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Sunday, March 08, 2009

"Snake-Oil Assets"

Robert Shiller:

A failure to control the animal spirits, by Robert Shiller, Commentary, FT: ...We are seeing, in this financial crisis, a rebirth of Keynesian economics. We are talking again of ... the Great Depression. This era, like the present, saw many calls to end capitalism as we know it. The 1930s have been called the heyday of communism in western countries. ... The General Theory became the most important economics book of the 20th century because of its sensible balanced message.

In times of high unemployment,... governments should expand demand by deficit spending. Then, in times of low unemployment, governments should pay down the resultant debt. With that seemingly minor change in procedures, a capitalist system can be stable. There is no need for radical surgery on capitalism. ...

[T]he General Theory also ... explained why capitalist economies,... without the balancing of governments, were essentially unstable. ... The key to this insight was the role Keynes gave to people’s psychological motivations. These are usually ignored by macroeconomists. Keynes called them animal spirits, and he thought they were especially important in determining people’s willingness to take risks. ...

There are times when people are especially adventuresome – indeed, too much so. ... These are the upswing of the business cycle. But then the animal spirits also veer in the other direction, and then people are too wary. ...

To a remarkable extent we have got into the current economic and financial crisis because of a wrong economic theory ... that ... denied the role of the animal spirits in getting us into manias and panics.

According to the standard “classical” theory,... the economy is essentially stable. ... What this theory neglects is that there are times when people are too trusting. And it also fails to take into account that if it can do so profitably, capitalism will produce not only what people really want, but also what ... people mistakenly want.

It will produce snake oil. ... [W]hen confidence is high, and since financial assets are hard to evaluate by those who are buying them, people will and do buy snake oil. And when that is discovered, as it invariably must be, the confidence disappears and the economy goes sour.

It is the role of the government at two levels to see that these events do not occur. First, it has a duty to regulate asset markets so that people are not falsely lured into buying snake-oil assets. Such standards ... make as much common sense as the standards for the food we eat, or the purchase medicine... But we do not want to throw out the good parts of capitalism... To take advantage of the good parts of capitalism, when fluctuations occur it is the role of the government..., through its counterbalancing fiscal and monetary policy, to maintain full employment.

The principles behind such an economy are not the principles behind a socialist economy. The government insofar as possible is only creating the macroeconomic conditions that will allow the economy to function well. ... Its role is to ensure a “wise laisser faire”. ...

I'm not sure that confidence and too much trust on the upside and the pessimism and fear we see on the downside are the causes rather than the effects of cycles (and I'm also not sure that Shiller is making that claim). That doesn't mean that psychological factors don't have important feedback effects that help reinforce booms and busts, or that these reinforcing effects can't produce volatile swings in the economy that need to be prevented or dampened through government action, only that the changes in mood seem to be more a part of the process than a primary cause of it. But I don't want to close my mind to the possibility.

    Posted by on Sunday, March 8, 2009 at 02:43 PM in Economics, Financial System | Permalink  TrackBack (0)  Comments (38)

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