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Friday, April 26, 2013

Reinhart and Roghoff respond

I have been following the mini-scandal of sorts in economics ever since the revelation that debt stars Carmen Reinhart and Kenneth Roghoff committed a basic Excel error in their famous paper that served as the basis for their very good 2009 book, This Time It's Different.  I refrained from jumping into it right away because I think it is usually best to hear what both sides have to say before attempting to reach any kind of judgment on the matter.

Also, from my neo-Austrian perspective, the basic idea that economic statistics can provide legitimate and meaningful guidelines for policy actions is a dubious one at best. The recent artificial boost to GDP by means of counting R&D expenditures twice, (to put it very, very crudely), is only one of many examples of the futility of attempting to derive economic principles from analyzing government-produced statistics.

Even so, I tended to suspect that the Neo-Keynesians were exaggerating the significance of the error, since the idea that beyond a certain amount, the addition of more debt will tend to reduce one's ability to spend is not exactly logically controversial.  The fact that Krugman and others immediately attempted to turn the matter into a policy debate was also suspicious, since the Reinhart and Roghoff paper was hardly the only one published on the subject. And, as it happens, Reinhart and Roghoff's response indicates that their admitted mistake was considerably less significant than the Keynesians and the inflationistas would like to pretend it is.
LAST week, we were sent a sharply worded paper by three researchers from the University of Massachusetts, Amherst, at the same time it was sent to journalists. It asserted serious errors in our article “Growth in a Time of Debt,” published in May 2010 in the Papers and Proceedings of the American Economic Review. In an Op-Ed essay for The New York Times, we have tried to defend our research and refute the distorted policy positions that have been attributed to us. In this appendix, we address the technical issues raised by our critics.

These critics, Thomas Herndon, Michael Ash and Robert Pollin, identified a spreadsheet calculation error, but also accused us of two “serious errors”: “selective exclusion of available data” and “unconventional weighting of summary statistics.”

We acknowledged the calculation error in an online statement posted the night we received the article, but we adamantly deny the other accusations.

They neglected to report that we included both median and average estimates for growth, at various levels of debt in relation to economic output, going back to 1800. Our paper gave significant weight to the median estimates, precisely because they reduce the problem posed by data outliers, a constant source of concern when doing archival research that reaches far back into economic history spanning several periods of war and economic crises.

When you look at our median estimates, they are actually quite similar to those of the University of Massachusetts researchers. (See the attached table.)

Moreover, our critics omitted mention of our paper “Public Debt Overhangs: Advanced-Economy Episodes Since 1800,” with Vincent R. Reinhart, published last summer, in The Journal of Economic Perspectives. That paper, which is more thorough than the 2010 paper under attack, gives an average estimate for growth when a country’s debt-to-G.D.P. ratio exceeds 90 percent of 2.3 percent — compared to our critics’ figure of 2.2 percent. (Also see the comparisons posted by the blogger known as F. F. Wiley, including his chart, a copy of which accompanies this essay.)

Despite the very small actual differences between our critics’ results and ours, some commenters have trumpeted the new paper as a fundamental reassessment of the literature on debt and growth. Our critics have done little to argue otherwise; Mr. Pollin and Mr. Ash made the same claim in an April 17 essay in The Financial Times, where they also ignore our strong exception to the claim by Mr. Herndon, Mr. Ash and Mr. Pollin that we use a “nonconventional weighting procedure.” It is the accusation that our weighting procedure is nonconventional that is itself nonconventional. A leading expert in time series econometrics, James D. Hamilton of the University of California, San Diego, wrote (without consulting us) that “to suggest that there is some deep flaw in the method used by RR or obvious advantage to the alternative favored by HAP is in my opinion quite unjustified.” (He was using the initials for the last names of the economists involved in this matter.)

Above all, our work hardly amounts to the whole literature on the relationship between debt and growth, which has grown rapidly even since our 2010 paper was published. A number of careful empirical studies have found broadly similar results to ours. But this is not the definitive word, as a smaller number of just as scholarly papers have not found a robust relationship between debt and growth. (Our paper in The Journal of Economic Perspectives included a review of that literature.)

