Dissonance and Debt

by Stubborn Mule on 1 September 2011 · 18 comments

Ever since Standard & Poor’s downgraded the US government from AAA to AA+ I have been drawn into debates about the risks posed by growing US government debt. Ever since reading the book Mistakes Were Made by Carol Tavris and Elliot Aronson I have been fascinated by cognitive dissonance and as my debt debates kept following the same pattern I became convinced the explanation for this pattern lay in cognitive dissonance. Coincidentally, I then read a post by Bill Mitchell discussing a paper by Adam Kessler analysing the views of mainstream economists in terms of cognitive dissonance.

For those as yet unfamiliar with the concept of cognitive dissonance, it refers to the discomfort people feel when faced with conflicting information. The brain tends to react to cognitive dissonance by quickly eliminating the conflict and restoring consonance.

One of many examples of cognitive dissonance in Mistakes Were Made arises when people with prejudices are presented with evidence that contradicts their prejudices. Tavris and Aronson quote Gordon Allport, who wrote The Nature of Prejudice over fifty years ago. Allport illustrated a typical pattern of dissonance-blocking in the following dialogue:

Mr. X: The trouble with Jews is that they only take care of their own group.

Mr. Y: But the record of the Community Chest campaign shows that they give more generously, in proportion to their numbers, to the general charities of the community, than do non-Jews.

Mr X: That shows that they are always trying to buy favor and intrude into Christian affairs. They think of nothing but money; that is why there are so many Jewish bankers.

Mr Y: But a recent study shows that the percentage of Jews in the banking business is negligible, far smaller than the percentage of non-Jews.

Mr X: That’s just it: they don’t go in for respectable businesses; they are only in the movie business or run night clubs.

Time and time again Mr X. shakes off contradictions to his prejudice with a non-sequitur, responding with a completely unrelated argument in support of his prejudices. My conversations about US debt have been eerily similar:

Me: This Standard & Poor’s downgrade is a bit silly. The US has got past the farce of the debt-ceiling and, unless they choose to default next time they run up against that ceiling, their debt is much safer than euro sovereign debt from the likes of Greece and Ireland.

Mr. Z:  But they’ve just kicked the can down the road. Unless they do something about their deficits and cut all their entitlement spending, they are basically bankrupt.

Me: But the US government is effectively the monopoly issuer of US dollars and all their debt is denominated in US dollars: they cannot run out. So, they never have to default, unless their crazy politicians choose to.

Mr Z: Oh, sure, they can fire up the printing presses and simply print money, but that will always be inflationary.

Me: What about Japan? They ran deficits and their government debt has been growing for years and that hasn’t led to inflation. In fact, they could do with a bit of inflation, but have been unable to generate it. Government deficits will only be inflationary if the government is spending at the same time as the private sector and is overheating aggregate demand.

Mr Z: But Japan has been a basket-case for years, no-one would want the US to end up like Japan!

See the similarity? Almost every time I try to make the point that countries which control their own fiat free-floating currencies and only borrow in that currency (such as the US, UK, Australia, Canada and Japan) can never be forced to default on their debt, the conversation quickly veers away to inflation, Japan and anything but the central point. That’s cognitive dissonance for you.


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{ 18 comments… read them below or add one }

1 Ramanan September 2, 2011 at 4:26 am

I do not think that such matters are straightforward.

Consider for example a closed economy in which there is a wage-price spiral happening. It could either be started by the government or the private sector and the starting point is slightly irrelevant to the argument that follows but let’s just assume the private sector starts it. The government while seeing a wage price spiral happening tries to increase output by a fiscal expansion and simultaneously increases the wages of its employees. This leads to a worsening of the wage-price spiral and an accelerating inflation and also leads to the public debt/gdp to increase without limit. At some point there is a default. Now, it can be argued that the default was purely volitional but when one thinks of the whole story, it doesn’t seem like volitional.

Nothing written above is Monetarist. The inflation process assumed above is purely out of abnormal wage increases.

Scenarios such as freely floating currencies with the official sector having no liabilities in foreign currency are extremely rare. UK and Canada’s official sectors have liabilities in foreign currencies, for example. Even the Reserve Bank of Australia incurred liabilities in US$ during the financial crisis because Australian banks faced funding issues in the Eurodollar markets. Of course, the RBA has retired it now but just saying – nations’ government do incur liabilities in foreign currency easily.

The European Central Bank used swap lines worth $300-$500 billion during the crisis (?)

Which brings me to a more important point. Few nations have the luxury where the official sector has no liabilities in foreign currency. The government typically ends up incurring liabilities because banks have run into funding issues in foreign currencies, while they find it difficult to rollover maturing debt/swaps. Its not a question of price. Foreign financial institutions simply refuse to lend them. The government has to enter the scene and borrow in foreign currency. Foreigners may take the risk because the government would have a higher rating. The objective is to not spend in foreign currency necessarily but to borrow and exchange the foreign currency with domestic banks so that their funding needs (in foreign currency) are met.

