Data Downgrading Uncle Sam’s Helicopter

There is, or at least can be, value in treating economic variables in the way econometrics does for the purposes of understanding generalized behavior. The problem for Economists, these statisticians, is that they’ve turned stylized lessons drawn from regression analysis into literal rules defining their worldview.

By 1957, Milton Friedman had already been busy publicizing just those. Positive Economics was meant to become the scientific standard for how economists might better understand – by testing their knowledge – the complex systems of the real economy and how they often interacted. To attempt to make this “soft” social science into a hard one like Physics required, Friedman reasoned, rigorous mathematics.

In the area of consumers and spending or income, how does any scientist reduce human behavior – all kinds – into one or a few variables purposed into an equation? The answer: tons of subjective assumptions, the origins of our 21st-century Greek tragedy.

Friedman in ’57 published his account of the Theory of the Consumption Function, contributing his Permanent Income Hypothesis (Chapter 3) to it. To test his theory(ies) required compacting and standardizing such behavior into “consumer units” before then proposing how the “average” or “typical” unit might act. Once decided by statistical analysis, then economists could divine further implications by solving for X.

As it related to the possible disparities between consumption and income arising from the complexities of real-world dynamics, Friedman required an exhaustive explanation and series of calculations for what otherwise might seem a simple knowledge problem:

For example, if Mr. A’s measured income fluctuates widely from year to year while Mr. B’s is highly stable, it seems reasonable that Mr. A’s measured income is a poorer index of his permanent income than Mr. B’s is of his.

The plain truth is that not all of our income is steady or near-fixed, nor are our expectations for it over any timescale you might choose (long run or short). The key issue, then, is how an economist might be able to piece together a more accurate puzzle of the economy presented by such complications for what may be its major piece: consumption.

Put another way, would we expect “transitory” contributions to income to raise consumers’ expectations for their “permanent” income treating, as we might, permanent income as an average? After all, any increase whether temporary or steady raises the average; the only question is by how much which becomes a function of time more than anything.

As Friedman wrote in his first paragraph:

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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