The Use of Economic Analysis to Affect Public Economic Policy: The Case of the Shadow Financial Regulatory Committee

By Kaufman, George G. | Business Economics, January 2003 | Go to article overview

The Use of Economic Analysis to Affect Public Economic Policy: The Case of the Shadow Financial Regulatory Committee


Kaufman, George G., Business Economics


Promotion of sound economic policy is frustrating, not so much because policy-makers do not understand its value but because its value is realized over the long run; and policy-makers have short-run perspectives. Crises, however, give rise to opportunity for good policy; and the banking and thrift crisis of the 1980s provided the impetus and credibility of the Shadow Financial Regulatory Committee. The success of the Committee was due in large part to its proposals for practical, effective remedies. The Committee has continued to provide a voice that is independent of industry and regulators in support of a sound and efficient banking financial system. It has a preference for market-based solutions, and its success has spawned similar organizations in fifteen other countries, with others being planned.

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I am delighted and honored to accept this year's Adam Smith Award that NABE has bestowed on me. But I am as much humbled as honored as I review the names of the previous recipients and of my two co-recipients. The award is presented primarily for our use of economic analysis and principles in helping to shape public economic policies. Rather than focus strictly on an economic issue, as is usual in these lectures and which my two co-recipients will do, I will help set the stage for them by reviewing briefly how Washington "outsiders" may be able to help shape public economic policy and the hurdles they face and provide a few examples of apparent successes. Lastly, I will review how the U.S. Shadow Financial Regulatory Committee, on which my two co-recipients and I are either currently serving or have served in the past, came into being and how it operates.

Attempting to influence public policy in the area of economics, as I need not remind this group, can and likely will be a highly frustrating experience unless one goes into the adventure with an awareness that failure is the most likely outcome and that any successes, no matter how marginal, are well worth the effort expended. But sadly even the few triumphs may be short-lived as later policy-makers can always modify or even undo any progress achieved. The major hurdle any economist who tries his or her hand in such undertakings faces is that economics tends to operate in the long-run and politics in the short-run. Paraphrasing Keynes, in the long-run all politicians are out of office. It is not necessarily that policy-makers do not understand or appreciate economics; it is more that they like keeping their jobs better. Thus, economists who try to influence policy are faced with the classic time inconsistency dilemma.

When there is a conflict between an economically sound long-run policy that has politically negative immediate effects and one that has economically lasting adverse effects but politically appealing immediate effects, the policy-makers have incentives to choose the latter, except possibly in their last days in office, when they may be concerned with their "legacy." As Charles Kindleberger has admonished us in his seminal study of asset price bubbles, "today wins over tomorrow" (Kindleberger, p. 149). Thus, in a non-crisis environment, expansive economic policies that temporarily lower interest rates and unemployment but accelerate inflation in the longer-run, when the policy-makers may be out of office, will--until late in the game--generally win over restrictive economic policies that temporarily but unpopularly raise interest rates and unemployment in the short run but lower inflation in the long-run.

In most periods, good economic policy advice is likely to be accepted and adopted only at the margin, if at all. At these times, the economic adviser's general objective probably should focus on curtailing as much as possible any long-term lasting economic damage of politically popular policies that are likely to be adopted. This strategy more or less holds for crisis as well as non-crisis periods, except that in crises the relevant time frame for political policymakers may even be shorter and the actions taken may need to be even more visible. …

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