I find that I have much more to say (or, rather, largely, republish), relevant to the current debate between Simon Wren-Lewis and Unlearning Economics.

Let me start by saying that I think Unlearning Economics is almost entirely wrong in his proposed solutions.

Indeed, they does not seem especially knowledgeable about their cases. For example:

  1. the trashing of the Grameen Bank is undeserved;

  2. the blanket denunciation of RCTs as having “benefited global and local elites at the expensive of the poorest” is just bonkers;

  3. Merton and Scholes’s financial math was correct, and the crash of their hedge fund did not require any public-money bailout;

  4. Janine Wedel is not a reliable source on Russian privatization, which I saw and see as the only practical chance to try to head off the oligarchic plutocracy that has grown up in Russia under Yeltsin and Putin (and, no, my freshman roommate Andrei was not prosecuted for “fraud in Russia”, but rather the Boston U.S. Attorney’s office overreached and was unwilling to admit it);

  5. Unlearning Economics confuses the more-sinister Friedrich von Hayek (who welcomed Pinochet’s political “excesses” as a necessary Lykurgan moment) with the truly-libertarian Milton Friedman, who throughout his whole life was dedicated to not telling people what to do, and who saw Pinochet as another oppressive authoritarian who might be induced to choose better rather than worse economic policies;

  6. and then there is Reinhart and Rogoff, where I think Unlearning Economics is right.

So Unlearning Economics is batting 0.170 in their examples of “mainstream economics considered harmful”. But there is that one case. And I do not think that Simon Wren-Lewis handles that one case well. And he needs to–I need to. And, since neither he nor I have, this is a big problem.

Let me put it this way: Carmen Reinhart and Ken Rogoff are mainstream economists.

The fact is that Carmen Reinhart and Ken Rogoff were wrong in 2009-2013. Yet they had much more influence on economic policy in 2009-2013 than did Simon Wren-Lewis and me. They had influence. And their influence was aggressively pro-austerity. And their influence almost entirely destructive.

Simon needs to face that fact squarely, rather than to dodge it. The fact is that the “mainstream economists, and most mainstream economists” who were heard in the public sphere were not against austerity, but rather split, with, if anything, louder and larger voices on the pro-austerity side. (IMHO, Simon Wren-Lewis half admits this with his denunciations of “City economists”.) When Unlearning Economics seeks the destruction of “mainstream economics”, he seeks the end of an intellectual hegemony that gives Reinhart and Rogoff’s very shaky arguments a much more powerful institutional intellectual voice by virtue of their authors’ tenured posts at Harvard than the arguments in fact deserve. Simon Wren-Lewis, in response, wants to claim that strengthening the “mainstream” would somehow diminish the influence of future Reinharts and Rogoffs in analogous situations. But the arguments for austerity that turned out to be powerful and persuasive in the public sphere came from inside the house!

Simon Wren-Lewis: On Criticising the Existence of Mainstream Economics: “I’m very grateful to Unlearning Economics (UE) for writing in a clear and forceful way a defence of the idea that attacking mainstream economics is a progressive endeavor…

…I think such attacks are far from progressive…. Devoting a lot of time to exposing students to contrasting economic frameworks (feminist, Austrian, post-Keynesian)… means cutting time spent on learning the essential tools that any economist needs…. Let me start at the end of the UE piece:

The case against austerity does not depend on whether it is ‘good economics’, but on its human impact. Nor does the case for combating climate change depend on the present discounted value of future costs to GDP. Reclaiming political debate from the grip of economics will make the human side of politics more central, and so can only serve a progressive purpose…

Austerity did not arise because people forgot about its human impact. It arose because politicians, with help from City economists, started scare mongering about the deficit…. Every UK household knew that your income largely dictates what you can spend, and as long as the analogy between that and austerity remained unchallenged, talk about human impact would have little effect…. The only way to beat austerity is to question the economics on which it is based…. Having mainstream economics, and most mainstream economists, on your side in the debate on austerity is surely a big advantage….

Where UE is on stronger ground is where they question the responsibility of economists…. Politicians grabbed hold of the Rogoff and Reinhart argument about a 90% threshold for government debt:

Where was the formal, institutional denunciation of such a glaring error from the economics profession, and of the politicians who used it to justify their regressive policies? Why are R & R still allowed to comment on the matter with even an ounce of credibility? The case for austerity undoubtedly didn’t hinge on this research alone, but imagine if a politician cited faulty medical research to approve their policies—would institutions like the BMA not feel a responsibility to condemn it?”

