I’ve never really understood the way many economists think. For instance, take the latest from Paul Krugman in which he tries to explain why his model of the economy helped him to predict some things in recent years. What’s so strange is how he assumes away reality:
“What I did in my old analysis was to radically simplify the dynamics by imagining an infinite-horizon model in which all the action takes place in period one.
I also, as a first pass, assume that there is no investment, just consumption.
Well, if we have rational expectations and frictionless capital markets — which we don’t, but let’s see what would happen if we did”
I know what he’s trying to do here. He’s just trying to simplify the model to control the experiment in essence. But this isn’t like an experiment in a lab. You see, in a real-world scientific experiment you might control the experiment to remove any outside variables that would produce a false conclusion. By controlling the experiment you can be more precise in your experiments before you apply them to the real-world. But the kicker is that the science still has to be applied to the real-world. All of those variables that you removed from the lab have to still be put back in when you actually apply the results in real-life.
What economists do is control their experiments in a fake setting and then just assume that the same thinking applies in the real-world. Except it doesn’t because you’ve created a fictional world in which you established your conclusion and then forgot to actually apply it to the real-world, which would have actually required you to put all those assumptions back into the model.
This just makes no sense to me. And it’s why I keep saying no one needed the ISLM model or anything like it to make the same predictions Paul Krugman made. After all, I made every prediction he did without using that model. I just looked at the real world for what it is and performed my own experiments in that real-world. No one needed fake models to understand why QE didn’t cause high inflation. All you needed was to understand the operational realities of how it actually works in the real-world.
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.