/When doves fly, by Scott Sumner

When doves fly, by Scott Sumner

I’ve consistently argued that shifts in fashion are far more important than personnel in setting the direction of monetary policy. And in a recent post, I suggested that the monetary policy zeitgeist was likely to shift in a dovish direction. Yesterday provided a couple of good examples. Start with the Financial Times:

The global bond market enjoyed a powerful rally on Wednesday as investors bet that Christine Lagarde’s nomination to be the next president of the European Central Bank will extend an era of ultra-loose monetary policy in the eurozone. . . .

“Markets are unfamiliar with her academic monetary leanings,” said Seema Shah, chief strategist at Principal Global Investors. “Yet, going by her previous support of Draghi’s decisions to introduce innovative monetary policies, they are making the safe assumption that she is in the dovish camp.”

Another example is the nomination of Judy Shelton for a spot on the Federal Reserve Board.  Shelton is the third consecutive choice that has a long history of favoring hawkish policy, perhaps including a return to the gold standard.  And she is also the third consecutive choice that recently converted to a much more dovish stance, for reasons that are exceedingly hard to understand.

These two news stories demonstrate the extent to which policy is driven by the zeitgeist.  At a global level, the repeated false predictions that QE would lead to high inflation has gradually undermined the position of the hawks, and the doves are ascendant.

But here’s where things get complicated.  Most people don’t understand the distinction between easy and tight money, or how to achieve either policy stance.  Indeed the FT story quoted above refers to an “era of ultra-loose monetary policy in the eurozone”, whereas policy has actually been quite contractionary in the eurozone for more than a decade.  Dovish intentions are not enough, we still don’t know if Lagarde will be able to make a meaningful change in actual eurozone policy.  (The markets are skeptical.)

My own views are almost entirely immune to shifts in the zeitgeist, and it’s interesting to consider the reasons why this is so.  I am currently working on a book entitled “The Money Illusion”.  The main theme of the book is that most people misdiagnose the nature of monetary issues, due to the “framing effects” of misleading macro variables such as interest rates.  This leads to long periods where even the experts are consistently off course in their views on policy.  Thus monetary policy was consistently too expansionary from 1965 to 1981, and consistently too contractionary from 2008 until just a couple years ago.  These policy mistakes were widely supported by the mainstream of the economics profession.

To an average economist, I look like someone who shifted from being a hawk during the Great Inflation to a dove during the Great Recession.  In fact, my views never changed significantly–I’ve always favored stable monetary policy, with slow and steady growth in NGDP.  That preference made me more hawkish than average in the late 1970s and more dovish than average in 2008-15.

Today, most economists recognize that the consensus (Keynesian) view of the 1970s was wrong, and that policy was indeed too expansionary.  I’m seeing increasing signs that the profession is now beginning to understand that the consensus view during the Great Recession was also wrong (with conservative Fed critics even more wrong), and that Fed policy was actually too contractionary at the time.

Don’t be swayed by the zeitgeist.  If you stick to your principles, and those principles are correct, the world will eventually come around to your perspective.

Christine Lagarde