Abstract
One of the intriguing puzzles from the Global Financial Crisis of 2007-08 was this one: To save the U.S. economy, why did the U.S. Federal Reserve System (under the chair, Ben Bernanke) open its central bank discount window to the unregulated money-market funds? The discount window of a central bank is usually only open to legitimate banks; and money-market funds are not banks. But the action proved correct, and the crisis slipped into an economic recession and not a depression. Yet how can one theoretically explain Bernanke’s economic reasoning underlying this critical decision? For explanation of that event, we integrate several traditional economic models: 1) the growth models of Harrod-Domar and of Solow, 2) the production-consumption model of Leontief, and 3) Minsky’s price-disequilibrium model. The integration of these models is methodologically possible through a system dynamics representation of the algebraic forms of the traditional economic models. In a system dynamics model, economic flows become explicit, as well as do the connections between institutions. In this explanation, we see evidence for the economic postulate that: it is financial crises which trigger depressions and not production business-cycles. Production business-cycles trigger recessions.
Highlights
The form of a model can assist or impede empirical validation of the model
Empirical evidence was the Rydberg formula, which summarized the patterns of spectral emission of hydrogen atoms
Some have sought to describe the economy as a dynamic system that continually changes its shape and composition, while others analyzed the economy as a static system consisting of a constant and stable set of interconnected parts
Summary
The form of a model (representation of an economic event) can assist or impede empirical validation of the model. Models can be directly validated or invalidated empirically, while theory cannot be so directly verified. A classic example in physics was Bohr’s quantified model of an atom which directly derived the empirical Rydberg formula and verified the model. Later Heisenberg’s quantum matrix theory and Schrodinger’s atomic wave theory provided the semantic theory in which to embed the Bohr model. Bohr’s model quantized the orbits of electrons in hydrogen atoms, from which Bohr derived Rydberg’s formula. Heisenberg and Schrodinger formulated quantum theories in which the Bohr model could be derived from fundamental assumptions (such as the Heisenberg uncertainty principle and Schrodinger’s Hamiltonian wave equation). The quantum model of the atom was directly verified by experimental data, while the quantum theory was indirectly verified by the quantized atomic model
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