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A One-Word Answer
Can all the socioeconomic variables in all their complexities be accurately accounted for to engineer a viable macro-economic policy? No.
I would like suggest that due to its complexity and immeasurable quantitative data points, the science of economics has failed.
(To be sure, the economic models that we have labored under have also failed us in the past. I am out of fingers and toes trying to enumerate the number of booms, panics, crashes and failed central banks since 1776.)
A simple analogy will illustrate my point. Let’s take a gallon of water. What is its evaporation rate at a specific temperature? It's a simple question with a specific answer – because we can quantify the elements and control the variables of the experiment.
However, what if the data from this experiment is used as a control for a more complex hypothesis – for example, one that calculates the monthly evaporation rate for the earth’s oceans? Suddenly the task gets far more complex. Still, we can make a very accurate estimate within a well-defined range. Then, we take that estimate to be a data point for an even more complex equation related to climate change. Now our ocean evaporation estimate becomes just one of many hard-to-quantify variables for an equation that may reveal the rate of change for global warming.
But before we even consider how this estimate figures into the larger equation, we must first consider the question itself – and even the context of the question. Is the earth warming? At what rate? If that can be established and verified, is this a good thing or a bad thing? The earth has seen, and will continue to experience, natural and extrinsically induced periods of climate change. Sub-Saharan Africa was once wet and tropical, and trees covered most of the U.S. in enormous, deciduous forests. Surely there are millions of Africans who would welcome a return to a wet climate. How do you factor in these natural shifts in ocean currents, the earth’s wobble along its axis – and the building of nearly one coal plant per month in China – into the total carbon equation?
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And now the really tricky part. Assuming we can be confident in the data that global warming is indeed detrimental, what do we do with that knowledge? Almost a quarter of the world’s population lives without electricity. Are the developed nations to dictate to lesser-developed ones how to generate "green electricity" when they don't yet have any at all? Suddenly the answers become as complicated as the questions.
This is not a political statement, but simply an analogy. Regardless of the economic theory behind it – be it monetarist, Keynesian, etc. – the science of applied economics, or econometrics, has led policy makers down a primrose path with painful and at times horrific consequences.
Friedrich A. Hayek, the 1974 Nobel Co-Prize winner in economics labeled this more than 30 years ago as the fallacy of the "scientistic" attitude towards economics. Hayek suggested that the science of economics was put on an equal footing with the physical sciences that brought so many wonderful technological and quality-of-life improvements. Surely this advancing field could finally sustain the balance between full employment, the savings rate, money supply and aggregate demand!
Now, nearly 100 years after the Federal Reserve Act, two post-crash world wars, a Keynesian New Deal response with picks and shovels, inflation, stagflation, disinflation – and now deflation – we still cannot decide on just what, exactly, is "full employment," what is our economy’s "full potential," the "proper savings rate," and if the velocity of money can be restored simply by printing more of it.
In the end, you have to ask whether all the socioeconomic variables in all their complexities can be accurately accounted for in order to engineer a single deterministic, macro-economic policy. With almost $9 trillion in rescue and stimulus spending to date in the U.S. alone, the loss of more than 500,000 jobs in a single month, and generations of younger Americans staring at a future of unimaginable national indebtedness, that answer would have to be no.
This essay originally appeared on December 8 in Bill Fox's Interest Rates Specialty Service. (See full menu for EWI's Specialty Services here.)
Bill Fox is EWI's Senior Bonds Analyst. He has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional bond traders spread around the globe.