“Regime Uncertainty” and “Big Players” Make the Economy More Dependent on “Animal Spirits” or “Confidence” Instead of “Economic Calculation”

The ‘rules of the game’ are the rules of economic exchange. They include tax law, the law of contract and regulations. If the rules of the game are ambiguous or changeable, investors experience uncertainty and ignorance of the future. If the rules of the game are known and stable, investors experience greater prescience. They have greater confidence in their guesses about the future. Irregular and arbitrary taxes, for example, make it harder to estimate the prospective profit of alternative investments; a simple regular and transparent tax code eliminates one source of uncertainty, helping investors to formulate a serviceable, if not perfectly strict, mathematical expectation of prospective yields. Robert Higgs (1997) has coined the term ‘regime uncertainty’ to describe situations in which the rules of the game are uncertain. As we shall see, regime uncertainty discourages investment (regime uncertainty is the cause, reduced investment the effect). 

Big Players are economic actors with three characteristics. Firstly, they are big enough to influence the market or markets in question. Secondly, they are largely immune from the discipline of profit and loss. Thirdly, they act on discretion and are not bound by any simple rules. Activist central bankers are paradigmatic Big Players. A private actor might be a Big Player, but only in the relatively short run or if it is a protected monopoly. As I argue below, Big Players are hard to predict. They reduce the reliability of economic expectations, which encourages both herding and contrarianism in financial markets. Big Player influence drives investors towards greater ignorance and uncertainty. For example, discretionary monetary policy makes it hard to estimate the future purchasing power of the currency and, therefore, the value of alternative investments: a simple monetary rule eliminates one source of uncertainty, helping investors to formulate a serviceable mathematical expectation of prospective yields. Koppl (2002) has developed the theory of Big Players and I will draw on that and related work in this monograph. 

When there is Big Player influence or regime uncertainty investors become more ignorant, less prescient. As they grow more ignorant their investment decisions cannot depend as fully on strict mathematical expectation, since the basis for making such calculations is correspondingly weakened. They are more likely to follow the crowd and to base their decisions on an overall sense of optimism or pessimism rather than independent judgements of prospective yield. In these circumstances, the state of confidence becomes more arbitrary and more self-referential. More or less arbitrary swings of optimism and pessimism are now more likely. Regime uncertainty and Big Players make the economy look more Keynesian as it is more dependent on ‘animal spirits’ rather than economic calculation, which becomes more difficult. As we shall see, there is a sense in which Big Players and regime uncertainty reflect ‘Keynesian’ policies, which suggests the self-defeating nature of Keynesian macroeconomic policy: Keynesian policies tend to create a Keynesian economy.

—Roger Koppl, introduction to From Crisis to Confidence: Macroeconomics after the Crash, Hobart Paper 175 (London: Institute of Economic Affairs, 2014), 14-16.