Mark Thoma posted a nice paper today about the misuse of economic models (you can see the paper by Paul Pfleiderer of Stanford here). This blends nicely with my post yesterday about how models need to better reflect the real-world and are only useful to the extent that we understand their limitations. Pfleiderer touches on how the profession of economics has become overly reliant on models that are not well grounded in reality. And who do we have to thank for much of this? The American economist who derailed economics for 40 years, Milton Friedman:
“In his 1953 essay “The Methodology of Positive Economics,” Milton Friedman famously argued that we should not judge a model based on the realism of its assumptions but only by the accuracy of its predictions. This claim has generated considerable controversy over the years and many have rejected Friedman’s arguments, although some have come to his defense.”
The ensuing 40 years basically threw reality out of the window and led to an excessive focus on deceptive concepts like the quantity theory of money and other math-based fictions which look like rigorous scientific work, but abuse the reality of the monetary world we live in.
Anyhow, I’ve trashed Milton Friedman enough for one day. Have a read of the paper here.
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.