Can we inject uncertainty into monetary policy?

By Felix Salmon
May 21, 2009

Just had an interesting lunch with Nick Denton, who clarified that his 27% rise in revenues was year-on-year in the first quarter, and that the second-quarter rise in sales is even larger. He also talked about his decision to cut back in the face of a coming recession: while he has pangs of regret about selling Consumerist, he said, he also feels that recessions can be helpful when it comes to forcing business owners such as himself to take tough decisions they otherwise might be able to avoid taking.

Denton has a theory about how we ended up in the midst of this huge economic crisis: he blames the hubris of central bankers in general and Alan Greenspan in particular — people who thought they had abolished the business cycle, and whose belief was shared by the business and finance worlds. It’s the theory of the Greenspan put, basically — we all reckoned that if things got really bad then the Fed would bail us all out, as they did in 1991-2 and then again in 2000-1. As a result people weren’t nearly as cautious as they might otherwise have been inclined to be, and dangers built up until they exploded.

How to fix this? Is it not the job of the Fed to try to minimize the severity of recessions? One alternative approach would be to consider it to be the job of the Fed to minimize the severity of the worst possible recession. What would happen if, for instance, rates were set using a random-number generator? Every FOMC meeting, some kind of virtual die would be rolled, moving rates up or down even if that was the opposite of “correct” monetary policy. The resulting uncertainty would force people to take a more defensive stance at all times, just in case rates went sharply upwards — even if the probability of such a rate hike was quite low.

Maybe monetary policy is a bit like optimal poker strategy: a certain percentage likelihood that you’ll do this, a certain percentage likelihood that you’ll do that. The Fed governors can then release a decision saying, essentially, “we plugged in a 10% chance of a 50bp cut, a 50% chance of a 25bp cut, a 25% chance of keeping rates steady, and a 15% chance of a 25bp raise, and rolled the electronic dice; guess what, we we ended up with the 25bp raise”.

OK, so that’s probably a silly idea. But some element of uncertainty is I think useful in monetary policy.


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An interesting idea is gdp futures. The Fed could adjust to counter deviations from constant growth.

Posted by Lord | Report as abusive

Monetary policy can not be used for controlling an economic system, it is only one input that enables or limits growth. Making money available doesn’t always mean people will spend or invest it, but making it available with no oversight and no rules will usually result in lots of it going up in smoke.

The only government policy that can strongly influence the direction of the economy is tax policy. And I’m not saying that cutting taxes will cause growth, there is no evidence to support that kind of wishful thinking. Cutting tax rates and hoping the savings will be invested is not a policy, it is lottery ticket. A tax system that rewards only investments that have been made, rather than ones that might be, is the only one that can have a repeatable correlation with economic growth.

Posted by KenG | Report as abusive

Maybe we need to go back to the old system where the Feds actions were a big state secrete and they did not tell us anything after a meeting.

Posted by spencer | Report as abusive

I fear spencer’s suggestion, though there is correlation if not causation in it.

Or have you been reading Truman Bewley again, Felix?

Why not apply the same thinking to a variety of assets? Make it part of regulator’s jobs to ensure that there’s a certain amount of volatility in the prices of securities. This would keep leverage down and thus help prevent asset bubbles. There are probably ways to do this that are cheap or even free for the regulators (e.g., by slightly relaxing market trading regulations for the agent or entity injecting the volatility.)

Posted by TonyP | Report as abusive

My sense is that ex ante, every recession is the worst possible recession. I recall lots of doom-mongering in 1982 (we’ve lost our competitiveness!), 1990 (the most bank failures since the Great Depression!), and 2000 (deflation!). This isn’t to say that our current situation isn’t bad; I just fear a “worst possible” creep (similar to “mission creep”).

Posted by Mike | Report as abusive

Looking at your post again, I realize that I may have misunderstood you, Felix.

By “worst possible” recession, did you mean (1) out of given set of recessions (1982, 1990, 2000, 2008), the Fed’s job is to intervene only in the most severe one; or (2) in any given recession, the Fed’s job is to make preparations that the worst possible outcome will not be too severe?

Am I making sense?

Posted by Mike | Report as abusive

[The resulting uncertainty would force people to take a more defensive stance at all times, just in case rates went sharply upwards — even if the probability of such a rate hike was quite low.]

How much does this “more defensive stance” cost in terms of a long term growth rate? Assuming it makes the difference between a 3% and 2% rate, then fifty years out, you’re substantially better off just putting up with a 5% recession every ten years (do it in a spreadsheet if you don’t believe me). In general, the optimal frequency of crashes is not zero. How do you think we would have got the Internet built if everyone was taking this “More defensive stance”?

Posted by dsquared | Report as abusive

If I am missing something someone please help me see the light. We have been swallowing all of this government doublespeak for years and we know it. The same types of people who made the policies and were, at least we thought, watching out for us are now saying they are going to solve the “crisis”. While it may be involving once in a lifetime corrections (aka the Great Depression when the banks collapsed) it is never the less a correction. In this case a correction of the banking and auto industries.

We trusted the government to get us this far. Now their policies will do nothing more than cost us money – taxes. Politicians can’t handle money as what they are best at if they are successful is getting elected. Back off the policies, stop taxing us, enough of new beginnings and change and let us keep our hard earned money which guess what we will spend. The economy works when there is an exchange of money for goods and servces. How about that for a concept?

Posted by Outraged | Report as abusive

You are essentially arguing human risk taking doesnt work and we ought to regulate it so it comes down. I believe the entire history of capitalism proves that wrong, even with periodic and serious crisis RISK TAKING WORKS