View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

REVISED September 24 , 198C

Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
at a
Pennsylvania State University Conference on the Political
Economy of Domestic and International Monetary Relations
University Park, Pennsylvania
June 13-15, 1980

Academic economists frequently express a desire to have a greater
impact on economic policy and seem disappointed with what they appear to be
achieving from the outside.

Policy makers frequently are heard to say that

they would like to get more help from academic economists, and seem disappointed with what they do get.

Does economics promise more than it can

Or, is the flow of communication less than adequate?
There are indications which suggest that it is lack of communica-

tion more than lack of communicable substance that is at fault.

For one

thing, the role of economists in government is by no means diminishing.


my agency, the Federal Reserve Board, from which most of the empirical observa
tions in this paper will be drawn, the role of economists is rising.
Increasingly the members of the Division of Research and Statistics, some
150 economists, and those of the Division of International Finance, some
50 economists, are drawn into policy advice and operations.

The same

applies to many of the Federal Reserve Banks, with their economists.



at the higher levels both of the Federal Reserve and of government agencies
generally, the role of economists as policy makers seems to have grown,
although the condition prevailing in 1975, when four Cabinet Members, the
Chairman of the Federal Reserve Board, and the Chairman of the Council of
Economic Advisers were professors of economics, and only the Secretary of
State was a professor of political science, may have represented a temporary
high point.

The public's estimate of the ability of economists to predict and

cope with economic situations and problems may have diminished in the light
of recent performance.

Nevertheless, popular interest in and newspaper

coverage of economic matters still seems to be on the upgrade.

The quality

of economic reporting in the press has improved visibly.
One possible reason for believing that economic inputs into policy
making are relatively neglected is that the allocation of time for such inputs
is never a high priority, for either side.

Academics may be reluctant to cut

a class in order to participate in an important government meeting.


makers are always under pressure to put the urgent ahead of the important.
Thus, they underinvest in economic advice, both from academics and from their
own staffs.

Subject Matter and Occasion for Economic Input Into Policy Making
Economic policy, and especially monetary policy, is strongly
influenced, of course, by economic theory.

Classical monetary thinking,

Keynesianism, and of late monetarism, have all shaped it, in different
degrees at different times.

There can be no question as to the importance

of these basic inputs into policy making.


Such basic inputs, naturally, differ widely for different policy

The government, in general, is not run by economists, but by a

congeries of politicians, businessmen, lawyers, and diverse technicians,
including economists.

In the process of running the country, they become

"men of affairs," if that had not been their role previously.

On the

Federal Reserve Board, the proportion of economists, of course, is higher
than in most other government agencies.

But it is never so high either on

the Board or on the Federal Open Market Committee that its economist members
would feel at ease becoming at all technical.

No blackboard, to my recollection,

has ever disfigured the splendid proportions of the Board Room at Constitution
Avenue and 20th Street.
The contingent of lawyers and businessmen have a practitioner's
background in various aspects of microeconomics —
prices and wages, credit, and many others.

taxes, accounting,

With such a background, it is

probably quite possible to vote intelligently on the FOMC, and to follow
the discussion, although some grounding in macro concepts would be helpful.
But as soon as macro concepts make their appearance we are apt to encounter
She influence of Keynes1 defunct scribbler, in the form of verities absorbed
in college and not updated since.

In Keynes1 day, these verities dealt with

the balanced budget, the gold standard, the public debt.

Of today's men of

affairs, very few, of course, predate the Keynesian revolution.

Big deficits,

high public debt, easy money, indifference toward inflation, and intolerance
of unemployment are their intellectual heritage.
from college days is still rare.

Monetarist indoctrination


Today's men of affairs, moreover, are not dependent on intellectual
baggage carried forward from the past.

They absorb contemporary economics

from their company economists, from organizations like the Committee for
Economic Development and the Business Council, from Congressional hearings
and, of course, from the press which today competently popularizes much
academic output.
There is, of course, a wide range of doctrines that the man of
affairs could assimilate and to which he could refer in speech and action
with equal intellectual respectability.

These doctrines aspire to objectivity

and their originators would be chagrined to find them interpreted as
manifestations of value judgments.

