Why this time is not different - revisiting debt and growth for the infinite time

Well, if I don't get this out now, I'm not likely to do it later because I would have read the whole paper and a lot more people would have too. It turns out there is something amiss this morning! - namely this. It's a paper by 3 UMass researchers that sought to duplicate the famous (infamous to me!) Reinhart-Rogoff narrative on what high debt levels do to growth, and among other things- median growth rates for countries with public debt over 90 percent of GDP are roughly one percent lower than otherwise; average (mean) growth rates are several percent lower.

I don't think I've been quite critical enough of these debt-growth studies - but most of the time, there are enough people doing the taking down. This time is not different.

Tim Fernholz at Quartz lays less into the study and more into the blatant disdain political figures showed while repeatedly misusing it. He quotes a passage from Republican senator Tom Coburn's book of debt that describes a scene where, in April 2011, 40 senators met R&R for a briefing - here's what transpired (all emphasis is mine):

“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.

Senator Kent Conrad...explained to his colleagues that when our high debt burden causes our economy to slow by 1 point of GDP, as Reinhart and Rogoff estimate, that doesn’t slow our economy by 1 percent by 25 to 33 percent when we are growing at only 3 to 4 GDP points a year.

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 present to you -  the "scratch-your-head-till-it-hurts-and-you-find-the-least-smart-comment-game"...STARRING...:

 -  “[I]t is widely acknowledged, based on serious research, that when public debt levels rise about 90% they tend to have a negative economic dynamism, which translates into low growth for many years.” — European Commissioner Olli Rehn.

 -  “Economists who have studied sovereign debt tell us that letting total debt rise above 90 percent of GDP creates a drag on economic growth and intensifies the risk of a debt-fueled economic crisis.” — House Budget Committee Chairman and former Republican vice-presidential candidate Paul Ryan.

 -  “It’s an excellent study, although in some ways what you’ve summarized understates the risks.”— Former US Treasury Secretary Tim Geithner. 

 -  “[W]e would soon get to a situation in which a debt-to-GDP ratio would be 100%. As economists such as Reinhart and Rogoff have argued, that is the level at which the overall stock of debt becomes dangerous for the long-term growth of an economy. They would argue that that is why Japan has had such a bad time for such a long period. If deficits really solved long-term economic growth, Japan would not have been stranded in the situation in which it has been for such a long time.” Lord Lamont of Lerwick, former UK chancellor and sometime adviser to current chancellor George Osborne.

 -  “The debt hurts the economy already. The canonical work of Carmen Reinhart and Kenneth Rogoff and its successors carry a clear message: countries that have gross government debt in excess of 90% of Gross Domestic Product (GDP) are in the debt danger zone. Entering the zone means slower economic growth.”— Doug Holtz-Eakin, Chairman of the American Action Forum.

This is a close one but I've just got to give it to L-cube for those really fancy initials and of course the Japan parallel. Your winner emeritus - Lord Lamont of Ler...

...Anyway, on to more serious critiques, Mike Konczal (Rortybomb/NextNewDeal) summarizes the three issues of the HAP do-over (I would think that this was the post on the econoblogosphere that set off things):

"First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. All three bias in favor of their result, and without them you don't get their controversial result."

There's more detail on these three here if it interests you. But there's something else too!

That would be the average excluding Belgium, which had a robust 2.6% growth in a "time of high debt". Yes, that's the cell not being dragged all the way down - it leads to the average being 2.2 instead of -0.1%. 

But Krugman has some more insight on this. He points to two studies that have acted as a sort of foundation for this harmful austerity drive. The first is the Alesina-Ardagna paper on the expansionary macro-benefits of austerity. The second of course, is the R-R study, and the point he makes (perhaps justifiably!), is that while some could obviously observe the effects of observed correlation and reverse causation, the "crime" so to speak, lies with all the policymakers that actually used it as a public defense of their agenda. Think of this in a David-Li-and-the-Gaussian-Copula way. Should he blamed because rating agencies and investment firms adopted his interpretation?  

Anyway, Krugman uses his own scatterplot but differentiates between countries so as to test the effects of the weighting system. His sample is only 1950-2009 and works for the G-7 only (which in retrospect might not be a bad thing at all). While he concedes that there does seem to be some sort of an association, "most of the apparent relationship is coming from Italy and Japan; Britain didn’t seem to suffer much from its high debt in the 1950s. And it’s quite clear from the history that both Italy and (especially) Japan ran up high debts as a consequence of their growth slowdowns, not the other way around."

