Rogoff on debt, growth, and the return of the New Consensus

Professor Rogoff has written an unusually angry letter to the New York Review of Books in response to Trevor Jackson’s critical review of his recent book, Our Dollar, Your Problem. It seems that someone never had a bad review before. Rogoff seems particularly offended that the reviewer did not sufficiently appreciate the success of his book or its favorable reception elsewhere (boo hoo).

But the substance matters more. Rogoff returns to the old argument that very high legacy debt weighs on growth. He acknowledges that the infamous 2010 Reinhart-Rogoff paper contained “one mistake,” but insists that the error did not affect the later and more complete work, which reached the same conclusion. He also argues that high debt may limit a government’s capacity to respond to financial crises, pandemics, and wars. Finally, he complains that progressive economists who once believed in a fiscal “free lunch” are now walking back their views because of the post-pandemic rise in inflation and interest rates.

The first problem is that the 2010 result was not a trivial early-stage slip. The Herndon, Ash, and Pollin replication found selective exclusion of available data, coding errors, and an inappropriate weighting procedure. Correcting those problems changed the alleged result dramatically. For the postwar sample, countries with debt ratios above 90 percent of GDP had averaged growth of 2.2 percent, rather than the minus 0.1 percent reported by Reinhart and Rogoff. More importantly, there was no robust historical cliff at the supposedly fateful 90 percent threshold.

That mattered because the paper was not merely an academic exercise. It became a central intellectual prop for post-2008 austerity. It was cited by US and European officials eager to defend smaller fiscal packages, and to present fiscal retrenchment as a matter of arithmetic rather than of class politics. The notion was that public debt above a certain level produces stagnation, so governments must tighten their belts even in the aftermath of a financial crash. That was always bad economics and worse policy.

Even the IMF later concluded that there was no magic threshold. Growth rates (that reduce the burden of debt), interest rates (that determine the growth of previous debt), currency denomination (never discussed), and the political limits of state action (often related to class issues) are the real issues. A country that issues debt in its own currency and has a central bank willing to act as the fiscal agent of the Treasury is in a radically different position from one that borrows in foreign currency or, as in the eurozone, lacks a genuine lender of last resort and unified fiscal policy.

Note that Rogoff does not discuss the distinction between debt in domestic and foreign currency. The relevant issue is not a universal public debt-to-GDP ratio in domestic currency that slows down growth. The issue is, for most countries, whether they have an external constraint and need debt in foreign currency. Hegemonic countries with the key currency don't face that constraint.

This is hardly a novel insight. Britain’s eighteenth-century experience should be enough to make anyone wary of universal debt thresholds. British public debt rose through the century and reached roughly 260 percent of GDP after the Napoleonic Wars. Yet that debt did not bankrupt Britain. It happened as the Industrial Revolution was underway (perhaps a coincidence). It financed war, helped sustain a powerful fiscal-military state, and formed part of the historical conditions under which Britain industrialized and became the dominant global power. The question, as I argued years ago, is not the size of debt in the abstract, but how it is used and how it is funded. Deficits that create employment, build infrastructure, expand public services, and increase productive capacity are not equivalent to deficits that rescue banks, subsidize rentiers, or finance tax cuts for the wealthy. Functional finance begins from that elementary point.

Rogoff’s invocation of the post-pandemic inflation episode is revealing. The issue is whether inflation and higher interest rates prove that the return of fiscal restraint was necessary, as he seems to think. To be clear; they do not. The pandemic inflation was shaped by supply disruptions, energy shocks, and bottlenecks. It was not a straightforward result of excess demand generated by government deficits, even if government spending did maintain demand and allowed for a fast recovery (that was the point, BTW). What Rogoff’s language reveals is the return of the New Consensus. In this view, inflation is presumed to the result of excessive demand, and higher rates restore discipline. In this context, fiscal policy must once again be constrained by fear of debt.

That was precisely the framework that made austerity appear reasonable after the Global Financial Crisis and the European Debt Crisis. The return of inflation anxiety now performs a similar ideological function. It allows the old argument to be revived in a new form. For Rogoff and the defenders of the old New Consensus, governments spent too much, public debt is dangerous, and the space for public action must therefore be narrowed. The danger is not simply that this misreads the causes of recent inflation. It is that it prepares the ground for the next round of fiscal restraint when public investment, housing, infrastructure, climate policy, and social protection are badly needed.

