EconTalk |
Alberto Alesina on Fiscal Policy and Austerity
Apr 25 2016

austerity.jpg Alberto Alesina of Harvard University talks with EconTalk host Russ Roberts about his research on fiscal policy and austerity. Alesina's research shows that spending cuts to reduce budget deficits are less harmful than tax increases. Alesina discusses the intuition behind this empirical finding and discusses other issues such as Greece's financial situation.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Apr 25 2016 at 4:08pm

Is opiate addiction a good analogy to deficit spending vs austerity, in the sense that once a government and society are addicted (deficit spending), the pain of withdrawal (austerity) is severe.

Whereas if you use the opiate for what a doctor would prescribe it for – temporary relief for severe pain, then it works.

Maybe it’s a terrible analogy, but it is what I always think of when someone describes long term deficit spending as “Keynsian.”

Apr 25 2016 at 5:57pm

I’m always amazed at how Japan has not managed to crumble in the face of huge debt to gdp levels. Japan has low immigration, a fast aging population, lots of entitlements, structurally corrupt financial institutions, and yet has almost record low interest rates that the bank of Japan is fighting tooth and nail to raise for some reason.

For people who love the fiscal theory of the price level, Japan feels like a big contradiction.

Apr 26 2016 at 12:09am

The whole episode left me very frustrated. At this rate, I find it hard to see how economics will ever resemble real science. Alesina may well be right, but you have to be willing to engage your critics, and to try and understand their arguments. What exactly is the difference between the Alesina’s study, and the IMF studies that Krugman likes to cite?

Apr 26 2016 at 12:53pm

I agree with Thomas, I found Alesina’s unwillingness to address his criticisms very counter productive. If we are all attempting to get to the bottom of certain disputes, we must be able to have open and frank discussions.

Neal Flask
Apr 26 2016 at 1:43pm

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John Alcorn
Apr 27 2016 at 8:53am

I have listened to the interview and have read the transcript. Prof. Alesina does address the various criticisms that have been made of his work on fiscal austerity. He answers all of Prof. Roberts’ questions head-on, by adducing evidence and examples, and by postulating economic and psychological mechanisms to account for the evidence. He takes care to distinguish the views of John Maynard Keynes, simpler ‘Keynesian’ models, and his own (Alesina’s) more complex model (even more complex than Keynes’). Reasonable people may disagree about the robustness of Prof. Alesina’s findings, given the limitations of macroeconomics and of econometrics. But the interview was informative, responsive, and constructive.
Prof. Alesina was wise to concentrate on the substantive issues (evidence, models, endogeneity, economics, psychology), rather than allow himself to be drawn into an indirect polemic with Prof. Krugman.
Thank you, Prof. Roberts and Prof. Alesina, for another stimulating EconTalk episode!

Mark Crankshaw
Apr 27 2016 at 10:33am

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Mark Crankshaw
Apr 27 2016 at 2:36pm

@ Thomas and Francois

Like John Alcorn above, I felt that Professor Alesina did address his critics. What struck me was the level of dismissiveness and politicization of those critics. It was the critics of Alesina that refuse to engage and try to understand Alesina arguments. Krugmanites like to cherry pick data, construct straw men opposition arguments, proceed to demolish them, then claim “victory” all to better serve their statist re-distributionist political ideology. Every argument I’ve ever seen from Paul Krugman just amounts to: “Nah,nah,nah,nah,nay-nah! I’m right! You’re Wrong! [Big Raspberry]”

What I find quite dubious is the notion that one can easily disentangle the “science” of economics and the “special-pleading” of politics. Keynes (and subsequent proto-Keynesianism) was transparently political. Henry Hazlitt demolished The General Theory in The Failure of the New Economics by simultaneously eviscerating the economics of Keynesianism as well as the politics that encapsulate them. Once the assumptions stemming from the Keynesian political framework (which is not science but rather political and economic class self-interest and mere technocrat special pleading) are questioned and then rejected, the “economics” of Keynesianism cannot survive any more than a human being can survive without a skeletal system.

