Recent Government Action and the Law of Unintended Consequences

posted by Curt, on October 8, 2008 07:04 am

Wikipipedia defines The Law of Unintended Consequences as follows:

The "law of unintended consequences" (also called the "law of unforeseen consequences") states that any purposeful action will produce some unintended consequences. A classic example is a bypass — a road built to relieve traffic congestion on a congested road — that attracts new development and with it more traffic, resulting in two congested streets instead of one.

This maxim is not a scientific law; it is more in line with Murphy's law as a warning against the hubristic belief that humans can fully control the world around them. Stated in other words, each cause has more than one effect, and these effects will invariably include at least one unforeseen side effect. The unintended side effect can potentially be more significant than any of the intended effects.

The law seems to be in full operation regarding the U.S. government's recent efforts to stabilize the economy. In order to build support for the bailout, Bush, Paulson, Bernanke, and Congress all told people that the world was going to end if they didn't act immediately. We'll never know what would have happened without the bailout, though I believe that the consequences of not acting probably would have been severe.

But what it seems clear that the government's actions have done is caused an even greater general financial panic. When the bailout didn't work immediately, people panicked even more. And now, it seems that any further government action on the economy simply convinces people that their panic is justified. All this results in people pulling their money out of the stock market, and, perhaps more importantly, hunkering down and refusing to spend--maybe accelerating the move of the problems from "Wall Street" to "Main Street." At this point, you really have to wonder how much control the government retains over the whole situation. Ironically, it's numerous attempts to control the situation may have resulted in the economy being more out of control that it might otherwise be. How significant this potential unintended consequence is, in relation to the alternative, still remains to be seen.

Now, Bernanke and Paulson are smart guys. They know that their actions will have unintended consequences, and I think they weigh the potential benefits of each decision against its potential costs (e.g. growth potential v. inflation potential for a rate cut). But I wonder about the extent to which they fully considered the potential psychological impacts of their actions, and the resulting impact that mass fear mobilization could have on their ability to retain whatever level of control they had over the course of the U.S. economy.

Now no one can foresee all the consequences of their actions. It's obvious that just because your actions may result in something happening that you don't expect you shouldn't quit acting altogether. But the government response to this crisis may provide yet more evidence that it is not always better to "do something, anything now" as opposed to waiting to do something better later.

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