The worldwide debate over fiscal policy and austerity was turned upside down last week by a paper co-authored by a University of Massachusetts grad student Thomas Herndon and two professors, Michael Ash and Robert Pollin (HAP). The paper uncovered serious calculation in errors in an important paper by Harvard professors Carmen Reinhart and Ken Rogoff (R&R).
The Reinhart and Rogoff paper, “Growth in a Time of Debt,” has been widely cited in policy debates in the United States and around the world as providing the basis for cutting deficits even at a time when the economy is suffering from large amounts of unemployment and interest rates are extraordinarily low. Ordinarily economists would argue that these are exactly the circumstances in which governments should undertake aggressive stimulus measures. Government spending can both boost growth and increase employment in the short-run, and also lead to long-run benefits insofar as the stimulus takes the form of investment in infrastructure, research and development, and education.
The Reinhart and Rogoff paper was used to argue against increased spending because it purports to show that high ratios of debt-to-GDP lead to large falloffs in growth. The implication of the paper is that the United States and other wealthy countries are at debt levels near a tipping point where further increments of debt can lead to decades of slow growth.
The moral of the Reinhart and Rogoff analysis is that we have no choice but to live with the pain of high unemployment and slow growth now, since the eventual cost in terms of a prolonged period of slow growth and high unemployment would be so awful. This is the sort of reasoning behind the austerity plans that are leading to double-digit unemployment across Europe and slow growth and high unemployment in the United States.
The paper by HAP was a body blow to the intellectual foundations for these policies. When corrected, the R&R analysis provides no basis for the concerns about a high debt cliff that they had been pushing for the last three and half years.
Following on this analysis, Arindrajit Dube, another professor at the University of Massachusetts, put out a paper that examined the direction of causality between growth and debt. He found a very strong causal relationship between slow growth and high debt. It turns out that high debt is a very strong predictor of poor growth in the prior three years. However, debt tells us almost nothing about future growth. In other words, R&R got the story backward, weak growth leads to high debt, not the other way around.
It is not an accident that this work came from the University of Massachusetts. The economics department at the UMass stands largely outside of the mainstream of the profession. You would need scuba gear to find it in standard departmental rankings. None of its faculty are fellows at the National Bureau of Economic Research, a credential that is a virtual prerequisite for employment at elite departments.
UMass has followed a different path that is not likely to gain it plaudits from the mainstream of the profession. It owes its current status to a group of progressive faculty, led by Harvard Professor Sam Bowles, who left some of the country’s top departments in the early 1970s to form a progressive department at UMass. While the original group has all since retired or moved on, the department continues to maintain its character as a center for progressive economics. [Disclosure, many of the faculty and grad students at UMass are friends and colleagues.]
As a result, the economists at UMass are less willing to adhere to the norms of the mainstream of the profession. They are more willing to challenge the received wisdom from the top economists in the profession without according them the deference they typically receive from less established economists.
For example, one prominent mainstream liberal economist complained that HAP should have shared their paper with R&R before going public. While it may have been polite to notify R&R of a paper that exposed their calculation errors before sharing it with the world, if R&R had advance notification they would have almost certainly made efforts at damage control to minimize the impact of HAP’s findings.
Economists concerned about their standing in their mainstream of the profession likely would have gone this route. HAP wanted to ensure that their paper would provoke a serious debate about R&R’s case for austerity and were less concerned about professional etiquette.
The fact that departments like UMass exist is incredibly important. The reason we are in this economic crisis is because of the extraordinary conformity of thought among top economists in the years leading up to the collapse of the housing bubble. In the summer of 2005, when all the alarm bells should have ringing at top volume, the Fed devoted its annual meeting of central bankers to an Alan Greenspan retrospective. They debated whether he was in fact the greatest central banker of all time.
The culture of sycophantism might be too deeply ingrained in the economics profession to expect any changes any time soon. For this reason we badly need departments like UMass (the New School, the University of Utah, and University of Missouri-Kansas City are three others that fit this bill, as is Colorado State University, where I spoke last week) to expose the consensus within the profession when it strays too far from reality. The R&R debacle shows clearly the importance of this dissenting voice.
[Note: The full identification of the University of Utah was left out of the original post, as was University of Missouri-Kansas City and Colorado State University. I blame an Excel spreadsheet error for the former.]