Commentary on Political Economy

Friday, 27 May 2022


 If you examine carefully (although it is an extremely simple exercise) Goodhart’s Law, you will find why Jay Powell MUST BE REMOVED from heading the Fed.

Goodhart’s Law, in a nutshell, says that once a central bank instrument applied to a target BECOMES KNOWN, it immediately loses its effectiveness. 

It’s a simple thing to understand. Goodhart just proved empirically that it is applicable in reality.

In a competitive regime, once market agents know how a central bank operates…they take measures aimed at avoiding the adverse effects that follow from that operation. With the inevitable outcome that the effectiveness of the central bank operations is dissipated and lost. 

In other words, Goodhart is saying that, whilst it is DESIRABLE that central banks keep markets informed, there are times when you have TO SHOCK AND AWE markets into a retreat by barring the escape route! Effectively, by punishing markets for challenging the central bank!

Goodhart was aiming at “moral hazard”: if I lend you a dollar, you have a problem. If I lend one million, I have a problem.

Similarly with central banks: if I telegraph every one of my moves in advance, it is obvious you will take preventive steps to elude or defeat my purpose.

And that is precisely what the Fed is doing with asset markets! By being “data driven”, the Fed keeps giving market agents ample room to jump ahead and give it very little room to change course ON PAIN OF CAUSING MARKET PANIC!!!!

Essentially, the Fed is allowing market agents to hold it to ransom by threatening “tantrums”!

So beholden is the Fed to markets, that it has lost all authority and now markets openly and aggressively DEFY its every move well ahead of time!!!

I discuss central banking and financial instability in a regime of rising rates and consequent disinflation/recession in this fairly technical paper:

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