DEBUNKING REINHART AND ROGOFF
20 May 2011 by Cullen Roche
78 Comments
Few market commentaries have been as widely cited as the Reinhart and Rogoff analysis regarding the fiscal situation on the United States and its imminent debt crisis. In “This Time Is Different”, Reinhart and Rogoff make a multitude of illogical comparisons when discussing the US financial situation. In this must read paper, Yeva Nersisyan & L. Randall Wray bust one of the most popularly cited myths of recent years (the paper is an oldie, but a goodie):
Source: Levy Institute
Can we finally stop talking about these two people now????
Not much new in this paper. To summarize: a country that issues debt in its own currency can avoid a hard default by printing money. Printing money isn’t inflationary when unemployment is high.
Its a pity there’s no mention of the impact of money printing on the value of the currency. If you keep printing, then expect the currency to keep weakening, and for inflation from imports to continue. There’s no free lunch.
Yes, MMTers don’t necessarily reject that high perpetual deficits will lead to inflation. But that’s the important component in this debate. We shouldn’t even be having this whole debt ceiling political charade….policy would take a different approach if we knew how the system worked….
Is this paper reflective of the impact of the Indian and Chinese economies vigorously fighting inflation and its feedback on the US avoiding default by continually driving the dollar lower ? Also how does the enormous Forex market play into this simple scenario analysis ? Does the paper reckon with the alarming weakness in Japan as demonstrated by the frank Panasonic statement today regarding the severe weakness moving through the rest of the year ? These types of papers seem to exist in a semi-serene world where complexity and fighting currents are ignored.
where is this “free lunch” critics keep talking about? Whether it’s direct spending or working americans spending more because they keep more of their money, businesses will WORK to produce the goods and services demanded.
Yeah, we should all be askig the 30MM Americans who don’t have a job why they’re having such a hard time finding lunch! According to the Rogoffs of the world the govt has “crowded them out”. Oh yeah, well, if the pvt sector is so crowded out then why won’t they hire all this available talent????
Excellent summary, Dodge. One ingredient you might wish to add, is that the real value of the U.S. public debt decreases as the currency depreciates. That is a bonus which few debtor countries have. I will never forget a German who angrily calculated that the cost of the first year of the war in Irak was paid by the decrease in value of the U.S. dollar reserves at the European central banks.
Dodge:
-if printing money helps to avert a depression and stimulate real growth, why should a currency weaken?
-surely fx rates are to be explained by CIP theory, PPP or safe haven concepts. I don’t see the mechanism through which money-printing, if non-inflationary, can lead to fx devaluation.
Interestingly, the recent USD decline seems partly driven by the realisation that there is so much spare capacity that rates cannot rise for a long time to come; and partly through the market agreeing with you – erroneously, I believe.
you say
“if printing money helps to avert a depression and stimulate real growth”
a big if! I believe there’s a reasonable argument that provided some justification for QE1, which was basically to stop the panic. However, I think that QE2 was a clear mistake, and will only make things worse.
For me the real recovery can only begin when debts have been properly written off and unviable businesses have been allowed to fail.We’ll probably have to go through a depression to reach that point, and we’re nowhere near it now.
Dodge – would you reach the same liquidationist conclusion if you felt you were personally at risk of suffering from a huge increase in unemployment?
The alternative to liquidationism is that the monetarily sovereign state assumes the burden of debt from the backs of the private sector, freeing them to grow again. Since the govt can manage its blended interest rate, any level of debt/GDP should be manageable, as long as it is ultimately prepared to print money – and you seem to concede that printing money isn’t necessarily inflationary. What’s the problem?
Anders:
Yes, in fact my wife is currently looking for work, and I’m sure that the liquidation scenario I advocate would make that search much harder. Yet I still believe its the best solution.
Correct me if I’m wrong, but MMTers appear to have something in common with the conventional (neo-Keynesian) camp. They present the available alternatives as either
1. further stimulus resulting in a softening of the economic impact
2. withdrawal of stimulus resulting in recession and hardship
I believe the alternatives are actually
1. kick the can down the road until at some unknown point in the future you run out of road and face complete disaster. Japan hasn’t got there yet, but it will.
2. allow a recession to unfold to clear the decks. After a few years we’d be in a position to start from a solid base. This in more like the Great Depression.
In that case, most people would take option 2, unappealing as it may be.
My replies to previous comments on post above:
Let’s forget the Euro for a minute. The price of oil and other essential commodities is going up, and this is I believe a direct consequence of the economic policy of the USA, UK and the China dollar peg. MMTers appear to believe that money printing is without negative consequences, a free lunch in other words. The rise in commodity prices demonstrates that there is no free lunch.
FWIW, my take on economics in general is that there are different schools of thought (Keynesian, Monetarist, Austrian, MMT) that have got at least part of the puzzle right, but none of them offer a complete solution, and there are valid criticisms of each approach. You wouldn’t know it from listening to the advocates of each camp though! A complete solution is extremely difficult to reach due the impossibility of running controlled experiments.
Are you claiming that QE is money printing? If so, that’s not accurate.
The recent USD decline is really just a function of stronger Euro….People need to start deciphering between inflation and FX changes…..They’re not necessarily the same.
Dodge; the point on inflation is important and subtle. We may not see core inflation, or wage inflation (which I think the ECB, Fed and BoE are actually using as the warning sign for an inflation spiral), but import price inflation and a fall in living standards.
