Nobel Prize Winners Have Opposing Views on US Economy

In economics, as in any professional field, Nobel Prize winners stand for the highest levels of creativity and intellectual achievement.

Those of us who practice the profession, those responsible for public policy, and the students we teach about economics all read the works of Nobel winners as a source of inspiration and wisdom.

The U.S. economy is fertile ground for policies that will bring sustained growth back to the world’s largest economy. Right now the views of two titans in the field, both Nobel recipients, could not be further apart.

On Feb. 4, The Wall Street Journal published 2004 Nobel laureate Edward Prescott’s critique of current U.S. economic policy. In his opinion, the package of financial reform brought about by the Dodd-Frank legislation, the bailout of the automobile industry, green energy subsidies, the $800-billion recovery and investment program, health care reform and numerous other labor-related decisions have compromised new business creation, as well as productivity. In Prescott’s view, the problem essentially lies in the realm of supply. For his part, as laid out in several New York Times articles, 2008 Nobel laureate Paul Krugman has diagnosed the problem as one of insufficient demand, which calls for policies to stimulate spending, including substantial fiscal and monetary stimulus measures sustained over time. In his words, “Easy money should, and probably will, be with us for a very long time. This, in turn, means we can forget all those scare stories about government debt …”

In economics, these disagreements are the rule, not the exception. Therefore the problem is one of finding the right criteria that will enable us to choose between two opposing proposals.

In our opinion, the best criteria between such dissimilar diagnoses should be based on an understanding of past experiences from other countries, as well as the use of eclectic approaches and economic theories considered appropriate. It is important to recognize that decisions are being made in a highly uncertain context. In the face of such huge problems, any vision runs the risk of being biased and incomplete, and of needing future revisions.

The recovery in the United Kingdom is one of the examples of austerity policies that cast doubt on Krugman’s vision. Fiscal and monetary laxity do not seem sustainable in any economy, including that of the United States.

For their part, opinions derived from Prescott, that none of the current administration’s policies, which were adopted to help select entities and sectors severely affected by the 2007-2009 crisis, are just too doctrinaire.*

In operational terms, proposals can be categorized in terms of their emphasis on supply and demand. On the ratio of supply to demand, Prescott would be 90 to 10, while Krugman would be 10 to 90.

There could be a more balanced formula, which allows for changes in the ratio over time. In particular, immediately after the crisis, a focus on demand was required because it was flexible and easy to implement. Six years later, it is overkill to maintain a focus on demand. It would be more sensible to emphasize supply-side reforms with a 60 to 40 ratio.

In summary, fiscal and monetary stimuli, if well-justified, should be gradually removed, and the supply-side reforms should be given a larger role. The big advantage of a pragmatic approach of this kind would be reducing the risks and costs of making mistakes. In addition, it allows the crisis response to include a more eclectic set of options in case the chosen strategy proves incorrect in hindsight.

*Editor’s note: Correctly translated, this sentence is an incomplete thought in the original Spanish.