Pethokoukis, Economics, U.S. Economy

Now what for Reinhart-Rogoff and the case for austerity?

Credit: Financial iImes

Credit: Financial iImes

So, has the US been handed a Get Out of Debt Trap Free card? Some proponents of more fiscal stimulus, mostly on the left, seem to be drawing that conclusion from the so-called debunking of the famous Reinhart-Rogoff study on the linkage between government debt and GDP growth. (The above chart shows the original R&R figures versus the modified data  from Herndon, Ash, and Pollin.)

Reinhart and Rogoff have offered a response, and the gist of it is this:

So where does this leave matters on debt and growth? Do Herndon et al. get dramatically different results on the relatively short post war sample they focus on? Not really. They, too, find lower growth associated with periods when debt is over 90 per cent. Put differently, growth at high debt levels is a little more than half of the growth rate at the lowest levels of debt. They ignore the fact that these results … are not very different from what we report in our 2012 Journal of Economic Perspectives paper with Vincent Reinhart—where the average is 2.4 per cent for high debt versus 3.5 per cent for below 90 per cent. … There is also the question of whether these growth effects can be economically large. Here it is very misleading to think of 1 per cent growth differences without recognizing that the typical high debt episode lasts well over a decade (23 years on average in the full sample.)

It is utterly misleading to speak of a 1 per cent growth differential that lasts 10-25 years as small. If a country grows at 1 per cent below trend for 23 years, output will be roughly 25 per cent below trend at the end of the period, with massive cumulative effects.

1. There are other studies, including from the IMF, OECD, and BIS, more or less arriving at the same conclusion as R&R. Dishonest critics will ignore that research as they continue to tout the debunking angle as a way of arguing for more government spending. Honest critics will continue to make the case that a) R&R have only proved correlation not causation, b) these results may be less relevant for countries that control their currency like the US.

2. The tipping-point argument is a distraction from more important macro fiscal issues: a) Higher debt can hurt growth by crowding out private investment, b) nations with larger public sectors tend to grow more slowly, and c) the coming wave of entitlement spending risks driving US debt to unsustainable levels. All these argue for a long-term debt plan instituted ASAP. I have argued that reducing debt/GDP by half over the next two decades might be a reasonable goal.

3. Arguments for a more accelerated debt reduction schedule or a balanced budget within five or ten years (or ever) are not strong. And expectations for near-term, austerity-driven expansion are likely to lead to disappointment without corresponding monetary easing. Thankfully, spending austerity + easier money seems to be exactly the economic formula the US is following at the moment.

15 thoughts on “Now what for Reinhart-Rogoff and the case for austerity?

  1. An additional warning to the critics, honest or otherwise. Regardless of the initial causality once debt as debt-GDP ratios increase the distribution (not the expected value) of future growth must begin to accummulate far many more “bad” fat tails than “good” fat tails. Some such “bad” fat tails are defaults/renegs/devals, and in my experience with emerging markets and it looks as if for many countries in the Euro zone, increases in debt-GDP tended to precede the fall.

    There is some validity to the claim that the US is different, but I doubt that this difference is unbounded and a proper accounting of the natio’s balance sheet would already be showing an erosion in net equity.

    Finally, a question. Isn’t another source of risk here the self-referntial nature of the accounting. If the “cost” of growing government indebtness (debt) need only be matched as a “benefit” by growth in GDP (a variable which would include a growing amount of government expenditures, all valued at face value), should not an increasing debt-GDP (redistributive) machine regularly show positive (and causal) relation with growth in GDP? Like it did in the old Soviet block?

  2. Umm, you are kinda skipping over the part where HAP found serious problems with RR’s work:

    ” Herndon, Ash and Pollin replicate Reinhart and Rogoff and find that coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the post-war period. They find that when properly calculated, the average real GDP growth rate for countries carrying a public-debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0:1 percent as published in Reinhart and Rogo f:
    http://www.peri.umass.edu/236/hash/31e2ff374b6377b2ddec04deaa6388b1/publication/566/

    And with the the Right pointing to the negative 0.1 percent mean result for GDP growth and shouting See! See!, it is somewhat downletting for RR to defend its work by saying, well, our median number is pretty close to HAP.
    Then we have the basic chicken and egg problem: Does high debt lead to bad economies, or do bad economies lead to high debt?

