Wednesday, July 15, 2009

Was the Fed fooled by randomness?

By this I mean, did it attribute too much of the moderation of the economic activity to its abilities to "guide the economy" using interest rate management?

Virginia Postrel argues a good case in Macroegonomics:

... what is striking about Romer’s lecture is not the chastened tone of its opening but the celebratory nature of its conclusions. “Better policy, particularly on the part of the Federal Reserve, is directly responsible for the low inflation and the virtual disappearance of the business cycle in the last 25 years,” she said (emphasis added). “In this area, the policy mistakes of the 1960s were a painful, but not permanent, detour on the road to excellent economic performance.” ... But containing inflation and eliminating, or noticeably dampening, economic downturns are two entirely different things. Congratulating policy makers for “the virtual disappearance of the business cycle” oversteps the evidence and encourages the hubris that fostered the current crisis and could make recovery more difficult. The conventional explanation for the Great Moderation gives too much credit to easily identifiable economic policy makers—“I feel the contribution of good policy cannot be overstated,” said Romer—and too little to all those anonymous managers and workers whose everyday actions get summarized in the aggregate statistics that Fed economists watch so closely.

But then this is not quite as audacious as:

The founder of the rational expectations revolution, Robert Lucas, is endlessly quoted as having stated in 2003 in his presidential address to the American Economic Association that the "central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades."


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