Confidence

This is a brief note on a Paul Krugman blog post from yesterday.  He's once again chiding Jean-Claude Trichet, who is a noted French civil servant who happened to be President of the European Central Bank from 2003 through last year.  Trichet is a big fan of austerity, because he thinks it creates confidence in pretty much everyone.  Here's the quote from Trichet, from 2010, that was cited in the Krugman post:

As regards the economy, the idea that austerity measures could trigger stagnation is incorrect.”
Incorrect?
“Yes. In fact, in these circumstances, everything that helps to increase the confidence of households, firms and investors in the sustainability of public finances is good for the consolidation of growth and job creation. I firmly believe that in the current circumstances confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today.”

 Krugman points out, with a graph showing the data from Europe over the last few years, that austerity has been a disaster.  Unemployment not only has not improved since that Trichet quote, it has, along with the European outlook in general, has seriously deteriorated, and will get even worse in the next few months.  Europe is now in a double dip recession.  Unemployment is over 10% overall, and is over 25% (real Great Depression territory) in Spain.  For Spanish young people, unemployment is over 50%.  And yet the keep on trying the same old austerity, hoping for the "confidence" that never comes.

My problem with the Trichet quote is slightly different from Krugman's.  Trichet says that austerity will "increase the confidence of households, firms and investors" in the sustainability of public finance---but neither he nor anyone else has a clear theory of how that is supposed to happen.  

Expectations-based models, whether rational, adaptive, exogenous or anything else, are at best flaky in their treatment of how humans think, or feel, or behave, particularly of how humans work in hard times.   Why, for example, should any person facing a severe recession be filled with confidence about the future as he or she watches the government doing its damnedest to make the already severe recession even worse?  Why would anyone even believe that doing that would improve the government's financial situation, which depends vitally on having a thriving economy to produce revenues and reduce social needs?  And why does Trichet believe that the average household, the average firm, the average investor, is making immediate personal economic decisions by looking at a extremely unreliable forecasts about a distant and incomprehensible budget created by squabbling legislators?  People, businesses, and investors make individual decisions based on their individual situation, and their individual opportunities, not based on abstract economic theory.   Businesses will not be convinced to invest in the short run by observing their government taking actions that will make it harder to sell their products next month or next year, or in the longer run by watching their nation's infrastructure deteriorate; households will not be convinced to invest in new appliances or cars or vacations, or additions to their houses, by seeing their government implement policies that make their continued employment less likely.