    • “Then we have the basic chicken and egg problem: Does high debt lead to bad economies, or do bad economies lead to high debt?”

      Absurd. It’s not chicken and egg when the government is actively pissing staggering sums down a rat hole.

      • The Economic Policy Institute:

        “The analysis and rhetoric in [R-R] (and those who use it to buttress the case for rapid fiscal retrenchment) assumes that causality runs from higher debt levels to slower contemporaneous economic growth. The data, however, do not speak to causality, and there is considerable reason to believe that causality may run the exact opposite direction. First, the theory that governs the relation between debt and growth suggests strongly that causality runs more firmly from slower growth to higher debt loads. Slow economic growth, and especially growth that is slower than policy makers’ expectations, will lead to higher levels of debt as revenues fall and as automatic-stabilizer spending increases.”

        http://www.epi.org/publication/bp271/

        Now let’s try something radical, eh Paul? Instead of ad hominem attacks on me and the EPI — yes it is union funded; check out AEI’s board — how ’bout linking a study besides R-R that says high debt comes first? That way we both get smarter and perhaps even more civil.

        • “Instead of ad hominem attacks on me and the EPI — yes it is union funded; ”

          Smart to head that one off, Todd, but still pointless. I wouldn’t trust the socialists over at EPI to tell me the time of day. It is odd, however, for a self-proclaimed libertarian like you to be linking them. :)

          “how ’bout linking a study besides R-R that says high debt comes first?”

          Why? Obama’s agenda since he took office, (and Bush to a lesser degree) has been to grow government. He’s been spectacularly successful, as the national debt clock demonstrates. Do you need an official study to verify that for you?

          • From Polifact, in describing Romney’s big government argument as “half true.”

            “The Office of Personnel Management tallies are done every quarter, not every month, so the numbers don’t exactly match what you find on the BLS web site, but the trends line up. In round figures, from September 2009 to September 2011, the federal workforce grew about 100,000. Counting permanent civilian employees, the departments of the Army, Air Force, Navy and Defense grew by 53,000 — more than half of the total. Veterans Affairs provides another 24,000, or about a quarter of the overall increase. Homeland Security contributes 12,000 — call that another 10%. All told, national defense, assisting veterans, and protecting the national borders account for close to 90% of all federal civilian employee growth.”

            http://www.politifact.com/truth-o-meter/statements/2012/jan/09/mitt-romney/mitt-romney-says-obama-hired-135000-bureaucrats/

            Dang that O! Spending Paul’s money on legless veterans.

          • So you go from the socialists at EPI to the leftist spinmeisters at Politifact and expect me to be convinced of anything?

            “Dang that O! Spending Paul’s money on legless veterans.”

            Wow, that’s some rank dishonesty right there. So much for Todd’s sincere attempt at civility.

            Yeah, the stimulus(now built into the baseline), Obamacare, his green jobs bullshit, food stamp explosion,war on fossil fuels, etc., all were for legless veterans. Also, his temper tantrum over the sequester was ignited by his concern for legless veterans.

    • (1) “There are other studies, including from the IMF, OECD, and BIS, more or less arriving at the same conclusion as R&R. Dishonest critics will ignore that research as they continue to tout the debunking angle as a way of arguing for more government spending.”

      (2) “It is utterly misleading to speak of a 1 per cent growth differential that lasts 10-25 years as small. If a country grows at 1 per cent below trend for 23 years, output will be roughly 25 per cent below trend at the end of the period, with massive cumulative effects.”

      (3) Your quoted critique sounds a lot like the critiques of global warming “science.” I wonder where you stand vis-a-vis those concerns.

