Best of the Week
Most Popular
1. Next Financial Crisis Is Already Here! John Lewis 99% Profits CRASH - Retail Sector Collapse - Nadeem_Walayat
2.Why Is Apple Giving This Tiny Stock A $900 Million Opportunity? - James Burgess
3.Gold Price Trend Analysis - - Nadeem_Walayatt
4.The Beginning of the End of the Dollar - Richard_Mills
5.Stock Market Trend Forecast Update - - Nadeem_Walayat
6.Hindenburg Omen & Consumer Confidence: More Signs of Stock Market Trouble in 2019 - Troy_Bombardia
7.Precious Metals Sector: It’s 2013 All Over Again - P_Radomski_CFA
8.Central Banks Have Gone Rogue, Putting Us All at Risk - Ellen_Brown
9.Gold Stocks Forced Capitulation - Zeal_LLC
10.The Post Bubble Market Contraction Thesis Receives Validation - Plunger
Last 7 days
Technical Analysis Points to DOW 30k Next Target - 19th Nov 18
Stock Market Consolidating in a Downtrend  - 19th Nov 18
Next Tory Leader, Prime Minister Forecast and Betting Market Odds - 18th Nov 18
The Fed's Misleading Money Supply Measures - 17th Nov 18
Stock Market Outlook: Why the Economy is Bullish for Stocks Going into 2019 - 17th Nov 18
NO DEAL HARD BrExit Tory Chaos, Theresa May Leadership Challenge - 17th Nov 18
Gold vs Several Key Investments - 17th Nov 18
GDX Gold Mining Stocks Q3 18 Fundamentals - 17th Nov 18
Is Gold Under or Overpriced? - 17th Nov 18
Active Managers are Bearish on Stocks. A Bullish Contrarian Sign - 16th Nov 18
Will The Fed Sacrifice Retirement Portfolio Values For The "Common Good"? - 16th Nov 18
BrExit War - Tory Party About to Replace Theresa May for NO DEAL BrExit - 16th Nov 18
Aspire Global Makes Significant Financial Strides - 16th Nov 18
Gold Oil and Commodities …Back to the Future ? - 16th Nov 18
Will Oil Price Crash Lead to “Contagion” for the U.S. Stock Market? - 15th Nov 18
How NOT to Be Among the MANY Stock Investors Fooled by This Market Myth - 15th Nov 18
Tory BrExit Chaos Cripples UK Economy, Wrecks Housing Market Confidence - 15th Nov 18
Stocks Could End 2018 With A Dramatic Rally - 15th Nov 18
What Could Be the Last Nail in This Stock Bull Markets Coffin - 15th Nov 18
Defensive Stock Sectors Outperforming, Just Like During the Dot-com Bubble - 15th Nov 18
Buying Your First Home? Here’s How to Save Money - 15th Nov 18
US Economy Ten Points or Ten Miles to ‘Bridge Out’? - 14th Nov 18
US Stocks: Whither from Here? - 14th Nov 18
Know exactly when to Enter&Exit trades using this... - 14th Nov 18
Understanding the Benefits of Keeping a Trading Journal - 14th Nov 18
S&P 500 Below 2,800 Again, New Downtrend or Just Correction? - 13th Nov 18
Warning: Precious Metals’ Gold and Silver Prices are about to Collapse! - 13th Nov 18
Why the End of the Longest Crude Oil Bull Market Since 2008? - 13th Nov 18
Stock Market Counter-trend Rally Reaches .618 Retracement - 13th Nov 18
How to Create the Best Website Content and Generate Organic Traffic - 13th Nov 18
Why the Stock Market Will Pullback, Rally, and Roll Into a Bear Market - 13th Nov 18
Stock Markets Around the World are Crashing. What Not to Worry About? - 12th Nov 18
Cyclical Commodities Continue to Weaken, Gold Moves in Relation - 12th Nov 18
Olympus Tough TG-5 Camera Stuck or Dead Pixels, Rubbish Video Auto Focus - 12th Nov 18
5 Things That Precede Gold Price Major Bottoms - 12th Nov 18
Big US Stocks Q3 Fundamentals - 12th Nov 18
How "Free Money" Helped Create Sizzling Housing Market & REIT Gains - 12th Nov 18
One Direction More Likely for Bitcoin Price - 12th Nov 18
The Place of HSE Software in Today's Business - 12th Nov 18

