With all the heated discussions of the last two weeks, it is important to keep perspective on which issues are in dispute and which are not. Let me state plainly something on which I think we ought to be agreed: Carmen Reinhart and Ken Rogoff’s 2009 book, This Time Is Different: Eight Centuries of Financial Folly, is a valuable work of scholarship that continues to deserve study and praise from any thinking person. Here I review some of my reasons for saying that.
Let me begin by taking us back to early in 2009 when the U.S. economy was plunging deeper into an unusually severe recession. One of the key questions people were asking at the time was, what would the subsequent recovery look like? If you looked just at the U.S. postwar record, you would notice that in recent U.S. history, deep recessions tended to be followed by dramatic recoveries. Here for example is part of a discussion by Professor James Morley published in Macroeconomic Advisers’ Macro Focus on April 27, 2009:
There is a strong historical “snap back” relationship between the strength of economic recovery and the severity of the preceding recession. Thus, recessions and their recoveries have a tendency to trace out a “V” shape. Because the current recession that began at the end of 2007 started out shallow and only recently became deep, a simple time series model of the “snap-back” dynamic implies that the current recession may have a lower-case “v” shape, although the fact that the economy is likely to continue to contract further before a recovery takes hold argues for the possibility of an upper-case “V”.
However (and as the above article also discussed), when one broadens the historical reference set, as Reinhart and Rogoff suggested we should, from 60 years of U.S. data to many hundreds of years of experience of dozens of countries, the outlook for the United States in early 2009 was much less sanguine. Here is what Reinhart and Rogoff wrote in an article that appeared in the Wall Street Journal on February 3, 2009 entitled Expect a Prolonged Slump:
when one compares the U.S. crisis to serious financial crises in developed countries (e.g., Spain 1977, Norway 1987, Finland 1991, Sweden 1991, and Japan 1992), or even to banking crises in major emerging-market economies, the parallels are nothing short of stunning….
Over past crises, the duration of the period of rising unemployment averaged nearly five years, with a mean increase in the unemployment rate of seven percentage points, which would bring the U.S. to double digits.
We now all know how events turned out. The U.S. unemployment rate, which had risen from 4.7% in November 2007 to 7.3% by December 2008, would go on to climb to 10% in October 2009. Even today– 5 years later– the unemployment rate remains at 7.6%, far above its historical average, and above the most recent value reported at the time Reinhart and Rogoff issued their warning.
Here is what Paul Krugman wrote in July 2010, in an article in which he expressed his differences of opinion but began by acknowledging some of the areas in which Reinhart and Rogoff’s research had proved crucial for understanding what had happened to the United States:
Regular readers will know that I’m a huge admirer of Ken’s work, both theoretical and empirical. Obstfeld and Rogoff is the definitive work on New Keynesian open-economy macro; Reinhart and Rogoff the definitive empirical history of financial crises and their aftermath. It was largely thanks to my study of Obstfeld-Rogoff that I realized, from the get-go, that many of the arguments we were hearing about how modern macro had proved Keynesianism wrong were just ignorant; it was largely thanks to my reading of Reinhart-Rogoff that I realized, early in the game, that this was going to be a prolonged slump rather than a V-shaped recovery.
But on other issues, Krugman and others have been slower to be persuaded. Even after publication of their book in 2009, many still seemed susceptible to the latest version of the “this-time-is-different” syndrome, insisting that modern governments would be immune to the kinds of fiscal crises that Reinhart and Rogoff documented had been repeated again and again throughout history. For example, on November 22, 2009 Paul Krugman wrote:
Belgium is politically weak because of the linguistic divide; Italy is politically weak because it’s Italy. If these countries can run up debts of more than 100 percent of GDP without being destroyed by bond vigilantes, so can we.
Again, we now know what happened next. Krugman’s “bond vigilantes” have so far left Belgium and the United States alone, but the yield on 10-year sovereign debt of Italy, Spain, and Portugal (which had all been below 4% at the time Krugman dismissed concerns about Italy), along with Ireland and Greece (below 5% at the time), subsequently spiked up to much higher levels, a development that brought significant hardships for the people in those countries, and whose final ramifications are yet to play out.
Reinhart and Rogoff (2009) summarized their core message on page 292:
All too often, periods of heavy borrowing can take place in a bubble and last for a surprisingly long time. But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked. This time may seem different, but all too often a deeper look shows it is not.
Is this a lesson that any of the statements zapping across the internet over the last two weeks do anything to undermine or dismiss? You could only imagine that the answer might be yes if you’ve just been following the controversy at the level of headlines and soundbites and ignoring analyses of the substance of the controversy. If that’s the case, please get yourself informed by reading this and this. To briefly summarize the facts that you’ll find developed more fully there, some researchers at the University of Massachusetts have challenged one tiny detail of one follow-up study by Reinhart and Rogoff having to do with an issue that I have yet to even mention so far in today’s discussion. That dispute concerns a measure of the correlation between sovereign debt levels and GDP growth. I say it is a tiny detail, because the dispute is completely restricted to just one of six different summaries of three different data sets in that one particular paper. The Massachusetts researchers correctly noted that there is an error in the spreadsheet which, if corrected, would have changed the number Reinhart and Rogoff should have reported for that one statistic by a few tenths of a percent. Bigger changes in that one statistic could be obtained if one adds some additional data and makes what I regard as a questionable change in methodology, but even with all the changes they want to make, the results preferred by the University of Massachusetts researchers are in fact very similar to the other 5 dataset summaries that will be found in Reinhart and Rogoff’s original paper, as well as a subsequent analysis of expanded data that Reinhart and Rogoff published in 2012 (which again the Massachusetts scholars did not mention or discuss).
So how does any of that cause us to discount or dismiss the contributions of This Time Is Different? You tell me.