The Value of Models in Policy Analysis

A Model as a Simplification of Reality There is no single model of an economic system. In general, a model is a simplified approximation of reality, and there must surely be many such approximations. Therefore, we have large and small models, real and nominal models, sector and aggregative models, dynamic and static models, long-and short-run models, and so on. The model being used at any one time is undoubtedly chosen, in part at least, according to the objectives for its use. Some models are very general in design, in order to be available for a variety of applications, but no economic model, in a very practical sense, stands apart from its end use. Special purpose models, to the extent that they can be made available, are the best for difficult problems. Among the many classes of models, I am going to be concerned, in this paper, exclusively with econometric models. Accounting models, mathematical programming models, systems-dynamic models, general equilibrium models and other types are not going to be considered or implicitly assumed. I shall work exclusively in this essay with mainstream econometric models, typified by those of Wharton Econometric Forecasting Associates, Data Resources, Inc., the Federal Reserve Model, the Michigan Model, and similar systems. These mainstream models are used in many ways, the most visible of which is in forecasting the macro economy or significant parts of it. The forecasting application is important and must continue to occupy a great deal of the model builder/operator's time, but surely the largest single use of econometric models is for study of economic alternatives. This is how they are best used in the policy