The austerian debacle — the Critique of Reinhart & Rogoff: conversations with profs. Pollin, Ash and blogger Konczal
«Austerity has no intellectual support and is an enormous policy failure»
An interview with Robert Pollin and Michael Ash, the two professors of University of Massachusetts at Amherst that co-authored the article with the Ph.D student Thomas Herndon about the Critique to Rogoff and Reinhart “debt iron rule of the 90%”
Pollin and Ash interviewed by Jorge Nascimento Rodrigues © April 25th 2013
After the discredit last year of the “expansionist austerity” based on very short findings of Alberto Alesina and Silvia Ardagna regarding a minority of 26 episodes of a sample of 107 where fiscal adjustment was associated with output expansion, last week a Ph.D student at the University of Massachusetts at Amherts, Thomas Herndon, 28, found serious mistakes at an NBER working paper of reference, “Growth in a time of debt,” co-authored by professors Carmen Reinhart and Kenneth Rogoff in January 2010.
While the influence of professors Reinhart and Rogoff on the initial push by European politicians for austerity is overrated, the critique to the “debt iron rule” of the 90 percent of GDP is clearly having a huge impact.
The problem with the papers of Alesina and Ardagna in 2009 and 2010 and Reinhart and Rogoff in 2010 was the fact they were published precisely during the end of the first wave of the Great Recession or in the beginning of a weak recovery in the advanced economies. Austerian politicians – as Jean-Claude Trichet, head of the European Central Bank at the time, and European Commissioner Olli Rehn – “pick” the working papers to justify the shift in fiscal policies.
There is a strong evidence that the austerian tide has suffered last week a huge blow, despite Reinhart and Rogoff distance themselves from austerity in their paper for the “Journal of Economic Perspectives” in the Summer of 2012. Professor Rogoff just recently was interviewed by Expresso weekly newspaper in Portugal criticizing the Eurozone policies.
In the financial community, Bill Gross from PIMCO is now a critic of austerity.
Pollin and Ash co-authored with Herndon a working paper for the Political Economy Research Institute. Titled “Does High Public Debt Consistently Stiffle Economic Growth? – A critique of Reinhart and Rogoff,” the working paper turns a viral weapon of mass destruction in the austerity debate last week.
Yesterday professors Reinhart and Rogoff published an op-Ed at “The New York Times” responding to almost two weeks of critics. They distance again from asterity policies in the euro zone: “Significant debt restructurings and write-downs have always been at the core of our proposal for the periphery European Union countries, where it seems to us unlikely that a mix of structural reform and austerity will work.” Also they mentioned: “We also note (…) that roughly half of all debt overhang episodes are associated with elevated real interest rates, suggesting the kind of vicious feedback loop between debt and growth that the periphery countries of the euro zone are currently suffering. In our view, the only way to break this feedback loop is to have dramatic write-downs of debt.”
Pollin: Truth is certainly a strong political weapon, but truth alone never settles political struggles
Ash: The evidence that austerity has no intellectual support and is an enormous policy failure has, I hope, contributed to turning the tide.
Ash: Reinhart and Rogoff have offered two messages in recent years: one against financial speculation buttressed by apparently solid historical evidence; and the other against public debt using faulty statistical evidence. It is ironic and unfortunate that many European and US policymakers have paid attention only to the argument backed by faulty evidence.
Q: When your paper was referred online at Rortybomb blog it was like a viral bomb. Have you expected this “non linear” effect around the world – in Portugal for example it was commented by common people?
Pollin: Speaking for myself, I had absolutely no idea whatsoever. How can you? I assumed this paper would get modestly more attention than the usual relative to the other papers I have written on this and related subjects. Boy was I off on that one.
Ash: Although Thomas, Bob and I worked hard on this paper and believe it to be an important finding, I did not expect it to receive so much attention. I corresponded early about the findings with Francisco Louçã, who has been an astute and articulate critic of austerity in Portugal and broadly in Europe. I’m very happy that our study has contributed to public debate.
Q: Do you think the austerian poltical mantra is blown up? Are we assisting to a tipping point even in the financial world, with Bill Gross from PIMCO criticizing austerity?
Pollin: I think the discussion around our paper has weakened the analytic foundations for austerity. Where we go from here I do not know. Truth is certainly a strong political weapon, but truth alone never settles political struggles.
Ash: Austerity has been severely damaging to national economies and human well-being. At the macroeconomic level, consider Blanchard and Leigh’s new findings on the systematic overconfidence of policy elites on the predicted benefits of austerity. At the human level, see the recent “The New York Times” coverage of children going to school hungry in Greece. The evidence that austerity has no intellectual support and is an enormous policy failure has, I hope, contributed to turning the tide.
Q: In table 5, page 23 of your paper, if we regard the 2000-2009 series we verify that the real annual average GDP growth in the 90 percent and above category is 1.7%. more than the 1.3% on the category 60-90 percent. This period is the bubble epoch and also the first two years of recession response policies. This means that the buildup of overhang debt had a positive impact in the growth dynamics?
