Sunday, April 15, 2012

More magical creatures for Polly

It's been a while since I visited here.  It seems to be a strange and somber place.

So.  Magical creatures.  To recap the story so far, a few blogs ago I talked about Paul Krugman's ridicule of many economists and government officials who profess a faith in what Krugman calls a "confidence fairy", who will, if only they are very very good and practice budget austerity as much as they can, reward them with bounty in the end.  His criticism is justified: the people who were suggesting that "confidence" would save them in the end failed really to specify what kind of confidence they had in mind, or who would have this confidence, but the implication was that international bankers and bond traders, and businessmen, and maybe even consumers, were watching them to see if they were serious about attacking their national budget deficits.  And I agree with Krugman that the way to expand the economies of Europe (and anywhere else) is to expand them, not to engage in national self abuse hoping that our willingness to endure pain will restore the world's confidence in us.  The active players in the world don't want us to be in pain, and aren't impressed by our willingness to endure it.  They want success, and prosperity, and will be impressed by our willingness to achieve that.  In fact the people who are proposing a confidence fairy are saying something truly absurd: they are saying that they can restore confidence in their governments by implementing bad economic policies that fail to restore prosperity!   

Really.  That's what they are saying.    They frankly admit that, in the middle of the worst recession since the nineteen thirties, their austerity policies will weaken economic growth in the short run.   So I think the ridicule they got from Krugman and others was richly earned.  

But I'm not so happy about dismissing the concept of confidence, or the concept of magic, in a sense, in the economic process.  I guess by "magic" in this blog I mean events that are beyond our control or understanding, that cannot really be forecast by probability based models.  

I think confidence that these magical things, these unknowable things, will break in our favor in the future does matter, and does move people to do things that matter.    And so have many other economists over the years, although they didn't use the word "magic" or even the word "confidence".  In the last episode of this story I quoted Keynes as saying: 

 "Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities."  

What I think he means by these words is that we have to act by a leap of faith, sometimes; we don't know, when we invest in a new capacity to produce something, whether we will be able to sell our product or not.  Maybe we will produce pet rocks or wacky wall-crawlers and become rich.  Maybe we will, at much greater expense, produce Edsels and lose our shirts.  In most cases when we relinquish one opportunity (such as putting our money into bonds with assured interest earnings) and pursue another (such as investing in productive capacity) we do so in the belief (the belief!) that the new opportunity will work, and that the magic that must happen to make them work will happen. 

Businessmen will invest if they believe that in the appropriate future customers will be there to buy their product.

Households will invest in cars and other large purchases if they believe that their careers are secure.  They will quit a job if they believe that a better opportunity will arrive to replace it; in general, that means they believe the future will provide employersThey will commit themselves to decades of mortgage payments to buy a house if they believe the future will provide them with a way to make those payments without leaving the area (employers or other opportunities), or that they will always be able to find customers to buy  the house when they need to leave.   

And so on.  If most of us have that kind of confidence that the magic we need will happen, we will act.  If we don't have that confidence, we will wait, preserve our options and hope for better times.


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