“First, Kill All the Economists!” Sounds Great to Some, But It Won’t Fix Monetary Policy
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.
Shrug. Theory with experience is great. I learnt economic theory in school and appreciate that. Parts of it are, surprisingly enough, even useful in markets.
Pure theory within a vacuum has no correction. Nothing falsifies your view quite like losing money. Having theorist on the board? Great. It would be great to have some retired traders, business owners, and bankers as well.
Nor could I imagine, in any other context, economist supporting a board to fix the price of a commodity — except the commodity of money.
Comment by FTR — February 14, 2017 @ 11:05 pm
You say: “First, kill all the economists!” is not a prescription for better monetary policy. True, but it would be so wonderfully refreshing, and good practice before the assault on lawyers.
Comment by dearieme — February 15, 2017 @ 6:42 am
I think one problem is that we went from ideology to “trying to fix things”. The 2008 financial crisis put the Fed into active overdrive. QE1 was okay. QE forever wasn’t. Combine that with behind the scenes politics where influence on policy was surely felt. Why not an interest rate rise in 8 years?
I’d be okay if it was classical economists running the show. Put John Taylor and John Cochrane in charge. The problem is the Keynesian philosophy. When acolytes of Tobin, Keynes etc are in charge, they spin spider webs we get stuck in instead of policy that is designed to let individuals/corporations make choices.
Comment by @pointsnfigures — February 15, 2017 @ 7:34 am
I suppose a better description of the problem comes from…that guy…whats-his-name…oh yeah, Hayek, in the Road to Serfdom. Academics have a habit of setting up institutions that dispense with things like respect for individual rights and democracy in order to implement their theories cleanly, and then get caught in the “useful idiot” role when the strongmen in charge betray the dictates of the oh-so-carefully-crafted theoretical model (and of human rights, and of democracy) with self-serving power grabs. E-Gold, for example, didn’t get crushed by the Feds due to theoretical or practical concern for sound monetary policy.
The problem isn’t the theoreticians in charge, but the process that puts theoreticians in charge. Therefore we Keynesian theoreticians instead of Von Mises acolytes, and practiced kleptocrats instead of modest and neighborly green-eyeshade types, since the former of each comparison are more useful to the political powers that be.
Comment by M. Rad. — February 15, 2017 @ 10:44 am
Having an economics PhD, and having worked at the Fed, then the industry, and finally a regulatory agency, I find Ms. Booth’s characterization of Fed economists in the above quote to be reasonable. Their limitations show up not only in monetary policy, but in regulation as well (SWP excepted!). My take is that neither theorists nor practitioners are wrong, but they are overly separated from each other, largely because many econ PhDs consider industry to be a less desirable path than academia or the Fed. Perhaps that both tribes would benefit if more theoretically-trained economists aspired to the industry and learned how theories play out in the real world.
Comment by DrD — February 15, 2017 @ 11:39 am
By the way, If we change “economists” to “lawyers” and “Fed” to the SEC or CFTC, we’d have a pretty good characterization of the opposite problem in market regulation.
Comment by DrD — February 15, 2017 @ 11:40 am
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Pingback by TheMoneyIllusion » What would happen if the Fed set a (positive) interest rate floor? — February 15, 2017 @ 1:42 pm
@DrD-That’s right. Reminds me of a story. Under Bush I and Wendy Gramm, economists had unusual power at the CFTC, and the lawyers resented the hell out of it. After the 1992 election, former Commissioner Philip McBride Johnson said “Now we can get rid of the economists and put the lawyers back in charge.” Another story. A former co-worker was interviewed for the chief economists job at the SEC in the late-80s. He met with the head of Enforcement (Ketcham) who told him: “I don’t care what you do, just stay the fuck out of my way.”
In theory, theory and practice are the same.
In practice, they are different.
Comment by Global Super-Regulator on Lunch Break — February 16, 2017 @ 3:29 am
Prof, I am curious as to what your thoughts are on Modern monetary theory as advanced by Warren Mosler and others. Some of its conclusions are very different from that of main stream economics, especially with regard to running deficits.
Comment by Surya — February 16, 2017 @ 9:10 am
@Lunching Regulator. No “Ex-“? Global Super-Regulator. . . hmmm. I hope you are bringing insight and reason to the benighted!
Yes prof, I’m back, I’m inside the matrix, and I’m on a mission to deliver generous helpings of righteousness, clear-thinking, and the best insights that our discipline has produced, to those most in need of them.
Grateful for all the ammunition you provide.
Comment by Global Super-Regulator on Lunch Break — February 16, 2017 @ 4:09 pm
@GSRoLB-Red pill or blue pill?
Congratulations, and Godspeed. Let me know how I can help.
Most definitely red pilled.
Comment by Global Super-Regulator on Lunch Break — February 17, 2017 @ 3:42 am
Did someone work out the equilibrium point for the supply curve of Agent Smiths?
Comment by pahoben — February 17, 2017 @ 5:11 am