Economy, Business And Markets

Of Overconfidence and Realism

Post-Doc and Teaching Fellow at Alzahra University
Of Overconfidence and RealismOf Overconfidence and Realism

It appears that the government in Tehran seems to be moving from the path of overconfidence, due largely to the more than expected decline in inflation and the July nuclear deal with the six world powers, to a rather conservative state. A move that helps to partly explain the delay in, and amendments to, the much-publicized stimulus package.

The incentive package was designed to ease the recession within six months. Irrespective of the merits of the package, it seems only two of its articles been fully implemented, namely the car loans, probably the most controversial and expensive of the lot, and intervention in the interbank market aimed to lower the borrowing cost of money.

There is no report on when, if at all, other promises will be fulfilled. These include the credit cards for purchasing home appliances, lowering reserve requirements for ‘good’ banks, spending on development projects and reducing the high and rising government debt.

As the stimulus measure was hardly welcomed by critics and leading economists and failed to trigger a psychological market response, the rational response of the government was to take a step back and reassess the ground reality based on the latest information and calls for better judgment.

One change in the stimulus package is expanding the credit card coverage. The scheme has been extended to include all those on payroll and covers imported goods, although at higher interest rates. This is welcome news as it renders the scheme less discriminatory. The initial plan was crafted to help domestic producers and was limited to government employees. More importantly, the new scheme has long-term objectives as opposed to short-term goals and can help people on payroll who have lost their purchasing power substantially.

Nevertheless, it demonstrates the underestimation of the government in foreseeing problems --normally the product of discriminatory policies (both intentional and otherwise) -- that are prevalent and often difficult to tackle.  

The government needs to avoid overconfidence and revisit its initial judgment. As Mark Twain noted, “It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so.”

The delay in implementing the stimulus package can also be related to the rather controversial report by the Statistical Center of Iran indicating 1% growth in the first half of the current fiscal year that started in mid-March. The tepid growth rate was despite reports on devastating recession. This could yet be an indication that the Rouhani government is following a trial and error policy knitted closely with the ups and downs of the economy.

The fact that the CBI refused to lower the reserve requirement in spite of the liquidity crunch, shows the regulator wants to see how inflation and deposit rates are moving and whether or not the measures taken so far had any effect. This approach is less costly than abrupt and insipid decisions when the going gets tough. However, when trial and error tends to become a norm rather than the exception it certainly undermines the credibility of the government and its macroeconomic plans.

Add the government overconfidence to its goal of helping the disadvantaged or increasing consumer demand when the economy is slowing. The weight of such goals also put pressure on sound judgment and the decision-making process as it carries nationwide impact. Hence, governments usually rely on different sources of information and experts to plan policy. In the planning procedure, however, they tend to overestimate their rate of success and/or underestimate how long it will take them to deliver or even assess a situation.

The planning fallacy is more conspicuous for long and complicated tasks with which governments usually are preoccupied. It often turns out that even the team preparing the plan is not certain that it will produce the desired results but still insist that sticking to the plan is crucial as a guideline if not a roadmap. Well, one problem with this thinking is that it raises the likelihood of delegating the whole plan to the periphery.

Governments tend to overestimate their knowledge and credibility of the given information, while underestimating risk and the unintended and possibly also unavoidable consequences of their actions. As such, they exaggerate their ability to control events that turn out to be heavily  influenced by an array of unknown factors of which recession is one.