Monday, August 11, 2008

In Defense of High Gas Prices: I Miss $5 Gas

As gas prices fall in recent days, why are only economists sad about this ? McCain's platform for President will be based on a promise of a constitutional amendment that gas will never cost more than $2 a gallon? It looks like smart politics to argue that effete environmentalists are the single cause of high gas prices.

I typed into google's search engine; "sierra club and high gas prices" and this was the 3rd entry.
As a nerd, I was hoping to find a vigorous defense of the benefits of high gas prices.

The Republicans smell a good issue here:

Given that the public is not strong at calculating general equilibrium models and it is probably is the case that not drilling reduces aggregate supply by a little bit, it is qualitatively true that not drilling everywhere raises gas prices. But how much? a penny? a dime?

Economists always talk about "clear signals" that prices signal scarcity; if energy prices are bouncing around like crazy and if consumers believe that big daddy government will step in with a bailout then why not keep driving the Hummer? While economists have stopped talking about the "communism of rational expectation models" that all agents in the economy know the true probability distribution of future states of the world --- we haven't done a good job modeling how people do form their expectations of future prices. Given that cars and homes are durables, and energy efficiency investments are durable long run decisions --- smart decision makers should base these decisions in part on expectations of what they think future energy prices will be. If Government steps in and mediates high price spikes, then the private incentive to "go green" is minimized.

So that's why I say ; "let's see some price spikes, let's see some pain" ---- fool me once shame on you; fool me twice, shame on me. If consumers demand energy efficient products, then our $ hungry firms will supply them but consumers will only demand such products if they expect that energy prices could soar. We need the right tail in our lives to scare us into action today.