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Economix Blog: Reinhart-Rogoff Study on Debt Faces a Challenge on Accuracy

April 16, 2013 by Leave a Comment

Kenneth Rogoff and Carmen Reinhart at Ms. Reinhart’s Washington home in 2010, the year their study Mary F. Calvert for The New York Times Kenneth Rogoff and Carmen Reinhart at Ms. Reinhart’s Washington home in 2010, the year their study “Growth in a Time of Debt” was published.

8:10 p.m. | Updated
WASHINGTON — In recent years, policy makers in Europe and the United States have fastened on the notion that reaching a certain heavy burden of debt would threaten future economic health — often to justify austerity budgets that increased unemployment and sapped economic strength in the here and now.

But now some economists are challenging the very foundations of that idea, raising questions about whether such a debt threshold even exists and setting off a fierce debate that flared up on Tuesday across the Internet about whether potentially flawed research is at least partly responsible for the slow growth that has bedeviled most advanced industrial countries since the recovery from the financial crisis began in 2009.

The debate comes at a particularly perilous time, as economic officials from the United States and other countries gather for the annual spring meeting of the World Bank and International Monetary Fund in Washington, where many are expected to urge high-debt Europe to ease up on its commitment to austerity in the face of rising unemployment and new economic contractions.

The controversy stems from a provocative new paper by economists at the University of Massachusetts, Amherst that claims to have found some basic errors in one of the most pathbreaking and influential economic studies to come out in the last few years.

That was a 2010 research paper by Carmen M. Reinhart and Kenneth Rogoff of Harvard, also authors of a best seller, “This Time Is Different: Eight Centuries of Financial Folly.” The economists, analyzing 3,700 separate economic observations, found little relationship between growth and debt for countries with debt-to-gross-domestic-product ratios of 90 percent or less. But for countries with debt loads equivalent to or greater than 90 percent of annual economic output, “median growth rates fall by 1 percent, and average growth falls considerably more.”

Many politicians interpreted the research as showing a direct relationship between debt and growth. If a country reached a debt burden of more than 90 percent of its annual economic output, the logic went, it would quickly fall into a debt trap that would leave it struggling to grow in the coming years. Prominent politicians — including Olli Rehn of the European Commission and Representative Paul D. Ryan, the chairman of the House Budget Committee — cited it as a reason to try to impose major budget cuts.

The Harvard economists’ research was always more nuanced about the causal relationship between debt and growth than the popular view. Some economists expressed skepticism of the “threshold” theory to begin with. And many others noted how hard it could be to draw straight lines between debt and economic growth, given the panoply of factors at work.

But now, Thomas Herndon, Michael Ash and Robert Pollin of the University of Massachusetts, Amherst, in trying to replicate the Reinhart-Rogoff results, are challenging the conclusions for a different reason. They say they found some simple miscalculations or data exclusions that sharply altered the ultimate results. According to their rerunning of the figures, “the average real G.D.P. growth rate for countries carrying a public debt-to-G.D.P. ratio of over 90 percent is actually 2.2 percent, not –0.1 percent,” they write. In other words, heavy debts were not associated with the malaise that Professors Reinhart and Rogoff — and much of the world’s economic elite — thought that they were.

The new paper, released this week, has set off a storm within the economics profession, with some commentators even arguing that it undermines the austerity policies that have proved so prevalent in the last few years.

“How much unemployment was caused by Reinhart and Rogoff’s arithmetic mistake?” asked Dean Baker of the left-leaning Center for Economic and Policy Research, for instance.

But in interviews, several economic experts cautioned that it would take time to sort out the statistical implications of any problems in the highly technical research.

“I think it’s totally fair to say it’s embarrassing,” said Justin Wolfers, an economist at the University of Michigan, who added that he had not had the chance to study the results and noted that debates over supposed statistical problems were common in the profession. “But the mistakes that are most embarrassing are the least consequential” to Professor Reinhart and Rogoff’s conclusion, he added.

