest rates to less than the inflation rate in
housing, which produced a perverse incentive for investment and speculation in
housing.

Houses are capital assets, and I wonder if the same explanation would hold true
for investment in education (i.e. interest rates on student loans compared with
the inflation rate in education expenses) or commodities (i.e. interest rate on
margin borrowing compared with the inflation rate in commodities/specific
commodity)?

Jim Thompson
Posted by ""Jim Thompson"" <james.thompson@strath.ac.uk>
posting date Thu, 16 Oct 2008 10:16:53 -0400
_______________________________________________
Carl Betterton <carlb@uga.edu
Junior Member
Posts: 7
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by Carl Betterton <carlb@uga.edu »

Posted by Carl Betterton <carlb@uga.edu>

Jay,

Can you (or others on the list) point me to a readily system dynamics model that
contains the elements of the description you gave about the ""current crisis""?
You
mentioned the MIT's SD Group Lit Collection, but apparently one must order a DVD
to access this material.

Thanks,

Carl
Posted by Carl Betterton <carlb@uga.edu>
posting date Fri, 17 Oct 2008 14:55:01 -0400
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""Balaporia, Zahir"" <Balapor
Junior Member
Posts: 3
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by ""Balaporia, Zahir"" <Balapor »

Posted by ""Balaporia, Zahir"" <BalaporiaZ@schneider.com>

On Wed, 15 Oct 2008 19:09:42 -0400 Jay Forrester wrote:
>> >> ... a complex social system in which a policy that is good in the
>> >> short run is almost always bad in the long run.
Also
>> >> ... Given the extreme degree of government financing that is now in
>> >> process, the outcome may this time be different from the 1930s.

My concern is that the ""extreme degree of government financing"" is possibly
another example of ""a policy that is good in the short run is almost always bad
in the long run."" What might give us some confidence that government financing
to resolve the current crisis won't create an even bigger crisis down the road?
Maybe the concept of a $700B fix is good for the long run, but its execution
could suffer from the same short term temptations.

My question is not motivated by a lack of faith in government involvement, but
rather in a lack of faith in peoples understanding of how this complex global
economic system actually works. I for sure don't understand it, and there seem
to be many ""experts"" with incomplete (best case) or incorrect (worst case)
mental
models of a very complex system.

If I had $700B to spend, I would take a small fraction and invest it in building
/ updating the National Model or another model with the same idea. Then, I
would
require ""National Model Certification"" before someone would be allowed to drop a
few billion dollars on the next ""fix"".

Zahir.
balaporiaz@schnieder.com
Posted by ""Balaporia, Zahir"" <BalaporiaZ@schneider.com>
posting date Fri, 17 Oct 2008 14:07:50 -0500
_______________________________________________
<ralf_lippold@web.de>
Junior Member
Posts: 2
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by <ralf_lippold@web.de> »

Posted by <ralf_lippold@web.de>

Hello Dave,
hello All,

You are quite right that we need a platform (or several) for exchange our
thoughts and bring them into the world.

As the first speaker at the ISDC in Athens has said, ""To change behavior one has
to change the language first!"" - seems to be that times around us have changed
pretty much. Information flows so quickly around the globe and boundaries are
almost not in place. Quite a few of are already working in the knowledge worker
2.0 mode using blogs (Drew Jones, Tom Fiddaman - to name a few distinguished
systemdynamicists), wikis and other means of web 2.0 tools.

I personally like listservers and mailinglists and yet sometimes the inflow of
information is overwhelming (sort of pushing and squeezing my time stock:-().

To me it seems to be that we are all in the midst of a big culture change into
the web age. Information is free floating and easily accessible and this gives
totally new opportunities for system dynamics and other fields to connect.

Let's take the chances that are there like the doors at MIT and new fields that
Jay glanced behind some decades ago (and still does:-)) not always knowing what
could emerge and evolve.

Looking forward to further thought exchange (for example at the mentioned blogs,
links will be posted at the WikiSD).

Best regards to all

Ralf
Posted by <ralf_lippold@web.de>
posting date Sat, 18 Oct 2008 8:22:00 +0200
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Bill Harris <bill_harris@faci
Senior Member
Posts: 51
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by Bill Harris <bill_harris@faci »

Posted by Bill Harris <bill_harris@facilitatedsystems.com>

""SDMAIL Jay Forrester"" <jforestr@MIT.EDU> writes:
> > First, the current crisis did not start with the burst housing
> > bubble. It started with the excessive credit that led to the
> > housing bubble.

Jay,

Without arguing with your analysis, I wonder if it can be usefully
traced back even further, as you noted in your ""Counterintuitive
Behavior of Social Systems."" I highlighted a pertinent part from page
27 in
http://facilitatedsystems.com/weblog/20 ... ocial.html

That brings up a question: if we buy into your quotation on that page,
what does that suggest about how we decide where and how to apply system
dynamics in the service of business? NB: I am _not_ saying business is
bad.

Bill
- --
Bill Harris

Posted by Bill Harris <bill_harris@facilitatedsystems.com>
posting date Wed, 22 Oct 2008 14:45:06 -0700
_______________________________________________
<richard.dudley@attglobal.net
Member
Posts: 26
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by <richard.dudley@attglobal.net »

Posted by <richard.dudley@attglobal.net>

A very interesting article on the financial collapse is available from this
Cornell Prof's web site.

http://www.orie.cornell.edu/orie/people ... netid=pep4

Note that one of his fields is ""financial engineering"".

