On Whose Research Is the Case for Austerity Mistakenly Based?

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.

  1. Reinhart and Rogoff’s 2010 estimates had already been superseded by a subsequent 2012 paper of theirs written along with Carmen’s husband, Vincent, which used a more extensive data set where the error does not appear.
  2. The debt-growth causality is debated.
  3. Some of Ferguson’s best friends are gay.”
  4. Keynes was actually bi-sexual.
  5. 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).

And…

“several fiscal adjustments have been associated with expansions even in the short run” (1998).

And…

“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”

and so,

“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.

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References

Alberto Alesina, and Silvia Ardagna, 1998, “Tales of Fiscal Adjustment,” Economic PolicyVol.13, no, 27, October, 487-545.
Alberto Alesina, and Silvia Ardagna, 2010,  “Large Changes in Fiscal Policy: Taxes versus Spending,” in Tax Policy and the Economy, Volume 24 (University of Chicago Press).
Alberto Alesina, Carlo Favero and Francesco Giavazzi, 2013, “The Output Effect of Fiscal Consolidations,” IGIER, May.
Alberto Alesina and Roberto Perotti. 1995, “Fiscal Expansions and Adjustments in OECD Countries,” Economic Policy, October.  NBER WP 5214.
Alberto Alesina and Roberto Perotti, 1997, “Fiscal Adjustments In OECD Countries: Composition and Macroeconomic Effects,” International Monetary Fund Staff Papers, vol.44, no.2, June, 210-248.
Francesco Giavazzi and Marco Pagano, 1990, “Can Severe Fiscal Contractions be Expansionary?NBER Macroeconomics Annual 1990, Vol.5, Olivier Blanchard and Stanley Fischer, editors (MIT Press) p. 75 – 122.
Thomas Herndon, Michael Ash, and Robert Pollin, 2013, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Political Economy Research Institute WP Series 322,University of Massachusetts Amherst, April.
Roberto Perotti, 2013a,”The ‘Austerity Myth’: Gains Without Pain?” A. Alesina and F. Giavazzi, eds.: Fiscal Policy After the Financial Crisis (University of Chicago Press). BIS WP 362.  NBER WP no 17571.
Roberto Perotti, 2013b, “The Sovereign Debt Crisis in Europe: Lessons from the Past, Questions for the Future,” Academic Consultants Meeting, Federal Reserve Board, Washington DC , May 6, 2013.  Bocconi University.
Carmen Reinhart and Ken Rogoff, 2010, “Growth in a Time of Debt,” AER, 100, May, 573-578.
Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff, 2012, “Public Debt Overhangs: Advanced-Economy Episodes Since 1800,” Journal of Economic Perspectives, Vol.26, No.3-Summer, 69-86.
[Comments can be posted at On Deck of Project Syndicate or on the site of the shortened op-ed version.]

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12 replies on “On Whose Research Is the Case for Austerity Mistakenly Based?”

  1. Those who believe that reducing the money supply will in some way, help grow the economy, never have explained exactly how that works.  
     
    GDP = Federal Spending + Non-Federal Spending.
     
    Deficit spending puts money into the pockets of potential spenders, which by definition grows GDP.
     
    Also, we rarely hear from the austerians, about the difference between monetarily non-sovereign governments (the euro nations and all local governments) and the Monetarily Sovereign governments (the US, Canada, China, Japan, Australia et al).  
     
    The former need austerity, because they, having no sovereign currency, can run short of money.  The later never need austerity, because they never can run short of their sovereign currency.
     
    The Harvard research doesn’t acknowledge the difference, and that — not a spreadsheet error — is what damns the research results to a well-deserved oblivion.
     
    Rodger Malcolm MItchell

  2. @RODGERMITCHELL Anybody can tell the difference between this writing and yours, either in form or in content! It’s like heaven and hell!!!

  3. ..[..]…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.”….So what Childreninherit what we leave near FOC let them pay cheaper input materials, labor, machines in their bigger dollars & Incomes, they are still cheaper interest costs than the asset they get FOC. Are children entitled to all FOC and better than Dad’s had. NO THEY ARE NOT they better appreciate what they pay part of.

