Michael Heller: Paul Krugman, The Ungracious Ideologue (And Loser):
For most people -- arguably even for most economists -- all that mattered was the knowledge that countries with debt over 90 percent of GDP tend to have slower growth than countries with debt below 90 percent of GDP. Simple and clear. Everyone who received that message recognised it for what it was. In the cloudy consciousness of humble non-statisticians, it was a vital warning on debt issued by two cautious and meticulous researchers - Reinhart and Rogoff.
Public availability of that knowledge exerted pressure upon policymakers to recognise adequately the risks of large debt. The Reinhart-Rogoff data planted seeds of caution in the minds of policymakers under ideological siege from Keynesians clamouring for additional public debit and deficit spending during slow growth. The discovery of a relatively insignificant “coding error” in the Reinhart-Rogoff data analysis aroused the Keynesian ‘Fourth International’ wolves. They seized on it as a sign of weakness, they circled, and they struck with lighting speed, salivating, and snarling feigned outrage.
Armed with the ‘coding error’ these Debt ‘n’ Deficit Defenders sought to undermine warnings about dangerous debt-to-growth correlations. Joseph Schumpeter may have been the first to notice that a natural constituency of the Keynesians are the anti-capitalist ivory tower intellectuals. This gives the Keynesians great influence in mass media and the academy, and, by extension, a disproportionate hold over public opinion. Luckily, key policymakers, politicians, and central bank chiefs were not fully swept up by Keynesian passion. Chaps like Krugman are angry about that. Right thinking people, however, will feel justifiably aggrieved that pseudo-scandalising about Reinhart-Rogoff data absorbed so much time and energy, so much scarce ‘public space’.
I am pleased to see that this time-wasting could be coming to an end. Yesterday the Keynesian kingmaker, wolf pack leader, and chief ideologue, Paul Krugman, ungraciously climbed down. In response to Carmen Reinhart’s polite but insistent and legitimately outraged letter, Paul Krugman conceded the following statement is TRUE -- “countries with debt over 90 percent of GDP tend to have slower growth than countries with debt below 90 percent of GDP”. (Not coincidentally this is the statement that I attributed - above - to ordinary folk drawing common sense conclusions from the pre-coding-error Reinhart-Rogoff data).
Krugman goes on to say another statement is UNTRUE -- “growth drops off sharply when debt exceeds 90 percent of GDP”. Well … a high school graduate would see straight away that in these historical data sets the ‘threshold’ is intended as a guide to potential cause-or-effect, and does not mean a cliff which you drop over suddenly and helplessly (it's not like the getting married threshold). Think of it, hypothetically, this way -- a person might be told of a 'statistical' threshold of 60 years of age beyond which brain functions decline. Krugman surely does not think any reasonable person would interpret the threshold as precipitous.
Did Reinhart-Rogoff even say this? I doubt it. I can’t find it. They do use the word “sharply”. Here’s a Reinhart-Rogoff statement with the word “sharply”. It’s in the famous paper ‘Growth in A Time of Debt’ whose ultimately trivial ‘coding error’ sparked the Keynesian pseudo-scandal:
A general result of our debt intolerance analysis [is] that as debt levels rise towards historical limits, risk premia begin to rise sharply, facing highly indebted governments with difficult tradeoffs. Even countries that are committed to fully repaying their debts are forced to dramatically tighten fiscal policy in order to appear credible to investors and reduce risk premia. The link between indebtedness and the level and volatility of sovereign risk premia is ripe for revisiting in light of the comprehensive cross-country data on government debt.
Words of wisdom. Things that can move “sharply” due to debt are perceptions of risk.
That’s the essential observation. I looked at this behavioural dimension of sovereign-level risk in a previous post. I pointed out that debt-to-GDP data don’t claim to tell us about why debt might damage growth prospects. Excessive debt, I concluded, can cause individuals, firms, and governments to change their behaviour in risky and self-defeating ways. My fellow contributor Michael Pettis seems to agree. He offers some great examples.
The manufactured pseudo-scandal over Reinhart-Rogoff’s trivial coding error ignores this question of why and how debt slows growth. In fact, Krugman, in his ungracious climb down yesterday, said a most strange thing. He accused Reinhart-Rogoff of “downplaying causality issues”. Of course they did! They are working economists in the field, not former-trade-theorists-turned-newspaper-columnists and self-confessed ideologues.
