Economists Defending the Use of Models

I found this video by the Institute for New Economic Thinking, in which a number of prominent economists discussing the use of models, more than a bit frustrating, with Jamie Galbraith’s comments at the very end a notable exception.

Mainstream economics fetishizes the use of models. Even if your insight could be stated clearly and concisely in a narrative, it is not economics unless a model is involved. For instance, two of our colleagues have gone through Mankiw’s introductory economics textbook and have ascertained that every use of a graph is not only unnecessary, but in most cases serves to impede rather than add to the presentation of the concept under discussion.

The preoccupation with models suggests that the economics discipline has unduly limited its problem-solving abilities by giving high priority to “models”. Recall how central bankers rejected William White and Claudio Borio’s well documented warning that an international housing bubble was underway. The basis for the bankers’ dismissal? White and Borio had no theoretical underpinning for their view.

Similarly, you’ll hear Brad DeLong mention, and later distance himself from a prescription promulgated by Milton Friedman, and embraced by many in the profession, that all that mattered was that a model make good predictions. We discussed the so-called “F-twist” in ECONNED:

Friedman, like his peer Samuelson, played an important role in defining what constituted proper methodology. An oft-invoked section of an influential 1953 paper:

Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality, and in general, the more significant the theory, the more unrealistic the assumptions. . . . The reason is simple. A hypothesis is important if it “explains” much by little, that is, it abstracts the common and crucial elements from the mass of complex and detailed circumstances surrounding the phenomenon to be explained and permits valid predictions on the basis of them alone. To be important, therefore, a hypothesis must be deceptively false in its assumptions; it takes account of, and accounts for, none of the many other attendant circumstances, since its very success shows them to be irrelevant for the phenomenon to be explained.

To put the point less paradoxically, 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 approximations for the purpose at hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.

Friedman’s statement that “unrealistic assumptions” often prove the best is willfully false. In the absence of any evidence to the contrary, unrealistic assumptions are worse than realistic ones. An “unrealistic” assumption is one directly contradicted by present evidence. This amounts to a “get out of reality free” card.

The deceptive aspect of this argument is the slippery word “unrealistic.” Now it is true that relaxing the known parameters of a situation can be very productive. In his paper, Friedman uses the example of how the “law” in physics that describes how bodies fall assumes a vacuum, which is an unrealistic assumption, at least on planet Earth. Similarly, a line in geometry has no thickness, again a condition never observed in real life.

But in this context, the vacuum is not an “unrealistic assumption” but an abstraction that eliminates a known condition, air resistance. It is not a feature grafted on to make a construct tidy, but the stripping away of an environmental element to see if getting rid of it exposes an underlying, durable pattern. This procedure is in keeping with how mathematics as a discipline evolved, through the successive whittling away of extraneous elements.

But in economics, core and oft-used assumptions necessary to make many theories work, such as “everyone has perfect information,” are unrealistic not in the sense of stripping out real-world aspects that are noisy, but in adding properties that are not observed or even well-approximated in reality. Yet they are deemed valid and those who protest are referred to Friedman. Economists may argue that that isn’t the case, that the “perfect information” assumption simply serves to eliminate the role of bad information in decisions. But the sort of all-encompassing knowledge often posited to make a model work goes well beyond that. Similarly, “rational” economic actors are super-beings with cognitive and computational capabilities beyond those of the best computers, capable of weighing all that perfect information.

Friedman and his followers have a ready defense. The assumptions don’t matter; all that counts is that the theory “works.” Even though Samuelson wrote a harsh criticism of Friedman’s “unrealistic” assumptions, both wanted economics to be “scientific.” The sort of science they had in mind was what philosophers call “instrumentalist,” which judges a theory by its predictive power alone…

But it is actually difficult to prove anything conclusively in economics. In fact, some fundamental constructs are taken on what amounts to faith.

Models, or any abstraction, is a way of whittling down reality to the point that we can get our limited brains around it. There is more than a touch of hubris in the way economists celebrate a compensation mechanism for our constrained cognitive capabilities.

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64 comments

  1. Adam Pearce

    “For instance, two of our colleagues have gone through Mankiw’s introductory economics textbook (and remember Andrew has a PhD in pure math) and has ascertained that every use of a graph is not only unnecessary, but in most cases serves to impede rather than add to the presentation of the concept under discussion”

    Was this published anywhere or just something said to you? I’d be curious to read any thoughts on the matter.

  2. Doctor Stock

    The problem with most of the economic models out there is similar to the problem with most technical indicators people use to trade stocks… they are lagging. That is, they tell us what happened and why, but they don’t necessarily lead us to accurate conclusions on what will happen and why. Of course, if all you use are the models, than you won’t realize this until it’s already happened… leading to a vicious cycle of failure.

  3. Tao Jonesing

    Steve Keen’s takedown of Friedman was better, which is not to say that yours is bad. It’s just that his book expressing that takedown was published many years before yours.

