Thursday, 2 May 2013

Comment on Reinhart and Rogoff's FT article

My letter to the FT responds to Ken Rogoff and Carmen Reinhart's opinion piece (2 May):

"In their article 'Austerity is not the only answer to a debt problem', Ken Rogoff and Carmen Reinhart argue:
"the debate needs to be reconnected to the facts. Let us start with one: the ratios of debt to gross domestic product are at historically high levels in many countries, many rising above previous wartime peaks."
 In an effort to reconnect myself with the facts, I consulted Rogoff and Reinhart's own database. Among G7 countries, their statement is false for the UK, US, Canada, France and Italy. They do not have data for Germany or Japan for the World War 2 peak. More importantly, the way that these very high debts were reduced was primarily by growth, not by rapid fiscal consolidation at a time of weak private demand.

Nevertheless, their call for more borrowing for public infrastructure investment, and their recognition that such borrowing can make the public finances more, not less, sustainable is welcome.   Many of us, including of course Martin Wolf in your columns, have been arguing for some time that in the UK with demand weak, interest rates at historically extraordinarily low levels, and a legacy of underinvestment, this is both basic macroeconomics and simple common sense.  The support of Professors Reinhart and Rogoff is welcome. 

Unfortunately, the UK government does not appear to be listening to our advice; despite the much-trumpeted, but very small, additions to capital spending announced recently, public sector net investment over the next five years is planned to average about 1.5 percent of GDP. Three years ago, it was more than twice.  So far, most deficit reduction in the UK has been achieved by cutting public investment.  That was a mistake which should be reversed."

The letter deliberately concentrates on the case for borrowing now to finance investment, where Reinhart and Rogoff have belatedly joined a growing consensus. In the interests of brevity and focus, I omitted a couple of points where their article is simply incoherent, which I will set out here. In particular, they argue that we should be cautious about borrowing because interest rates might rise:
"Unfortunately, ultra-Keynesians are too dismissive of the risk of a rise in real interest rates.No one fully understands why [real interest] rates have fallen so far so fast, and therefore no one can be sure for how long their current low level will be sustained...Economists simply have little idea how long it will be until rates begin to rise. If one accepts that maybe, just maybe, a significant rise in interest rates in the next decade might be a possibility, then plans for an unlimited open-ended surge in debt should give one pause."
Leave aside the silly straw man (repeated elsewhere) that "ultra-Keynesians" want an "unlimited open-ended surge in debt." Who are these "ultras"? Not Martin Wolf and Simon Wren-Lewis in the UK, or Paul Krugman and Brad Delong in the US. And, as Reinhart and Rogoff know perfectly well, of course we think (and hope!) that real interest rates will rise at some stage, when demand and confidence returns and the private sector wants to invest. Bringing that time forward is precisely the objective of the policies we advocate.

The broader point here is that Reinhart and Rogoff seem to have got their logic completely inverted.  At the moment the UK (and US) can borrow very long term at very low or even negative real interest rates; the UK index-linked gilt maturing in 2055 has a real yield below zero.  So what Reinhart and Rogoff are arguing is that we should not lock ourselves into long-term debt at very low real interest rates now, because real interest rates might go back up.  Suffice it to say that if your financial adviser told you not to take out a long-term fixed rate mortgage now, because interest rates might go up next year, you might reasonably doubt her competence. 

As for the reference to Keynes:

"John Maynard Keynes himself wrote How to Pay for the War in 1940 precisely because he was not blasé about large deficits – even in support of a cause as noble as a war of survival."
I am genuinely puzzled as to what point they are trying to make here.  Of course Keynes was worried about the inflationary impact of high deficits during the War, when demand (for both guns and butter) was effectively unlimited, and supply constrained (with full employment and much of the workforce off fighting).  To say the least, that's not where we are now.  It's always a little silly speculating what eminent dead people would do today, but it's hardly difficult to figure out what Keynes' prescription would be when unemployment is far too high and investment too low.  

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