Austerity Strikes Back: Budget Hawks Regroup After the Reinhart/Rogoff Affair

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In recent years, we have had no shortage of pundits, politicians, and writers telling us of the economic doom — soaring interest rates, slower economic growth, and choking credit markets — facing the U.S. government if it doesn’t reign in its debt. Since the financial crisis, however, the U.S. has consistently experienced low interest rates, while a bevy of creditors have been ready to lend them money for next to nothing. And although the economy has grown somewhat slowly, there’s been scant evidence that this sluggishness is the result of high government debt.

Then, two weeks ago, the austerity argument suffered a major setback when a paper written by Carmen Reinhart and Kenneth Rogoff — which purported to show that countries with debt loads above 90% of GDP see a dramatic decline in economic growth — was found to be rife with errors. It’s hard to underestimate how hard the unraveling of this seemingly arcane argument has hit the economic policy world.

(MORE: Why the Argument for Austerity Took a Big Hit Yesterday)

The affair has put the austerity movement in a bit of a bind. A recent report in The Washington Post suggests that some in the Republican Party want to move away from demanding entitlement cuts and towards fighting for revenue-neutral tax reform in the upcoming round of budget negotiations. While these shifting tactics are probably not the result of one debunked academic paper, it’s not a stretch to suggest that the right has failed to convince a majority of Americans of the urgent need for cuts to Social Security and Medicare.

The problem with macroeconomics, however, is that it’s very difficult to prove any fact beyond the shadow of a doubt. So while America has not seen soaring interest rates, or fleeing creditors, and has experienced faster economic growth that European countries which have embraced austerity, not everyone is convinced of the wisdom of government debt in times of economic depression. Instead of admitting defeat, advocates of austerity have regrouped and retooled their arguments, which fall roughly into three camps:

Keep Calm and Carry On: Many advocates of cutting government spending, like Erskine Bowles, are now simply arguing that despite the flaws in Reinhart and Rogoff’s paper, the basic logic that government debt is risky stands. As Bowles told The Hillregardless of whether 90% debt/GDP represents a tipping point, “My own personal experience in both the public and private sector [is] that when any organization has too much debt that it is an enormous risk factor and [when] your risks go up then people lending you money will want more money for their money.”

What this argument ignores is that we appear to be experiencing an extraordinary economic situation right now. The Federal Reserve can’t lower interest rates any further, yet the economy remains depressed and unemployment high. So while it is true that, all else being equal, a government should strive to decrease debt as much as possible, Bowles doesn’t address whether that course of action is wise right now given the weakness in the economy.

The Real Problem Is Uncertainty: Bill McNabb, chairman and CEO of the Vanguard Group took to the pages of the Wall Street Journal to argue that economic uncertainty — including uncertainty regarding economic debt — was slowing economic growth. McNabb relies on research by economists Nicholas Bloom, Scott Baker, and Steven Davis that calculates an “uncertainty index” by counting uncertainty-themed newspaper articles and economic forecasts, and the number of tax policies that are set to expire in the next ten years. From this index, economists at Vanguard have estimated that “since 2011 . . . policy uncertainty has created a $261 billion cumulative drag on the economy.” McNabb goes on to argue that because of this drag, “developing a credible, long-term solution to the country’s staggering debt is the biggest collective challenge right now.”

(MORE: When Will the Federal Debt Cause a Greece-Like Crisis in the U.S.?)

There are several problems with this analysis. First, as Mike Konzcal of the Roosevelt Institute has pointed out, the index reflects media and academic discussion of uncertainty, which is not the same as actual uncertainty. The idea that uncertainty is killing the economy has been a favorite argument of the political right for years now, of course — and when politicians discuss a topic, it gets covered in the news. It is circular logic to say that the persistance of a political talking point makes the premises of that talking point true.

