Financial Institutions Admit Austerity Failed

The Market Giveth and Taketh Away
by KEN KLIPPENSTEIN


The first part of 2013 has been something of a confessional period for the economic managerial class. The IMF’s chief economist, Olivier Blanchard, conceded that “forecasters significantly underestimated the increase in unemployment and the decline in domestic demand associated with fiscal consolidation.” (‘Fiscal consolidation’ is a polite way of saying ‘austerity’.) U.S. Treasury Secretary Jack Lew admitted that “there has to be a focus on what the impact on unemployment is” of austerity policies; also, that “you cannot be in the world where austerity just leads to more austerity”; and finally, that “the rush to do all the [austerity] front-end has actually made the problem harder in some countries.” He even suggested that “Europeans need to look as well what they can do to generate more demand in their economy.”

Managing Director of the IMF, Christine Lagarde, confessed that “we don’t see the need to do upfront, heavy duty fiscal consolidation as was initially planned”; and “the best way to create jobs is through growth.” EU Economic and Monetary Affairs Commissioner Olli Rehn said that the IMF and the US’ recent calls for less austerity “are preaching to the converted.”

Meanwhile, Carmen Reinhart and Kenneth Rogoff, the Harvard economists responsible for one of the more influential studies used to defend austerity, have admitted that “austerity is not the only answer to a debt problem.” This came after three economists at the University of Massachusetts accused them of “selective exclusion” of data. Reinhart and Rogoff have since admitted that their critics “correctly identified a spreadsheet coding error.” In my view, their most striking error is being ignored: the failure to recognize that austerity didn’t work during the Great Depression and won’t work now, during the Great Recession. Anyone can make a spreadsheet error. It takes a Harvard professor to forget basic history.

It’s not particularly interesting when doctrinal managers like Reinhart and Rogoff change positions. The ability to turn on one’s heel and switch from one ideological conviction to its opposite, like a schoolchild running the pacer test, is probably the ideological manager’s main duty. The ones who collapse from exhaustion are weeded out long before they become IMF chiefs. What’s more interesting is why the coach is having them run in the opposite direction now.

In a correspondence I had with economist Jack Rasmus, he explained the economic managerial class’ reversal:

First, it may signal a future shift to business-investor tax cuts as a preferred ‘stimulus’ (which doesn’t work either). However, since tax cuts will raise the deficit, they have to justify an increase in the deficit if they’re going to move ahead with the tax cuts. Thus, the attack on ‘austerity’ (stimulus in reverse) as not as productive as they thought is first necessary. On the other hand, it’s important to note that the shift to ‘stimulus’ doesn’t mean a shift from social spending cuts; it means a shift to more deficit via corporate tax cuts.

Second, the abandonment of austerity may represent a prelude to a still greater reliance on monetary policy. Let the central bank bear all the burden (and blame) and take the heat off politicians more visibly responsible for spending cut austerity. Monetary policy (i.e. increasing liquidity to banks, investors and businesses) has in turn two prime goals. One: to boost the stock and financial securities markets and ensure more profits for speculators, and, second, to lower their currency’s exchange value to allow competition with other currency centers…A sure sign that capitalist policymakers are getting more desperate and trying to grow by beggaring their competitors. It’s competitive devaluations—not by fiat as in the 1930s—but by liquidity-exchange rate manipulation.

Whatever the case may be, the financial institutions’ current ideological inflection should probably be regarded with suspicion. It is much too sharp an inflection to indicate any sort of honest change in thinking.

The solutions that the economic managers are advocating demonstrate a useful point. They simultaneously demand stimulus and deficit reduction. As Treasury Secretary Jack Lew put it, “We shouldn’t choose between growth and job creation and getting our fiscal house in order.” This is like a child wishing he could stay up all night and get a good night’s sleep: either choice negates the other. These mental exercises in self-contradiction further illustrate the way in which the elite must accept mutually conflicting views. Orwell called this ‘doublethink.’

Today we call it things like ‘nuance.’ Example: Reinhart and Rogoff said that “the recent debate about the global economy has taken a distressingly simplistic turn,” by which they mean austerity is finally being firmly rejected. In elite circles, ‘simplistic’ explanations are any which involve elementary truths: that authentic stimulus increases the deficit, as do corporate tax cuts; that privatization makes things unaccountable to the public; that a middle and under-class recovery requires an upper-class tax. (These simple facts are incomprehensible to the elite because they suggest a world in which extreme wealth causes injustice rather than eradicates it.) Derivatives and credit default swaps, on the other hand, are ‘nuanced’ tools which anyone without an advanced degree in finance shouldn’t comment on.

