US opinion polls expose mainstream economic theory

I am currently quite interested in the formation of consumer expectations after being asked by a major financial institution to consider constructing a new series for them. So in developing the project I have been enmeshed in technical detail the last week or so. I am also interested in the way different polls are interpreted. In the last few days two major polls in the US have been released. They are broadly in agreement but there are some interesting differences. The other interesting aspect of the polls is that they provide further evidence against the way the mainstream of my profession thinks about the economy. They reveal that individuals are not likely to behave as Ricardian agents. The mainstream theorist claim that individuals will spend once governments cut deficits and politicians have used this assertion to justify imposing (or suggesting) harsh fiscal austerity. The reality is very different as these polls suggest.

As an aside – I was going to discuss the Euro Summit outcomes today but I should have known better. Nothing moves fast in that region of the World so all we know so far is that the banks have agreed under the so-called PSI to absorb 50 per cent of the losses on Greek debt.

French president Sarkozy is apparently claiming this means “there will be no Greek default” which is a total joke.

It might surprise readers to know that I do not support the Euro leaders conniving – just to protect their flawed monetary union – to penalise private banks who invested in good faith in Greece (or anywhere else for that matter).

But that is different from supporting the democratic rights of the Greek people to withdraw from the EMU and re-negotiate all Euro obligations in terms of their own currency. You might think they are the same thing – and to some extent they have the same outcome – but philosophically they are quite different.

The Greeks will be pilloried under this scheme until at least 2020 – they are effectively in “receivership” at the behest of the Euro elites. The people should revolt and restore their currency.

While newspapers that I read each day such as Le Monde carried banner headlines reporting the negotiations and the fact that the French were working late into the night – and then some, the Le Monde headline that caught my attention was “Le chômage en nette hausse en septembre” (that is, unemployment rose sharply in September).

The economists are focusing on the beginnings of the financial market attacks on French public debt (the spreads against the German bond have been widening recently), the data shows that the real crisis is playing out in the labour market.

Economic growth is now slowing quickly in France and the gains in the labour market since growth resumed after the downturn are now being lost. Young and workers over-50 years of age suffered the most in the sharp deterioration. That is a common trend in labour markets. The prime-age workers remain insulated for a time in the early stages of a downturn.

Long-term unemployment rose in September by 0.7 per cent (annualised at 7.7 per cent).

The Minister of Labour, Xavier Bertrand was quoted by Le Monde as saying that:

… mauvais chiffres … au ralentissement de l’activité … sa mobilisation absolue sur le front de l’emploi, notamment en direction des jeunes.

The first part is correct the second is a total lie. The rising unemployment numbers are very bad and do reflect the plunge in economic activity, but the French government is not doing everything they can to create employment (especially for the youth).

The Euro crisis has been poorly constructed as a sovereign debt crisis. Sure enough the Euro is the problem and all the states are effectively using a foreign currency, but the leadership should be focusing on unemployment and poverty and inequality. If they adopted that perspective and prioritised low unemployment then they would quickly realise their monetary system is incapable of meeting their goals.

Anyway, there will be more to say about Europe tomorrow I am sure.

US polling of the unemployed

I read this New York Times report (October 27, 2011) – Jobless Go Without, but Stay Hopeful, Poll Finds – with some interest.

The article provides commentary on the latest results published by the New York Times/CBS News polls – which was conducted during the week October 19-24, 2011 (sample 1,650) and October 19-25, 2011 (which covered a sample of 445 unemployed persons).

The full results are fascinating – especially the way sentiment changes over time and in many cases the lack of correspondence between the survey responses and movements in the hard data. That is the part that interests me.

What it tells me that economic theories such as rational expectations are not sustained by appeal to the facts.

I last discussed this theoretical approach in this blog – Rewarding those who are culpable. I also considered it is some detail in this blog – The myth of rational expectations.

By way of summary, rational expectations (or “RATEX”) evolved in the late 1970s and claimed that government policy attempts to stimulate aggregate demand would be ineffective in real terms but highly inflationary. People are alleged to anticipate everything the central bank or the fiscal authority is going to do and render it neutral in real terms (that is, policy changes do not have any real effects). But expansionary attempts will lead to accelerating inflation because agents predict this as an outcome of the policy and build it into their own contracts.

