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Which economic theories are especially widely misunderstood?

Cowen, Τ. (2015) “Which economic theories are especially widely misunderstood?“, Marginal Revolution Blog, 20 Ιανουαρίου.

 

A lot of them are, actually.  The efficient markets hypothesis might be one, as I’m not sure I understand it myself!  (Would the existence of just one investor “beating the market” disprove it?  Probably not, but then how many are needed?  How many of them have to beat the market “for the right reasons”?  And for how long?  How many dimensions exactly does this problem consist of?)

But today I’ll nominate Rudi Dornbusch’s exchange rate overshooting model.  When I see it cited, and I mean by professional economists or economics writers, more than half the time  people seem to get it wrong.  They use it to refer to all sorts of back and forth exchange rate movements, whereas the Dornbusch logic requires that the overshooting be in line with covered interest parity and thus the subsequent adjustment of the exchange rate is both expected and predicted by interest rate differentials in advance.  That’s hardly ever how it happens.

What else?  How about real balance effects and price level determination, as analyzed by Patinkin, Pesek and Saving, Harry Johnson, and others in the 1960s and 70s?  Most people get the right answer, but if you push them on it they fall apart, quivering and begging for mercy.  “Hey bud, that explanation sounded nice!  How about applying it to the difference between inside and outside money?  How does that shake out?”  Talk about microaggression.

Most economists do pretty well stating the Modigliani-Miller theorem.  They do less well when you ask them how it relates to the infamous “spanning condition,” which indeed it does.

Paul Krugman has remarked a few times on how many economists seem to get Ricardian Equivalence wrong.

 

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