Faith Based Economics Threatens Democracy

This report from The Financial Times makes an interesting point about the recent introduction of the concept of credibility into economic models.  It has become a big factor in the way that the sovereign debt crisis has been framed.  Debtor nations must establish credibility to market participants by the fiscal and monetary policies that they establish.  The problem with this idea is that there is no good way to measure success or failure in building credibility.  If efforts to establish credibility do not lead to good outcomes, the true believers argue that the efforts were not strong enough.  Faith in the concept of credibility is a firm assumption in the economic models. Security markets become the de facto means by which credibility is measured.  Bond traders replace democratic institutions as the arbiter of government performance. The recent flight to safety by bond traders confirms that some government efforts to establish credibility have failed.  On the other hand, governments that have been praised for their efforts to establish credibility, have also seen an increase in their interest rates.  It is assumed that credibility will follow if they try harder. It is not possible to test the assumption of the necessity to establish credibility, or the role of bond markets in measuring government performance.

Paul Krugman posted a similar critique of the credibility concept.  He argued that it was necessary for the Fed to create very high unemployment rates to disinflate the US economy in the 1980's.  Credibility of the Fed had little to do with the disinflation.