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Last week, Federal Reserve Board Chairman Janet Yellen was awarded the Radcliffe Medal at Harvard’s Radcliffe Institute for Advanced Study. At a lunch in Yellen’s honor, Lizabeth Cohen, dean of the institute, praised the Fed chair’s “steadfast commitment to robust growth” and the way the she “steers our economy,” guided by the philosophy of her Yale mentor, Keynesian economist James Tobin.
Embedded in Cohen’s seemingly innocuous presentation of the award — as well as Yellen’s subsequent conversation with Harvard economist Gregory Mankiw — are several important premises about what economics is and what economists do. For generations, the mainstream of the economics profession — personified by Yellen and her predecessor, Ben Bernanke — has treated fiscal and monetary policy as, in Yellen’s own words, “tools” to promote growth and end economic inequalities.
That Yellen’s views are sincerely held is beyond question. But it is an open question whether the central bank really can “steer” the economy and whether its policies deliver the promised results.
A recent report from the St. Louis Fed suggests that Federal Reserve policies such as quantitative easing and artificially low interest rates do not moderate inequality. On the contrary, by focusing on buoying stock prices, these policies have inadvertently funneled more money to the very rich — especially to those with enough disposable incomes to invest in the equities market.
Thus, as economist Charles Wolf, Jr. has argued, the Fed’s policies have aggravated wealth and income inequality in the United States. Citing a rise in the country’s “Gini coefficient” — a way that economists measure inequality — Wolf notes that “private equity, hedge funds and venture capital funds [are among the] major beneficiaries of near-zero short-term interest rates.”
Libertarians have, since the Fed’s founding, warned that such monetary manipulations would benefit special-interest groups, in particular, the financial-world insiders who are best situated to take advantage of them. There is a disconnect between the Fed’s stated goals and the strategies it implements — a disconnect that can be traced back to a fundamental flaw in current, mainstream economic thinking.
In his forthcoming book Specialization and Trade: A Re-Introduction to Economics, economist Arnold Kling attempts to “expose and try to correct” certain widespread misconceptions about economics — in particular, about the dynamic phenomena of specialization and trade. Kling contends the economics profession went astray in the 20thcentury, with economists settling into a flawed paradigm during World War II, one that treats the economy as an apparatus to be controlled and repaired by appointed experts.
Following journalist Greg Ip, Kling categorizes economists into two groups: “ecologists” and “engineers.” The engineers try to “steer” the economy by employing mathematical models as tools. The ecologists, by contrast, are skeptics; they are reluctant to generalize from discrete data sets and mathematical equations. As Friedrich Hayek put it in his Nobel Prize lecture “The Pretense of Knowledge,” these economists are distrustful of the tendency of their discipline to “imitate … the procedures of the brilliantly successful physical sciences.” For this reason, the ecologists are less inclined to try to steer the economy.
It may not be immediately obvious why economics shouldn’t imitate the physical sciences. Given the remarkable advancement of scientific methods, the processing power of our computers, and the ostensibly boundless sophistication of our mathematical models, we might believe that central bankers, armed with latest economics research, are capable of treating economic infirmities.
But Hayek recognized something few economists understand today: that what we misleadingly call “the economy” is infinitely more complex than any machine or edifice human beings could ever design or build. The economy is in fact a living, changing, moving web of disparate actions and entities, each of which is composed of multiple, subjective judgments and motivations.
This is a difficult notion for economists who have been trained to regard themselves as practitioners of a “hard” science such as physics. The problem is that, unlike physicists, economists can’t come even close to controlling conditions in their laboratory — the economy — making it difficult, if not impossible, to isolate the causes of a given economic outcome. For this reason, Kling argues, economists must rely instead on “hard-to-verify interpretive frameworks.” These are the sets of philosophical ideas and normative claims that inform our judgments about the events we observe.
The ecologist’s skepticism is not global or unqualified; it’s not as though economics is entirely outside the realm of human understanding. The point, rather, is that we can know very little about this infinitely complex thing we call “the economy” at any given time. For that reason, we should hesitate to inflict our ignorance upon it.
Central bankers such as Yellen would do well to heed Hayek’s call for a humbler approach to economics.