Statement Prepared for the NSF Vistor's Committee by David K. Levine

Broadly speaking, the NSF sponsors research not only for the direct benefits it brings to society, but because knowledge and understanding of the world around us is important. This is no less true of knowledge about society and economic systems than it is about knowledge about, say, astronomy, on which the NSF spends substantially more money than on social science programs. However, research in economics also has a direct payoff. The current economic context is relevant: the United States has just enjoyed a decade of unparalleled growth and prosperity. No one would claim that economists, or the NSF Economics Program, is responsible for this: developments in technology such as computers and the internet, and broader developments such as the end of the cold war are responsible. But economists have been instrumental in providing an economic environment in which growth and prosperity have been able to flourish. Most significant of all has been the absence in the United States during this decade of major policy blunders that would have blunted growth and prosperity. If you doubt the significance of this, consider the last decade in Japan, which has made a number of serious policy blunders, or Europe, which has also fallen behind the United States. Or consider the firm monetary policy and modest response to the recession in the early 90s as compared with such policy blunders as inflationary monetary policy, wage-price controls and energy rationing that marked the reaction to the recession of the early 70s and helped turn that recession into a period of prolonged stagnation. While economists do not claim to have a magic bullet for solving economic problems, we do have a much clearer understanding of what consitutes a major policy blunder and how to avoid it. The reduction of even a few percent in the probability of a major policy blunder leading to a decade of stagnation pays the NSF economics budget many times over. And NSF sponsored research has been an important ingredient in establishing our current understanding. It is worth pointing out that several major current policy makers: Stanley Fischer, Joseph Stiglitz and Larry Summers, for example, all had their earlier research careers sponsored by the NSF.

Turning to more specific details of my own research, I am a theorist and the impact of theoretical work on practical policy does not generally take place in a five year time frame - rather it may take a decade or more before improvements in theory lead to improved understanding about policy making. However, I can illustrate the significance of some of my NSF sponsored research with two examples. The first is research I conducted in the early 1980s with Tim Kehoe on the determinacy of equilibrium. This research developed theoretical tools for determining whether crises in an economic model occur because of self-fulfilling crises or because of economic fundamentals. The difference between these two sorts of crises is significant: a crisis brought about as a self-fulfilling prophecy can be avoided, and, after the fact, mitigated by careful economic policy. An economic crisis brought about because of fundamentals cannot be easily avoided, and after the fact attempts to remedy the crisis through policy are likely to do more harm than good. These theoretical tools developed nearly two decades ago have been instrumental in the last five years in the development of specific models that help us diagnose which economic crises are brought about by self-fulfilling prophecies and which by fundamentals. Some of my own current research (with Michele Boldrin) helps shed light on the latter. Consider the current boom, driven as it is by the implementation of improvements in computer technology and the internet. These improvements cannot last forever. While we cannot predict when the benefits of these technologies will be played out, we can predict that it will happen, and the resulting consequences. When we find that there is little room for continuing technological progress, the stock market will crash substantially and ubruptly. Moreover, efforts to remedy this through economic policy will only aggravate and lengthen the subsequent recession. So if this research helps tilt the balance against ill-considered and hasty policies it too will pay for itself many times over.