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Kenneth Rogoff
Published: Sunday 3 June 2012
The debt-ceiling absolutists grossly underestimate the massive adjustment costs of a self-imposed “sudden stop” in debt finance.

Austerity and Debt Realism

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Many, if not all, of the world’s most pressing macroeconomic problems relate to the massive overhang of all forms of debt. In Europe, a toxic combination of public, bank, and external debt in the periphery threatens to unhinge the eurozone. Across the Atlantic, a standoff between the Democrats, the Tea Party, and old-school Republicans has produced extraordinary uncertainty about how the United States will close its 8%-of-GDP government deficit over the long term. Japan, meanwhile is running a 10%-of-GDP budget deficit, even as growing cohorts of new retirees turn from buying Japanese bonds to selling them.

Aside from wringing their hands, what should governments be doing? One extreme is the simplistic Keynesian remedy that assumes that government deficits don’t matter when the economy is in deep recession; indeed, the bigger the better. At the opposite extreme are the debt-ceiling absolutists who want governments to start balancing their budgets tomorrow (if not yesterday). Both are dangerously facile.

The debt-ceiling absolutists grossly underestimate the massive adjustment costs of a self-imposed “sudden stop” in debt finance. Such costs are precisely why impecunious countries such as Greece face massive social and economic displacement when financial markets lose confidence and capital flows suddenly dry up.

Follow Project Syndicate on Facebook or Twitter. For more from Kenneth Rogoff, click here.

Of course, there is an appealing logic to saying that governments should have to balance their budgets just like the rest of us; unfortunately, it is not so simple. Governments typically have myriad ongoing expenditure commitments related to basic services such as national defense, infrastructure projects, education, and health care, not to mention to retirees. No government can just walk away from these responsibilities overnight.

When US President Ronald Reagan took office on January 20, 1981, he retroactively rescinded all civil-service job offers extended by the government during the two and a half months between his election and the inauguration. The signal that he intended to slow down government spending was a powerful one, but the immediate effect on the budget was negligible. Of course, a government can also close a budget gap by raising taxes, but any sudden shift can significantly magnify the distortions that taxes cause.

If the debt-ceiling absolutists are naïve, so, too, are simplistic Keynesians. They see lingering post-financial-crisis unemployment as a compelling justification for much more aggressive fiscal expansion, even in countries already running massive deficits, such as the US and the United Kingdom. People who disagree with them are said to favor “austerity” at a time when hyper-low interest rates mean that governments can borrow for almost nothing.

But who is being naïve? It is quite right to argue that governments should aim only to balance their budgets over the business cycle, running surpluses during booms and deficits when economic activity is weak. But it is wrong to think that massive accumulation of debt is a free lunch.

In a series of academic papers with Carmen Reinhart – including, most recently, joint work with Vincent Reinhart (“Debt Overhangs: Past and Present”) – we find that very high debt levels of 90% of GDP are a long-term secular drag on economic growth that often lasts for two decades or more. The cumulative costs can be stunning. The average high-debt episodes since 1800 last 23 years and are associated with a growth rate more than one percentage point below the rate typical for periods of lower debt levels. That is, after a quarter-century of high debt, income can be 25% lower than it would have been at normal growth rates.

Of course, there is two-way feedback between debt and growth, but normal recessions last only a year and cannot explain a two-decade period of malaise. The drag on growth is more likely to come from the eventual need for the government to raise taxes, as well as from lower investment spending. So, yes, government spending provides a short-term boost, but there is a trade-off with long-run secular decline.

It is sobering to note that almost half of high-debt episodes since 1800 are associated with low or normal real (inflation-adjusted) interest rates. Japan’s slow growth and low interest rates over the past two decades are emblematic. Moreover, carrying a huge debt burden runs the risk that global interest rates will rise in the future, even absent a Greek-style meltdown. This is particularly the case today, when, after sustained massive “quantitative easing” by major central banks, many governments have exceptionally short maturity structures for their debt. Thus, they run the risk that a spike in interest rates would feed back relatively quickly into higher borrowing costs.

With many of today’s advanced economies near or approaching the 90%-of-GDP level that loosely marks high-debt periods, expanding today’s already large deficits is a risky proposition, not the cost-free strategy that simplistic Keynesians advocate. I will focus in the coming months on the related problems of high private debt and external debts, and I will also return to the theme of why this is a time when elevated inflation is not so naïve. Above all, voters and politicians must beware of seductively simple approaches to today’s debt problems.


per year
Bush I-------625,000
Bush II------375,000

Democrats = 10.100,000
Republican = 5.883,000

Rogoff needs to expand his

Rogoff needs to expand his economic understanding to how we got here in the first place and quit trying to sell this official take on economics, which is a cover for how the system really operates for the plutocracy. At least that is what he appears to be doing in this set up for the future articles announced here.

