Saturday, 8 March 2014

Policy and Self-Fulfilling Prophecies

I've been raging about confidence for a while now. Since any other form of stimulus is either unproductive (e.g. monetary policy due to the ZLB) or infeasible (e.g. QE or government spending), the only way we could actually see growth in the region is via an increase in confidence, which basically means an improvement in our current expectations about the future. Simply put, if I am going to either spend or invest more, I have to know that I will continue to have a job in the near future or that the overall situation in the economy will be better than now.

The problem is that many of us (especially journalists) take a particular liking to bad news; it appears that they sell more than good ones and that is why we tend to emphasize on that (disclaimer: I may have fallen into that trap myself at times). This wouldn't necessarily be hurtful to the economy if we did not live in a world where we somehow create it ourselves. In physics, bad news about a specific group of atoms would not cause all other atoms to stop obeying natural laws. In economics though, bad news about some may cause others to react badly as well.

Think for example what happens when austerity measures on the public sector are imposed: although it may be right that some workers in some countries are overpaid, lowering their wages in a recession comes at a cost. As civil servants lower consumption, the private sector sees its demand fall and reduces investment, causing unemployment to rise. Then, until we adjust to the situation, the economy moves in cycles of reduced demand and investment, causing unemployment to rise and incomes to fall. In the Eurozone, we are now experiencing the time where most of the adjustment has already taken place and even though demand is weak and investment is low, we are much better off (expectations-wise) than a year ago.

Yet, some still point out to the bad things; while, for example, the outflow of deposits from Cyprus appears to be stabilizing with the overall amount registering ups and downs in the past couple of months (compared to huge decreases before), some focus on the downs. The problem of over-focusing on the bad news is that it creates another cycle of uncertainty, one which, on its own, can cause more damage than policies can. You see, if I am bombarded with constant emphasis on how bad the economy is doing (it's not doing good by the way but it does certainly fare better than last year) then I will be more than skeptical to invest or spend. The cycle, as described in the previous paragraph, is indicative of what will happen when confidence falls; the issue here is that over-exposure to "bad" news means that these will turn out to be true if people believe them to be. It is the equivalent of fiat money: it works just because you trust it, nothing more and nothing less.

This kind of over-emphasis can actually derail many of the countries already in a bail-out agreement. Biased information about Greece is what made Greeks believe that they are faring worse than expected, pushing the vicious cycle of austerity deeper into the economy. Now that they are faring much better, biased information and vastly exaggerated opinions are still appearing on popular websites. While I am certainly not a fan of irrational optimism (remember I was one of the first to note that the Cypriot economy was badly in need of a rescue package in 2012 and that Spain is not really out of its trouble) I do think that we should really think before we offer an opinion, especially if it is bound to affect millions.

The bottom line is simple: be very careful of the information you use to make decisions. Emphasis on what could go wrong never really helped anyone; and neither  it will in the future

P.S. As far as forecasts are concerned here are my own (obviously biased) ones: Greece will need no more loans after 2014, but she will most probably not exit the bailout programme by year-end as the Greek PM has predicted. Cyprus will have a tough year but it may actually show us some quarter-to-quarter growth in late 2014. Spain will be rather stable with a slight increase in GDP compared to last year but the big question is what will happen in Italy and whether Slovenia will opt for a bail-out. On the latter two we just wait and see.

1 comment:

  1. Indeed: every move that could help has been vetoed. But now all people are not anymore thinking of solutions, but are dreaming up things that might still be realistic, in an environment where those things we need will all be vetoed and blocked. So now we're down to 'hope' for the sake of hope itself? So let's hold back on negative words, and hope we will convince ourselves it isn't quite so bad..

    For me the good news is that I'm sensing a slow tidal move against the religion of austerity. It is slow. But maybe there's hope that we'll get some of those necessary things before the Euro really collapses, causing another big crisis. Hope, and (glacial) change.