“I agree with what you have to say on imperfect information and agency problems – and insofar as we can identify and understand them there is the potential to improve outcomes. But some of this targeting seems like merely introducing a new policy because things seem to be unpleasant.”
I see where your coming now.

I see what you are saying about the idea that theory should be what guides us away from a “default” position. But the key thing is that I would term the default as where we are right now. The very action of changing policy presupposes a justification for doing so.

I agree with what you have to say on imperfect information and agency problems – and insofar as we can identify and understand them there is the potential to improve outcomes. But some of this targeting seems like merely introducing a new policy because things seem to be unpleasant.

“Now when deciding policy we have to choose between a weaker “free market” theory and a weak imbalance or intervention theory.”

We have a single methodology, one which provided us a bunch of results – however, we have reservations about some of them. When we can articulate what ways theory has been impacted upon we can change policy – otherwise we cannot.

There are always many many theories, and if a set of theories were being used to justify action that is fine. This isn’t a case of that, this is a case of ignoring theories that were popular to give the perception of taking action.

See this single economic framework exists, and can be used to discuss WHY we need to do things transparently – their refusal to “indulge” in it for describing some policies is abjectly poor for an economic organisation.

On the note of theory, I am hesitant to call anything “free market theory” – this doesn’t make any sense to me. Economics is the study of scarcity and incentives, the fact that people make choices within the constraint of scarce resources. Our perceptions of some market failures may have changed – but in that case policy could be justified by re-evaluating the parameters we placed on these variables, and then this would suggest different outcomes.

THIS action would provide understanding – but there are interventions being discussed that have nothing to do with the crisis or anything we learned from it. This is opportunism that is being cloaked by their unwillingness to add perspective.

“Some iterventions, like liquidity requirements, work to make the economy more resistant to shocks. I think the case for these sorts of interventions are strong because they’re a response to “shocks” in general.”

There is always a cost though – if we think people choose liquidity requirements that are too low we need to ask why. Once we know about the trade-off, and why the choice of individuals and firms may be subject to some type of market failure, then we can come up with sensible policy. I think issues like “too big to fail” create a definite issue here that justifies liquidity requirements – so there we are, we have a reason for the policy.

Again, my critique isn’t on policies that have a justification – it is when the IMF says we need to target output variability. This involves ignoring piles of previous economic and econometric evidence and theory – there is no reason for what they are saying, it is irrelevant in terms of what happened during the GFC, but they decided to sell it under the guise of “new policy”.

I am not saying don’t do anything persee, I’m saying could you please have a justification for what you are doing before you start fiddling – and could you make it transparent so that people can look at it, discuss it, and offer feedback.

Now when deciding policy we have to choose between a weaker “free market” theory and a weak imbalance or intervention theory. In other words, we have no strong theory on which to base policy. Thus we should choose policy somewhere in the middle and try to learn as much as we can from the effects of these policies. I think that’s what the IMF article is trying to get at. We have no solid theory to go off, so we have to work in the middle. Thus saying ‘the onus is on you’ doesn’t make sense if we think free market theories has been weakened.

Of course it all comes down to how well you think free market theories have survived the crisis. But I think this gives us a better way of viewing the IMF article and other ‘interventionists’. It’s not that they’re quick to intervene, they just think free market theory has been damaged.

(I think at this point it’s a bit silly to talk about “interventions” generally. Some iterventions, like liquidity requirements, work to make the economy more resistant to shocks. I think the case for these sorts of interventions are strong because they’re a response to “shocks” in general. Other interventions are more targeted at specific imbalances and so the case for them is weaker.)

Also, for a clearer idea of what I think is a well argued and thoughtful take on macro-prudential regulations there is this:

http://www.economist.com/economics/by-invitation/guest-contributions/countercyclical_regulation_could_be_more_effective_contr

Looking at the evidence, and coming up for a description of the world where the behaviour of individual actors leads to a problem (akin to what we have experienced) – and then describing what macro-prudential regulation is useful in this case.

Indeed. My preference really does stem from the ability to react to incentives.

There are important institutional issues, and I just don’t think policy is focusing on quite the right place given the information and knowledge we have available at present.

I would also note that economists love to be technocrat and problem solve – so there is an inherent bias to start “organising” the economy to improve outcomes. This is a slippery slope, and one of the reasons our reductionist method focuses on individual choices so much – to illustrate the limits of our own “intelligent design”.

The less we know about what an imbalance is, the less we can really say about what it means.

People who make decisions relative to the risk and uncertainty have to face the consequences of their choices, as a result they take all this into account. Policy makers meanwhile do not face the same feedback, they rely on information and understanding in order to develop mechanisms that can improve outcomes.

If we can explain why a given imbalance arose, and what negative welfare consequences are associated with that, then we can come up with a justification for intervention – however, the burden of proof is on those making the intervention.

Evidence based policy is an overused term, but using data and theory to describe what we should do is even more important following a crisis – however, we seem more interested in trying to hit the symptoms of issues rather than tackling any underlying causes.

One thing to keep in mind as well is that we’ve had a big crisis, and a lot of people are worse off as a result – however, under what realistic counterfactual would things have been better? Many of the interventions being discussed now wouldn’t have actually lead to better outcomes – many of the problems were to do with financial sector institutional structure, and exchange rate management that occurred following the Asian financial crisis. Yet we are starting to talk about a whole bunch of macro-prudential regulation which seems only very loosely to do with the issues we’ve faced.

Now don’t get me wrong, if this regulation is justified by strong theory, put in, and then supported by evidence I will be happy – but we do need to do the first step first.

I personally don’t think economists should be policy makers – they should sit back and describe, explain, discuss, and try to help understanding. Then people with an understanding of the pressure of policy can use this information and toss up trade-offs. Economists have no experience, or training, in policy – so they tend to respond in a knee-jerk way to crises.

Of course, I’m exaggerating and making a ridiculous simplification of a large discipline. The problem is that it just rings so true all through the history of political economy :/

I don’t think we have the answer to that yet but at least it’s something to work on.

Most economists I’ve met do not think they know much – I think it is the typical thing where the people who like to act they know get more attention.

Part of the reason currencies do not represent fundamentals is because they are an asset price – and asset prices can deviate from fundamentals for sustained periods of time. However, I would note that a chronic current account deficit is not an issue – countries can run them forever. It is just a sign that one country has a different time preference than another on average.

Free markets aren’t perfectly efficient – but we shouldn’t intervene unless we have some conception of how our intervention can actually improve outcomes (in terms of welfare – not in terms of arbitrary variables).

Indeed. I think the image of economics has been “we know everything” and “we have all the answers” when it’s been plain to see that is not the case. It’s always been an evolutionary process and now we are at a point where we need to understand not just the excessive imbalances (credit, currency, trade) but how they eventuate.

For example, why do currencies not reflect fundamental economic circumstances? Surely freely floating currencies would automatically correct imbalances such as chronic deficits. Apparently not.

Perhaps the free market is not as efficient as some think.