Monday, February 17, 2014

Is Monetary Policy a Science? - The Interaction of Theory and Practice Over the Last 50 Years – by William R. White

And in case you missed the two quotes from White that I posted on Twitter last night as I was listening to his McAlvany podcast (these were in regards to economic modeling and the desire to try and control the economy through monetary policy):

"I'm becoming more and more convinced that all of the models that we use are basically useless."

"..maybe..our ambitions about control are too ambitious for the knowledge that we have."

He also mentioned Danny Kahneman’s work when discussing the psychology of how different governments are acting today. Germany, because of its experience of the 1920s hyperinflation, thinks that a hyperinflation is the worst of all outcomes, so they act to keep balanced deficits, as unbalanced ones were some of the triggers leading to the earlier problems. The U.S. experience of the debt deflation during the Great Depression is the event that is largely driving its actions today, as it also seeks to avoid a repeat of its most vivid financial crisis. Etc.  

In recent decades, the declarations of “independent” central banks and the conduct of monetary policy have been assigned an ever increasing role in the pursuit of economic and financial stability. This is curious since there is, in practice, no body of scientific knowledge (evidence based beliefs) solid enough to have ensured agreement among central banks on the best way to conduct monetary policy. Moreover, beliefs pertaining to every aspect of monetary policy have also changed markedly and repeatedly. This paper documents how the objectives of monetary policy, the optimal exchange rate framework, beliefs about the transmission mechanism, the mechanism of political oversight, and many other aspects of domestic monetary frameworks have all been subject to great flux over the last fifty years. The paper also suggests ways in which the current economic and financial crisis seems likely to affect the conduct of monetary policy in the future. One possibility is that it might lead to yet another fundamental reexamination of our beliefs about how best to conduct monetary policy in an increasingly globalized world. The role played by money and credit, the interactions between price stability and financial stability, the possible medium term risks generated by “ultra easy” monetary policies, and the facilitating role played by the international monetary (non) system all need urgent attention. The paper concludes that, absent the degree of knowledge required about its effects, monetary policy is currently being relied on too heavily in the pursuit of “strong, balanced and sustainable growth.”