Credibility

To me, a real handicap of economic theory is that it has no way of studying the role of 'credibility' in helping determine economic outcomes. In any given economic context, the need for credibility on the part of the actors shapes the behavior as well as the consequences of the behavior.

For example, a few months ago the WSJ reported (in an article I fleetingly read and haven't found again, either on-line or hard copy) that a significant part of Sec. Paulson's reasoning for letting Lehman fall back in September was to maintain a semblance of free-market orthodoxy, particularly for public relation reasons. At least that was my reading of part of the report. (But again, I haven't tracked it down to read it again and confirm that.)

I found that provocative. Here's the Secretary of the Treasury, determining fateful Treasury policies -- the decision to let Lehman fall led to extraordinary consequence -- according to whether they conform to the sacred truths that the American public tells itself about their 'free markets.'

On one hand, it would probably suit us well to find a more realistic theory about our economy, if what we think actually matters for policy.

And on the other, it is remarkable how significantly public credibility shaped the Treasury actions in the first place. This is a good thing, but a scary thing, too. It's democracy, or at least democratic.

But again, if major economic actions are going to be decided, at least in part, according to the habits and truths of the public sphere, then it would suit us well for public knowledge to be updated and then disseminated more broadly, so we can think in new ways, to fit these new conditions. Economic theory, in other words, has a lot of work to do. It has to create new knowledge, and then disseminate it as new habits.

This is why when I view the perfect stimulus package I see it being an investment in American education. If the public is so important, we probably should get smart(er).