Tuesday, April 20, 2010

Economic Lessons from the European Flight Ban

I have always been critical of econometrics because of the impossibility of modeling an economy where you literally have millions of independent variables, i.e. humans. There are simply no constants in the world of human action, like the types that exist in the world of physics, chemistry etc.

Water freezes at 32 degrees Fahrenheit, pretty much end of story. There are no such constants in the world of economics. The price of corn can stay unchanged for years, but that doesn't mean that the price can't change tomorrow. Econometricians keep on blowing up the financial world because they assume a variable that has remained unchanged is actually a constant that will never change. That's what happened at Long Term Capital Management, and part of the housing crash can be blamed on these fundamental modeling flaws (Although the primary cause of the housing crash was Federal Reserve manipulation of the money supply).

These thoughts come to mind as a result of this report from FT:

Flawed computer models may have exaggerated the effects of an Icelandic volcano eruption that has grounded tens of thousands of flights, stranded hundreds of thousands of passengers and cost businesses hundreds of millions of euros.

The computer models that guided decisions to impose a no-fly zone across most of Europe in recent days are based on incomplete science and limited data, according to European officials. As a result, they may have over-stated the risks to the public, needlessly grounding flights and damaging businesses...

European authorities were not sure about scientific questions, such as what concentration of ash was hazardous for jet engines, or at what rate ash fell from the sky, Mr Ruete said. “It’s one of the elements where, as far as I know, we’re not quite clear about it,” he admitted.
As complex as modeling must be for tracking the volcanic ash (Where there are some constants), it comes nowhere near the complexity of millions of independent variables walking the planet.


  1. Orszag noted the need for health care to move away from double blind clinical studies to modeling, like econometrics.


    Orszag's brother works for a firm that does econometrics, one under contract from the federal government.


  2. Orszag's statement is scary. Could this be an unintended consequence of Healthcare Bill momentum? The politicos gain confidence in their ability to manipulate the real world based on their success in the legislatiove world? Wenzel warned passage of the HC bill would lead to poorer health and shorter lifespans but I never expected this. An application of faulty econometrics could certainly accelerate life quality deterioration.