The title of this post refers, of course, to Hayek’s warning about really smart guys thinking they understand a complex system well enough to start tinkering with it. Nick Rowe has had the generosity (and intrepidity) to hang out in the comments of my post criticizing his optimism over QE3. He told me he didn’t really understand what I was driving at, especially since the two of us agreed on what (Nick claimed) was the sole point of his post.
As Obama would say, let me be clear: I am saying that guys like Paul Krugman, Scott Sumner, Nick Rowe, and (so help us) Matt Yglesias think they understand the global economy well enough to say that the Fed buying another $40 billion per month of MBS until it works, is a “step in the right direction” or evidence that “we’re winning.” Yet their models are incredibly crude. The only reason they don’t understand how problematic this is, is that they spend most of their time talking to each other. Paul Krugman actually spends a lot of time bragging about how much you can learn about fighting this crisis from studying a chart of two lines intersecting each other, and Nick actually wrote the following, thinking it was a slam-dunk against (some of) the people opposing more monetary stimulus:
Even suppose the financial system totally collapsed. Why should that prevent monetary and fiscal policy working to increase demand? The biggest flaw of orthodox macroeconomic models is that they have no financial sector. So, if the financial system disappeared, that ought to mean those models would work even better.
Now look, I understand “what Nick meant by that.” He is making a very specific point to a subset of analysts who (a) agree with him that a shortfall of generic aggregate demand is “the problem” and (b) doubt that more QE will help on this front. What I am saying, however, is that if you find yourself typing out the above statements, you should pause before being so sure that creating another $40 billion per month–indefinitely–in propping up the housing market is a good idea.
There are lots of areas of scientific inquiry where the experts involved simply don’t understand the phenomenon very well. If, say, some physicists approached Congress and asked for $40 billion per month to fund the development of a cold fusion reactor, and Congress said, “How much total money do you need?” and they said, “Until we get it right,” that would be alarming. Especially if they admitted their models didn’t include electrons because that took up too much computing time.
Notice in this scenario, that these physicists could still be the world’s experts on the processes involved. The critics in Congress and the public who thought the $40 billion monthly funding wasn’t justified, wouldn’t have to prove they knew the physics better, nor would they have to perform better on a prediction of how subatomic particles would behave in experiments 6 months prior to the funding request. We could still imagine circumstances in which it would be perfectly correct, “rational,” and “scientific” to tell the physicists and engineers, “You guys are all really smart, you have done pioneering work in these fields, but sorry, we just don’t feel you understand Nature enough to get this kind of funding right now. We have seen you guys arguing with each other, and it’s not pretty. We’re not at all convinced that you have an adequate handle on this to justify what you’re asking.”
So I claim we have something similar with mainstream macro and monetary economists right now.
UPDATE: As always, Blackadder tries to keep me honest in the comments. His caustic barb reminded me of something I meant to say in the original post: I now believe more than ever, that if someone made me Fed chief, the proper thing to do would be to resign. Libertarians often say that type of thing in Q&A sessions, and it’s partly to be funny I suppose, but in reality it’s the right answer: There is no “proper” way to run a central bank. Even in terms of shutting it down, it’s really hard to start writing on this topic without just making stuff up. For example, Carlos Lara and I had a proposal (deep into this book) for going back to gold money and free-market banking (not to be confused with “free banking” necessarily), but it involved some arbitrary features. After reading Mises’ proposal (which also was “second best”) I realized he had thought of some things we hadn’t.
What I am saying is, I would like to think if I actually were offered the option of scaling back (but not eliminating) the government’s influence over the monetary and banking sector, that I would have the wisdom and courage to throw the ring of power back. The virtue of the Austrian School is that it understands the limits of our ability to predict what will happen in something as complex as the global economy. We think we have a qualitative understanding of how market forces work to correct disequilibria, but the claim really isn’t that “our model is better at prediction than the Keynesian ones.”