  4. 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…[..]… Right “Stimulus” can’t go on forever there is a time and right things to pay at differing junctures, in the end the piper must be paid. “Stimulate employment not “Trickle out to profits” by phony words. Pay debt ASAP and stimulate man employment off the Welfare they become Consumers and “Trickle up” profits far better, the welfare saving pays more than half the fed bill then. But stop waste like wars that are not Bloody minded proselytizing USA dream of World Domination. .
    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. ..[..].. Don’t worry 1929 will repeat timely on Professor Kondratiev 300 years evidenced wave proof statistical history, these Wall street puppets selling stories to raise USA Growth in the 1% gains 2012 11% while the nation averaged a bare 2.7% proves this, that recent 20-60 years histories is no sound basis for these purely theoretical waffle of the bribed expert puppets of the rich chansing casino gains in short terms.

  5. Overall a good article, as GWB answered when asked how will history treat his record he answered “They will say he is dead”. and yes:-
    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”
    and so,
    “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.
     
    Pay what pressing debt you can when even under fiscal constraints, stimulate employment and new consumer disposable income for “Trickle Up” forget “Trickle down” that is “trickle out” profit growth as 2012 proved. Remove waste as the “Austerity” measure at same time. Keynes did not sayyou can’t have “Stimulus” and “Austerity” simultaneouslt he merely gave boundaries based on fiscal factors.

  6. “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.”
     
    It puzzles me that Rogoff and Reinhart wrote a book, “This Time It’s Different,” and yet everyone mentions their papers. The saarcastic title of the bok is meant for those who said that debt does not lead to radically low growth.  Turns out, debt does not lead to radicaly low growth.  The 90% inflection point is patently wrong.  U Michigan researchers now show that low growth more likely leads to high debt than high debt leading to low growth. Rogoff and Reinhart did not quickly concede their mistake, as Frankel says here.  Instead,  they quickly conceded A mistake and then restated the underlying error.  I have not heard them say, We were wrong.

  7. @AlanHarvey surely doesn’t puzzle you really? We all now know they wrote a book now and many will buy hoping for more mistakes by so-called Yankee EXPERTS.
     
    This stands good the old adage that any publicity even bad is good for the primary purpose of selling ones offering.The profits justify the probably deliberate error and self exposure by a friend on their tip off. They are cunning Yankees and only want the profit of book sales and such massive FOC publicity has done them a World of good that way?
     
    Far more use the $$$$$$$$ in hand than accolades of fellow acedemics who don’t have a dime to scratch their buts?

  8. @robcartervn  @AlanHarvey Or “butts,” as the case may be.  But my point is that the only thing the critics, even Krugman, mention is the papers.  The public bought the book.  The public knows the debate by the title of the book.  Why not say, “No, This time is not different, it is the same — high debt does not lead to radically low growth, especially in advanced economies which print their own money.” Just mentioning the papers gives credibility to the idea that it is just some sort of academic debate, and that the evidence might be okay if you screwed your eyes on right.
     
    Though I must say that the evidence has not changed the debate in Congress.  They apparently don’t need evidence to prove that Social Security’s balance in twenty years is reaching back from the future to cause our problems today.

  9. @AlanHarvey  Ok Alan I can agree bgut please don’t mention Krugman you spoil your point. He sold out to act as expert disinformation on the left as a GOP plant from the right, he has no credibility in practical economics, couldn’t be trusted to run an SME treasury (Accounts or Budgets) would see advertising as God and go bankrupt in a year .He waves a Nobel as a qualification, Suu Kry in Burma has proved the worth of a Nobel when it comes to maintaining the premise that won it, the $$$$$$$ in the bank and power gleaned has it’s own drive on auto.

  10. @AlanHarveyYes Alan “high debt does not lead to radically low growth, especially in advanced economies” but not when 90% leaks out to Subcontract Corporate America war type pockets. They grew 11% in 2012 but the Nation only averaged 2.7% why? As Keynes said depends where the money goes to on what necessity. “Stimulate” in good times and “Austerity” in other aspects of good times, or bad. Sure fix the roof when the rain stops. But mark the Corporate profits to get less in the Bad times.

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