Peter Diamond Wins Nobel, But Not Federal Reserve Seat

Federal Reserve Board nominee Peter Diamond, under whom Ben Bernanke studied; Dale Mortensen and Christopher Pissarides have won the Nobel Peace Prize in Economics. Marginal Revolution has an excellent summary of Diamond’s works. MarketWatch explains the economists’ Nobel-winning theory in layman’s terms:

Diamond, Mortensen and Pissarides reject (the economic theory that all unemployment is voluntary), arguing that it’s costly to find just the right job — that is, one that matches your skills and abilities and pays you what you are worth. From the employer’s point of view, it’s just as costly: All the applicants look pretty much the same at first; it’s not easy to tell beforehand if they can do the job, or whether you can find someone who’ll do the job for less. Searching, in sum, is costly.

The upshot of this research is that this searching — they called it “friction” — can make markets inefficient. Taking the first job offered, or hiring the first applicant would mean the economy wouldn’t work as well as it could. We’d get Ph.D.’s driving cabs, and high-school dropouts running nuclear plants.

Sometimes government policies can reduce the inefficiencies, but sometimes they can make them worse. Providing unemployment benefits can keep workers from accepting the wrong job out of desperation, but providing too many benefits can lead to search times running even longer than necessary.

The Washington Post’s Ezra Klein explains why Republican Senator Dick Shelby keeps blocking Diamond’s nomination to the Federal Reserve:

Shelby’s argument against Diamond is cover for his actual objections against Diamond. One of those objections is simple partisan politics. But another, I’ve heard, is odder: Shelby hates behavioral economics.

This White House, as has been endlessly well-known”>pointed out, is big on behavioral economics. See Peter Orszag, Jeff Liebman and Cass Sunstein for more on that. But the administration’s embrace of the discipline has provoked a response that the White House never anticipated. Republicans have grown suspicious of behavioral economics. And Diamond, it turns out, has done a fair amount of work in the field (for instance, here). Insofar as Shelby’s got an actual objection to DIamond, that’s it, and one of the things he wants is another hearing focusing on Diamond’s behavioral work.

….Diamond has published in many areas, but two particular points of expertise are labor markets and entitlement programs, both of which the Federal Reserve will need considerable knowledge of over the next few years. Without Diamond — or someone like him — on the Board, it’s no exaggeration to say they’ll be learning on the job.

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