1. Modeling Models do not represent literal truth. Rather, they are tools for viewing the world, its problems, and contexts. (Poirier, 1995: 2) WHAT ARE MODELS, AND WHY ARE THEY NECESSARY? To better understand phenomena associated with money and banking, we will make extensive use of economic ‘models.’ Models are simple characterizations of forces that inﬂuence our empirical reality, and are necessary to examine diﬃcult to track issues in a logically consistent manner. Every problem that individuals confront is a simpliﬁed version of ‘reality.’ In the extreme, inherent physical limitations preclude us from immediately sensing many aspects of what is ‘true,’ and thus from ever acting on a problem without ﬁrst simplifying it. We rely on models long before bumping into physical limitations, however. Consider, for example, the last time you used a road map.1 Was your map a ‘simpliﬁed representation’ of an empirical reality? Of course it was – indeed, a ‘real’ map would have never ﬁt in your car! But notice that, rather than clouding the issue under consideration (for example, directions from one town to another), this simpliﬁcation made it more transparent – that is, it let you see past relatively unimportant issues to carefully contemplate questions of particular interest (such as how far, and in what direction, is your destination?). The question before us is thus not whether to simplify, but rather how to simplify problems so that they become tractable (without becoming trivial). The simpliﬁcation on which we’ll progressively build...
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