Tuesday, December 7, 2010

macro-economic modeling, going forward

An interesting article from Mark Whitehouse in the WSJ on post-crash macro-economic modeling...

Of course, the quick response here is to look at Austrian Economics which has had a lot to offer on macro policy, especially over the last three years. But their work is not formalized/math-heavy enough to count, here, as "models".

In any case, this points to the inherent difficulties in trying to model something as complex as a macro-economy with equations. Such modeling is helpful, but limited. And keep in mind, that we're talking about macro vs. micro (which is a lot clearer and less complex)!

Physicist Doyne Farmer thinks we should analyze the economy the way we do epidemics and traffic.

Psychoanalyst David Tuckett believes the key to markets' gyrations can be found in the works of Sigmund Freud.

Economist Roman Frydman thinks we can never forecast the economy with any accuracy.

Disparate as their ideas may seem, all three are grappling with a riddle that they hope will catalyze a revolution in economics: How can we understand a world that has proven far more complex than the most advanced economic models assumed?...

The problem, says Mr. Farmer, is that the models bear too little relation to reality. People aren't quite as rational as models assume, he says. Advocates of traditional economics acknowledge that not all decisions are driven by pure reason.

Mr. Farmer sees a perhaps greater flaw in the models' mathematical structure. A typical "dynamic stochastic general equilibrium" model—so called for its efforts to incorporate time and random change—consists of anywhere from a few to dozens of interlinked equations, which must agree before the model can spit out a solution. If the equations get too complex, or if there are too many elements, the models have a hard time finding the point at which all the players' preferences meet.

To keep things simple, economists leave out large chunks of reality...

Mr. Farmer says he thinks the traditional models will always be useful for certain types of analysis, but isn't optimistic they'll provide the whole solution. "Economic forecasts have never been very good, and it's not clear that if we stick with the methods we're pursuing we'll do any better," he says. "We need to try something new."


At December 7, 2010 at 4:56 PM , Blogger Jenna said...

So, where do you think we're headed Eric? -- if you had to make an educated guess (pun intended).

You think people should just hang tight to their bank accounts and equities and wait for the storm to "blow over"?

btw, I realize you don't know what will happen for sure.


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