@ Kevin

Is opiate addiction a good analogy to deficit spending vs austerity, in the sense that once a government and society are addicted (deficit spending), the pain of withdrawal (austerity) is severe.

Well, of course it is. Generally, the metaphor is alcohol (as in a “punch bowl”), but opium works just as well.

One plank in the “political framework” of Keynesianism is that political leaders and government technocrats are typically public serving “stewards” of the economy, that they make rational, intelligent decisions, and are prone to sacrificing their self-interest for the “general welfare” of society. The political assumption underlying this particular set of economic prescriptions is that the political mechanism will unite to act in the general “public interest” rather than each political agent independently pursuing their own narrow zero-sum self-interest. The fact that such politicians are about as common as pink unicorns might be a slight problem with this theory.

In my view, a theory must fail if it must rely on the completely unreliable. Keynesianism, as Keynes proposed it, must rely on the political class forgoing the confiscation of public wealth in the “good times” (and to pay down the debts incurred in the “bad times”). Public splurging during an economic downturn naturally appeals to politicians bent on cynically buying votes with public monies, not a hard sell at all. Public restraint, at any time, does not sell at all. The temptation to splurge during the good times is as alluring to the overwhelming proportion of politicians as a mound of crack is to a crack-addict. Ergo: The theory put forth by Keynes in The General Theory fails.

Greg G
Apr 27 2016 at 5:09pm


>—-“Public restraint, at any time, does not sell at all. The temptation to splurge during the good times is as alluring to the overwhelming proportion of politicians as a mound of crack is to a crack-addict. Ergo: The theory put forth by Keynes in The General Theory fails.”

OK then, know what “fails” even harder politically due to its inability to “sell at all”? Libertarianism! I think the best showing ever for a Libertarian Party presidential candidate was 1%.

I call special pleading if you are intending only to apply this criticism to Keynesianism and not also to libertarianism.

Apr 27 2016 at 8:38pm

Grab a bourbon, because this is going to be another long one…

  • Although I disagree with almost all of Keynes’ theories, he did say that deficit spending would work if, during times of surplus, a reserve was built up to later spend in deficit years, so as not to run up a large debt. Naturally, politicians and Keynesians found this difficult, so they ignored it (or imagined ways to believe that debt didn’t matter) for the next 80 years.

    And it is not as if this is a new phenomenon, politicians have been taking the easy way out for thousands of years, overpromising, overspending, defaulting and then collapsing. Whether it is von Mises cycles, Minsky Moments or Hemingway (“How did you go bankrupt?” – “Two ways, gradually and then suddenly.”), the result is a hard to forecast, but surprisingly rapid, collapse.

  • Greece is not a special case, it is an example to all. If you rely on deficit spending, lie about your finances to your investors and electorate (and in their case, the EU), and institute a heavy regulatory burden on business, your economy will collapse. Due to the fact that there are so many variables and EU financed stop gaps, it is impossible to predict when this will occur, but it is inevitable.
  • Because government spending and deficits both take money from the private sector – the only engine for building wealth – then raising taxes, spending and deficits will be harmful and cutting taxes and spending will be beneficial to both the economy and a country’s wealth. Alesina and I agree on this, but maybe from different positions. Keep in mind that GDP is a measure of spending, not wealth, and since government spending is a defined component within it, can be easily manipulated to show a temporary increase if massive government spending is done. The resulting debt is of course very harmful in the long run.

    To put it in perspective, it is as if you didn’t measure your personal net worth but instead measured your personal net spending. By borrowing a massive amount to take luxurious vacations and dine at five star restaurants, you can say that you had a great year (and you probably did…). But then the debt will have to be paid and you will have nothing to pay it with. The US never retires debt, it only refinances it. You can also do this in your personal life, but only for a short while, because you cannot print money while the US can.

