It's a Harvard-Yale Smackdown!
Words failed me when I read Yale's Robert Schiller's guest editorial in the WSJ this morning. Schiller is taking the Bidenesque position that the most important thing about the stimulus is its ginormousness.
So what must we do to revive our animal spirits and economic growth? We must be certain that programs to solve the current financial and economic crisis are large enough, and targeted broadly enough, to impact public confidence. Not only do we need a fiscal stimulus significantly greater than the proposal that is currently on the table, government action is also needed to take the place of the credit markets that seemingly worked so well when animal spirits were high.
I bristle at the notion of encouraging our illustrious legislative branch to make sure they spend enough. And I was going to write a serious, witty and trenchant reply. Thankfully for all concerned, Professor N. Gregory Mankiw (from Team Hahvaad) did it for me:
I think a lot of economists would agree with that. The question is what it would take to make people more confident. Bob thinks that confidence would rise if the government borrowed more and spent more. Other economists think that confidence would rise if the government committed itself to, say, lower taxes on capital income. The sad truth is that we economists don't know very much about what drives the animal spirits of economic participants. Until we figure it out, it is best to be suspicious of any policy whose benefits are supposed to work through the amorphous channel of "confidence."
Economics and Markets
Posted by John Kranz at January 27, 2009 1:36 PM
This is where Ayn Rand trumps all these morons, particularly Keynes. If you want to call it confidence, fine, call it that. But don't call it anything related to "animals."
"You keep using that word. I do not think it means what you think it does." People throw out nice-sounding words but rarely stop to think about what they're really saying.
Keynes' term is a complete misnomer because "animals" use instinct and similar non-thinking passions as the basis for their actions. Man is not an animal. Man is a thinking, reasoning being that weighs decisions on the basis of trade-offs (i.e. what is to be gained). A decision may be made quickly or "spontaneously," but that hardly means the decision was not rational. (Side note: here I speak of "man" in a general sense. There are plenty of people who act little better than animals.)
I don't want people's "animal instincts" to come out or otherwise encouraged in any way. Animals' instincts are to do whatever seems right at the time, with no rational judgement, even if it means killing their own young. Do lions worry about being confident about pursuing prey? Do deer similarly worry about finding vegetation? Hardly. Animals merely do, so using the term "animal spirits" to mean confidence is completely absurd.
Contrary to what Shiller asserts, to "trust" isn't to act like an animal -- in fact, it's exactly the opposite. Animals have no sense of "trust" because their nature has no doubt to suspend. On the other hand, when humans "trust," it actually is not dismissing any fear or hesitation, but in fact making a rational judgment based on information.
What happened with the current crisis, and I'll get to this in a subsequent paragraph, is that the government created an artificial sense of "trust" in housing and other markets. People were not suspending any doubt, because government made things look better than they actually were. Shiller is correct to point out specific things like the collateralization of mortgage-backed securities, but he misses the big picture that government was the problem in everything that happened. It wasn't the case that "confidence was blind," but that people believed they saw more than they actually was. This is not mere semantics; the logical distinction is important. People were led to believe there was more reason to be confident than not confident when the former didn't really exist, not that they turned a blind eye.
Furthermore, these economists who want to promote "confidence" typically don't understand a simple point: why do we want people to have confidence when it's not necessarily warranted? Note that politicians, and most economists too, aren't even talking about making certain people more confident in a certain industry. They're talking about increasing confidence in general, but confidence for its own sake is a bad idea. Just one of many examples: I don't want banks loaning out tons of money just because, just one of many reasons TARP is a bad idea. There are plenty of would-be borrowers who don't deserve the least bit of confidence insofar as repaying the debt. It was home ownership for home ownership's sake that helped fuel the housing bubble, followed by the Fed injecting hundreds of billions of new dollars into the global economy -- liquidity for liquidity's sake.
Now, I'm on record as saying the crisis is one of confidence, not liquidity (there's plenty of the latter). But that doesn't mean we should do things to make people more confident, which is to effect confidence for its own sake. We should let market processes work on their own, unfettered by government, so that people can compete and be worthy of confidence. If people are generally not confident about something, there's a damn good reason: their information tells them not to be. There may have proper information showing its a bad company, they may not yet have enough information to be confident (but could in the future), or government skews information so that people can't make rational decisions. The third happens all the time, but so badly today that it's the direct cause of this crisis.
The one thing few people point out is that government has a monopoly on confidence. You can mistrust it, but in most cases it ultimately gets its way.