Winning Trust Must be the First Step to Recovery

In his inaugural speech, United State’s President Barack Hussein Obama said that “The World has changed”.

By Ovais Subhani

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Published: Thu 22 Jan 2009, 11:31 PM

Last updated: Sun 5 Apr 2015, 9:37 PM

True. And he also laid bare the challenges facing the country and its economy, without any exaggeration or understatement. But he went on to say that his country still remains the most powerful and the most prosperous of all. A lot of people might look at the later statement with a bit of skepticism. In fact, even as Obama spoke, investors were busy selling US financials, taking the stock market down sharply.

So how could Obama imagine his country holding on to power and prosperity after the economy looses trillions in assets and millions in jobs and its banking sector goes bust? But Obama was not alone.

Despite being in the midst of its worst financial crisis and probably the deepest recession it has seen yet, nearly two million enthusiastic Americans braved sub-zero temperatures to cheer their new president on his inauguration.

So why the Americans are not as pessimistic or depressed about the state of the economy as one would have thought. The answer is simple. Because they know how bad the situation is and they know how the Obama administration is going to deal with it.

Knowledge and information are not just vague concepts any more. They have become powerful tools that policymakers use to manage expectations that drive consumption and investment trends.

Of course I am assuming that we understand each individual as an economic unit that consumes, invests and creates wealth. So just like a company that needs to know all facts about the economy it is operating in to plan ahead, individuals also need information and knowledge to know how to get a better job, what to buy and at what price and how to save.

But if policymakers choose not to share the state of the economy, they loose trust and fear grips the economy.

In pure economic terms, the Taylor Rule recommends a relatively high interest rate (a tight monetary policy) when inflation is above the Central Banks target or when the economy is above its full employment level, and a relatively low interest rate (easy monetary policy) in the opposite situations.

That’s why most Central Banks have a benchmark interest rate which becomes the target rate for the monetary policy.

However, in reality Central Banks do not just stop at announcing the target rate but to stabilise expectations they communicate periodically, in various ways, on how the target would be achieved.

A Central Bank that is inscrutable gives the markets little or no way to ground perceptions about its policy in any underlying reality. That could open the door to asset price bubbles, based on misconceived expectations, and can make the effects of its policies hard to predict.

The above rule, in my opinion, equally applies to government’s economic policies, especially in countries where the state leads the economy.

The reason more people trust Obama to meet the challenges facing the US economy is that he appears to be more approachable than his predecessor and, more importantly, he talks in a language people understand.

Obama has given hope to many. So let’s hope his communication skills become popular elsewhere and politicians across the world understand that people, not just big business, have to be taken in confidence if any success is desired in challenging times.

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