Brad DeLong links to what he calls a “DeLong-Summers ‘Simplistic Keynesians’ Smackdown Watch“—a piece by Ken Rogoff calling “dangerously facile” those who argue for the “simplistic Keynesian remedy that assumes that government deficits don’t matter when the economy is in deep recession; indeed, the bigger the better.”
Since “simplistic Keynesianism” is a pretty good description of my diagnosis and remedy for today’s U.S. economic troubles, and since I don’t want to ever be “dangerously facile,” I read both the Rogoff commentary and the Reinhart, Reinhart, and Rogoff (2012) paper that it links to.
I did learn one thing—it turns out that my earlier post about the likely provenance of a Rogoff claim about the potential damage from high public debt isn’t quite right—but the new provenance of this claim isn’t right either.
There’s not much particularly new in either piece. Instead, they recycle the finding that, looked at over several centuries, there is an odd threshold of debt-to-GDP ratios—90 percent—that sees growth beneath the threshold run about 1 percentage point higher per year than growth above the threshold. They then do the arithmetic and argue that every year that the public debt-to-GDP ratio is over 90 percent is a year of GDP growth 1 percent lower than it would otherwise be and voila, the damage from high debt has been documented.
Or not. We’ve already noted why we think this threshold, while it might be an interesting (if odd and deeply atheoretical) curiosity, has no relevance to current U.S. policy debates (and yet somehow the 90 percent scare-mongering won’t stop—see David Brooks’ latest invocation of it).
The main reason for this judgment is that the causality between slow growth and high public debt is extremely two-way. There have almost surely been times when exogenous decisions to add to public debt have hampered countries’ growth. But there have also surely been times (and many more times, in my guess) when slow growth has led directly to rising debt-to-GDP ratios. And when this is the case, noting a simple negative correlation between GDP growth and a particular debt-to-GDP threshold tells us nothing about how dangerous—or, more likely, useful—a policy of further fiscal support would be.
And, there is no doubt that the increase in public debt over the past four years in the U.S. is directly the result of the Great Recession, and not a cause of it. Further, adding to this public debt going forward (so long as it was intelligently spent on job creation) would not only not harm the economy, it would reduce the debt/GDP ratio.
To be blunter, applying results gleaned from the over 80 percent of the country-years in their high-debt sample period that began before World War II, as well as the other clear-as-day cases where high debt was driven by slow growth (Japan in the 1990s and 2000s) does nothing to aid policy analysis about fiscal support in the here-and-now.
The authors even miss an obvious clue regarding those episodes in their data where high debt is driven by slow growth—the failure of elevated public debt to lead to upward pressure on interest rates. High public debt-to-GDP ratios combined with no upward pressure on interest rates is a key tell that it’s likely that below-potential growth is driving the debt ratio and not vice-versa.
Further, if interest rates are not pushed up by rising debt-to-GDP ratios, there is no mechanism for rising debt to impede growth. The authors gloss over this—just noting that “the growth-reducing effects of public debt are apparently not transmitted exclusively through high real interest rates.” More likely, the growth-reducing effects of public debt are simply non-existent when economies are deeply depressed.
Lastly, the paper makes a mistake that I think is key to understanding why policymakers keep getting blindsided by bad news (like the last two-months’ poor job growth) that just should not be that surprising: it assumes that economies naturally heal themselves from recessions, and quite quickly. Specifically, the paper makes the claim that high debt-to-GDP ratios are likely not driven by growth that is constrained by demand (i.e., Keynesian recessions) because:
“The multi-decade long duration of past public debt overhang episodes suggests that at [the] very least, the association is not due to recessions at business cycle frequencies.”
But, there is in fact plenty of reason to believe that when hit by large-enough shocks, economies can stay demand-constrained and linger at below-potential performance for decades at a time. This is why the Keynesian revolution began—an explanation for why the global Great Depression ground on so long with no relief was needed, and not being provided by the economics of the time.
Lastly, I should note that this proposition that one needn’t be concerned at all about the size of public debt-to-GDP ratios when making fiscal policy in a depressed economy (i.e., simplistic Keynesianism) is not particularly radical. Take Ben Bernanke, Federal Reserve Chairman, who wrote:
“Isn’t it irresponsible to recommend [an increase in the budget deficit], given the poor state of [American] public finances? To the contrary, from a fiscal perspective, the policy would almost certainly be stabilizing, in the sense of reducing the debt-to-GDP ratio…Indeed, nothing would help reduce [the United States’] fiscal woes more than healthy growth in nominal GDP and hence in tax revenues.”
He wrote the above in 2003 about Japan, I just substituted Japan for the United States, the Bank of Japan for the Fed, and “tax cuts” for “increase the budget deficit”—Bernanke was just using “tax cuts” as an example of generic fiscal support, and since they tend to be pretty inefficient fiscal support, I figured I’d just make the broader point.
In the end, simplistic Keynesianism remains not just the most effective, but the most analytically-grounded approach to today’s slow growth.