Working Papers

Should We Use Monetary Policy to Regulate Human Nature?

Writing in the letters page of today’s AFR (no link), Des Moore says:

Whether or not a targeting of asset prices warrants more attention, any review of policy surely needs to address the difficult issue of changes over time in human nature…

There is a long history of swings in attitudes from optimism to pessimism, often “inspired” by governments, that result in changes in risk behaviour: our most recent swing of optimism was reflected in the boom in investment in commodity production. 

If monetary policy does not pay sufficient regard to such swings, it is very likely that we will end up with a “bust” - and high unemployment. That is what happened in the 1980s and what is happening now…

The idea that human nature is variable at business cycle frequencies is highly questionable, as is the assumption that the monetary authorities are somehow immune to these ‘swings of attitude’.  Des falls into the classic trap identified by public choice theorists of assuming that human nature changes when we relocate people from the private to the public sector. 

In arguing that the recent boom in commodity investment was a ‘reflection’ of ‘our most recent swing in optimism’, Des Moore identifies himself with behavioralists like Robert Shiller, who maintain that sentiment drives economic activity, rather than the other way around.  But as I argue in Bubble Poppers, the more asset prices are thought to be disconnected from the real economy, the weaker the case for using monetary policy to regulate asset prices via the real economy.

posted on 06 April 2009 by skirchner in Economics, Financial Markets, Monetary Policy

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Yeah those silly behavioralists.  Imagine doing surveys and experiments to test your ideas.  Shocking!

You’d never catch a libertarian wasting time on experiments, because they already know the answer.

I mean, if you surveyed people on Ricardian equivalence who knows what you might find.

Posted by .(JavaScript must be enabled to view this email address)  on  04/06  at  05:25 PM

As an undergraduate, I was part of the sample for experimental tests of Ricardian equivalence run by David Gruen.  The results and other literature are summarised here:


Posted by skirchner  on  04/07  at  09:04 AM

Coincidentally Krugman has some comments on Ricardian equivalence this week:

Brad DeLong is, rightly, horrified at the great Ricardian equivalence misunderstanding. It’s one thing to have an argument about whether consumers are perfectly rational and have perfect access to the capital markets; it’s another to have the big advocates of all that perfection not understand the implications of their own model.

So let me try this one more time.

Here’s what we agree on: if consumers have perfect foresight, live forever, have perfect access to capital markets, etc., then they will take into account the expected future burden of taxes to pay for government spending. If the government introduces a new program that will spend $100 billion a year forever, then taxes must ultimately go up by the present-value equivalent of $100 billion forever. Assume that consumers want to reduce consumption by the same amount every year to offset this tax burden; then consumer spending will fall by $100 billion per year to compensate, wiping out any expansionary effect of the government spending.

But suppose that the increase in government spending is temporary, not permanent — that it will increase spending by $100 billion per year for only 1 or 2 years, not forever. This clearly implies a lower future tax burden than $100 billion a year forever, and therefore implies a fall in consumer spending of less than $100 billion per year. So the spending program IS expansionary in this case, EVEN IF you have full Ricardian equivalence.

Is that explanation clear enough to get through? Is there anybody out there?

Posted by .(JavaScript must be enabled to view this email address)  on  04/09  at  10:26 AM

That assumes the government’s commitment to lower spending in the future is credible.  Given the secular expansion in spending, no such credibility exists.

Posted by skirchner  on  04/09  at  10:59 AM

Just wondering:  If its so obvious to consumers that they’ll have to pay back Kev’s largesse in higher taxes, why does Malcolm Turnbull feel the need to bang on about it at every opportunity?

Surely consumers should just know this without being told and behave like rational little consumer-bots and save their pennies from Kevin.

Posted by .(JavaScript must be enabled to view this email address)  on  04/09  at  03:57 PM

Because he knows people are worried about it and is tapping in to that concern.

Posted by skirchner  on  04/09  at  05:49 PM

Because he knows people are worried about it and is tapping in to that concern.

But we’re all supposed to be 100% rational consumer-bots.  What has fear and worry got to do with it?

Would you say that consumers concern about future higher taxes is greater than their concern about job security and the global economic situation?

In other words, would you say the primary reason for consumers saving rather than spending the $900 handouts, is because they know they’ll have to pay it back in higher taxes?

Posted by .(JavaScript must be enabled to view this email address)  on  04/09  at  06:22 PM

David, all RE requires is that taxpayers are forward-looking.  It is inconsistent to say people are forward-looking in relation to their employment prospects, but not in relation to their future tax burden. I suspect the weights people give to this vary widely.

Posted by skirchner  on  04/14  at  11:21 AM

Hmmmm.  Let me see, what would I worry about more:  I could lose my job in the next few months, or my marginal tax rate could go up a few points in a few years?

Tax increases are years away and hardly life-shattering.  Job losses are imminent, and financially devastating.  I cannot imagine that more than 10% of population would worry more about tax than employment security.

I mean, isn’t this blindingly obvious?

Posted by .(JavaScript must be enabled to view this email address)  on  04/15  at  09:19 AM

Those most likely to become unemployed probably do very little of total saving.

Posted by skirchner  on  04/15  at  10:23 AM

While I don’t have a particular view on this issue, it is surely more than a coincidence that the big spending US govt has attracted the formation of a grass-roots anti-tax protest movement.

Tax Day Tea Party, 15 April


Posted by .(JavaScript must be enabled to view this email address)  on  04/15  at  06:36 PM

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