Make Up Your Mind Already or Why I Fear the Conventional Wisdom

Remember the conventional wisdom from like 2005 - we weren't saving enough. We were a nation of sinful debtors who needed to save more like our soon to be new Overlords, the Chinese. There was a country of wonderful savers. We were addicted to credit cards like smack addicts to heroin. We had used our homes like ATM machines mortgaging ourselves into oblivion.

Now, if you read any news analysis of this recession, all you hear from pundits and economists is that Americans are a worthless bunch of misers who won't mortgage our futures for a new flatscreen. Declining consumer spending is a PROBLEM, and as the front page of the WSJ documented this morning (I won't even bother to link to the article because you have to pay for it), the fact that people are choosing to save in this widely reported time of crisis is now hurting the economy. To quote the article:

But in a recession, increased saving - or its flip side, decreased spending - can exacerbate the economy's woes. It's what economists call the "paradox of thrift."

The Journal then goes on to document "What a Penny Saved Costs."

This whole episode reminds me of when the experts were telling us in the 1990's that fat was the ultimate health enemy. The government got on the bandwagon, and it led, perhaps directly, to an explosion in Type II diabetes. So now the economics experts are telling us that all that savings stuff is really making this recession worse. So we are supposed to listen to all of the experts now that we are finally saving?

To be fair, part of this is what economists would call a prisoner's dilemma. We would be better off as a whole if we were spending more, and it would lead to better economic performance. But since we're all scared we're going to lose our jobs, we act "selfishly," as economists would call it, and put our interests first and save rather than spend. It does hurt the economy. I'm not normatively judging this behavior, but it does lead to a "sub-optimal" outcome.

But it seems to me that public behavior is not the problem during this recession, it's been mistakes by the experts who help to build the conventional wisdom. Remember when Alan Greenspan was a demi-god who was so respected he could be Fed Chairman even if he was dead? Well Greenspan had the spigot wide open, we spent, and that seems to be a big reason we got into this mess. When unemployment hits nearly 7%, the housing market stinks, and we feel insecure we pull back. It strikes me that neither action is irrational, and both are fairly wise responses to what is in our individual self-interest. But both actions are motivated by institutions that are led, imperfectly, by experts.

One branch of economics, experimental economics, understands that people can often solve social problems naturally without the direct interference of consciously constructed institutions, led by really smart people like the Fed..........sometimes institutions led by smart people get the incentives wrong - badly.

We may not do exactly what the experts would like us to do, but the public isn't nearly as stupid or misguided as the Inside the Beltway types and Ivy League elites think we are. Instead the experts need to respect the ability of individuals to solve problems unconsciously based on natural cooperation and not try to manipulate things (i.e. easy money and the crusades against excessive spending or fat consumption). The conventional wisdom needs to trust the ability and right of the public to simply seek what it wants instead of deciding what they should want and how they should get it. It strikes me that the risks of trying to manipulate or "correct" public preferences are far greater than the risks of doing nothing, but I'm open to correction on this point.