There is one final issue. From Rogoff’s letter alone (since I haven't read this great book that is immensely popular and everyone liked but Mr. Jackson), his argument about the dollar appears problematic. He emphasizes the forces that might weaken dollar dominance, including the weaponization of finance, fiscal policy, and threats to Federal Reserve independence. A confidence argument. The overuse of sanctions, to the extent that it leads to the search for alternatives, might be a real source of pressure, the others are more doubtful.

What he does not say is that there are also powerful reasons to expect continuity of dollar hegemony. The dollar is  not sustained by confidence in US market-oriented policies and rule of law abiding institutions, but by deep Treasury markets, a global payment infrastructure, and its correspondent banking and legal jurisdiction, which, in turn, rest upon American military power. The dollar system is resilient, as I noted recently, precisely because it is embedded in a broader fiscal-military architecture. That does not make it eternal. It does mean that predictions of imminent decline are exaggerated. Predicting catastrophe might sell books, but is often poor scholarship.

Ken Rogoff on Milei and the IMF

 

Another Excel... ent work*

This is from a few weeks ago, but only now I had some time to post about it. Ken Rogoff has been doing the rounds of podcasts, after the publication of his most recent book, Our Dollar, Your Problem. He was on Ezra Klein, where he claimed basically that Bernie is as bad as Trump on trade (essentially saying that Biden, that had moved in the direction of Bernie is as bad too; good for Klein that he pushed back on that point). More on that in another post.

He was also on Tyler Cowen's podcast were he discussed, very briefly, the Argentina case. Here a short clip.

Here is the transcript of that bit of the conversation.

COWEN: Is Milei going to make it succeed in Argentina? What does it depend upon?

ROGOFF: I hope so. I think he’s the best chance that Argentina’s had in a long time, which is, fair to say, a very low bar. The thing that he’s done that I have not seen before is balancing the budget. If you’re a big borrower and you keep defaulting, a starting point is figuring out how not to have to borrow money, and he’s managed to do that. I don’t know that all his libertarian visions necessarily will come to pass, but he’s provided some stability, bringing inflation down.

It’s so sad. Argentina, as you know, was one of the richest countries in the world by any measure at the turn of the 20th century in 1900. Now they’re a lower middle-income country. Their per capita income is below Brazil, which is hard to get your head wrapped around. I think there are many reasons, but certainly Peronism, socialism has not done well by Argentina.

COWEN: But has he balanced the budget? I know he announced a balanced budget, but this is April 2025, and they just borrowed $20 million from the IMF. It doesn’t sound like a very balanced budget.

ROGOFF: It’s counting the interest payments on the IMF, and yes, he inherited this big debt. They’re paying the interest. It’s very low interest on the big debt, and I don’t know how that’s ultimately going to get resolved. They have a lot of problems ahead, but there’s a lot of strength in Argentina if they can grow again. I don’t want to sound Panglossian about Argentina, but goodness, they had inflation of 200 percent when he took over. The economy was in free fall. Look, there’s no magic wand you can wave over the last 80, 90 years of Argentina and make everything right.

A few things, that I think are important to contextualize, in particular given the relevance of Rogoff, who was the chief economist at the IMF, and whose textbook, co-authored with Maurice Obstefeld, another ex-chief economist at the IMF, is one of the main graduate texts for international macroeconomics.

First, the notion here is that the problem was fiscal in nature, and the debt in domestic currency is what matters. Of course that is NOT a problem. Inflation was not caused by monetary emissions, and neither was Milei's stabilization. In fact, the IMF first, by forcing a devaluation while Massa was still the minister, and candidate, and then Milei in December of 2023 accelerated inflation. He only managed to stabilize prices so far, because he has held the exchange rate under control, and that has led to many complaints that the real exchange rate is overvalued (that's a topic for another discussion). The fiscal adjustment caused the recession in 2024. That is on Milei, as well as the initial collapse of real wages.

