December 8, 2023

Economix: Fed Existentialism

Questions at the Federal Reserve’s first-ever press conference broadly fell into three categories:

  1. Why isn’t the Fed doing more to ward off inflation?
  2. Why isn’t the Fed doing more to lower unemployment?
  3. Can the Fed actually do more?

The first two kinds of questions sort of canceled each other out, in that “doing more” on one-half of the dual mandate would undermine efforts to “do more” on the other half. It was the third category of questions that was more provocative, and that provided an important reminder that economics is not as precise or powerful a “science” as we often imagine or hope it to be.

In one case Ben S. Bernanke, the Federal Reserve chairman, was asked “whether there’s anything that the Fed can or should do about” rising gasoline prices. And Mr. Bernanke lightheartedly acknowledged that this was beyond the Fed’s control:

There’s not much that the Federal Reserve can do about gas prices per se. At least not without derailing growth entirely, which is certainly not the right way to go.

After all, the Fed can’t create more oil. We don’t control the growth rates of emerging market economies. What we can do is basically try to keep higher gas prices from passing into other prices and wages throughout the economy and creating a broader inflation which will be much more difficult to extinguish.

Fair enough. The Fed doesn’t have the power to fix this particular problem. But then, at the very end, a thematically similar question came up, about the Fed’s ability to solve economic problems in general these days:

Mr. Chairman, [Carmen Reinhart and Kenneth Rogoff] wrote a book looking at 800 years of financial history and discovered when you have a financial crisis it takes a lot longer for the economy to recover.

Are people expecting too much from the Federal Reserve in terms of helping the economy recover? Has that complicated your monetary policy making?

Mr. Bernanke wasn’t ready to concede that the Fed is quite as powerless as the questioner suggested:

I enjoyed that book very much. I thought it was informative and as you say, it makes the point that as a historical matter, recoveries following a financial crisis tend to be slow.

What the book didn’t do is give a full explanation of why that’s the case. Part of it has to do with the problems in credit markets. My own research when I was in academia focused a good deal on the problems in credit markets on recoveries.

Other aspects would include the effects of credit problems on areas like housing and so on. We are seeing all that, of course, in our economy.

That said, another possible explanation for the slow recovery from financial crises might be that policy responses were not adequate. That the recapitalization of the banking system, the restoration of credit flows and the monetary fiscal policies were not sufficient to get as quick a recovery as might otherwise have been possible.

And so we haven’t allowed that historical fact to dissuade us from doing all we can to support a strong recovery. That being said it is a relatively slow recovery.

In other words: Monetary policy makers just didn’t know what to do before! But now we do! Even though we, uhh, still don’t completely understand what went wrong before.

This is the perpetual problem with economics, with economists and with others who look to their expertise.

Economics includes a lot of technical, specific theories, formulated by a lot of brilliant people, about how the economic world works and what the effects of various economic policies would be. But despite the mathematical precision of these many theories and forecasts, economics is still a relatively primitive science, especially since it’s impossible to run controlled macroeconomic experiments the way you can in a physical science like chemistry.

As Guy Sorman, a French economist, once said to me, economics is roughly where medicine was about 200 years ago. Its “experts” can give you rudimentary guidelines for how to stay alive and such, but when it comes to complicated diagnoses and specific treatments, there’s still a lot of guesswork involved.

Acknowledging this lack of control and certainty, though, can be very discomforting for all parties.

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