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The path of least regret is a hugely important concept to understand.
Mainly because it's how our illustrious leaders and their key policymakers actually make decisions (most of the time).
Nowhere has this been better illustrated than the recent inflation debates (although the coming Winter of Covid measures and semi-mandatory vaccine nudgefests will run it close).
Whilst it's fantastic fun to bash policymakers for every mis-step, they're not just total idiots with no real-world experience. It's far worse than that. They're a form of manager.
And this manager point is pretty key. If you've ever been in the unenviable position of making decisions that involve more than a handful of people, you'll know how hard it is to reach a consensus.
- Family: "Where shall we go for dinner tonight?"
- Pub Football Manager: "We haven't got a goalie again, so who's up for it?"
- Workplace: "Some of you will have to work weekends so..."
And there's a million other scenarios like this.
When it works out, everything's fine.
When it doesn't, everyone's an expert with a lot to say...
- Family: "Told you we shouldn't have come here, everyone got food posioning. I don't even like French food"
- Pub Football: "We lost 10-3, why didn't Fat Pete go in goal second half? He couldn't even run after the first 15!"
- Workplace: "Why is it always us working the weekends? Taking us for mugs. We're leaving!"
Whilst all of these critiques might be obvious and accurate in hindsight, it wouldn't necessarily have been so clear at the time.
Which is why, most of the time, policymakers, just like managers will opt for the path of least regret: A decision that nobody is excessively happy or unhappy about.
“You can please some of the people all of the time & you can please all of the people some of the time...,
but you can’t please all of the people all of the time”
So why bother trying? Just make sure that nobody hates you enough that you lose your job.
Back to the inflation debates...
Central banks have taken massive amounts of criticism this year with their reckless easy money policies™
What if they'd listened to the baying masses and started hiking as soon as inflation came in a little bit hot...?
Well, that's exactly what the Bank Of England's Deputy Governor Ben Broadbent covered in this speech:
Key Points 👇
One is that it takes time for policy to work. A change in interest rates has its peak impact on inflation only after a significant delay – probably eighteen months or more.
One implication is that, fully to offset the inflation we’ve seen through the course of this year, monetary authorities would have to have foreseen the various things that have pushed it up (including, for example, the recent problems with gas supplies).
Another is that they would have to have tightened policy pretty aggressively – by enough to push up unemployment materially, with the explicit aim of depressing nominal wage growth – just ahead of or during the first wave of the pandemic.
Using the Bank’s economic model, and assuming perfect foresight of the rise in tradable goods prices, a simulation suggests you would have needed comfortably more than an extra 2% points on the rate of unemployment – something around eight hundred thousand jobs – to have kept overall CPI inflation at 2% in the fourth quarter of this year (Charts 5a and 5b) 👇
The path of least regret was taken, and that's brought the economy to where it is now. What next?
Now that the employment picture has vastly improved, the furlough scheme has ended and the economy is standing on it's own two feet, the path of least regret will change too.
As Broadbent says:
Although it’s made little contribution to higher inflation so far, the risks to future inflation from the tight labour market may well be more significant.
Developments in domestic costs tend to be more persistent than those in tradable goods prices (Chart 6 is one indication of that).
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Would the outcomes actually have been markedly different if central banks had started hiking sooner?
Nobody knows for sure.
The goods data in that chart only covers the past 20 years, a period when China has been consistently providing low-cost goods. Maybe Chinese production issues lead to more persistent goods inflation as firms choose to reshore or move production...
OK, maybe toy manufacturers aren't the best leading indicator for reshoring!
One thing that is relatively certain... Policymakers the world over will rarely aim for optimal solutions.
Policy will forever be sub-optimal on all kinds of levels. That's not to say that it's always going to be a disaster. It's just the nature of the beast.
"The path of least regret will (almost) always be favoured by policymakers"
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