Monetary Policy and the Knowledge Problem

The knowledge problem in economics is most closely associated with Friedrich Hayek, who articulated it in analyzing the role of prices in markets, the socialist calculation debate, and monetary policy. In this article, I summarize and apply Hayek’s analysis to contemporary monetary policy debates. I also connect Hayek’s work with that of Milton Friedman, who articulated his own version of the knowledge problem in his monetary work. Friedman’s views in this area are underappreciated.

Hayek argued that knowledge is inherently dispersed and localized across the population of economic agents. It is not possible to assemble the totality of knowledge existing in society in any one mind or place. Individuals may reveal their localized knowledge by their actions, but only if incentivized. Moreover, knowledge is often tacit and cannot be articulated. What the totality of individuals knows far exceeds what any policymaker can know, no matter his or her expertise and wisdom.

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