Fighting the Last War

Paul Krugman makes an interesting analogy between macroeconomic policy and the process of “generational forgetting,” whereby the harms of abusing certain kinds of illicit substances come to be well-known and then culturally lost after use plummets.

But in some ways I feel that we suffer not so much from forgetting as from learning. The current cohort of central bankers around the world simply seems deeply invested in the story of the heroic triumph over inflation in the early 1980s. It was the finest hour of the institutions they head, and they will desperately do anything to avoid jeopardizing what they invariably term the “hard won gains” of that era. To those of us who are from a younger generation, this looks puzzling. It’s simply not clear why your loss function would be so heavily weighted toward this particular fear. If anything, the moral of that era looks to me to be the opposite of the one central banks have drawn—once the conceptual issues were understood correctly, it was really easy for central banks to break the back of inflation. It’s a moment central banks celebrate because their tools worked so very well, and, consequently, there’s no need to run around acting paranoid about the small chance of the recurrence of that situation. What we should worry about is the situation we’re actually in, which has quite different dynamics and is alarming in part precisely because we can’t be as sure we know how to tame it.

If you read John Hilsenrath on how Ben Bernanke won the Fed over to more expansionary policy, you’re just left with an overwhelming impression of how fundamentally backward-looking the whole institution is. “Unemployment is really high and inflation is low, so we should do monetary stimulus” is not a principle that it should be this hard to persuade people of. It’s like saying we should turn up the heat if we want the house to be warmer.