The Common Man Has Economic Clout

Article excerpt

IF a mother tells her son that he better not poke his little sister again, or he will be spanked, and then he does it and she doesn't spank, the mother loses some credibility. If mom does that a few times, the boy isn't likely to believe future threats.

This lad has a "rational expectation," and it is "rational expectations" applied to economic theory that this week won Robert Lucas Jr. the 1995 Nobel Memorial Prize in Economic Science with its $1 million award.

Dr. Lucas, a professor of economics at the University of Chicago, is an economists' economist. He doesn't write for the general public. Yet, he not only has had a "profound effect" on other economists but also on economic policymakers, notes Allan Meltzer, an economist at Pittsburgh's Carnegie-Mellon University, the school where Lucas did his prizewinning work in 1972.

In the specialized language of economists used by Lucas, "there obtains a class of stochastic neutrality propositions that imply severely limited possibilities for engaging in successful activist countercyclical policy."

In layman's terms, the common man often can foil government efforts to control the economy. Like the boy, individuals, households, and companies soon figure out that government economic threats and promises are not being implemented and act according to rational expectations and self-interest.

Say the Federal Reserve promises tight money to bring down inflation, but it doesn't actually cut growth in the nation's money supply. The financial community and consumers may be fooled the first time, and interest rates may fall briefly as investors expect a slowdown. But prices will rise anyway and fewer people will be fooled the second time the Fed tries this. As a result of this new awareness of the importance of expectations, the Fed today shows greater concern with the credibility of its anti-inflation policy than did some earlier Fed administrations.

"The Federal Reserve is paying much more attention to price stability than it used to," says Paul Romer, an economist at the University of California at Berkeley. "It is taking a much longer view than it did in the 1970s."

Similarly, some West European nations have 9 percent or more unemployment. …