    The only way that Keynesians can get their theories to work (and remember, Keynes had nothing but a theory based on highly selective data – it is a problem with economics in general) is to assume that there is some >1 magical multiplier to government spending, but this has been disproven over and over.

  • Alesina was very diplomatic in his response to the Krugman question. I will not be. Krugman can no longer be considered a serious economist. He simply argues against straw men of his own invention and makes unsupportable assertions that he characterizes as fact, and in a holier-than-thou and condescending tone, all in support of unlimited deficit spending (he does admit that there may be a limit, he just hasn’t seen it yet – which is why his advice to Japan to spend like a drunken sailor is popularly known as “going full Krugman”). This advocacy provides Krugman with a top 0.1% lifestyle while hypocritically railing against income inequality.

    The first article that Russ mentioned, Krugman attacked Alesina, but then didn’t provide ANY justification. The only issue he raised was that Alesina may not have taken into account a confounding variable regarding Norway’s stock market for Norway only. He then dismisses the rest of the work. Unfortunately, Krugman constantly relies on ignoring confounding variables in his own work, assuming that most readers simply won’t notice.

    In the second Krugman article, Krugman takes a specious metric that even he doesn’t believe, compares it to pre-crisis IMF forecasts and models, NOT actual data (and the IMF is a TERRIBLE forecaster) and somehow sorta, kinda “indicates” that it “implies” a multiplier of 2. Based on this series of errors, he declares the science of economics is complete and Keynes has won. Nonsense.

    As Alesina notes, Krugman tends to find one paper that agrees with him, assert that it is the last word, and accuse anyone that disagrees with him of being a liar. Hardly an open minded academic.

  • I disagree with Russ that payroll taxes should be incorporated into the income tax. While we both agree that the money from taxes is fungible (I can’t say whether he would agree that SS is basically a Ponzi scheme), the problem is larger than that. The question is – what is the responsibility of a citizen? Do the almost 50% of taxpayers (let alone non-income generating citizens) that in total pay less than 5% of the income taxes also have a right to pay that little for payroll taxes? There has to be some level of participation from each citizen in sharing responsibility, not just in sharing benefits.
  • I didn’t quite follow Alesina on expectations. However, I think that we agree that temporary tax cuts don’t work, people focus on permanent changes to the tax structure, as it is the only way that they can plan. Hence, people tend to simply save a temporary tax cut, frustrating the Keynesians to no end.
  • Japan is a bug in search of a windshield. I admit to being confused as to why they haven’t blown up yet, the long held belief that the domestic bond market will buy JGB out of national pride should have run out by now, but who knows. In any case, the math is inescapable. (BTW, Kuroda’s predictions of a Keynesian boom from his tripling down on deficit spending have only produced a recession).

    The US is behind Japan, but as discussed in the podcast, not that far behind when one takes into account unfunded liabilities. The $20T in debt that we have now will grow to a point where a small increase in interest rates will put us into a death spiral. At that point, like Greece and soon Japan, we will have to default, either outright or via the slow motion defaults of inflation or debasement.

Keynes said (and Krugman agrees) “in the long run we are all dead”. That is true, but I am not worried about my life. I am worried about the tens of trillions of debt and the estimated hundred trillion dollars of unfunded liabilities that our children will have to bear.

Mark Crankshaw
Apr 28 2016 at 9:35am

OK then, know what “fails” even harder politically due to its inability to “sell at all”? Libertarianism! I think the best showing ever for a Libertarian Party presidential candidate was 1%.

Actually, Greg, I quite agree with you (though I disagree with the reasons why this is so).

I am quite sure that you believe that the political structure of any State represents a choice by the subjects of the State to “select” a ruling class. I, on the contrary, believe that the political structure of any State represents an imposition on the subjects of the State by the ruling class of that State.

