Posts Tagged 'austerity'

The Reinhart-Rogoff Rally

In the current issue of the New York Review of Books, Paul Krugman explains “How the Case for Austerity Has Crumbled,” focusing at length on the infamous Reinhart-Rogoff 90% debt-to-GDP threshold, and how it became a sort of banner, especially in the US and Europe, for the worldwide austerity caucus. Aside from some quibbles, I don’t have much to criticize in Krugman’s treatment, though I am puzzled by his Figure 1, showing, insofar as I can understand it, that government spending increased sharply in 2008 and tapered off thereafter. But Krugman asserts:

[A]fter a brief surge in 2009, government spending began falling in both Europe and the United States.

In his Figure 1 (reproduced below), Krugman identifies his zero year as 2007 (“zero year is the before global recession (2007 in the current slump) and spending is compared with its level in that base year.”) But government spending equals 100 in year -1 and increases sharply in year 0. So his figure indicates that spending increased in 2008 not 2009. It therefore seems to me that the horizontal axis in Figure 1 was mislabeled.


The 90% debt-to-GDP threshold was derived from a paper, “Growth in Time of Debt,” by Reinhart and Rogoff. After other researches had repeatedly failed to replicate its results, Thomas Herndon, Michael Ash, and Robert Polin identified a coding error, missing data, and an unconventional weighting of summary statistics by Reinhart and Rogoff, the three together accounting for the existence of the otherwise inexplicable 90% threshold in the paper.

Despite several attempts Reinhart and Rogoff to minimize the misleading implications of their paper, the 90% threshold, which never had any theoretical credibility, is now thoroughly discredited; any citation of  it as authoritative would rightly invite scorn and ridicule.

Krugman comments:

At this point, then, austerity economics is in a very bad way. Its predictions have proved utterly wrong; its founding academic documents haven’t just lost their canonized status, they’ve become the objects of much ridicule. But as I’ve pointed out, none of this (except that Excel error) should have come as a surprise: basic macroeconomics should have told everyone to expect what did, in fact, happen, and the papers that have now fallen into disrepute were obviously flawed from the start.

What has not yet been commented on as far as I know is the extent to which the discrediting of the Reinhart-Rogoff 90% threshold has had tangible economic consequences.

When the Herndon, Ash, and Pollin paper was posted on the internet about 5 weeks ago on April 15, the S&P 500 closed at 1552.36. The S&P 500 began 2013 at 1426.19, surpassing1500 on January 25. From January 25 until April 15, the S&P 500 fluctuated in the 1500 to 1550 range, only occasionally rising above or falling below those limits. On April 16 and 17, the S&P 500 rose and then fell by about 20 points, closing at 1552.01 on Wednesday April 17. On Thursday April 18, Krugman wrote his New York Times column “The Excel Depression,” the S&P 500 fell to an intraday low of 1536.03 before closing at 1541.61. The S&P 500 has subsequently risen 17 of the next 21 trading days, closing at 1667.47 on last Friday, an increase of almost 126 points, or more than 8%.

I suggest that the most important economic news since April 15 may have been the collapse of the austerity caucus following the public exposure of the Reinhart-Rogoff 90% threshold as a fraud, so that the markets are no longer worried (or, at least, are less worried than before) about the risks that further fiscal tightening will offset the Fed’s modest steps in the direction of monetary ease.

Another positive development has been the decline in the CPI in both March and April, reflecting fortuitous supply-side expansions associated with declining energy and commodity prices. With falling inflation expectations caused by positive supply-side (as opposed to negative demand-side) forces, real interest rates have risen sharply, the 10-year TIPS yield rising from -.69% on April 15 to -.31% on May 17. That increase in real interest rates presumably corresponds to an increase in expected future real incomes. So the economic outlook has gotten a little less bleak over the past month. Call it a reverse Reinhart-Rogoff effect.

They Come not to Praise Market Monetarism, but to Bury It

For some reason – maybe he is still annoyed with Scott Sumner – Paul Krugman decided to channel a post by Mike Konczal purporting to show that Market Monetarism has been refuted by the preliminary first quarter GDP numbers showing NGDP increasing at a 3.7% rate and real GDP increasing at a 2.5% rate in Q1. To Konczal and Krugman (hereinafter K&K) this shows that fiscal policy, not monetary policy, is what matters most for macroeconomic performance. Why is that? Because the Fed, since embarking on its latest splurge of bond purchasing last September, has failed to stimulate economic activity in the face of the increasingly contractionary stance of fiscal policy since them (the fiscal 2013 budget deficit recently being projected to be $775 billion, a mere 4.8% of GDP).

So can we get this straight? GDP is now rising at about the same rate it has been rising since the start of the “recovery” from the 2007-09 downturn. Since September monetary policy has become easier and fiscal policy tighter. And that proves what? Sorry, I still don’t get it. But then again, I was always a little slow on the uptake.

Marcus Nunes, the Economist, Scott Sumner, and David Beckworth all weigh in on the not very devastating K&K onslaught. (Also see this post by Evan Soltas written before the fact.) But let me try to cool things down a bit.

If we posit that we are still in something akin to a zero-lower-bound situation, there are perfectly respectable theoretical grounds on which to recommend both fiscal and monetary stimulus. It is true that monetary policy, in principle, could stimulate a recovery even without fiscal stimulus — and even in the face of fiscal contraction — but for monetary policy to be able to be that effective, it would have to operate through the expectations channel, raising price-level expectations sufficiently to induce private spending. However, for good or ill, monetary policy is not aiming at more than a marginal change in inflation expectations. In that kind of policy environment, the potential effect of monetary policy is sharply constrained. Hence, the monetary theoretical case for fiscal stimulus. This is classic Hawtreyan credit deadlock (see here and here).

If monetary policy can’t do all the work by itself, then the question is whether fiscal policy can help. In principle it could if the Fed is willing to monetize the added debt generated by the fiscal stimulus. But there’s the rub. If the Fed has to monetize the added debt created by the fiscal stimulus — which, for argument’s sake, let us assume is more stimulative than equivalent monetary expansion without the fiscal stimulus — what are we supposed to assume will happen to inflation and inflation expectations?

Here is the internal contradiction – the Sumner critique, if you will – implicit in the Keynesian fiscal-policy prescription. Can fiscal policy work without increasing the rate of inflation or inflation expectations? If monetary policy alone cannot work, because it cannot break through the inflation targeting regime that traps us at the 2 percent inflation ceiling, how is fiscal policy supposed to work its way around the 2% inflation ceiling, except by absolving monetary policy of the obligation to keep inflation at or below the ceiling? But if we can allow the ceiling to be pierced by fiscal policy, why can’t we allow it to be pierced by monetary policy?

Perhaps K&K can explain that one to us.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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