Ash: We are not definitive about a positive relationship in the short 2000-2009 period. The relationship between the public debt/GDP categories and GDP growth has weakened over time. Second, as with the full sample, we see a wide range of GDP growth experience at every level of public debt in the more recent data. The evidence suggests a weak relationship or the specificity of the relationship to the particular conditions of the period and country. As we note in our Financial Times piece “When the US and Europe were hit by the financial crisis and subsequent collapse of private wealth and spending, deficit-financed government spending was the most effective tool for injecting demand back into the economy. The increases in government deficits and debt were indeed historically large in these years. But this was a consequence of the crisis and a policy tool for moving economies out of the deep recession. The high levels of public debt were certainly not the cause of the growth collapse.”
Q: Also from table 5, we found that there’s a consistent slowdown of the average GDP growth after the 1980s series in every category. There’s a true problem with growth in the advanced economies beginning in the 1980s, irrespective of the “behaviour” of the debt ratio? Financialization has something to do with this slowdown?
Pollin: As to financialization and growth, I think the answer has two parts: Financialization has definitely been happening. Some of the best research of which I am aware regarding its impact on growth comes from someone else who was once a graduate student of ours, Ozgur Orhangazi, who is now a professor in his native Turkey. He worked with U.S. evidence alone. His research shows that financialization has produced a diversion of investment away from productive activity in favor of speculation. However, speculative bubbles can accelerate growth for a while. The additional spending in the economy, financed by high leverage, promotes growth for a time, before the crash. I am working on an EC-sponsored project analyzing exactly such questions about financialization. The project is called FESSUD (Financialisation, economy, society and sustainable development).
Q: In page 11, when you mention the new two categories of 90-120% and 120-150%, we found a consistent slowdown of the average GDP. Curiously less 0.8 pp from category to category after the 60-90% category. In the higher category the average went down to 1.6%. Rogoff and Reinhart reply in the Financial Times that a differential of 1pp growth that lasts more than 10 years is not small, it is relevant because of its cumulative effects. Although there’s no tipping point or not a fall off a nonlinear cliff, this consistent slowdown is important for public policies, despite austerian policies has no historical valid argument?
Ash: There is no discussion of anything lasting ten years either in RR 2010 or in our replication. There is no question that it is bad for countries to have long recessions. And, high public debt will often result as a consequence of slow GDP growth, as it has in the current crisis. RR 2010 does not show evidence that public debt causes GDP growth slowdowns, let alone sustained GDP growth slowdowns. Our paper acknowledges (p.14) that GDP growth is modestly lower at higher public debt/GDP, but not necessarily because of higher public debt/GDP. The nonlinear cliff was central to the RR argument and is not supported at all by the data.
Q: Why Herndon only tested the series of 1945-2009 in the 2010 paper of RR and not the longer series in the 2010 paper and mainly in the 2012 JPE paper of Rogoff, Reinhart and Reinhart? Rogoff and Reinhart claim that the 2012 JPE paper rectified the gaps.
Ash: As we note in the paper, “We replicate the results only from the first sample [that is, the advanced economies in the postwar period] as these are the most relevant to current U.S. and European policy debates, and they require the least splicing of data from multiple sources.” Reinhart, Reinhart, and Rogoff (2012) does not address the serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the post-war period. These errors have not been rectified, and they have exerted a major influence on policy debate.
Q: Paul Krugman “extracts” the book “This Time is Different” of Reinhart and Rogoff from the present debate. What is your opinion about “This Time is Different”?
Ash: I found Reinhart’s and Rogoff’s “This Time is Different” to be highly engaging and well argued. The main message is a warning against speculative financial markets and a strong case for the effective regulation of finance. Reinhart and Rogoff have offered two messages in recent years: one against financial speculation buttressed by apparently solid historical evidence; and the other against public debt using faulty statistical evidence. It is ironic and unfortunate that many European and US policymakers have paid attention only to the argument backed by faulty evidence.
RELATED INTERVIEW WITH BLOGGER MIKE KONCZAL FROM RORTYBOMB BLOG
«The timing of the critique of Rogoff and Reinhart was pretty key»
Interview with MIKE KONCZAL, the blogger that call the world attention to the UMass paper criticizing Rogoff and Reinhart «90% debt iron rule» © April 25th, 2013
«Clearly an additional 10% of public spending would boost the economy and I don’t see the downside.»
«I look to the recent work by the IMF about fiscal multipliers, and their open criticism of some of the current actions, as really important for the intellectual community. But also the fact that it is clearly not working; cuts are not making any country, including the United States, grow faster.»
«I was interested in trying to replicate the R-R results for some time, and knew people who had tried and failed. So, I was happy that someone succeeded because it had a large grasp on the debate.»
The blog Rortybomb “engineer” a weapon of mass destruction (WMD) on the April 16. Mike Konczal, the blogger of Rortybomb, published a viral post in the blogosphere and provoked a new mortal “discredit” on austerity policies.
It is the second WMD after the now famous “technical note” about the “error of the fiscal multiplier” authored by chief-economist Olivier Blanchard in last October published at the World Economic Report, the bible of the International Monetary Fund (IMF), that is published twice a year.