The paper holds Galbraith’s Great Crash in very high esteem.
I know I am going to annoy the MMTers here again, but a question regarding the statement: “When unemployment is high, deficit spending can / should be higher without causing inflation”.
So how does the deficit translate into lower UE? Does it imply govt jobs programmes? These are only efficient if there are some large scale infrastructure projects, etc. Or goes the deficit to private contractors? Then there is no guarantee they will hire more people to do the work. Which is similar to the US situation right now – food stamps work, but otherwise the structural unemployment remains. If you have structural UE, you can boost the deficit as high as you want, UE will not come down. (Ok so far we have not seen much inflation either.)
Most of the expansion in the government deficit is just the automatic stabilizers (falling tax revenues and rising unemployment insurance payouts). They are meant to keep the economy from falling further and faster but do not prevent a drop in overall aggregate demand and GDP.
You could achieve a larger deficit and lower UE by expanding aggregate demand and that could come from higher infrastructure spending and or lower taxes (or even a job guarantee program). Anything that boosts domestic spending will grow the economy and create jobs. Ideally the spending (or tax cuts) is targeted in such a fashion to maximize the expansion of the domestic economy – tax cuts to the rich will primarily yield higher savings and little growth. A complete payroll tax holiday would boost the working mans take home pay quite a bit and most of it will be spent.
As for structural UE… it’s mostly a myth. If there is sufficient demand even marginally employable workers eventually get hired. By the beginning of WWII there had been a lot of workers who had been “structurally” UE for about a decade and yet we achieved full employment in short order when aggregate demand was pushed to the max to support the war.
Beyond Adam’s very good comments, let me just say that–though we generally reject the concept of ‘structural unemployment’ as long as there’s no job guarantee–we absolutely agree that different types of spending/tax cuts have very different “multipliers.” We are very much against traditional “pump priming” (which would include most of Obama and the Democrats’ definition of “stimulus”) and have published several articles explaining why–Wray wrote back in 2000 something like “how many bombs would you have to build before you create one job in Harlem?”
Ok, thanks for replies.
These scums have been paid by the US government to write this nonsense. Anyone seen ‘Inside Job’? Then, you must know that these academics get paid huge amounts of cash to write favourable stories.
What’s next? An academic paper stating that debt is good and assets are bad.
Morons!
Yes, and our views are so important to the government that the checks will keep coming in even when the rest of the govt shuts down as the debt ceiling is reached. I hope that really pisses you off.
Paul,
Minsky had been predicting the predatory nature of Wall St for decades before this crisis. If anything, the crisis proves that MMTers are NOT on the govt bankroll….
Many of the arguments actually ring true and generally speaking they are right about the issue of default. Where I would pick holes is in their understanding of inflation mechanisms.
I agree that currency does matter and the type of exchange rate mechanism (floating or not)you use is important, but I think they are wrong to reject the idea that whether debt is held externally or internally and whether you are a net importer or exporter matters. In my view all three mechanisms matter.
The argument that when an economy is operating below full capacity lower taxes or more government spending will not be inflationary is not exactly true. No it is not going to generate inflation from excess demand or wage rises, but as dodge points out, its not the only source of inflation.I think the recent run up in commodity prices shows that prices are global and your currency value matters.
The argument that fiscal stimulus once underway will restore growth and reduce the budget deficit, only holds true if the multiplier effect of the stimulus is greater than 1 and up till now policies dont seem to have achieved that. It only works out if growth exceeds the growth in the deficit. Yes you can print to reduce the deficit, but you get a feed back mechanism through the value of your currency.
Next up we have the statement high debts are also related to inflation because governments are tempted to inflate away their debts. Followed by query that this is somehow supposed to lead to slow growth?. What I think they are missing here is that exports and imports tend to be sticky in volume along with the mixture of goods being important. You cannot build a clothing factory quickly nor will sales of Microsoft windows pick up much if the price drops. My view is that significant changes in currency value lead to a short term downturn which negates the longer term positive effects of the change. Its not a bad assumption that the dollar will hold stable since its a reserve currency but going forward this may not be true as policy across the world comes out of alignment.
There are hints that they fundamentally know the risk is not default but linked to currency and inflation when they say.
Too much spending can drive inflation but they do not face solvency constraints in their own currency.
and
Did not find a relation between government debt ratios and inflation among advanced economies except for the case of the US.
Ok so the US was under a different currency mechanism then, but it worries me that the US will be and exception.They are right to challenge the assumptions in my view, but have left some holes so that in turn they can be challenged.There are just too many parameters ignored for me to be confident in either view.
The external debt matters enormously. You can’t default in a currency that you alone can print. That’s just simple logic. You’ll find that many defaults occur due to foreign denominated debts….That’s why MMTers like to focus on truly sovereign nations….
Yes, an economy operating below full capacity can experience inflation. In recent times, that has come in the form of energy cost push inflation. Wray wouldn’t reject this point. But we also can’t really control it. What a sovereign nation can control is the amount of money issued in its currency.
MMTers have been very upset with the spending allocation of the last few years. Yes, inefficient spending gets sent down a rats hole.
Not sure about your export argument. Currency float is what helps create trade equality. The Euro appears to prove that as the trade deficit nations have been wrecked at the benefit of Germany….
