HICKS: Post-recession policies matter more than theory

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.•

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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.