Despair is a negative emotion and one to be avoided. Yet it is hard not to feel that way when thinking about the state of economics. Macbeth, when he opines, “Life . . . is a tale, told by an idiot, full of sound and fury, signifying nothing” could easily have had an economist in mind. Macroeconomics –- the study of the big picture – is similar to designing aircraft. Models are built and tested to see if they will fly. Then full-scale aircraft are sent up to see if they will stay up. The ones that behave properly are the ones that get used – and that’s where the comparison ends.
As economist Noah Smith has pointed out that notwithstanding the abundance of models we still haven't come close to being able to decide which one is right, which model economy can stay in the air.
Dodgy conclusions
We don’t even have an agreed method for choosing the correct model.
Paul Romer
, tipped as a future Nobel winner, has caused a storm with an accusation of “mathiness”: he reckons at least two Nobel prize winners build their models with dodgy conclusions obscured behind a wall of mathematics. Other academics say not only is maths used in finance to obfuscate but also to make money via fraud.
Edmund Phelps, a Nobel laureate, has a thoughtful essay in the current New York Review of Books on what he reckons is wrong with economics and its models.
These academic fist fights have real consequences. We observe predictions that minimum wage hikes might either raise or lower unemployment.
Heavyweight theorists argue that near-zero interest rates will soon debase currencies with hyper-inflation; yet others build elegant models that show how low interest rates cause deflation.
Anyone who studied the quantity theory of money in school will have learned how increases in the money supply will cause inflation: this turns out not to be true. John Cochrane, a Chicago professor, points out that the US money supply recently went up 10,000 per cent and inflation went down.
Well-known American economists rail against the policies of the euro area. Less well-known German economists applaud.
When interest rates are lowered, the economy, supposedly, is given a boost. The leading light of "market monetarists", Scott Sumner, tells us that negligible interest rates are a sign of overly tight money.
There is tons of evidence clearly demonstrating that all the "big data" combined with all those models has not improved our ability to make accurate economic predictions. IMF economist Prakash Loungani wrote about all of this 15years ago. Last year, he revisited his earlier work and got the same result: we can't forecast.
Some economists think it is partly due to hopeless data. GDP is poorly measured and conceptually inadequate. Maybe we mis-measure inflation: thanks to the digital economy, we overestimate the extent to which prices are rising.
Real incomes
If true, real output is higher than we think, as are real incomes, wealth and debt; productivity is better and interest rates still too high. Hence, another great policy mistake is in the offing with inappropriate rises in US and UK interest rates a matter of months away. Unless, of course, the view that higher interest rates will cause higher inflation is the right model. Who knows?
One side-effect of this mess is that anyone can claim to be an expert. Philosophy professors and art critics don't write articles about how to cure cancer but they do offer entrenched views about economic policy. Unreconstructed state socialists can be serious candidates for the leadership of the British Labour Party. At the same end of the nuttiness scale, the economic opinions of Donald Trump are headline news.
Just as it was wrong for physicians to claim too much when they were applying leeches, it was equally incorrect to despair about medical progress.
So it is, we hope, with economics. Pay attention to facts rather than theories. Spending time with the numbers pays dividends. Learn some economic history.
The answers to questions about taxes and government spending aren’t simply “more”. History and data can be informative; models and dilettantes, not so much.
