On The Keynesian Lunacy Of Targeting Outcomes

Tyler Durden's picture




 

The pages of the financial press overflow with opinions on what targets would make the world safer: what ratio of risk-weighted-assets banks should target, what RoE targets they would be safe at, what inflation target the central bank should aim for, or what growth target is appropriate for China. When SocGen's Dylan Grice was asked if he was a fan of the idea of nominal GDP targets! He snapped he is not and thought it "a terrible idea". As he opines, today’s various issues – the euro, China’s economy, over-indebtedness – are the cumulative unintended consequences of such past targets, and the naïve presumption that complexity can be commanded. Even mildly complex systems, any outcome is the wrong thing to target, with the process being where the focus should be. Expressing how little time he has for macroeconomics, reasoning that it’s obsessed with the targeting of interest rates, GDP, inflation, unemployment, exchange rates, et cetera, as though such a thing was possible without unintended consequences; Grice notes that Austrian economists understood this too. Ludwig von Mises distilled social phenomena to the simple observation that "man acts purposefully".

Dylan Grice - The tyranny of targets: process, outcome and the complexity of it all

The pages of the financial press overflow with opinions on what targets would make the world safer: what ratio of risk-weighted-assets banks should target, what RoE targets they would be safe at, what inflation target the central bank should aim for, or what growth target is appropriate for China. Someone even asked me if I was a fan of the idea of nominal GDP targets! I’m not. It’s a terrible idea. Today’s various issues – the euro, China’s economy, over-indebtedness – are the cumulative unintended consequences of such past targets, and the naïve presumption that complexity can be commanded.

 

All outcomes are caused by an underlying process.

 

But I’d argue that for even mildly complex systems, any outcome is the wrong thing to target. As we just saw, targeting one outcome of such a process changes that process, and changing the process subsequently changes all the other outcomes. In any kind of complex system where the underlying outcome generating processes aren’t well understood – whether a company, or a society – the effects of changing the process won’t be well understood either. Unintended consequences must ensue.

 

Yet even a cursory glance at the news shows ‘outcome targeting’ to be endemic: in response to the damage caused by Basle II, we’re given the ‘new and improved’ targets of Basle III (now already being traduced); the insurance industry now faces Solvency II targets; investors fret that banks won’t be able to hit their RoE targets; investors wonder if China will be able to hit its 8% GDP growth target; most major central banks target some sort of CPI inflation rate.

 

This is lunacy. How much damage has already been caused by banks that overreached themselves in trying to meet their RoE targets? How lopsided and capital destructive has China’s insistence on hitting its breakneck GDP growth targets at all costs been? How much of today’s painful credit deflation was caused by the credit inflation central banks pumped up while aiming for their CPI inflation target? In targeting these outcomes, underlying processes were distorted. Unforeseen outcomes resulted. But regulators continue to prescribe capital targets, banks continue to target RoE, China continues to target a growth rate, and central banks continue with ever more experimental methods in defence of their inflation targets. Indeed, today in Europe we’re seeing the unintended consequences of imposing outcomes (i.e. an exchange rate) on the eurozone economies.

 

Regular readers know how little time I have for macroeconomics. One reason is that it’s obsessed with the targeting of interest rates, GDP, inflation, unemployment, exchange rates, et cetera, as though such a thing was possible without unintended consequences. Since such variables are actually outcomes of a complex process, most macroeconomics seems to me to be an embarrassingly naïve study of outcomes which completely neglects process.

 

I’m not sure when this started. Adam Smith’s observation on the ‘invisible hand’ of selfinterested but mutually advantageous behaviour might have been our species’ first articulation of a complex adaptive process. Austrian economists understood this too. Ludwig von Mises distilled social phenomena to the simple observation that ‚man acts purposefully,? while Hayek coined the phrase ‚spontaneous order? to describe the market. And all this before complexity had been given its name by mathematicians.

The thing is, Adam Smith and the Austrians didn’t fall into the trap of focusing on outcomes. And we’re trying to avoid that trap too.

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Fri, 06/15/2012 - 14:27 | 2530156 WALLST8MY8BALL
WALLST8MY8BALL's picture

ManBernKrugneysian!

