Andy Haldane’s successes: tropical forests, Frisbees and finance
Central bankers are not, as FT editor Chris Giles said, the kind of people who wake up in the morning and say ‘fuck I’m going to do something crazy today’. This partly explains why Andy Haldane, the soon-to-be-departed chief economist of the Bank of England, was such a breath of fresh air.
In the aftermath of the great financial crisis and the Northern Rock affair, the Bank was (rightly in our opinion) pilloried as a hive of collective thought, where received opinion remained unchallenged. We are not saying that Threadneedle Street has since become a hotbed of radicalism. But that’s not the ivory tower it once was.
Outgoing Chief Economist Andy Haldane was instrumental in this change – in large part thanks to his speeches, which were among the most original we’ve come across since we started looking at the central bank in 2007. .
So, to celebrate, we thought we’d pick a few favorites.
Rethinking the financial network
What we liked about Haldane’s speeches was that they looked at what economics could learn from other disciplines.
This speech, delivered in the spring of 2009 when he was Executive Director of the Bank for Financial Stability, is a classic example. Haldane was inspired by the work of Lord Robert May, who had shown how biological ecosystems can reach a tipping point of interconnectivity where they have gone from robust to fragile. This was perfect for explaining why, rather than spreading and diluting the risk, practices like securitization could exacerbate it:
Tropical rainforests are a complex adaptive system. In the immediate post-war period, these ecosystems were often used as a case study to demonstrate why complex systems tended to exhibit greater stability. In Elton’s words, this is because there are “always enough enemies and pests available to ignite any species that begins to be unusually large.”
The complexity has reinforced the self-regulatory forces of the systems, thus improving the robustness. It was the dominant ecological wisdom until the early 1970s. This conventional wisdom has since been overthrown. Beginning in the 1970s, orthodoxy was altered by a combination of enriched mathematical models and practical experience. Counter-examples have emerged, with a few simple ecosystems – savannahs and grasslands – which have proven to be very robust and some complex ecosystems have been shown to be vulnerable to attack. Perhaps revealing, the large-scale clearing of tropical forests has highlighted their inherent fragility. It is not for nothing that tropical forests have become a “non-renewable” resource since the early 1970s.
Finance seems to follow in the footsteps of environmentalists, but with a generational lag. Until recently, mathematical models of finance emphasized the stabilizing effects of the exhaustiveness of the financial network. Connectivity meant dispersal of risk. Real-world experience seems to confirm this logic. Between 1997 and 2007, rocked by oil price shocks, wars and the dotcom mania, the financial system held its own; he appeared to be self-regulating and self-repairing. The echoes of the ecology of the 1950s were loud and long. The past 18 months have revealed a system that has proven to be neither self-regulating nor self-healing. Just like tropical forests, faced with a great shock, the financial system has sometimes risked becoming non-renewable.
Patience and finance
A year later, he sought to slaughter another sacred cow from the pre-crisis era – the idea that the faster the trade, the more efficient the system. Like fellow sandy-haired Gary Barlow, Haldane wanted us to have a little patience:
Liberalization has resulted in much greater information and liquidity in financial markets. Maybe these developments have helped good finance drive out bad ones, pushing money down the path of patience? Not necessarily.
Take information. In an evolutionary game, information is a double-edged sword. It supports the cause of the long-term investor, making it easier for them to compare prices with fundamentals. But it also tests the patience of the untested investor who is subject to regular performance reviews. Investors whose judgment is fair, but whose timing is bad, are more and more likely to come out of the game. .
. . . Liquidity is also a double-edged sword. It reduces the impact of dynamic trading on prices, thus increasing the efficiency of the market. But it also reduces the costs of implementing such strategies. In other words, liquidity releases the gene for impatience. Investors whose judgment is wrong, but whose timing is right, can guarantee immediate gains. Liquidity, too, can pollute the gene pool by allowing impatient people to thrive. Like information, liquidity can be too good a thing.
Is it just us, or could this last paragraph be applied to the modern trader based on a commission-free app?
The dog and the frisbee
In 2012, the Haldane star was bright enough to be granted a slot at the prestigious Jackson Hole conference, hosted by the Kansas City Federal Reserve. He used it to warn that officials risked overly complicating their regulatory response to the crisis. This being Haldane, he did so by saying that a better approach was to be like a Border Collie grabbing frisbees and follow a simple rule of thumb. (In the case of the dog, the rule is to “run at such a speed that the angle of gaze on the frisbee remains roughly constant.” Which doesn’t sound that simple to us, but there you go.)
Catching a fit, like catching a Frisbee, is difficult. To do this, the regulator must weigh a complex array of financial and psychological factors, including innovation and risk appetite. If an economist saw crisis capture as an optimal control problem, he should probably seek the help of a physicist.
Yet despite this complexity, efforts to catch the Crisis Frisbee have continued to intensify. Occasional empiricism reveals an ever-growing number of regulators, some with doctorates in physics. However, ever larger litters did not improve the frisbee catching abilities of guard dogs. No regulator had the foresight to predict the financial crisis, although some have since demonstrated supernatural powers of hindsight.
So what’s the secret to guard dog failure? The answer is simple. Or rather, it’s complexity. Because what this article explores is why the type of complex regulation developed over the past decades could not only be expensive and cumbersome, but suboptimal for crisis control. In financial regulation, less can be more.
The speech was seen as an affront to Mark Carney, who was leading the global regulatory response. Carney ended up becoming Haldane’s boss the following year. To the new governor’s credit, Carney promoted him to chief economist.
Readers’ choices are welcome below.