There have been many attempts to compare economics with the so-called “hard sciences” of biology, chemistry and the like. The comparisons usually fall short because economics is not an experimental science — it is an observational science. And without experiments there is no reproducible method to test theories.
There is one area, though, where a comparison is useful to us as we try to develop monetary policies that make sense in our uncertain times: quantum physics. The comparison might seem a bit of a stretch at first, but the parallels are useful to sharpen our view of the policy questions that the Federal Reserve faces.
The Fed faces an uncharted, unexplored economic environment. In many respects we haven’t seen anything like it since World War II, when military service took away most of the then-known labor force. The economy at that time, though, was so laced with price controls, production priorities and wage freezes that it has little guidance value for policy makers in today’s free-wheeling, global economy.
The central bank is concerned that our rapid economic growth will unleash inflationary forces that will be difficult to get under control, a view shared by many other economists. One of the key elements, though, isn’t behaving as expected. Inflation is often driven by wage growth, but even though our current labor market is very tight, the growth in wages has been modest. Usually the rising demand for labor would accelerate wage growth, a relationship described by the “Phillips Curve.” Some of the old laws of economic motion are not providing reliable predictions.
How does this relate to quantum mechanics?
In 1900 physicists faced the unknowns of what we still call the “invisible universe” — the world of molecules, atoms, and sub-atomic particles. That world was not visible to humans, yet we knew it existed. We knew, or believed, that every material thing in our world was made up of atoms — that we knew essentially nothing about.
The physics of Isaac Newton dealt with objects in our world that we could see … things we could see and understand. His laws involving things like mass, velocity, acceleration, inertia, friction, etc. could be tested, measured, and most importantly, readily understood.
The invisible world of atoms and electrons and their energetic particle pals isn’t anything like Newton’s world. It shouldn’t surprise us, then, that its occupants do not behave according to Newton’s laws. His laws allowed us to explore our solar system and even the outer reaches of our universe. But they cannot accurately predict the motion of particles or the orbits of charged particles. That would take quantum mechanics, the math that opened the door to the “invisible universe.”
Unfortunately, quantum mechanics isn’t easy to understand. In fact, when it was first introduced there probably weren’t more than a handful of people in the world who fully understood it.
We are probably not going to need that level of math to chart our course to a new level of understanding economic behavior and its implications for economic policy. But we will need to know a lot more about the math, logic, and implications of aggregating the data that makes up human behavior.
Economists at the Federal Reserve Bank of San Francisco have been probing that invisible world. The initial question they examined was straightforward enough: “Does Ultra-Low Unemployment Spur Rapid Wage Growth?”
It is an important question because we are already pushing into unknown territory of prolonged ultra-low unemployment and need to know if we should expect an explosive, inflationary growth of wages and prices.
The aggregate, national data masks the wide variations in unemployment from state to state. To reveal the economic behavior, then, they focused on state-level unemployment and matched it up with Census Bureau data on wage growth from 60,000 households.
From a monetary policy standpoint their findings were reassuring. The relationship between unemployment and wage growth, as portrayed by the “Phillips Curve,” does not seem to change when we hit the “ultra-low” levels of unemployment. In other words, we are not sitting on an inflationary time bomb and should not need to prevent its going off by cooling down the economy.
“Of course,” as the researchers state, “…the current period may be different from the past,” and that is an important difference between economics and other sciences. The behavior of an oxygen atom, for example, is probably pretty much the same now as it was a million years ago. Our economy, though, is never the same even from day to day and this often presents an obstacle to understanding it.
We are on the threshold of a new understanding of economics as we seek and find ways to analyze data without aggregating it into lifeless averages. It’s pretty exciting stuff.
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