By Frank Shostak

Most economists are in agreement that, through statistical and mathematical methods, one can organize historical data into a useful body of information, which can serve as the basis both for economic theory and assessments of the state of the economy. It is also believed that the knowledge secured from the data is tentative since it is not possible to know all the information and future empirical information might falsify previous theory.

Milton Friedman held that since it is not possible to establish how things really work, then it does not really matter what the underlying assumptions of a theory are. According to Friedman, what matters is that the theory can yield accurate predictions. For instance, an economist forms a view that consumer outlays on goods and services are determined by disposable income. Based on this view, he formulates a model, which is then validated by means of statistical methods. The model is then employed in the assessments of the future direction of consumer spending. If the model fails to produce accurate forecasts, it is either replaced or modified by adding some other explanatory variables. What matters here is how well consumer outlays are correlated with various variables. In this sense, all that an economist requires is to establish a good fit between dependent variables and various other independent variables.

According to this thinking, we form a view regarding the real world based on how well the various pieces of information are correlated with each other. Observe, however, that by establishing a correlation between consumer outlays and the various other pieces of information, one does not really explain the nature of consumer outlays, one just describes things. This type of analysis does not tell us much regarding the underlying cause and effect.

For example, the fact that a strong correlation was established between consumer outlays and disposable income does not imply that consumer outlays are caused by disposable income. It is quite possible that one could find a very good correlation with some other variable. Does this then imply that the other variable is the cause of consumer........

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