Confidence Games

One way to address this Robert Shiller commentary at Bloomberg is to point out the obvious irony. A man who is promoting a book he co-wrote on the importance of psychology in the business cycle has a column entitled, "Depression Lurks Unless There's More Stimulus." Feel the confidence! Matthew Yglesias goes a different route and takes on the policy recommendations:

Ever since it initially became clear that the administration might have some trouble getting a stimulus bill through congress, the administration has taken basically the reverse tactical approach. They've taken as much stimulus money as they can get, and have been declaring the resulting stimulus program to be likely to work. Similarly, on the banking front they're scrambled to put together the PPIP with funds that they've already been giving and have been declaring that program likely to work. In both cases, however, mostly outside analysts who broadly share the administration's perspective think that the political constraints are forcing them to do too little.

A different take would be to establish targets. We want demand at this level, and credit at this level. Then you could be clear that the measures currently underway will probably help, but are unlikely to be fully adequate. Shiller says "It is time to face up to what needs to be done. The sticker shock involved will be large, but the costs in terms of lost output of not meeting either the credit target or the aggregate demand target will be yet larger."

It's interesting to reflect on this passage while considering the president's rationale for avoiding nationalization of troubled banks:

On the other hand, there have been some who don't dispute that we need to shore up the banking system, but suggest that we have been too timid in how we go about it. They say that the federal government should have already preemptively stepped in and taken over major financial institutions the way that the FDIC currently intervenes in smaller banks, and that our failure to do so is yet another example of Washington coddling Wall Street. So let me be clear--the reason we have not taken this step has nothing to do with any ideological or political judgment we've made about government involvement in banks, and it's certainly not because of any concern we have for the management and shareholders whose actions have helped cause this mess.

Rather, it is because we believe that preemptive government takeovers are likely to end up costing taxpayers even more in the end, and because it is more likely to undermine than to create confidence. Governments should practice the same principle as doctors: first do no harm.

I actually think that's a very compelling reason for handling the banking situation as the administration has (assuming they're actually thinking through the potential effects of their choices -- see: stress tests). And consider this story in today's Post:

Economists say many still-flush consumers are handcuffed by psychological traps that cause them to tighten their purse strings even though economic hardship is not their reality. Underscoring the crucial role that consumer psychology will play in turning around the economy, President Obama and Federal Reserve Chairman Ben S. Bernanke have both been on the hustings this week sounding notes of optimism.

These are the idle resources that will be unleashed when expectations shift from continued contraction to expansion. That's consumer power the administration can't hope to match via stimulus spending alone.

Now if Shiller were an economist who believed the models of rationality and looked only at fundamentals, then I could see him arguing for the risky approach he's advocating in his column -- ignoring political constraints and threatening Congress (and America) with depression if policy targets aren't met. But Shiller thinks that psychology is crucial. We appear to be at an inflection point for the broader economy, and the administration has reacted to the policy constraints it faces by doing everything it can to boost public confidence. And to a surprising extent, the economic data is obliging. It would be bizarre to ask the administration to change course at this point and 1) publicly admit that everything the president has done so far has been horribly inadequate, and 2) declare that much more must be done immediately or collapse is imminent. Particularly when Congress might not deliver more money, thus generating the worst of all possible outcomes.

Shiller's approach here makes no sense to me.