Monday, 27 May 2013

Michael Boskin makes excuses for Rogoff and Reinhart.

When one Ivy League academic economist is in trouble, the others can be relied on to come to the rescue. After all, one doesn’t want one’s profession to look silly, does one?

And Michael Boskin (econ prof. at Stanford) tries to come to Rogoff’s rescue.

Boskin starts by saying that deficits are justified in a recession, but not otherwise. Agreed. And doubtless every clued up Keynsian would also agree.

In other words, given NO RECESSION, it irresponsible for a government to fund itself to any great extent from borrowing: what it should do is to fund its spending (or at least the large majority of it spending) via tax. (I deal with the EXACT proportion that should be funded via tax vis a vis borrowing in a non-recessionary environment in a footnote below.)

Boskin then tells us that notwithstanding Rogoff and Reinhart’s flawed research, there are other researchers who have shown that high levels of debt depress economic growth. He does not tell us who the latter researchers are, so that claim can be taken with a pinch of salt.

But let’s assume these “researchers” exist and that they’ve found the evidence that Boskin claims. Unfortunately their discovery is quite possibly a complete non-discovery, and for reasons alluded to by Boskin himself. It’s that governments sometimes borrow for totally unjustified reasons!!!!

That is, politicians sometimes fund government spending from borrowing PURELY SO AS to ingratiate themselves with voters – because voters notice tax increases more acutely than they do the effects of more government borrowing. And do doubt that irresponsible borrowing impairs growth.

I.e Boskin’s argument (and indeed R&R’s) is as illogical as saying that because driving with too much alcohol in your blood is excessively dangerous, therefor driving PER SE is excessively dangerous.

Interest rates.

Boskin also tries to bolster his argument by citing evidence that high deficits and debts tend to lead to high interest rates. That evidence may easily be correct. But the explanation is very mundane. It’s an explanation with which advocates of Modern Monetary Theory (MMT) tend to well versed, and it is as follows.

Recessions are caused by inadequate private sector spending, i.e. too much private sector saving (that’s saving in the sense of accumulating money rather than accumulating physical investments). I.e. in a recession, there is a POSITIVE DESIRE by the private sector for more “net financial assets” (NFA) as MMTers tend to say. And if someone has a positive desire for something, they’re not going to charge anything much for holding the item in question. I.e. interest rates will be low.

In contrast, in a non-recessionary environment, the private sector DOES NOT HAVE a desire for more NFA. Thus the only way a government will be able to get the private sector to hold more NFA (and not spend it) will be to offer a decent reward to the private sector for doing so. I.e. interest rates will tend to rise.

So . . . given that there is always a proportion of the World’s governments who behave irresponsibly (i.e. borrow heavily in a NON-RECESSIONARY environment – just when they shouldn’t), it’s no big surprise that if you take a sufficiently large sample of governments thru history, you’ll find an association between borrowing and interest rates.

Is Krugman “irresponsible”?

Boskin then ends by claiming that Krugaman in this debate says repayment of debt can be left for 10-15 years and that that, according to Boskin, is “beyond irresponsible”. Well what Krugman ACTUALLY SAID was this:     

“It was irresponsible to be running deficits when the economy was at full employment..” (see around 3 minutes). Well that’s exactly the point I made above wasn’t it?

Moreover, Krugman says over and over again in this debate that the REAL PROBLEM will come in ten to twenty years’ time when health care and similar costs will rocket, and those costs, if they are incurred, will have to be funded not by borrowing, but by extra tax. Now that doesn’t sound to me like the words of someone who plays fast and loose with borrowing, deficits or debts.

In other words far from being “beyond irresponsible”, Krugman agrees with the point I made above, and with which Boskin seems to agree, namely that substantial deficits are justified in a recession, but not when the economy is at full employment.

As to whether Krugman really does say in that debate that debts can be left for 10-15 years, he certainly did not say that in the first 20 minutes. And if Boskin wants us to believe the remarks he attributes to Krugman, then Boskin needs to tell us exactly where in the debate Krugman says that.

Normal procedure by academics who attribute words to others is to let readers know EXACTLY where they can find those words. And I’m not wading thru the full 50 minutes of that debate just to find a quote which Boskin says is there.

What’s wrong with long term debt?

And finally, even if Krugman does say that current debt levels can be left in place for 15 years, what if it? As already pointed out, assuming the private sector WANTS TO HOLD a bigger stock of NFA for the next 15 years than was the case 20 or 30 years ago, so what? If that’s what the private sector wants, it won’t charge any significant interest for holding that debt. So where’s the problem?

Conversely, if the private sector goes into irrational exuberance mode in three years’ time, far from it being irresponsible to leave existing debts in place for 10-15 years, it would be irresponsible to desist from reducing those debts in three or four years’ time.

In short, it is nonsense to try to specify in advance how big debts should be any given number of years in the future: the size and pace of increase or decrease in those debts will depend on what the private sector is doing at various points in the future – that is whether the private sector is in subdued mode or irrational exuberance mode.

Footnote: why a significant deficit is needed even at full employment.

Assuming a country aims for the standard 2% inflation and actually achieves that, then the monetary base and national debt will decline in real terms at 2% a year. Assuming (for the sake of simplicity) that those are to remain constant relative to GDP, then they will need to be constantly topped up. And that can only be done via a deficit.

To illustrate with a back of the envelope calculation, if the debt and base are to remain at 50% of GDP, and GDP is constant, then the deficit would need to be 2% x 50% of GDP, i.e. 1% of GDP.

But that of course leaves out economic growth. If growth averages say 2% a year, one would need yet more deficit (another 1% of GDP worth). So total deficit needed on the above assumptions would be equal to 2% of GDP.

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