Great Debates: Smoothing the Cycles

Are Economic Disasters Avoidable?

By Andrew Hayenga

 

sp10cov_econpaperFor the past two years, following the stock market has required a strong dose of Dramamine. After spending nearly a decade riding high on the great American real estate boom, our roller-coaster economy plummeted into a valley that some have called “the Great Recession.”

Quick federal intervention in the last months of 2008 is the only thing that prevented a deeper multiyear, Great Depression-like slide, says Andreas Rauterkus, Ph.D., assistant professor of finance in the UAB School of Business. “The Great Depression lasted four years because the government did nothing in reaction to the collapse of the economy in the early 1930s,” Rauterkus says. “The country learned something from that experience.”

For many people, the lesson of our own Great Recession is that markets need government oversight to prevent wild risk-taking and other abuses. And indeed, legislators are already radically reshaping the country’s financial system.

But it’s impossible to regulate booms and busts out of existence, says Rauterkus. They are part of the inescapable ebb and flow of the American economy: Tighter regulation leads to slowed growth, followed by loosened regulation that allows for free-market abuses or mistakes, which in turn prompts financial failures and retightened regulation.

Solution for Slowdowns

“You will always have slowdowns in the economy,” Rauterkus says. “New innovations spur growth, but when those innovations run their course, the marketplace slows while waiting on the next great innovation.”

The advent of the Internet pulled us out of the recession of the early 1990s, Rauterkus says. The engine for future growth, he notes, could well be innovations in alternative energy. Of course, investment and spending are required to foster economy-spurring innovations. That is the chief reason governments must not regulate too much, Rauterkus warns.

“The economy must be protected from the kinds of abuses that led to the most recent financial crisis,” he says. “Too much regulatory protection, however, can stifle growth and investment and create deeper, more frequent slowdowns in the economic cycle.”

While the perfect balance between free-market policies and government regulation may never be reached, Rauterkus says one thing is certain: The markets will always return. “It may take a couple of years, but soon enough unemployment will return to more acceptable levels and the economy will be humming along.”

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