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.
Many economists and market participants applauded the Federal Reserve’s decision in September 2012 to make monthly purchases of $85 billion in Treasury and mortgage-backed securities, and hold short-term interest rates at near zero until unemployment fell to 6.5 percent. Now, however, the issue of when to end bond buying is being debated both within and outside the Fed. Some think the central bank isn’t doing enough to deal with the still-fragile economy, while others argue that its actions will result in future price inflation. There is also growing concern that the rapid run-up in prices of stocks and other capital market assets reflects greater risk taking and more leverage and may be signs of yet another bubble.
Updated May 9
In this new paper, Thomas Herndon, Michael Ash and Robert Pollin look carefully at the analysis underlying a cornerstone of government austerity plans: studies by Carmen Reinhart and Kenneth Rogoff which correlate national debt-to-GDP ratios over 90% with sharp declines in growth. Their critique has struck a live wire in the media. Some interesting highlights are:
Paul Krugman’s blog in The New York Times
Mike Konczal on RortyBomb
Moneybox blog on Slate
Wonkblog in the Wall Street Journal
FTAlphaville blog in the Financial Times
Dean Baker in The Guardian
Josh Bivens on the EPI blog
Jared Bernstein’s blog
Arin Dube on RortyBomb
Mary Bottari on PRWatch
and a sampling of the rest…
Are you concerned with unemployment and the effects of austerity on the very slow recovery? The Congressional Budget Office (CBO), with the help of mainstream theory, has a solution. Just hike the natural rate of unemployment. Now there are less people involuntarily unemployed, and we are only about 2.2% above ‘full employment.’ If they hike it a bit more we are done, and John Taylor and Martin Feldstein will be correct in pressing the Fed to hike the rate of interest.
It is a convenient solution no doubt. Mind you the most typical way of deriving the natural rate is from some kind of average of the actual unemployment. In other words, they [mainstream] tell you that the average of a series is the attractor of the actual series. Talk about having things upside down!
This reminds me of the time Bob Solow gave a talk
at the New School (in 2001) and suggested at the beginning that the idea of the natural rate was incorrect and should be avoided. By the end of the talk he argued that most analysts think that the natural rate was, back then, at around 5.2%. There it is, the natural rate doesn’t exist, but it is 5.2%.
In “Political Aspects of Full Employment,” a still widely cited article from 1943, Michal Kalecki raised many questions about the ability of a capitalist economy to maintain prolonged full employment — even though in light of the understanding of tools for stimulating aggregate demand and the use of fiscal policy brought about by the Keynesian ‘revolution.’ In a series of papers, Kalecki showed that the arguments against the use of budget deficits to secure full employment were invalid. Among these arguments, and their rebuttals, were that:
> deficits add to government debt, which is a burden on future generations
(rather, the government debt is bonds owned by individuals, pension funds etc.);
> deficits crowd out investment
(rather, they allow savings to take place and enable investment); and
> deficits cause higher interest rates
(the current situation makes the rebuttal to this clear).
Yet those arguments are still trotted out.