Archive for March, 2009

Feedback about ‘feedback’

Monday, March 30th, 2009

Economic cycles are feedback in action.テつ Economists, regulators, legislators, and pundits need to discuss this feedback during exciting times.

One of the confusing side-stories of the last few years’ crash has been the sporadic misuse of the phrase “negative feedback.”テつ It sounds so natural:テつ it’s a negative outcome from feedback, right?テつ No, not right.

Wikipedia: “Negative feedback feeds part of a system‘s output, inverted, into the system’s input; generally with the result that fluctuations are attenuated. […] In response to a perturbation, a negative feedback system […] will tend to re-establish equilibrium.”

There are two completely independent dimensions for describing feedback:テつ mechanism and outcome.

Outcomes can be bad (adverse, vicious circle) or good (favorable, virtuous circle).

The process or mechanism can be positive (self-reinforcing, pro-cyclical) or negative (self-correcting, self-attenuating, counter-cyclical.)

Our problem today, counter-intuitively, is that we’re in a positive-feedback economic episode. Adverse, even vicious, yes, but positive-feedback.テつ Layoffs mean less spending power, which means less buying, which means more layoffs.テつ Doubt about banks’ health causes cash-hoarding rather than lending, which stresses some banks, but no one knows which banks are vulnerable, causing more doubt.テつ And so it goes.

How did we get into this fine mess?テつ Again, it was positive feedback.テつ Rising house prices encouraged real estate speculation which raised house prices.テつ Easy lending created a sense of a benign economy which encouraged more easy lending.テつ It can seem like a virtuous circle, but left to itself it goes too far.

The boom-bust cycle is the result of positive feedback.テつ Booms reinforce themselves until something pricks the bubble;テつ busts reinforce themselves until most of the economy is reduced to barest necessities for the working and middle classes, less for some.

The government can play a role by supplying negative feedback.テつ Regulation prevents the financial community from goosing the boom too much.テつ (Booms are almost always the result of reckless lending or investing.)テつ Unemployment compensation, deposit insurance, increased infrastructure investment spending, and bail-outs or mop-ups for failed banks prevent the bust from falling too far or too fast.テつ The government works to attenuate the boom, and then to attenuate the bust.

Even rabbits on an island will have boom-bust cycles, of population explosion followed by famine.テつ From the mid-20th century onward humans have been learning to employ our own systems of collective negative feedback to reduce the adverse effects of our cycles.