Researchers at the Bank of International Settlements and the International Monetary Fund have weighed in with their own independent work. The World Economic Outlook published last October by the International Monetary Fund devoted an entire chapter to debt and growth. The most recent update to that outlook, released in April, states: “Much of the empirical work on debt overhangs seeks to identify the ‘overhang threshold’ beyond which the correlation between debt and growth becomes negative. The results are broadly similar: above a threshold of about 95 percent of G.D.P., a 10 percent increase in the ratio of debt to G.D.P. is identified with a decline in annual growth of about 0.15 to 0.20 percent per year.”
It's important to understand how deep we are into uncharted waters here, as only 8 percent of the postwar observations in advanced economies exceeded 90 percent of GDP and levels over 120 percent are almost unheard of.  But regardless, as Reinhart and Roghoff point out, there are only four options: slow growth and austerity for a very long time, elevated inflation, financial repression and debt restructuring.  And the only one that offers any possibility of success without massive social disruption and violence is the last one.

More importantly, as we'll be discussing in the next round of the Inflation/Deflation debate, policy makers may not have anywhere nearly as much choice in the matter as they believe they have.

As Zerohedge notes, US Government Debt/GDP presently stands at 104.8 percent, up from 103 percent three months ago.

Labels:

32 Comments:

Blogger Positive Dennis April 26, 2013 10:40 AM  

I am not sure that any economic measurement is accurate enough to make any projections. The whole system is too corrupt. As a life long real estate investor, I feel that I can say I no longer trust any of figures I am given, including appraisals. The market is too bifurcated and manipulated. One can not invest, one can only speculate.

Anonymous jack April 26, 2013 10:40 AM  

I enjoy these econ posts. That said, I understand, post collapse, I offer you one viable 12 gauge shell for your pig. No fancy charts, no studies by academics, etc.
Simplistic? Yes. Immediately understandable, again yes.

Anonymous JartStar April 26, 2013 11:08 AM  

Even Krugman said in an interview that there's some debt to GDP ratio that would be bad, but I don't remember the number. Considering that Japan is now +220% we have a long way to go.

Anonymous JP (real one) April 26, 2013 11:08 AM  

Oh, come on. That paper committed some grievous error, and now austerity measures are 100% disproven. Gov't spending can and will save the day! I read an article about this in the MSM..."The Death of Austerity" or something like that.

Who needs details like "their admitted mistake was considerably less significant"? We just need the printing press, more spending and wasteful New Deal-type public work boondoggles to employ the unemployed (who would rather collect checks for nothing), etc.

Blogger jamsco April 26, 2013 11:10 AM  

"I refrained from jumping into it right away because I think it is usually best to hear what both sides have to say before attempting to reach any kind of judgment on the matter."

Vox Day: Model of Restraint

Blogger IM2L844 April 26, 2013 11:10 AM  

I expect slow growth and progressive austerity for a very long time will be the frog in the pot until it becomes extrardinarily clear it's unequivocally untenable.

Anonymous Outlaw X April 26, 2013 11:16 AM  

This is a new Pardigm, none of it matters. It is all BS. Economist don't know chit. I am tired of the end of the world crap. As long as people are slapping dollars on counters to buy horse chit made in China, and other people are taking them all is well.

Anonymous a_peraspera April 26, 2013 11:16 AM  

How unfortunate. At this point, whatever Reinhart and Roghoff say - from now until the end of time - will be dismissed based on one slight error.

In fact the Keynesians will now try to dismiss all of Austrian economic theory based on this. When dealing with Leftists you can never miss a trick or they will really shove the knife home.

Doubly ironic that Leftist sacred cows like global warming and socialism have been proven wrong time and again, yet few call them out for THEIR mistakes....

Blogger Joshua_D April 26, 2013 11:19 AM  

" Outlaw X April 26, 2013 11:16 AM

This is a new Pardigm, none of it matters. It is all BS. Economist don't know chit."

I believe you mean, "shit".

Blogger James Dixon April 26, 2013 11:32 AM  

> I expect slow growth and progressive austerity for a very long time will be the frog in the pot until it becomes extrardinarily clear it's unequivocally untenable.

Well, as I noted in an earlier thread, only if you consider austerity to be only spending $1 trillion you don't have instead of $1.t trillion.

All spending bills must start in the house, and they have a republican majority, yet the spending continues. Neither party wants to actually cut spending.

> ...yet few call them out for THEIR mistakes....

They're called out all the time. But when you control the media...

Anonymous John Regan April 26, 2013 11:43 AM  

Debt "restructuring"? Lawyers and courts do that, not economists. Maybe that's why economists don't like dealing with the subject.

In any case, debt restructuring is perfectly compatible with "...slow growth and austerity for a very long time, elevated inflation [and] financial repression...". Indeed this is the plan, for many reasons.

