Understanding the Wall Street View of the World–and Why It Doesn’t Change: Monday Focus: March 17, 2014

Let us start with Paul Krugman, commenting on a piece by Noah Smith:

Paul Krugman: Charge of the Right Brigade: “Noah Smith writes about what he calls the ‘finance macro canon’… that money-printing and deficits lead inexorably to runaway inflation,

plus assorted other arguments about why easy money is a terrible thing even in a depressed economy… a view that is dominant on much of Wall Street. I’ve had several recent conversations with finance-industry people… who talk with some wonderment about the failure of high inflation and a plunging dollar to materialize, because “all the experts” told them to expect that outcome….

The really smart Wall Street money doesn’t buy into this canon. Jan Hatzius and the rest of the economics group at Goldman have an underlying macroeconomic framework pretty much indistinguishable from mine, and have consistently talked down the risks from easy money and deficits. But the great Armani-suited unwashed apparently don’t know that…. What makes this even more peculiar is the way the canon continues to dominate despite having failed the reality test in the most dramatic way possible…. So how can this disastrous a failure of the canon’s predictions have failed to make a dent in its dominance?… If you believe that prices should move in proportion to the monetary base, there’s simply no way to rationalize triple-digit money growth associated with 2 percent or less inflation….

Class interest arguably explains the policy demands: tight money is what rentiers always want. But most of the consumers of this bad analysis are trying to make money, not influence policy, so what’s in it for them? Noah suggests that it’s the need for the illusion of knowledge; but this in itself doesn’t explain why goldbug cranks should dominate so completely. Why haven’t the kind of people who listened to Peter Hyperinflation-by-2010 Schiff switched to, say, Warren Mosler? It has to be in some sense political; the canon appeals to certain kinds of prejudices, in particular the prejudices of angry old white men with money to invest. But it remains amazing how little those prejudices have been dented by their failure to meet the most decisive real-world test you could imagine…

Let’s think about the political economy first. I used to think–or there used to be–four groups pushing for various price-level policies:

1. Labor, which wanted a high-pressure economy to boost real wages (and was not unhappy with resulting higher-than-expected inflation).
2. Debtors, who wanted higher-than-expected inflation.
3. Creditors, who wanted lower-than-expected inflation.
4. Equity holders, who by and large wanted a high-pressure economy because what they gained via economies of scale and high capacity utilization was worth more than what they lost via having to pay higher real wages.

And I saw an American political economy in which (a) creditors neutralized debtors, equity-owners did not care much, and labor pushed for higher inflation but was blocked by the non-majoritarian tight-money institutional instincts of the Federal Reserve (save for when oil shocks hit or when Richard Nixon’s reelection was at stake).

Now labor no longer has a voice. But where have all the debtors gone? And why are the equity holders so confident that a low-pressure economy gains them more in terms of reduced wages than they lose through a failure to reap economies of scale and high capacity utilization? It is a great puzzle.

I think I understand why people are clinging to beliefs that justify policies that they think are in their interest given that labor and debtors are out of the picture, and given that equity holders have decided that they are more interested in waging economic class war than in full capacity utilization. But why have equity holders decided that?