The Stash

Niall Ferguson Hits Back

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Ferguson, who's carried on a back-and-forth with Paul Krugman this last month, took to the FT yesterday to weigh in on the inflation question Zubin highlighted. Not surprisingly, he sides with the John Cochrane view and against Krugman. Like Cochrane, he notes that the Fed has had to print money to keep interest rates low by buying government-issued debt (actually, no one disputes this). Like Cochrane, he argues that this extra money will likely create inflation (this is where he and Krugman disagree). In the meantime, interest rates are ticking up anyway as investors and foreign governments get queasy over the U.S. fiscal position and dump U.S. debt (the Fed can only buy up so much, after all). Or, as Ferguson puts it:

The fact is that people – not least the Chinese government – are already distinctly dubious. They understand that US fiscal policy implies big purchases of government bonds by the Fed this year, since neither foreign nor private domestic purchases will suffice to fund the deficit. This policy is known as printing money and it is what many governments tried in the 1970s, with inflationary consequences you do not need to be a historian to recall.

No doubt there are powerful deflationary headwinds blowing in the other direction today. There is surplus capacity in world manufacturing. But the price of key commodities has surged since February. Monetary expansion in the US, where M2 is growing at an annual rate of 9 per cent, well above its post-1960 average, seems likely to lead to inflation if not this year, then next. In the words of the Chinese central bank’s latest quarterly report: “A policy mistake ... may bring inflation risks to the whole world.”

The policy mistake has already been made – to adopt the fiscal policy of a world war to fight a recession. 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.

I guess my question is the question Krugman highlighted in his column, and which Zubin touched on in his post: As long as the banks are just sitting on the extra reserves created by the Fed's printing press, what's the mechanism for producing inflation? Is the argument that it will be difficult to vaccuum up the money once the banks stop sitting on it? (I guess that's part of Cochrane's argument.) Would they stop sitting on it while the economy is still operating at well-below potential? I wish I had answers...

--Noam Scheiber

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