Second, Argentina was never a developed country. It did have a high level of income per capita, but that is true of Saudi Arabia now. Petro-States and Beef-States are not necessarily developed, even if some people might be very wealthy. Peronism (which cannot really be considered socialism) did not cause a decline, not only because there was no glorious past in which the country was developed, but also because it was not in power all the time. There were periods of industrialization with conservative-authoritarian regimes, like Ongania in the 1960s, that did not align with the liberalism that Rogoff seems to prefer.

In fact, Prebisch, the father of the intellectual defense of state-led, import substitution industrialization, was a well-known anti-Peronist, and supported the 1955 coup.

Finally, it is true that Milei inherited a large external debt in dollars, and no significant reserves in the central bank. But that debt was accumulated during the Macri administration, an ally of sorts of Milei, under the same economic team (both Caputo and Sturzenegger were in both governments). This was not caused by the excesses of Peronism (read the Kirchners), but by the excesses of neoliberalism.

I have my issues with the implied notion that laissez faire, both in the US, and even more so in the periphery, is a rational strategy for development. On this Rogoff seems out of sink with the times, that have rediscovered industrial policy, and state-led growth. And I also think that Milei can, in particular with the help of the IMF, hold exchange rates for a while (even longer if external markets help him) and ride a reelection as Menem did in the 1990s. But then things will eventually crash.

* On the Reinhart and Rogoff affair read the piece by Cassidy in the New Yorker.

Can Trumponomics work?

Work for whom?

That's what Martin Sandbu (subscription required) asks in the Financial Times. In his view, it might. He cites Ken Rogoff -- of spreadsheet fame -- who also has said that it's a possibility. Sandbu cites Summers doubts on Trumponomics, which are all based on supply side factors, but has very little to say about that.* Like Rogoff, Sandbu thinks that what matters is private investment that matters, meaning demand, and, as it must be in these cases, the confidence fairy makes an appearance. In his words:

"What matters, of course, is whether business investment will increase under a Trump economic policy. If it does, it could be because regulations are made business-friendly, because fiscal stimulus boosts aggregate demand and expectations of future demand growth, simply because there is something about Trump that changes the "animal spirits" of investors and business decision makers."

Keynes' animal spirits, also valued by New Keynesians, become relevant. However, the really relevant stuff in there is the fiscal stimulus and how much in terms of actual spending rather than tax cuts for the wealthy, and on what he will spend (e.g. infrastructure). On that, by the way, Trumponomics remains a mystery. But he is right that if: "if a greater fiscal deficit would have boosted growth under a president Hillary Clinton, it should also boost growth under a president Trump."
But the important point Sandbu makes is that:

"Whether greater spending leads to greater (sustained) growth depends on, as Rogoff rightly points out, whether there is much spare capacity in the economy today, or more intriguingly, whether supply capacity itself responds with faster productivity increases in a 'high-pressure economy' of strong demand."

Note that Rogoff only makes the point about spare capacity, and the intriguing idea that the supply constraint responds to demand is Sandbu's own. In other words, he argues that some sort of Kaldor-Verdoorn Law might be at work in the economy. And yes, that's absolutely right.

So can it work? Sure, but for whom is the important question you should ask. And it will be for the few? A boost to infrastructure spending would certainly help, and even military spending (and I'm not discussing the foreign policy implications of a Trump presidency), which is the way the US promotes industrial policy, might stimulate growth. But I would expect after his choices for the economic positions in the cabinet, including his last very anti-union Labor Secretary (and his twitter rant against the Carrier union leader) that the benefits will not be very well distributed.

* Rogoff thinks the economy is not growing less because of secular stagnation, as Summers, meaning it's not a permanent supply-side problem (negative natural rate of interest, or whatever version of the argument you prefer), but the result of debt overhang (more on this for a later post).

Not even the IMF believes in Reinhart and Rogoff debt limits

From the intro to a new paper by two economists from the research department at the IMF:

"Influential papers such as Reinhart and Rogoff (2010) and Reinhart, Reinhart, and Rogoff (2012) argue that there is a threshold effect: when debt in advanced economies exceeds 90 percent of GDP there is an associated dramatic worsening of growth outcomes. Others dispute the notion that there is such a clear threshold and suggest that it is weak growth that causes high debt rather than high debt that causes weak growth (Panizza and Presbitero, 2012; Herndon, Ash, and Pollin, 2013). Using a new approach we found little evidence that there is any particular debt ratio above which growth falls sharply."

