The great Argentine footballer, Diego Maradona, is not usually associated with the theory of monetary policy, but his goals were used by economists to explain how central bankers have modernized.
Maradona scored both Argentina's goals in the FIFA World Cup quarterfinals against England, and each of them was iconic for different reasons.
In 2005, the Bank of England governor, Lord Mervyn King, said that a central bank managed to control inflation perfectly by responding to all shocks instantaneously. The outcome would be a constant inflation rate. Households and firms would know that potential movements in inflation would never emerge because all future shocks would be instantly offset by changes in interest rates. Interest rates would change with no apparent link to or effect on inflation.
To an observer – whether journalist or econometrician – interest rate changes would appear to have little to do with inflation. The central bank would appear to be behaving almost randomly. But that inference would be false. Indeed, if people did expect the central bank to behave randomly, then the behaviour of households and firms would change and inflation would no longer be stable.
This is what I call the Maradona theory of interest rates, Lord Mervyn King said.
Lord Mervyn King described the two goals that Argentina scored against England in the 1986 World Cup in Mexico to describe how interest rates in modern economies work.
The first, dubbed the "Hand of God," refers to a goal scored by Maradona during an Argentina-England match in Mexico on June 22, 1986. Maradona jumped to head the ball but ended up hitting it with his hand, which went past the goalkeeper, Peter Shilton, to give Argentina a 1-0 lead during the game.
The illegal hand ball went unseen by the referees in a game Argentina took 2-1, on its way to winning the world championship one week later. The 1986 World Cup against England elevated Maradona to the status of a legend.
This, Lord King said, summed up the old "mystery and mystique" approach to central banking. It was "unexpected, time-inconsistent, and against the rules" and "he was lucky to get away with it".
The second "Goal of the Century". Well, here’s how Lord King put it: Maradona ran 60 yards from inside his own half beating five players before placing the ball in the English goal.
This solo goal is often classed as the greatest goal ever scored.
The truly remarkable thing, however, is that Maradona ran virtually in a straight line. How can you beat five players by running in a straight line? The answer is that the English defenders reacted to what they expected Maradona to do. Because they expected Maradona to move either left or right, he was able to go straight on.
Monetary policy works in a similar way, said Lord King. Market interest rates react to what the central bank is expected to do.
They headed in a straight line to their goals. How was that possible? Because financial markets did not expect interest rates to remain constant. They expected that rates would move either up or down. Those expectations were enough, at times, to keep private spending stable while official interest rates moved very little, he said.