Missed you Cullen. PragCap was down in my RSS since Tuesday. Good to get you back (it’s a lot easier accessing through RSS).
Why is it so difficult for some people here to understand that the point of Reinhart/Rogoff is DEFAULT, technical default, NOT inflation. And THEREFORE, the point of a CRITIQUE of Reinhart/Rogoff (since that’s in the TITLE of the paper) is to address Reinhart/Rogoff’s analysis of technical DEFAULT, NOT INFLATION. That doesn’t mean inflation isn’t important (and I count at least three times where they say that, and they don’t go into it in detail OBVIOUSLY BECAUSE THE PAPER IS ABOUT TECHNICAL DEFAULT)–don’t say a hammer isn’t a good hammer because it doesn’t drill holes.
It’s so much easier to have a discussion when people can actually understand what they’re reading and don’t expect every single paper or blog post to address every single point they might have thought about at some point in their lives.
This is exactly why I require my students to prepare an essays when they read articles describing only the logic of the articles’ arguments, never their own opinions–then, once they show they can do that, we discuss their views on the strengths/weaknesses of the article. Hopefully they won’t grow up to be blog commenters who don’t have the ability to actually understand what they read before blurting out why what they’ve read is completely wrong or doesn’t address these other 17 points that seem to be really important to them.
Of course, as Wray/Nersisyan note, R/R do equate inflation to default, but the former present their argument as to why that’s wrong or at least a separate point. (Thought I’d say that before someone did actually read the paper and note that everything in the paper wasn’t necessarily about technical default, as I originally stated.)
I wish I had had you as professor, Scott. I had professors that urged students to pick at hole in someone’s point. Usually there was a noticeably stronger urging when they themselves didn’t like the argument being made.
I thought the most important point of Rogoff was slow-down in GDP growth when debt/GDP ratio reaches certain point… Probably I missed something. It looks like in this paper they also discuss growth.
Please, people, default is irrelevant – let’s at least recognize it in this blog. It can always happen in any country, but in the US it would be 100% political, not fiscal/monetary driven.
Returning to the growth, I think Rogoff is right.
They did go into the debt ratio vs growth debate in the paper, actually. I think the R/R view on this is absolute data mining, spurious correlation. Beyond the critiques in this paper, R/R use the “gross” debt ratio rather than net–there’s no economic reason whatsoever to use the gross measure, since the net measure is the actual debt held by the non-govt sector that the govt can legally default on. In the US, the difference b/n the net and gross measures is largely the SS and Medicare trust funds–so, what R/R are actually suggesting is that the more legally “solvent” SS and Medicare are (since that would mean the trust funds increased and thus the gross debt), the worse it is for growth. Makes no sense.
I think the argument is superficial. The ral argument is – can the FED through monetary policy make the real economy perform one way or the other. It definitely can slow it down with tight money. But there is nothing it can do with easy money if people cannot afford anymroe credit. And this is wheere we are. So, since all the wasy money is not doing for the real economy, then what is the point? All these programs achieved so far is misallocation of resources and clouding of the picture. They didn’t solve anything. so, may be they should stop the programs and just let the time heal the wounds.
In a balance sheet recession there is only one entity that can pick up the slack. If they don’t, look out below….
The merits of recession are a different topic. Personally, I think we would have been fine letting the banks sink to the bottom of the ocean while helping Main St via tax cuts and other stimulus…..
Good paper
“…-greed overtook fear, as it must when losses are socialized.”
Does anyone know why Russia defaulted in 1998? The ruble was a sovereign currency yet they chose to default. Perhaps they had debt denominated in foreign currency?
I am Russian, I lived htere when it happened. Here is my observations, which might be different from the official version. I don’t know.
There were several causes. Most of it was USD denominated foreign debt, economy that was crushing due to IMF imposed austerity measures plus the Finance department had no clue what they were doing since most of them only knew how USSR planned economy worked. So, they had to listen to western “experts” such as Larry Summers who advocated “shock therapy” to quickly transition from government-dependent society to a free market society. Of course, as the govenment withdrew any support for enterprises, unemployed, schools and so on, the economy cratered immidiately and debt cirsis ensued. The govenment couldn’t meet it onligations on the USD denominated debt, it pulled foreign reserves from private banks, banks collapsed on the lack of liquidity. US FED or IMF weren’t intrested in helping Russia with their liquidity problems. One wonders why is that.
In the end it took Russia 10 years to “quickly” transition to free market at the enourmous cost to the population and corruption florished in the process ebcause nobody was thinking that free market also needed a stong law base.
ES’s summary is very good. I would only add:
They were a classic case of hyperinflation and foreign denominated debt occurring around a regime change failure. Russia was saddled with substantial Soviet debts and USD foreign denominated debts, IMF “aid” that would later prove unpayable, a highly flawed currency peg, collapsing real wages (half of what they were in 1991) and a very high deficit as the result of poor tax collections. So we can see that the table for hyperinflation already well in place. In fact, Russia’s hyperinflation had never really ended. Although inflation declined from 131% to 22% in 1995 and 1996 the situation was tenuous at best. In 1998 the Russian government cited the tax issue as a serious risk to the regime. They attempted a complete overhaul of the tax system, but the damage had already been done. The currency peg forced Russia to defend the currency which resulted in depleted reserves. A collapse in the oil and metals markets as a result of the Asian financial crisis crushed the one stable revenue source in Russia. The rest is history.