I want to avoid getting bogged down in the specifics of this example, but instead just talk about generalities…. If some professional body started ruling on what the consensus among economists was… [that] would go in completely the opposite direction from what most heterodox economists wish…. There is plenty wrong with mainstream economics, but replacing it with schools of thought is not the progressive endeavor that some believe. It would just give you more idiotic policies like Brexit.

What did Reinhart and Rogoff say? What Let me turn the mike over to Tom Cotton:

Reinhart and Rogoff had… dismantl[ed] the mistaken belief… that this particular group of [Democratic] policymakers in this moment in history was somehow smarter than all the others and could run up debt forever without catastrophic consequences…. They wrote:

We have been here before. No matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities with past experience from other countries and from history. Recognizing these analogies and precedents is an essential step toward improving our global financial system, both to reduce the risk of future crisis and to better handle catastrophes when they happen…

The student senators began asking questions with a sincere curiosity cynics would find disarming. Johnny Isakson, a Republican from Georgia and always a gentleman, stood up to ask his question: “Do we need to act this year? Is it better to act quickly?” “Absolutely,” Rogoff said: “Not acting moves the risk closer,” he explained, because every year of not acting adds another year of debt accumulation. “You have very few levers at this point….” Neither Reinhart nor Rogoff said we could fix our debt problem with just tax increases. Both emphasized the need for comprehensive tax reform and tax code simplification…. “I don’t want to be fire and brimstone,” Rogoff said. “No one knows when this will happen.” Yet, he added, “It takes more than two years to turn the ship around…. Once you’ve waited too long, it’s too hard to take radical steps”…

Plus there are things like Rogoff’s:

Debt levels of 90% of GDP are a long-term secular drag on economic growth that often lasts for two decades or more…. There is two-way feedback between debt and growth, but normal recessions last only a year and cannot explain a two-decade period of malaise. The drag on growth is more likely to come from the eventual need for the government to raise taxes, as well as from lower investment spending. So, yes, government spending provides a short-term boost, but there is a trade-off with long-run secular decline…

Simon Wren-Lewis wants to say:

  • mainstream economists good
  • City economists bad
  • Feminist, Austrian, post-Keynesian economists unhelpful because they distract focus from the powerful mainstream arguments that austerity is bad.

And the problem is that Carmen Reinhart and Ken Rogoff are not “City” but mainstream economists—as are Martin Feldstein, John Taylor, Greg Mankiw, Glenn Hubbard, Eugene Fame, Robert Lucas, Robert Barro, and a huge host of others pro-austerity throughout 2008-2017. That is the elephant in the room that Simon needs to face. And when he writes that he wants to “avoid getting bogged down in the specifics of this example”, he evades UE’s big question and fails to make the argument he needs to make.


Background:

Why Are Reinhart and Rogoff—and Other Mainstream Economists—so Wrong?

On a psychological level—for an explanation of why they said and wrote what they said and wrote—I have no explanation. On the technocratic level, there is a lot to say:

When Carmen Reinhart and Kenneth Rogoff wrote their “Growth in a Time of Debt”, they asked the question:

Outsized deficits and epic bank bailouts may be useful in fighting a downturn, but what is the long run macroeconomic impact or higher levels of government debt, especially against the backdrop of graying populations and rising social insurance costs?

They concluded that over the past 200 years:

[T]he relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of [annual] GDP. Above 90 percent, median growth rates fall by one percent, and average growth… more… in [both] advanced and emerging economies…. [In] emerging markets… [w]hen external debt reaches 60 percent of GDP, annual growth declines by about two percent…. [T]here is no apparent contemporaneous link between inflation and public debt levels for the advanced countries…. The story is entirely different for emerging markets, where inflation rises sharply as debt increases.

And the graph that caught the world’s imagination was:

NewImage

The principal mistake Reinhart and Rogoff committed in their analysis and paper–indeed, the only significant mistake in the paper itself–was their use of the word “threshold”.

It and the graph led very many astray.

For example, it led the almost-always-unreliable Washington Post editorial board to condemn the:

new school of thought about the deficit…. ‘Don’t worry, be happy. We’ve made a lot of progress’, says an array of liberal pundits… [including] Martin Wolf of the Financial Times… their analysis assumes steady economic growth and no war. If that’s even slightly off, debt-to-GDP could… stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth…

(Admittedly, experience since the start of the millennium gives abundant evidence that the Washington Post needs no empirical backup from anybody in order to lie and mislead in whatever way the wind blows.)

