Last Friday, The New York Times published a lengthy response by Reinhart and Rogoff to our critique of their work in “Growth in a Time of Debt,” and the ensuing worldwide debate. We have replied to them, which appeared in the Times online Monday night. As you can see below, we did not find their defense at all convincing. We also go into these issues in much more depth in a technical appendix here.
Debt and Growth: A Response to Reinhart and Rogoff
The debate over government debt and its relationship to economic growth is at the forefront of policy debates across the industrialized world. The role of the economics profession in shaping the debate has always come under scrutiny.
There have been an extraordinary number of reactions to the paper we wrote with Thomas Herndon that critiqued the highly influential 2010 Reinhart and Rogoff paper “Growth in a Time of Debt.” Not surprisingly, these reactions have run the gamut. It is obviously impossible for us to respond to all the points raised. One of the most thoughtful critical responses was from Prof. James Hamilton of UC San Diego. Prof. Hamilton is an eminent econometrician. He posted his critique on his own blog site Econbrowser here. We are reposting here his critique of our work along with our response, below. Prof. Hamilton was kind enough to post our response on his site as well.
In 2010, two Harvard economists published an academic paper that spoke to the world’s biggest policy question: should we cut public spending to control the deficit or use the state to rekindle economic growth? Growth in a Time of Debt by Carmen Reinhart and Kenneth Rogoff has served as an important intellectual bulwark in support of austerity policies in the US and Europe. It has been cited by politicians ranging from Paul Ryan, the US congressman, to George Osborne, the UK chancellor. But we have shown that several critical findings advanced in this paper are wrong. So do we need to rethink austerity economics more broadly?
In a speech last month, Federal Reserve Vice Chair Janet Yellen identified some causes of the “painfully slow recovery for America’s workers.” Some of the causes she mentioned can’t be easily remedied; they’re at the core of the problem itself. In particular, residential investment has historically served as the leading edge of recovery. In this recession, which was largely triggered by the enormous bubble and bust in the housing sector, it’s not surprising that residential investment isn’t leading the way out.
But other causes of the slow recovery are deliberate and self-inflicted. Yellen highlighted the drag created by austerity. The figure below (Yellen’s Exhibit 3) compares what “discretionary fiscal policy” did for the economy in two recent recessions with its role in the Great Recession. The azure, blue, and lavender bars show the impact of discretionary fiscal policy on GDP growth one, two, and three years into each recovery.
Estimated effect of discretionary fiscal policy on the economy during recoveries: average contribution to GDP grown, percentage points (annual rate)
Note: Average recovery from postwar recessions excludes recovery after 2007-09 recession because of data limitations; average also excludes recovery after 1948-49 recession. Source: Federal Reserve Board staff calculations.
We got off to a reasonable start with the Obama stimulus. The contribution to growth was not quite as vigorous as Ronald Reagan’s military-Keynesian and tax-slashing buildup in the early 1980s or even George W. Bush’s early 2000s reprise thereof (second-time farce). Right off the bat Reagan’s deficit spending was adding almost one percentage point to GDP growth and did so for three years, and the Bush results were pretty similar. After one year Obama’s stimulus was actually more responsive to the recession than the average government response in post-WWII recessions (and it was done with less military expansion and fewer tax cuts for the very rich than were the Reagan and Bush stimuli).
But then the brief Keynesian moment passed. First states, cities, and towns slashed jobs and services to meet balanced-budget obligations. Instead of buying groceries, clothes, and new green cars, laid-off teachers and state workers joined the unemployment rolls. And then the austerity bug caught in Washington. In years two and three of the recovery and since, our government’s deficit obsession has been actively dragging down the economy, a headwind, in Yellen’s terms, of -0.2 percentage points compared to a Reagan-era tailwind of 1 percentage point per year. The worst part is that is that the damage is self-inflicted and could well have been avoided.
A friend who teaches in the social sciences–but not economics–wrote:
“Did you read this Marty Feldstein piece in the WSJ yesterday? I know bupkes about Fed policy, but it seems to me the Fed is between a rock and a hard place. It continues to buy U.S. securities (in part, by printing money) to keep the economy afloat. But Feldstein suggests this is all going to come crashing down. Do you agree? Who should I turn to for an alternative perspective?”