Fri, 06/15/2012 - 14:43 | 2530241 NotApplicable
NotApplicable's picture

Excellent article. Too bad those ideas will never be discussed in a serious fashion by the status quo. The closest thing we'll get will be a hatchet job by Larry "I don't drink the Kool-Aid, I mix it!" Kudlow, and his panel of bobble-head dolls.

Fri, 06/15/2012 - 15:35 | 2530452 CrashisOptimistic
CrashisOptimistic's picture

I got $5 that says the ECB, under the guise of emergency liquidity in the wake of Greece upheaval, uses the excuse to circumvent Germany and buy Spain and Italy bonds directly.

Takers?

Fri, 06/15/2012 - 16:08 | 2530570 WALLST8MY8BALL
WALLST8MY8BALL's picture

Make it 31.85 Yuan and you are on! That rhymes!

Fri, 06/15/2012 - 16:16 | 2530607 AldousHuxley
AldousHuxley's picture

uhh....ECB is pretty much France + Germany banks with half of ECB funding.  They also hold greek and spanish bonds. So they will be just bailing out themselves with their own money.

 

don't look at it as one country bailing out another.

 

But how can a country bail themselves out?

Toxic bonds are held by banks and retirees in Germany and France...so they are getting bailed out with taxes on their grandchildren's future productivity.

 

Spain and Greece are like Latin American countries for USA. They are a play thing for bankers to screw with. There is even a video game now...call Tropico.

Fri, 06/15/2012 - 14:28 | 2530161 veyron
veyron's picture

We all know that economics is bullshit ...

Fri, 06/15/2012 - 14:54 | 2530287 CURWAR2012
CURWAR2012's picture

The dismal science I believe it is called... but I like bullshit too

Sat, 06/16/2012 - 06:39 | 2531659 daily bread
daily bread's picture

It is unfair to real sciences to call economics a "science".  It belongs more in the category of alchemy.

Fri, 06/15/2012 - 20:48 | 2531129 Stuck on Zero
Stuck on Zero's picture

The Author is wrong in denouncing "targeted outcomes."  Of course we want a targeted outcome.  We want a stable currency.  The term is another piece of propanda thrown at Americans to think that the powers that run the country are doing wonderful things to make the country better.  ZHers know it's a smokescreen for fraud, theft, and power grabbing.

 

Sat, 06/16/2012 - 07:59 | 2531715 SeattleBruce
SeattleBruce's picture

"The term is another piece of propaganda thrown at Americans"

If that's the case, why not denounce it?

Fri, 06/15/2012 - 14:29 | 2530165 RobotTrader
RobotTrader's picture

We are so far away from experiencing any form of Austrian inflation.

 

Might as well bring out the Bazooka and start printing checks and hand them out to the sheep.

So they can buy the Apple iPhone 5 this summer, stuff their faces with more Buffalo Wild Wings and Chipotle burritos, buy wigs and makeup and ULTA salons, and purchase cheap vacations on the new Expedia mobile app.

And don't even get me started on LULU.  Went there to buy some charcoal shorts, they were over $75 so I said forget it....

LOL....

Fri, 06/15/2012 - 14:33 | 2530186 Dr. Richard Head
Dr. Richard Head's picture

Oprintmore recently pointed to a $3,000 sheep thingamajig giveaway, so perhaps we are not too far away. 

Fri, 06/15/2012 - 14:48 | 2530261 SemperFord
SemperFord's picture

Was he just talking about the 3,000 or is he really going to give it away now? I don't care about the Deficit anymore as it wont be paid so I could buy 100OZ of silver with those Benny Bucks!

Fri, 06/15/2012 - 14:55 | 2530290 SemperFord
SemperFord's picture

Looks like I am going to buy more silver bars, hopoefully they won't get lost in another boating accident!

Fri, 06/15/2012 - 14:34 | 2530197 junkyardjack
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lol, Its like I'm taking crazy pills.  In NY everyone is up in arms because Bloomberg wants to take their 32oz soda from their chubby fingers and they are calling it a war on the poor.  Last time I checked a bag of rice at the super market costs way less than any meal for a family at McDonalds.  It really is quite amazing how people have been trained to spend, as long as there is a means there is a way.  I keep waiting for all these stores to need to do like 75% off to get rid of clothes but prices barely budge, I don't understand it.  I know I'm not buying any $200 jeans but I guess someone still is...