It is precisely on grounds of value

judgment, however, that the man of affairs is likely to pick his economics.
He will identify Keynesianism with expansionism and monetarism with price

Even worse, he may come to identify Keynesians with left-of-

center and monetarists and rational expectations proponents with right-ofcenter politics, however wrong such identifications may be.
These broad perceptions do not necessarily apply in every individual
policy decision.

One may place great value on price stability and still

favor a particular cut in the discount rate.

More technical economics,

especially in the area of forecasting, then assumes considerable importance.
Every policy maker necessarily acts on expectations.

The question is only

whether these expectations are formed by casual observation or by systematic
forecasting techniques.


The forecast presented by the Federal Reserve Board's staff, based
on the Board's version of the MPS model modified by judgmental contributions,


plays a powerful role in FOMC deliberations.

Given the wide range of

outside forecasts, the weight given to the Board staff forecast may well
be excessive despite its good performance in comparison with other major
macro models.

Nothing is more sobering, in evaluating any single forecast,

than inspection of an array of 20 or 30 widely differing forecasts of GNP,
prices, and unemployment.

The Reserve Bank presidents on the FOMC do have

the advantage of being exposed to their own Bank's forecasts in addition
to the Board forecast.

Board Members have a harder time forming their own

quantitative projections.
As far as forecasts are concerned, the views of the major producers
in any event are readily obtainable.

How much weight any forecast should carry is

debatable, particularly in the light of recent performance in the profession

Theory tells us that the more uncertain the forecast the

smaller should be the policy reaction.

The growing acceptance

of the belief that we do not know enough to fine-tune the economy
properly relates not only to our uncertainty about the effect of policy
actions, but also to the uncertainty of the forecasts upon which these
actions might be based.
All this adds up to saying that the input of economics on policy
making is pervasive and strong but that nevertheless it rarely points
unambiguously toward any particular policy, either in the long run or
the short.

This gives great importance to the ability to form individual

opinions, which, in turn, leads back to the need for continuing contact with
the sources of ideas, a very important part of which has been


past acadcmic contributions.

But the question that the policy maker today

addresses to the theorist is "what have you done for me lately?"

The answer

is that, after monetarist concepts and recommendations had made their recent
mark, not much that is new and powerful has been added to the theoretical
base of monetary policy making.
One reason for the present low level of economic inputs into
monetary policy making, therefore, may be that not many good new ideas have
been around lately.

This weakness on the side of academic supply can be

seen in the diminishing credibility of many Keynesian propositions, the
observed limitations of monetarists' ideas as they are increasingly
implemented by policy, and the remoteness from reality of rational expectations

For new ideas in labor market analysis, which seem to have flowed

well, there seems to have been inadequate demand on the government side.
The needs of government for economic inputs, moreover, also come in waves.
For instance, the Bank Holding Company Act amendments of 1970 created a
strong demand for microanalysis of banking markets, but as it happened a
large body of research in this field had been completed during the 1960's
off which the bank regulators still are living.

This clearly has implica-

tions for the kind and volume of economics produced within the Federal

Trends in Research Activity at the Federal Reserve


In recent years, there appears to have been a trend toward a
reduction in research activity by the economic staff of the Federal Reserve,
both at the Board and at the Reserve Banks.

A greater proportion of


research has become more directly policy oriented.

The reason is not a

reduction in the number of professional economists employed, which has
remained roughly constant.

It is, rather, that the Federal Reserve Board

particularly has been handed a wider range of functions, and has had to
meet increasing demands on existing functions.

This has been met in

good part by shifting staff time from research to policy advice and related

The Bank Holding Company legislation of 1970 brought a massive

surge in activity in this area, through a bunching of applications for

As these activities diminished, the International

Banking Act, the Financial Institutions Regulatory Act, and the Monetary
Control Act began to make heavy demands on staff time.
Congressional staffs have increased massively, and this has led
to an increase in Congressional demands for reports, Congressional
correspondence, and the writing of testimony for appearances of Board
Members before Congressional committees.

Economic developments such as

floating exchange rates, the development of the Euromarkets, a larger
number of international meetings, and growing inter-agency activities have
added to the need for staff work in the international area.
All this has meant that at each staff level there is less time for
the kind of research work that used to be done some years ago.


are drawn into policy work at an earlier stage in their careers than in the

Some people like this and some do not.

