Lack of trust is one reason why macro policy is underperforming

From my latest NYT column, here is one excerpt:

During the financial crisis, the prices of stocks, homes and other assets all fell, leaving the American public feeling less wealthy. In fact, the Federal Reserve reported last week that the crisis had erased almost two decades of accumulated prosperity for a typical family. The American economy and its financial system failed a giant stress test, at least when compared with previous expectations. Feeding the fears today are the crisis in the euro zone, the slowdown in China and political polarization at home.

In short, there is a prevailing sense that we are simply not as safe, financially speaking, as we used to be. The productive capacity of the economy may appear largely intact, but the perceived risk is significantly higher.

Think of hiring as a business investment, and that investment often requires:

1. A not too high risk premium

2. Consensus within organizations, and thus trust within organizations

3. Commitments from banks that they will provide liquidity when needed and not flinch in light of pressures to cut their balance sheets

4. Ability to afford concomitant capital costs

5. Ability to scale up rapidly if the new projects “hit paydirt”

6. Consumers perceive they have enough wealth to (potentially) become captive customers of a new and successful product

7. Affordable real wages

Inflating away the real wage helps with #7 — and that can be a big help indeed — but it is far from the entire picture.  When trust is low, both monetary and fiscal policy will underperform, relative to textbook predictions.

Here is another bit:

In response, some people have moralized about this shift — sometimes by telling voters they’re stupid to let government shrink. But that kind of talk can lower public trust even further.

If your blogging or writing doesn’t increase the degree of trust among people who do not agree with each other, probably you are lowering the chance for better policy, not increasing it, no matter what you perceive yourself as saying.  I also wrote:

Although Sweden and Switzerland have had effective monetary policies recently, both of those countries have especially high rates of trust in government.

And high trust in each other.  I could have added Iceland to that list.


Ok. Next time I'll trust that a bailout deal that entails an equally insolvent country to pony up a good portion of the funds at a rate lower than they can borrow will work just fine.

It isn't trust. It is consequences. Iceland got kicked in the teeth. So did Sweden back in the 90's with their banking crisis. Free markets aren't about creating winners or doing wonderful things, they are about forcing loss when ideas or execution are poorly done.

I agree with the sentiments but feel that it is too late. There is a very good reason why you don't encourage by policy or by social norm a banking crisis. The crisis occurs because of a breakdown in trust, usually for the simple reason that no one involved is trustworthy at all. By then you are lucky to survive.

Swiss bankers are liable for the losses. Engenders a slightly different attitude by bankers and towards bankers.

So, you identify a lack of trust as one of the main problems and you are unquestionably aware of Robert Putnam's findings that diversity kills trust, yet you are a staunch open borders supporter. That cognitive dissonance - do you ever feel it?

Yeah but the R. Putnam findings are not that strong. The degree of growth per annum between a heterogeneous open (free market) society and a homogeneous open society was about 0.3%/yr last I checked--good but nothing to close your border over, since it's impossible to close an open society border anyway (ask George Soros). I liked this part of Tyler's post: "If your blogging or writing doesn’t increase the degree of trust among people who do not agree with each other, probably you are lowering the chance for better policy, not increasing it, no matter what you perceive yourself as saying." That means that trolls and flame warriors are arguably lowering GDP! Maybe the SEC was right when they proposed rules to limit free speech for bloggers, under the theory that they might spread false rumors about stocks? I doubt it makes a difference though.

Also banning low-trust speech does not raise trust; you can't create a desired condition by enforcing its symptoms.

I am more concerned with the low quality of the moral case for open borders. It has often been pointed out that the moral case for big government rests on conflating private charity with quasi-charitable spending of coercively extracted tax money. Similarly, the moral case for open borders states that I (the insulated knowledge worker) will take things from you (the unskilled worker whose border protections are being stripped away) and give it to someone else who I believe needs it more. Regardless of whether I am right, this is not a charitable act on my part.

Trust is not the only factor, that's why. A close-knit, clannish society can end up being high-trust-low-productivity; that's not an equilibrium you want to be in.

Diversity, not for diversity's sake but simply because useful skills are diversely distributed.

Both Sweden and Switzerland have very large foreign-born populations, and very strong social trust.

citation please? very large compared to what?

It's working really well for Sweden:

Pay attention to that "90% of them unemployed" line.

"Yeah but the R. Putnam findings are not that strong"

Just strong enough to make him sit on them for ten years. academia a high-trust environment?

it's a mood affiliated environment.

