Macroeconomics and Politics

In 2008, many economists were left scratching their heads. How was it possible that macroeconomic models hadn’t factored in the financial sector?

The surface level critique was that neoclassical economists assumed that the financial sector was frictionless, supply and demand in efficient financial markets having no impact on the “real” economy.

But the financial sector obviously has “real” impacts in the sense that an expansion of credit leads to real investments. And sometimes scams.

Nevertheless, my goal here is not to rehash whether or not the government dropped the ball (it did), whether free markets can lead to bubbles (they can), or whether moral hazard or interest rate manipulations or bi-partisan pushes for home ownership exacerbated the situation (they did).

Instead, my goal is to argue that just like the 2008 financial collapse showed macroeconomists they should model the financial sector for real reasons, I argue the 2020 Covid Crash and the 2022 Market Relocation are rooted in politics. Consequently, macroeconomists must model the body politic.

How dare I make such an accusation? Mustn’t economists attempt to be non-political? Isn’t economics already so laden with ideological toxicity that it must be purged?

I think this is the wrong approach. It’s not just that I believe economists should embrace their ideology and be transparent about it; it’s that politics has real effects on the macroeconomy. So, as scientists, we should model politics if we are trying to be objective.

This is not an easy task, of course. In some sense, the economists must be reflexive, modeling how their own ideologies have impacts on the macro. As an illustration, if Keynes the man never existed, macroeconomics, and the real economy, would certainly be different, in uncomputable ways.

But to initiate the conversation for why the two most recent crashes can be described as political in nature, I return the reader, first to the 2020 Covid Crash, and second to the 2022 Market Relocation.

I will be basing these events on memory, but these facts can easily be confirmed or denied.

Whispers that Covid may be spreading came to my attention in February 2020. I was obviously late to the game, as Nassim Taleb Et Al issued a paper warning about Covid on January 26th, 2020.

Nevertheless, while there was an initial sharp bearish sentiment to news that China was issuing a quarantine in two cities on January 24th, 2020, the market actually hit all time highs for a couple of weeks until February 20th, 2020, when the market absolutely ripped in half.

Multiple days in February (3 days in a row, if I recall correctly) trading was stopped after a 7% drop. It was at this point that I realized something was going on.

But interestingly enough, this historical market collapse coincided exactly with the Democratic primaries, in particular Super Tuesday and, in my humble opinion, expectations that Bernie Sanders may just become the next president of the United States.

If I remember correctly, there was even shenanigans with futures markets and Pete Buttigieg’s fake victory of Iowa. Or maybe I’m confusing with Iowa’s refusal to publish that Bernie Sanders was the Iowa favorite. Whatever, the point is that the political impacts the macro.

Perhaps you don’t find this evidence convincing. Maybe this was just another coincidence. Personally, I actually wanted Bernie Sanders to win the nomination and presidency. But as an investor, I knew the market reaction to this would be bearish.

Nonetheless, the point remains. Insofar, as it is possible that the political affects the macro, economists better get to modeling.

Furthermore, I contend that the Federal Reserve of the United States, the US’ central bank, is influenced by politics. This may seem like a heretical claim. After all, the Fed is an “independent” organization. It’s not even considered entirely government, as it is partially a private organization.

Yet, astute investors have always known that the Fed was influenced by politics. Volcker was only able to cause a recession and eliminate inflation with the backing of Reagan.

Greenspan was an Ayn Rand follower with everything but interest rates and mortgages, thanks to the neoliberal policies of Clinton and Bush. And Powell was never able to turn hawkish when Trump would threaten to hang Mike Pence.

For a case study of political impacts on macroeconomics, see “The Fed is Politically Non-Political Incorrect”:

This is the current situation we find ourselves in. When Covid hit, the Fed immediately panicked and cut interest rates. They told the market that we should be concerned (which we should be), so the market crashed instead of stabilized. Moreover, the Fed initially cut 50 basis points on March 3rd, 2020, or Super Tuesday.

On the surface, this was supposedly done in reaction to Covid. But the market of course priced in the political element of that decision. Essentially, the Fed wanted to tell the market “We are so not political that we will cut to make sure the market doesn’t think we are political”, but what the Fed actually said was “we are scared that Bernie Sanders will tank the stock market if elected, so we must be proactive rather than reactive.”

What about what I am calling the 2022 Market Relocation? How is this bear market political?

First, I contend that the Fed is reacting based on political factors, such as the general environment an institutionalist like President Biden allows. But on a deeper level, my controversial take is that the market is actually attempting to manipulate the macro, essentially a self fulfilling crash that is intended to help Republicans in the mid-terms.

This is not to say we should use simplistic models of politics, like Republicans support smaller government and reducing the deficit, while Democrats don’t support defense spending, as examples. Or Republicans good for stock market. Democrats bad. (Obviously fake news.)

Instead, my claim is that there is “a game of visions” where corporations are eager to pit politicians against one another in a way that maximizes intertemporal profits. Long term? We’ll find out.

In this case, the representative agent can be modeled as a psychopath who will use political ends in much the same way economists view the average consumer.

In conclusion, this isn’t just another public choice theory rant about how economists should model the government as self interested entrepreneurs. Instead, it is a call to action for any macroeconomists to take seriously the challenge that factoring in the body politic into theory poses.

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