Brad DeLong — Larry Summers on How We Know More than We Write Down in Our Lowbrow (or Highbrow) Economic Models

Larry Summers on monsters under the bed.

LS: Paul asserts that a damaging confidence crisis in a liquidity trap country without large foreign debts is impossible, because if one developed the currency would depreciate, generating an export surge.

Paul is certainly correct in his model, but I doubt that he is in fact. Once account is taken of the impact of a currency collapse on consumers’ real incomes, on their expectations, and especially on the risk premium associated with domestic asset values, it is easy to understand how monetary and fiscal policymakers who lose confidence and trust see their real economies deteriorate, as Olivier Blanchard and his colleagues have recently demonstrated. Paul may be right that we have few examples of crises of this kind, but if so this is, perhaps, because central banks do not in general follow his precepts.

I do not think this is a pressing issue for the US right now. But the idea that policymakers should in general follow the model and not worry about considerations of market confidence seems to me as misguided as the view that they should be governed by market confidence to the exclusion of models.

WCEG — The Equitablog
(Early) Monday DeLong Smackdown: Larry Summers on How We Know More than We Write Down in Our Lowbrow (or Highbrow) Economic Models
Brad DeLong