This is literally the most influential article cited in public and policy debates about the importance of debt stabilization, so naturally this is going to change everything.
Or, rather, it will change nothing. As I've said many times, citations of the Reinhart/Rogoff result in a policy context obviously appealing to a fallacious form of causal inference.
nobody is ever willing to make the kind of cutbacks needed to balance that spending. In fact, since 1969, the only president who did not run a deficit every single year was Bill Clinton.
I would note in particular that the entire debate completely fails to acknowledge the main flaw in the R&R research. As they themselves acknowledge in the response, the empirical correlation that we're arguing about is completely irrelevant to the policy debate at hand. They write that "we are very careful in all our papers to speak of 'association' and not 'causality.' " This genuinely ought to settle the debate. Nothing Reinhart and Rogoff present, under any interpretation or any methodology offers any reason to believe that a high debt:GDP ratio causes slow growth. Yet much political rhetoric, including some from Reinhart and Rogoff themselves, presents their work as offering important policy guidance.
It's great that when challenged they retreat to the more defensible claim that their work is actually irrelevant, but many policymakers and pundits seem to feel otherwise.
@brianbeutler: Just got the R-R statement, timestamp 5:07p.m. Clearly placement on their priority list inversely related to debt/earnings ratio.
Third, they point out that even cleaned-up data do show a negative association between debt and growth. Yes, but that’s where the issue of reverse causation comes in.
But I’ve coded the points by country — and if you look at it, you see that most of the apparent relationship is coming from Italy and Japan; Britain didn’t seem to suffer much from its high debt in the 1950s. And it’s quite clear from the history that both Italy and (especially) Japan ran up high debts as a consequence of their growth slowdowns, not the other way around.
Science is kudzu, it grows wherever it finds the materials; the first paper in an area doesn't need to be right, it needs to have grandchildren -- be cited later by other work looking into the interesting questions raised.
moorooka: No matter what the debt ratio, a sovereign government that issues its own currency can choose to grow the economy.
No matter what the debt ratio, a sovereign government that issues its own currency can choose to grow the economy.
We noticed that their data just did not add up. Leave to the side the silliness of simply aggregating across 8 centuries of experience, and adding up debt ratios of countries as disparate as the USA today or, say, Greece in 1932, let alone some feudal state operating on a gold standard a couple of hundred years ago. As I’ve remarked, any real historian would find the methodology ludicrous.
More importantly, they have no idea what sovereign debt is. They add together government debts issued by states on gold standards, fixed exchange rates and floating rates. They aggregated across governments that issue debt in their own currency and states that issue debt denominated in foreign currency. It is not even possible to determine from their book exactly what is government debt versus private debt.
When we couldn’t make sense of their results, Yeva wrote to them to get the data. After all, their book touted their contribution to good research by proclaiming they were accumulating all this data for the good of humanity. They ignored our request. I have heard from several other researchers that Rogoff and Reinhart also ignored their repeated requests for the data.
So, finally, someone was able to obtain the data. And as we suspected, it did not add up. Rogoff and Reinhart committed the cardinal sin of academics: while their purported results fit their theory, the data they supposedly used does not. Either they fudged or they erred. It really doesn’t matter. Their results were completely, utterly wrong. And their own data proves it.
the man of twists and turns: "George Osborne should ease off on austerity, IMF warns"
However, in practice, it's political suicide to cut spending during a healthy economy, so Keynesian economics usually ends up with the government spending more during a recession (as a stimulus package) and then even more when the recession ends (because the economy is healthy).
However, recessions are the only time that it is possible to make significant long-term cuts to government spending since it's the only time that the bleating masses are frightened enough that they will allow politicians to take an axe to all that dead wood without fear of hurting their careers.
From 1993-2001, spending as a percentage of GDP went down significantly, and taxes as a percentage of GDP went up significantly.
Most politicians are nowhere near Clinton's level of competence, and thus will not be able to get the public to accept the cutbacks that he did. A sensible economic system should understand and allow for this level of mediocrity. Keynesian economics does not - it assumes a government that is capable and willing of forcing the public to accept cutbacks during times of economic prosperity.
Increasing taxes and reducing spending during boom times are both appropriate Keynesian interventions, and there are other examples outside of the Clinton years where taxes were raised during good times to avoid overheating the economy, e.g. in the early to mid 1950s and the mid to late 1960s.
