The Horror of the Confidence Fairy (part ii)

(From Part i)

(From "Annie", 1982. Aileen Quinn, as the adorable Annie, sings "Tomorrow")

And then, a miracle seemingly happened.

At the New York Review of Books conference "What's Wrong with the Economy -- and with Economics?" (NY, March 14-15, 2015) Baron Skidelsky, keeper of Keynesian arcana, debated the Confidence Fairy with Paul Krugman.

Some days later, Lord Skidelsky published "Messed-Up Macro" (Project Syndicate, March 24), summing up his views:

"As a Keynesian, I firmly believe that market economies need to be stabilized by policy. But Keynesians have to face the uncomfortable truth that the success of stabilization policies may depend on the business community having Keynesian expectations. They [i.e. Keynesian economists] need the confidence fairy to be on their side."

In other words, stabilization policy has two opposed effects:

1. Government spending increases aggregate demand, which increases aggregate output, and employment/income. Like dominoes falling in sequence, one thing leads to the next. Given idle productive capacity, there's no need for new investment until full capacity, output, and, presumably, employment are reached.
2. At the other hand, instead of spending their share of Government spending (a.k.a. consumption subsidy), consumers could save it, uncertain about the future, but expecting increased taxes; if so, their aggregate demand won't increase: the chain is broken. Even if aggregate demand increased, instead of investing and employing additional people to meet demand, employers, also uncertain about the future, could divert additional revenue to the financial markets in prevision of increased taxes. Conversely, even budget cuts could, contingent upon the favourable expectations generated, lead to growth: uncertainty and highly subjective expectations (particularly business people's expectations) are key.

That is, for good or ill, collective well-being depends on these fickle, all-powerful mythical Atlases, "who, with whatever faults, are the quality of life and surely carry the seeds of all human advancement."

At any event, the consensus among "Austerians" (as Krugman calls them) is that (2) dominates (1): the Confidence Fairy.

Until March, the Keynesian econ tribe, too, was unanimous: (1) overwhelms (2).

Skidelsky broke that unanimity: the seemingly helpless Confidence Fairy could derail fiscal stimulus, after all: "They need the Confidence Fairy to be on their side".

Confy, it seemed, had finally found her Keynesian "Daddy" Warbucks!

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A week or so after the conference, a short but very significant post ("Unreal Keynesians", March 23) appeared at Krugman's blog (we shall leave it for coming posts).

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Confy's happiness, however, was short-lived.

On April 22 -- barely a month after the conference -- Skidelsky's "Debating the Confidence Fairy" appeared at Project Syndicate:

"I recently debated this point with Krugman at a New York Review of Books event. My argument was that adverse expectations could affect a policy's results, not just the chances that it will be adopted. For example, if people thought that government borrowing was simply deferred taxation, they might save more to meet their expected future tax bill.
"On reflection, I think I was wrong."

The Keynesian unanimity was restored and hapless, orphaned Confy, once more, was left all alone, in the street (or so it seemed), searching desperately for her daddy.

Who on earth is Confy's father?

(To be continued)