No Coherent Plan

Sounds like government as usual. The congressional panel to oversee the bail out says that the government still does not seem to have a coherent strategy for easing the financial crisis.

Elizabeth Warren, the chairwoman of the oversight panel, said in an interview Monday that the government instead seemed to be lurching from one tactic to the next without clarifying how each step fits into an overall plan.

“You can’t just say, ‘Credit isn’t moving through the system,’ ” she said in her first public comments since being named to the panel. “You have to ask why.”

If the answer is that banks do not have money to lend, it would make sense to push capital into their hands, as the Treasury has been doing over the last two months, she continued. But if the answer is that their potential borrowers are getting less creditworthy with each passing day, “pouring money into banks isn’t going to fix that problem,” she said.

One of my complaints about using government to solve crises is that the solutions rarely address the actual problem. One reason is that politicians make the decisions and as such they aren’t interested in what is the solution to the problem, but what policy will be best for them. For example, does it make sense to clamp down on pseudoephedrine to the point that law abiding citizens who have severe allergies are suddenly law breakers? Well who cares if you are in a tough election and you are worried your opponent is going to attack for being weak on crime. Sending a small number of people to prison, ruining their lives, and devestating their families…pfffft, that is a small price to pay in aquiring power. Another reason is rent seeking behavior on the part of people who would be impacted by the policy. Naturally they are going to try and get the best deal possible and they will waive around donations, and other enticements to politicians. And even absent these kinds of problems the government has problems implementing an optimal policy and sticking to it as Professors Kydland and Prescott pointed out just over thirty years ago.

A significant upshot is that governments unable to make binding commitments regarding future policies will encounter a credibility problem. Specifically, the public will realize that future government policy will not necessarily coincide with the announced policy, unless the plan already encompasses the incentives for future policy change. In other words, sequential policymaking faces a credibility constraint. In mathematical terms, optimal policy decisions cannot be analyzed solely by means of control theory (i.e., dynamic optimization theory). Instead they should be studied as the outcome of a game, where current and future policymakers are modeled as distinct players. In this game, each player has to anticipate the reaction of future players to current play: rational expectations are required. Kydland and Prescott analyzed general policy games as well as specific games of monetary and fiscal policymaking. They showed that the outcome in a rational-expectations equilibrium where the government cannot commit to policy in advance—discretionary policymaking—results in lower welfare than the outcome in an equilibrium where the government can commit. –emphasis added

This result is in a setting where there is a benevolent social dictator–that is a dictator whose only concern is increasing the welfare of the citizens of economy in question. This is a major blow to discretionary policy…not that it has actually made much progress when it comes to fiscal policy and politicians passing legislation. So I’m not really shocked that right now the government via Paulson and Bernanke are stumbling about trying this that and everything else, that Congress is acting wildly inconsistently (we’ll bail out this company, but not that one, but that other one over there…uhhh let me flip my coin, sure you get a bail out too….).

In fact, it could very well be the case that the mad scramble in Washington is actually making things worse. We’ll try that…no wait, that isn’t working…I think. Try this. No. That. Hold on!! Uhhhmm, we’ll do this. Sorry, I’m not sure that will do it either. Okay, okay we got an idea here….

That kind of behavior is what you see in people who:

  1. Don’t know what to do, and
  2. are panicking.

When the Secretary of the Treasury and the Federal Reserve are at wits and and engaging in frantic behavior the markets will notice and things wont be good. And things are not good.

Everyone talks about credit/financial markets collapsing and that we must act with haste. Really? I’m not sure that is a good idea. Calming down, and maybe putting a little thought into it and trying to figure the right solution would be better. Of course the problem is that the right solution might mean the end of various political careers…and of course we can’t have that. Without these wonderful politicians around…why who is going to save us?

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Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.


  1. As far as government and Big Media are concerned, the appearance of doing something is more important than what they actually do. This is true whether we are talking about this “crisis”, homeland security, TSA, immigration, the UN, etc.

  2. odograph says:

    I’ve always loved the metaphor “pulling all levers.” I imagine a railroad engineer doing everything he can …

    It’s unfortunate when you find yourself in such a situation, but sometimes you are.

    That said I think the Congressional oversight committee should grind the Fed and Treasury for coherent action. That is also “pulling all levers” :-/

  3. Scott Swank says:

    The main players right now are Bernanke & Paulson. How do their actions fit your description of the problem?

    “Calming down, and maybe putting a little thought into it and trying to figure the right solution would be better. Of course the problem is that the right solution might mean the end of various political careers…and of course we can’t have that. Without these wonderful politicians around…why who is going to save us?”

    Are you honestly suggesting that if Paulson & Bernanke just calmed down and stopped worrying about their political futures that they’d be making different decisions?

  4. Steve Verdon says:

    The main players right now are Bernanke & Paulson….

    So you think they are making the correct choices? Okay, good to know. I’ll hold you to that.