The Quest for Certainty

“As far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality.”

– Albert Einstein

“To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states. First principle: any explanation is better than none… The cause-creating drive is thus conditioned and excited by the feeling of fear …"

– Friedrich Nietzsche

“Very few beings really seek knowledge in this world. Mortal or immortal, few really ask. On the contrary, they try to wring from the unknown the answers they have already shaped in their own minds – justifications, confirmations, forms of consolation without which they can't go on. To really ask is to open the door to the whirlwind. The answer may annihilate the question and the questioner.”

– Anne Rice, The Vampire Lestat

The last two weeks we have been looking at the problems with models. First we touched on what I called the Economic Singularity. In physics a singularity is where the mathematical models no longer work. For example, models based on the physics of relativity no longer work if one gets too close to a black hole. If we think of too much debt as a black hole of sorts, we may understand why economic models no longer work. Last week, in “The Perils of Fiscal Cliff,” we looked at the use of fiscal multipliers by economists in order to argue for or against governmental economic policies. Do you argue for austerity, or against it? There is a model that will support your case, most likely using the same data that your adversary uses.

These letters have generated a great deal of positive response and conversation. While I very rarely suggest to readers to go back and read previous letters, but reading these may help you appreciate why it is so difficult to understand what is happening in the global economy today.

This week, in a somewhat shorter letter, we once again consider the vagaries of measurements and models. Growth of the US economy, we are told, was 2% last quarter. That number will of course be revised, but what is it we are measuring? Should we attach any importance to the measurement at all? The short answer to the last question is yes, but it is important to understand that there is no certainty in that number. Or at least not any certainty according to the generally accepted meaning of that word.

The Problem with Dynamic Condition-Dependent Multipliers

I use the above subhead with a great deal of irony. I garnered that phrase from a rather insightful letter from my friend Rob Arnott (founder of Research Affiliates, whose brilliant work is used to manage over $100 billion). I am going to start this week’s Thoughts from the Frontline with his letter, with my comments inserted in brackets [and italicized]. He was responding to last…