RE: PKT Seminar: FRB Theories

["James K. Galbraith" <lpgc403@xxxxxxxxxxxxxxxxxxx>]

Eric Nilsson asks whether my search for a coherent theory in all the wrong
places (e.g., at the Federal Reserve) indicates a belief, on my part, that
the Federal Reserve in fact operates on the basis of theory, as opposed to
hidden interests of one sort or another.

This is an interesting question. The answer, actually, is no; I do not draw
the implication that theory rules over interests on Constitution Avenue.
But it is a "no" that comes in two parts.

On one hand, I'm indulging in a game of elimination. Had I found a theory,
an argument about macroeconomic conditions consistently applied to the
evidence over time, behind Federal Reserve actions this year, I would have
had to concede at least the possibility that a theory governed policy. But
it is precisely my inability -- and I think that of anyone else looking at
the record -- to find such a theory that raises the grave possibility
that some other agenda, largely unrevealed to the public, is driving
monetary policy. I mention some possibilities, including party politics and
a desire to shore up the market position of banks as against stock and bond
mutual funds. There is circumstantial evidence for the first and some actual
hints in the public record for the second. And each would be a more
consistent account of monetary policy actions than is offered by the
supposedly macroeconomic discussion in the official record. But while I
can't eliminate these possibilities, the evidence I have falls short of
allowing me to confirm them, either.

On the other hand, I'm trying to make a point that is perhaps not so much
about the actual basis on which the FRB and FOMC make policy, as it is about
the way that a dialogue over monetary policy can be conducted between the
Central Bank and its constitutional overseer, the Congress. My argument is
that such a dialogue, to be coherent and candid, must be a discussion about
a theory of policy, conveyed in official testimony from the FRB to the
Congress. Failing that, oversight can only be a matter of propaganda on one
side or the other.

The distinction I'd draw between Paul Volcker and Alan Greenspan is that
Volcker at least offered a theoretical rationale for the policy steps he
took in October of 1979. When he began to deviate from the dictates of that
rationale in 1981, there was a clearcut issue that Congress could raise with
him: why is money so tight relative to your own targets? When he abandoned
monetarism in 1982, Congress could fairly say, "monetarism is dead: what
next?" And so on.

But with Alan Greenspan, we have a differing rationale with virtually every
statement, and sometimes flat contradiction from one public statement to the
next. Examples are given in the article. To me, this is powerful evidence
that the institution is failing in its most basic mission, which is, after
all, the conduct of monetary policy. Why should we continue to delegate vast
power to a Central Bank that cannot communicate a coherent account of its
actions? These are not atomic secrets, after all. If such an
account exists at all, it should be possible to render it into intelligible
English, and to give sources and methods, as we are all out here in the real
world required to do if we seriously want to persuade anyone of anything.

I'd be curious as to the reactions of other pkt-ers to this line of
argument.
****

James Galbraith
The University of Texas at Austin
LPGC403@xxxxxxxxxxxxxxxxxxx
fax (512) 471-1835