Many staff members have to

work harder to maintain the academic credentials that economists hired from
among the more talented graduates of the higher-ranked universities are
normally concerned with.

I believe that similar cycles have occurred at other government
agencies from time to time.

Historically, this has sometimes been followed

by a concentrated effort to restore a research component to staff activity
by creating some new kind of research department.

The circumstances that

produce such a concentrated effort, which usually is a severe burden on
the budget, may differ —

a new agency head, evidence of inability to cope

with agency problems or to keep up in bureaucratic infighting with other
departments, are among the observable sources of impulse.
Occasional relief from budgetary squeezes plays a role.
agencies may find themselves in different stages of this cycle.
doubt is true of different academic disciplines.

The same no

It is my impression that

in economics generally now the cycle is at a stage where demand for and
expenditures on economists are relatively low.

That is bound to affect

the attractiveness of jobs in the economics area within government and
the distribution of research between academia and government.

Academic Versus Governmental Research
The declining trend of research activity in certain government
agencies raises not only the question of career attractiveness for those
with a basic orientation toward academia, but the more fundamental one of
the distribution of research between academia and government.

The standard

allocation is, of course, that basic research belongs in the universities
and the research institutions and applied research in government, without
anything like a rigid line being drawn.
in both places.

Obviously there is room for both

The reduction in government research means that it would


be desirable to have a larger volume of policy-oriented research done in

This shift seems to accord with the shift in priorities

observable in National Science Foundation grants, which increasingly seem
to stress applied research.

But if, as seems to be the case, the founda-

tions also arc leaning increasingly toward "results," while the universities'
own resources are clearly stretched more tightly than they used to be, the
burden of cutbacks will fall heavily on basic research.
Concern about this trend has been expressed many times.


of economics the risks and costs of running out of basic research may well
be much larger than in our field.

Nevertheless, the trend is very worrisome.

If it cannot be reversed or stopped, a possible antidote would be more rapid
circulation of academics through government.

The United States is fortunate

in having a high degree of mobility between academia and government.

If the

trend is toward an imbalance to the disadvantage of basic research, a possible
compensatory factor would be a more rapid return of academics from temporary
government employment.

The decline in the relative attractiveness of

government employment for academics with a bent for basic research would
encourage this, at the cost, of course, of frustrating the government's
effort to attract more academic talent for operating and policy work.
In any event, this "circulation" through government would remain a feasible
prospect for only a small part of the economics profession and would be open
in even lesser degree to non-economist academics such as political scientists.


Dcmand for and Supply of Economic Expertise
To make academic economists' inputs into government effective,
both sides must understand their market.

Academics as well as policy makers

must understand clearly what academics have to offer.

On both the supply

and the demand side, considerable improvement in understanding is possible.
In the course of my own work, I have been on both sides of this
market from time to time.

Let me first lay out my past perplexities as an

academic supplier to the government of what goes under the name of economic
expertise, and then describe my present frustrations as a user of such
The academic adviser to government may see himself in the role
of a Max Weber type value-free expert, or as somebody pleading a point of
view -- in either case, he will have positions that he wants to defend and
others that he wants to oppose.

The difference between the Weber style and

the other kind of expert is only that the first makes his case on technical
grounds, while the second weights his technical argument with his values.
In either case, the outside expert faces the problem of making his/her
advice effective.
Advice is effective to the extent that it is accepted and to the
extent that it affects the view and action of the advisee.
normally are inverse to each other.

The two effects

The advice most likely to be accepted

is to the effect that the advisee is doing the right thing and should go on
doing it.

By adopting the same point of view as the advisee, however, the

adviser changes nothing.

The farther the adviser's viewpoint moves away


frora that of the advisee, the greater the potential change that he can
effect, but the less also the probability of acceptance.


of advice can be defined as the distance from the advisee's point of view
weighted by the probability of the advice being accepted.

So measured,

effectiveness is zero both when the adviser's point of view coincides with
that of the advisee and when it differs so much as to have zero chance of

Somewhere in between there is a maximum.

With some simple,

but not implausible, assumptions about these relationships, we can conclude
that the maximum occurs mid-way between the advisee's view and a totally
unacceptable view.
Different advisers, of course, may have different utility functions
and not all may derive maximum utility from maximum effectiveness of their

The yes-man will value acceptance of his advice above everything

and therefore place his bets close to the viewpoint of the advisee.


congenital oppositionist will prefer to insist on his own point of view
even if he is sure to be totally rejected.

