Hoisted from the Archives from Spring 2009: This Is Getting Damned Annoying: Will I Ever Be Allowed to Disagree with Paul Krugman Again About Anything? (Niall Ferguson Edition):
There have been two annoying things about the past decade. The first is that I feel like I have been living in a Ken Macleod novel--and one of the more dystopic ones too, at least up until January 21, 2009 (I am glad he has stopped: Ken: please don't get cranky again).
The second is that the best way to understand the world is through these two rules:
- Paul Krugman's analysis is correct.
- If you think that Paul Krugman's analysis is incorrect, see rule number 1. Most recently, I thought that Paul Krugman must be being too harsh on Niall Ferguson.
Ferguson could not really have forgotten so much economics as to believe that when interest rates are zero deficit spending is inherently contractionary, could he? But Paul said he did:
Liquidity preference, loanable funds, and Niall Ferguson (wonkish): Joe Nocera... fails to mention... the most depressing aspect... further confirmation that we’re living in a Dark Age of macroeconomics, in which hard-won knowledge has simply been forgotten. What’s the evidence? Niall Ferguson ‘explaining’ that fiscal expansion will actually be contractionary, because it will drive up interest rates. At least that’s what I think he said....
I imagine Niall Ferguson was thinking... of... the ‘loanable funds’ model.... Keynes pointed out was that this picture is incomplete if... the economy is not at full employment.... [A]dd ‘liquidity preference’, the supply and demand for money. In the modern world... the central bank adjusts the money supply so as to [try to] achieve a target interest rate.... [But r]ight now the interest rate that the Fed chooses is essentially zero [and cannot go any lower], but that’s not enough to achieve full employment.... So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending... until the excess supply of savings has been sopped up... [and the interest rate consistent with full employment rises above zero]. Now, there are real problems with large-scale government borrowing — mainly, the effect on the government debt burden. I don’t want to minimize those problems; some countries, such as Ireland, are being forced into fiscal contraction even in the face of severe recession. But the fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.
And Krugman reiterated his judgment:
China and the liquidity trap - Paul Krugman Blog - NYTimes.com: By the way, I’ve had a chance to see the transcript of the PEN/ NY Review event, and I don’t think I was misrepresenting Niall Ferguson’s position...
Sure enough, now that I have taken a look at the transcript, I have to once again agree that Paul Krugman's analysis is correct. This is annoying. This is damned annoying. In fact, this is beyond annoying:
Niall Ferguson: Now we are in the therapy phase, and what therapy are we using? Well, it is very interesting because we are using two quite contradictory courses of therapy. One is the prescription of Dr. Friedman, Milton Friedman, that is, that is being administered by the Federal Reserve: massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the 1930s. I am fine with that. That is the right thing to do. But thre is qnother course of therapy that is simultaneously being administered, which is the therapy prescribed by Dr. Keynes, John Maynard Keynes, and that therapy involves the running of massive fiscal deficits in excess of 12 percent of gross domestic product this year and the issuance therefore of vast quantities of freshly-minted bonds.
There is a clear contradiction between these two policies, and we are trying to have it both ways. You cannot be a Keynesian and a monetarist simultaneously, at least I cannot see how you can, because if the aim of the monetarist policy is to keep interest rates down to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.... [T]here is going to be... a very painful tug-of-war between our monetary policy and our fiscal policy...
A real monetarist--like Milton Friedman's teacher Jacob Viner, say--would argue (in fact, did argue during the Great Depression) that when the interest rate is near zero monetary expansion and deficit spending do not offset but reinforce each other, for essentially the reasons set out by Krugman. As Paul said in rebuttal to Ferguson: 'There is... no contradiction between the Federal Reserve's actions and... fiscal stimulus. It is very much necessary to do both...'
Normally the banking system buys bonds from corporations which then spend the money investing in plant and equipment. Right now that process has broken down, and until the banking system gets fixed the second-best is to have the government step into the role. As Krugman writes:
By buying a lot of private securities, the Federal Reserve is... playing the role the private banking system is no longer playing properly... debt-financed spending on infrastructure by the Obama administraiton is filling the hole left by the collapse in business investment.... Conclusion? Once again: There is not an excess demand for savings that is going to drive up interest rates...
Niall Ferguson does indeed know a lot less than economists knew in the 1920s. Back then when R.G. Hawtrey was laying out the Treasury View he claimed that fiscal policy was ineffective--and was wrong. Niall Ferguson's belief that fiscal policy is destructive shows that he has not even got that far.
UPDATE: As a 'friend' points out, Ferguson spent considerable time trying to bait Krugman into losing his cool:
- As d2 points out, the references to 'Dr. Keynes' appear for some reason to work like a red flag to a bull on status-conscious Englishmen--for Keynes never got a Ph.D.--but it doesn't work on Dr. Krugman.