ES and TPC got it right.
If I might add, the problem is with the outside “experts”.
Each and every time they recommend the same:
Austerity, Less government, privatization.
That is supposed to transform the economy, increase competition, generate foreign investments etc.
The actual goal is the Privatization. Get money making enterprises for a fraction of the cost. That is the one and only goal. The collapse in Russia, the whole eastern block and now Greece and Ireland is not an accident it is the ULTIMATE GOAL.
Amen, at least it certainly seems that way!
Here’s an interesting article by Warren Mosler where he addresses the ruble crisis.
http://www.epicoalition.org/docs/exchange_rate_policy_and_full_em.htm
Thanks CR- oldie( my first look) I’m 3 months new to your blog.
U are the hardest working man in the blog world.
I’m convinced your one of four quaddruplates with the same name.
Carmen Reinhart: I was very disappointed given his conclusion he was one of the few who had a chance to ask Bernanke a sober question at the press conference. He might as well brought that tee for him to hit off.
Thanks ES. Was the ruble plummeting prior to default also? If not, it seems the central bank could have purchased dollars with rubles to raise the funds to service the debt.
> Thanks ES. Was the ruble plummeting prior to default also? If not, it seems the central bank could have purchased dollars with rubles to raise the funds to service the debt.
There was rumpant printing of the rubles going on for several years prior to that to support all who relied on the govenment , so the inflation was completely out of control. This is why they (finance ministry) tried austerity trying to stop that. Yet they were also trying to maintain a peg to the dolar, thus depleting foreign reserves. And then the price of oil fell. I think most of it was just blind leading the blind, trying to fix one problem and then jcompunding it and on top of that prices of oil fell and left them with no income. The issue was building for years and because they depleted foreign reseves and a had foreign debt there was no way out.
This is where US differes, it has no foreign debt. So, no matter how loud everyone is moaning about debasement of the dollar, US can continue with the same game plan as long as USDs are a reserve currency. It is a good thing that there is no risk of a major shock. It is bad bacause sometimes a shock is needed to drastically change the course. But I ahve no interest in living through anymore shocks.
ES,
Is it me or have you changed your tune a bit on sovereign defaults (especially with regards to the USA?)
> Is it me or have you changed your tune a bit on sovereign defaults (especially with regards to the USA?)
TPC, I always understood that USA is different because it is the issuer of the reserve currency. But I still can’t stand the wasteful ways of the USA that the reserve currency enables. I grew up very poor, and for this reason I cannot stand waste in any form because I always think about all other poor people who could use a piece that wealth.
As for the US current policy I see both side of it. My family and friends in Russia hold their savings in USDs and Euros. They are very angry at how cunny americans debasing their currency and resolving their debt issues at other peoples expense. This point is never heard in the US, but it is very prevalent in emerging markets which lack their own stable currency and are stuck with USDs. USDs are more liquid than gold.
On the other hand I live in the US, so, of course, I want US to get through this as little pain as possible. And having lived through a few riots in Russia I am not interested in seeing any shocks or riots in the US because when you get to this point angry people don’t care whose side you are on, they just want to hurt somebody. It is very scary.
US still has immense wealth, but it is wasting it pretty quickly and this is what I don’t’ like. Just a bit more responsibility on the part of US government, a little less speculation, and a little bit more productive investments could turn us around in 5-10 years. But the issues US has have been festering for 30 years at least and I am not very optimistic. This is why I believe that US will continue on this path of slow deterioration of its wealth and becoming more equalized with the rest of the world in its standard of living. The only possible way to achieve it that I see is through further debasement of US dollar. I know it and yet I hate it because somewhere deep in my sub-consciousness “the caveman” knows it is my wealth being stolen from me, the products of my labor and I hate it. Though lower standard of living is not a big deal for me, it isn’t going to be any lower than what I had in the USSR. I even think we’ll be happier if we are not so focused on the material things.
ES,
Always appreciate your comments. Glad to see we’re on the same page with wasteful spending!
Does it mean you support austerity?
Uh, do you read my work?
The argument in this paper is superficial and not supported by data or any research. The two ideas I find most problematic are whether inflation can be called default and the correlation between high debt and slow growth.
First, the paper argues that a sovereign issuer can’t default on it’s debt. Obviously, this is technically correct. The issuer can always print more money to pay it’s debt. However, the paper also says the following:
“While some do call inflation a default (and Reinhart and Rogoff do just that in
their book), we believe this is completely unjustified in the case of a sovereign currency.”
With this line of thinking, no amount of inflation can ever be defined a “default”. Default can be a subjective idea, but if a government inflates its currency at the expense of debt holders, I’d call that a default. I don’t care about the motivation or causes of the inflation.
Secondly, the authors use anecdotes to substantiate the claim that high debt loads don’t cause low growth. They claim there’s an issue with the tail wagging the dog. At least R&R did a regression from a specific data set on growth and debt loads. That regression showed slower growth with higher debt loads. Where’s that regression in the N&W paper?
Far from repudiating R&R, this paper uses anecdotes and uncritical thinking to attack R&R. I guess the MMT fanboys will eat this up, but no one who has actually read R&R will bite.
Ultimately, this all goes back to another paper I read on the Levy webite concerning the nature of money. Is it a commodity or not? Without agreement on that point, these two ships will always pass in the night.
