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Our Economic Feedback Loop is Accelerating

December 4, 2008

Our Economic Feedback Loop is Accelerating

Not only does new technology mean that innovations are faster and more pervasive, but the increased speed of communication has accelerated the feedback loop in our economy, for both positive and negative feedback.

Negative feedback operates like the thermostat in your house. When the temperature goes up the heating system shuts off and cools things down. Economically, when the dollar declines in value, US exports get cheaper to buy, so demand heats up and the US economy improves, but that tends to drive the dollar back to a higher value.

Positive feedback works the other way around. It's what causes the sound system to emit an ear-piercing squeal when your microphone goes live right in front of the speakers. And positive feedback drives market bubbles and crashes. I see you buy a stock so I think it must be good and I want to buy it, too. Then I see you sell, and so I want to sell.

The recent economic turmoil is compounded by a long list of positive-feedback mechanisms. An financial services company's stock declines, so investors worry it might go out of business, which drives the stock down further. Or the mortgage banker is willing to lend 95% of the appraised value of a home, with a below-market introductory interest rate, which means more people can afford to buy that home, so increased demand raises the home's appraised value, and therefore the bank is willing to lend even more.

Here's my point: Feedback is driven by information disseminating from one source to other sources, and the speed of information dissemination now is extremely fast. During the Depression, information about just how bad things really were, traveled largely at the speed of a daily newspaper cycle and a personal meeting or a face-to-face conversation among two or three people at a time.

But today, economic information flows at Blackberry speed, and the online conversations that inform others will happen among hundreds or thousands of people, more or less simultaneously.

This is just my thought, and I'm not really sure what it means, but I'd be interested in your view, if you have one.

Since negative feedback should operate in an accelerated fashion, too, will this have the effect of dampening down the booms and busts faster?

Because people increasingly expect governments to take actions designed to correct these imbalances, will that expectation itself have the effect of diminishing the effectiveness of government actions?

Does the increasingly global nature of our economy mean that opinions in Brazil, or Germany, or Bahrain will play a more important role in the economic health of the US, or Japan, or China?

What do you think?

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