    1. Yves Smith Post author

      Keen and I were coming at this from very different perspectives. My critique was focused on how economics restricts itself to comparatively few tools, so the invocation of Friedman was from that vantage, and not intended as a general takedown. You could write an entire book eviscerating Friedman, but that was not my objective. Lots of people have pilloried the F-twist as well as instrumentalism, there is a very large literature here.

      I read Keen (you will see his book cited) and had dinner with him last week. I thought only certain parts of his argument fit in my story line (and those I did rely on).

  4. crw

    Personally I’ve found game theorists to be the worst about this, in that not only are the assumptions often ridiculous, but they don’t even stand by the as-long-as-the-model-works criteria. And when it comes to hubris, they’re also high achievers.

    I once sat through a paper presentation by a game theorist where their model found that the majority of drug addicts will check themselves into rehab. When someone remarked upon the fact that, “Yeah, sure, but in reality this doesn’t happen”, his response was “Well, maybe they just haven’t read my paper yet.” Jackass.

    1. craazyman

      that’S a good idea.

      you can tell the drug addict, “either you go to rehab, TODAY! Or you stay here in this room forever and read Game Theory papers and discuss them with the authors.”

      Oh man, put me in the padded room already. I’ll take my chances with the Cold Turkey himself. ha ha

      Well the “unrealistic hypothesis” theory could be tolerated if the theories actually worked. But they don’t. so they’re zero for two. The hypotheses are ludicrous and the theories don’t work anyway.

      But there may be a meta-theory that explains it all. I call this the Money Magnet Theory. This is not MMT, but MOMATH They only thing that seems to work is the Money Magnet — no matter how ridiculous the hypotheses or how hopeless the theory as a predictor of anything — the money keeps flowing.

      Maybe that’s the crux of the phenomenon under observation, the hypotheses are irrelevant and the preditive value of the theories are irrelevant. They only thing that really matters is the money flow. And the hypotheses and the theories change if there’s any danger the flow will stop.

    2. Economom

      crw,

      I am a professional economist, with a Ph.D. in economics, and I have to say as a student, and a professional economist, I have come out of many seminars and presentations having the exact same conclusion you did. If fact, it got to the point that I couldn’t stand economics or economists, and I left the field for 6 years. Now that I am back in the field, I am very happy to know that there are so many people critiquing the field with many of the issues that I had. Hopefully it will end up a better field, with a lot less of those jackasses, and more people who actually make a contribution to society, though we may have to wait for the current generation to die out.

      Thanks.

      1. Rodger Malcolm Mitchell

        The main problem in economics today is the false belief a Monetarily Sovereign government is no different from a monetarily non-sovereign entity, and so should reduce deficit spending.

        Those who do not understand Monetary Sovereignty, including virtually all old-line economists, do not understand economics.

        Rodger Malcolm Mitchell

        1. Fiver

          How many true sovereigns do you suppose actually exist today? If Bernanke was completely free to do what he wanted, he’d have doubled the amounts of QE at least. Maybe more. But he didn’t. What stopped him? Certainly not any tangible “political pressure”. What then, if not the certainty of a direct conflict with other powerful players already holding instruments denominated in the specified currency and durations of insturmenst, and what their likely reaction would be to having their holdings trashed. You may be “sovereign” and have no pot to piss in if you as Central Banker or Federal Government by your actions force a serious collision between existing and future holders of your currency or debt.

        2. Calgacus

          Old-line isn’t really the right word. Recent “mainstream” is more like it. The interesting thing is that pretty much everyone from the 20s, 30s to the 70s, 80s understood monetary sovereignty, monetary economics more or less. My current working hypothesis is that aliens from outer space set up an orbiting stupidity ray broadcasting satellite back then that affects most humans by making them morons when studying economics and a number of other fields.

          Fiver – QE didn’t trash anybody’s holdings – how could bidding up bond prices / lowering interest rates do this? Thing is, it didn’t and couldn’t do much, and if anything could have been deflationary, although Rodger might disagree. Monetary sovereignty has more to do with fiscal policy, not monetary policy. And there are plenty monetarily sovereign states – the members of the Euro suicide pact being the prominent exceptions.

      2. Valissa

        Thanks for your comment! I’m glad to know there are people in the field working on re-thinking and re-formulating. My research into economics humor shows that there is a common perception that economics does not model the real world very well. Most jokes had that as their basis in some form or another. Secondarily jokes made fun of how boring economics/economists are and/or how superior they think they are.

        1. Economom

          Especially compared to sociologists! I bet sociology humor has a lot of asshole economists jokes!

          Keep up the good work, sometimes humor is the only thing keeping people going. Hence my heroes, Jon Stewart and Stephen Colbert!

  5. psychohistorian

    Yves ended the quote of her book with these lines:

    “But it is actually difficult to prove anything conclusively in economics. In fact, some fundamental constructs are taken on what amounts to faith.”

    Since you can say the same thing about religions it should not shock anyone here that these groups are aligned in our world that can’t seem to make it beyond the Enlightenment.

