>>Today’s Keynesians have learnt nothing >> By Niall Ferguson
>>… When Franklin Roosevelt became president in 1933, the deficit was already >>running at 4.7 per cent of GDP. It rose to a peak of 5.6 per cent in 1934. >>The federal debt burden rose only slightly – from 40 to 45 per cent of GDP – >>prior to the outbreak of the second world war. It was the war that saw the US >>(and all the other combatants) embark on fiscal expansions of the sort we >>have seen since 2007. So what we are witnessing today has less to do with the >>1930s than with the 1940s: it is world war finance without the war. >> But the differences are immense. First, the US financed its huge wartime >> deficits from domestic savings, via the sale of war bonds. Second, wartime >> economies were essentially closed, so there was no leakage of fiscal >> stimulus. Third, war economies worked at maximum capacity; all kinds of >> controls had to be imposed on the private sector to prevent inflation. >> Today’s war-like deficits are being run at a time when the US is heavily >> reliant on foreign lenders, not least its rising strategic rival China >> (which holds 11 per cent of US Treasuries in public hands); at a time when >> economies are open, so American stimulus can end up benefiting Chinese >> exporters; and at a time when there is much under-utilised capacity, so that >> deflation is a bigger threat than inflation. << The third point that we don’t have a World War II-type war economy is a point in favor of Keynesianism. Keynesian stimulus isn’t the recommended dosage when unemployment is a low as during WW2. Instead, it’s a medicine that should have been applied during the 1930s. Second, the point “leakage of stimulus” to other countries has already been noted by the Keynesians: the idea is that all or most rich countries should be engaging in stimulus so that it leaks to everyone (including the US), as part of “mutually assured construction.” Third, the issue about US financing of federal deficits using foreign rather than domestic savings is a result of the high dollar exchange rate in terms of Yuan (and similar currencies). If the Yuan (etc.) were revalued, then the federal deficit (and the private-sector deficits) would be financed more domestically. This policy would also slow inflation in China. Also, if more countries were engaging in stimulus, they would likely be lending to each other more, so the whole issue of “domestic savings” becomes irrelevant. BTW, it should be mentioned that the US already lends money to other countries to help finance their deficits. (That is, people in the US buy foreign government bonds.) In discussions of US deficit finance using foreign funds, we should be looking at numbers net of US lending to finance other countries’ deficits. Maybe the change would be small, but it’s important for completeness. >>Are there precedents for such a combination? Certainly. Long before Keynes >>was even born, weak governments in countries from Argentina to Venezuela used >>to experiment with large peace-time deficits to see if there were ways of >>avoiding hard choices. The experiments invariably ended in one of two ways. >>Either the foreign lenders got fleeced through default, or the domestic >>lenders got fleeced through inflation. When economies were growing >>sluggishly, that could be slow in coming. But there invariably came a point >>when money creation by the central bank triggered an upsurge in inflationary >>expectations.<< This is totally irrelevant, since the US economy (and its place in the world) is quite different from Argentina et al. I’d call it a “red herring,” except that Ferguson’s no “red.” >> In 1981 the US economist Thomas Sargent wrote a seminal paper on “The Ends >> of Four Big Inflations”. It was in many ways the epitaph for the Keynesian >> era. Western governments (not least the British) had discovered the hard way >> that deficits could not save them. With double-digit inflation and rising >> unemployment, drastic remedies were called for. Looking back to central >> Europe in the 1920s – another era of war-induced debt explosions – Professor >> Sargent demonstrated that only a quite decisive policy “regime-change” would >> bring stabilisation, because only that would suffice to alter inflationary >> expectations.<< Sargent’s paper is about hyperinflation, not the kind of inflation we had in the 1970s. Only a Thatcherite would confuse the 1970s stagflations with post German World War 1 hyperinflation and the like. >> Those economists, like New York Times columnist Paul Krugman, who liken >> confidence to an imaginary “fairy” have failed to learn from decades of >> economic research on expectations. They also seem not to have noticed that >> the big academic winners of this crisis have been the proponents of >> behavioural finance, in which the ups and downs of human psychology are the >> key.<< Behavioral finance contradicts Sargent’s “rational expectations” perspective. It fits well with the Keynesian perspective. In addition, Sargent’s theory assumes that we’re always at full employment (in contrast to Keynes, who assumed that less-than-full employment could happen, as it does). >> The evidence is very clear from surveys on both sides of the Atlantic. >> People [i.e., rich people?] are nervous of world war-sized deficits when >> there isn’t a war to justify them. According to a recent poll published in >> the FT, 45 per cent of Americans “think it likely that their government will >> be unable to meet its financial commitments within 10 years”. Surveys of >> business and consumer confidence paint a similar picture of mounting >> anxiety. << These opinions partly reflect the fact that people like Ferguson keep on encouraging people to have such opinions. Also, the aftermath of an extremely severe recession is a time when people doubt almost all institutions. (How does business or banking do in the FT’s poll?) >> The remedy for such fears must be the kind of policy regime-change Prof >> Sargent identified 30 years ago, and which the Thatcher and Reagan >> governments successfully implemented. Then, as today, the choice was not >> between stimulus and austerity. It was between policies that boost >> private-sector confidence and those that kill it.<< Keynesian policies can boost private-sector confidence, if done right. If businesses actually start being able to sell stuff for a change, reducing their interest burdens per dollar of sales and the amount of their unused productive capacity, that would boost business confidence in a big way. Similarly, if fewer prospective borrowers and other bank clients were having a hard time paying debts because their incomes are low, that would help financiers’ confidence in a big way. There’s no guarantee, of course, among other things because of the scare tactics of people like Ferguson. “Business confidence” is a tool that pro-business types (like Ferguson and the late Joseph Schumpeter, who actually studied economics) use to fight for short-term business interests, i.e., more deregulation or more anemic re-regulation, tax cuts for the rich, etc. Keynes was very conscious of this issue and argued that what counts is long-run business expectations. In a way, Keynes was a (Fabian) social-democrat, arguing that government policy was needed to save business from its own short-run expectations (Ferguson’s “business confidence”) in order to save capitalism. The question is how to reconcile short-run expectations with long-term ones. Here, Ferguson may be onto something: businesses usually like wars a lot, especially ones that are pro-business (and before the stagflationary effects hit like they did during the late 1960s). World War 2 was thus not only good for capitalists in the long run, but was seen as good for them in the short run. They thought that they might have to make sacrifices – but also that they could do war-profiteering. Is there anything that could reconcile short and long except for a bigger war? Obama is trying, by being (and, more importantly, by appearing) to be as pro-business as possible. According to Ferguson et al, he’s not trying enough. Back in the 1930s, FDR was criticized (by Schumpeter) for scaring business and for allegedly stretching out the depression, even though he tried to appear pro-business too. But I don’t think that’s right. FDR had an advantage that made him okay as far as business was concerned: he wasn’t fascist or communist (except in the eyes of some extremists) and back then, the fascists and communists were very scary to the businesscritters. This largely cancels out the Schumpeter effect. The fact that FDR didn’t engage in Keynesian stimulus until “Dr. Win the War” took over explains why the depression persisted. Maybe if there were more people criticizing Obama from the left, maybe that would convince business to see him as the “lesser of two evils” so that his pro-business approach would have a more positive impact on business expectations. -- Jim Devine "All science would be superfluous if the form of appearance of things directly coincided with their essence." -- KM _______________________________________________ pen-l mailing list [email protected] https://lists.csuchico.edu/mailman/listinfo/pen-l
