Monday, 1 October 2012

Rogoff’s debt “overhang”.

Rogoff and the Reinharts recently published a paper entitled “Public Debt Overhangs…”. They rarely use the word debt without the suffix “overhang”. You’re supposed to imagine yourself under a cliff with “debt” hanging over you and about drop on your head.
I suspect it says something about the weakness of their arguments that they employ that sort of propaganda.
They claim debt to GDP ratios over 90% tend to lead to low growth for the next decade or two. The tendency is not a strong one, but I have no quarrel with their claim that the tendency is there.
As to possible CAUSAL effects running from large debts to poor growth, they offer just one possibility namely that those debts crowd out private investment, either via a quantitative effect or via a price effect (i.e. large government borrowing raises interest rates).
As to the interest rate effect, they themselves say (p.83) that there is little relationship between high interest rates and growth. So that rules out the price effect.
As to the quantitative effect, that is a possibility.
However, there is simpler explanation as follows. Politicians and a significant proportion of the economics profession just don’t understand deficits, debt, and so on. That is, most politicians and too many economists see national debts and deficits as working in the same way as household debts and deficits. I.e. the latter individuals just don’t understand macroeconomics – or at least macroeconomics as it applies to national debts and deficits.
To expand on that, the above misguided individuals think the best way to reduce national debts is to raise tax or cut public spending, in the same way as a household has to raise its income or cut its spending if it wants to speed up the reduction in any debt it owes. (We must be thankful that at least Rogoff & Co don’t fall into that trap.)
And of course the result of that crude application of microeconomics at the macroeconomic level is to bring about a reduction in demand: it condemns an economy to operating at below capacity.
Moreover, about half of the countries and periods of elevated debt examined by Rogoff & Co were in the pre-Keynsian era. That was an era in which the above “crude” thinking was dominant. So there is possibly a very simple explanation for the “high debt leads to low growth”: ignorance on the part of the elite.
Unfortunately we are in danger of returning that at “crude” era, as Krugman points out.
Or rather, we’re already there. Why are there millions more unemployed in the U.S. than there should be? Reason is that about 95% of members of Congress don’t understand the above macro/micro point. Nor do politicians in other countries. Plus Republicans and Democrats are more interested in squabbles which involve the unemployed being caught in the cross fire than doing anything about the unemployed. Or as former defence secretary Robert Gates accurately put it, they are more concerned with “scoring ideological points than with saving the country”. (h/t to Mike Norman)
That’s not to say that Keynes’s ideas are necessarily the best solution and that structural facts might not be the main explanation of high unemployment (though I suspect that structural factors are NOT the explanation). The point is that even if it was 100% clear that structural factors were not the culprit, the West’s politicians would still make a hash of trying to implement Keynes’s ideas. Plus my guess is they made a similar hash of it prior to Keynes when trying to reduce national  debts.
H/t to John Cochrane for bringing Rogoff’s paper to my attention.

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