Sunday, 7 July 2013

Keynes vs Friedman - What is the Mix Today?



There is plenty of discussion nowadays as to whether to bailout or not to bailout. This short blog does not have the objective of adding more in support of one option over the other. The goal is to show the mix of today's economy in terms of Keynsian and Friedmanian models.

The two opposed versions of the economy may be epitomized (albeit simplistically) by the visions of Keynes and Friedman. The state and regulations versus a de-regulated and shock-therapy philosophy. According to the Wikipedia:

"Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle."

"Friedman rejected the use of fiscal policy as a tool of demand management; and he held that the government's role in the guidance of the economy should be restricted severely. Friedman also argued for the cessation of government intervention in currency markets, thereby spawning an enormous literature on the subject, as well as promoting the practice of freely floating exchange rates."

We have recently analyzed the complexity of the World based on data from the World Bank (see our previous blogs). We know that for every system (such as the World's economy) complexity ranges from a minimum value to an upper bound, known also as critical complexity. In the proximity of the lower bound things are predictable, controllable, full of deterministic rules. Like a watch movement. Close to critical complexity things are totally different. Dynamics is governed by chaos, uncertainty and is essentially highly turbulent. Like a tornado or a storm. We could, ideally, place the models of Keynes and Friedman at these extremes. 

Setting aside the numbers, the situation today looks more or less like this:







The above result allows us to state that the global economy today is approximately 80% Friedmanian and 20% Keynsian. What is the optimal mix? Is there an optimal mix? No, there is no such thing as optimality in a dynamic, changing and turbulent setting. However, there exist many acceptable compromises and these depend on each single player in the market, on his objectives and constraints.  The point is that given the current economic situation, decisions must be made in which direction to seek the cure? More Friedman or more Keynes?