Huebscher: Misreading Reinhart & Rogoff

Bravo, Bob Huebscher of!

Bob has provided a sober and sorely-needed critique of the popular misapplication of economists Carmen Reinhart and Kenneth Rogoff’s (R&R) recent empirical studies on government debt.  

If the rallying cry for deficit reduction rests on an intellectual framework, it would be the work of Carmen Reinhart and Ken Rogoff, whose book, This Time is Different, has been hailed for its exhaustive historical study of financial crises.  A key finding of those scholars – that economic growth slows once the ratio of debt-to-GDP exceeds 90% – has been widely cited by those calling for decreased government spending. 

But those calling for deficit reduction have largely ignored a number of caveats that Reinhart and Rogoff gave with respect to their 90% threshold, and as a result many warn that the US faces the imminent danger of a Greek-like sovereign-debt crisis.

He also makes the critical point that people should not infer causation—i.e., high government debt leads to slower economic growth—from R&R’s work. In fact, the association between high government-debt levels and slow GDP growth could run the other way, or they could both be driven by other variables that R&R didn’t look at. (As we’ve pointed out many times, the role of population age structure has been largely overlooked in macroeconomic analysis.)

These kinds of critiques of R&R and popular interpretations of their work are long overdue, but still very relevant. (Martin Wolf took a nice stab at it, registration required, in September 2011.) We would add a few additional criticisms:

  • R&R did not distinguish between sovereign (debt issued in domestic, inconvertible currency) and non-sovereign (debt issued in, or pegged to, external or other forms of hard currency) governments.
  • Prevailing macroeconomic models still do not account explicitly for the fact that under a soft currency system, government deficit spending and debt constitute private sector saving and net financial assets.
  • Finally, although Bob obtained much of his ammunition from an interview with Rogoff, R&R haven’t been completely innocent of letting the “90%” and similarly bad memes spin out of control.

You can read our prior R&R critiques and related posts here:

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (SCM) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy. Past performance is not indicative of future results. This material does not take into account your personal investment objectives, your personal financial situation and needs, or your personal tolerance for risk. Thus, any investment strategies or securities discussed may not be suitable for you. You should be aware of the real risk of loss that accompanies any investment strategy or security. It is strongly recommended that you consider seeking advice from your own investment advisor(s) when considering any particular strategy or investment.  We do not guarantee any specific outcome or profit from any strategy or security discussed herein. The opinions expressed are based on information believed to be reliable, but SCM does not warrant its completeness or accuracy, and you should not rely on it as such. All views and positions are subject to change without notice.