It’s monetary policy, not a morality play

by on September 9, 2007 at 8:02 am in Economics | Permalink

Here is my now-on-Sundays NYT column, on the recent subprime crisis.  Excerpt:

Nonetheless, Fed watchers should resist the tendency to put all
events into a simple or a morally plausible narrative. Monetary policy
is a largely technical subject, and its ups and downs don’t usually fit
into the kinds of emotion-laden stories that human beings apply to
daily life. The “us versus them” tag registers in human memory, but
monetary policy is not always or even usually about moral issues. As
Freud famously noted, sometimes a cigar is just a cigar.

Financial
market news, which is by nature unpredictable, suffers from distortion
when it is crammed into the form of a simple story. Unlike most
well-structured narratives, the zigs and zags of daily profit and loss
defy simple categorization in terms of moral precepts.

In the case of subprime mortgages, many investors did not foresee
the risk of collateralized debt securities. In response to this crisis,
the Fed has been trying to keep a steady hand and prevent a credit
crunch. We don’t yet know how well the Fed has succeeded, or how well
it could have done in the first place. And the storm has not yet fully
passed.

Of course, such an account of recent financial history
sounds mundane and offers less human conflict. It’s less like the
stories that people have gossiped about for thousands of years and thus
will have less traction, even if it is a better guide to monetary
policy issues.

Here is commentary from Mark Thoma; he believes I should embrace government bail-outs more, without moralizing against them or citing moral hazard so much. 

I might add that this desire to fit everything into a story lies behind recent blogosphere discussions of supply-side economics.  Many Democrats need a story of the following form: "The Republican Party makes decisions in a systematically worse way — much worse way — than do the Democrats."  (Otherwise they might be led to favor restrictions on state power, because Republican rule has not been pretty.)  While I don’t assign p = 0 to this possibility (e.g., Clinton did govern better than Bush has), I think most of the Democratic bloggers give it a far higher p than it deserves, and they retreat into moral strictures to "be more progressive" when faced with contrary evidence.  So a description like "the Republicans have complex motives, not all of which are noble, and end up making lots of mistakes" doesn’t, for them, sound different enough from the Democrats (whom they know) for comfort.

Tom G. September 9, 2007 at 8:31 am

I am Marginal Revolution fan but …

If I can summarize the last paragraph, Democratic are biased against Republicans. I am sure that’s true, and of course libertarians might be biased in favor of tax cuts. On the topic of long-term, widespread deceit in the promotion of tax cuts, libertarians might retreat into discussions of the biases of Democrats.

In general, I don’t think bias arguments are fruitiful. Better, to demonstrate the bias through showing the “contrary evidence” and demolishing the argument than asserting the evidence and maligning the opponent.

Tom

mickslam September 9, 2007 at 9:14 am

“I might add that this desire to fit everything into a story lies behind recent blogosphere discussions of supply-side economics. Many Democrats need a story of the following form: “The Republican Party makes decisions in a systematically worse way — much worse way — than do the Democrats.” (Otherwise they might be led to favor restrictions on state power, because Republican rule has not been pretty.) While I don’t assign p = 0 to this possibility, I think most of the Democratic bloggers give it a far higher p than it deserves, and they retreat into moral strictures to “be more progressive” when faced with contrary evidence. So a description like “the Republicans have complex motives, not all of which are noble, and end up making lots of mistakes” doesn’t, for them, sound different enough from the Democrats (whom they know) for comfort.”

You should write more on this.

Take a look at Matt Y.s most recent posts on Charles Krauthammer, and it becomes hard to think that liberal bloggers are overestimating p. Essentially every major decision of the last decade made by republicans has turned out to be a disaster. If you recall the age of young Mister Y, the liberal blogger p value becomes much more understandable, because given their data set, it is correct.

M. Hodak September 9, 2007 at 10:21 am

The irony of Mark Thoma exhorting someone to not moralize is too much. I remember beginning to read Thoma as an economist, but quickly realized it was not economic reasoning that was at the center of his posts, but moralizing. Any time someone uses the term “should” with respect to government policy, they have abandoned the realm of economics and entered the realm of morality.

Patrick R. Sullivan September 9, 2007 at 12:23 pm

I had the same reaction as M. Hodak (having been on the receiving end of Thoma’s moralizing).

