Simplicity vs. Complexity : It’s Not That Simple

Everyone knows that the Dodd-Frank law passed in 2010 to regulate the financial industry is incredibly complex.  As those who took  Money and Monetary Policy last fall learned from alum Jim Lyon, it will take years just to write the implementation provisions.  Furthermore, these provisions will be influenced significantly by those (especially in the banking industry) whose behavior will be affected.

Andrew Haldane, in the most recent Kansas City Federal Reserve Bank symposium in an article entitled “The Dog and the Frisbee”, argues that such complexity is far from optimal in an economic environment in which uncertainty prevails.  He uses the concept of uncertainty in the same way that Frank Knight and John Maynard Keynes did almost a century ago; that is, situations in which assessing the probability of different outcomes is quite low and that risk cannot be easily measured and therefore, hedged against.  Haldane argues for simple rules, such as existed under the Glass-Steagall Act which forbids the mixing of commercial and investment banking.

In a recent blog entry on the EconoMonitor, Ed Dolan analyses this argument in terms of Goodhart’s Law, which suggests that as soon as a particular indicator becomes an explicit policy variable, it loses its predictive power because economic agents change their actions in response to expectations of the  authorities using this indicator for policy action.  Some of you might recall this as a variation of the Lucas critique of traditional monetary and fiscal policy actions.

All of the above is prologue for our next Economics Colloquium to be held next Monday.  Our visitor, 1971 Lawrence alum, Elijah Brewer, will address the topic “Regulating Wall Street:  Did We Go Too Far?”  Be sure to come to his talk at 4:30 PM, Monday, October 8th in Steitz Hall 102.

 

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