Tyler Cowen is a professor of economics at George Mason University. He co-writes Marginal Revolution, a popular economics blog. This discussion can be followed in its entirety here.

I AGREE with Olivier Blanchard that fear and lack of confidence are major problems behind the current economic downturn. I also agree that the banking sector requires recapitalisation and that this is hard to do. But I dissent from his analysis in a few key regards.

First, to the extent that the real problem is fear, this militates in favour of placebo policies. By that I mean initiatives which appear bold and have great symbolic value, but which don't necessarily cost us very much. I haven't seen us make a major attempt to identify such proposals, but it is unlikely that an $800 billion stimulus fits the bill. I would sooner beef up automatic stabilisers, and aid to state and local governments, and claim that this, along with some regulatory changes, will help the economy. Unorthodox monetary policy, as the Fed is intent on pursuing, should be presented in this guise as well. The reality is that we don't actually know what will work, precisely because the problem goes beyond just stimulating aggregate demand.

I'm not opposed to the idea of “ring fencing” the bad assets on bank balance sheets, but that alone doesn't solve any problems. If the assets are to be bought, the question is at what price. Buying at a low price doesn't help any. Buying at a high price means a giveaway to the banks. Such giveaways might be necessary at this point but they could cost trillions. Today the key problem is that we don't know how to turn zombie banks into real banks.

I'm not sure we should be encouraging consumers to spend so much more. We need to make the painful adjustment to lower levels of spending and debt. Consumers have to spend less at some point and I believe that point is now, however painful the results may be. Mr Blanchard focuses on insufficient spending as a key problem but I am more likely to see the economy as needing to adjust to real shocks. We need to reallocate resources out of construction, finance, and debt-financed consumption. Boosting aggregate demand could make that adjustment harder rather than easier. Mr Blanchard never tells us when he thinks that consumer spending should fall.

Most generally, we all need to keep in mind that trying to restore public confidence is tricky. If you try hard and fail, confidence then plummets and it is even harder next time around. This is a potential problem with both the stimulus approach and the placebo approach.

Most of all, I don't think we are paying enough attention to the placebo idea. It is well known in the medical literature that sometimes placebos work as well as the drugs themselves.