May 23, 2011
A Dose of Economic Theory
I am a bit hesitant to fill this column with the technical aspects of economy theory. These lessons are rarely successful in my pragmatic household, but there is a time and place for everything; and this time of high budgets, incipient inflation and modest national recovery is a time for thinking folks to better understand the economic debate of our times.
Despite many jokes to the contrary, economists largely share a common set of beliefs forged by empirical observation of the world. Among these is that people respond to incentives with their best interests at heart and that left to its own devices, an economy will recover from even the worst recession of its own accord. The questions that remain in dispute are: How fast will the recovery be? and How much can government policy improve the speed of recovery?
Many demagogues would have us believe that there are two schools of thought in economics: old line Keynesians and pure free-market types. The caricature of both groups of economists is that they are, respectively, free-wheeling spendthrifts or cold-hearted social Darwinists. These descriptions are simple to understand, convenient and wrong.
Virtually all practicing economists fall into a broad middle. At the risk of sounding elitist, I need to define practicing economists as those who conduct their own technical research, not those who solely interpret the work of others or who spout ideological dogma. Most active researchers conclude that markets adjust slowly from recession to recovery. The technical research on the matter is painfully obtuse and often densely mathematical. Yet there is an easy reality to the findings of this work. It describe workers reluctant to concede to pay cuts, families unwilling to uproot at the first sign of economic hardship and businesses afraid to slash prices when demand drops. So most economists who study recessions and publish their own research argue that something can potentially be done to ease the transition from recession to recovery, if well timed and executed. Of course, these are big ifs. This something comes in the form of monetary policy (lowering interest rates to spur more investment in new capital) or fiscal policy (a combination of lower tax rates and increased government spending to stimulate demand for goods and services).
Despite high rhetoric to the contrary, we live in a world that has enshrined these ideas. Unemployment insurance, a progressive tax and most social programs automatically reduce taxes and increase spending as we move into a recession. These automatic stabilizers implicitly accept the reality that some government action can ease the effects of a looming recession.
So I argue to the angst of some of my colleagues, most disagreement over economic policy is not based on theory; rather it is based on the discordant views about the ability of government to quickly and efficiently spend a stimulus or target a tax cut. In that regard, the past two years have provided a great boost to those who argue for less, not more government intervention.
About the Author
Educational Attainment, the 21st Century Fund and the Future of SchoolingIndiana ranks 42nd in educational attainment.
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