There is a single sentence in Lawrence Summers’s Washington Post op-ed, cautioning the Fed governors, that tells us an enormous amount. Here’s the sentence:
Given how little the administration has actually changed policy, recent economic performance was pre-determined before Donald Trump took office.
Contrast that with this passage from John Maynard Keynes’s seminal work, The General Theory of Employment, Interest and Money:
Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.
That comparison illustrates why Keynes was the greatest economist of the 20th century while Summers is an enormously lesser figure. Keynes understood that economics is a science of human behavior and can only be understood in the context of enormously variable and mercurial human behavior. It is not mathematics; it is not physics.
As long as prominent economists insist on treating economics as though it were mathematics or physics rather than a science of human behavior, we should be very cautious in taking their advice.
Economic behavior is not determined by underlying physical factors. It is subject to random and even irrational variations from what those factors would dictate.
One of the reasons for the Clinton boom was that Bill Clinton was a cheerleader for the economy. One of the reasons that the economy has not had as robust a recovery following the financial crisis of 2007 as it might have was that Barack Obama wasn’t that kind of a cheerleader.
We ignore animal spirits at our risk.
Like most things in life, beware absolutism. Both cold analytical and emotional factors are at work.
Just consider the stock market. Over-valued by every historical metric, and even by the newly fashionable yield adjusted multiples, it appears irrational. But there it is. Analytically one can at least have a discussion about yield chase and the appropriateness, or not, of risk adjusted returns. Emotionally it’s just “I’m gettin’ me some of that.” I would note the current divergent attitudes of inside holders vs retail.
Management teams, especially entrepreneurial ones, are notorious for animal spirit driven optimism. Boards are more oriented towards analytics and preservation of capital.
Reagan an Clinton were optimists who could communicate with the populace. It showed. GHWB couldn’t generate that. Obama was so over the top it was embarrasing, but he stuck to what he thought were societal changing issues, much less economic. And you got the feeling if you succeeded economically it was his to appropriate. He catered to the uber-wealthy for campaign donation reasons, scared the devil out of the middle and upper class (where the volume is) and gave the poor their good helping of gruel. Hence we got middling.
I don’t have much use for Summers. But to the degree he is pointing out that Trump inherited a painfully sluggish, long in the tooth recovery that Trump hasn’t had time to affect, he’s correct, Trumps relative optimism notwithstanding. My first report card for Trump is the end of Q2-Q4. I think it’s quite unclear how this is shaking out.
If you look at Summers achievements, Chief Economist of the World Bank, Treasury Secretary, President of Harvard, Chair of the NEC, and various corporate boards, I think most people would rather be wrong and succeed like that.
If one doesn’t reward truthful ideas and punish failed ones, what kind of ideas will you get?
This is not a knock on Summers, it seems endemic to economics, including folks at the FED.