Perverse Reputational Incentives In Central Banking

Moneybox
A blog about business and economics.
Dec. 21 2011 4:26 PM

Perverse Reputational Incentives In Central Banking

I was reading recently in Hjalmar Schacht's biography Confessions of the Old Wizard (thanks to Brad DeLong for getting me a copy) and part of what's so incredible about it are that Schacht's two great achievements—the Weimar-era whipping of hyperinflation and the Nazi-era whipping of deflation—were both so easy. The both involved, in essence, simply deciding that the central bank actually wanted to solve the problem.

To step back to the hyperinflation. You might ask yourself how things could possibly have gotten that bad. And the answer really just comes down to refusal to admit that a mistake had been made. To halt the inflation, the Reichsbank would have to stop printing money. But once the inflation had gotten too high for Reichsbank President Rudolf Havenstein to stop printing money and stop the inflation would be an implicit admission that the whole thing had been his fault in the first place and he should have done it earlier. It was easier to say that hyperinflation was a necessary consequence of allied demands for reparations payments and that he had no choice but to print currency in the quantity demanded. Similarly, the rapid collapse of the value of the mark led private firms to want to issue their own bills. This caused further inflation, but was permitted as a necessary accommodation to the inflationary conditions. Again, as a technical matter there would have been nothing difficult about reversing this policy. But to reverse course would be to admit that a mistake had been made. So things continued for several years until a new government brought Schacht on as a sort of currency czar. Schacht stopped the private issuance of money, launched a new land-backed currency and simply . . . refused to print too much of it. The problem was solved both very quickly and very easily. His later work helping Hitler rebuild the German war machine was a bit differentnt, but again essentially just involved looking at what the previous failed policy had been (gold standard and deflation) and doing the reverse.

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The institutional and psychological problem here turns out to be really severe. If the Federal Reserve Open Market Committee were to take strong action at its next meeting and put the United States on a path to rapid catch-up growth, all that would do is serve to vindicate the position of the Fed's critics that it's been screwing up for years now. Rather than looking like geniuses for solving the problem, they would look like idiots for having let it fester so long. By contrast, if you were to appoint an entirely new team then their reputational incentives would point in the direction of fixing the problem as soon as possible.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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