Is libertarian-ism a hard sell to the political class, intent on economically exploiting the subject class to the fullest extent they can politically get away with? Absolutely! That speaks to the merits of the idea. That’s a feature, Greg, not a bug. Of course the ruling classes are repelled by any political idea that restrains their power and diminishes the takings of their ‘legal plunder’. This is no more surprising than their enthusiastic embrace of proto-Keynesian policies that increase their power and generously ramp up their plunderous and vote-buying activity.

Voting and the political party system in the US (and in all the rest of the world’s “democracies”) is quite transparently manipulated and controlled by the economic and political elites. The ‘voting public’ is allowed merely to rubber stamp the extremely limited and unpalatable choices offered to them by the ruling elites (heads the elites win, tails the voting public lose).

There is always going to be political resistance against the diminution of the political power and politically generated wealth of the ruling classes by the ruling class and their obedient lackeys. As I’ve said before, Greg, the move towards a more sane, equitable, and prosperous political mechanism will be a slow one. Monarchy wasn’t dispensed with overnight, totalitarianism and absolutism are still practiced in the more wretched parts of the world. Eventually, however, that monarchical dominance waned in the more enlightened parts of the globe, and the ‘divine right of Kings’ gradually faded into a musty anachronism. Let’s just see if the ‘divine right of government’ follows suit. I still think the move towards placing limitations on political power is still in its infancy, still evolving towards a higher form (you could call it…libertarianism, if you like). This is a marathon not a sprint, Greg, so get comfortable. Viva la Evolución!

Apr 29 2016 at 3:27pm

I have a really pedantic point which always bothers me: debt/gdp is not a ratio, it has units. Debt/gdp is a length of time. When you say the debt to GDP ratio is 100%, what you mean is debt divided by GDP equals one year. This statement even has a nice, clean interpretation: it would take one year of current output of your economy to pay off your debt. On the other hand, deficit to GDP is an honest-to-god ratio.

Apr 29 2016 at 11:50pm

… when you have no choice and you have to do something quickly, in most cases it is actually much easier to raise taxes, because you have an immediate effect on the budget… To cut spending: Figure out what to cut, how to cut, how to do it. To minimize social cost takes a while. And when the time is not there, you just raise taxes.

This quote occurred early in the interview, and caused me to take a rather jaundiced view of the rest. It is of course no easier to figure out how to minimize social cost when raising taxes than it is to figure out how to minimize social cost when cutting spending, just politically easier when the decision is being made by tax-eaters.

Of course Alesina hasn’t gone nearly as native as this quote might indicate, since he comes down on the side of cutting spending rather than raising taxes, but the fogginess does extend to his inability to clearly explain why his data supports that conclusion. We get the one example that Britain did better by making a gesture towards cutting spending than Italy did by raising taxes… but why is this not just an anecdote? Romer’s “narrative” approach requires finding tax increases to examine that are causally unconnected to the state of the economy, which the Italian ones were not, so suggesting that that can be used to validate Alesina’s results seems to make no sense whatsoever.

Mort Dubois
May 1 2016 at 6:36am

Why wasn’t the American economy in the 90s mentioned? Taxes got raised, deficits turned to surpluses, and everyone did well. At least that’s how I remember it.

Having listened to Econtalk since 2007, my take is that, given a reasonably designed economy, when the mass of people feel confident, economies do well. When they feel fear, the opposite. Policy in modern democracies is usually just tinkering, as nobody can pass a bold enough stroke to really change the game.

May 1 2016 at 11:03am


True, dollars of debt divided by dollars per year of GDP is not a ratio, but that is not its intent.

It is used as a metric to service your debt, just as the bank wants to know how much you make per year to service a mortgage.

Of course, the bank actually expects you to pay off the debt, which has now become a quaint and outdated concept when discussing government debt. But when only considering paying the interest, GDP is still relevant. As Reinhart–Rogoff showed, at a point somewhere over 90%, a country is at greatly increased odds of defaulting on their debt. Japan is proving that the inflection point may be as high as 300% but others have collapsed at much lower points.