I only cited the Romer/Romer paper to show that I'm not substituting my own judgement for which tax cuts were explicitly counter-cyclical and which just happened to occur during boom times. It's by no means the core of my argument.
If you're too busy to read the paper or whatever, I'd settle for an affirmative case for your original position that Presidents/Congresses don't do Keynesianism during booms. You keep saying these things as if they're established fact, but they're not. There are several more falsehoods, generalizations, and fact-free assertions in your comment, but I'm not going to bother rebutting those unless you can back up your original point that all of this is built on.
Since you haven't tried to connect those dots yourself, I created this chart showing expenditures and receipts as a percentage of GDP on the same graph to make it easier. A 100% ideal application of Keynesian economics would mean that red (spending) goes up and green (taxation) goes down in the shaded regions, with the opposite (red goes down, green goes up) in between them. (This gets a bit fuzzy, since you can be outside the shaded recession area but still not have a healthy enough economy to begin increasing taxes and cutting spending, (e.g. right now) but it's close enough for this discussion.)
So let's take a look. We could just eyeball the graph, but I wanted as accurate a look as possible, so I pulled the source data into Excel. What I've found is that, of 23 distinct intervals in the graph (12 "booms" and 11 "busts"), Keynesian spending was correctly applied 18 times, and Keynesian tax policy was correctly applied 21 times. In boom times (the times you said politicians always increase spending) spending as a percentage of GDP went down 9 out of 12 times, and taxes as a percentage of GDP went up 10 out of 12 times.
observation_date: beginning of the recession or healthy economic period being measured
Recession?: whether the observation period is a recession or not
FGEXPND_GDP: federal spending as a percentage of GDP
FGRECPT_GDP: federal receipts as a percentage of GDP
SpChg: Spending at the end of the period minus spending at the beginning of the period
KS: 1 if spending during the observation period was countercyclical, i.e. if it went up during recessions and down during non-recession periods.
RcChg: Revenues at the end of the period minus revenues at the beginning of the period
KR: 1 if tax revenues were countercyclical i.e. went down during recessions and went up during non-recession periods
A statistical study that merely establishes the existence of a broad correlation between high debt and slow growth is uninteresting in this context because the correlation is easily explained by reverse causation (slow growth causes high debt:GDP ratio) and the interest rate channel. The question is whether there's some other reason—macroeconomic dark matter—to worry about debt accumulation even when the interest rate channel is irrelevant.
The allegedly interesting Reinhart and Rogoff empirical finding in this regard was the discovery of a debt tipping point that occurs at a debt:GDP ratio of 90 percent. Such a tipping point is difficult to explain in terms of interest rate dynamics, and thus is either a random statistical artifact or else evidence for the existence of dark matter. Since the original publication of their study, R&R have been engaged in a loud and noisy political activist campaign in favor of the dark matter interpretation of their research. What we see not only from their critics but also from their response is that there is no evidence of dark matter.
When pressed R&R disavow having evidence for any strong causal claims. It's also clear that their research method is inappropriate for judging the tipping point question. What they did was put countries into different buckets and discovered that growth was slower in the >90% bucket than in the <9>9>
It's an imperfect analogy, experts say. The United States has important levers that families do not: It can tax citizens, and it has enormous access to global credit markets, so government can treat debt differently. Still, the comparison is appealing to politicians eager to explain and simplify their budget strategies. And, limited though it may be, putting federal and household budgets side by side reveals the basic philosophical differences between the two parties.
A little bit of economics can be a truly terrible thing, for the introductory classes in micro and macro-economics are the most dogmatic and myth-filled part of the neo-liberal curriculum. Dogmas that have been falsified for 75 years (such as austerity) are taught as revealed truth. The poor indoctrinated student is then launched into the world “knowing” that austerity is the answer and that mass unemployment and prolonged recessions are small prices to be paid (by others) to achieve the holy grail of a balanced budget. Students are taught that national budgets are really just like household budgets. These dogmas are not simply false, they are self-destructive and cruel.
Here’s another way to put it. Let’s concede the weighting point for the sake of argument. If Reinhart and Rogoff had not made any spreadsheet errors in their original paper—that is, if the only factors at issue were country weighting and data exclusion—they would have calculated average GDP growth in the high-debt category of 0.3%. If they then added the additional country-years as they expanded their data set, while sticking with their preferred weighting methodology, that figure would have jumped to 1.9%—and the 90% “cliff” would have completely vanished. (See Herndon et al., Table 3.) What happened is that Reinhart and Rogoff’s choice to weight by country rather than country-year makes their method extremely sensitive to the addition of new data.
