Central bankers are a powerful lot and so it's an easy to assume that they're also prescient. When you're making decisions that affect the livelihoods of millions of people—billions on a global scale—confusing people with their institutional authority can become habit forming. But central bankers are mortal, and therefore prone to mortal decisions, a.k.a. flawed decisions. Heck, it happens to the best of us at times. The only difference is that most people's day jobs don't cast a long shadow over a nation's money supply.
No less an expert on central banking than Paul Volcker, the patron saint of inflation slayers everywhere, advises that "central bankers suffer from hubris like everybody else." That's not surprising, but it does have consequences.
The monetary policy du jour, as a result, may not be exactly what the macroeconomic gods ordered. A mismatch between the optimal monetary policy and current events is in some sense fate. Working with limited information makes it hard to know if today's actions will suffice for the uncertainty that arrives tomorrow. As a result, we can talk of monetary policy in terms of its degree of inaccuracy or accuracy.
Intelligently dispensed or not, monetary policy steers economic activity, ranging from decisions in asset pricing to lending preferences to choices that affect the labor market. Alas, poor decisions have a habit of delivering less-than-satisfying results.
Remember all the talk of the Great Moderation? "One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility," Ben Bernanke pronounced in early 2004 in his then-current position as a Fed governor. "Reduced macroeconomic volatility," he went on to explain, "has numerous benefits. Lower volatility of inflation improves market functioning, makes economic planning easier, and reduces the resources devoted to hedging inflation risks. Lower volatility of output tends to imply more stable employment and a reduction in the extent of economic uncertainty confronting households and firms. The reduction in the volatility of output is also closely associated with the fact that recessions have become less frequent and less severe."
It's debatable how much the Fed was influenced by the past for setting monetary policy in 2004 and beyond, but some observers of central banking suggest that the calm history in those halcyon days led policymakers astray.