- 'I rather fear that, at the risk of provoking the man sitting on the other side of me, that it says 1936 on the bottle of Dr. Keynes’ medicine...'
- '[I]if you listened carefully to what Paul Krumgan said, he actually agreed with me [laughter]...'
- 'So, I hate to teach arithmetic to a Nobel laureate, it doesn’t quite add up...'
- Madrick: 'Let’s let Paul speak...' Krugman: 'Oh, Dear...' Ferguson: 'Oh Dear indeed...' Krugman: 'Let’s talk national income accounting offstage...'
Hoisted from Summer 209: Eeyore the Donkey vs. Felix the Cat:
Two--substantive--things struck me about Ferguson's column. The first is Ferguson's reversal of field on the stimulus package. Today:
A runaway deficit may soon test Obama’s luck: His stimulus bill has clearly made a significant contribution to stabilising the US economy since its passage in February.... [C]redit where it’s due... the president deserves at least [a] bronze [medal]. According to Moody’s, the ratings agency, the stimulus package has saved more than 500,000 jobs. Without the jump in government spending, GDP would still be in a nosedive.... [T]he stimulus package had a sound macroeconomic rationale...
Ferguson last April:
Now we are in the therapy phase, and what therapy are we using? Well, it is very interesting because we are using two quite contradictory courses of therapy. One is the prescription of Dr. Friedman, Milton Friedman, that is, that is being administered by the Federal Reserve: massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the 1930s. I am fine with that. That is the right thing to do. But thre is qnother course of therapy that is simultaneously being administered, which is the therapy prescribed by Dr. Keynes, John Maynard Keynes, and that therapy involves the running of massive fiscal deficits in excess of 12 percent of gross domestic product this year and the issuance therefore of vast quantities of freshly-minted bonds. There is a clear contradiction between these two policies, and we are trying to have it both ways. You cannot be a Keynesian and a monetarist simultaneously, at least I cannot see how you can, because if the aim of the monetarist policy is to keep interest rates down to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.... [T]here is going to be... a very painful tug-of-war between our monetary policy and our fiscal policy...
Andrew Purcell: Krugman was lost for words. ‘Boy,’ he shook his head, ‘Oh dear.’ He took issue with Ferguson’s sums and with neoconservative economics as a who.... On the core subject of deficit spending, Ferguson could not find a single ally.... [I]n one last defiant gesture, revelling in his role as pantomime villain, reached for the ultimate conservative put-down: ‘If you wanna try the Soviet model, fine...’ Krugman and Soros groaned loudly. The audience booed. Moderator Jeff Madrick interrupted once, then twice, talking over Ferguson’s objections. ‘We’re doing you a good turn by not extending this ten minutes,’ he suggested...
It is progress that Ferguson now [August 2009] thinks the stimulus program has the macroeconomic rationale that he thought it lacked three months ago [in May 2009] when it was 'the Soviet model.' This is good in the same way that it is good for your health status when you stop hitting yourself on the head with a hammer.
The second is that there is still a certain amount of incoherence here:
[T]he two parties would be neck and neck if the midterm elections were held today.... [T]he growing structural imbalance between federal revenue and spending scares the hell out of voters.... The deficit this year is likely to be $1,800bn.... The gross federal debt is just about to bust the $12,100bn limit set by Congress.... [P]ublic debt could rise from 44 per cent of GDP last year to 87 per cent by 2020. Spending on healthcare alone could rise from 16 to 22 per cent of GDP.... The administration itself has no plan to balance the budget. Its own budget forecasts a trillion-dollar deficit as far ahead as 2019.... The nightmare scenario is that mounting fears over US creditworthiness push up long-term interest rates, thereby choking off the nascent recovery.... Anyone expecting private consumption to bounce back is dreaming.... [T]he property crisis is far from over. The number of prime borrowers behind on mortgage payments rose 13.8 per cent between March and June. The business default rate is already above 11 per cent and is heading towards 13 per cent. The contribution of the stimulus to growth... has now passed its peak and by January 2010 will be zero. The public-private partnership to buy toxic bank assets has flopped. The official jobless rate conceals a surge in long-term unemployment to a postwar record...
Most of what worries Ferguson are short-term business-cycle worries--that the stimulus package was not big enough and that the hopes that the PPIP program could massively shrink interest rate spreads and thus boost private investment demand have been largely dashed and that hopes that property prices would start rebounding have failed to come true. These all seem to call for even larger short-run fiscal stimulus: if the private sector isn't spending enough to keep the economy near full employment, the government should.
But Ferguson says--or at least implies--not: his critique is not that the stimulus package was not big enough. Somehow Ferguson believes that these short-term worries are caused by the medium-term fiscal gap between U.S. government revenues and expenditures and the 'nightmare scenario... that mounting fears over U.S. creditworthiness push up long term interest rates.. choking off the nascent recovery.'
Why these are supposed to be linked is not clear. And why the nightmare scenario is to be feared is not clear either...