Confidence: In what?

It's a very old argument, and there's some truth in it. Financial crises and recessions are caused by a loss of confidence. And policies that might normally help end the recession might actually make things worse, if they worsen confidence.

Confidence in what?

The problem right now is that there is too much confidence: in money, and perhaps in government bonds too. And too little confidence in real investment, and perhaps in corporate bonds and shares too. Everybody wants to hold money, and government bonds. Nobody wants to spend money on real investment and on the corporate bonds and shares that finance real investment.

If you accept that diagnosis, then you want policies that worsen confidence in money, and perhaps in government bonds too. And if you worsen confidence in money, so that people try to get rid of it, and spend it, that should increase confidence in real investment, because firms will be able to sell the extra goods produced by that investment.

Comments

[Patrick]

"If you accept that diagnosis, then you want policies that worsen confidence in money"

AKA Inflation expectation? So CB's have to do what they've spent the better part of a generation promising they'd never, ever do - and if they did it by accident they'd work their Volcker mojo and undo it, no matter how painful. Not very encouraging.

What would your policy prescription?

[Patrick]

Of course, I meant to write "What would *be* your policy prescription?"

Still early in my part of the world...

[babar / q]

excellent post. i have been saying the same thing, but to nobody. thank you.

[Nick Rowe]

Patrick: M. Trichet (head of the ECB) invoked the "confidence" argument (see the link to Paul Krugman's post). Whatever it is that M. Trichet wants to do to restore confidence in the Euro, I want to do the exact opposite.

babar/q; thanks!

[Andy Harless]

Yes. I tried to make this point last year (for the US in particular, but the argument is applicable to most other developed countries too), and I think it's still valid, and probably more relevant than it was then, since at the time the pro-confidence moves were purely rhetorical. The only real argument I can see for trying to increase confidence in own-currency sovereign assets is a long-run argument that looks forward to a successful recovery and argues for getting a head start on the adjustments that will be necessary then. But we are actually hearing people argue that austerity will help the recovery by increasing confidence, which makes no sense to me.

[Nick Rowe]

Andy: Yep. Good post you have there. We are on the same page. I was trying to make a similar point in my very old post "I hope Hillary fails [to persuade the Chines to keep on buying US bonds]". I now emphasise money more than bonds (part of my monetarist/keynesian/Clowerian monetary disequilibrium approach), but didn't want to stress that distinction here, since it's a side-question.

[Patrick]

Nick: Sorry if I'm missing something obvious... I'm just wondering if you had any specific policies in mind for doing the opposite of what Trichet wants to do.

[Balance Junkie]

Perhaps we have too much confidence that the government will bail out the economy. But bailouts and stimulus money don't make for a firm foundation. That's why every uptick in the market is tenuous at best and every negative data point is met with a wave of selling. Investors know that this "recovery" is running on fumes. We need something real to invest in if we are to have sustainable confidence in the markets, the economy and the financial system as a whole. Let's have a little pain now so that we can rebuild the economy on a sound, sustainable foundation.

Failure to fail is not working. Consumers and corporations need to know that they (not taxpayers) will be responsible for poor decisions. Perhaps confidence in failure would restore discipline and accountability to the financial system. I would certainly be happy to move out of bonds and cash if I saw real growth in the economy and felt confident that no more of my tax dollars would go to failed companies like GM and Chrysler.

[andrej]

Alert: non-economist here, confused by the logic.

If people are avoiding corporate bonds and "real investment" and flocking to money and government bonds, might that not be a a symptom of *lack* of confidence in the corporate sector, rather than *excessive* confidence in government?

Why would the solution be to knock down confidence in government bonds to the same low level... enjoyed... by the corporate sector?

Why wouldn't a solution include reining in the corporate bandits who have destroyed confidence in the corporate sector and "real investment", and restoring confidence in that sector, rather than making the alternative just as unpalatable?

[Andrew F]

Is the commitment to attain the targeted inflation rate not enough to sufficiently reduce confidence in money? Seems to me that concerns about deflation are what is causing excess confidence in money as a store of value. Sounds like a job for price level targeting.

