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Missing the Bigger Picture in the Reinhart & Rogoff Debate
Posted By Washingtons Blog On April 28, 2013 @ 1:30 am In Really, really bad calls,Think Tank | Comments Disabled
You’ve heard that an incredibly influential economic paper by Reinhart and Rogoff (RR) – widely used to justify austerity – has been “busted” for “excel spreadsheet errors” and other flaws.
As Google Trends shows, there is a raging debate  over the errors in RR’s report:
Even Colbert is making fun of them .
Liberal economists argue that the “debunking” of RR proves that debt doesn’t matter, and that conservative economists who say it does are liars and scoundrels.
Conservative economists argue that the Habsburg, British and French empires crumbled under the weight of high debt, and that many other economists – including Niall Ferguson, the IMF and others – agree that high debt destroys economies.
RR attempted to defend  their work yesterday:
Researchers at the Bank of International Settlements and the International Monetary Fund have weighed in with their own independent work. The World Economic Outlook published last October by the International Monetary Fund devoted an entire chapter to debt and growth. The most recent update to that outlook, released in April , states: “Much of the empirical work on debt overhangs seeks to identify the ‘overhang threshold’ beyond which the correlation between debt and growth becomes negative. The results are broadly similar: above a threshold of about 95 percent of G.D.P., a 10 percent increase in the ratio of debt to G.D.P. is identified with a decline in annual growth of about 0.15 to 0.20 percent per year.”
This view generally reflects the state of the art in economic research
Back in 2010, we were still sorting inconsistencies in Spanish G.D.P. data from the 1960s from three different sources. Our primary source for real G.D.P. growth was the work of the economic historian Angus Madison. But we also checked his data and, where inconsistencies appeared, refrained from using it. Other sources, including the I.M.F. and Spain’s monumental and scholarly historical statistics, had very different numbers. In our 2010 paper, we omitted Spain for the 1960s entirely. Had we included these observations, it would have strengthened our results, since Spain had very low public debt in the 1960s (under 30 percent of G.D.P.), and yet enjoyed very fast average G.D.P. growth (over 6 percent) over that period.
We have never advised Mr. Ryan, nor have we worked for President Obama, whose Council of Economic Advisers drew heavily on our work in a chapter of the 2012 Economic Report of the President, recreating and extending the results.
In the campaign, we received great heat from the right for allowing our work to be used by others as a rationalization for the country’s slow recovery  from the financial crisis. Now we are being attacked by the left — primarily by those who have a view that the risks of higher public debt should not be part of the policy conversation.
But whether you believe that the errors in the RR study are fatal or minor, there is a bigger picture that everyone is ignoring.
Initially, RR never pushed an austerity-only prescription. As they wrote  yesterday:
The only way to break this feedback loop is to have dramatic write-downs of debt.
Early on in the financial crisis, in a February 2009  Op-Ed, we concluded that “authorities should be prepared to allow financial institutions to be restructured through accelerated bankruptcy, if necessary placing them under temporary receivership.”
Significant debt restructurings and write-downs have always been at the core of our proposal for the periphery European Union countries, where it seems to us unlikely that a mix of structural reform and austerity will work.
Additionally, economist Steve Keen has shown that “a sustainable level of bank profits appears to be about 1% of GDP”, and that higher bank profits leads to a ponzi economy and a depression . Unless we shrink the financial sector, we will continue to have economic instability.
Leading economists also say that failing to prosecute the fraud of the big banks is dooming our economy . Prosecution of Wall Street fraud is at a historic low , and so the wheels are coming off the economy .
Moreover, quantitative studies provide evidence that private debt levels matter much more than public debt . But mainstream economists on both the right and the left wholly ignore private debt  in their models.
Finally, the austerity-verus-stimulus debate cannot be taken in a vacuum, given that the Wall Street giants have gotten the stimulus and the little guy has borne the brunt of austerity.
Steve Keen showed that giving money directly to the people would stimulate much better than giving it to the big banks .
If we stopped throwing money at corporate welfare queens , military  and security  boondoggles and pork, harmful quantitative easing , unnecessary  nuclear subsidies , the failed war on drugs , and other wasted and counter-productive expenses, we wouldn’t need to impose austerity on the people.
And it is important to remember that neither stimulus nor austerity can ever work … unless and until the basic problems with the economy are fixed . 
Indeed, stimulus and austerity are not only insufficient on their own … they are actually 2 sides of the same coin.
Specifically, the central banks’ central bank warned in 2008  that bailouts of the big banks would create sovereign debt crises. That is exactly what has happened.
A study of 124 banking crises by the International Monetary Fund found  that propping up banks which are only pretending to be solvent often leads to austerity:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.
All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.
In other words, the “stimulus” to the banks blows up the budget, “squeezing” public services through austerity.
Instead of throwing trillions at the big banks, we could provide stimulus to Main Street. It would work much better  at stimulating the economy.
And instead of imposing draconian austerity , we could stop handouts to the big banks, stop getting into imperial military adventures and stop incurring unnecessary interest costs  (and see this ). This would be better for the economy as well.
