The Hulk's Handshakes and Optimal Monetary Policy
By Garett Jones
The world’s a complex place and we don’t know a lot about how it works. To make matters worse, it’s not just that we’re ignorant about the world, we’re ignorant about ourselves: We rarely know our own strength. Given our ignorance, how should we interact with the world around us?
William Brainard worked out one answer. With just a little bit of math, he looked at a situation where a policymaker was trying to reach some policy target by pushing on one particular policy lever. Perhaps it’s the central bank trying to reach a GDP target over the next two years by setting short term interest rates, perhaps it’s a doctor trying to reach a blood pressure target by prescribing a medicine, perhaps it’s a dictatorial economic reformer trying to decide how many reforms to enact.
In all these cases, the more the policymaker does, the more uncertain she probably is about the effect of her actions. Experts have a lot of experience raising or lowering interest rates by half a percent so they have a sense of what happens afterward. But they have little recent experience cutting rates by 8 percent in a year in the rich countries. The same is true with blood pressure and economic reforms–experts know a lot about how tinkering works and have a tougher time guessing the effects of bigger changes.
So in many policymaking situations, more action means more uncertainty about the effects of the action. And if your goal is to be close to your target, then more uncertainty is a genuine cost of taking more action.
Hence, Brainard’s Conservatism Principle. Alan Blinder, formerly vice chair of the Fed, summed the Brainard Conservatism Principle this way when he applied it to monetary policy:
Estimate how much you need to tighten or loosen monetary policy to “get it right.” Then do less.
Why do less? Why isn’t the best strategy for hitting the target to try to hit the target? Because more action creates more uncertainty, and you face a real tradeoff.
Extreme versions of this idea turn up in economics and politics from time to time. When the drunk looks for “keys under the lampost” he’s taking the certain, low-risk path. When people say “Don’t just do something, stand there,” they are often noting that people who try to fix problems often create problems of their own. The Brainard Principle shares in those pieces of wisdom but sticks to cases where action is a continuum, where there are a range of options. And it tells us that whatever plain common sense recommends, we probably should do less.
1. If William Tell had been placed further away from his son, he would have aimed higher.
2. It’s prudent to try out medium-size quantitative easing if the Fed doesn’t know much about how QE works in large quantities.
3. When the Hulk shakes hands with people, most folks come away saying, “Gosh, that seemed like a pretty weak handshake.” Also true for the teenage Clark Kent.
Yes, part of the reason to “do less now” when trying out new superpowers like QE is because you can try again later. But even if you only get one shot, Brainard proved that in some cases it’s wise to pull your punches.
Humans, we don’t know our own strength.
Coda: This is my last day here at EconLog, and I want to thank my co-bloggers Bryan and David for helping to make this such a rewarding experience, and I look forward to reading Art’s posts over the coming months. EconLog is a great intellectual environment, I hope it continues for many, many years to come.
I will continue tweeting, so feel to follow: @GarettJones.