Filling in the Black Box

Even after the Federal Reserve poured billions into Banks under the TARP scheme, banks did not resume lending. To those of us who study management, this was not a surprise at all – why would any bank in its senses lend to anyone in such an era of uncertainty? To economists, however, it was astonishing: there is supposed to be a Multiplier..banks are supposed to lend some multiple of their reserves, which in turn.. and so on..but they didn’t! The multiplier was actually below 1.0 (as the Australian economist Keen correctly notes in his excellent book ‘Debunking Economics’).
I remember posting comments on various blogs around the world at the time, essentially saying that if the Fed wants lending to increase, they would have to do it themselves – banks were not going to. I didn’t expect, of course, that top managers of banks would be so downright shameless as to pay it out to themselves as bonuses, but that is another story.
More than anything else, it seems to me to highlight the difference between Economics as a discipline and the field of Management. Economists try to understand, and model, very large systems – like the economy itself. To keep their models manageable, they have to simplify them, to the point where, sometimes, what really matters in a given situation is assumed away. Like banks. How do banks behave? To an economist, banks are simply a black box, a conduit for the transmission of the money supply.
To someone concerned with the field of management, the really interesting question is: how are banks managed? How do they respond to external challenges? What drives them? The mechanism of the black box, in other words. I had created just such a course at IIM Ahmedabad during the ten years I taught there .. unfortunately, nobody seems to have kept it alive after I left, and we are back to ‘Bank as a black box’ level of understanding.
At times like these, it turns out, understanding the internal mechanics is crucial. No wonder TARP failed – almost a trillion dollars wasted, all for lack of understanding of how the black box works.