It's not lack of trust, it's lack of imagination. There's a lot of dilapidated infrastructure that can use repairing and upgrading, but no one is bringing it up. Instead people would rather focus on wedge issues and trying to beat the other side politically. You can't discuss what are good ways to increase public spending if the very idea of increasing it is taboo.

Taboo? You've just brought it up.
Wasn't infrastructure spending part of the stimulus? How did that work?
Your point about "beating the other side" -you ask people to stop disagreeing and then agree to your spending plan? Do you understand how disagreement works?

"You can’t discuss what are good ways to increase public spending"

You've got this exactly backwards. THEY broke it buy moving from public goods spending to wealth transfers.

Show. Me. Where. I. Am. Wrong.

Show me.

This. The money for infrastructure improvements is there, abundantly even. It's just that it's spent on other things and it's not until the very end that people start thinking about funding infrastructure.
"We need more money"
"Infrastructure, obviously it's needed and has a positive return on investment."
"Can't you find the necessary funding somewhere in the close to four trillion?"
"No. We need more money"

More money comes...

"What about the infrastrucure, it's still not been fixed"
"Well, we spent that money on transfers and defense... We need more money"

"Wasn’t infrastructure spending part of the stimulus? How did that work?"

It worked just fine as all the independent analyses of the infrastructure spending in the stimulus have shown.

Citation please. No linky, no believy.

The problem with repairing infrastructure in many American regions is that it is hard to see much additional productivity gains coming out of it.

Especially not when the projects are adding public goods with little social value (wheelehair ramps) and they are replacing existing public goods that work fine and have plenty of useful life left in them.

How are you so sure of this? To me, that's giving up on America. You're essentially saying that America is not worth investing in anymore. It's not like a private corporation where we can return the capital to investors. This is the only "corporation" we got.

For basic public infrastructure, there's no one else that provides that but the government. Private individuals or companies are not going to replace the govt role, because there's too much consumer surplus or spillover social benefit to it.

What?! Sorry I haven't read the full column, but from the quotes this looks almost like a parody of Fox-style paranoia and scaremongering. You're conflating so many different things I'm getting whiplash.
First, in the big quote, you talk about household wealth. Then you jump directly to hiring. But, hello! Households aren't the unit that do most of the hiring. Corporate wealth is doing pretty well, thank you very much.

Then you draw this distinction: "Feeding the fears today are the crisis in the euro zone..." as opposed to "Sweden and Switzerland...both of those countries have especially high rates of trust in government". These things have nothing to do with one another. American investors' fears about a Euro slowdown are well-motivated, (at least partly) rational economic worries. Trust in one's own government is a completely separate issue. It's an economically relevant issue, but it can't be compared with rational worries about a failing export market.

And the jibes at Krugman are just pathetic. He's got a more popular blog than you. Get over it.

Two years ago I was here complaining of the Krugman bull. Now most everyone sees it.
Maybe in two more years even his sycophants will see it. Just the fact that you know (and is obvious to everyone else as well) that he alludes to Krugman shows that you see it, maybe you just don't quite realize it. When everyone sees it here is what he will say, as he already has started to, "I just care too much, so screw off."

You're whole first paragraph is a mess. Households are worried about their finances or are deleveraging, therefore not spending. Without that spending, companies aren't hiring. This is the typical AD issue that Krugman speaks of. I'm not sure what you're accusing Tyler of conflating.

'Affordable real wages' reminds me of this Adam Smith quote. Highly applicable to our current situation:

"In reality high profits tend much more to raise the price of work than high wages. [...]In raising the price of commodities the rise of wages operates in the same manner as simple interest does in the accumulation of debt. The rise of profit operates like compound interest. Our merchants and master-manufacturers complain much of the bad effects of high wages in raising the price, and thereby lessening the sale of their goods both at home and abroad. They say nothing concerning the bad effects of high profits. They are silent with regard to the pernicious effects of their own gains. They complain only of those of other people."

"the Federal Reserve reported last week that the crisis had erased almost two decades of accumulated prosperity for a typical family."

Wouldn't it be more accurate to say that the crisis exposed the truth about the value of a typical families accumulated assets? i.e. that they weren't worth anywhere near what they thought they were, for a wide variety of reasons both structural and economic?

Most of the article was speculatory; but this one hard (and surprising) fact caught my eye:

Since Mr. Obama took office, 780,000 private sector jobs have been created, while the number of public sector jobs has fallen by about 600,000.

Rahul, look beyond the numbers.

That is not because government is just a firm scrambling for cash. It is solely because people like me are assholes.

