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What Could Possibly Go Wrong?

Summary:
Watch this very important video lesson from Tyler Cowen on How the Fed Works. [embedded content]  Now, go read Milton Friedman's 1947 review essay of Abba Lerner's The Economics of Control in the JPE.  Are the "administrative costs" being taken into account in this evolving Fed and the public policies chosen?  Those administrative costs include both incentive alignment issues and information processing issues, let alone more subtle issues having to do with knowledge and learning.  In short, any institutional regime that presupposes for its operation omniscient and benevolent public servants is going to have issues in practice.  As Friedman warned in Capitalism and Freedom, any institutional arrangement for monetary policy where a sincere error by a few can threaten the long-term

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Watch this very important video lesson from Tyler Cowen on How the Fed Works.

 Now, go read Milton Friedman's 1947 review essay of Abba Lerner's The Economics of Control in the JPE.  Are the "administrative costs" being taken into account in this evolving Fed and the public policies chosen?  Those administrative costs include both incentive alignment issues and information processing issues, let alone more subtle issues having to do with knowledge and learning.  In short, any institutional regime that presupposes for its operation omniscient and benevolent public servants is going to have issues in practice.  As Friedman warned in Capitalism and Freedom, any institutional arrangement for monetary policy where a sincere error by a few can threaten the long-term performance, and perhaps even viability, of the economic system is perhaps an institutional arrangement we cannot afford.

So Cowen's depiction of how the Fed operates seems to nicely capture the way monetary policy was followed in the wake of the Great Recession, but I personally would always place in juxtaposition George Selgin's rather damning portrayal of Fed policy in "Operation Twist the Truth." All the parts Cowen describes are there, but the purpose and the consequences are interpreted in a more critical light.  Selgin's views in general can be found in his collection of articles Money: Free and Unfree. Roger Koppl's From Crisis to Confidence also provides an excellent primer on macroeconomics after the crisis, and one that takes seriously the problem of "expert failure", especially failure by an monopoly expert, which of course the Fed is institutionally established as in the realm of monetary policy. See Koppl's new book Expert Failure for a general discussion of these points of social epistemology and public policy.

Larry White, of course, has long asks us to consider whether our monetary policies are being pursued according to the Rule of Law, or by the Rule of Central Bankers?

Dan Smith and I have written about the evolving views of Hayek, Friedman and Buchanan on monetary policy because of their frustration to effectively bound the discretionary authority of the Fed.  Fed discretion, on the other hand, has continually meant historically that political influence impacts monetary policy in a counter-productive manner, as Dan and I also argue in a separate article.

The video is a great teaching tool, but the political economy question is whether such tools of monetary policy bring sound money to the economic system, or represent simply the latest evolution of the techniques for creating the illusion of prosperity in the short-run while distorting economic relations, and in fact, deforming the economic system in the long-run.  If you include in your analysis of "macroeconomic policy" also fiscal policy, then you get a sort of perfect storm that has bothered economists since the time of Adam Smith -- unsound money and irresponsible fiscal policy, which has been the hallmark of the government "juggling tricks" from ancient times to modern times.  Juggling is all well and good, but even master jugglers sometimes fail.

 Perhaps we better think hard about the downside risk of monetary mismanagement for the economic health of the economy when contemplating the evolving powers and responsibilities of the Fed and the central bankers we entrust with the system. 

Peter Boettke
Peter Joseph Boettke (January 3, 1960) is an American economist of the Austrian School. He is currently a University Professor of Economics and Philosophy at George Mason University; the BB&T Professor for the Study of Capitalism, Vice President for Research, and Director of the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at GMU.

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