Aiming at the point of maximum

effectiveness does mean, usually, shading one's own preferences and adapting
them somewhat to those of the advisee, but it is this advisory strategy
that has the biggest impact.
Choosing among these alternative strategies of advice requires,
of course, that the adviser know the lay of the land pretty well, both as
regards the policy issues involved and the political and other options facing
the advisee.

In practice, I have found very often that my advisee knew a

great deal more about the issue than I did and that the things I did know


were not necessarily applicable to his situation.
economics often supplies a good guide to policy.

Competition, optimal

allocation of resources, the marginal principle, can all be helpful in
disentangling conflicting pros and cons.

Economics does have something

to offer even if its precepts do not always prevail.
The adviser is aided by the fact that the policy maker, in the
last analysis, must boil down and simplify his problem in order to be able
to act.

At an early stage of the decision process, governmental delibera-

tions typically dissolve into a welter of often unrelated details.

But the

human mind, and particularly that of a person with many decisions to make,
cannot cope with all these complexities.

In one way or another, some

aspects of the problem are eliminated as unessential and others get
elevated to a key role.

On these the final decision then is made.


the adviser is able to focus on them, he has a good chance of being effective.

The Realities of Policy Making
How does this process look from the point of view of the policy

Temperaments vary, from the self-confident operator who feels sure

he is right, to the worrier who needs to rehash all options before he can
make up his mind.

It is the worrier who thus becomes an attractive advisee

for the academic.

The worrier will feel this need particularly if at one

time he was an academic and is aware of the fact that he has not kept up with
his discipline.

Given the pace and workload of government, that eventuality

becomes a virtual certainty within a very few years in office.

Few things


arc more unnerving than the feeling that one has overlooked something
that one ought to be aware of.

Y>y the same token, it is reassuring to

touch base with an adviser who is on the frontier of thought, or simply to
make sure that the expert does not know much more than the policy maker does.
When one has touched all the bases in that way, one has become a kind of
negative expert knowing that there is nothing new to know.
The policy maker's principal problems, with respect to receiving
advise, are when, on what topics, and from whom to solicit it.

The first

two -- when and on what -- require some knowledge of the state of the arts
and the state of professional opinion on rapidly evolving situations.


congenital worrier can spend too much time learning that there is nobody
who can help him.

It is on the third -

difficult decisions.

from whom —

that he faces his most

Given the tested principle that there is no conceivable

view that is not backed by some economist, the policy maker can proceed, of
course, on the principle of "pick your policy, pick your adviser."

Or he

can pick a gaggle of advisers of predictably different views, which also
makes him appear impartial and, having received conflicting advice, proceed
to do what he wanted to do in the first place.
Assuming, however, that he is seriously interested in receiving
advice, he needs to know a good bit about his advisers.

In a world of

value-free economists, he would be able to ignore ideology.
that would be naive.

In practice

He, therefore, needs to know ideological biases very

well if he wants to adjust for these and arrive at value-free views.


wise, he needs to understand the variance around the views with which he is



Academic economists do not have to live with their mistakes and

some of them, therefore, are prone to understate the degree of uncertainty
attached to their analysis.

For instance, in 1975 the Federal Reserve was

advised by leading experts on both sides of the fence dividing monetarists
and Keynesians that it should sharply raise the stock of money to make room
for recovery.

This was clearly high-risk advice which in the light of

subsequent history does not stand up well.
Much of the time, of course, advice from the two sides of the
Keynesian-monetarist fence is conflicting (ignoring the fact that there are
a few right-of-center Keynesians whose policies may come closer to those of
the monetarists).

In that case, the Board and the FOMC will be reasonably

safe in the middle.
at each other.

If they duck in between, the two sides will be shooting

Even more important than such balance between academic

partisans is similar balance in the Congress.

Monetarism has enjoyed a

considerable vogue among politicians, understandably, since it tends to
absolve them from responsibility for the consequences of poor fiscal policy.
In that view, most of the responsibility rests with the Federal Reserve,
which therefore tends to acquire some Keynesian leanings in self-defense.
The difficulties of obtaining good advice may be particularly severe for
the Federal Reserve because these difficulties reflect differences of view
about macroeconomics.

