Our worldviews shape the ways in which we approach problems, challenges, and questions. Our “worldviews,” as I refer to them in this post, are so deeply embedded in our minds that we don’t usually realize our thoughts are driven by them. Monetary policy is not free from this “worldview” effect.
There is a big debate in monetary policy on whether central banks should follow a monetary rule or have the ability to decide how to perform monetary policy at the policymaker’s discretion. In a world of second bests, the question underlying this debate is how errors would be minimized: by following the right rule (in itself another issue) or by giving central bankers discretionary powers. In many cases, what one side sees as an argument on their side, the opposite side sees as an argument in favor of theirs. For instance, the lack of precise knowledge about the economic situation can be an argument for a rule-based monetary policy or for a discretionary approach. Proponents of a rule-based monetary policy would argue that because our knowledge is limited, we should follow a rule that will, say in average, minimize the errors. However, one could also argue that because our knowledge is limited, a rule will be biased and therefore discretionary policy (if an expert is in charge) is a better option than an imperfect rule.
Yet in monetary policy, there are broader splits than the rules vs. discretion argument. This broader separation is delineated by economists’ worldviews on how markets work. Both advocates for a rule-based monetary policy and a discretionary central banker have a rule of experts worldview. The expert can build an accurate enough model of the economy that would inform how to run an optimal (or second best) monetary rule. Both the rule follower and the discretionary policy makers are experts. But both positions rest on the unquestioned assumption, given by the expert’s worldview, that there is a certain amount of information and knowledge given to the expert. By information and knowledge I am not referring to economic information, such as macroeconomic aggregates, but to the same worldview knowledge assumed by the theorist. In other words, the economic agent in the economist model is assumed to know the model that he’s living in and therefore, the same assumption is applied to the policymaker in the real world. But, of course, the fact that we can create a model does not mean economic agents are given such information in the real world.
Another worldview, particularly emphasized by Austrian school thinkers, is that the information that is necessary for the expert to be a successful expert is actually not given. This means that the policymaker cannot perform as an expert and, therefore, there needs to be an alternative to the rule of the expert. This theory argues that this information cannot be given to the policymakers because of the complexity of the market process. The fact that we can understand how the market works once it exists does not mean we can be an expert and create it. This complex spontaneous order, however, does have rules. But the expert does not give those rules to the system (market process); these rules come from the market process itself. There is, as it were, a rule of law of monetary behavior that should govern what the policymaker can and cannot do, rather than the other way around. The challenge is that the presence itself of a central bank and, therefore, of policy makers, overshadows the rule of law embedded in the market process.
This second worldview is more concerned with what type of central bank should we have, if any. While the first worldview asks what should be done under a certain institutional arrangement, the second worldview asks what said institutional arrangement should be. This larger question is based on a more humble position, as it does not assume that the information needed by the expert is somehow given.
The possibilities of a sound monetary system are constrained by the institutional arrangement in which the policymaker should act. How to remove or relax these constraints is the problem of the second worldview.