A blind regression without explaining the actual channels that lead from high debt to low growth doesn’t settle anything. Of course the causation can (and does!) run exactly in the opposite direction. And there are enough counterexamples, such as this:
http://traderscrucible.com/2010/12/09/the-most-important-event-in-the-history-of-humanity-since-the-domestication-of-animals-and-plants-had-a-debt-to-gdp-greater-than-150/
Debt numbers in themselves are only a reflection of some underlying economic realities. As such, targeting certain debt- or deficit-to-GDP ratios should not be the goal of economic policy. As Abba Lerner’s rules for Functional Finance state:
1. The government shall maintain a reasonable level of demand at all times. […]
2. […] the government shall maintain that rate of interest that induces the optimum amount of investment.
3. If either of the first two rules conflicts with the principles of ‘sound finance’ or of balancing the budget, or of limiting the national debt, so much the worse for these principles.
That said, a very large deficit most probably means something is wrong with the economy – the real culprits could be large unemployment, low productivity, big spending on nonproductive activities such as wars etc. Therefore targeting a certain deficit number is akin to treating a symptom instead of the underlying disease and is quite likely to be futile or even counterproductive. For example, a huge chunk of our projected debt growth is due to growing costs of Medicare and Medicaid. Trying to reduce the deficit by simply cutting those programs will do little (or nothing) to control the growth of medical costs in the economy and will not achieve anything beyond driving households into more debt and most likely higher deficits due to transfer payments and falling tax revenues (the automatic stabilizers). Similarly, saying that we should stop fighting wars because “they cost too much” is a funny rationale for what in most cases is a good goal. Seen this way, the deficit should be left alone and if the right policies are pursued the improvement of the underlying economy will deliver deficit reduction on its own.
Yes, GT4′s comments are garbage. It’s as if he/she didn’t even read the paper, as I was suggesting above. The point is to critique how R/R have organized their research–R/R provide enough data by themselves to hand them on that point.
Regarding inflation, the argument for large deficits leading to inflation is usually because that is how default on unbounded increases in debt service is avoided. But Wray/Nersisyan explain quite clearly in my view why such unbounded increases in debt service don’t happen to nations issuing debt in their own currency and operating under flexible exchange rates. This was one of the key arguments in the paper, yet GT4 didn’t even address it. Garbage.
R&R cherry picked data. This isn’t really even a dispute any more. Most of the high debt/low growth effect came from an 18 month period just after WW II ended – and when I say just after, that’s exactly what I mean. Throw out those huge outliers and the rest of the data doesn’t show anything like that.
Now you could debate that the R&R wanted to include all the data. But any honest appraisal of the data would have been far more upfront about what caused them to get their results. If you have a few data points after the greatest war in history that are the sole reason you are able to make a claim about economic history, you should let every reader know.
R&R did not do that. Instead, they made a bold sweeping claim about debt load, and it turns out to be closer to a lie than to what most people would consider the truth.
GT4, thanks for bringing them up. I am adding them to my Wall of Shame, where I put misleading and wrong statements about our monetary system.
http://traderscrucible.com/wall-of-shame/
I may even give them a place of honor – because they are professional economists and they must – THEY MUST – have noticed that just a few observations were skewing the data. There isn’t that many data points that they would miss the outliers. There is a reason R&R hesitated on releasing the data for so long. It’s because as soon as you look at it for just 1 minute, you think “Oh Hell, its all due to the wind down after WWII – and it didn’t even last that long.”
The devastating TC! Love it
Lol!
R&R are very, very smart people. They knew.
Randall Wray dances around the issue because there are standards for appropriate discourse in formal academic papers. But he must have been thinking something like this. The data all but demands you think this.
Yes, great job, TC!
Cullen, there are some real gems in the comments here worth saving!
“If debt really does correlate to growth then the relationship should be linear and the growth rate should be higher at the 30-60% range”
Dear Cullen,
Actually it is higher. You just have to look at the current growth rate of emerging markets countries to convince yourself, or read the below in your spare time…
By 2016, Advanced countries debt to gdp ratio will be around 100% whereas emerging markets will be at around 30%.
http://www.imf.org/external/pubs/ft/fm/2011/01/pdf/fm1101.pdf
Notice page 45 of this lengthy but interesting paper – Fiscal Monitor April 2011:
“Under a scenario in which interest rates on new debt issuances are 100 bps higher than in the baseline, by 2016 the interest burden in advanced economies would increase by 1 percentage point of GDP on average (1.25% for the United States and 1.5% for Japan; figure 3.2). If larger fiscal deficits resulting from this scenario were accompanied by a further increase in interest rates reflecting a risk premium, the effect on debt servicing costs would be even greater. For example, if rates were to rise an additional 20bps for each percentage point increase in a country’s deficit-to-GDP ratio – consistent with the existing empirical evidence – interest payments in 2016 would be 1.5 percentage points of GDP higher than the original baseline on average (with increase of 1.5% for United States and 2% for Japan)”.
Best,
Martin
perhaps Russia did it for strategic reasons. perhaps they thought it would help them get easy
money from the IMF or some other generous entity. That wouldn’t be strategically wise for
the USA to emulate since we kinda own the IMF.
Hey Dr Scott (& TPC)
Maybe Peter D can help as well.