And the policy prescription should be: "If the market doesn't want to invest in corporate bonds or equity, the CB will"? QE through stock and bond index purchases.

[Determinant]

I think this is a variation on the balance-sheet recession idea.

Firms can either borrow, invest and earn a return or pay down debt. If you think in Bayesian terms a sufficiently large shock can move the preference toward paying down debt.

When firms do this they won't invest, expand and create employment, which leads to higher unemployment. Higher unemployment over an ever-longer period of time leads to loss of demand as individuals (consumers and employees) have less and less money to spend.

The solution seems to me to be inflation by expanding the money supply. This would enable firms to pay off their debts sooner and get back to investing. The problem is that there is a second class of people who hold a large amount of nominal rents. Pensioners are prime example of this. Inflation would reduce their earnings.

The rent-holders don't want inflation at all.

They seem to have won the argument.

[Andy Harless]

andrej,

It surely does reflect (in large part, if not entirely) a lack of confidence in the corporate sector, but restoring that confidence is a slow process at best, and in the mean time, there are all sorts of difficulties that may have a long-term impact (deterioration of the work force, possible deflation, etc.). The absolute degree of confidence doesn't really matter, because people have to choose what to do with their wealth: either spend it or invest it in one of the assets that are available; there is no "none of the above" choice for those who don't like any of the options. So, in terms of the impact on the economy, reducing confidence in one asset is essentially the same as increasing confidence in other assets.

[Jon]

Confidence and expectations are the same idea. The framing of the phrase confidece though is to blame the people (they lack confidence) versus blaming the policy makers (the people perceive the policy maker are screwing up the future).

Now the people can ve rational or you can take keynes's extra icing and call it animal spirits (irrational).

[Nick Rowe]

Patrick: I don't have anything very specific in mind (in the context of this post). Loosen monetary policy and fiscal policy, rather than tighten them. (It may be a bit different for some countries in the Eurozone, because the relation between monetary and fiscal policy is very different there, since Greece can borrow money but can't print money).

Balance Junkie: "Let's have a little pain now so that we can rebuild the economy on a sound, sustainable foundation."

But how does pain help us do that?

"We need something real to invest in if we are to have sustainable confidence in the markets, the economy and the financial system as a whole."

There are lots of things real to invest in, but they will only be profitable investments if the demand for goods returns, rather than people hoarding money.

andrej: I echo Andy Harless' reply. I wouldn't rule out any policies that increase confidence in investment, but the recession itself has become the biggest reason for the loss of confidence in real investment. There is no confidence in investing even in well-managed firms, if there's a recession.

Determinant: firms yes, but also ordinary people, in their spending and portfolio decisions, and individual investment decisions.

Jon: yes, there's a funny relation between "confidence" and "expectations". Confidence is in things and people, and expectations are about events and facts. But when you drill down into confidence, and ask what it really means, I think you end up with expectations.

[crf]

Plans for increased spending, beyond current stimulus, could increase confidence as well, I think.

If the markets are worried about a protracted reduction in demand, then there are several avenues of long term investment which the government could undertake.

1) Intracity rail
2) Intercity rail
3) Highways
4) Long term financing for new nuclear reactors and hydro to replace coal plants.
5) Sewage treatment upgrades
6) Fiber Optics links

Sell long term bonds for those particular projects, or finance them directly. These are all projects that pay out over the long term (citizens pay their train fares and utility bills), which could attract private investment in bonds. But they are also projects that may have a high variance of risk, so that any individual investment may be seen as too risky by a private financing entity (like a bank or stock-market investors), but not if an entity could invest in the whole sector (spreading the risk): but the trouble being that the capital cost of the sum of the projects in a sector is so high that it is difficult for the private sector to raise funds (To me, that's an obvious reality: how else to explain the relative lack of investment in such needed projects? Especially when you compare the relative decline in large capital-intensive sectors in countries with market-fundamentalist tendencies compared to, say, Asian countries?). This is a financing-risk problem that the government can help with.

