David Wessel, IMF Economists’ Surprising Advice on Federal Debt: Don’t Worry About It Wall Street Juornal 06/02/2015
Katie Allen, A more radical approach to debt: do nothing The Guardian 06/02/2015
Anna Yukhanonov, IMF economists say some countries can 'just live with' high debt Reuters 06/02/2015
The paper itself is When Should Public Debt Be Reduced? by Jonathan D. Ostry, Atish R. Ghosh, and Raphael Espinoza IMF Staff Discussion Note June 2015.
Ostry et al note, "What constitutes a safe level of debt (or ample fiscal space ...) is, needless to say, very difficult to pin down precisely in practice, and can never be established through some mechanical rule or threshold."
This is a major caution around discussion of the right or proper debt level. The infamous notion that 90% of GDP is some special percentage beyond which national debt should never go should have been thoroughly discredited by now. (Dean Baker, Excel Spreadsheet Error: Lessons from the Reinhart-Rogoff Controversy Truthout 05/27/2013; Peter Coy, FAQ: Reinhart, Rogoff, and the Excel Error That Changed History Bloomberg Business 04/18/2013)
As Dean Baker put it in 2013:
The Reinhart-Rogoff 90 percent cliff was widely accepted policy wisdom for more than three years, which suggests the internal policing in the economics profession is pretty damn weak.Ostry et al draw a vague distinction among three categories:
Of course the more fundamental point that came up in the wake of Excelgate is that Reinhart-Rogoff show nothing about causation. Efforts to examine the direction of causation show that it goes almost entirely from slow growth to high debt (here and here) not from debt to slow growth as is generally implied in the policy debate.
And, those who ever learned accounting would recall that debt is only half of a balance sheet. We would have to consider assets also if we really wanted to tell a story about how debt could impact growth.
These points were made to a large swath of the public not because of the internal policing of the economics profession, but because of an Excel spreadsheet error. For this reason, those who care about honest academic and policy debates should be celebrating the spreadsheet error. If this embarrasses important people in the economics profession, that’s because it is a profession that deserves to be embarrassed.
Stress testing public-sector balance sheets is essential to form judgments at the country level of what constitutes a safe public debt level. It may be helpful to think of debt levels as falling into three zones: a green zone, in which fiscal space is ample; a yellow zone, in which space is positive but sovereign risks are salient; and a red zone, in which fiscal space has run out.Paul Krugman had seen through the faults of the 90%-of-GDP notion that Carmen Reinhart and Kenneth Rogoff had posited even before the infamous spreadsheet error was discovered. In The Excel Depression New York Times 04/18/2013, he wrote:
At the beginning of 2010, two Harvard economists, Carmen Reinhart and Kenneth Rogoff, circulated a paper, “Growth in a Time of Debt,” that purported to identify a critical “threshold,” a tipping point, for government indebtedness. Once debt exceeds 90 percent of gross domestic product, they claimed, economic growth drops off sharply.He explains the objections to accepting their conclusions even before the spreadsheet error was discovered:
Ms. Reinhart and Mr. Rogoff had credibility thanks to a widely admired earlier book on the history of financial crises, and their timing was impeccable. The paper came out just after Greece went into crisis and played right into the desire of many officials to “pivot” from stimulus to austerity. As a result, the paper instantly became famous; it was, and is, surely the most influential economic analysis of recent years. [my emphasis]
As soon as the paper was released, many economists pointed out that a negative correlation between debt and economic performance need not mean that high debt causes low growth. It could just as easily be the other way around, with poor economic performance leading to high debt. Indeed, that’s obviously the case for Japan, which went deep into debt only after its growth collapsed in the early 1990s.See also Krugman's Reinhart And Rogoff Are Not Happy 05/26/2013.
Over time, another problem emerged: Other researchers, using seemingly comparable data on debt and growth, couldn’t replicate the Reinhart-Rogoff results. They typically found some correlation between high debt and slow growth — but nothing that looked like a tipping point at 90 percent or, indeed, any particular level of debt.
