by Jeffrey Frankel, Jeff Frankel’s Weblog
Several of my colleagues on the Harvard faculty have recently been casualties in the cross-fire between fiscal austerians and stimulators. Economists Carmen Reinhart and Ken Rogoff have received an unbelievable amount of press attention, ever since they were discovered by three researchers at the University of Massachusetts to have made a spreadsheet error in the first of two papers that examined the statistical relationship between debt and growth. They quickly conceded their mistake.
Then historian Niall Ferguson, also of Harvard, received much flack when asked to comment on Keynes’ famous phrase “In the long run we are all dead”, he suggested that –
“Keynes was perhaps indifferent to the long run because he had no children, and that he had no children because he was gay.”
There is more to be said about each of the two cases.
- Reinhart and Rogoff’s 2010 estimates had already been superseded by a subsequent 2012 paper of theirs written along with Carmen’s husband, Vincent, which used a more extensive data set where the error does not appear.
- The debt-growth causality is debated.
- “Some of Ferguson’s best friends are gay.”
- Keynes was actually bi-sexual.
- He tried to have children. And so forth. Most of this has already been said many times by now. Apparently people are even more fascinated by Harvard than they are about macroeconomic theory.
But what does it all have to do with the debate between austerians and stimulators? Not much. But the battle lines of the austerians have been wavering lately under the continuing onslaught of facts (most notably the recessions in Europe and Japan’s recent conversion to stimulus), and the stimulators find the missteps of Reinhart-Rogoff and Ferguson to be convenient stones to throw into the attack as well. But they are barking up the wrong tree. Sorry; they are throwing the wrong stones.
The Reinhart-Rogoff controversy is not in fact relevant to the question whether governments should expand or contract at a given point in time. The basic finding in their papers continues to hold up, that subsequent growth tends to be lower among countries with debt/GDP ratios above 90% than below 90%; but neither that finding nor their policy advice was designed so as to support the proposition that a recession is a good time to undertake fiscal contraction.
The Ferguson controversy is even less relevant, because the phrase “in the long run we are all dead” was neither about fiscal policy when Keynes wrote it nor an argument against deferred gratification. Nor was Keynes in favor of uninhibited fiscal stimulus regardless of economic conditions; he argued, rather –
“the boom, not the slump, is the right time for austerity at the Treasury.”
Fix the hole in the roof when the sun is shining, not when it is raining.
Neither of the controversies bears on the policy proposition that is important at the moment, which is the Keynesian claim that under conditions of high unemployment, low inflation, and low interest rates (the conditions that hold in rich countries today, as in the 1930s), fiscal expansion is expansionary and fiscal contraction is contractionary.
Some research by yet another highly valued colleague at Harvard does bear much more directly on this important proposition. Alberto Alesina has not been receiving his “fair share of abuse.” His influential papers with Roberto Perotti (1995, 1997) and Silvia Ardagna (1998, 2010) found that cutting government spending is not contractionary and that it may even be expansionary.
It is true that sometimes a country may have no alternative to fiscal “consolidation,” if its creditors insist on it, as has been the case with Greece and some other euro members. But that does not mean austerity is expansionary, especially if the currency cannot depreciate to stimulate exports.
As with Reinhart and Rogoff, the Alesina papers themselves are much more measured in their conclusions than one would think from the claims of some conservative politicians that academic research finds fiscal austerity to be expansionary in general. Nevertheless, the conclusions are clear:
“Even major successful adjustments do not seem to have recessionary consequences, on average” (1997).
“several fiscal adjustments have been associated with expansions even in the short run” (1998).
“spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns. In fact, we uncover several episodes in which spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions” (2010, p.3).
Most recently, a May 2013 paper with Carlo Favero and Francesco Giavazzi finds –
“that spending-based adjustments have been associated, on average, with mild and short-lived recessions, in many cases with no recession.”
Alesina’s recent policy advice is that the US should cut spending “right away.” By contrast, the advice of Reinhart and Rogoff seems to favor postponing fiscal adjustment (trim entitlements in the future, but increase infrastructure spending today) and considering financial repression. In more far-gone cases like Greece, they lean toward restructuring the debt. If the thunderstorm is too severe and the roof is too far-gone to be fixed, it may be necessary to rebuild from scratch.
A new attack on Professor Alesina’s econometric findings comes from an unlikely source – Perotti – the co-author of the first two of the five articles, has now recanted (2013a, b). He points out some problems with the methodology (including the papers that Alesina wrote with Ardagna). Under the dating scheme, the same year can count as a consolidation year, a pre-consolidation year, and a post-consolidation year. It turns out that some of what have been treated as large spending-based consolidations, though announced by the governments, were in fact never implemented. Currency devaluation, reduced labor costs, and export stimulus played an important part in any instances of growth, for example, the touted stabilizations of Denmark and Ireland in the 1980s. His conclusions:
“the notion of ‘expansionary fiscal austerity’ in the short run is probably an illusion: a trade-off does seem to exist between fiscal austerity and short-run growth”
“the fiscal consolidations implemented by several European countries could well aggravate the recession” (2013b, p.10).
To me, this is a more powerful indictment of the reasoning behind recent attempts at fiscal discipline during recession than is a spreadsheet error or a too-flippant line about Keynes’ sexuality.