CAMBRIDGE ― Several of my Harvard University colleagues have recently been casualties in the crossfire between fiscal “austerians” and fiscal stimulators. The economists Carmen Reinhart and Kenneth Rogoff have received an astounding amount of press attention since it was discovered that they made a spreadsheet error in a 2010 paper that examined the statistical relationship between debt and growth. They quickly conceded their error.
Soon after, the historian Niall Ferguson ― also at Harvard ― received much flack when, asked to comment on Keynes’ famous phrase, “In the long run we are all dead,” he “suggested that Keynes was perhaps indifferent to the long run because he had no children, and that he had no children because he was gay.” Ferguson, too, quickly apologized.
But Reinhart and Rogoff’s estimates in 2010 had already been superseded by a 2012 paper that they wrote with Vincent Reinhart, which used a more extensive data set that did not contain the error. And “some of Ferguson’s best friends” are gay, while Keynes actually tried to have children.
Clearly, as the austerians’ barricades have weakened under the continuing onslaught of facts (most notably the recessions in Europe, and now Japan’s conversion to expansion), the stimulators have found the missteps of Reinhart/Rogoff and Ferguson to be convenient weapons. But they are the wrong weapons.
Neither controversy bears on the Keynesian claim that under conditions of high unemployment, low inflation, and low interest rates (which hold in rich countries today, as in the 1930’s), fiscal expansion is expansionary and fiscal contraction is contractionary. The Reinhart/Rogoff papers’ basic finding continues to hold up: growth tends to be lower on average among countries with debt/GDP ratios above 90 percent. But that finding, like the policy advice that they offered in the aftermath of the 2008 financial crisis, was not intended to support the proposition that a recession is a good time to undertake fiscal contraction.
The Ferguson controversy is even less relevant, because Keynes’s phrase concerning the long run was not about fiscal policy when he wrote it, and it was not an argument against deferred gratification. Nor was Keynes in favor of uninhibited fiscal stimulus, regardless of economic conditions; rather, he argued that “the boom, not the slump, is the right time for austerity at the Treasury.”
But research by yet another Harvard colleague, Alberto Alesina, does bear much more directly on the proposition that austerity is appropriate under today’s conditions. Alesina’s influential papers with Roberto Perotti in 1995 and 1997, and with Silvia Ardagna in 1998 and 2010 suggested that fiscal contraction is not contractionary, and that it may even be expansionary.
It is true that sometimes a country may have no alternative to fiscal “consolidation,” if its creditors insist on it, as has been the case with Greece and some other eurozone members. But that does not mean austerity is expansionary, especially if the currency cannot depreciate to stimulate exports.
As with Reinhart and Rogoff, the Alesina papers themselves are much more measured in their conclusions than one would think from the claims of some conservative politicians that such academic research finds fiscal austerity to be expansionary in general. Nonetheless, the conclusions seem to leave little room for doubt: “Even major successful adjustments do not seem to have recessionary consequences, on average,” while “several fiscal adjustments have been associated with expansions even in the short run.” Moreover, “spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns.” Most recently, a May 2013 paper with Carlo Favero and Francesco Giavazzi reports that “spending-based adjustments have been associated, on average, with mild and short-lived recessions, in many cases with no recession.”
Alesina’s recent policy advice is that the U.S. should cut spending right away. By contrast, the advice of Reinhart and Rogoff leans more toward financial repression, postponement of fiscal adjustment (trim entitlements in the future, but increase infrastructure spending today), or, in more far-gone cases like Greece, debt restructuring.
A new attack on Alesina’s econometric findings comes from an unlikely source. Perotti, his co-author on two articles, has now recanted, owing to methodological problems (which also affect Alesina’s later papers with Ardagna). Under the dating scheme that they used, the same year can count as a consolidation year, a pre-consolidation year, and a post-consolidation year, and it turns out that some of what they treated as large spending-based consolidations were, in fact, never implemented. Currency devaluation, reduced labor costs, and export stimulus played an important part in any instances of growth (for example, the touted stabilizations of Denmark and Ireland in the 1980’s).
Perotti concludes that “the notion of ‘expansionary fiscal austerity’ in the short run is probably an illusion: a trade-off does seem to exist between fiscal austerity and short-run growth.” As a result, “the fiscal consolidations implemented by several European countries could well aggravate the recession.”
This is a more powerful indictment of the reasoning behind recent attempts to justify spending cuts during a recession than is a spreadsheet error or a flippant remark about Keynes’s sexuality. Neither misstep supported the case for austerity, and reality has been far more damaging to it.
By Jeffrey Frankel
Jeffrey Frankel is professor of capital formation and growth at Harvard University. ― Ed.