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Home Publications Blogs Beat the Press Reinhart-Rogoff One More Time: Why the 90 Percent Never Should Have Been Taken Seriously

Reinhart-Rogoff One More Time: Why the 90 Percent Never Should Have Been Taken Seriously

Saturday, 11 May 2013 10:09

As a general rule economists are not very good at economics. This is why almost none of them were able to recognize the $8 trillion housing bubble that sank the economy. (No, this isn't bragging, it only took simple arithmetic and basic logic.) Most economists are unable to conceptualize anything that someone with more standing in the profession did not already write about.

This is the only reason that the Reinhart-Rogoff 90 percent debt-to-GDP threshold was ever taken seriously to begin with. The point that I have tried to make in the past, apparently with little success, is that debt is an arbitrary number. It is not something that is relatively fixed, like the age composition of the population or the supply of land.

The country's debt is something that can and often is easily altered through simple steps. In this way the debt-to-GDP ratio can be thought of as something like the color of a house. Suppose Reinhart and Rogoff told us that people who lived in blue houses had 40 percent less income than people who lived in houses painted other colors. Presumably people would be skeptical of the results, but if their finding was really true, then we would probably want to encourage people in blue colored houses to paint them a different color.

In effect, Reinhart and Rogoff were making the same sort of claim about debt and GDP. Let me try to explain this in a way that even an economist can understand it.  

I have often pointed out that the value of long-term debt fluctuates with the interest rate. I didn't think this is a secret, but apparently few economists have followed what happens to bond prices when interest rates change. The point is that the value of our debt will plummet if interest rates rise, as the Congressional Budget Office and other forecasters expect. This means that we could buy back long-term debt issued today at interest rates of less than 2.0 percent for discounts of 30-40 percent. This would sharply reduce our debt-to-GDP ratio at zero cost.

Yes, this is really stupid, but if you believed the Reinhart-Rogoff 90 percent debt cliff, then you believe that we can sharply raise growth rates by buying back long-term bonds at a discount. It's logic folks, it's not a debatable point -- think it through until you understand it. 

The other obvious point is that we can reduce debt by selling off assets. We may not want to sell assets, but if we thought there was some huge growth premium from say, going from a debt-to-GDP ratio of 100 percent to a debt-to-GDP ratio of 80 percent, then we would be foolish not to offload some assets. These assets take a wide variety of forms, including the power to tax.

If that sounds strange, let's pick one that has often been discussed: carbon permits. Suppose we decide to issue carbon permits in a quantity where we expect they will lead to a fee equal to 1.5 percent of GDP from carbon emissions. If we sold off permits to emit carbon over the next two decades, then we could probably raise an amount that is close to 20 percent of GDP.

There are good reasons why we might want to do something like this in any case in order to slow global warming, but if we believed the Reinhart-Rogoff 90 percent curse, then this sale of permits would add more than 1 percentage point to annual growth, making us more than 20 percent richer by 2033. Of course countries that already taxed carbon, like those in the European Union, would not have this option, but Reinhart-Rogoff would put them in the exact same situation.

There are many types of asset sales that could quickly reduce debt-to-GDP ratios in big ways. Some countries have far more ability to make such sales than others because they hold far more assets. Again, if anyone believed the Reinhart-Rogoff story, then we should be looking to such sales, even if they might not otherwise be good policy.

In short, the whole idea of a 90 percent curse is just plain silly and everyone who knows any economics should have recognized this fact immediately. The biggest scandal of the Reinhart-Rogoff affair was not that they initially refused to share their data or their silly spreadsheet errors. The biggest scandal is that something so obviously absurd was ever taken seriously in the first place. 



Since the issue of interest rates and bond prices has been raised in comments and e-mails, I'll quickly clarify the point. Bonds carry a face value, meaning the amount that will be paid off when they reach maturity. This is what gets entered in our debt figure. However bonds also carry a market price, which fluctuates inversely with interest rates. The longer the term of the bond, the more its price will vary with interest rates. 

