Business, Economics, Economy, Macroeconomy, MBA, Politics, Thoughts

Is Economy as a science solid enough to define what’s true and what’s not?

As I wrote yesterday, ideologies and ideals do matter. And they define too the way we think and the way we use reasoning. So, if there are different ways to define justice, and each one of these ways means different ways of thinking and reasoning, each one of us might even end up with different economic conclusions. And that means trouble for Economy as a science.

How can we know if the things taught at business schools are true? Some used to be true, from a classical point of view, like Say’s Law: there can be no supply without demand.

Then keynesianism sent them back to the closet: supply creates its own demand. And the economy will keep growing until full use of resources: full employment.

Until 1929, something went wrong and that didn’t happen. Keynes himself realised. (I’ll write another day about liquidity traps and monetary policy)

But one of the essential instruments of keynesianism was the Phillips curve, remember it? More trouble.

The Phillips curve revealed: let’s reduce unemployment just changing prices!

It relates unenployment and inflation. It used to be said that raising inflation then the actual value of salaries go down and unemployment goes up because you have a cheaper workforce. (As a curiosity Samuelson and Solow were the ones to grasp the concept, not Phillips who had only collected data, and there was another previous economist: Fisher, who had understood the concept first)

Another of the advances of economy in post second world war, along with the IS-LM model of John Hicks, that of course is taken for granted in schools and its the foundation of what we call Macroeconomy.

Seen it before? The IS-LM model

But, although they didn’t know it, the Phillips curve was born already dead.

Milton Friedman and Edmund Phelps realised that the fact that people knew about the Phillips curve rendered it unusable.

Why? If prices were expected to change, salaries would change accordingly. We change our wages taking into account the yearly change of prices. (At least that’s what my contract says)

The death of the Phillips curve gave birth to the theory of expectations: there is a natural rate of unenployment and you can have some effect on the short run, but not on the long term because *people do know what you’re trying to do*.

Monetary policy (remember my blog about Euro exchange rates?) or fiscal policy? The war had begun and it’s still not over.

It is Robert Lucas who said that people’s behaviours change in response to government policies. (In other words, we citizens are sort of numb, but not too dumb.) And the Lucas critique says that you cannot make political decisions solely based on series of historical data, because when you change the rules things won’t happen the same way.

And back to the beginning, how many sciences do you know whose rules can be changed by politicians?

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3 thoughts on “Is Economy as a science solid enough to define what’s true and what’s not?

  1. Pingback: Logit models in Econometrics and bit entropy: there's something going on here « Gabriel’s scarcity rent

  2. Pingback: Economy: art or science? « Gabriel’s scarcity rent

  3. Pingback: The darker side of economics (how well intended theories can get the worst of MBAs) « Gabriel’s scarcity rent - it’s management stupid!

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