By Arnold Kling
even though earthquakes cannot be predicted, at least not yet, it would be wrong to conclude that science has nothing to offer. First, understanding how earthquakes occur can help us design buildings and make other changes to limit the damage even if we don’t know exactly when an earthquake will occur. Second, if an earthquake happens and, despite our best efforts to insulate against it there are still substantial consequences, science can help us to offset and limit the damage. To name just one example, the science surrounding disease transmission helps use to avoid contaminated water supplies after a disaster…
So even if we cannot predict earthquakes, and we can’t, the models are still useful for understanding how earthquakes happen.
His point is that we should approach macroeconomic analysis similarly. Many people want to dismiss macro models because they do not predict particularly well. But perhaps they still have uses.
I wish I knew more about earthquake science. For example, have there been competing theories of earthquakes? How did scientists go about choosing among competing theories? In macroeconomics, what is frustrating is that people want to subject competing theories to forecasting contests (or backwards curve-fitting contests), but such contests turn out to be indecisive. It is like a Bayesian situation in which the evidence is weak and people have strong (and differing) priors, so the data do not have much impact. (To an earlier thread, that may explain the fascination and the frustration with the Great Depression. Here is a seemingly high-impact set of data points. Can’t we move some people’s priors with that data?)
Anyway, what I like about the earthquake analogy is that it gets you to focus on the propagation process. Just how is it that shocks in the financial sector produce unemployment?
For what it’s worth, I have taken the view that in the 21st-century Great Recalculation, the fact that part of the shock took place in the financial sector (the other big part was in housing construction) is no big deal. In my view, the financial sector was too big to begin with, and the issue with shrinking it is to put the shrinkage behind us as quickly and cleanly as possible. I think that the economic contraction is due to the need to recalculate, not to the problems with inter-bank lending and repo markets. So, when I see international trade figures decline and international lending for trade decline, my instinct is to see the causality running from the decline in trade to the decline in lending. Other folks are inclined to see the exact opposite in terms of causality, and the policy implications of our divergent points of view are pretty stark.
Continuing with the earthquake analogy, the automobile sector was like a rickety building close to the fault line. The reason it toppled is that it did not take much to topple it.
Anyway, I think it is an interesting analogy, and much more could be done with it.