Tag Archives: prediction

Alex Rosenberg and Tyler Curtain recently wrote an essay criticizing the idea that economics is a science. While I am skeptical of any joint undertaking between Duke and UNC – where Rosenberg and Curtain teach, respectively – it’s important to dismiss, or severely injure, the notion that economics can – at a philosophical level – predict the business cycle.

An oft-lodged complaint of neoclassical macroeconomics was its inability to foresee the recent financial crisis and recession that followed. Many critics – left, right; idiotic, and lauded – complain that if economics wasn’t so tied up in senseless assumptions and adopted a “more scientific” approach to its methods its predictive capacity could be expanded.

Of course, critics admonish economists to become “more scientific” without explaining what exactly that means, but the vacuity of this claim is far deeper. The business cycle cannot be predicted by a credible model.

First, let’s distinguish logical predictions, from random frets of fury that are eventually vindicated. The former derive legitimacy from logical assumptions that are substantiated by reality, and hence are expected to hold true for the future. The latter comes from one man’s “intuition” (perhaps that credit booms will cause a crash) without  an accompanying model – and describes most “correct” predictions about the recent crash.

The only point of predicting a recession from a correct logical model is for it to remain credible among society. There’s no point in having a right model that no body believes (and if it’s right for long enough, people by definition of Bayesian revision, will come to believe this is true – so this distinction is an artifact).

Let’s say I’m a brilliant economist that finally got rid of those dumb assumptions. Agents are no longer rational, and I’ve even measured how irrational each of Earth’s seven billion inhabitants are so that I can fine tune heterogeneous tastes and preferences perfectly. And because, let’s say, P = NP I can tractably compute even the most complicated world’s to predict the economy. I have a perfect model founded on the most scientific and empirical of observations. Everyone has complete faith in my brilliance.

And let’s say one morning I forebodingly write in the Wall Street Journal that in six months it is 75% likely the United States economy will contract (YoY) by ten whopping percent. But until then it will continue to grow, or stagnate. Even my beautiful model is not invincible against what happens next.

Since my model can logically predict the recession, all firms expect consumer demand to crash in six months. To maximize expected profit, firms lay off workers and curtail all but the longest term of investments. (If I’m building something that is expected to generate profits in two hundred years, the near term horizon will not affect this decision).

Suddenly, regardless of what my model predicted would happen today, the economy tricks itself into a recession. This has nothing to do with the kind of model I write, the assumptions I make, the math I use, the abstractions I allow, the realities I ignore, or the ideology to which I subscribe. Any and every model, will definitionally fall prey to fickle human expectations. No amount of devotion to the scientific method can fix this.

At this point, maybe the critics retreat and say, but then why can’t economics tell us that fiscal expansion works (does not work). For one, there’s no conclusive proof that it doesn’t (does). But more importantly, let’s say a completely trustable model tells us that deficit spending in recessions is magical and brings the economy roaring back. When the government, following economists’ advice, expands its budget drastically, expectations will drive the economy into a boom. The model, its merits aside, becomes a self-fulfilling prophecy. 

A lot of this is common sense to anyone whose taken more than five seconds to think about what’s wrong with the economics profession. It’s foolish to expect models to be founded on the same, rigorously true assumptions – or adhere to the same scientific method – of physics and economics.

It is easy to appeal to human nature – to which economics is ultimately connected – as a cop out of the scientific method. But even in the most mundane of senses, an economist does not have the luxury of a model that is forever and always correct. Self observation produces confusing – even paradoxical results – which economists can never overcome. Sure, they can add frictions representing momentum of human expectations, but once we learn (formally) of this addition there will be yet another meta level expectational conflict.

This logic can be taken to an extreme. Not everyone believes a model and business decisions aren’t formed on economic theory. But ultimately it illustrates an important distinction between economics and every natural science.

Asking economists to follow the stylistic and epistemological guidelines of physicists and chemists is not the best way to improve the profession. In fact, it is impossible.