What both Krugman and Ferguson miss

Each week, Symposium Magazine invites authors to guest-blog. This week’s featured article is Why U.S. Financial Hegemony Will Endure by Sarah Bauerle Danzman and W. Kindred Winecoff.

Two of the most prominent academics in the United States are squabbling again. Niall Ferguson, a historian at Harvard, believes that sovereign debt is a major concern. Paul Krugman, economist at Princeton and Nobel laureate, disagrees. Ferguson has now accused Krugman of repeatedly making incorrect statements regarding the future of the euro.

These two generate more heat than light when they engage each other, but what’s interesting is what their disagreement is really about: models. Krugman bases his worldview on relatively simple extensions of Old Keynesian models, such as the IS-LM model. Ferguson has taken his lessons from history. According to Krugman, political demands for public-sector austerity have ravaged countries from southern Europe to the North America. Ferguson believes that severe debt crises are in our future if public budgets are not consolidated now.

Both approaches give insufficient attention to the patterns of financial interdependence in the global economy, and how that conditions outcomes in dynamic systems. Ferguson does not acknowledge how the dollar’s role at the core of the world’s financial network provides significant advantages regarding debt management. This take a page from the nineteenth century, when the United Kingdom served in that capacity and was able to service debt in excess of 200% of GDP. Today, the U.S. currently pays negative net interest on its debt once inflation is considered. Moreover, since this is a dynamic and adaptive system, this status is unlikely to change. So while Ferguson may be correct about Ireland, the United States is not Ireland.

Ireland is Ireland, however. Krugman’s assertion that austerity has harmed European growth may be accurate, but it is not especially useful. The extreme imbalances in the eurozone resulted from particular forms of economic interdependence generated by divergent development models in the eurozone.

While Krugman realizes this, he does not seem to fully grasp the implication: austerity was inevitable because some European sovereigns tried to move closer into the core of the world economy by increasing their foreign indebtedness. Austerity could come in a variety of forms – internal devaluation in the indebted countries, external devaluation through leaving the eurozone, or defaults that push adjustment onto creditors – but it cannot be avoided. So Ferguson is probably correct in stating that macroeconomic adjustment is required to put these economies on a sustainable long-term trajectory, even if Krugman is correct that demand shortfalls have an immediate depressing effect.

Fortunately, our network model suggests that the amount of exposure others have to the European periphery is limited. This was revealed when Greece partially defaulted on its obligations, when Cyprus was cut off from the rest of the financial network almost entirely, and at every other stage of instability in Europe. This, too, is something that neither Ferguson nor Krugman can adequately explain; it’s not in their models. Our model suggests that global financial health is determined by American financial health, and American financial health is improved by its position at the core of the system.

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