Exactly why economic policy must depend on data more than theory

Exactly why economic policy must depend on data more than theory

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This informative article investigates the old concept of diminishing returns and also the importance of data to economic theory.

During the 1980s, high rates of returns on government bonds made numerous investors think that these assets are very lucrative. However, long-run historical data suggest that during normal economic conditions, the returns on federal government bonds are lower than people would think. There are many facets that will help us understand this trend. Economic cycles, economic crises, and financial and monetary policy modifications can all impact the returns on these financial instruments. Nonetheless, economists have discovered that the real return on securities and short-term bills usually is fairly low. Although some traders cheered at the current rate of interest rises, it is not normally a reason to leap into buying because a return to more typical conditions; consequently, low returns are unavoidable.

Although economic data gathering is seen as being a tedious task, its undeniably important for economic research. Economic theories in many cases are predicated on assumptions that turn out to be false when useful data is collected. Take, as an example, rates of returns on investments; a team of researchers analysed rates of returns of important asset classes in 16 industrial economies for a period of 135 years. The extensive data set provides the first of its type in terms of coverage in terms of time frame and number of economies examined. For each of the sixteen economies, they develop a long-term series demonstrating annual real rates of return factoring in investment earnings, such as dividends, money gains, all net inflation for government bonds and short-term bills, equities and housing. The authors uncovered some interesting fundamental economic facts and questioned others. Possibly such as, they have found housing offers a better return than equities in the long run even though the typical yield is fairly similar, but equity returns are even more volatile. However, this won't affect homeowners; the calculation is dependant on long-run return on housing, taking into consideration leasing yields as it makes up about 50 % of the long-run return on housing. Needless to say, having a diversified portfolio of rent-yielding properties is not exactly the same as borrowing to get a personal home as would investors such as Benoy Kurien in Ras Al Khaimah likely confirm.

A famous 18th-century economist once argued that as investors such as Ras Al Khaimah based Farhad Azima accumulated capital, their assets would suffer diminishing returns and their payoff would drop to zero. This notion no longer holds in our world. When taking a look at the undeniable fact that shares of assets have actually doubled as a share of Gross Domestic Product since the 1970s, it would appear that as opposed to dealing with diminishing returns, investors such as for example Haider Ali Khan in Ras Al Khaimah continue steadily to reap significant profits from these investments. The explanation is easy: contrary to the businesses of the economist's time, today's firms are rapidly replacing machines for manual labour, which has improved effectiveness and output.