Thursday, October 16, 2008

The Los Angeles Lifestyle and Second Guessing Bernanke

What do UCLA faculty do all day? We go to 7 year olds birthday parties and eat cupcakes near the pool. Here is Exhibit A. In case you didn't figure it out, I'm the old guy in the upper left of the picture.

Ben Bernanke may not want to visit UCLA soon. Smart people here are saying that Bernanke may have caused our current troubles with his "excessive" doom and gloom.

Here is the story;

1. A month ago, the Chairman convinced himself that the Wall Street banks needed a massive capital injection from Congress.

2. To persuade the sketpical Congress that "Main Street should bail out Wall Street" he needed to sketch a nasty depressionish counter-factual of what would happen in the absence of a bailout.

3. Step #2 achieved his goal of getting Congress and the lame duck president to act but had the unintended consequence of spooking the American people.

4. People have in mind an asymmetric information story. The man on Main Street says to himself, everything looks pretty good from my vantage point but if the smart bald guy at the Fed is very nervous --- he must know something that I don't . I think I will scale back my consumption, my hiring and perhaps sell some stocks and hunker down until this chaos passes.

5. Step #4 when aggregated up yields us today despite the fact that the "real fundamentals" aren't so bad.

There is a fascinating economics literature on how politicians speak to two different constitutencies. You should read this Glaeser paper.

Bernanke may have been a bit naive thinking that he could speak bluntly to Congress without the American people hearing him and reacting.