    Ask the next economist you talk to why there are no public models of American Imperialism, its effects on the military industrial complex and US foreign policy.

  6. mikec

    Overuse of models confers pseudo rigour which is an underpinning of pseudo science. Mortis ad augere charta!

  7. Andrew

    It’s interesting to note that the ‘oft-cited 1953 passage’ by Friedman on the desireability of “unrealistic assumptions” is stated as a narrative. Apparently, no models are necessary (realistic or fantasy) for such bold claims.

  8. larry

    It is not whether models are used per se, it is how they are used and the context in which they are deployed and how they are tied to their evidential base. Ecologists use models all the time, but with an empirical application in mind. A number of economists appear to construct models for their own sake. An example is Hahn and Arrow’s General Competitive Analysis in which the authors admit that their modelling exercise had no application to reality.

    Another problem is the excessive dependence on the Quine-Duhem saving the hypothesis gambit by economists when their models come up against recalcitrant evidence. This should be scandalous, but either isn’t noticed or is applauded for its cleverness.

  9. Middle Seaman

    Economics is not the only field in which rigor, math and models are heavily used frequently with no relevance to the real problems to be solved.

    Rigor rather than proper analysis has a charismatic hold on many scientists. In most sciences it is merely a waste of time; in economics the consequences may be dire.

  10. Walt

    Pardon this retired poor politics prof for commenting, but this discussion brings back memories of arguments between the quants and normative theorists in my department. As a grad student I was required to take a minor and luckily chose economics where I took my courses under Robert Heilbroner and Michael Hudson. Lucky me – my whole history studying economics was devoid of Greek letters, associated formulas, and and graphs. I recall that Heilbroner’s text had only one graph – the old standard supply/demand curve. How refreshing it was. And the only “model” used was a very simple exercise Heilbroner employed to illustrate that one simple curve.
    I spent over thirty five-years teaching, never called myself a political scientist (much to my departments dismay)and now find solace in the fact that so many practitioners in both disciplines are questioning the “”scientific” underpinnings.

  11. Dan Duncan

    Models should only be used for simple things…

    Like measuring the interactions of a synergistic system consisting of the atmosphere, land surface, snow and ice, oceans, tides, currents and the connection along with other bodies of water, and all living things from humans to bacteria…while taking into account, of course, all feedback-loop effects.

    Once you perform this simple task, you merely integrate the copious interactions it into a single atmospheric component…and from here to get what is generally referred to as “Climate”.

    Now at this point, you gotta remember: Climate is often defined as “average weather”, which, of course, is as vague as it sounds. Assuming that you like the result, you are fine with describing Climate in terms of the mean and variability of temperature, precipitation and wind over a period of time, ranging from months to millions of years.

    If you don’t like the result…ie if your Grant will be denied…then just change your initial set of assumptions until you do like the result. Changing the Mean to Median is often quite the robust and effective alternative. But by no means, are you limited here: You can change time frames, stochastic inferences, smoothing coefficients….whatever it takes.

    And for all this, models are really, really, really good.

  12. Zone Press

    I fear that when the fall of our civilization is written the cause of the fall will be attributed to five simple words “they listened to the economists.”

    Sommehow our society seems to have come to the erroneous conclusion that economics and the economy is all that matters.

    The debate is framed in terms of the economy because those who control it don’t want it to be framed by what they really mean: corporate profits.

    Both sides of the debate would like to get us to believe that their side is supported by scientists; in this case economists (who are not scientists, but philosophers). On one side, the left, the scientists are inept. They come up with indirect ineffective solutions. On the other, they are mean. They try to convince us their arguments are based in reality and serving corporate masters is best for everyone (and why not? They do).

  13. Philip Pilkington

    Very dodgy. I like Galbraith’s painting them as a cult at the end. Incidentally, proving that the project is not completely useless, they’ve run an interview with Philip Mirowski on their site. I’m hoping to do an interview with him soon. In the meantime, perhaps you’d consider posting this important piece as a balance to the above rot, Yves:

    http://ineteconomics.org/video/30-ways-be-economist/philip-mirowski-why-there-nobel-memorial-prize-economics

  14. Jason A. Voss, CFA

    I am an advocate for using the whole brain, not just the left, analytical brain. Solely analytical methods are doomed to failure. I say this as a retired, successful, portfolio manager of a mutual fund and curren investment professional. Check out this editorial on my blog…http://www.jasonapollovoss.com/web/2010/11/30/solely-analytical-methods-are-doomed-to-failure/

    Naked Capitalism continues to have some of the most compelling content on the web. Hear here.

    1. Valissa

      Superb topical essay, thanks! This describes the problem with academic intellectual approaches in general, not just economics.

      “The problem is that researchers are looking for a solution within the bounds of the analytical left-brain, which happens to be the source of the problem to begin with!”

