Thursday, May 3, 2012

Confidence in What?

“A widespread lack of trust in public finances weighs heavily on growth: there is uncertainty regarding potential future tax increases, while funding costs are rising for private and public creditors alike. In such a situation, consolidation might inspire confidence and actually help the economy to grow.”  – Jens Weidmann, President of the Bundesbank
Confidence.  This is the main argument for austerity, repeated in a thousand forms but always more or less the same.  Wealthy people, who hold the reigns of the global economy, have to be propitiated, and if we can manage to ease their stress they will reward us with low interest rates and high levels of investment.  If you put it that way, it has the feel of a hostage syndrome.

But Keynesians also argue from confidence.  In a slump, investors lose their urge to invest, their animal spirits.  Low investment reduces the demand for output, which validates low investment in a vicious circle.  The way to break out of it is to visibly stimulate the economy, even if temporarily.  This is the rational notion behind the old priming-the-pump metaphor.

Taken at face value, this is an uneven contest.  The problem with the austerian confidence story is that it is entirely speculative, for two reasons.  First, there is no way to measure it.  One could administer a survey to rich people and ask them to rank their worries, but a survey of investor sentiments alone would not be enough to establish the link between mood and action (or inaction).  Just because I don’t like current government policy doesn’t mean I’m going to cut production.  Second, there isn’t really a formal argument that connects the diffuse sentiment encapsulated by the orthodox notion of confidence to outcomes that show up in the national income accounts.  Just perhaps, you could model in a general way how cascading anxieties could set off a financial panic, although calibrating it (being able to call the tipping point) is in the realm of sci-fi, and in any case this is about a liquidity crunch, not generally dampened investment.  How exactly do you go from “uncertainty regarding future tax increases” to reduced investment outlays?  (Investment has at most a weak relationship to actual taxes.)

Meanwhile, the Keynesian version of confidence has a plausible theoretical basis that also permits measurement.  The idea is simply that firms care most about the potential market for their output.  If they think consumers will be flush with income and eager to spend it, they will invest more; if they think otherwise, they invest less.  To a large extent, the PMI index captures exactly this; it is Keynesian confidence in action.  There are disputes among Keynesians as to why the instabilities to which investors respond arise, but at the policy level the dynamic is approximately the same.

So what is it that leads some people to embrace the Keynesian understanding of confidence and others to enlist with orthodoxy?  Noah Smith thinks it comes from somewhere in the digestive system.  He could be right.  My view, which I set out a few days ago, is that it is really about different primary objectives.

Keynesians care mainly about flows.  Income growth.  Output gaps.  Employment.   The production of new goods and services.  Their theories are optimized, so to speak, to elucidate the causes of interruptions to these flows and make the case for policies to keep them flowing.  The followers of orthodoxy, on the other hand, are primarily concerned with the protection and expansion of wealth.  They fear inflation, default, and various forms of expropriation, while promoting conditions that favor more profit-making.  There is a bit of overlap, insofar as both see a link between income and wealth via profitable investment, but the difference in perspective is even larger.  Each side is better at arguing for its own core concerns and weaker in making the case for the other’s concerns.  The problem is that political reality demands that both issues be addressed.

Supporters of economic orthodoxy speak naturally in a way that makes sense to wealth-holders.  Don’t add more debt and run the risk of default.  Don’t try to pay for stimulus programs with higher taxes on the rich.  Don’t accommodate populist experiments by printing money and inviting inflation.  Alas, an appeal to wealth-holders alone would be politically stupid.  The argument has to be extended to address concerns about employment and growth.  That’s the function of the “confidence” trope: it connects the entirely understandable concern about wealth-erosion to the world of income determination.  It bears a ton of weight because it has to do this, but not because there is any particular reason why actions that make wealth-holders more comfortable also make economies grow.  That’s why the confidence touted by austerians is a fairy.

Keynesians are not flawless either, however.  They can make an excellent case for policies that promote growth, but political reality requires them to win over the wealthy too.  Thus, they also argue that expansionary policies in a slump will be good for assets, or at least not bad.  More borrowing to promote near-term growth will reduce the risk of public and private default, while better economic conditions will be peachy for equities too.  Redistributive taxes?  Well yes, but this will produce a warm glow in the hearts of the well-to-do, since money buys the most happiness when it is given away.  And don’t worry about that “euthanasia of the rentier” bit.  I am being facetious, but is it really so different?  The point is that the argument for Keynesian policies being favorable to wealth is much, much weaker than the argument about incomes.

Where am I going with this?  In part, I just want to understand the intellectual environment we live in, and my starting point is always the classical theory of ideology: different people have different interests, and this causes them to see the world in different ways.  The second part is that, if I am right, this way of framing the debate disabuses us of the naive notion that a smarter or more precise argument will win the day, and leads us to the political transformation that’s needed instead.


Barkley Rosser said...

"confidence" aka "animal spirits"

john c. halasz said...

What about the Kalecki-Kaldor equation that shows that government deficits actually add to business profits?

Peter Dorman said...

John, I don't put much faith in this model, to be honest. I think the treatment of wages is ad hoc and unconvincing, for one thing. There is the larger point, of course, that fiscal deficits pump income into the private sector and, under normal circumstances, make it more likely that debtors will avert default. The question then comes down to two classes of credit, public and private. Holders of existing sovereign debt are unambiguously made worse off by the issuance of more of the same. Holders of private debt may be better off, but that depends on the identity/location of the debtor, since we are talking now about heterogeneous credit relationships. As a first cut, I think these creditors would approve of bailouts targeted to their specific debtors, but they might be more skeptical that a circuitous process would pass along general income generation to them (rising tides, boats, etc.). And the people who hold one kind of debt typically hold the other.

Why do you think the creditor class is unimpressed with Kalecki-Kaldor?