The author incorrectly titled his commentary “The Biggest Tragedy In Economics.” I have corrected it in the title of my post. The author makes clear that he is not speaking of the economy, but of the profession – for this reason (and others which I will come to shortly), I believe renaming the commentary as I suggest is appropriate. I am sure the author will disagree.
For the author, Joe Weisenthal, the biggest tragedy is that economists in positions of power and control (think central bankers) are not open to try something new and different in this grand experiment of central planning.
Last week at the Jackson Hole Economic Symposium, the world's foremost monetary economist Michael Woodford presented a groundbreaking paper on ways the Fed could do to better accomplish its mission of stimulating the economy and getting to full employment.
Who is this “world’s foremost monetary economist,” Michael Woodford?
Michael Dean Woodford (born 1955, in Chicopee, Massachusetts) is an American macroeconomist and monetary theorist who currently teaches at Columbia University.
Woodford holds an undergraduate degree from the University of Chicago and a law degree from Yale, and completed his economics doctorate at MIT in 1983. He began his teaching career at Columbia, and then taught at Chicago and Princeton before returning to Columbia to accept the John Bates Clark chair in 2004.
All the right credentials.
He is one of relatively few economists to have been awarded the John D. and Catherine T. MacArthur Foundation Prize Fellowship, which financed his research from 1981 to 1986. In 2007, he was awarded the Deutsche Bank Prize.
What is the “MacArthur Foundation Prize Fellowship”?
The MacArthur Fellows Program or MacArthur Fellowship (nicknamed the Genius Grant) is an award given by the John D. and Catherine T. MacArthur Foundation each year to typically 20 to 40 United States citizens or residents, of any age and working in any field, who "show exceptional merit and promise for continued and enhanced creative work".
A “genius grant.”
According to the Foundation's website, "the fellowship is not a reward for past accomplishment, but rather an investment in a person's originality, insight, and potential." The current amount of the award is $500,000, paid as quarterly installments over five years. As of 2007, there have been 756 recipients who have received a total of more than $350 million. Recipients have been as young as 18 and as old as 82.
One hundred thousand dollars per year for five years, and presumably the equivalent in real terms in the years 1981 – 1986 when Woodford was a recipient of this grant. That is an awful lot of “research funding” for the “potential” of a 26 year old.
The Fellowship has no application. People are nominated anonymously by a body of nominators who submit recommendations to a small selection committee of about a dozen people, also anonymous. The committee then reviews every nominee and passes along their recommendations to the President and the board of directors. Most new MacArthur Fellows first learn that they have been considered when they receive the congratulatory phone call. An editorial published in The New York Times by MacArthur Fellow James Collins describes the experience.
The nomination process is anonymous; the committee is anonymous. The road ends here.
And what is the MacArthur Foundation?
The John D. and Catherine T. MacArthur Foundation is one of the largest private foundations in the United States. Based in Chicago but supporting non-profit organizations that work in 60 countries, MacArthur has awarded more than US$4 billion since its inception in 1978. With an endowment over $5.6 billion, the foundation provides approximately $230 million annually in grants and low-interest loans.
In addition to selecting the MacArthur Fellows, also known as "genius grants," topics of interest to the foundation include international peace and security, conservation and sustainable development, population and reproductive health, human rights, international migration, community development, affordable housing, digital media and learning, juvenile justice, and public interest media, including public radio and independent documentary film. The Foundation also gives grants to more than 200 arts and cultural institutions in the Chicago area.
John D. MacArthur (1897–1978) owned Bankers Life and Casualty and other businesses, as well as considerable property in Florida and New York.
Woodford certainly caught the eyes of the right people when he was young – somewhere at Chicago, Yale, or MIT.
Back to Woodford:
Woodford's argument -- that the Fed should target a nominal GDP -- was actually a synthesis of a lot of work that's been done by several economists in the last few years on how monetary policy works when interest rates his 0% (what economists call the Zero Lower Bound).
Consider the term “nominal GDP.” A measurement of the economy without consideration of monetary or price inflation. Nothing would be better for central bankers than to be judged on how well the economy grows in nominal terms. This they can control much better than actually providing stable prices (defined as “reasonable” price inflation) or creating employment, I suspect.
But nominal GDP does not even measure the economy (neither does real GDP). It measures how much money is in the economy and at what velocity the money is moving. This, like most if not all macro measures, says nothing about the quality or desirability of the underlying transactions. I intend on developing this idea further in a future post, but in summary the idea of subjective value suggests that the measuring of the movement of money through the system says nothing about the health or state of the economy.