And Berkeley's Brad DeLong also weighed in on Accurate and Inaccurate Ways of Portraying the Debt-and-Growth Association 05/26/2015: "We are supposed to be scared of a government-spending program of between 2% and 6% of a year's GDP because we see a causal mechanism at work that would also lower GDP in a decade by 0.01% of GDP? That does not seem to me to compute."
The most urgent sovereign debt problem in the world right now is that of Greece, because of the possibly far-reaching implications of a Greek default. Greece can't repay its current level of debt, which has soared to around 170% of GDP. But Greece doesn't borrow in its own currency, it borrows in euros. So the limitations of a currency zone, and the structural faults of that particularly currency zone, come into play. A similar problem was present in the Argentine financial crisis of 2001-2, because Argentina's currency had been pegged to the US dollar.
Japan, on the other hand, borrows in its own currency and has run debt levels of twice its GDP for years without borrower fears of a possible default driving up its interest rates to any kind of problematic levels. The US borrows in its own currency, which is also the world reserve currency. Under those conditions, a US default is effectively impossible.
Ostry et al make a different sort of argument about advanced economies like the US, which is one of their "green zone" countries. They describe the logic of using public funds to pay down public debts ahead of schedule:
Why do we think that high public debt should be reduced? The main rationale is essentially one of risk management, the desire for additional margins to cope with unanticipated or contingent risks. The option value of lower debt is particularly high if there are risks of catastrophic events (an example would be a financial crisis in which a public backstop is essential), in which the government would need to ramp up borrowing massively (the more so given the political and economic limits to raising taxes sharply in a pinch). If debt is high when such a shock occurs, a heavy penalty may be exacted as sovereign risk premiums rise and, in extreme cases, a shutout from markets would ensue. In other words, debt needs to be reduced today to lower the potential risk of a sovereign crisis tomorrow.They argue a more than plausible point, that in developed countries not facing a fiscal crisis, advance paydown of debt doesn't make good economic sense. Using the public funds that go to debt paydowns to instead stimulate growth would be expected to grow the economy and in doing so reduce the percentage of GDP represented by the outstanding debt.
A second rationale for why high public debt needs to be brought down is the belief that high public debt weighs on economic growth. While causality runs both ways, an important causal channel is taxation: high public debt implies the need to distort economic activity (labor, capital) to service the debt (either through taxation or cuts in productive spending), which dampens economic growth. A reasonable idea is that laying the foundation for sustainable growth requires paying the upfront cost of reducing the debt today. [my emphasis]
The Herbert Hoover/Heinrich Brüning/neoliberal austerity policies so beloved of oligarchs near and far simply denies the logic behind all this in favor of wishful thinking and blind assertions of what is necessary without little or no basis at all in macroeconomics.
But Ostry et al want to hold open the door for application of austerity policies in their "yellow" and "red" zone countries with the debt burden as justification: "For countries with significant risk of fiscal distress, it is unlikely that they could afford to take the chance of going on a borrowing spree, no matter how large the public investment deficiencies."
It's important to note that Ostry et al base their analysis by explicitly excluding "Keynesian demand management and risk of fiscal crisis." While it doesn't mean the analysis is invalid, it does mean that to be useful in formulating macroeconomic policies, both essential macroeconomic fundamentals (including "Keynesian demand management") and concrete debt crisis situations (including the special conditions and structrual faults of the eurozone) have to be taken into account.