An outgrowth of this tendency toward ‘nuance’ is the peculiarly mystical tone that the economics profession has taken on. For example, the view that the business cycle will inevitably restore us to prosperity, and that the present downturn is just some sort of random misfortune. I recall a friend in university remarking that he planned to enter a PhD program in hopes of “waiting out the recession,” as though it were a spell of rain or some other act of god. The market giveth and taketh away. To suggest any sort of human agency behind these downturns—namely, a relationship between the wealth and poverty—is to commit the dreaded error of viewing economics as a zero-sum game. This of course is a fallacy, because economics is a magical process by which the concentrated wealth simultaneously diffuses its wealth (i.e. trickle-down theory).

Exploding the Debt Threshold Myth

Friday, 26 April 2013 | By Salvatore Babones, Truthout | Op-Ed

In January 2010, two prominent Harvard University economists, Carmen Reinhart and Kenneth Rogoff, published a highly influential paper in which they argued that high levels of government debt are associated with low levels of economic growth.

They concluded that above the threshold where government debt exceeds 90 percent of national income, "median growth rates fall by one percent, and average growth falls considerably more."

Following on the heels of the 2008 global financial crisis and the associated spike in government borrowing in Europe and the United States, the Reinhart-Rogoff paper quickly became a touchstone for the small-government crowd. Austerity is the order of the day. Reinhart and Rogoff are its prophets.

Now three economists at the decidedly less upscale University of Massachusetts - Thomas Herndon, Michael Ash and Robert Pollin - have uncovered a series of errors and outright blunders in the Reinhart-Rogoff results.

Not only did the trio show that Reinhart and Rogoff misinterpreted and misanalyzed their data, they also found a simple spreadsheet error that dramatically changed the statistical results. Austerity, it turns out, only works if you don't know how to use Excel.

Reinhart and Rogoff have acknowledged their errors, though they are at pains to stress that the errors are largely immaterial to their overall conclusions that government debt levels of more than 90 percent of national income are associated with low levels of economic growth.

They also disingenuously point out that "We are very careful in all our papers to speak of 'association' and not 'causality.' " Disingenuously, since their pro-austerity stance shines through all their work. After all, the title of their 2010 paper was "Growth in a Time of Debt," not "Debt in a Time of Recession."

Especially misleading is a chart in their paper that shows US economic growth rates for four different levels of US government debt, with the bars becoming alarmingly redder as the debt levels increased.

Reinhart and Rogoff analyzed 220 years of US economic history to conclude that, on average, the US economy has consistently grown at rates over 3 percent per year at all levels of government debt from 0 percent to 90 percent of national income. But when US government debt has risen above 90 percent, the US economy has contracted, they found.

Nowhere in their paper do they mention just when it was that US government debt rose above 90 percent of national income. Was it the Great Depression? No. The Bush or Obama years? No. Perhaps back in the 19th century? No.

In fact, in its 220-year recorded economic history, the United States has only ever experienced four years in which federal government debt exceeded 90 percent of US national income: 1944, 1945, 1946 and 1947.

In those four years, real economic growth was 8.1 percent, -1.1 percent, -10.9 percent and -0.9 percent, respectively. Which tells us absolutely nothing, except that after a huge world war it takes some time for an economy to readjust to peacetime production. Anyone who says that America's sudden recession in 1946 was due to government debt, not the end of the war, is either crazy, deceitful or stupid.

Carmen Reinhart is the Minos A. Zombanakis Professor of the International Financial System at Harvard's Kennedy School of Government. Kenneth Rogoff is the Thomas D. Cabot Professor of Public Policy and Professor of Economics at Harvard University. You be the judge.

Actually, Reinhart and Rogoff do recognize the warping effects of World War II - on Australia and New Zealand. In those two countries Reinhart and Rogoff found that high debt was actually associated with stronger than average economic growth. But they (correctly) wrote this off as a distortion caused by the war.

In fact, of the 20 rich countries studied by Reinhart and Rogoff, only one example shows negative growth resulting from high debt: the United States after World War II. But despite the fact that they are American, live in America and mainly study the US economy, they fail to note that the only period of high debt coupled with recession in US history was the 1946 demobilization after World War II.

Apparently war distorts the data when it makes debt look good, but war isn't worth mentioning when it makes debt look bad.

It gets worse. University of Southern California professor Richard Green raises an even bigger issue. In a column for Forbes magazine, he suggests that it may be the case that debt doesn't cause low growth. It may be that low growth causes governments to go into debt.
Green presents very preliminary statistical results in his column based on a standard econometric technique called the Granger causality test. His results suggest that the impact of high debt on economic growth is either positive or neutral, while the impact of economic growth on high debt is either negative or neutral.

