Reinhart and Rogoff’s 90 Percent Fiscal Cliff: It’s Academic When You Count All the Liabilities
Krugman and others have been doing a victory dance, claiming that the Reinhart-Rogoff work on the relationship between debt and growth has been repudiated. Hardly. The R&R spreadsheet error (but I repeat myself) is embarrassing, but of minor consequence. The other criticisms leveled by Thomas Herndon, Michael Ash and Robert Pollin are matters of judgment and interpretation, not definitive error.
James Hamilton has a balanced overview, as do Betsy Stevenson and Justin Wolfers. Matthew Klein dissects the matter of New Zealand, which proves pivotal in the analysis.
Not surprisingly, Niall Ferguson is quite scathing in his criticism of Krugman’s gloating. Ferguson just points out the obvious. There is a limit to debt, and accumulation of too much debt leads to either default or inflation. You can’t borrow a trillion (or about 6 percent of GDP) forever, or even for a modest period, without coming a cropper.
The most interesting part of Ferguson’s analysis draws an analogy I’ve used before: between governments and Enron. (And Niall is nice, not pointing out that Krugman took Enron’s checks as an “advisor.”) What do they have in common? Hiding huge liabilities off balance sheet. Well, that’s not really correct. Governments don’t have proper balance sheets. “Government accounting” is something of an oxymoron. But in the main, the point holds. The debt that was on Enron’s books was only a fraction of its actual liabilities, and the official debt of the US government (and most governments, for that matter) is only a fraction of its (and their) actual liabilities. Indeed, Medicare, Social Security, loan guarantees, and so on are so large compared to official debt that the US government makes Ken Lay and Jeff Skilling and Andy Fastow look like petty grifters.
So debating whether debt greater than 90 percent of GDP results in a substantial reduction in growth is really a sideshow. The US is around that level now (somewhat over it when all government debt is counted, somewhat under it when only debt in public hands is)-but when you tote up only Treasury bonds, notes, and bills. When you add it the off-balance sheet items, 90 percent looks like the epitome of prudence and thrift.
Of course the government has off-balance sheet assets too-like its taxing power. How do you value that? (Which is perhaps one of the reasons governments don’t keep formal balance sheets.) But that taxing power is not unlimited. What’s more, due to the deadweight costs of taxation, it is precisely using that “asset” that can be a drag on growth.
All in all, though, when you consider the true state of US government finances and count all the liabilities, the academic debate over whether there is a growth threshold when debt hits 90 percent of GDP appears, well, academic.
[…] May 1st, 2013 Rogoff and Reinhardt: Krugman does a victory […]
Pingback by Breakfast Links | Points and Figures — May 1, 2013 @ 6:05 am
Interesting stuff, Professor, on a subject I’ve been researching.
https://blogs.ucl.ac.uk/resilience/2013/03/11/the-myth-of-debt/
Enron were able to conceal liabilities ‘off-balance sheet’ because they went beyond the Twin Peaks of modern finance capital – ie interest-bearing debt and joint stock company equity – into the twilight zone of Prepay. There’s nothing new about prepay, of course: it’s just that it has been forgotten, although as you’ll know, the Russians these days are using little else.
For hundreds of years prepayment of taxes – in the form of the tally stick ‘stock’ which gave rise to the expressions ‘tax return’ and ‘rate of return’ – was how UK sovereigns funded themselves until the (then private) Bank of England came along to intermediate between Treasury and Taxpayer.
That’s where the government accounting got hazy, and later came to obscure the accounting reality of the relationship between banks and government. The point being that government – unlike Enron – does not, by definition, have any ‘equity’.
But the truth is that it does: just not equity has we know it, Jim. We are accustomed to calling the national equity the national debt while Treasury Bills and Bonds are to all intents and purposes dated interest-bearing preference shares in US Inc, and dollars are equivalent to non interest-bearing redeemable preference shares in US Inc.
In relation to fiat money issuance there is no banking counter-party relationship between Treasury and Federal Reserve Bank. The Fed creates fiat money as fiscal agent of the Fed and a Fed credit equates to a Treasury credit. A US Treasury Note and a Federal Reserve Note spend exactly the same and are functionally equivalent.
Where the Fed refers to ‘liabilities’ this obscures the fact that an undated ownership claim/liability over productive assets is diametrically opposite to a dated debt claim/liability.
As for deadweight costs of taxation, I think it was Milton Friedman who argued that the most efficient tax (in terms of the absence of deadweight costs)is a tax on land rental values.
I agree. I think that taxation of earned income should be minimal and that to the extent tax is needed at all then it should fall on the economic rent from privileges such as use of land and non-renewable resources, IP, and limited liability.
With a fair and rational tax system the ‘liabilities’ to which you refer could be routinely met.
Comment by Chris Cook — May 1, 2013 @ 5:18 pm
@Chris. Thanks for that. Yes, we want non-distorting taxes. And taxes on true rents are non-distorting. It was Henry George (back in the 19th century) who advocated “single tax” on land. Adam Smith had also argued for such a tax:
I am skeptical whether IP and limited liability are analogous to unimproved land.
[…] Reinhart And Rogoff’s 90 Percent Fiscal Cliff: It’s Academic When You Count All The Liab… at Streetwise Professor Reinhart and Rogoff’s work on the relationship between debt and growth has recently come under scrutiny, after a significant “spreadsheet” error was discovered. In this article, Craig Pirrong discusses his thoughts on the error, highlighting what he thinks are the most important takeaways from the research. […]
Pingback by 7 Articles ETF Investors Must Read: 5/1 | ETF Database — May 2, 2013 @ 7:02 am