Sometimes the metaphors that people come up with to understand complex systems are really smart. I stumbled on one last night at a debate on the causes of the housing crisis, having popped outside for a cigarette, I had a chat about economics with the bouncer who told me that for her ‘Money is like electricity, it needs to flow, it doesn’t really matter who’s holding it, as long as it moves things get done’. At the time I thought that was a pretty smart thing to say. When I thought about it later I realised it was brilliant.
Imagine the economy as an electrical circuit. The government is our power supply. By forcing electric current from the positive (central bank) terminal to the negative (taxation) terminal it creates a circular flow of income. This is a brilliant metaphor for the relationship between government and money, because always and everywhere, money only has force because of the existence of nation states that mint coins and then demand them in taxation. The components in our system are economic actors. The usefulness of our circuit is that it powers the components – not that it carries electricity. The use of an economic system is that it produces goods and services – not that it ‘makes money’. The metaphor is brilliant because you can immediately see the relationship between money and stuff – money is required to make stuff happen. Of course all of this needs connecting up with wires. Wires are banks. The channel money to the economic components in our system. If they’re too thin, they become hot, wasting energy by radiating it away as heat. If you allow banks monopoly powers to control the flow of credit, they end up creaming off profits and channelling it to tax havens! I told you this metaphor was brilliant… It also shows brilliantly the relationship between banks, governments and households/firms. Firms pull spending power towards them by doing useful work, banks channel it by opening paths for it to flow, and governments provide the impetus. It perfectly mimics the real economy where banks create the actual tokens of exchange, but the government provides the ‘voltage’ (taxation + setting front end interest rates) for them to flow around the system.
So, why is this cool? Firstly, it’s far better than the ‘flows of water’ metaphor that lead economists to build the Philips machine that sits in the Marshall library – a mechanical computer modelling the flow of money through the economy as flows of coloured water between tanks. The reason it’s better is that the water in the Philips machine has to be pumped around, it requires some force to move it from place to place. Electrical current is much more like money. It follows the path of least resistance, and it isn’t about physical objects moving around. It’s a way of transferring ‘energy’ from component to component in a system, in the same way that money signals economic agents to produce things and do work. Components in an electrical system are not interested in accumulating money either, they are interested in doing stuff – which is true of humans as well – a capacitor is a much better model of saving than a water tank because a capacitor builds up charge to be discharged to do work and make things happen in the same way that people save money to enable future consumption. Secondly, an electrical circuit is a good way to think about policy. In an electrical circuit, if you route too much current to one place, it overheats and wastes energy. You want all your components to have enough current to do their work, but you don’t want anything to overheat. It’s also a great way to think about the limits monetary policy – your aim should be to keep current flowing to all the components, which you accomplish by increasing or decreasing the total current in the system – but if something happens that breaks one of your components, or a wire is overheating, you can’t just pump in more current to solve the problem without overheating or damaging your circuit. You have to take action to fix the broken part.
If the current government were as smart as the bouncer I met last night they would not have engaged in the policies they did. When they took office, they discovered an electrical circuit where many of the wires and components had degraded due to overheating (banks with bad loans on their balance sheets), because of decades of policy where we pumped more current into the system but didn’t replace many of the components, especially on the half of the circuit board where most of the smaller components live! Rather than trying to replace the components, they opted to simply disconnect many of them (especially the smaller ones), and keep using the same shoddy wires to channel current to the bigger components – running them to maximum capacity and generating a lot of heat (saving bad banks, slashing benefits and allowing big companies to generate big profits and hide them offshore). They forgot what the purpose of the circuit is, to link all the components and have them all working in unison, concentrating instead on keeping the current flowing. They didn’t understand that the circuit is not for carrying electricity – it’s for doing things. UK GDP may be going up, but all the stuff we want the economy to do is going nowhere – the current is flowing – but the lights are going out.