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People Aren’t Irrational — Government Policy Is

David Brooks thinks both parties have put too much faith in rationality — at least with respect to how people make economic decisions:

For years, Republicans have been trying to create a large investor class with policies like private Social Security accounts, medical savings accounts and education vouchers. These policies were based on the belief that investors are careful, rational actors who make optimal decisions. There was little allowance made for the frailty of the decision-making process, let alone the mass delusions that led to the current crack-up.

Democrats also have an unfaced crisis. Democratic discussions of the stimulus package also rest on a mechanical, dehumanized view of the economy. You pump in a certain amount of money and “the economy” spits out a certain number of jobs. Democratic economists issue highly specific accounts of multiplier effects — whether a dollar of spending creates $1.20 or $1.40 of economic activity.

But an economy is a society of trust and faith. A recession is a mental event, and every recession has its own unique spirit. This recession was caused by deep imbalances and is propelled by a cascade of fundamental insecurities. You can pump hundreds of billions into the banks, but insecure bankers still won’t lend. You can run up gigantic deficits, hire road builders and reduce the unemployment rate from 8 percent to 7 percent, but insecure people will still not spend and invest.

But perhaps people are more rational than Brooks gives them credit for being. People are swimming in consumer debt and the President-elect is telling them our problems are getting worse. Isn’t it rational to save rather than spend that one-time rebate check? Businesses observe bailout mania, so isn’t it rational to wait before they invest or make long term decisions — to see if the government may come along and give them something for free? And those homeowners have probably figured out that if they don’t stay current on their mortgage payments the government has a rescue plan just for them. Pretty rational, actually.

In short, very bad and confused government policy skews decision-making and transforms economic decisions into political calculations. Perhaps if government were more rational, people would behave in predictable and economically advantageous ways. We shouldn’t be surprised when shoveling pork and coming up with yet another round of rebate checks  don’t encourage recession-busting behavior. Rather, substantial tax-rate cuts, easily understood payroll and business tax breaks, and some clear signals that bailouts won’t be available for purposes other than stabilizing financial institutions might just get people to return to making economically sensible decisions. But the government needs to stop its nonsense first.



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