A lot of misery has resulted from administrators getting stuck in status quo

Monty Hall is a famous probability puzzle, inspired by the American game show Let’s make a Deal. It leads us to a psychological state that makes us value what we currently have more than what we could get even if the alternative is superior — aka the status quo bias. The Swedish psychologist and Nobel laureate, Daniel Kahneman, immortalised all such biases in his epic volume Thinking, Fast and Slow, which is a must read for people interested in the complexities of the human brain.

The lesson of Monty Hall is that intuition rarely gives us the correct answer. This should motivate us to question the assumptions for the solutions we currently think we have. The real world provides enough examples to illustrate this point.

Management solutions

Let’s start with a simple one. One of the modern mysteries is why companies — big, successful, intelligent companies — pay bags of money to acquire management solutions from consultancies. Especially since those consultancies rely, in large parts, on 20-somethings who until a few weeks ago had no clue about the inner workings of their clients’ organisation. The truth appears to be that many (not all, of course) of those big clients already know the right steps to be taken from internal sources, but cannot implement those steps since they would face substantial resistance and backlash from their existing structures. So they bring in the reputed consulting brand, and that consultancy makes it easier to implement those changes. They do so by taking over the mantle of the big, bad wolf upon themselves. This example tells us about the status quo bias in companies.

Financial crisis

A different kind of example of the same bias has acquired immense significance in the last five years. The financial crisis which started in the year 2008 with the (Fed sanctioned) collapse of Lehman Brothers led to what we now term the Great Recession. As we know, the recession stemmed from a collapse in aggregate demand due to balance sheet deleveraging, a non-functioning financial market in desperate need of liquidity and safe assets, and central banks up against the Zero Lower Bound (ZLB) (the state where nominal interest rates are at or near zero, and thus cannot be lowered further by the central bank).

What was required in the short run was a government sector stimulus, both in monetary and fiscal terms, along with a long run view of reducing systemic risk in the unregulated shadow banking industry. Let’s focus on monetary policy alone here, since the central bank is an independent organisation in each country and not subject to the same political pressures as fiscal policy and financial regulation.

Before having a look at what actually transpired, let’s check out the status quo. The Fed had flexible policy tools and a double mandate of maintaining low inflation and unemployment. The ECB, meanwhile, had a single mandate in its constitution, that of price stability, and carried forward a legacy of hard money ever since an episode of hyperinflation in Germany in the 20s.

Here is what happened in the two markets. The Fed in the U.S. provided unconventional stimulus through:

Quantitative Easing (QE) (buying risky long term securities from the private sector to flatten the yield curve) which reduced risk in the economy, providing safe assets and liquidity to the credit markets

Targeting a threshold rate of unemployment of 6.5 per cent, and sustained inflation of 2.5 per cent. The Fed did much more than has ever before been done, revived the U.S. economy, and deserve kudos.

The ECB, however, hardly moved from its single mandate. Unlike the Fed, it did precious little apart from acting as a last minute firefighter through sovereign bond funds, leaving the EU in a far worse position than the US, with unemployment reaching 20 per cent in major countries. On top of that, the ECB supported fiscal contraction policies in the EU, thus lowering output and long-term employment.

A lot of unrequited misery has resulted due to administrators stuck in the status quo. Of course, human beings are prone to value factors apart from efficiency such as ego, power, fear and their ilk, which feed into the status quo bias. It is a tough ask to give all that up in a single go, no matter how educated and sophisticated you might be. We have indeed journeyed afar, but would be wise to remember Frost’s famous words.

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