Of dentists and economists – the importance of a consistent economic policy framework..

A nice speech by Jens Weidmann, President of the Deutsche Bundesbank.

It is obviously based on the famous Keynes quotes on how econs would be seen doing a good job if they are as respected as dentists:

economic policy must fulfil two tasks. First, it has to spell out these principles in the form of suitable rules to ensure that they become operable – which in some circumstances may also mean justiciable -, that they can be set in relation to each other, and that they actually develop a binding force. Second, economic policy must align the requirements of a competitive order with other political ends, for example if the results of market processes are undesirable from a social-political perspective.

Keeping an eye on the social consequences of market processes is an important supplement to regulatory policy and the hallmark of a social market economy. The relationship between market forces, their social consequences and interventions to correct them is often complex. This means that obvious measures aren’t always the best ones, and sometimes they aren’t even effective: it is indeed true that good intentions do not always produce good results.

It’s for policy-makers to weigh up different objectives, and economists cannot take that responsibility from them. But economists can and should point out the economic costs and side-effects of the different courses of action available.

A cursory consideration of this job description perhaps seems to suggest that the Keynesian ideal of the economist as a dentist might become reality. To quote Keynes: “If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.”

I am afraid, however, that this notion of the economist’s role will remain a pious hope. Most economists are indeed humble or competent people – and sometimes they are both.

But in the past few years, insights gained in the field of economics have probably experienced more ardent debate than the latest findings on dentistry. For given the complexity of reality, the dynamics of an increasingly interlinked global economy and the uncertainty that upheavals like the financial and economic crisis in particular generate, there are often no simple answers to economic policy questions. What is more, these answers may change with time.

Hmm.. rules are important for sure. But one another problem is how rules are being made one size fits all. The rules should be based on each country’s political and economic structure.

Liked this example on time inconsistency:

A key problem in the sphere of monetary policy – one which is a factor in many other areas of economic policy as well – is that of time inconsistency. Let me illustrate this phenomenon using an example originally created by the US economist Professor Alan Blinder.

Imagine a professor who is pursuing two goals. First, he wants his students to study as hard as possible; second, he wants to spend as little time as possible marking examination papers, say. The professor then announces that he intends to set an examination at the end of the semester. This, he hopes, will provide the students with an incentive to acquire the necessary knowledge.

However, once the students have studied for the end-of-semester examination, the professor has an incentive not to set an examination after all because he does not want to mark the examination papers. But because the students are aware of the professor’s incentive, they will study insufficiently or not at all.

How can this problem be solved? By stating in the examination regulations that an examination will be set at the end of the semester, come what may. In other words, the university binds itself in advance to a fixed rule.

In their renowned paper “Rules, discretion and reputation in a model of monetary policy”, the US economists Robert Barro and David Gordon 3explain why the time-inconsistency problem gives rise to an inherent inflation bias.

🙂 This is so true…

 

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