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Economics: still a pseudo science after so much effort?

Economics: still a pseudo science after so much effort? Anthony Harrington

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I am once again indebted to the US markets analyst and commentator John Mauldin, for a wonderful gem thrown up by his omnivorous trawling of so many key papers, blogs and analyses. This gem was penned by Dylan Grice, who produces a sporadic publication called the Edelweiss Journal,  the latest issue of which muses on the fact that everyday use of key economic terms simply creates the illusion that we have a lot more understanding of economic processes than we actually do - particularly on a national or international scale. Grice’s starting point is fascinating and I give it in full:

“Regular readers of our irregular publication will be aware of our thoughts on inflation, but for those who are not we would summarize them thus: inflation is not measurable. We can summarize our views on money with similar succinctness: it is poorly understood. And as for the economy, we know only this: it is a complex system. From these observations can be derived a straightforward corollary on economic policy makers: trying to control a variable you can’t measure (inflation) with a tool you don’t fully understand (money) in a complex system with hidden, unobservable and non-linear interrelationships (the economy) is a guaranteed way to ensure that most things which happen weren’t supposed to happen.”

Grice’s point about inflation would have economists of all stripes shouting out rebuttals. Those same economists, having clubbed Grice to pulp, would then break into two schools, those who know CPI and RPI are mere approximations of the underlying inflationary processes they purport to measure, but who are content with that approximation. They may be privately irritated with political attempts to tweak the measures, by for example, declaring that food and fuel should be excluded from the basket of products defining one or another measure. But they believe the measures relate meaningfully to the real world and have their uses.

The other “school”, to call it that, would come to blows over their various pet “improvements” to measuring inflation. Politicians, for their part, are now all thoroughly schooled in the classical notion that 2% inflation is good, 0% or negative inflation is bad, and anything over 2% is, progressively more concerning, requiring at least the carpeting and scolding of whatever central banker currently holds the top job. This last, of course, is particularly funny and makes Grice’s point in spades. As if the governor of the Bank of England has inflation in his gift and is willfully withholding it and thus deserves a spanking.

His point about money is just as cogent. The whole point about quantitative easing (QE), if you read the speeches made by central bankers and the IMF, is that it is an extraordinary policy measure. What makes it extraordinary is that it is not usually done (yes, we are in the presence of a tautology) but it is not usually done because central bankers in an “ordinary” frame of mind, regard it as daft. To them it is axiomatic that you do not print vast amounts of money, in the ordinary way of things, to stimulate the financial sector in the economy, in the hope that this will trickle down to the real economy. The 2008 crash threatened to generate an all engulfing Depression, so normal policy went out the window and “extraordinary” measures took over. Now, we are in uncharted territory with dangerous shoals ahead. The US would like to start tapering off its QE program, and it seems a safe bet that it will do so at some point if the US economy keeps on ticking upwards. However, when it does so, the negative impact on some emerging market economies is likely to be profound. The resulting emerging market (EM) crisis could well throw global growth into reverse which will, one imagines, knock the US economy backwards and call a halt to tapering.  What all this means is that, instead of stabilizing things, the actions of the Fed will simply have injected substantial volatility into the system – proof again of Grice’s point that we simply do not know what we are doing and what we do has outcomes that were not part of the grand plan.

Does this mean that we don’t understand economics? Austrian economists would be pulling their hair out in frustration. No it doesn't, they would say. What it means is that we are refusing to accept a basic economic lesson, namely that busts are a part of the normal economic cycle and are healthy in that they rectify misallocations of capital made during the boom period. Letting central bankers muck about with the process just amplifies error in all directions. That doesn't mean that no one could come up with a valid description of the economic processes that create the bust; rather, it means that democratic processes trump economic processes every time. Democracies “always” choose the soft option and will, if they possibly can, keep on kicking the can down the road right up to the cliff edge and beyond.

By now, we have all learned this lesson, but no one knows how to halt what has become a runaway process...

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Further reading on booms and busts:

Tags: 2008 crash , Bank of England , boom-and-bust cycles , Dylan Grice , economics , Edelweiss Journal , Federal Reserve , Great Depression , IMF , inflation , John Mauldin , QE , quantitative easing
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