And then we all became economists …

One of the few positive consequences of the recent financial crisis is that people do know now much more about how markets work, on the scope and limits of Government intervention and, even more important, on the unintended consequences of ill-designed policies and bad regulation. We might not be fully aware of it now, but better informed people will be an essential requisite to better monitor and control discretionary and inflationary policies in the future. Those who have a degree in Economics will be familiar with what economists usually call  “rational behaviour” or “rational agents”, who are able to escape from another very important concept, “money illusion”. Let me explain then very briefly.

Being rational in economics means that we make decisions by exploiting all the information and resources at our disposal in order to get a particular outcome (whichever the final goal is: increasing the value of a portfolio or that of a charity). This rational assumption does not necessarily imply that people cannot err; of course they can, but then they will learn by their own experience and incorporate past failures in order to improve how to make their expectations in the future. So the key point is that they cannot be cheated systematically! One example of this is the ability of people to react to anticipated inflation; after suffering substantial losses in the past, as a consequence of recurrent inflationary policies, people have learned that (1) real variables is what really matters in making economic decisions and that (2) printing money is not tantamount to prosperity or economic growth (quite the contrary!). In consequence, in a nutshell, in the face of excessive fiscal spending and money growth, inflation will be expected; so people, instead of keeping on increasing their spending more and more, will be saving part of their income in deposits and other financial assets adjusted to inflation in order to maintain their purchasing power along the time. By doing so they will not have “money illusion” and will act rationally.

People may have finally seen that the expansionary monetary policies conducted before 2007 led to inflation and provoked market distortions and major financial instability. Let´s see if we have learned this important and painful lesson of the recent crisis, so we can counteract these policies should they persist in the near future.

Finally, find here a very brief and funny (fiction) movie that depicts a conversation amongst traditional Spanish housewives (in Andalusia), who wisely discuss on the current policies to overcome the crisis in a typical and beautiful southern spanish “patio”. I wish most economic ministers and Governments´economic advisers had their knowledge and vivid conversation! Enjoy it:

– Hablando en Plata (Directed by Mikel Gil, “Producciones Varadas”):

Juan Castañeda

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