I’ve received several requests to comment on the controversy surrounding the famous Rogoff-Reinhart study on government debt and economic performance.
For those who haven’t followed this issue, Kenneth Rogoff and Carmen Reinhart wrote an influential paper in 2010 arguing that government debt above 90 percent of GDP was associated with weaker economic performance.
It turns out that the Rogoff and Reinhart made a mistake in their excel spreadsheet and this error was publicized in a recently unveiled article by three other economists.
This has led to a renewed debate about “austerity,” with R&R cast in the role of fiscal hawks and various critics saying that the mistake in their paper discredits that approach and that it’s time for Keynesian policies.
If you’re interested in the broader debate, here’s what Rogoff and Reinhart wrote in the New York Times to defend themselves, and here’s Paul Krugman’s criticism.
But if you want to know my opinion, I’m not a fan of either side. Unlike the Keynesians, I don’t think debt is good for growth. But I also think it doesn’t make sense to myopically focus on red ink.
Which explains why I’m very frustrated by the debate in Europe. On one side, you have the Keynesians advocating higher spending and on the other side you have “austerians” advocating higher taxes.*
No wonder I want both sides to lose!
As I’ve repeated over and over again, the real fiscal problem in most nations is the size of government. Excessive government spending is bad for prosperity, regardless of whether it is financed by taxes or borrowing.
To be sure, governments can accumulate so much debt that investors will get suspicious and demand very high interest rates before lending more money (sometimes referred to as an attack by “bond vigilantes”).
But it’s important to realize that debt is the symptom. The underlying disease is a bloated public sector. That’s true in Greece, Spain, Italy, and other nations that have had trouble borrowing money.
By the way, it’s also true in nations such as France and Belgium. Those countries also have governments that are far too big. They haven’t been hit (at least not yet) by the bond vigilantes, but they’re suffering from economic stagnation as well.
In other words, deficits are bad, but the real problem is spending. I elaborate in this Center for Freedom and Prosperity video.
The wise fiscal policy, needless to say, is to follow Mitchell’s Golden Rule. If the burden of government spending grows slower than the private economy, any nation can climb out of a fiscal ditch. Especially if they lower tax rates and avoid class-warfare tax policy.
*In theory, the “austerians” ” also advocate less spending, but you won’t be surprised to learn which option politicians select when given a choice between higher taxes and less spending.
P.S. You also won’t be surprised that Paul Krugman doesn’t do his homework when he writes about “austerity” in Estonia and the United Kingdom.
P.P.S. Please do not confuse “austerian” economics with “Austrian economics.” The former is a political rationale for tax hikes. The latter is a sensible school of economic thought.
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The biggest problem with the coverage of the issue has been that most of it ignores the fact that even the paper critiquing R&R shows a correlation between high debt and slow growth. The only disagreement is over the amount of the dropoff. A number of other papers have found the same thing, they just disagree over how to characterize the drop, which isn’t surprising since there are so many different factors involved. There is other work on “crowding out” showing it makes sense.
Those that try to say “slow growth drives debt” are essentially saying incompetent politicians cause it because it is their choice to speed more than they take in. It is like someone saying “Don’t blame me for my credit card debt, my boss didn’t give me the raise I planned on so it is his fault”.
The real lesson re: R&R is that work needs to be replicated. Unfortunately many government forecasts that have far more concrete impact on us never are critiqued well enough. The Social Security Administration’s long term forcecasts list their data sources and a large chunk of them are “unpublished data” they don’t provide on the net, and they even only provide a subset of their projection figures (hiding others that would call them into question). Someone fro the tech biz world critiqued their work using some of the data that is available as if it were a “business plan” and found major problems with it that it is amazing no one notices, but being an outsider to the policy world the word isn’t spreading as it urgently needs to, here is the critique (which btw applies to some things that are used in the Medicare forecast SSA also does):
http://www.politicsdebunked.com/article-list/ssaestimates
The problem with any macroeconomic prescription for an economy is that the devil is in the details. Yes, Rogoff-Reinhart made a serious clerical errors, but when dealing with concepts like GDP and CPI, you begin on unstable ground.
We know that even bad government is better than anarchy, but once government grows beyond 5% of the economy, the alternatives become efficiency of the [non-crony] private sector verses the so-called social benefits of government direction.
R-R’s biggest mistake was to assign causation to the Debt/GDP ratio. While I would agree with Dan that the Rahn Curve indicates that excessive government spending is the culprit; not all government spending is wasted and the private sector is efficient only because prices and profits tell when to stop making mistakes.
Economists are asked for big answers to incredibly complex issues, because it is assumed that “government” will be the respondent. But “government” is not a single entity. It’s no surprise that those within government who actually make decisions reject advice that will diminish their personal authority.
Due to the Laffer curve, excessive public spending and increasing debt are inevitably linked — if we define “excessive spending” as spending more than can be collected in taxes at the peak of the Laffer curve. Once
you get to that point, what is more insane: to raise tax RATES, or to increase spending? I’d think the latter, but i am not sure.
Of course the only sane thing to do is to cut spending until you are on the safe side of the Laffer curve; and then cut it some more.