True or False?
False. For the statement to be true the central bank must also have the ability to forecast the position of the economy at various future points in time both leaving out and including the effects of its own policies. For example, if the central bank incorrectly predicts that a business downturn will be a long one when, in fact, it will be short, its expansionary policies will prove too strong and will take effect just as the economy is moving out of the recession. The result will be to amplify the next boom. The central bank could make its superior information publicly available and let the private sector respond on its own to the future aggregate demand shocks. This will give better results, however, only if the private sector can utilize this information more effectively than can the central bank.
This emphasizes the reasons why some economists believe that central banks should not engage in fine-tuning. There is no reason why governments should do better at forecasting than private sector forecasters. And, given the limited forecasting ability of economists in both sectors, the government might end up adding variability to economic activity rather than smoothing it. A counter-argument to this is that wages and prices are often frozen for short periods on account of contracts previously entered into. This would imply that the central bank could adjust aggregate demand to compensate for the private sector's inability to adjust wages and prices. Again, however, this assumes that the central bank can usefully forecast future economic activity and the timing of the effects of its policies on it.