Not only that, but a couple of real papers, from the Macroeconomics blog I subscribe to.

The first has empirically proven something that motivates monetary thinkers like Scott Sumner, who depend (too much, you might say) on the idea of the Fed working through expectations management.  The basic view is very simple: the Fed can achieve anything, since it has the printing presses.  With enough credibility, it could in theory make everyone expect any level of NGDP.  By expecting it, it kind of happens.   This paper provides proof of some part of this mechanism:

We find that changes in expected future economic activity are a quantitatively important driver of economic fluctuations: a perception that good times are ahead typically leads to a significant rise in current measures of economic activity and inflation

However, note the next sentence:

We also find that the short-term interest rate rises in response to expectations of good times as monetary policy tightens.

In Sumner’s world (I think) it is the expectations of loose monetary policy that drives higher NGDP; in fact, he virtually defines loose monetary policy that way.  But it seems in this world the expectations are much more like Keynesian ‘animal spirits’, which exist external to the monetary stance and are driven by all sorts of things and whatnot.

I had a good look at this in Credit Where It’s Due – actually enjoyed the expectations section the most.  While being hugely influenced by Sumner and willing to recommend his favourite policy, I personally go for the Keynesian view that the central bank does not have the expectations on a tight hold.  I think ‘animal spirits’ can be out of the central banker’s control; when the financial world seems about to end, there is no amount of central bank credibility that will overcome expectations effects.

Biggest injustice of the century (financial): why did the European economy –  where  they presumably foreswore the mad Anglosaxon bonus culture* of we Brits and the US – tank just as much as the rest of us?    Charles Wyplosz has a go at answering.  The paper seems a little premature in its assessment of the success of the euro so far.

But what makes me link here is this final thought:

With limited direct exposure of households to financial events and a limited impact of declining exports, why is the recession so severe? Policy reactions have been subdued and late, but this does not quite explain the rapid decline in consumption and productive investment. An intriguing possibility is that demand was reined in simply because households and firms became overly cautious, thus triggering a self-fulfilling prophecy.

Which links back to the theme of the first paper.  How extraordinary; you can do many things better than those crazy subprime gorging bonus driven Yanks, and yet because you are spooked collectively by the whole thing, your economy tanks just as badly!   In a final backflip to another theme, this is why I disagree with Jock’s blanked condemnation of Fractional Reserve Banking.  Things that are not real, that are only supported by mutual illusions and confidence and ‘fraud’, can nevertheless have real effects for such a very long time that the difference seems arbitrary.  The greater optimism of the US seems to have made up for its greater tendency to fool and defraud itself … I find something oddly admirable about this.

(PS of course, unemployment sucks over there, and they ain’t out the woods yet)

*read Ben Chu’s latest commentary on this


4 thoughts on “Some economics, for once

  1. We’ve now reached a position where 90% of the population is in debt to the other 10%, who own the vast bulk of unencumbered assets. eg as Philippe Legrain pointed out in an excellent article in the FT, 69% of UK land is owned by 0.3% of the population.

    Now, of course, our 10% of rational economic agents may indeed adjust their behaviour and quantum of greed to expected inflation. But what about the other 90%? I think their calculus is somewhat different.

    Certainly inflationary expectations have applied to asset prices – the thought that land prices could only ever go up was what underpinned the bubble. But I very much doubt that Joe Public gives the remotest consideration to expected retail price inflation when he puts in a pay claim: he’s looking at how much prices HAVE risen and thereby reduced his purchasing power.

    The Fed does have control of the printing press but that’s not fiscal power, and as far as I know it has no power to ensure that money is spent or lent into the real economy. That’s the fiscal function of the Treasury.

    “An intriguing possibility is that demand was reined in simply because households and firms became overly cautious, thus triggering a self-fulfilling prophecy.”

    I think it’s more likely that people – and many businesses – became aware of their actual or potentially imminent insolvency, at least in asset/liability terms, and they went into de-leveraging mode, so that even where banks are prepared to lend, they are not prepared to borrow.

    Unless and until the current unsustainable inequality in wealth and income distribution is addressed our current problems are insurmountable, and there is IMHO categorically NO effect that any amount of liquidity can ever have on that.

    In other words, Central Banks are now as much use as a chocolate teapot, and the solution lies with Treasuries, and the urgent deployment of massive amounts of Public Credit aka QE to be invested into the economy (public and private sectors) under the professional management of service providers with a stake in the outcome, and with accountable and independent supervision of a Monetary Authority.

    Once new productive assets are completed they may then be refinanced by (say) pension investors with existing money, and the QE development credit will be retired and recycled.

  2. Fascinating point that the European economy has suffered just as much – and indeed that the US and UK may bounce back quicker. Didn’t Keynes argue along these lines at the back of the General Theory? That our natural instincts are to save too much and we’ll get stuck in a stagnant mess (I paraphrase)? Maybe there’s some truth to this after all.

    1. I agree: I would be willing to make a GDP/head bet on UK outperforming Europe over the next 10 years. Though whether it is down to a willingness to do high investment Keyensian style is another matter

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