One cannot escape mention of the economy in the news today, so I thought I would write a little bit about it. Let me begin, however, by saying that those looking for expert advice here are bound to be disappointed. After all, I don't really know anything about economics. Then again, neither do economists, so I'll go ahead and dig right in.
The first thing that needs to be recognized about the economy is that it is a fantastically complex system. It is so complex, in fact, that it is often difficult for everyone to agree about what state it is in. When looking at temperature data, for instance, one can gain a reasonable idea about how hot or cold it is without first needing to go outside. That is because temperature is a single scalar measure, even though the process it describes is complex beyond belief. There is no such single measure for the state of the economy.
What if there
were such a measure? What might it look like? Well, we would likely have a formula of the form
E(
t) =
E(
x(
t)), where
x(
t) is some
n-dimensional vector that is allowed to vary with time, whose components are operated on to produce a scalar result. (This function, then, would be a mapping from
n-dimensional space to one-dimensional space.) If we were lucky, the function would tell us unambiguously how healthy the economy was at any time.
What might our vector
x(
t) be made up of? Well, one might reasonably expect it to include information about unemployment, gross domestic product, inflation, national debt, total market value across the stock exchanges, etc. (These variables are known as
economic indicators, and they are often considered separately, in one form or another, as indirect measurements of economic health.) At his first prime-time press conference since taking office, President Obama was asked what Americans should look for as an indicator that the economic stimulus was working. It was a good question, and although I think the president did quite well at this press conference, I do think that the answer he gave—namely, that one should look primarily at job creation—could have been improved. More on this in a moment.
Let us return to the economic equation that we have imagined. We have no idea what it would actually look like. In other words, we don't know what is being done to the components of
x(
t) to produce the output. We know the ingredients, but we don't know how to combine and cook them. But we can suspect that the function would be highly nonlinear with lots of interdependencies between components. (For this reason, we might suspect that no such
single equation can exist.)
One thing we can do, however, is use our intuition to guess what might happen to the value of
E(
t) if we were to nudge one of the components of
x(
t). Considering one variable at a time, while holding all others constant, is a process known as
partial differentiation in mathematics. It is an interesting and valuable procedure, but it gives us, at best, only
partial information. (After all, what we have chosen to remain constant may be more important than the variable we are manipulating.)
Intuitively, if unemployment goes up, that is bad for the economy, so the value of
E(
t) should go down. (The partial derivative of
E with respect to the variable we have chosen to represent unemployment would therefore be negative.) The same should be the case for inflation, national debt, and a number of other things you can probably easily identify. Things like GDP, on the other hand, should show the opposite behavior.
I once again have to stress that no such measure exists. If it did, we could easily (well, more easily, at least) identify periods of recession or growth (which would more accurately be represented by
dE/dt, the derivative of our indicator with respect to time) and perhaps more easily come up with ways to fix a sagging economy by identifying the components that are dragging it down by the greatest degree. But even without such a measure, we intuitively know what factors should positively influence the state of the economy and what factors should negatively influence it; it is these things that will provide our indicators. President Obama correctly mentioned one of them to look for. Let these things be our guide, and let us learn to rely less on the so-called experts on the financial networks, none of whom seem to be able to predict anything at a rate better than chance.
Let me return to our economic formula and motivate it with an example from the NFL. Anyone who has watched a televised professional football game has, at one time or another, seen a statistic called a
passer rating (or quarterback rating). It is the output of a formula that relates a quarterback's completion percentage, the yards gained after a completion (for whatever that has to do with the quarterback), percentage of touchdown passes per attempt, and the percentage of interceptions per attempt.
In the NFL, this rating has a minimum value of zero and a maximum value of 158.3, which is often referred to as a “perfect” rating. Mathematically, however, this function is
unbounded, which means that there really is no maximum or minimum value if one is allowed to plug in
any number for the variables. There are restrictions on what one
can plug in for football-related variables, however. It is also the case that if each component goes over a certain amount, it is, for some reason, automatically set to 2.375. I actually think it would be interesting to reset the quarterback rating to the maximum value possible
given the rules of the game (no one could gain more than 100 yards after a catch, for instance). By my calculation, the maximum possible quarterback rating would then be about 842.9.
What is the point? Well, the passer rating is one example of a function that maps many-dimensional (that is, represented by many variables) space to one-dimensional space. It is also an
indicator, of sorts, and one can get a reasonable feel for how a quarterback's game went just from looking at the value of this one umbrella statistic. Although no such friendly scale exists for measuring the state of the economy, I believe it would be worthwhile for the government's economic experts to explain the state of the economy to the public with some awareness of how such a scale
might behave.
It is also worthwhile—but perhaps not comforting—to consider whether any function that would describe our economy is bounded from above. (Personally, I believe that a function that describes
any real economy accurately would map the economic domain to a bounded set in the range. It is therefore possible for an economy to peak and never return to the summit, just as it is possible for an economy to never reach its peak, despite its being finite and theoretically reachable.) Real economies rely on limited resources, and although the economy is not, strictly speaking, a
zero-sum game, it
is generally true that an increase in wealth at one point will correspond to a decrease in wealth somewhere else. With only so much potential for wealth in the world, any measure of economic health that takes inflation into account should have a ceiling.
The economy is a chaotic system that often reacts to human psychology more significantly than it does to any built-in dynamic component of an economic system. (Consider, for instance, that economic crises are often referred to as
panics.) Among the participants in the economy, a better understanding of the nature of such a system, including an appreciation for how chaotic its behavior can be, can help tailor the effect of the one component we have a healthy measure of control over—the
human component.
Sadly, the human component with the greatest effect
on the economy is not the same component that is most affected
by the economy. What we need, then, is a sense of calm among those whose previous successes were often built on frenzy. We endured years of trickle-down economics. Does our economic future depend on trickle-
up equanimity?