The Holodeck and the grain of salt

Excerpts:

1.

In Star Trek: Next Generation, when they had a problem they couldn't figure out, they'd take it to the Holodeck and run a simulation. As a fan, I was supposed to believe the computer could figure out things the people couldn't. I never bought that. The computer only does what you tell it. If you write an economic model for the Holodeck based on Y=C+I+G+NX then the Holodeck economy will be based on consumption and investment and government spending and net exports. But if the real economy is based on a different formula, your model won't model the real economy.

I'm not questioning Y=C+I+G+NX. I'm questioning the confidence that comes out of the holodeck of economic thought.

2.	If we assume the program we wrote for the Holodeck accurately mirrors reality, then we can assume the results the Holodeck shows us are correct.

That is a lot of assumption.

3.

If you don't know all the relevant information to begin with, you cannot put that information into your holodeck program. You cannot put it into your economic-policy rules. Neither the rules of a simulator nor rules of economic policy can provide guidance when basic principles are unknown or overlooked.

Garbage in, garbage out.

4.	The Taylor rule [for example] produces a number that economists think should be the right number, based on their incomplete and flawed understanding of the economy. Confidence in the Taylor rule presupposes that the modern understanding of economic forces is accurate and complete.

The Taylor rule is just one example.


This all comes up now because (Laubach and Williams 2001) write:

Economic theory implies that the natural rate of interest varies over time and depends on the trend growth rate of output. In this paper we apply the Kalman filter to jointly estimate the natural rate of interest, potential output, and its trend growth rate ...

They add:

For this purpose, it is useful to define the natural rate of interest to be the real short-term interest rate consistent with output converging to potential, where potential is the level of output consistent with stable inflation.

Their paper, titled Measuring the Natural Rate of Interest, gave rise to an estimate of the natural rate of interest. That is a very useful piece of information to gain. However, it is best to remember that such information arises not from reality but rather from a form of virtual reality.