“GIVE me a one-handed economist,” demanded a frustrated American president. “All my economists say, ‘on the one hand…on the other’”. The words of Harry Truman have captured the quintessential characteristic of economists well: their reservations in taking bold positions. The 33rd president of the United States, whose administration started measuring monthly unemployment in 1948, groused about economists who gave him on-the-one-hand-on-the-other-hand recommendations. Truman’s words have seemed to take on a personality of their own today – what was once the antithesis to catalysing progress in the area of public policies are now considered as stewards of markets.
MACROPRUDENCE AS A GOSPEL
IN today’s highly connected and deeply leveraged links between economies, macro-prudential management is embraced as a key approach in accommodating for downside risks and forecasting scopes for growth. It is consensus, that the central bank or the government operates in an environment with information asymmetry. No matter how advanced their indicators and models are, each comes with imperfections that render economic analyses an approximation at best. In facing the random-walk nature of developments, public officials often highlight two-sided possibilities – some even more – to the public in order to convey the complexities of economics.
ONE-HANDED ECONOMIST DRAWS ATTENTION
HOWEVER, this is often interpreted as ‘indecisiveness’ by the public, who consider macroprudence to be an euphemism of the former. In such discourse, some emerge as more a prominent voice, such as Nobel Laureate Paul Krugman who is widely known for taking bold stands in economics. Krugman’s rise to prominence in the econosphere (he also has weekly columns in the New York Times, with full capability of drawing criticisms) seem to demonstrate one point: that only a determinant stance can draw conclusive and constructive debates over the complexities of issues, and being two-handed don’t. This has intrigued me for quite some time. What I’m curious about this this: is taking a bold stance in shaping guidance more pro-market, or does being macro-prudential – or vague – somehow sends a deterministic force that allow markets to guide themselves?
BERNANKE, YELLEN AND DRAGHI: UNORTHODOX SOURCES OF OPTIMISM
THE developments in fragile markets in recent years have propelled monetary policy into the limelight, likewise with the return of two-handed economists. Back in 2012 when the U.S. growth was still fragile from the 2008 financial crisis, Ben Bernanke remained vague in his stance of whether to introduce further quantitative easing, saying that “it remains a tool to be used only when needed.” He’s lack of specificity is also emulated by successor Janet Yellen, who recently gave mixed signals of labour market improvements that earned her the moniker ‘an octo-economist‘. In 2012 when the Eurozone was suffering from high unemployment and unsustainable debt levels, European Central Bank President Mario Draghi also shared a similar tone, voicing that the bank will act if needed but stops short of saying if the European monetary policy authority will renew its accommodative policy tool of choice. Fast forward to today: after lowering interest-rates from 0.15% to 0.05%, Draghi left markets hanging on the prospect of a fed-style quantitative easing by saying “some of our council were in favour of doing more than presented.” While the vagueness in such guidance enhance volatility, it seems to be the case that such vagueness embody a form of optimism that can drive markets. Central bankers are basically saying: we are not sure whether this is good enough, but we’ll take one step at a time and see. And if it’s not enough we’ll do more. As for financial markets in general, they respond with this: okay these guys are going to save us. Let’s not be so scared anymore.
CONTROVERSIAL ART OF POLARIZING ECONOMICS
TWO ideas emerge when considering the (ir)relevance of a one-handed economist:
THE first looks at conferring integrity to the subject itself. Perhaps it is a matter of requirement that economists need to nuance their judgments and therefore, be inevitably vague. The subject of economics, at its very root, is built on the factors that drive decision-making which can all be categorized under the parent branch of rationality and irrationality. In theory, economics establish a series of cause-and-effect relationships under the assumption that agents in the economy are rational and have perfect information to make the best decision that maximizes their utility. On a macro scale, this is even more exaggerated when we study the cumulative effects of one variable to another and so forth on a aggregate scale. So two-handed economists preserve the integrity of the subject by acknowledging the plausibility of theories and ideas being wrong. We consider the possibility of irrationality – such as irrational greed and fear – and how the assumption of ceteris paribus may not hold. We know that for policies to work, many elements of this universe must be aligned together with the precision of time.
