Reinhart-Rogoff A Week Later: Why Does This Matter?

by: Rortybomb

Well this is progress. We are seeing subtle distancing by conservative writers on the Reinhart/Rogoff thesis. In Feburary, Douglas Holtz-Eakin wrote, “The debt hurts the economy already. The canonical work of Carmen Reinhart and Kenneth Rogoff and its successors carry a clear message: countries that have gross government debt in excess of 90% of Gross Domestic Product (GDP) are in the debt danger zone. Entering the zone means slower economic growth. Granted, the research is not yet robust enough to say exactly when and how a crisis will engulf the US, but there is no reason to believe that America is somehow immune." (h/t QZ.)

Today, Holtz-Eakin writes about Reinhart and Rogoff in National Review, but drops the "canonical" status. Now they are just two random people with some common sense the left is beating up. "In order to distract from the dismal state of analytic and actual economic affairs, the latest tactic is to blame ... two researchers, Carmen Reinhardt and Kenneth Rogoff, who made the reasonable observation that ever-larger amounts of debt must eventually be associated with bad economic news."

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!

This is getting a bigger audience. (If you haven't seen The Colbert Report on the Reinhart/Rogoff issue, it's fantastic.) But going foward, a plan beats no plan. And a critique isn't a plan. So what should we conclude about Reinhart-Rogoff a week later, now that the critique seems to have won? How should the government approach the debt?

One thing about the "cliff" metaphor is that there's no tradeoff that would make it acceptable. If you are driving, there are all kinds of trade-offs you make with your route, but you'd never agree to a trade-off that has you driving off a cliff. There were numerous other ways of describing this scenario, either the technical "nonlinearities" or the "danger zone" of Eakin just a few motnhs ago.

With the danger zone metaphor now out of play, perhaps economists can see the relevant trade-offs more clearly. Reinhart-Rogoff stand with a small negative relationship between debt and growth, one that is likely driven by low growth rather than high debt. And despite what you've heard, there's no literature that shows the casuation in the other direction.

But let's say they found it. Well, what's the relevant trade-off? If there's even a basic fiscal multipler at work, the upside more than compensates for the downside. As Brad DeLong notes, if you consider a multipler of 1.5 and a marginal tax share of 1/3, the small correlation people are finding - Delong uses 0.006 percent from an in-house estimate - are more than canceled. Spending 2 percent more causes a bump of 3 percent of GDP, while debt goes up 1 percent of GDP. As Delong notes, "3% higher GDP this year and slower growth that leads to GDP lower by 0.06% in a decade. And this is supposed to be an argument against expansionary fiscal policy right now?"

And as the IMF noted recently, "Studies suggest that fiscal multipliers are currently high in many advanced economies. One important implication is that fiscal tightening could raise the debt ratio in the short term, as fiscal gains are partly wiped out by the decline in output." Now is the time to move away from austerity.
This is very crucial right now, because the debate people are having is what level of debt-to-GDP we should level out at and how quickly that debt should begin to come down. Look at what the debt-to-GDP looks like with the sequestration-level amount of deficit reduction that President Obama wants to do vjus. st repealing the sequester and doing nothing.

Click to enlarge

If there was a cliff, we'd have what Holtz-Eakin wrote in February: "The US will reside in the debt danger zone for the foreseeable future in the absence of action," and thus action was needed. Without the cliff, we need to consider the pros and cons vis-a-vis what monetary policy is capable of and where full employment is. And this will be relevant for the fight over raising the debt ceiling that will happen at the end of the summer.

Meanwhile, Ryan Avent at The Economist's Free Exchange writes about Reinhart-Rogoff here. To address two of his points:

Ryan also argues that "As a general principle, pursuing a low level of government debt is a good idea for most countries at most times. That's because there are relatively uncontroversial ways in which high levels of government debt can and do affect growth."

I'd like to read more about this consensus. Certainly when it comes to government debt and interest rates, for instance, Glenn Hubbard in 2011 wrote, "Despite the volume of work, no universal consensus has emerged." There are issues about taxes required to service the debt, even though debt servicing as a percentage of GDP has collapsed and is expected to return to normal levels several years from now. Even an aggressive measure, by Eric Engen and Glenn Hubbard, found that a 1 percent increase in debt-to-GDP increases government interest rates two basis points. How much weight should we give that when even the IMF thinks fiscal multipliers are large? For growth, I think there's more reason to believe government spending is crowding-in, rather than crowding-out, spending right now.

Ryan Avent also thinks that the Reinhart-Rogoff cliff results are overplayed as something that actually impacted policy. This is always a tricky question to answer, but Reinhart-Rogoff certainly dominated the sensible, mainstream conversation over the deficit and was a favorite go-to for conservatives in particular. I also think it was popular among journalists, because it was a straight-line number that was supposed to not require complicated modelng. Media Matters put together this video of people discussing the Reinhart-Rogoff cutoff:

I think the ideas matter. (Why else would we do this?) I think it's important to understand this revelation in light of other players moving against austerity, including both the IMF and the financial industry. As people reposition themselves, understanding that one of the core old ideas is now out of play allows a different reconfiguration of power. Also, it's important to point out, austerity has failed. It didn't even do the actual goal, which was reduce the debt-to-GDP ratios of the countries that were being targeted. People are re-examining what happened, so these critical examinations are important. So I'm glad we are having them.