RATEX theory argued that it was only reasonable to assume that people act rationally and use all the information available to them. RATEX theory claims that individuals essentially know the true economic model that is driving economic outcomes and make accurate predictions of these outcomes with white noise (random) errors only. The expected value of the errors is zero so on average the prediction is accurate.

Everyone is assumed to act in this way and have this capacity. So we all understand the QTM and understand that whenever the central bank expands the monetary base or the treasury increases the deficit there will be inflation.

So “pre-announced” policy expansions or contractions will have no effect on the real economy. For example, if the government announces it will be expanding the deficit and adding new high powered money, we will also assume immediately that it will be inflationary and will not alter our real demands or supply (so real outcomes remain fixed). Our response will be to simply increase the value of all nominal contracts and thus generate the inflation we predict via our expectations.

The most obvious retort to economists who teach this theory is that if everybody is rational and has the same information as the government and understands the true “model” of the economy that the policy makers share then what use is the economics profession and why would we be bothered studying economics.

If we can get our forecasts from the postman or around our kitchen tables what can we learn by studying economics? Extending the logic of RATEX we would conclude that studying economics adds nothing to what we already know. So as an “efficiency” measure we should sack all the mainstream economists in universities and central banks.

Why would we waste trees publishing economic papers if we already know understand the economy at an intricate level – down to the last $ allocated? Why would we pay economic forecasting agencies because RATEX says they are useless because we already know what they are going to produce?

The fact that households answer questions in one survey in one way (say, expressing optimism) and then in another survey – indicate pessimism – indicates that either the survey instruments are flawed (leading questions etc) or that people are very confused about the way the economy is moving.

The fact that responses defy the movements in the hard data suggest that people make guesses based on very limited information about what is happening and systematically make errors. That is, behave antithetically to what RATEX teaches.

In the NYT/CBS survey, it is clear that Americans do not think the US Congress is “handling its job” well with 84 per cent saying no (81 per cent among the unemployed poll).

When asked whether the US economy was getting better, worse or remaining the same the two samples said:

Total sample: 14 per cent better, 36 per worse, and 49 per cent the same.
Unemployed: 20 per cent better, 40 per worse, and 40 per cent the same.

The NYT/CBS poll asked whether the respondents thought the jobs that have been lost would come back or not. The results of the same question in December 2009 were:

Total sample: Yes 52 per cent, No 35 per cent
Unemployed sample: Yes 46 per cent, No 40 per cent

In the recent poll (October 2011) the results were:

Total sample: Yes 44 per cent, No 41 per cent
Unemployed sample: Yes 41 per cent, No 46 per cent

But despite this apparently negative outlook, the majority of the unemployed were optimistic about gaining employment.

The following graphic displays the results to that question:

The NYT article (noted above) comments:

… despite enduring hardships and being even more pessimistic about the nation’s economy than the general public, unemployed Americans remained optimistic about eventually landing a job. A little more than half of those polled said that they were either very or somewhat confident that they would find long-term employment in the next year, and a majority said that they expected that when they did find permanent work, it would be at a similar or higher salary level than they had received in the past.

Is there any hard evidence to support this optimism?

I examined the US labour market in some detail in September in this blog – The US labour market is looking grim. I refer you back to that discussion for detail.

In part, I used gross flows analysis which allows us to assess how much easier it is for an unemployed worker to gain employment now compared to some past periods and whether new entrants into the labour market are more likely to gain employment now than in the past. It also allows us to estimate the probability that a worker who is employed will lose their job now.

The data for the gross labour flows analysis is available from the US Bureau of Labor Statistics. I updated my databases today to include September 2011.

To fully understand the way gross flows are assembled and the transition probabilities calculated you might like to read these blogs – What can the gross flows tell us? and More calls for job creation – but then. For earlier US analysis see this blog – Jobs are needed in the US but that would require leadership

By way of summary, gross flows analysis allows us to trace flows of workers between different labour market states (employment; unemployment; and non-participation) between months. So we can see the size of the flows in and out of the labour force more easily and into the respective labour force states (employment and unemployment).

The various inflows and outflows between the labour force categories are expressed in terms of numbers of persons. But a useful alternative presentation is to compute transition probabilities, which are the probabilities that transitions (changes of state) occur. For example, what is the probability that a person who is unemployed now will enter employment next period.

