Greg Ip, The Economist’s U.S. Economics Editor, explores the different roles economists and traders play in financial markets. Economists tend to assume market prices are correct until they are told otherwise. Traders assume prices are incorrect until they make money. But traders, by design, will have opposing views of the incorrectness – so on average the economist should be right.
However, the economist won’t change the price to reflect “non-fundamental stuff”, the trader will. Yes, sometimes he changes prices too much one way or the other. And yes, estimating the probabilities of a million possible states of the world is going to make the output look like the interaction of a 2 year-old holding red and green crayons and a newly painted living room wall. But, as Greg points out, there is a signal in all the noise that those setting monetary policy should heed (carefully!).
Central banks can only control the interest rates that permeate through economies to a limited degree, so they are reliant on the markets to enact certain policies accordingly. The interaction between monetary policy and the market is at a critical juncture – neither can afford to get it wrong.