If interest rates rise, as just about everyone expects over the next 3-5 years, then the market price of the bonds we have issued in the current low interest rate environment will fall sharply. Since we count our debt at the face value of the bonds, not their market price, we could take advantage of the drop in bond prices to buy up trillions of dollars of bonds at sharp discounts to their face value.

The question is why would we do this, we would still pay the same interest? The answer is that the policy would make no sense for exactly this reason.

However, if we accept the Reinhart-Rogoff 90 percent curse, then reducing our debt in this way could make a great deal of sense. Suppose we can buy back debt with a face value of 60 percent of GDP at two-thirds its face value, or 40 percent of GDP. In our debt accounting we would have reduced our debt-to-GDP ratio by 20 percentage points. If this gets us below the 90 percent threshold then suddenly we can have normal growth again.

This is one of the reasons why a moment's thought should have allowed economists to realize that the Reinhart-Rogoff thesis made no sense. They were telling us that people who live in blue houses earn 40 percent less money. Serious economists should have recognized that this was absurd, even before they were able to get their hands on the spreadsheet.

Comments (14)Add Comment
written by Chris Engel, May 11, 2013 1:03

We've all learned a good lesson from the whole debacle: read CEPR's blogs and reports and pay attention!

Seriously, you were right on housing and skeptical of R&R way before it was hip to do so (also on debunking the myths behind minimum wage, chained CPI -- the list goes on and on).
As a general rule economists are not very good at accountability
written by Sandwichman, May 11, 2013 2:50
The rules of evidence in Anglo-American common law disallow the raising of allegation without a basis in provable fact.

The rules of evidence in Anglo-American economics... well, there are no rules of evidence.

It's hard to think of another field, besides advertising, where assertion trumps analysis with such such impunity. Perhaps "impunity" is too mild a word. There seems to be a smug self-satisfaction in economists' lack of accountability -- as if being "above" accountability was itself a badge of honour. Badges? We don't have to show you any stinking badges!
Lessons I learned from the Reinhart-Rogoff debacle
written by John Wright, May 11, 2013 3:09
Here are some lessons I took away from the R-R incident:

1. Well established academic economists can rely on other academic economists to rush to their defense, even when caught doing sloppy work.

See Larry Summers "Rogoff and Reinhart are rightly regarded as careful, honest scholars."

And Stevensen-Wolfers "Embarrassing? Yes. Important? No."

2. In this day of computer aided design and complicated modeling programs, a small 20 row Excel spreadsheet can be consequential.

Good news for Microsoft and the power of Excel.

3. Even when one is on the faculty of a well regarded university "working" economic papers should be viewed as unverified, particularly when input data is not shared and independently verified.

4. When caught in several embarrassing mistakes, "stay on message" as R-R did in their responses by continuing to assert the conclusion that increasing government debt slows economic growth is still valid.

written by JSeydl, May 11, 2013 5:25
To make matters worse, fiscal sustainability was an important topic that was recently covered in my graduate macro course. And the entire discussion revolved around stabilizing debt-to-GDP ratios.
But wouldn't the amount paid on the Debt Burden stay the same??
written by jumpinjezebel, May 11, 2013 10:53
So would not our actual interest costs stay the same??
more information please
written by keenan, May 12, 2013 5:23
Could somebody please explain in greater detail the idea that the debt will fall precipitously if interest rates rise?

Dean Baker wrote: "The point is that the value of our debt will plummet if interest rates rise.... This means that we could buy back long-term debt issued today at interest rates of less than 2.0 percent for discounts of 30-40 percent."

So how does this discount work? Let's say the government has a debt of 1,000 dollars. If interest rates rise, can the government then buy back this debt for 600 dollars (a 40 percent discount)? How does this work? And why would it be "stupid" to do this?
written by Chris Engel, May 12, 2013 8:47

Read about bond valuation -- when you buy a bond you're purchasing a stream of cash flows at a coupon rate -- and the bond is traded on the market either at a discount or premium that represent the yield of the bond. So, if rates on traded bonds suddenly shoot up, market price of all those bonds outstanding becomes a lot less.

