The confidence fairy bleeding

25 April, 2015 at 12:31 | Posted in Economics | 2 Comments

The confidence factor affects government decision-making, but it does not affect the results of decisions. Except in extreme cases, confidence cannot cause a bad policy to have good results, and a lack of it cannot cause a good policy to have bad results, any more than jumping out of a window in the mistaken belief that humans can fly can offset the effect of gravity.

cashreserve1The sequence of events in the Great Recession that began in 2008 bears this out. At first, governments threw everything at it. This prevented the Great Recession from becoming Great Depression II. But, before the economy reached bottom, the stimulus was turned off, and austerity – accelerated liquidation of budget deficits, mainly by cuts in spending – became the order of the day.

Once winded political elites had recovered their breath, they began telling a story designed to preclude any further fiscal stimulus. The slump had been created by fiscal extravagance, they insisted, and therefore could be cured only by fiscal austerity. And not any old austerity: it was spending on the poor, not the rich, that had to be cut, because such spending was the real cause of the trouble.

Any Keynesian knows that cutting the deficit in a slump is bad policy. A slump, after all, is defined by a deficiency in total spending. To try to cure it by spending less is like trying to cure a sick person by bleeding.

So it was natural to ask economist/advocates of bleeding like Harvard’s Alberto Alesina and Kenneth Rogoff how they expected their cure to work. Their answer was that the belief that it would work – the confidence fairy – would ensure its success.

More precisely, Alesina argued that while bleeding on its own would worsen the patient’s condition, its beneficial impact on expectations would more than offset its debilitating effects. Buoyed by assurance of recovery, the half-dead patient would leap out of bed, start running, jumping, and eating normally, and would soon be restored to full vigor. The bleeding school produced some flaky evidence to show that this had happened in a few instances …

With the help of professors like Alesina, conservative conviction could be turned into scientific prediction. And when Alesina’s cure failed to produce rapid recovery, there was an obvious excuse: it had not been applied with enough vigor to be “credible.”

The cure, such as it was, finally came about, years behind schedule, not through fiscal bleeding, but by massive monetary stimulus. When the groggy patient eventually staggered to its feet, the champions of fiscal bleeding triumphantly proclaimed that austerity had worked.

The moral of the tale is simple: Austerity in a slump does not work, for the reason that the medieval cure of bleeding a patient never worked: it enfeebles instead of strengthening. Inserting the confidence fairy between the cause and effect of a policy does not change the logic of the policy; it simply obscures the logic for a time. Recovery may come about despite fiscal austerity, but never because of it.

Robert Skidelsky

 

2 Comments »

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  1. Fabulous analogy!

  2. Any policy that requires confidence that it will work for it to work, and expects the policy itself to generate that confidence is floating on air.

    In the US, I think that the reception to Obama’s “Yes We Can” speech indicates that there was a possibility of instilling the confidence that would help make a policy of economic recovery work. For some reason, when Obama took office, he abandoned any effort to instill confidence. (I suspect that Larry Summers talked him out of it, since Summers was not an advocate of full recovery. Strange that he doesn’t blame himself for secular stagnation.)


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