Niall Ferguson on Keynesianism

Steve Baker’s researcher, Tim Hewish, found an interesting CNN interview with Niall Ferguson on the US approach to the economic crisis:

… the way that the discussion is conducted it seems like there is only a Keynesian option and the alternative is just sort of passively waiting for disaster. I think there is a better strategy that we could adopt. Imagine radical fiscal reform that attacked not only the entitlements problem — that fundamental problem of Medicare and Social Security that is going to bankrupt the country if something isn’t done — and rationalised the tax code: simplified income tax, maybe even created just a simple flat tax rate; simplified, and indeed reduced corporate tax; created a federal sales tax. There is a way of creating a confidence-boosting fiscal reform … I’m depressed at how few people in Washington are prepared to talk about this option.

And later on:

one reason I’m sceptical of [Krugman’s proposed] response is that we used to do this. It’s not like we haven’t tried Keynesianism in the past. Indeed it was orthodoxy for most of the 60s and 70s that what you did in the face of unemployment was that you ran deficits and printed money. And guess what we ended up with? The 1970s — stagflation: double digit inflation and low growth. I don’t quite understand why Keynes is suddenly so fashionable … we need to look at some radical alternatives.

In his Ascent of Money, Ferguson takes a view of economic history that many Cobden Centre readers would question. Even after the financial crisis, he wrote,

The historical reality, as should by now be clear, is that states and financial markets have always existed in a symbiotic relationship. Indeed, without the exigencies of public finance, much of the financial innovation that produced central banks, the bond market and the stock market would never have occurred.

Read into that what you will. Personally, I suspect that two parasites can coexist symbiotically on a shared host. More encouraging was Ferguson’s December 2009 endorsement of Laurence Kotlikoff’s Limited Purpose Banking proposals.

Mutual funds are, effectively, small banks, with a 100 per cent capital requirement under all circumstances. Thus, LPB delivers what many advocate – small banks with more capital. Will this work? It has. Unlike so much of the financial system, the mutual fund industry came through this crisis unscathed. True, the Primary Reserve Fund broke the buck by investing in Lehman and had to be bailed out. But under LPB only cash mutual funds (invested solely in cash) would never lose investors’ principal. The first line of all other funds’ prospectuses would state: “This fund is risky and can break the buck.”

In any case, this interview is worth watching. High profile questioning of Keynesianism is always welcome.

There’s a follow-up article on Ferguson’s website:

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One reply on “Niall Ferguson on Keynesianism”
  1. Nail Ferguson may be a good historian. His grasp of economics is hopeless as is that of much of Capitol Hill and the U.S. political elite. Fergusson’s opening few sentences are thus.

    “We are going to have to come to terms with the reality of tax increases or spending cuts quite soon if the US is to retain some sort of fiscal credibility with the international bond market. Now that is a very unpleasant set of options that treasury secretary Geisner is contemplating. If you go for another stimulus, but the financial markets say “that’s a stimulus too far, they’ll charge you a higher interest rate for your borrowing” then you end up in a worse place. If you go for fiscal tightening and tax increases are coming, then you risk choking off the recovery.”

    First, the idea that the U.S. needs to borrow more to fund more stimulus is bunk (which is what Fergusson seems to be saying). Both Keynes and Milton Friedman advocated plain old money printing for stimulus purposes. As to Freidman, see here:

    Second, there is no RATIONAL reason why markets should charge more given a money printing stimulus as long as the AMOUNT printed is enough to raise employment but not so much as to cause excess demand and hence excess inflation. (Another cautionary note is that Western economies cannot just pump themselves back up to where they were pre-crunch without fundamental bank reform, else we just get another crunch. But my guess is that Basle III plus a few extras might do the trick (as is being implemented in Switzerland, I think)).

    Third, if the markets want to behave IRRATIONALLY and up interest rates because they THINK that money printing is necessarily inflationary, that is still not a problem for the U.S. and for the following reasons.

    i) The increased interest only applies to NEW debt or debt being rolled over, rather than to existing U.S. national debt. So all the U.S. need do here is a calculation as to what is in its best interest, roughly along the following lines. If the markets up interest by 1%, and the consequential additional amount of interest paid to foreigners is less than the rise in GDP attributable to the stimulus, then the country on balance will gain.

    ii) On the other hand if the markets want to charge silly rates of interest, all the U.S. need do is print dollars with which to repay debt as it comes up for roll over, which on its own would be too inflationary. So that needs to be mixed with a DEFLATIONARY method of debt repayment: get the money for repayment from tax increases or spending cuts. (for more on this, see here:

    Assuming the above stimulatory and deflationary methods of debt repayment are mixed in the right proporion, the net effect on aggregate demand is neutral or zero, thus there is effect on the recovery.

    Whether the above debt epayment results in a standard of living hit for U.S. citizens depends on what foreign Treasury holders do with their money. To the extent that they just plonk it in U.S. banks earning little interest, U.S. living standards would rise in line with the increased GDP coming from raised aggregate employment. Alternatively if they take the money out of the country, the dollar falls in value and that means lower living standards for a few years than would otherwise obtain (possibly reduced living standards).

    As to Fergusson’s claim that tax increases would “choke off the recovery”, there would be no “choke off” in the sense that raising employment levels is thwarted. In that living standards would be less than they might be, well, repaying creditors costs, and that’s that. Borrowing short is always a risk.

    And finally, note that to the extent that foreigners plonk their money in U.S. banks where it does nothing, there would be no demand increasing and no inflationary effect, and thus no need for the above mentioned tax increases.

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