Sat, 06/16/2012 - 09:17 | 2531856 rgrdnrjr
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I'd guess prices are fixed out of China. There were 38,000 price-fixing cases discovered in China last year so it seems that it is a pretty common practice.

Fri, 06/15/2012 - 14:40 | 2530224 LULZBank
LULZBank's picture

Whats up with you RobotTrader? You seem to be switching sides or is it despair that makes you say such things?

C'mon man, we need some predictions from yesterdays good picks.

The first paper dollar was also printed, nothing new.

Fri, 06/15/2012 - 14:48 | 2530265 Shameful
Shameful's picture

Oh I'm watching prices steadily move up, but people are ever willing to spend.  There is always more credit somewhere.  While I'm no fan of fast food I do look at the prices from time to time.  Get a chuckle over how much a "Value Meal" costs now.  Hell hear my old man complain "I can't go to a restaurant for lunch without paying $10 anymore!"

Fri, 06/15/2012 - 14:57 | 2530297 shovelhead
shovelhead's picture

Hmmm,

Who's the sheep that shop at lulu?

Fri, 06/15/2012 - 14:30 | 2530169 fbrothers
fbrothers's picture

Very good article. Have never thought about it. But, so true.

Fri, 06/15/2012 - 14:31 | 2530172 Stimulati
Stimulati's picture

"The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again."

Fri, 06/15/2012 - 14:31 | 2530174 Dr. Richard Head
Dr. Richard Head's picture

Targeting inflation, or anything else in financial matters as outlined in this article, are kind of like the rhythm method. The ecstacy of the point of no return can result in some life changing unintended consequences - asset value crashes, wild fluctuations in valuations, inflation, CHILDREN!

Fri, 06/15/2012 - 14:32 | 2530177 carbonmutant
carbonmutant's picture

Heisenberg outcomes...

Fri, 06/15/2012 - 15:01 | 2530314 Matt
Matt's picture

Heidelberg outcomes?

Fri, 06/15/2012 - 15:10 | 2530360 ali-ali-al-qomfri
ali-ali-al-qomfri's picture

Hindenburg...

Fri, 06/15/2012 - 16:24 | 2530636 carbonmutant
carbonmutant's picture

Good ones...

Fri, 06/15/2012 - 14:32 | 2530178 Decay is Constant
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Still looking for that one handed economist so that they can't say "...on the other hand..."

Fri, 06/15/2012 - 14:37 | 2530209 mayhem_korner
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Economists just hedge their words.

Fri, 06/15/2012 - 15:14 | 2530370 CommunityStandard
CommunityStandard's picture

Their other hand is invisible.

Fri, 06/15/2012 - 14:32 | 2530181 Newsboy
Newsboy's picture

The system will be revised, following collapse.

(You can start now, if you know what you are doing. Expect derision.)

Fri, 06/15/2012 - 14:35 | 2530201 fonzannoon
fonzannoon's picture

These marketwatch guys are fkin lunatics. They make cramer look sane.

Fri, 06/15/2012 - 14:36 | 2530208 Winston Smith 2009
Winston Smith 2009's picture

What passes for current economic models couldn't target the broad side of a barn.  It's simplistic garbage with vastly inadequate numbers of input data points, doctored input data from lying governments, the unknown variable of human nature and illogic, etc., etc. and yet they try to run the world with this crap:

http://www.youtube.com/watch?v=jIP7ES1lCGk

 

Fri, 06/15/2012 - 14:37 | 2530210 fonzannoon
fonzannoon's picture

Whats going on right now with the miners is funny. It is all out flaunting in our face at this point.

Fri, 06/15/2012 - 14:45 | 2530243 Grand Supercycle
Grand Supercycle's picture

SPX & EURUSD bullish daily charts dominate further.

As mentioned, shorts will be slaughtered next week.

