What Makes A Good Economic Model?

Authored by Frank Shostak via The Mises Institute,

In order to make the data "talk," economists utilize a range of statistical methods that vary from highly complex models to a simple display of historical data. It is generally held that by means of statistical correlations one can organize historical data into a useful body of information, which in turn can serve as the basis for assessments of the state of the economy. It is held that through the application of statistical methods on historical data, one can extract the facts of reality regarding the state of the economy.

Unfortunately, things are not as straightforward as they seem to be. For instance, it has been observed that declines in the unemployment rate are associated with a general rise in the prices of goods and services. Should we then conclude that declines in unemployment are a major trigger of price inflation? To confuse the issue further, it has also been observed that price inflation is well correlated with changes in money supply. Also, it has been established that changes in wages display a very high correlation with price inflation.

So what are we to make out of all this? We are confronted here not with one, but with three competing "theories" of inflation. How are we to decide which is the right theory? According to the popular way of thinking, the criterion for the selection of a theory should be its predictive power. On this Milton Friedman wrote,

The ultimate goal of a positive science is the development of a theory or hypothesis that yields valid and meaningful (i.e., not truistic) predictions about phenomena not yet observed.

So long as the model (theory) "works," it is regarded as a valid framework as far as the assessment of an economy is concerned. Once the model (theory) breaks down, we look for a new model (theory). For instance, an economist forms a view that consumer outlays on goods and services are determined by disposable income. Once this view is validated by means of statistical methods, it is employed as a tool in assessments of the future direction of consumer spending. If the model fails to produce accurate forecasts, it is either replaced, or modified by adding some other explanatory variables.

The tentative nature of theories implies that our knowledge of the real world is elusive.

Since it is not possible to establish "how things really work," then it does not really matter what the underlying assumptions of a model are. In fact anything goes, as long as the model can yield good predictions. According to Friedman,

The relevant question to ask about the assumptions of a theory is not whether they are descriptively realistic, for they never are, but whether they are sufficiently good approximation for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.

Why the Predictive Capability for Accepting a Model Is Questionable

The popular view that sets predictive capability as the criterion for accepting a model is questionable. Even the natural sciences, which mainstream economics tries to emulate, don"t validate their models this way. For instance, a theory that is employed to build a rocket stipulates certain conditions that must prevail for its successful launch.

One of the conditions is good weather. Would we then judge the quality of a rocket propulsion theory on the basis of whether it can accurately predict the date of the launch of the rocket? The prediction that the launch will take place on a particular date in the future will only be realized if all the stipulated conditions hold.

Whether this will be so cannot be known in advance. For instance, on the planned day of the launch it may be raining. All that the theory of rocket propulsion can tell us is that if all the necessary conditions will hold, then the launch of the rocket will be successful. The quality of the theory, however, is not tainted by an inability to make an accurate prediction of the date of the launch.

The same logic also applies in economics. We can say confidently that, all other things being equal, an increase in the demand for bread will raise its price. This conclusion is true, and not tentative. Will the price of bread go up tomorrow, or sometime in the future? This cannot be established by the theory of supply and demand. Should we then dismiss this theory as useless because it cannot predict the future price of bread?

Or consider a situation when a stock market is following an "up" trend over several years. As a result, an analyst has established that it is possible to outperform the stock market by following the barking of a dog.

If the dog barks three times it is a buy and if he barks once it is a sell. Should such a framework be accepted as a valid theory because it makes good forecasts?

Contrary to the popular way of thinking the criteria for selecting a model is not how well it worked in the past — i.e. passed the criteria of back testing and a life test — but whether it is theoretically sound.

Robots are just a catalyst shifting to new paradigm

The news, even the "fake news" and "alternative news" has been reduced to the bottom of the Maslow pyramid, personalizing things while dismantling the small amount of journalistic integrity that existed.  The only next lower step is name calling "you are stupid-head, poopy face" or throwing food.  Liberals are angry that Trump won, Trump supporters are angry that liberals are so angry, blacks are angry because one of their own is out; women are angry because a "Man" is President, what"s next?  When will protests and holidays be labelled as big "Pity Parties" where protestors gather with psychologists and beat cotton dummies with rubber bats, all while wearing protective gear, monitored by "government specialists" - I can see it now.  It"s an extention of the "cry rooms" from Universities; sections of major cities can be closed for these "necessary events" where angry people will get out their feelings in a controlled setting without damaging real property or getting themselves arrested.  You think it"s a big joke, do you - checkout these startups offering services to "break things" for a fee:  The Smash Shack;  Anger Room – Relieve Stress & Anxiety | Anger Room™ | "Nothing You Expect, Everything You Deserve"

Where is national coverage of these businesses - these guys need to get on Shark Tank there"s a national need here.  Parts of Detroit can be used for a mass destruction in controlled "riots" like they did for the Zombie apocalypse trend.

Unfortunately it seems, that"s just about all the unenlightened uneducated masses are good for, so you can"t fault the globalists too much for trying to turn them into good worker consumer zombies.  

There"s a lot happening in the "backoffice" of America, Inc. that we"re seeing the surface of the big iceberg such as the Vault7 revelations, and more goodies to come.  We"re still catching up to previous data dumps such as the CIA releasing electronic access to a huge amount of records previously not online.CIAs role in financial markets EXPOSED by documents release.

