What do economists do?

We have seen that the economy is extremely complex; the result of the interaction of a lot of agents, either individuals, or people grouped into firms making decisions along a large number of dimensions.

How can we try to understand what is going on? First we need to evaluate what is happening, by gathering data. It is the data that we want to understand. Economists do this by constructing models, or mathematical equations, that they hope will be able to demonstrate patterns in the data. The purpose of the exercise is to understand what has happened and predict what is going to happen to the economy in the future. This is important in several respects. For instance, when governmental policies are changed, what happens to the economy? Knowing this for sure would allow us to evaluate policies. Unfortunately, there are not enough certainties. The more we understand the economy, the better we can predict what will happen. Also, when a firm is looking whether to invest, knowing how the economy will fare is crucial. Of course, experiments would make it a lot easier to understand how things work. This, of course, is not a possibility when studying the economy: we can't ask a state to tax at 90% income, and observe if what happens corresponds to the prediction in our model. So, we are left with models that we constantly compare against actual data.

Models are logical constructs, built on numerous assumptions. But the economy is very complex, so what economists do is simplify as much as possible. Using stringent assumptions, they try to understand as much as possible with simple models, and then increase the complexity of the models.

The US government has assembled some of the best economists to help guide US monetary policy. By evaluating economic data and models, they try to predict proper monetary policy to optimize the economy. These independant individuals lead the Federal Reserve, which controls the interest rates charged to banks by the US Federal Reserve System and the cash reserve requirements of US banks. These two factors are a large part of the US monetary policy. The Federal Reserve Open Market Committee (FOMC) evaluates monetary policy in meetings throughout the year.

Later on, you should be able to use very simple constructs, or models, to grasp some of the implications in changes in the indicators. We will not claim that the models replicate the economy, just that they allow us to understand some part of the mechanism that makes up the economy. You may want to check out what a model is in a little more detail, with simple illustrative examples.