The "Science" of Monetary Policy

Sometimes you have to wonder what future historians will have to say about mainstream economic thought during the current era.

More than thirty five years clear of any semblance of a "hard money" standard, with a government facing gargantuan long-term liabilities that are joined at the hip with the "official" inflation rate, and currently in the midst of what may go down in the history books as the greatest economic calamity since the Great Depression, the hubris of some economists at the highest levels continues to be at odds with what might be a more reasonable response to the current mess, namely, a "reality-based" approach to their profession.

This report in Reuters on the latest wisdom from outgoing Federal Reserve "Boy Wonder" Frederic Mishkin once again demonstrates just how detached some economists are from reality as monetary policy is referred to as a "science" with no hint of that characterization being facetious.

The U.S. Federal Reserve can improve its communication and better anchor inflation expectations without losing policy flexibility by agreeing on a goal for price stability, a top Fed official said on Monday.

"I believe that the science of monetary policy indicates that the FOMC needs to go even further," Fed Governor Frederic Mishkin said, referring to the policy-setting Federal Open Market Committee, as he argued for greater communication.

"The FOMC should lengthen the horizons of its projections, reach a consensus on a specific numerical value for the mandate-consistent inflation rate, and indicate that this consensus value would be modified only for good scientific reasons," he told the Peterson Institute for International Economics in a speech....

"Some commentators have worried that establishing a specific numerical inflation objective might lead to an overemphasis on controlling inflation and not enough concern about stabilizing real economic activity.

"My proposal is, however, consistent with the dual mandate, because it has the advantage of being less likely to be misinterpreted as a commitment to control inflation within a tight range over short horizons, since it only involves a consensus on the mandate-consistent inflation rate," he said.

Given the current predicament that central bankers now find themselves in, a good "scientist" would be more concerned with the questionable data collection and flawed analysis that has gotten us to the current juncture (see Numbers Racket by Kevin Phillips at Harpers) rather than focusing on communication, "inflation expectations", or the new and improved "mandate-consistent inflation rate".

Aside from the obvious one, has there ever been a better example of "groupthink" than what passes as the "science" of contemporary monetary policy?

Comments

[flow5:]

science is using bank debits, legal reserves and the rates-of-change in monetary flows (MVt)

these variables make forecasts mathematically infallable

inflation is a chronic across-the-board increase in prices, and all transactions (prices), clear thru bank debits, regardless (whether average, or segmented) etc.

go fish

2008 Jul 29 11:53 AM

[Charlie Str...:]

"Groupthink" was worse with both the Facists and Commies, but I agree with you that economics is rightfully known as the "dismal science".

For example, since WWII there have been double blind (often placebo controlled) experiments in medicine, but such experiments are not possible in economics.

2008 Jul 29 12:02 PM

[David M:]

Groupthink is the best explanation I have heard so far for the "hear no evil speak no evil" tone that has been a hallmark of this
administration.

In foreign policy, the neocons set the agenda, and they literally reject facts that are contrary to their ideology. Mission NOT
accomplished? Hey, let's all agree to redefine what we call "success" so that in a semantic sense "failure is not an option." This is a
complete detachment from the reality of the Iraqi occupation.

The reality is that we've lost more Americans and spent more money in Iraq than we lost on 9/11/2001. In an administration that
frequently speaks about sending signals, what kind of message or "signal" did we send to the world; that no one can hurt us more than we can hurt ourselves? Yeah, that'll show 'em!

This relates to our current domestic economic problems in a simple, common sense way. (Iraq War spending + ill timed and ill-targeted tax cuts) = high budget deficits = weak dollar = expensive oil. BTW, the fanatics who attacked us were from Afghanistan and Saudi Arabia.

It is no coincidence that the last time we had to deal with "stagflation" was the last time we had a war we did not pay for. With Vietnam, we tried to pay for the war and social welfare programs at the same time, when we only had the money to do one or the other.

This time, the administration decreased tax revenue as it increased government spending. A common sense reading of history tells us that the policies that led to stagflation in the '70s were ruinous to our economy; yet this administration repeated them.

A common sense understanding of underwriting tells us that packaging lots of risky loans together does not magically make them less risky.

Apparently common sense disappears from a room full of people engaged in Groupthink, whether it is geopolitics or wall street.

2008 Jul 29 12:48 PM