John Kenneth Galbraith memorably put down his fellow economist
The same observation might be made of Carmen Reinhart and
Since the publication in 2011 of their bestselling book, This Time Is Different, and their subsequent research on the relationship between debt and growth, the professors have left no doubt that they believe the data show there is a 90 per cent threshold of debt to gross domestic product beyond which economic growth declines rapidly. Many policy makers have interpreted this rule as a call to reduce debt to below that level for the sake of growth. Reinhart and Rogoff have thus become the intellectual godmother and godfather of austerity.
To see their enormous influence on the European debate, it is worth quoting an extract from a speech by
The Reinhart and Rogoff thesis, as it is understood by policy makers, incorporates two separate myths. The first is the existence of the 90 per cent threshold. The second is about causality.
The first was debunked last week by
For the policy discussion, this point is hugely important. It pulls apart the notion of 90 per cent as some magic number - which European policy makers now obsess about, just as they used to about annual budget deficits not exceeding 3 per cent of GDP, for which there was no theoretical basis.
The reduction of everything to a single number was followed by an exaggeration of the impact. Causation could go from high debt to low growth, as the authors suggest; or the other way round; or in both directions. Or the relation might be spurious. Or something altogether different might cause both. If causality is the other way round, the story is much less exciting for someone who peddles economic policies. You might as well say: people are poor because they have no money. If your growth is negative, your debt ratio rises for the simple reason that it is expressed in terms of nominal GDP.
Statistics cannot tell you which causes what. For that you need a theory. But macroeconomists have no theory about optimal debt levels. The only known answer is that it depends - on real interest rates, on growth, on the type of economy, the exchange rate regime, and many other factors.
Unlike Reinhart and Rogoff, Friedman did have a theory when he pushed monetarism in the late 1960s and the 1970s. There were no fat-finger errors in the 1960s equivalent of an Excel spreadsheet. He had solid empirical evidence. The theory subsequently failed, but one can understand why central bankers bought into it at the time. The 90 per cent rule, by comparison, is unbelievably flimsy. And even though it has been refuted, it will continue to shape the policy debate for a while.
As for Reinhart and Rogoff, I suspect that they, too, will be mostly remembered for the fact that their policies have been tried.
Copyright The Financial Times 2013.