Beyond the numbers it's mostly ideology.

What's unsurprising is the audacity of mendacity.

True, the nation has about 600,000 fewer public sector jobs, but the federal government has ADDED employees while state and local government, racked by deficits, are making all the cuts. Did Obama personally call each mayor and governor and ask them to cut jobs? No, in fact he funded higher levels of state and local employment for a year through cash transfers.

It's also a dubious notion that he created any substantial portion of the private sector jobs.

Well, leaders so rarely have a causal relation with things that happen on their watch. You just get stuck with the credit and blame for whatever happens while you are there.

What is surprising is total government spending (fed,state,local) has gone up over that period, but they lost net 600k jobs.

How did that happen?

Doesn't this line up perfectly with the whole low-demand point of view? People aren't confident that things are going to be OK in say five years, so they're citing on their cash. Because no one's spending, corporations are also not investing. But a great way to get people to loosen up with their wallets is to inflate a bit. If your money will be worth 0% less in a year, there's not much point in buying now, but if it will be worth 7% less, you're more likely to. We need to find the tipping point.

"citing" = "sitting" (writing too many papers...)

My only safe asset is worth 7% less next year. I feel better already!

Uh, I did say that fearing it'll be worth less was the whole point...

I have no faith in 7.
Here is why.
1. Inflation requires Federal Reserve debt, buying treasurys, giving the government money, which it destroys.
2. If the delta between our real wages and the wages of offshore labor is great, inflation will do nothing.
3. Inflation mucks with the capital structure.
So, what you might be doing with inflation is accelerating capital out-flight by doing nothing marginal for the labor pay gap, increasing the instability of capital increasing the driving force for off-shoring, and undermining the overall stability of the economy thus undermining the driving force for capital in-flight.

I hate it when people treat lack of trust as a cause instead of a symptom.

There is a good reason for lack of trust.

Here here! The lack of trust is fully warranted, given the actions of our political class. And it's those actions which have caused both the economic downturn and the lack of trust. Your "lack of trust" is my "realistic assessment of our political class and their ideas."

They trusted Jim Jones ...

I think this post is mistaking TRUST for EXPECTATIONS.

For example, a futures contract that I enter into involves my expectations of a future reward based on my assumption of future demand. Other than counterparty risk, no one would regard a futures contract as an item of trust--it is an item of a contract for a future exchange.

If you look at Tyler's list, ask how many involve EXPECTATIONS of future demand, futures markets, etc., and how many involve actual TRUST, the ability of the counterparty to perform the contract.

"I think this post is mistaking TRUST for EXPECTATIONS."

Tyler does this constantly. He keeps seeing a correlation then drawing the causal arrow in the wrong direction.

Do people trust the Chinese government?

As another commenter noted, trust seems more like a symptom than a causal factor.

Switzerland, Sweden, and Iceland are relatively small countries and homogenous ones as well (the Swiss may have 4 different languages, but the culture and ethnic makeup of the people are remarkably similar across the languages). They also can get away with trade policies and currency devaluations that the U.S., as would be global Hegemon, would not dream of. America is a huge continental nation, with deep sectional and racial divisions (since the 1960s most middle class white voters think their taxes have been going to swarthy minorities who folks on this blog presume have ZMP or foreign aid to countries filled with swarthy people). Hence welfare policies that are consider just common decency in those countries are considered matters of outrage in this one (see Scott Walker's meme of "hard working taxpayers" no longer willing to subsidize lazy (insert public school teachers, unemployed, lazy Black families in Milwaukee, etc.). And they also distrust the elites since their basic standard of trust is measured by whether life is more secure, freer, and easier or not, and by that standard, for the lasst 40 years, it has been declining for about 90% of Americans (as their labor and marginal productivity has come into competition with several billions of people in China, the Indian Sub-Contenent, Southeast Aisia, Latin America, and Eastern Europe. And ther is another resevoir of people about to join the crowd from Africa and the Middle East.

Inflating away the real wage helps with #7 — and that can be a big help indeed — but it is far from the entire picture. When trust is low, both monetary and fiscal policy will underperform, relative to textbook predictions.

It seems then that #1-6 are just a hypothesis that can easily be tested by pushing monetary and fiscal stimulus until we get to the point of inflation (and I don't mean hypterinflation, say just 3-4% which was considered 'low inflation' not too long ago). If at that point everything else still seems bad, we can give this 'trust hypothesis' some weight. If everything starts to correct itself, we can toss it on the dustbin of failed economic hypothesises.