[JP Koning]

Despite Andrej's warning about being a non-economist, I think he is entirely right.

If someone is stranded at sea with two rubber dinghies, and one springs a leak (i.e. private assets), the boatman is going to jump to the other dinghy (government money). Nick wants to spring a leak in the second dinghy to force the poor guy to return to the faltering first dinghy. But why would he go back to it if its already sinking?

There are any number of schemes to spring a leak in the second dinghy. One that comes to mind is Mankiw's idea of picking a number from 1-9 out of a hat, and destroying all dollars who's serial numbers end with the chosen number.

http://www.nytimes.com/2009/04/19/business/economy/19view.html?_r=1

Also is Nick’s idea of destroying central bank assets.

http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/06/why-its-a-really-good-thing-that-the-ecb-has-overpaid-for-greek-junk-bonds.html

Silvio Gesell wanted currency to expire every month unless currency holders got it stamped for a fee at a post office.

Never mind the callousness of destroying the frantic boatman's remaining functioning dinghy (not to mention the violation of monetary law and property rights it entails). This plan forgets that there is always a third dinghy; alternative monetary assets which are not being riddled with holes.

This third dinghy can take a number of forms. If a money is being purposely debauched by a central planner with some overarching macroeconomic goal x or y, alternative monies which are not being so debauched will emerge as a viable third dinghy. This is the process of dollarization – the market’s spontaneous substitution of bad money with good money - and though we aren't familiar with it in industrialized nations, it is a fact of life in the rest of the world (In Zimbabwe, US dollars, South African Rand, Euros, and Bostswanan Pula expelled the old Zim dollar). Another alternative is holding a store of goods in order to barter. The third dinghy could also take the form of gold purchases.

By purposely springing a leak in dinghy 2, the option of choice for the stranded boatman will not be the already faulty dinghy 1 but rather dinghy 3... some combination of dollarization, a regression to non-monetary exchange, and the mother of all gold bull markets.

[Andy Harless]

OK, to be a devil's advocate, here's a counterargument: suppose that people want to assure a certain minimum amount of consumption for themselves in the future. If they're unsure of the return on the safest asset, they're going to have to save more, and consume less, today, in order to assure that minimum amount of future consumption. If you reassure them that the safest asset is really safe, then they can consume more today, because they don't need to do extra saving as a precaution against losses. So money and government bonds are like a Giffen good: the more attractive you make them, the less people will buy.

[Andy Harless]

JP Koning:

Your dollarization argument doesn't make sense under a floating exchange rate regime. Dollarization is exactly what we want (where by "we," I mean the economy of a non-dollar nation, though I happen to live in the US, but one could in principle talk just as well about yenization). If people sell domestic assets and buy foreign assets, it makes domestic goods more competitive and results in exactly the desired stimulus. So foreign assets are, in effect, right on dinghy 1 where we want the sailor to be.

I'm also skeptical about gold, since there is only so much gold available, and eventually the price will be bid up high enough that it won't seem safe either. (In principle, policymakers should be willing to bid up the price of gold as high as necessary to take that asset off the market -- or to weaken the domestic currency, about which see the previous paragraph.)

And I don't buy the "non-monetary exchange" argument at all. It might apply if there were a dramatic increase in current inflation, but that is not what we are contemplating. We're talking about assets, whose value might be vulnerable to inflation at some point in the not-too-near future. If significant current inflation happens, then we have already won the battle against deflation and our whole argument is moot.

In short, there is no dinghy 3.

[Andy Harless]

...though I suppose the non-monetary exchange argument would make sense in principle if you're considering the Mankiw or Gesell ideas (and taking them literally, which I wouldn't, at least in Mankiw's case, since I think he was just giving a hypothetical example, not making a serious policy proposal). But if you look at actual experience, economies have been subject to moderate inflation in the past, and it has not resulted in a degeneration into barter.

