Bernanke Vs. Greenspan

Bernanke Vs. Greenspan

Tue, 08/28/2007 - 18:23 — moneysage

According to one recent news report, former Fed Chairman Alan Greenspan remarked privately that he would have cut the FED FUNDS rate by now, had he been in Bernanke's shoes। Greenspan denied making the remark. Be that as it may, there has been a lot of interest in the differences between the two, especially in light of the current credit crisis.

What seems clear to us is that Greenspan's policymaking -- especially at crucial moments -- was substantially, if not decisively, influenced by pragmatic, seat-of-the-pants judgments। The role of computer models was NOT decisive for Greenspan. Bernanke, in contrast, seems to accord the computer models decisive importance.

Greenspan's approach, while inevitably "subjective," was superior to Bernanke's। It is not merely that the FED must live in the real world, not in an academic ivory tower. The key point is that computer models typically fail at critical moments because they are INHERENTLY INCAPABLE OF EITHER IMAGING reality at crucial moments, or predicting the course of events during a financial crisis. Consequently, they give bad advice.

Why is this? The problem is that in the real world, human emotion, and particularly mass emotion, play a vital role। In financial crises they can have decisive impact। Models only measure what is measurable: since mass emotion and the range of possible consequences cannot be quantified, it cannot be imparted to a computerized model। Hence the fatal flaw in models.

In the final analysis, all judgmeNts about non-physics matters cannot be made without a significant subjective component। Economics is not merely mathematics or statistics or models: it is raw emotion, the emotion of the herd.

When his seat gets too hot, Bernanke WILL make subjectively-influenced, and even subjectively determined decisions. He will learn, the hard way, that he is no longer in academe. What the cost to the economy will be, and what the quality of his judgment will be, remain important unknowns.