Fiscal Fever Breaks

In numerous conversations over the past few years, and in comments on these pages, I have repeated the findings from a pair of Harvard economists whose study about the relationship between debt and Gross Domestic Product (GDP), and its effect on growth, caused concern. There was a lot of talk about the study during the most recent presidential election. I opined to my listeners and readers that despite the desperate need for the US government to stimulate more job production, great care had to be taken to assure that government debt did not exceed 90 percent of GDP, due to the drag on growth that it would surely produce. 

Today, I take it all back.

Thomas Herndon

I learned in a holiday chat with Mike Childress from UK's Center for Business and Economic Research that earlier this spring the Harvard study fell apart. The way the story goes, a grad student in economics at U Mass Amherst got a assignment from his econometrics professor to replicate the famous study, "Growth in a Time of Debt" by Reinhart and Rogoff. The famous study had been heavily relied on by many people - including many of those who guide national fiscal policy in Europe and America...and including your humble reporter.

Thomas Herndon, the 28-year-old grad student, dutifully obtained the data set from the authors and set about his task. But he could not replicate the study. The problem, it turns out, was the presence of several errors including an erroneous formula in a data cell, which then miscalculated effects.

This is yet another case underscoring the importance of peer review in the scholarly process.

So to recap recent revelations: The rich are getting richer and the middle class is not. CEO pay is through the roof while the average worker spends longer hours earning less money. The promised trickling down of economic benefits which should surely show up in such a disparate economic climate (if the trickle-down economic theory were true) has not materialized, and is showing no signs of doing so. Private sector job growth is slow. The rich are paying a lower percentage in taxes than was the case during more productive times.

I'm sensing a pattern here.

Public investments aimed at schools, pensions, unemployment insurance, healthcare and other supports for the common citizen are necessary and proper - and we should get back to a fiscal policy that stimulates economic growth while restraining only those who would gamble our economy away in market swaps or other unsecured schemes that produce no tangible value.

This from Paul Krugman in the NY Times:

In 2012 President Obama, ever hopeful that reason would prevail, predicted that his re-election would finally break the G.O.P.’s “fever.” It didn’t.

But the intransigence of the right wasn’t the only disease troubling America’s body politic in 2012. We were also suffering from fiscal fever: the insistence by virtually the entire political and media establishment that budget deficits were our most important and urgent economic problem, even though the federal government could borrow at incredibly low interest rates. Instead of talking about mass unemployment and soaring inequality, Washington was almost exclusively focused on the alleged need to slash spending (which would worsen the jobs crisis) and hack away at the social safety net (which would worsen inequality).

So the good news is that this fever, unlike the fever of the Tea Party, has finally broken. 

True, the fiscal scolds are still out there, and still getting worshipful treatment from some news organizations. As the Columbia Journalism Review recently noted, many reporters retain the habit of “treating deficit-cutting as a non-ideological objective while portraying other points of view as partisan or political.” But the scolds are no longer able to define the bounds of respectable opinion. For example, when the usual suspects recently piled on Senator Elizabeth Warren over her call for an expansion of Social Security, they clearly ended up enhancing her stature. 

What changed? I’d suggest that at least four things happened to discredit deficit-cutting ideology.

First, the political premise behind “centrism” — that moderate Republicans would be willing to meet Democrats halfway in a Grand Bargain combining tax hikes and spending cuts — became untenable. There are no moderate Republicans. To the extent that there are debates between the Tea Party and non-Tea Party wings of the G.O.P., they’re about political strategy, not policy substance. 

Second, a combination of rising tax receipts and falling spending has caused federal borrowing to plunge. This is actually a bad thing, because premature deficit-cutting damages our still-weak economy — in fact, we’d probably be close to full employment now but for the unprecedented fiscal austerity of the past three years. But a falling deficit has undermined the scare tactics so central to the “centrist” cause. Even longer-term projections of federal debt no longer look at all alarming. 

Speaking of scare tactics, 2013 was the year journalists and the public finally grew weary of the boys who cried wolf. There was a time when audiences listened raptly to forecasts of fiscal doom — for example, when Erskine Bowles and Alan Simpson, co-chairmen of Mr. Obama’s debt commission, warned that a severe fiscal crisis was likely within two years. But that was almost three years ago. 

Finally, over the course of 2013 the intellectual case for debt panic collapsed. Normally, technical debates among economists have relatively little impact on the political world, because politicians can almost always find experts — or, in many cases, “experts” — to tell them what they want to hear. But what happened in the year behind us may have been an exception. 

For those who missed it or have forgotten, for several years fiscal scolds in both Europe and the United States leaned heavily on a paper by two highly-respected economists, Carmen Reinhart and Kenneth Rogoff, suggesting that government debt has severe negative effects on growth when it exceeds 90 percent of G.D.P. From the beginning, many economists expressed skepticism about this claim. In particular, it seemed immediately obvious that slow growth often causes high debt, not the other way around — as has surely been the case, for example, in both Japan and Italy. But in political circles the 90 percent claim nonetheless became gospel. 

Then Thomas Herndon, a graduate student at the University of Massachusetts, reworked the data, and found that the apparent cliff at 90 percent disappeared once you corrected a minor error and added a few more data points. 

Now, it’s not as if fiscal scolds really arrived at their position based on statistical evidence. As the old saying goes, they used Reinhart-Rogoff the way a drunk uses a lamppost — for support, not illumination. Still, they suddenly lost that support, and with it the ability to pretend that economic necessity justified their ideological agenda. 

Still, does any of this matter? You could argue that it doesn’t — that fiscal scolds may have lost control of the conversation, but that we’re still doing terrible things like cutting off benefits to the long-term unemployed. But while policy remains terrible, we’re finally starting to talk about real issues like inequality, not a fake fiscal crisis. And that has to be a move in the right direction.