The question to ask is this: If a method produces results that can drastically change by the addition of a few more data points, are those results worth anything? The answer is no.
If governments tax too much, they ruin investment spending and fewer new businesses get created. If they print too much money, then inflation runs out of control and the currency collapses in favor of alternate black-market currencies that are more stable. If they default on their debt, then institutions and other nations charge a disproportionate amount for goods and services to compensate for the risk they are taking in accepting that currency, and they we're back to the hyperinflation scenario again.
Right now I am having trouble in wrapping my mind around the thinking of the intellectual adversaries of my little band, my Light Brigade of believers that fiscal policy right now is not expansionary enough. I am having a hard time figuring out not who our intellectual adversaries are--we know who they are--but how and why they think. What is the case they want to make against the aggressive use of expansionary fiscal policy right now, given the very sad state that the OECD economies are in? ...
this isn't a Hayekian recession in which we invested too much in housing capital and must suffer until the housing overhang is worked off.
It’s thus a great moment for the government to print money and buy stuff and so put people to work. From a societal point of view, it doesn’t cost anything--nobody's taxes have to go up to amortize the interest-bearing debt because their is no interest bearing debt. From a societal point of view, it is win-win. What is the downside? ...
I divide the adversaries into three groups. The first group is the pain caucus: the people who think that depression is in some strong sense functional and healthy for an economy...
The second group of adversaries is the "we don’t do our homework" caucus--people who say things they really shouldn’t say....
But there is also a third troop of adversaries: serious doubts from real economists. ... This is what John Quiggin now calls "zombie economics". No matter how many times they are defeated and staked, the same ideas keep coming back, and back, and back.
The high-status thing to say is always that politicians focus too much on the short term and we ought to be worried about the long-term fundamentals. And back in 2009 and 2010, you certainly heard a lot of this kind of rhetoric that was aimed at establishing the seriousness of the speaker by disparaging the idea of juicing the economy in favor of the need to work on the long-term economic fundamentals. But six months is a relatively short span of time in the course of human history. And it turns out that a six-month spell of unemployment leads to a significant decrease in a potential worker's attractiveness to employers. That means a six-month spell is relatively likely to turn into a yearlong spell or a two-year one. And that kind of prolonged absence from the labor force doesn't just represent lost income and economic output for two months or 24 months. It represents lost opportunities to learn on-the-job skills and build organizational capital. It represents a worker who'll probably drop out of the workforce altogether if he can get himself eligible for disability benefits or plausibly recast herself in a socially validated housewife role.
Back in the 1940s, our Depression-era version of this problem was solved by World War II. When mass conscription is on the agenda, suddenly weak labor force attachment or statistical discrimination against the long-term unemployed isn't a big deal. But we (hopefully) won't have a new gigantic war. Consequently, 10 or 20 years from now, we're going to be poorer than we would've been had we responded more effectively in 2009 and 2010 to restore full employment. The failure to adequately and appropriately address the economic short term is proving to be a long-term disaster.
The counter-Keynesian arguments fell into two broad categories. The first is that the economy has no short-term, demand-driven cyclical problems that the government can address and that the real problems come from the supply constraints of our economy. The second focuses on the discovery of serious limits to how much debt a country can carry, as well as evidence that austerity can create enough growth to offset itself.
Though austerity seekers move effortlessly between the two, those are separate lines of argument, the first having to with the issue of supply, the second with the issue of universal limits. And neither has done particularly well in the past several years.
The interesting part of the first set of arguments is that despite their pessimistic view of government’s effectiveness, they usually depend on government-provided data rather than market information. Worse, those data usually turn out to be wrong.
As for the second line of argument, anyone who’s read Timothy Mitchell’s excellent book on the creation of the Egyptian economy through colonialism, “Rule of Experts,” should know that when economists show up claiming to have found “principles true in every country,” you should watch out. And sure enough, the most notable thing about the second wave of arguments was how they were meant to abstract from the specific situations countries face.
First: note well: no cliff at 90%.
Second, RRR present a correlation--not a causal mechanism, and not a properly-instrumented regression. There argument is a claim that high debt-to-GDP and slow subsequent growth go together, without answering the question of which way causation runs. Let us answer that question.