Debt cancellation and/or forgiveness by law, or decree or some such (that is, a jubilee) is very different. And this is most emphatically not the plan.

The problem with the planned "moderate" course envisioned by Reinhart, Rogoff, et al is, as with so many economist musings, not so much the theory but the practice. In practice, political influence will determine who gets a really good deal and who doesn't. If you're TBTF you won't suffer at all; if you're small fry you'll be homeless.

This will fly for a while, maybe even for a long while as long as they continue such practices as "zombie titles":

http://www.nakedcapitalism.com/2013/04/bank-zombie-title-rises-hurting-communities-and-borrowers-as-occ-and-fed-sit-pat.html#comment-1224495

Sooner or later the bill comes due. I would prefer to be proactive on this and have a jubilee but, you know, I don't see that happening.

http://strikelawyer.wordpress.com/2011/12/27/saving-the-world-revised-edition-part-ii/

Anonymous Razoraid April 26, 2013 11:43 AM  

If you don't agree with Krudman's hypothesis on ending the depression, you're against the kids.

Blogger San Mack April 26, 2013 11:49 AM  

If you don't agree with Krugman, you aren't just misguided, but downright evil. These days, if good ideas aren't PC, they are off the table.

Blogger James Dixon April 26, 2013 12:01 PM  

> Sooner or later the bill comes due. I would prefer to be proactive on this and have a jubilee but, you know, I don't see that happening.

Not for the average folks, no. But for the government? Absolutely. As Glenn Reynolds says: Debts which can't be paid... won't.

Austerity won't work because no elected government seems capable of practicing it. Inflation is a tiger which cannot be controlled (though they may try). And financial repression doesn't really work to solve the problems.

So debt restructuring it finally will be. And the best and easiest way for a government to restructure debt is to repudiate it.

Anonymous JP (real one) April 26, 2013 12:10 PM  

"How unfortunate. At this point, whatever Reinhart and Roghoff say - from now until the end of time - will be dismissed based on one slight error... Doubly ironic that Leftist sacred cows like global warming and socialism have been proven wrong time and again, yet few call them out for THEIR mistakes...."

Very true. This is a good article on someone who tried to buck the establishment on global warming. (It also shows how well homeschooling can work,)

http://www.independentscientist.com/

An excerpt:

"Trapped by government money. Filling out grant requests, politicking to be well-liked, serving on grant review boards, going to the meetings to be seen by others, will take half your time. The project itself had better be popular. 'You're only going to get the money for something that everyone has heard of and thinks is the coming thing,' he said. As for politically sensitive areas such as global warming, 'your research had better come up with the results they want.'"

Anonymous WaterBoy April 26, 2013 1:51 PM  

Outlaw X: "Economist don't know chit."
Joshua_D: "I believe you mean, "shit"."

It's cultural -- he's part Cheech.

Anonymous scoobius dubious April 26, 2013 2:22 PM  

There's nothing to worry about. 30 or 50 years from now, when it becomes time to stiff the Chinese on the debt, we won't have to worry at all about retaliation from them, because all those state-of-the-art high-tech weapons systems built by our newly imported mestizo majority will keep us safe from all harm.

And then I woke up, and my legs were broken and my pillow was gone.

Anonymous John Regan April 26, 2013 3:09 PM  

>>Austerity won't work because no elected government seems capable of practicing it. Inflation is a tiger which cannot be controlled (though they may try). And financial repression doesn't really work to solve the problems.<<

Inflation?

As far as "austerity" goes, it's already well in progress, both in the US and in Europe. The balance they're trying to achieve is to see if they can clamp down a bit on lending, generate a little inflation through government spending but restrain government spending at the same time to preserve whatever integrity the money has left.

Like I said, it's incoherent and has no hope of "working", unless by working you mean delay, pretty much exclusively. By that metric, as VD might put it, they may succeed. A recent experiment along these lines and still underway that also has yet to implode after about 20 years is, of course, Japan.

There shouldn't be much mystery in all this, but for some reason there is. A simpleton could see it but the wise are confounded: if you over-promise you're going to have a problem when the bill comes due. You can start reneging on promises or pretend that the due date is still in the future. The latter is the natural approach when political considerations determine things. Competing claims which in the aggregate are impossible to satisfy completely are fudged as best lying, cheating and fudging can manage, though it's called something else, and in some ways IS something else, at least at the beginning.

