The chart above shows GDP growth by quarter in the United Kingdom over the past five years. According to preliminary estimates released by the ONS yesterday, Britain eked out a 0.3% increase in GDP, avoiding the over-hyped triple dip. British Chancellor of the Exchequer George Osborne had this to say about the results:
“Today’s figures are an encouraging sign the economy is healing. Despite a tough economic backdrop, we are making progress. We all know there are no easy answers to problems built up over many years, and I can’t promise the road ahead will always be smooth, but by continuing to confront our problems head on, Britain is recovering and we are building an economy fit for the future.”
Osborne has said in the past that his austerity approach is the right one and has pointed to a 2010 paper on government debt and growth by Carmen Reinhart and Kenneth Rogoff as evidence his approach is the right one. Given the recent furore over errors in the data used in that influential Reinhart-Rogoff paper, the British data and Osborne’s conclusions based on that data take on more significance internationally.
And just today, Reinhart and Rogoff have come to their own defense in a New York Times Op-Ed.
“Our view has always been that causality runs in both directions, and that there is no rule that applies across all times and places. In a paper published last year with Vincent R. Reinhart, we looked at virtually all episodes of sustained high debt in the advanced economies since 1800. Nowhere did we assert that 90 percent was a magic threshold that transforms outcomes, as conservative politicians have suggested.
We agree that growth is an elusive goal at times of high debt. We know that cutting spending and raising taxes is tough in a slow-growth economy with persistent unemployment. Austerity seldom works without structural reforms — for example, changes in taxes, regulations and labor market policies — and if poorly designed, can disproportionately hit the poor and middle class. Our consistent advice has been to avoid withdrawing fiscal stimulus too quickly, a position identical to that of most mainstream economists.
In some cases, we have favored more radical proposals, including debt restructuring (a polite term for partial default) of public and private debts. Such restructurings helped deal with the debt buildup during World War I and the Depression. We have long favored write-downs of sovereign debt and senior bank debt in the European periphery (Greece, Portugal, Ireland, Spain) to unlock growth.
In the United States, we support reducing mortgage principal on homes that are underwater (where the mortgage is higher than the value of the home). We have also written about plausible solutions that involve moderately higher inflation and “financial repression” — pushing down inflation-adjusted interest rates, which effectively amounts to a tax on bondholders. This strategy contributed to the significant debt reductions that followed World War II.
In short: many countries around the world have extraordinarily high public debts by historical standards, especially when medical and old-age support programs are taken into account. Resolving these debt burdens usually involves a transfer, often painful, from savers to borrowers. This time is no different, and the latest academic kerfuffle should not divert our attention from that fact.”
I think that’s right. We should separate the academics and their views from the politicians who are using the academics for their political agendas. I have already written enough about this debate but I want to add a few more comments given the Reinhart-Rogoff defense.
First, on the causality, it has always been clear that you couldn’t make the claim that causality runs entirely in one direction – from high government debt to slow GDP growth. Personally, I believe the evidence suggests the causality runs mostly from slow growth to high debt. But I also believe the professors are right that they never excluded reverse causality i.e. slow growth leading to high debt. However, the reason the Reinhart-Rogoff paper has been so influential is in part because the professors have indeed suggested repeatedly in interviews and articles that the causality from high debt to slow growth is the one that they are most concerned with. One particularly clear example comes from a 2011 Bloomberg piece the two penned called “Too Much Debt Means the Economy Can’t Grow“:
As public debt in advanced countries reaches levels not seen since the end of World War II, there is considerable debate about the urgency of taming deficits with the aim of stabilizing and ultimately reducing debt as a percentage of gross domestic product.
Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP. Nevertheless, many prominent public intellectuals continue to argue that debt phobia is wildly overblown.
Do you see what I mean? That’s how this piece begins. The professors don’t actually come out and say high debt leads to slow growth. Nevertheless, the way this piece is written, with talk of the 90% threshold and the risk debt trajectories pose to growth right at the start, there’s no other inference one can draw except that high government debt is bad and must be reined in.
Near the end of this piece, the professors are even direct about this:
Even absent high interest rates, as Japan highlights, debt overhangs are a hindrance to growth.
Again here, they do not actually say high debt causes growth to slow. However, they do use the most extreme case of high government debt today. I believe they use Japan, a country with a government debt to GDP of over 200%, as a proxy for other countries then. It is as if they are saying, “look everyone agrees Japan’s debt is definitely slowing growth. This is why we need to be careful.”
In sum, the overall effect of their media appearances has been to amplify the concerns over high levels of government debt, which does work in favour of those supporting cutting this debt through austerity.
Second, all of that said, Reinhart and Rogoff have never actually said that they supported harsh front-loaded austerity. Their contention that they have supported a more balanced approach seems accurate to me. Reinhart and Rogoff talk more about debt restructuring and structural reforms. In fact, as you might imagine given the name of this site, I would agree that credit writedowns are key to getting through this economic depression. My problem however is that it is private debt that is the real problem in most cases, Greece and Italy being notable exceptions.
I do find it curious, however, that, in defense of their work, Reinhart and Rogoff name Greece and Italy explicitly without also naming Ireland and Spain. They write:
In “This Time Is Different,” our 2009 history of financial crises over eight centuries, we found that when sovereign debt reached unsustainable levels, so did the cost of borrowing, if it was even possible at all. The current situation confronting Italy and Greece, whose debts date from the early 1990s, long before the 2007-8 global financial crisis, support this view.
OK. But what about Spain and Ireland?
When I first wrote about the Reinhart-Rogoff errors, I mentioned these countries because it’s important to note that they have been having difficulties despite having had low levels of public debt.In Spain and Ireland, the higher levels of public are clearly a result of slow growth and crisis and not a cause. As I put it three years ago regarding Spain, “it is total nonsense for people to act like Spain’s government has been reckless and irresponsible in managing it’s finances. The numbers tell a completely different story. If you pointed to Portugal, Greece or Italy, you might have a point.”
My view: this is really not an economic debate at all. It is a political or philosophical debate about the role of government. All of the figures and economic talk is used to give a veneer of logical empiricism to something which is inherently subjective. What people are really debating is the role and size of government. The debate is political and it’s is about the limitations of government. Some believe in small government and want to hold government in check at all times, irrespective of the economic circumstances. These individuals are much more likely to support austerity. And it would make sense for them to latch on to Reinhart and Rogoff as the intellectual cover for their political view. Others believe in bigger government and think that an increase in the size of government is not only justifiable but entirely necessary in severe economic downturns because of the vacuum left by the private sector’s deleveraging. And these people are invariably on the other side of the austerity debate.
Look, we are living through a painful phase transition from carefree prosperity to crushing economic depression. I believe this has been brought on by the end of a private debt supercycle. But irrespective of the causes of the shift, the psychological impact has been immense in terms of how vulnerable we feel economically. And it makes a lot of sense then that the role of government should take a central role in economic debates. This is healthy. What is unhealthy is the disingenuous way this economic and political debate is being carried out. Everyone seems to be hiding their political agenda behind the numbers, acting as if there is some politically-neutral way of interpreting the data. There isn’t. Let’s strip away that thin veneer of empiricism and see this for what it is: a philosophical argument about the role of government. Choose your sides, but do so knowing you are making a political and philosophical argument, not an economic one.
This post was originally published at Credit Writedowns and is reproduced here with permission.