The mental model the Federal Reserve had was to review economic growth and take steps to avoid a depression and the public pressure that came with it. The policy the Fed enacted was to control the Federal Funds Rate and increase or decrease the supply of money in the economy and balance out economic growth. What the Fed failed to account for was that by keeping the interest rate low for so long was that after an initial delay, the availability of cheap money lead to the rise in unscrupulous lending. This drove up the competition for assets and asset prices such as houses and reinforced economic growth.
My first comment didn't come through so if this double posts, i appologize. It looks to me like you need to change the S to an O between unscrupulous lending and competition for assets, as compettiton would seem to go down if more money is available. This would also make that loop reenforcing, like you have it labeled, as right now it is a balancing loop. Another thing to note, although maybe outside the scope of this exercise is that congressional legislation actually pushed banks to make risker loans to less qualified buyers, so legislation is also partly to blame for the bubble/bust.
ReplyDeleteI think the CLD makes sense and the variables are properly named when considering Ken's description of the system. The polarities are clear and support the fed's idea of balancing out the system (by controlling the funds rate) shown in the "Fed's View of the World" loop and they seem to be correct in portraying the reinforcing bubble shown in "Bubble is Born" loop (the unscrupulous lending fuels the demand/competition for assets and thus drives up the price/value and reinforces econmomic growth). This effect is consistent with the speculative bubble theory discussed in Sterman's text (later leading to the recession when the bubble popped). The mental model and unintented consequences are clearly defined and appear unambiguous. I agree with Rob's comment that there are some other variables that could be represented, but within the scope of Ken's description of the problem all variables are accounted for.
ReplyDeleteKen, Can you send this to Congress so we can get over this and move on!
ReplyDeleteI think there is some confusion Unscrupulous Lending to Competition for Assets link. Perhaps if you labeled the Competition variable Number of Potential Buyers of Assets then the loop would make sense as you have it.
Another issue I see is that there is no mechanism for the Burst because the Fed rate stayed low which in your CLD is the only balancing factor.
This is a good attempt at displaying the very complex mechanisms that led to the worst recession since World War II. It is true that an increase in lending could lead to less competition for financial assets, but we should bear in mind that the competition is not a constant in this case, as the pool of members of the public willing and able to come in and compete is now significantly enlarged by the possibilities of easy credit (people who are arguably ''unfit'' to borrow money are now borrowing, or attempting to borrow), which in turn could actually increase competition.
ReplyDeleteKen,
ReplyDeleteA nice example. The discussion points out that there are some problems/ambiguities in your CLD. Your "bubble is born" loop is actually balancing (as you have labeled the links). Hence, there is no reinforcing feedback in this CLD, and therefore no mechanism for explaining the runaway growth of house prices. After all, according to your CLD, as house prices rose (and the economy grows), the Fed will raise interest rates, thereby making money less available and reducing growth...i.e. no bubble! I think this can maybe be clarified by following a structure similar to our speculative bubbles exercise, where you have "value based supply", "value based demand" and "speculative based demand." Might that work?