Konczal posted about a paper from people of the University of Massachusetts at Amherst, US, showing evidence that the so-called 90 percent of GDP threshold for sovereign debt overhangs of Kenneth Rogoff and Carmen Reinhart (R-R) 2010 paper was simply wrong.
Just to remember, R-R, in their 2010 paper, claimed that when a country’s sovereign debt surpasses 90% of GDP the economy enter in a debt danger zone and then growth turns recession in advanced economies. Later, R-R, in a 2012 paper co-authored with Vincent Reinhart for the “Journal of Economic Perspectives”, changed the conclusions – there’s no more a cliff for recession at the 90% threshold – and claimed their paper should not be interpreted as a manifesto for rapid public debt deleveraging exclusively via fiscal austerity in an environment of high unemployment.
The austerians suffered a huge blow on April 16 and the following days. The paper co-authored by a Ph.D student Thomas Herndon and his professors Michael Ash and Robert Pollin (TAP) was published in the Working Papers of the Political Economy Research Institute, titled “Does Hig Public Debt Consistently Stiffle Economic Growth? A Critique of Reinhart and Rogoff”.
After this episode, even in the high rank financial community new voices appeared against austerity policies. The mainstream is changing. Monday, Bill Gross, manager of the world’s largest bond fund for PIMCO, just told the Financial Times that “bond investors want growth like equity investors, and to the extent that too much austerity leads to recession or stagnation then credit spreads widen out – even if a country can print its own currency and write its own cheques.” Gross said: “You’ve got to spend money.”
Many people and some institutions are repositioning themselves.
Recently at the IMF meeting in Washington DC, managing director Christine Lagarde’s team also argued that Germany, the US and the UK are tightening their belts too fast. In the G20 meeting last Friday, the communique omit specific deficit or debt-to-GDP targets. Even the European Commission President, the Portuguese Durão Barroso, talked this week about the limits to austerity, although saying that those policies are “fundamentally right.” He thinks austerity “has reached its limits.” Enrico Letta, the new Italian prime minister, called for an easing of austerity policies in the European Union. Letta demand that the euro zone should switch from austerity straight to stimulus. The Portuguese Elisa Ferreira, an european lawmaker in Brussels, shouted “Basta!” (That’s enough!) to the European Commmissioner Olli Rehn, one of the faces of the austerian mantra.
Mike is a fellow with the Roosevelt Institute, where he works on financial reform, unemployment, inequality, and a progressive vision of the economy. His blog, Rortybomb, was named one of the 25 Best Financial Blogs by Time Magazine.
Interview by Jorge Nascimento Rodrigues, © April 2013
Q: What was your first reaction to the paper of TAP from UMass?
A: I was very excited. I was interested in trying to replicate the R-R results for some time, and knew people who had tried and failed. So, I was happy that someone succeeded because it had a large grasp on the debate. I knew one of the authors too, so I knew it would probably be good work that stood up.
Q: Were you surprised with the viral impact of your post?
A: Yes! I thought a handful of journalists and economics writers would be interested, and that it would be a medium impact kind of post. But the response was overwhelming. I think more people are interested in the idea of austerity, what is happening, and in a critical re-evaluation of the “cuts all the time” mentality that is dominating the conversation. People is repositioning themselves and this allows a different reconfiguration of power.
A: People are reconsidering if austerity is worth it and the evidence isn’t good. That could mean a shakeup
Q: This paper from the 28 year old doctorate student was the tipping point regarding the austerian “building”? Bill Gross, an important voice from the financial community, just criticized the austerity strategy. These are signals of a reversal?
A: I look to the recent work by the IMF about fiscal multipliers, and their open criticism of some of the current actions, as really important for the intellectual community. But also the fact that it is clearly not working; cuts are not making any country, including the United States, grow faster. And, debt-to-GDP is often increasing (!) as a result of austerity in Europe – so it’s not even doing what it wanted to do. So the timing of the paper was pretty key.
Q: In page 11 of TAP paper, when they mention the new two categories of 90-120% and 120-150%, we found anyway a consistent slowdown of the average GDP. Curiously less 0.8 pp from category to category after the 60-90% category. In the higher category the average went down to 1.6%. Rogoff reply that a differential of 1pp growth that lasts more than 10 years is not small, it is relevant because of its cumulative effects. Although there’s no tipping point or not a fall off a nonlinear cliff as TAP say, this consistent slowdown is important for public policies, despite austerian policies has no historical justification?
A: I would say causation is the big problem with these. If you control for past growth, you will see a lot of this decline falls away. So, I think understanding that context is important. And, nobody is saying take on debt for the fun of it! The question, now that the “cliff” aspect of the debate is behind us, is about relevant trade offs. Clearly an additional 10% of spending in the US would boost the economy and I don’t see the downside.
Q: Paul Krugman “extracts” the book «This Time is Different» of R-R from the present debate. Do you think it is correct to separate «This Time is different» from the 2010 paper and keep the research for the book about financial crisis and defaults from the present tsunami?
A: Yes. I think that is appropriate and correct. The book is a very important work. That paper of 2010 was a small side project (it seems to me), that blew up way beyond what it was capable of intellectually sustaining.