Obama's illusion of confidence

So now we have a stimulus deal, a surprisingly speedy agreement (albeit with some bumps along the way) between the House, the Senate and the White House. The price tag is about $US785 billion, 35 per cent of which is tax cuts, with the remainder adding up to a smorgasbord of spending initiatives.

There has been plenty of quibbling about the day-to-day strategy and tactics followed by the new administration in pushing the "recovery" package along, but I think that in retrospect, this will be viewed as a pretty clear win for President Obama. In his first press conference after Election Day, he stated unequivocally that his number one priority would be the passage of a significant economic stimulus plan. Now, just four weeks after his inauguration, he looks set to sign into law a bill of almost exactly the size his team originally proposed.

Meanwhile, judging by the polls, the American public is treating Obama's bipartisan outreach to the Republicans as sincere, while the GOP has come off looking like a crew of irrelevant obstructionists.

What we don't know is whether the plan will work. It may be too small, or too weighted toward tax cuts, or too stuffed with non-stimulative "pork." It may not give enough money to the states to shore up their deteriorating finances or direct enough cash toward building real stuff that will exert a lasting positive effect on the economy.

It might even be that John Maynard Keynes was wrong and the efficacy of counter-cyclical government spending is a liberal pipe dream. The great irony inherent in the entire stimulus bill drama is that, while the debate it has provoked over the relative merits of Keynesian versus Chicago-school free market economics has given economists of all stripes endless grist to discuss, we really don't know what's going to happen. Even more fun: no actual economist would have designed a stimulus plan along the lines of the crazy mish-mash we've ended up with.

Such is the beauty of the American political system. Perfection isn't just impossible, it isn't even conceivable. Horse-trading between politicians representing wildly varying constituencies results inevitably in a monstrous hodge-podge. Economists, believing as they do in the rationally behaving economic actor, don't like messiness. Their models of the economy attempt to abstract all the nasty stuff away. And models are only as good as the assumptions that are embedded in them, and everyone starts with different assumptions. Which is why we have been treated to the delightful spectacle of Nobel Prize-winning economists fundamentally disagreeing about such topics as whether fiscal stimulus works at all, or what the relative potency of tax cuts versus government spending are in terms of boosting economic activity.

But we may all be thinking too hard. At least in part, a successfully growing economy is an illusion predicated on a shared hallucination. If we all believe the economy is healthy, we feel confident enough to take risks and spend and invest and create. But if we believe the economy is unhealthy, we pull back, we avoid risk, we save our pennies. The great paradox is that when we, as individuals, prudently pull back, we can end up making things much worse for all of us collectively.

The key ingredient in our collective delusion is confidence. And on that score, I think that Obama's success at steering a stimulus package from promise to reality is a confidence booster, in and of itself, almost without respect to the actual content of the package. A couple more accomplishments like this, and he might begin to create the illusion that he is an effective leader who can get things done. For a nation shell-shocked after eight years of fiascoes, that could be a pretty key step toward facilitating an eventual recovery.

Confidence is a fragile flower, however. As proven by the ubiquitous negative reaction to Treasury Secretary Geithner's unsatisfying outline of a new "financial stabilisation" plan on Tuesday, the jury is still very much out on whether the Obama administration has a coherent strategy for dealing with the woes afflicting our financial system. But even there, could it be possible we're getting a little too caught up in day-to-day jitters, while the White House sails along, undaunted – and according to plan?