Financial Stability News

Flashing news about financial stability and central banking

The Reinhart – Roghoff story

The highlight of this week has been the high-profile critique by Pollin & Co from UMassAmherst of professors Reinhart and Roghoff and their “austerity” paper, where they showed that the danger zone of public debt is 90 % of GDP. Their results has been used by the UK finance minister Osborn to justify their current harsh budget policy, and by many otheres to justify the current fashion of “austerity growth driven policies”.

Financial Times has given the debate wide coverage, see here and this very good summary blog post by G. Davis here. But you may also be interested in these posts by Prof. Mitchell here and prof. Wray here that is much more direct in their critique of R&R and also show the absurdity in their initial paper. As Wray and co-author Nersisyan noted in a Levy WP from 2010:

R&R … have no idea what sovereign debt is. They add together government debts issued by states on gold standards, fixed exchange rates and floating rates. They aggregated across governments that issue debt in their own currency and states that issue debt denominated in foreign currency. It is not even possible to determine from their book exactly what is government debt versus private debt.

So, it does not make sense to compare apples and oranges; the debt ratio of Spain (w/o its own currency) is obviously not the same as the debt ratio for the UK. And the debt ratio for Japan (borrowing mainly domestically) has a different meaning than the US debt ratio (most US debt is to foreigners; and the US dollar enjoy resever currency status).

This has huge implications for macroeconomic policy going forward. The IMF is gradually coming around to a “less austerity” position, and the FT notes that they will get into a fight with the UK government in the forthcoming Article IV discussion. So watch out for the continuation of the contiuation of the R&R story.

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