Before presenting a quick summary of their findings, let me make two preliminary notes. First they validate what Yeva Nersisyan and I first pointed out three years ago: the crappy empirical research of Reinhart and Rogoff was driven by a small number of outliers, and by confusion of causation and correlation. Yes, some countries–Japan most notably–have high debt ratios and slow growth. R&R aggregated in such a way as to give very high weights to those countries. And those countries had high deficits and thus high accumulated debts because growth was low. Hence, there was never any support for their claim that 90% marks a causal turning point.
Second, more recently when UMASS PhD student Thomas Herndon exposed the “errors” made by R&R in their empirical work, Professor Epstein of UMASS contrasted UMASS’s economics with that of UMKC’s as follows:
“And even the “left Keynesians” of Amherst don’t go as far as some of their peers at, say, the University of Missouri – Kansas City in dismissing the possibility of high deficits leading to inflation later on. “It’s almost a talmudic claim that since no country with its own currency can go bankrupt, no deficit can be bad,” Epstein says. “They’ve made important contributions, and a lot of them are my friends, but we try to look at things more critically and not assume there are absolutes.” http://www.washingtonpost.com/blogs/wonkblog/wp/2013/04/24/inside-the-offbeat-economics-department-that-debunked-reinhart-rogoff/
Well, what do you know. UMKC students can look at things critically, too! But note that no UMKC-affiliated faculty member (and probably no student) has ever said something as silly as “no deficit can be bad”. I do not even know what that could mean. Deficits can be bad. Very bad. Very very bad. A sovereign country that issues its own currency cannot be forced into involuntary default so long as it floats its currency. That is certainly a true statement–accepted by anyone who knows anything about sovereign currencies. Whether it is talmudic I have no idea. If you’ve got the magic porridge pot, you can provide the porridge.
Can too much porridge be bad? You betcha–just read the damned story. Inflation? Yes. Currency depreciation? Probably. Leave too few resources for the private purpose? No doubt. Create a nation of couch potatoes? You’ve got it. Bury everything under a thick layer of suffocating porridge? Read the story.
Where do people like Epstein get this stuff? I have no idea.
Aside from the fact that we do not say stuff like that, I do not know why this has become the ultimate test of just how crazy MMT is. Krugman goes on and on and on about how MMT claims “deficits don’t matter”. Epstein claims we say “no deficit can be bad”. Others claim we always support deficit spending, and the bigger the better. Aside from the fact that we’ve never said anything of the sort, how is it that this has become the litmus test for “serious” or “critical” economics?
Oh, Pete Peterson, that’s why. He’s got everyone on the left just scared to death that they’ll be pegged as too dovish on deficits. Yes, we all remember those attacks back in the 1960s, on those who were just a tad bit too dovish on the pinko commies supposedly in our midst. Deficit owls–those who reject the whole Pete Peterson lie–are just too far out there. Wouldn’t want to go there! We need to retain respectability–we fear deficits, we hate them, but we’ll accept just a bit of them as the lesser of evil evils.
Here’s the reality folks. We do not argue deficits cannot be too big. Nor do we argue that government ought to try to deficit spend. Deficits are mostly nondiscretionary–the outcome of the automatic stabilizers. We could ramp up government spending today, and cut tax rates, and might find deficits actually go down. Or up. Or stay the same. Who cares? Not Moi. Functional. Finance. That is what we advocate. Sensible policy, not arbitrary deficit or debt ratios. Full employment. Low inflation. Greater equality of distribution. More democracy. Accountability of our public officials. Prison terms for banksters. What’s wrong with that?
Ok, end of rant. Here’s a summary of the great work by (probable future PhDs) Berg and Hartley:
We find that the correlation between government debt-to-GDP ratios and future growth in Reinhart and Rogoff’s (2010a and and 2010b) dataset results from outliers which come from the country most suggestive of the hypothesis that slow growth causes high levels of government debt – Japan. This evidence strengthens and reinforces criticisms recently made by Herndon, Ash, and Pollin (2013) of research suggesting a negative relationship between government debt-to-GDP ratios and real GDP growth rates. As Reinhart and Rogoff (2013) recently and quite correctly noted, “the frontier question for research is the issue of causality.” We join Reinhart and Rogoff’s call for more research illuminating this important question. To that end, we use Reinhart’s and Rogoff’s dataset, as corrected by Herndon, Ash, and Pollin (2013). Following and reinforcing Dube (2013) and Basu (2013), we use LOWESS regressions and distributed lag models and find evidence suggesting that correlation of government debt-to-GDP ratios and future growth are much more likely explained by “reverse” causation running from slow GDP growth to high government debt-to-GDP ratios than by “forward” causation running from high government debt-to-GDP ratios to slow growth. Furthermore, what little evidence there is for forward causation appears to stem almost entirely from Japanese outliers. Because – as economists generally recognize – Japan is the clearest of all cases of reverse causation, this considerably weakens the argument for forward causation. In addition, we find tremendous heterogeneity on the level of individual countries in the relationship between current government debt-to-GDP ratios and future growth. This suggests that even if substantial evidence for forward causation is eventually discovered in cross-country studies, the effect will likely be small in size and unreliable, and therefore not relevant to economic policy decisions in any particular individual country. Our findings are suggestive, but not conclusive, and more research is needed. We suggest that simultaneous equations models may offer a way forward on the “frontier question” of causality.
Read the rest over at NEP.