There is a alignment in the thinking of both the Riksbank and many economists which may have a logical explanation but which unfortunately risks harmful outcomes. It’s time we talk more about this, writes Martin Enlund, former currency chief strategist.
After September’s interest rate announcement, the governor of the Riksbank was asked why the Riksbank could not have raised interest rates earlier. Then Ingves replied that “…then you will see something in the crystal ball that no one else has seen”.
This is a truth with modification. There were actually those who warned both of high inflation, “green stagflation”, galloping food prices and heightened geopolitical risks already during the last year.
Such individuals are found in at least two groups: fund managers and market strategists. It is probably not a coincidence that these groups also have “skin in the game” to a certain extent, to borrow a term from Nassim Nicholas Taleb. Within these groups, creativity and outside-the-box thinking also tend to be rewarded. Unfortunately, it is my experience that economists are often uninterested in listening to the ideas of these groups. A strange hierarchy of values seems to prevail.
Some suggestions for the future:
Stop hugging models – given how wrong they risk leading us – and also use other motivations in our decisions.
Think more about the consequences of events rather than the probability of events.
Let more heterodox perspectives be seen and heard, maybe even listened to. It is time to widen the monetary policy opinion corridor.
If the above is too much to ask, can we at least see a little more epistemic humility from concerned parties?
Just over ten years ago, the governor of the Riksbank declared that the interest rate could end up “anywhere between zero and seven percent”. It ended up at -0.5 percent.
And when you then stand there with your beard in the mailbox, you choose to screw up a parameter in the sheet and pretend that nothing has happened. But it is actually possible to imagine that one could instead draw the conclusion that the models are actually unreliable and that to a greater extent one should therefore also use other motivational grounds when making decisions – for example one’s judgement, or ethics and morality. I am reminded of Friedrich Nietzsche in Thus Spoke Zarathustra:
“But the people told me that the big ear was not just a man, but a great man, a genius. But I have never believed the people when they have spoken of great men, and maintained my belief that it was a reverse cripple, who had too little of everything and too much of one.”
Now of course I want to not accuse any individual of having particularly large ears, but instead state that the Riksbank sometimes seems to get stuck in too narrow a perspective – you have “too much of a single. Between the wall and the wall in financial Stockholm, there is sometimes even talk of a bunker mentality.
The world may need economics doctors, but too many can be harmful. Recently, it was also possible to read that Dagens industri’s shadow management before the Riksbank’s September meeting predicted an end point for the recently renamed policy rate somewhere between 2.25 percent and 2.75 percent. However, the same shadow gang was equally united a year ago, when only one wanted to raise the interest rate during the forecast horizon. And then with a meager 0.25 percent.
But you can here not asking whether it is actually reasonable that these different individuals, or representatives of different analysis houses, still end up in almost exactly the same forecasts? Wasn’t diversity a virtue? And this despite the extreme economic fluctuations of the past three years? Perhaps you are simply a little too comfortable in your prognostication, after all, it is nice to be wrong together. Then you risk nothing. (After 17 years in banking, I could give a whole lecture on such incentive structures.)
“You can’t rally with monetary policy”, I was told some time ago at a meeting with one of the Riksbank’s board members. This was the response to a proposal that the Riksbank could use its judgment to a greater extent and rely a little less on its models when making its decisions. The answer could not be interpreted in any other way than that the board member in question put an equal sign between “driving a rally” and using his own judgement.
However, I agree still not with, but would instead claim that after September’s massive interest rate increase, we can state that driving a rally is exactly what has been done. It is a historical patchwork we have witnessed. A year ago, the Riksbank forecast that the zero interest rate would be with us until the fall of 2024. Now it is believed to have raised the key interest rate to around 2.5 percent already next summer.
What I meant at the meeting above was that the Riksbank’s faith in models seemed to have gone too far. Time after time, one tries to reduce a complex, irreducible reality to fit in an Excel sheet. There is nothing wrong with this in itself, the error occurs when you base your decisions solely on the results of the same sheet.
My former client, Erik Thedéen, will be the new head of the Riksbank on the first of January. In his impressive CV, we can deduce that in his career he has also had a background as a risk taker and a strategist, the same two groups that were praised at the beginning.
I hope he hasn’t forgotten his experiences from that time. To quote Nietzsche again: “one must still have chaos within to be able to give birth to a dancing star”. Having said that, I seem to remember that it was precisely a couple of Excel sheets that I once helped him with. Good luck Erik!