So if a transition probability for the shift between employment to unemployment is 0.05, we say that a worker who is currently employed has a 5 per cent chance of becoming unemployed in the next month. If this probability fell to 0.01 then we would say that the labour market is improving (only a 1 per cent chance of making this transition).

The following table shows the schematic way in which gross flows data is arranged each month – sometimes called a Gross Flows Matrix. For example, the element EE tells you how many people who were in employment in the previous month remain in employment in the current month. Similarly the element EU tells you how many people who were in employment in the previous month are now unemployed in the current month. And so on. This allows you to trace all inflows and outflows from a given state during the month in question.

The transition probabilities are computed by dividing the flow element in the matrix by the initial state. For example, if you want the probability of a worker remaining unemployed between the two months you would divide the flow (U to U) by the initial stock of unemployment. If you wanted to compute the probability that a worker would make the transition from employment to unemployment you would divide the flow (EU) by the initial stock of employment. And so on.

So for the 3 Labour Force states we can compute 9 transition probabilities reflecting the inflows and outflows from each of the combinations.


The following graph shows the history of UE (blue) and UN (red) transition probabilities since March 1990 to provide some perspective. The current recession is notable because it is the first time in the history of this data series that it is more likely a person who is unemployed will exit the labour force (UN) than to gain employment.

The UN probability continues to rise which means that the broader BLS measures of labour underutilisation (which encompass hidden unemployment etc) will probably be rising over time.

The UE probability is more or less stable. In December 2007, just as the crisis began UE = 0.27. In September 2011 it is 0.175. That is a very large decline in opportunity.

There is nothing in the data that tells me that the prospects for the unemployed are improving (or good). So there is a disconnect between the way people feel and the opportunity set that they confront. The unemployed might think they have a good chance of landing a job but the reality is very different.

What about other indicators? The Summary Report – September 2011 provides some further insights.

They estimate that real GDP will grow by 1.5 per cent in 2011 and that GDP per Person Employed will grow by 1.1 per cent. That is down on the actual 2010 data which shows that real GDP grew by 3.0 and labour productivity grew by 3.6 per cent.

In my recent blog – What if economists were personally liable for their advice – I presented a simple framework for assessing likely movements in the unemployment rate.

The approximate rule of thumb is that if the unemployment rate is to remain constant, the rate of real output growth must equal the rate of growth in the labour-force plus the growth rate in labour productivity.

Remember that labour productivity growth reduces the need for labour for a given real GDP growth rate while labour force growth adds workers that have to be accommodated for by the real GDP growth (for a given productivity growth rate).

If the Conference Board estimates for 2011 are accurate (and they have a good track record) then labour force growth will have to be below 0.4 per cent for the US unemployment rate to fall over this year.

According to data from the US Bureau of Labor Statistics, the average growth in the civilian labour force since 2001 has been 0.66 per cent per annum. At present, the growth is below this rate but that is atypical.

The reasonable expectation is that real GDP growth will not be strong enough to absorb both labour productivity and labour force growth and thus eat into the unemployed pool in any significant way.

So once again, the expectations of the unemployed are somewhat at odds with the reality.

The disconnect is broad. The NYT article commented that despite the parlous nature of the US economy:

… the unemployed continue to believe in the idea of the American dream. Two-thirds of the unemployed people surveyed said that they still believed it was possible to start out poor in this country, work hard and become rich – only a little lower than the three-quarters of all Americans who said that they believed that …

That level of delusion is connected to the dysfunctional nature of the polity in the US. The politicians (who the poll shows are held in a bad light by the respondents) clothe their lack of decision-making skill and poor judgement in the American flag – god and country.

On policy matters, despite the vast majority blaming the politicians for the malaise in the US, both samples were strongly for the government creating jobs as against cutting public spending.

There appears to be a major dissonance between what the media (dominated by financial commentators including my own profession, and politicians) is talking about (public debt, budget deficits etc) and what the people on the ground think.

The following graphic displays the results to that question:

Similarly, the majority (in both samples) thought that “it is probably a good idea … for the federal government to provide money to state governments so they can avoid layoffs of public employees”. So where is the Republican narrative coming from that says that people want to eliminate wasteful public employment?

