Krugman, DeLong's Keynes Model Flawed, Harvard's Ferguson Says: Tom Keene

The economic assumptions of Paul Krugman and Bradford DeLong are based on “flawed” versions of John Maynard Keynes’s model, according to Niall Ferguson, a history professor at Harvard University.

“They have a flawed Keynesian model in their minds about what fiscal stimulus can do when you already have a highly indebted economy,” Ferguson said in a radio interview today on “Bloomberg Surveillance” with Tom Keene. “We’ve seen this movie in Japan before where you end up with an explosion of public debt but a flatlining economy, and gradually that debt burden, even at low interest rates, begins to be more of a burden than a source of stimulus.”

Krugman, a Nobel Prize-winning economist and a Princeton University professor, said Aug. 30 that the U.S. economy is still fragile and that another $800 billion in stimulus is necessary. DeLong, a former Treasury official who is now a professor at the University of California at Berkeley, said in April that he wanted a bigger fiscal stimulus in the third quarter of 2009.

Keynes’s theory says that government can tax or borrow from the public and use that money to pay people to perform work to stimulate the economy. The British economist came to Washington in 1934 to persuade President Franklin D. Roosevelt to spend more to revive the U.S. economy.

The recession that began in 2008, lined up with the Great Depression, has only progressed as far as July 1932, Ferguson said.

“The recovery we’ve got at the moment is so anemic, so feeble if you look at the developed world, that it would be a very, very rash person who said there is no probability of a double dip,” Ferguson said. “There is a real risk.”

‘Asleep at the Wheel’

The global recovery may weaken as European governments cut spending to push down budget deficits that soared during the recession and signs appeared that the U.S. recovery is waning. Federal Reserve Chairman Ben S. Bernanke said on Aug. 10 that the American recovery is likely to be “more moderate” than previously forecast.

Krugman’s right that the Fed is “asleep at the wheel,” Ferguson said.

“I’m surprised frankly that Ben Bernanke is so relaxed right now,” Ferguson said. “I can only assume he’s constrained by something because his theoretical pre-government work would lead you to expect a much more aggressive stance by the Fed right now. It’s a second round of quantitative easing that we need, not a second round of fiscal stimulus.”

Quantitative Easing

Treasuries rallied and stocks fell after the Fed announced Aug. 10 that it would reinvest principal payments on its mortgage holdings into long-term U.S. debt securities, adding to speculation policy makers would expand purchases in a policy known as quantitative easing if the economy showed more signs of weakening. The central bank bought $1.7 trillion of Treasuries and mortgage agency debt last year.

The U.S.’s unofficial M3 money supply growth, an indicator of future inflation, shows an annualized contraction of more than negative 5 percent, which Ferguson says is a “big deflationary signal.” The Fed no longer publishes figures on M3, which is a money supply category that includes institutional shares in money market funds and term repurchase agreements.

To contact the reporters on this story: Mary Childs in New York at mchilds5@bloomberg.net; Tom Keene in New York at tkeene@bloomberg.net

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