Commentary on Political Economy

Thursday 15 September 2011

The Confidence Fairy - Comments on Krugman and Gavyn Davies

Karl Jaspers (existentialist philosopher) once said that "a little philosophy takes far away from reality, but a lot of it brings us much deeper into it". One is led to ponder: how far are "technicians" who never question their "working tools" from penetrating ("go deeper into") the "reality" with which they deal every day? For every category or concept we employ, whether "scientific" or not, there is a level of "relevance" or "concreteness" beyond which the concept becomes not just "irrelevant" but even absurd. (Alfred North Whitehead called this "the fallacy of misplaced concreteness".)
One eminent example of this in "economics" is "the fallacy of composition", which dates from Marx and reaches Keynes... and was last used by Paul Krugman (link below) in the NYT. This fallacy is rather simple to summarise: each capitalist firm wants its own workers to consume less so they can be paid lower wages, and the workers of other firms to earn more, so they can spend more. It is the problem of "effective or aggregate demand" as described by Keynes. If we do not isolate the "relevant level" of analysis, we become entangled in insuperable contradictions. Now, when we consider government deficits and public debt, we use these concepts as if they were "immutable", "eternal", without history - especially after the Rogoffs published "This Time IS Different" - indicating that, at least where public debt is concerned, nothing ever changes. But look at what Krugman writes: "Now, liquidationism isn’t the only argument the G.O.P. report advances to support the claim that reducing employment actually creates jobs. It also invokes the confidence fairy; that is, it suggests that cuts in public spending will stimulate private spending by raising consumer and business confidence, leading to economic expansion."

You see what I mean - and Krugman calls this appropriately "the confidence fairy". Look at his argument carefully: he is saying that "government deficits" do not "discourage private investment". And conversely, "government austerity" does not "encourage private investment". The two things (imagine that I am screaming this out loud for added emphasis) "are not linked! They are separate realities!"
Stop there. Now go back to Gavyn Davies: - his two separate replies to readers recently:
 “It is not the Fed's language that matters per se, but the fact that they are promising to keep short rates at zero, and that they can back this with real action. As long as they keep short rates at zero, I believe that there is a limit on how high bond yields are likely to rise, because the yield advantage on bonds rapidly becomes compelling to investors who are currently starved of yield. Or, to put it another way, there is a limit to how steep the yield curve can become. That is probably more important than the amount of bonds the Fed actually buys in any given period.
 Several people are arguing that I am underestimating the impact of QE/Fed action in propping up markets, and that I am too complacent about its disappearance. I plead not guilty to these charges. I think Fed action has 3 components: 1) zero short rates; 2) a balance sheet approaching $3trn; 3) new bond purchases of $80bn per month. This blog is about what happens if they eliminate 3), while keeping 1) and 2) intact (which is what I think they will probably do in June). I believe that the evidence suggests that 3) is the least important component of Fed action. Provided 1) and 2) remain in place, I think the bond market can get through June intact. If not, then not."
And now ask yourself the oldest philosophical question: how much can you darn a sock.... before it becomes.... a "different sock"? That is, when does "quantity" turn into "quality"? Because this is what is happening with "the stock" of public debt, and "the flow" of debt issuance. The "function" of the State is changing. The State no longer acts "as a function of" so-called "private sectors". It is the other way around! And that means that even the "meaning" of "public debt" has changed - because "public debt" is all there is! The "appearance" has become "the reality" - all of it, or nearly! If you are a "technician", you will delude yourself that "this time is NOT different", you will try to measure every ripple on the ocean's surface - econometrically or otherwise.... But then you will miss the massive undercurrents sweeping beneath the surface!!!  Tsunamis have tragically become fashionable of late. I am told that "the impulse" that propagates the tidal wave from the epicentre of an underwater earthquake to our inhabited coastlines is not "felt" even minimally by boats on the open sea. But once the tidal wave reaches the vicinity of land, it starts "to ripple" as the water nearest land gets "pushed" by the "impulse" moving toward the fated land - and the wave surges to frightening heights.... You know what happens next.

What do I mean? I mean that if we have reached this "pass" where government debt is so high - it may well be for a reason. If "Keynesianism" is in crisis - that does not mean that we will return to "pre-Keynesian" capitalist conditions! History may very well "rhyme" (Mark Twain) - but it does not repeat itself (whatever Nietzsche might say on "the Eternal Return" - incidentally, his assault on "scientificity" offers perhaps the greatest insights ever in Western thought - challenging even the majestic peaks reached by Marx or Kant, or even Plato and Aristotle!). We may well be in "uncharted waters". The entire "nature" of the capitalist economy is changing. The political "stalemates" we are witnessing point to a "crisis" (remember Schumpeter - "crises are intrinsic to capitalism" - no "continuity" there!) that we need to understand and hopefully "resolve" - even with Bernanke's "Rooseveltian Resolve". (If you need further elucidation, you may well re-read the Bernanke pieces on Japan I linked earlier. Or even read Minsky "critically". Or our earlier ling discussion of an article by Mishkin.) Above all, we need a new political institutional and economic framework. We need new "tools", new concepts to achieve that. Good week end.

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