Butterflies in the World Economy
Can a corn farmer in Nebraska who hit the snooze button on his alarm clock cause the next recession? Or can a mentally exhausted computer programmer who let a bug slip by in his code at 3a.m. in the morning be the cause behind the stock market crash? These both are questions of the sensitivity of the dependence of initial conditions on a later state outcome. To quickly expel the validity of this question would be foolish to not include all the input factors of a system in determining its output.
In 1961, Edward Lorenz built a mathematical Meteorologial model involving the way gases moves in Earth’s atmosphere. He discovered that his model was extremely sensitive to the initial conditions. His claim was that the flap of a butterfly’s wings in Brazil could alter the direction of a tornado in Texas. He coined his discovery the “butterfly effect”. Coincidently, another system that also very highly dependent on the initial states is an information cascade.
In the 2010 article titled, “The Butterfly Effect and World Economics”, the author discusses the importance of globalization on the economy. We live in a world connected by the world wide web, submarine transatlantic cables, satellites, and international trade routes. One decision by the US Federal Reserve Board to print more money causes twenty or so other nations around the world to rise up in anger as the value of the dollar plummets. The idea that one decision can have drastic effects sometimes thousands of miles away is most profound in the financial industry because markets and thus predictions change rapidly sometimes based on few private signals and a resulting information cascade. In his second term, President Bush’s push to increase home ownership may have been the cause of the Great Recession. With interest rates lowered, more people were encouraged to buy houses that they couldn’t afford earlier. With additional options to re-finance mortgages based on the fact that the house’s value increased as demand in the market increased, buyers were motivated to leave their price range. Finally, banks were encouraged to disregard the risk associated with giving out mortgages to subprime customers as government agencies such as Freddie Mac and Fannie Mae were instructed to buy all the mortgage backed securities from the banks as they were seen as safe assets. Ultimately, the housing bubble collapsed from the information cascade produced by a series of initial decisions and events.
Source: http://www.bbc.co.uk/worldservice/business/2010/12/101207_stelzer_interconnected.shtml