Obama's Economic Policy and Reagonomics

Aug. 21, 2008 4:22 AM ET18 Comments
Mark Thoma profile picture
Mark Thoma
130 Followers

This article by David Leonhardt describes Barack Obama's view of economic policy, and it is very similar to my own. Most of the time, it is best to leave markets alone, to let them work without intervention, and that should be our starting point. But markets fail, and part of the disagreement with those holding more conservative views is over how often markets fail, whether they can easily self-correct when there are problems, and how effective the government is at fixing problems when they exist.

On the last point, I am a proponent of market-based regulation when it is possible to use it. For example, if you want to regulate the profit of a public utility, one way to do it is through rate of return regulation. Under this approach, prices are set so as to guarantee investors a particular "fair" rate of return. The problem with this is that there is no incentive for the firm to control its costs, the rate of return to investors will be the same whether it is efficient or inefficient.

An alternative to this approach is to set a price cap and then tell the firm that it can keep some fraction of any profit over a certain amount, with the rest to be returned to its customers through rebates or lower prices. For example, regulators could set a base return of 5%, and anything over that amount is shared equally with taxpayers (you occasionally see these rebates on your phone bill). Thus, if the firm makes 8%, it would keep 6.5%, and 1.5% would be returned to customers. Under this form of regulation, there's an incentive to cut costs - every dollar saved is another dollar in profit - and there's also an incentive to innovate (unlike with rate of return regulation). The price cap, which can be adjusted to target the 5% base rate, prevents the firm from exploiting monopoly power through

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Mark Thoma profile picture
130 Followers
Mark Thoma is a member of the Economics Department at the University of Oregon. He joined the UO faculty in 1987 and served as head of the Economics Department for five years. His research examines the effects that changes in monetary policy have on inflation, output, unemployment, interest rates and other macroeconomic variables with a focus on asymmetries in the response of these variables to policy changes, and on changes in the relationship between policy and the economy over time. He has also conducted research in other areas such as the relationship between the political party in power, and macroeconomic outcomes and using macroeconomic tools to predict transportation flows. He received his doctorate from Washington State University. Visit his site: Economist's View (http://economistsview.typepad.com/economistsview/)

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