These days, international newspapers and magazines are full with the detection that one of the internationally most influential threshold numbers of the last year, Reinhard’s and Rogoff’s finding that a government debt ratio of more than 90% of GDP will slow down growth significantly (below zero), as based on a faulty handling of the data. Not only the British government, but EU Commissioner Rehn, plus a plethora of international policy makers had cited this 2010 finding as their basic argument that austerity policies were necessary to escape from the 5-year-long depression. And, Reinhard and Rogoff are not just anybody. Both renowned Harvard professors, Rogoff for several years the chief economist of the IMF and policy adviser to many US presidents. So, once again, a “magic number” has been debunked as basis for sound economic policy making.
But what about other “magic numbers”, e.g. the “Maastricht criteria” as the main driving force of EU economic policy making, the 2% inflation target by the ECB and the Bank of England, and other such simple guideposts?
All of these, also Reinhard/Rogoff’s are not based on any theory, but they are “convenient” guideposts, sometimes developed by economists, at the behest of politicians who are loath to contemplate Churchill’s desire to meet a one-armed economist, since all the ones he knew constantly said “one the one hand….on the other hand”. So it is the interaction of –frequently willing- economists with their politicians that leads to simplified policy conclusions, not backed by tested theory. Politicians love to put it all into one number, frequently without realizing the intricacies involved in calculating or estimating this number. Which politician knows or wants to know about national income accounting, the imputations, assumptions and generalizations involved in calculating GDP? No, the are happy to proclaim that an increase in GDP at the second digit behind the comma, e.g. from 1.65% to 1.67% is “growth”, of course due to their own beneficial economic policies.
So, what is the result of the Reinhard/Rogoff “scandal”, which not only is based on wrong numbers, but also on a causality which they themselves – at least in their book – do not establish: is a high debt ratio over 90% the cause of slow growth, or its result? We all know that when we have a fraction, debt divided by GDP, that when debt stays constant and GDP falls, the debt ratio increases. This is a mathematical relationship, not a causal one – but EU, UK and German (among others) policy makers maintain steadfastly that we need to cut the deficits and thus debt ratios, in order to revitalize growth.
Do they now stand corrected and reverse their depressing insistence on austerity? Well, no, even though EU authorities have given Greece, Ireland and Portugal a little more time to reach a balanced budget, but they stay with their pernicious and outdated model of “cutting the deficit” as the panacea towards growth. Even the rating agencies, normally the paragons of fiscal rectitude, have last week downgraded the UK again, because growth is not coming and a triple-dip recession is occurring; even the staunchly orthodox IMF is imploring Britain and Germany and others to relax their austerity stance. But neither of them is proposing a reversal of a policy whose ineffectiveness in achieving its self-proclaimed targets (cutting the debt ratio) we see every day when we look at the non-existent growth and the sky-rocketing unemployment figures.
The hope that loose monetary policy – which certainly up to now has prevented an even deeper recession – alone can lead to recovery, has disappeared. (Japan, with its promise to double its monetary base within 2 years is the exception). The intended policy mix of loose monetary policy with austerity fiscal policy is not working, in Europe this failure is reinforced by the fact that the banking sector has not been cleaned up, that each country attempts to save its own banks by subsidizing and recapitalizing non-viable banks.
It is high time that industrialized countries’ policy makers, especially those in the EU, reverse course and stimulate growth with guided investments in infrastructure, in energy conservation, in climate change, in addition to education, R&D and innovation. The tardiness in the EU to complete the banking union, both with respect to unitary supervision, a joint deposit insurance and a joint bank resolution fund (plus a sovereign bankruptcy mechanism) is damaging the prospects of our future generations. The fact that refinancing costs of “problem governments” are still too high, should speed up plans for Eurobonds, for monetary financing by the ECB, or even the recent proposal to add a clause to government bonds that in case of default they can be used to pay taxes in the respective country (see David Graeber’s proposal in The Guardian of April 22).
Politicians could blame such a policy reversal on a mistake by two eminent economists. The economic profession has been bashed in the past, Reinhard and Rogoff will also survive that. If not, they will have perished for a good cause.