Constructing Models of the Economy

When there are discussions of which model of the economy is “true”, I like to keep one particular analogy of the economy in mind.  It is an analogy with physics and the balancing of forces.

Donald E. Simanek has a picture in his article S-1 VECTOR ADDITION OF FORCES that is a useful starting point to understand my view.

Image of Balance of forces

In the above picture we see a balance of four weights of equal size.  See if you can use your imagination to expand this picture to millions of weights on millions of strings arranged at millions of angles on the above balance wheel.  You can look at any one of these strings with weights on both ends as a single model of one of the forces in the economy.  Whether or not that string tilts the balance wheel toward one side of the other  surely depends on the sizes of the weights on both ends of that string.  If these weights dominate all the other weights in size, then measuring the size of the weights on this particular string will tell you which way the wheel tilts.  However, if the weights on this particular string are very small compared to the other weights, then they will have very little impact on the tilt of the wheel.

There are even more complicated problems about the small  difference in weights in a set of very large weights, but we don’t need to get into that to understand the issue.  When you discuss systems involving people, as opposed to ones that are only composed of inanimate objects, then there are even more complications which we don’t need to consider here.

Even if the weights you are  concerned with don’t change much, all the other weights can be undergoing huge changes.  If you think your particular economic theory explains all economic behavior in all possible circumstances, then you will be mystified by real world behavior which varies wildly even when the parameters you measure hardly change at all. In another circumstance, the factors you measure may change wildly, but the behavior of the system doesn’t change much at all.  That could be because the sum of the other weights and their changes are much larger than the changes in the weights you are looking at.

When you study any particular economic theory such as MMT (Modern Monetary Theory), you have to consider the circumstances under which the changes in the economic elements of the theory can have large impacts on the economy and when they are unlikely to have much impact.

I think a lot of arguments among theorists and bystanders have to do with not understanding when a theory is important to apply and when it  isn’t.  When arguing against a theory, it is important not to think that behavior of the economy under circumstances where the theory is unlikely to have much impact become a valid argument against the theory.  You shouldn’t assume that the people proposing the theory are unaware of the limitations of their theory, unless they explicitly demonstrate their lack of awareness.

When arguing for a theory, it is beneficial to mention the circumstances that must exist for the theory to apply.  It helps people to get in the right frame of mind to understand your theory.   People will not have a host of subconscious thoughts of where your theory does not apply in history, if you limit the explanation to be clearly appropriate only under the right circumstances.

Few will take your explanation into account when they try to debunk your theory, but you can always remind them of what you said when they get away from the area of applicability of your assumptions to prove that it is a bad theory.

April 20, 2018

When I originally wrote this article, I made the cryptic remark:

When you discuss systems involving people, as opposed to ones that are only composed of inanimate objects, then there are even more complications which we don’t need to consider here.

Today, I made a blog post that explains that remark – see Soros: General Theory of Reflexivity

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