Awkward Utopia

Economics is widely considered a science, up to a point. What kind of a science is an issue still up for debate. Some believe it merely a “social” science, and it is, though it is much more than any of the other social sciences. In particular, it seems that microeconomics forms the basis for the most solid part of this science. As Matt pointed out, Stigler made a case for economics as a science in The Theory of Price textbook where he described why we use theories (so that we can explain and predict things across some common trait) and when we should use them (whenever a theory is right more than the previous theory, or at the very least, when the theory is right more than 50% of the time). In the end, one of the more important concepts is that of ceteris paribus, which means “all other things are equal.” Economics try to tease out the effects of changes in one variable by holding all the other variables constant, insofar as this is possible.

But not every economics theory survives scientific rigor, tested empirically for verifiable results. One field that traditionally was far from a science but that we have been learning more about is the science of monetary policy. In the United States, the direction of monetary policy is the exclusive purview of the Federal Reserve Bank, which has few friends within the UF University Economics Society. Frederic Mishkin, a member of the Board of Governors for the Bank, a very powerful position, delivered remarks regarding the development of this science in September 2007 during a conference in Germany. He highlighted the following revelations of monetary policy science:

1. Inflation is always and everywhere a monetary phenomenon.
2. The benefits of price stability.
3. No long-run tradeoff between unemployment and inflation.
4. The crucial role of expectations.
5. The Taylor Principle.
6. The Time-Inconsistency problem.
7. Central Bank independence.
8. Commitment to a nominal anchor.
9. Financial frictions and the business cycle.

A full review of these principles is beyond the scope of this blog post, and my own knowledge of economics, so I will omit them here. However, I will say that the paper explains how advances in the understanding of these issues have led to certain applied monetary policies and that the paper is well worth reading. More controversially, the author seems to think that having a Central Bank is a good idea, the currency for which seems to have run out a long time ago (pun intended).

In any event, even Austrian economists would be hard-pressed to disagree with most of the aforementioned findings. Ron Paul openly admits on behalf of the Austrian movement the first one, which Milton Friedman also pointed out. These CB naysayers just think of money as a commodity that should not be controlled by the government. The reality, however, is that the United States will have a Central Bank for the foreseeable future and we all have an interest in making sure that it acts responsibly, well-insulated from political pressures. The reason why political pressures would be bad is because they will often be based on judgments unrelated to prices, not real prices, which are the most knowledgeable and therefore efficient allocators of goods.

Unfortunately for the European Union, which must deal with its own Central Bank (the ECB), political pressures are mounting against those who have maintained a tight monetary policy. The alliance stretches across political lines because the thing that they have in common is not ideology, unless statism is an ideology, but rather that each leader’s country is undergoing a painful economic slowdown or sluggishness. Here’s more from Ambrose Evans-Pritchard in the Telegraph:

Silvio Berlusconi’s return to power in Italy is a nightmare come true for the European Central Bank, opening the way for a Rome-Paris axis with the political muscle to force a change in monetary policy. The billionaire politician has pledged an alliance with France’s Nicolas Sarkozy aimed at humbling the bank and asserting the primacy of elected leaders over interest rates and the currency. “A very strong euro is hurting Italy’s economy. I will discuss intervening with the ECB with Sarkozy,” he said. […] “Politics is everything in EMU, and the re-election of Berlusconi represents a big shift in the political balance of power,” said Bernard Connolly, global strategist at Banque AIG. “Spain will probably join France and Italy before too long, so you will have three of the big four eurozone countries in the same camp. They can set ‘broad guidelines’ for the ECB. It is a total misperception that the ECB should not be subject to political influence.”

Politicians with weak economies are anxious to shake off some principles monetary policy science for short-term political gains. It is hard to say in the absence of the private sector dealing with money whether or not a looser money supply would lead to more efficient outcomes, but there can be little doubting that the ECB is consciously pursuing a strong currency policy which makes its exports far less attractive to firms in the United States. Conversely, despite the myriad news of soggy economic conditions, one of the policies keeping the economy afloat in the United States may very well be its relatively loose policy.

Update: An article on BBC today highlighting that Zimbabwe’s octogenarian dictator, Robert Mugabe, is a voodoo priest of monetary policy science. His country printed $500m notes this week, only 10 days after publishing $250m notes. The government is ignoring science trying to keep its people alive and its murderous elders in power, but only succeeds in putting the country on a treadmill to nowhere.