As the Keynesian revolution was merged with the models of Robert Lucas, it eventually morphed into something called neoclassical economic thought. The general gist was that economic agents can be tricked into changing their behaviour through surprises in monetary policy, which yes, has somewhat miraculously become the mainstay of central bank economists.
As Jeffery Snider of Alhambra Investment Partners succinctly puts it, the academic transition led to the “economics of money shifting to economics of psychology”. In old Keynesian thinking, recession came as a result of “animal spirits” changing, which roughly translated into modern day parlance, equates to ‘irrational exuberance’, albeit with an ‘apathetic’ twist.
Confused? Don’t be. If collective exuberance and apathy is the sole cause of the business cycle, then it logically follows that human emotions need to be manipulated accordingly. Only by doing so can policymakers smooth out the ups and downs in economic activity. And what better way to do that then to change the money supplied to the general public. If we, as society, have more money then we will surely feel better and apathy can be turned into exuberance. If psychology was not a “soft” science self-conscious economists would view them self as therapists for the collective.
While this sounds eerily like 1984, it’s unfortunately much closer to the truth than most of you think. Why else spend time and resources conducting consumer and business confidence surveys to guide monetary and fiscal policy? Why else blatantly lie when asked about the status of the economy? Only if people feel better will they spend money and revive economic activity.
Prior to the complete corruption of academia, economists analysed the economic system as an allocation mechanism, whereby prices were not given but rather part of a coordinated entrepreneurial process. How people felt about these prices were completely irrelevant, they were pure signals, nothing more, nothing less. Today on the other hand, ‘Goebbelnomics’ attempt to raise the prices you care about such as houses, stocks and bonds and for optimal ’wealth effect’ preferably reduce the ones we feel bad about through collective conditioning. The main tool to achieve this is interest rates, which, if lowered sufficiently, will support the housing market and divert more capital to commodity production. Conveniently boosting “good” prices and simultaneously reducing “bad” prices.
As you all know, interest rates are manipulated by changes to the overall money supply through open market operations conducted by the central bank. But more recently, a more devious system of so-called ‘forward guidance statements’ has been created to condition the minions. It’s hard not to think about the Pavlovian term psychic secretion as investors’ starts to salivate on the mere prospect they will be fed more free money every time Yellen, Draghi or Kuroda enters the room.
While Professor Lucas’s seminal 1972 paper included the concept of non-neutrality of money, he did so to resurrect the Phillips Curve, but changes to the money supply is still assumed to be neutral to economic output in the longer term. In his latest blog post, Bernanke espouses conventional economic thinking by writing that “monetary policy is “neutral” or nearly so in the longer term, meaning that it has limited long-term effects on “real” outcomes like the distribution of income and wealth.” From that, you end up with the logical conclusion that monetary policy remains an eminently viable tool to fight business cycles.
However, we will argue that classical conditioning of the masses through ‘Fedspeak’, accompanied with the occasional bit of QE now and then as the conditioning wears off, has important long term effects on the economy and society.
We will leave aside the discussion of the psychological effects borne by a society tricked into making foolish choices such as buying a house in 2006 on the assurance from Bernanke himself that there was no bubble; a bubble that subsequently left many workers long-term unemployed and scarred for life. Or the fact that it promotes a transaction based society while penalising a relationship- and production based society; ripping apart the very social fabric that creates the mutual trust that is so vital to a capitalistic society.
What we will discuss though is the change in relative prices that follows from centralised monetary mischiefs. Change in price A relative to price B due to accommodative monetary policy means more resources flows into producing A, while substitution effects changed demand patterns toward B.
Note that this new structure of production can only be maintained through continued injection of ever more money. Pull the plug, and the free market equilibrium will reassert itself by bringing resources back to the production of B. In addition, it’s pretty fair to assume that the absolute price of both A and B will increase, confusing entrepreneurial signals even more.
Take for example the business of oil and gas extraction. From December 2007 to the end of the latest Fed induced QE, employment rose over 30 per cent compared a mere 1 per cent growth in total non-farm employment. This obviously came on back of perceived increases in oil prices measured against a debased dollar (not so much against gold) and change in price of credit as yield starved investors jumped the shale bandwagon. With high output prices and low input prices a boom was created. People moved to North Dakota and brought their demand patterns with them. Production lines shifted, bringing more goods and services into the town of Williston. Service providers followed suit to cater to purchasing power being created there.
It all looks well and good, until the Fed changes course and end free money by increasing interest rates. Output prices fall back while input prices go up. The boom ends abruptly, but the production lines and service provides has sunk capital into it. It takes time to change back and society has become that much poorer. These are real long term consequences.
Now, multiply this example with the thousands upon thousands of trades that are similarly affected, and the destructive forces of Goebbelnomics becomes apparent. But hey, hear it once from Yellen, twice from Draghi, and the third time from Kuroda, and why wouldn’t you ‘apathetically’ believe it…