In defence of Reinhart and Rogoff


Facepalm, as they say

Academic economic papers rarely receive the sort of mass reception that brings coverage in the Guardian and the Telegraph so by the standards of its field ‘Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff was something of a blockbuster.

The eponymous Carmen Reinhart and Kenneth Rogoff are economists who, in a 2010 paper,  ‘Growth In a Time of Debt‘ found that “whereas the link between growth and debt seems relatively weak at ‘normal’ debt levels, median growth rates for countries with public debt over roughly 90 percent of GDP are about one percent lower than otherwise; (mean) growth rates are several percent lower.”

These results, fleshed out to book length for the successful ‘This Time Is Different’, have been quoted by George Osborne, Paul Ryan, and Olli Rehn in support of their measures to get spiralling government debts under control.

Last week’s paper by Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts Amherst claimed to have proved this wrong. They had recreated Reinhart and Rogoff’s results and found that the pair had reached their figure of a GDP ‘growth’ rate of -0.1 percent per annum for economies with government debt of over 90 percent of GDP thanks to “coding errors, selective exclusion of available data, and unconventional weighting of summary statistics.” Most embarrassingly, the ‘coding error’ was a proper schoolboy error; Reinhart and Rogoff missed some of the numbers out of their calculations.

In truth the idea that there was an Iron Law such that an economy would shrink as soon as it’s government debt hit 90 percent of GDP, the ‘strong form’ of Reinhart and Rogoff (pushed more by the political practitioners than them it ought to be said), was always iffy. It smacks of the sort of bogus causation derived from correlation which is the basis for much modern macroeconomics.

There are, for example, different types of debt. Advocates of higher spending often point to the 260 percent of GDP the British government owed in 1816, the 180 percent it owed in 1919, or the 220 percent it owed in 1945. This, they tell you, proves that Britain’s economy can bear an even greater burden of debt than the 70 percent of GDP it has doubled to in the last five years.

But you don’t have to be David Starkey to know that in 1816, 1919, and 1945 Britain had run up that debt to pay the cost of defeating a tyrant and as soon as that was done we stopped. It was an expense we had to meet and defray over time, the wartime borrowing was classic ‘consumption smoothing’.

To put it another way, when the British government started spending heavily in 1792, 1914, or 1939 there was a definite endgame for this spending: the restoration of the Bourbon monarchy, the defeat of the Kaiser, the overthrow of Hitler. The very moment those goals were accomplished spending would fall rapidly.

Our current level of government spending, by contrast, is not being undertaken to safeguard this country and its neighbours from conquest but to maintain a public sector and welfare state grown fat on borrowing and tax revenue from an unsustainable bubble in the absence of that bubble and those tax revenues. We are not smoothing consumption, we are sucking it out of tomorrow. And, unlike Pitt the Younger, Herbert Asquith, or Neville Chamberlain, present day advocates of higher spending cannot give an endgame for their proposed accrual of debt.

The point of this for evaluating Reinhart and Rogoff’s work is to note that one load of debt is not necessarily the same as another. There ought to be a little nuance to the picture, there are no magic numbers.

But even with that said it can still be argued that Reinhart and Rogoff have been hard done to this last week. They are, as they say in ‘This Time Is Different’, involved in the on-going process of growing their data set (which, rather unwisely, they have been quite proprietary about) and since 2010 they have revised their conclusions in the light of new data which Herndon, Ash, and Pollin had access to.

As Reinhart and Rogoff wrote in the Wall Street Journal, in a 2012 paper with Vincent Reinhart they found GDP growth rates of 2.4 percent for economies with government debt over 90 percent of GDP, pretty close to the 2.2 percent calculated by Herndon, Ash, and Pollin.

Indeed, and despite what some excitable commentators have proclaimed, Herndon, Ash, and Pollin have not found no correlation between high debt and low growth. They have found a weaker one than Reinhart and Rogoff in 2010 and about the same as they found in 2012, but they have still found one.

As page 21 of their paper states: if debt is below 30 percent GDP growth comes in at 4.2 percent, if debt is between 30 percent and 60 percent of GDP growth comes in at 3.1 percent, if debt is between 60 percent and 90 percent of GDP growth comes in at 3.2 percent, and if debt is over 90 percent of GDP growth comes in at 2.2 percent. Even on Herndon, Ash, and Pollin’s figures higher debt is correlated with lower GDP growth.

And there is perhaps a more profound point to note. Reinhart and Rogoff have fessed up to the coding error but the “selective exclusion of available data, and unconventional weighting of summary statistics” which Herndon, Ash, and Pollin accuse them of is, in fact, the very stuff of modern macroeconomics.

