(Disclaimer: I am not an economist, nor a political analyst, nor a statistician.)
J K Galbraith (son of the J K Galbraith and a notable economist in his own right) and two co-authors have published an analysis of the US Federal Reserve's monetary policy, purporting to give strong evidence that, since 1983,
- the Fed's goal is to keep unemployment from getting too low, not to keep inflation from getting too high; when both unemployment rates and inflation rates are included in their model, the dependence on the former is much stronger than on the latter (and this is true robustly across multiple models);
- the Fed does not ease its monetary policy when unemployment is very high, as you might expect if it aims to fight recessions;
- the Fed systematically, consistently, manipulates interest rates as presidential elections approach, lowering them when the incumbent is a Republican and (to a lesser extent) raising them when the incumbent is a Democrat;
- this last political consideration plays as big a role in determining the Fed's monetary policy as inflation and unemployment together do.
It seems to me that the first point could have a not-so-odious interpretation: if low unemployment is (or is believed to be) a good leading indicator of high inflation, reacting to low unemployment might be a better way of keeping inflation down than waiting for high inflation rates. Or reacting to some other leading indicator of inflation might look like reacting to low unemployment. However, the paper also purports to show that low unemployment is not in fact a good predictor of high inflation in the future. (Maybe it isn't one because the Fed reacts so promptly to low unemployment. But that seems like a stretch.)
Galbraith talked about this to the House Committee on Financial Services, and his comments offer some useful further insights, especially on inflation.
I wonder what a similar study of the Bank of England would find.
Before I read the paper, I'm seeing the acronym VAR in the abstract, and that bothers me. Value-At-Risk is a model of risk that typically assumes that fluctuations in prices and so forth are normally distributed. This is inaccurate: the distributions of such fluctuations tend to have much fatter tails: ten-sigma events (close to impossible for normal distributions) are not uncommon in the stock market for instance, and indeed the accumulation is dominated by occasional extreme fluctuations rather than the mass of everyday changes.
Anyway, I have no idea whether that applies, I just thought I'd mention it. I've just finished Nassim Taleb's The Black Swan, which is all about extreme unlikely events and distributions that are dominated by them.
Oops, VAR means vector autoregression and not Value At Risk.
Never mind...
D'oh, Clive is of course right. So let me rephrase my final remark: It would be interesting to do a similar study on the UK, and compare the results. The UK's, as Clive says, would have more "excuse" for being politically motivated, but I wonder whether they actually would be.
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A similar study of the Bank of England would find that it's been in charge of setting interest rates for less than one economic cycle and only while Labour has been in power.
Before that, UK interest rates were set by the Chancellor, whose responses range from the canny (Lawson on a good day) to the asinine (Lamont) but would be unlikely intentionally to work against the government of the day.