I certainly do not reject the idea that coordinated, population-wide changes in beliefs and/or preferences have macroeconomic effects. I think herd psychology and fool-in-the-shower-style updates of expectations about lifetime income can and do have big macroeconomic effects. In fact, I think we are seeing some of this now. But booms and busts are not only about aggregate demand and animal spirits. Nor are they only about government-induced capital misallocation. I’d like to see somebody with the wherewithal to explain how policy-led misallocation interacts with herdy consumer and investor psychology. Then I’d have a reason to really believe someone who says we merely need to wait and let all the malinvestment shake out, or someone who says we merely need to prop up the confidence of consumers and creditors.
It seems likely that there are in fact a lot of bad bets that need to get squared and that the herd could use some prozac. But what dose? How much is too much; how much leads to just the sort of systemic malinvestment that leads the herd to panic again? This is the sort of thing I feel like no one really knows anything about, though I am more than eager to be shown the secret science.
Daron Acemoglu’s VoxEU op-ed reminds me of another piece of macropsychoeconomics I’d like to know a hell of lot more about: backlash threat:
Decisive action on the crisis is necessary; not just soften the blow of the recession but also to avoid a backlash that could be deeply harmful to long-run growth. A deep and long recession raises the risk that consumers and policymakers start believing that free markets are responsible for the economic ills of today. If so, we could see a move away from the market economy. The pendulum could swing too far, bypassing properly-regulated free markets, towards heavy government involvement that could threaten future growth prospects of the global economy.
A comprehensive stimulus plan, even with all of its imperfections, is probably the best way of fighting these dangers. Nevertheless, the details of the stimulus plan should be designed so as to cause minimal disruption to the process of reallocation and innovation. Sacrificing growth out of our fear of the present would be as severe a mistake as inaction. The risk that the belief in the capitalist system may collapse should not be dismissed.
OK. I find the backlash hypothesis totally plausible. The idea here is that (1) good economic institutions require sufficient cultural support, (2) the “do nothing” response will erode cultural support and thereby threaten future economic performance, so (3) we should do something that prevents backlash, but nothing that screws up the very institutions we’re trying to preserve by not doing nothing.
So what’s the actual evidence for (2)? Acemoglu notes that populist, anti-market backlash is a big problem in developing economies, and I agree with him. But surely places with durable, high-quality economic institutions already have a lot of both elite and popular buy-in, which should limit the magnitude of any backlash. If the point of “doing something” is really institution-preserving political theater (like Acemoglu, I’m an institutionalist, and think this does count as “economic policy”), then how much theater do we need? What is the minimum that will suffice to keep the pitchforks in the barn? Over the medium- and long-term how much can upgrades in economic literacy do to reduce backlash threat? Obviously, institution-preserving political theater creates a political opportunity to screw up economic policy, or Acemoglu wouldn’t be warning us against it. So maybe good long-term economic policy involves prioritizing economics education as a prophylactic against future backlash.
Interesting thought Will: economics education as the centerpiece of a recovery plan. We'd get more bang for the buck out of that than anything else (not to mention the obvious short-run increase in the average wage for econ profs!
)
You've seen Caplan's “Idea Trap” piece, right?
This crisis is in part a failure of the “elites”. It is apparent that the academic economic elites
did not have a clue about the financial markets and the crisis until it hit them in the face-witness the comments in response to Raghuram Rajan's paper at the celebration for Mr. Greenspan. Furthermore, the upper management in most banks in Wall Street have been shown to be incompetent and effective only at driving the financial sector into the ground. This is sufficient grounds for a backlash-the difference between a country like the United States and many developing countries has been that the elites have a larger interest in the greater social good, while the general attitude in many developing nations is more cynical-that the elites would be happy to line their pockets at the slightest opportunity. Given this crisis, it is likely that similar cynicism sets into the average persons' perception of society even here.
These sorts of changes in expectations should result in changes in prices.
The fundamental realties of scarcity and gains from trade should not break down because of fear. Prices shoud adjust, perhaps to a heroic degree, to coordinate social production.
It is possible that uncertainty about the future will result in most production being devoted to consumption goods and services. Opportunities for large increases in future consumption might be possible, but forgone because fo risk.
It is even possible that some people might concentrate on home production. Or, there might be even people who can enjoy leisure. They don't work because the pay off it just too uncertain.
But what is counterproductive is a situation where people are all trying to sell resources to be used for current production in order to obtain money to hold now and spend later when everything works out.
That is impossible. Not that people can't try it, but that they can all do it at once. Having a response to this of producing less and not using resources for current production, is a coordination faiulre. We can't all have the money at the same time and not cutting current production doesn't help anything.
In my view, the “obvious” solution would be negative nominal interest rates on money. If everyone wants to hoard cash, they need to pay for it. Spent it or lose it. Accept the risk of buying capital goods and getting a possible real return. Or, consume now. (Or,
work less if you really are only working to save and earn interest.) When it is all over, then nominal interest rates would rise again.
The more tradtional solution is for the prices of all goods, services and resources to immediately drop to a level, so that the real value of the existing money supply is so high that people will spend some of it on consumer goods or capital goods. Enough so that total spending matches what people want to produce. They will be so wealthy they will want to consumer goods and/or will be willing to take a risk of losing a bit of all of this wealth in some risky venture involving capital goods. When it is all over, the price level rises again, and the real quantity of money falls back to its previous level. (To the degree this is anticpated, that expectation further motivates spending when prices are extra low. The expecation of a return of the price level creates a negative real interst rate on money at the low price level.)
