After reading the coverage of Janet Yellen’s Fed Chair nomination yesterday, it feels as though it’s 2006 all over again. Confidence in our central bankers seems to be approaching all-time highs, little more than five years after it collapsed alongside the financial sector. Justin Wolfers’ endorsement of Yellen was typical:
Yellen is quite simply more qualified for the job than any of her predecessors. She’s an imaginative and technically adept economist possessed of a brilliant and precise mind. … Tonight, I feel reassured that my daughter’s economic future is in good hands.
With such enthusiasm on display, it’s worth turning back the clock and remembering attitudes about Fed leadership in the Alan Greenspan era. Here’s an example from outgoing Chairman Ben Bernanke’s legendary idol, Milton Friedman, writing in 2003 (emphasis mine):
Fifteen years ago … I wrote, “No major institution in the U.S. has so poor a record of performance over so long a period as the Federal Reserve, yet so high a public recognition.” [T]hat judgment is amply justified for the first seven decades or so of the Fed’s existence. I am glad to report that it is not valid for the period since … Sometime around 1985, the Fed appears to have acquired the thermostat that it had been seeking the whole of its life.
And here’s Bernanke in 2004, concluding a speech about the so-called Great Moderation:
I have argued today that improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation … but to the reduced volatility of output as well. … This conclusion on my part makes me optimistic for the future…
We heard sentiments such as these repeatedly until 2008. Outside of recessions and financial crises, economists have shown a habit of complementing the Fed’s leaders (self-congratulations for those at the Fed), while they rally around the story that contemporary policies are:
- A major improvement on past failures
- A huge success in stabilizing the economy
Another feature of the public discussion was a disregard for dangers that eventually shattered the Great Moderation. Greenspan stated in 2004 that “outright declines in mortgage debt seem most unlikely.” Bernanke argued in 2005 (with more than a little ignorance of housing market history) that house price declines were a “pretty unlikely possibility … we’ve never had a decline of house prices on a nationwide basis.” We heard similar dismissals of credit and asset market risks right through the housing boom.
In hindsight, Friedman’s picture of successful, post-1985 central banking was a chimera. Whatever analysis prompted him to condemn the Fed’s first seven decades should rightly yield the same conclusions about more recent decades.
That’s worth thinking about for a moment.
The intellectual father of the Fed’s easy money and asset inflation policies was grossly mistaken about their effects, and yet, now we’re told to feel “reassured” once again by the Friedman/Greenspan/Bernanke approach. Or, more precisely, a mutated version that’s staunchly supported by über-dove Yellen and characterized by ZIRP, QE, forward guidance, tapering, untapering, potentially retapering and more.
We’ve presumably entered a brand new period of policy acumen, just after Friedman’s assessment of the Fed’s poor performance stretched from seven decades to over nine by any objective analysis.
Does anyone else see something wrong with that picture?
Galbraith may have said it best
You may wonder, as I do, how to understand exuberance about the Fed’s future leader.
We can turn to the late John Kenneth Galbraith for one possibility, based on personal incentives. Galbraith argued: “In any great organization it is far, far safer to be wrong with the majority than to be right alone.” He may have been referring to somewhat centralized organizations, but the same thing can be said of economists in general. I’m reminded of a 2009 investigation by the Huffington Post, in which Ryan Grimm concluded:
The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession.
In other words, the Fed’s vice-like grip on economics may be just as powerful as the C-suite of any corporation. And economists pander to the Fed’s leaders just as naturally as corporate managers brownnose their superiors.
Too cynical an explanation for Yellen’s welcome, you say? Okay, let’s walk it back slightly. I’ll accept there’s no way of knowing if economists’ comments are heartfelt or not. I suspect they probably were in Wolfers’ case, although not in all cases. In any event, I don’t feel any better about the latest instance of economics groupthink. And once again, there’s a Galbraith quote that may explain my unease, this one a shortened version of his argument above.
The overwhelmingly positive response to Yellen’s nomination is worrisome because, well, it’s overwhelming positive. As Galbraith once astutely observed: “In economics, the majority is always wrong.”
(Note – I can’t help defending Paul Volcker’s chairmanship from Friedman’s criticism. Friedman’s griping during Volcker’s 1979-87 stint at the Fed was well off the mark, as shown by a remarkable string of forecasting errors not to mention his flawed conclusions about post-1985 policies.)