Wednesday, November 26, 2014

A Fateful Mistake

PARIS – Controversy is essential to the advancement of science. So the debunking of methodological flaws and a coding error in a paper by the economists Carmen Reinhart and Kenneth Rogoff is just part of everyday life in academia. Yet coverage of the controversy by the news media and the blogosphere has been astonishingly intense – and simplistic.

“Growth in a Time of Debt,” the short 2010 paper in which Reinhart and Rogoff claimed that public debt starts to have a significantly detrimental effect on economic growth once it reaches 90% of GDP, was never a celebrated piece of economic research. As a rough empirical characterization of stylized facts, it was received somewhat skeptically by the academic community, and both authors were known for much more noted contributions. Google Scholar, the academic search engine, records more than 3,000 academic citations of Rogoff’s most cited paper, compared to less than 500 for “Growth in a Time of Debt.”

What would have normally remained a subject for post-seminar small talk has, however, become a topic for discussion by journalists, commentators, and policymakers. For all of them, what matters is that the sorry fate of the Reinhart/Rogoff paper undermines the case for fiscal austerity.

A few months ago, Olivier Blanchard, the International Monetary Fund’s chief economist, had already criticized his colleagues and policymakers in advanced countries for systematically underestimating the recessionary impact of fiscal consolidation programs. The debacle of the Reinhart/Rogoff paper is widely regarded as another, fatal illustration of austerity’s shaky intellectual foundations.

But this is only partly true. Until the Reinhart/Rogoff paper, the main argument for fiscal retrenchment rested on concerns about the sustainability of public debt. The question was whether a sovereign would ultimately be able to repay its debt, given specific economic and financial conditions, long-term trends such as the aging of the population, and uncertainty about the future course of policy.

The problem was that economists were unable to say how much is too much. There was no given threshold below which debt was innocuous and above which it was dangerous. So the message to policymakers was confusing. Economists were like doctors telling patients that, while some wine may be beneficial, too much is certainly dangerous – without being able to tell them how many glasses per day they were allowed. They were right, but hopelessly imprecise.

Confusion was especially acute in early 2010, when “Growth in a Time of Debt” was published. The global economy was just emerging from the deepest recession in the post-World War II period. A global Keynesian stimulus had prevented the worst, and the most urgent policy question was whether to continue supporting the economy or start consolidating.

Some argued in favor of delaying consolidation, because the economy was still in a deep recession; too harsh an adjustment, according to this view, would have a major impact on a still-weak private economy. Some claimed the opposite, arguing that, given the scale of the task, there was no time to lose.

The Reinhart/Rogoff paper appeared to provide the perfect argument in support of rapid consolidation, which is why it was cited intensively in policy discussions. Austerity, it was argued, was needed to stem the rise in the debt ratio and safeguard long-term growth.

To be sure, retrenchment could entail some short-term costs; but the longer-term benefits would be much bigger. Even though Reinhart and Rogoff themselves did not draw that conclusion explicitly in their paper, many drew it for them. It was so tempting for a minister or a senior technocrat to explain that consolidation had to start immediately, because the 90% threshold was approaching, that most of them did not resist it.

Heavy reliance on what turns out to be disputed evidence now leaves the fiscal hawks in a weak position, to say the least, vis-à-vis their opponents. This is especially true in Europe. Having promised that rapid consolidation would be good for growth, and having delivered recession, the European Union has disappointed its citizens. Adjustment fatigue is setting in, and governments risk losing support if they go much further in their consolidation efforts.

The danger is that the discrediting of hasty austerity could undermine the case for fiscal responsibility in the long run. If so, financial markets could conclude that public-debt sustainability is in serious danger – a perception that could have highly adverse effects on financing conditions. In the end, growth would indeed suffer, ironically proving Reinhart and Rogoff right.

This episode once again underscores the importance of intellectual rigor. Of course, that is not always an easy credo by which to abide. Researchers are tempted by persuasive results that can attract the interest of policymakers, who are tempted by a selective reading of the evidence that can provide them with ammunition in domestic and international debate. Submitting to either temptation, as the Reinhart/Rogoff episode has shown, is never advisable.

The views expressed here are the author's own.

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    1. CommentedJames Ross

      If austerity ends in the Euro-Zone, then can we expect the bond vigilantes to up the ante re. debt?

    2. CommentedGary Foxwell

      Economics is a wonderful profession. What other professions allow you to be constantly wrong and still argue that you are right. A weatherman comes to mind, but the weather proves them right or wrong every day. Economist are like accounts, they should be listened to, but not put in charge of anything.

