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Rogoff and Reinhart strike back

ReinhartFig4.gif

It doesn't say this exactly, but my sense is that Carmen Reinhart and Kenneth Rogoff's latest paper on debt is something of a response to Paul Krugman's critique of their last paper on debt. In short, they find, and have previously found, that growth dampens when debt hits 90 percent of GDP. Krugman and others have responded that with so few data points, and America's situation and position being so different from most of those data points, that you can't really draw any conclusions. I'd say Reinhart and Rogoff's strongest response comes in this paragraph:

Only about 2% of the observations are at debt-GDP levels at or above 120% – and that includes the aforementioned cases. If debt levels above 90% are indeed as benign as some suggest, one might have expected to see a higher incidence of these over the long course of history. Certainly our read of the evidence, as underscored by the central theme of our 2009 book, hardly suggests that politicians are universally too cautious in accumulating high debt levels. Quite the contrary, far too often they take undue risks with debt build-ups, relying implicitly perhaps on the fact these risks often take a very long time to materialise. If debt-to-GDP levels over 90% are so benign, then generations of politicians must have been overlooking proverbial money on the street.

Underlying this argument is a debate that's really about timing, not debt. Rogoff and Reinhart think we should begin debt reduction now. Krugman thinks we need to worry about growth now and begin debt reduction soon. Meanwhile, Congress is planning to add more than $3 trillion to the deficit to extend the Bush tax cuts for another 10 years, and they have no plan for offsets or deficit reduction. If you take that as the real center of this debate, Rogoff and Reinhart and Krugman may not be as far apart as they think.

Update:Krugman responds.

By Ezra Klein  |  August 11, 2010; 2:50 PM ET
Categories:  Budget  
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Comments

Are they really talking about extending the cuts for ten whole years for all the tax brackets? That's just insane. Obviously, I'd prefer to let them all expire and use the revenue to do some short term stimulus for the middle class and lower, but if we're extending them at all then can't they at least be limited to certain brackets and only as long as the recession lasts?

Posted by: MosBen | August 11, 2010 3:18 PM | Report abuse

"Underlying this argument is a debate that's really about timing, not debt."

Is it really so? Or the real debate is about what to 'cut' to reduce debt?

It is clear that for this Nation to remain competitive, sustainable and strong in years to come; we need strong employment in USA which is not there today. To do something about unemployment and longer term investment will cost us. But if we cannot increase the debt, then it is important that Fed would reduce its expenses (main choices are Medicare and to some extent Social Security and Defense).

What it means, the true leaders of America (Obama and Dems are still not qualifying for that) will present a program to reduce spending and at the same time make available resources to address 'structural unemployment'. Dems are not selling Affordable Health Care Act for its deficit reducing features. Even so, more is needed and it is needed now.

Addressing 'structural unemployment' is the ultimate need here but that is not addressed unless both the resources are freed somewhere (so that not much tax increase) and credibility for fiscal discipline is established.

Posted by: umesh409 | August 11, 2010 3:33 PM | Report abuse

The 3 trillion the Democrats are adding to the debt are coming from an extension of the Bush tax cuts??? Puleeze. The Democrats, aided and abetted by Paul Krugman, have managed to convince themselves that spending trillions we don't have is some kind of a virtue. Let the Bush tax cuts expire and they'll all sprout halos and wings, they'll spend so much.

I wonder, do Reinhart and Rogoff take a position on tax increases vs. spending reductions as being the vehicle of choice for debt reduction, or are they agnostic on the subject?

Posted by: bgmma50 | August 11, 2010 3:37 PM | Report abuse

I don't find this argument from RR that convincing. Basically, they're saying that the fact that there are so few data points is proof of what they're saying. I find the argument that politicians rarely act rationally to be an equally valid explanation.

Also, I would like to put a big DON'T FEED THE TROLLS sign on bgmma's post.

Posted by: DKOSullivan | August 11, 2010 3:45 PM | Report abuse

"Also, I would like to put a big DON'T FEED THE TROLLS sign on bgmma's post." posted by DKOSullivan

To what are you taking exception, DKO? That the 3 trillion the Democrats are adding to the debt has a huge component of increased spending? (I have some charts I'd be happy to show you) Or am I just not allowed to ask whether the authors of the study have taken a position on the "best" way to achieve debt reduction?

Posted by: bgmma50 | August 11, 2010 3:57 PM | Report abuse

Isn't the 90% threshold based on public (government) debt? The graph included plots total debt. Minor detail.

