Liberal Vision

Niall Ferguson on fiscal stimulus

In yesterday’s Financial Times, the historian Niall Ferguson writes:

[W]hat 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.

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…

Also in the article, he notes (almost in passing) that:

In an influential paper published earlier this year, Carmen Reinhart and Kenneth Rogoff warned that debt burdens of more than 90 per cent of GDP tend to result in lower growth and higher inflation.

If memory serves, the Labour budget earlier this year referred to a then-current national debt of c.£800 billion, rising to £1,400 billion by 2014. That is likely to be roughly equal to GDP even if we recover and grow quite well over the next few years.