Why didn’t you guys also post this resource as well? (I have about 5-8 more pages to read), I think I got this from Peter D. :
“Interest Rates and Fiscal Sustainability”, Scott T. Fullwiler, Working Paper No. 53
Oh and I already read Wray’s paper – it is quite good.
I know I’ve posted it before. It’s one of Scott’s best pieces of work so I know he’s posted it before. Perhaps we’re commenting too fast for you to keep up!
Thanks!
Seems to me that with that one, Wray/Nersisyan here, Galbraith on sustainability, and Cullen’s piece on hyperinflation, not to mention several rather thorough blogposts by Bill Mitchell on some of these topics (notably, Weimar and Zimbabwe), and probably some others I’m missing here, there’s a considerable MMT counterargument to R/R and the unsustainable fiscal policy fears.
TPC
You guys are (posting too fast for me to catch up)! (grin)
It’s what happens when you get old! (laughing)
But to be more clear:
I just meant re-posting Scott’s paper in this post as well. I got Scott’s paper from here on a previous post – so we’re good there.
have a good weekend… I’ll catch up on the comments here Sunday morning
thanks for the support!
http://seekingalpha.com/article/270306-we-shouldn-t-be-concerned-about-inflation-really
Mr. Roche, I would be interested in your thoughts on this inflation argument? Too simple?
yeah yeah 800 years of data all pointing towards the same conclusion, SO WHAT!
this is the USA baby, and if you haven’t heard the chants we are #1. party don’t stop ’round here and if you disagree it is obviously because you don’t understand how our monetary system works. you better ax this blog some.
CORRECTION: Carmen Reinhart: Ay vay…I meant Kenneth Rogoff…Bernankes chess partner at Harvard.
Scott,
I appreciate your response to my post. This is fascinating stuff to me and the debate between the MMTers and Austerians is great. I’ll touch on two points regarding inflation and “default” risk.
In response to your comment on deficits and inflation I’d say the following. The idea that deficits automatically lead to inflation is clearly wrong. We need look no further than today’s Japan to see proof of this fact. However, the paper says
“But when an economy is operating well below full capacity, lower taxes or more government spending (with proper controls on prices paid by government) will not be inflationary.”
This is obviously wrong at the extreme (trillions of dollars) and must also be wrong at the margin (billions of dollars). The only issue is one of degree. Small increases in fiat money have no measurable impact on overall price levels. However, at some point, money supply matters. Furthermore, capacity utilization is not the driver of inflation. The U.S. had substantial unemployment in the late 70s and also high inflation. Throughout the world, countries with high inflation seem to be beset with the problem of high unemployment. I’d argue that confidence in the value of a currency is the ultimate driver of inflation. Once people question it’s sustainable value, the currency is in big trouble.
This leads to the second point, regarding default risk. N&W correctly say that for sovereign issuers of debt in their own currency,
“there is no default risk with regards to ability to pay”.
This is obviously true. However, ability to pay government debt with fiat currency and people’s willingness to accept payment for non-government obligations are unrelated. The dollar was considered a “hard” currency throughout the world in places with high inflation. Would it really be such a Black Swan event if someday Americans decided the Peso was a better store of value than the dollar? Obviously, the U.S. taxes and debt would all transact in dollars, but the real economy could transact in Pesos if people lost confidence in the dollar. It’ll never happen to us? There would be no technical default, but there would be a “real” default as the purchasing power of dollars got hammered.
It’s all a game of confidence and if people lose confidence in the dollar, the U.S. will default in real terms. If Argentina renegotiates its outstanding external debt and agrees to pay 50 cents on the dollar, that is no different than the U.S. government engineering 3 years of 15% inflation. The “real” purchasing power of the repayments is the same. I consider both cases a default. I’d argue a sovereign issuer of fiat currency can default by inflating the money supply. Heck we basically did it after WWII with 2 years of double digit inflation. Fortunately for us, all the other productive economies were destroyed.
“This is obviously wrong at the extreme (trillions of dollars) and must also be wrong at the margin (billions of dollars).”
Not necessarily. Depends on how prices are set on average and multiplier effects of particular spending/tax cuts. Many of the newer long-tail markets have zero marginal costs, for instance. But, for the record, the word “inflationary” here should be taken to mean “beyond a reasonable policy target.” So, “deficits don’t raise inflation when there is significant slack” really means (and should probably be stated as) that it’s unlikely inflation will rise above a reasonable policy target. Wray/Nersisyan did specifically mention that there could be bottlenecks before that point, and also it’s clear that not all types of spending/tax cuts have the same multiplier effects.
“Small increases in fiat money have no measurable impact on overall price levels. However, at some point, money supply matters.”
The money supply is a result, not a cause. It’s the cause that matters. The Fed’s raising the money supply right now by historic proportions, depending on the measure, and it’s not causing anything. Bank deposits are initiated by desired spending or govt deficits. Again, better to look at the causes.
“Furthermore, capacity utilization is not the driver of inflation. The U.S. had substantial unemployment in the late 70s and also high inflation.”
completely agree.
“I’d argue that confidence in the value of a currency is the ultimate driver of inflation. Once people question it’s sustainable value, the currency is in big trouble.”
You’re talking about exchange rates, which is different from inflation, though not completely unrelated.
“However, ability to pay government debt with fiat currency and people’s willingness to accept payment for non-government obligations are unrelated.”
