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Thoughts from the Frontline

Assume a Perfect World

April 13, 2013

An engineer, a chemist, and an economist are stranded on a deserted island. They are starving, when miraculously they find a box filled with canned food. What to do? They consider the problem, bringing their collective lifetimes of study and discipline to the task.

Being the practical, straightforward sort, the engineer suggests that they simply find a rock and hit the cans until they break open. “No, no!” cry the chemist and economist, “we would spill too much food and the birds would get it!”

After a bit of thought, the chemist recommends that they start a fire and heat the cans. The pressure in the cans will force them open and the food will conveniently already be heated. But the engineer and economist object, pointing out correctly that the cans would likely explode and splatter the food all over the beach.

The economist, after carefully studying the cans and reading the labels, starts scrawling a series of equations in the sand, which eventually cover the entire beach. After much pondering, he excitedly announces, “I’ve got it! I’ve got it!” as he points to the final equation. They ask him to explain, with their visions of finally getting a meal causing them to regard the economist with a new sense of respect. 

The economist clears his throat and begins, “First, assume a can opener …”

I am not sure how old that joke is, but it dates to about the time when economists discovered mathematics and models, which is to say, about the time when economists developed physics envy and decided they would like to be regarded as scientists rather than philosophers. This week we continue to look at the data and models developed by economists, with a view to understanding both their usefulness and their limitations. The specific data we will examine this week is inspired by the release of the President’s FY 2014 US budget proposal this week. While it and the House and Senate budget proposals may appear to be widely divergent, there are some underlying and quite disturbing similarities among them.

Specifically, all three proposals assume away the real world. It does not matter which version you prefer; they all lack the basic precautions and hedges that those of us involved with preparing family and business budgets make sure to include in our own forecasts. While whole books could be written about the underlying assumptions in these latest budget proposals, we will examine (hopefully briefly) just a few of the more glaringly problematic ones.

Assume a Perfect World

Like our castaways with their abundance of canned food but no can opener, a US budget forecaster is faced with the problem of predicting the fiscal future of a very large, very real economic system, but without a crystal ball. And as we saw last week, economists are not particularly good at telling us what happened in the year that just passed, let alone in the year to…

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Lawrence Burns

April 12, 2013, 11:45 p.m.

Mr. Mauldin,
Thanks for one of the most concise and informative (if distressingly frank) assessments of Washington budget-think I’ve ever read.  As always, I’m entirely grateful and appreciative that you remain willing to share such important and informative insights with uneducated readers like me.

John Seater

April 12, 2013, 6:18 p.m.

As a professor of economics (macroeconomics at that), I find this article multiply irritating.

First, about forecasting.  It is always easy to poke fun at economic forecasts, especially because they usually turn out to be wrong, often by a large margin.  However, before laughing them off, think about what is being asked of those forecasts and the economists making them by considering the following analogy.  I presume that most of you reading this own a car and have a license to drive it.  The license certifies you to be minimally competent drivers, sort of the way a PhD certifies an economist to have a minimal command of economics.  Nonetheless, it is very easy to prove that you are all incompetent fools who know nothing about how a car works or how to drive it and thus to prove that driver’s licenses are a big joke.  Answer the following simple question: What will be the Mercator grid coordinates of your car exactly 2,190 hours from now (that’s three months), what direction will it be traveling, and how fast will it be going?  You obviously don’t know.  I have just proven that you are an incompetent driver and a fool deserving of ridicule because you claim to know the basics of how a car works and how it is to be used.

Asking an economist to predict where GDP (a far, far more complicated object than any automobile) will be in 3 months or a year and then ridiculing him for getting it wrong is exactly the same.  An economist can tell you a lot about what makes GDP move around.  Asking him to predict where GDP will be some months in the future, what direction it will be going, and how fast it will be going that way is very different.  It is asking for an unconditional forecast without providing any information about what the driver (the American people and their government) wants to do, whether he will step on the brake or the accelerator, whether he will have the gears in forward or reverse, and so on.  Of course economists get it wrong, and often wildly so, just the way you can’t answer my question about your car.

Second, the article grossly confuses economists with politicians.  Each time the article ridicules economists, it then moves on to illustrate the joke by referring to the behavior of politicians.  Of course the Obama administration issues rosy forecasts.  Would you expect anything different from a politician who wants to stay in office?  What does that prove about economics as a profession or as economists as professionals?  Nothing at all.

The CBO forecasts are an especially egregious case of tarring perfectly good economists because of the rules imposed on them by the politicians.  The CBO forecasts are ridiculously rosy because *the law requires them to be so.*  By law, the CBO must base its official forecasts on existing tax law, even if existing law is demonstrably unsustainable.  Indeed, the politicians in Congress enact short-term “fixes” that they know they will have to abandon in the near future in part because they know tose fixes will force the CBO to generate obviously silly forecasts.  The CBO tries to mitigate the damage by issuing documents that discuss more realistic alternative scenarios, but those are not the official forecast and so are treated differently by the press and the politicians, if they are mentioned at all.  The economists at the CBO know perfectly well that their official forecasts are garbage and they know why, but by law they cannot do anything about it.

Third, John Mauldin may not know what M1 is all about, but monetary economists do.  They also know what the monetary base, the money multiplier, and the money supply are all about.  They can tell you why the Fed’s injecting a lot of cash (monetary base) into the economy in the wake of the financial turmoil after 2008 did not increase the money supply (MZM), something that most commentators did not and still do not understand even though it is the stuff one learns in an intermediate-level college course in money and banking.  But then most commentators have studied little or no economics and so typically have no idea what they are talking about.

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