I would be lying if I said this didn’t depress me. Economists, great economists, economists I idolize stating that there are “imbalances” we must solve – and then telling us how to solve them without actually describing what the imbalance is and why it exists.
Now I welcome the idea of imbalances as an analytical topic, I am over the moon that people are actually studying capital controls, and admitting that we need to go further with micro-foundations. But I find what the IMF is doing with these policy prescriptions sickening. Trust me, I’m sure they have an implicit model, a framework they agree with each other on – but unless that is put out for external criticism all such models do is create an illusion of confidence!
At first you might think I’m contradicting myself. How can I be so happy that we are discussing and studying policy issues, but then get so depressed when people try to put policy into action! Well the answer is simple, after the large crisis the world has experienced many analysts have jumped on the bandwagon of “doing something” rather than focusing on trying to understand why things are happening.
In my opinion, until we know “why”, until we “understand”, we are pissing in the wind when we introduce policies to “fix” perceived imbalances. Economists have a method that drives this home, we have to understand, we have to frame a situation before we can make any conclusion – but for some reason when economists are put in a policy situation they are willing to throw that away in order to give people the perception they are doing something.
Let me show an example of this:
Monetary policy has to go beyond inflation stability, adding output and financial stability to the list of targets, and adding macro-prudential measures to the list of instruments.
Now don’t get me wrong, I see a role for macro-prudential regulation – I just think when its introduced the trade-offs need to be explained. We don’t just do it because we are afraid.
But in this statement the framing is ALL WRONG, monetary policy doesn’t target “stability” in output in itself – it tries not to create undue volatility in output. This seems pedantic, but the one thing I’ve taken as believable from Real Business Cycle theory is that there are constant supply shocks – negative and positive. The economic environment is fluid, and this variability is part of how things are. Trying to smooth this would create undue distortions.
As we can’t view what part of the variability is due to market fundamentals and what part is to do with the vagrancies of demand we DO NOT target output stability – as it would have a negative welfare impact. Central banks DO smooth the economic cycle as much as is possible with their price level target.
Please, can the disciple stop and recognise it needs to know WHY imbalances happened, identify the market failures, and then introduce institutions and policies that help to improve outcomes given this (and given the constraint of government and policy failure). If we start adjusting policies without providing explanations we are doomed to create hardship for people.
Update: This reminder me of one of the main differences you get between micro and macro economists. Micro is about understanding why, trying to dig down and reduce everything it essential components to answer “why”. In macro on the other hand, people start with “empirical facts” and will make some semblance of an effort to explain why – however, it is hard not to get the feeling that sometime macro has its conclusions BEFORE it tries to explain why.
Such a rough and ready breakdown appears to be consistent with the way policy is moving – I find it funny that people are saying that we should increase microfoundations in macro (which I agree with) while ignoring exactly what microfoundations imply – namely understanding.
Anti-Dismal comments here.