If taxes can only be settled with reserve balances, then there will always be a non-trivial demand for reserve balances, assuming the tax liability can be enforced. This means that the interest rate set by the cb will “matter,” since it sets the price of obtaining reserves to settle taxes. And it also ensures that the interest rate on the govt’s debt is a policy variable, or at least can be if desired. None of this is to suggest deficits can’t be too big–that’s obviously wrong, but rather that this still doesn’t on its own affect the acceptability of reserves to settle taxes. Beyond that, the govt doesn’t really care which form of money or which currency you use, aside from legal tender laws if you’re trying to go to court over contractual obligations with some other party.
“The dollar was considered a “hard” currency throughout the world in places with high inflation. Would it really be such a Black Swan event if someday Americans decided the Peso was a better store of value than the dollar? ”
Again, you’re talking about exchange rates. Under flexible fx, aside from the potential but not necessarily certain effect on inflation, it doesn’t matter all that much. If the rest of the world doesn’t want to hold US dollars, then that just means they want a trade deficit with the US. Seems to me most Americans would be in favor of running a trade surplus, actually.
“Obviously, the U.S. taxes and debt would all transact in dollars, but the real economy could transact in Pesos if people lost confidence in the dollar. It’ll never happen to us? There would be no technical default, but there would be a “real” default as the purchasing power of dollars got hammered.”
Again, you’re talking about exchange rates, which is different from “purchasing power,” and assuming that a reduction in the exchange rate necessarily raises inflation and destroys the US economy. I don’t agree.
“It’s all a game of confidence and if people lose confidence in the dollar, the U.S. will default in real terms. If Argentina renegotiates its outstanding external debt and agrees to pay 50 cents on the dollar, that is no different than the U.S. government engineering 3 years of 15% inflation.”
Argentina was coming off a currency board. Apples and oranges. We’ve explained this over and over.
“The “real” purchasing power of the repayments is the same. I consider both cases a default.”
They’re different. Conflating the two is a remnant of the gold standard, just like conflating purchasing power and the exchange rate.
“I’d argue a sovereign issuer of fiat currency can default by inflating the money supply.”
Better to say a sovereign issuer can destroy the purchasing power via inflation rather than to confuse default and inflation. As above, under a gold standard or currency board they are effectively the same, but not under a flexible fx regime. Further, since we’re no longer on the gold standard (or a currency board), the exchange rate and purchasing power are not the same thing at all anymore. We can have substantial fluctuations in the fx rate (and have–rememeber about 30 years ago when $1 = more than 300 yen?) and still have economic growth, low inflation, and rising standards of living.
Overall, you don’t seem to have understood much of the article, since it was trying to explain how fx regimes and currency of debt issuance make all the difference in the world. I haven’t seen you demonstrate you have even the most remote understanding of the distinction they are drawing; everything you are saying assumes (that is, assumes rather than demonstrates) they are wrong, since it is all based on the gold standard paradigm.
I think that’s not a fair critic. He acknowledges there is a difference between defaulting the debt and inflation.
However, for a creditor, a partial default on US$ debt like Argentina implemented or an inflationary “default” in local currency are pretty much the same. The fact that Argentina had a pegged currency which was later abandoned is totally irrelevant for the creditor.
The point is that GT4′s analysis of the US case assumes a gold standard or currency board arrangement, because that’s the only case in which exchange rates and purchasing power are roughly the same thing. In the flexible fx case, the path from deficits–assuming they do not push demand beyond a reasonable inflation target, because no MMT’er would support deficits beyond that anyway–to inflation that everyone is currently worried about and which R/R detail over and over again–bond markets raising default spreads and thus debt service to the point that the govt must choose between default and inflation–doesn’t exist.
Just look at Greece–deficits aren’t anywhere near a level that would normally create inflation given the recession there, but because of bond markets raising default spreads on Greek debt, without a bailout of some sort (ECB, IMF, etc.), or massive austerity, they may ultimately be faced with the choice to default or inflate (default, obviously, would probably be their only real option given the euro arrangement). Same thing happened to Argentina, the poster child of the Washington Consensus view until they weren’t–forced to default or inflate, and they chose to default.
Not so in the US, UK, Japan, Australia, Canada, etc., etc. As Wray/Nersisyan explained, the ability to issue your own currency, issue debt in your own currency, and operate under a flexible exchange rate makes all the difference. And Reinhart/Rogoff’s own data, organized properly to account for this, supports this.
In other words, the “default and inflation are the same thing to the creditor” argument isn’t wrong as much as it is a gold standard relic. It’s only under a gold standard, currency board, and similar regimes that default vs. inflation becomes the dilemma facing the govt, since those are the only regimes in which a repudiation of the govt’s debt can actually happen and thereby send the chain of causation in motion that brings us to that point. Under flexible fx, debt service becomes a policy variable, and that makes all the difference.
And the 15% inflation for 3 years = ARgentina debt at half of face value is a red herring–MMT’ers would be against 15% inflation, and (as above) the mechanism that would create such inflation in a gold standard or currency board regime isn’t present under flexible fx.
By the way, 15% inflation for 3 years reduces purchasing power to 66% of original value, not 50%, so (not that it matters) even those aren’t the same (if you now have to pay 1.15^3=1.52 for something that you used to pay 1.0 for, you’ve lost about 1/3 of purchasing power, not 50%).
Cullen,
You argue that because R&R show a non-linear relation between debt load and growth, their thesis in invalid. I don’t know of many linear relations in finance and economics that hold over the entire range of data.
