Ferguson versus Krugman

Two prominent public-policy intellectuals are in the midst of a very public dispute over the threat of higher interest rates.

I refer to Paul Krugman, professor of economics at Princeton University -- and the most recent recipient of the Nobel Prize in that field, who believes the present difficulties can and should be addressed through Keynesian fiscal stimulus, and that the present administration is not doing nearly enough of it, and Niall Ferguson, an Oxford-trained historian, author most recently (and pertinently) of THE ASCENT OF MONEY: A FINANCIAL HISTORY OF THE WORLD, who thinks both that higher rates are a grave threat and that President Obama's massive spending plans are compounding it.

The spat began, as near as I can tell, on April 30, when both men appeared as part of a panel discussion of the ongoing financial crisis hosted by PEN, the writers' association.

Ferguson said, "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," is likely to push interest rates up, although the administration appears to be of the (Keynesian) opinion that such policies will push interest rates down, stimulate borrowing, thereby stimulating the economy.

Krugman defended that Keynesian opinion, and on this point at least the adninistration. Krugman said, "There's a global savings glut ... There is no excess demand to drive up interest rates."

On May 2, in his column in the New York Times, Krugman was much more emphatic at blasting Ferguson. He said that it is "sad" that Ferguson hasn't studied the right textbooks. Indeed, Ferguson's ignorance is so great it is "confirmation that we're living in a Dark Age of macroeconomics." Then he takes us through a condensed lesson on the Keynesian view of how interest rates are formed. Four supply-and-demand charts in the course of a single newspaper column. Surely that counts as what economists and historians both would consider a glut!

The government can and should keep on borrowing the money it needs, however scary the deficit numbers look, because Krugman assures us, this borrowing: [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, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap.

Over the days and weeks since Krugman made that confident assertion, market interest rates have headed ... up. The economy does not seem to have escaped from the trap it is in just yet, so why are they heading up? It may be too early to declare victory for Ferguson on this point, but it is understandable that he has already declared victory for himself.

Krugman, after all, isn't the only one in this debate though who can argue from out of the pages of a major newspaper. Ferguson is a contributing editor at the Financial Times. And from that post, he has had this to say.

In the event you are too impatient to read that, I'll give you the final graf here:

In the absence of credible commitments to end the chronic US structural deficit, there will be further upward pressure on interest rates, despite the glut of global savings. It was Keynes who noted that “even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist”. Today the long-dead economist is Keynes, and it is professors of economics, not practical men, who are in thrall to his ideas.