What are economic models?

You will often read or hear in the news economists and financial news analysts talk about economic models. If you have taken any college courses in economics you will also have hears and learned about some economic models. But what exactly are economic models?

First off there are many types of economic models but they all have one thing in common. The goal of most economic models is to be predictive. They simplify existing data or encapsulate a strategy that will allow the user of the model to predict future economic events. Such as the rate of unemployment, or GDP based on changes in tariffs or trade agreements.

Almost all models are encapsulated as a mathematical formula that uses some number of variables as inputs to compute an output, these are quantitative models. Some models are qualitative and do not compute a value, such as decision tree models, these are qualitative models.

But now lets get to the real issue with economic models. They flat out don't work. None of the economic models have accurately predicted any market crashes, economic downturns, recessions, depressions, financial bubbles or bank failures.

What are the top flawed economic models today? The two most egregious are know as rational expectation theory and efficient market hypothesis.

Rational expectations theory is the basis for the efficient market hypothesis. And it has been shown by more than one economist and non-economist (probably the more important indicator) that rational expectations theory is deeply flawed. Now building another theory from a deeply flawed theory does not seem like the most rational ways to model an economy.

Isn't it strange that economists who constantly talk of rational expectations and efficient markets are some of the most irrational people? These very same economists who have a blind faith in efficient markets have been shown to be empirically wrong for the majority of their lives. Looking at you Alan Greenspan.

So that leads us to the questions of who builds these economic models. The answer of course is economists. And that leads to the next inevitable question which is; why have economists failed society?