Q: When the economy hits the wall, people despair of their financial futures. Those psychological factors are every bit as dangerous to the economy on its way down as over-exuberance can be on its way up, no?
A: Right, and the problem that is not recognized very much at all is that this fearfulness and this sense of lost opportunity is a basic parameter of our thinking, and so it doesn’t swing back fast. We may have a recovery, and the recovery may look optimistic for us, but there’s a real possibility that any recovery we have will not bring us back to ripping prosperity, because our confidence is damaged. We’ve changed a basic assumption. Just as the real estate boom of the 2000s was a consequence of the stock market boom of the ’90s, so too we may have on the other side of it a period of slow economic growth for years, a recovery, maybe, but not a strong recovery, because of our changed attitudes. Everywhere around the globe people are concluding this just isn’t the time to be starting a new business, or hiring people, or investing in expansions. People think that we’re not in good times and that is a self-fulfilling prophecy, and it’s hard to get out of it.
Q: At present we have central banks and governments throwing a lot of money at the economy in order to give it a goose and improve confidence and dispel this prevailing mood of gloom. Is that the correct way to dispel the negative spirits?
A: Well, the problem with stimulus is that it brings up national debt, and if it doesn’t work we’re left with a bigger national debt, and so it’s a risky strategy. It has to be pursued but it’s risky. Unfortunately the political process doesn’t encourage the taking of such risks, and so there’s a tendency all over the world to under-stimulate. In Canada, the Harper government has created a stimulus package but it’s small change, and that is not big enough. Similarly in the U.S. we had a stimulus package earlier this year of $787 billion. Again, it’s not enough. Even with the White House’s optimistic forecast of what the effects will be, it’s not enough,and the situation looks worse than just a couple months ago when they created this stimulus package.
Q: Aren’t people always going to overreact in both positive and negative ways? We’re going to tell each other stories that whip up our confidence, and then we’re going to scare the hell out of each other when things go badly—isn’t that human nature? How does the market organize itself in order to deal with our shortcomings?
A: It’s important for policy makers to understand aspects of human behaviour. That doesn’t mean that it’s a simple matter, but any politician has to be a psychologist, and anyone who’s trying to manage public confidence has to understand psychology. Still, the main tool for managing confidence is not talk, it’s action. That’s why we need stimulus packages. One thing that we learn from the study of psychology is that ideally a stimulus package should come on strong before anything serious really happens, we want to apply the stimulus before massive numbers of people are laid off, because once they’re laid off it creates a different psychology that’s hard to correct. We’ve already missed that opportunity substantially, but of course I think the unemployment rate is at risk of going much higher. We still have an opportunity now to stop the worsening of this crisis.
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