Tuesday, March 13, 2007

Confidence Games

This comes from the comment by Snailman – Thanks for the great comment.

Sorry it took so long to get to this, I’ve been out of town.

Consumer confidence is definitely a strong predictor of economic events. This is why you see the consumer confidence index reported in the news. We aren’t just talking about specialty news here, but your basic 6 o’clock news. An increasing portion of the public is aware of the importance of consumer confidence.

This can create a different problem. If the economics community makes the impacts of consumer confidence even more public (if we had that kind of sway over the media) the problem would likely get worse not better. Consider: a news broadcast reports that consumer confidence is falling rapidly. If all consumers know a drop in consumer confidence is likely to lead to a recession, there are two very different ways they are likely to respond. The ideal way (which I suspect Snailman had in mind) is go on spending as they were before and ignore the report. Essentially, if consumers all know the economy is under their control they can decide not to have a recession. This is a collective action problem, much like the voluntary provision of public goods. Ad campaigns in the US were quietly used to this effect in the US in 2001 and 2002 and at other times. The other way consumers might respond (which I think is more likely) is they can reduce their spending in anticipation of the hard times ahead. If you know that reductions in consumer confidence often lead to recessions, the individually optimal response is to save. If all consumers do this, we end up with a recession. In fact, if all consumers understand the economic theory (perhaps due to a public education campaign run by economists) the recession is likely to worse than otherwise. Public education on economics can be scary that way. It can be a very sharp double edged sword.

There are very few economists who could possibly generate the media attention required to effectively influence the situation. Ben Bernanke, head of the American Federal Reserve comes to mind. Alan Greenspan had the same kind of influence when he held that position. David Dodge (the Canadian equivalent) has much less power to manipulate expectations. Generally speaking, these prominent economists are very careful about what they say and how they say it for fear of unduly influencing expectations. The old line was, "If Greenspan sneezes the world economy gets a cold."

I shouldn’t leave you with sense that the “economics community” is acting in the best interest of society all the time. It isn’t. I honestly believe economics should be a required course for all university students, maybe even in high school. The problem is economics is often taught poorly. It can be incredibly dry. Thus most students don’t want to take it, or if they do they don't get the truly valuable lessons.

A final issue needs to be raised. A lot of people don’t like to hear what economists have to say. People tend to believe what they want, and not what theory (which is very flawed anyway) and evidence indicate.

There is another method of dealing changes in expectations that is already being used in virtually all developed countries, government spending. During a recession government spending tends to increase through increased transfer payments to individuals and by conscious act of government. This offsets some or all of the recessionary pressure and expectations aren’t often realized. The defence mechanism is already in place. The “economic warfare” aspect arises by forcing a government to spend on staving off a recession and not other goals.

I’d like to end on a quote from Alan Blinder. "Economists have the least influence on policy where they know the most and are most agreed; they have the most influence on policy where they know the least and disagree most vehemently."


Anonymous said...

i like the quote by Blinder but the economist Robert Lucas also stated that everything really is dependent upon whether people believe governments - in this case the central bank - are credible when it comes to economic policy. If they are credible, the economy 'should' hum along with no recession (and in this case no boom - always at y-bar) - i think that's what i always had in mind when i mentioned rational expectations (although i agree it has it's limitations - primarily that a lot of people have to believe, which rarely occurs and the information is more or less correct and up to date - a diffcult thing).

you know, back to development economics and the developing world and let me for argument sake pick on Africa. All the policies that I have looked at coming from many organizations (such as World Bank and so on) and governments, they all seem to focus on medium and long-run effects, that is, trying to make an economy all of a sudden jump-start and catch up with everyone else, but it's always (well most times) failed. I think when it comes "poorer" countries, short-term is more the viable option, and when that is taken care of, tactics to improve the medium and long-run economic viability of the country can be taken care of.
One issue here is that the developed world when it comes to its relations with the seriously underdeveloped/developing world cannot or should not expect reciprocity - you do it because it's necessary and good for long-term stability. It's ironic that short-term needs are neglected for the poor but yet short-term "profits" or opportunities of the developed world are not - no wonder nothing or very little good has taken place in poor regions of the world.

Anonymous said...

midlife crisis, eh? too bad i wasn't there to tackle you.

well to be honest, it's not like i didn't go through one, and i now consider it a badge of honour. so it's nice to have some company now.

oh, greenspan needs to learn to keep his mouth shut. his comments are having a greater ripple through the economy (ie: stock market) than bernanke's. opinions?