Does Fed see real picture of economy? Let us refer to economic thinking...

As history shows, the U.S. Federal Reserve's grasp on economic reality hasn't been anywhere near as strong as you might hope or expect. Thus, maybe it is high time to start using a new economic model.

Paul Gambles, Co-Founder of MBMG Group and an advisory board member of IDEA Economics, shared an interesting analysis on why financial policy-makers failed to predict the global financial crisis and set a question on whether the economic tradition should be blamed.

Why do the doubts persist? Back in 2011, Mr Gambles was critical of Janet Yellen's predecessor, Ben Bernanke, an acknowledged academic expert on the Great Depression. He suggested that Bernanke, his predecessor, Alan Greenspan, and many others in the economic establishment are associated with a single strand of economic thinking, neo-classical (and more specifically, monetarist) economics - the approach which has been widely disconsidered.

Despite its utter failure to anticipate the global financial crisis (GFC) and any other significant financial crisis, this school of economic thinking remains dominant. Economists belonging to this group include Larry Summers, Ken Rogoff, Paul Krugman and the IMF's Olivier Blanchard, who all studied the same courses taught by Stanley Fischer at the Massachusetts Institute of Technology.

The group's views are informed by a uniform economic framework and differences in opinion tend to be about details rather than fundamentals. Therefore, selective mass blindness prevents the economics profession answering the question posed by Queen Elizabeth II to the London School of Economics "Why did nobody notice it (the GFC)?"

The answers tend to range from Bernanke waxing lyrical about "the Great Moderation" to Blanchard telling us, as late as August 2008, "The state of macro is good", in the times of apparently poor health of global economies in 2007-2008.

Although GFC is already behind us, concerns persist, as the lack of any better understanding of its causes among most influential mainstream economists and policymakers.

Mr Gambles says notes that they tend to believe debt is merely a liquidity preference; one wealthy retiree's deposits fund, via bank intermediation, is another borrower's home or business loan. This ignores the fact that in the USA or the U.K. over 95 percent of 'money' is simply created by bank lending.

Economists who did not recognize approaching GFC, did not know where to look for the signs. They still ignore the role of private debt in creating booms and busts, while asking an expanded money supply to do the heavy lifting of stimulating economic activity (for which it is totally unequal to the task) while the risk of creating asset bubbles goes largely ignored (once again). These economists tend to be unaware that stability can be destabilizing. They see the economy as a linear system. However, as anyone in business knows in reality the economy is non-linear.

Mr Gambles considers that the above-mentioned economists tend to view human responses to situations as rational and homogenous. But the history of capital markets is of irrationality and imperfect information and of panics and crises which policymakers and their models failed to anticipate.

Is there any other alternative to the present economic model? Steve Keen has been developing a dynamic, non-linear double entry book-keeping economic model for many years. This one, unlike the Fed's model, produces recessions and downturns rather than being able to be manipulated to produce never-ending economic expansion.

It accurately predicted the nature and extent of the Global Financial Crisis. The model has uniquely been able to explain what and why the consequences of policy will be but not exactly when or where. While the model is not yet complete, Mr Gambles hope for new breakthrough soon.