      So true! As this is an interest of mine, I have been experimenting with different ways of thinking and talking about that issue too, so have added your commentary to my own research notes. Sometimes I attempt to describe it as the problem of Logos and Mythos… with Logos on a very high intellectual pedastal, far above it’s twin, Mythos, who has been almost completely demoted. Another way to look at that is as the difference between literal and metaphoric approaches to understanding the nature of reality (noting that people often use metaphors as if they were literally real).

      The intellectual process of reduction-abstraction-reification and over-reliance of linear causality has it’s uses, but much important information about the real world is lost or obscured by it. It’s an important epistemological issue, IMO, that has long been discussed in non-establishment circles but rarely get’s any “serious” attention.

      1. Jason A. Voss, CFA

        Valissa,

        So nice to see a fellow thinker out there and not just a dogmatic scientist preaching scientism. I couldn’t agree with you more about the mythos. “Myth” in the modern definition means a lie. In the actual definition it means science explained through metaphor. Likewise, metaphor is often used interchangeably with the word ‘analogy.’ But metaphor is meant to be experienced inseparably from reality. Sounds like there is much of mutual interest to share here. How do I contact you?

        Jason

  15. Knut

    Aghion’s comments are the giveaway. That economics might conceivably have something to do with social life is not a part of his mindset. It is just another piece of science or engineering. An interesting game for which those who do it well are well-paid. Completely self-referential.

  16. Jim Haygood

    ‘Friedman’s statement that “unrealistic assumptions” often prove the best is willfully false. In the absence of any evidence to the contrary, unrealistic assumptions are worse than realistic ones.”

    Instead of assuming away air resistance (a physical world example which doesn’t translate too well to the more abstract field of economics), why not take an example that was being discussed here last week — the assumption of normally-distributed price changes?

    We know for sure that real-world markets have ‘fat tails’ — once-in-a-million-year events such as a 20% crash in stock prices happen twice a century. Yet the ‘unrealistic assumption’ of normally-distributed price changes is still widely used, such as in volatility and options valuation calcs. References to ‘x-standard-deviation’ moves are a staple of market analysis.

    The unrealistic assumption of normal price distribution is hardly due to ‘willful falsity.’ It’s because the normal distribution is mathematically tractable. By comparison, ‘fat tails’ models are a complex-math rats nest, and it’s not even clear which one should apply.

    Justin Fox’s book The Myth of the Rational Market provides a layman’s view [Fox is a journalist, not an economist] of the displacement of 19th century narrative-style economics with 20th century mathematical economics, of which Irving Fisher was one of the early prominent proponents.

    http://www.amazon.com/Myth-Rational-Market-History-Delusion/dp/0060599030/ref=sr_1_1?ie=UTF8&qid=1317045129&sr=8-1

    Fox’s sympathies seem to lie with the latter group, who evidently won the academic battle. And a cultural battle as well: what’s most striking about newspapers of 100 years ago is the absence of graphics — it’s all text! Edward Tufte made a career out of the Graphical Revolution:

    http://www.edwardtufte.com/tufte/

    A generation of kids raised from birth on GUI digital devices aren’t going back to tombstones of grey text, no matter how the old guard heckles them. Nor are they going to soil their agile fingers on a grimy old newspapers like the Times-Titanic.

  17. Rodger Malcolm Mitchell

    The single biggest problem in economics is the false belief a Monetarily Sovereign government is like a monetarily non-sovereign entity, and so should reduce deficit spending.

    Those who do not understand Monetary Sovereignty, meaning virtually all politicians, the media and the old-line economists, do not understand economics.

    Rodger Malcolm Mitchell

  18. Jane Doe

    Modeling and narratives aren’t the problem. The problem is a lack of testing of ideas to determine if they are right or not.

    Compare the ego of physicists to those of economists. Compare how the physicists at CERN who discovered that neutrinos may travel faster than light to how economists few their own theories and ideas about say inflation as issue right now in a depressed world economy. The physics professionals responded by checking their views 15,000 times, releasing the data saying that they question its accuracy, and asked other to disprove.

    Economists, on the other hand, release papers with models to prove their theories correct, attack any school of thought that differs from them and refuse to question their own ideas (as a general rule).

    I am trained as both a lawyer and a scientist. Economists act more lawyers with an agenda than scientists pursuing an area of inquiry.

    All the things you describe are just incidental to the core problem. They are just the tools. The tools would not be a problem if the core mindset were different, would it?

    1. Knut

      Yes, economists on the whole are like lawyers, in part because once upon a time economics had policy relevance, and so the arguments turned on policy. Economists typically choose their policies before they run the analysis to demonstrate the rightness of the policies they prefer. This is especially true of (but not unique to) the Chicago brand of economist.

  19. Susan the other

    Would it be impossible to do an economic model not based on the flow of money but on resource based societies? We are resource-based whether we believe it or not. We cannot keep dumping our garbage barges in the Pacific Ocean. Nature just doesn’t say, OK we don’t want this shit any more, we’ll just dump it over here. A model that looks at the natural economies of the real world and the complex biological systems that create them. We have all sorts of science that basically says that at every level of the chain of life there is an organism that fits its niche and adapts itself to it. Would it be impossible to actually adapt our use of money to make it flow at this natural pace? Like looking at a large economy as an ecosystem. Or are there lots of books on this already? It just seems like money itself, which is nothing more than a symbol, is the thing that messes up the model.

