Monday, February 15, 2010

A Question About Regime Uncertainty

An argument that is often advanced by free-market types (such as myself) is that regime uncertainty is responsible for sustained recession and slow recovery. The theory is that the unpredictability of policy causes businesses to be reluctant to invest and hire. The owner of a business doesn't want to commit to a costly course of action if government spending, taxation, and regulation could quickly render those decisions incorrect. Instead, the business owner prefers to sit and wait, and as a result, recovery takes longer.

Bob Higgs argued that this was the case during the Great Depression, and some argue that this is happening today--that the Federal Reserve is changing its role too unpredictably, that Obama's proposals for cap-and-trade and health care reform are costly and uncertain, and that Congress, too, can easily change policies in unpredictable ways.

My question is, how would one test to see if this hypothesis were correct today? How would one find evidence to support this view and reject, say, the Krugman view, which is that the stimulus just hasn't been big enough? There's always uncertainty about future policy. How do we know it matters more now than it did in the past?

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