Second, even if we assume there is greater uncertainty today than in the past, the causality behind this phenomenon — just as with the Reinhart/Rogoff thesis — is unclear. Is uncertainty slowing the economy? Or is the slow economy causing uncertainty? In addition, there’s no solid connection between this supposed uncertainty and the projected deficits that McNabb warns about. After all, projected deficits from entitlements are not expected to begin increasing our total debt load for another decade, so why would we be feeling the effects now?

We’re Measuring the Wrong Thing: Historian Niall Ferguson has been very critical of U.S. economic policy since the crisis, and has not backed down from his critiques even though his prediction that loose monetary policy and fiscal stimulus would lead to inflation has not yet panned out. And yesterday, in an interview with Yahoo FinanceFerguson argued that the entire debate over the danger of high debt-to-GDP levels is a sideshow. “Debt-to-GDP is not a good measure of fiscal sustainability,” Ferguson said. “If governments looked more like companies in the way they accounted for their finances, we’d get a very different picture.”

He went on to argue that if the U.S. government were compared to a private sector firm regarding accounting, it would look a lot like Enron. He compared the unfunded liabilities of Medicare and Social Security to the “off-balance sheet vehicles” that sunk the energy giant more than ten years ago. Basically Ferguson is arguing that because governments don’t account for debt in the same way, comparing the experiences of one to another using debt-to-GDP is effectively useless. And because we don’t know when government debt will begin to be a problem, we should immediately do our best to cut as much as possible.

Of these three arguments for fiscal restraint, this is the most sound — if only because it admits how much we simply don’t know. But of course this argument too fails to address the question of whether it really is wise to cut government spending now, during a time of economic depression. Because the Federal Reserve can’t lower interest rates any further at a time of high unemployment and low economic output, how do we get the economy moving again if not with government debt? This is the question that austerity proponents have been consistently unable to answer.

(MORE: What’s Behind the Crash in the Gold Market?)

12 comments
MatthewCreation-stationNoell
MatthewCreation-stationNoell

Cheesus t!tty Fu(&!N Christ......

"He went on to argue that if the U.S. government were compared to a private sector firm regarding accounting, it would look a lot like Enron. He compared the unfunded liabilities of Medicare and Social Security to the “off-balance sheet vehicles” that sunk the energy giant more than ten years ago. Basically Ferguson is arguing that because governments don’t account for debt in the same way, comparing the experiences of one to another using debt-to-GDP is effectively useless."

   First off, the Government IS NOT A BUSINESS!!!! It is not in "Business", and it's goal is not to make money! SO OF COURSE the government does not approach debt the same way....and yet the author claims this argument is the most sound????????  No wonder people keep voting against their interests....they keep trusting hacks like this author and rags like TIME to do their thinking for them.



VjLaxmanan
VjLaxmanan

Is US National Debt Out of Control? 

A Trillionaire’s Club, which includes 13 countries, is conceived here based on the GDP values for 2012 (compiled by the Economic Intelligence Unit, see The Economist, global debt clock). The countries that make it to this first Trillionaire’s Club for 2012 are, in order of decreasing GDP, USA, China, Japan, Germany, France, UK, Brazil, Italy, Russia, India, Canada, Mexico, and Australia. 

An analysis of the GDP-Debt data for this Trillionaire’s Club reveals that the current, astoundingly large, US national debt ($16.829 trillion on April 30, 2013), relative to its GDP, is, statistically speaking, entirely consistent with the debt and GDP values of other members of this Trillionaire’s Club of nations.  

See further details at http://www.scribd.com/doc/139114239/Is-US-National-Debt-Out-of-Control-The-Trillionaires-Club-of-Nations

shepherdwong
shepherdwong like.author.displayName like.author.displayName 2 Like

"Because the Federal Reserve can’t lower interest rates any further at a time of high unemployment and low economic output, how do we get the economy moving again if not with government debt?"

This is the correct question. *golf clap*

shepherdwong
shepherdwong like.author.displayName 1 Like

Oh, and a follow-up: if we don't use government debt to get the economy moving, how will we ever be able to pay down the government debt?

grape_crush
grape_crush like.author.displayName like.author.displayName like.author.displayName 3 Like

> Of these three arguments for fiscal restraint, this is the most sound.

