Thursday, March 14, 2013

The Bank of England's Dreaming

Yesterday this post - A Plea for Neutral Money - from @Britmouse appeared in my twitter timeline.

Now, leaving aside the issue of whether Money is or can ever be neutral, the thrust of the post is that the Bank of England is making it up as it goes along. Britmouse claims that "The actions of the Bank have not been consistent or logical since 2008" and at the end summarises by saying " if the patient is hyperactive, do not prescribe steriods." We'll come back to that last one.

Coincidentally, before reading Britmouse's post I'd just read this in Ingham's Nature of Money. I'll quote the whole thing. It's rather long but worth bearing with it. At the very least, after reading it you'll be able to totally rule any dinner party discussion around central banking.

"... academic economics sees the relationship between theory and practice as one in which the later is brought closer to the theoretical optimum. However, on closer inspection, it is clear that the expertise and transparency of monetary policy making is not securely grounded in the basic tenants of mainstream monetary economics. To be sure, the central bankers pay lip-service to the basic tenets of orthodox monetary theory, especially in the long-run correspondence of the quantity of money and the level of prices. But they acknowledge that this cannot guide their practice in dealing with what they see as short-term disequilibria. It is conceded that there is no satisfactory way of constructing empirically based models of these short-run effects, or of judging the relative merits of the models (Issing 2001 p7,21). If 'the key issue of exactly how monetary policy impacts on "real" variables over time is still only imperfectly understood' (Issing 2001 p7), how then do central banks and their experts actually go about their business? It seems that they do as they have done for several decades. Central banks depend upon accumulated conventional wisdom on the most important empirical signals of impending inflation. These conventional signals are, of course, modeled in ad hoc econometric analysis, but 'a straightforward selection of the "best", if not the "true", reference model becomes a matter of faith (Issing 2001 p40 emphasis added by Ingham).

Geoffrey Ingham The Nature of Money (2004) p.145-146

The book to which Geoffrey refers is Monetary Policy in the Euro Area by O. Issing (2001). 

So, central bankers aren't scientists. They're pragmatists. I'd say that the theoretical basis of their decisions is less relevant and less revealing than the political basis of them. It's just so much hot air. Look at what Montagu Norman, said of his time as Governor. "....we collected money from a lot of poor devils and gave it over to the four winds." I watched Mervyn King on Bank of England video say that "... money is just bits of paper, really". Really? It's a wonder why poverty is such a bugger to deal with then, if all you need to solve it is bits of paper.

Some folks liked Andy Haldane's 'Occupy was right' speech. For me it was more evidence of the inherent political 'nature' of central banks. The very thing they're not supposed to be, but inevitably are. I'd suggest the excellent Lords of Finance by Liaqaut Ahamed (my ramble on it) if you're unconvinced. It's a very well written history and the portraits of the four central bank governors are exquisitely made. My criticism would be that in judging the merits of the Governor's decisions Ahamed does labor under the idea that this economics malarkey makes some kind of sense. A mistake in my view.

I really think Central banks are sophists. But it's not like they have a choice. They have to be. It's their job.

Wanting them to be 'consistent and logical' is all well and good. But what we really want is reassurance. Reassurance that they know what they're doing and that everything's going to be all right. Whereas infact, we're asking them to turn lead into Gold; to deliver monetary and financial stability using mix of broken and partial theories about economy. And clearly they have no more of a clue as to what Money is, or where Value comes from, than anyone else. Or at least if they do, it's tacit knowledge. It's not available for deconstruction, modeling and prediction.

A few years ago I read Economics and Reality by Tony Lawson. A Cambridge colleague of Geoffrey Ingham. I'm not sure I understood everything Lawson was saying, but effectively what he was trying to do was to give a coherent philosophical basis (of 'critical realism') to the 'science' of economics. He (respectfully) critiqued Hayek and argued for a 'rule of thumb' approach to economics. He didn't mention Money once, nor I think does he mention central banks. I have his follow up Reorienting Economics unread on my book shelf.*

This gives you a flavour of Lawson's beef with economics.

