How Are Economic Theories Validated?

[devil-fire]

it seems to me that in economics there are a huge number of possibly factors but a small number of results so how are theories checked for validity? if something is good for an economy it should add up to a higher GDP or quality of living but I find it hard to imagine getting anything but a far fetched connection between GDP and a 'small' contributor because there are so many contributors and I don’t see a way to isolate them.

how do theories get checked in this field?

 

[russ_watters]

For some things, its not too bad - watch gasoline prices for a lesson on the law of supply/demand. For the more complicated things: the stock market, the economic cycle, its a lot tougher. Massive computer models compared with actual data is about it for testing.

 

[NoahAfrican]

You should note that economics is partly a behavioral/psychological science and not an exact science. Also, most economics have a hard time predicting the economy, because there are so many ever changing variables and indicators that they use for forecasting. Given this so called “new economy”, it has become even harder to gauge or predict the economy. All the different variables, every changing simultaneously, is making predicting the economy kind of like predicting the weather. However, economist are less accurate than weathermen in even their short term predictions. Most economist predicted that there would be over 200,000 jobs created in July. When the figures cam in there were only 32,000...and those figures may be revised downward in the coming future, as previous figures have been. It may sound as if 32,000 jobs is a net gain, but it really is not. In order to compensate from the growth of the population and the labor pool, the economy needs to add about 140,000 jobs each month to provide opportunities for the new labor supply. Thus, the way it exist now, more people are being created than jobs, which is bad.

The economy should be very worrisome for the nation. However, consumer confidence is a big factor in economic performance, because if the citizens have real fears about the future direction of the economy or nation, they will reduce their spending and thus create a self fulfilling prophecy…making the economy bad. This is due to the fact that 2/3 of GDP come from domestic consumer consumption. So if consumer stop consuming and start saving, GDP will fall precipitously and people will be laid off due to reduced demand for goods and services.

Our economy is extremely fragile…the banking system has been allowed to decrease the amount of its reserves, which allows them to lend out or invest more money of peoples deposits. This is very risky because the reserves are the systems safety net. Also, the dollar is threatened in world markets and if the Euro dollar replaces the dollar as the currency of exchange for Oil, it could be calamitous to our economy. Add in terrorism, globalization, the off shoring of jobs and the fact that nearly every economic stimulant has been applied to energize the economy…with not REAL change…one should be very concerned.

 

[selfAdjoint]

This is a good summary of the true state of the economy. I might bring up the issue of consumer debt service, since I saw an item that consumer debt had reached something like 115% of income. Consumer confidence is still up, but reality is coming to bite it real soon now.

 

[devil-fire]

Thanks for the information, interesting stuff.

i may have more, general questions soon...

 

[russ_watters]

I should add that those computer models are largely historically based - look at a gdp history graph and you can see repeated boom-bust cycles. This data can be corrolated with other data ie, unemployment is a "lag indicator" meaning it generally goes up after the gdp goes up and down after the gdp goes down.

The problem with this, of course, is the psychology that NoahAfrican mentioned. Things like terrorism add an element of unpredictability to human behavior and that's likely a cause of a large part of the issues we see today.

Another problem that makes predictions tough is major changes in society: the internet is such a change and is affecting the cycle.

 

[selfAdjoint]

One of the oddities that is bothering economists right now is the soaring growth in productivity. They can't see where it's coming from. The obvious idea that it's due to offshore outsourcing has been tested and ruled out (or so they say). The latest numbers show productivity is continuing to grow at 2.5% annually, which is like a rocket going up for that kind of measure.