But as you proceed the dishonesty of it all becomes more apparent, and eventually flagrant. We are there now. The disparate treatment of TBTF as opposed to some schmuck that might be engaging in, say, food stamp fraud is one example, but there are so many others. Rolling Stone's Matt Taibbi might be sort of a commie, but he chronicles facts and the facts speak for themselves. I'd recommend his reports to anyone. His blog is on my blogroll.

One reason the jubilee is such a good idea is that it is an act of honesty reversing decade upon decade of increasingly grotesque, and at this point institutionalized dishonesty in financial matters.

Another reason it's such a good idea is that it's the only way out.

In the US it would have to be a constitutional amendment, which could be done with sufficient popular pressure. That's really what the constitution was designed for.

I should add that a baby boom would help ease things quite a bit - that is part of Japan's problem, too - but the likelihood of that is about the same as a constitutional amendment implementing a jubilee.

Like I said, it's not looking good.

Blogger LP 999/Eliza April 26, 2013 3:46 PM  

Post of the week! People need to pour over the data while wearing their thinking caps.

Blogger FALPhil April 26, 2013 4:02 PM  

"I should add that a baby boom would help ease things quite a bit - that is part of Japan's problem, too - but the likelihood of that is about the same as a constitutional amendment implementing a jubilee."

The demographic problem is that the more affluent a society becomes, the less children they want. The affluent turn inward and focus on self and entertainment. Children would be a burden that would interfere with that. Western Europe is a case in point. By 2050, there will statistically be no more ethnic Greeks because their birth rate is so low. Spain and France will follow, and then probably Germany. Russia is interesting. They are offering huge tax incentives to couples for having children.

Anonymous Noah B. April 26, 2013 4:09 PM  

"As Zerohedge notes, US Government Debt/GDP presently stands at 104.8 percent, up from 103 percent three months ago."

So this redefinition of GDP should help. Maybe they'll be able to just keep doing that.

Anonymous John Regan April 26, 2013 4:28 PM  

@FALPhil:

Yeah, kind of, although post WWII USA was fairly affluent and that didn't stop the baby boom.

One thing to keep in mind. The fertility thing, unlike a lot of other factors, can turn on a dime. I mean, who would have thought that we'd ever have below replacement levels in Europe and here in, say, 1950?

And one other thing: it's much more natural to have children than to avoid having them. You have to do things to avoid having them; but if you just behave naturally they tend to come along.

I guess what I'm saying is that there should be a natural tendency to fertility, not to infertility, which gives fertility an advantage. Not that it's an advantage that can't be overcome as it has been for 40 years or so, but it's still there.

Blogger FALPhil April 26, 2013 4:49 PM  

"I guess what I'm saying is that there should be a natural tendency to fertility, not to infertility, which gives fertility an advantage. Not that it's an advantage that can't be overcome as it has been for 40 years or so, but it's still there."

Well, brown people and Mohammedans surely think so.

Anonymous DAS April 26, 2013 6:21 PM  

How would a jubilee work? what kinds of debt would be forgiven? Is this another bankster trough or would it help the rest of us?

Anonymous Grinder April 26, 2013 7:49 PM  

Debt restructuring and/or repudiation? This does not fix the underlying problem. And the best case scenario depends on the proper implementation of a restructuring policy which is highly unlikely under the current regimes.
The claims I have heard that countries would be in the black if they did not have to carry debt is naïve, overly simplistic and incorrect. The economy would shrink drastically if debts were cancelled as pensioner incomes are paid from the interest earned. What would step up to offset the severe leftward shift in the demand curve? Would pensioners re-entering the workforce competing for min wage jobs to pay for their groceries and heat their hovels help?

Anonymous John Regan April 26, 2013 7:59 PM  

@DAS: I can only tell you how far my thinking has taken me. I've gotten very little valuable feedback.

The first thing is to realize just how huge this proposal is. So much depends on debts being paid: pensions, social security, taxes, and so on. Wiping out all debt wipes all of that out, too.

On the other hand, at the end nobody owes anybody anything, so no bills have to be paid to keep going. I exempted two things in the proposal: Federal Reserve Notes and bank deposits. These would still be owed and would be covered by government gold at a price of something like $30,000 per ounce.

The reason for this is to keep some money. Circulating money is usually debt, and if all that debt was canceled too there wouldn't be any money.

The biggest losers would, of course, be creditors. The biggest winners would correspondingly be debtors. Most people are both to some extent.

