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Do central banks rely too much on economists?

Economics is of only limited help in understanding money

If  economics is likened to a religion it is easy to see how it may be viewed as dangerous. It may blind its devotees to the claims of competing world-views. If  economists arrogantly claim that their special insight gives them the right to prescribe policy, it may provide spurious legitimacy for harmful actions. It may lead them to ignore the fact that differences in values may lead people to prefer different outcomes to that which appears economically “efficient”..

The target of critics who compare economics to a religion is usually a particular school of economics – the rational expectations/efficient markets hypothesis. They then summarise this (rather unjustly) as the naive belief that “markets are always right”.  That’s not what I have in mind.

But there are other ways in which reliance on economics can be an obstacle, rather than an aid, to good policy.

The key distinguishing feature of the global financial crisis (GFC) is not that no mainstream economist saw it coming. It is, rather, that it was the first to occur under the watchful eye of hundreds of economists, of central banks largely run by economists and an international effort at financial regulation unprecedented in its scale and sophistication.

This gigantic structure was designed – at vast cost ultimately paid by the public – to reduce the probability of another crisis, or to limit its potential destructiveness if one nevertheless occurred.

An enormous wager

The structure had taken 40 years to build – a period puctuated by varous crises that were at the time considered shocking. In the 1980s and 1990s we were fully aware of the historical frequency of crises. Only a few months before the GFC broke out, in 2007, I was personally reassured by a senior executive at the Bank of England that “we are constantly scanning the horizon” (and here he raised his hand to his brow as might a sailor on the bridge of a large vessel) “for icebergs, hidden reefs and other dangers” to the financial system.

The experience of the crisis – which was larger and more destructive than any before it – has led to reforms. What it has not done is made society alter its  approach or change the kind of people in charge of the ship. Economists are still deemed to have a special insight into the world of money.

Society has wagered an enormous bet on economists getting it right next time. Years of world GDP  growth could be at risk.

In the light of experience is it not time to reconsider the claims of economics to provide the intellectual basis for such exercises in  “social engineering”?  After all, that is  what current regulation, especially so-called macro-prudential regulation, amounts to. We have doubled down.

This is dangerous

True, politicians must take the ultimate blame. In the run up to the crisis, they eagerly used the excuse of delegating supervision to outside expert bodies to advance their own agendas. They put pressure on regulators to lighten their surveillance and on central banks to allow the expansion of money and credit. But they could only do this because we were all gullible.

In fact, economics does not provide by itself any special insight into the nature of the raw material of central banking – money.

More on that in a moment. But first, some reflections on central bankers’ attitudes.

It may surprise people to know that, in my experience, central bankers do not like money – I mean, they do not like to see their job as handling money. They hardly ever mention money in their communications. An authoritative review of central banks’ inflation targeting regimes and communications strategies does not once mention the word “money”.

Andy Haldane of the Bank believes that money is a subject dear to the hearts of central bankers.  I don’t agree. Of course, they are only human; they do not decline a decent salary. But professionally, they tend either to dismiss it or run away from it. Especially in the UK and US – continental Europeans and Japanese have somewhat different historical experiences and different cultural attitudes.

Ever since I can remember, the Bank of England has distanced itself from both the word and the idea. Post World War II, up to and including the 1960s, it left such matters to the Treasury. In the 1970s, its executives thought that inflation was the result of cost-push pressures, conflict over the distribution of incomes and government sfiscal policy- i.e. nothing to do with money or with the Bank.  In the 1980s it fought a bitter battle with Margaret Thatcher’s government to avoid being saddled with targets for money.

What the Bank hated most

The Bank hated, above all, being told to target the money base.  It won the struggle. It thus avoided being held accountable for the only thing it could, without any doubt, control – its own balance sheet.  It later dropped all monetary aggregates with indecent haste. As Charles Goodhart among others has often pointed out, money does not feature in the models central banks use to – well – manage money. Just look at any Inflation Report. They are all about output gaps, prices, etc.

It is ironic that only since the collapse of all central bankers’ dreams of financial stability – only since the Great Crash – have they openly turned to money itself. Indeed,  they have tried to create as much of it as possible. They even admit to it. They embrace it as the cure for so-called deflation (which is more myth than reality) while turning their eyes away in distaste. But society has not returned the embrace. Private money has shrunk in the face of the tsunami of official money.

Some central bankers were so cross about this they propose to nationalise money creation once and for all.

What really went wrong was that  their failure to understand what money is meant that when the central banks finally embraced it, they did so at the wrong time and in the wrong way.

