Attacking Reinhart-Rogoff to revive the spending machine.
Perhaps
you've read that America's debt burden is no longer a problem. Former
White House economist Larry Summers says the U.S. should borrow even
more money today because interest rates are low, and his Keynesian
brethren are busy trying to discredit economists Kenneth Rogoff and
Carmen Reinhart for their famous claim that a country's economic growth
begins to fall when debt hits 90% of GDP. Time for Stimulus 5.0!
The Reinhart-Rogoff duo have admitted a
math error while defending their core argument, though we've never
considered their 90% figure to be dogma. Their main contribution was to
remind politicians amid the post-crisis Keynesian spending blowout that
public debt isn't a free lunch. It has to be repaid, which means a
country must either spend less, tax more, grow faster, repudiate the
debt or inflate it away.
The Keynesians are attacking Reinhart-Rogoff with such vitriol now
precisely so they can rev up the spending engines once again. In their
economic model, more government spending equals more GDP. So governments
must keep spending more no matter what they spend it on.
This
isn't how these columns, or the classical economic models we follow,
think about debt and growth. In our model, every dollar of government
spending has to come from somewhere, which means it is either taxed or
borrowed from the private economy. Thus the crucial issue isn't merely
the level of debt, though at some point that can become a problem. The
important matter is what that additional debt is buying.
The nearby chart shows U.S. federal debt held by the public as a
share of GDP since the beginning of World War II. Debt soared to well
above 100% of GDP during the war, but few thought defeating Hitler and
Tojo was a bad investment. Once victory was attained, the debt ratio
fell rapidly along with government spending. Private growth resumed
despite Keynesian predictions of doom at the time as government spending
fell, and debt as a share of GDP continued its gradual decline.
The next big debt burst came in the 1980s, as the Reagan
Administration sought to break both the Soviets abroad and stagflation
at home. The cure was a tax cut plus more defense spending, which in the
short term led to higher deficits. Even then the peak Reagan deficit
was only 6% of GDP in 1983, compared to President Obama's first term
deficit average of 8.7%.
The key point is that those deficits were buying faster growth and
defense goods such as aircraft carriers that would win the Cold War. As
rapid economic growth returned, deficits and debt both declined. And
when the Soviets surrendered, the Clinton Administration was able to cut
(too rapidly) defense spending to 3% of GDP in 2000 from 4.8% in 1992.
Modest deficits returned as President Bush cut taxes and boosted defense
spending after 9/11. But debt as a share of GDP was still only 40.5% of
GDP as recently as the first recession year of 2008.
Contrast that experience with where we
are today. President Obama's stimulus spree and the mediocre recovery
have doubled the debt to an estimated 76.6% of GDP this year. This is
despite a record tax increase in January. The Administration now says
the debt to GDP ratio will peak in 2014 at 78.2%, but that will be true
only if spending growth slows and economic growth is more rapid.
uters
Harvard Professor and Economist Kenneth Rogoff
One reason to be more worried about
debt now is what we're borrowing to finance. Spending on wars eventually
ends. But today most spending by far goes to social welfare payments
and entitlements that are difficult to reduce. Those payments are only
going to increase as the baby boomers retire, and as ObamaCare takes
effect.
These income transfers spread the wealth but they do nothing to
increase the growth of the economy. To the extent that they are financed
by higher taxes, they retard growth by taking money that would be
invested more productively in the private economy.
Mr. Summers says governments should borrow more now at near-zero
interest rates to invest in future growth. But this is what we were told
in 2009-2010, when Mr. Summers was in the White House, and the $830
billion stimulus was used to finance not primarily roads or bridges but
more unionized teachers, higher transfer payments, and green-energy
projects that have since failed. Why will it be different this time?
Another reason to reduce debt today is to create some breathing room
if we have another recession or an emergency such as a war. At least
going into the 2008 financial panic, the U.S. had room to borrow. The
Obama era has blown out the U.S. balance sheet, and it will take many
years to restore it to that pre-crisis level.
***
Where we agree with at least some Keynesians is that the
main policy goal now should be faster economic growth rather than rapid
debt reduction. Where we disagree is how to promote that growth. The
Keynesians are now using a false choice between "austerity" and growth
to justify more of the government spending they think drives economic
prosperity. The brawl over Reinhart-Rogoff is thus less a serious
economic debate than it is a political exercise to turn more of the
private economy over to government hands.
After five years of trying, we should know this doesn't work. The
real way to promote a stronger economy is more austerity and reform in
government, and fewer restraints on private investment and risk taking.
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