Harvard duo argue that advanced countries will not be able to return to more sustainable levels of debt through austerity and growth
For Carmen Reinhart and Ken Rogoff, 2013 has been a year to forget. The big news in the world of academic economics was that a celebrated and hugely influential paper by the Harvard duo on the link between government debt and growth was wrong. The paper, cited regularly by supporters of austerity programmes, said countries where the national debt was higher than 90% of national output (GDP) could expect to see a marked drop off in growth. On examination, the data used by Reinhart and Rogoff showed there was no such link, with the pair's (many) critics saying that the line of causality lies in the opposite direction: low growth leads to high levels of debt rather than high debt leading to low growth.
R and R continue to churn out papers in their chosen field, the latest of which has just been published by the London-based Centre for Economic Policy Research. The study – Financial and sovereign debt crises: some lessons learned and those forgotten – is no less incendiary than their now infamous "Growth in a time of debt".
Why? Because Reinhart and Rogoff say that if history is any guide countries will not be able to return to more sustainable levels of public debt through a combination of austerity and growth. They cite Europe, where the assumption is that normality can be restored by a combination of belt-tightening, forbearance and rising output, as an example of Panglossian thinking.
"The claim is that advanced countries do not need to apply the standard toolkit used by emerging markets, including debt restructurings, higher inflation, capital controls and significant financial repression. Advanced countries do not resort to such gimmicks, policy makers say."
Historically, this is poppycock according to Reinhart and Rogoff. Rich countries, when faced with high levels of debt in the past have been more than happy to default, inflate away their debts or indulge in financial repression (capping interest rates or putting pressure on savers to lend to the government).
The paper veers close to the contested territory of "Growth in a time of debt" when it says that debt overhangs of the sort affecting advanced countries are typically associated with a sustained period of sub-par growth, lasting two decades or more. That was certainly the case in the aftermath of the first world war, when austerity was much in vogue, but not after the second world war, which was followed by the longest uninterrupted period of growth the west has ever experienced.
It is true, however, that many advanced countries – including Britain and France – welched during the Great Depression on their debts to the United States amassed between 1914 and 1918. After the second world war, financial repression was the weapon of choice for heavily indebted countries. They capped interest payments by keeping interest rates low and used capital controls to prevent money from leaving the country. Given the tight curbs on capital, it is no coincidence that the "financial repression" period of 1945-79 had far fewer crises than earlier or subsequently.
Reinhart and Rogoff say that central government debt is "approaching a two century high" in advanced countries and – even leaving to one side off-balance liabilities such as the cost of paying for ageing populations – and is unlikely to be cured by growth alone. Governments, they say, may need to revert to approaches "that have long been associated with emerging markets and that advanced countries themselves once practised not so long ago."
The reality is that many governments are already doing just that. Financial repression is very much in vogue in the UK and the US, where quantitative easing has been used to drive down long-term interest rates and regulations on the banks have been toughened up. The Japanese government is actively seeking higher inflation while the European Central Bank cut interest rates earlier this month in an attempt to halt the slide towards deflation in the euro zone. An old-fashioned default remains the last taboo, although looking at the debt to GDP levels in Japan, Italy or Greece only the bravest would gamble that it will never happen.
EconomicsEurozone crisisFinancial crisisEuropeAusterityLarry Elliotttheguardian.com © 2013 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds |
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