Central Banks And Governments Need To Work On Market Psychology

by: Lok Sang Ho

Operation Twist did not get the reception intended. Markets from Europe to America to Asia tumbled. Partly to blame is the disheartening comments from Bernanke. But he certainly needs to speak his mind. If the outlook is gloomy, he ought to tell it like it is.

Yet he - as well as other central bankers and finance ministers - need to understand that the task that they are dealing with is not purely economic, and certainly not mechanical relations. They have a job of "reengineering market psychology." They all need a good understanding of human nature, as noted in my book Public Policy and the Public Interest, a link to which is provided in my author's page.

Because of a lack of understanding of human nature, policy makers are shooting themselves in the foot when they press on with extreme fiscal austerity - particularly cutting large numbers of public sector jobs. When they do so, businesses are more likely to keep watching and waiting, rather than investing.

The euro bond is a grand idea that will help salvage market psychology. But the longer it takes for it to happen, the less effective it will be.

Actually, any attempt to reduce deficits must be assessed carefully in terms of the costs and benefits it brings. Some deficit cutting efforts will bring more benefits than costs, and therefore should be made. Others will bring more costs than benefits, and they should be avoided. A heartless, across-the-board cut is not just bold, but reckless, and should be avoided. The effectiveness of the deficit cutting effort will be undermined if by slashing spending you plunge the economy into a deeper and deeper recession. The Cameron government is now seeing the fruits of its own reckless policy. The U.K. economy was not in worse shape than other economies when it entered into recession, but is now clearly trailing behind other economies, notwithstanding a very weak pound - something that the Japanese would very much envy.

We do have a massive debt problem that we need to deal with. But without a meaningful recovery, all effort to cut deficits will be to no avail. Once again, Keynes reminded us of the need to beware of "animal spirits." He was referring to psychology.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.