• Sergio Focardi

Why should I be interested in radically new economic theories? Will they help me in my job?


In my site www.sergiofocardi.net and in many articles and posts I propose new economic ideas and new economic theories. Why should a fund manager, a bank manager or a manager at an industrial firm be interested in these ideas? This is a critical question for the diffusion of new economic ideas. We have to make a distinction between new ideas about economic structure and patterns of consumption and new ideas about theoretical changes. The probability that far reaching economic changes are implemented soon is thin but theoretical changes can be very useful even without true economic changes.


Let’s first summarize the new critical ideas that I proposed:


Inflation.

The notion of inflation as an average of price increase that applies to an entire economy does not make sense in modern economies that are complex evolutionary systems. Products and services change qualitatively, new products and services are introduced old ones discontinued. Inflation is largely overestimated because it does not take into account qualitative changes and innovation. (This statement is not rigorous. When qualitative changes and innovation anre taken into account the concept of inflation is blurred and must be replaced by generalized inflation. But current methods compute qualitative changes as classical inflation)


Real and nominal quantities

Real quantities are obtained discounting nominal quantities with inflation. As inflation is overestimated, real quantities are underestimated. In particular, real GDP is underestimated and real growth is also underestimated.


Macroeconomic models

Macroeconomic models can only be monetary models. Macroeconomic models cannot represent the real economy primarily due to problems with aggregation. In fact, we can aggregate only through prices. Therefore, macroeconomic models are abstract models, where the observables are financial quantities. Production functions must be interpreted as abstract relationships that allow to link monetary variables to empirical reality. Our new macroeconomic models include two abstract variables, quantity and quality, that represent quantity and quality of the economic output. Inflation is a residual term. Economic output, represented by real GDP, is determined by the two factors quantity and quality.


Economies as Complex Evolutionary Systems

Advanced economies are made of several interconnected sub-economies and include a banking system which is responsible for the production of money. Production of money generates purchasing power, partially determine the profit circuit, and might be a destabilising factor. When correctly implemented a macroeconomic models that follows the above principles is able to represent a sustainable economy that grows mainly through qualitative improvement. However, a model of this type can also represent the current economy. Compared with current macroeconomic models it would arrive at a different dynamics for growth and inflation. Of course growth has a different interpretation in the two models.


Employment

The usual relationships assumed by current macroeconomics, including the Phillips curve, break down. The circuit of profit is determined by several factors including the pattern of debts, the money generated by the central banks, and the relative power of salaried people and firms. When the segmentation of the economy include multiple sectors, then the relative dynamics of sectors has to be considered.


Now the question is: Are these new models useful today? Do they help a fund manager in making investment strategies or a manager at a manufacturing firm in planning products?

The answer is generally yes, as the new models offer a more accurate view of economics. Note that the new models will be able to represent future economies designed for growing qualitatively thus decoupling growth and the use of natural resources. However, the same models could be applied now to current economics.


For example, according to current estimates, inflation is very high, the Buffet ratio (Market cap/GDP) is high, total debts are high, while indexes such as SP500 are declining. It is expected that central banks will increase interest rates and will start reducing Quantitative Easing. Many economists and experts are forecasting a prolonged recession with stagnant wages and increasing unemployment. It is reasonable to forecast reduced interest in the green transition, a flight to safety and reduced investment in innovation.


But this is probably a wrong strategy. Let’s look at the same current economies through the lenses of our new models. First and foremost, our models point out that current estimates of inflation are both wrong and misleading. They are wrong because compute qualitative improvement of products as inflation, misleading because they give no monetary value to innovation.


As a conseguence, both current estimates and forecasts of real GDP are misleading. Due to innovation and quality improvement, our model would forecast a higher real GDP and a lower inflation ( more correctly a generalized inflation lower than current inflation) than mainstream models. Our models would probably avoid forecasting a recession though higher interest rates would affect the purchasing power of households. Our models would be very attentive to the evolution of credit as it is a key determinant of monetary profit. Reduced lending and unwinding of Quantitative Easing create the threat of a crash.


Bottom line, our models would suggest investing in innovation. In fact, innovation is the true driver of growth even if misleading estimates might suggest the contrary. This is an example of how new economic ideas might suggest to look at current situation from a perspective different from mainstream thinking. Of course, our new ideas would suggest a different global package of economic and political decisions. However, even if these decisions will not be implemented, our model still offer a better view of the economic situation.

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