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yeah yeah yeah, but how are you going to increase that production before your competitors do? we've already taken the money out of the production side to give it to the demand side. if more people want my toys, but i can only make 1,000 toys a month, and the capital to expand my production has already gone into Bonds to be given to the people now using that same money to buy my toys.....
....then all that happens is i increase the price of my products; my production capability is shackled.
There can be lots of reasons people behave irrationally. Dan Ariely covers some of the obvious examples in his book "Predictably Irrational." Some of the reasons when people are unwilling or unable to think rationally:
- Wishful thinking. People WANT to believe that "this time is different," and so they come up with justifications for why obvious bubbles are actually sustainable.
- The ownership bias. People generally overvalue what they already have. For example, when presented with the opportunity to sell something they own, people think about everything they're going to have to give up, instead of how much the underlying asset is actually worth.
- The comparison bias. If given a choice between A) a high-end, expensive product and B) a low-end, cheap product, people will buy whichever suits their needs better. But if they ALSO have the choice of buying C) an equally high-end, but slightly MORE expensive product, they are vastly more likely to choose A over B.
- Loss aversion. Potential losses loom much larger in the minds of most people than potential gains do. (This isn't necessarily irrational on a personal level, but from the perspective of financial markets it is.)
These are just a few of the cognitive biases in human psychology that distort the economy. I strongly disagree with the notion that "people generally are smart." They are smart in certain areas and stupid in others. People make many predictable, irrational mistakes which can distort the market.
It's not sapping capital; the Fed just spat $600 billion into the economy. More demand CAUSES more production, which in turn causes more people to be hired.
But there is no epidemic of people being unwilling to work. There are vastly more unemployed people than there are jobs available, which is why unemployment is so high right now. So increasing people's desire to work doesn't actually do anything, if the jobs simply aren't there. Now if we had a SYSTEMIC unemployment rate approaching 9%, that would be a different matter. But it's only been in the last couple years since the recession that that's been a problem, which indicates to me that it's temporary.
Many businesses are currently awash with capital but are not investing it.
Then one of your better-financed competitors will do it, and you'll go out of business. In either case, the aggregate effect is more production.
In any case, the federal funds rate is close to its all-time low right now. It's unlikely that this is having a significant negative effect on your ability to produce more, as the interest rates that T-bonds are paying are not exactly attractive for lenders...
So people continue to throw a lot of money into the wishing well expecting their wish to come true? If people acted irrationally, this would happen.
It is a temporary solution to help the economy/people back on their feet.
Then one of your better-financed competitors will do it, and you'll go out of business. In either case, the aggregate effect is more production.
aggregate across the economy none of my competitors have the capital to do so. it's all been sucked up by the governments' need to borrow apocalyptic amounts of money in order to fund important and stimulating things like studies on robot bees.
1. IPO's are doing horribly this year.
2. if there is one thing everyone is rightfully leary of right now, it's taking on higher costing debt.
in a normal economy perhaps the governmtn can avoid sucking up all the capital
but our government seems to have spent the last couple of years in a mad experiment to find out just how far it can push Moody's.
Yes, essentially. But instead of wishing wells, they call them "credit-default swaps" or "zero-down mortgages" or "dot-com stocks" or "treasury bonds" or whatnot.
You see that is where interest rate differentials are important
The government has to compete with corporate debt, typically the government can borrow at a low rate as it is generally considered safe. Any company can offer to pay a higher interest rate for its debt, and attract investors. Or it can actually sell shares, offering a potential higher rate of return then what government bonds typically do. In a normal economy the government can not suck up all the capital without paying high interest rates
But they don't with wishing wells. If your theory was true then people would do it, but they don't. Your explanation is lacking.
The missing link between yours and Kandahar's argument is learning. How do we learn? By observing the actions of others. This is a rational foundation for a bubble and is known as an Information Cascade.
But they don't with wishing wells. If your theory was true then people would do it, but they don't. Your explanation is lacking.
Huh? Why?
I'm afraid I don't understand what you're asking me to explain...
Bubbles have happened before and we should have known that home prices were going to fall. So why the mass delusion?
You said that people throw money away on unreasonable expectations. That's basically what you called derivatives and other financial products. Why don't they do this with wishing wells? Answer: people aren't irrational, something caused the strange action in this case.
That's inflationary! Remember that in the end we're really trading goods for goods. Putting more money into the economy devalues those bills. What does that mean for savings? It decreases. So what does that mean for investment? It also increases. There is no way around it, if you try to increase spending you're necessarily going to decrease investment (any growth in investment would be malinvestment).
And how do you prove that the unemployment is due to there not being enough jobs rather than people's demands being too high because of the benefits they are getting from being out of work?
So you throw money down a wishing well expecting it to grant your wish? This is a regular occurrence for you?
How should we have known? Seems like you just assume the solution here.
No they ARE irrational, just not in that particular way. The reason they throw money away on SOME unreasonable expectations and not others could have many different causes. In this specific case, it's a lot easier to justify to one's self that "this time is different" when it comes to a fancy financial derivative than it is when it comes to a superstition.
The idea that people are fundamentally rational actors (and that the markets, therefore, are rational) is one of the biggest misconceptions of standard economics.
Lets think about this logically though. If there is more inflation, the public will shift its holdings out of money and more into other assets. This will achieve the lower savings rate you suggest, but what it will also do is increase investment spending (and consumption for that matter).
From a basic flow diagram, or common sense, we know if there is more spending peoples incomes will rise. Investment is not strictly a function of the saving rate, but the saving rate times income.
The standard neoclassical answer would be that real wages are sticky, ie they will not fall. You could attribute this to people's demands being too high or a number of coordination failures. Regardless, people must now demand lower wages because there are currently less jobs.
Psychology clearly demonstrates that heuristics, schema, stereotypes and emotion far exceed rationality for primary motivations on decision making. It makes sense. Thinking takes time and effort. We are lazy species. And schema, heuristics, and stereotypes, short cut thinking and make decision making less taxing and easier.
If you make a decision over and over again and keep failing, eventually you're going to stop making that decision. If you keep making that decision and expect a different outcome, that would classify you as insane. Since we don't do that (except for a select few), we are rational.
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