Thursday, December 1, 2011

I'm fairly confident that most of the bickering over confidence is stupid

Bob Murphy, Paul Krugman, and Karl Smith all weigh in on "confidence" in macroeconomics.

Without diving into any of the issues any of these guys specifically raise, I would say this:

1. Expectations matter for economic decision making
2. Assessments about the quality of our expectations matter for economic decision making

Both can be referred to as "confidence". Sometimes the exact meaning is a little garbled. When someone has this thought in their brain: "I am not confident in the prospect of future growth", that is an important collection of firing synapses from the perspective of the macroeconomist. It's unclear exactly what it means of course. It could mean "I am very sure the economy will not do well", or it could mean "I am not very sure how well the economy will do". The very ambiguity of the sentence says something important about the way we think about uncertainty and the future, and which meaning we are communicating has important consequences for the economy.

Regardless, confidence is clearly important.

All this mocking of the "confidence fairy" by Krugman can be very misleading, I think. What he means is that some uncertainties play a more important role than others. He doesn't think the uncertainties that Don Boudreaux or Robert Higgs talk about play a very important role right now. He does think that other uncertainties do play an important role.

But talking abstractly about "confidence" and "uncertainty" doesn't make much sense. We expect things about the world, but we aren't always very sure about what we expect. What matters is those expectations, and people should talk more about that.

What Krugman should just come out and says is "austerity will not cause people to expect more growth or to be more sure of their current expectations about growth". That's all he really means when he talks about "the confidence fairy". We need to drop the metaphysics around "confidence". It's all about human guesses about the world we live in, and action on the basis of those guesses.

7 comments:

  1. We live in a time with low weight of evidence, Daniel. That's why we're having this debate over confidence fairies and all that. The trick is, how do we boost those expectations and thus the weight of evidence?

    ReplyDelete
  2. I'm quite fond of the confidence fairy myself. I think it demonstrates the absurdity of the argument that, by cutting government expenditures (and driving up unemployment while doing so), expectations of the future will improve. Where exactly is that confidence coming from? Increased misery?

    Most importantly though characters like the confidence fairy and VSP's make his blog much more enjoyable for non-academics to read.

    ReplyDelete
  3. That I can agree with, Carl. I love Paul Krugman's use of language...it's no wonder he's widely known to the public as a result.

    ReplyDelete
  4. I agree with the Keynesians that in the short run nominal and real incomes are confused and real incomes are judged from nominal incomes. That means falling nominal incomes cause recession if they are unexpected. That certainly causes short-run uncertainty in the incomes of businesses, which may cause them to withhold capital spending.

    But that's not all that's going on, there's also the long run to think about and there the picture is much more complicated. What I don't understand is why you guys think this effect dominates over all others.

    ReplyDelete
  5. Well i'd argue that if larger short run deficits help get us back to full capacity utilization faster then we benefit in the long run too.

    ReplyDelete
  6. Carl, what you're talking about there is how short-run behaviour can affect the long-run. That's not quite what I'm talking about.

    What Daniel is discussing here is different sorts of uncertainty that have different effects. In Keynesian economics there are two sorts of uncertainty that seem the most important. Firstly, there is that of future yields in investments which causes investors to prefer to stay liquid and reduces demand for investment goods. Secondly, there is money illusion, the uncertainty of worker/consumers over their real wage - I'm not sure that's best described as an uncertainty.

    But, there are more and different drivers of uncertainty. And apart from these confidence related problems there are "real" problems.

    What I'm asking here is why do you guys only look at these ones you prefer?

    Here's a related question too... Does anyone know if any economists have tried to produce a measure of total societal wealth (not *income*, *wealth*)? Have there been any attempts to produce a time-series of that?

    ReplyDelete
  7. Confidence is largely about how we frame uncertainty. So, Daniel is right, it is about expectations. If the level of uncertainty is too large, we cannot even frame expectations upon which to act. Below that level, the greater the ambit of uncertainty, the more unstable confidence, and so our expectations, are likely to be.

    Which is why it is so important for central banks to have explicit targets (but not policy rules).

    ReplyDelete

All anonymous comments will be deleted. Consistent pseudonyms are fine.