The CPI has grown at an annualized rate of 2.6% since December 2008, not too far off from where you appear to be advocating it to be.

The idea that we have no inflation today mystifies me. The fact that it's happening in an environment of 0% nominal rates tells me savers have been punished, in the best Keynesian tradition, more thoroughly over the past four years than over any comparable length of time during the 20th century in this country.

The CPI has been well below 2% until just recently (when just recently we started getting some positive jobs reports). shows accumulated inflation and you'll note even with the recently slight uptick we are still below where trend would have left us.

As for 'punishing savers', what do you want? A planned economy? Savers provide the funds for investment spending. If the economy doesn't want to do much investment spnding, it's not going to reward savers anymore than people who try to sell winter coats in the middle of July are going to make much profit.

It's not "the economy" making the decisions about investment levels when the entire tax and regulatory structure is set up to incentivize debt over equity. Especially so when the debt channels are highly regulated (and politically connected).

1. There's been no dramatic shift in regulatory or tax structures since 2008 or even before.

2. Equity has plenty of tax incentives. Capital gains, for example, is taxed at a rate much lower than income. Since one pays tax only on 'realized' gains, you can store you wealth in stock for years and decades never paying a penny on increasing values until you actually sell. Perhaps most importantly trillions of dollars are invested via 401Ks and IRAs which are basically exempt from tax giving debt and equity a neutral playing field to draw from.

3. Yes the economy is 'making decisions' about investment. Savers fund investment and are rewarded *either* by the benefits of equity (dividends, stock appreciation) or the benefits of debt (regular interest payments, priority in bankruptcy etc). If investment spending is desired, then it will reward savers who provide for it either by debt or equity purchases. When the claim is made that 'savers are being punished', those making it should explain to us how they claim to know what the 'right' level of reward is for saving.

Can't speak to regulatory changes, definitely not my field. Not sure why you're picking 2008 as your start date, though; bubbles obviously take time to ramp up. And Sarbanes–Oxley was 2002, and it wasn't exactly a minor change, nor the only one.

Equity does have tax incentives, but I'm talking about the borrowing side, not the lending side. Companies are incentivized to take on debt in favor of raising funds via equity. It's not dramatic enough to eliminate equity, but it matters on the margin.

Savers fund via equity, but I don't know many who fund via debt. Equity has low barrier to entry on the lending side; all you have to do is sign up for an E-Trade account and buy some stocks or corporate bonds. Debt has a huge barrier to entry on the lending side, once you get past the "loan to uncle Vinnie" level. Unless you have the funding and expertise to make yourself a bank, you aren't going to be doing any serious level of debt funding.

I'm picking up on 2008 as our start date because the argument here seems to be that some massive structural change has happened leading us to think that what used to be normal levels of employment and inflation should no longer be considered normal, and the argument also seemed to be fuzzy 'regulatory and tax' biases between equity and debt are the cause of this change. Well nothing major happened in that field in 2008 nor did it happen in 2002 for that matter. Yes Sarbanes-Oxley was big when it came to financial reporting but that's not a fundamental shift in the rules of the game when it comes to the question of debt versus equity.

Beyond that you're right, when 'the market' desires investment spending there's two ways to fund it, Equity or Debt. I can borrow $50 to open my lemonade stand and pay back $51. Or I can use $50 of my own cash and keep all the proceeds big or little. What doesn't change, though, is that the funding comes from savers. Whether I chip in my own $50 as an 'equity purchase' or someone 'loans' me $50, what could have been $50 of current consumption spending turns into $50 of investment spending. The 'reward to savers' or 'punishment for savers' is not some epic battle of good versus evil but trying to find the balance between giving up consumption today in return for expected consumption tomorrow. It doesn't seem clear to me what the balance between saving in the form of equity or lending has to do with it. Both have a host of pros and cons and there's almost certainly no one right answer between them.

Savers fund via equity, but I don’t know many who fund via debt.

You, as a saver, can fund via debt by simply keeping your money in a bank that makes various loans. Or a money market account which trades in short term commercial paper is the same thing. If you're talking about a 401K or larger fund you can buy corporate bonds quite easily by a nearly infinite array of mutual funds and other vehicles.

