Thursday, July 8, 2010

A new dimension in Economics - Econophysics

Econophysics is an interdisciplinary research field, applying theories and methods originally developed by physicists in order to solve problems in economics, usually those including uncertainty or stochastic processes and nonlinear dynamics. Its application to the study of financial markets has also been termed statistical finance referring to its roots in statistical physics. Physicists’ interest in the social sciences is not new; Daniel Bernoulli, as an example, was the originator of utility-based preferences. One of the founders ofneoclassical economic theory, former Yale University Professor of Economics Irving Fisher, was originally trained under the renowned Yale physicist, Josiah Willard Gibbs.

Econophysics was started in the mid 1990s by several physicists working in the subfield of statistical mechanics. They decided to tackle the complex problems posed by economics, especially by financial markets. Unsatisfied with the traditional explanations of economists, they applied tools and methods from physics - first to try to match financial data sets, and then to explain more general economic phenomena.

One driving force behind econophysics arising at this time was the availability of huge amounts of financial data, starting in the 1980s. It became apparent that traditional methods of analysis were insufficient - standard economic methods dealt with homogeneous agents and equilibrium, while many of the more interesting phenomena in financial markets fundamentally depended on heterogeneous agents and far-from-equilibrium situations.

The term “econophysics” was coined by H. Eugene Stanley in the mid 1990s, to describe the large number of papers written by physicists in the problems of (stock and other) markets, and first appeared in a conference on statistical physics in Calcutta in 1995 and its following publications. The inaugural meeting on Econophysics was organised 1998 in Budapest byJanos Kertesz and Imre Kondor.

Currently, the almost regular meeting series on the topic include: Econophysics Colloquium, ESHIA/ WEHIA, ECONOPHYS-KOLKATA, APFA

If "econophysics" is taken to denote the principle of applying statistical mechanics to economic analysis, as opposed to a particular literature or network, priority of innovation is probably due to Farjoun and Machover (1983). Their book Laws of Chaos: A Probabilistic Approach to Political Economy proposes dissolving (their words) the transformation problem in Marx's political economy by re-conceptualising the relevant quantities as random variables.

If, on the other side, "econophysics" is taken to denote the application of physics to economics, one can already consider the works of Léon Walras and Vilfredo Pareto as part of it. Indeed, as shown by Ingrao and Israel, general equilibrium theory in economics is just based on the physical concept of mechanical equilibrium.

It should be noted that econophysics has nothing to do with the "physical quantities approach" to economics, advocated by Ian Steedman and others associated with Neo-Ricardianism.

Basic tools of econophysics are probabilistic and statistical methods often taken from statistical physics.

Physics models that have been applied in economics include percolation models, chaotic models developed to study cardiac arrest, and models with self-organizing criticality as well as other models developed for earthquake prediction. Moreover, there have been attempts to use the mathematical theory of complexity and information theory, as developed by many scientists among whom are Murray Gell-Mann and Claude E. Shannon, respectively.

Since economic phenomena are the result of the interaction among many heterogeneous agents, there is an analogy with statistical mechanics, where many particles interact; but it must be taken into account that the properties of human beings and particles significantly differ.

There are, however, various other tools from physics that have so far been used with mixed success, such as fluid dynamics, classical mechanics and quantum mechanics (including so-called classical economy and quantum economy), and the path integral formulation of statistical mechanics.

There are also analogies between finance theory and diffusion theory. For instance, the Black-Scholes equation for option pricing is a diffusion-advection equation.

Papers on econophysics have been published primarily in journals devoted to physics and statistical mechanics, rather than in leading economics journals. Mainstream economists have generally been unimpressed by this work. Some Heterodox economists, including Mauro Gallegati, Steve Keen and Paul Ormerod, have shown more interest, but also criticized trends in econophysics.

In contrast, econophysics is having some impact on the more applied field of quantitative finance, whose scope and aims significantly differ from those of economic theory. Various econophysicists have introduced models for price fluctuations in financial markets or original points of view on established models.

Saturday, July 3, 2010

UN raises voice to ditch Dollar as an international currency.

I just received a mail yesterday, while I was in my office, that the UN has called for ditching the dollar as an internationally accepted currency. Suddenly my mind started racing ... what would be the effect of such a step in International Economics and International Business.

I asked my canteen incharge, Tapash, for a cup of coffee. I sank into the huge leather sofa in my office, all alone, sipping coffee and thinking of the repercussions. From my understanding of International Finance and Exchange Rate dynamics, a fall in the overall acceptability of US dollar will result in the decrease in demand of dollar. Countries holding dollars in their foreign exchange basket will try to sell them off, resulting in an excess supply of dollars in the international market. Unless the Obama government takes a huge initiative to buy back the dollars at the existing rate, the price of the dollar, i.e the Exchange Rate of dollar is sure to fall. Dollar will depreciate.

Now, what happens if dollar depreciates? In this era of Globalisation, some countries trading with the US will have a trade surplus. Definately good for the Indian Economy. But the US economy, who haven't yet recovered fully from the Financial Crisis, will further sink. The US government will definately try to recover, with the Federal Reserves decreasing the Rate of Interest, and the US government reducing their imports. The latter is critically important, as the US will suffer greater losses with imports in the era of Exchange Rate depreciation.

Now, lets see the very important repercussion. China is the major trading partner of the US. A decline in the imports of the US means a decline in the exports of China. China, who boasts of their GDP growth rate hovering around 10%, will suffer a setback, since the growth of the Chinese economy is mainly fuelled by exports. So, the Chinese growth will be hit. Contrastingly, Indian growth is mainly domestic demand driven. So, the Indian economy won't be severely hit. We definately do have a fair chance of overtaking the Chinese economy in the growth rate of Real GDP.

