Wednesday, March 5, 2014

Economists' "just so" stories...

A "just so" story is one that gives a nice comforting but ultimately fantastic explanation for some puzzling and unexplained thing. Rudyard Kipling of course made the idea famous in his book of that name. The Leopard's spots, in his story, were originally painted on by an Ethiopian, after that Ethiopian had first painted himself black.

Modern economists have picked up the ball and now, with their sophisticated Dynamic Stochastic General Equilibrium models, tell similar just so stories to explain (after the fact, of course) how economies work. It's all comes down to a lot of infinite forward thinking, rational optimization and equilibrium. I do wonder in fact if there is anything that could conceivable happen in an economy that DSGE modellers wouldn't be able to "explain" after sufficient work. Indeed, that would be an interesting exercise for DSGE lovers: can you make a short list of economic happenings that would clearly be inconsistent with your theories?

On a related matter, I think there is something very fishy about economists' defense of DSGE models as being useful for "telling stories." I've heard this excuse several times recently. No, they may not find much empirical support, and no, they're not much good for prediction, and no again, no one on Wall St. uses them in making practical investment decisions. BUT STILL -- these things are really very useful because they let us tell stories about how the economy works. That to me smells rotten.

I've written an essay on these "just so" stories over at I'm experimenting with writing over there a little, and will continue exploring themes relevant to The Physics of Finance. I'll always put a link here so anyone interested can go through. 

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