"...the continuing failure of the discipline [of economics] must be put down to the often quite irrelevant, typically formulistic, methods and techniques which economists naively and unthinkingly wield in a forlorn hope of thereby gaining illumination of a social world that they do not 'fit'.
Of course, a failure to appreciate this, coupled with the corresponding persistent failure of the project to achieve any result of interest leads, in its turn, to the development of immunising strategies, ever increasing levels of technical complexity of models, the resort to computer simulations, and so forth. It leads, in short, to any response that is consistent with the misconceived, taken for granted, yet hardly fruitful standard conception of science being sustained." (p 225)

So its not central banks you should blame. It's economics and its ill-fitting white coat.

I'd say I'm more pragmatic libertarian than collectivist who believes in individual freedom (although I recognise the contradictions in both those descriptions). I'm more Hayek than Keynes. However, I do find myself in some agreement with Ingham and Lawson and the undercurrent in Modern Monetary Theory (MMT) that to some extent, it is science that will have to change if economists are to act as Keynes hoped as "trustees, not of civilisation, but of the possibility of civilisation". There's something wrong with science. Money and Value exist and science's failure to get to grips with them is not their failure, it's science's failure. Having said that, I don't think MMT, Lawson and Ingham are on the right path with their projects. I think ultimately a true understanding of Money and Value will be concomitant with a science that's tighter and narrower rather than looser and wider.

And not to let Freidrich off the hook either, as I've explored briefly in recent posts (and at length in some unpublished posts) his whole Value-Price-Money thing is wrong. Ingham is right on that. Money comes before price.

I think Hayek would agree about wanting economics to exist in a tighter and narrower science, rather than a looser and wider one. He was very hot on all that sort of thing. He doesn't generally give a great soundbite, but this is not too bad. If you watch the video you'll see a cheeky, almost self-satisfied smile after he says it.

"The fact however that socialism is a logical result of rationalism does therefore not prove that socialism is right, but rather rationalism is wrong."
(here at about 41 minutes)

You wonder why we bother listening to central bankers at all. (Or perhaps we don't?)

[I recommend keeping an eye on Magic, Maths and Money by Tim Johnson for a high-level critique and discussion of the maths/money/science nexus (I don't claim to understand all of Tim's work - I feel mathematically illiterate when I read his blog)]

Anyway, back to that patient being hyperactive, but prescribing steroids (originally from an article in FT - it's paywalled so I won't bother linking). Economists/central bankers being like medical doctors is a good comparison. (Although I'm not sure the steroids/hyperactivity metaphor holds water, but we get the gist).

Nassim Nicholas Taleb NNT says “Doctors most commonly get mixed up between absence of evidence and evidence of absence” - You could equally apply this to central bankers.

I have a problem with Doctors, too. For me, the very idea of medical science sounds a klaxon in my head. If there's a blog out there like this one, except by a van-driving frustrated biologist or medic, instead of 'What is Money?' their question would be 'What is Life?' I suspect that the exploration of either question would expose the same deep fissure in science. Below the level of NNT's complaints about evidence there are fundamental problems with theory. With ideas. Specifically with descriptions of phenomena (Money, Life) morphing into definitions.

However, just like the general population with the proclamations of central banker, if I, or a loved one feel ill, I'd visit a doctor, listen to what he has to say, and whatever my thoughts on the efficacy and applicability of scientific methodology to the health of living organism, I'd probably follow the doctor's advice.

Unless of course, I felt otherwise. And my faith in my feeling outweighed the credibility and authority of the doctor's advice.

It all comes down to Value in the end.

* mindful that NNT says;
“Read books are far less valuable than unread ones. The library should contain as much of what you do not know as your financial means, mortgage rates, and the currently tight real-estate market allow you to put there.” The Black Swan. The Impact of the Highly Improbable

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