Wednesday, November 6, 2013

Evidence-Based Central Banking?

Frank Dulaney: Counsel for the prosecution has already used this witness to establish the state of mind of the deceased. He opend the can, your honor.
Judge Burnham: And I do see worms crawling all around you, Mr Garrett.
--Body of Evidence

Evidence-based management is grounding practices in the latest and best knowledge of what actually work (Pfeffer & Sutton, 2006). John Hussman's review of several theories and beliefs upon which current Fed policies are based provides a sense of how well those policies are grounded in evidence.

One theory is the infamous Phillips Curve, which posits that unemployment declines with higher inflation. Beyond the weak theoretical argument upon which this relationship is proposed, the empirical evidence shows that, if anything, there is a positive relationship between inflation and unemployment.

Another belief is that quantitative easing (QE) reduces unemployment. Again, ignoring the weakness of a theoretical argument positing that printing money to buy bonds will add jobs, the empirical evidence shows no effect of QE on jobs growth.

What about the wealth effect? Empirical evidence shows a positive relationship between change in the S&P 500 index and GDP growth. Casting aside the spuriousness of this relationship, the durability of any manipulated effect, and the idea that this relationship can be perfectly manipulated by central bankers, the estimated size of the effect is small. Each 1% change in the SPX is associated with 0.05% of GDP change. As such, driving stock prices up by 50% might generate a temporary increase of 2.5% in GDP.

Of course, to the extent that the increase in asset values was artificial, movement in the opposite direction should be expected as well.

It is difficult to imagine central bank policies being further removed from the concept of evidence-based management.


Pfeffer, J. & Sutton, R.I. 2006. Evidence-based management. Harvard Business Review, 84(1): 62-74.

1 comment:

dgeorge12358 said...

It is a capital mistake to theorize before one has data. Insensibly one begins to twist facts to suit theories, instead of theories to suit facts.
~Sherlock Holmes