Saturday, December 27, 2014

Central Banks and Philosopher Kings

Let me put in another comment about the difficulty of democracy in dealing with economic crises.  It comes down to one basic thing: Counter cyclical is counter intuitive.  Contrary to what many people believe, democracy is good as calling for sacrifices, so long as those sacrifices are intuitively satisfying.  What it is not good at is violating people's intuitions about what should be done.

An oligarchy is even worse.  Elite and popular intuitions about how to deal with an economic crisis are the same.  The difference is that if the situation gets bad enough, the public becomes willing to do anything, even violate its intuitions, for an improvement.  Elites, feeling the pain less and the need to be right more, seem to have an unlimited appetite for other people's pain in defense of their intuitions.

So it can be very tempting to look for a philosopher king, or at least an economist king, to take over in times of economic crisis to trample on people's intuitions and revive the economy and then turn power over to usual democratic process when the crisis is over.  Of course, the big question is where to find those philosopher kings, how to make them do the right thing, and how to get rid of them once the crisis is over.

The first one is the easiest to answer.  The accepted candidate for philosopher king is the central bank.  Now what?  Europe's economic crisis, besides undermining my faith in democracy and in "enlightened" elites, has not given me a lot of confidence in central banker philosopher kings either.  Of course, I never had much confidence in central banker philosopher kings to begin with. Watching the IMF in action can do that to you.  But in the latest crisis, the IMF gives evidence of having actually learned something.  The Federal Reserve has done reasonable job, at least compared with everyone else in this country.  The Bank of Japan is working on it.  And (if Krugman is to be believed) even the European Central Bank is starting to show some common sense except for its German members.

So, if we are going to look to central banks to be our philosopher kings, how will we get them to take the role, and to relinquish it?  The most promising answer I find there is with Scott Sumner and his proposal for nominal GDP targeting.  Basically, in Sumner's view, we should keep our central banker philosopher kings permanently, but theirs should be strictly a limited monarchy.  They should keep our nominal GDP growing at a certain rate per year and leave everything else to the normal democratic process.  In this, it should be noted, he comes into conflict with a slightly trollish commenter who insists that central banks should act as a sort of domestic IMF from the bad old days, deciding what our policy should be and enforcing it by the threat to blow up the economy.  Sumner disagrees.  Central banks should keep nominal GDP growing at a steady rate and let the public decide what to do with it.

This approach, if it can be made to work, has some huge advantages.  The most obvious one, and the one that makes central banks the usual candidate for philosopher kings, is that central banks operate somewhat outside of the public eye, and most people do not understand monetary policy or even think much about it.  Central banks are not trampling so much on people's intuitions if people do not have intuitions about central banking to begin with.

It also resolves Paul Krugman's primary problem with monetary policy.  Monetary policy, he warns, can work at the zero lower bound, but only if central bankers solemnly pledge to raise inflation rates.  But calling for higher inflation goes against most people's intuition, especially when they are feeling a squeeze, because most people think of inflation solely in terms of increased prices and not increased wages.*  And furthermore, increasing inflation goes very much against central bankers' intuitions, since they traditionally see their job as taking away the punch bowl before the party gets out of hand. But calling it nominal GDP targeting allows central bankers to pledge to deliver higher inflation without coming right out and calling it higher inflation.  The question, of course, is whether they can be convincing while using euphemisms.

And it allows central bankers to work their way around another intuition that had gotten in the way of fighting the economic crisis -- the idea that policies should reflect universal and timeless truths and therefore never change.  The idea that what is a good policy in good times is not a good policy in bad times, or when we hit the zero lower bound, the old rules no longer apply, is simply not one that a lot of people can grasp.  But nominal GDP targeting gives bankers a convenient out.  They are not changing policy, they are always applying the same one -- seeking a fixed nominal GDP growth.

And, as discussed above, it limits the role of our philosopher kings to keeping a steady growth rate while the rest of us can continue democratic politics as usual about everything else.

And, although not one of the advantages of nominal GDP targeting, it at least helps me understand why certain libertarians, especially Austrian and Austrian-esque types hate central bankers so much. They fear central bankers as potential philosopher kings.

As for the drawbacks of having nominal GDP-targeting central bankers as our limited philosopher monarchs, the drawback is obvious -- will it work in the real world.  Or, as Brad DeLong puts it:
I believe in nominal GDP targeting–especially if coupled with some version of “social credit” at or near the zero lower bound. But a look back at the history of ideas about a proper “neutral” monetary policy–Newton’s fixed price of gold, Hayek’s fixed nominal GDP level, Fisher’s fixed price-level commodity basket, Friedman’s stable M2 growth rate, the NAIRU targeting of the 1970s, Bernanke’s inflation-targeting—leads immediately to the conclusion that anybody who claims to have uncovered the Philosopher’s Stone here is a madman. How can you reassure me that I (and you) are not mad?
*Nor is this intuition altogether wrong.  Inflation is used as relatively painless way to reduce real wages by having prices rise faster than wages.

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