A bedtime story for Polly.

 

I promised to tell Polly a bedtime story, about magical creatures scampering about the economic landscape.

I’ll start with one she already knows. 

For a long time now Paul Krugman has been excoriating the Europeans and austerians everywhere because they have openly stated that their goal is to recover the confidence of---well, of someone.  Of international bankers to get loans to cover the deficits of Spain, Ireland, Greece, whoever.  Of businessmen to induce them to invest.  Of consumers to induce them to consume.  It’s not really clear whose confidence is supposed to blossom as a result of government budget austerity, but many of those Krugman calls Very Serious People (VSPs, in Krugmanese) have demanded reduced spending by government to create some kind of confidence somewhere, thus creating a sense of gladness about the future, and restoring fertility to the land.  Or whatever.  Krugman made fun of these Austerians, saying that they believe that if we only flay ourselves with the austerity whip the demons called the International Bond Vigilantes would leave us in peace, and a magical Confidence Fairy would come to save the world.  This was pure faith on their part, since no serious economic theory supports that view.  Start here and here and here to read a bit  of Krugman on this.  Oh, and definitely here. 

I love this stuff from Krugman, because I agree with everything he intends when he says it.  Austerity when the economy is booming might be a good idea, but austerity in the middle of a major slump is not just catastrophic, it's stupid.  And it's the official favorite stupidity of VSPs.  

But my problem is that I do have a kind of faith in something beyond the mathematics that moves the economic world.  I believe that there is a group of magical creatures out there, a special kind of creature that makes the economy come alive; when they arrive in large numbers, businesses pop into existence like mushrooms in the woods after a spring rain; when they arrive jobs are created, and wealth is created.  When they leave, jobs are lost, wealth is lost and businesses die.  Really.  I’m not making this up, and I’m not the only one who believes in these creatures.  Sober businessmen know about them and seek them out, and spend large amounts of money hoping to coax them from their hiding places. 

We call these creatures “customers”.

I don’t think consumers and businesses are that focused on government deficits, at least as a determinant of their daily activities.  Yes, everyone is worried about the burden of future debt.  We complain about it, and chatter about it, and we will all do our political bit to curb it.  We have our own opinions about how that curbing should best be done.  But I think households make consumption decisions based on their current situation, their current needs, and on their confidence that in their own future there will be customers for their labor (called “employers”).   In other words, they do not base their current consumption on some politician’s guess about a possible distant and abstract future government debt; they base their consumption on the current facts and expectations in their own life.  To the average household the government’s budget is a distant phantom controlled by incomprehensible and Byzantine political interactions among policy wonks. 

And businesses are not basing investment decisions right now on a possible government debt in 2050.  If businesses have confidence that customers will arrive in, say, six months or a year to buy their goods, they will be willing to invest today to achieve the ability to produce those goods. 

Even the dreaded Bond Vigilantes are more likely to respond to the prospect of a healthy economy in the near future than to slashed budgets, because if a nation’s economy is thriving it will be much more likely to be able to pay its debts.  And if a nation fails to invest in its own future, it will be less likely to be able to pay its debts when that future comes.

All of this sounds pretty mystical, and not the stuff of serious economic theory.  But let’s go to the master himself. Here’s what Keynes said in the General Theory of Employment, Interest and Money:

“ a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. 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.”

So I don’t want to be too dismissive of confidence fairies, or of the animal spirits that confidence evokes in businessmen, consumers, and even, as difficult to imagine as this is, in bankers.  A lot of economic good can come from exuberance, whether rational or irrational; optimism about success can help create success, and the spiral of economic recovery can start with improving confidence that recovery is near.

What does all that have to do with yesterday’s talk about the Modern Monetary Theorists, and accounting identities, and the reserve ratio, and the money multiplier?  I’m not sure, really.  There’s something there, a connection, but I’ll have to put off that topic until tomorrow, or maybe the weekend.  It’s late.