A confounding factor is that in the 500 or so years that they studied, Reinhart–Rogoff never came across the concept of negative interest rates, as they had never before existed (because previous to the unproven, highly speculative theories of QE, no serious economist believed that they made any economic sense).

We are all living in a theoretical monetary world never imagined twenty years ago. Chances are that Reinhart–Rogoff’s tongue in cheek book title “This Time is Different” will prove to be prescient.

Mort Dubois,

Clinton raised taxes in 1993 without a single Republican vote (ACA anyone?). It was one of the signature issues that led to the Republican landslide in 1994. With a Republican House and Senate in control, they passed a capital gains tax CUT in 1997 (and new tax deferred savings plans) over Clinton’s objections which led to a four year boom and a small surplus.

As Reagan and now Obama have proved, Presidents can have major impacts in transforming America, some extremely positively and some extremely negatively.

May 2 2016 at 1:14pm

Im more inclined to believe it was good monetary policy and opening up to free trade that explains the 90s

Mr. Econotarian
May 3 2016 at 1:40am

I cringe whenever someone talks about “infrastructure spending” – perhaps in Africa this is an issue, but not in OECD countries. In the USA, we have plenty of roads, they are just packed full of people who can’t afford to live in city centers trying to drive into/out of city centers.

The best kind of infrastructure spending in the US would be more private housing construction in productive cities (like San Francisco) if freed of NIMBYist regulation, and you could build 60 story towers on every block (maybe even with some green space between them). Now that’s infrastructure that would benefit the economy as a whole, raise taxes for schools/public transport/safety net, and could even lower rents.

May 3 2016 at 8:10am


NAFTA certainly contributed, but that was a trade agreement with only Canada and Mexico, so it couldn’t explain the entire boom.

Greenspan’s moves at the Fed were notoriously obtuse, so trying to replicate them and retest them is problematic. There is no way to differentiate them from chance, so there is no way to give them credit for the boom.

Obviously, neither NAFTA or Greenspan changed in 2001 when it spectacularly ended.

Ajit Kirpekar
May 13 2016 at 11:05pm


I agree in with your points, though one could make a modern economic argument to say that those moves influenced expectations – NAFTA being a signal for a trade liberalization policy and the Fed following a taylor rule principle. In fact, Fed announcements at the time and in the data suggest that’s what they were doing and it was anticipated.

Does that largely explain the 90s? Of course not. Macro can’t explain those well because they are deep structural issues that aren’t well measured or even easily identified.

I just think those two effects explain more about the 90s heyday than Bill Clinton’s charisma does(not to debase the argument, but its a favorite talking point among so called “progressives” – using it to justify a larger and more pervasive government).

Malcolm C. Harris, Sr.
May 18 2016 at 2:31pm

The 1980s tax cuts lowered marginal rates continuing the momentum of the 1978 Steiger amendment. These were combined with regulatory reform, a movement that originated from both sides of the aisle in the 1970s and continued in the 1980s. Nowadays this latter might be called “structural reforms.” The major policy mistake was implementing Kemp-Roth in stages contributing to the 1982 recession.

The 1982 recession illustrates well how expectations influence behavior. With Kemp-Roth stretched out in a known pattern, it paid economic agents to delay some productive decision into the future to take advantage of the future lower marginal rates.

The Kennedy-Johnson tax cuts unintentionally illustrated supply side economics. Kennedy’s advisors recommended two rounds of tax cuts: investment tax incentives first to be followed two years later by personal income tax cuts. The former was to stimulate investment, i.e. both boosting demand and increasing the supply of goods when the demand stimulus of the personal tax cuts were to take hold. All this was primarily Keynesian thinking at its best. Yet cutting the top personal marginal rates from over 90% to 70% and increasing the after tax rate of return on investment led to the long 1960’s expansion: a great confirmation of the supply side.