    1. Ming

      Susan, That is so interestig that you have come to that conclusion? After several years of thinking and reading blogs such this, I have also come to that conclusion. I believe that a healthy environment, plus access to natural resources, plus strong human spiritual/social Capitol (trustworthiness, respect and civility toward others(
      , healthy competition, cooperation, adaptability, investigation, innovation), represent the key facillitors of human prosperity. I beleive the reason why successful capitalist economies out performed socialist economies was because the governments focused most of the resources of the nation toward the welfare of their peoples and allowed in individuals to use their own initiative to create useful innovations, while also checking that these innovations were actually useful and not fraudulent or dangerous. Communist countries were execessively control oriented, an easily corrupted by elites who focussed on military power and their own comfortable lifestyles; although they were successful at swiftly industrializing their nations, they oriented the resources toward maintaing social control and building military power, neglecting some of the needs of their people.
      Hence non-military, non-social control industries stagnated, and the material needs of the nations were stagnated or slowly declined.

      I would add that say Human Social/spiritual Capitol (trustworthiness, goodwill, civil negotiation, adaptability, cooperation), along with the typical view of human resources (entrepreneurial, innovation, hard working),

      1. nobody

        Have you read Charles Eisenstein’s *Sacred Economics: Money, Gift & Society in the Age of Transition*?

        I haven’t yet – it just arrived a few minutes ago in fact – but there’s talk of ecology in there.

    2. Aquifer

      Try Herman Daly’s stuff …..

      Can’t help thinking that Annie Leonard’s “The Story of Stuff” rather says it all …

  20. Ming

    Yves, your seventh paragraph was an excellent summation on how engineers and scientists use assumptions to study and model real world phenomena.

    I studied and worked as a Mechanical engineer, and one of the favourite sayings of both my profesors and some of the senior engineers, when referrng to the useless model results due to bad assumptions or bad data input was:
    ‘Garbage in, Garbage out’

  21. Tyzao

    I touched on this issue a bit recently, and have argued the trend is towards more data not less data, and while common sense is clearly important, and qualitative understanding equally so, what we need is to start building geographic simulation systems which integrate different types of models (discrete choice, regressions, etc…) in order to make predictions or trends about what is possible or likely under different scenarios (low-high population/economic growth — weak sustainability, BAU, etc…) Multi-agent systems or agent based models are the next step from optimization and equilibrium approaches. If you are interested, I wrote a piece which touches on some of these issues in the recent UGEC publication (The Greater Accra Urban Simulation). http://ugec.org/docs/ViewpointsV_final.pdf

    There are also many other very good and interesting articles in this publication.

    I read a reference to Samuelson, and I always like to quote Solow when it comes to the idea of a “model” and our modern struggle to “compute” the incredible amount of information at our disposal. I’ll go ahead and share it.

    Simplifying assumptions are not an excrescence on model-building; they are its essence. Lewis Carroll once remarked that a map on the scale of one-to-one would serve no purpose. And the philosopher of science Russell Hanson noted that if you progressed from a five-inch balsa wood model of a Spitfire air plane to a 15-inch model without moving parts, to a half-scale model, to a full-size entirely accurate one, you would end up not with a model of a Spitfire but with a Spitfire. Robert M. Solow (1973)

    I think the bottom line is cities and our increasingly populated planet, are Complex Systems, for which there will never exist enough data to recreate as a one-to-one map. All we can do it try.

  22. Bev

    I wanted to note the upcoming weekend American Monetary Institute Conference and hope that someone here might report on it, if able to attend.

    http://www.monetary.org

    2011 Monetary Reform Conference Speakers/Schedule

    The 7th Annual AMI Conference will be held at University Center, in Chicago, Sept. 29 – Oct. 2, 2011. The deadline for early registration is soon! We continue to confirm additional speakers for this year’s conference.

    http://www.monetary.org/stephen-zarlengas-talk-at-the-2007-green-party-national-convention/2010/11

    
http://www.monetary.org/news

    
How the Economists Facilitated the Crisis and How HR 6550* Solves it


    On June 13, 2011, in The State’s Crisis, by AMI


    I thank the EEA for this opportunity to address you. This talk is not meant as an attack but as a challenge to “young economists.” It’s important that the economic profession be held to account for its’ part in this crisis.
The crisis gives a rare opportunity for reform. There’s no denying that the present “Economics” regime has been a key cause of the pain, suffering, illness and even death inflicted on America’s less affluent; and of the worldwide economic destruction we see. My observations are admittedly from an outsider and there should be a value for you from that perspective, but this was well expressed by Economist Jamie Galbraith in testimony to the Senate Crime subcommittee on May 4th, 2010:

    
“I write to you from a disgraced profession. Economic theory, as widely taught since the 1980s, failed miserably to understand the forces behind the financial crisis.”

