Reinhart & Rogoff’s Scary Red Line

One frustrating fact regarding Reinhart & Rogoff’s controversial paper Growth in a Time of Debt — which incidentally was never peer reviewed, even in spite of its publication in the American Economic Review — is that the arbitrary threshold for diminished growth of “above 90%” seems to have no relation whatever with recent events in the United States.

When the financial crisis happened in 2008, and the United States was plunged into deep recession the public debt was actually moderate — higher than the level that Bush inherited in 2000, but less than the level Bill Clinton inherited in 1992. After the crisis, the deficit soared, but as soon as the deficit rose above Reinhart and Rogoff’s red line real growth actually picked up again.


This very much suggests that in this case the soaring debt was a reaction to recession. Lowered growth preceded soaring public debt, not vice verse.

This is a result supported by econometric analysis. Arindrajit Dube finds a much stronger association in Reinhart and Rogoff’s data between a high debt-to-GDP ratio and weak growth in the past three years than between a high debt-to-GDP ratio and weak growth in the following three years, strongly implying that America’s experience of weak growth preceding soaring public debt is the norm not the exception:


Reinhart and Rogoff claim that their empirical study never made any claims about causality, although their 2011 editorial for Bloomberg reads as an exposition for the virtues of austerity:

As public debt in advanced countries reaches levels not seen since the end of World War II, there is considerable debate about the urgency of taming deficits with the aim of stabilizing and ultimately reducing debt as a percentage of gross domestic product.

Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP. Nevertheless, many prominent public intellectuals continue to argue that debt phobia is wildly overblown. Countries such as the U.S., Japan and the U.K. aren’t like Greece, nor does the market treat them as such.

Reinhart and Rogoff’s interpretation, then, is clearly that the debt trajectory itself – as opposed to underlying factors driving the debt trajectory — that is the risk, which is a claim unsupported by their own and other research. But the problem is larger than this.

Other empirical work on debt has focused on a broader range of debt while still following Reinhart and Rogoff in attempting to draw arbitrary danger lines on graphs. Cechetti (2011) attempts to factor in household debt (drawing a danger line at 85% of GDP) and corporate debt (90% of GDP) as well as government debt (85%), implying a cumulative danger line of 260% in total credit market debt:


Total debt seems to have been a more appropriate metric than public debt, because it was in the danger zone when the crisis hit, and after the crisis hit total debt began gradually deleveraging after forty years of steady rises as a percentage of GDP, implying a deep and mechanistic connection. But there is still a lot of room between the crossing of the red line, and the beginning of the deleveraging phase. The red line itself doesn’t tell us anything about the phenomenon of 2008, or the period preceding 1929, where a similar phenomenon occurred, other than implying in a nonspecific way that the rising debt load was becoming unsustainable.

Drawing an arbitrary line on a graph implies that negative effects associated with excessive debt are a linear phenomenon; cross the line, and bad things are more likely to occur. This is an unsophisticated approach. The bursting of debt bubbles is a nonlinear and dynamic process that occurs when credit dries up, and leverage collapses. This specific effect is not tied to any specific nominal debt level, but instead to an unpredictable mixture of market participants’ expectations about the economy, profit taking, default rates, the actions of the central bank, input costs (e.g. energy), geopolitics, etc.

Steve Keen’s modification of Goodwin’s models may be an important step toward a clearer and more mechanistic understanding of the credit cycle and how an economy can be driven into a Minsky Moment.  One of the keys to modelling Minsky’s notion of a credit-driven euphoria giving way to credit contraction, asset price falls and despair is the notion of credit acceleration, the speed at which growth in credit grows. While total credit growth acceleration is clearly a signal of an impending Minsky Moment and debt deflation, drawing scary red thresholds is a fundamentally fruitless exercise, especially in sole regard to government debt levels which do not appear to drive an economy into a Minsky Moment followed by deleveraging and weakened growth and employment.

19 thoughts on “Reinhart & Rogoff’s Scary Red Line

  1. If you eat yourself into obesity, there is no way of telling exactly how your body will revolt, but you know that sooner or later, the devil will collect.

    Debt works the same way.

      • Optimal weight for good health probably varies from individual to individual, but I believe we can assume that obesity is not a longevity inducing state.

        Debt, on the other hand, is theft [by the creditor] of the debtor’s future income. How can that end well?

        • Yes, that is true, and once in a while a slave would kill his master, but …

          I definitely like the new format. Very clean. Perhaps you can put the comments link up at the top?

        • If debt is theft, why did so many people willingly go into it to fund lifestyles better than they could earn, leading to a huge private debt bubble? Victims of theft do not give up their property voluntarily.

          And why is it that those of us who did not go into debt, and saved so that we could have decent pensions when we retire, are amongst those worst hit by the financial collapse? (Private pensions are financed by the rents, interest payments and profits of others, but presumably we were promised results based on the anticipated endless expansion of debt.)

