by Roger Koppl
At the Cobden Centre‘s website (and here), Steve Baker discusses recent Fed signals in the context of Big Players theory. The more active the Fed (or other central bank), the greater the fraction of entrepreneurial attention devoted to Fed watching rather than productive activity. As Baker says, “traders must pay attention to the Big Player and not the fundamentals.”
In my BRACE manuscript I predict that economists will pay increasing attention to the state of confidence, though under the label “animal spirits.” Big Players theory is a theory of the state of confidence. It is thus a theory of “animal spirits” as the term is used in macroeconomics today. Big Players theory offers an alternative to more Keynesian theories in which animal spirits are inherently volatile and act as a market-psychology tail wagging a real-economy dog. Big Players theory identifies observable institutional factors that influence the volatility of animal spirits. The tail wags the dog only when we do not have proper market rules. In particular, “Keynesian” policies of discretionary action by central banks, regulatory authorities, and other Big Players encourage herding and make animal spirits more volatile. That is when the tail wags the dog. In this sense, Keynesian policies create a Keynesian economy. After bleeding the patient, the Keynesian doctors declare him anemic and prescribe further extensive bleeding.
Big Players theory has been subjected to a variety of potentially falsifying statistical tests and seems to have passed just fine. While I don’t really buy into Popperian philosophy of science, I do think falsifiability is a value and counts in favor of a theory. More testing is always in order, and my book on the topic has examples of how to do it. Think of Big Players theory as Higgsian regime uncertainty with analytical bite. The big application now, of course, is the Great Recession. The history of the Great Recession seems to fit Big Players quite nicely, but we need disciplined empirical work in solid academic journals. Sound statistical analyses should form a part of such work.
As Steve Horwitz has pointed out forcefully quite a bit rides on what “narrative” of the Great Recession is told. Was it market failure or government failure? It seems hard to deny that the animal spirits have been volatile. The broadly Keynesian explanation is that they are inherently so. The Big Players explanation links volatility to macroeconomic institutions. The market failure narrative may prevail if we do not take advantage of a theory of animal spirits that makes the Big Players connection. An empirically grounded theory linking the volatility of animal spirits to Big Players and regime uncertainty bolsters the government failure narrative.