Having the private sector increase the money supply would be great, but this requires that banks be willing to take the risk in face of the panic. (With negative nominal interest rates on money, they would be paid to take the risk, but realistically..)
Of course, a government central bank might do it. Like the Federal Reserve.. purchasing an ever greater variety of longer term and more risky assets. People can hoard currency and claims to balances in Federal Reseve banks, and the Federal Reserve banks take the risks for them. I think this “quantitative easing” will work if the Fed does enough of it. Once the problem is over, the Fed will sell off all these risky assets. Which, of course, people will want to hold now. It will destroy all that money it had created, which people don't want to hold.
And then, tax and govenrment spending approach. This would appear very likely to work if people are just as happy to hoard short term government bonds as money. The government can issue them and get money that people would otherwise hoard and then the govenrment produces things. People sell resources to use to produce current goods and services and use (part) of it to obtain bonds to hoard until things look up. The govenrment issues bonds to them and hires them to produce goods and services.
Unfortunately, when the panic ends, the bonds are still there. The govenrment has to collect taxes to pay the interest. And, the private investments that would have been made after the bank with the funds that are now tied up in the govenment bonds are “crowded out.”
Of course, combining a money creating central bank with government spending means that the combined effort involives creating the money people want to hoard and producing goods and services. If people are happy with the government bonds, fine. If they really want currency, that can be arranged as well. However, if the situation passes, then the money must be removed from ciculation and the bonds issued. Interest must be paid on them. And, at that point, private investment is crowded out.
Of course, the govenrment might not remove the money from circulation. So that when the panic passes and people no longer hoard currency, the result will be inflation. If people beleive this will happen, that will actually motivate people to spend more during the crises. It is related to the first solution. Rather than have a negative nominal interest rate on money, the anticpated inflation rate creates a negative real interest rate.
In every scenrario, it is all about the supply and demand for money. Create more money. Create a substitute for money. Lower the nominal interest rate on money. Lower the real interest rate on money. Supply and demand.
Or, of course, we can arrange things so that there will never an excessive increase in the demand for money.
Consider an analogy. Suppose we decided to make sure that there was sufficient gasoline to meet people's needs at the traditional price by varying amounts of hectoring about fuel convervation. If there are surpluses, the government will sponser off road clubs in all the public schools to build up demand. Green propaganda will be used to solve shortages.
I believe that the total failure of economic education is one of the reasons why we are in this mess to being with. 'Improving' education by emphasizing failed theories that have a terrible track record will not help us. What is required is a move towards true free markets in which there are no central banks creating purchasing power out of thin air in order to save bad decisions made by speculators and we eliminate regulations designed by governments to target certain behaviours by savers and consumers. Crony capitalism and socialism are failures and will always be failures. It is time that we started to respect entrepreneurs, workers and savers by letting them keep their earnings and maintain their purchasing power.
“Men may live together in society with some tolerable degree of security, though there is no civil magistrate to protect them from the injustice of those passions. But avarice and ambition in the rich, in the poor the hatred of labour and the love of present ease and enjoyment, are the passions which prompt to invade property, passions much more steady in their operation, and much more universal in their influence. Wherever there is great property there is great inequality. For one very rich man there must be at least five hundred poor, and the affluence of the few supposes the indigence of the many. The affluence of the rich excites the indignation of the poor, who are often both driven by want, and prompted by envy, to invade his possessions. It is only under the shelter of the civil magistrate that the owner of that valuable property, which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security. He is at all times surrounded by unknown enemies, whom, though he never provoked, he can never appease, and from whose injustice he can be protected only by the powerful arm of the civil magistrate continually held up to chastise it. The acquisition of valuable and*23 extensive property, therefore, necessarily requires the establishment of civil government. Where there is no property, or at least none that exceeds the value of two or three days labour, civil government is not so necessary.”
– Just wanted to post some Adam Smith that I thought was relevant.
I believe that the total failure of economic education is one of the reasons why we are in this mess to being with. 'Improving' education by emphasizing failed theories that have a terrible track record will not help us. What is required is a move towards true free markets in which there are no central banks creating purchasing power out of thin air in order to save bad decisions made by speculators and we eliminate regulations designed by governments to target certain behaviours by savers and consumers. Crony capitalism and socialism are failures and will always be failures. It is time that we started to respect entrepreneurs, workers and savers by letting them keep their earnings and maintain their purchasing power.
“Men may live together in society with some tolerable degree of security, though there is no civil magistrate to protect them from the injustice of those passions. But avarice and ambition in the rich, in the poor the hatred of labour and the love of present ease and enjoyment, are the passions which prompt to invade property, passions much more steady in their operation, and much more universal in their influence. Wherever there is great property there is great inequality. For one very rich man there must be at least five hundred poor, and the affluence of the few supposes the indigence of the many. The affluence of the rich excites the indignation of the poor, who are often both driven by want, and prompted by envy, to invade his possessions. It is only under the shelter of the civil magistrate that the owner of that valuable property, which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security. He is at all times surrounded by unknown enemies, whom, though he never provoked, he can never appease, and from whose injustice he can be protected only by the powerful arm of the civil magistrate continually held up to chastise it. The acquisition of valuable and*23 extensive property, therefore, necessarily requires the establishment of civil government. Where there is no property, or at least none that exceeds the value of two or three days labour, civil government is not so necessary.”
– Just wanted to post some Adam Smith that I thought was relevant.