@bgmma50: "The 3 trillion the Democrats are adding to the debt are coming from an extension of the Bush tax cuts??? Puleeze."

Even Alan Greenspan wants to erase the mistakes of the past.
http://www.nytimes.com/2010/08/07/business/economy/07greenspan.html

But if Obama gets his way and fulfills his campaign promise, Congress will probably settle for the lesser of two evils and allow the top brackets to expire.

Posted by: tuber | August 11, 2010 4:00 PM | Report abuse

tuber, pointing out that the Democrats' spending tsunami is responsible for a substantial portion of the 3 trillion they are adding to the debt (all of which, by the way will be added in 2009 and 2010 before anything is done to the Bush tax cuts...2011 and beyond isn't even included in the 3 trillion)is not the same as being for extension of the Bush tax cuts. I'm fine with letting the Bush tax cuts expire. ALL of the Bush tax cuts. But if they expire, I want real debt reduction, not just more spending.

Posted by: bgmma50 | August 11, 2010 4:09 PM | Report abuse

The sort of counterfactual response that R&R make can be pretty messy to evaluate. There could be a lot of reasons why they don't have a lot of high debt levels in their data set, but...in the spirit of their argument, if as they assert:
#1 Politicians are willing/eager to run up high levels of debt.
#2 High levels of debt slow GDP growth.

It seems to me that this would imply a large number of observations at high levels of debt. Politicians would run debt up to the 90% threshold, and then as GDP growth slows, the debt to GDP ratio would grow even more quickly(because GDP is the denominator), and it would become even harder to extricate themselves from their debt; because of high interest payments, and downward pressure on growth.

In other words, countries would fall into a "Debt Trap". So if the trap exists, and countries move around the space fairly randomly(or non randomly as their assertion about politicians preferences implies), they should all eventually get stuck in the debt trap and stay there. (Or statistically spend more time there, consequently making up a larger fraction of the data set)

So we are left with the question. Why isn't a bigger fraction of their data set trapped above their GDP decline threshold?

Posted by: zosima | August 11, 2010 4:13 PM | Report abuse

With all due respect for R&R that's pathetic. Assuming that politicians are rational leads one to conclude that there is no need to advise them. Also R&R know perfectly well that, in the past, many policymakers were obsessed with preserving the parity of their currency and gold.

A high debt to GDP ratio makes it hard to do this. The experience of going off the gold standard (see Brad DeLong's blog) shows how stupid this obsession was, yet it remained an obsession.

The argument "The data don't show it but poicy makers must know it" is not worthy of your time. It can also be used to prove that the ACA was all a big mistake as the old system was accepted by policy makers for decades.

Posted by: rjw88 | August 11, 2010 4:15 PM | Report abuse

Bgmma, just stop digging the hole. You have no idea what you're talking about. The 3 trillion figure is referring to additional debt caused by extending the Bush tax cuts. Additionally, the reason the debt has increased so massively over the last two years is due to a decline in revenue because of the recession. President McCain and a Republican Congress would also be facing a shortfall of over a trillion dollars per year (and probably more, since if we look back to stimulus, the GOP alternative would have cost 2.4 trillion over ten years).

Posted by: jldarden | August 11, 2010 4:16 PM | Report abuse

bgmma, I'm going to ignore my own sign because I think you might actually be ignorant rather than just belligerent.

The idea that the Democrats will just spend any money they make from the Bush tax cuts is absurd. If you look at the last time the Democrats controlled congress and the White House before Obama the budget they passed actually cut spending. It was in 1993, look into it.

As for our current situation, we're in the middle of the worst crisis since the Great Depression. We desperately need more fiscal stimulus so the fact that Democrats are trying to avoid firing teachers doesn't really upset me.

By the way, that spending tsunami you mention? Spending is basically unchanged from the Bush years, and the huge deficit has more to do with the collapsing revenues than with increased spending.

As for whether the stimulus (the only large spending program enacted by the Democrats which adds to the debt) was a good idea I have a chart for you to look at:
http://yglesias.thinkprogress.org/2010/08/saving-the-economy-reduced-the-deficit/

Posted by: DKOSullivan | August 11, 2010 4:24 PM | Report abuse

Rogoff and Reinhart continue to push junk-science. Either they started with a conclusion and have tried unsuccessfully to provide evidence, or they drew a bad conclusion from a faulty argument and are now too embarrassed to admit it.