A lot of potential austericide mischief can hide behind formulations like this:
Higher debt, as just mentioned, requires higher distortive taxation for servicing. Such taxation is likely to reduce the productivity of labor and capital (factors that are complementary to public capital), meaning that both output and public capital should be lower than in a situation in which there is less public debt. Thus, there are implications of public debt for warranted public investment and, in turn, for the growth path of the economy.And leaving out "Keynesian demand management" considerations allows them to make statements like this, which have no real-world relevance outside of the realities of "Keynesian demand management":
Inherited public debt represents a deadweight burden on the economy, reducing both investment potential and growth prospects. Although the debt may have been incurred for good reasons, for a given stock of public capital, the higher the inherited debt, the poorer the economy (by the present value of the distortionary costs of the taxation needed to service the debt). Efficiency dictates that the larger the inherited debt, and thus the higher the level of taxation, the lower will be both public and private investment, and the lower will be output growth. Higher-debt economies will rationally invest less in public infrastructure than less-indebted economies. [emphasis in original]In fact, despite their seemingly pragmatic and realistic view of debt paydown in developed countries, Ostry et al seem to be advocate something very similar to the flawed and discredited Reinhart-Rogoff "It is a feature of the framework adopted here that higher public debt leads to lower investment, slower transitional growth, and a lower long-run level of output: debt is bad for growth." As the entire discussion over Reinhart-Rogoff and their phony 90% benchmark showed, at the very best the notion that "higher public debt leads to lower investment, slower transitional growth, and a lower long-run level of output" is only a partial truth. But Ostry et al continue in the very next sentence to call it a "clear causality."
This, however, is an important factual observation for both the US and Europe:
The global financial crisis has resulted in sharp increases in advanced-economy public debtIn their conclusion, they formally disavow any direct policy implications of their paper:
ratios, on a scale unprecedented in peace time. ...the deterioration in primary balances [i.e., increased deficits] corresponded mainly to the loss of revenues and the operation of automatic stabilizers during the Great Recession; very little represented discretionary stimulus, and of that, only a small fraction was investment in public infrastructure. Thus, while the accumulation of public debt was generally for good reasons (averting an economic or banking system collapse), the fact remains that most advanced economies have built up large stocks of debt but have little or no more public infrastructure to show for it. [my emphasis]
Advanced economies are facing some of the highest ratios of public debt since World War II. For those countries that are not at imminent risk of losing market access, current policy debates center on the appropriate pace at which to pay down public debt. Those who believe that debt is bad for growth favor a rapid reduction in indebtedness, whereas those who stress Keynesian demand management considerations argue for a measured pace of consolidation, perhaps with a ramping up of public investment while interest rates remain at historic lows. Somewhat lost in this debate is the possibility of simply living with (relatively) high debt, and allowing debt ratios to decline organically through output growth. The purpose of this paper is not to provide direct policy advice, but rather to elicit a debate on whether governments should actively seek to pay down public debt or simply live with high debt.It's notable how they frame the choice: "actively seek to pay down public debt" and "simply live with high debt". That disreputable "Keynesian" notion that wild and crazy characters like Krugman advocate of "a ramping up of public investment while interest rates remain at historic lows" isn't really of interest to them here. But then, their analysis explicitly sets aside those dreary "Keynesian demand management" stuff, aka, basic macroeconomics.
Stan Collander puts emphasis on the good part of the Ostry et al paper (You're Wrong If You Want To Reduce The National Debt Forbes 06/03/2015):
This should be a huge blow to all those (and you know who you are) who perpetually insist that the national debt is a tool of the devil and the federal budget must always reduce or eliminate it. The IMF is saying that those individuals, deficit scold groups and candidates that insist on fixing the debt are just wrong because there’s nothing to be fixed. To the contrary, the spending and taxing policies needed to pay down the debt in most circumstances will do far more damage to the U.S. economy than reducing the borrowing.
The IMF report should be thought of as a public rebuke of those who continually say the federal government must do what families do by balancing their budgets. The IMF is actually saying the federal government should do what homeowners do when their mortgage becomes less of a financial burden because their income increases, not because they have stopped making improvements on the house or paying college tuition to pay off the mortgage faster. As [David] Wessel notes, the IMF says the U.S. and several other countries would be better off if the do what many families do by borrowing “at today’s exceptionally low interest rates and live with their debt but allow the ratio of debt to GDP to decline over time.”