Other experts said that separate pieces of research had found similar results to the Harvard professors’ paper, using alternative data sets and significantly strengthening the argument that higher-debt economies suffered from slower growth. Those include studies by the I.M.F., the Organization for Economic Cooperation and Development and the Bank for International Settlements.

“There’s nothing about this that will change my view of the universe,” said Douglas Holtz-Eakin, a former director of the Congressional Budget Office and prominent Republican economist. “The sun still rises in the east. It sets in the west. And a lot of debt is still bad.”

In an e-mailed statement, Professors Reinhart and Rogoff did not directly address the assertions of mathematical errors, and noted that they had only just started to sift through the new paper. But they argued that the Amherst authors had also found lower growth rates when a country had debts equivalent to or greater than 90 percent of annual economic output. “It is hard to see how one can interpret these tables and individual country results as showing that public debt overhang over 90 percent is clearly benign,” they wrote.

The seemingly esoteric debate within the economics profession has collided this week with a broader challenge to excessive budget-cutting in countries around the world. The I.M.F. cautioned Washington against cutting its budget too fast, too soon, even as it saw the American economy strengthening. And on Tuesday, Olivier Blanchard, the fund’s chief economist, warned that Britain was “playing with fire” with its austerity policy.

Professors Reinhart and Rogoff “are right to say the basic structure of the result stands,” Professor Wolfers said. “The authors of the critique are right to say its force is lessened.”

The debate, he added, is far from over.

Article source: http://economix.blogs.nytimes.com/2013/04/16/flaws-are-cited-in-a-landmark-study-on-debt-and-growth/?partner=rss&emc=rss

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Home Resales and Midwest Factory Activity Increase

December 28, 2012 by Leave a Comment

WASHINGTON (Reuters) — Contracts for home resales hit a two-and-a-half-year high in November and factory activity in the Midwest expanded this month, suggesting some economic strength despite the threat of tighter fiscal policy.

The National Association of Realtors said on Friday that its pending home sales index, based on contracts signed last month, increased 1.7 percent to 106.4, the highest level since April 2010, when the homebuyer tax credit expired.

November was the third consecutive month of gains for signed contracts, which become sales after a month or two. There was a 5 percent rise in October.

A separate report showed that the Institute for Supply Management’s Chicago business barometer rose to 51.6 in December, from 50.4 in November. A reading above 50 indicates expansion in the regional economy. It was the second consecutive month of growth and was driven by a rebound in new orders.

The data suggested that some of the growth momentum from the third quarter carried into the final three months of 2012, even as businesses and households braced for sharp cuts in government spending and higher taxes in the new year.

Data in the fourth quarter, including consumer spending, housing, employment and various manufacturing indicators, have been fairly upbeat so far.

“We don’t see much evidence that the economy was slowing as we headed into the end of the year, but everything could change on Jan. 1,” said John Ryding, chief economist at RDQ Economics in New York.

There are fears that budget talks in Washington will fail to prevent $600 billion in government spending cuts and higher taxes, which could tip the economy back into recession.

“There is nothing here to suggest that the economy has enough momentum to withstand the shock if we go over the fiscal cliff with no quick return,” Mr. Ryding said. “The good news right now is it looks like we could have the mid-2s kind” of G.D.P. growth in the fourth quarter.

The economy grew at a 3.1 percent annual rate in the third quarter. The latest Reuters survey of economists put fourth-quarter G.D.P. growth at a 1.2 percent rate, with the decline a result mostly of Hurricane Sandy, which struck the East Coast in late October, and of cutbacks in business spending.

Though the employment gauge in the I.S.M.-Chicago survey fell to a three-year low in December, economists expect a rebound given the strength in new orders.

“The drop in employment reflects the weakness in new orders in November and, to a lesser degree, the fiscal cliff,” said Eric Green, an analyst at TD Securities in New York. “With the bounce-back in new orders, employment will also bounce back.”

The pending home sales report indicated a strengthening in the housing market recovery. Contracts were up 9.8 percent in the 12 months through November.

