In her book, Ms. Booth describes a tribe of slow-moving Fed economists who dismiss those without high-level academic credentials. She counts Fed Chairwoman Janet Yellen and former Fed leader Ben Bernanke among them. The Fed, Mr. Bernanke and the Dallas Fed declined to comment.
The Fed’s “modus operandi” is defined by “hubris and myopia,” Ms. Booth writes in an advance copy of the book. “Central bankers have invited politicians to abdicate leadership authority to an inbred society of PhD academics who are infected to their core with groupthink, or as I prefer to think of it: ‘groupstink.’”
“Global systemic risk has been exponentially amplified by the Fed’s actions,” Ms. Booth writes, referring to the central bank’s policies holding interest rates very low since late 2008. “Who will pay when this credit bubble bursts? The poor and middle class, not the elites.”
Ms. Booth is an acolyte of her former boss, Dallas Fed chair Richard Fisher, who said “If you rely entirely on theory, you are not going to conduct the right policy, because policies have consequences.”
I have very mixed feelings about this. There is no doubt that under the guidance of academics, including (but not limited to) Ben Bernanke, that the Fed has made some grievous errors. But it is a false choice to claim that Practical People can do better without a coherent theoretical framework. For what is the alternative to theory? Heuristics? Rules of thumb? Experience?
Two thinkers usually in conflict–Keynes and Hayek– were of of one mind on this issue. Keynes famously wrote:
Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.
For his part, Hayek said “without a theory the facts are silent.”
Everybody–academic economist or no–is beholden to some theory or another. It is a conceit of non-academics to believe that they are “exempt from any intellectual influence.” Indeed, the advantage of following an explicit theoretical framework is that its assumptions and implications are transparent and (usually) testable, and therefore can be analyzed, challenged, and improved. An inchoate and largely informal “practical” mindset (which often is a hodgepodge of condensed academic theories) is far more amorphous and difficult to understand or challenge. (Talk to a trader about monetary policy sometime if you doubt me.)
Indeed, Ms. Booth gives evidence of this. Many have been prophesying doom as a result of the Fed’s (and the ECB’s) post-2008 policies: Ms. Booth is among them. I will confess to have harbored such concerns, and indeed, challenged Ben Bernanke on this at a Fed conference on Jekyll Island in May, 2009. It may happen sometime, and I believe that ZIRP has indeed distorted the economy, but my fears (and Ms. Booth’s) have not been realized in eight plus years.
Ms. Booth’s critique of pre-crisis Fed policy is also predicated on a particular theoretical viewpoint, namely, that the Fed fueled a credit bubble prior to the Crash. But as scholars as diverse as Scott Sumner and John Taylor have argued, Fed policy was actually too tight prior to the crisis.
Along these lines, one could argue that the Fed’s most egregious errors are not the consequence of deep DSGE theorizing, but instead result from the use of rules of thumb and a failure to apply basic economics. As Scott Sumner never tires of saying (and sadly, must keep repeating because those who are slaves to the rule of thumb are hard of hearing and learning) the near universal practice of using interest rates as a measure of the state of monetary policy is a category error: befitting a Chicago trained economist, Scott cautions never argue from a price change, but look for the fundamental supply and demand forces that cause a price (e.g., an interest rate to be high or low). (As a Chicago guy, I have been beating the same drum for more than 30 years.)
And some historical perspective is in order. The Fed’s history is a litany of fumbles, some relatively minor, others egregious. Blame for the Great Depression and the Great Inflation can be laid directly at the Fed’s feet. Its most notorious failings were not driven by the prevailing academic fashion, but occurred under the leadership of practical people, mainly people with a banking background, who did quite good impressions of madmen in authority. Ms. Booth bewails the “hubris of Ph.D. economists who’ve never worked on the Street or in the City,” but people who have worked there have screwed up monetary policy when they’ve been in charge.
As tempting as it may sound, “First, kill all the economists!” is not a prescription for better monetary policy. Economists may succumb to hubris (present company excepted, of course!) but the real hubris is rooted in the belief that central banks can overcome the knowledge problem, and can somehow manage entire economies (and the stability of the financial system). Hayek pointedly noted the “fatal conceit” of central planning. That conceit is inherent in central banking, too, and is not limited to professionally trained economists. Indeed, I would venture that academics are less vulnerable to it.
The problem, therefore, is not who captains the monetary ship. The question is whether anyone is capable of keeping such a huge and unwieldy vessel off the shoals. Experience–and theory!–suggests no.