Why is Wall Street so divorced from reality? A psychological explanation.
Noah Smith and Paul Krugman have both noted the strange fact that the financial class, almost across the board, continues to argue for more austerity and a tighter monetary policy, despite the adverse effects these policies could have on the economy as a whole. This kind of blinkered thinking is a hallmark of the 1 percent, which compared to the rest of the country is obsessed with deficit reduction and cutting social insurance.
When Smith talks about motivated reasoning — noting that low inflation and higher interest rates both benefit moneyed interests — I think he's on to the nut of the answer: That class interests are at work. This is a basic struggle over resources, which in this case means that maintaining one's social position is more important than the theoretical benefits of more growth in the broader economy.
But I think the full case is a bit more subtle than that. The reason why Wall Street continues to push the austerity line also has to do with a) class psychology and b) how elite conventional wisdom is shaped.
Think about the days of feudalism. Back then, nobody bothered to justify their position in an egalitarian ethical framework. Instead, there was the "natural" superiority of the aristocracy, which allowed landlords to pillage the peasantry without even a scrap of justification. Concepts like meritocracy or equality were barely even considered; most people simply accepted their place in society.
But these days, the ideas of democracy and egalitarianism carry enormous cultural force. Acting the rentier would expose the 1 percent not just to violent social condemnation, but to internal cognitive dissonance. Of the two effects, the second is the more important. After all, to admit that millions of people's livelihoods should be scrapped to preserve your status would mean admitting to yourself that you're a terrible person.
And most people can't abide an overtly corrupt or unethical self-image.
In other words, Wall Street has internalized the values of a democratic society. That doesn't mean that it follows those values (haha, of course not), but that there's enormous psychological pressure to scare up some kind of disinterested rationale for a selfish, classist position. Thus, the inflationist/austerity canon serves as a psychological barrier between class interests and democratic values.
Normally I'm a bit suspicious of lay psychology, but when the doctrine in question has failed spectacularly and repeatedly, one's got to look past evidence and reason.
A bigger problem, though, is how a convenient psychological security blanket becomes a foundational assumption of the elite, spreading from Wall Street to the halls of power in Washington. One percenters have enormous cultural leverage: They talk to politicians far more than average people do, they own media properties, and they fund foundations and think tanks. Read how Krugman describes bewildered traders who are just amazed to find someone who doesn't subscribe to the rentier-ist agenda:
I've had several recent conversations with finance-industry people — including traders — who talk with some wonderment about the failure of high inflation and a plunging dollar to materialize, because "all the experts" told them to expect that outcome. When I found myself on CNBC with Joe Kernan, he described me as a "unicorn" — he couldn't believe that there was anyone out there who didn't believe that deficits and QE were going to lead to rapid doom. [New York Times]
That's exactly how cultural hegemony works: Ruling-class positions just become something that "everybody knows." They then become very hard to dislodge, because people build them into their presumptions, and won't acknowledge that there's disagreement. Indeed, keeping these policies away from dispute is critical to their success, because the minute austerians get in a straight fight on the evidence, they get torn to shreds.
This cultural pressure fades the farther you get from the financial elite, but it has absolutely permeated the culture of Washington and much of the mainstream media. Without this mechanism, I don't think you can explain the otherwise baffling fact that most of the political elite became feverishly obsessed with deficit reduction, for years, during a time of mass unemployment.
Of course, that's not the whole of the story. Deficit cutting has a certain surface plausibility that can't be ignored. And Republicans in Washington, previously Keynesians in times of economic distress, had cynical motivations to embrace austerity just as President Obama was pushing stimulus. But the influence of cultural hegemony is stronger and more pervasive than has been generally appreciated.