It misled European Commissioner Olli Rehn to claim that:

When [government] debt reaches 80-90% of GDP, it starts to crowd out activity in the private sector and other parts of the economy…

Both of these–and a host of others–think that if debt-to-annual-GDP is less than 90% (or, in Rehn’s case, 80%, and I have no idea where the 80% comes from) an economy is safe, and that only if it is above 90% is the economy’s growth in danger. And in their enthusiasm when they entered congressional briefing mode it led Reinhart and Rogoff themselves astray.

Yet the threshold at 90% is not there. In no sense is there empirical evidence that a 90% ratio of debt-to-annual-GDP is in any sense an “important marker”, a red line. That it appears to be in Reinhart and Rogoff’s paper is an artifact of Reinhart and Rogoff’s non-parametric method: throw the data into four bins, with 90% the bottom of the top bin. There is, instead, a gradual and smooth decline in growth rates as debt-to-annual-GDP increases. 80% looks only trivially different than 100%.
Owen Zidar provides what seems to me at least to be a much more informative cut at the data:

NewImage

and he writes:

I took all countries with Public Debt to GDP ratios above 50… evenly divided them into 50 equalized sized bins of Debt to GDP… plot the mean of the outcome of interest for each bin…. [This] would show clean breaks at a Debt to GDP ratio of 90 if they actually exist…

There is no 90% threshold. Making policy under the belief that risks at 100% are very different than risks at 80% is in no way supported by any of the data.

Moreover, there is the big question of how much of this decline in growth as debt rises is cause for fear? Correlation, after all, is only sometimes causation. Ken Rogoff claims that this is one of those cases. Is he write?

First, a good deal of this high-debt-to-GDP growth-decline correlation comes from countries where interest rates tend to be higher and the stock market tends to be lower where government debt is higher. That is simply not relevant to the U.S. today.

Second, a good deal of this correlation comes from countries where inflation rates are higher when government debt is higher. That is not relevant to the U.S. today.

Third, a good deal more of this correlation comes from countries where growth was already slow, and high government debt relative to GDP is, as Larry Summers constantly says, a result not of the numerator but of previous trends in the denominator. That is not relevant to the U.S. today.

How much of this correlation is left for a country with low interest rates, low inflation rates, buoyant stock prices, and healthy prior growth? We need to know that before we can even begin to analyze causation.

And the answer is: not much, if any. Until interest and inflation rates begin to rise above normal levels or the stock market tanks, there is little risk to accumulating more government debt here in the United States. And there are large potential benefits from solving our real low employment and slack capacity problems right now

What did I mean by “not much”? Let me highlight a passage from the “Understanding Our Adversaries” evolution-of-economists’-views talk that I have been giving for several months now, a passage based on work by Owen Zidar summarized by the graph above:

The argument [for fiscal contraction and against fiscal expansion in the short run] is now: never mind why, the costs of debt accumulation are very high. This is the argument made by Reinhart, Reinhart, and Rogoff: when your debt to annual GDP ratio rises above 90%, your growth tends to be slow. This is the most live argument today. So let me nibble away at it:

  1. Note well: no cliff at 90%.

  2. RRR present a correlation–not a causal mechanism, and not a properly-instrumented regression. There argument is a claim that high debt-to-GDP and slow subsequent growth go together, without answering the question of which way causation runs. Let us answer that question. And the answer is that the bulk of causation is not there, and provides no reason for the U.S. to fear.

  3. Note is how small the correlation is.

Suppose that all of the correlation is causation from higher debt to slower growth. Let us then consider two cases: a multiplier of 1.5 and a multiplier of 2.5, both with a marginal tax share of 1/3. Suppose the growth-depressing effect lasts for 10 years. And suppose that we boost government spending by 2% of GDP.

Let us boost government spending for this year only in the first case. Output this year then goes up by 3% of GDP. Debt goes up by 1% of GDP taking account of higher tax collections. This higher debt then reduces growth by… wait for it… 0.006% points per year. After 10 years GDP is lower than it would otherwise have been by 0.06%. 3% higher GDP this year and slower growth that leads to GDP lower by 0.06% in a decade. And this is supposed to be an argument against expansionary fiscal policy right now?

The 2.5 multiplier case is more so. Spend an extra 2% of GDP over each of the next three years. Collect 15% of a year’s extra output as a plus in the short run. Taking account of higher tax revenues, debt goes up by 1% of GDP, and we have the same ten-year depressing effect of 0.06% of GDP.

15% now. -0.06% in a decade.

The first would be temporary, the second is permanent, but even so the costs are much less than the benefits as long as the economy is still at the zero lower bound.