Not that there was much of a debate at this point. 

Economists and austerity errors

By Srinivas Raghavendra

Sir, – The famously infamous spreadsheet error by economists Carmen Reinhart and Kenneth Rogoff (Martin Wolf, Business, April 24th) and the subsequent debate on austerity has rightly or wrongly brought forth one important issue: the sensitivity of techniques, tools and methods that economists use to analyse economic data have immense consequences for economic policy.

The Massachusetts economists’ study that replicated the original Reinhart and Rogoff’s paper argues that in addition to the coding error they have also uncovered a non-standard weighting scheme and selective exclusion of available data, and they show that taking all these into account leads to the conclusion that the average GDP growth for countries with public-debt-to-GDP ratio of over 90 per cent is actually 2.2 per cent and not -0.1 per cent as estimated by Reinhart and Rogoff.

Read the rest here.

Who's afraid of foreign public debt?

Ricardo Hausmann decided to get his two cents on the public debt debate started by the Reinhart and Rogoff debacle. Hausmann was a famous defender of dollarization (see here his instructions for implementation, because, you know, it's a no brainer; you can go here to see his predictions that emerging markets will no longer have national currencies, since they cannot borrow long term in their own currencies) in the past, when he was the chief economist at the Inter-American Development Bank, and was for it in Argentina, Ecuador and other places.

Coming from Venezuela, Hausmann knows that foreign debt and domestic debt should not be mixed. He fudges the issue and does not explicitly says that public debt in national currency is not a problem (and that you cannot default on a currency you print), but he does say that: "The level of debt does matter, and its currency composition matters even more." In other words, foreign denominated debt does matter, since a government cannot monetize a foreign denominated debt. The level that matters is the foreign one, that is, the composition. That's all, and actually this points out a significant problem in Reinhart and Rogoff's work, which does not distinguish carefully enough between foreign and domestic denominated debt.

Note that the examples given by Hausmann of countries were high public debt became problematic ("Mexico in 1994, Russia in 1998, Ecuador in 1999, Argentina in 2001, Uruguay in 2002, the Dominican Republic in 2003, and even the UK in 1976") are all in countries which debt was denominated in foreign currency (dollars for the most part). His explanation that Spain could not pursue expansionary fiscal policy, because as deficits increased interest rates also increased, misses the point that Spain debt is in Euros, and the European Central Bank (ECB) has been, for the most part, unwilling to buy enough Spanish bonds to keep their interest rates low.*

So his conclusion that you must be an Austerian in a boom in order to be able to be a Keynesian in the crisis is plain wrong. Like his defense of dollarization (which he later retracted, and suggested a plan B for Argentina). The principle that debt in domestic currency is not problematic is fine, but his defense of austerity in the face of a recession for certain situations is just plain wrong. Hopefully he will change his principles on this subject too.

* Interestingly enough Spain is like a dollarized country, something he defended in the past.

Should the AER retract Reinhart and Rogoff's paper?

The case of Dutch social psychologist Diederik Stapel fraud, now in the news, which led to the retraction of several of his papers by academic journals suggests that this might be the right course of action for the American Economic Review (AER). Even if Reinhart and Rogoff's (RR) results do not necessarily amount to fraud, something that I'm sure could become a matter of dispute, it's still a fact that they are incorrect, as admitted by the authors. So the AER should clear the record and retract the paper that suggests that growth collapses when a country has a debt-to-GDP ratio of more than 90%.

PS: As the NYTimes notes there is a blog about scientific papers that are retracted here. The blog dealt with RR case here.

Rogaine and Braveheart on Austerity

More on the Reinhart and Rogoff debacle. It says a lot about the state of mainstream economics.

Does High Public Debt Consistently Stifle Economic Growth?

