Rational Policy

Why is it that so many economists assume that private agents are rational but policymakers are irrational?

Breaking with that rather silly custom, Nick Rowe (hat tip: Mark Thoma) applies the rational expectations concept to policymakers and reaches the conclusion that we will never be able to find evidence of policy effectiveness, even if policies are actually quite effective.

One way to think about it, perhaps, is that all we observe in the data are the effects of policy mistakes. We cannot observe policy successes because they are negative events -- non-recession, non-inflation, etc. Only if policymakers were irrational would their "successes" -- the success of perverse policies at producing perverse effects -- correspond to positive events like recessions and inflation, so that we could find correlations between policy measures and outcomes.

To be more precise, any unusual events (recessions, inflations, etc.) that we see in the data must have been unpredictable; otherwise policymakers would have predicted and avoided them. But if they were unpredictable, that means they couldn't have been correlated with any variable that is supposed to measure policy; otherwise policymakers could have observed that variable and predicted and avoided the unusual event.

I made a similar point a couple of years ago: the inability of economists to forecast recessions is actually a point in favor of the economics profession, because it means that economists who guide public policy are doing their job well and avoiding all the predictable recessions.