Last week Bank of England chief economist Michael Haldane used an event at the Institute for Government to warn against putting too much faith in economists and their forecasts. He compared the failure to predict the Global Financial Crisis to a famously inaccurate weather forecast by BBC weatherman Michael Fish, who failed to predict a major storm in the UK in 1987. The comparison is kind to his profession: Fish’s slip-up was a one-time error, whereas professional economists for years completely ignored dangerous imbalances building up in the world economy. And they’re at it again. With bubbles in most major asset classes after years of extremist monetary policies, few mainstream economists see any danger of a repeat of 2008 (we do). Widespread predictions of economic decline in the aftermath of Brexit also so far has proved way off the mark. The BoE was obviously amongst the highest profile doomsday prophets leading up to the EU referendum, but despite getting the prediction of stagnation in the 2nd half of 2016 completely wrong, the official BoE line is still that the downturn will come – just not yet.
While it was refreshing to hear a high profile economist recognise the poor track record of the profession, Mr. Haldane stopped well short of drawing any conclusions. He sees no issues with a profession, which according to himself is ‘in crisis’ due to their poor performance, being in charge of price fixing in the most important markets in the world economy, the money markets. Central bankers may routinely get it wrong, but they should still be left in charge of executing monetary policy as they see fit, based on their erroneous forecasts.
The BoE, and especially Governor Mark Carney, has of course come in for much criticism since the EU referendum and Mr. Carney was under some pressure to resign. But there have been no calls for a rethink of the reliance on central banks to engineer economic outcomes.
And this despite the list of casualties of central banking being long and growing. The history of central banks is a tale of burst bubbles, recessions and recoveries. The Austrian theory of the business cycle (see appendix below) explains how artificial monetary expansion distorts capital allocation and leads to bubbles which eventually bursts. Interest rates serve as prices on intertemporal consumption and are integral to the capital allocation process. Interference by central planners will lead to sub-optimal outcomes, unless the planners possess perfect information. The error-prone guesswork of discredited economists is no substitute for market based price formation.
With economic forecasting increasingly exposed as nothing more than guesswork, the debate we should be having is why we leave so much power in the hands of the profession? Surely the calls for sound money and market based interest rates should be louder than ever. But no, Mr. Haldane’s answer is to work on the models, which are too ‘narrow and fragile’. The solution to the bankruptcy of the science of economics is more academic work.
He should rethink. Prices should not be given by dictate, they should always be generated in the market by dynamic interaction of supply and demand. As no one party can possibly possess the aggregate information of all market participants, only by free exchange can the price of any good be discovered. This is as true for interest rates as for any other good. But while price fixing is luckily generally denounced as unworkable by most economists, in the most important realm of money this is still bizarrely deemed not to be the case.
There is general recognition of the fact that the field of economics is in crisis. How bizarre is it then, that we still put faith in the profession to run the world economy? But calls for abolishment of the current system is only heard from the Libertarian fringe. We will have to suffer the consequences of economists folly for a while yet before the calls grow loud enough for the mainstream to hear.
Appendix: The Austrian Theory of the Business Cycle in 200 words
Interest rates are the price of money over time. A higher savings rate drives interest rates down and encourages business to engage in long term investment. This is appropriate as the consumer, by the very act of saving, has decided to spend income in the future as opposed to the present. The decision by consumers to defer consumption to the future makes available the resources that business invests for production. In this way interest rates coordinates consumption and production over time.
When interest rates are kept artificially low however, businesses are encouraged to over-invest, producing to meet demand in the future, when actual demand is more skewed towards present consumption. Consumers are even encouraged to increase current consumption, as the return on savings have dropped. This over-investment in longer-term investment projects are based on too little real saving of resources (consumers have actually not made the resources available through deferred consumption) and as a result not all projects will be able to come to completion. This is the inevitable recession, caused by artificial monetary largesse. The recession will, if given the opportunity to run its course, re-allocate production resources in line with real, inter-temporal demand.