This is strong first-look evidence that recessions cause debt, not the other way around. But no one - Green included - expects to solve this complex statistical issue in a 600-word column. The travesty is that Reinhart and Rogoff didn't even raise the issue in a 25-page academic paper.

Lies, damned lies, and statistics. It is easy to massage data. For example, why should one expect high government debt to have an immediate impact on economic growth? Reinhart and Rogoff could just as well have studied the impact of government debt on growth rates several years later.

If they had, they might have found that in the United States, high government debt was associated with rapid economic growth. US government debt peaked in 1945 at 112.7 percent of national income. Five years later, in 1950, the US economy was racing ahead at an 8.7 percent growth rate.

The potential lesson for today? If we borrow heavily in 2013, we can enjoy a huge growth dividend in 2018.

Of course, that lesson is no more valid than Reinhart and Rogoff's austerity lesson. But it's no less valid.

If we borrow now to invest in education, job training and infrastructure, it's likely we will have robust growth in 2018. But we don't know that from Reinhart and Rogoff's historical data. We know that from common sense.

Even if the expected economic growth doesn't materialize, we will still have the education, the job training and the infrastructure to show for our spending. That's something.

At a time when the US government can borrow for five years for less than 1 percent annual interest and for 30 years for less then 3 percent annual interest, it's crazy to be cutting government spending instead of investing in our future. Well, it's either crazy, deceitful or stupid. You be the judge.

The Sorta Funnies

The Excel Depression

By PAUL KRUGMAN - NY Times
Published: April 18, 2013


In this age of information, math errors can lead to disaster. NASA’s Mars Orbiter crashed because engineers forgot to convert to metric measurements; JPMorgan Chase’s “London Whale” venture went bad in part because modelers divided by a sum instead of an average. So, did an Excel coding error destroy the economies of the Western world?

The story so far: At the beginning of 2010, two Harvard economists, Carmen Reinhart and Kenneth Rogoff, circulated a paper, Growth in a Time of Debt, that purported to identify a critical “threshold,” a tipping point, for government indebtedness.

Once debt exceeds 90 percent of gross domestic product, they claimed, economic growth drops off sharply.

Ms. Reinhart and Mr. Rogoff had credibility thanks to a widely admired earlier book on the history of financial crises, and their timing was impeccable. The paper came out just after Greece went into crisis and played right into the desire of many officials to “pivot” from stimulus to austerity. As a result, the paper instantly became famous; it was, and is, surely the most influential economic analysis of recent years.

In fact, Reinhart-Rogoff quickly achieved almost sacred status among self-proclaimed guardians of fiscal responsibility; their tipping-point claim was treated not as a disputed hypothesis but as unquestioned fact. For example, a Washington Post editorial earlier this year warned against any relaxation on the deficit front, because we are “dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth.” Notice the phrasing: “economists,” not “some economists,” let alone “some economists, vigorously disputed by other economists with equally good credentials,” which was the reality.

For the truth is that Reinhart-Rogoff faced substantial criticism from the start, and the controversy grew over time. As soon as the paper was released, many economists pointed out that a negative correlation between debt and economic performance need not mean that high debt causes low growth. It could just as easily be the other way around, with poor economic performance leading to high debt. Indeed, that’s obviously the case for Japan, which went deep into debt only after its growth collapsed in the early 1990s.

Over time, another problem emerged: Other researchers, using seemingly comparable data on debt and growth, couldn’t replicate the Reinhart-Rogoff results. They typically found some correlation between high debt and slow growth — but nothing that looked like a tipping point at 90 percent or, indeed, any particular level of debt.

Finally, Ms. Reinhart and Mr. Rogoff allowed researchers at the University of Massachusetts to look at their original spreadsheet — and the mystery of the irreproducible results was solved. First, they omitted some data; second, they used unusual and highly questionable statistical procedures; and finally, yes, they made an Excel coding error. Correct these oddities and errors, and you get what other researchers have found: some correlation between high debt and slow growth, with no indication of which is causing which, but no sign at all of that 90 percent “threshold.”

In response, Ms. Reinhart and Mr. Rogoff have acknowledged the coding error, defended their other decisions and claimed that they never asserted that debt necessarily causes slow growth. That’s a bit disingenuous because they repeatedly insinuated that proposition even if they avoided saying it outright. But, in any case, what really matters isn’t what they meant to say, it’s how their work was read:  

Austerity enthusiasts trumpeted that supposed 90 percent tipping point as a proven fact and a reason to slash government spending even in the face of mass unemployment.

