Wednesday, July 28, 2010

Indiviglio on Uncertainty

David Indiviglio, at The Atlantic, shares an interesting looking paper arguing that recessions cause uncertainty and not vice versa. What does this mean for a Keynesian? I have a few thoughts:

1. Well it could mean the Keynesian emphasis on uncertainty about the futureis wrong. I don't think it means that, and even if this one paper means that I don't think one paper overthrows an enduring theoretical framework with a lot of explanatory power, but let's start by being up front and making clear (if it was unclear to any readers) that this presents a challenge.

2. I'd have to read the paper, but this could just be a better explanation of the way declining animal spirits work. "Animal spirits" is a vague and nebulous term. I don't think there's anything wrong with saying that collapse in asset values or a real downturn or a downturn in consumer demand causes a decline in animal spirits and an increase in uncertainty which worsens a downturn. This whole "secondary depression"/"feedback loop" mechanism is very common across a lot of business cycle theories, including Keynesian ones.

3. The Keynesian understanding of uncertainty is primarily tied to liquidity preference, and the idea is that even in good times liquidity preference keeps us below our output potential. I'm not sure how any paper could pick up this "baseline" liquidity preference, which is really the primary way that it comes into the Keynesian model.

4. I wonder how macroeconomic policymaking plays into the paper. In the United States, we actually have taken macroeconomic stability more seriously as a policy objective than a lot of the rest of the world (see the Crooked Timber article I shared earlier on Keynesianism as a substitute for social democracy). If macroeconomic policy is done right and it's not taken into account in the model then I'm sure the effect of uncertainty would be weakened.

5. The paper only looked at the manufacturing sector. Not sure what the implications of this are.

Real Time Economics also picked up the paper, and had this to say:

"One conclusion from the paper is that policy makers can talk about the need to end uncertainty all they want, but jaw-boning won't make much difference. Only increased demand will make business executives feel more confident."
Indiviglio also writes on consumer confidence here.

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