Avoiding the Next Crisis: Can Central Banks Learn?
In this essay published in the CATO Journal, Robert Hetzel writes that any effort to avoid future recessions must rest on an organized way to learn from the past. However, the absence of such efforts within central banks renders such learning problematic and makes likely the recurrence of episodes of recession and financial market turmoil. Critical to learning is the use by policymakers of models to evaluate the past performance of monetary policy. These models should not be the complicated, multiequation models favored by the forecasting departments of central banks. Rather, they should be simple models that require policymakers to take a stand on the basic issues in monetary economics: the nature of the price level (mone- tary or real) and how well the price system works to maintain output at potential (full employment). They should serve as a safeguard to the understandable tendency of central bankers to attribute eco- nomic disturbances exclusively to real shocks rather than monetary shocks.
This article explains how learning requires that policymakers use models to disentangle causation from correlation.