Differences on the relative evils of inflation and

unemployment are wide, and they tend to be associated with different
evaluations of the cost of dealing with either.

It would be a rare adviser

who believes that inflation could be dealt with at moderate costs but prefer
expansion, or who sees the costs as enormous but nevertheless proposes to
incur them.


At a micro-level, as I have noted before, differences tend to
become more technical. It becomes easier here to give "value-free" advice.
In some cases, nevertheless, there are more clearly defined
on micro-issues than there are on the broad issue of inflation versus

Frequently, in these cases, the division is between business

and the consumer, or business and labor.

Where clear partisanship is

involved, the policy maker knows whose advice he is getting and will treat
it, not as technical advice, but as ex parte.
In surveying the professional scene, one becomes aware of one
peculiar anomaly.

Relations between the Federal Reserve and the academic

profession are not as cordial as one would wish them to be.

The Federal

Reserve is the professional home of large numbers of economists.

It is

probably the most "economically oriented" of all the Washington agencies.
Its subject matter is the bread and butter of economic thinkers and

Nevertheless, economists have conspicuously abstained

from treating the Federal Reserve as "their" agency in the way in which,
one might say, large parts of the profession have identified with the fiscal
policy process.
That the Federal Reserve should be a political whipping boy is
understandable, perhaps even desirable.

When the Fed acts as a buffer

between the politicians and the printing press, it is fulfilling its proper

This is not, however, its ideal role with respect to the economics

The credibility of monetary policy with the public is
damaged by comment from the profession implying that monetary policy
is a simple matter that, with a little intelligence and good will,


could reliably produce predictable results.

Nor is the credibility of

monetary policy strengthened by comment about a small number of individuals
pursuing objectives that are not in the national interest and ignoring the
needs of the people.

The public is very much in need of information about

the Federal Reserve, as frequent press comments on the mysteries of the
Fed make clear.

This purpose would be better served, however, by a less

consistently negative attitude on the part of the profession.

The Policy Maker and His Staff
The economic enlightenment which I have discussed so far comes
to the policy maker from the academic consultant.

In fact, the policy maker

ordinarily receives a much larger input from the agency's staff, especially
at the Federal Reserve.

Much more can be said about the Federal Reserve's

outstanding staff than can be encompassed in this paper.

Because of its

intellectual strength, it is by far the most important source of economic
input into the Federal Reserve Board and Federal Open Market Committee.
Even though its research function has somewhat declined of late, it reflects
enormous concentration of strength in the areas it covers, greatly exceeding
the density of coverage of major topics that is possible even in the economics
departments of leading universities.

It is precisely, however, because the

staff is not an economics department of a university that its intellectual
influence on the advisees is of a peculiar nature.
The staff, being hierarchically organized, at the Board and within
each Reserve Bank, tends to speak with one voice.

Sometimes, of course,

when there are significant differences among its members, such differences



Differences within the staff may show through in the various

decision options that the staff usually produces on particular issues.
In other circumstances, such options may represent structured alternatives
not indicative of any particular positions within the staff.

Board Members

can, of course, deal with individual staff members and learn their views,
but, by the nature of its organization, the staff tends to resist systematic
attempts by Board Members to infiltrate its decision processes.

It may

reasonably fear that such intrusion may affect the staff's objectivity
or that it might interfere with the achievement of a single voice.


would also take time away from work for the Board as a whole.
These bureaucratic imperatives carry over into the relations of
the staff with academics, with whom most professional staff members can
reasonably view themselves on an intellectual level.

Given the great

resources that the staff is able to throw into any particular investigation, the staff can reasonably assume that it has done, or at least
could readily do, as much research on any point of major interest as
single academics.
The staff, moreover, on many issues is guided by prior decisions
of the Board.

This is particularly true in the regulatory area.

Once the

Board has made up its mind, the staff's function becomes one of implementing
and defending.
Much of the staff's work is in the public domain, through the
large volume of reports, testimony, material prepared for open meetings,
and individual publications by staff members.

The staff, therefore, is

by no means sheltered against the public gaze and against criticism from
their professional peers.

An important exception is material prepared for


immediate monetary policy purposes.

Confidentiality of this material helps

to preserve the objectivity of the staff.

