Leaning Against Thin Air: on the inconsistencies of a monetary policy debate (original) (raw)

Proponents of central banks ability to "lean against the wind" of asset-price bubbles call for tighter monetary policies during unsustainable price booms, as observed during the 2000s. Those against such a shift in policy (including all of the major central banks) argue that: a) central bankers are no better at identifying bubbles than investors, and; b) even with accurate identification monetary policy is too blunt to appropriately limit such bubbles. While the second, technical point must be vetted against empirical evidence, the former, theoretical argument is based on a false assumption of what constitutes a "price bubble". Although most economists implicitly view "bubbles" as price deviations from "fundamental value", this is a fallacy. Such a definition (rampant though it is) relies on the belief that commodities have an intrinsic value - an objective price. Clearly, since the theory of marginal utility replaced the Labour Theory of Value in the 1870s no liberal economic theory has supported the idea that market value exists beyond the rate of exchange (price) set by the freely exchanging parties. This is the very basis of the free market. Thus the entire 'lean against the wind' debate is askew insofar as discussants believe such a policy shift would require identifying 'fundamental value' better than investors. Instead monetary authorities and economists must recognise that bubbles have meaning only in the sense of price changes that are likely to quickly reverse course. Although 'fundamental value' is a useful fallacy for investors, theorists and policymakers must not be blinded by this unfounded rhetoric.