Politicians are at the mercy of game theory and they don’t even know it. Have you ever wondered why presidents implement bad monetary policy? Want to understand the psychology of bailouts? Then read on my friend.
Depending on your economic school of thought you either think the economic stimulus by the government is a good thing or a bad thing. In my opinion quantitative easing (QE) is a bad thing. There have been rumors that QE3 is around the corner and may come before the next presidential election.
Let’s say for arguments sake that QE3 occurs sometime around the beginning of 2013. That’s 3 stimulus packages since Sept, 2008. Even Greece would be proud of that. The first bailout was never coined Quantitative Easing but was implemented (thanks for opening the can of worms) by George Bush in 2008 and roughly totaled $985 billion dollars in bailout money.
QE 1 followed and concluded on March 31st, 2010 and roughly totaled 1.6 trillion dollars. This was also implemented by George Bush but ran into Obama’s first term (he will probably get another one). QE 2 was implemented by Barack Obama on Nov 3, 2010 and resulted in 600 Billion dollars.
That’s a total of roungly 3.2 trillion dollars in quantitative easing. Quantitative easing can be thought of as bailout money, printing money by the FED and the creation of digital money for banks to lend. All of it however is created by the government and not backed by anything. (google fiat money for an understanding of the current monetary policy of the USA).
If you believe what I believe, which is that the Federal Exchange Department is a bad entity, then you understand why it is so appealing for a president to be enticed by quantitative easing. In my opinion, quantitative easing is a short term solution that creates a bubble that will eventually burst. Most people still believe and apply Keynesian economics but Austrian economics has recently made a comeback thanks to Ron Paul. I always thought the economics applied by the government (keynesian) was a bad idea but I never knew there was another economic school of thought until Ron Paul was advocating the Austrian (not actually from Austria) school of thought.
It can be debated, but quantitative easing creates money out of nothing and usually results in some type of bubble. When this bubble occurs everyone is happy that the economy is good and nothing needs to be done. The bubble eventually bursts or at least the trend line reverses itself (free market correction). When this happens (our current recession/depression) people demand that politicians put policies in place that correct the error. However what most people don’t understand is that the error is the bubble and the solution is the hopefully temporary free market correction.
As promised I will outlay why psychology and game theory are the reasons that quantitative easing will most likely be implemented by whomever the next president is.
I only have one rule for this scenario and the rule is “no president wants to be in office when there is a recession or depression in the economy”. Since they do not want to have a recession they implement policies that will make the economy look like it is doing well. So, they formulate an economic stimilus that creates a temporary bubble (think government housing). When this crashes they must react swiftly so the economy does not self correct itself and result in a mini recession. This happened when George Bush bailed out the banks and wall street during his presidency, then followed it up with QE1.
When Obama took office he inherited a recession. Instead of letting the market correct itself he introduced QE2 and advocated more government spending and regulations. This is the time frame we are in now. There are conflicting reports of what the state of our economy is in now, but if you ask the average person they would report some type of negativity. As you can see it’s advantageous to the current president and the president before him to push quantitative easing because it creates a temporary bubble that makes the economy look like it is doing well. The only problem with this is, well, take a look at Greece and tell me if they have problems.
Let me try and make a table to better understand why psychology and game theory (dominant positions) can explain why politicians use quantitative easing even though in the long run it may be extremely harmful to the economy. (I’m trying not to be too biased with my agreement with the Austrian ecnomic school of thought, so if you want to argue with those ideas go right ahead).
See Attached Images
Hopefully you are able to read the table in the images section. As you can see scenarios #1 and #3 make the decision in the short term look really good and decisions #2 and 4 look weak. Since a president or any other politician does not want to be seen as weak on the economy, most likely they will choose #1 or #3 (depending on the state of the economy). Unless the politician truly understands economics they will most likely go with the most dominant position (game theory) which is short term gains but long term deficits. This also reminds me of the psychology idea of immediate gratification. One does not want gratificaiton later they want it now. Options 1 and 3 give the economy immediate gratification.
Now you understand a little bit more about why an economy is at the mercy of politians and the politicians are at the mercy of psychology and game theory.