Wednesday, 21 July 2010

Kenneth Rogoff.

The Financial Times debate this week on the deficit versus austerity argument continues. Wednesday’s anti-deficit contributor is Kenneth Rogoff.

The title of his article is “No need for a panicked fiscal surge”. Attributing “panic” to one’s opponents is fair enough if this is substantiated is the article that follows. No such substantiation appears.

Advocates of more deficit only advocate enough deficit to counteract the effect of the credit crunch and bring us back to full employment hopefully in two or three years or thereabouts. That does not constitute panic. It is a perfectly reasonable and measured response.

Rogoff’s first substantial claim is that “anaemic growth with sustained high unemployment is par for the course in post financial crisis recoveries”. OK, then: death was par for the course two hundred years ago on contracting various diseases. Thankfully the medical profession has not spent the last two hundred years just chanting the phrase “par for the course”. They’ve done something to solve the relevant problems.

Next, Rogoff refers to current “record peace-time” national debts. Well current national debts are nowhere near record levels. U.S. and U.K. debts were well over double their present level in the five or so “peaceful” years after WWII.

But Rogoff claims paying off these post war debts was made easy by the fact of large numbers of military personnel returning to civilian jobs. Now why on earth having large numbers shift from one section of the economy to another should make paying off debt any easier is a mystery. Rogoff offers no explanation and I can’t think of one.

The next, Rogoff deals, as indeed he must, with the fact that Japan has a national debt of around 200% of GDP without any big problems. He attributes this to its “ability to sell debt domestically”. So it’s not debt per se that is the problem apparently, but the source of funds to finance the debt.

This is a great new theory for which Rogoff offers zero words by way of explanation.

And it’s a weak theory. The first problem with it is that there are hundreds of international “cross holdings” of national debt. For example the amount of U.K. national debt held by U.S. entities is roughly the same as the amount of U.S. debt held by U.K. entities. So in that a country’s foreign held national debt is cancelled out by cross holding, there is presumably nothing stop it doing a “Japan”. And doubtless this applies to dozens of countries.

Moreover, if say China suddenly stops buying U.S. national debt, what of it? If it stops buying because it regards the U.S. government as not credit worthy, then U.S. citizens will probably react similarly, i.e. not lend to their government. So in this case the “foreign / domestic” point is irrelevant: the fundamental problem is the government’s lack of creditworthiness.

Alternatively, if China stops buying for reasons that have nothing to do with credit worthiness, then U.S. entities will probably step into the breach.

That in turn would mean a small standard of living cut for U.S. citizens, but that shouldn’t be a problem. The standard of living cut would be nowhere near the cut they’ve taken as a result of the credit crunch. In short, Rogoff’s “theory” looks a non starter.

Next Rogoff claims that the “evidence on Keynsian growth effects of fiscal deficits is thoroughly inconclusive”. Well I sort of agree with that, though we have to be VERY CAREFUL about what is mean by fiscal deficits, a crucial point which Rogoff (like almost everyone else who uses the phrase fiscal deficit) glosses over.

If one means government borrows and lets interest rates take care of themselves, the interest rates are likely to rise in reaction to the borrowing and negate some of the stimulatory effect of extra spending.

If one means government borrows and at the same time drops interest rates (which is what has happened over the last two years) then the result will be stimulation. But to do this, the government – central bank machine has to print money and at least to some extent monetise the debt. So in this case, it is the money printing doing most of the work.

So what Rogoff is doing here is saying that Keynsian borrow and spend is of doubtful effectiveness, while keeping quite about the measure (interest rate cuts) which make it effective. Clever sleight of hand that one.

And finally, for a more effective demolition of Rogoff’s ideas than I’ve managed above, see here.

P.P.S. For another flaw in the Rogoff argument, see here.

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