Thomas Herndon, Michael Ash and Robert Pollin show in this new paper that the studies by Carmen Reinhart and Kenneth Rogoff which correlate national debt-to-GDP ratios over 90% with sharp declines in growth are not correct. They find that when properly calculated, meaning using the full data set not just part of it, the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90% is actually 2.2 percent, not -0.1 percent as published in Reinhart and Rogoff (RR). That is, contrary to RR, average GDP growth at public debt/GDP ratios over 90% is not dramatically different than when debt/GDP ratios are lower. Reinhart and Rogoff claim the mistake resulted from a technical error involving a spreadsheet, and say that they “do not, however, believe this regrettable slip affects in any significant way the central message of the paper.” You would think that growing at 2.2% rather than a recession of 0.1% would make them think that their results are incorrect.

Not so fast, the premature recovery problem

There is a certain brouhaha about the speed of the recovery. John Taylor says financial crises do not lead to slow recoveries (also Michael Bordo here). On the other hand, Krugman (and also Reinhart and Rogoff here) say that slow recoveries from financial crises are the norm. At stake, obviously, whether Romney is right and Obama is at fault for the slow recovery. Don't get me wrong, I would tend to agree that recoveries are relatively slow after a financial crisis, since deleveraging is a slow process.

Yet, that is not the main issue about this debate. The point is that ALL involved agree that the system has a natural (automatic) tendency to move back to the trend. Bordo refers nicely to Friedman's 'plucking' model. He reminds us, how it works:

"Friedman imagined the U.S. economy as a string attached to an upward sloping board, with the board representing the underlying long-run growth rate. A recession, in this view, was a downward pluck on the string; the recovery was when the string snapped back. The greater the pluck, the faster the bounce back to trend."

So the deeper the recession was, the faster would the recovery be. In other words, for the GOP economists (Taylor in this case) Obama is aborting holding back the economy and precluding what should be a premature or fast recovery. However, the point the critics make is that debt deleveraging makes the recovery slow, but it is more or less automatic anyway. Government is necessary to speed up something that markets, if they weren't imperfect, would do.

Krugman ideas are based on a recent paper on what he called the Fisher-Minsky-Koo model. Steve Keen has provided a full critique of a previous version here (h/t Lord Keynes who also provides an invaluable bibliography on debt deflations here). The essential point that generates an imperfection in the case of Krugman's model is that an external shock (a Wile E. Coyote moment in his terms, since agents finally notice the floor is gone) brings down the natural rate of interest, which becomes negative for a while (see my discussion on Krugman and the natural rate here). In that case, monetary stimulus is not capable of getting the economy naturally back on track, since the interest rate cannot fall below zero, and as a result agents cannot increase consumption enough to bring full employment automatically.

Hence, in the New Keynesian model of debt-deflation the change from more conventional neoclassical models is that they allow for a sudden (and exogenous) reduction in the debt limit that agents can borrow to reduce the natural rate. It's a financial shock (not a real one) that makes the rate of interest that would equilibrate investment with full employment savings (the inverse of consumption) negative. Agents suddenly understand that they would need a negative interest rate to satisfy their intertemporal consumption plans. From a post-Keynesian (I prefer classical-Keynesian but who cares), the problems are not related at all with the natural rate (yes the capital debates have shown that this makes no sense, where did I read that before?). So deleveraging has a direct effect on the ability of consumers to spend, and there would be no automatic bounce back if the equilibrium rate was not negative.

You may think it is a minor issue, and from a policy point of view it certainly the differences are minor. However, note that the New Keynesian version of the recovery suggests that markets are fundamentally, in the long run, efficient (again against logic and evidence) which is an essential totemic myth that they need to preserve.* And that has policy implications. Recoveries from financial crises are slow, as Krugman says, but not because the natural rate is negative. It is a political problem that involves class conflict. It is because agents that cannot consume out of wages (which have stagnated) cannot borrow themselves out of the crisis, and the federal government, the only one that can, will not do it for political reasons (to keep workers demands in line). That's why heterodox economists are not just for expansionary fiscal policy (and don't think that if the Fed signals more inflation investment confidence will pick up), but argue for higher wages, stronger unions, and debt relief.

* Let alone the funny thing that both sides in this dispute are basically arguing that the economy gravitates around a trend that is exogenous and attracts the actual economy (in a stronger or weaker way), and the way they actually measure the gravitational center (the natural trend) is by averaging the actual rates.

