Should monetary policy be implemented by economists?

In a recent interview of Alex Tabarrok, I saw this exchange:

Auren Hoffman (52:52.27)

Now, your colleague, Tyler Cowen, he recently made an argument that we reached peak economist, that you don’t even need to be an economist anymore to be a member of the Federal Reserve Board. What do you think about that?

Alex (53:09.104)

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

There’s a lot to unpack there:

1. Have we reached peak economist?
2. And do we need economists determining monetary policy?

In my view, monetary economics peaked in the period before the Great Recession of 2008, and has declined a bit since that time.  The second question is much more difficult to answer.  Let’s begin with an analogy, which shows a common mistake when thinking about this sort of problem.

Suppose you are asked for an opinion on how to fix things in democratic country that suffers from poor governance.  What is your solution?   Perhaps you despair over the fact that voters are picking the wrong politicians.  You suggest 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 are the dictator, you don’t get to pick which person gets appointed.  Once a country becomes a dictatorship, it’s a dog-eat-dog world of competition to climb to the top.  The person that succeeds is far 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 issue is what type of person is likely to achieve the best outcome.  To complicate things even further, the performance of the Fed chair is not identical to the performance of the Fed as a whole, as decisions are made by committee.  In my view, the Fed as a whole did better under Yellen than either her predecessor or her replacement, but I cannot be sure how much of that was due to her decision-making, and how much was due to the others being dealt a bad 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 serve on the SEC?  Is it desirable?

It won’t be long before we’ll be asking whether an AI might be just as effective as a human being.

I am an elitist, but not a credentialist.  I strongly favor of staffing the Fed with people with a high level of expertise in monetary policy.  (Today, that’s true of some top Fed officials, but not all.)  However, I don’t much care whether they have a PhD in economics.  For instance, I think Tyler Cowen would be an above average Supreme Court justice, despite the fact that (AFAIK) he doesn’t have a law degree.  Of course, he’ll never be appointed because his votes would not be “reliable”.   

I have observed that most people are overconfident of their ability to do good monetary policy.  That’s probably also true of me, as it’s always difficult to have an unbiased view of your own ability.  When people are overconfident, they tend to have the following thought process:  “The Fed chair really screwed up there!  I could do a better job than him.”  On the first point they are often correct, on the second point I’m not so sure.

People tend to recall their successes much more than there failures, for very natural reasons.  Thus they recall asset price bubbles they correctly called, but forget about the assets that went up much further after they called it a bubble.  I’ve noticed an almost perfect negative correlation between those who had sound opinions on monetary policy in 2009, and those who had sound opinions on monetary policy in 2021—including yours truly.

You may have heard the remark about it being better to be governed by a random group of people picked from the Boston phone book rather than the faculty at Harvard.  But on closer examination, is that really true?  Professors hold lots of nutty views, but so do average people.  For instance, polls suggest that average people are supportive of some shockingly authoritarian policy proposals.  And even if average people have sounder views than most professors on “woke” issues, I doubt whether they have sounder views on questions such as where to set the interest rate on bank reserves.

Some might argue that they are not advocating picking Fed officials out of the phone book; rather they favor appointing highly experienced people from banking and finance.  Sorry, I’d rather have plumbers appointed to the Fed.  At least with plumbers, we’ll understand that they don’t know what they are doing, and we’d be more likely to constrain them with a restrictive policy rule, or let the Fed staff decide.  Many top people in finance and banking are shockingly ignorant of the basics of monetary economics, but don’t know that.  If you think “reasoning from a price change” is a failure of some economists (and it is) check out some of the comments made by top business people.  “Maybe a big interest rate cut would scare people, and hence reduce demand.”  “Maybe a big interest rate increase would boost 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 low-grade fever.  Among non-economists, it’s a global pandemic.

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

PS.  In this post I am describing averages.  I’ve met a number of people in business and finance that are well informed on monetary policy.

PPS.  In this post, I’m focusing on the issue of monetary policy determination.  Obviously, we need people with banking expertise for banking regulation.  I wish we followed the UK practice of having separate boards for these two tasks.

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

(0 COMMENTS)