The third thing to note is how small the correlation is.
You are insolvent when you can't pay your debts. Households and firms have struggled with insolvency for centuries. Insolvency is usually a balance sheet concept based around the valuation of assets. When the value of your assets is less than the value of your liabilities, you are insolvent. Usually you work out a repayment schedule with your creditors via a restructuring process.
For countries the notion of national insolvency is a newer, and potentially very misleading, idea. Countries aren't corporations. Technically almost every country would be insolvent if if was asked to pay all of its debt using its available assets. All governments in practice secure their national debts on their abilities to levy taxes. You can't really repossess a country, in fairness.
Adam Posen: A dose of reality for the dismal science: A casual perusal of 20th-century economic history, let alone more rigorous econometric analysis, turns up multiyear periods in the UK and US following the second world war, and in Belgium, Italy, and Japan in the past 20 years, when public debt was greater than 90 per cent of GDP but nothing much happened. Either stagnation in economies led to slowly rising debt levels, as in Italy or Japan of late, or growth returned and debt levels declined, as in the UK and US in the 1950s.
You can already see quite a few people reacting to this affair by declaring that macro is humbug, we don’t know anything, and we should just ignore economists’ pronouncements. Some of the people saying this are economists themselves!
But the truth is that basic macroeconomics — IS-LM type macro, the stuff that’s in Econ 101 textbooks — has performed spectacularly well in the crisis.
The true test of an analytical framework is how it performs in unusual or extreme circumstances, how well it predicts “out of sample”. What we have experienced since 2007 is a series of huge policy shocks — and basic macroeconomics made some very counterintuitive predictions about the effects of those shocks. Unprecedented budget deficits, the model said, would not drive up interest rates. A tripling of the monetary base would not cause runaway inflation. Sharp government spending cuts wouldn’t free up resources for the private sector, they would depress the economy more than one-for-one, so that private spending as well as public would fall.
Quite a few people considered these predictions not just wrong but absurd; they braced for soaring rates and inflation, they waited for the good news from austerity. But the model passed the test with flying colors. Remember how Romer and Bernstein were savaged for assuming a multiplier of around 1.5? Four years later, after much soul-searching from the IMF about why it underestimated the costs of austerity, estimates seem to be converging on a multiplier of … about 1.5.
When it comes to inflicting pain on the citizens of debtor nations, austerians are all steely determination – hey, it’s a tough world, and hard choices have to be made. But when they or their friends come under criticism, suddenly it’s all empathy and hurt feelings.
And indeed, the Reinhart-Rogoff paper that began the threshold discussion, which was published as a working paper in January of 2010, was a contribution to a discussion that was already well under way. In 2009, the IMF's Fiscal Monitor was already sounding the alarm. Barack Obama's 2010 State of the Union speech which also dated to January of 2010, warned of the dangers of high debt and included plans for a spending freeze. There was no world in which elected leaders didn't begin to worry about and move to address indebtedness.
That's not to excuse analytical errors, of course. But it is important to keep things in perspective. Critics of austerity have argued often enough that their opponents are immune to facts. To then blame a piece of research for their opponents' position seems unfair.
I'd be delighted if my fellow free-market economists' high theory and belittling quips were entirely correct. But they aren't. The high theory's wrong: Nominal wage rigidity is both strong and durable. And the quips are far less insightful than they sound. Yes, unemployment insurance discourages job search; but this hardly means that most unemployed people affirmatively prefer the dole to a job. Yes, the unemployed could move to North Dakota; but in a market-clearing model of the labor market, workers wouldn't have to flee their state to sell their skills. Yes, some workers overestimate their own abilities; but the typical unemployed carpenter is competent in his craft. Yes, many workers have low marginal products; but almost no one has a marginal product of zero.
The "government" sector, which shrunk by 0.9 per cent last quarter, grew by 0.5 per cent this quarter. That means it goes from contributing a 0.2 per cent contraction to the headline figure in Q4 2012 to adding 0.1 per cent to the headline figure this quarter. As the government has quietly put its deficit reduction plan on hold, shrinking PSNB by nominal amounts, it has been able to start spending on infrastructure. We're now seeing that effect.
