The Biophysical Economy and Central Bank Risks

Nicholas Walldorff

Chief Information Officer

Covington Investments, LLC

Atlanta, GA

Abstract

The modern central banking system is responsible for many activities including payment settlement and regulatory oversight of the modern financial system. Central bank policy seeks to optimize macro economic output around certain unique mandates however control over the economy is limited. Currently a prevailing mandate among central bank institutions is the objective of “price stability”, the idea that price levels should grow at predictable rates anchoring the inflation expectations of economic agents. To the extent that traditional macroeconomic models fail to account for the biophysical constraints to sustainable production, central banks will face significant unanticipated policy risk in determining optimal policy directives.

Central banks have a history of model misspecification and associated policy errors, now biophysical resource constraints pose a new and expanding class of risks to our central banking system. These constraints will have broad implications for the evolution of price level indexes as currently measured as well as policy decisions that will follow. As history has shown, the outcome of a central bank policy error carries significant cost to human well-being and resource allocation. Central banks must evolve to properly account for risks identifiable through the biophysical economic lens.