And this isn’t the graph that you were looking for. You want the causal graph. That, worldwide, growth is slow for other reasons when debt is high for other reasons or where debt is high for other reasons is in this graph, and should not be. Control for country and era effects and Owen reports that the -0.06% becomes -0.03%. As Larry Summers never tires of pointing out, (a) debt-to-annual-GDP ratio has a numerator and a denominator, and (b) sometimes high-debt comes with high interest rates and we expect that to slow growth but that is not relevant to the North Atlantic right now. If the ratio is high because of the denominator, causation is already running the other way. We want to focus on cases of high debt and low interest rates. Do those two things and we are down to a -0.01% coefficient.

We are supposed to be scared of a government-spending program of between 2% and 6% of a year’s GDP because we see a causal mechanism at work that would also lower GDP in a decade by 0.01% of GDP?

That does not seem to me to compute.

As a very smart old Washington hand wrote me:

True, but the 90% red line seemed to say there is nothing more important than moving debt down relative to GDP (though Ken and Carmen would probably acknowledge that faster growth, say through some even more forceful unconventional monetary policy, was a legitimate means to do that).


And why not add more? From my Notre Dame Paper:

IV. We Dwell Not in the Republic of Plato But in the Sewer of Romulus

In the last days before the coming of the Roman Empire, Marcus Tullius Cicero in Rome wrote to his best correspondent Titus Pomponius Atticus in Athens:

You cannot love our dear [Marcus Porcius] Cato any more than I do; but the man – although employing the finest mind and possessing the greatest trustworthiness – sometimes harms the Republic. He speaks as if we were in the Republic of Plato, and not in the sewer of Romulus…

Whatever you may think about economists’ desires to use their technical and technocratic expertise to reduce the influence of both the Trotskys and the St. Benedicts in the public square, there is the prior question of whether here and now – in this fallen sublunary sphere, among the filth of Romulus – they have and deploy any proper technical and technocratic expertise at all. And we seem to gain a new example of this every week.

The most salient relatively-recent example was provided by Carmen Reinhart and Kenneth Rogoff[39][39] – brilliant, hard-working economists both, from whom I have learned immense amounts. Rogoff’s depth of thought and breadth of knowledge about how countries act and how economies respond in the arena of the international monetary system is a global treasure. Reinhart’s breadth and depth of knowledge about how governments have issued, financed, amortized, paid off, or not paid off their debts over the past two centuries is the greatest in the world.

Debt to GDP Ratio and Future Economic Growth pdf page 5 of 6

However, they believed that the best path forward for the developed economies – the U.S., Germany, Britain, and Japan – was for them to shrink their government deficits quickly and quickly halt the accumulation of and begin to pay down government debt. My faction, by contrast, believed that the best path forward for these economies was for them to expand their government deficits now and let the debt grow until either economies recover to normal levels of employment or until interest rates begin to rise significantly.

Why does my faction disagree with them? Let me, first, rely on the graph above that is the product of work by Berkeley graduate student Owen Zidar, plotting how economic growth in different industrialized countries in different eras has varied along with the amount of government debt that they had previously accumulated. And let me give the explanation of why I disagree with Reinhart and Rogoff that I was giving at seminars around the country in the early 2010s:

The argument [for fiscal contraction and against fiscal expansion in the short run] is now: never mind why, the costs of debt accumulation are very high. This is the argument made by Reinhart and Rogoff: when your debt to annual GDP ratio rises above 90%, your growth tends to be slow.

This is the most live argument today. So let me nibble away at it. And let me start by presenting the RRR case in the form of Owen Zidar’s graph.

First: note well: no cliff at 90%.

Second, RRR present a correlation – not a causal mechanism, and not a properly-instrumented regression. Their argument is a claim that high debt-to-GDP and slow subsequent growth go together, without answering the question of which way causation runs. Let us answer that question.

The third thing to note is how small the correlation is. Suppose that we consider two cases: a multiplier of 1.5 and a multiplier of 2.5, both with a marginal tax share of 1/3. Suppose the growth-depressing effect lasts for 10 years. Suppose that all of the correlation is causation running from high debt to slower future growth. And suppose that we boost government spending by 2% of GDP this year in the first case. Output this year then goes up by 3% of GDP. Debt goes up by 1% of GDP taking account of higher tax collections. This higher debt then reduces growth by… wait for it… 0.006% points per year. After 10 years GDP is lower than it would otherwise have been by 0.06%. 3% higher GDP this year and slower growth that leads to GDP lower by 0.06% in a decade. And this is supposed to be an argument against expansionary fiscal policy right now?

