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HICKS: Post-recession policies matter more than theory

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Mike Hicks

There’s a wonderful fight brewing between some of the world’s best-known economists. The headline pugilists—Paul Krugman and Robert Lucas—are Nobel laureates. It is the kind of purely intellectual debate of which there is too little.

The fight measures up something like this. There are two dominant explanations and one peripheral one for why recessions happen. The first two share the same intellectual origins, crafted carefully over the past century. The peripheral explanation depends heavily on rules of thumb about how financial markets behave.

The dominant theories account for recessions in two ways: a real shock to the economy like a rapid rise in gas prices, or the inability of businesses to smoothly adjust prices to the right level. Both of these approaches more than partially explain the last recession. The gas-price increase everyone remembers all too well, but it was the helplessness of homeowners to cut the price of their homes to a point they would sell that was central to the housing crisis.

One of these explanations (which Lucas favors) does not admit significant frictions between people and businesses in the conduct of trade. The other (favored by Krugman) bases its conclusions on small frictions between people and business that prevent markets from operating smoothly. Both treat individuals and businesses as fairly similar beasts (rational within the narrow scope of gaining profits, yet imperfectly knowledgeable about the world).

Both of these models are effective at explaining other characteristics of the world’s economy, and they share similar (but not identical) policy prescriptions. For the record, my doctoral dissertation and some later research focused on measuring these small frictions. That puts me squarely in the Krugman camp.

The peripheral explanation argues that many recessions develop from the bursting of financial bubbles, which leave firms thirsting for access to their lifeblood of capital. The result is, in the quaint wording of J.M. Keynes, a “liquidity preference” for holding cash that places a stranglehold on commerce. This explanation has an all-too-familiar ring to it. Krugman has become recently fond of some of these arguments and wants them incorporated into the dominant theories.

Having hastily summarized 75 years of significant writing into 300-odd words, I probably need to offer an apology. But, in the end, it is not the theory, but rather the policies they spawn, that matter.

The types of fiscal stimulus Congress passed earlier this year fell from favor not because of economic theory, but rather because such plans rarely work well. The role of the Federal Reserve became ascendant not because of crafty economic models, but because it was exceedingly successful.

Two years hence, the Fed will be working its magic and economists will be arguing over the effect of the stimulus. I don’t know how the debate will end, but one thing is for sure: We’ll still be paying for it when the argument is over.•

__________

Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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  1. to mention the rest of Molly's experience- she served as Communications Director for the Indianapolis Department of Public Works and also did communications for the state. She's incredibly qualified for this role and has a real love for Indianapolis and Indiana. Best of luck to her!

  2. Shall we not demand the same scrutiny for law schools, med schools, heaven forbid, business schools, etc.? How many law school grads are servers? How many business start ups fail and how many business grads get low paying jobs because there are so few high paying positions available? Why does our legislature continue to demean public schools and give taxpayer dollars to charters and private schools, ($171 million last year), rather than investing in our community schools? We are on a course of disaster regarding our public school attitudes unless we change our thinking in a short time.

  3. I agree with the other reader's comment about the chunky tomato soup. I found myself wanting a breadstick to dip into it. It tasted more like a marinara sauce; I couldn't eat it as a soup. In general, I liked the place... but doubt that I'll frequent it once the novelty wears off.

  4. The Indiana toll road used to have some of the cleanest bathrooms you could find on the road. After the lease they went downhill quickly. While not the grossest you'll see, they hover a bit below average. Am not sure if this is indicative of the entire deal or merely a portion of it. But the goals of anyone taking over the lease will always be at odds. The fewer repairs they make, the more money they earn since they have a virtual monopoly on travel from Cleveland to Chicago. So they only comply to satisfy the rules. It's hard to hand public works over to private enterprise. The incentives are misaligned. In true competition, you'd have multiple roads, each build by different companies motivated to make theirs more attractive. Working to attract customers is very different than working to maximize profit on people who have no choice but to choose your road. Of course, we all know two roads would be even more ridiculous.

  5. The State is in a perfect position. The consortium overpaid for leasing the toll road. Good for the State. The money they paid is being used across the State to upgrade roads and bridges and employ people at at time most of the country is scrambling to fund basic repairs. Good for the State. Indiana taxpayers are no longer subsidizing the toll roads to the tune of millions a year as we had for the last 20 years because the legislature did not have the guts to raise tolls. Good for the State. If the consortium fails, they either find another operator, acceptable to the State, to buy them out or the road gets turned back over to the State and we keep the Billions. Good for the State. Pat Bauer is no longer the Majority or Minority Leader of the House. Good for the State. Anyway you look at this, the State received billions of dollars for an assett the taxpayers were subsidizing, the State does not have to pay to maintain the road for 70 years. I am having trouble seeing the downside.

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