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There’s a raging debate going on.

July 22, 2012

The gun-control debate is not where my comparative advantage lies. I feel like I have very little to bring to the table. So let me stick to what I truly *don’t* understand: monetary theory. First of all, this is a really difficult subject with a good amount of graphs and equations such as PQ=MV etc…not for the light of heart. But from reading here and there, the debates over QEIII (that’s not a cruise-ship), and how the Fed and ECB are behaving etc…whether they’ve been tightening or loosening (nobody seems to agree), whether the Euro is a good thing or a bad thing etc…one thing seems to emerge from the fog: Central banks are great when they do the right thing. Somehow, a century or so of central banking has not been enough practice, the learning process is still in full swing, central bankers while arguably much more knowledgeable than before still have a long way to go, and they may in fact have *caused* the current mess.

It’s helpful to me to apply two opposite models to the situation. In one model, which I’ll call “cork in the ocean”, the Fed is just a bank trying to manipulate an oceanic market. Here ‘oceanic’ does not, again, have to do with cruise-ships, it’s just a term I once found in a game-theory book. In this model, every move the Fed makes, every breath Bernanke takes, is immediately voided and absorbed  by some local change in the global economy. My bias lies here, I’m very attracted to this position, in fact I tend to subscribe to this theory even for the fiscal levers, independently of the zero bound, recessions and whatnot.

The other model, which I’ll call “thermostat tyrant”, is one where central bankers have great powers, they can pull certain levers, crank some knobs and stir the whole economy in the right direction, if they know what they’re doing, or down a completely disastrous road, if they’re tragically mistaken. Within this model it is easier to “explain” some historical events, point to hyperdeflations or hyperinflations and claim that they could have “easily” been avoided.

There are also intermediate models such as the “stirring the titanic with long bungee jump ropes from the dock”: you pull really hard in one direction and when you finally see movement you have to start pulling really hard in the opposite direction. In technical jargon, there’s a “lag”.

In any case, these are some ways of thinking that one can adopt when trying to make sense of what’s going on. Personally I see the thermostat tyrant as being an ideal theory to use as reference point, while the cork in the ocean as a more realistic assessment.



From → Monetary Theory

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