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Wednesday, August 31, 2011

Great Balls of Fire Expectations

I guess the idea actually goes back to Keynes, himself, if not earlier.  Economists from Krugman (who provides a supporting narrative) to Karl Smith (who indicates relevant expectations can be/are captured in price data*) cite expectations management as some sort of a way to manage and control the economy.  Just today two economists referred to it.

David Beckworth said:

If the Fed were to announce a nominal GDP level target it would provide a big expectation shock that would reverse much of this buildup.  {of a large stock of money assets - JzB}

Beckworth has been pushing NGDP targeting for as long as I've been reading him.  He goes on to explicitly credit  "a much needed shock to nominal spending and inflation expectations.  As a result, there was robust recovery from 1933 to 1936."  He also explicitly states that  "by raising inflation expectations, it would increase the cost of holding money assets for the non-bank public."

I can't say for sure that Beckworth is a New Deal denialist, but I don't recall ever seeing him refer, even in passing, to fiscal policy as part of a solution to the current malaise.

 James Hamilton said:

As far as monetary policy is concerned, the most fundamental ingredient is what the public expects to happen in the future-- managing those expectations is the basic tool that the Fed could rely on in this situation.

In all of these cases, expectations (animal spirits to Keynes then and Elliott Wavers now) determine reality.  IMNSHO, this is dog-wagging on a monumental scale.  So much so, it strikes me as being scarcely at all removed from magical thinking.

I don't deny that expectations can, or might, play some roll.  But to matter for more than some transient period, and in more than some trivial way, reality has to follow suit.  One can expect inflation - as, indeed, many do today, despite there being absolutely no good reason for them to do so - and not get it.  (I expect Valverde to blow the save every time he takes the mound, and I've been wrong on all 40 of his chances this year.)  So - what good is an NGDP target if the Fed doesn't have the tools and the cojones to make it a reality? Beckworth, Sumner  and others have proposed an NGDP futures market.**  Smith demurs, thinking an inflation target is more practical than an NGDP target.

Targets can be missed - the Fed's utter indifference to the employment half of it's dual mandate, while it fails miserably to generate core inflation in the other half, illustrates a lack of both capability and will.  Expectations can be dashed on the shoals of forlorn hope, perverse fate or simple ineptness. 

The expectations-to-reality flow chart is based on ifs and assumptions.  It's a fragile chain that can be broken at any link.  More fundamentally, expectations are ideas.  But it's actions, not ideas, that cause change and generate results in the real world.  (A case in point being the administration of President B. Hoover Hopey-Changey.)

Maybe I'm being overly skeptical, but saying, "I do believe in inflation, I do believe in inflation," is the stuff of Neverland.

* The strong form, at least, is about 90% of the way to the Rational Expectations hypothesis - which is 90% bull shit.
** This simply strikes me as being bat-shit crazy.

1 comment:

The Arthurian said...

Good post.

T'other day I read that monetary policy ain't working. And it's long-standing economist claptrap that fiscal policy doesn't work. So there's nothing left but regulation -- gasp! -- and expectations-management. At least from their point of view.

All perfectly logical, given the unfounded assumptions, etc, etc.

Expectations are based on results. Since economists don't get results, they now say results are based on expectations.