Last week, in part I of this essay, we discussed why a central planner cannot know the right interest rate. Central plannerís macroeconomic aggregate measures like GDP are blind to the problem of capital consumption, including especially capital consumption caused by the central plan itself. GDP has an intrinsic bias towards consumption, and makes no distinction between consumption of the yield on capital, and consumption of the capital per se. Between selling the golden egg, and cooking the goose that lays golden eggs.

One could quibble with this and say that, well, really, the central planners should use a different metric. This is not satisfying. It demands the retort, ďif there is a better metric than GDP, then why arenít they using it now?Ē GDP is, itself, supposed to be that better metric! Nominal GDP targeting is the darling central plan proposal of the Right, supposedly better than consumer price index and unemployment (as Modern Monetary Theory is the darling of the Left).

There is No Way A Central Planner Could Set the Rate

Anyways, last week we said we would look at the other premise (from the Surest Way to Overthrow Capitalism):

ďthere is no way a central planner could set the right rate, even if he knewĒ.

Itís one thing to argue that the central planners havenít got a metric to help them know the right rate. Itís another to argue that no such metric exists. But letís go beyond that and concede for a moment that the central planner somehow does know the right rate. How is he supposed to set it?

One problem in setting the right rate is that the very question presumes that the right rate is static. Or at least that it does not move in realtime. But of course, in a real market prices are moving constantly. Here is a graph of the Federal Funds Rate, which is dictated directly by our central planners.

There is one glitch, because this graph shows the effective rate (which may sometimes deviate from the number dictated by the Fed), but this square stair-step pattern looks nothing like any real market price.

Another flaw in the very idea of centrally planning interest, is to think of the economy in low-resolution terms. For example, many might say that, ďinflation is moderate, unemployment is low, and GDP is growing.Ē At best, this is like looking at a duck gliding in the water. Above the surface, the duck appears calm. Below the waterline, the bird is paddling like mad.

Letís put this view into explicit words. We realize that few would do this (clear and explicit statements are practically taboo in certain topics). But here goes:

ďThere are only a few variables. And each variable can be described in the language you see on paintbrushes at the home improvement store: good, better, best.Ē

This view oversimplifies the economy, the way a low-resolution FAX (remember FAX machines?) of a picture of the Grand Canyon oversimplifies the experience of hiking down to the bottom, camping there, and then rafting down the river.

This view may be sufficient for the evening news, but you will never get anywhere in understanding economics by looking at GDP, CPI, and unemployment in paintbrush terms. Suppose someone proposes raising the tax on the rich, and not just taxing their income but also taxing their wealth. And you say it wonít be good. That person retorts that we had higher taxes in the 1950ís, and GDP was growing faster.

How would you answer that?

Not with the paintbrush model of macroeconomic metrics!