Nope.  It just sounds that way to the rubes. Given Ferguson's history of providing (weak) counterfactual pseudo-intellectual justifications for right wing talking points, I would hope that journalists approach his opining with a healthy dose of skepticism.

Feguson's dishonesty is clear in his Yahoo interview: "A minor error in the Rogoff and Reinhart paper does not refute the case that governments with excessively large public debt have to bring them under control.” There wasn't just a single minor error, there were several large errors, including a couple that have just been discovered, Excluding some data and overemphasizing other data in order to support a desired conclusion just isn't good science; Ferguson can say austerity measures are necessary as much as he pleases, but there's no real data that backs him (and others) up.

> He went on to argue that if the U.S. government were compared to a private sector firm regarding accounting, it would look a lot like Enron.

That's a strawman set up to distract attention from the fact that Ferguson is on very weak footing. On top of that, it's an apples-and-oranges comparison; the private and public sectors don't have the same imperatives or the same means of generating revenue.

> And because we don’t know when government debt will begin to be a problem...

Government debt will be a problem when we are unwilling to generate the funds to make payments on it. Governments don't have to rely on growing revenue or cutting overhead as a the only means of meeting its obligations, like companies do. They have a tool called taxation that can be used.




shepherdwong
shepherdwong

@grape_crush 

"The key to understanding this is that the anti-Keynesian position is, in essence, political. It’s driven by hostility to active government policy and, in many cases, hostility to any intellectual approach that might make room for government policy." 

-- Paul Krugman

scottpressman
scottpressman like.author.displayName 1 Like

@grape_crush ...and nations with their own currency have another tool...called the printing press (theoretically...these days its just a couple of keystrokes).  If they need currency, they can issue more.  Taxation is the means by which fiat currency is made credible. You have to pay your taxes in dollars (in US) so you have to have dollars.

forgottenlord
forgottenlord like.author.displayName like.author.displayName 2 Like

One other point about uncertainty: needing to solve uncertainty is not the same as needing to solve the deficit.  Solving uncertainty is best dealt with by not tying up things like debt ceiling raises, budgets and sequesters until the last minute.  If you know that the deficit is going to continue, you have certainty.  If you know the government is going to keep its lights on, you have certainty.  If you know that the government isn't going to suffer a monumental spending collapse next month, you have certainty.  You can have the sequester kick in, but if you say three months in advance that there is no way it's going to disappear, people are certain about its future.

drudown
drudown

The real "problem" is that the GOP's Corporate campaign contributors think the People live in a vacuum, i.e., oblivious to the lessons of History unfolding before our eyes in the EU. Whether it be "austerity" measures creating social unrest- or unrestrained "immigration" exacerbating tensions with dwindling fiscal resources- the GOP wants to pull the proverbial wool over the Media's eyes and point to meaningless "polls" or paid-for-expert-witness "reports" that back into the desired conclusion supporting the emasculation of the State via "no new revenues, ever."

Er, I mean taxes.

"To know and to act is one and the same." - Samurai maxim

scottpressman
scottpressman like.author.displayName like.author.displayName like.author.displayName 3 Like

Historian Niall Ferguson...doesn't sound like "economist" Niall Ferguson.  Anyone with any knowledge of economics knows a business is nothing like the funding of government for "fiat currency" nations.  If his is the best argument, then there is almost no argument at all for austerity

ViableOp
ViableOp

This time, the recovery really is different largely due to what governments can afford to spend on stimulus as shown here:

http://viableopposition.blogspot.ca/2013/05/why-this-recovery-is-different.html

This time, unlike past post-recession periods, the governments of most of the world's largest  and most developed economies have been unable to spend their way out of trouble.

drudown
drudown

@ViableOp 

Tell me, how then can you create jobs without stimulus funds?

Honestly. 

No credible, learned mind will acquiesce to the unfounded proposition that "austerity" creates jobs in light of the lack thereof in the EU.

Res ipsa loquitur.