27 March 2009

Expecting to get what you deserve, more or less

The government's role in setting macro-policy according to Akerlof is based on its ability to correct money illusion and the various misconceptions the permanent income hypothesis or rational expectations would lead policy-makers in the private sector to believe. An alternative way to look at the matter is to posit that people take their wages as a measure of their self-image and of what they believe they deserve. The role of government would therefore be to make sure just deserts prevails in the society because just deserts is an important factor in how people make their individual decisions. When the economy heats up so that people are making too much easy-money, money they do not deserve, when the economy starts to head toward an asset bubble with its attendant mis-allocation of resources, then the government needs to intervene to correct the situation.

Seen this way, the role of government is not a matter of regulation so much as it is the setting of long term expectations in society to match what they believe they deserve, the consequence of which would be that people would be able to coordinate better.

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