Questions that don't get asked very often
By Scott Sumner
I don’t recall many articles written by neoconservatives discussing how certain aspects of modern global instability might have been caused by US intervention. Perhaps that’s because they favor intervention.
I don’t recall reading many articles written by progressives discussing how American socioeconomic problems might have been caused by the side effects of well-intentioned public policies. Perhaps that’s because progressives favor well-intentioned public policies.
And I don’t recall many articles written by mainstream economists discussing whether (in retrospect) Fed monetary policies in 2008 worsened the Great Recession.
Nick Rowe has an excellent new blog post that quotes from Brad DeLong. Here’s Nick quoting Brad (and fixing an apparent typo):
“The non-lunatic right holds that market economies are indeed macroeconomically unstable but they can be balanced by minimal interventions in aggregate variables: that is, by assigning the central bank the [task] of controlling the money supply in order to make Say’s Law true in practice even though it is false in theory.” [He actually says “cost”, not “task”, but I think that was a typo.]:
It’s clear to me that most economists look at things the way that DeLong does; the economy is unstable and the Fed may or may not choose to try to reduce that instability. Very few think in terms of the Fed causing the instability.
Just think about 2008 for a moment. Mainstream macro theory says that central banks basically control aggregate demand. That’s their job. The nudge AD up and down in order to hit their inflation and employment objectives. When AD is stable, enormous amounts of praise are given to central bankers. Alan Greenspan is a “maestro”.
When AD falls at the sharpest rate since the 1930s, you’d expect lots of economists to write articles evaluating monetary policy. After all, interest rates were above zero during 2008, so the zero bound constraint is not an “excuse.” You might expect a lot of that sort of research, but you’d be wrong. Although macroeconomists give the Fed credit for smoothing AD prior to 2008, and for giving us 2% inflation (on average) since 1990, they do not blame the Fed when things go wrong.
But it’s even worse than that, not only don’t they blame the Fed; they don’t even do studies to investigate if mistakes might have been made. You’d think the huge drop in NGDP in 2008-09 might have led economists to be at least a tad curious as to whether, in retrospect, monetary policy was too tight in 2008. But you’d be wrong. They are not at all curious (with a few exceptions like Robert Hetzel, and of course the tiny band of market monetarists.) Economists are so sure that this gigantic AD failure could not possibly have been caused by overly tight monetary policy that they don’t even investigate, even though their models imply that the central bank controls AD, and even though they credit the central bank when AD does well. I find this very curious, and very revealing.
Nick Rowe points out that DeLong’s claim isn’t just wrong, it’s unintelligible. There is no such thing as a central bank deciding to “do nothing”.
Government-owned central banks exist, and so we cannot not have a macroeconomic policy. The non-lunatic right (like the non-lunatic left) must try its best to answer the second question: what macroeconomic policy would be best? It gets us precisely nowhere to say that central banks should “do nothing”, because there are 1,001 different ways of “doing nothing”. Does it mean doing nothing with the stock of base money, the target rate of interest, the price of gold, or what?
From this perspective, “are market economies macroeconomically unstable?” is a stupid question to ask. (No disrespect to those who ask that question; I myself used to think it was the most important question in macroeconomics, until a few years ago, when it slowly dawned on me it was a stupid question.)
Central banks steer AD. That’s what they do. It’s bizarre to ask whether in an emergency central banks should steer AD. They do it all the time. It’s like asking whether a person should be assigned the duty of steering a ship during stormy weather. Yes, but ships should also be steered during non-storms. Of course there are also sorts of side questions that are interesting. Should the wheel be lashed to an ENE heading? Can they overcome the force of wind and waves? In monetary policy one might ask whether there should be target rules, instrument rules, bureaucratic steering, market steering, etc., etc.
I have a hard time understanding the views of conventional macroeconomists, unless I assume they suffer from profound confusion about distinctions between “errors of omission” and “errors of commission” that are philosophically unsupportable in the arena of monetary policy. If this sort of philosophical confusion does not exist, then what explains the apathy? Why don’t economists want to study monetary policy in 2008, with an eye on the question of; “Could the Fed had adopted a different stance of monetary policy, and achieved a better path of AD in 2008-09?”
Indeed I’d go even further. Why doesn’t the Fed produce an annual report telling us whether, in retrospect, the previous year’s policy stance was too easy, too tight, or about right? It seems bizarre to engage in this very important policy, without consistently reviewing one’s previous decisions. And please don’t tell me that I am naive about the selfish motives of powerful institutions, as this oversight is equally apparent among non-Fed economists. Indeed Robert Hetzel works for the Fed!
Some will ask, “What makes you think the Fed could have influenced AD during the 2008 hurricane?” Umm, how about the Fed itself? Throughout 2008 it told us that it believed its policies would affect AD. It told us that it didn’t cut its target rate in September 2008 because of worry about high inflation (we were in the early stages of a sharp deflation at the time.) Or maybe the markets, which reacted very strongly to unexpected monetary policy decisions during 2007-09. Or maybe it’s macroeconomic theory, which does not say that monetary policy stops influencing AD when there is financial market stress. Or maybe it’s economic history, which showed a 57% rise in industrial production and sharp inflation in the 4 months after March 1933, despite the worst financial crisis in US history. All due to easier money.
And what makes you think they couldn’t have done better. Gut instinct?
So other that monetary policymakers, financial markets, monetary theory and monetary history, I guess there’s no reason to investigate this issue. Nothing to see here folks, move right along.