But I saved the defence for the last! Here's what Reinhart-Rogoff state in a WSJ piece (in response to the HAP research):

"...On a cursory look, it seems that that Herndon Ash and Pollen also find lower growth when debt is over 90% (they find 0-30 debt/GDP , 4.2% growth; 30-60, 3.1 %; 60-90, 3.2%,; 90-120, 2.4% and over 120, 1.6%). These results are, in fact, of a similar order of magnitude to the detailed country by country results we present in table 1 of the AER paper, and to the median results in Figure 2. And they are similar to estimates in much of the large and growing literature, including our own attached August 2012 Journal of Economic Perspectives paper (joint with Vincent Reinhart) . However, these strong similarities are not what these authors choose to emphasize.

The 2012 JEP paper largely anticipates and addresses any concerns about aggregation (the main bone of contention here), The JEP paper not only provides individual country averages (as we already featured in Table 1 of the 2010 AER paper) but it goes further and provide episode by episode averages. Not surprisingly, the results are broadly similar to our original 2010 AER table 1 averages and to the median results that also figure prominently.. It is hard to see how one can interpret these tables and individual country results as showing that public debt overhang over 90% is clearly benign...

...By the way, we are very careful in all our papers to speak of “association” and not “causality” since of course our 2009 book THIS TIME IS DIFFERENT showed that debt explodes in the immediate aftermath of financial crises. This is why we restrict attention to longer debt overhang periods in the JEP paper, though as noted there are only a very limited number of short ones...

...Lastly, our 2012 JEP paper cites papers from the BIS, IMF and OECD (among others) which virtually all find very similar conclusions to original findings, albeit with slight differences in threshold, and many nuances of alternative interpretation.. These later papers, by the way, use a variety of methodologies for dealing with non-linearity and also for trying to determine causation. Of course much further research is needed as the data we developed and is being used in these studies is new. Nevertheless, the weight of the evidence to date –including this latest comment — seems entirely consistent with our original interpretation of the data in our 2010 AER paper."

=================================

In a way, it's kind of what you expect, perhaps a bit more defensive, a little less calm - I wouldn't know, I'm not too good at gauging reactions. 

What I do know is that any kind of study that seeks to establish an association, tries to imply causation and uses historical data that might be of little use in the world we live in today must be taken with a pinch of salt. 

It can be used to provide perspective and complement or contradict other lines of thought. What it shouldn't do however, is be misused as a tool, and treated as "evidence" just so that politicians and policy makers can advance an agenda. 

================================

P.S: Some further further reading (because it just never stops):

 - Ryan McCarthy has a good encapsulating summary at Counterparties

 - Matt Yglesias at Slate asks what exactly this will really change

 - The folks at Alphaville (Garcia/Cotterill) have a far more specific critique of the study in general and the lack of vetting that went along with it

 - Tyler Cowen, at Marginal Revolution, on a lighter note, has an interesting and fair point-by-point take on future consequences. He asks whether this should change the ratios (quant/narratives) of what he reads.

 - Dean Baker at CEPR emphasizes the implications that this paper led to (it's provocatively  titled "how much unemployment was caused...") along with a follow-up of his own post post-response

 - Noah Smith has his own noahpinion where he chooses to focus instead on the book that sheds light on historical financial crises. He also excuses the "gotcha" excel moment (which I do think is fair, hey it could happen to me!)

 - Owen Zidar has his own take presenting us with two graphs from a collaborative effort on an IMF presentation with Tyson and DeLong.

 - Dylan Matthews at Wonkblog had a detailed "debt/deficits/spending etc" piece just over a week ago. One of the sections is "Countries with debt over 90 percent of GDP enter a danger zone". Worth the read

 - Ryan Avent plays the twitter role

 - The last word should go to Robert Shiller for his Project Syndicate piece almost two years ago with this gem, 

"A paper written last year by Carmen Reinhart and Kenneth Rogoff,...found that when government debt exceeds 90% of GDP....

...One might be misled into thinking that, because 90% sounds awfully close to 100%, awful things start happening to countries that get into such a mess. 

But if one reads their paper carefully, it is clear that Reinhart and Rogoff picked the 90% figure almost arbitrarily. They chose, without explanation, to divide debt-to-GDP ratios into the following categories: under 30%, 30-60%, 60-90%, and over 90%. And it turns out that growth rates decline in all of these categories as the debt-to-GDP ratio increases, only somewhat more in the last category".