This is a key point. No one can directly observe the natural unemployment rate or potential GDP. “They must be estimated based on the movements of other variables,” Bernstein says. Much of our economic data is similarly inferred.
Astronomers can look into the heavens and infer that planets they cannot see are revolving around stars they can see. They can do this because they understand with some precision how gravity works. Moreover, gravity doesn’t sometimes work differently because people wish it would. Wile E. Coyote kept learning this the hard way. Economics enjoys few such certainties, even though many economists think it does, or at least wish it did.
Zero Confidence
This brings us to the present market conundrum. Is the economy close to overheating, or not? Perfectly sincere people look at the same data and come to radically different answers. That wouldn’t happen if economics were a hard science. We would apply the data to known laws and the correct answer would be obvious. It isn’t obvious at all, but policymakers act like it is.
I’m not saying we should go to the other extreme, doing nothing until we have 100 percent certainty. That’s not wise, either. The key is to recognize that we have blind spots and then work around them. For instance, physicians don’t know everything (certainly not as much as we like to believe they do) about the human body, but they make good use of what they do know. The lab tests show an infection, and they treat it; the CT scan shows a suspicious mass, and they remove it.
Would you let a doctor cut you open based on data as reliable as, say, GDP or unemployment? Of course not. That would be crazy. And your doctor would probably agree, because the Hippocratic Oath says “Do no harm.” Economists have no such oath. Maybe they should.
Airplanes are an even better example. Your pilot delivers you to your destination safely thanks to extensive, accurate data on the plane’s course, altitude, speed and so on. Now imagine a plane in which Federal Reserve staff had filled the cockpit with instruments meeting their standards. Would you get on that plane?
Let me think for a nanosecond. No. I would not board such a plane because I would have zero confidence that it was taking me to the right city. A San Francisco flight could easily end up in Cleveland—if it arrived anywhere at all without crashing.
All this is very obvious to people who lack graduate degrees, yet for some reason the economics profession persists in thinking it knows things it simply does not. Economists have physics envy. They want their profession to be a hard science, when it is probably one of the softer of the soft sciences.
Believing that the data they have is precisely meaningful gives people like Federal Reserve governors the mistaken impression that they have what they need to manage the economy successfully. They don’t. They have lots of data and not so much information.