Who’s Afraid of the Big Bad Debt?

Apr 30, 2013 Ricardo Hausmann

The ongoing debate over findings by the economists Carmen Reinhart and Kenneth Rogoff that high public debt weakens economic growth is considered important because it is supposed to have implications for the choice between austerity and fiscal stimulus. In fact, the debate's relevance is limited largely to the US.

CAMBRIDGE – It has been a while since a debate among academic economists attracted so much interest from the mainstream press as has the row between Carmen Reinhart and Kenneth Rogoff, on one side, and Paul Krugman, on the other. In fact, it has even become fodder for television comedy shows.

At issue is an influential 2010 paper by Rogoff and Reinhart that purports to show that high levels of public debt are associated with lower long-term economic growth. A new paper by Thomas Herndon, a graduate student at the University of Massachusetts at Amherst, and two of his professors, Michael Ash and Robert Pollin, questioned this finding, and Krugman made their work famous.

Herndon, Ash, and Pollin argue that the results obtained by Reinhart and Rogoff are based on coding errors and questionable methodological choices. But, after all their quibbles, their paper weakens but does not refute the Reinhart/Rogoff paper’s main result. So why all the fuss?

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0 Comments on this paragraph, 14 Comments on this article

Omololuoye Majekodunmi May 27, 2013

People like misquoting krugman. krugman has always acknowledged the advantages of having ones own currency. Spain is a wrong example to use because it doesnt borrow in its currency and big brother Germany is not ready to help. look at US/JPN and look at the euro area. the difference is as plain as noonday.in fact look at UK which has its own currency but pursued austerity. its a shame academic economists believed in the confidence fairy and expansionary austerity.

You mentioned that 'fiscal contraction may end up being expansionary to the extent that it reestablishes financial confidence and lowers sky-high interest rates'. my response is where has the confidence fairy been?
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Leo Arouet May 15, 2013

En total desacuerdo. En Perú hemos aplicado políticas anticíclicas sin haber sido austeros antes... Simplemente es necesario estimular la economía porque de lo contrario una austeridad rigurosa traerá una mayor precariedad. Y si esto de ve como en Estados Unidos que necesita infraestructura, aumentar los sueldos y conservar los empleos mucho mejor, bienvenido Keynes.
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jack lasersohn May 7, 2013

Krugman's argument is a bit more subtle than how it is portrayed. He does not argue that debt does not matter, but rather that stimulus now will lower debt/gdp ratios in the future, by causing GDP to grow faster than the debt is accumulating.
The real gap in this argument , that he never addresses (ever), is whether that is true or not. He simply assumes that because austerity does not seem to be working that the inverse must be true: that stimulus will produce a permanent increase in the rate of GDP growth. This is not necessarily true and is frankly not very likely to be true.
It is hard to imagine how a temporary stimulus should produce a permanent increase in output. The only way is if it leads business to permanently expand production (through hiring and capital investment), but i can assure you that most businessmen are much more likely to meet what is obviously a temporary blip in government induced demand by temporary hiring or simply ignore it completely. Krugman is an extremely smart guys who has been right most of the time, but he has simply never made a persuasive argument in support of the idea that temporary stimulus will actually produce permanent increases in growth rates (frankly, neither did Keynes).
The real role of stimulus is to very inefficiently provide funds to persons who would otherwise be in financial extremis and default on their debt obligations causing a Minsky cascade of defaults. It would be vastly more efficient to do this by providing highly target debt relief to aid in rapid deleveraging , but even liberals find the moral hazard and inequity of that approach unacceptable.
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Oliver Kovacs May 6, 2013

Stimulus or austerity? In my opinion, a potential solution may be somewhere in between. The real question is whether we can find a new growth model, fields that are worth to concentrate on fiscally which may lead to not only quantitative, but qualitative growth.

