Reinhart and Rogoff, in Context

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The list of genuine heroes of the financial crisis of 2007-08 is a short one, as opposed to the roll of pretenders, which is as long as my arm. High on the former are Carmen Reinhart, of Harvard’s Kennedy School of Government, and Kenneth Rogoff, of the university’s economics department. The recent controversy about an error in their arithmetic has kicked up a cloud of dust, but, when that dust has settled, will have done little to damage their standing.

Their best-selling book, This Time Is Different: Eight Centuries of Financial Folly, which appeared in September 2009, was a triumph, but it was a publishing triumph, a compendium of previous excursions on their data base, assembled in a hurry, and wrapped around a brilliant diagnosis of what was about to happen next. The apex of Reinhart’s and Rogoff’s professional reputation consists of three technical papers  since 2009, each illuminating some previously unnoticed fundamental aspect of the crisis.

The first of these, “The Aftermath of Financial Crises”  (locked up tight from non-paying eyes by the American Economic Review), was written at the height of the maelstrom in the autumn of 2008 and presented at the American Economic Association meetings in San Francisco in January 2009 (it appeared substantially intact as chapter fourteen in This Time Is Different). It warned that, because the previous autumn had seen a systemic banking crisis, the resulting recession would be much deeper and the recovery slower than had previously been expected – a prediction thoroughly on the mark.

The second paper, “Growth in a Time of Debt,” whose conclusions had been hinted at in chapter seventeen of their book, was presented at the AEA meetings in Atlanta in January 2010.  It contained the finding for which they have been criticized, the proposition that for most countries  there exists a threshold – around 90 percent of GDP – at which external indebtedness impinges on prospects for future growth. They subsequently elaborated on their argument, with Vincent Reinhart, in “Public Debt Overhangs: Advanced-Economy Episodes since 1800,”  in the Journal of Economic Perspectives.

The third, “The Liquidation of Government Debt,”  by Reinhart and graduate student M. Belen Sbrancia, of the University of Maryland, circulating as a working paper but not yet published, makes the point that there is more than one way to fleece a sheep, sometimes in such a way that the creature only notices when a chill is in the air.  Previously Reinhart and Rogoff had examined more extreme forms of working down debt: explicit defaults, restructurings and hyperinflations. The new paper, in familiar Reinhart style, surveys various episodes in which the more subtle forms of non-transparent taxation known as “financial repression” were employed to reduce the burden of massive public debt, mainly at the expense of savers, especially in the years after World War II.

In an op-ed in the Financial Times last week, “Austerity Is Not the Only Answer to a Debt Problem,” Reinhart and Rogoff argued that various policy alternatives exist to tight-fisted austerity and free-wheeling spending in a time of historically high debt.. Keynes himself, they argued, had identified several in his hastily written and thoroughly neglected 1940 book, How to Pay for the War.  (You can read their op-ed for free, but minimal registration is required.) Moreover, they reminded readers, deliberately engendering a certain amount of inflation in order to ease debt burdens remains a possibility– Rogoff himself has advocated an inflation target of 4-6 percent for a few years as a relatively equitable way of dealing with the problem.

It is true that in the second paper they made what econometrician James Hamilton, of the University of California at San Diego, calls “a numbskull error” in creating a spreadsheet, omitting the first five countries in the alphabet from a set of cells with which they calculated an average. (Including them would have changed the value of the average only a few tenths of one percent, Hamilton says).

It is true, too, that Reinhart and Rogoff chose to emphasize a mean (an average) instead of the median (the middle value) when combining various observations in one of three data sets they examined. (Again, it didn’t alter the fundamental conclusion — that higher levels of debt are associated with slower growth, especially, according to the authors, after debt reaches 90 percent of GDP.)

If you are mainly interested in the argument between Reinhart and Rogoff and the University of Massachusetts at Amherst team that last month criticized them, read Hamilton’s lucid evaluation of the controversy (and the Amherst team’s reply.) Pay special attention to the chart. Check out the entry on The Contributions of Reinhart and Rogoff. Peruse the comment sections. See why Hamilton’s Econbrowser is among the most widely followed of all economics blogs.

If you are following the debate about the relationship between debt and global growth, stay tuned.  That the workout is turning in the direction of financial repression was clearly to be seen last week in “There Will Be Haircuts,” a commentary by global asset manager PIMCO’s bond-buyer-in-chief, William Gross, who oversees $1.9 trillion in other people’s money. The aftermath of the financial crisis of 2007-08 still has a long way to go.