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Edward Prescott's Wrongheaded Analysis

June 22, 2009

The kings and queens of graduate economics classrooms -- real business cycle sophists, have been surprisingly mute on causes and consequences of the Second Great Depression. The silence is probably best explained by the feelings of shame for the utter failure of their models and predictions. But, alas, no need to wait any longer! Edward Prescott, Nobel Laureate of 2004, has finally chosen to creep out of the woods and enlighten us here.

If one just skims through the slides, one might notice some good points about 100 percent bank reserves, lower tax rates, the evil of stimulus packages etc. and, perhaps, conclude that Prescott makes sense after all and that we should be glad to have such a distinguished economist weigh in on the battle. Superficially, perhaps. But if looked at the thing in its entirety, one will see why the entire analysis is rife with enormous errors and contradictions -- reflecting the utter intellectual bankruptcy of neoclassical theorizing. The fact that he's more or less in favor of free enterprise is totally irrelevant in the face of such lapses in analysis. In fact, it is potentially disastrous for the cause of economic freedom.

1. Prescott liberates the Fed of any responsibility and says it's been actually doing what it should. (slide 52). "Only Fed should issue money" and maintain price stability -- "a good thing." (slide 44) This fallacious doctrine of price stability is actually an integral part of neoclassical economics, to which Prescott, to his credit, is thoroughly faithful. In this vein, one of the myths in macroeconomics, Prescott writes in this article, is that "monetary policy causes booms and busts."

2. If not monetary policy, then what? Prescott argues it were actually, of all things, "expectations" of higher tax rates that brought about the financial meltdown, unseen before losses in equity, unprecedented reductions in all kinds of spending, bankruptcies, bank failures, mounting unemployment. That all because of a few expected hikes in tax rates?

3. Advances the usual "supply-side" lower-taxes-higher-tax-revenues nonsense.

4. Blames the loss of Japan's "lost decade" on "lower productivity." Banks subsidizing inefficiencies caused the low productivity.

5. Calls for a ban on financial intermediation.

6. Plus such bizarre statements: "Overbuilding in 1929 and in 2008, which depresses employment and output, but not welfare (sic)." "If mistake made and worked too much in the past building too many houses, best to enjoy more leisure (sic)." In times when people don't know how to pay bills, Prescott suggests enjoying more leisure. I already see leftist intellectuals jumping all over this alleged defender of free markets.

What a shame.

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