That's not actually what they said, and if you read Holtz-Eakin in February Reinhart-Rogoff is sufficient evidence to enact the specific plans he wants. Now there's no defense of the "danger zone" argument; just the idea that the stimulus failed. Retreat!
Austerity is collecting a lot of high-flying enemies these days. In the past month the manager of PIMCO, the largest bond-buying firm in the world, top figures at Blackrock, one of the most influential investment banks in the world, the President of the European Commission, Jose Manuel Barroso, and Martin Wolf, world-renowned finance commentator for the Financial Times, have all come out vigorously against austerity.
Meanwhile, a recent IMF report shows (again) in painstaking econometric detail that some of the most influential European research purporting to show the merits of “expansionary austerity,” and which showed up in ECB reports, basically cooked its books. Most embarrassing of all, a famous paper by Ken Rogoff and Carmen Reinhart, quoted by austerians as diverse as the EC’s Olli Rehn and the US’ Paul Ryan, has been shown to be based on bad data, dodgy assumptions, and a basic inability to use Microsoft Excel. Suddenly the sado-monetarists look less like a counter-revolutionary fiscal vanguard and more like petty crewmen busily rearranging their intellectual deck chairs while the rest run for the anti-austerity lifeboats.
To say the obvious: we’re now in the fourth year of a truly nightmarish economic crisis. I like to think that I was more prepared than most for the possibility that such a thing might happen; developments in Asia in the late 1990s badly shook my faith in the widely accepted proposition that events like those of the 1930s could never happen again. But even pessimists like me, even those who realized that the age of bank runs and liquidity traps was not yet over, failed to realize how bad a crisis was waiting to happen – and how grossly inadequate the policy response would be when it did happen.
And the inadequacy of policy is something that should bother economists greatly – indeed, it should make them ashamed of their profession, which is certainly how I feel. For times of crisis are when economists are most needed. If they cannot get their advice accepted in the clinch – or, worse yet, if they have no useful advice to offer – the whole enterprise of economic scholarship has failed in its most essential duty.
And that is, of course, what has just happened.
The discovery of this simple math error eliminated one of the key "facts" upon which the austerity movement was based.
It also, in my opinion, settled the "stimulus vs. austerity" argument once and for all.
The argument is over. Paul Krugman has won. The only question now is whether the folks who have been arguing that we have no choice but to cut government spending while the economy is still weak will be big enough to admit that.
But will any of this make a difference? The story of the past three years, after all, is not that Alesina and Ardagna used a bad measure of fiscal policy, or that Reinhart and Rogoff mishandled their data. It is that important people’s will to believe trumped the already ample evidence that austerity would be a terrible mistake; A-A and R-R were just riders on the wave.
Clearly, though, mitigating pain is the last thing on Stockman’s mind. For him, pain is the way we learn discipline, and, the more closely you read “The Great Deformation,” the more you sense that the impulse behind it isn’t so much economic as moral. Stockman, who studied at Harvard Divinity School, favors language that is explicitly theological: Keynesian “sin,” the “demon” of debt, the “devil’s workshop” of the New Deal. “The Great Deformation” looks like monetary history, but it’s really a classic example of the American jeremiad—a twenty-first-century counterpart to Jonathan Edwards’s famous sermon “Sinners in the Hands of an Angry God.” Stockman laments our fall from the path of righteousness and foretells destruction if we do not repent. This is bad economics—the economy is not a morality play—but it is excellent preaching, which explains why this is Stockman’s moment. In times of crisis, as the Puritans knew, Americans never tire of hearing how we’ve lost our way.
Like Europe today, the initial response in Latin America was austerity, and the results were underwhelming. The region muddled through years of poor growth while development stagnated. It was not until 1985 that the dialogue—let alone the policy—expanded to incorporate growth. However, this policy shift eventually facilitated Latin America’s resurgence. Current Brazilian-Chinese trade tops $60 billion and Mexican-U.S. trade eclipses $350 billion, while the Pacific Pumas (Mexico, Colombia, Peru, Chile) are signing free trade agreements the world over.
What do these questions have in common? They’re factual questions, with factual answers — and they have absolutely no necessary relationship to the “proper scale and scope of government”. You could, in principle, believe that we need a drastically downsized government, and at the same time believe that cutting government spending right now will increase unemployment. You could believe that discretionary policy of any kind is a mistake, and at the same time admit that the expansion of the Fed’s balance sheet isn’t at all inflationary under current circumstances.
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