Why aren’t we doing this?
Profits are being privatized and losses are being socialized . So the big banks get to keep the mana from heaven being poured out of the stimulus firehose, while austerity is forced on the public who has to bear the brunt of Wall Street’s bad bets.
The big banks went bust, and so did the debtors. But the government chose to save the big banks instead of the little guy , thus allowing the banks to continue to try to wring every penny of debt out of debtors. An analogy might be a huge boxer and a smaller boxer who butt heads and are both rendered unconscious … just lying on the mat. But the referee gives smelling salts to the big guy and doesn’t help the little guy, so the big guy wakes up and pummels the little guy to a pulp.
Economists note :
A substantial portion of the profits of the largest banks is essentially a redistribution from taxpayers to the banks, rather than the outcome of market transactions.
(Obama’s policies are even worse than Bush’s  in terms of redistributing wealth to the very richest. Indeed, government policy is ensuring high unemployment levels , and Obama – despite his words – actually doesn’t mind high unemployment . Virtually all of the government largesse has gone to Wall Street  instead of Main Street  or the average American . And “jobless recovery” is just another phrase for a redistribution of wealth from the little guy to the big boys .)
We noted  in 2011:
All of the monetary and economic policy of the last 3 years has helped the wealthiest and penalized everyone else.
Economist Steve Keen says :
“This is the biggest transfer of wealth in history”, as the giant banks have handed their toxic debts from fraudulent activities to the countries and their people.
Nobel economist Joseph Stiglitz said  in 2009 that Geithner’s toxic asset plan “amounts to robbery of the American people”.
And economist Dean Baker said  in 2009 that the true purpose of the bank rescue plans is “a massive redistribution of wealth to the bank shareholders and their top executives”.
The money of individuals, businesses, cities, states and entire nations are disappearing into the abyss …
… and ending up in the pockets of the fatcats .
In other words – underneath the easing-versus-tightening debate – this is not a financial crisis … it’s a bank robbery .
Article printed from The Big Picture: http://www.ritholtz.com/blog
URL to article: http://www.ritholtz.com/blog/2013/04/missing-the-bigger-picture-in-the-reinhart-rogoff-debate/
URLs in this post:
 raging debate: http://www.google.com/trends/explore#q=Reinhart%20Rogoff
 Image: http://www.washingtonsblog.com/wp-content/uploads/2013/04/Reinhart-Rogoff.jpg
 making fun of them: http://www.colbertnation.com/the-colbert-report-videos/425748/april-23-2013/austerity-s-spreadsheet-error
 defend: http://www.nytimes.com/2013/04/26/opinion/reinhart-and-rogoff-responding-to-our-critics.html?pagewanted=1&_r=1&
 April: http://www.imf.org/external/pubs/ft/weo/2013/01/index.htm
 slow recovery: http://www.bloomberg.com/news/2012-10-15/sorry-u-s-recoveries-really-aren-t-different.html
 wrote: http://www.nytimes.com/2013/04/26/opinion/reinhart-and-rogoff-responding-to-our-critics.html?pagewanted=1&_r=1
 2009: http://online.wsj.com/article/SB123362438683541945.html
 breaking up the big banks: http://www.washingtonsblog.com/2013/03/stunning-list-of-bankers-economists-and-financial-experts-who-say-we-need-to-break-up-the-big-banks.html
 write down debt: http://www.washingtonsblog.com/2011/08/never-ending-depression-and-scalping-of.html
 higher bank profits leads to a ponzi economy and a depression: http://www.washingtonsblog.com/2010/08/a-sustainable-level-of-bank-profits-appears-to-be-about-1-of-gdp-higher-bank-profits-lead-to-a-ponzi-economy-and-a-depression.html
 dooming our economy: http://www.washingtonsblog.com/2013/03/the-government-has-it-bass-ackwards-failing-to-prosecute-criminal-fraud-by-the-big-banks-is-killing-the-economy.html
 historic low: http://www.washingtonsblog.com/2011/11/obama-prosecuting-fewer-financial-crimes-than-under-either-bush-presidency.html
 the wheels are coming off the economy: http://www.washingtonsblog.com/2012/12/amateur-and-professional-investors-lose-faith-in-the-economy.html
 private debt levels matter much more than public debt: http://www.washingtonsblog.com/2012/11/top-economists-told-obama-that-economic-recovery-required-a-reduction-in-private-debt.html
 on both the right and the left wholly ignore private debt: http://www.washingtonsblog.com/2012/09/138-years-of-economic-history-show-that-keen-and-minsky-are-right-and-all-of-the-mainstream-economists-are-wrong.html