It minimizes the staff's risk

aversion that would no doubt limit some of its expressions of judgment if
every word could be brought into the political arena.

For the Board,

confidentiality of staff forecasts and related advice is essential to
maintain confidence in the professional quality of the.staff's judgment.
If staff reports and recommendations were to become a basis for
political debate, policy makers' desire to obtain such materials would
diminish and the risks to the Federal Reserve of publicly aired conflicts
would increase.
For the outsider, all this may add up to an impression of
inflexibility on the part of the staff.
subjective reaction.

But that may well be an excessively

Not every bright new idea can be sure of the full

welcome that its outside originator may feel it deserves.

Moreover, con-

tinuing involvement with the ideas o^ outside academics on the part of
staff members can make life as difficult for senior staff as involvement
with individual Board Members.

That there is no suppression of thought

is evidenced by the Board's liberal publications policy for staff members,
including points of view that differ from those of the Board, so long as
the Board's operations are not seriously prejudiced.
Bureaucratic tendencies toward a single staff position also
reflect the operating responsibilities of the staff.

The greater the

responsibility to get things done and get them done on time, the less is
the opportunity to dawdle by the wayside in purely intellectual pursuits.
All the greater is the need for deliberate efforts to seek academic inputs
and to cultivate activities that will help staff members maintain the
professional quality that they and the organization prize.


Group Dynamics
On major policy issues involving values such as the choice
between more and less expansive policies, the general tendency of any
well-known academic usually is predictable.

It is easy for the policy

maker, therefore, to elicit the kind of advice that he would like to

Groups of academics, nevertheless, seem to manifest subtle

shifts in attitude that supply more objective policy guidance.


remains true even though the individual members of such a group may vary
from time to time, so long as they are replaced by others of broadly similar

The position of members of such a group relative to each other

tends to remain the same.

But the spectrum shifts, and that is highly

significant for a policy point of view.

It is the nearest thing to

unanimity that a diversified but continuous group is likely to achieve.
Few things are harder for an academic than to confess error.
The annals of advice that academic advisers have given to policy makers
contain interesting exhibits of policies that fortunately were not adopted.
But it is not customary to bring up old mistakes.

The policy mistakes of

academics are buried in dead storage files in some warehouse.

The mistakes

of policy makers are republished monthly in the nation's major economic time
In addition to gradual shifts in the direction of policy advice,
there appear to be shifts in value judgments, such as the relative cost of
inflation and unemployment.

There also seem to be trends affecting the

spectrum of opinion as regards the variables that should be empirical rather
than ideological, such as the level of full-employment unemployment or its
latter-day counterpart, the nonaccelerating inflation rate of unemployment.


These shifts are part of the group dynamics observable in panels or rotating
groups of policy advisers.
There are several groups in Washington to which these observations

They deal with macro policies as well as with other policy-oriented

topics, at the Federal Reserve, at the Treasury, at Brookings, at the American
Enterprise Institute, among no doubt many others.

These groups involve a

considerable overlap of individuals and have a considerable degree of continuity
of particular individuals.

They all serve as a means of communication between

academics and government officials, although they differ considerably in the
emphasis on, respectively, new research and communication to government
officials of existing research.
In some cases, a substantial effort is made at rotation of
academic participants, with particular emphasis on bringing in younger
members of the profession.
to communicate.
is difficult.

It is these, very often, who have new ideas

Experience nevertheless has shown that this communication
Lacking government experience, younger academics who are new

in these groups do not find it easy to hit the right level of abstraction and
relevance, and to put their ideas across clearly to people who surely are
listening with a great deal of interest.

The old hands have a considerable

advantage in this respect and their ideas come across more clearly and easily.
As a result, a frequency distribution of participants in such meetings reads
pretty much like a standard list of the leading members of the economic departments of the leading universities, making allowance for the absence of distinguished
names that are not known to have strong policy interests.
This situation is symptomatic of a much broader problem of communication
between academics and government.

There is willingness and interest on both sides.


But the information, the knowledge of new ideas, does not flow smoothly.
Broader, more frequent, and more intensive contacts are needed if government
is to be enabled to absorb all the academia has to offer.

It seems in keeping

with the trend of the times to suggest that this impediment will not be removed
by some macro approach, but only by a multitude of painstaking micro efforts.