The reason why it's stupid is because mathematically it makes no sense to refinance discounted debt at a higher current market rate just to reduce the notional outstanding debt load. Lowering the face value of outstanding debt just for the sake of reducing it is nonsensical, because the rate burden is equal.

tl;dr Bond prices have an inverse relationship with interest rates -- that's people call the government bond market "a bubble" right now, because rates are zero so the prices are really high relative to the par issuance.
more consequential measures of debt?
written by pjm, May 12, 2013 9:31
Dean, if one wanted to construct a model showing correlation between debt and something else (say growth), either negative or positive, what would make more sense? You have mentioned the interest burden of the debt before, is that a likely candidate. Or do you suspect that the relation of debt to
the macroeconomy, business cylce, etc, is just too contingent on other things?

All of this is highly suggestive that RR either went cherry-picking for a model that would produce a scary debt model or that they has just imbibed so much of the conservative zeitgeist for which government spending is a priori bad that there made just made "common sense".
written by Jeffrey Stewart, May 12, 2013 10:34
"Most economists are unable to conceptualize anything that someone with more standing in the profession did not already write about." -D. Baker

Sheep mentality?

Combine this with the willful ignorance of capitalism's normal, profitable operation in favor of chimerical, sterile, models with no discernible relationship to capitalist reality and what do you have? Neoclassical economics.
written by Ellis, May 12, 2013 11:32
Of course government debt is huge. U.S., state and local debt has to be close to $20 trillion now. That is about 125% of U.S. GDP. On top of that, there is all that private debt: corporate, consumer, etc. This is many times bigger than government debt, yet, economists barely notice this.

All this debt boosts the already monstrous growth of the financial sector, which is sucking the life out of the rest of the economy.

The banks love it, because they grow richer. So, yes, open the floodgates of more debt! That'll do the trick!
Would this anyway amount on assessing a firm's debt-to-earnings?
written by Dennis, May 12, 2013 6:12
I find the proposed insignificance of the debt-to-GDP ratio quite convincing, although even Paul Krugman apparently got into staring at scatter-plots and pondering causality (see http://krugman.blogs.nytimes.c...straw-men/) - I was wondering whether this measures might even be analogous to evaluating the prospects of some firm only based its debt-to-earnings ratio (absurdly disregarding assets, growth prospects, profits, etc.); I have not read the R&R paper, but what macro-specific mechanisms would anyway suggest that debts might have economy-wide implications... ?
Peer Review: Economists and the Rhetoric of Groveling
written by Sandwichman, May 12, 2013 10:22
A follow up to my above comment:

is debt the real problem
written by mel in oregon, May 12, 2013 11:03
Nope, fed debt is nowhere near the problem corporate America wants the center ignorant people to continue believing. The biggest problem? easy the population explosion & resulting wasting of the resources Mother Earth has provided. By 2050 we will have 10 billion people on the planet; there won't be enough food & what's left of usable water to go around. Think that won't lead to nuclear war? Haha, except it's not funny, it's tragic. Pakistan & India are both nuclear nations with millions that will suffer, not that they aren't suffering now. China & Russia won't stand by & watch their people & resources ruined by the radiation fallout. Once they enter, the USA will be in it too. If by some miracle, this doesn't occur, we will still face melting ice caps, meaning far less usable water, more massive hurricanes, many areas that grow crops no longer farmable. Plus we will run out of oil, with no valid alternative at all. We are in for a helluva a mess.
bond behavior
written by keenan, May 13, 2013 6:49
Thank you, Chris Engel, for responding to my query.

By the way, for anyone interested, here's a very clear explanation of why bond prices and interest rates move in opposite directions:


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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.