[Nick Rowe]

If it were that easy to degenerate into barter, we wouldn't be having this problem now. An unemployed person who wanted wages to buy food, clothes, and a car, would just swap his labour for food, clothes, and a car. Problem of deficient demand solved!

[Min]

Nick Rowe: "It's a very old argument, and there's some truth in it. Financial crises and recessions are caused by a loss of confidence."

I don't know that argument. Can you spell it out, or give a reference? Thanks. :)

Nick Rowe: "And policies that might normally help end the recession might actually make things worse, if they worsen confidence."

You have lost me. If recessions are caused by a loss of confidence, then why would something that worsens confidence **normally help end the recession**? Wouldn't that be an abnormal state of affairs? If you spell out the argument, this might make more sense. :)

Nice Rowe: "Confidence in what?

"The problem right now is that there is too much confidence: in money, and perhaps in government bonds too."

I have the uneasy feeling that you have shifted the meaning of confidence. Most money these days is backed by the "full faith and credit" of something, the Canadian gov't, the U. S gov't, the U. K. gov't, maybe the European Central Bank (?). The confidence I have in their money depends upon the confidence I have in them. I have some South Korean money at home. The confidence I have in it is no different from the confidence I had in it a few years ago. I don't know how much confidence I have in the ECB, though. Fortunately, I don't have any euros at home. ;)

Nick Rowe: "And too little confidence in real investment, and perhaps in corporate bonds and shares too."

Again, confidence in those things depends upon who is behind them. I have little confidence in Citi, but I doubt if it is too little. ;)

Nick Rowe: "Everybody wants to hold money, and government bonds. Nobody wants to spend money on real investment and on the corporate bonds and shares that finance real investment."

Confidence certainly seems to be a factor.

Question: Is that factually correct? (I know it's an overstatement, never mind that. :)) From what I hear, a lot of corporations are cash rich now. Are people not buying their bonds?

Nick Rowe: "If you accept that diagnosis, then you want policies that worsen confidence in money, and perhaps in government bonds too."

That's a non-sequitur. Remember, your original argument is that loss of confidence causes recessions. Worsening confidence in anything should then worsen the recession, in general. Worsening confidence in money and gov't bonds means taking away their status as safe havens. And that means worsening confidence in gov't. That will simply make things worse.

Nick Rowe: "And if you worsen confidence in money, so that people try to get rid of it, and spend it, that should increase confidence in real investment, because firms will be able to sell the extra goods produced by that investment."

You are assuming a kind of conservation law of confidence. Loss of confidence in one area will produce more confidence in another. Aside from the fact that that is patently false, the original argument could not work with that assumption. You could have no overall loss of confidence that would lead to a recession.

If people lose faith in money and gov't bonds, they will most likely buy gold and other durable commodities and hoard them. Or they will hole up in the Rockies, or otherwise divorce themselves from society and the economy.

What needs to happen is to restore confidence in banks, businesses, and corporations, in Wall Street and Main Street, in neighborhoods and communities. :) Not to erode confidence in money and gov'ts.

[Andy Harless]

Min:

"You are assuming a kind of conservation law of confidence. Loss of confidence in one area will produce more confidence in another. Aside from the fact that that is patently false, the original argument could not work with that assumption. You could have no overall loss of confidence that would lead to a recession."

Confidence is a zero sum game, because the only way (besides spending, which would also be good for the economy) that you can decrease your holding of one asset is to increase your holding of another asset. You're not going to throw away any of your assets just because you lose confidence in them. So the "conservation law" is not "patently false," provided you define confidence in terms of the demand for assets. (As to "the original argument," Nick wasn't arguing that; he only said there was "some truth." The truth is that the recession resulted from a loss of confidence in private sector assets, not a loss of confidence in assets in general.)

You do make the point that there are other kinds of assets (gold, commodities) that Nick hasn't considered. But those assets are also products. If the prices of hard assets go up, it will result in increased employment by firms that produce those assets. And at some point, if people are rational, they will lose confidence in those assets when they become too expensive and start investing once again in productive assets. (At least, I'll tell you, if gold goes to $4000/oz, I don't have much confidence that it will retain its value.)

