ASPO Ireland is kicking off its first event for 2012 by inviting back the two leading economists it brought to Ireland last year, Dr. Michael Kumhof from the research team at the IMF and Professor Steve Keen from the University of Western Sydney. Both Kumhof and Keen are participating in the influential INET conference in Berlin next month and we’ve taken advantage of the opportunity to get them both in Dublin together. The IIEA is kindly hosting the event.
Kumhof and Keen’s work is of interest because of their attempts to model how the economy works, and by so doing, attempting to forecast how the economy might unfold in the future under different sets of scenarios. What’s particularly interesting about the models they’ve built is that they’re based on fundamentally different theories of how the economy is believed to work. Kumhof’s model is based on the economic theory thought to everyone today as ‘economics’ based on the assumption of equilibrium between supply and demand, called general equilibrium theory, and also known as neoclassical economics. In stark contrast, Keen’s starting point is that the economy is rarely if ever in equilibrium, a dis-equilibrium theory.
Kumhof was centrally involved in a piece of research published in the IMF’s World Economic Outlook last April on the impact of peak oil on the global economy: Oil Scarcity, Growth, and Global Imbalances. Included below is a graphic showing the oil supply scenarios considered and another showing the model’s forecast global GDP based on the shock associated with each scenario:
Kumhof gave a very compelling presentation in Dublin last October when he came to present on this work.
Eqaully, Keen, when he presented at the IIEA last November, gave a compelling presentation on how the Global Financial Crisis, or GFC as the Australians like to call it, was no black swan event and was forewarned by a small group of economists outside the mainstream (see Bezemer for an overview of who saw it and why). Keen actually built the foundation for his economic modelling approach back in 1995, and forewarned back then that we were on an unsustainable track. Curiously, around the same time ASPO’s founder, Dr Colin Campbell started his work to warn the world of peak oil. He has since coupled his purely monetary model with a physical stocks-and-flows model to look at carbon emissions and energy consumption in the Asia Pacific region as part of a study for UNEP on resource efficiency (REEO). The scenarios considered and the results emerging are fascinating.
The Irish Context
Macroecocomic modelling along similar lines to that above is carried out in Ireland by the ESRI. There, Prof John Fitzgerald
heads up the Energy Research Policy Centre
(EPRC). The ESRI macroeconomic model was originally developed out of a model called HERMES
, a model built immediately after the Seventies oil shocks, curiously enough, to help economists understand their impacts and develop policy.
In 2010 the ESRI published a study entitled ‘Recovery Scenarios for Ireland: An Update
‘ which considers two scenarios for Ireland’s economic future, one called the High Growth
scenario and the other called the Low Growth
scenario. Disturbingly, the Low Growth
scenario assumes an annual average GDP growth rate over the period 2011-2015 of 3.2% (Table 3.2) and the deficit problem arising from this can be seen in Figure 7, included below:
Clearly, based on recent performance, we’re not on a trajectory to get our deficit under control. Not surprising considering the growing chatter about the need for a second bailout, a la Greece.
Unfortunately, what’s not considered by this model is the output of Kumhof’s research, above. Not that we need sophisticated models like those used at the ESRI or the IMF to tell us what the general impact of a continuing hike in the price of oil might be on the economy. But more importantly, and this is Keen’s contribution, these traditional equilibrium models also ignore the role of debt in the economy. It’s interesting to note that these mainstream models ignore two primary sources of power, the rate of energy consumption (the scientific definition of power), and the rate of credit creation. The power to create and allocate credit is arguably the primary source of economic power, a power very capable of corrupting both itself and our political and social systems, as the documentary Inside Job
so deftly demonstrated.
Unfortunately, understanding the ‘general impact’ is not enough, and indeed this is probably where much of the ‘peak oil impact’ narrative has stultified by quickly descending into apocalyptic tales of societal collapse. [As always, when the topic of societal collapse comes up, I direct people to a professional on the topic (Vinay Gupta
) for a sense of perspective.] When I met Dr Campbell first back in late 2004, he told me the first sign of peak oil will be a banking crisis. It took me until relatively recently to properly understand what he meant. Given our recent experience in Ireland, we have a very vivid image of what a banking crisis looks like and the damage that gets inflicted on the general public when the banking system over-lends and our politicians fail to stop the bankers dumping to cost of cleaning up the mess in the public lap.
As our banks reign in their lending to repair their balance sheets and purge them of their non-performing loans (at our expense) to get back to a state of ‘prudent banking’, deflating the economy in the process, they’re contemplating returning to a world that existed in the Nineties, before Greenspans’ Irrational Exuberance took hold. Problem is, back in the Nineties, oil was less than $20/barrel. Now with oil prices remaining consistently over $100/barrel, an enormous increase, the floor at which our bankers think they need to get to in order to hit ‘prudent banking’ has dropped considerably. We can now start to understand the transmission system for the impact of high and increasing oil prices. Sadly, it will look like more of what we’ve been seeing since the bubble burst in 2008. Peak oil is a systemic risk to our banking system, much like Anglo was, and with similar implications. At a macro level, higher oil prices lower global economic activity, the reduced aggregate demand leading to job losses. At the micro level, as more disposable income gets diverted towards the increased price of oil, our ability to put petrol in the car to get to work to earn the money to pay the mortgage is reduced, and that’s for those lucky enough not to have been impacted by the reduced aggregate demand and haven’t lost their job. Increased loan impairments start to impact on bank balance sheets, and well, you know the rest.
If the above analysis is correct, then the focus of peak oilers needs to grow beyond collapse rhetoric and talk about specifics: banking policy. Peak oil should be an issue keeping the governor of our central bank awake at night (not that he has a shortage of such issues at the moment). More positively, it points the way to the lever to pull to help turn the heaving behemoth that is a national economy away from the iceberg of energy security: lending policy. To elaborate, you only get a loan if the net impact of the money spent will be to reduce your overall exposure to future energy price rises/availability.
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