Sunday, July 10, 2022

"Fool in the Shower:" Milton Friedman's Caricature of Bad Central Bankers

Click here to read the original Cautious Optimism Facebook post with comments

1 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff credits (of all places) an online student exam guide and Investopedia for their concise descriptions of Milton Friedman’s “fool in the shower” depiction of central bankers.

Study guide: “Nobel Prize winner Milton Friedman said that a bad central banker is like a ‘fool in the shower.’ In a shower, when you turn the faucet to change the temperature of the water, there won't be an actual change in the temperature for a few seconds. If a ‘fool in the shower’ is always making big changes in the temperature based on how the water feels right now, the water is likely to swing back and forth between too hot and too cold…”

Investopedia: “The expression is best summed up as the scenario when central banks or governments overreact to swings in the economic cycle and loosen monetary and fiscal policies too far and too fast, without waiting to gauge the impact of their initial actions. When the fool realizes that the water is too cold, they turn on the hot water. However, the hot water takes a while to arrive, so the fool simply turns the hot water up all the way, eventually scalding themself.”

Study guide: “Milton Friedman was arguing that there are inherently many lags in monetary policy which cause it to lag behind the state of the economy. For example, there is a data lag that exists because it takes time to collect the data for statistics such as GDP growth and unemployment. You also need many data points in order to spot a reversal in trend and then it takes time to implement monetary policy and for changes in the money supply to affect the overall economy. This all builds up to where the Fed may be implementing expansionary fiscal policy based on historical data when today we are in an expansionary gap and do not yet know it.”

(Economics Correspondent comment) Actually over the last nine months the Jerome Powell Fed has been more like a “fool falling asleep in the shower” when the water is already too hot and he falls asleep murmuring "the heat is just transitory" and "the correlation between steaming hot water and skin burns has not been valid for quite some time," inevitably scalding himself.

However, now that the Fed is reacting to the inflation that it previously created and trying to make up for lost time by tightening aggressively, we may just see a “fool in the shower” scenario if it overshoots and creates not only the expected recession, but a more painful recession than necessary.

To draw a parallel between the overtightening and fool depictions, Jerome Powell might turn the cold and hot water taps too quickly and go from scalding his skin to putting his entire body in a deep freeze.

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