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April 29, 2013

Risk of Debt?

Brad DeLong on when government debt is problematic, and when it's not -- a short excerpt from a much longer discussion:
Risks of Debt?: Extended Version, by Brad DeLong: ... The principal mistake Reinhart and Rogoff committed in their analysis and paper--indeed, the only significant mistake in the paper itself--was their use of the word "threshold". 
It and the graph led very many astray. It led the usually-unreliable Washington Post editorial board to condemn the "new school of thought about the deficit…. 'Don’t worry, be happy. We’ve made a lot of progress', says an array of liberal pundits… [including] Martin Wolf of the Financial Times…" on the grounds that "their analysis assumes steady economic growth and no war. If that’s even slightly off, debt-to-GDP could… stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth." (Admittedly, experience since the start of the millennium gives abundant evidence that the Washington Post needs no empirical backup from anybody in order to lie and mislead in whatever way the wind blows.)
It misled European Commissioner Olli Rehn to claim that "when [government] debt reaches 80-90% of GDP, it starts to crowd out activity in the private sector and other parts of the economy." Both of these--and a host of others--think that if debt-to-annual-GDP is less than 90% (or, in Rehn's case, 80%, and I have no idea where the 80% comes from) an economy is safe, and that only if it is above 90% is the economy's growth in danger.
And in their enthusiasm when they entered congressional briefing mode it led Reinhart and Rogoff themselves astray. ...
Matthew O'Brien relays Tim Fernholz of Quartz's flagging of the following passage from Senator Tom Coburn:
Johnny Isakson, a Republican from Georgia and always a gentleman, stood up to ask [Reinhart and Rogoff] his question: "Do we need to act this year? Is it better to act quickly?"
"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.
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."
And O'Brien quotes Reinhart and Rogoff writing in Bloomberg View:
Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP…. The biggest risk is that debt will accumulate until the overhang weighs on growth…
Yet the threshold at 90% is not there. In no sense is there empirical evidence that a 90% ratio of debt-to-annual-GDP is in any sense an "important marker", a red line. That it appears to be in Reinhart and Rogoff's paper is an artifact of Reinhart and Rogoff's non-parametric method: throw the data into four bins, with 90% the bottom of the top bin. There is, instead, a gradual and smooth decline in growth rates as debt-to-annual-GDP increases. 80% looks only trivially different than 100%. ...

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