Anyway, ‘Clinton did govern better than Bush has’, was just dumb luck on Clinton’s part. He inherited an economic expansion almost two years along, then lost congress to the Republicans. People like Dick Armey and Phil Gramm checked Clinton’s (and his wife’s) worst instincts.

Take a hard look at the last half century (1958-2007). We had a lot better governance in the last twenty five years with its three to one ratio of Republican presidents to Democrat than in the quarter century that preceded it.

Patrick R. Sullivan September 9, 2007 at 12:26 pm

The “recent blogosphere discussions of supply-side economics” were started by a patently false post by Megan McArdle…

She was replying to a silly argument by Jonathan Chait, iirc. But, your reaction confirms Tyler’s point.

robertdfeinman September 9, 2007 at 1:52 pm

In every movement there are “true believers” (if there weren’t there wouldn’t be a movement).

So let’s take the members of a movement and divide them into several categories:
1. The followers – not well informed, but they “know it when they see it”.
2. The discerning followers – better informed, sometimes critical, but, in general, they buy the positions of the movement.
3. The cheerleaders – these can be further divided into the “true believers” and the shills. Sometimes they are one and the same, but not always.
4. The leaders – their motivations vary: power hungry, self assured and self righteous, and/or hypocrites.

It is easy to point out the foibles of groups 1-3, Mencken made a career out of this, for example. But this is just criticizing human nature.

The real issue comes with the leaders. We have seen enough examples of madmen running nations that there is a whole science devoted to understanding why people follow them: Adorno, Arendt, and more recent people like Robert Altemeyer have written about this.

Now to the issue at hand. There is ample evidence that things have not gone well for the past decade, at least for a large sector of the country. Some blame this on fundamental problems with the guiding philosophy, some with just the implementation.

Those who have been on the outside looking in are now enthusiastic about a chance to have their turn. Many of these people are young enough so that they have never experienced a time with a functional Democratic majority, in my opinion that would be LBJ. So, many of them imbue the Dems with better motives than they might deserve – they are bound to be disappointed to a lesser or greater extent.

Criticizing their enthusiasm or naiveté may be fun, but it’s a cheap shot. The real discussions aren’t taking place. To my mind they are:
1. The degree that militarism controls priorities in this country
2. The level of social services to be provided by government (or as I like to say, government-administered)
3. The level of social inequality that will be permitted, both in terms of opportunity and wealth
4. The degree that private firms will be allowed to set priorities and the degree of regulation that is needed

Other areas that get a lot of attention, such as tax policy and actions by the Fed, are actually implementation details, not the issues themselves.

So what we get is lots of discussion about implementation, but not much discussion of the goals. One reason that this may be so, is that the goals of those on both sides of the political spectrum don’t differ by that much. Neither group is willing to scale back on militarism. Both sides support robust economic growth via a capitalistic, free-market model and both sides expect that it is a “national interest” that we have access to raw materials and finished goods at favorable terms.

There are no socialists, communists, anarchists, Georgists or any of a large number of similar philosophies in the public space. There certainly aren’t any in government.

So the big endians fight with the little endians and the world spins along. When people will wake up to the fact that this time is not just like the past is the big question. Resource constraints, over population and climate change may be of concern, but actually addressing the issues seems not on anyone’s agenda.

David J. Balan September 9, 2007 at 2:44 pm

I know next to nothing about monetary policy, and I’m prepared to take Tyler’s word for it that the policies that the Fed is pursuing really are the right ones, and are not just a way to transfer wealth to the super-rich. But we are living in a time when a huge amount of what the government does *really is* just a way to transfer wealth to the super-rich. It is highly rational to have strong priors that any particular policy that benefits the rich is really just upward wealth redistribution. Since it is very difficult for most people to tell the policies where this is true from those where it is false, they can be forgiven their suspicions. This doesn’t mean giving in to the cruder versions of populism, which can be very ugly and illiberal, but it does mean fitting an argument like Tyler’s in the proper context.

John September 9, 2007 at 4:38 pm

Something bugged me about Tyler’s article. In the midst of his good points, he says next to nothing about how guilty the Fed is in all this…and…goes a step further to somehow insinuate that they’ve done a decent and justified job in all the aftermath of the subprime crisis and thereby validating the role they assume.

