In a second New York Times article Carmen Reinhart and Kenneth Rogoff (RR) have gracefully acknowledged their error and defended themselves from their critics. At issue was their empirical analysis relating debt and growth in advanced economies since 1800. The debate was really about a Microsoft Excel coding error and the statistical distinction between medians and averages. Still, in the larger picture the inverse relationship between debt and growth is unambiguous.
Whether government debts should try to cause growth is an as yet unanswered question. In the economic system we live in where money is supplied by buying and selling government debt, fiscal discipline and austerity are good things but not Victorian chastity belts.
Europe is facing the commonsense choice, in the medium to long run, between commitment to rules-based fiscal discipline a.k.a austerity or fiscal consolidation and Victorian chastity belts. Flouting fiscal discipline now will not only unravel the European project but will require chastity belts later.
America calls the chastity belt fiscal cliff. To this end the 90% national debt-to-gross domestic product (GDP) threshold matters. Beyond that, though coding errors, medians and averages can muddle things up at the margins to the delight of frenzied academics, the essential point is that barring disruptive Schumpetarian outliers such as the Industrial Revolution, any country will face the wrath experienced by Louis XVI in 1789 after the American Revolution. RR should have begun their story in 1789, not 1800. This is why the debt-to-GDP ratio of 60% is an article of faith in the Economic and Monetary Union’s (EMU) binding Maastricht Convergence Criteria, not something Reinhart and Rogoff conjured up more recently. If anything, their argument is a rehash of the Maastricht debt criterion.
The policy inference from RR is that especially beyond the 90% debt-to-GDP ratio pro growth policies which do not use more debt to grow the economy will work.
RR make the point in their article that Japan is a net creditor nation despite its 240% debt-GDP ratio because of its dollar reserves and holdings of US debt but this is where the problem lays: US debt cannot be seen in exclusion of those who hold it. China’s and Japan’s combined US dollar reserves and debt holdings are triggers of the next great cascading financial crisis. A run on US debt by China and Wall Street can lead to a Japanese crisis given its faith in the United States.
United States and Japan are the next crises to come. You ain’t seen nothin’ yet. Perhaps we need a debt-to-GDP criterion in the United States also.