Debunking Reinhart & Rogoff

Few market commentaries have been as widely cited as the Reinhart and Rogoff analysis regarding the fiscal situation on the United States and its imminent debt crisis.  In “This Time Is Different”, Reinhart and Rogoff make a multitude of illogical comparisons when discussing the US financial situation.  In this must read paper, Yeva Nersisyan & L. Randall Wray bust one of the most popularly cited myths of recent years (the paper is an oldie, but a goodie):

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Source: Levy Institute

 

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Can we finally stop talking about these two people now????

Reply 05/20/2011 at 3:11 AM Dodge

Not much new in this paper. To summarize: a country that issues debt in its own currency can avoid a hard default by printing money. Printing money isn’t inflationary when unemployment is high.

Its a pity there’s no mention of the impact of money printing on the value of the currency. If you keep printing, then expect the currency to keep weakening, and for inflation from imports to continue. There’s no free lunch.

Reply 05/20/2011 at 4:14 AM Cullen Roche

Yes, MMTers don’t necessarily reject that high perpetual deficits will lead to inflation. But that’s the important component in this debate. We shouldn’t even be having this whole debt ceiling political charade….policy would take a different approach if we knew how the system worked….

Reply 05/20/2011 at 11:33 AM Thomas Barton, JD

Is this paper reflective of the impact of the Indian and Chinese economies vigorously fighting inflation and its feedback on the US avoiding default by continually driving the dollar lower ? Also how does the enormous Forex market play into this simple scenario analysis ? Does the paper reckon with the alarming weakness in Japan as demonstrated by the frank Panasonic statement today regarding the severe weakness moving through the rest of the year ? These types of papers seem to exist in a semi-serene world where complexity and fighting currents are ignored.

Reply 05/20/2011 at 2:26 PM Joe

where is this “free lunch” critics keep talking about? Whether it’s direct spending or working americans spending more because they keep more of their money, businesses will WORK to produce the goods and services demanded.

Reply 05/20/2011 at 12:00 PM Cullen Roche

Yeah, we should all be askig the 30MM Americans who don’t have a job why they’re having such a hard time finding lunch! According to the Rogoffs of the world the govt has “crowded them out”. Oh yeah, well, if the pvt sector is so crowded out then why won’t they hire all this available talent????

Reply 05/20/2011 at 12:03 PM anders

Dodge: -if printing money helps to avert a depression and stimulate real growth, why should a currency weaken? -surely fx rates are to be explained by CIP theory, PPP or safe haven concepts. I don’t see the mechanism through which money-printing, if non-inflationary, can lead to fx devaluation.

Interestingly, the recent USD decline seems partly driven by the realisation that there is so much spare capacity that rates cannot rise for a long time to come; and partly through the market agreeing with you – erroneously, I believe.

Reply 05/20/2011 at 4:58 AM Dodge

you say “if printing money helps to avert a depression and stimulate real growth”

a big if! I believe there’s a reasonable argument that provided some justification for QE1, which was basically to stop the panic. However, I think that QE2 was a clear mistake, and will only make things worse.

For me the real recovery can only begin when debts have been properly written off and unviable businesses have been allowed to fail.We’ll probably have to go through a depression to reach that point, and we’re nowhere near it now.

Reply 05/20/2011 at 5:44 AM Anders

Dodge – would you reach the same liquidationist conclusion if you felt you were personally at risk of suffering from a huge increase in unemployment?

The alternative to liquidationism is that the monetarily sovereign state assumes the burden of debt from the backs of the private sector, freeing them to grow again. Since the govt can manage its blended interest rate, any level of debt/GDP should be manageable, as long as it is ultimately prepared to print money – and you seem to concede that printing money isn’t necessarily inflationary. What’s the problem?

Reply 05/20/2011 at 6:56 AM Cullen Roche

Are you claiming that QE is money printing? If so, that’s not accurate.

Reply 05/20/2011 at 11:36 AM Cullen Roche

The recent USD decline is really just a function of stronger Euro….People need to start deciphering between inflation and FX changes…..They’re not necessarily the same.

Reply 05/20/2011 at 11:35 AM BlackRaven

Dodge; the point on inflation is important and subtle. We may not see core inflation, or wage inflation (which I think the ECB, Fed and BoE are actually using as the warning sign for an inflation spiral), but import price inflation and a fall in living standards.

The paper holds Galbraith’s Great Crash in very high esteem.

Reply 05/20/2011 at 5:15 AM InvestorX

I know I am going to annoy the MMTers here again, but a question regarding the statement: “When unemployment is high, deficit spending can / should be higher without causing inflation”.

So how does the deficit translate into lower UE? Does it imply govt jobs programmes? These are only efficient if there are some large scale infrastructure projects, etc. Or goes the deficit to private contractors? Then there is no guarantee they will hire more people to do the work. Which is similar to the US situation right now – food stamps work, but otherwise the structural unemployment remains. If you have structural UE, you can boost the deficit as high as you want, UE will not come down. (Ok so far we have not seen much inflation either.)

Reply 05/20/2011 at 5:21 AM Adam

Most of the expansion in the government deficit is just the automatic stabilizers (falling tax revenues and rising unemployment insurance payouts). They are meant to keep the economy from falling further and faster but do not prevent a drop in overall aggregate demand and GDP.

You could achieve a larger deficit and lower UE by expanding aggregate demand and that could come from higher infrastructure spending and or lower taxes (or even a job guarantee program). Anything that boosts domestic spending will grow the economy and create jobs. Ideally the spending (or tax cuts) is targeted in such a fashion to maximize the expansion of the domestic economy – tax cuts to the rich will primarily yield higher savings and little growth. A complete payroll tax holiday would boost the working mans take home pay quite a bit and most of it will be spent.

As for structural UE… it’s mostly a myth. If there is sufficient demand even marginally employable workers eventually get hired. By the beginning of WWII there had been a lot of workers who had been “structurally” UE for about a decade and yet we achieved full employment in short order when aggregate demand was pushed to the max to support the war.

Reply 05/20/2011 at 6:52 AM Read Full Article »