Soft landing hope built on faulty framework assumptions

January 4th, 2009

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Looking forward, what will happen to Australia’s economy in 2009? Currently, the mainstream economic forecast is for a soft landing. As Shane Oliver was quoted in this article,

But with the economy on track for a mild recession…

Shane Oliver’s opinion is fairly representative of the mainstream economists, which include those bureaucrats in the Reserve Bank of Australia (RBA). Why are the mainstream economists’ forecasts so tame and mild? As Professor Steve Keen criticised their neo-classical economic thinking here,

This is not a prediction by the model as such, but a product of its structure, which assumes that the economy will always return to a supply-side driven equilibrium in a relatively short time frame.

Built into the blinkers of the mainstream neo-classical economic framework, the assumption is that the economy is like an elastic band that will spring back to its previous un-stretched state of ‘equilibrium’ after being stretched by external ‘shocks’ (e.g. global financial crisis). For those who studied economics at university, you will realise that the phrase “external shock” is often used in the text-books to describe phenomena that are beyond the scope of economic model. Furthermore, you will find that your text-book are full of simultaneous equations, which implies some sort of ‘equilibrium’ has to unquestionably happen.

But this is a very erroneous assumption built into the framework of mainstream neo-classical economic thinking. Does the economy always have to return to equilibrium the way an elastic band spring back into its previous relaxed state? Can there be other forces that can pull the economy further and further out of equilibrium until a breakdown occurs? Can there be snowball effects? Mainstream economics do not entertain those questions seriously. They consign the answers to those questions (that they do not understand) as an excuse called “external shocks.” As a result, their forecasts are next to useless, especially during turning points (see our guide, Why are the majority so wrong at the same time and in the same ways?).

Thus, we are very sceptical of the mainstream economic opinion that Australia is on track towards a soft landing. Such thinking is more of a reassuring, good-feeling hope and less of serious analysis.

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