Policymakers Favor Theory Over What Works

Imaginary models clash with real-world consequences

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Context is key.

During last week’s Friday Gold Wrap podcast, Mike Maharrey emphasized the importance of understanding sound economic theory.

Without a firm grasp of basic economic principles, it becomes impossible to properly evaluate any observations you make and to properly interpret economic data.

As economist Frank Shostak put it in a recent article published at the Mises Wire, “In order to really make sense of the data one must have a theory, which stands on its own feet, and did not originate from the data. By means of a theory, one could scrutinize the data and could then try to make sense out of it.”


Shostak goes on to explain the most fundamental economic concept and how we can use the framework of “human action” to better understand economic data.

The following article by Frank Shostak was originally published on the Mises WireThe views expressed are his own and do not necessarily reflect the views of Peter Schiff or SchiffGold. 

Could historical data by itself serve as the basis for the factual assessments of the world of economics? It is believed that through the application of statistical methods on historical data, or just by gazing at the data, one could extract the facts of reality regarding the world of economics. But in order to really make sense of the data, one must have a theory, which stands on its own feet, and did not originate from the data. By means of a theory, one could scrutinize the data and could then try to make sense out of it.

The key ingredient of such a theory is that it must originate from something real that cannot be refuted. A theory that rests on the foundation that human beings are acting consciously and purposefully fulfills this.







Ludwig von Mises, the founder of this approach, labeled it as praxeology. By stating that human beings act consciously and purposefully Mises was able to derive the entire body of economics.

Causes in economics originate from human beings


For instance, by looking at the data without a coherent framework of thinking one could fit any theory to provide an explanation of what the heart of economic growth is all about.

However, if we start from the fact that human beings are operating in the means-ends framework then one is likely to establish that without an expansion in the means of sustenance no sustainable expansion in economic growth is going to emerge.

In his framework of thinking, Mises was very precise in presenting the essence of the terms he employed. For Mises defining the terms was the key for successful analyses. For instance, his analysis of money begins by establishing the definition of money. To do that Mises started from the beginning — at the point where the world was in a state of direct exchange.

According to Mises the distinguishing characteristic of money, that it is the general medium of exchange. It has evolved from the most marketable commodity. On this, he wrote,




Once the definition of money is established, we are now ready to explore the interactions between money and various parts in an economy.

Two Kinds of Economists

In mainstream economics there are two types of economists — in one camp, there are the so-called theoreticians, or “ivory-tower economists,” who generate various imaginary models and use them to form an opinion on the world of economics.

In the other camp, we have the so-called “practical” economists, who derive their views solely from the data.


Economic theory, however, must have only one purpose — to explain the essence of the subject matter of economics. However, statistical methods are of no help in this regard. All that various statistical methods can do is just compare the movements of various historical pieces of information. These methods cannot identify the driving forces of the world of economics.

(Photo by NikolayFrolochkin/Pixabay)


For example, in order to explain the economic crisis in Japan, the famous mainstream economist Paul Krugman employed a model that assumes that people are identical and live forever and that output is given.1 Whilst admitting that these assumptions are not realistic, Krugman nonetheless argued that somehow his model could be useful in offering solutions to the economic crisis in Japan.

Using Data Within the Context of Human Action

The knowledge that human actions are conscious and purposeful allows us to make sense out of historical data. According to Murray Rothbard,




Data and Money Production

Alternatively, consider the situation in which the central bank announces that increasing money supply growth while price inflation is low could lift real economic growth. To make sense of this proposition we must examine the essence of money. Money is the medium of exchange. Being the medium of exchange, money can only facilitate existing real wealth. It cannot create more wealth. Money cannot be used in production. It cannot be used in consumption. Hence, we can conclude that printing money is not the right mean to promote economic growth. In other words, the goal — of lifting real economic growth — cannot be achieved by means of printing money. On the contrary, we can establish that printing money is going to set in motion an exchange of nothing for something and thus the weakening in the wealth-generating process.

The knowledge that people are pursuing purposeful actions also permits us to evaluate the popular way of thinking that holds that the “motor” of an economy is consumer spending — i.e., demand creates supply. We know, however, that without means, no goals can be met. However, means do not emerge “out of the blue” — they must be produced first. Hence, contrary to the popular thinking, the driving force is supply and not demand.

The fact that man pursues purposeful actions implies that causes in the world of economics emanate from human beings and not from outside factors. Whilst it is true that people will respond to increases in their incomes, the response is not automatic. Every individual assesses the increase in income against the particular set of goals he wants to achieve. He might decide that it is more beneficial for him to raise his investment in financial assets rather than to raise consumption.



Gazing at the data cannot assist an analyst in establishing causes in the world of economics. All that gazing will do is to help describe things. To ascertain the underlying causes one requires an explanation that can be made by a logically worked out theory.

The arbitrary nature of mainstream economics has given rise to the view that there is a gulf between theory and practice. There is no such thing as a good-but-not-applicable theory. A good theory is also an applicable one.

Economists and various other financial experts who derive their knowledge of the economy solely from statistical correlations of various historical data or from pure gazing at the data run the risk of misleading themselves and their audiences.


Words have become redefined by the left over time. Owen Benjamin breaks down how that shapes reality.