Looking forward to the coming few months. I will definately revert back to this issue in my next posts. Until then, lets keep our fingers crossed.

The question that remains is ... Is it time to end the Monopoly???

Friday, December 4, 2009

NEGATIVE INFLATION - Whom are you fooling dude?

NEGATIVE INFLATION - Are we heading towards a recession?

A few months back, this was the headline in almost every news channel and news paper (assuming the language of the channels and papers constant, ceteris paribus). Common people (or cattle class) were ecstatic as because negative inflation signifies that the general price level is recording a sustained gradual fall over time, which means cheaper goods and increased value of money.

On the other hand, the Industrialists (or sucker class, as I love to call them) were devastated at this sight, as it implies lesser profits, and of course, less sucking. The Economists believe that negative inflation is not at all a healthy signal for an economy. On the contrary, a mild inflation acts as a lubricant in the wheels of an economy. Allow me to explain this point. A mild inflation signifies a very slow, gradual, sustained increase in the general price level. A mild dose of inflation is required as it encourages the producers to produce more, thus boosting production, output and employment. On the other hand, the general income level rises due to this, and consumers have more purchasing power in their hand, which increases the level of Aggregate Demand in the economy.

Oh sorry, I am deviating from the point I started to explain. We already know that the price of general goods are at an all time high. Look at the price of vegetables. At this point of time, potatoes are generally Rs. 4/5 per kg, but now its Rs 30 per kg (plus minus something, since I am not a regular visitor to the veg market). Inspite of this, the inflation is negative - BULLSHIT.

Now the organisation dedicated to release these figures are not dumb asses. This apparently vague comments have deep rooted mathematics embedded inside them. There is something called Price Index (I would love to teach this concept, but for this you need to attend my Statistics classes ... lol) which records changes in prices of the current year as compared to the base year. Now in the Inflation Equation, weights are assigned to basket of commodities, like agricultural commodities, industrial commodities, durable consumer goods, etc.

Now, if you notice, the price of industrial and consumer goods didnt increase proportionately. Its the agricultural output prices that screwd up our life. The Economists in these agencies removed the higher weight from the agricultural output to the other commodities whose prices didnt record any upward thrust. After this, high school mathematics follows. Obviously, the inflation figures reveals a downward drive and eventually surpasses the bottomline. See, the beauty of mathematics - which I keep on telling my students. That is why Mathematics is the most beautiful subject in the world.

Now, the question is "Why did the government do this?"

Well, the answer is - The government is forced to show a lower fiscal deficit to the IMF in order to secure long term loans. Soaring inflation prices doesnt help the case. So, lowering of inflation figures helps lower the fiscal deficit (atleast on paper), and thus loans are secured.

Now the question for the readers to answer is -


Thursday, October 29, 2009

Is it possible to eliminate poverty?

About three-forth of the total population of this planet are victims of poverty. Those who are fortunate and well endowed do not spend time thinking about the problems of the poor. The poor themselves are so preoccupied with the survival that they do not enjoy the luxury of thinking beyond the next meal. The largest proportions of the poor reside in South Asia and the Sub-Saharan region.

Everyone is familiar with the Nobel laureate Mohammad Yunus and the story of the successful model of poverty eradication of Bangladesh’s Grameen Bank. Prof. Yunus asserts that poverty is not a naturally ordained state of human existence. Poverty is unnatural as is human slavery and the colonial domination of countries. It is therefore natural to conclude that poverty need not be everlasting as indeed slavery or colonization were not.
Prof. Yunus believed that every human being is born with equal abilities, but with access to different degrees of opportunities. So he prescribes that if there was a way by which opportunities could be evenly spread out and made available to all, deprivation and poverty might be eradicated.

Prof. Yunus’s anguish and enquiries were triggered by the spectre of widespread deaths owing to starvation of the poor during a famine in Bangladesh. This reinforced the fact that not only do the poor not have access to resources during normal times, but this lack of access becomes fatal during periods of crisis. This further reinforces the fact that credit is only available to the prosperous section, while the poor who desperately need credit has no one to lend them.
The success story of Bangladeshi Grameen Bank is widely known. It started 30 years ago and according to Prof. Yunus, 80% of poor households in Bangladesh today have access to micro credit. Their target is to cover all households by 2010. The impact is reflected by Bangladesh’s superior ranking as compared to it’s South Asian neighbours in terms of social indices like infant mortality, maternal mortality, sanitation, nutritional balance and evil social customs such as dowry and child marriage. Prof. Yunus’s concept of “not - for – profit social corporate bodies” and a stock exchange for such “not - for – profit social companies” is under discussion in places like Harvard Business School and MIT – Sloan School of Business.

I had the priviledge of attending a seminar held in the Department of Economics, University of North Bengal, from 22nd to 24th March, 2007. I was fortunate enough to listen to eminent economists and scholars and I learnt that there are a number of success stories of Self Help Groups (SHGs) and NGOs in alleviating poverty in some isolated places in India. But given the vastness of our problems, the question arises that is it really sufficient. Micro credit has to become the core of India’s banking operations.

One of the greatest events of the 20th century was the innovation of ‘Satyagraha’ by Mahatma Gandhi to rid India of colonial occupation. It is probable that the concept of micro credit for the dispossessed to end poverty could be the biggest innovation of the 21st century.