And see my earlier comments about the problems with restoring confidence &c.

[Nick Rowe]

Min: whoooh!

It's an old argument, but never spelled out to my knowledge. M. Trichet never speeled it out (see the link in my post). I think I remember Bagehot talking about loss of confidence, so it must be old.

"And policies that might normally help end the recession might actually make things worse, if they worsen confidence."

You misread me there. Let me re-phrase it. One person says "expansionary monetary and/or fiscal policy will help end the recession, by increasing demand". A second person counters "No, because if expansionary monetary and/or fiscal policy worsens confidence, it will make the recession worse". I think this counter-argument goes back to Ralph Hawtrey, and the "Treasury View", in the 1930's UK. We are hearing it again now, explicitly from M Trichet, and from others, IIRC.

[Frank Strain (Economics, Mount Allison University, Canada)]

Nick

This not on the current topic but I have been wanting to ask this question for a long long time. Like you I was a Ph.D. student who had to take Patinkin, Clower, Laffont, Malinvaud, et. al (and Peter Howitt) seriously when they made money something people might under certain conditions want to hold. (We know rational people would never want to hold money in "normal times" given every other asset yields some kind of return and money does not ....thus in normal times people should only want to hold money for transactions they forcast they will have to make and the interest inelastic LM curve makes complete sense as does abandoning IS/LM completely). But why, in your opinion, has Barro abandoned all of the disequilibrium macro he and Grossman covered with such brilliance in their extention of Patinkin in an AER paper way back when (early seventities) and bought completely in to the Lucas continuous market clearing model. If times are not normal and you are afraid of default, bankruptcy, etc. on loans and equity investments you want to hold money (right now I do given I am within15 years of retirement). I think Barro is smarter than me and would really like your opinion of why he does not believe his paper with Grossman is relevant today. Most economists have never had to deal with the disequilibrium literature and can be forgiven for ignorance. But Barro contributed to this stuff in a major way.

[RSJ]

"Confidence is a zero sum game, because the only way (besides spending, which would also be good for the economy) that you can decrease your holding of one asset is to increase your holding of another asset. You're not going to throw away any of your assets just because you lose confidence in them."

No, I don't think so. Credit is not a zero sum game. It can expand and contract. Credit comes from the Latin credo or "I believe". When you no longer believe that a firm will earn enough profits to allow it to service its debt, or when you no longer believe a house will appreciate in value, then this does not mean that you must believe that some other firm will increase in profitability by an equivalent amount.

Didn't Nick write a post about the bubble economy? Bubbles can expand and contract. The contraction of one bubble need not result in the expansion of another bubble. Only if you assume fixed discount factors and constant capital growth will this be the case. But we know that investment is the most volatile component of GDP. Investment as a whole can be negative, or flat, or quickly rising. It would make sense then, that the assets that collectively give the market value of that capital stock can also as a whole increase or decrease in value. Add to that the actual returns are dependent on faith in a non perfect foresight world, and you have the possibility of a general decline in asset values as well as a general decline in investment without violating walras' law.

And from looking at the data, households, which own all assets, can as a whole become poorer, and the relative price increase of government bonds need not offset the price decrease of other assets. Neither would a price decrease in government bonds force the price of other assets to increase.

[OGT]

RSJ would appear to be more correct, as far as I can tell there is no universal law of the preservation of confidence. This doesn't suggest that Trichet is in any way right, no one started extending credit because they thought government budget projections looked awesome, nor did they stop because they thought central bank 'credibility' might be impaired. It has far more to do with a reassessment of their counterparties' balance sheets and the sudden dodginess of their assets, as well as the risk in debt that needed to be rolled over.

In short, if not debt deflation then debt deceleration or velocity deceleration. The answer is still to maintain and expand the monetary base as near money as become much less money-like and to maintain velocity through fiscal policy.