The ‘facts’ which dominate and guide our economic lives such as GDP, the CPI, or even unemployment, are not objectively given but are constructed using just such subjective methods, a prime example are the nonsensical unemployment figures of the United States. If this furore provokes a little scepticism so much the better, but it should spread much further than one paper.

This article originally appeared at The Commentator

Ground control to Major Krugman


Paul Krugman was ill/The Day the Earth Stood Still…

One of the standard charges against believers in smaller government is that we are all fans of Ayn Rand and imagine ourselves as John Galt. I get this thrown at me despite the fact that I have never read a single thing Rand wrote.

Indeed, Paul Ryan got a roasting for his admiration of Rand from New York Times columnist Paul Krugman who called Rand “a very unserious, unreasonable novelist”. And maybe Krugman is right? Perhaps basing your political and economic philosophy on an old science fiction novel is the height of weirdness.

But hang on, what’s this? In an article for the Guardian titled ‘Asimov’s Foundation novels grounded my economics‘, Krugman writes, “I grew up wanting to be Hari Seldon, using my understanding of the mathematics of human behaviour to save civilisation.”

It’s worth reading that again and remembering that it’s from the same man who quotes the well-worn joke about Atlas Shrugged and Lord of the Rings; “the unrealistic fantasy world portrayed in one of those books can warp a young man’s character forever; the other book is about orcs.” If nothing else, at least Krugman’s suggestion that a fake alien invasion could rescue the economy makes a little more sense now.

For those who haven’t waded through Isaac Asimov’s several Foundation novels, Krugman explains:

In Foundation, we learn that a small group of mathematicians [including Krugman’s hero Hari Seldon] have developed ‘psychohistory’ (a) rigorous science of society. Applying that science to the all-powerful Galactic Empire in which they live, they discover that it is in fact in terminal decline, and that a 30,000-year era of barbarism will follow its fall. But they also discover that a carefully designed nudge can change that path…The novels follow the unfolding of that plan

There’s only one brief description of a space battle – and the true purpose of the battle, we learn, is not the defeat of an ultimately trivial enemy but the creation of a state of mind that serves the Plan

There are a series of moments in which the fate of the galaxy seems to hang in the balance… Each of these crises is met by the men of the hour, whose bravery and cunning seem to offer the only hope. Each time, the Foundation triumphs. But here’s the trick: after the fact, it becomes clear that bravery and cunning had nothing to do with it, because the Foundation was fated to win thanks to the laws of psychohistory. Each time, just to drive the point home, the image of Hari Seldon, recorded centuries before, appears in the Time Vault to explain to everyone what just happened.

You can see how Krugman pictures himself. He is one of a small band of Psychokeynesians who possess an insight, the IS/LM model, which enables them to predict the future of economies and gives them the tools – vast deficits and credit expansion – to steer them.

Anything that supports the Psychokeynesian analysis is evidence; anything that doesn’t is simply a ruse. And when the next bit of corroborating evidence floats along, Hari Krugman emerges from a Time Vault to say “told you so”.

But there’s a problem. It’s true that Krugman spotted the housing bubble in 2005 but then he had been calling for it in 2002. This might lead you to question Krugman’s omnipotence. Or you might want to wait for Hari Krugman to appear and explain how this crafty Knight’s Move is actually part of The Plan.

Hari Krugman celebrates his clairvoyance:

The IS-LM model (don’t ask) told us that under depression-type conditions like those we’re experiencing, some of the usual rules would cease to apply: trillion-dollar budget deficits wouldn’t drive up interest rates, huge increases in the money supply wouldn’t cause runaway inflation. Economists who took that model seriously back in, say, early 2009 were ridiculed and lambasted for making such counterintuitive assertions. But their predictions came true.

But considering that they also predicted that this mountain of debt and avalanche of new money would lead to economic recovery then no, their predictions didn’t come true.

Remember former Chair of the Council of Economic Advisors Christina Romer’s prediction that President Obama’s Keynesian stimulus would see American unemployment peak at 8 percent in late 2009 and fall to a little over 5 percent today? Remember that American unemployment actually peaked at over 10 percent in late 2009 and stands at 7.9 percent today?

This doesn’t worry Hari Krugman a bit. In the course of a spat with economist Robert P. Murphy, Krugman wrote:

[I]t’s really important to distinguish between fundamental predictions of a model and predictions that an economist happens to make that don’t really come from the model… [T]he unfortunate Romer-Bernstein prediction of a fairly rapid bounceback from recession reflected judgements about future private spending that had nothing much to do with Keynesian fundamentals, and therefore sheds no light on whether those fundamentals are correct. In short, some predictions matter more than others.

