Monetary Policy under Uncertainty

The Federal Reserve Board ^ | August 29, 2003 | Alan Greenspan

[Starwind]

we cannot be certain that our simulations provide reasonable approximations of the economy's behavior in times of large idiosyncratic shocks.

Translation: Bureaucratic idiots do shocking things to the economy that defy reasonable simulation.

For example, following the Russian debt default in the fall of 1998, the Federal Open Market Committee (FOMC) eased policy despite our perception that the economy was expanding at a satisfactory pace and that, even without a policy initiative, was likely to continue to do so.

Translation: Even though we knew we had already inflated the stock market bubble, we inflated some more just to be safe.

For example, inference of how market participants might respond to a monetary policy initiative may need to reference past behavior during a period only roughly comparable to the current situation.

Translation: Sheesh! Who would have thought those crazy bond traders would really believe we were fighting deflation and we would cut rates further and buy back long bonds?

[Starwind]

fyi...

[Starwind]

An analysis has been posted by Arete on FR at Greenspan's Uncertainty Principle -- Economic Commentary by John Mauldin

[hauerf]

Greenspan has lost it if he ever had it. Steve Forbes for Fed Chairman.

[Tauzero]

"our knowledge about many of the important linkages is far from complete and in all likelihood will always remain so...

"Every model, no matter how detailed or how well designed conceptually and empirically, is a vastly simplified representation of the world that we experience with all its intricacies on a day-to-day basis....

"the relationships underlying the economy's structure change over time in ways that are difficult to anticipate...

"These assumptions--linearity in the structure of the economy, perfect knowledge of the interest-sensitivity of aggregate spending and other so-called slope parameters, and a very specific attitude of policymakers toward risk--are never met in the real world..."

"Our problem is not the complexity of our models but the far greater complexity of a world economy whose underlying linkages appear to be in a continual state of flux.

"And even these risks are generally quantifiable only if we accept the assumption that the future will replicate the past. Other risks are essentially unquantifiable--representing Knightian uncertainty, if you will--because we may not fully appreciate even the full range of possibilities, let alone each possibility's likelihood..."

These passages make a great case against central planning -- and central banking.

Does he comprehend the implications of his own words?

"That any approach along these lines would lead to an improvement in economic performance, however, is highly doubtful. "

On the contrary, Mr. Chairman, fixed rules are more easily accomodated and hedged by the markets, which are much bigger and robust than any fed banker or fed bankers. By adhering to a set of simple rules, the fed would eliminate uncertainty from some important variables -- variables set by the fed itself.

But such self-restraint is difficult for someone in power. What central banker or legislator wants to believe they can be replaced by, and the public be better served by, a simple fixed rule?

"Rules by their nature are simple, and when significant and shifting uncertainties exist in the economic environment, they cannot substitute for risk-management paradigms, which are far better suited to policymaking."

He misunderstands the purpose of a rule. And misstates the case. It is not true that if the fed adheres to formal rule, that rules are being substituted for risk-management. It means the responsibility for risk management will lie, where it should lie, with the multitude of market participants, rather than a small group of bankers.

The question is not whether rules make for better policy, but whether there should be policy at all.

[Starwind]

He misunderstands the purpose of a rule. And misstates the case. It is not true that if the fed adheres to formal rule, that rules are being substituted for risk-management. It means the responsibility for risk management will lie, where it should lie, with the multitude of market participants, rather than a small group of bankers.

Rules also mean a definite criteria has been set, against which performance can be measured and refinement and extension of the rules and models done.

Without rules, you don't know where you are going and accordingly any road will get you there.

It is the performance measurement Greenspan and the Fed wish to avoid. With rules in place and being missed without reason, their incompetance, and the fallacies of central banking, would be exposed.

[Tauzero]

The simplest rule, of course, is a gold standard. ;)

[Starwind]

The simplest rule, of course, is a gold standard. ;)

Follwed by "he who has the gold makes the rules"? :)

[TopQuark]

What nonsense!

Don't try to translate from the language that you clearly do not comprehend.

[TopQuark]

These passages make a great case against central planning -- and central banking.

Absolutely! As well as a great case against any other institution.

[TopQuark]

On the contrary, Mr. Chairman, fixed rules are more easily accomodated and hedged by the markets,

Really?

Would you care to tell us what these rules are?

[TopQuark]

By adhering to a set of simple rules, the fed would eliminate uncertainty from some important variables -- variables set by the fed itself.

Have you ever built a model? Of anything?

The above-quotes internally inconsistent statement suggest that you have not.

[TopQuark]

The question is not whether rules make for better policy, but whether there should be policy at all.

That question may be asked and discussed. It was, however, outside the scope of the speech.

[TopQuark]

The simplest rule, of course, is a gold standard. ;)

Yeh! And even simpler one: don't forget to breeth on Frifays.

Has as much relevance as the one you suggested.

[Tauzero]

"Would you care to tell us what these rules are?"

Any fixed rule.

[Tauzero]

" Have you ever built a model? Of anything?"

Indeed.

[Tauzero]

" That question may be asked and discussed. It was, however, outside the scope of the speech."

Yes. A deliberate omission.

[Tauzero]

" Has as much relevance as the one you suggested."

Of course -- I've been informed that's outside the scope of the speech.

[Tauzero]

" The above-quotes internally inconsistent statement suggest that you have not."

There's no inconsistency. You've just missed the point.

[Tauzero]

"As well as a great case against any other institution."

Not at all.

It's a case only against those institutions established by force of law and primarily dependent on articulated, centralized knowledge.