Acemoglu, The Financial Crisis and The Stimulus

In a recent post, "Acemoglu on Greed," I tried to highlight the difference between economists and others on the impact of greed on society.  His paper, "The Crisis of 2008: Structural Lessons for
and from Economics," is the best of two worlds: short on words but long on economic content, and I wish to share with my students and other readers a few of this thoughts, and recommend the entire paper.  To cut to the chaff, he gives guarded support for the stimulus as a way to avoid an "expectational trap" in which consumers and policymakers turn away support from a market system.

Acemoglu believes that preserving and strengthening market institutions and regulatory underpinnings of free markets is more important than escaping from the current recession.  

[I]t is obvious why we should heed issues of economic growth. Barring a complete meltdown of the global system, even with the ferocious severity of the global crisis, the possible loss of GDP for most countries is in the range of
a couple of percentage points, and most of this might have been unavoidable given the overexpansion of the economy in the prior years. In contrast, modest changes in economic growth will accumulate to much larger numbers
within one decade or two. Thus, from a policy and welfare perspective, it should be self-evident that sacrificing economic growth to deal with the current crisis is a bad option.

In an expectational trap, consumers and policymakers become pessimistic about "future growth and the promise of markets." 

We may see consumers and policymakers start believing that free markets are responsible for the economic ills of today and shift their support away from the market economy. We would then see the pendulum swing too far, taking us to an era of heavy government involvement rather than the needed foundational regulation of free markets.  I believe that such a swing and the anti-market policies that it would bring would be the real threat to the future growth prospects of the global economy.  Restrictions on trade in goods and services would be a first step. Industrial policy that stymies reallocation and innovation would be a second equally damaging step. When the talk is of bailing out and protecting selected sectors, more systematic proposals on trade restrictions and industrial policy may be around the corner.

He offers guarded support for the stimulus package.

A comprehensive stimulus plan, even with all of its imperfections, is probably the best way of fighting off these dangers, and on balance, there are sufficient reasons for academic economists as well as concerned citizens to support current efforts as insurance against the worst 0utcomes we may face.  Nevertheless, the details of the stimulus plan should be designed so as to cause minimal disruption to the process of reallocation and innovation. Sacrificing growth out of our fear of the present would be as severe a mistake as inaction.

In addition to the paper, interested readers would profit from listening to Russ Roberts interview with Daron Acemoglu.