Title: The Financial Meltdown, How did we get in this mess? by Philip
Protter. September 29, 2008

This 6 page article begins with the passing of the (USA) Glass-Steagall act
of 1933 and, over the years, the gradual removal of protections that it and
other laws and regulations had created.

Thanks to Chuck Nicholson for bringing this interesting article to my
attention.

- Richard

_____________________________
Richard G. Dudley
Posted by richard.dudley@attglobal.net
posting date Thu, 23 Oct 2008 16:15:10 -0700
_______________________________________________
""Alan Graham"" <Alan.Graham@
Junior Member
Posts: 4
Joined: Fri Mar 29, 2002 3:39 am

QUERY Economic System

Post by ""Alan Graham"" <Alan.Graham@ »

Posted by ""Alan Graham"" <Alan.Graham@paconsulting.com>

Hello,

I expect that the present financial meltdown will be understood with
considerable precision as a classic case of inappropriate policy and
regulation, but only after the fact when quantitative modeling is able
to separately identify the destabilizing influence of several factors.

There are a number of things we can say qualitatively about the
meltdown, based on extant SD studies.

Most fundamentally, we know that the ubiquitous structures of
investment, employment and spending can cause 3-8 year ""business
cycles"", as documented in the National Model papers Jay refers to,
Sterman's Business Dynamics and elsewhere. So when we look for causes
for a financial meltdown, we're looking for structures that can
transform ordinary business downturns (which have been in evidence since
well before the meltdown started) into more severe behavior. The
business cycle pretty much guarantees that proximate causes for
instability will be there when the system is vulnerable.

I know that there's wide consensus that the meltdown was caused by
""insufficient market supervision"", but that's based on almost no
knowledge of the facts on the ground. It's sort of like saying that
World War I was caused by ""insufficient bodyguards"" for Archduke
Ferdinand. Proximate cause is not root cause. The public perception of
dot com crash didn't really include any specific event that was thought
to have caused the reversal from growth to decline. In the sense of
having fewer red herrings to obscure understanding of root causes, the
dot com crash was better understood than the present one.

So in thinking about structural root cause, we should be especially
attentive to factors that have changed since the dot com ""crash"" of
2000-2002. Why didn't this meltdown happen then?

We know from the example of wholesale electric power that regulatory
changes alter the stability of markets (remember the California energy
crisis?). One quantitative analysis is reported in Kadoya et al.,
Utilizing System Dynamics Modeling to Examine Impact of Deregulation on
Generation Capacity Growth, Proceedings of the IEEE 93(11) November
2005, pp. 2060-9. This is one example of market regulation implementing
changes that are well-aligned with good general principles, that have
severely undesirable impact (strong market cyclicality).

Even before the dot-com crash, the US Fed policy has been
well-established for decades of not responding to asset price bubbles
(just ""intervene quickly when they burst"", to paraphrase one Fed
chairman). Likewise, the Depression-era separation of retail and
investment banking of the Glass Steagall Acts was repealed in 1999. And
many types of financial institutions were able to get technical changes
that required smaller capital reserves relative to other financial
holdings.

But two important changes were made after the dot com crash. First, the
so-called ""uptick rule"" which put limits on short-selling was tested
during an up market and found to have little impact then, and so was
removed in 2007. And seemingly most importantly, the ""mark to market""
principle was implemented in Europe and the US in 2004. These
accounting standards required financial institutions to use ""fair market
value"" instead of purchase price in computing their balance sheets, in
particular, the value of capital assets held in reserve.

Mark to market created a new and (we know now) powerful positive
feedback loop, where if asset prices fall, capital requirements
increase, and financial institutions must sell off assets (or issue new
equity) to raise capital. This action will further lower asset prices.
And so on. It's a funny system, where the goal posts move away,
primarily as a consequence of trying to move toward them.

The present recession is the first recession in which mark-to-market has
been in place.

And sure enough, the downward curve of the stockmarkets could have come
straight out of a textbook example of (downward) exponential explosion.

It seems likely that mark-to-market, or at least the capital
requirements rules that it drives, will be seen as another example of
regulatory change in accordance with good general principles (market
transparency) that has highly undersirable effects.

We also know (if nothing else, my MIT EE thesis way back when) that when
systems are seeking goals that themselves move in response, that the
time constants of the resulting behavior can be far longer than any of
the structural time constants (e.g. the time required for financial
institutions to bring their capital reserves into compliance with
regulatory requirements or market expectations). So we can suspect that
problems will go on far longer than anyone might expect.

Completely in line with that principle, after the initial bailouts were
enacted, the situation has continued to worsen (even though the stock
markets bottomed out). And around the world, there has been a steady
stream of additional financial initiatives. (""This time for sure, we'll
get to those goal posts"") Time will tell how long it really takes for
the financial system to heal.

Wouldn't this make a great thesis topic? Game subject? Op-Ed subject
for prestigous professors?

Regards,

Alan

Alan Graham PhD
PA Consulting Group
One Memorial Drive
Cambridge
MA 02142-1344
United States
Posted by ""Alan Graham"" <Alan.Graham@paconsulting.com>
posting date Thu, 23 Oct 2008 12:21:15 -0400
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