There were three posts yesterday. The first was “The Non-Secret Of Our Non-Success:”
Chris Giles of the FT reports that central bankers are worried that they are “flying blind”; he quotes Lorenzo Bibi-Smaghi, formerly of the ECB governing board, saying “We don’t fully understand what is happening in advanced economies.”
Um, guys, that’s because you don’t want to understand. Nothing about our current situation, except maybe the absence of outright deflation, is at all surprising or mysterious.
We had a huge financial crisis, and the combination of a housing bust (on both sides of the Atlantic) and an overhang of household debt (also on both sides) has acted as a drag on private demand. Monetary policy quickly found itself up against the zero lower bound, while fiscal policy, after providing some stimulus, soon turned strongly contractionary. Here’s real primary (non-interest) spending, from the IMF’s latest World Economic Outlook, with the blue lines representing the historical average in recessions and aftermath, the red lines representing current policies:
It was obvious both from history and from textbook economics that the turn toward austerity would greatly damage prospects for recovery; this isn’t hindsight. But many central bankers and other officials chose to ignore all that and place their faith in the confidence fairy instead. So now that it has all gone wrong, they throw up their hands and say that it’s a mystery — how could this happen?
No mystery, guys; you messed up.
The next post of the day was “The Good Glitch:”
I’ve been cynical about the likelihood that the Reinhart-Rogoff fiasco would lead to any real change in policy, and I still have doubts. But reflecting on the debate so far, I’m wondering a bit if I have been too cynical — or at any rate, cynical in the wrong way. For my vague, unquantifiable sense is that the debacle is changing the conversation quite a lot, even among the guys in suits. And it was the coding error that did it.
Now, the truth is that the coding error isn’t the biggest story; in terms of the economics, the real point is that R-R’s results were never at all robust, both because the apparent relationship between debt and growth is fairly weak and because the correlation clearly goes at least partly the other way. But economists have been making these points for years, to no avail. It took the shock of an outright, embarrassing error to shake the faith of the Very Serious People in a result they really wanted to believe.
The point is that the next time Olli Rehn, or George Osborne, or Paul Ryan declares, sententiously, that we must have austerity because serious economists (i.e., not Krugman and friends) tell us that debt is a terrible thing, people in the audience will snicker — which they should have been doing all along, but now it has become socially acceptable.
Will this translate into actual policy changes? Well, Keynes told us that ideas, not vested interests, are dangerous for good or evil; so maybe, just maybe, that coding error will turn out to have been a real force for good.
The last post of the day was “Other Austerity Bloopers:”
While the Reinhart-Rogoff fiasco is fresh in our minds, it’s worth recalling the other paper that swept through the ranks of the VSPs, briefly becoming orthodoxy, what everyone knew, until people took a hard look at the data. Remember Alesina and Ardagna? That was the paper that supposedly showed that spending cuts were actually expansionary, because of Confidence (TM). It was so influential that Peter Coy at BusinessWeek wrote,
Alberto Alesina is a new favourite among fiscal hawks…This is Alesina’s hour. In April (2010) in Madrid, he told the European Union’s economic and finance ministers that “large, credible and decisive” spending cuts to rescue budget deficits have frequently been followed by economic growth. He was…influential enough to be cited in the official communiqué of the EU finance minister’s meeting
It was also cited by everyone from Paul Ryan to George Osborne, more or less reproduced verbatim in the ECB monthly report, paraphrased by Jean-Claude Trichet, and so on.
But the IMF took a hard look (pdf) at the alleged evidence, and found it wanting. A-A (beware of papers where both authors have the same initial?) used a statistical technique that was supposed to identify episodes of large fiscal contraction; but if you compared that estimate with actual policy changes, it bore very little relationship.
What seems to have been going on was that the statistical filter was picking up extraneous effects, often correlated with good economic developments. For example, a stock market boom would increase revenue, reducing the deficit; A-A would count this as a contractionary fiscal policy, and marvel at the expansion that followed.
Mike Konczal, who co-authored another careful critique, wrote
To be frank, when I dug into the Alesina and Ardagna paper and finally understood the work their 1.5% primary deficit reduction was doing I wandered around stunned for a day or two. I called a bunch of people I trusted on macroeconomics and tried to see if I was missing something; was our elite discourse, the Sensible People Stuff, really being driven by this?
The point, as with Reinhart-Rogoff, was that the paper told austerity-minded people what they wanted to hear, and they seized on its message without carefully examining the underlying research.
Now, A-A didn’t crash-land the way R-R did, because it didn’t contain anything as easily ridiculed as the Excel error. Instead, it was damaged by the IMF study, and thereafter got gradually discredited as the disastrous results of austerity in Europe became apparent. So there wasn’t a sudden moment of realizing that the emperor wore no clothes. Nonetheless, the underlying story, of dubious research put on a pedestal because it was what the VSPs wanted, was the same.