Wednesday, February 13, 2013

Why Doves Are Really Hawks


Machismo is a type of commitment mechanism. 

If you’re a perfectly rational nerd, people will always expect you to do the rational thing.  You won’t be able to make credible threats unless it would be rational to carry out the threat.  And it seldom will be.  After all, how often is it really rational to whoop someone’s ass?

On the other hand, if you’re a tough, macho badass, people will always expect you to do the tough, macho badass thing.  You’ll always be able to make credible threats, because carrying out threats is always the tough, macho badass thing to do.  And since the threats are credible, you mostly won’t have occasion to carry them out.

This principle has a traditional application to monetary policy.  If your central banker is a perfectly rational nerd, he’s going to let the inflation rate get too high, because he won’t be able to make a credible threat to cause a recession.  People won’t expect him to carry out the threat, because in most cases it won’t be rational to carry out the threat.  After all, how often is it really rational to cause a recession?

On the other hand, if your central banker is a tough, macho badass, he’s not going to let the inflation rate get too high, because he will be able to make a credible threat to cause a recession.  People will expect him to carry out the threat, because causing a recession is the tough, macho badass thing to do (for a central banker).  And since the threat is credible, people will keep their prices down, and he won’t have to carry it out.  (OK, the economics is a little more complicated, but that’s the general idea.)

So what kind of central banker do you want if you hope to keep the inflation rate from getting too high?  Obviously you want a tough, macho badass.  You want the kind of central banker that likes to pick up small animals in his talons so that he can crush them to death and serve them for dinner.  You sure as hell don’t want the kind who just likes to fly around looking pretty and making cute cooing noises.

That theory made a lot of sense in the 1980’s, but the world has changed.  The inflation rate hasn’t been too high for 20 years.  We are in the middle of a minor depression, and the way to get out of it is to threaten inflation.  Tell people they had damn well better start doing something useful with their cash or else, as soon as you get a chance, you’re going to make its purchasing power start evaporating.  Of course, when the time comes, it won’t be rational to carry out that threat.  If you’re a perfectly rational nerd, the threat won’t be credible.

So what kind of central banker do you want if you hope to get out of this depression?  Obviously you want a tough, macho badass.  You want the kind of central banker that likes to pick up small animals in his talons so that he can crush them to death and serve them for dinner.  I’m certainly no expert in ornithology, but it just seems to me that “dove” is not the right term for that kind of central banker.



DISCLOSURE: Through my investment and management role in a Treasury directional pooled investment vehicle and through my role as Chief Economist at Atlantic Asset Management, which generally manages fixed income portfolios for its clients, I have direct or indirect interests in various fixed income instruments, which may be impacted by the issues discussed herein. The views expressed herein are entirely my own opinions and may not represent the views of Atlantic Asset Management. This article should not be construed as investment advice, and is not an offer to participate in any investment strategy or product

68 comments:

Nick Rowe said...

Yep. What we need is a symmetrical hawk.

João Marcus said...

In other words: You need 'Chuck Norris'!

Peter said...

We need some Rooseveltian resolve.

Will said...

If that's right, seems like we need to install Mr. Robert Magabe at the Federal Reserve. Hjalmar Schacht would be my first choice, but he's tainted by his political associations and, even worse, dead.

Kaleberg said...

It isn't rational to expect tough macho bad asses to carry out their threats, because most of what they do is posturing. There are always jumped up tin pots making a lot of noise, but they typically cut and run when the going gets tough and they have to make hard choices.

The ones who tend to do what has to get done are usually the quiet, mousey types. They'll jump nine feet in the air when a car backfires, but they'll shiv granny and the five year old it that's what it takes.

(A good example is George W. Bush who made a lot of mouth noise about getting Bin Laden, but wimped out horribly. It took Poindexter Obama to actually gut the guy.)

As for fighting inflation, it was quiet, low key Paul Volcker who did what had to be done to fight inflation after all the pissing and moaning of the 70s. He put the economy into a tailspin without batting an eyelash.

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