Mark Thoma has a good piece on CBS Money Watch explaining how economists “figure out how the world really works”. It’s a good look into the thought process that leads to so many of today’s understandings in economics. In short, Thoma explains the process as follows:
- Economist A creates hypothesis X.
- Economist A studies historical data set to test whether hypothesis X holds up to empirical data. Economist A tests hypothesis X by inputting historical data into economist A’s model of choice.
Thoma concludes by stating:
“These complications make progress slower then [sic] it would be if economists could do their analysis in a lab. But although the progress is slow, and sometimes hard to see, there is progress nonetheless.”
We can begin to see why the progress has been so slow when we look at this process. In my view, the process more closely resembles this:
- Politically biased economist A creates hypothesis X.
- Politically biased economist A studies evolving and insignificant data set to test whether hypothesis X holds up to insignificant “empirical” data. Politically biased economist A tests hypothesis X by inputting flawed historical data into economist A’s model that is not based on operational understandings.
We saw this process play out a number of times over the last few years. For instance, Austrian economists often portray a politically biased view of the world which leads to a certain hypothesis. So, during 2008 we saw something like this:
- Austrian economist dislikes government and intervention in markets and claims that QE will cause high inflation due to “money printing”.
- Austrian economist A uses flawed concept of the quantity theory of money and misunderstanding of banking to argue that more bank reserves will lead to hyperinflation and “proves this” by arguing that “money printing” in Zimbabwe and Weimar led to hyperinflation.
The reason these predictions were wrong was because they were politically biased, not grounded in operational understandings and compared to faulty or misleading historical data. But this is what so much of economics is these days. It’s not science at all. It’s mostly just politics masquerading as science. And so here we are with this muddled mess of understandings and a policy perspective that no one can agree on and actually appears to be resulting in almost no progress. It’s a sad state of affairs if you ask me and isn’t helping anyone get any closer to understanding our reality.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.