Speaker:
Date of Talk:
9/23/10
Affiliation:
Department of Applied Mathematics, University of Colorado- Boulder
Title:
Financial Alchemy
Abstract
The world financial system is vast, complex, and unstable. Many books have been written to describe and explain the banking system and its influence on the “real” economy. My work is intended as an introduction for the layman. The important questions to ask are: What are the rules? How does the system work?
The financial meltdown and great recession of 2007-2009 are in the past (we hope). Financial re-regulation is making headlines. The public wants to know what happened, who to blame, and how to fix the system. What happened? By popular opinion it is agreed that “the housing bubble burst”. Who is to blame? The culprits are: Wall Street, sub-prime mortgages, derivatives, leverage, Alan Greenspan, Congress, Leman Brothers, AIG, Freddie Mac and Fannie May.
How to fix the system? The financial reform bill passed by Congress in July 2010 is a hefty 2319 pages. I must admit I do not intend to read the gory details. By comparison, the Federal Reserve Act of 1913 that created the Federal Reserve banking system is 31 pages. So is the financial system fixed? I don’t think so.
Before fixing something it is first necessary to understand it. To cast some light on how the system works I have created several models of financial systems that interact with simple economies. The point is not to build a complex model of the world, but to mimic some of the essential aspects of money and banking in order to provide a qualitative understanding of the real system.
In my view, an economic system evolves by decisions of active agents. The agents (people) meet and transact business. Goods and services are produced, bought, sold, and money changes hands. The devil is in the details.
The basic ingredients in my models are governments, central banks, commercial banks, and economies. A government enforces rules and raises money by taxing transactions between the economic agents. A central bank creates money, keeps accounts and lends money to the government and commercial banks. Commercial banks lend money to the agents of an economy, keep their accounts, pay interest on deposits, and collect interest on loans. The agents of the economies buy and sell their goods and services.
I have written several matlab programs to run increasingly complex models of monetary-economic systems. The programs keep track of account balances, sales, taxes, government spending, and bank spending.
I’m looking for feedback and constructive criticism of the models.