Reinhart-Rogoff know they cannot pinpoint causality in debt-to-GDP ratios. It’s a judgement call based on weight of evidence and theory accumulated over many years from many sources. In this judgement call I trust the try-genuinely-to-be-objective-and-non-political authors of ‘This Time Is Different’, the book summarising the most comprehensive comparative historical study of its kind. Based on that study (and for the same reasons outlined in my earlier post and the piece by Pettis) they might justifiably lean toward a view that the Truly Big Issue is causality from debt to growth. Yet Rogoff is on record as saying the causality could run both ways.
"Everyone has an ideology … So yes, I’m an ideologue … Let’s not pretend we share more than we do” said Krugman. I agree 100%. I respect an ideologue who is proud to wear his ideology well.
Tiresome and rude as he becomes, Krugman has in the past worn the vulgar Keynesian ideology in entertaining fashion. It’s a relevant social role he has there.
But when a thought-leader is wrong, when he is tacitly admitting to having been wrong, and after having wasted so much of our collective reading time in the past 5 weeks with the hysteria about Reinhart & Rogoff, Paul could now be a little more gracious. To be frank, Paul owes Carmen and Ken an apology. He should grovel for it.
In my view, RR did a disservice to the debate--made us, collectively, less smart--when they began writing about how a 90% debt-to-annual-GDP level was an "important marker". Countries with >100% ratios have slower growth rates than countries with less. Countries with >150% ratios have slower growth rates than countries with less. Countries with >75% ratios have slower growth rates than countries with less. There is nothing special about 90%.
And you, Michael, I think are succeeding in making us, collectively, less smart with this piece. The point is not to issue a "vital warning [to]... policymakers under ideological siege from Keynesians" nor to claim that RR are "meticulous researchers"--a claim by you that now is triggering howls of laughter from UMass, the Roosevelt Institute, the CEPR, and so forth--but to assess what the benefits and risks of fiscal expansion vs. fiscal consolidation are right now.
As I see it, from the "Understanding Our Adversaries" evolution-of-economists'-views talk that I have been giving for the past five months now:
The argument for fiscal contraction and against fiscal expansion in the short run is now: never mind why, the costs of debt accumulation are very high. This is the argument made by Reinhart, Reinhart, and Rogoff: when your debt to annual GDP ratio rises above 90%, your growth tends to be slow.
Let me start by referring you to Owen Zidar, who points out--and note this well--that there is no cliff at 90%.
Let me go on to tell you that RRR present a correlation--not a causal mechanism, and not a properly-instrumented regression. Their argument is a claim that high debt-to-GDP and slow subsequent growth go together, without answering the question of which way causation runs.
And note is how small the correlation is. Suppose that we consider a multiplier of 1.5 and a marginal tax share of 1/3. Suppose the growth-depressing effect lasts for 10 years. Suppose that all of the correlation is causation running from high debt to slower future growth. And suppose that we boost government spending by 2% of GDP this year in the first case. Output this year then goes up by 3% of GDP. Debt goes up by 1% of GDP taking account of higher tax collections. This higher debt then reduces growth by… wait for it… 0.006% points per year. After 10 years GDP is lower than it would otherwise have been by 0.06%. 3% higher GDP this year and slower growth that leads to GDP lower by 0.06% in a decade. And this is supposed to be an argument against expansionary fiscal policy right now?….
And this isn’t the relationship that you were looking for. You want the causal one. That, worldwide, growth is slow for other reasons when debt is high for other reasons or where debt is high for other reasons is in this graph, and should not be. Control for country and era effects, and Owen reports that the -0.06% becomes -0.03%. As Larry Summers never tires of pointing out, (a) debt-to-annual-GDP ratio has a numerator and a denominator, and (b) sometimes high-debt comes with high interest rates and we expect that to slow growth but that is not relevant to the North Atlantic right now. If the ratio is high because of the denominator, causation is already running the other way. We want to focus on cases of high debt and low interest rates. Do those two things and we are down to a -0.01% coefficient.
We are supposed to be scared of a government-spending program of between 2% and 6% of a year's GDP because we see a causal mechanism at work that would also lower GDP in a decade by 0.01% of GDP? That does not seem to me to compute. The risks associated with incrementally larger debt are small. The benefits associated with the current-year government purchases funded by an incremental increase in debt look to be large.
If, Michael, you wish to raise rather than lower the level of the debate, show us some number: show me a calculation suggesting that the risks are large, the costs are expensive, and the benefits small…
Two months have passed...
And if there has been a peep out of Michael Heller presenting any evidence that the risks are large, the costs high, and the benefits small from short-term fiscal expansion programs that raise the debt of credit-worthy sovereigns from 85% of GDP to 95% of GDP, I have missed it.
Without a benefit-cost calculation, Michael, you do not have an argument.