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.

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