Sunday, October 25, 2015

All economic theory is bunk

Or at least, macroeconomic data can often mean whatever you want them to mean. Or they can mean nothing at all. 
In a way, the debate over how much faith the Fed puts in the Phillips curve shows the broader dilemma of economic policy. For all the researchers over the decades and centuries who have tried to understand how the economy really works and to predict its course with precision, our ability to know where the economy is heading next year is no better than the ability of weather forecasters to predict whether it will rain three weeks from today. The United States economy is, after all, determined largely by the endlessly complicated interactions of 320 million people producing $17 trillion worth of stuff, which even relatively complex models can’t keep up with.

Most importantly, policy is determined by politics. And in that context, even seeming ironclad laws of conventional theory like the Phillips Curve are just means to limit the scope of policy to conform to what the politics will allow. In our case, we have arrived at an argument that says, "don't let unemployment get too low, or else." But the basis for making that argument is less strong that what we often admit.

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