The Failure of Economic Models

The root factor that separates the Austrian school of economics from others such as the Keynesian and Chicago schools is the fact the Austrian school acknowledges the fact that economic models can’t actually be made. While the Keynesian and Chicago schools keep trying to model economics using mathematic formulas the Austrian school says economics can’t be studied like natural sciences because individual factors can’t be separate for study and humans are adaptable and non-passive. Instead of using mathematical models the Austrian school relies on praxeology, the study of human action, which involves using logical deductions to arrive at conclusions. While the Austrian school keeps predicting the next series of bubbles and crashes the schools depending on mathematical models continue getting their models shot to hell:

When it comes to assigning blame for the current economic doldrums, the quants who build the complicated mathematic financial risk models, and the traders who rely on them, deserve their share of the blame. [See “A Formula For Economic Calamity” in the November 2011 issue]. But what if there were a way to come up with simpler models that perfectly reflected reality? And what if we had perfect financial data to plug into them?

Incredibly, even under those utterly unrealizable conditions, we’d still get bad predictions from models.

The reason is that current methods used to “calibrate” models often render them inaccurate.

In computer science we have a phrase called “garbage in, garbage out.” Simply put if you start with garbage data you’re only going to end with garbage data. The mathematical models using by economists are garbage because humans are not passive non-adaptive subjects. As humans adapt old models are rendered useless. While the Austrian school bases their economic predictions on deductive logic the Keynesian and Chicago schools are constantly trying to rework their economic models to fit new data. Nothing thing to note is if you have to change your economic models to fix the data then your models are worthless. Models are supposed to help predict future outcomes based on current data not be formed around changed data due to failures of the previous models to predict an outcome.

The Keynesian and Chicago schools of economics would only be workable in an environment where prefect data is had. When people make criticisms about capitalism based on consumers lacking perfect data they’re correct only so far as the Keynesian and Chicago schools of thought go. The Austrian school outright acknowledges that perfect data regarding economics doesn’t exist and probably never will so planning economies is impossible meaning the hands-off approach is the only viable economic system.