Saturday, 14 March 2009

Economists' snake-oil - Invisible hands and animal spirts

A large part of the confusion about the current directions and policy that need to be taken at the G20 summit and, on an ongoing basis at the national level, stems from, what is now becoming increasingly acknowledged, the fundamental limitations of macro-economics. Some part of it comes from the quality of the political leadership e.g. Tim Geithner who, at least on the evidence so far, appears not to be up to the job, but perhaps the biggest part of it comes from something more disturbing and more insidious.
All potential avenues that policy could take lead to the same place which is that there are no easy solutions for an economy which has massively overstated the value of the assets on its balance sheet.

All governments/central banks can do is tinker here and there with different initiatives - designed mainly to look as though they're doing something while pumping in colossal amounts of bridging liquidity and waiting for asset prices to show some signs of recovery which will then re-kindle the animal spirits.

Some have called these animal spirits "irrational" but I am not sure why. It is more accurate to see them as human and pragmatic.

Any nascent macro-economic theory, hopefully aligned to a global ecological survival strategy as well, which has any chance of avoiding the recent disasters should surely have human traits like fear, greed and herding instincts as its cornerstone assumptions. This would be starting out from a much better place than current economic orthodoxy which seems to rely on the patently non-rational assumptions that private investors, monitoring and imposing self-disciplines on their own propensity to take risks, will mysteriously avoid the rampant leverage which will inevitably crash the system.

To assume that there is an "invisible hand" or collective prudence and rationality underlying the behavior of private economic "agents" is even more absurd when there is an implicit and limitless backstop, courtesy of the public sector, to rescue them from their miscalculations and greed.

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