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Home Publications Blogs Beat the Press Glenn Hubbard Refuses to Consider the Economists' Solution to Groupthink

Glenn Hubbard Refuses to Consider the Economists' Solution to Groupthink

Saturday, 12 October 2013 07:49

Glenn Hubbard and Justin Muzinich had an interesting piece in the Post today discussing whether the Fed's mandate should be explicitly broadened to include preserving financial stability. While I am inclined to agree with Fed governor Jeremy Stein, that attacking bubbles is already implicit in the Fed's goal of maintaining full employment, the more interesting issue is Hubbard and Muzinch's shyness in dealing with the problem of groupthink at the Fed and among other economic policymakers.

They write:

"This propensity to follow the herd is at the root of financial instability. In the most recent crisis, homeowners, investors and, notably, the Fed so succumbed to groupthink that we were almost unanimously blind to the risks of rising housing prices and bank leverage. So, how to create a Fed that guides its governors to be skeptical of crowd-induced financial excess?"

Their answer of course is a change in the Fed's mandate. The more obvious solution would be to change incentives. Economists usually think it is important that it is possible to fire workers who perform their jobs badly. This gives workers the incentive to do their jobs well.

If Fed officials, along with other economists in policymaking positions, could lose their jobs and see their careers ruined by failing to stem the growth of destructive asset bubbles then they would have some real incentive not to engage in mindless groupthink. As it is, economists suffer almost no consequence for even the most momentous failures.

None of the Fed governors lost their jobs for failing to stem the growth of the housing bubble. In fact, according to administration sources, President Obama was considering two of these governors (Donald Kohn and Roger Ferguson) as possible replacements for Ben Bernanke as Fed chair.

Unless economists know that they can face real career consequences from engaging in groupthink their incentive is to go along with the herd. Resisting the herd will always carry risks, since it is possible that they will be shown wrong or at least will not be proven right before they lose their job. Given such asymmetric incentives basic economics would show that economists in policymaking positions will almost always choose to just follow the herd. 


Note: Typos corrected.

Comments (8)Add Comment
It's not just the Fed, typo
written by Jennifer, October 12, 2013 8:53
Unfortunately, the "falling up" phenomenon is all over, Washington especially. Witness the range of "foreign policy" experts from the GWB administration, many who could quite reasonably be considered war criminals, giving their opinion on Syria recently.
I think most people would be more inclined to fire Congress, but that is much more difficult.

also: "it si possible"--> it is possible
written by nineteen50, October 12, 2013 9:05
It should be the same case for the lousy Media pundits that are 80% wrong fire them don't promote them. The media group think among these guys stinks.
Carrots, Sticks, Tenure and Incentives: Silence is Golden Because It Pays to Be Mute
written by Last Mover, October 12, 2013 9:17

In government, one ostensible reason for appointing positions from a higher elected position, rather than electing everyone by popular vote, is to keep politics out of the appointed position.

Take Supreme Court justices who are appointed for life. The idea is they have no incentive to game the system or follow the herd in order to keep their jobs.

Beyond this inner sanctum, Fed officials and economists in policy-making positions fall into a broad category of upper class occupations for which seriously rocking the boat can eventually end one's career, whether one goes out with a whimper or an occasional outright dismissal bang with no feigned "personal reasons" exit.

Today in America for this group, it is much more about parsing differences in the shared carrot than actually facing the consequences of a stick. Let somebody else draw the ire of a stick, someone who has no stick to fear.

Guess who that is, usually the ones at the top within the 1% who have an agenda carefully doled out among the masses made to look as if it's rising up from the bottom. Actually responding to ongoing issues with ones presumed skills for which one was presumably hired has become beside the point.

The primary objective for many once proudly independent professionals in both the public and private sector has morphed into going along to get along. Damn the torpedo issues, mediocre speed ahead.

America the Muted Silent Majority doesn't lead the parade anymore, which is led by rolling waves of fringe issues and reactionaries ducking back and forth at the MSM microphone to get their licks in for their particular single-issue political position.

Meanwhile, the Great Ship America that takes a long time to turn never gets turned at all ... because that's part of the agenda, to coddle the policy makers with just enough carrots to keep their mouth open in the desired direction and shut in the other direction, no stick required.
Fund managers did not get fired either...
written by SB, October 12, 2013 9:25
The economist's solution has worked either. 99% of fund managers did not see the size of the bubble or predict its consequences. They also did not kept their funds from loosing money. Why are they still at work? In some sense, groupthink is precisely the result of managers being afraid of getting fired if they do something wrong that the others did not also do wrong...
Dean Needs a copy of The Dilbert Principle
written by JayR, October 12, 2013 9:31
Dean Baker needs to read the book "The Dilbert Principle". Promoting incompetent people upward is very common in business. Why would we expect government, with roughly the same human properties at play, to perform any different?
written by skeptonomist, October 12, 2013 4:12
There is a major conflict of interest in having the Fed be the regulator. The recent housing bubble was a perfect example. In the recession of 2001 the Fed was charged with stimulating the economy, and for several reasons housing has usually been an important part of this; so Greenspan and other policy-makers did everything they could think of to stimulate housing. Since they are pretty much all closely allied with banking and finance in one way or another, they did this by offering big rewards to banking and finance. What they were seeing was a boom restoring prosperity - they were simply unable to view it as a bubble and didn't think they were doing anything wrong, so the threat of consequences afterwards would have meant absolutely nothing. The regulators have to be people who are not responsible for the policies which cause or encourage the bubble.

As for the malfeasance of those actually in banking and finance, this is a perennial problem, and always gets worse in booms or bubbles because confidence increases and there is less scrutiny. But again, the bankers of the Fed are not the ones who should be trying to enforce regulations which could restrain profits in banking.

Despite all the evidence that the Fed does not control the economy, too many economists still have such blind faith in monetary policy that they want to keep increasing the powers of the Fed Chairman. It's long past time for them to wake up - he's not our Daddy (or she won't be our Mommy).
written by skeptonomist, October 12, 2013 4:24
As I have said before (and many others have said before that), generally regulations have to be automatic, not discretionary. Restraints have to be built in. People, even including economists, can recognize the dangers of groupthink in principle, but when it comes to real life situations they fall right in - they can't help it, it's instinctive. Again, the threat of punishment has absolutely no effect in such situations.

The New Deal actually did a number of things which addressed this problem. Of course most of these have been rescinded or bypassed.
written by ReturnFreeRisk, October 14, 2013 8:04
This is a very important point. If US were any other country in 2008, the treasury sec and the Fed chairman would have been immediately fired. Here, Paulson, Bernanke and Geithner were made into heroes for doing more of the same. Yellen, is now winning accolades for being right in a sickening case of revisionist history (by her supporters - not her). She declared a "beautiful soft landing" in 2006 as her backyard in California was burning due to a collapsing housing market. Enough said.

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.