Bleeding the Economy

December 17, 2009

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.

4 Responses to “Bleeding the Economy”


  1. “Keynesian Policies create a Keynesian economy.” Roger is on to something.

    As soon as the Fed starts raising interest rates, the herd will begin stampeeding in different directions. Do we then get a classical economy?

  2. koppl Says:

    Thanks, Jerry. Your rhetorical question reminds me of a point people often find difficult. I say Big Player encourage herding. Even sympathetic readers will sometimes interpret this to mean that each bubble can be traced to some particular action of the Big Player. They sometimes miss the comparative institutional point. It’s not that we want to decide whether each particular bubble represents either “market failure” or the evil consequences of some *particular action* by the Big Player, the latter representing “government failure.”

    Think of it like this: Big Players dim the lights and people start crashing into each other in the dark. In some sense each crash in the dark is to be blamed on the poor vision of market actors. If they had superhuman vision, they would see each other and not crash into one another. If I neglect the fact that Big Players dimmed the lights and compare real people to gods with superhuman vision, I may blame the people in the room for bumping into one another. If I neglect the fact that Big Players dimmed the lights, but note the sudden increase in crashes, I may blame all that discoordination on a sudden increase in myopia, just as some have blame the housing bubble on a sudden increase in greed. The point, of course, is that the market’s coordinative powers are not independent of the institutional regime. Big Players corrupt market institutions, thereby reducing the coordinative powers of markets.


  3. I think my comment on Mario’s recent post applies here. Too much has been packed into “rationality.” Your players are all rational in a Misesian sense, but operating in a financial fog.

    Just befoe he lost his job as CEO of Citigroup, Chuck Prince said that as long as the music kept playing, it was necessary to keep dancing. That view seems consistent with your Big Players argument.

  4. Lee Kelly Says:

    Somewhat off-topic:

    Talk in the U.K. is that recent regulatory proposals (such as controlling executive compensation) may drive financial companies out of the U.K.; some of the industry have pointed out that government may shoot itself in the foot, because it enjoys considerable tax revenue from the financial indsutry.

    Question: by “voting with their feet,” can large financial organisations have governments compete to provide “better” regulatory environment *for the banks*, i.e. deposit insurance, bailouts, barriers to entry, etc? Presumably governments enjoy great short-term boosts to tax revenue when banks are doing “well,” but does it alter into incentives that government officials confront when creating “regulation.”


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