On debt’s centrality to modelling complex economic systems

The following video is about modelling economic data. The takeaway for me here is that modelling complex systems is hard to do. The standard approach in mainstream economics is to strip the system down to as simple a form as is possible without stripping out essential layers. The goal is to reduce the apparent complexity of the system in order to ascertain how its key determinants interact. The problem, however, is that this process risks stripping out determinative layers of complexity that render the model useless. If you listen to Bill White in the video from my 2010 post on the origins of the next crisis, you can see this is what he is saying.

My view as developed in that post is that debt is central to understanding economic systems, and not just because it has a redistributive element in apportioning losses between creditors and debtors when recession forces credit writedowns. More importantly, debt accumulation adds to an economy’s ability to sustain economic growth (and malinvestment) by adding to aggregate demand. That is to say, in modelling any economy we cannot treat credit supply as a constant dependent on available savings because, as I have recently remarked, “There is no natural check on the amount of credit that can be created under this arrangement” for credit in modern economies. Ostensibly, creditworthiness is the check on credit supply since financial institutions want to be repaid and so should not lend to debtors that cannot repay. You know the saying: “debts that cannot be repaid, won’t be.” The reality, however, is that people (and hence financial institutions) don’t operate this way. The profit motive is too great and animal spirits take over to force a business cycle irrespective of government intervention. I need to underline the last point because a lot of people act like central banks are the root of all evil when we know the business cycle pre-dates central banks and is endemic to capitalist systems.

In any event, I think the standard approach of simplifying complex economic systems leads to simplistic models that are inadequate for anyone interested in tail risk. And so we get blindsided by these 100-year flood like economic events every 5 years. There is a better approach. This video has some useful suggestions and talks about Steve Keen’s efforts to model economic systems. Take a look. It’s not clear whether the complex modelling approach works is something that will work either. We’ll just have to wait and see.


Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.