I think what should be noted here is that debt and equity are not different at all, it's like having a swimming pool and insisting the water at the bottom is somehow special 'bottom water' versus the 'top water'

Some time ago someone had a nifty little web site and went to a friend and said they needed like $5,000 to buy the server space to accomodate all the people who wanted to use it. The idea here is $5,000 spent on servers today would somehow allow more money to be spent in the future on fun consumption things like Starbucks coffess, car payments, vacations etc. Split the returns in two, you have the recovery of the original $5,000 and you have all the fun stuff that will come in beyond the $5,000. The first we call 'debt' and the second we call 'equity'.

The friend gave something like $5,000 not for a promise of $5,000 plus interest back in the future but shares of Facebook. He now has millions because of that little move. But if the company went belly up with just $5,000 in the bank account left, he would have wished he had *loaned* the $5K to Facebook so he could recover it whereas as a shareholder he gets nothing.

So just imagine it was totally illegal to ever lend money to anyone. Everything would be funded by equity purchases. All that would really happen is that some types of shares would be produced that were exceptionally low risk (say preferred shares with guranteed dividend payments, priority in bankruptcy etc, maybe even tied to individual assets of the company) and others would be exceptionally high risk. Savers who want something more like debt would just buy low risk equity and other savers would buy the higher risk equity. In either case, though, all investment spending is funded via savers.

High levels of public trust aren't nearly as valuable as food trucks that serve authentic pupusas.

Surprisingly, Tyler offers no measure for the degree of this loss of trust, nor any evidence that loss of trust has recently increased. (That people have become poorer and so feel they cannot afford as much government as before does not show that they have become more mistrustful of government.) Nor does he do anything to show that Americans’ (alleged) loss of trust (in their government) is *unjustified*.

Thus I wonder at the wistful tone of this: “We have become skeptical of our own macroeconomic authorities and abilities, and that, in turn, makes successful policy harder to pull off.” After all, public skepticism also makes it harder for government to put in place bad policies that would be unsuccessful.

Tyler’s tone seems inappropriate--unless he regards himself as a member of the ruling class, which naturally wants to be trusted.

For what it's worth Tyler, I'm giving you the benefit of the doubt on this one. One of the most important elements of my own work is about restoring trust.

Trust? That's what we're

Trust the Fed/Treasury/Wall Street axis that rigs interest rates, cartelizes the banking industry, and places naked bets with Other People's Money? Those guys?

And #7: Tyler, if you really want cheap chalupas that bad just go to Taco Bell. Long term, you'll get a lot more from one employee in a harvester than a dozen slaves with sacks over their shoulders.

You are assuming that the harvester is a cost competitive substitute for labor?

It's always funny how high-g economists are all uber technology and automation and investment ... until it comes to labor. Then they turn into a bunch of antebellum Southern planters. "Suh, you can not profitably run a cotton plantation without a stout team of darkies from the Chahleston mahket. Why next you'd have us b'lieve they have invented an auto-mated cotton pickin' sort of device!"

"A backhoe for diggin' a ditch? Ah just use those coolies ah bro't back from Frisco!"

"A sixty-mile-an-howah motor-ized wagon? Suh, the human physiognominy cannot handle such speed!"

Somebody write Solow and tell him Tyler says he should give his Nobel back.

From your New York Times column:

"Hard-to-manage shift away from government investment." And:

"Should government double-down on these risks by borrowing more money and pursuing more investment?"

So you're saying "investment," not "spending"... Some government spending is reasonably termed investment, but the bulk is plain old spending. When people use the euphemistic phrases, instead of the honest ones, my trust definitely goes down.

Ezra Klein makes a really good case that it is the other way around: people don't trust government and active fiscal policy because of congressional gridlock, not doing what people want.

That was a "really good case"?

Congress has done almost nothing except scare people for two years. They prove everyday that government won't do anything to help.

Can there ever be an Over-supply of trust?

Germany and Japan, circa 1930s.

I don't know the Japanese case, but there was plenty of distrust in Germany (of Communists. of Socialists. of Fascists. of Jews. &etc).

Jim Jones, 1978.

no sorry, i do not agree. this country was founded on skepticism of government, so much so that we embedded the right to bear arms in the constitution just in case the blood of some tyrants was necessary to sow the seeds of freedom. The American people reserve the right to throw the bums out every 2 years, for any reason whatsoever (including no reason at all) in order to try something new. In fact the 2 years statute is more like a guideline, and every once in a while we get a bug and get 1 million people to push for a recall election. Then we all kiss and make up and move on to getting things done.

its not a lack of trust, its the lack of a credible policy. If FOMC members were elected we would have thrown them out. eventually we would stumble on a better policy.

Just tap you heals 3 times and say "There is an alien invasion", "There is an alien invasion", "There is an alien invasion".

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