Robert Lucas Presents His Views on the Great Depression and Great Recession

link here to article

Robert Lucas won a Nobel prize for his work in developing rational expectations theory. He is one of the economists from the University of Chicago who have opposed the use of fiscal policy to deal with the US recession. In general, Chicago economists have been leading proponents of a very limited role for government in the economy. I have linked to a recent presentation that he gave at the University of Washington, in which he compared the Great Depression with the Great Recession. He points out the similarities and differences between these large departures from the long term growth trend and concludes that both lasted too long for similar reasons.

He agrees with the conclusion of Milton Friedman, that the Fed contributed to the Great Depression by failing to increase the money supply, and he adds a few other reasons. The Smoot-Hawkley bill reduced international trade; government supported the growth of unions, and FDR demonized business. In other words, government was responsible for the extended duration.

The recovery from the Great Recession has also been extended because government has been doing too much. High income earners anticipate higher taxes (this leads them to save up to pay the taxes). Government has increased its role in the market for healthcare, and banks are threatened by increased government regulation. He argues that the US is following the lead of the European welfare states, and it is choosing to reduce the rate of per capita GDP growth to that of the low growth welfare states.

If one starts out with the premise that a market economy, with a very limited role for government, is the best of all possible worlds, it is not surprising that Lucas found that government was the problem in the two large deviations from the long term GDP growth trend. FDR and Obama advocated policies that destroyed business confidence, and that was primarily responsible for the slow recoveries from recession. We certainly don't want to move in the direction that Europe has taken by increasing the role of government in the economy. He is so certain of his conclusions that he is not aware of the faster recovery that has taken place in Germany, Sweden and other European countries with stronger social support systems. He also seems unaware that business investment as a percent of GDP has been relatively high in relation to the the level of unemployment in the US. Moreover, he does not even mention the decline in household net worth, and the deleveraging that has resulted from the bursting of the housing bubble. Who needs to examine evidence that run counter to a firmly held conclusion that was reached without evidence?