A Canadian Economist Looks at US Federal Reserve Policy Makers

This is funny but frightening. It is funny because of the language (you Americans are so screwed!), it is funny because it points out something so incredible it is really, really had to believe, but it is tragic because this is how really, really badly the key policy makers in the US misunderstand fundamental economics. From Nick Rowe, economist at Carleton University, writing in the Worthwhile Canadian Initiative blog:

Why "everyone" should be forced to take Intro Economics

The reason is not what you are expecting. It's because maybe if he had been forced to take Intro Economics, the 12th President of the Federal Reserve Bank of Minneapolis, who holds a PhD in Economics from the University of Chicago, who is a specialist in money and macro, who has a CV that creams mine 100 times over, would not be making mistakes like this.

"To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation."

That could be interpreted two ways: a wrong way, and maybe, just maybe, a right way.

"When real returns are normalized, inflationary expectations could well be negative, and there may still be a considerable amount of structural unemployment. If the FOMC hews too closely to conventional thinking, it might be inclined to keep its target rate low. That kind of reaction would simply re-enforce the deflationary expectations and lead to many years of deflation."

Nope. He definitely meant it the wrong way. If the economy returns to normal, and the natural rate of interest rises, the Fed must raise its target rate of interest. (So far so good). If it doesn't, the result would be....deflation. ("Inflation" would be the right answer).

I never did understand how the Fed makes decisions. But if the President of the Minneapolis Fed, and people like him, have any sort of power over monetary policy, we ( OK, Americans especially, but probably Canadians too, getting caught by the implosion) are so totally screwed.

I notice he has an undergraduate in maths, then went straight into a PhD in economics. My conjecture: I bet he never took Intro Economics, or anything vaguely similar. I bet he waded straight into the mathematical deep end. And so he never really learned economics.

Nick Lowe doesn't expand on this, but this policy maker's views reflect the right wing "fresh water" economics of the University of Chicago and the pseudo-scientific economics pushed by that school, i.e. a mathematical fantasy land assuming "rational" economic actors fully informed making all decisions in a way that optimizes money and nothing else. It is a heartless, unworldly "economics" that has infected the whole discipline. For this reason, modern economics had -- and has -- no answers for the Great Recession. According to their theories, this kind of banking panic is impossible. In their world prices fully factor in all knowledge so the idea that the banking system would collapse or that companies would now sit on cash makes no sense. But in the real world, trust and credit collapse and sensible businessmen become risk-averse in a world of failing markets. But you can't find that in the equations pushed by the Chicago school.

Oh... and notice how Nick Lowe points out that "Canadians are probably screwed too". Canada's economy is deeply integrated with the US. When Bush decided to "tighten security" he didn't consult with Canadians, so immediately miles and miles of trucks started building up on the border because the "just in time" manufacturing spread across the border got screwed as over-worked border security guards started "inspecting" things not inspected before. It threatened to sink the Canadian economy and it was done by the US without a single thought.

You can see the asymmetry of the relationship by the fact that today, the anniversary of Katrina, when Obama is giving a speech in New Orleans, it is carried live on three of my cable channels (the government English language channel, the government French language channel with simultaneous translation, and the independent CTV channel). There is only one US channel carrying Obama's speech live, CNN. It isn't on NBC, ABC, or CBS. Invariably major addresses and key US political events are carried live on Canadian TV. I've never seen any major Canadian event ever carried live on any US channel. What this means is that Canadians know more about the US than most US citizens. You can see this fact when Canadian contestants show up on US game shows and are able to compete effectively. An American put onto a Canadian game show would be completely lost. Americans know nothing about Canada other than that it is the land of igloos and polar bears. Yeah, right!