    With rare exceptions, those in control of the World’s monetary/economic agenda and the theories supporting it have helped bring the world to its knees. Shouldn’t they (and their theories) be held accountable? The challenge will be for “youngsters” like yourselves, to bring your chosen profession to its senses.

    False “monetary” beliefs (some call them theories) have misdirected public policy decisions for decades, with devastating effect! Errors of Concept, methodology and factual errors led to disastrous outcomes for our nation and have the potential to gradually take America down into an unprecedented abyss of lawlessness and deprivation. Consider the present insane calls for austerity. Economists have allowed the idea to prevail that a government has to be run the way a shopkeepers runs his store. These times call for greater care and some heroism among economists; and cowardice is no longer tolerable among those who do understand.

    Which particular monetary errors? Most importantly, economists have not understood or appreciated the difference between money and credit. That using credit for money is dangerous, harmful and unnecessary. Can’t they read Knapp’s “State Theory of Money, available in English since the early 1920s, to understand credit is just one type of money system, and not a good one at that? Even Minsky who pointed out that such a fractional reserve system always collapses, regarded that as a problem inherent in “Capitalism, and didn’t consider eradicating it but merely called for government providing jobs when the credit structure was in collapse. A solution that one of AMIs researchers said was like “trimming poison ivy!”

    Many economists have falsely concluded that “all money is debt,” and while most money in our particular mis structured system is debt, this attitude ignores the possibility and necessity to define a better system based on government money, not private debt. This failure to understand the concept of government money as opposed to private credit, has had immense and deadly repercussions. The Great Henry Simons summed it up in one magnificent sentence in the 1930s:

    “The mistake … lies in fearing money and trusting debt.”

    Henry Simons, (Economic Policy for a Free Society, 1930s, P.199)

    This fundamental error has allowed the most egregious banking and money system to dominate our society for a century. It has caused immense damage:

    For example: The privatization of our monetary system, with control over public policy being in unelected hands, for whoever controls the money system, over time will control the nation.

    And look what they have done with that power:

    * They’ve given special privilege to create money to some, and disadvantage to others; which has led to an obscene concentration of wealth and a corresponding poverty! This has encouraged lawlessness and corruption among the privileged; pushing them to diseased excess for acquisition, and ignoring those among us in great need.

    * They’ve turned economics into a primitive religion, and worshipped the “market” as a god, despite all evidence to the contrary. A primary tool they use is to denigrate and ignore evidence. “Anecdotal” was the description Greenspan used for real evidence that challenges their theories. A fundamental sin of poor methodology.

    * They have placed an unnecessary ball and chain on the leg of every producer by having the money supply itself bear an unnecessary interest cost to society.

    * They’ve foisted a “fractional reserve” system on us prone to periodic collapse. Credit will collapse during a crisis. Money does not collapse. Credit will collapse during a crisis. Money does not collapse. Money does not collapse.

    In our present system most of what we use for money – more accurately purchasing media – comes into existence as an interest bearing debt, when banks make loans. In that sense, most money in our fractional reserve system – is debt. But economists can’t seem to grasp that those rules can and must be changed. Afraid to confront their paymasters, who are benefitting from the injustice, they can’t conceive of practical ways we can use real government issued money for money instead of substituting private debt for it. They ignore previous attempts such as the Chicago Plan of the 1930s; and smear prior periods when such real money was used successfully.

    Errors of methodology regarding money include refusal to examine the facts and a tendency to ignore history where the monetary facts are found. This leads to the silliest errors of fact regarding monetary history including:

    * Being unaware of the colonial periods’ excellent experience with government money.

    * The Continental Currency – they are generally unaware they were destroyed by Brit counterfeiting.

    * The Greenbacks – which is mistakenly characterized as worthless paper money, ignoring that they ultimately exchanged one for one with gold.

    * The French Assignats – where they have again ignored Brit counterfeiting and enshrined the propaganda book written by a banking heir as unbiased fact (White’s Fiat Money in France)!

    * The German Hyperinflation is not recognized as occurring under a privately owned and privately controlled Reichsbank!

    * Regarding the FED as part of the government!

    * The Free banking Schools misidentify the Free banking period because New York’s “Free Banking Law” gave better results. But despite its title it imposed much stronger requirements and regulations and was the opposite of free banking!

    Jamie Galbraith ended his testimony to the Senate’s Crime Subcommittee with this warning: “But you have to act. The true alternative is a failure extending over time from the economic to the political system. Just as too few predicted the financial crisis, it may be that too few are today speaking frankly about where a failure to deal with the aftermath may lead.

    In this situation, let me suggest, the country faces an existential threat. Either the legal system must do its work, or the market system cannot be restored. There must be a thorough, transparent, effective, radical cleaning of the financial sector and also of those public officials who failed the public trust. The financiers must be made to feel, in their bones, the power of the law. And the public, which lives by the law, must see very clearly and unambiguously that this is the case. Thank you.”