Posted by: bcbulger | August 11, 2010 5:00 PM | Report abuse

'Bgmma, just stop digging the hole. You have no idea what you're talking about. The 3 trillion figure is referring to additional debt caused by extending the Bush tax cuts." Posted by jldarden

The 3 trillion I'm talking about is the $1,412,686 Obama and the Democrats are adding to the deficit in 2009 and the $1,555,582 they're estimated to add in 2010. They're the ones who need to stop digging a hole.

"Additionally, the reason the debt has increased so massively over the last two years is due to a decline in revenue because of the recession." Posted by jldarden

“and the huge deficit has more to do with the collapsing revenues than with increased spending.” Posted by DKOSullivan


Uh huh. Here is the data:

Receipts Outlays
2008 $2,523,999 $2,982,554
2009 $2,104,995 $3,517,681
2010 $2,165,119 $3,720,701 projected

“If you look at the last time the Democrats controlled congress and the White House before Obama the budget they passed actually cut spending. It was in 1993, look into it.” Posted by DKOSullivan

I looked.
Outlays
1993 $1,409,392
1994 $1,461,766

“Spending is basically unchanged from the Bush years,” Posted by DKOSullivan

Uh huh.

Outlays Bush and a Republican Congress
2001 $1,862,906
2002 $2,010,907
2003 $2,159,906
2004 $2,292,853
2005 $2,471,971
2006 $2,655,057


Outlays Bush and a Democratic Congress
2007 $2,728,702
2008 $2,982,554


Outlays Obama and a Democratic Congress
2009 $3,517,681
2010 $3,720,701

Posted by: bgmma50 | August 11, 2010 5:07 PM | Report abuse

@zosima: "So we are left with the question. Why isn't a bigger fraction of their data set trapped above their GDP decline threshold?"

When smaller countries reach the point when they can't service their debt, they seek foreign aid, renegotiate the terms of the debt, devalue their currency, or in rare cases, default.

Posted by: tuber | August 11, 2010 5:21 PM | Report abuse

"The idea that the Democrats will just spend any money they make from the Bush tax cuts is absurd." posted by DKOSullivan

Really? Check out the very first comment on this thread. Mosben wants to use the revenue for stimulus. (halos and wings)

While I'm poking holes in Democratic memes, let me take a shot at the Bush tax cuts for The Rich. Of the 3 trillion added to the deficit for extending the cuts, 2.3 trillion comes from the lower and middle income brackets. Millions of people taken off the tax rolls by Bush will be added back in. That's the trap Ezra thinks Republicans set for Democrats.

Posted by: bgmma50 | August 11, 2010 5:22 PM | Report abuse

'The idea that the Democrats will just spend any money they make from the Bush tax cuts is absurd. If you look at the last time the Democrats controlled congress and the White House before Obama the budget they passed actually cut spending. It was in 1993, look into it.'

And if you look at the time before that, we enacted the Federal Department of Education.

The time before that? Well, we created trillions of dollars in liabilities in Medicare/Medicaid, and of course, the Kennedy/Johnson war in Vietnam.

http://www.gpoaccess.gov/usbudget/fy11/pdf/summary.pdf

The truth is we have a decade's worth of spending at 23+% of GDP. That compares to the last 2 decades of <20% of GDP.

Posted by: krazen1211 | August 11, 2010 9:55 PM | Report abuse

1. when comparing dollar amounts across time, its best to use real amounts, not nominal amounts.

2. Budgets are decided the year before. EG: 2009 budget was passed by 2008 gov't. so all your separations along political lines are incorrect.

3. You really should divide outlays up between discretionary and non-discretionary spending.

You can't blame one gov't for paying the interest on a debt caused by an earlier one.

Posted by: nylund | August 12, 2010 4:35 PM | Report abuse

There are various laws that say, "if you make less than X, you get Y," (foodstamps, etc.)

If person A does something that causes many people to make less then X, then the amount paid out in Y will go up.

Now who is responsible for Y going up? Or, in plain English a financial crisis and a very bad recession will cause a lot of government expenses to increase REGARDLESS of who is in power.

Your choices are just ignore that aspect of spending, or try to ascribe blame to someone for the cause of the recession. That latter gets very partisan, hence my suggestion you limit it to discretionary spending.

Posted by: nylund | August 12, 2010 4:42 PM | Report abuse

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