  3. a) Higher debt can hurt growth by crowding out private investment

    This is indeed a long-term, theoretical issue, but as has been pointed out, it’s “not a plausible story with excess capacity, the Fed funds rate at zero, and companies sitting on cash that they could invest with if they saw good reasons to do so.”

    b) nations with larger public sectors tend to grow more slowly

    The US has among the very lowest taxation in the OECD (Australia might tax even less). I don’t think we’re going to be pushing Sweden territory on spending/size of government anytime soon.

    (Also, we’d need to get into the weeds a bit more on this assertion. From the study you linked: “Welfare states with high taxes can compensate negative growth effects from large government by applying other growth-promoting policies. The validity of this explanation may be hinted at by the way Scandinavian welfare states since the mid 1990s have been characterized by very market oriented policies and institutions, as evidenced by the values of the economic freedom index shown in table 5. This is an especially promising line of inquiry if the first dimension of the economic freedom index, measuring size of government, is excluded.” Also, Posner blogged a little while back, “I am nevertheless surprised that my crude analysis should yield no correlation between per capita GDP and percentage of public workers in a nation’s workforce.”)

    c) the coming wave of entitlement spending risks driving US debt to unsustainable levels.

    The “wave of entitlement spending” is actually health care costs. (Not government health care costs, just *health care costs*.)

    Currently, we spend 2.5 times the OECD average on health care, for none-better results.

    As the CBO put it a little while back, “[t]he bulk of that projected increase in health care spending [on Medicare and Medicaid] reflects higher costs per beneficiary rather than an increase in the number of beneficiaries associated with an aging population.”

    There appears to be no theoretical or empirical reason to prioritize deficit reduction over stimulus spending at this point in time, for the reasons you spell out in Point 3.

    What’s more, the deficit reduction plans from the GOP prioritize near-term reduction (bad) in a frivolous and unserious manner (worse; see, e.g., Macroeconomic Advisers on the Ryan plan a little while back: “the macroeconomic analysis released in conjunction with the House Budget Resolution is not relevant to the coming discussion. We believe that the main result — that aggressive deficit reduction immediately raises GDP at unchanged interest rates — was generated by manipulating a model that would not otherwise produce this result, and that the basis for this manipulation is not supported either theoretically or empirically. Other features of the results — while perhaps unintended — seem highly problematic to us and seriously undermine the credibility of the overall conclusions. This is indeed unfortunate, since it might encourage some legislators to believe that slicing federal debt dramatically can produce long-run gain without short-run pain.”)

    So the sooner we turn the conversation in DC from the long-term deficit issue to the ongoing jobs crisis, the better.

    • To clarify– that CBO comment about health care costs is about the very long term. Even if health care costs grew at 0% over the next ten years, the growth of the population would be a cause of increased government spending. That wasn’t clear from the way I wrote my comment.

      The larger point I made is unaffected– now is not the time, for fiscal policy reasons and for current political discourse reasons, to prioritize deficit & debt reduction.

  4. I just did a very simple spread sheet to quantify R-R’s point. Assume in Scenario A with a low debt burden a country grows GDP 3% per year. Then assume in Scenario B with a high debt burden it grows GDP at 2% — 1% slower. Now assume population grows 1% each year.
    At the end of 23 years, per capita GDP has grown 54% in Scenario A. In Scenario B it has grown 24%. That’s a pretty significant standard of living difference between the two scenarios.

    • Those are countries that don’t have their own currencies and thus lack the primary safety valve in high debt situations: currency devalues; exports become more competitive; the economy mends. The dollar has an extra advantage as the defactor global currency. China keeps buying US Treasuries at negative real returns to protect the competitiveness of its exports, and effectively shoulders some of our burden.
      As to Reflections’ point above about Scandanavia, Thatcher’s intellectual heir, David Cameron, wants Britain to be Sweden. That should tell you something.
      Finally, anyone notice the oxymoron “long-term solution needed ASAP.” What we need ASAP is some sign that tea party Rs can recognize reality.

      • China has not bee buying more USTs. And if anyone does, the Chinese understand the problems with paper currency. After all, it was the Chinese who invented it in the first place.

        What I find fascinating is that both sides have fallen for the promise of free lunches. The left wants to keep expanding government while the right wants to go back to the size it was five years ago.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>