What Do Recent Nobel Prize-winning Macroeconomists Say about the Prospects of the Stimulus?

by Will Wilkinson on February 21, 2009

I decided to ask!

I talked to Edward Prescott and Edmund Phelps the day Obama signed the stimulus into law and wrote about it in my latest column for The Week.

I’m persuaded that the general logic of Prescott and Kydland’s work on time inconsistency applies to the present situation (and I don’t think you need to accept the strict rational expectations framework to see how it applies), but I was especially taken by Phelps’ concerns about the potentially damaging effects of the stimulus on entrepreneurship and innovation. Please check it out.

Talking to these giants of macro has convinced me that we need to be talking about is how to get the institutions right and keep them stable. What the government is now doing amounts to a pretty radical restructuring of our scheme of economic institutions, but with shockingly little deliberation about or regard for the optimality or stability of the overall incentive structure. This mess was precipitated by what turned out to be a disastrously unstable alignment of incentives. That fact would seem to prescribe taking a lot of care in thinking through how various large interventions might ramify through the system before jumping in. But our government’s behavior increasingly looks a bit like a zealous small-town narcotics squad, excited by its slick new SWAT gear, that’s just kicked down the door to a meth house and has started shooting at anything that moves.

  • Thanks for posting this one. I love their answers.
  • > But our government’s behavior increasingly looks a bit like a zealous small-town narcotics squad, excited by its slick new SWAT gear, that’s just kicked down the door to a meth house and has started shooting at anything that moves.

    You were not given permission to describe the Obama stimulus so succinctly and perfectly.

    Consider this a first warning. Keep this up for a few thousand more times, and there will be consequences, mister.
  • Never feature a lie so early, if you want to hold this reader:

    "Stimulus is not part of the language of economics," says Arizona State University economics professor Edward Prescott. </bockquote>
  • Well, I wish I could have given that more context. He's saying something like "not a part of the language of the progressive research program of a truly scientific economics." Prescott went on to compare the vocabulary of "stimulus" to the vocabulary of chemistry before Dalton. The claim is not that economists don't actually talk about stimulus all the time, but that when they do, they're stuck in a superseded paradigm. It's an incredibly bold claim that he might be wrong about, but it's not a lie. I thought his meaning was clearly enough implied in his talk about "an old, discarded theory that's been tried and failed spectacularly" but I guess not.
  • I got from "There is an old, discarded theory that's been tried and failed spectacularly" that he was pushing an ideological agenda, which puts us back where we've been for the last 3-4 months, with economists splitting into trench warfare.

    From his entrenched position "Stimulus is not part of the language of economics." I could quote someone from an opposing trench, but I don't have to when we all have seen Mankiw's list of list of economic agreement:

    "Fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90%)"
  • That's the nice thing about economists...you can always find one that shares your opinion.

    I think adapting China's policy of executing corrupt businessmen would do far more for our economy than "getting the institutions right and keep them stable."

    Has anyone gone to jail yet for helping bring about our little economic hubbub yet/?
  • John V
    Nope. But most of them have been continually re-elected. ;)
  • JB
    Seriously. Reason has a good article tracking the debacle of the housing bubble.

    At one point, Congress (led mainly by Democrats) forced Fannie Mae and Freddie Mac to make sure 50% of the loans they backed were given to people with incomes UNDER the median income of an area. That's crazy.
  • Let's dial down the abstraction a little bit. The biggest slice is tax cuts. I doubt Prescott and Phelps are worried about that hurting entrepreneurship. The next biggest is aid to states and municipalities. I'm pretty sure their net expenditure will still be down, so that's not really an issue either. Eventually you get to infrastructure projects, which might be make work projects, but they're going to be carried out by the private sector. Those construction contractors aren't that busy right now. I suppose you could argue that they need to starve so they'll get busy inventing flying cars and cold fusion.

    I mean, if we were all suddenly reduced to subsistence farming, we'd all get entrepreneurial pretty damned fast, but who needs that kind of innovation?

    I get the thing about changing tax regimes making your NPV calculations unpredictable, but success with innovation depends on a lot more than the difference between capital gains taxes being 15% and 25%.

    I don't know, the threat to entrepreneurship looks like a lot of hand-waving to me.
  • Edmund Phelps looks a lot like he has a Nobel Prize to me!
  • John V
    The Nobel itself isn't the key. It's what the Nobel is FOR.

    Phelps has a Nobel for work related directly to the topic at hand.

    A Nobel prize winning stimulus cheerleader like Krugman got his prize for trade theory.

    Hayek got his knowledge coordination in economics.

    I'd say that makes Hayek's and Phelps' prize-winning insights more relevant to the stimulus debate than Krugman's.

    In fact, Hayek's insights strike me as absolutely devastating to very foundations of stimulus debate itself.
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