I give the shopkeeper a dollar; he gives me a candy bar. We both are better off after the trade, feeling we gave less than we received – else why would we have done the trade? There is no way to measure how much better off I feel, or how much better off the shopkeeper feels after the trade. It is just known that each of us feels better off. The end result for the macro-economist is that GDP grows by one dollar.
The government taxes my dollar away from me and spends it. Someone else is better off at my expense – a zero sum game (actually a negative sum game, given the destruction in the confidence of private property – never good for the economy). Yet GDP has grown by a dollar.
Is the economy equally better off in the second instance as it is in the first? Of course not. Yet these are equally “good” transactions in what some, including Woodford, would apparently like the central bank to target.
But unfortunately, it appears that the Fed is moving in the monetary direction.
Yes, it is unfortunate – but I suspect not for the reasons the author believes. The author shares comments by Paul Krugman as to why the new theories might not find favor with central bankers:
In an email, [Krugman] shared three reasons for new academic theories not getting through:
First, in general you don’t expect policy to be based on current research – realistically, would you really want to rely on politicians to assess the quality of econometric exercises? In a better world we would have come into the crisis with well-established results from years of work. It so happens that we didn’t in this case; given that, the failure of recent research to matter much for policy isn’t surprising.
Think about this: we have lived in a Federal Reserve world for 100 years; if you consider the Bank of England, scholars in the field of economics have had over 400 years to study and examine central banking in action. What works, what doesn’t work, causes of booms, causes of busts, incentives for overleverage, tools for employment, causes of unemployment, incentives for investment, etc. All of it - yet there is no research available – after 400 years – to explain what has happened in the last five years or to explain what course should now be taken. (One school has explained these things, but that is the school that cannot be named.)
If this isn’t the epitome of quackery…what is? What “science” could survive such a track record?
The arrogance behind this article and the apparent position of many in the economics profession come through clearly in the following sentiments:
Michael Woodford, himself, just chalked it up to the character and state of central bankers. We asked him about the theory/policy gap:
I agree with you about the gap. Part of it is simply the fact that central bankers are, as a character type, generally fairly cautious --- and we usually want them to be.
Bernanke is cautious? He more than tripled the Fed’s balance sheet in a few short years, loading up with assets of unknown quality. Draghi has announced an unlimited bond buying program. Trillions extended in liquidity. Actions unprecedented in the annals of central banking. And none of them expected or explored beforehand by any of the advocates of the institution.
Yet, according to Woodford the economist, it is not the fault of the economists but the politicians – and technically not the politicians but the people, whose eyes are awakening, putting pressure on the politicians:
But there is also another very important factor right now, and that is the intense political pressure under which the Fed must operate. They know they are going to be shot at no matter what they do, but the anticipation probably inclines one toward a more defensive posture. Experimentation with new ideas can seem very risky under those conditions.
Economists want to be left free to experiment. Experiment in the laboratory of the real world, populated by real people. Experiment with unproven and untested policies. Experiment with the single commodity that makes the modern division-of-labor economy and the standard of living that comes with it possible. An experiment for which the cost of failure would be devastating to the standard of living for billions of people – and death for many.
They want to be free to experiment on the lives of billions. Even the medical industry, with its countless interventions, does not profess to be so bold. Airplanes, automobiles, computers, all are tested for countless hours before sprung on the public. But money and credit? The laboratory is the world; the people are the guinea pigs.
Some might suggest there is no way to “experiment” with monetary policy. If one accepts monopoly central banking, this is true. We cannot go back to 2008 and run a parallel test using other policy prescriptions.
However, the free market allows for countless experiments in the production of countless goods and services – eliminate the monopoly and the same would be true for money and credit. Entrepreneurs can experiment to their heart’s content. Success will be built upon, and failure will be discarded. No bad theory put into practice can become too big before it fails.
Free markets in money, credit, banking and currency would allow for experimentation on levels that do not bring systemic risk. Free markets have solved problems that are far more complex than money.
But a free market in money would not be conducive to 26-year-old economists winning “genius grants.” A free market in money would not give economists – who have had 400 years to develop working models for central banking and failed – a continued position of authority over life and death. Finally a free market in money would eliminate one of the greatest tools invented for extraction of wealth from the productive class.
There is only one reason for the money monopoly – no other monopoly offers the same opportunity for control and wealth extraction. This is tempting for the politicians, and it offers credibility to the macro-economists.
Credibility for the quacks. This is the biggest tragedy in economics.