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Liberal Iranian
Liberal as in Liberty and Freedom. Iranian as in Cyrus and Ferdowsi.
Tuesday, June 26, 2007
Psychological Impact on Economy
There is no such thing as the psychological impact on economy.
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I always find it baffling when I hear or read about the psychological impact of an event on economy. I don't understand what is really meant by the term. Does it mean that the event in question somehow affects the psychology of the people in some unkown but pathological way and then this unhealthy state of mind impacts the economy? What I usually suppose they mean is that the said event either falsely signals a particular, non-existent situation, or that it is interpreted falsely due to invalid but popular theories. But to take people's reaction in such cases to be "psychological" and its economic consequences to be a sort of "psychological impact" on the economy, especially as a way of analyzing the situation, is hardly worth consideration in a rational, objective theory.

An example is this economic focus article in The Economist, which is concerned with the sensitivity of the Chinese economy to a stock market bubble burst. After giving a detailed account of who in China and how owns shares of the stock market and the proporion of companies and how much they issue shares in the market, The Economist concludes

The direct economic impact of a fall in Chinese share prices would therefore be modest.
But right afterward it continues
Some indirect effects could be larger. For instance, the psychological impact of a sharp sell-off could severely puncture consumer confidence.

But this way of viewing things is fishy. If the detailed analysis leading to the first conlusion is right then there remains nothing left to the psychology of the general consumer. Why should they care about a stock market sell-off if it doesn't affect them? What could be the case is that the consumers are not aware of this analysis. They have their own analyses. They act on them. If the result is a state of severly puncutred consumer confidence when the economic data show it need not be the case, I can't see this as the "psychological" impact of the stock market crash. It is the consequence of widespread false theories of what that crash means. It is perfectly non-psychological in exactly the same sense an otherwise solid consumer confidence would be.

Similar and much worse analyses prevail about inflation and prices in Iran. For instance, Davoud Danesh-Jafari, then head of the Economic Commission of Majlis and now the Minister of Economic Affairs and Finance, has the following theory:
"People expect the prices to go up when the new-year starts and this automatically pushes up the rates."
The fallacy of such claims is apparent on a little thought. Why, for instance, do people expect the prices to go up? As the same newspaper article also notes,
A close and impartial look at the budget statement and reasons behind chronic deficits show that unless the government comes up with ways to put a stop to the unchecked rise in liquidity, inflation will continue to haunt the economy not only during the next year but for years to come.
The psychological theory of inflation, of course, has no room in serious economics.

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