    3. Commentedandrea naldini

      The real question is different: why austerity policy has been so important when its scientific bases are so weak?

        CommentedRalph Musgrave

        Reason is that 99% of the population think that government debt (macroeconomics) can be compared to the debt of micro economic entities like households. The two are actually as different as chalk and cheeze.

        The pros and cons of increasing or decreasing government debt are almost entirely different to the pros and cons when it comes to households or small firms.

        Unfortunately even so called professionals like Jean Pisani-Ferry are quite obviously confused on the latter point.

    4. CommentedJuraj Lörinc

      Well, conclusions drawn based on the Reinhart/Rogoff paper are wrong as there were mistakes there, right?

      Did anyone try to correct the mistakes and then follow all subsequent steps to come to in a sense equivalent conclusions? Or is it impossible due to any of following:
      a) inability to do the methodology right,
      b) some catastrophic point in the implications chain that prevents drawing conclusions or
      c) some other obstructions on the path?

      From the layman's point of view it seems there should be solution to all problems once the main direction is set here. I imagine the corrected conclusion in a way like "debt 60% of GDP is sustainable with probability close to certainty, debt 120 % of GDP is unsustainable with probability close to certainty given the current knowledge etc". So no really hard numbers, rather some grey zone.

      By the way - are there any other generally accepted views on the sustainable level of sovereign debt backed by data and methodology all right?

      Anyway, it seems that mistake of paper is really fateful as it gives ammunition to the side of debtists. They know too well that it won't be their money repaying the debts in the future...

        CommentedRalph Musgrave

        It was impossible to correct the mistakes because for three years after publication Rogoff refused to let anyone see his famous spreadsheet, despite numerous requests: a measure of his intellectual dishonesty. I got that from this source:

    5. CommentedFrank O'Callaghan

      The paper by Carmen Reinhart and Kenneth Rogoff is illustrative of the fact that Economics is not a science. It may not even be an Art or even a craft.

      The fact that the paper stood until now is clear proof of the fact that Economics is a grave but not a serious discipline.

      The experiment of mistimed austerity has been repeated too often and with the same results. The only reason to continue the policy is to achieve more of the results that we know spring from it. Austerity destroys demand and depresses economies. It cannot be the way out of a recession.

      The clear path out is through redistribution of surplus wealth from the beneficiaries of the unregulated boom of the last thirty years to those who will use it to increase demand. Bloated bureaucracies and absurd concentrations of unconscionable unconsumable wealth are obstacles that can be solved.

    6. CommentedProcyon Mukherjee

      A very caustic comment: "Researchers are tempted by persuasive results that can attract the interest of policymakers, who are tempted by a selective reading of the evidence that can provide them with ammunition in domestic and international debate."

      R&R's 90% threshold acted like an 'availability heuristic' regardless of conditions of economies across the globe in form of generalizations. How can U.S. economy be at all compared with European conditions, where no country can keep printing money and do any amount of monetary release?

    7. CommentedZsolt Hermann

      The real fateful mistake is that we still do not leave the artificial bubble we are in.
      Humanity created an illusion, the illusion of constant quantitative growth, and then built a whole socio-economic structure around it.
      All our life is now conducted within this cocoon, all our methods, theoretical knowledge, Nobel prize winning scientific work, all is based on laws, subsystems that are artificial, without any natural foundations.
      When the whole building started, we were at a stage of development where this was possible, as our deviation from the natural principles, laws was minimal, so by corrections, forceful adjustments we could convince ourselves that what we do is all natural and good.
      But if we look back to history how much suffering, how much bloodshed, terror we have been going through to keep our illusion alive?!
      This should not happen as in a natural system, where all elements complement each other in a mutual way everything is effortless. We think we are pioneers, heroes but in fact we are simply fools going head against the wall.
      But by today we reached such an opposition to the natural system and its laws of general balance and homeostasis around us, that our artificial structure is falling apart whether we want it or not.
      But we still ignore all the scientific data collected, scrutinized, published over and over, we ignore the "field data" coming out of the crisis day by day, and still want to stubbornly remain within the cocoon. The whole discourse of austerity vs stimulus is futile since there is no further growth possible in the way we are used to it.
      The "child", the human sociaty has grown up, it has matured into a globally interconnected, interdependent network within the closed and finite, vast natural environment.
      From now on only qualitative changes, continuous adaptation and merging with the natural system is possible. Otherwise the system will put more and more pressure on us, more precisely since we go against its laws, we ourselves put pressure on ourselves since the natural laws, like the law of gravity for example, are unbending and if we go against them we pay the price.
      Only we ourselves and the human system we build can change. The rest of reality is unchanging.