Reinhart and Rogoff - Battered but not beaten

Like boxer who has taken a pounding Reinhart and Rogoff, the Harvard economics duo, have donned the dark glasses and have been responding to their critics.  They strongly contest that their research was slipshod and that their Excel skills are childlike, but the accusations that they doctored the figures to suit their point of view just won’t go away.

To remind you they published a paper “Growth in a Time of Debt,” in May 2010 that asserted they had empirical evidence to show that once the debt to GDP ratio exceeded 90% any country would hit the wall and crumble to economic dust.  Unfortunately for these high minded scholars a number of intellectually challenged politicians appropriated they idea as justification to embark on a path of austerity, and we all know where that has got us.

The rebuttal of their opponents claims is becoming increasingly laughable and technical – ‘we included both median and average estimates for growth, at various levels of debt in relation to economic output, going back to 1800. Our paper gave significant weight to the median estimates, precisely because they reduce the problem posed by data outliers, a constant source of concern when doing archival research that reaches far back into economic history spanning several periods of war and economic crises’.  To summarize their defence – “ours (median) is much smaller than yours (University of Massachusetts)” – not a great boast I think you will agree!

There are two things going on here that are important.  The first is that virtually all economists are trying to over simplify a very complex world.   Any rational person knows that as the level of debt increasing the likelihood of a default will also rise.  But what is also painfully obvious that the sustainable level of indebtedness with vary dependent on interest rates, growth rates, currency valuation, balance of trade, etc.  Of-course all of these are interconnected but to postulate that there is a definitive tipping point is both dim witted and annoying.  The second point of importance is that government debt is only one piece in the jigsaw puzzle, as we know to our cost private debt and bank solvency are just as important.  A country with public debt at 90% of GDP with solvent banks and strong private deposits may well be in better shape than a country with lower public debt but high private debt and insolvent banks.

Perhaps the most irritating thing of all is that the spat arising from this mistaken and badly executed ‘research’ is giving the Keynesian left an opportunity the raise their tattered flag.  Many bankers and politicians who should know better are now using this statistical cock-up to puncture the arguments for fiscal prudence.

There is no doubt that, despite this fiasco Reinhart and Rogoff are brilliant economists, but sadly their best and most interesting ideas around ‘allowing financial institutions to be restructured through accelerated bankruptcy,.” And their plea that – “First and foremost, governments must be prepared to write down debts rather than continuing to absorb them” shine a light on the real issue.  Economic growth depends upon the desire to make money being stronger than the desire to hold on to money, not earth shattering but true.  In 2008 the Western world was shattered economically and is now hanging on for grim death, since 2009 it has used negative interest rates as its life line.  In normal conditions low interest rates should stimulate economic activity but when there is a preponderance of distressed debt, low interest rates have the opposite effect, encouraging a lock down of private capital (Zombie businesses and Zombie Householders). 

It is true that any indebted person, society or economy who's survival is dependent on reducing the value of money to a negative real number must be consigning themselves to an unending period of stagnation.  The evidence for this is all around us, Japan has ‘survived’ with very high levels of debt (up to 200% of GDP) because interest rates have been negative for years.  In ‘surviving’ they have avoided some pain but they are still terminally ill and have no prospect for recovery.  Some say that monetarist are sadistic and that they just want to inflict pain for the sake of it is to misconstrue the nature of things.  Humans contest and compete (read Darwin) and its clear that without the natural clearing out of the unproductive and noncompetitive parts of our economy (public and private) the whole is doomed to a slow but quite painless decline.