Friday, June 18, 2010

Behavioral political economy

Superhero economist Paul Krug-man, and his favorite sidekick J. Bradford, are hopping mad over the turn toward fiscal austerity in European (and, potentially, American) policy circles. Krugman has written blog post supporting more stimulus spending here, here, here, here, here, and here, as well as full-length columns here, here, and here, and DeLong has made arguments here, here, and here.

As they themselves lament, however, almost no one is listening. Why not? The models Krugman and DeLong are using are unambiguously better than anything stimulus opponents can come up with. And the apparent success of stimulus policies in America and China are hard to ignore. Why, then, is everyone other than America's leading economist, from politicians to Fed officials to pundits, suddenly a deficit hawk? Are they, as Krugman claims, falling victim to the idea that fiscal austerity and lengthy periods of low growth are morally virtuous?

I doubt it. My guess is that the fear of increased deficits is mostly due to other less ridiculous psychological factors. Specifically, these three:

1. Policymakers don't trust economists. And with good reason; economic models are usually pretty bad at forecasting the economy, and pretty ambiguous when evaluating the effect of a past policy choice. When Krugman gives a laundry list of countries that boosted their economies even while cutting deficits, and then gives a different reason why each example doesn't apply today, people who don't understand - or who don't believe - the underlying assumptions tend to increase their skepticism as each new wrinkle is introduced. Given economists' lousy track record, of course we're skeptical when even a famous and brilliant economist tells us to do something counterintuitive.

2. Many policymakers are risk-averse. Most economists are fine picking their most plausible model, cranking out the results, and drifting off to sleep assured that their policy recommendations are as correct as they could have possibly been. Fed officials, whose decisions directly affect the lives of millions (and their own jobs), naturally tend to be quite a bit more cautious, risk-averse, and (small-c) conservative when selecting from among the enormous constellation of economic models. They tend to judge those models based not on what the models say is the most likely outcome - which experience shows us rarely happens - but what they say is the worst-case scenario (if only the Fed controlled carbon emissions, right?).

The worst-case scenario of Krugman's model is that fiscal austerity leads to a decade of high unemployment. That's bad, but the worst-case scenario of any model in which stimulus doesn't work is that fiscal expansion leads to sovereign default. And sovereign default is very bad for a country. Like, 1990s Argentina bad. When Paul Krugman claims that debt markets are not worried about current U.S. levels of debt, cautious policymakers remember that markets were not worried about the housing bubble either - until it burst.

And, finally:

3. Policymakers have different priorities than economists. Stimulus spending almost certainly involves some degree of tradeoff between the present and the future. Stimulus is justified by the idea that reducing unemployment over the next few years is worth the drag on future growth caused by debt. But that is dependent on a value judgment, namely, Keynes' idea that "in the long run, we're all dead." Some policymakers, especially independent technocrats like central bankers, may not feel that being dead in 10 years is a good plan. Though many elected politicians seem willing to spend their countries into the ground (! Republicans! !), central bankers could easily take a longer view, and decide that the cost of piling up, say, an additional 100% of GDP of debt is not worth putting 5% more of the country to work over the next decade.

Now, policymakers may be wrong to instinctively mistrust Krugman's models. They may be overly cautious. And they may be caring about the future too much and the present too little. But these failings are far more forgivable, and far more understandable, than simply having moral values that insist that economic pain is good.

And who knows - maybe in this case the crowd is right, and the experts are wrong, and more stimulus spending really
would be a boondoggle. I myself think that stimulus would work, and that it would be worth the cost. But I'm not willing to say that with 100% confidence. And Krugman and DeLong, if they are scientists first and policy advisers second, could stand to show a little more of the doubt that is the foundation of science itself.

1 comment:

  1. Good post. Now wait for Super-Krugman to come rip out your spine...