Great Expectations: Beliefs in Economics and Monetary Policy

Article excerpt

In the description of the topic for this year's Penn Humanities Forum, Carol Ann Muller wrote that the Forum "seeks to probe the nonmaterial dimensions of human existence, and the places where the physical and metaphysical intersect." She went on to say that the Forum hopes "to create a conversation about the nature of belief as it shapes, and is integral to, both humanistic and scientific research and investigation."

In my remarks this afternoon, I will offer my perspectives on the important role beliefs play in economic decisions and economic policymaking. I will provide some examples of how the beliefs held by both consumers and businesses lead to physical results in terms of the amount that a nation produces, the opportunity for employment, and the formation of both personal and national wealth. The connection here is the effect that beliefs have on people's demand for goods and services, and on businesses' willingness to invest in new equipment and the construction of new facilities. That is, borrowing Professor Muller's apt description, I will illustrate cases from the field of economics "where the physical and metaphysical intersect."

I will argue that beliefs are important to the decisions people make. Whether one looks at consumers or businesses, perceptions of reality--people's beliefs--are driving forces of every economy.

Further, I will argue that how beliefs are formed matters, in part because the economic outcomes one can expect from public policy are affected by the way beliefs are formed and how they vary over time. I will illustrate that it matters whether people form their beliefs by looking at the past or by looking forward ... by either trusting economic policymakers' promises or forecasting economic conditions.

I will conclude my remarks with some observations about how beliefs impact one current debate in particular within monetary policy circles. Here I will stress the importance of people's beliefs in the credibility of the policymaker in determining the outcome of any monetary policy action.

Beliefs in an Economic Context--Economic Expectations

To begin, I will note that you will not see the word "beliefs" very much in the field of economics. Rather, you will find the phrase "economic expectation." This is because economists generally talk about people's "beliefs" in the context of their expectations about the future. Yet, these expectations are at the heart of virtually every economic decision people make today.

For example, when consumers make decisions to spend or save, expectations play an important role. When making these decisions, people base their actions on both their current income and future prospects. This implies that actions today are predicated upon their belief in the future and future expected earnings. On campus we see this play out every day. MBA, law, and medical school students generally spend more than doctoral students, even during their graduate school days. Unfortunately the life of a scholar tends to be less remunerative than a career in business, law, or medicine. Knowing this, student spending habits begin to emerge early, and these patterns develop not because of current stipends, but because of earnings expected well into the future. Likewise, as each of us saves for retirement, we base our decisions on how long we expect to be employed, our expected future annual income, and what we expect to obtain from our accumulated wealth over the intervening years until retirement. Again, expectations about the future matter in an important way, as our beliefs dictate the steps we take today and the plans we make for tomorrow, aimed at achieving our economic and personal goals for the future.

Business decisions are similarly impacted by their view of the future. In fact, their behavior is perhaps even more dependent on an assessment of the years ahead. Businesses routinely try to project future gains that can be derived from current investments. …