PS: And no, it's not a joke, they do actually sell that T-shirt!

I know, I know, I should be grading (or working on my diss), but c'mon Mr. President, 400K jobs a month!

A 1932 Low cartoon via Luke Ashworth via Worthwhile Canadian Initiative.

I promise I am grading, but Ken Rogoff was just sounding like a total idiot (sorry, nothing pejorative intended for those who truly deserve our support) arguing (need I even add badly?) with Paul Krugman on Fareed Zakaria's GPS. So I can't help myself.

We do need to do whatever possible to shake this President out of his torpor. Here is the beginning of a campaign I just posted on Economist's View, and will be posting wherever there are smart readers. Quoting

"C'mon Mr. President!!! 400,000 jobs a month. Private, public, we need them all. If Plouffe and Daley disagree, tell them to get with the program.

Listen to your economists, present and former. Romer in particular is showing the right brand of spunk ... watch her Bill Maher appearance... and has the economics right. Sperling has both the politics and the economics right. 400,000 pragmatic jobs a month. Hell or high water. You're the President. C'mon.
Here's just one of many links to Romer (this one from HuffPo):
Send the kids out of the room."
I am actually beginning to like Christy Romer in spite of past peccadilloes.
Ok, back to grading, but not before I pose a related question: How is that austerity thing going after the riots this week Mr. Prime Minister Cameron?

Rogoff on the euro and common currencies



Ken Rogoff wrote a peculiar op-ed (subscription required) on the euro.  He correctly points out that the euro is very close to breaking up, and that the alternative would be to "deepen into a fiscal union."  His comment on what exactly the fiscal union would mean is criptic.  He says that the euro would fail "because European leaders are constitutionally incapable of making tough decisions on how to trim periphery debt burdens."  Does he mean that the fiscal adjustments imposed on the periphery are not tought enough? Or is he favoring a renegotiation of the debts, admiting that they cannot be paid?  It seems that his options are either more fiscal adjustment or default.

Default could be an option, don't get me wrong, in particular, because the ECB is not going to monetize the debt of the periphery.  But the interesting thing is that, either way, he does not even consider that the debts in the periphery are in euros, and the ECB can actually print euros.  And I won't explain again why that shouldn't be a problem (like in the US; read more here).  The 'debt' problem in Europe is only a problem, because the ECB allowed a domestic debt, in which there is no default, to become an external debt problem.

Rogoff also muses about the possibility of a common North American currency bloc "possibly extending to include a significant part of Latin America."  I would assume that he does not mean a common currency, or votes in a common central bank, but just dollarization.  Or is the former chief economist of the IMF suggesting that the US will reliquinsh its own currency? Not very likely!

He concludes, in very conventional fashion that:

"Having a smaller number of currencies is a phenomenon that makes a lot of sense economically, economising on transactions' costs and leveraging economies of scale.  The real questions is whether common currency is sustainable politically."

In other words, the economics would be fine, but it is the lack of political will to make tough decisions as he said before, that make the euro unsustainable.  This is nonesense.  Common territorrial currencies are not important because they reduce transaction costs, and that is not the reason why they appeared.  Territorial currencies appear because a strong State can enforce the use of particular token to promote domestic expansion (in general of a particular class), and guarantee the secure functioning of the financial system (to fund the State) providing a default free asset.

At this juncture the problem of the euro is an economic one.  The countries in the periphery eliminated one instrument to deal with their external problems (current account deficits), and are forced into adjustment for that reason.  No amount of political will would solve that under the conventional logic according to which monetization of debt is inflationary.  At a deeper level common curreencies are always a political project, and once political unity exists  there is no economic problem with having a common currency, because fiscal transfers allow for subnational units to avoid default, and the federal government becomes responsible for fiscal policy.

This is not the story of weak and corrupt politicians destroying the good functioning of the market economy; this is a story of haywire markets forcing politicians to do terrible things. Some politicians wanted to do this terrible things even in the absence of the euro (see the fiscal adjustment in the UK, for example).  Shame on them for doing it, but shame on economists for pushing this sort of intellectual drivel.