About a month ago, I wrote a piece on animal spirits, pointing out that optimism and pessimism have economic consequences. In a pleasant, blog-affirming twist of fate, the Wall Street Journal yesterday made mention of a research paper published by the Federal Reserve Bank of San Francisco, brought to my attention by the excellent Abnormal Returns blog. The researcher, Sylvain Leduc, concluded that confidence really did have a big impact on the economy. According to the WSJ article:
What Leduc found was that current confidence does indeed have an impact of future activity to a significant extent. For example, when the survey forecasts became more optimistic, the unemployment rate was more than one percentage point lower a year later.
Maybe my background in psychology has warped my view, but it often seems to me that confidence is the whole ballgame. Any given asset is really only worth whatever we agree it’s worth. Intrinsic value is a better theoretical concept than a practical one. A supermarket isn’t going to take a chunk of metal for your groceries, even if it is gold. The real store of value is confidence. The whole financial system operates smoothly if all participants are confident that everyone else will meet their obligations. With a situation like Lehman Brothers, confidence evaporated and the whole mechanism locked up.
The study suggests central bankers should pay attention to changes in confidence when deciding policy moves.
And, I would suggest, legislators and policy makers should also pay attention to how some of their regulatory iniatiatives and/or poorly crafted legislation impacts business confidence. It’s more important than they seem to realize.