    James K. Galbraith to the Subcommittee on Crime, Senate Judiciary Committee, May 4, 2010.

    Prof. Galbraith rightfully identifies confronting and punishing the criminal element as a matter of national survival! The AMI agrees and then goes to a more fundamental level. Regulation alone will not work in a money system which unfairly concentrates wealth to obscene levels because that concentration of money and power, can and will eventually overcome the regulators.

    This in fact is what is happening, going back to the Carter, and Reagan administrations where airlines, trucking, and savings and loans were de-regulated leading to the Savings and Loan Crisis. Accelerating under Clinton where Gramm-Leach-Bliley repealed part of Glass Steagall and the Gramm Commodity Futures act of 2000 exempted OTC Derivatives from regulation. The Great Brooksly Born was forced out of the CFTC Chairmanship and replaced by Gramm’s wife! Where NAFTA was approved, attacking American jobs and where the law allowing media concentration was passed which has kept any reasonable discussion of the monetary and economic travesties off the airwaves until the banker’s malfeasance broke onto the front pages! A media that has promoted a divisive, even treasonous politics of hatred.

    This slow moving “Coup d’état” reached the US Supreme Court, which installed a president who twice could not be elected; and their recent obscene decision allowing corporations to dominate our electoral process.

    Our malformed money and banking system is at the bottom of these travesties and therefore must face fundamental reform. But that requires your help. How can this be done?

    Enter The Congress’ Best Economist- Congressman Dennis Kucinich

    On December 17, 2010, Congressman Dennis Kucinich introduced the National Emergency Employment Defense Act (“NEED,” HR 6550*) which contains all the monetary reform provisions of The American Monetary Act- see the brochure at
    http://www.monetary.org.
    It is much more than regulation; it fundamentally reforms our private CREDIT/DEBT system now wrecking our nation and harming all humanity, and replaces it with a government MONEY system.

    The Act achieves reform with 3 basic provisions. All three are necessary; doing one or two of them wouldn’t work and could cause more damage.

    In brief:

    First the Federal Reserve gets incorporated into the U.S. Treasury where all new money is created by our government – what people think happens now.

    Second, It ends the fractional reserve system. Banks no longer have the accounting privilege of creating our money supply. All their previously issued credit is converted into U.S. Money through an elegant and gentle accounting change. The banks are held accountable for this conversion and from that point operate the way people think they do now – as intermediaries between depositors and borrowers.

    Third, new money is introduced by the government spending it into circulation for infrastructure, starting with the $2.2 trillion the engineers tell us is needed to properly maintain our infrastructure over the next 5 years. Infrastructure will include the necessary human infrastructure of health care and education.
    Banks are encouraged to continue lending as profit making companies, but are no longer allowed to create our money supply through their loan making activity.
    Thus, The NEED Act nationalizes the money system, not the banking system. Banking is absolutely not a proper function of government, but providing the nation’s money supply is a key function of government. No one else can do it properly. Talk of nationalizing the banking business really acts like a poison pill to block real reform. Same for talk of the states going into the banking business keeping the fractional reserve system in place, and allowing the banks to continue creating what we use for money! That would reform nothing and actually endorses the fractional reserve system! It is a farcical diversion, misleading some good people away from real monetary reform at the only time reform is possible – during a crisis. All serious Monetary reformers understand that banks can not be allowed to create our money supply.

    Despite prejudice against government, most people are surprised to learn that history shows government has a far superior record in controlling the money system than private controllers have. And yes that includes the continental currency, the Greenbacks and even the German Hyperinflation; which by the way took place under a completely privatized German central bank, with all governmental influence removed! These facts, though not taught in your econ classes, are discussed at length in my book The Lost Science of Money available here.

    Why listen to me? My University of Chicago training regarding independent thinking and reading fundamental sources; about 400 of which got into the bibliography. I’ve approached it honestly. I’ve been Director of the American Monetary Institute since 1996, after being its co-founder.

    Perhaps you will consider Prof. Kaoru Yamaguchi’s Systems Dynamics study of the American Monetary Act? He examined it with the most advanced computer systemology and found that:

    It pays off the national debt

    It provides the funds for infrastructure (solving the unemployment problem)

    It does this without causing inflation. You can read his results at http://www.monetary.org

    We invite thoughtful input from economists and others who have studied our money system. From you people who still have open minds. Ladies and Gentlemen, Thanks for your attention. We have some materials for you.

    *HR 6550 was the bill number in the 111th Congress. It may get a new number on re-introduction into the 112th Congress, expected soon.

    
Sincerely,
    Stephen Zarlenga
    
Ami

    
…….

    2011 Monetary Reform Conference Speakers/Schedule
    The 7th Annual AMI Conference will be held at University Center, in Chicago, Sept. 29 – Oct. 2, 2011. The deadline for early registration is soon! We continue to confirm additional speakers for this year’s conference.

