“[Historian Niall] Ferguson and [economist] Paul Krugman ... locked horns at a public symposium in New York on April 30. The historian ... asserted that large fiscal deficits would push up long-term interest rates. This implied they would have a zero stimulatory effect: public spending would simply "crowd out" private spending. An enraged Mr Krugman responded ... that Keynes had proved that such crowding-out could occur only at full employment: if there were unemployed resources, fiscal deficits would not drive up interest rates without also expanding the economy. Prof Ferguson's ignorant remarks only confirmed that "we're living in a Dark Age of macroeconomics, in which hard-won knowledge has simply been forgotten".
However, this is not a debate between economists and historians. It is a battle within the economic profession – between the New Classical Economists and the New Keynesians. What is fascinating is that it is an almost exact rerun of the debate between Keynes and the British Treasury in 1929-30. The Treasury view was that bond-financed public spending was bound to diminish private spending by an equal amount. Keynes replied that if this were true it would apply to any new act of private spending. "In short, the fatalistic belief that there can never be more employment than there is is altogether baseless". ....
Are we doomed to rehearse the same arguments time and again? In this particular debate, I am on Prof Krugman's side, but I do not agree that Prof Ferguson's position represents a retreat to a phlogiston state of economics. This is to take economics to be like a natural science, which Keynes never believed it was ....
Ultimately, the Keynesian revolution was a triumph not of good science over bad science, but of good judgment over bad judgment.”
Robert Skidelsky, "Economists clash on shifting sands", Financial Times (10 June 2009).
www.ft.com/cms/s/0/31e89136-5511-11de-b5d4-00144feabdc0.html
www.skidelskyr.com/site/article/economists-clash-on-shifting-sands/
Historian Robert Skidelsky (1939-) is a member of the British House of Lords and author of a prize-winning biography of the economist John Maynard Keynes. Niall Ferguson (1964-), a British citizen from Scotland, is the Laurence A. Tisch Professor of History at Harvard University and the William Ziegler Professor of Business Administration at Harvard Business School. His specialty is financial and economic history and the history of empire. Paul Krugman (1953-) is a professor of economics and international affairs at Princeton University, a centenary professor at the London School of Economics, and an op-ed columnist for The New York Times.
As background, let me mention that the New Classical Economics emerged as a school of thought during the 1970s. It views macroeconomics from the perspective of neo-classical economic theory, rather than Keynesian theory, and stresses the importance of rooting macroeconomics in the behavior of microeconomic agents that are utility-maximizing and possess rational expectations. In a New Classical Economics framework, the economy is seen as having an equilibrium at full employment and maximum potential output, which can be achieved through market-clearing adjustments to prices and wages. Niall Ferguson is seen as in the classroom of this school of economic thought, which captured much of the intellectual momentum of the past few decades, with its adherents winning several Nobel Prizes in Economics. The tenets of New Classical Economics underlies much “conservative” economic thought today.
New Keynesian Economics was developed in reaction to the New Classical Economics. It strives to provide microfoundations for Keynesian economic analysis. The New Classicals called into question many of the precepts of the Keynesian revolution, especially as they relate to the “stickiness” of prices and wages. New Keynesians, in contrast, maintain that the market clearing approach of the New Classicals cannot explain short-term economic fluctuations, and they say the failure of prices and wages to adjust quickly to new conditions leads to involuntary unemployment and recurrent declines in economic activity. Add to this failures of coordination among economic actors and imperfect labor markets and in the view of New Keynesians you have the possibility of deep and prolonged downturns in economic activity. Paul Krugman can be seen as a member of this school of thought, which is shared by many economists in the Obama Administration.
Now, no one economist actually adheres completely to the tenets of any school of thought and these two competing sets of ideas are not the only ones in circulation today. They can in some sense, however, be seen as a continuation of the old non-Keynesian vs. Keynesian debates of the past. The debate between these two contemporary schools goes way back, and today’s debates are merely the latest incarnation of a long intellectual fight. If you want to think of it in the simplest terms possible, New Classicals think that economies adjust to the constant changes introduced by new technologies, different consumer preferences and investor opportunities, exogenous shocks from abroad and stupid government policies at home mainly by changes in (relative) prices and wages, with some (but not much) change in output and employment levels. New Keynesians, on the other hand, think the opposite, namely, that all the changes occurring in the economy lead mainly to ups and downs in employment and economic activity, and only secondarily to changes in (relative) prices and wages. Exaggerating, but with much truth, the fights about fiscal policy you see in Washington today are between these two groups and their different views on the nature of the economic adjustment process underlying economic change.
Let me quickly add that politicians know little or nothing about this debate and could not care less about it. They are not thinkers and are often blind to the forces that shape the present and the future. But whether they realize it or not they are dependent very much upon advisors who are rabid participators in the debate, with strong view that they are right and the other camp is wrong. The success of Barack Obama’s terms in office, whether he realizes it or not, will depend critically on whether the New Keynesians advising his Administration are right or wrong in their assessment as to exactly how the economy adjusts to the problems it confronts.
While the spat between Ferguson and Krugman appears to be about bond yields and the inflationary pressures of large deficits, it is really about the adjustment process and the role of government. If, as Ferguson and conservatives insist, the macroeconomic adjustment process plays out mainly through the price system and the changes that take place to relative prices and wages, as New Classicals insist, the Administration’s policies will aggravate the difficulties before the economy and delay any recovery. Interfering with prices and wages, they will argue, is interfering with adjustment process.
If, as Krugman and liberals insist, the macroeconomic adjustment process works mainly through large changes in incomes and employment because prices and wages refuse to adjust, policy must both mitigate the adverse impact that job losses have on welfare and directly counter the decline in aggregate demand. Hence, the Administration’s stimulus package and Krugman’s argument that public spending cannot crowd out private spending. Sticky prices and wages mean government spending affects quantities (output and employment), not prices (and hence, not the price adjustment process).
To conservatives, prices and wages are not that sticky and government policy cannot help an adjustment process guided by changes taking place simultaneously in millions of different prices and wages, although it might be helpful mitigating the negative effects of any downturn on individuals who are particularly hard hit. To liberals, government policy can control the adjustment process, indeed, the entire economy, because it can set the level of aggregate demand and in doing so determine quantities produced and jobs provided. Prevailing prices, in their view they are sticky, are divorced from cost and demand considerations anyway. One sees the economy best guided by a flexible price system; the other sees the economy as one that can be shaped by mandates and commands to perform better.
Skidelsky sides with Krugman. I side with Ferguson, both on the narrow question of the impact of large deficits causing rising bond yields and, ultimately, inflation and on the broader question of the nature of economic change and the adjustment process. I also fear the power of government as corrupting and threatening to freedom.
A Tdj by Doug Walker with thanks to Larry Willmore for the pointer.
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