If there were more linear relationships we wouldn’t have to endure so many of the faithful believers in the Fed’s view on the economy or our elected Mandarins’ ability to guide the economy through difficult waters.
The problem is the relation has the opposite sign for a period, then the sign they desire. It’s completely spurious since they can’t explain why the sign would be negative. It’s not about linear vs. non-linear.
Why would a learned man linchpin an entire hypothesis on a single ingredients.. ?
“If my government becomes corrupt, spends well in excess of productive capacity or mismanages the economy then there is an increasing chance of currency collapse (hyperinflation). In essence, this occurs when the citizenry lose faith in the sovereign currency and slowly refuse to transact and produce in that currency.” I’m quoting TPC.
Our government, in bailing out Wall Street with no accountability, established its corruption beyond doubt. As QE2′s effects demonstrated, even an asset swap can have market moving and destabilizing effects if enough people believe that the swap is “money printing”. The precious metals markets are a good indicator of a corrosive loss of faith taking hold as even central banks begin to add to gold reserves after 40 years of declines. A frightened herd may not be interested in a sectoral balance analysis; this is the challenge of applying the operational realities of MMT to human behavior. Outcomes do not have a Gaussian distribution in finance and economics. This means that unpredictability and fat tails are inevitable. Benoit Mandelbrot was a genius.
R&R’s big mistake is their blindness to the obvious, as pointed out by Nersisyan and Wray. MMTers must remind themselves that, although they are clearly correct in their objective analysis, their own obvious qualifier is: outcomes do not have a Gaussian distribution in finance and economics and so beware of excessive faith in your equations’ predictive capacity. In other words, hedge your bets.
And interestingly it’s the MMT’ers and their Post Keynesian brethren that are the ones that actually have read Mandelbrot and find it consistent with their own world view. Keynes understood 80 years ago that risk and uncertainty weren’t the same, and that our world is characterized by fundamental uncertainty, largely driven by the effects of humans acting on their own expectations. Minsky furthered Keynes’s analysis by applying to what he termed modern “money manager capitalism,” a term he coined 25 years ago (most now refer to the same phenomenon as “financialization”).
Your comment about our belief in our “equations’ predictive capacity” suggests you don’t understand what we’re saying, since we’re not suggesting we can predict the things you seem to think we are. I honestly don’t know where anyone gets that sort of stuff, cause we’ve never said it.
In fact, we noted last year that the expectational effects of QE were possible, and were among the few that understood this was the only possible route for QE to offer actual stimulus (perverse as that stimulus might be, particularly if expectational effects lead commodity prices to rise). We obviously couldn’t predict exactly how that would play out, and didn’t try to, but we did know that aside from expectational effects, QE would be a non-event. And we were right. Even with the expectations going fairly crazy, we still have a weak economy and little more than a “blip” upward in inflation.
If you understand how things work operationally, you can then know where causation can and cannot come from. THAT’S what we do, and nothing else in terms of predictions. But you can’t predict when or how much, usually, so we don’t try to. Again, this is all in Minsky and Keynes.
“And interestingly it’s the MMT’ers and their Post Keynesian brethren that are the ones that actually have read Mandelbrot and find it consistent with their own world view.”
Have you by qny chance heard about Maurice Allais, 1988 winner of the Nobel Prize and his book “La crise mondiale d’aujourd’hui” published in 1999?
“In 1974, massive speculation began to expand worldwide. 1983 was the start, in New York, of a period of breakneck expansion of gigantic markets for stock-index futures, stock-index options, hedge funds, and all derivative instruments, presented as cure-alls (…).
With speculation on the currency market, speculation in stocks, and speculation in derivative instruments, the world has become a vast casino, with gambling tables located at all latitudes and longitudes. The gambling and bidding, in which millions of players participate, never stops. New York prices are followed by Tokyo and Hong Kong prices, then London, Frankfurt and Paris prices. This speculation on all markets, feverish and frenetic, is permitted, fueled and magnified by credit. Never before has it reached such heights (…).
Never before, certainly, has such potential instability emerged with as significant a threat of global collapse.”
I plead guilty to seeking some predictive capacity in finance and investment analysis. When TPC said that massive boosts in bank reserves and then QE2 would not have the intense inflationary results many were expecting, and he explained why in terms of MMT and functional finance, and the equations “worked”, and the outcome was as he said, and what he was saying about monetary and fiscal functions proved true upon my due inquiry, my thought was (to paraphrase Lao Tzu): “you’re the one I’ve been looking for”.
Many commenting on this site appear to be very certain that, for example, inflation in the current environment is impossible due to slack in the economy and high unemployment, and rely on MMT for that certainty. That certainty is an implicit prediction of stability in outcomes. My thought to them is: hedge your bets (if you’re making them), as I am confident TPC does, because highly educated guesses aren’t the same thing as predictions. Another quote from Lao Tzu: “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.”
OK, that makes sense. I think MMT’ers would argue that, while inflation is absolutely possible over the next few years, there are some sources from which it could come and others from which it will not, or will very likely not. We think most are focusing on the latter. Yes, hedge your bets in any event, as inflation’s chains of causation are ultimately not reducible to accounting. This is different from, say, QE2, for which we can rule out with 100% certainty some of the suggested chains of causation that aren’t actually possible if one understands accounting and monetary operations.