DeLong vs. Ferguson...

This post was prompted by two dueling op-ed pieces by Brad Delong and Niall Ferguson in today's Financial Times.  The two sides can be best summarised by their respective titles:

• "It is far too soon tom end expansion," and
• "Today's Keynesians have learnt nothing"

I am a big fan of the work of Hyman Minsky which figures prominently in DeLong's piece and I would highly recommend Minsky's "Stabilizing an Unstable Economy" to anyone interested in macroeconomics and financial crises.  Minsky's argument, which is aptly summarised by DeLong, is that in a recession (or depression) brought about by a financial crisis there is an excess demand for safe, risk-free financial assets.  This excess demand is then balanced by excess supply in the labor market (i.e., high levels of unemployment).  Given his diagnosis, Minsky's remedy is to have the government expand the supply of safe, risk-free financial assets by acting as the "lender of last resort." From a practical standpoint, this can be done in three ways:

1) Expand the money supply.  This is the monetarist's cure...
2) Create reserve deposits...
3) Further expand the supply of safe, risk-free government bonds by selling them and using the proceeds to buy risky private sector securities...

All of this rests on the implicit assumption that people view government issued and backed securities as safe and risk-free.  What happens if this is not the case? or perhaps more importantly, how can we tell if people are starting to alter their risk-free expectations concerning government securities?  DeLong argues that financial markets will send a strong signal (in the form of rising interest rates on government securities) when people have had enough expansionary policy, and that currently these markets are sending strong signals (in the form of falling interest rates) that additional expansionary policy is needed.

Ferguson's argument has a predictably more historical flavor, and compares today's economic environment with the economic environment leading up to the second World War.  See here, and here for substantive critiques of his argument.  In the end he arrives at the conclusion that the real debate is not between austerity policies and expansion policies, but between those policies that increase private-sector confidence and those that do not.

Now...if you believe that Minsky's diagnosis is correct, then policies whose sole purpose is aimed at boosting private sector confidence will not help very much (and could very well be counterproductive).  Increased private sector confidence is typically interpreted to mean increased private sector investment.  As such policies aimed at increasing private sector confidence are typically designed to induce private sector investment.  The reason that such policies will be ineffective is that a la Minsky, the excess demand is for safe, risk free assets and NOT for private sector securities (which are inherently risky).