The housing market has turned a corner after the collapse that dragged the economy through its worst recession since the Great Depression.

Home sales and prices are rising, encouraging builders to pursue new construction projects. Home resale contracts were up in three of the country’s four regions, and steady in the South.

“The housing revival seems to be happening in a way that puts some positive feedback loop, a virtuous cycle, into the economy,” said Jerry Webman, chief economist at OppenheimerFunds.

Article source: http://www.nytimes.com/2012/12/29/business/economy/existing-home-sales-increase.html?partner=rss&emc=rss

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Study Predicts Future for U.S. as No. 2 Economy, but Energy Independent

December 11, 2012 by Leave a Comment

Russia’s clout will wane, as will the economic strength of other countries reliant on oil for revenues, the assessment says.

“There will not be any hegemonic power,” the 166-page report says. “Power will shift to networks and coalitions in a multipolar world.”

The product of four years of intelligence-gathering and analysis, the study, by the National Intelligence Council, presents grounds for optimism and pessimism in nearly equal measure. The council reports to the director of national intelligence and has responsibilities for long-term strategic analysis.

One remarkable development it anticipates is a spreading affluence that leads to a larger global middle class that is better educated and has wider access to health care and communications technologies like the Internet and smartphones. “The growth of the global middle class constitutes a tectonic shift,” the study says, adding that billions of people will gain new individual power as they climb out of poverty. “For the first time, a majority of the world’s population will not be impoverished, and the middle classes will be the most important social and economic sector in the vast majority of countries around the world.”

At the same time, it warns, half of the world’s population will probably be living in areas that suffer from severe shortages of fresh water, meaning that management of natural resources will be a crucial component of global national security efforts.

The study also warns of the risk that terrorists could mount a computer-network attack in which the casualties would be measured not by the hundreds or thousands killed but by the millions severely affected by damaged infrastructure, like electrical grids being taken down.

At least 15 countries are “at high risk of state failure” by 2030, the report predicts, among them Afghanistan and Pakistan, but also Burundi, Rwanda, Somalia, Uganda and Yemen.

The study acknowledges that the future “is malleable,” and it lists important “game changers” that will most influence the global scene through 2030: a crisis-prone world economy, shortcomings in governance, conflicts within states and between them, the impact of new technologies and whether the United States can “work with new partners to reinvent the international system.”

The best-case situation for global security until 2030, according to the study, would be a growing political partnership between the United States and China. But it could take a crisis to bring Washington and Beijing together — something like a nuclear standoff between India and Pakistan resolved only by bold cooperation between the United States and China.

The worst-case situation envisions a stalling of economic globalization that would preclude advancement of financial well-being around the world. That would be a likely outcome after an outbreak of a health pandemic that, even if short-lived, would result in closed borders and economic isolationism.

The chief author and manager of the project, Mathew Burrows, who is counselor for the National Intelligence Council, said the findings had been presented in advance in more than 20 nations to groups of academic experts, business leaders and government officials, including local intelligence officers.

In an interview, Mr. Burrows noted that the audiences in China were far more accepting of the American intelligence assessments — both those predicting China’s economic ascendancy and those warning of political dangers if there was no reform of governance in Beijing — than were audiences in Russia.

To assess the validity of this study, the research and analysis team graded its past work on global trends, an effort undertaken every four years since 1996. Past studies, it found, underestimated the speed with which changes arrived on the global scene.

Concerns were raised that past reports may have suffered “blind spots and biases.” And while grand “isms” like fascism and communism might not be on the horizon, this study noted, previous assessments should have paid greater attention to ideology.

The risk of conflict within a state — like a civil war or an insurgency — is expected to decline in Latin America, but will remain high in sub-Saharan Africa, in parts of the Middle East and South Asia, and in some Asia-Pacific island hot spots, the study warns.

“A more fragmented international system increases the risks” of conflict between states, the study says. “Additionally, increased resource competition, spread of lethal technologies and spillover from regional conflicts increase the potential for interstate conflicts.”

