John Kay has a good piece about the damage done by the obsession with policy “credibility”. This is one of those ideas rooted in theoretical models that happened to mate perfectly with political prejudices, and hence became part of the orthodoxy almost immediately despite a lack of convincing evidence that it really does matter. (Moral hazard plays much the same role in health care discussion).

The big test of the credibility hypothesis was supposed to be disinflation. A really credible commitment to bringing down inflation was supposed to reduce the “sacrifice ratio”, the cost in terms of protracted high unemployment to get underlying inflation down. The big proving ground was supposed to be the Volcker disinflation of the 1980s.

In fact, however, that disinflation was incredibly expensive. Here’s actual unemployment versus the CBO estimate of the natural rate:

It took a gigantic sacrifice to get inflation down, with no real sign that the Fed’s credibility made any difference.

The same slump, by the way, made nonsense of much of what the equilibrium business cycle theorists were saying.

Yet both the doctrine of credibility and equilibrium business cycle continued to flourish, indeed to establish a growing dominance.

Something similar but even worse is happening now: the economic doctrines that are gaining strength politically — hard-money obsession, anti-Keynesianism — are precisely the doctrines that have totally failed in their predictions.

I really think we need to figure this out.