Political And Psychosocial Reasons For Recent Central Bank Inefficiency

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Includes: AGG, DIA, IWM, QQQ, SPY
by: David Deuchar

Summary

Is there a qualitative approach to explain the recent decline in central banks' capacity to achieve substantive results?

We shall examine examples of possible psychosocial phenomena, such as groupthink mentality or political pressure, that may be affecting central banks' efficiency.

Recent surges of political populism in the United States, such as the #AuditTheFed movement, represent a serious, dangerous threat to global monetary policy.

Preface

"Economists are indeed fortunate to have avoided the fate that befell three Italian seismologists a few years ago, when they were jailed for having failed to forecast an earthquake in their region!" -- Raymond Parsons via The Economist

Unfortunately, as it is with most professions in history, even in the field of macroeconomics, human instinct often trumps empirical thinking and logical rationale, especially when the loudest and most demagogic of those within a social group assert their positions more aggressively. This has never been more true than in the circles of monetary policy thinktanking and congressional committees of the past several decades as the global economy has inexorably become more intertwined and the efforts of central bankers have been put into question, such as with the recent misstep by the Fed. Rather than take the quantitative approach of criticizing models and rules or analyzing the effects of certain policies, etc., what if there are qualitative reasons as to why central banks' are seemingly losing their capacity to achieve results or even reach consensus within their own social groups?

Groupthink

(Source: Carol Simpson)

In 1971, psychologist Irving Janis began to research the way individuals make decisions in certain social groups, especially with the added element of stress.

"...[Janis] looked at studies of a number of 'disasters' in U.S. foreign policy (Pearl Harbor, Vietnam, etc.) and confirmed that what social psychologists had already demonstrated in studies of students: stress produces an increased need for solidarity and consensus within the group." -- Jennifer Lem via LinkedIn

Janis' findings led him to coin the term 'groupthink' to describe how individuals, even when faced with contrary information or opinion, often acquiesced to the prevailing social sentiment especially in high-stress environments.

There was likely no more a stressful time in the past half-century for economists and investors alike than in 2008 during the financial crash that shocked markets across the world and forced the world's leaders to come face-to-face with the reality of the highly overleveraged financial system that they had wrought. This was particularly visible in the decisions made by former Fed Chairman Ben Bernanke. An already soft-spoken and submissive character by nature, it seems Bernanke was perfectly prone to the behavior of groupthink. As Fed governor during the Greenspan-era, Bernanke was subject to an environment rife with camaraderie and consensus decision-making, like that of a country club. An analysis of the transcripts of the FOMC meetings in 2006 by the New York Times reveals how Fed staff repeatedly ignored economists' warnings of the housing bubble or the increased complexity and leveraging of the financial sector, while praising themselves and Greenspan for residing over one of the greatest eras of economic expansion in history.

In particular, in the early 2000s, Bernanke had been an advocate for aggressive monetary policy such as aggressive, long-term inflation targets higher than the traditional 2% and currency depreciation, something I have talked about in previous articles as well in regards to Japan. Yet, Bernanke did not aggressively promote his ideas amongst his circle of monetary policy makers and eventually left them behind. This article from the VOX research portal examines the case for why Bernanke may have deviated from his own more aggressive theories:

"The obvious answer, at one level, is that Bernanke attended the Federal Open Market Committee meeting of June 24. At that meeting, the Committee heard a briefing on policy at the zero bound prepared by the Board's Division of Monetary Affairs and presented by its director, Vincent Reinhart. The policy options that Reinhart emphasised were close to those that the Fed has actually implemented since 2008; Reinhart either rejected or ignored the more aggressive policies that Bernanke had previously advocated. In the discussion that followed, Chairman Greenspan and other Committee members generally supported Reinhart's views.

Bernanke spoke toward the end of the meeting, and he joined the consensus supporting Reinhart. The meeting's impact is clear from Bernanke's July speech, in which he mostly echoed Reinhart's proposals. In January 2004, Bernanke and Reinhart co-authored a paper that closely followed Reinhart's reasoning at the June meeting. Since the US hit the zero bound, the Fed has implemented the proposals in the Bernanke-Reinhart paper."

Could social pressure have prevented Bernanke from speaking up for his less orthodox prescription of monetary policy and what implications could this have had on the U.S. economy? We may never know.

Political Pressure

One other factor that may have also had a disproportional impact on monetary policy as of late is political pressure. In the U.S., the likes of anti-Keynesian conservatives such as Alan Grayson and Ron Paul have long been outspoken in criticizing Fed policy, but this indignation and anger with which central banks are viewed has begun to seep its way into the mainstream public discourse with increasing vigor. Most of the time, these political stunts masked as calls for transparency have gone ignored, such as the Federal Reserve Transparency Act (H.R. 1207; S. 604) which has been repeatedly defeated in the legislature. But, now with previously derided political outcasts such as Bernie Sanders or Donald Trump leading in the presidential race, this antagonism towards the Fed may become more pronounced and dangerous.

The main problem with this is that transparency is counter-effective to the Fed's objectives. Sometimes, it is necessary for the Fed to lead the market in one direction while expecting an entirely different outcome; this has been an explicit strategy theorized by nonconventional monetary theory. Another example is the collateralized overnight loan market: if the Fed were to disclose or make public those specific financial institutions to which it loans credit to, it would be counter-productive to the entire program.

(Source: WikiMedia)

With so much political antagonism against the Fed as of the past few decades from even some of the more moderate politicians, it would be of no surprise to suspect that Fed officials are scared to death and have to reveal their detailed outlooks and objectives even if that action in itself is counter-productive to those very objectives. A similar situation has unfolded in Japan over the past decade as further political pressure from governmental administrations to assign certain inflationary targets or macroeconomic goals have been met with indignation by Japan's bank governors; former BoJ Chairman Masaaki Shirakawa had to voluntarily step down in 2013 after political pressure to solve Japan's deflationary slump had left him feeling unable to do his job.

Conclusion

There are certainly quantitative reasons for why specific policy decisions made by central banks may be misguided or not enough, however, perhaps the more important element is the human one. Psychosocial influences on human behavior may have a far greater impact on policy than data, ideology, or intelligence, and this is an important factor in considering the past and future decisions of central banks.


Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.