I.

Your home has a thermostat that wants to maintain a temperature of, say, 70 degrees.

One day, while it happens to be slightly cold outside, your thermostat randomly happens to break. Your house gets cold, and it is miserable.

Both of the following statements are true in a sense:

1. “The cold weather outside caused your house to freeze.”
2. “The broken thermostat caused your house to freeze.”

You can say both of these statements.

It seems quite plausible, though, that describing your broken thermostat as ‘the’ cause of your cold house is a more useful way of talking about the world. The most useful way of thinking about the world is that your thermostat should, by default, keep a constant internal temperature – but that in this instance it failed.

(Causality is a property of the map, not of the territory; but some maps are more useful than other ones.)

If someone asked you, “Why is your house so cold?”, you would say, “Because my thermostat broke”; you would not say, “Because it’s cold outside.”

II.

Your economy has a central bank that wants to maintain output at potential and inflation on trend.

One day, there is a financial crisis; your central bank “breaks” and screws up. Your economy crashes below potential, and it is miserable.

Both of the following statements are true in a sense:

1. “The financial crisis caused the economy to crash.”
2. “The incompetent central bank caused the economy to crash.”

You can say both of these statements.

It seems quite plausible, though, that describing your incompetent central bank as ‘the’ cause of the recession is a more useful way of talking about the world. The most useful way of thinking about the world is that the central bank should, by default, keep an economy out of recession – but that in this instance it failed.

(Causality is a property of the map, not of the territory; but some maps are more useful than other ones.)

If someone asked you, “Why was there a recession?”, you should say it’s because your central bank screwed up; you should not say it’s because there was a financial crisis.

III.

To close, a related syllogism:

1. Recessions are periods when output is below potential.
2. Output below potential is, almost by definition, a shortfall in aggregate demand.
3. Central banks control aggregate demand.

Therefore, all recessions (in the sense of output being below potential) are caused by central banks.

PS.

If you are unhappy with the logic above, the syllogism also provides a natural taxonomy of possible counterarguments. Considering each point of the syllogism #1-3 in turn:

1. Perhaps we should not define recessions as periods when output is below potential. The real business cycle theory that economic fluctuations are due to productivity or other ‘real’ shocks would be one version of this.
2. Perhaps output can be below potential without “aggregate demand” (whatever this means) falling, as in theories of macroeconomic multiple equilibria.
3. Perhaps central banks do not have perfect control of aggregate demand.
1. For example: some argue that central banks cannot control aggregate demand at the zero lower bound.
2. Alternatively (and, really, a generalization of the ZLB problem): perhaps aggregate demand is not a one-dimensional concept, and it is impossible to simultaneously set all dimensions at the right level. For example, a recession might involve “a shortfall in demand” in one region but “excess demand” in another region. The central bank might not be able to perfectly control demand in each region at the same time, and can only ensure zero shortfall in one region at a time.

The counterargument 3b is how I would frame the mainline New Keynesian view (eg).

It is analogous to the problem of having a single thermostat set the temperature for all of the many rooms in your house, and asking what is to blame when your bedroom is too hot but your kitchen is too cold. To me, if your bedroom is consistently too hot but your kitchen too cold, the most useful way of talking about the world is to say, ‘my thermostat is not working very well’ and to think about ways to make your thermostat work better – not to blame the weather outside.

Likewise, even if central banks cannot perfectly set all dimensions of “aggregate demand” to the right level simultaneously, the most useful way of talking about the world is to say, ‘my central bank is not working very well’ and to think about ways to make it work better (eg, eg).

PPS.

If it keeps breaking, have you thought about replacing your monetary institutions thermostat with a newer version?

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