The majority strengthened (in both sample) when asked “Do you think it is probably a good idea … for the federal government to provide money to state governments so they can avoid layoffs of workers such as teachers, police, and firefighters?”

And even more emphatic was the affirmative for “do you think it is probably a good idea … to spend money on the nation’s infrastructure such as bridges, airports, and schools”.

There was only a bare majority for the proposition that “existing regulations on U.S. businesses” should be reduced or repealed.

Other interesting results that caught my eye included:

The majority of the unemployed are now spending more time searching for jobs than when they were first unemployed – which disputes the claim made by mainstream economists that benefits erode the incentive to seek work).

The vast majority of unemployed consider they have more or enough skills relative to the jobs they are applying for – which reflects on the skills shortage ruse that the conservatives are wheeling out at present to deflect attention from the fact that there are not enough jobs being created).

The overwhelming majority of unemployed said they were applying for “available jobs that you think you would be hired for” – which disputes the mainstream claim that increased duration of unemployment reflects workers becoming too choosy about wages and conditions.

The majority of unemployed “have taken money out of any savings account, including retirement savings, in order to make ends meet” and “have … borrowed money from family members or friends” The majority do not consider they “will have enough money to live comfortably” in retirement.

The NYT/CBS poll did uncover some of the broader costs of unemployment – beyond income loss. The majority of unemployed do not “have some form of health insurance or health care coverage” and say the reason is that they are unemployed (cannot afford it).

The majority of unemployed say that as a “result of being unemployed” they now experience “emotional or mental health issues, such as anxiety or depression”.

On political preferences, 18 per cent of the unemployed supported the Tea Party, the same percent supported the Republicans and 22 per cent described themselves as being conservatives.

Consumer sentiment

The October Consumer Confidence Survey published by the Conference Board (since 1977) has declined sharply

The following graph shows the complete history of the index (1985=100). In the history of the Survey, US consumers have never been as pessimistic as during the recent downturn. There were signs of recovery as the fiscal stimulus underpinning the return to growth from the trough in 2009-10.

But with that fiscal support waning and the politicians sitting on their hands, the economy has slowed somewhat and consumers have reacted accordingly.

The next graph shows the CB Consumer Confidence index from its most recent peak (May 2007) to October 2011 to provide more detail of the current period. The index is now been declining steadily throughout 2011 and is now approaching its 2009 recession levels.

The Conference Board comment that:

The Index now stands at 39.8 (1985=100), down from 46.4 in September … Consumer confidence is now back to levels last seen during the 2008-2009 recession. Consumer expectations, which had improved in September, gave back all of the gain and then some, as concerns about business conditions, the labor market and income prospects increased. Consumers’ assessment of present-day conditions did not fare any better. The Present Situation Index posted its sixth consecutive monthly decline, as pessimism about the current economic environment continues to grow.

None of that is surprising.

But think about the unemployed responses in the NYT/CBS poll relating to their own job prospects. As consumers they are deeply pessimistic. The connection between their own spending propensities and their own job prospects are not well defined it seems.

The reality is if they (consumers) are pessimistic and not spending and the politicians are not spending then the job prospects of the unemployed will worsen. There will be a diminished hope of them securing long-term employment.

The respondents also noted in the Conference Board survey that they were less optimistic about jobs growth in the coming months – “Those anticipating more jobs in the months ahead edged down to 11.3 percent from 11.9 percent” and “The proportion of consumers anticipating an increase in their incomes declined to 10.3 percent from 13.5 percent”.

A tale of two polls.

This New York Times article (October 25, 2011) – When Confidence Is Lower Than the Economy Itself.

The article notes that “Americans are worried” and:

There is no question that these sentiments reflect a grim reality: the poverty level is up. Inequality has grown exponentially since the 1970s. The European debt crisis remains unresolved. Unemployment is stuck at 9 percent, and if you count the people who have either given up looking or those who have taken part-time jobs because they can’t find full-time work, close to one in six people is underemployed.

The argument in the article is that the Confidence Board Consumer Sentiment series is not consistent with the “fact that the economy is still, believe it or not, growing”.

The author quoted a commentator on the CB Survey as saying:

This recession, followed by sluggish recovery, is not the experience of pretty much anyone today … So for all intents and purposes nobody in America has any experience for an economy behaving like this. Economists don’t even understand it. So if people don’t really understand what’s going on in the economy, how can they frame reasonable expectations of where it’s going?

