The Mood Always Matters, So Restore Confidence First By TYLER COWEN

The New York Times
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November 9, 2008
The Mood Always Matters, So Restore Confidence First By TYLER COWEN

HIGH deficits and a declining economy will limit the hand of the new president in many matters of economic policy. Health care reform usually proves more expensive than promised, and voters are in no mood for higher gasoline or energy taxes. Still, President-elect Barack Obama faces the very important task of restoring confidence in our nation’s economy.

He will need to appear calm and purposive, and to articulate to the American people the underlying economic strengths. Even if some of this is wishful thinking, there is a chance that positive attitudes will improve the reality on the ground.

Over the last several months, the Bush administration has mishandled this issue.

Most of all, the “Paulson plan” to bail out the economy was not executed gracefully. The Treasury secretary, Henry M. Paulson Jr., warned the nation that something terrible would happen if the plan were not passed; that terrified both Wall Street and Main Street.

The early version of the plan would have given the Treasury secretary almost unlimited powers, without checks and balances on his decisions. The market took that extreme proposal as a sign that the situation was truly dire.

After the scare came indecisiveness. Whether or not the Paulson plan was a good idea, no one articulated how it would work or why it was needed. The initial plan was then dumped for a successor plan — laden with Congressional pork, by the way — and then this second plan turned out to be less important, after it was passed, than the need for an immediate recapitalization of the banking system.

Along the way it was never clear what Congress favored or why, and the regulators appeared to be stumbling from one crisis to the next, scaring the American public along the way. Political uncertainty hardly caused the crisis, but politics made it much worse.

EVEN if you believe the dubious proposition that an initial scare was needed to pass legislation, the time has come to patch up confidence. The federal government lacked a commanding presence during the early stages of the financial crisis.

Rebuilding confidence might seem a small matter, but it is not. The truth is this: America is a wonderful and magnanimous nation when it is a winner, but Americans are not used to losing and Americans are not used to panic.

Often we respond to negative events badly, so we need to be especially careful when we are in a losing or risky position.

Very bad events can cause a panic among the citizenry or its leaders, which translates into subsequent bad decisions. For a classic example of a negative policy dynamic, look at 9/11. The United States lost 3,000 lives and a great deal of wealth and confidence. The government then took actions, most of all the Iraq war, which led to even greater losses.

We are in danger of getting stuck in another negative dynamic, but this time in the realm of economics. We might follow up the financial crisis with some worse responses and policies.

It’s not just the country’s future that is on the line. Despite the commonality of anti-American rhetoric, the United States sets the tone for much of the world.

If America is seen as turning the corner and stabilizing its economy, that will be a positive cue for many other countries.

The notion of a downward spiral of ideas and events is not unprecedented. Starting in the early part of the 20th century, the West experienced one awful event after another, including a world war, a flu pandemic and a major depression. The response was a global spread of totalitarian ideas, a loss of confidence in democracy and capitalism and, eventually, another war.

While today’s world is far from this point, there is a small chance that we will move in an unstable and worsening direction. Steering away from it should be a priority for the next president.

Rebuilding confidence won’t be easy. If our next president seems flip or overconfident, observers will be skeptical above all else. Denying our basic economic problems will erode credibility, but those problems — most of all our debt and a collapsed financial sector — need to be acknowledged in a way that shows a path forward.

We need to avoid overreaction at the same time we need to return to feeling in control.