 much better than giving it to the big banks: http://www.washingtonsblog.com/2009/09/steve-keen-out-thinks-larry-summers.html
 isn’t really helping people : http://www.washingtonsblog.com/2012/08/proof-positive-that-governments-homeowner-relief-programs-are-really-aid-to-banks-and-not-aimed-at-helping-homeowners.html
 instead: http://www.washingtonsblog.com/2011/08/by-choosing-the-big-banks-over-the-little-guy-the-government-is-dooming-both.html
 hundreds of billions a year: http://www.washingtonsblog.com/2013/03/top-banking-analyst-subsidies-to-giant-banks-exceed-780-billion-year.html
 corporate welfare queens: http://www.washingtonsblog.com/2013/03/cutting-corporate-welfare-queens-off-from-the-dole-would-offset-the-need-for-sequestration-budget-cuts.html
 military: http://www.washingtonsblog.com/2013/02/the-sequestration-debate-misses-the-real-issues.html
 security: http://www.washingtonsblog.com/2013/04/americas-anti-terrorism-policies-since-911-have-been-a-dismal-failure.html
 quantitative easing: http://www.washingtonsblog.com/2013/03/fed-spends-as-much-in-a-month-as-the-sequestration-budget-cuts-cost-in-a-year.html
 unnecessary: http://www.washingtonsblog.com/2013/04/nuclear-is-not-a-low-carbon-source-of-energy.html
 nuclear subsidies: http://www.washingtonsblog.com/2013/03/want-to-reduce-the-debt-stop-billions-a-year-in-nuclear-subsidies.html
 failed war on drugs: http://www.washingtonsblog.com/2013/03/stopping-the-failed-war-on-drugs-would-more-than-pay-for-the-sequester-cuts.html
 can ever work … unless and until the basic problems with the economy are fixed: http://www.washingtonsblog.com/2011/07/what-both-sides-are-missing-in-the-debt-ceiling-debate.html
 .: http://www.washingtonsblog.com/2012/05/liberal-stimulus-draconian-austerity-two-sides-of-the-same-coin.html
 warned in 2008: http://www.washingtonsblog.com/2008/12/the-central-banks-central-bank-says-bailouts-putting-nations-at-risk-as-confirmed-by-higher-credit-default-swap-spreads.html
 found: http://www.imf.org/external/pubs/ft/wp/2008/wp08224.pdf
 draconian austerity: http://www.washingtonsblog.com/2012/05/overwhelming-majority-of-u-s-citizens-want-deep-and-immediate-cuts-in-military-spending-but-congress-votes-to-slash-food-stamps-and-other-social-programs-to-preserve-high-military-budget.html
 stop handouts to the big banks, stop getting into imperial military adventures and stop incurring unnecessary interest costs: http://www.washingtonsblog.com/2010/03/raise-taxes-and-cut-services-why-not-stop-unnecessary-bailouts-unnecessary-wars-and-unnecessary-interest-costs-instead.html
 this: http://www.washingtonsblog.com/2010/04/bernanke-we-must-raise-taxes-and-cut-services-%E2%80%A2-sane-people-no-we-need-to-stop-endless-bail-outs-imperial-adventures-and-fraudulent-schemes.html
 Profits are being privatized and losses are being socialized: http://www.washingtonsblog.com/2010/04/banana-republic-with-no-bananas.html
 note: http://www.huffingtonpost.com/2009/10/15/fannie-freddie-and-citi-t_n_322603.html
 this: http://www.washingtonsblog.com/2010/11/its-not-the-great-recession-its-the-great-bank-robbery.html
 this: http://www.washingtonsblog.com/2011/06/america-is-being-raped-just-like-greece.html
 this: http://www.washingtonsblog.com/2011/07/big-banks-are-waging-warfare-against.html
 even worse than Bush’s: http://www.washingtonsblog.com/2013/02/more-rape-of-americans-by-elites-more-erosion-of-freedom.html
 ensuring high unemployment levels: http://www.washingtonsblog.com/2011/07/of-course-unemployment-is-rising-government-policy-is-guaranteeing-it.html
 doesn’t mind high unemployment: http://www.washingtonsblog.com/2011/09/obama-unemployment-okay-jobs.html
 gone to Wall Street: http://www.washingtonsblog.com/2012/03/big-banks-continue-to-suck-at-the-government-teat-with-never-ending-stealth-bailouts.html
 Main Street: http://www.washingtonsblog.com/2011/01/government-says-no-to-helping-states-and-main-street-while-continuing-to-throw-trillions-at-the-giant-banks.html
 redistribution of wealth from the little guy to the big boys: http://www.washingtonsblog.com/2009/06/what-a-jobless-recovery-really-means-a-massive-redistribution-of-wealth-from-the-little-guy-to-the-big-boys.html
 noted: http://www.washingtonsblog.com/2011/08/worlds-money-is-draining-away-wheres-it.html
 said: http://web.archive.org/web/20090328010046/http://www.cnbc.com/id/29848741
 said: http://www.washingtonsblog.com/2009/02/leading-economist-says-true-purpose-of.html
 in the pockets of the fatcats: http://www.washingtonsblog.com/2013/02/economic-leaders-pay-lip-service-to-decreasing-inequality-while-pushing-policies-which-increase-it.html
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