Economic Modeling in the Post Great Recession Era

CHAPTER 1 Setting the Context

Returning from holiday on September 3, 1928, Alexander Fleming began to sort through petri dishes containing colonies of Staphylococcus, a bacterium that causes boils and sore throats.

Fleming noticed something unusual, imperfect, on one dish. The dish was dotted with colonies of bacteria, save for one area where a blob of mold was growing. The zone immediately around the mold—later identified as a rare strain of penicillin—was clear, as if the mold had secreted something that inhibited bacterial growth.

Fleming found that his “mold juice” was capable of killing a wide range of harmful bacteria. Such was the beginning of penicillin and a better life for all of us here.

In economics, it is the unusual, the imperfect, that provides the clues about the way forward—stagnation in the 1970s, tax policy and deregulation in the 1980s, and the financial crisis and subsequent reforms over the past 10 years.

THE PROBLEM WITH UNCRITICAL ASSUMPTIONS IN A LESS-THAN-PERFECT ECONOMY¹

Yet in empirical work, economists are too frequently guided by a number of uncritical assumptions on how the world works. First, as economists, we must recognize and discourage straw man arguments that improperly identify the false choices in economic decisions or portray the outcomes of such decisions only in the context of an idealized economic model.

Second, we must be more critical of arguments that fail to recognize the assumption—or violation—of ceteris paribus when the outcomes ...