David R. Henderson  

Tools and Objectives

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Let's say I notice that a screw is loose on a handle of a pot. This often happens with one particular old pot we have that we love. So I go get a Phillips screwdriver and tighten the screw. Would you say that the screw is a tool? Or would you say that the screwdriver is a tool? I say that the screw is the object I'm trying to affect and that the screwdriver is the tool.

What does this have to do with economics? Here's what. On a blog post recently Scott Sumner writes:

Because central banks are used to using short term rates as their primary policy tool, policy may well become sub-optimal once rates hit zero.

But interest rates can't be a tool. They're an objective: they're like the screw on our old pot. They might not be the ultimate goal. But fixing the handle to the pot isn't the ultimate goal either. The ultimate goal is to use the pot to cook something. I see this a lot in the writing of monetary economists: it's a basic category error. It's hard to believe that making such an error won't ever lead to other errors in thinking.

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CATEGORIES: Monetary Policy

COMMENTS (9 to date)
jsalvatier writes:

It's easy to frame it the other way: 'short term interest rates are the central bank's main tool for pushing the economy in the right direction'. Anyway, scotts point is correct, thinking about monetary policy in terms of interest rates is a terrible practice.

Nick Rowe writes:

Funny. Your post is almost something Scott would have written.

What Scott should have said (meant to have said) was: "Because central banks are used to *thinking of* short term rates as their primary tool, policy may well become sub-optimal when rates hit zero".

And central banks, indeed the whole Neo-Wicksellian macroeconomic orthodoxy, most certainly do think of short term interest rates as the policy tool. They find it very hard to think about monetary policy in any other way. They find it hard to communicate monetary policy in any other way. Yep, it is a category error. That, basically, is what Scott himself keeps saying.

Brad Warbiany writes:

Well, I think it'd be fair to say that when the Fed board meets, the room is full of tools.

That said, I see your point, but at the same time disagree. Interest rates are both a tool and an object. The economy is a complex system, and interest rates are one factor in its behavior. The Fed sets interest rates (i.e. they're an object), but the level of interest rates is then a tool to effect change on the rest of the system.

azmyth writes:

But interest rates can't be an objective. An interest rate target alone leaves the inflation rate indeterminate. The Fed's mandate specifies price level and unemployment. If they let either get out of control, they would be chastised by Congress, even if they perfectly hit their interest rate target. Interest rates are neither an objective nor a tool. They are a strange way of communicating a monetary policy stance.

Philo writes:

The screw that attaches the handle to the pot has only instrumental value; it is not a “tool,” because ordinarily it carries out its function without any manipulation by us. The screwdriver, which also has only instrumental value, *is* a tool because it must be manipulated by us in order that our purpose be achieved. The immediate purpose (objective) is getting the screw to do what we want it to do; this objective is itself a means to a further objective, and so on. Ultimately, as they say, we must arrive (conceptually) at a final objective, which (we think) has not merely instrumental but *final* value. (I believe Aristotle was the first to make this point.)

Whatever the Fed’s objective—supposedly, price-stability-cum-full-employment—it tries to achieve this objective by manipulating the Fed Funds rate; the Fed Funds rate is, precisely, a *tool* that the Fed is using. (Here we need not concern ourselves with what the *final* goal is; it probably is not price-stability-cum-full-employment, but something grander.)

In order to manipulate this tool, the Fed uses open market operations—something like a further “tool,” though it sounds unnatural to say that open market operations “manipulate” anything. It is as if, in order the better to grip the screwdriver, you put on a rubber glove. The glove is something like a “tool,” used to facilitate the manipulation of the screwdriver. Open market operations are something like a “tool,” used to accomplish the manipulation of the Fed Funds rate.

I see no error in Sumner’s remark.

Noah Yetter writes:

Several commenters seem to be forgetting that the Fed doesn't set interest rates, it influences them through open market operations. This is why they are not the tool.

perfectlyGoodInk writes:

Well, the screw is both an object and a tool. It's part of the pot, which is a cooking tool.

I think a much better analogy would be open market operations being setting the height of the flame on the stove and interest rates being the temperature of the water in the pot.

Scott Sumner writes:

I got sloppy. I meant to say using the fed funds target as a policy tool. The Fed controls the fed funds target directly, they influence the fed funds rate via open market operations.

pandaemoni writes:

It seems a minor semantic niggle at worst. Merriam Webster defines "tool" in multiple ways, including "something (as an instrument or apparatus) used in performing an operation . . . " or as "a means to an end."

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