Tuesday, May 7, 2013

Don't Jump to Conclusions

Though economists often expect
Their proposals be put in effect,
It's best if one will
Just hold off until
The model's been triply checked.

It seems as though tout le monde économique is still abuzz over Reinhart, Rogoff and the buggy spreadsheet that powered their argument against national over-indebtedness. As we previously noted in rhyme, Harvard economists Carmen Reinhart and Kenneth Rogoff sold many US and UK fiscal austerity advocates on the idea that public debt levels above 90% of GDP would doom a nation to a no-growth economy. Along came Thomas Herndon, an economics graduate student at the University of Massachusetts in Amherst, who tried to replicate the Harvard professors' results and found that, when their Excel spreadsheet model was corrected, the expected growth rate at 90%+ debt/GDP was more like 2%; not great, but not flat either.

As the shouting and schadenfreude attending Mr. Herndon's discovery is simmering down, economic heavyweight Larry Summers has weighed in with some sober reflections on the meaning of the R&R cause célèbre. First, says Dr. Summers, "authors and journals and commentators need to devote more effort to replicating significant results before broadcasting them widely. More generally, no important policy conclusion should ever be based solely on a single statistical result." Second, those who join in policy debates should remember that, as in the investment world, past performance does not guarantee future results. Just because, for example, housing prices have risen for forty years does not mean they will continue to do so. Lastly:
While there may be no threshold beyond which debt automatically becomes catastrophic, and while the British and American experiences are both suggesting that fiscal contraction in a slack economy where interest rates are near zero is inimical to growth, it is a grave mistake to suppose that the debt can or should be accumulated with abandon.
In other words, while now is not the time for reckless debt reduction, neither is it the time for reckless disregard of our future solvency.

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