The crisis is still out there by summoning the bad times of earlier economic history. Even though Marx stated that history repeats itself first as tragedy, if we are cautious and aware enough, we can pursue a solution / http://icegblog.blogspot.hu /
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Juan Daniel Montenegro Cabrera May 4, 2013

Another interesting part of the debate is their claim that high debt is the cause of low growth, when in fact there is only a negative correlation demonstrated and not the direction of the cause which could also be the other way around, low growth can be the cause of high debt.
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Juan Daniel Montenegro Cabrera May 4, 2013

the author forgets that this rock-bottom interest rates are true for countries who still have their own currency to devaluate which is no longer true for countries like Spain which have taken the Euro and have no such mechanism.
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Mark Pitts May 2, 2013

Japan has had huge debts for a generation, and little growth. Italy and Greece had huge debts and little growth (even before 2007). Now, the whole developed world has huge debt and little growth. The pattern seems to prove Rogoff and Reinhart right.
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Tomas Kurian May 2, 2013

Only countries that does not have their own central bank are at the mercy of bond vigilantes. Thats the point of having one, private lenders can panick - central bank is the final defense.
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Ralph Musgrave May 1, 2013

Ricardo Hausmann doesn’t understand this subject. His basic argument is that countries that are reliant on foreigners to fund deficits (e.g. EZ countries) cannot ignore deficits and debts. Well obviously!!!! He then concludes that “countries in recession” should be careful with deficits and debts. Well as he himself just pointed out, it’s countries that are reliant on FOREIGN FUNDING that face a problem there. In contrast if you can print your own money (like the US, Japan, UK, etc) then it’s INFLATION that is the real constraint. Debts and deficits are irrelevant.
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Frank O'Callaghan May 1, 2013

Rogoff and Reinhart have become a joke. However they say something very important; Nonsense, no matter how crude or obvious, can be accepted in economics as long as it serves the ends of the dominant ideology.

The lesson should be restated frequently. To do otherwise is to collude in the selective amnesia that marks conspiracy or complicity in deceit.
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Procyon Mukherjee May 1, 2013

When lack of humility is replaced by an arrogance that instead of believing in the 'gradual increase of assurance' that Hume summarized in his Treatise on Human Nature, we have the current genre of Economists muddled in the virtues of a science that is not based on falsifiability, but in inductive reasoning, that at best could serve the needs of a partial inquiry which must be held with due skepticism as to the nature of their applicability.
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Ken Presting Apr 30, 2013

It's just astonishing at this date to read an article on the Rogoff-Reinhart paper which does not mention that it had blatant admitted errors, not just in calculations, but as Brad DeLong points out, in the essence of its non-parametric method. It was never the data which showed a "threshold" effect where debt became dangerous. It was only the authors who created an arbitrary-sized category over 90% debt-to-GDP.

Anyone who stumbles across Prof. Hausman's dubious apologia here, should quickly turn to Prof. DeLong's piece on this same site. There is a stimulating discussion already in the comments there too.
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Peter P Apr 30, 2013

The level of debt does matter for interest rates ONLY for countries on pegs and using foreign currency. Not to sovereign issuers. Please read up on MMT, it predicted this result long before the crisis and thus warned against the Euro: not because monetary policy cannot be adjusted, but because of exploding debt costs in the event of a continent-wide recession.

http://krugman.blogs.nytimes.com/2013/02/24/debt-spreads-and-mysterious-omissions/

neweconomicperspectives.org/p/modern-monetary-theory-primer.html
- Robert Lunn Apr 30, 2013
  
  Maybe a bit of an over read? Krugman started attacking R&R piece as something the talking heads latched onto in order to explain macroeconomics like home economics.
  I read their book and came away thinking the evidence showed some cause and effect but not total. Subsequently, Rogoff has positioned himself in the "balanced" approach camp.
  I'd caution Krugman to be a little careful. When the likes of Joe Scarborough used R&R to make his case, R&R should have scrambled. Now, Krugman has the same issue upside down. He should be careful if not humble.
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Who’s Afraid of the Big Bad Debt?

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