I read The Map and the Territory by former Federal Reserve chairman Alan Greenspan. It's about the economy and the financial system after the 2008 financial crisis.
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Here are six things I learned.
1. Economics is a soft science:
The degree of certainty with which the so-called hard sciences are able to identify the metrics of the physical world appears to be out of the reach of the economic disciplines. But forecasting, irrespective of its failures, will never be abandoned. It is an inbred necessity of human nature. The more we can anticipate the course of events in the world in which we live, the better prepared we are to react to those events in a manner that can improve our lives.
2. That makes forecasting all about probabilities:
Astronomers have the capacity to forecast when the sun will rise outside my bedroom window exactly six months from now. Economists have no such capabilities. We seek instead to infer what history tells us about our future by disaggregating the "causes" of our economic past and assuming they will prevail in the future. In short, we endeavor to learn what caused, for example, capital investments to behave as they did in the past, and where they will settle if those forces are replicated in our future. To assist in that daunting task, economists rely heavily on the discipline of regression analysis -- statistical techniques whose roots lie in probability analysis, a discipline well known to all who play games of chance.
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3. Still, we're not very good at it, especially when it matters most:
But leading up to the almost universally unanticipated crisis of September 2008, macromodeling unequivocally failed when it was needed most, much to the chagrin of the economics profession. The Federal Reserve Board's highly sophisticated forecasting system did not foresee a recession until the crisis hit. Nor did the model developed by the prestigious International Monetary Fund, which concluded as late as the spring of 2007 that "global economic risks [have] declined since ... September 2006. ... The overall U.S. economy is holding up well ... [and] the signs elsewhere are very encouraging." 5 JPMorgan, arguably America's premier financial institution, projected on September 12, 2008 -- three days before the crisis hit -- that the U.S. GDP growth rate would be accelerating into the first half of 2009.
4. Proposed bankregulationused to have teeth:
To eliminate moral hazard, it should not be necessary to follow Hugh McCulloch, our first comptroller of the currency, in 1863, who went somewhat over the edge in proposing that the National Bank Act "be so amended that the failure of a national bank be declared prima facie fraudulent, and that the officers and directors, under whose administration such insolvency shall occur, be made personally liable for the debts of the bank, and be punished criminally, unless it shall appear, upon investigation, that its affairs were honestly administered."
5. Finance is really important for the economy, and it's driven by emotion:
Our propensities related to fear, euphoria, herding, and culture, however, virtually define finance. Because finance importantly guides a nation's savings toward investment in cutting-edge technologies, its impact on overall economic outcomes, for good or ill, is far greater than its less than 10 percent share of GDP would suggest. Moreover, financial imbalances are doubtless the major cause, directly or indirectly, of modern business cycles. Finance has always been the most difficult component of an economy to model.
6. We'll be arguing for decades:
Keynes's approach was a direct challenge to classical economists' belief that market economies were always self-correcting and would, when disturbed, return to full employment in relatively short order. By contrast, Keynes argued that there were circumstances in which those self-equilibrating mechanisms became dysfunctional, creating an "underemployment equilibrium." In those circumstances, he advocated government deficit spending to offset shortfalls in aggregate demand. Remarkably, more than seventy-five years later, economists continue to debate the pros and cons of that policy.
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The article 6 Things I Learned From "The Map and the Territory" originally appeared on Fool.com.
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