Some commentators in the blogosphere suggest that in such situations, the government should capitalize banks in domestic currency but it’s difficult to believe that foreigners’ confidence is won by such a trick.

Which brings me to the United States. S&P’s article “Sovereign Government Rating And Methodology” talks about some issues. Suppose just like other nations, the United States has some issues. One example I could think of is that US banks have issues abroad in raising funding just like banks of other nations had issues with dollar funding. Faced with such issues, the Federal Reserve enters into swap lines with foreign central banks and in the process incurs liabilities in foreign currency. This immediately goes against the rule that US government sector has debt only in local currency because that statement is only about the present. In fact the S&P article talks of “official funding” via the IMF and foreign central banks/governments.

Else, with or without the above, there is a massive loss of confidence in the US and foreigners want to transfer funds in another currency. In order to prevent this, the US government defaults on foreigners.

There is nothing preventing the US from incurring liabilities in foreign currency in the future – say in 15 years. S&P as a rating agency shouldn’t be waiting for such an event to happen because by the time, the damage would have already been done for clients who hold a 30y US Treasury now.

Of course I understand that a lot of what I wrote above is a bit hypothetical but the prospects for the United States are not bright. Either it continues suffering or attempts to reach full employment by a fiscal expansion. The latter will put the public debt/gdp and the external debt/gdp into an unsustainable path because soon the current account deficit will reach 6% of gdp (just like mid 2000s) in such a scenario and keeps increasing with deflating demand as the easiest option to put this under control. For S&P to continue rating the United States government AAA is to indirectly convey the message that nothing can go wrong with US government finances.

I think Willem Buiter has similar ideas but his solution (deflating demand) is completely unacceptable.

The recent move by S&P was politically driven of course, but its a bit hard to beat them in a logically coherent way.

PS: This post doesn’t appear as the latest.

2 Stubborn Mule September 2, 2011 at 8:28 am

@Ramanan: while I won’t respond in detail now (I’ll have to think about it a bit and maybe there’s a post in it), but I will say that I’d love it if the debates I’ve had were more like this! My point in this post was not to make a drop-dead argument for the integrity of US debt, but rather that debating the subject always seems to be a slippery business. Rather than sticking to a single point (e.g. can the US be forced into default or is deficit spending inevitably inflationary), the debates just leap from point to unrelated point.

3 Stubborn Mule September 2, 2011 at 8:29 am

P.S. thanks for pointing out the order problem: I’ve corrected the publication date of the post.

4 Zera September 2, 2011 at 9:42 am

Part of the problem is that when the economy is going well everybody is so happy they don’t really want to focus on Govt debt even though this is precisly the right time to repay it or at least cut borrowing and govt spending as the private sector takes up unused capacity from the previous recession or just general growth. But everyone is so happy with their eye on the sunny upklands of economic prosperity that it is politically untenable to do so. Even the people who aren’t doing thaat well borrow like crazy to keep up with the Joon’s and the Jain’s so it seems churlish to expect the Govt to show restraint when we all secretly know we are overborrowing. That causes it’s own cognitive dissonance of course as we ignore the signs and encourage the Govt to spend even more. Then it all crashes and we expect the govt to show the same constraints as the rest of us even if economically speaking it is precisly the wrong time to do so. But politically it makes sense.

The problem is that economics as a science has lots of gaps in it due to it’s intrinsically difficult problems and just as religion fills in the gaps in the physical and biological sciences so politics fills in the gaps in economic science. And if there is anywhere that cognitive dissonance occurs it is on the edges of scientific debates like evolution and climate change. It’s hardly surprising something similar takes place in economics where the probelms are harder to define let alone solve.

ps. good post by the way.

5 Marc Lehmann September 2, 2011 at 1:07 pm

I think it’s really simple. It’s everywhere. People justify their failures, inabilities and actions constantly against their underlying belief. It’s simply about looking good, not bad and being right, not wrong, winning not losing. Living with yourself however you are no matter what that looks like. AKA… trying to achieve happiness.

6 Magpie September 2, 2011 at 8:29 pm

Hey Stubborn,

Although this post deserves a re-reading, I have the feeling you may be confusing two different things: in the first example I believe Mr. X could be making up excuses for his beliefs (maybe due to the critical dissonance, you mentioned); while in the second example, Mr. Z is simply repeating talking points heard somewhere else and accepted without any critical scrutiny, because they are genuinely unable to analyze them.

I’ll ponder some more about this. I’ve gotta go to work!

7 Manny C September 3, 2011 at 5:24 pm

This comment probably belongs in your cognitive dissonance post, but there’s an excellent, large scale forecasting competition being run by Phillip Tetlock and his researchers. I’m in. The training material addresses some of the things you noted in your post. Not sure whether rego is still available.

