Should monetary policy be implemented by economists?

In a recent interview by Alex TabarrokI saw this exchange:

Auren Hoffman (52:52.27)

Your colleague, Tyler Cowen, recently argued that we have reached the top economist, that you don’t even have to be an economist anymore to be a member of the Federal Reserve Board. What do you think?

Alex (53:09.104)

I think Arthur Burns was the first with a PhD. There have been quite a few since then, but before there were plenty of people at the Federal Reserve without PhDs in economics.

There’s a lot to unpack:

1. Have we reached the top economist?
2. And do we need economists to determine monetary policy?

In my opinion, the monetary economy peaked in the period before the Great Recession of 2008, and has declined slightly since then. The second question is much more difficult to answer. Let’s start with an analogy, which shows a common mistake when thinking about these types of problems.

Suppose you are asked for your opinion on how to resolve issues in a democratic country suffering from poor governance. What is your solution? Perhaps you despair that voters are choosing the wrong politicians. You propose that the country become a dictatorship and appoint someone like Lee Kuan Yew as head of state.

I hope you see the problem. Unless You If you are the dictator, you cannot choose which person is appointed. Once a country becomes a dictatorship, it’s a world of competition to rise to the top. The person who succeeds will be much more likely to resemble Nicolas Maduro or Vladimir Putin than Lee Kuan Yew.

In the case of monetary policy, the issue is not whether Ben Bernanke, Janet Yellen, or Jay Powell did the best job; the question is which type of person is likely to achieve the best outcome. To complicate matters further, the performance of the Fed chairman is not identical to the performance of the Fed as a whole, since decisions are made by a committee. In my opinion, the Fed as a whole has done better under Yellen than either her predecessor or her replacement, but I’m not sure how much of that was due to her decision-making, and how much was due to the others getting a bad deal. hand. In plain English it’s complicated.

Other government institutions face similar dilemmas. Is it necessary to have a law degree to serve on the Supreme Court? Is it desirable? Is it necessary to have a finance degree to work at the SEC? Is it desirable?

It won’t be long before we wonder whether an AI can be as effective as a human.

I’m an elitist, but not a credentialist. I am a strong believer in staffing the Fed with people with a high level of expertise in monetary policy. (These days, that’s true of some top Fed officials, but not all.) However, I don’t really care if they have a PhD in economics. For example, I think Tyler Cowen would be an above-average Supreme Court justice, despite the fact that he (AFAIK) doesn’t have a law degree. Obviously he will never be appointed because his votes would not be “reliable”.

I have found that most people are overconfident in their ability to implement good monetary policy. That probably applies to me too, because it’s always difficult to have an unbiased view of your own abilities. When people are overconfident, they tend to have the following thought process: “The Fed Chairman really screwed up there! I could do better than him.” They are often right on the first point, but I am not so sure on the second point.

People tend to remember their successes much more than their failures, for very natural reasons. For example, they remember the asset price bubbles that they rightly called, but forget the assets that rose much further after they called it a bubble. I noticed an almost perfect one negative correlation between those who had a healthy opinion about monetary policy in 2009, and those who had a healthy opinion about monetary policy in 2021 – including the undersigned.

You may have heard the comment that it is better to be governed by a random group of people picked from the Boston telephone book rather than by the Harvard faculty. But upon further investigation, is that really the case? Professors have a lot of crazy views, but so do average people. For example, polls show that the average population supports some shockingly authoritarian policy proposals. And even though average people have healthier opinions than most professors on “woke” issues, I doubt they have healthier opinions on questions like where to set interest rates on bank reserves.

Some may argue that they are not advocating removing Fed officials from the phone book; rather, they prefer to appoint highly experienced people from the banking and financial sector. Sorry, I’d rather have plumbers appointed to the Fed. At least when it comes to plumbers, we’ll understand that they don’t know what they’re doing, and we’ll be more likely to rein them in with a restrictive policy, or let the Fed staff decide. Many top executives in the financial and banking industries are shockingly ignorant of the basics of monetary economics, but they don’t know it. If you think “reasoning from a price change” is a failure of some economists (and it is), take a look at some comments from top business people. “Maybe a big rate cut would scare people and thus reduce demand.” “Maybe a big rate hike would stimulate demand by putting more money in the pockets of savers.” It makes you want to cry.

Among economists, reasoning from a price change is like a mild fever. Among non-economists it is a global pandemic.

So yes, on average an economist will know more about monetary policy than a non-economist. But Fed chairs don’t just have to be smart; they must be effective leaders, an area in which business people often have an advantage. Ultimately, I suspect this is one of those 55%-45% issues, where economists are slightly better, but non-economists will outperform economists so often that it will be difficult to tell the difference. Nevertheless, if serving at the Fed is actually a position where ignorance is better than knowledge, then this is the only such position I know of.

P.S. In this post I describe averages. I have met a number of people from the business and financial world who are well informed about monetary policy.

PPP. In this post I focus on the issue of monetary policy determination. It is clear that we need people with banking expertise to regulate the banking industry. I wish we followed the British practice of having separate boards for these two tasks.

PPPS. Readers of this blog know that I am against discretionary monetary policy. This post is based on the assumption that I won’t get my way, at least in the near future.