“Why do we keep on getting it so wrong?” asked an economist in the Evening Standard this week. The headline was sadly a lot more interesting than the article itself, which went nowhere towards answering the question. But that doesn’t matter – the answer’s pretty obvious. Economists keep getting it wrong because the theories their discipline rests upon are often just plain daft.
First there was the idea that people behave rationally at all times, or that markets are completely efficient. These are easy to dismiss because they’re clearly wrong – you wouldn’t get bubbles or busts otherwise. But in trying to explain why their original theory failed, economists are just swapping one bad idea for another.
The current concept gaining ground is the notion of the importance of ‘animal spirits’. This term, popularised by John Maynard Keynes, refers to a vague mish-mash of investor psychology, consumer confidence, trust in the system, and general excitability. If animal spirits are in decline, investors won’t invest, consumers won’t spend, and the economy slumps. If animal spirits are on the up, then investors stick their money into anything that moves, consumers gorge themselves on credit, and the economy soars.
It seems that economics is moving from viewing us as profit-maximising automatons, to seeing us as mindless sacks of hormones veering from blind optimism to depression for no particular reason. But this is drivel too.
Our recent crash had nothing to do with a random shift in ‘animal spirits’ and everything to do with the price of money. If you give banks an endless supply of free money and tell them you’ll bail them out if they make any really big mistakes, then they will make the biggest bets they can. If consumers see that everyone else is getting on the property ladder and getting rich, and that the authorities have no intention of bursting the bubble, then they’ll want a piece of it too, regardless of how overpriced houses are. If anything, that’s logical behaviour.
And when the boom finally ends in tears, it also makes sense for people to rein in spending, because they know they’ve overstretched themselves. These aren’t mood swings – they’re sensible reactions to changes in the economy.
But it looks like economists will have to learn the hard way. The man responsible for much of this mess – Ben Bernanke – has just been reappointed as Fed chairman. His solution to the mess? Buck up our animal spirits with yet more cheap money. So far this solution has delivered us the tech bubble and bust and the property bubble and bust. What can he blow up next? I suspect we’ll find out sooner than we’d like.