And you get paid a small sum.

8 Zebra September 3, 2011 at 5:41 pm

I’d like to be able to say all those grocer’s apostrophe’s were a deliberate attempt at irony but it looks like I need to do a little more self editing before posting comment’s.

9 Magpie September 4, 2011 at 6:57 pm


Its okay!

10 Magpie September 4, 2011 at 7:12 pm


Back to the post: if my idea is right, a long conversation with Mr. X will only yield an endless succession of replies, possibly contradictory ones. After all, the guy is simply improvising.

With Mr. Z, if he is just repeating talking points heard somewhere else, it is possible that he eventually runs out of replies. In any case, depending on the quality of the ideas underlying the talking points, it’s less likely he will contradict himself. It’s not certain that he will agree, but at least he could stop.

However, there is a third possibility: Mr. Z, finding himself against the wall, could adopt Mr. X’s stance (like Marc Lehman said) and start improvising answers.

The question is: do you have the patience and time required to keep the conversation on until one of the two things happen?

And, of course, there’s another thing: maybe in your Mr. Z example it’s clear who has the reason. In other circumstances, though, it might not be that easy to tell. Maybe Mr. Z could be asking himself similar questions!

11 Ramanan September 5, 2011 at 5:12 pm

Stubborn Mule September 2, 2011 at 8:28 am,

Yes, very difficult to talk to people in a logical manner. The Monetarist “intuition” is deeply ingrained in people.

12 Stubborn Mule September 6, 2011 at 9:41 pm

@Magpie: thinking about it, I think there’s a lot in your point of view. Perhaps it’s not so much a case of cognitive dissonance as cognitive dissonance by proxy: the cognitive dissonance is in the “experts” that everyone picks these talking points up from. Certainly the fact that the pattern of responses is so consistent supports your view.

13 Zebra September 11, 2011 at 12:36 pm

I read an interesting example of dissonance in The Sunday Age where Rob Ward the Victorian director of the Australian Christian Lobby was asked what he thought of the Galaxy Poll results that showed that 62% in favour of gay marriage, 33% opposed and 5% uncertain. His response was that the pollsters had got it wrong.

Invoking the argument that the majority of people share your views is probably the most powerful political argument in Western democracies. I wonder if it is so powerful in non-democratic countries like China? Maybe there your argument is more powerful if you can claim that your views are shared by some powerful person than the powerless majority. Then of course the dissonant arguer only has to claim that you have misunderstood their views…which is easier than claiming that a neutral pollster’s entire polling methodology is flawed and it turns out they only asked people in Newtown’s King Street on a Saturday night…

14 Magpie September 11, 2011 at 6:54 pm

I’ve just read this McCloskey paper with an unusual perspective on how national economies started to be seen as analogous to households.

As Prof. Mitchell always emphasizes how wrong this is, perhaps you guys could find it interesting.

Accounting as the master metaphor of economics
Arjo Klamer and Donald McCloskey
European Accounting Review, 1992, vol. 1, issue 1, pages 145-160


“In view of its importance in their work the economists could be expected to have an interest in accounting. Once they did. But now they don’t. For all practical purposes the accounting metaphor in economics discourse is dead and its reputation buried with it.”

“The circular flow, or ‘wheel of wealth’, was an identification of the linkages among the accounts of households and businesses”

“Here – not in the pages of eighteenth-century philosophers, who were concerned chiefly with moral sentiments – is Economic Man. Defoe is cannily realistic about the type. Crusoe calculates, but also frequently and disastrously miscalculates”.

“Instructed by literary artists, economists were accustomed by the nineteenth century to view the economy as analgous to a single household or business.”

15 Magpie September 13, 2011 at 2:53 pm

I love this kind of coincidences. I talking about “talking points” and, presto!, talking points materialize.

Coalition distorts facts in campaign on pollution charge
Lenore Taylor. SMH. September 13, 2011

Follow the link to the TPs!

I should start talking about winning the lottery…

16 Pfh007 September 14, 2011 at 10:25 pm

Events in Europe are proving to be an interesting case study.

History, politics, nationalism, economic theory and ideology all bubbling away and pulling the debate in every direction.

It is very hard to pick what note in the current dissonance will eventually prevail and drive events. It is even harder to assess whether the wishful thinking of the leaders in europe is approching a point where public confidence just snaps. When it happens it will be so clearly predictable even though few will spot the precise moment in advance.

At a distance it feels that the thread of post WW2 Europe is starting to unravel.

17 Stubborn Mule September 18, 2011 at 8:34 pm

@pfh007 unravelling certainly sounds like an apt term for what is happening at the moment!

18 Magpie September 21, 2011 at 7:09 pm

In a related subject, this is a very thought-provoking piece:

The Right’s Favorite Strike

Be warned that the article follows a Marxist perspective and, for that very reason, will probably not be welcome reading for many.

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