More on political trust and credibility

I see since my last post Paul Krugman, MR, and the WSJ have all picked up on the similar topic of the role trust in government plays in the debate surrounding fiscal adjustment now vs. later (each with slightly different takes).  I’m happy to see such credibility questions getting greater coverage; as Tyler Cowen says, trust is an underused word in macroeconomics.

One aspect of the issue I find particularly interesting is the use of “rules” designed to constrict future actions, and to what extent they’re designed to change current behavior or future behavior.  For example, a recent German law compels the government to limit structural deficits to 0.35% of GDP from 2016 on — do you think this law is designed to alter behavior in the years 2016 on, or send the message today that no matter what else happens in Europe, Germany maintains its fiscal rectitude?  Note that this isn’t just an economics issue; when President Obama promises not to use nuclear weapons against non-nuclear states that comply with the NPT even if attacked by chemical or biological weapons, the goal is clearly to change behavior today, not actually restrict what the US will do under a hypothetical attack.

There are two drawbacks to making promises about future actions.  The first is that, broadly speaking, the more options available to policymakers the better.  Within development economics, for example, it’s widely recognized that “policy space” is very important to successful development, to allow governments to adjust to changing circumstances and implement policies suited to the particular time and place.  This is why many developing country governments fight against WTO agreements that restrict their options in years ahead.  Simply put, we should be cautious about tying the hands of future policymakers.

The second challenge is the question of, when push comes to shove, will policymakers abide by rules made by yesterday’s politicians?  For example, even if we pass a  law stating the government can’t bail out any banks in the future, I imagine that if during a future crisis such a move was deemed necessary, the Fed and/or Treasury would find a way to get it done. (The Fed in particular has shown amazing creativity over the past 18 months.)  I think it’s next to impossible for governments to make credible promises about what they will or will not do during a crisis.  Moreover, I don’t think we really should be making rules about how the government will act in crises; as the saying goes, rules were made to be broken.

The real problem, however, with “rules” designed to control future government actions is who will enforce them?  There’s some role for international organizations (like the WTO) in some cases, but when it comes to the question of fiscal adjustment there’s no real cop.  Other than, of course, the bond markets…


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