Fri, 06/15/2012 - 15:03 | 2530319 LowProfile
LowProfile's picture

Yep, I think a 20-30 point rip might do it.

After that you better get on your helmet.

Fri, 06/15/2012 - 14:49 | 2530267 FreedomGuy
FreedomGuy's picture

Assigning and hitting targets turns men and politburo's into gods. That is the attraction. It is also the same attraction for the socialist-collectivist-welfare state. They are all about outcomes and never process which is why freedom is always sacrificed for some greater result. It would be fine except they never ever never get the desired result.

Economically an economy is like a rain forest, too complex to be managed. Central planners pour fertilizer from the sky. It kills and poisons some things and helps others. They only count the plants and animals that benefitted and tell you the rain forest would have died without them. They also say rain forests need management for a better result when it is a contradiction in and of itself. Only the botanist (Austrian economist) knows the truth.

Good thinking in this article.

Fri, 06/15/2012 - 20:27 | 2531100 BigJim
BigJim's picture

++ Nice analogy

Fri, 06/15/2012 - 14:50 | 2530271 skepticCarl
skepticCarl's picture

The article has it backwards: it's the continuation of the money printing/public debt as-a-stimulus process which is and has been the most important thing, regardless of the outcome.

Fri, 06/15/2012 - 15:09 | 2530354 Matt
Matt's picture

However, the reason for the money printing and stimulus is to try to attain the objective of targeted outcomes. 

The plan is to create targeted outcomes, which is a flawed plan.

The execution of the plan is issuing debt to pay off debt and to spend more than revenues to try to force growth to achieve the targeted outcome. This is also flawed.

 

Fri, 06/15/2012 - 14:51 | 2530276 onebir
onebir's picture

Academic economists at least pay lip service to these ideas: http://en.wikipedia.org/wiki/Goodhart's_law

Not sure why it gets brushed under the carpet by policy makers.

Fri, 06/15/2012 - 14:52 | 2530280 skepticCarl
skepticCarl's picture

Almost every stock index, international and domestic, is moving above its 21 day moving average.  Another rally leg is occurring.  Get long.

Fri, 06/15/2012 - 14:52 | 2530282 Clayton Bigsby
Clayton Bigsby's picture

I'm sure Krugman favors targeting

Fri, 06/15/2012 - 18:17 | 2530906 akak
akak's picture

I favor targeting Krugman --- preferably with a .44 Magnum.

Fri, 06/15/2012 - 20:31 | 2531108 BigJim
BigJim's picture

LOL. But make a martyr of him?

Much better to expend that energy educating people so they can see what a fool the man is. You can slay (figuratively) a million Krugpots this way, as understanding spreads exponentially.

Austrian economics... once understood cannot be forgotten.

Fri, 06/15/2012 - 14:57 | 2530293 ebworthen
ebworthen's picture

Allowing failure manages outcomes without micro-managing every step from start to finish.

Consequences of choices completes the loop from the end to the reason for a beginning.

Once failure and consequence are removed from decision making, failure and success along with recklessness versus responsibility lose their meaning.

Such a simple concept, but one that central planners, enablers, apologists, and outcome chasers cannot seem to grasp - or don't want to because it won't allow the outcomes that enrich them without sacrifice or effort.

Fri, 06/15/2012 - 14:57 | 2530298 Debugas
Debugas's picture

managing developement of a society is very simple (but hard to find honest people to implement it) - one simply has to control and keep reducing parasitic behavior


Fri, 06/15/2012 - 15:04 | 2530326 shovelhead
shovelhead's picture

Open season on Neo-Keynesians?

Fri, 06/15/2012 - 14:59 | 2530305 mjk0259
mjk0259's picture

An organization that is able to gamble with huge sums of money and pay no significant penalty when it is wrong is going to be a problem no matter what it's goals are. Bring back Glass-Steagall.

 

Fri, 06/15/2012 - 20:34 | 2531112 BigJim
BigJim's picture

We'd need TARP x 10 to recapitalise the banks if Glass-Steagal were (re)introduced. They're already practically insolvent.

Take away the FDIC's distorting effects, and the ability of banks to issue national currency as debt, and the system would sort itself out soon enough.

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