    1. steelhead23

      Thank you for posting this – I hadn’t heard of AMI although I knew of Kucinich’s bill. Yves, any chance of you weighing in on this. My views on this may be a tad jaded as I trust bureaucracy much more than political leaders and would like to see the banking system treated as a public utility or publicly owned outright. I haven’t focused on the issue of money as debt – which forces government to be subservient to the big banks as a debtor. By the way, the concept that all money is brought into existence as debt is one of those assumptions that only fits the current model. We could change that.

      1. citizendave

        Here’s an alternative introduction for the American Monetary Institute’s conference in Chicago next weekend. Hi, I am an unemployed or retired prole from a Wisconsin city with a 13% unemployment rate, currently the highest in the state. Most of my knowledge of economics was gained from reading Naked Capitalism. I am in favor of government money.

    2. citizendave

      Bev, I wanted to attend the conference this year. Chicago is only 90 minutes from my house, but I didn’t take advantage of the early registration fee. And I was afraid Bill Black or somebody would say hello, are you an academic, or? And I would say, no, I’m just a citizen who reads Naked Capitalism. I bought Stephen Zarlenga’s “The Lost Science of Money” from AMI. He inscribed it with a nice personal note. I really wish I could attend. Maybe next year.

  23. citizendave

    Alfred Korzybski’s catchphrase was “the map is not the territory”. He argued that full sanity depends on maintaining a constant awareness of the distinction between the real world and our various symbolic representations of it. If our thinking about the world becomes divorced from the context of the actual world, we are apt to drift off into a delusional worldview. I learned from Econned that an obsessive over-reliance on economic models led to a widespread failure to smell the first wisps of smoke from what became an economic conflagration in 2008. Or to offer another metaphor, while studying the map, they drove off the cliff.

    Alfred Korzybski, “Science and Sanity”, General Semantics: http://en.wikipedia.org/wiki/General_semantics

  24. Jim

    What is it like to exist in a condition of not knowing for certain?

    On many days its a bitch–because–on those days I feel like their ought to be no limits on my ability to grasp the truth.

    This is when pride and anger enter the picture. Both seem to be about a denial of limits–a refusal or inability to live with and tolerate theoretical insufficiency and to insist that my sense of mastery must be fortified.

    On my better days, which are far fewer, I take some comfort in the idea that there has to be a decision in order to have a problem and that this decision does not transparently reflect a situation that exists independent of my formulation.

    Our processess of conceptualization and categorization do help to hold our world together but what we end up not allowing in the front door often seems to end up sliping in the back door.

  25. steelhead23

    I have no quarrel with models, per se. The problem really comes when models are not only counter-intuitive, but counter-factual and the purveyors of such models continue to believe they are right. The bigger problem is that some Nobel laureates have a very hard time saying “my model was wrong”, as Alan Greenspan eventually did. An old professor of mine said this about models: “All models are wrong. Some are useful.” Unfortunately, he wasn’t teaching economics.

  26. Eric L. Prentis

    Economic models at the Federal Reserve and Chairman Bernanke did not see the housing bubble or the credit crisis coming. Not only are the Fed’s economic model assumptions wrong but their models predict nothing useful. The Fed sponsors most economic academic research, which has to support the Fed’s dogma or no more funds.

  27. Fiver

    But models aren’t built just to “model reality”, they are built to CHANGE reality. And in that light, they’ve done a far better job of changing our behavior to match the model than we’ve done changing the model to fit our behavior.

  28. a

    to reiterate some of the earlier points, the issue is not with models per se, but with what economists expect of them. models can be an important way to impose some intellectual discipline on your thinking; the problem is, in practice, beautiful models (that are nevertheless wrong and imply ridiculous things) seem to be prized over correct ones that may not have the same aesthetic appeal (i.e. real business cycle theory versus garden variety ISLM; see Krugman’s nyt magazine essay from a while back).

  29. Jason Rines

    Bottom line: Predictive modeling requires septillions of variables to be crunched based on behavior.

    The first set of variables to start with are longevity. By studying the effects of of longer or shorter life cycles in a society, it reveals the set of behavioral variables of cause.

    I could go deep on this topic because it is a personal hobby of mine and what I would do every second if I could. The net out is that even when the septillions of variables are crunched into an eight set box, it would require a quantum computer to crunch them all to be as a best guess, 95% accurate. Such a system will happen but greed will slow its availability like everything else. For when it is built, investing will be far less profitable.

    The supposed ‘Quant’ guys still using 3D model and code set which means the predictive outcome is throttled by heat of the computations leading current mainframes to melt attempting the calculations. Thats if they even figured out how to stack the fractals in the first place which I very much doubt. Coding a 3D, pyramid structure a quant was marketing to investors, not reality.

  30. Cahal

    ‘the more significant the theory, the more unrealistic the assumptions’

    To start, I will assume all people are suicidal. Anyone who isn’t is just a deviation from predicted behaviour.

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