Pitfalls in Financial Model Building: A Clarification
In their well-known paper, William Brainard and James Tobin advocated 'general disequilibrium' framework for the dynamics of adjustment to a 'general equilibrium' system. The Pitfalls framework has subsequently been widely used in the construction of flow of funds models of financial markets. The Brainard-Tobin paper has also elicited notes from Mark Ladenson and Kevin Clinton in this Review which attempt to interpret and elaborate upon the Pitfalls model. However, these authors seriously misinterpret the model and seemingly obscure rather than extend the Pitfalls framework in a maze of unnecessary mathenatical techniques and notation. Ladenson and Clinton both attempt to work with linearly dependent explanatory variables whose coefficients are not identified and cannot be meaningfully interpreted. Clinton uses this indeterminacy to provide a superficial counterexample to a BrainardTobin argument. Ladenson, on the other hand, discusses two (of many possible) sets of expedient parameter restrictions which will allow him to assign values to all of the coefficients of the linearly dependent variables. He believes that estimation of the model necessitates substantive behavioral assumptions, whereas in fact the elimination of a redundant explanatory variable alters only the appearance of the model and the interpretation of individual coefficients. In addition to discussing the errors of Clinton and Ladenson, this paper will demonstrate the simplicity with which adding up constraints can be derived, the relationship between the form of a model and the interpretation of its coefficients, and how the parameters might be estimated subject to adding up constraints. In Section I the Pitfalls model is compared with the ClintonLadenson formulation; Sections II and III concern the respective details of the Clinton and Ladenson articles; and estimation procedures are discussed in Section IV.
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