Sound Money

I read Shiller and Akerlof’s 2009 book Animal Spirits in late 2016 on recommendation from a friend. It was a departure from the economics that I usually engage with and I faced some difficulty as a result but it was rewarding to push myself to better understand a different school of thought and gain insight into the psyche of other economists within the profession. The authors are clearly very smart individuals who have thought deeply about their subject matter. Throughout the book I found myself agreeing with a large amount of information however with almost every idea assessed that the focus or emphasis was slightly incorrectly placed. The misplaced focus resulted in what I perceive to be misleading conclusions and potentially dangerous policy outcomes - Many of which have been implemented since the 2008 crisis and this serves as a motivation for this article.

The confidence animal spirit is a major focus of the book and it provides an accurate example of the contrast between an important economic factor that was well articulated in the book and a potentially incorrect interpretation and policy response to that factor. To set the scene, the authors view the post-2008 economic troubles as a confidence crisis. Shiller and Akerlof argue that government should do everything within its power to revive confidence, which should get the wheels of the economy turning and pull us through the on-going malaise.

The positive angle: a useful articulation of an important economic factor, confidence

I firmly agree that confidence is a critical aspect in every human engagement. When we enter a meeting with confidence, go to work with confidence or play sport with confidence this generates positive spin-offs. Sceptics are more likely to listen to confident speakers, opponents are wary of confidence and a confident start to an engagement often gives an individual the opportunity to deliver all the nitty gritty detail that he/she has come to deliver rather than ignored pushed out the door. These positive spin-offs are visible both for the principal individual as well as colleagues/partners, agents and even opponents and they can lead to much better outcomes than entering into engagements with lower levels of confidence.

The same can be said on a macro level. A country where people have a high degree of confidence in their ability and where they are mentally determined to get the job done can generate better outcomes than a similar country with low confidence. The USA is probably viewed as the best example of this where the “American Dream” is sometimes sighted as a foundation on which the success of the country is built.

Bizarre interpretation of confidence leads to misleading policy conclusions

While I firmly agree that confidence is very important, I don’t think it is possible to singularly target confidence particularly not on a macro level as a central policy tool. Modern day myopic focus on confidence might actually lead to unintended consequences and net-net a negative outcome for the economy. To explain my point I’ll revert to a micro-level individual example.

Confidence is very important in an individual business meeting but it cannot be the sole focus in preparation for that meeting. Prior knowledge, skills, a good product/service are all probably far more important than actual confidence in the meeting. Yes some people might be able to just “wing-it” with confidence in a meeting but showmanship without delivering the goods very rarely results in great long-term outcomes. The very same logic applies on a macro-level, confidence without great product/services amounts to nothing. Chinese people wouldn’t just buy American products because Americans are confident, they view significant economic value in those goods and services and thus continue to buy them over an extended period of time.

Taking this argument a step further, too much confidence can lead to terrible economic outcomes. An individual who is overly confident in a run-of-the-mill business opportunity might enter in large debt in an attempt to make the business a success. If the underlying skills, systems and hard-work aren’t in place the debt origination might have been a terrible idea, bankrupting the individual.

On an individual level, examples of overconfidence and mistakes are commonplace and economic policy can do very little to avert them but the outcomes are much more problematic in the macro space. A country might be very confident that it is producing the best goods and services in the world in a new pioneer industry and that the rest of the world is definitely going to import these goods and services in the future. That country might invest heavily into those industries, re-allocate resources and take on debt. But what the confidence was unwarranted and the “pioneer industry” was merely a pet project of a President seeking personal aggrandisement? Of course pet projects from a President is an extreme example but the idea holds. If a country’s economic policies are tilted in an unfavourable trajectory then additional confidence in that trajectory isn’t going to lead to favourable outcomes – the risk becomes skewed towards economic misfortune.

Good policies generate confidence, not the other way around

Thinking through these analogies makes me wonder whether Shiller and Akerlof and trying to run before they can walk. If the fundamental economic policies started to work, generate sustainable growth, employment, etc. confidence will recover all by itself.

Confidence vs. Reality

The discussion above highlights that there are many different forms of confidence and many different aspects that can make individuals confident. What might make one individual confident might not necessarily make me confident. Putting all of these complications aside, what type of confidence should policymaker’s target? Generally they seem to target confident broader economic conditions. Leaders hope that confident economic feelings will result in positive economic outcomes. I think that this activity is clear to see in the speeches from all the major economic bodies around the world. The Federal Reserve, the US Treasury, the Presidency, the World Bank, the IMF, etc. all paint a positive economic picture to generate the much vaunted “confidence”. Economic growth forecasts from these major government institutions are almost always higher than reality. Can we attribute their positivity to attempts by the authorities to try and create economic confidence?

Looking at this scenario from a different angle, what if this incessant confidence targeting divorces economic leaders from reality leading to economic resentment from voters?

Joblessness has always existed - even during good economic times there are unemployed people who don’t believe that their leaders are speaking to their individual reality. But what if real macro conditions are deteriorating, real wages are falling, hours worked are declining, people are being forced into part-time rather than full-time employment (I.E. an across the board deterioration in conditions) and at the same time economic leaders remain confident? The leaders are confident for noble reasons - they believe the right policies are in place and that a little belief is required to get the economic wheels turning. But this confidence can easily be interpreted as arrogance by voters who view the positive outlook as disconnected from reality. This contrast could create resentment and disenfranchised voters rather than instil confidence in them.

I sense that this disconnect is the current economic reality facing the western democracies. Economic conditions aren’t particularly good with weak rates of growth and rising inequality. Many policymakers feel like they’ve done all that they can to solve the crisis and that all is required is a bit of confidence to get the economic wheels turning. So the authorities force-feed voters with positive rhetoric, that economic conditions are improving but in doing so the authorities alienate themselves from voters. 2016’s political outcomes suggest that political alienation reached a new extreme. I’m not suggesting that this is the primary reason but I think we should perhaps conduct a reality check next time a major economic or political leader argues that “all we need is a little confidence.”