Which from the standpoint of mainstream economic theory is a major indictment. What happened to all those rational individuals who knew how the economy worked?

What happened to all the households and business firms who were considered “Ricardian” by my profession – that is, anticipating high deficits to be equivalent to higher future tax obligations and were thus doing the rational thing and saving now (that is, not spending) in order to have the funds available to pay their future taxes?

After all these sort of conceptual arguments have been used by the mainstream commentators to justify the imposition of harsh austerity in the advanced world.

The evidence once again runs contradictory to the major predictions of mainstream macroeconomics.


Some economists have a clear understanding of what is going on. People are pessimistic and adopting conservative spending patterns because they fear unemployment – notwithstanding the curious (but selective) optimism of the unemployed in the NYT/CBS poll – which defies their reality.

There is a fear of unemployment because there is not enough aggregate demand. With private sector spending flat and exports markets hardly booming, there is an urgent need for renewed fiscal stimulus.

The reluctance of politicians to recognise that reality is the major reason that the global economy is in such a mess. It is actually very easy to understand the situation once you take off the ideological glasses that mainstream economists (and their media mouthpieces) wear which blind them from reality.

Tonight I am giving a talk to union members in NSW as part of the Campaign to defend energy assets. It is at the Newcastle Workers’ Club, King Street, Newcastle if you are around.

Upcoming Conference

This Saturday I will be speaking at this Conference – Building a Creative Economy which might be of some interest to readers.

The Conference is being held at the Balmain Town Hall in Sydney over the coming weekend. I am talking on the Saturday around 14:00 and will be on a panel a little later on Saturday. I expect there will be some interesting discussions although this is not a MMT conference.

The Conference is a grass-roots effort and is trying to promote alternative ways of thinking about the economy and our lives which sit with social justice and environmental sustainability. It deserves support for that reason if nothing else especially in the light of the “Occupy” protests that have emerged in the last month.

That is enough for today!

This Post Has 6 Comments

  1. Doesn’t ‘rational expections’ just allow neo-classical economics to ignore the issue of genuine uncertainty and limited time in their models?

    It’s just a way of getting around Keynes’ fairly obvious point that there are things you cannot know at any point in time, and you don’t have the time to work it out before a decision must be made.

    Give people a theoretical aggregate crystal ball, by waving optimistically at the wisdom of crowds, and assume the future is no longer uncertain in aggregate.

    Tell that to the Greeks.

  2. Nice article, Bill. Ricardianism and rational expectations are two ideas that always made me vomit. Most academic economists (Bill excluded of course) don’t give a toss for the unemployed. They are primarily interested in sitting in their ivory towers, and keeping themselves employed by dreaming up and discussing patently unrealistic ideas like Ricardianism.

    Given that professional economists are famous for disagreeing with each other (which means that at least half of them are “irrational”), it is patently obvious that the average employee (who hasn’t opened a basic introductory economics text book) cannot possibly make “rational” predictions about the economy.

  3. With respect to the poll findings, Americans tend to be delusionally optimistic re the so-called American dream. It is buttressed by a simplistic social norm about individual initiative along with its accompanying implausible, but often believed, success narrative. It is depressing.

  4. The answer is to move the goal post, and I see two possibilities for this.

    First, claim that RATEX applies at the producer level far more than at the consumer level, as most output comes from companies large enough to have economics expertise on staff. This works nicely for the supply siders who, after all, make all the really big salaries in economics. Of course, when you try to find consumers for those producers, … but why ask that question? After all, Keynes is dead, and, Marx who?

    Second, claim that RATEX applies to people with more money, who, after all, buy more stuff. I personally find this option far more satisfying, as it is quite consistent with what I’ve found to be the basis of most economic thought; a theme I find repeated over and over, most especially when some favored theory falls flat, and always in some tortured form designed to hide the theme itself, a mere four words: The rich are different.

  5. The most obvious retort to economists who teach this theory is that if everybody is rational and has the same information as the government and understands the true “model” of the economy that the policy makers share then what use is the economics profession and why would we be bothered studying economics.

    haha. And in which case, how can professional economists be called rational? Checkmate? 😀

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