Former BoE policymaker Adam Posen discovers groupthink at BoE

On his Financial Times blog, Andrew Hill looks at Adam Posen's attack on how the Bank of England operates and notes that the BoE is not the only economic institution that is prone to group-think.  Other examples he provides are the IMF and Treasury.

What do all three of these institutions share in common?  They employ a significant number of macro economists.  In particular, they employ neoclassical economists.

You might recall these neoclassical economists.  They are the economists who according to Nobel prize winning Professor Joseph Stiglitz built econometric models based on the "standard model" of the economy that assumed perfect transparency and left out the financial sector.

This combination of assumption and omission is very interesting as the banking sector had an incentive and ability to create opacity as opacity was a source of tremendous profit for the sector.

In short, the neoclassic economists were blind to the cause of our current financial crisis: opacity.

Of course, admitting that they were blind to the cause of the financial crisis would undermine their profession.  As a result, the neoclassical economists instinctively engage in group-think and become an obstacle to economic recovery by refusing to acknowledge that opacity was the problem.

More importantly, by refusing to acknowledge that opacity was the problem the neoclassical economists cannot champion addressing opacity.

Think about how many times a Bank of England official has talked about the need for restoring confidence in UK banks.

Of course, the problem is how to restore confidence in banks that are drowning in liquidity but that are 'black boxes' so everyone doubts their solvency.

Everyone knows that confidence in the financial system comes from transparency.  It is only when market participants have access to all the useful, relevant information in an appropriate, timely manner that they can independently assess the banks.  Trusting in their independent assessment, confidence about the banks then returns.

However, when was the last time you saw a central bank economist call for banks to provide complete transparency?

Adam Posen’s attack on the management and culture of the Bank of England may be the strongest yet, but it is by no means the first – and won’t be the last – criticism of a persistent and dismaying lack of robust governance at the UK central bank. 

What is astonishing is that despite countless warnings – three independent reviews, several newspaper editorials and sundry MPs’ warnings – the central charge that the governor is over-mighty and under-governed still stands. 

It’s more than three years since the court of directors, the nearest the bank has to a board, was reformed to make it smaller, less ceremonial and, in theory, more capable of mounting a challenge to Sir Mervyn King. But, as Mr Posen, who served on the BoE’s monetary policy committee until August 2012, told members of parliament on Tuesday: 

Supervision of the executive was very lax and there was a very strong culture and precedent that, if the governor or the broader bank executive made a decision to do something … then it was seen [that] there was no point in challenging them. 

Hello, it is hard to mount a challenge to a decision when each of the participants on the Monetary Policy Committee has essentially the same training (a PhD in economics with a comfort level with neoclassical economics).

The bank is not the only economic institution that has suffered criticism of a culture that tends towards dangerous group-think. The International Monetary Fund and the UK Treasury (also criticised by Mr Posen for not taking the governor to task) were both prone to a lack of challenge and insularity, according to recent reports into why they failed to perform well in the run-up to and immediate aftermath of the financial crisis....

The only way to end the insularity is to remove the economists from the committee that makes monetary policy decisions.  Economists at the Bank of England could "advise" on policy, but they could not vote on it.

So long as economists sit on the monetary policy committee, they will simply be engaging in the same debates they had over beer when they were graduate students.

It is, frankly, embarrassing that Britain’s highest profile institution of economic governance – which will soon receive a new governor, Mark Carney, and even more powers to oversee the financial system – still seems to have a free pass to ignore governance principles to which almost all listed companies in the land adhere.