The 2.5 multiplier case is more so. Spend 2% of GDP over each of the next three years. Collect 15% of a year’s extra output in the short run. Taking account of higher tax revenues, debt goes up by 1% of GDP and we have the same ten-year depressing effect of 0.06% of GDP. 15% now. -0.06% in a decade. The first would be temporary, the second is permanent, but even so the costs are much less than the benefits as long as the economy is still at the zero lower bound.

And this isn’t the graph that you were looking for. You want the causal graph. That, worldwide, growth is slow for other reasons when debt is high for other reasons or where debt is high for other reasons is in this graph, and should not be. Control for country and era effects and Owen reports that the -0.06% becomes -0.03%. As Larry Summers never tires of pointing out, (a) debt-to-annual-GDP ratio has a numerator and a denominator, and (b) sometimes high-debt comes with high interest rates and we expect that to slow growth but that is not relevant to the North Atlantic right now. If the ratio is high because of the denominator, causation is already running the other way. We want to focus on cases of high debt and low interest rates. Do those two things and we are down to a -0.01% coefficient.

We are supposed to be scared of a government-spending program of between 2% and 6% of a year’s GDP because we see a causal mechanism at work that would also lower GDP in a decade by 0.01% of GDP? That does not seem to me to compute.

Now I have been nibbling the RRR result down. Presumably they are trying to see if it can legitimately be pushed up. This will be interesting to watch over the next several years, because RRR is the heart of the pro-austerity case right now.

That ends what I would typically try to say.

And that is as concise and simple an explanation of why I disagree with Reinhart and Rogoff as I can give.

If you are not a professional economist and have managed to understand that, I salute you.

They disagree with me, first, they started with different prior beliefs – different assumptions about the relative weight to be given to different scenarios and the relative risks of different courses of action that lead them to read the evidence differently. Second, they made some data processing errors – although those are a relatively minor component of our differences – and are now dug in, anchored to the positions they originally took, and rationalizing that the data processing errors do not change the qualitative shape of the picture. Third, they have made different weighting decisions as to how to handle the data. Is Owen Zidar putting his thumb on the scales, and weighting the data because he knows that the effects of high debt in reducing growth are small? I don’t think so: his weighting scheme is simple, and he is too young to be dug in and have a dog in this fight. But I am, perhaps, not the best judge.

But when we venture out of data collection and statistics and the academy into policy advocacy in the public square the differences become very large indeed. Matthew O’Brien quotes Senator Tom Coburn’s report on Reinhart and Rogoff’s briefing of the Republican Congressional Caucus in April 2011:

Johnny Isakson, a Republican from Georgia and always a gentleman, stood up to ask his question: “Do we need to act this year? Is it better to act quickly?”

“Absolutely,” Rogoff said. “Not acting moves the risk closer,” he explained, because every year of not acting adds another year of debt accumulation. “You have very few levers at this point,” he warned us.

Reinhart echoed Conrad’s point and explained that countries rarely pass the 90 percent debt-to-GDP tipping point precisely because it is dangerous to let that much debt accumulate. She said, “If it is not risky to hit the 90 percent threshold, we would expect a higher incidence.”

I think we have by far the better of the argument. Yet it is very clear that even today Reinhart and Rogoff – and allied points by economists like Alberto Alesina, Francesco Giavazzi, et al., where I also think we have the better of the argument by far – have had a much greater impact on the public debate than my side has.

Thus, the key problem of knowledge: Since technical details matter, conclusions must be taken by non-economists on faith in economists’ expertise, by watching the development of a near-consensus of economists, and by consonance with observers’ overall world-view. But because political and moral commitments shape how we economists view the evidence, we economists will never reach conclusions with a near-consensus – even putting to one side those economists who trim their sails out of an unwarranted and excessive lust for high federal office. And note that neither Carmen Reinhart nor Kenneth Rogoff have such a lust.

We do not live in the Republic of Plato. We live in the Sewer of Romulus. In this fallen sublunary sphere, the gap between what economists should do and be and what they actually are and do is distressingly large, and uncloseable.

And this leaves you – those of you who must listen to we economists when we speak as public intellectuals in the public square – with a substantial problem.


V. Should You Pay Attention to Economists as Public Intellectuals in the Public Square?

You have to.

You have no choice.

You all have to listen.

But you have nearly no ability to evaluate what you hear. When we don’t reach a near-consensus, then Heaven help you. Unless you are willing make me intellectual dictator and philosopher-king, I cannot.