More On Economics
Governments try to steer the economy by changing interest rates. The idea is that this effects the money supply. There are a number of problems with this but here I want to write about the concept of feedback as applied to economics.
Feedback can be positive (technically, in phase), or negative (out of phase). An example of positive feedback is when you bring a microphone next to a loudspeaker. At first nothing may happen but then if you make a noise, such as by knocking the microphone, you get a very loud noise. What happens is that the sound is amplified and comes out the loudspeaker where it is picked up by the microphone, amplified again and so on until the initial sound has turned into a load screech limited only by the maximum sound of the amplifying system. The feedback is positive: an initial sound is boosted and then boosted again and so on.
For an example of negative feedback imagine you are driving down a straight, undulating road and you are concerned about breaking the speed limit. You accelerate up to the speed limit, say 100 K/h, and keep an eye on the speedo. As you drop below this speed you put your foot on the accelerator, as you speed up you take your foot off. So as you get to a hill the car slows down and you apply more power. When you get to the top of the hill and start going down the car speeds up and you take your foot off.
This is negative feedback in action and serves to stabilise the speed of the
car. It is what the cruise control of a car does. Negative feedback is used
across a wide range of applications in order to make them more stable. Governments
attempt to utilise negative feedback when the change interest rates to effect
the economy.
Now imagine we are driving the car as above but the engine is slow to respond
to changes. So when we put our foot down the engine doesn't respond for 10 or
so seconds, and similarly when we take our foot off the engine continues as
it was for a similar time.
Now when we get to a hill we apply more power in order to speed up but the car will continue to slow down well below our desired speed until finally the power kicks in and the car accelerates. When we get to the top of the hill and the car starts accelerating we take our foot off, but power is still being applied for 10 or so seconds and it will continue to speed up. In fact, the adjustments we are making serves to make the speed changes worse then they would be if we applied the same power continuously. We are no longer applying negative feedback but positive feedback.
There is a way round this however. If we know that there is a 10-second lag and we can see that we approaching the top or bottom of a hill we can anticipate and apply or reduce power beforehand.
When the economy slows down the reserve bank reduces interest rates and when it speeds up it increases them. However, the lag between cause (the change in interest rates) and effect (the stimulation of the economy) is unknown.
Another problem when dealing with economic issues is that there are a number
of factors that can influence the economy. Going back to our example of driving
the car, imagine that there is an intermittent strong head wind. If the car
responds quickly when we depress the accelerator there is not too much of a
problem. When the wind blows and we slow down we apply power; when it drops
off we decrease power. There is a slight delay after the wind starts up until
we realise we have slowed down, and similarly there is a sudden burst when the
wind dies down until we decrease the power. However, if we are driving the car
with a delay then applying or decreasing power in response to wind changes is
worse than useless. By the time the power comes in the wind may have dropped
off. It may even be going in the opposite direction. The best course of action
in this instance is to do nothing and weather the storm. This is all very well
if we are driving a car but if we are driving a bus with passengers complaining
of going too fast or too slow we may have difficulty staying focused So it is
with government policies.
