Dealing With Worsening Macroeconomic Conditions: Insights from Quantum Physics
During a November 2008 visit to the London School of Economics, Queen Elizabeth reportedly asked her guests, ‘Why didn’t anyone see it coming?’. It was responded by LSE the following year, which concluded that “the failure to foresee the timing, extent, and severity of the crisis and to head it off, while it had many causes, was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.”
Something is destroying traditional economics, and it’s most likely an inside job. Reliance on ludicrous assumptions due to the lack of imagination has pushed the field into disfavor, especially after the 2007 Global Financial Crisis (GFC). Nonetheless, economics is still an important subject, one of the most powerful ways we have to understand the world. Thus, it’s time to rethink it. As the world is becoming more complex and economies are currently having a tough time, understanding the economy means drawing insights from other disciplines.
One would suppose that quantum concepts and procedures apply solely to the subatomic level and have no use in our daily lives, and this was formerly widely held. However, in recent years, a number of social scientists working in subjects ranging from psychology to business have used principles from quantum mechanics to novel applications in their respective professions. This essay aims to draw insights from quantum physics to better understand our economy.
The Workhorse Problem
One reason no one saw the GFC coming was the limited economic instruments available to assess macroeconomic circumstances. The Dynamic Stochastic General Equilibrium (DSGE) model (which was used to forecast economic conditions) is the archetypal example of this. The name is deceptive since the words are utilized in a unique fashion that has little to do with their typical meaning.
The term ‘dynamic’ solely refers to changes in the model’s equilibrium over a period as it reacts to external shocks, but never internal changes. ‘Stochastic’ refers to random disruptions that are treated as external effects; however, these are usually assumed to be ergodic, meaning that they come from a stable distribution and can thus be approximated from previous history, and linear in the sense that a shock twice as big as another has double the effect and small shocks have little impact. The term ‘general’ implies that the model is intended to cover all markets, but it excludes items like financial entanglement (derivatives, options, and so on).
The model suggests that supply and demand drive prices to an equilibrium position where consumers maximize utility, corporations maximize profits, and all markets are clear. Consumers and businesses are often represented by one or a few representatives, as are the items offered for consumption. Monetary variables do appear, but they are reactive.
Meanwhile, these models are essential as predictions based on these models inform policy making. However, as we saw during several crises, including the 2007 GFC, 1997 AFC, these models failed to forecast economic conditions. Even during the US Federal Open Market Committee Meeting in December 2007, their forecast was that despite all the financial turmoil, the economy will avoid recession and, even with steeply higher prices for food and energy and a lower exchange value of the dollar, the US will achieve some modest edging-off of inflation.
Today, economies all around the world are experiencing severe macroeconomic fluctuations. Based on the Economic Conditions Outlook survey by McKinsey (September, 2022), the primary danger to growth in most regions, according to respondents, is inflation. Geopolitical instability and wars remain a major concern, and are frequently considered as the largest danger to the global economy in the coming year.
There is also a geographical divide in outlooks, with respondents in Europe expressing greater anxiety about energy price volatility and more pessimistic views about their home economies. Those in North America, on the contrary, were less pessimistic about their own economies.
Economists, central bankers, and governments must be careful on their following actions. History has shown us that Macroeconomic workhorse models were not enough to show what was going on in the real world. Some of us may have remembered the inflation narratives during the recent surge in 2021 up to 2022 that inflation is transitory. Yet, it shows no signs of slowing down.
Meanwhile, the Federal Reserve Bank of New York published a report in March 2022 titled “Drivers of Inflation: The New York Fed DSGE Model’s Perspective”. The model shows that inflation is largely transitory (which is false) or it might persist in the medium term (only time will tell). However, the report states that it has omitted many aspects of reality and it just shows us that inflation right now is cost-push.
Insights from Quantum Physics
“The real reason economists didn’t see the crisis coming was because they ignored its (money) entangled, quantum nature.” — David Orell
The term ‘quantum’ has a long history. Over a century ago, physicists used it to describe the exchange of energy between subatomic particles. And it ultimately disproved our most fundamental ideas about the universe by demonstrating that it was not a deterministic machine, but rather something more alive, intertwined, and complex.
Classical or Newtonian physics, which was widely accepted in the early 20th century, was based on the notion that matter was made up of protons and neutrons that only interacted by bouncing into one another. Deterministic rules might be used to understand and predict the movement of these particles. Quantum physics changed everything by demonstrating that quantities like position and momentum were fundamentally indeterminate and could only be roughly evaluated through a method that affected the object being measured and appeared to some theorists to depend on the choices made by the people performing the measurements.
To better economic models, a quantum approach needs to be adopted. By definition, quantum physics is the study of matter and energy at the most fundamental level. In this context, economists must view economics from the smallest bit, with its fundamental level, money. However, the problem of mainstream economics is that money is never included in the workhorse model.
The quantum theory of money was proposed by David Orell in his book Quantum Economics. Money should be viewed as the primary driver of the economy, rather than merely a vehicle of transaction. Money objects are entities that have a monetary value associated with them. Due to the basic difference between number and value, such money objects show dualistic features. For anything other than money objects, the link between value and price arises indirectly from the usage of money, and it is an emergent attribute that is influenced by a wide range of social conditions (Orell, 2016).
Money objects, because of their dual real or virtual nature, have one foot in the abstract realm of numbers and computation and the other in the actual world of tangible things. Commercial transactions entail the exchange of money items, whose dualistic features — both contradicting and reinforcing — flow into the economy and are documented as oscillations between actual and virtual phases in the 5000-year history of markets. While money holds a unique position at the crossroads of physical goods and conceptions of social worth, its dualistic features are felt by society (Orrell and Chlupat, 2016, pp. 169–175).
When money is not included in the model, the model is insufficient. The 2007 GFC shows us how money objects and its creation process — money creation, complex derivatives, and loan defaults played a key role in shaping the crisis. Thus, a holistic approach through money as an “atom” should be considered. We can also learn just like how quantum physics discovered that the universe is complex and alive, so is economics.
Instead of having a rational economic person, we have a quantum economic man, who is not always rational; rather than having perfect competitive markets, we have markets with a combination of competition and cooperation; rather than having an intrinsic value, we have a spectrum of eigenvalues; as opposed to random economic shocks, we have uncertainty and shared responsibility. And, rather than viewing money as a passive intermediary, it should be regarded as the most powerful technology ever devised.
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