Market Oracle FREE Newsletter

Free Online Trading Session

Why the Fed Gets Economics Wrong

Economics / Economic Theory Feb 06, 2017 - 06:24 PM GMT

By: John_Mauldin

Economics

Economics (in general) is populated at its core by a lot of bad ideas. And these bad ideas have come to be accepted as the correct interpretation of how the economy functions and thus have become the basis for economic policy. This news shouldn’t come as a shock since I’ve written about this many times over the years in Thoughts from the Frontline.

Economics is an enormously useful tool for those of us who are trying to understand business and investments and government policy. But to paraphrase Dirty Harry, “An economist has to know his limitations.”


The whole concept of an economy’s being “in equilibrium” is simply academic nonsense. The real world is a complex, dynamic, out-of-balance mess that doesn’t fit inside anyone’s box. Those theories and equations only work when you assume away the real world.

The people who best understand economics are the worst at managing it

One of my favorite Keynes quotes (and there are lots of them) is:

Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. 

How can the very people who claim to understand how the economy works be so bad at predicting and managing it? The quick answer is that the real economy is far more complicated than they’re willing to admit.

Fortunately, some economists recognize these limitations and are looking for better ways to understand the economy. Unfortunately, that group is vastly outnumbered by old-school economists in government, central banks, international institutions, corporations, and universities.

As much as I like to quote John Maynard Keynes (he does have the best quotes in economics), I find his basic thesis to be the fundamental flaw in current macroeconomic thinking.

There’s a fatal flaw in their assumptions

It’s that aggregate demand is the most important factor in economics, and that if aggregate demand isn’t sufficient, then it is up to the government to run deficits to stimulate that demand.

Essentially, Keynesians of all stripes see the recovery that followed a recession as the result of the deficit spending enacted to rescue the economy. Look, they say, it has happened every time.

They fail to recognize that the activities of individual businessmen and women, plus the self-interested acts of millions of individuals, were the true driving force behind the recovery.

Thus they unwisely prescribe even greater deficit spending and more debt to counter recessions but routinely fail to adhere to Keynes’s dictum that during good times, that debt is to be paid down.

They refuse to recognize the obvious connection between distorted debt levels and the lack of growth in an economy—a connection that has been demonstrated time and time again all over the world.

The point—as we will confirm in a moment when we reconsider classical economics—is that income is the driver for the economy.

The great majority of economists have been trained to see consumption and government spending as principal drivers of the economy. I see these two as secondary, and productive behavior in the private economy as the primary driver.

Central bankers should not be surprised

Then we come to the concept of general equilibrium. Pretty much every economist accepts some variant of the concept of general equilibrium. I have come to the point where I completely reject the notion: it’s utterly false. There is no general equilibrium of any kind.

Today’s most popular macroeconomic models come in a flavor called “Dynamic Stochastic General Equilibrium.” The cool kids call them “DSGE” models. They are “dynamic” because they show economic changes over time, and “stochastic” because unexpected shocks to any of the inputs can drastically change the outputs.

Central banks are the most enthusiastic DSGE model users. If you believe their policies have worked well in recent years, then you may be a DSGE believer. I am not. I think a main reason DSGE models fail is that they assume everyone is similarly informed and always makes rational decisions. Neither of those things is true in the real world.

This sort of equilibrium never exists in the real world because the real world never stops changing. Thus neither we, nor our estimable central bankers, should be surprised when DSGE models don’t deliver much useful information.

Get a Bird’s-Eye View of the Economy with John Mauldin’s Thoughts from the Frontline

This wildly popular newsletter by celebrated economic commentator, John Mauldin, is a must-read for informed investors who want to go beyond the mainstream media hype and find out about the trends and traps to watch out for. Join hundreds of thousands of fans worldwide, as John uncovers macroeconomic truths in Thoughts from the Frontline. Get it free in your inbox every Monday.

John Mauldin Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules