Framing and Macroeconomics at the FOMC
It is useful to develop my arguments about why the FOMC failed to see the crisis in more detail. Obviously, the FOMC is a committee that has members, holds discussions, and arrives at conclusions.
It is embedded in a large bureaucratic organization. As such, our general understanding of how such meetings work and how conclusions reflect group processes can be illuminating in making sense of why the FOMC never caught up to what was going on in the link between the financial industry and the housing sector and downplayed the worsening financial crisis.Central to my discussion is the idea of a framework by which people interpret the world. The key explanatory tool here is the frame construct, defined by Goff- man (1974: 11) as “principles of organization which govern subjective meanings we assign to social events.” As Goffman (1974: 21) explains, framing gives order and meaning to our experience by enabling us “to locate, perceive, identify, and label a seemingly infinite number of concrete occurrences defined in terms of a given frame.”
Frames are not just mental structures situated in individuals. They are inter- subjective constructs that must be maintained in ongoing interaction (Diehl and McFarland, 2010: 1717). Framing and the situation in which framing takes place form a coherent whole that helps make interaction possible (Goffman, 1974). Actors have a set of rules and roles, and it is within those that they use, share, and modify a common set of frames to produce meaning (Fligstein and McAdam, 2012). As Diehl and McFarland (2010) point out, this interactionist perspective implies that the content of frames is a product of history and setting.
While a particular frame in a particular setting is likely to be unique in time and space, the process of framing itself is ubiquitous. Since it is both a system of particular meanings and a general way to make sense of what is going on, any frame will be open to some interpretations of reality and closed to others.
Thus, it is conceptually necessary to separate the general features of the framing process that limit thinking from the specific ones that create historically and situationally variable blind spots. In trying to understand how frames work, one must keep in mind that all frames have blinders that cause us to pay attention to some things and not others. But different frames will blind us to different things. Frame analysis implies that if we are to understand how a group interaction works, we need to decode its primary framework and observe it in action. Framing will lead actors to concentrate on a certain set of terms and facts and leave out others.To apply frame analysis to the context of the FOMC, it is necessary to consider how such a frame would be formed at the FOMC. The FOMC is a case where professional economic knowledge is at the core of the framing problem (Hirschman and Popp Berman, 2014). Its legal mandate is to guide the economy by focusing on controlling inflation and promoting employment. It accomplishes those goals through the use of economic theory by its members. Such professional and expert work involves the creation, communication, and application of expert knowledge, knowledge used to solve concrete problems (Gorman and Sandefur, 2011: 282-283).
Part of the problem of using expert knowledge is to take abstract principles and apply them to solve a particular problem. Indeed, the meetings of the FOMC entail exactly this task: use abstract principles and current information and decide whether to change interest rates, which are the main policy tool that they use to control inflation and promote employment. Interpreting the current state of the economy and its potential for change is a difficult task. As new potential problems emerge, the FOMC must decide whether they are significant enough to justify changing the course of interest rates in the economy. In order to do this, framing around the meaning of “facts” and deciding what those facts are in the first place is the topic of discussion and argumentation.
There are three relevant aspects to the application of professional knowledge. First, the abstract knowledge of economics forms a set of styles of reasoning that can be used to inform policy ideas (Hirschman and Popp Berman, 2015). Second, that knowledge implies the use of policy devices that allow people to make sense of the world through the use of statistics, measurement, and models (Muniesa et al., 2007). Finally, the experiences of actors either in their training as economists or in the public or private sectors will shape how they see what is going on (Fourcade, 2009). I suggest that macroeconomics is a particular version of economics that contains a style of reasoning, relies on particular kinds of evidence to support its argument, and is the dominant training of the members of the FOMC.2
Macroeconomics as a form of abstract knowledge focuses on aggregate-level economic features such as output, growth, productivity, employment, inflation, and interest rates. Macroeconomists’ models explain the relationships among indicators of these and related factors like savings, investment, and consumption (Palgrave Dictionary of Economics, 2008). The particular version of macroeconomic theory and modeling that dominated academic and policy circles during our period of interest is the new neoclassical synthesis, also sometimes called the “new Keynesian synthesis” (Goodfriend and King, 1997; Woodford, 2003, 2009). This approach seeks to develop dynamic general-equilibrium models of entire economies that synthesize neoclassical theories of the perfectly efficient business cycle with a neo-Keynesian understanding of so-called rigidities and frictions, especially regarding prices and wages.
There is good reason to believe that this way of approaching macroeconomic issues prevailed at the FOMC from 2000 to 2008. The primary model of the US economy employed by the Federal Reserve Board during this period, the FRB / US modei, was endlicitln founded onthe principlesof the new neoclassical synthesis (Brayton et al., 1997).3 This model can be seen as a policy device by which participants analyzed the economy (Sbordone et al., 2010). Academics and Fed economists writing in the 2000s took for granted that such principles directly informed the FOMC’s efforts to analyze the economy and make monetary policy (Chari and Kehoe, 2006: 3-5; Goodfriend, 2007: 65; Schorffieide et al., 2010).
Indeed, these scholars saw the victory of the new neoclassical synthesis as marking an unprecedented level of consensus among academics and central bankers worldwide (Solow, 2008). As the macroeconomist Michael Woodford (2009: 274) put it, “there are not really alternative approaches to the resolution of macroeconomic issues any longer.”The FRB / US model is the basis for many predictions as to how shocks might impact the US economy. For example, at a meeting where the FOMC discussed whether there was a bubble in housing prices in the summer of 2005, one of the participants, John Williams of the San Francisco Federal Reserve, made a presentation to consider the macroeconomic effects of a bubble bursting. Mr. Williams's presentation was based on his use of the FRB / US model. His presentation consisted of constructing several scenarios about how a decrease in housing prices might affect the economy. He used the model to provide upper- and lower-bound estimates of the potential hit on GDP. He concluded, “In summary, assuming that the FRB / US model does a good job of capturing the macroeconomic implications of declining house prices, such an event does not pose a particularly difficult challenge for monetary policy” (FOMC, 2005b: 19). This use of the model worked to give a set of reasons why even if a financial bubble existed, its demise would not have a large impact on the American economy. This use of the model led the members of the FOMC to miss or underestimate the relationships between the housing market, financial instruments, the financial system, and the economy as a whole.
Quantitative macroeconomic models, like the Fed's FRB / US model, take as their core the “real business cycle” theory that formed a central element in the neoclassical revolution of the 1970s and 1980s (Brayton et al., 1997; Goodfriend, 2007).4 Real business cycle theory reinterprets economic fluctuations, such as the business cycle, as an efficient response to exogenous shocks (Plosser, 1989: 52, 71).
It locates such shocks in “purely real factors... such as productivity shocks, fiscal shocks, and international terms-of-trade shocks” (Goodfriend, 2007: 59). The new neoclassical synthesis (Goodfriend and King, 1997; Woodford, 2003), by contrast, is more attuned to nominal factors, incorporating a variety of neo-Keynesian rigidities and frictions—most important, sticky prices and wages. It does not reject real business cycle theory per se; rather, it regards the real business cycle as a special case (Woodford, 2009: 269). Indeed, it suggests that the goal of monetary policy, in particular, is to smooth wage-price rigidities to “make the economy conform to its underlying real business cycle core” (Goodfriend, 2007: 61; emphasis added). The implication of this, one could argue, is that the real business cycle really does exist in the world and would operate according to its theory absent certain obstacles, which it is the role of monetary policy to remove.This had two important effects on the FOMC's ability to perceive the risks associated with a financial crisis. First, to the extent that participants leaned toward the neoclassical aspects of their framework, they would maintain a default position of optimism in the face of any economic disturbance, since they viewed fluctuations themselves as elements of a self-regulating economy. Second, even if participants leaned toward the neo-Keynesian aspects of their framework, they were unlikely to direct attention to the key place that could undermine optimism—the housing-finance nexus—precisely because the new neoclassical synthesis overwhelmingly brackets the real economy from the financial system. That is, because this framework incorporates “nominal” factors (such as money and financial intermediation) as rigidities and frictions atop a “real business cycle core,” it retains the basic assumption that economic shocks have “real” (non- financial) sources (Borio, 2014: 182).5
Seen from this perspective, financial markets and the banking system may distort, extend, or amplify underlying economic fluctuations (Bernanke et al., 1999), but they do not generate such fluctuations (Borio, 2011, 2014).
Instead, the underlying model of the economy is a set of sectors that have relationships to one another. The business cycle is a function of how events in one sector might affect other sectors and the overall economy. The tendency is to view the spillover effects of such shifts as relatively minor. As a result, events in the financial sector were no more or less likely to lead to spillovers than events in any other sector.Finally, the professional composition of the FOMC leans toward macroeconomics as well. Table 8.1 contains a list of the members on the FOMC from 2000 to 2008. It includes information on their education and work background. The table shows that twenty-two out of thirty-six (61 percent) of those with permanent or rotating votes on the FOMC had received an economics PhD with an emphasis in macroeconomics. These figures do not imply complete dominance by macroeconomists, but they do suggest that their way of seeing was likely to constitute the majority position at the FOMC. By contrast, only five governors and Reserve Bank presidents (14 percent) had prior experience working in the financial sector.