Mon, May 27, 2013 - Page 9 News List

Concerns over high debt harming long-term growth are real

By Michael Boskin

The recent controversy over errors in a 2010 paper by the economists Carmen Reinhart and Kenneth Rogoff is a sad commentary on the demands of the 24/7 news cycle and the politically toxic atmosphere surrounding fiscal policy in the US, Europe and Japan. In their paper, “Growth in a Time of Debt”, Reinhart and Rogoff estimated large declines in growth associated with public-debt/GDP ratios above 90 percent. However, it contained coding errors discovered by a University of Massachusetts graduate student. When corrected, the effect is substantially smaller, but nonetheless economically consequential.

The Reinhart/Rogoff paper is just a small part of a voluminous academic literature that shows high debt levels to be economically risky. A more fundamental question is causality: The state of the economy certainly affects the fiscal position, just as taxation, spending, deficits and debts may affect economic growth.

Research errors in economics are not uncommon, but they are usually caught at an early stage, as happened once to me in a prepublication draft. Sometimes, errors are not discovered until later, when they are working papers, as with Reinhart and Rogoff, or after publication, as with Nobel laureate Ken Arrow, who had to correct a mistake in the proof of his famous impossibility theorem.

Economists use different methods to analyze fiscal issues: stylized analytical models; macroeconometric models fitted to aggregate data, such as those used by the US Federal Reserve, the European Central Bank and the US Congressional Budget Office (CBO); empirical estimation of key parameters, such as spending multipliers; vector autoregressions; and historical studies. Each of these approaches has its strengths and weaknesses, and serious economists and policymakers do not rely on a single study; rather, they base their judgments on complementary bodies of evidence.

Thus, there is no excuse for the outrage, the exaggerated claims for one paper’s influence and the attempt to use the error to discredit legitimate concerns over high levels of debt (let alone to vilify the authors).

DEFICITS

While large deficits are usually undesirable, sometimes they can be benign or even desirable, such as in recession, wartime or when used to finance productive public investment. In normal times, deficits crowd out private investment (and perhaps crowd in private saving and/or foreign capital), and hence reduce future growth. By contrast, in a deep, long-lasting recession, with the central bank’s policy rate at the zero lower bound (ZLB), a well-timed, sensible fiscal response can, in principle, be helpful.

However, the political process may generate poorly timed or ineffective responses — focused on transfers rather than purchases, infra-marginal tax rebates and spending that fails cost-benefit tests — that do little good in the short run and cause substantial harm later. The US’ 2008 stimulus barely budged consumption upward, and the 2009 fiscal stimulus cost hundreds of thousands of dollars per job — many times higher than median pay.

We should adopt policies that benefit the economy in the short run at reasonable long-run cost, and reject those that do not. That sounds simple, but it is a much higher hurdle than politicians in Europe and the US have set for themselves in recent years.

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