Here I reply to some of the comments to my post “Understanding Economics” of a few days ago.
Economist regularly fail to predict things like the Housing bubble burst in the US. Back then, some nutcases (like Peter Schiff) who are not economists predicted it exactly. At the same time Nobel prize winning economists completely discarded it on television shows. If economic models can’t even predict such big things, I wonder what are they good for? In other words, isn’t the current economic theory just some mathematical model that has nothing to do with reality?
I would like to have some examples where economic theories have been successful and reasons why they have failed miserably in other occasions.
Economists often fail and so do other professionals, including doctors, engineers, architects and journalists. Humans are imperfect and even under the best of circumstances, bounded rationality and imperfect information don’t make it easy for anyone to predict stuff. Predictions are hard, especially about the future. Those who are foolish enough to do so usually end up badly. But that does not mean that all of economic theory is just stuff and nonsense. You cannot discard advances in, say, medical sciences just because some doctors have made mistakes.
People have put in lots of effort into figuring out how the world works. Yes, they don’t know everything, and perhaps they will never know everything. But even though our understanding of complex systems is incomplete, we still know things that are indubitably true. This core set forms the solid foundation on which we can continue to extend our understanding of the world.
Economic models do predict with surprising accuracy a wide range of behaviors. But like Heisenberg’s uncertainty principle which states that there is a limit to how accurately you can simultaneously know the momentum and location of a particle, there must be limits to how accurately you can predict both the timing and the extent of any particular bubble. Too many factors at play that we have no knowledge of.
Modeling economic phenomena using mathematical models is useful, although it may be hard for non-economists to appreciate their utility. But that does not mean that one cannot go overboard with too much esoteric mathematics.
What the vast majority of us should know about the fundamentals of economics does not involve much mathematics at all. Just plain arithmetic and a bit of high school algebra suffices. If you really want to, you can throw in a bit of differential calculus — but only if you want to manipulate the variables with ease. Add a few simple diagrams, such as supply and demand schedules, and you are fairly well equipped to explain quite a bit of the world.
DJ replied to Tanno thus
@Tanno You’ve asked for economic models that would predict the crisis. Minsky is an economist who had models for ponzi debt cycles which would explain and predict the debt crisis. Schiller has behavioral models which predicted the housing bubble and various bubbles born out of irrational exuberance. Didier Sornette while not an economist, uses mathematical models to predict when asset prices will peak. Schiller is not a good example, he is like a broken clock who will be right eventually at some point in time.
Fiat currency intrigues me. Fiat currency helps us avoid the complications of Barter system, this much is understood.
Hence it seems to me that amount of fiat-currency printed/released by a Fed/RBI should be equal to value of goods that its citizens are going to exchange.
Question1: How can the RBI/Fed print money with such abandon then?
Question2: How does RBI/Fed go about deciding the amount of money to print?
Question3: Excess money printing is a mechanism by government to take money out of the hands of citizens’ savings without explicitly calling it tax. Please confirm.
Abhijat too wants to know “what is money.”
Money is hard to get — in more than one sense. I will try and get around to it eventually. I say eventually because I don’t think it is useful to introduce money into the discussion too early. It just confuses people. We can get a fairly good understanding of the basic principles of economics without reference to money. After that, we can talk about money and it will then become quite clear that money is not all that important.
Yes, money matters but there are others things that matter more. Money matters to accountants but not so much to economists. Money is nominal, not real. Stuff is real. Stuff is wealth. Stuff matters.
The answer to the question 3 above is, “Yes, inflation is a disguised tax brought about by printing money and putting it in circulation.”
I have a question about free-market philosophy. How does the philosophy of free-market or minimum govt justify govt funding of scientific research and primary education?
Good question. Even a brief answer would be fairly long. The answer will have to start with “what is a market?” Then you have to go to “what is a free market?” Then we have to ask how the cost of production of something is recovered. Then we will get to kinds of goods for which it is hard to allocate the costs and the difficulty of recovering the costs of these goods. Then we will figure out that there are other mechanisms for funding such goods, etc.
In exploring that, we will also have to visit the role of governments and why a minimal government is better. All this is worth exploring.
I like the idea of a free market and am aware of the advantages of an incentivized system. Looking at the economic disparities in our society i would like to see you explore some policies or “regulations” enacted the government that are consistent with the idea of a free market economy (without any form of redistribution) and provide a better moral ground to justify a greed based system. Such policies, if any, will help us avoid situations like the sub-prime mortgage crisis which was the result of nothing but pure GREED.
Exploring the role of greed is an excellent point. Also economic disparity and what to do about it. All of this has to start with an understanding of what we mean by “government.” The starting point is to recognize that governments are people too. That means that whatever human characteristics you and I have as people, the people who constitute the government also have the same. If we are greedy, so are the people in the government. Therefore it may be asking too much to expect the “government” to fix the problem of greed.
DJ wrote in response to the matter of greed
@VirtualPresence Greed is not a property of a system, but of human beings (at least some large subset of humans). You cannot have a system that does not take that into account. Greed will always exist, no matter what system you come up with. Greed is not bad in a competitive, fair, accountable framework where it can be channeled into productive activities. Markets are the best system of determining when greed goes too far and companies get punished accordingly. Its only when the framework isn’t fair, or if the accountability mechanism is broken, or when there are distortions from regulators or govt that you have a problem. The problem is that greed is usually one step ahead of regulators, or greed can corrupt regulators, then what do you do?
Kumar_N asked about taxation. Among other questions, he asked
What does taxation theory say about the best model to ensure effective disbursal of tax monies across the nation? Thanks in advance.
I am sorry I can’t answer to those questions, only partly because I don’t know much about it. I may get to them if time permits me later on in the work.
Finally Suramya wants to know about “market failures.” That is an absolutely essential topic and it has to be addressed in the book.
Thanks all for the inputs. I will address them as I go along.
Categories: Understanding Economics