Quite so Paul. Apparently the predictions that come true matter; those that don’t, don’t.

In his Guardian piece Krugman excitedly writes of “the possibility of a rigorous, mathematical social science that understands society, can predict how it changes, and can be used to shape those changes.” Well, looking at the record it’s clear that Hari Krugman hasn’t found it.

Or maybe he has, and we mere mortals simply need to wait for his shimmering likeness to appear from the Time Vault and say “told you so.”

This article originally appeared at The Commentator

It’s anything but the economy, stupid

Wrigley Field, Chicago, 2040 AD

Walking around the ruins of the old Roman town of St Albans can make you feel like Shelley’s “traveller from an antique land”. As you look down into the remains of the Roman amphitheatre, where the town’s inhabitants flocked in the second and third centuries AD, you wonder what those people thought and talked about as Roman Britain approached its collapse.

You’d like to think they talked about that looming collapse. Perhaps they did. It was, after all, the existential issue of the day. But looking at behaviour in another, contemporary, troubled great power, you do wonder.

The United States government hasn’t balanced its budget since 2001. In the past ten years, starting in 2002 when Republicans controlled the Congress and the White House, Federal government debt has more than doubled from $6.5 trillion to over $15 trillion, or nearly $51,000 for every US citizen. Since September 2007 that debt has been increasing by nearly $3.9 billion a day. The Congressional Budget Office reported last week that in 2012 the Federal government’s debt increased by over a trillion dollars for the fourth year running.

Over the same ten year period the dollar has lost about 25 percent of its value. The rampant credit creation of the Federal Reserve which fuelled the housing bubble has created $1.4 trillion of new base money since 2000. At the moment most of this is sitting on banks’ balance sheets but if it emerges into the wider economy the US will have an inflation crisis.

Likewise, if the foreigners who hold nearly a third of America’s debt decide to dump these depreciating assets, the dollar will collapse.

These are the existential issues for the United States as November’s presidential election nears. But to look at the media you’d never know it.

Instead the American media has lately been preoccupied with a fast food chicken chain. More precisely, it has been preoccupied with what the president of that chain thinks of gay marriage.

“Who cares?” might have been the appropriate response. If you’re a Chick-fil-A shareholder and you don’t agree with him, sell up and invest somewhere else. If you’re a customer, go and buy your artery clogging food down the street. Capitalism, more so than any other system, gives you scope to exercise your morality.

Instead the views of one guy became a minutely discussed national news event. Democrats in a number of cities called for local branches of Chick-fil-A to be shut down, a curious course of action in the face of high unemployment. Supporters of Dan Cathy’s views had a Chick-fil-A Appreciation Day where they filled their faces to show solidarity. They should have called it Cholesterol for Christ.

Then, last week, media attention fixed upon the previously little known Republican Representative from Missouri, Todd Akin. In an interview with a local TV station Akin aired the unusual view that women couldn’t become pregnant through “legitimate rape”.

Worryingly Akin sits on the House Science Committee. This provides yet another argument for leaving more to free markets and less to government. Under free markets science ends up in the hands of people like Bill Gates and Steve Jobs. Only government could put someone like Akin in charge of science.

Neither gay marriage nor rape should be belittled as issues. Laurie Penny, not someone I’m given to quoting approvingly, noted in a moving blogpost that between ten and twenty percent of women in America have experienced rape, 90,000 in 2008 alone. This is awful and ought to be tackled.

But neither should silly remarks from a silly man like Todd Akin drown out the great existential issue in American politics: the economy.

And America’s solvency ought to matter to everybody. It ought to matter to Democrats who care about redistribution of wealth: watch your economy disappear over a cliff and then try and redistribute nothing; see how far that gets you.

It ought to matter to neo-conservatives: America’s economic wellbeing is a sine qua non of American strength. The United States did not become rich because it had powerful armed forces; it got powerful armed forces because it was rich. If the wealth goes so does the power.

And, most importantly, it ought to matter to every ordinary American citizen who will suffer if the economy continues on its current, Hellenic path.

But instead of this discussion we have the ongoing row about Mitt Romney’s taxes. With unemployment stuck above 8 percent and poverty at record levels, Obama’s supporters are trying to turn an election that should be about how much money Americans have in their pockets into one about how much money Mitt Romney has in his.

President Obama’s economic track record has been dismal so you can’t blame him for running away from it. Bill Clinton’s strategist James Carville famously said it was “The economy, stupid” but Obama and his supporters are desperately trying to shift the focus of this election to anything but. And the Republicans have been lead-footed enough to let them.

Ultimately, Americans have a decision to make. What matters most: Tax returns or job reports?