He also obscures the word “indpendent” when referring to central banks and how much better independent central banks handle monetary policy. When “indpendent” means “do whatever they feel is necessary”, I don’t think that’s greatest or most important point to take from all this. Independent should mean “independent of the whims of the Fed”. And that’s a good point to take from this.

Of course, I don’t know how “Austrian” Cowen is on this matter…so I can’t say for sure that he would agree.

In light how admits that people are poor at understanding monetary policy when they can’t even understand simple concepts like free trade, I’m not so sure his article will leave readers very clear on the best lessons to take from all this.

Yes, “forget the narratives, it’s not that simple so stop trying to find one” is a good lesson…but I think some clarity on the nature of what really causes these problems deserved a little more attention.

David R. Henderson September 9, 2007 at 8:49 pm

Tyler,

Very nice piece. You mentioned “random luck.” Is there another kind of luck? :-)

Best,

David

thehova September 9, 2007 at 9:19 pm

yes, this sounds like a critique of Matthew Yglesias.

why don’t libertarian/conservative bloggers critique him more? there’s something likable about him which I don’t get.

G September 10, 2007 at 6:29 am

Brian,

I don’t know if I’d call Enron market failure, as it took advantage of loopholes in (non-market) regulation. I also don’t know if I’d call the housing bust market failure either, for the same reason. The USA’s financial and banking institutions are not market-based. Banks are heavily regulated and run by congress and the Fed. Mortgage securities of course aren’t a government creation, but I don’t think they were the source of the problem in itself. I believe they served as a vehicle for bad investments to be flipped before the inevitable bust.

If we had severe shortages or excesses in things like IT, wave-runners, or cars, I’d call those market failure (like the dot-com boom-bust).

I don’t buy that investors didn’t know the risks. I’m sure some were fooled, but most people knew housing was in a bubble, just like most people knew IT was as well ten years ago. Investors got burned because they were hoping to flip their investments before the bubble burst, and they weren’t able to. Markets already produces deals of a complexity which both parties in a trade are comfortable with (although I wouldn’t want to suggest that purposefully obfuscated deals shouldn’t be treated as fraudulent).

The best explanation I’ve heard for the housing boom painted the decision of banks to engage in bad lending practices as a prisoner’s dilemma (or the plural of which, the “tragedy of the commons”). Because a bank does not bare the full cost of a bad loan it gives out (due to credit crunches effecting the whole lending industry), it is in the self-interest of profit-seeking banks to take advantage of low interest rates and do a lot of lending. The ability for a loan to be flipped as a MBS or whatever helps the process along even more. If a bank does not increase lending with lower rates, it won’t make as much money will still suffering much of the harm from a credit-crunch.

Granted, none of this would be a problem if the loans given out were “good” ones. But does anyone really think that the number of wise investments increased just because Greenspan dropped the Federal Funds Rate to 1.0%?

Brian Slesinsky September 10, 2007 at 12:46 pm

Given how poor most people are at risk assessment, I think it’s naive to assume that investors understood the risks. Yes, they “understood” in the sense that we all know there are risks, but there is an all-too-human tendency to discount them.

It also seems fair to say that the original lender should have more information about the customer than is available to third parties and should bear some responsibility for the outcome. Maybe there should be a limit on how much of a loan may be resold, just as there are limits on margin?

The “prisoner’s dilemma” of banks making bad loans (where they knew or suspected or didn’t care about the ultimate outcome) is only a dilemma if you assume that all decisions must be profit maximizing. Moral decisions do, sometimes, involve forgoing profit. A market that creates incentives to do the wrong thing is a badly designed one, but that doesn’t eliminate all responsibility for the people involved.

TGGP September 10, 2007 at 2:10 pm

Matthew Yglesias gets slammed from a conservative/libertarian perspective here.

jp September 10, 2007 at 10:15 pm

First Tyler pleads†¦ “Fed watchers should resist the tendency to put all events into a simple or a morally plausible narrative.†

Then Tyler goes on to craft his own simple narrative of the event, contradicting what he originally asked of us.

Then he admits to buckling in to the temptation of story-creating when he says that his “account of recent financial history sounds mundane and offers less human conflict† than the others.

So what is he saying? Folks, don’t come up narratives! I mean†¦ wait! Come up with a narrative, but it should be more boring than the others, kinda like the one I just came up with.

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