Dear Monetary Policy Observer,
This latest Forbes article by Ralph Benko begins by covering a fairly simple question: Would you ask a dog to catch a Frisbee by first applying Newton’s law of gravity, or just have him catch it? The question, surprisingly enough, was expanded at the Bank of England recently to include central banks’ monetary theories. The author acknowledges that Yogi Berra said it better, though: “In theory there is no difference between theory and practice. But in practice there is.”
We hope you find this material of interest.
American Principles In Action
Catching A Frisbee Is Difficult: The Bank Of England Tells It Like It Is
Ralph Benko, Contributor
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.