Wednesday, 6 March 2013

Are central bankers intelligent?


I have had many fantasy careers but, so far as I can recall, I have never wanted to be a central banker. Well, not until recently. In my youth I could see the advantages of being a film star, a pop star, a racing car driver, even a kindly mediator preventing world wars and, failing that, the wise leader of a suitably large country. In all these pursuits I thought I would be able to impress girls. The thrill of banking passed me by. Riches I could understand, but setting interest rates never excited me.
Why now, at a time of supposed maturity, should I be idly thinking of the remote possibility of becoming a central banker? It fails the fundamental test of drawing in girls, or I presume it does. 
At this particular moment (midday Greenwich Mean Time) the Dow Jones is at an all-time high, and Associated Press reports:
 “Investors are cheered by major central banks' commitments to keep supporting growth in the world biggest economies — the U.S., China, the 17-country eurozone, Japan and Britain”.
After some cautionary words from an investment advisor that markets could go down as fast as they go up, they continue:
Federal Reserve chairman Ben Bernanke has recently suggested that the central bank would continue its campaign of massive bond-buying, known as "quantitative easing," to support the world's biggest economy. The issuance of bonds has pushed their prices down, steering investors toward stocks”.
"The lesson is clear. Don't bet on Capitol Hill. Bet on Fed Chairman Ben Bernanke instead. To be sure, it was Bernanke's reassurance, as last week's congressional testimonies on monetary policy, to keep QE3 on its present course that turned a worried stock market into a record high," said analysts at DBS Bank Ltd. in Singapore.

My interest lies in trying to understand what central bankers do. The job apparently requires a very high level of intelligence, with a concomitant capacity to deal with highly abstract concepts, yet with considerable impact on practical matters. Running a central bank is a highly complex task with massive impact on society. Perhaps the mostly male practitioners do attract the fair sex after all. This moment of glory will be prime time for them in the mating game, if one gives any credence to evolutionary psychology.

To understand central banker’s craft it is necessary to understand money, economic theory and, though they might deny this, politics. Central bankers always claim to be independent, but they are dependent on the state for their function, their salary and their pensions. Nonetheless, most of them are judged to be well-qualified for their roles. Their pronouncements show, at the very least, the vocabulary one expects of an intelligent person, and a command of jargon which inspires admiration, if not always confidence. By the standards of our tribe, they have high status, and deserve the attention paid to them. They ought to know what they are doing.

How can we judge whether they are making intelligent decisions?  This is a particular form of the general question, which is how we judge the intellectual demands of a role or profession. One approach, combining biography with clever statistical analyses, is to look through all the major encyclopedias and reference books, and simply measure how much space is allocated to each person. To avoid the immense bias of our focus on the present time we exclude recent developments. For example, in Human Accomplishment Charles Murray (2003) looked at the period 800 BC to 1950. Understandably, he concentrated on subjects like Mathematics and Physics where it was possible to achieve a consensus. He made no such attempt for Economics, and left politics well alone.

We cannot look at the long historical track record of central bankers, because they are a relatively recent job creation. By common consent the first national central bank was established on 27 July 1694, and served as a template for all others. Created purely to raise money for William III so that he could continue a war against France, it was called The Bank of England.  Modesty is no part of central banking. The US Federal Reserve was not established until December 1913, and Brazil had no central bank until 1945. It is possible to function without them. It may be better. Scholarly debate continues as to whether bank failures and business cycles have been altered for the better by these governmental agencies.

The financial experts seem to know what they want in a central banker. Usually they choose academics or bankers who feel confident that they can find ways of controlling money for the public good, by means of interest rates, printing new money, and by the way in which they operate the relationship between the central bank and the major clearing banks, buying up some debt and then selling it back again years later. Setting interest rates is probably the central task and the easiest to understand. The rest is clothed in jargon and requires specialist knowledge.

However, to the lay observer their actions seem rather odd. After all, currently central bankers are dealing with a debt crisis by making it cheaper to borrow money. In contrast, citizens are usually asked to pay off their debts. Central bankers are withdrawing “bad” debts and putting them into “bad” banks, as if someone had broken wind and it was impolite to mention the fact. In contrast, citizens are not allowed such tricky accounting. Central bankers are relaxed about creating money (and inflation). Citizens are put in jail if they print their own money. Central bankers do not mind distorting prices by manipulating interest rates. Usually, citizens must pay the rate the lender offers, unless they can find a more favourable provider of funds. Citizens are in the market, not manipulating the market.

So, on this day of all days, when central bankers have most cause to celebrate, I still want to ask whether they are behaving intelligently. However, the question needs to be sharpened up a bit, because intelligent people can often behave unintelligently. They do it less often than less intelligent persons, but can sometimes cause more trouble. Clever sillies can be dangerous.

A typical setting in which even clever people end up making unintelligent decisions is a social trap.  In my view all central bankers are in the position beautifully described by Martin Shubik (1971) "The Dollar Auction: a paradox in non-cooperative behaviour and escalation" The Journal of Conflict Resolution, 15, 1, 109-11. (http://www.math.toronto.edu/mpugh/Teaching/Sci199_03/dollar_auction_1.pdf)

In this auction it appears to all participants that they can get a dollar for 5 cents. However, if they enter the auction they must agree to pay the highest bid they have made, whether they win the auction or not. It looks great to begin with, because the dollar looks very cheap. However, once committed, the participants find they are trapped, and try to minimize their inevitable losses by bidding even higher. I used to conduct such auctions with students, and found it easy to drive them higher than a dollar, though I never collected any money from them.

In all social traps there is a short-term individual gain which in the long run leads to a loss for the whole group. For example, fish are free in the sea for anyone with a big enough net, but if we fish out the sea we will have lost a good source of food for ever. Similarly, I benefited from an hour of central heating today, but if we all keep burning fossil fuels we might deplete our resources or, conceivably, over-heat our planet.

However, we cannot be sure that world-wide quantitative easing is a social trap. It may be a brilliant, well-coordinated strategy to pump liquidity into a timorous public, a public who have now, finally, got the message.

Gold is $1574 at the moment. In dollar terms this is a 30 year high. In inflation adjusted dollars, so long as one ignores a brief spike in 1980, it is also very near a 30 year high.

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