So the Reinhart-Rogoff fiasco needs to be seen in the broader context of austerity mania: the obviously intense desire of policy makers, politicians and pundits across the Western world to turn their backs on the unemployed and instead use the economic crisis as an excuse to slash social programs.

What the Reinhart-Rogoff affair shows is the extent to which austerity has been sold on false pretenses. For three years, the turn to austerity has been presented not as a choice but as a necessity. Economic research, austerity advocates insisted, showed that terrible things happen once debt exceeds 90 percent of G.D.P. But “economic research” showed no such thing; a couple of economists made that assertion, while many others disagreed.  

Policy makers abandoned the unemployed and turned to austerity because they wanted to, not because they had to.

So will toppling Reinhart-Rogoff from its pedestal change anything? I’d like to think so. But I predict that the usual suspects will just find another dubious piece of economic analysis to canonize, and the depression will go on and on.

How Much Unemployment Was Caused by Reinhart and Rogoff's Arithmetic Mistake?

Tuesday, 16 April 2013 | Beat the Press

That's the question millions will be asking when they see the new paper by the University of Massachusetts, Thomas Herndon, Michael Ash, and Robert Pollin. Herndon, Ash, and Pollin (HAP) corrected the spreadsheets of Carmen Reinhart and Ken Rogoff. They show the correct numbers tell a very different story about the relationship between debt and GDP growth than the one that Reinhart and Rogoff have been hawking.

Just to remind folks, Reinhart and Rogoff (R&R) are the authors of the widely acclaimed book on the history of financial crises, This Time is Different. They have also done several papers derived from this research, the main conclusion of which is that high ratios of debt to GDP lead to a long periods of slow growth. Their story line is that 90 percent is a cutoff line, with countries with debt-to-GDP ratios above this level seeing markedly slower growth than countries that have debt-to-GDP ratios below this level. The moral is to make sure the debt-to-GDP ratio does not get above 90 percent.

There are all sorts of good reasons for questioning this logic. First, there is good reason for believing causation goes the other way. Countries are likely to have high debt-to-GDP ratios because they are having serious economic problems.

Second, as Josh Bivens and John Irons have pointed out, the story of the bad growth in high debt years in the United States is driven by the demobilization after World War II. In other words, these were not bad economic times, the years of high debt in the United States had slow growth because millions of women opted to leave the paid labor force.

Third, the whole notion of public debt turns out to be ill-defined. Countries can sell off assets to pay down debts, would this avoid the R&R high debt twilight zone of slow growth? In fact, even the value of debt itself is not constant.Long-term debt issued in times of low interest rates will fall in value when interest rates rise. If there is a high debt twilight zone effect as R&R claim, then we can just buy back bonds at steep discounts and send our debt-to-GDP ratio plummeting.

But HAP tells us that we need not concern ourselves with any arguments this complicated. The basic R&R story was simply the result of them getting their own numbers wrong.

After being unable to reproduce R&R's results with publicly available data, HAP were able to get the spreadsheets that R&R had used for their calculations. It turns out that the initial results were driven by simple computational and transcription errors. The most important of these errors was excluding four years of growth data from New Zealand in which it was above the 90 percent debt-to-GDP threshold. When these four years are added in, the average growth rate in New Zealand for its high debt years was 2.6 percent, compared to the -7.6 percent that R&R had entered in their calculation.

Since R&R country weight their data (each country's growth rate has the same weight), and there are only seven countries that cross into the high debt region, correcting this one mistake alone adds 1.5 percentage points to the average growth rate for the high debt countries. This eliminates most of the falloff in growth that R&R find from high debt levels. (HAP find several other important errors in the R&R paper, however the missing New Zealand years are the biggest part of the story.)

This is a big deal because politicians around the world have used this finding from R&R to justify austerity measures that have slowed growth and raised unemployment. In the United States many politicians have pointed to R&R's work as justification for deficit reduction even though the economy is far below full employment by any reasonable measure. In Europe, R&R's work and its derivatives have been used to justify austerity policies that have pushed the unemployment rate over 10 percent for the euro zone as a whole and above 20 percent in Greece and Spain. In other words, this is a mistake that has had enormous consequences.

In fairness, there has been other research that makes similar claims, including more recent work by Reinhardt and Rogoff. But it was the initial R&R papers that created the framework for most of the subsequent policy debate. And HAP has shown that the key finding that debt slows growth was driven overwhelmingly by the exclusion of 4 years of data from New Zealand.

If facts mattered in economic policy debates, this should be the cause for a major reassessment of the deficit reduction policies being pursued in the United States and elsewhere. It should also cause reporters to be a bit slower to accept such sweeping claims at face value.

(Those interested in playing with the data itself can find it at the website for the Political Economic Research Institute.)