This article originally appeared at The Commentator

Paul Ryan’s 40 year detox: America can’t rely on China

And now a word from our sponsors…

The reaction of some to the release of the Path to Prosperity budget last week by Representative Paul Ryan, Chairman of the House Budget Committee, was incandescent fury.

A New York Times editorial painted a picture of America under the Ryan budget as

one where the rich pay less in taxes than the unfairly low rates they pay now, while programs for the poor — including Medicaid and food stamps — are slashed and thrown to the whims of individual states. Where older Americans no longer have a guarantee that Medicare will pay for their health needs. Where lack of health insurance is rampant, preschool is unaffordable, and environmental and financial regulation are severely weakened”

The Washington Post exhumed Dickens and Orwell on the way to saying

“Ryan would cut $770 billion over 10 years from Medicaid and other health programs for the poor, compared with President Obama’s budget. He takes an additional $205 billion from Medicare, $1.6 trillion from the Obama health-care legislation”

According to The New Republic the budget

“would take health insurance away from tens of millions of people, while effectively eliminating the federal government except for entitlements and defense spending”

The Huffington Post quoted one Eddie Vale, a spokesman from pressure group Protect Your Care, as saying “A Republican budget to end Medicare is a Republican budget to end Medicare, no matter what you call it”

What’s most striking about all this is what’s missing. Mr Vale and the others quoted haven’t asked themselves the crucial question about Medicare and food stamps and all the rest; will the Chinese be happy to keep paying for it all?

The United States government borrowed $4 billion today. It borrowed $4 billion yesterday and it will borrow $4 billion again tomorrow and so on. Federal government debt, which was rising by about $625 billion a year under George W Bush, is, under President Obama, rising at $1 trillion a year. According to official figures in December Federal government debt passed 100% of GDP.

In National Review Mark Steyn does an excellent job of conveying the full scale of this explosion of debt

“The 2011 budget deficit, for example, is about the size of the entire Russian economy. By 2010, the Obama administration was issuing about a hundred billion dollars of treasury bonds every month — or, to put it another way, Washington is dependent on the bond markets being willing to absorb an increase of U.S. debt equivalent to the GDP of Canada or India — every year”

And what is the Ryan budget, cause of such wailing and gnashing of teeth, proposing to do about this financial catastrophe? Under what the New York Times called “the most extreme budget plan passed by a house of Congress in modern times” Ryan doesn’t actually propose to balance the Federal budget for another 40 years.

So far America has gotten by through buying consumer goods from China and sending dollars in return. The Chinese then effectively loan these dollars back to America by buying Federal government debt, Treasury bonds. The Federal government then spends the receipts from these Treasury bond sales on Medicare and food stamps and all the rest. This is how the Federal government pays its way and it is why China is the world’s largest owner of US government debt with holdings of $1.148 trillion.

Why have the Chinese been so willing for so long to fund the consumption of Americans who’s per capita GDP is nearly six times higher than theirs?

One reason is geostrategic. America will not be able to confront the emergent power of China over Taiwan or anything else if the US government has to borrow the money from the Chinese to do so.

Another is connected to the economy and domestic politics. It has long been an article of faith among China watchers that China’s economy needed growth of 8% a year to guarantee jobs for the millions of young people entering the workforce every year, failure would lead to political unrest. If the Chinese government could only guarantee these jobs in factories producing goods for sale in the US by loaning the US the money to buy them, so be it.

Either way the entire edifice of the United States government is dependent on a line of credit from China and elsewhere. In total one third of US government debt, $5 trillion, is held overseas. With a bit of help from the Quantitative Easing of the Federal Reserve this vast market for Federal government debt has kept bond yields historically low while debt has ballooned. The Federal government is dependent upon the continuation of this line of credit for its own continuation.

But there are signs that the willingness of poor Chinese to keep lending money to rich Americans is coming to an end. Last year the previously insatiable Chinese reduced their holdings of US government debt for the first time since records began in 2001. Not only China is suffering indigestion at the amount of US government debt it is being asked to swallow. Russia and India have drastically reduced their holdings.

The reason is obvious. As a borrower, like America, piles debt upon debt it becomes ever less likely that they will be able to pay it back so you stop lending to them. Indeed, this outcome was, at some stage, inevitable.

But what of the effect on America? Like anything else as the buyers for Treasury bonds disappear their price will fall. In the world of bond financing this means higher bond yields, rising American borrowing costs in other words.

The Federal government’s debt binge will come to an end. It is simply a question, to paraphrase Von Mises, of whether this should happen sooner as the result of a voluntary abandonment of increasing indebtedness, or later amid the catastrophe of default and inflation. Maybe Ryan’s 40 year detox isn’t so bad after all?

This article originally appeared at The Commentator