The Economy as a Complex System

This post will use the criteria that I have outlined earlier in order to establish how we can view the economy  as a complex system.

• The system contains a collection of many interacting objects, whose behavior is affected by memory or „feedback“ (the objects include some capacity for adaption and learning)

This does certainly apply. The interacting objects are  roughly speaking consumers, firms and governments. Each of these market participants  makes decisions according to  a certain set of decisive parameters and history shows that agents adjust or complement these decision rules, according to their experience.

• 
  The system is open, meaning that the system can be influenced by its environment

This also goes without much saying. What is going on in the economy is surely not solely caused by events that happen within the economy. Wars, natural influences and  also political frameworks are examples for ways in which the environment can influence the system.

• 
  The system evolves in a highly non-trivial way and is generally far from equilibrium, meaning that in principle anything could happen and provided that we observe the system long enough, it probably will.

It is at this point where economist's might at least scratch their heads. Intuitively, it seems to make sense to suggest that the economy is generally far from a stable equilibrium, based on our experience with short-term fluctuations and sudden starts and stops. There exist concepts of a natural level of output and employment or ceteris paribus long-run steady states in macroeconomics, which suggest that in the long run there might exist something like an equilibrium. But if we focus on the short-run (especially for our purposes, the study of business cycles, this seems appropriate) it seems to be fair to say that the economy generally seems to be far from equilibrium.

• 
  The emergent phenomena are not brought about by some central controller

If this wasn't true, then Economics would be an entirely useless subject (some might argue that it is, yet this is not  the point of this discussion). It seems to be sensible to suggest that no regulatory institution like for example central banks, the FSA or governments have the power to ultimately cause the emergent macroscopic behavior that the economy exhibits. Our hope as policy makers is to be able to partially influence this behavior and it is exactly the point of this project to determine ways in which we might be able to do so more effectively. But it certainly does hold that there would be a central controller with ultimate decisive power.

• 
  The system exhibits a mix of ordered and disordered behavior

This criterion seems to be a tricky one and requires the most thinking. Chaos is formally defined as the behavior of a non-linear, dynamic system, which is highly-sensitive to initial conditions. Lorenz's "butterfly-effect" is the most common example of this phenomenon.  The term chaos is due to everyday experience quite misleading, in fact mathematical chaos does not celebrate utter disorder but a new kind of order. This can be phrased as "self-organization", the spontaneous emergence of order out of seeming chaos (note that the little applications in the active essay try to make exactly that point). In the context of social systems such as the economy this is called "spontaneous order", a concept that has been widely elaborated by Friedrich Hayek (who calls it "extended order"in his book The fatal Conceit). Hayek argues that the spontaneous order (resource allocation) that emerges out of the free interaction of self-interested individuals in a competitive market is superior to any other possible allocation. Similar to the way  in which the temperature (another example of an emergent macroscopic behavior) is subject to change, this allocation is not stable. As we observe the  economy over time, we will constantly observe new spontaneous orders. This is why we might be able to say that the economy exhibits a mix of ordered and disordered behavior. Looking at this simulation (http://llk.media.mit.edu/projects/emergence/on-the-edge.html) might clarify this point (even though this system eventually reaches a steady state at some point).

So summing it up it seems as if we can justify the description of the economy as a complex system. The next posts will introduce the reference models and will look at how we can use the fact that all the economy and  the reference models exhibit complex behavior to learn more about hot and cold flushes in business cycles.