Why central bankers distance themselves from money

Low status. In most societies for most of recorded history classes of people dealing in money have had a low social status. And quite right too, you may murmur. It is a method of social control we have dispensed with to our cost. In the old days, after making your pile in the City you would buy a country estate, dress up in country garb and pretend it was all “old” money. Now the filthy rich still buy estates in Wiltshire etc and buy artworks but often vaunt their background in the money industry! What, no shame?

But for many it still carries a social stigma. Central bankers have always prized social status highly because their pecuniary rewards (money in their pockets, ha, ha) were, traditionally, relatively low compared with what they could get in the markets (though matters have changed recently). Most still prize their image as public servants.

The unsavoury Freudian myth

Then, Sigmund Freud said that the root of your love of money lies in infancy. Yes – in your infantile fascination with the waste products of your body. Psychoanalysis taught the 20th century that it was impossible to talk plainly about money. As discussed in “The Currency of Desire”, a new book by David Bennett, all money discourse is heavy with meaning. It must be decoded. By experts.

Money, for Freud and his followers, was a veil – not, as it is for economists,  a veil covering the real economy, but rather a veil concealing irrational and often unconscious motives.  People’s behaviour towards  money needed to be interpreted  through a language quite foreign to – and hidden from – the actors themselves.  Their real motives usually were quite different from what they thought:

“From its inception, psychoanalysis has viewed the psychology of money as profoundly irrational – as a realm of illusion, neurosis, phantasy and psychopathology, both individual and collective”.

(David Bennett, New Formations, Issue 72, Winter 2010 )

The basic Freudian story about money is familiar enough. Born and raised in the days of the classical gold standard, in a society dominated by the “Victorian” values  of orderliness, cleanliness and thrift, Freud heretically suggested that these  should be viewed as  “reaction formations” against the infant’s interest in its excreta. He pointed out that the everyday language of money had always been closely linked with dirt, as in “filthy lucre”.

Central bankers would rather think about their job in different terms – assuring “price stability” etc.

Money is good for buying opera tickets

Freud influenced Maynard Keynes. Though a monetary historian and theorist, as well as an active investor, Keynes turned up his sensitive Bloomsbury nose at the very idea that money was an object worth possessing:

“The love of money as a possession— as distinguished from the love of money as a means to the enjoyments and realities of life — will be recognised for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease ….”

It’s all OK, however, if you spend money on opera tickets.

I recall, as if it were yesterday, presenting an essay – I think it was on the consumption function – to Joan Robinson, a famous disciple of the great man and one of my tutors at Cambridge. I happened to have been reading Milton Friedman – oh, dear – and made the mistake of mentioning money. “Money?”, she queried, “do you mean monetary income?” (as distinct from real income).

Needless to say, you didn’t learn much about money at university economics courses in those days.

Sublimation through economics?

Economics provides a way of sublimating a dirty business. It elevates such talk into rarified maths and abstract concepts. Yet at the same time it serves as a barrier to understanding markets powered by lust for money.

Economists’ notions of money as a means of payment, store of value etc, etc describe some of its functions in some (not all) societies, not what it is.  The classical Greeks knew better. We can learn more about the nature of money from the myth of King Midas.

The moral of the myth is clear: as soon as money is real, it immediately turns into an ominous, threatening object. It controls you. (See an interesting if challenging new book “What Money Wants: An Economy of Desire”by Noam Yuran with an excellent preface by Keith Hart.) Yuran defines money not as anything that is widely accepted as money but as an object desired as money. It is an object that makes possible unlimited desire. He points out that orthodox economics totally fails to account for many phenomena – e.g. greed.

Keynes was on the right lines. But he did not explain the reason. Love of money as a possession necessarily means being possessed by money. In the 1920s DH Lawrence warned that society was already possessed by it. Over the following 50 years, another world war, the Cold War and innumerable lesser conflicts distracted people from this obsession.

But in the past 20-30 years, as a natural accompaniment of the creation of a global monetary space, it has spread worldwide – along with other associated monetary diseases. People possess more money than ever before. But more people than ever before are also possessed by it.

Yet as long as they mistake the nature of money, central bank economists will remain far from understanding the importance and implications of all this.

New waves of credit

Headlines again proclaim that we are “awash in a sea of easy credit” (The Times, July 26).

Our defences are weak. We have money but no true standard.  Yes, some central bankers have started to warn about the risks of credit expansion. But the system forces central banks to go on misusing money. They see it as a technique of social engineering. That is to mistake its nature.

Although reforms have been made, they have not changed the social attitudes that led to the GFC.

These go far beyond the specific fields of central banking and bank regulation.The enigma of money holds us all in thrall. But we do rely unduly on economics and economists to avoid (and/or minimise) future crises. The discipline certainly has its uses. It is not the root of all evil. But far too much is being asked of it.

Unintentionally, we are at risk of being misled again.

That is why my book is called The Money Trap.

For why we are still in it, see here.