The problem is a debt based monetary system based on fractional reserve banking practices where the bankers control the quantity of money and who gets or doesn't get credit, and all for their own profiteering. Everyone and everything included, especially governments who borrow from private bankers when they could from their own bank at low rates with the profits from this bank owed to the government itself.

Anyone reading this gobblygook has just wasted some of the time alotted for their life.

Well put. The debt created by

Well put. The debt created by post 9/11 spending spiraled us into 62 trillion in debt. Add up what the nation spent on war, what the banks lent to everyone else, what they gambled with at their house table, and what they left in disarray for someone else to clean up.

When a 12 year old can express the need for public banking, a government backed by it's own money and an end to indebtedness to a system that has run 99% off the tracks to prosperity with its fractional reserve banking, then it is high time for us to get the message out.

Our incumbent is sleeping with the spawn of Rockefeller, Morgan and the Rothschilds. Every president who ever challenged the banks didn't finish their term, except Jackson, but only because they missed. The challenger would simply say you are fired and file bankruptcy.

dear hill took your advice

dear hill took your advice --Hoover tried to combat the ensuing Great Depression with volunteer efforts, public works projects such as the Hoover Dam, an increase in the top tax bracket from 25% to 63%, and increases in corporate taxes. These initiatives did not produce economic recovery

Well, OK. I'll agree with

Well, OK. I'll agree with some of what you say, but I think you are missing the key points. Sure debt matters. Unlike families and businesses, governments are not required to support their debt with assets. The only criteria is their ability to handle the debt service. Today the US debt load is about equivilant to 100% of GDP. That is very high. But the debt service is only about 3% of GDP. Not too bad for now. So the need is to put people to work so as to generate payrolls and thereby disposable income for folks to use to buy things they need or want. That gets manufacturers busy making stuff and distributors working moving all that stuff to stores and retailers selling it, etc., etc., etc.. It also generates lots of tax revenue. But the idea is not to make this a permenant situation, it is only a temporary means to get things rolling. Once the system is rolling along on it's own, than the government needs to back out and start using the additional tax revenues to begin retiring the debt it built up getting there. Prime example: From 1940 to 1945, due to the war effort, the US money supply quadruptled. The consumer was out of the game as all efforts were to win the war. The only consumer was Uncle Sam. But once the war was won, all that stimulus took hold and produced 30 years of unpresidented economic growth. As for the nations debt; it only seems to be important when Democrats are in power. The day Mr. Obama was sworn in the GOP started screaming about all the terrible debt the country faced. While only a few years earlier Vice Pres. Cheney told us that the debt didn't matter. So which is it? Then there are the Clinton years. By controlling spending in a booming economy the country found itself with a budget surplus in '98, '99 & 2000. Money which should have been used to pay down the debt. Instead, President Bush decided it would be better to give it back to the taxpayers. Then to add insult to injury, he had congress pass 2 huge tax cuts which benefitted mostly on those who pay the most tax so that the nations debt grew larger. Add 2 wars fought off budget and a perscription drug plan for seniors which is designed to benefit the drug companies and the insurance companies even more than seniors and you send the debt into the stratisphere. What is really going on here is that the arguements put forth by the right are fictious, designed to convince people that black is white, that up is down that what is false is somehow true. And you must admit that they are very, very good at it. But then there is "the google." OOPS!

Larronm, Your analysis is

Larronm, Your analysis is what we're all supposed to believe. Sorry, but it need not be this way. Running through your comment is the question of debt. Over 97% of our money is created as debt. If all debts to the private bankers were to be paid off we would in fact extinguish the money supply except for a very small percentage. Don't take my word for it...go to You Tube and watch "The Secret of Oz." You'll be amazed at what you will learn....

"Of course, there is two-way

"Of course, there is two-way feedback between debt and growth, but normal recessions last only a year and cannot explain a two-decade period of malaise."

What CAN explain the two-decades and counting final demise of the industrial-growth, debt as money, fossil fueled experiment of the last couple of centuries is the fact that we've hit the limits of a finite Planet.

By over-exploiting natural resources while polluting the web of life that feeds us, by pretending that the "Economy" rules nature instead of the other way around, by buying into the nonsensical myths of "dominion over the Earth" we have planted the seeds of Planet Death...

Tinker all you like with the microcosm you describe in this article, it ain't gonna' do you any damn good...

Steady state local economies, powering down, relocalization, reskilling and decreasing the 5 billion human overshoot (preferably naturally with empowerment of women and birth control of all kinds on demand) is the only way to survive the coming Long Emergency.

Time for massive public works

Time for massive public works projects rebuilding infrastructure giving unemployed people paychecks. It helps tax bases and creates demand for manufacturers of consumer goods.

Austerity gives us another Great Depression -- study Herbert Hoover and 1930s American History.

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