        • Why do people go into debt voluntarily? The same reason they do everything else…desire.

          People do not understand the true nature of value, and of its abstraction, money. This is how “the system” steals from people.

          In this age of information, it is the weapon that has always been used to take advantage of people, ignorance, that allows the elite to accumulate their great wealth.

          Just like Henry Ford said in the early 30’s [and I paraphrase], If the American people found out tonight how the banking system worked, tomorrow morning there would be revolution.

  2. what puzzles me from Dube’s charts is how small the (95%?) corridor is for debt/GDP ~ 30%; granted, the lines become very steep there which always makes things look narrower than they are, but what the graphs seem to be saying is

    whenever debt/GDP was ~ 40% then past growth was between 4-4.25% and future growth was 3.5-3.75% (just eyeballing the number, but you get the point- the corridor is surprisingly narrow at this level)

      • my point is – I somehow cant believe that the range of possible growth scenarios is so narrow; there should be a much wider dispersion – unless you essentially have no data (say, two data points) there is no way that 95% of the values lie in a range 0.25% wide

  3. What we have here is a giant screw that needs to be properly driven in order to solve our fiscal and economic woes. But, we’re told that we only have hammers [and, of course, we all know that hammers do a really poor job of driving screws], so instead of acknowledging that a hammer is only going to create a temporary fix [at best], the debate centers around exactly what type of hammer is best for doing the job.

    The idea that another tool exists [a screwdriver] is beyond the scope of the debate, as this will actually do the job correctly. Even the alternative community is fixated on hammers, some liking this type, some the other, but few are willing to put the idea of hammers down, while picking up a screwdriver and finally fixing this problem properly.

  4. I never went into debt, never had a loan. I found that once I saved up for something I changed my mind about it. Now I buy nothing except essentials. We only need food clothing and shelter. I still have my first car! 399,000 kms! Part of it was financed form aluminium cans collected as a kid. Boy did I research that first purchase.

    Maybe if the government saved up, it would change its mind about spending it.

    Now that people have to save more, they are finding they don’t need that bigger house or newer car. Monetary expansionism is basically like adding petrol to a fire, a big burst of flames, then the fire burns out quicker.

    Imagine if people did not take on so much debt, how much disposable income would be saved for other things, even donations to medical causes. We have the new car but die from cancer??

    • Imagine if there was ZERO debt. How reasonable would prices be then?

      Debt is simply a method of spending future income on the consumption side, while making people pay dearly for this “privilege” on the other.

      Debt allows for massive wealth accumulation to which destroys every attempt at socializing wealth production through sound money, as well as gutting any attempt at properly social investment [utilities, etc.].

      Debt is like a very beautiful woman who is more than happy to completely give herself to you for as long as you can legally commit to pay for her maintenance [which is, of course, unlimited :].

  5. The problem is the economy has become too reliant on recycled taxes. Government taxes too much and has to spend to keep the economy going. This is socialism. Europe the home of socialism is showing symptoms. Russia, the home of Communism died.

    Provided people have food clothing and shelter, life will go on. Maybe they will have more time to pursue leisure pursuits. Austerity is not a dirty word. It is like taking medicine for a disease (Socialism) it tastes yuck, but you get better.

    I just hope that legislation that increases red tape is repealed. Until then, business won’t take risks to expand, innovate. I bet a flying car would not be invented in today’s regulatory environment. Could you imagine back in 1900 if EPA emissions and safety rules were around. Ford would have never got off the ground. Same today.

    People died in car crashes or plane crashes. But that is the price of progress.

    If I invented a car that got 1000 MPG, drove it, I would be arrested today. Because it would not meet “Standards”. Well let the market decide. The students, heavily in debt, would be the first purchasers of a frugal transport machine. I would employ staff (Note Ford and GM is sacking workers in Australia as we speak)

    I read in Australian papers that most investment in Australia were financed by company balance sheets (Cash flow from high prices paid for Australian resources) and not bank finance. Many CEO realise that a good dividend is good for the share price (Retirees chasing yield), so I think they are all winding in investment (Paying out dividends), and generating cash (This does not bode well for investment lead recoveries)

    Human nature is self preserving, and I don’t see CEO making decisions to better the country (Spend to improve national GDP, take risks, employ workers). In this regulatory environment, who would take risks.

    More job lay offs, less investment, less mergers and acquisitions (Animal spirits are gone)

    But remember, the average person does not concern themselves with economics. They will spend and consume as normal until fired. This keeps the economy motoring along.

    On a positive note, I note the oil price has declined. Energy is a non discretionary cost, so lower pump prices translate to higher activity in other areas.

  6. Pingback: Flonder | Australia just scrapped its debt ceiling — should the US follow suit?

  7. Pingback: Flonder | Australia just scrapped its debt ceiling. America should, too.

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