[Min]

@Nick Rowe

Thanks for the clarification. :)

"I think this counter-argument goes back to Ralph Hawtrey, and the "Treasury View", in the 1930's UK. We are hearing it again now, explicitly from M Trichet, and from others, IIRC."

Bernanke said something similar, defending not raising the inflation target because people would lose confidence in the Fed. I took that as defending his turf. ;)

[Nick Rowe]

Hi Frank! Welcome! Did you follow over from Brad deLong's blog? One of your students tells me you've been inspiring her in macro!

I was taught that stuff by Peter Howitt. There was only a narrow window, those of us in exactly the right age-group, who learned it; then it died.

Why did Barro abandon Barro and Grossmann 1971? My hunch is that the answer is in this paper by Barro: http://ideas.repec.org/a/eee/moneco/v3y1977i3p305-316.html

In a nutshell (as I said in a previous comment to RSJ a few weeks back): Barro showed/realised that implicit contract theory might give the appearance of sticky wages, but that quantities might also be set by contract, and if so would be set at the Arrow-Dedreu efficient level. In short, wage (and price) stickiness might be just a facade. Quantities (of output and employment) might be determined *as if* prices and wages were perfectly flexible.

More generally, despite all the effort, there really still isn't a good theory of price or wage stickiness. And if you insist on full micro-foundations, you only model what you can build on full micro-foundations (an attitude I sympathise with, but ultimately reject).

[Econ Observer]

People are losing faith in the system, and for very good reason. When Wall Street destroys the economy yet continues to hand out record bonuses at taxpayer expense, people get cynical. When a major corporation posions an entire ecosystem for decades to come (BP in the gulf) and gets away with it, people get cynical. When accounting rules are revoked because they paint an unappealing picture of reality (mark to market replaced with mark to fantasy), people get cynical.

Honestly, why should it be surprising to see people are reluctant to go out and invest in this kind of environment. This is no longer capitalism - this is crony capitalism. There is very little meaningful justice carried out at the moment. I mean jeepers, it took 7 years for the SEC to do something about Madoff, despite one prominent investor basically laying out the entire case for them years ago.

This garbage has been going on for years and years. As any social scientist will tell you, trust is absolutely necessary for a functioning, prosperous society. I see trust eroding before our eyes. We need to take some steps to restore trust to the system, or it won't matter what economic policies we put in place to deal with our economic ills.

End of rant, and sorry if this content diverges from your more technical view of the issues...

[Winston]

I thought this issue was settled with Keynes ... and with business owners centuries before him.

[Andy Harless]

RSJ (and OGT),

Confidence is zero sum for the individual, because at any particular time, an individual only has a certain amount of wealth to invest, and putting more of it in one asset means putting less of it in another asset. When you aggregate individuals, an increase in demand for one asset means a decrease in demand for another asset (barring a change in consumption). At least if you're talking about net assets.

I guess your argument is that, if people have more confidence, they will take short positions in certain assets, thus increasing their gross assets. But in order for this mechanism to result in increased investment, it would have to induce people to take short positions in the relatively safe assets to finance long positions in the relatively risky assets (plant and equipment). But government assets (money and bonds) -- the ones in which we are ostensibly making people more confident -- are precisely the kind of safe asset in which we would want people to take short positions. Increasing confidence in those assets would make people less inclined, not more inclined, to take short positions in them.

[Andy Harless]

An overall decline in asset values occurs specifically when people shift their demand from risky assets to safe assets, because the values of risky assets vary more than the values of safe assets. This is exactly the effect that increased confidence in money and government bonds would have.

Even if people also maintain, or slightly increase, their confidence in risky assets, the greater relative increase in confidence in relatively safe assets will cause people to shift their demand toward those safe assets, causing the risky assets to fall in price and resulting in an overall decline in asset values. Thus, increased confidence (if you define "confidence" in such a way that it can increase overall rather than just in a relative sense) can easily be associated with reduced asset values and reduced investment.

