Frank Shostak
In order to make the data “talk,” economists utilize a range of statistical methods that vary from highly complex models to a simple display of historical data. It is generally believed that one can organize historical data through quantitative methods into a useful body of information, which in turn can serve as the basis for assessing the economy.
Now, it has been observed that declines in the unemployment rate are associated with a general rise in the prices of goods and services. Should we then conclude that decreases in the unemployment rate trigger price inflation? To confuse the issue further, it has also been observed that price inflation is well-correlated with changes in money supply.
What are we to make out of all this? How are we to decide which is the right theory? According to Milton Friedman, we cannot know the facts of reality. In this way of thinking, the criterion for the selection of a theory should be its predictive power. If the model (theory) “works,” it is regarded as a valid framework assessing the economy. Once the model (theory) breaks down, we look for a new model (theory). If the model fails to produce accurate forecasts, it is modified by adding some other explanatory variables. By this way of thinking, anything goes, as long as the model can yield good predictions.
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