Ken Rogoff and Carman Reinhart – the two academics who wrote that rather controversial paper suggesting that when public debt to GDP rises over 90 per cent, growth falls sharply – have come out fighting. And you know what, their observations not only make a lot of sense, they are pretty much smack on in agreement with what has long been argued here.
Let’s be fair to Rogoff and Reinhart, they are not arch Austerians. It is just that their work is often quoted by arch Austerians. And when serious loopholes were found in it, the likes of Krugman practically danced on what some say was Rogoff and Reinhart’s grave. The Austerians responded by saying that the errors found in the Rogoff Reinhart model were trivial, and did not unduly affect the conclusion.
Sometimes, however, you need to stop listening to the interpreters and listen to the original instead.
Take as an example this extract from the Rogoff and Reinhart paper: The Aftermath of Financial Crises published in 2009. “The main cause of debt explosions,” states the paper, “is usually not the widely cited costs of bailing out and recapitalizing the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis.” In short, the paper states the case of the anti-Austerians; government debt does not cause GDP to slow, rather slowing GDP causes government debt to rise.
Rogoff himself has gone on record as saying that the conclusions of the paper he co-wrote are often exaggerated.
In today’s FT, Rogoff and Reinhart produced an article that says it, clearly in black and white.
“To be clear,” they said, “no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched.”
“Nevertheless,” they continue, “given current debt levels, enhanced stimulus should only be taken selectively and with due caution. A higher borrowing trajectory is warranted, given weak demand and low interest rates, where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis.” See: Austerity is not the only answer to a debt problem
Hear, hear to that. We need both. We need austerity and stimulus. This is no contradiction.
We need investment into infrastructure, energy, education, and (this is the one that ‘Investment and Business News’ has spoken up for more than anything else) into entrepreneurs.
But actually, move away from Rogoff and Reinhart and look instead at the National Institute of Economic and Social Research (NIESR), which under its director Jonathan Portes has looked very Keynesian in its attitude towards government debt and stimulus.
In NIESR’s latest paper on the growth prospects of the UK economy it recommended: “Investment in education, innovation and infrastructure is essential for future economic growth.” The paper stated: “With 10-year government bonds attracting yields of less than 2 per cent, the government can finance additional investment in much needed infrastructure at little cost. With an economy in such a depressed state the fiscal multipliers are likely to be far higher than in normal times.”
In short, the darling boy and girl of the Austerians, and NIESR, headed by one of the UK’s most articulate and apparently switched on Keynesians, are saying much the same thing.
Of course we need to see austerity, not just in Britain, but across much of Europe. In Greece, the public sector has been a drain on the economy for decades.
Of course we need stimulus, no stimulus at a time when households and companies are saving more will automatically mean less GDP.
So we need austerity in areas of the public sector that are bloated. We need stimulus in areas that will create not only more jobs in the short term, but also improved productivity in the long term.
What we don’t need are stimuli that just hand money to households and companies via tax cuts. Much of this money will be saved. There is no point in the government borrowing money to fund tax cuts that help the private sector to save more.
© Investment & Business News 2013