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Feet of Clay

Posted By George Selgin On January 28, 2014 @ 6:40 pm In The Fed & Central Banks | 60 Comments

I never thought it would happen–perhaps I'm slipping.  But as I was preparing to bang-out this post, my first in over a month here, I discovered that, a couple hours ago while I was toiling away in class, Paul Krugman stole my thunder.

Despite that bad omen, I'm plunging in with my two-cents, which, like Krugman's, has been provoked by an article in today's New York Times.  The article, which is mainly about Minneapolis Fed President Narayana Kocherlakota, who just recently rotated onto the FOMC, includes a quote from Ed Prescott, who is himself (among other things) a member of the Minneapolis Fed's research staff.  What Prescott said–and what put Krugman in high dudgeon–is: "It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed."

That's right: no effect–none, nada, zero, zilch–on output, or on employment, ever.  Not even in the 30s.  Or in the 70s.  Or recently.  Why, the Fed might as well set its policy targets by throwing darts at a board, for all the difference it would make to real activity.  Money's just a veil, after all.  We know that–what's more we know it "scientifically."

Krugman rightfully pours scorn on Prescott's assertion, which states a "scientific fact" only in the peculiar sense that distinguishes such facts from ordinary, unqualified, plain-old facts, that is, the sort of facts one might glean from experience.   A "scientific fact," apparently, is not such a grubby affair.  It is, rather, something much more pure, even virginal; it is a fact implied by a theory.  The theory in this case is of course the "real business cycle" theory for which Prescott (and coauthor Finn Kydland) are famous.  The theory starts with the New Classical premise that prices always adjust instantly to their general equilibrium levels, thereby all but eliminating any scope for real consequences of monetary disturbances.  It then proceeds–hey presto!–to the conclusion that, if real variables bounce around, they must do so in response not to monetary but to real shocks.   It follows, as a matter of logic, that the world economy must have met with a whale of an adverse supply shock in the 1930s.  What shock, you wonder?  What difference do such details make?  There had to be a big bad shock, dontchyasee: the theory proves it.   If the historians and econometricians can't find it, well, so much the worse for history and econometrics.

Some Austrian economists like to insist on the a-priori nature of their discipline, while many non-Austrians, myself among them, fault this sort of Austrian economics for its failure to to be swayed by experience.   But when it comes to dogmatic a-priorism,  even the most doctrinaire praxeologist can't hold a candle to some of the economics profession's perfectly mainstream superstars.


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