Sunday, November 08, 2009

Illustrating The Failure Of Econometric Models

From Greg Mankiw's blog:

What does that say? A tempting interpretation is that it proves that the policies implemented by the Obama administration have failed. That could be the case, and on theoretical grounds there are reasons to believe that it is at least part of the explanation, but the chart itself doesn't prove that it is the case. It could also mean that the underlying economy was far worse than predicted.

What we can say for certain is that shows that the standard models used by the Obama administration to predict the future fail in their task. And while no one can predict the future perfectly even using correct theories, the standard models fails more than others. And the reason for that is that they are based on false theories for the purpose of making it more purely mathematical, something which in turn is ironically motivated by a desire to make theories more "operational" (more able to predict future data). Something which means that these econometric models are simply useless.