The most extravagantly indebted would be the biggest winners of all. This is the downside to the proposal.

The upside is that nobody would lose anything. Everyone would just have what they have now, without owing anything for it.

The rationale for this trade off is that no matter what anyone does there will be winners and losers. If things just happen under the current regime the politically favored will win. Under what I have proposed the biggest winners, I suppose, would be people holding gold. And then those mining it.

I am open to any suggestions, from anyone, anywhere, although I have heard the objection very often that it's wrong to "reward" people who over-borrowed. I mean, even if you didn't personally over-borrow, your government over-borrowed for you. A jubilee will always benefit borrowers. It's the nature of the thing.

Anonymous Roundtine April 27, 2013 12:33 AM  

How would a jubilee work?

Everyone gets a flat payment. The Treasury would send every American $50,000 or $100,000 (At $100,000 that is $30 trillion). It could be worked in a way that it must first be used to pay off debt, or not, but mostly likely it would be earmarked for debt AND there would be financial reform that keeps the system from taking off again. Effectively a one-off devaluation in the U.S. dollar with Americans being cushioned from the blow by the cash payment, and the financial sector restrictions serving to prevent runaway hyperinflation. For example, it might be illegal to take on consumer debt, mortgage down payments might be set at a minimum of 20-30%, corporations and banks will be severely restricted in their use of debt, and so on.

Anonymous sprach von Teufelhunden April 27, 2013 3:15 AM  

Screw a jubilee! This is not Israel, or the Old Testament.

What Debt? I really do want to know. What debt needs to be repaid?

I will not repay back one cent of debt not owed. Again, what debt?

Funny, how I see ~$300 TRILLION coming back in legal clawback. That is restitution for monies taken fraudulently in the very first place.

What debt? This entire inflation/deflation debate is moot. Don't worry about who owes who. Just cancel the debt. That is the legal and moral thing to do. Then hang the bastards in a public display. And take everything back from them.

Begin with the Provost Marshall acting for the JCS. This is how it is done under international law in wartime. And yes, we are at war. The PMG, was reinstated in 2003, after a 29 year absence. Imagine that. Just when we need it.

Anonymous scoobius dubious April 27, 2013 3:37 AM  

"How would a jubilee work?"

Internationally, by cancelling/repudiating all our national debt to foreign countries, and telling our various large-scale creditor nations that we consider the cancelled debt to be payment for services rendered. Very valuable services.

To the Saudis: we keep you from being invaded, and we keep your ruling class from being butchered in the streets. You're welcome. Now we're even.

To the Japanese: for not wiping you off the earth or enslaving you when we had the chance, and also for rebuilding you, bringing you back into the international community when you were the most reviled monsters on the planet, and then defending you from various Pacific threats, real and imaginary. You're welcome. We're even.

To the Chinese: for jump-starting your new economy by buying all your shoddy crap, thus dragging you out of the hell-hole of communism while we gradually explore that hole ourselves; for giving you all our heavy industries on a plate, and also for letting your "graduate students" steal all our technology; for not executing the hundreds of thousands of spies you've sent here. Oh, and also, for saving your asses from the Japanese by defeating their military and crushing Japan. You think Chiang and Mao could have stopped them without us? Eight Route Army, my ass -- you jerkoffs would have been Japanese slaves for the next thousand years. You're welcome. We're even.

And so on.

Would it work? Well, no and yes. They'd retaliate by crashing the dollar, at a minimum, one supposes. But then we'd just issue the New Dollar. Who needs to be the world's reserve currency? We are a world unto ourselves (these days, literally-- the whole fucking world seems to live here). Let the world go fuck itself. For all our flaws, we're still considered the only honest broker on the planet, and everybody knows it. Let them come back crying. And if they don't, that's even better. Piss off, rest of planet. This country's full. (And about to get a whole lot fuller, thanks to the GOP and the Gang of 8. They should really be called the Gang of 9, because the Ninth Circle, the circle of traitors, is where they're destined for.)

Blogger Nate April 27, 2013 9:13 AM  

That's another point we agree on vox... This is going to end according to natural laws of economics. Not according to the wishes of policy makers.

Anonymous John Regan April 27, 2013 8:12 PM  

@Nate:

When it comes to debt, the "natural laws of economics" are not self-executing. Think about that.

Blogger Nate April 28, 2013 9:22 PM  

"When it comes to debt, the "natural laws of economics" are not self-executing. Think about that."

John

That's one of the dumbest things I have ever read here.

Think about that.

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