Increasing confidence in that sense doesn't solve anything. What matters is relative confidence.

[Nick Rowe]

What Andy Harless said. I'm off canoeing. Back on the blog in a few days.

[RSJ]

"An overall decline in asset values occurs specifically when people shift their demand from risky assets to safe assets, because the values of risky assets vary more than the values of safe assets. "

No. An overall decline in asset values occurs when people change their expectations of future cash-flows. The value of assets is guessed at, and those guesses are often.

As a side-effect of the above, there is a rush to safety.

The rush to safety does not cause the risky asset price decline. The rush to safety is itself caused by the rediscovery and re-assessment of risk. The house appreciating is no longer a sure thing. It used to be a sure thing when confidence in appreciation was high. When the confidence declined, so did the asset price. Similarly businesses made investments in the expectation of large future cash flows. When condifence in those future cash-flows declines, then so does investment and the value of the assets.

These effect can be modeled independent of the existence of, or demand for, safe assets. Even in a world with no safe assets -- e.g. a pure cashless credit economy without government, still you would see assets increase and decrease in value, and this would affect incomes as well as output.

Given the (reduced) level of wealth, it is true that you have a choice of what to spend that wealth on. But the point is that the stock of wealth itself shrinks and expands due to a loss or increase in confidence.

[Doc Merlin]

Nick, could your argument for "too much confidence in government" translate also into "too little confidence in governments making correct choices" people could be fleeing to cash and gold and treasuries, because they think that the state will harm debt and equity markets?

[tjfxh]

The Fed has been trying mightily to undermine confidence in the dollar (create inflation) for some time now with no success. The loud calls for fiscal austerity in response to very loose fiscal policy also indicate a fear of inflation, but there are no actual signs of inflation.

The "loss of confidence" seems to be a loss in confidence in the entire system and that is a much more complicated problem to solve either monetarily or economically. It really is a political problem as FDR realized and treated as such. President Obama is apparently no FDR.

[Andy Harless]

RSJ,

You assert "no" to my statement, but I don't see that you substantively contradict it. Whether or not one calls the rush to safety a side effect, it is simultaneous with the loss of confidence in risky assets and part of the same process. And safe assets (in the sense of assets perceived as safe) do exist: people do have a haven to which to run when they lose confidence in risky assets. The existence of those safe assets enables people (individually) to continue saving without investing, thus resulting in a much larger decline in income than would occur in a cashless economy. If we make those safe assets safer, it only makes the problem worse.

Frankly, I don't see how a loss of confidence in assets could have much short-run effect on incomes in a cashless economy. It will slightly increase the value of leisure relative to work (but that's not a particularly bad thing, and to the extent that that is what is happening now, it's hardly a major problem). It may cause people to increase or decrease consumption slightly, depending on whether income or substitution effects predominate. But people will still want incomes, so they will still work.

The biggest problem today -- high unemployment -- is specifically a problem with the excess value of a safe asset called money. People are willing and eager to work at prevailing wages, but money is considered too valuable to justify hiring them at those wages. A drop in prevailing wages -- if it could be done all at once without disastrous effects on morale or future expectations -- would solve the problem, but it isn't going to happen that way. Accordingly, the only solution is to reduce the value of safe assets. Why are policymakers trying to do the exact opposite?

In this respect, the preoccupation with "confidence" is largely an attempt merely to extinguish the match that started the fire. Economies can operate perfectly well when the expected returns on real assets are low. The problem is not the low level of confidence but the loss of confidence, after sticky wages and prices had come to an equilibrium based on the old, higher level of confidence. We probably can't restore confidence in real assets to anything like its old level. What we can do is to reduce the value of nominal assets so as to create a new equilibrium consistent with the lack of confidence in real assets. Again, why do the opposite?

[Determinant]

The devil's advocate response is that devaluing safe assets like government bonds causes somebody to suffer a loss. People hate losses. It's a balance sheet vs. income statement view. Inflation haters generally have a more balance-sheet centric view with fixed, inflexible nominal income.