What impact all this will have is unclear - what is clear is that we"re on the precipice of a major paradigm shift, that from an "old model" to a "new model" speaking from the perspective of systems theory, which is really the best objective perspective.  Robots are simply the catalyst ushering in the paradigm shift.  The idea of "manufacturing jobs" is widely misunderstood by luddites that populate the mainstream - they will have us believe that the idea of a resurgence in US manufacturing is a bad move, i.e. we"re building the wrong economy, and reverting back to a 50s style system.  But this just shows the lack of understanding on their part, the world has changed in the last 10 years, checkout this clip from leftist Bloomberg: Trump"s Plan to Bring Back Manufacturing Isn"t Crazy - Bloomberg View

But there are plenty of other reasons to want to bring supply chains back to the U.S. High-value-added manufacturing -- robot factories pumping out goods -- creates jobs for Americans in other ways. As economist Enrico Moretti explains in his book "The New Geography of Jobs," high-tech manufacturing creates higher-paying service-sector jobs in a local area. The dollars that come into a town with a robot factory get spent on doctors and waiters and personal trainers, and the money circulates throughout the community, leaving everyone better off.

from another article:

Moretti demonstrates that there really are two Americas -- one that"s healthy, rich and growing, and a second that"s increasingly being left behind. The two nations-within-a-nation are divided not so much by region or race or religion, but by the kinds of industries they support. Those cities and towns that are home to innovative industries -- information technology, pharmaceuticals, advanced manufacturing and the like -- are wealthier, healthier and safer, while the places without these industries are steadily declining.

Checkout this chart "Vanishing Blue Collars":

The book fails to mention the fact that there were ALWAYS two Americas, USA was founded by a group of rich white male slaveowners who said all men are created equal.  But the demographic trend away from manual labor exploitation is exemplified well, although the point here is not about booming tech centers vs. rural economic deserts - it"s about the changing world and how robots really are replacing mundane tasks.  Those without skills in I.T. or computers will be left unemployed or on the dole chronically.  This is why - ahem - Republicans - ahem - you can never ever touch the welfare state, it"s about a class of technologically redundant workers, white or black or latino all the same.  You can"t take away food stamps, medicaid, and other programs - these people are not going to be the innovators of tomorrow, and without food they"ll simply riot and cause trouble - better keep them fat and happy and watching TV popping pills.  Seriously.  And the good news - money can easily be printed and given to them at a very low cost (about .01 per $100 electronically).    

Robots are better, robots don"t make mistakes, robots can go places man can"t go (like inside Volcanoes, deep under the sea, and so on).  Don"t forget about software robots, that we speak about when talking about trading.  Algorithmic trading is far superior to human trading - 10 years from now will anyone "trade" their own account?  Or they will just "trade" robots - buy and sell various algorithms that work well.

The point here is that what we are seeing is not a political trend at all.  The Clinton "pay for play" model of politics is outdated, they are cave-men banging there clubs and grunting around a fire.  While Trump doesn"t represent technology per se, he represents business - and as traders know, the market itself has an intelligence, maybe the markets are the first form of Aritificial Intelligence.  So what"s going on is that the demographic shift is allowing a pro-business and thus pro-technology shift which will allow business and technology to thrive.  In fact, the idea of "politics" is outdated too - why can"t all this be organized online - like the markets?  Because the 10% of the population that doesn"t have computers?  The good news is like the market, we"ve been proven, that intelligence finally wins; because what is unnatural cannot continue - if your car has no gas, you"ll stop driving.  Physics is really simple.

What"s happening is a massive paradigm shift into a new paradigm where the "old model" is being transitioned to a "new model" - this is seen in business, politics, medicine, education, construction, engineering, and basically all fields.  The CIA was a product of World War 2, as eloquently explained here on Zero Hedge by Dr. Steve Pieczenik, the CIA was a byproduct of World War 2 and was created by real spies that had a real purpose, and it served its purpose well - against a real enemy (Hitler).  (Of course, the CIA was created after the war but it was based on the spy network that fought Nazi Germany).  Dr. Pieczenik notes intelligently that the current generation of Rockefellers, and would be world dictators are not interested in world domination or one world government plans created by their parents and grandparents.  The CIA, sort of died when its founders died; and the new generation turned it into something else - instead of serving the purpose for which it was originally intended, it was used to further special interests, build the business of the military industrial complex, and most recently influence domestic political elections.  It"s just another example of this old model vs. new model paradigm shift - it"s become outdated, it should be closed.  

The idea of a "spy agency" needs to be re-evaluated in the context of modern society, where there are cameras everywhere and instantaneous global communications that are all recorded by NSA.  Maybe a new, modern agency will be a team of trained analysts and "hackers" commissioned for good purposes, such as monitoring electronic communications for crimes, terrorism, violent acts, and other behaviors to be stopped.  In any case, whatever it looks like - one thing is clear - it will be run by robots, not humans.

- Global Intel Hub

To see how robots run the world"s biggest market (FX) checkout Splitting Pennies - and get a new perspective on investing and trading.  To see another example of the "new model" vs. the "old model" - shop online, in your pajamas - don"t go to the Mall.  Shopping Malls are dangerous!