THE second looks at conferring integrity onto the economist. Although there is no definite truth, economists shoulder a responsibility to convey the better truth to stakeholders of the economy. The trust put onto economists could well be eroded if they take definite stands and be wrong for several times. Like the story of the boy who called wolf, this could lead to dangerous consequences for the economy eventually should the words of the economist be ignored when the predictions eventually come true. The value of humility is embodied by the two-handed economists who know that their judgments may not be entirely correct. Perhaps they express their sincerity through nuances, as a way of taking social responsibility for the uncertainty they are presiding over.
PERILS OF TAKING A BOLD STANCE
CURRENT literature available highlights how difference nuances only affect the volatility of expected interest rates at a shorter horizon. This could be due to the fact that markets do not seem to have confidence in the ability of central banks to make long-term commitments as a result of uncertainty. Given so, is there then a need for central banks and economists to take a clear stand and be ‘one-handed’?
WHILE there is no definite answer, the better answer here is likely a ‘no.’
THE clarity emerges when we come to an understanding on the purpose of giving public statements by central banks or public economists: to calm markets down in whatever circumstance, and deliver aid when required. Common sense has it that when central bankers give a definite answer, markets take it for its face value and hence facilitates price discovery to an optimum and efficient equilibrium as prescribed by Fama’s efficient-market hypothesis. However, this is not without hidden dangers. in doing so, central banks take a bet on the market that by a certain time duration, some indicators will fulfil market expectations of today’s announcement. This is a risk that could easily develop into higher levels of volatility, threatening any foreseeable progress or recovery.
THE Bank of England faced precisely this problem at the start of this year: Mark Carney, the governor, buried plans to raise interest-rates even when the unemployment rate has lowered to the lower bound of 7.1% (he had previously announced plans to hike rates once unemployment reaches 7%). Markets were thrown off balance as his words were built into expectations. Therefore, much is at stake when the economist takes a singular stand. What’s more is this leaves no room for compromise, or at a high cost, when things do not go accordingly to plan.
IN December 2012, the U.S. Federal Reserve took a specific stance in saying it would keep the federal funds rate at 0% to 0.25% as long as key indicators of inflation and unemployment continues to disappoint. Then, in May 2013, Fed Chairman Ben S. Bernanke mentioned the possibility of “tapering” bond purchases. Markets were thrown off balance, again. While this may be a case of overreaction by the market (the US economy was in fact doing slightly better – just slightly), it proves that a broader interpretation or recalibration of the guidance could lead to disruptive market reactions when financial markets project a narrow focus on the central bank’s forward guidance.
USING THE POWER OF SILENCE
LIKE those of great philosophers and writers, the words of economists have the magical ability to evolve by itself. As their words echo through the entire ecosystem, the democratic landscape allows only the distinctive truth to remain. With the help of automatic network effects, these words evolve into a grand order unifying and leading world markets. That is the beauty of giving vague guidance. When central bankers tug the curiosity of financial markets, the underlying force of speculation may enact certain set-ups to prepare markets for what is about to knock on the doors. This effect, which may be expansionary or contractionary in nature, has the potential to bring out the intended aims of guidance as a byproduct. When central banks keep corporations in suspense, it may also be an implicit application of game theory: that governments should be free from any lobbying, and they have to help.
The bottom line is, the struggle of economists and central bankers is real. As much as they would like to tell markets everything from the bottom of their heart, sometimes they can’t because the truth would scare financial markets that are highly leveraged and volatile. They do so to protect the pensioners, the hard-labourers and ultimately the bread-and-butter society whose stability is hinged on that of the financial markets’. A quote from Theodore Dreiser comes to mind:
“Words are but the vague shadows of the volumes we mean. Little audible links, they are, chaining together great inaudible feelings and purposes.”
Jerry
10 September 2014
Rethinking utopian economics. 