Tuesday, December 27, 2011

A Stronger Argument is Needed

In Debt and Growth in the G7, Paul Krugman writes: "I’ve written fairly often about the often-cited Reinhart/Rogoff claim that terrible things happen to economic growth if the ratio of debt to GDP exceeds 90 percent. It’s a claim that has been pretty thoroughly debunked," he says, linking back to his own stuff.

PK shows a graph of

the debt/GDP ratios of the G7 countries since 1946, together with a line representing the famous 90 percent threshold. What do we see? The answer is that the >90 club consists of the English-speaking nations in the immediate aftermath of World War II, Britain for a longer postwar stretch, Italy since the late 80s, Japan since the mid-90s, and a couple of years in Canada.

I would call his tone dismissive. Krugman notes the occasions when the ratio was over 90, but does not dwell on the problematic aspects of those occasions. Fair enough. His point is that debt above the 90% level isn't a problem. But he does not make a strong argument. He notes the facts and dismisses them.

Krugman provides one paragraph in defense of his view, and a summary line:

The English-speaking economies contracted in the years immediately after the war, not because of debt, but because Rosie the Riveter went back to being a housewife. Italy and Japan both experienced sharp growth slowdowns before their debt went so high, and you can make a strong case that slow growth caused high debt, not the other way around.

So this really looks like a case of spurious correlation...

The "Rosie the Riveter" line could be developed into an argument about an economy dealing with major changes due to the ending of a major war, but Krugman doesn't bother. Nor does he explain why the (presumably brief) contraction after the war was brief, nor why it was immediately followed by a golden age of economic growth. Here again, this could be a strong argument.

And as for Italy and Japan, PK says "you can make a strong case that slow growth caused high debt" (my emphasis). But Krugman does not make that case, either.

1. Krugman does not make clear that his discussion excludes private debt.
2. He dismisses claims that 90% is a problematic level for debt.
3. He admits there was a contraction after the war and provides an explanation but no evidence to support it.
4. He fails to point out the 25 years of superb growth that followed the brief contraction, and fails to show how this growth occurred despite (or perhaps because of) the high level of debt.
5. He fails to make the one "strong case" that he says can be made. And what is Krugman's strong case? "Slow growth caused high debt". Even if PK made this case, it would be a weak argument.

When you leave private debt out of the picture, it is difficult to show that private debt is the cause of the slow growth that "caused high debt".

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