Robert J. Shiller this morning,

A critical aspect of animal spirits is trust, an emotional state that dismisses doubts about others. In talking about animal spirits, Keynes sought to convey the message that swings in confidence are not always logical. The business cycle is in good part driven by animal spirits. There are good times when people have substantial trust and associated feelings that contribute to an environment of confidence. They make decisions spontaneously. They believe instinctively that they will be successful, and they suspend their suspicions. As long as large groups of people remain trusting, people's somewhat rash, impulsive decision-making is not discovered.

Unfortunately, we have just passed through a period in which confidence was blind. It was not based on rational evidence. The trust in our mortgage and housing markets that drove real-estate prices to unsustainable heights is one of the most dramatic examples of unbridled animal spirits we have ever seen.

One certainly does not need to be Keynesian to talk about trust. Tim Harford calls it "responsible for the difference between the richest countries and the poorest." I wrote about this in our last Quarterly Business Report as well:

What we await is the restoration of trust in financial transactions and between banks, which accounts for the sharp increase in banks� holding cash rather than lending to customers. That will take some time, and no government policy will quicken the rate at which banks will decide to lend again.

During last night's presentation, my co-author Rich MacDonald expressed serious skepticism about the financial industry, which has laid off a relatively small number of workers compared to the size of the industry (based on his numbers, less than 4% of the FIRE workforce.) I think that key determinant in this is the degree to which Americans generally trust each other. That level has been sufficient to support democracy in the English-speaking world or Anglosphere. I'm more optimistic that our culture and moral fiber maintains trust even when confidence is shaken as it surely has been the last 18 months. To the extent it does, this recession shall pass, and like Shiller I'm not inclined to think stimulus does anything to shake that.

Labels: economics