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Excessive symmetry at the Fed

February 28, 2014

In that the quest for unanimity rather than democracy is the attempt to close the circle of Platonic symmetry leading to tragedy and bad poetry. But here’s the thing:

The Curse of Unanimity” by Binyamin Appelbaum, NYT:

The transcripts that the Federal Reserve released last week of its policy makers’ 2008 meetings record in painful detail the ignorance of its officials about economic conditions during that crisis year …

What the transcripts do not explain is why the Fed failed at one of its most basic tasks.

I wrote last week that the cause was a combination of bad data, bad models and bad assumptions. But that does not explain why the Fed discounted good data, failed to build better models or persisted in its mistaken assumptions. It does not explain why other people were able to see the cliff.

Neil Fligstein, a sociology professor at the University of California, Berkeley, argues in a recent paper that the broader problem was cultural …

Fed officials like to describe themselves as guided by data, but Professor Fligstein says the transcripts portray a kind of storytelling competition in which Fed officials select data that fits with their broader narratives about the evolution of economic conditions. Thus accounts of mortgage fraud were dismissed as anecdotal because officials believed that markets were operating efficiently. “They had a meeting about whether there was a bubble and it’s a whole meeting about why there wasn’t a bubble,” Professor Fligstein said. “It’s all about, ‘This can’t be true in theory so it can’t be true in reality.’”

Moreover, it is clear in the transcripts that Fed officials strongly prefer to agree with each other. They are not satisfied with making decisions by a majority vote …

Professor Fligstein said the Fed would benefit from a more diverse set of decision-makers.

Janet Yellen was sworn in as Chair of the Board of Governors of the Federal Reserve System on February 3, 2014, making her the first woman to hold the position. A cultural change in itself.

Why the Federal Reserve Failed to See the Financial Crisis of 2008: The Role of “Macroeconomics” as a Sensemaking and Cultural Frame, by Neil Fligstein, Jonah Stuart Brundage, Michael Schultz. Excerpt from the summary:

One of the puzzles about the financial crisis of 2008 is why the regulators were so slow to recognize the impending collapse of the financial system. In this, paper, we propose a novel account of what happened. We analyze the meeting transcripts of the Federal Reserve’s main decision-making body, the Federal Open Market Committee (FOMC) … This lack of awareness was a function of the inability of the FOMC to connect the unfolding events into a narrative reflecting the links between the housing market, the subprime mortgage market, and the financial instruments being used to package the mortgages into securities. We use the idea of sense making to explain how this happened. The Fed’s main analytic framework for making sense of the economy, macroeconomic theory, made it difficult for them to connect the disparate events that comprised the financial crisis into a coherent whole.

The study defines “macroeconomics” in ways to distinguish the “cognitive limits of FOMC members,” who for example did not sufficiently focus on trying to understand connections between what is referred to as the “real economy” and the “financial economy.” The importance of interdisciplinary relationships is evident. Also in this connection, you may have come across Justin Fox‘s The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street. If not, ‘nough said!

But then there’s this: The Inflation Obsession by Paul Krugman. I am tempted to further connect, obsession, yet again, with “closing the impossible circle of pure symmetry” that keeps springing open in Unicycle, but I will resist.
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