From this post by Arnold Kling:
For a while, the postponed adjustments and maladjustments are papered over by financial enthusiasm. Financial euphoria allows profits and wealth to seemingly persist in spite of accumulating underlying imbalances. When the euphoria breaks, the imbalances are exposed, and it takes a long time to Recalculate.
I’m still thinking about the recalculation question in terms of information distortions. How ideology is loosed in the economy deliberately, to produce the “financial euphoria” that allows bubbles to grow. Sometimes there is a tendency in the financial press to reduce “confidence” to a matter of interest rates — rates down, confidence up, and vice versa. Or there is an over-reliance on confidence surveys, as if confidence is unaffected by the very reports in the press about confidence.
Since the manufacture of confidence prolongs profits, the press is under pressure to do its part to prolong the euphoria, and a counter-discourse explaining the “underlying imbalances” tends to be suppressed, marginalized, ignored. If we are serious about preventing bubbles, regulating finance, it’s important to identify the tactics by which this marginalization occurs and develop ways to counteract it.
The underlying issue is to minimize distortions in the messages financial markets communicate, an intrinsically difficult problem — at the macro level we want everyone to be honest; at the micro level we are all trying to screw others over and leave them holding the bag of bad investments we’re at some fundamental level trying to pump and dump. At the micro level, we all have incentive to distort information about our investments if we are trying to realize cash profits. But the question of whether we want to be in cash is determined by the macro picture, which are own disinformation is muddying.
So how does skeptical, nuanced information get conveyed in markets, which can only send one-dimensional signals through price? How does the press convey that nuance when it is beholden to interests demanding it help maximize asset values, despite the social interest in achieving “true asset values” to forestall the need for drastic recalculation?
Manufacturing confidence seems like a problem that standard mathematical economic tools can’t capture; it’s a sociological question. I think this is what Brooks was getting at in his review of Kling’s book — that equations and their implications still need to be mediated, tempered by a sociological discourse surrounding them. The point is that structural adjustments occur according to the information available to entrepreneurs, but the information by which to make such plans is now corrupted by several factors — purposeful distortions by interested parties, the sheer volume of information now available to individuals, the free-floating ideological imperative to be “confident” in capitalism and stoke “animal spirits”. After all, the animal spirits thesis seems to suggest that entrepreneurs must already be misinformed in order to risk investing at all. How to integrate that with a macro story that says entrrepreneurs are using information to make for a more sustainable economy, with fewer inbalances.