Most worrisome — and already a part of the global security dynamic — is an assessment that future wars in Asia and the Middle East could include nuclear weapons.

Other important demographic trends will be aging populations in Europe, Japan, South Korea and Taiwan, which could slow their economies further. The report warns that Russia’s economy will join those places in experiencing “slow relative declines.” The United States will benefit from its domestic oil and natural gas supplies and new technologies to tap them, allowing the nation to become energy independent and even a net exporter of fuel.

In general, it found, “the health of the global economy increasingly will be linked to how well the developing world does — more so than the traditional West.”

In addition to China, the developing nations that “will become especially important to the global economy” include Brazil, Colombia, India, Indonesia, Nigeria, South Africa and Turkey.

Article source: http://www.nytimes.com/2012/12/11/world/china-to-be-no-1-economy-before-2030-study-says.html?partner=rss&emc=rss

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News Analysis: Downgrade of U.S. Debt Echoes the Nervousness of Global Markets

August 6, 2011 by Leave a Comment

Governments on both sides of the Atlantic have avoided grappling with fundamental problems, counting on renewed growth to help borrowers who cannot afford to pay and creditors who cannot afford to walk away.

But four years into this age of financial contagion, the global economy cannot seem to pick up steam. Every promising leap seems to end with a sickening thud. The easy answers are exhausted, and political leaders face a rising tide of anger that is constraining their ability to make more difficult choices.

S.P. said Friday that it was losing faith in America’s political leaders. After all, the movements of markets are collective predictions of future prosperity, and the continuing sell-off of riskier assets suggests that investors, too, are losing hope.

“Europe’s plan was to have growth fix the problem. America’s plan was to have growth fix the problem. And that’s not going to work,” said Kenneth Rogoff, an economics professor at Harvard. “I think it’s really starting to sink in that we’re not anywhere near an endgame.”

The United States and Europe face parallel debt problems. Here, banks and investors are pitted against homeowners. There, banks and investors are pitted against nations. In both cases, governments have struggled to rebalance their books.

There is no surplus of economic strength to throw at the problem. The United States and Europe ran up great debts in the years of plenty, living well and promising to pay later, even as they made expansive promises to aging populations.

“The restorative forces of the economy are very weak and the immediate forces that will be in place are worsening the problem,” said Joseph E. Stiglitz, an economist at Columbia University. “We already know it’s not going to be a V-shaped recovery. I had said in my book that it would be more of an L-shaped, slow recovery. I think the answer now is a Japan-style malaise.”

The weakness of the American economy is most evident in the lack of jobs. Only 55 percent of working-age adults held full-time jobs in July, the lowest level in modern times. Some 25 million American adults want but cannot find full-time work, the government said Friday. The unemployment rate fell slightly, but mostly because 193,000 people stopped searching for jobs.

Consumer spending makes up 70 percent of the nation’s economic activity, and people without jobs spend less money. For more than a year the government has reported that the economy was expanding more quickly than employment, fueling hope that hiring would follow.

But last week the government said in a new estimate that it was mistaken, and that the economy actually had expanded at an annual rate of only 0.8 percent during the first half of the year — about the rate of population growth.

Falling home prices also shadow the recovery. Total household wealth remains 12 percent below its prerecession peak, according to the Federal Reserve. Consumer spending has not suffered a comparable decline, suggesting that people still see brighter days ahead. If they are wrong or if they lose faith, economists say, spending could dip even more sharply — and with it, the broader economy.

Corporate profits have climbed to record heights, but companies are not hiring. Long-term prosperity depends on investment in research and equipment and workers. But short-term fears are driving a turn toward austerity, said Gary P. Pisano, a professor at Harvard Business School.

“The dynamic that our government has gotten trapped in, companies are trapped in as well,” he said.

Professor Stiglitz said that falling stock prices could exacerbate the problem.

Article source: http://www.nytimes.com/2011/08/07/business/global/standard-poors-downgrade-of-united-states-credit-rating-echoes-nervousness-of-global-markets.html?partner=rss&emc=rss

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