Psychology Says We Should Have Prosecuted

One of the most beautiful miracles of humanity is the contradiction of reason. We’re blessed with the capacity to reason carefully — but we’re not disposed to most of the time.

Nowhere is this principle more clear than in economics, where academics and practitioners have developed advanced theories of utility to determine the best way to make decisions, the most return for the least investment, when to “satisfice,” etc. And yet, consumers make horrible decisions all the time, because they go by instincts that may have been useful in our caveman ancestors’ information-poor environments but lead them down incorrect paths in today’s complex economies. And it’s not just consumers: it turns out that governments make horrible economic decisions, too.

I may just be an unfrozen caveman, but your modern concept of stimulus in recession frightens and confuses me!

Paul Krugman has an interesting piece in the current New York Review of Books examining why governments keep turning to austerity in times of recession and depression when the preponderance of economic evidence shows stimulus to be more effective. He points to our drive to find moral meaning in amoral stories and our hunger to atone for mistakes:

When applied to macroeconomics, this urge to find moral meaning creates in all of us a predisposition toward believing stories that attribute the pain of a slump to the excesses of the boom that precedes it — and, perhaps, also makes it natural to see the pain as necessary, part of an inevitable cleansing process. When Andrew Mellon told Herbert Hoover to let the Depression run its course, so as to “purge the rottenness” from the system, he was offering advice that, however bad it was as economics, resonated psychologically with many people (and still does).

It’s tempting to say we would all have been better off if we didn’t get dominated by this drive to atone, since we could have thereby taken more stimulus measures during the Great Recession and recovered more quickly and more fully = better life for all!

When it comes to atonement, Keira Knightly > economic austerity.
When it comes to atonement,
Keira Knightly > economic austerity.

The real (and more practical) lesson is that this urge to find moral meaning is why letting the financiers and regulators responsible for the economic collapse of 2008 go largely uninvestigated and unprosecuted was so harmful.

The politics of prosecution were complicated at the time, but in retrospect, one of the most important reasons to do it may have been the drive to atone. Without prosecutions, a gap was left in the moral story people were writing in their heads about the crash. There was no atonement, so it felt incomplete. De facto atonement on a societal level — rather than a personal level by the actual perpetrators — stepped in to fill the gap. In other words, many people embraced a sense that the country must feel the pain of starving itself to atone for its gluttony, i.e. accept the economically harmful and counterproductive austerity measures.

So add the debt ceiling debacle of 2011, the sequester, and other harmful austerity measures of the past several years to justice, deterrence, and the other reasons the architects of the 2008 collapse should have been prosecuted.