When central banks try to create optimism

In Japan, Europe and the US, central banks have tried to alter consumer pessimism – that might lead to deflation – by flooding financial markets with money. Can a behavior of hope be 'nudged' in this way?

The Monitor's View

Can you buy hope?

If you have tracked what central banks in the world’s advanced economies have done since the 2009 financial crisis, you might have doubts.

In the United States, Japan, and Europe, top officials in charge of money supply have poured trillions in new money – dollars, yen, and, to some degree, euros – into their economies. The purpose? To nudge consumers to buy more and investors to back new business.

These central banks, in other words, have acted with optimism that newly created money will alter the pessimism of the public. They believe people must be lured to act against their caution and become confident of the future.

The officials themselves, however, have worried that consumer attitudes could create deflation. This is a self-perpetuating downward spiral of prices if consumers delay purchases in anticipation of even lower prices. It is the opposite of inflation, and more difficult to stop.

The United States may have dodged the deflation bullet in part because the Federal Reserve opened a spigot of money to banks, a program known as quantitative easing. The “QE” loosened credit for private investment, especially in the housing market. The spigot officially closed last month as the growth of the US economy topped three percent.

In contrast, Japan still faces a long battle against the threat of deflation. Last Friday, its central bank took a radical step to “reflate” the world’s third largest economy. Haruhiko Kuroda, the Bank of Japan governor, announced he will push about $725 billion into the economy. It was the second big stimulus in less than two years. 

Mr. Kuroda was clear about its purpose. He wants to eradicate a “deflationary mindset” among the Japanese. He blames undue pessimism while also seeking to induce a “wealth effect,” or a feeling of confidence.

The problem has been, however, that the Japanese have caught on to such attempted manipulation of behavior. They may see themselves as the rational actors more than the central bank.

In Europe, deflation has only begun to hit a few countries. The European Central Bank has largely avoided the kind of giant purchases of debt as seen in the QEs of the US and Japan. The bank’s president, Mario Draghi, says he will “do whatever it takes” to prevent a financial collapse. But he is also quite open about not manipulating the public.

When asked in September if he should stop warning Europeans about the risk of inflation getting too low, he said: “Would the truth be a risk? In other words, do we really think that telling people things other than the truth would affect their behavior? And the answer is no. We think that we ought to state things as they are. We don’t see deflation.”

With people in the West more savvy and informed about economics, it is difficult these days for officials to attempt to manipulate behavior. As mathematical models have lost favor among many in the field, more governments have turned to behavioral economists to find ways to influence consumers, especially in Britain and the US. One popular approach, known as “nudge theory,” assumes government is rational in directing options at consumers to alter “irrational” behavior. New workers, for example, might be automatically enrolled to pay into a retirement plan unless they choose to opt out.

This benign paternalism is based on the notion that most people are not capable of reasoned reflection and, short of using bans or taxes, government must guide consumers by clever “choice architecture,” or subtle manipulation.

As the struggle against deflation has shown, the better choice for government is to be open and honest, treating people as capable not only of reason but the ability to reason together.

An economy should be run with the best view of human behavior. As Adam Smith wrote in his 1759 “The Theory of Moral Sentiments”: “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.”

 Can hope be bought? It is better to find it than to fabricate it.