Rogoff on Leverage

2 August 2011 at 2:21 pm Peter G. Klein 3 comments

| Peter Klein |

An important point from Ken Rogoff:

Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession.” But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions.

For example, governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation. An analogous approach can be done for countries. For example, rich countries’ voters in Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms.

I don’t agree with all of the discussion, for example Rogoff’s call for price inflation to mitigate the burden on debtors, but this is a big advance over the vulgar Keynesianism that passes for analysis at the New York Times. (See also Peter L.’s post on Rumelt.) The main point is that a recession like the present one is structural, and has nothing do with shibboleths like “insufficient aggregate demand.” I wish Rogoff (here or in his important book with Carmen Reinhart) talked about credit expansion as the source of structural, sectoral imbalances that generate macroeconomic crises.

Entry filed under: - Klein -, Austrian Economics, Bailout / Financial Crisis, Business/Economic History, Public Policy / Political Economy.

A Krugmanian Slasher Flick Warning to My Future Biographers

3 Comments Add your own

1. Jesus Godoy | 2 August 2011 at 7:44 pm

Raghuram Rajan suggests an insightful explanation. The strategies of politician are the key. Rajan (2010). “Fault Lines: How Hidden Fractures Still Threaten the World Economy”
2. Peter Klein | 2 August 2011 at 9:44 pm

Yes, I like the Rajan book. While my analysis would be somewhat different from his, we agree that structural problems, not “greed” or “deregulation,” are at the root of the problem.
3. Michael Marotta | 4 August 2011 at 5:24 am

From Kenneth Rogoff’s Project-Syndicate for Aug. 2, ’11: “I argued that the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years. Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But, at the end of the day, such a transfer is the most direct approach to faster recovery.”

Many errors are enclosed in the above. The implied assumption is that “the” monetary medium is the legal tender of government (central) banks: euros, FRNs, etc. But we know that money is more than this. So, Rogoff is really suggesting that the governments extend themselves more credit, buying up more goods and services.
But, the reality of power-versus-market necessitates that political choices from farm subsidies to wars are malinvestments. Government purchase of a million ballpoint pens and legal pads ultimately prevents the next iPod: it is the problem of the broken window.

“Savers and debtors” is an easy gloss, but like weight versus mass or energy versus matter, those terms are related, not isolated distinctions. Even if debtors borrowed cash to hold in tubs, (or savings were only the penny jars of the employed) double-entry bookkeeping would call the borrowing an asset against the debt. (Debit cash; credit accounts payable.) Penny jars aside, the vast quantity of savings is in the form of loans (bank deposits; equities investments). Loans carry interest which includes the risk of inflation; interest rates would rise, buoyed by that 4-6% inflation.

Repeated historical examples demonstrate that any bank that did not go along would by stronger by contrast, attracting depositors, depressing the values of those other currencies being exchanged. Thus, the Swiss Franc and other currencies are havens. And that is only for currencies. Other hedges include gold of course, and that brings up the problem of those many other forms of moneys not perceived by the non-Hayekians.

Rogoff’s theory, of course, is that with more cash on hand people buy more goods and services, which are replaced by producers, returning us to prosperity. Again the broken window. Producers must replace raw materials and tools at greater costs than the goods sold in the early phase of inflation. Thus, they lose.

And this only affects those producers who already exist. No accounting can show the things that did not happen as a result of these malinvestments and misallocations.

Thirty-five years ago, we called it “stagflation” and the Keynesians wrung their hands wondering what went wrong.

The only solution is to reduce government to those activities that you (you personally, not you deciding for your neighbor) are willing to suffer a deadweight loss to obtain such as rule of law.