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.