Are central bankers about to embrace the real world? The events at most central banking conclaves are a total, excruciating, bore. The recent gathering of the Federal Reserve’s tribes at Jackson Hole, however, produced an elegant, compelling, presentation by rising star central banker Andy Haldane. Finally, a youth in the banquet hall declaring that the Emperor has no clothes.
Haldane’s speech, as analyzed by my colleague Charles Kadlec, comes down to this: “The essence of Haldane’s point is the shift from simple, easily understood broad based rules under Basel I to more complex rules is very dubious. This approach made the assessment of risk more opaque. These attempt to manage the risk of the banking system through the superior guidance of complex rules based on black box mathematical algorithms. In addition, these formulae, by their nature, ignore uncertainty by assuming the future can be captured by the past. This combination made the financial panic of 2008 more likely, and the ability of regulators to spot the risk less likely. His major insight is that simple approaches are more effective at managing complex systems than complex approaches in a world of uncertainty.”
Haldane’s speech, The dog and the frisbee, just possibly could give the trajectory of the world’s international monetary and financial system a decisive nudge away from its bitter cling to elitist postulates — what public intellectual Axel Kaiser aptly calls “witch doctors and … economic astrology” — and toward motherwit reality. Here’s some of what Haldane said:
Catching a frisbee is difficult. Doing so successfully requires the catcher to weigh a complex array of physical and atmospheric factors, among them wind speed and frisbee rotation. Were a physicist to write down frisbee-catching as an optimal control problem, they would need to understand and apply Newton’s Law of Gravity. Yet despite this complexity, catching a frisbee is remarkably common. Casual empiricism reveals that it is not an activity only undertaken by those with a Doctorate in physics. It is a task that an average dog can master. Indeed some, such as border collies, are better at frisbee-catching than humans. So what is the secret of the dog’s success? The answer, as in many other areas of complex decision-making, is simple. Or rather, it is to keep it simple.
… To ask today’s regulators to save us from tomorrow’s crisis using yesterday’s toolbox is to ask a border collie to catch a frisbee by first applying Newton’s Law of Gravity.
So begins and ends the speech by Andrew G Haldane, Executive Director, Financial Stability and member of the Financial Policy Committee, co-authored by Vasileios Madouros, Economist, Bank of England. Haldane delivered this at the Federal Reserve Bank of Kansas City’s 36th economic policy symposium on August 31.
It’s a lucid treasure, one deserving to be, and perhaps destined to become, a classic in the literature. It primarily critiques the labyrinthine banking regulations of Basel III. Its implications are broader.
I’m not aware of any unconditional support for central banking as such around The Cobden Centre but, nevertheless, occasionally a central banker says something worth hearing. Today, that central banker is often Andy Haldane….
So what is the secret of the watchdogs’ failure? The answer is simple. Or rather, it is complexity. For what this paper explores is why the type of complex regulation developed over recent decades might not just be costly and cumbersome but sub-optimal for crisis control. In financial regulation, less may be more.
… Haldane’s speech is an intellectual tour de force which concerns some of the epistemological problems which will be so familiar to Austrians.
Haldane’s thought displays, somewhat alien to the recursive world of central bankers, a becoming reliance on empiricism rather than dogma. Haldane, at Jackson Hole, critiquing an over-reliance on assumptions by the economics profession:
Those strong assumptions about states of knowledge and cognition have not always been at the centre of the economics profession. Many of the dominant figures in 20th century economics – from Keynes to Hayek, from Simon to Friedman – placed imperfections in information and knowledge centre-stage. Uncertainty was for them the normal state of decision-making affairs.
Hayek’s Nobel address, “The Pretence of Knowledge”, laid bare the perils of over-active policy if we assumed omniscience (Hayek (1974)). For Friedman, lack of knowledge justified a k% monetary policy rule (Friedman (1960)). For physicist Richard Feynman: “It is not what we know, but what we do not know which we must always address, to avoid major failures, catastrophes and panics.”
In a long, fresh and quite fascinating interview published in OurKingdom, Haldane is introduced as someone who
“has been hailed as a new type of policy expert and intellectual. In this interview… he sets out his vision for the future of economics and economic policy-making. It is a future where central banks are humble, ‘listen as often as they speak’, and own up to their mistakes.”
My proposed stories about the crisis were not that behaviours were driven by stupidity or wickedness, but rather that the rules of the system had been designed in ways that may have made sense individually, but the actions of those individuals and institutions were added up, it made for a system that did fairly crazy things.
William Davies: And did you discover this approach from your own reading? How on a professional level have you managed to combine being a public servant and an economist, while also developing this quite rich intellectual research agenda?
AH: Economics needn’t be restrictive. Economics as a discipline grew out of a broader concern with political economy, with sociology, with philosophy. And that was true right through until the latter part of the 1960s and early part of the 70s. The towering economists of the twentieth century had a much richer idea of what economics was about than the recent neo-classical synthesis. They were all some hybrid of economist, sociologist, mathematician, political scientist and philosopher. Hayek, Keynes, even Friedman were very much cut from that cloth.
In some ways, we’re just starting to rediscover that now, of how little we really knew, both pre and post-crisis, of how this complex adaptive economic and financial system really behaves. So I don’t think of this as being outside of where economics has been, other than over the past 20 or 30 years where it’s taken a rather narrower track, a rather narrower view of itself, than it did over the previous 200 years.
The Bank of England, the dean of the central banks, can claim over three centuries of experience. It effectively administered the classical gold standard, invented in 1717 by another Englishman of whom you may have heard, Sir Isaac Newton. It did so with (mostly) superb proficiency for a good two centuries.
The Old Lady of Threadneedle Street, as the Bank is nicknamed, commands enormous respect. And no less than the Bank of England — the very division headed by Haldane — published arguably the most rigorous and important empirical assessment of the actual performance of the fiduciary currency standard in place since 1971. This white paper, Financial Stability Report No. 13, confidently titled “Reform of the International Monetary and Financial System,” available here, unflinchingly gives the fiduciary currency standard lowest marks, across the board. It argues persuasively for a rule-based system.
The world’s greatest living public intellectual, Yogi Berra, once, it is said, said; “In theory there is no difference between theory and practice. But in practice there is.” (Also attributed to Jan L. A. van de Snepscheut.) If Andy Haldane represents the new class of leading public servants — empirical, based in practical outcomes rather than on rather dubious theories — the world economy well may prove to be poised on the verge of a new golden age.