The 1960s and 1980s tax cutting versus the attempt to rein inflation in with the 1968 budget are all U.S. episodes that seem to confirm Alesina’s findings.

Mort Dubois writes: “Why wasn’t the American economy in the 90s mentioned? Taxes got raised, deficits turned to surpluses, and everyone did well. At least that’s how I remember it.”

There was a fairly small rise in marginal tax rise in 1993 followed, as jw points out, by the 1997 capital gains tax cut. The recovery was weak in the first half of the decade. The 1990s gain from the continued effects of the tax cuts (including the 1986 tax reform) and the decelerating inflation the latter caused by growth, restrained monetary policy, and those structural reforms. Lower inflation rates reduce the tax wedge between pre-tax nominal returns on investment and the after-tax real returns.

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Podcast Episode Highlights
0:33Intro. [Recording date: March 21, 2016.] Russ: Now, we're going to start with fiscal policy; we're going to see where we end up. But it's an issue that a lot of people are very interested in; it's an issue that has been in the news as well as the economic conversation for the last, really, 5 years, with a lot of intensity. So, I want to start with this seemingly simple question, which is: What is austerity? Guest: Austerity [?] simple question, because the word 'austerity' has been used in many, many different ways. But the way I think of austerity is a situation in which, for whatever reason, fiscal policy--budget deficit, government debt--have gotten sort of out of hand in the previous years. And for whatever reason it is decided that now is the time to return to a more rigorous fiscal policy, and reduce the deficit, reduce the growth of debt. In principle, there should never be any need for austerity if government followed the rules of optimal fiscal policy--namely, having deficit during recession or in period of exceptionally high government spending needed for a war or for a natural calamity or whatever; and then having surpluses during booms and periods in which government spending is not high, is not especially high. So, if the government followed these optimal fiscal policy rules, there would never be any need for austerity. Austerity comes about when, for some reason, government has gone out of whack and they increase debt and deficit too much. Or, there were a combination of, say, a financial crisis and government not having had [?] good fiscal policy before the financial crisis. So, the point of what I'm trying to make is that austerity is something that should be considered as something out of the ordinary, something that happens occasionally when government has done something wrong in the past. Russ: You can think of it as, it's described, it's talked about, I think, in two different ways in the press. Which is: Austerity--some people paint it as a strategy: 'Well, we're not doing very well. The economy is not doing well. We need to do something; and we should cut spending, or raise taxes; cut the deficit as a way to engender confidence.' That's one story you hear. I think sometimes you hear it from the critics rather than the supporters of austerity. But that's one story. The other story is: 'We don't have a choice. We're going to have a crisis, and so we're going to have to do something dramatic to return to fiscal sanity.' Are those two cases different? Do you hear them talked about? Do you hear austerity talked about in those two different ways? Am I right? Guest: Yes. I mean, I would say there are even more than two different ways. But certainly these are two of the different ways. I would say, there are many reasons why an economy may not be doing well. I'm talking about the first avenue: There are many reasons when an economy may not be doing well--excessive deficit and excessive public debt is of course one of them. And there are reasons to believe that if, say, government spending is very high, taxes are very high; and the theory is that these are creating a burden on the economy, and therefore you need to do something about that. That's one view about the [?] correcting some imbalances in the economy when rightly or wrongly it is believed that those imbalances are causing problems to the economy. And that has happened--before the financial crisis, there have been many, many, many cases, many examples of austerity exactly along those lines. Countries failed like they were in a difficult situation, partially due to fiscal imbalance and the need to do something about it. Sooner or later they needed to do something about it. And in fact, the more they waited, the more costly would it be to engage in these policies. As you said, the second type of austerity is one in which we are in a crisis: for whatever reason, the market doesn't believe in us any more. Interest rate on the debt going through the roof. And there is nothing else we can do. And then of course there have been several examples of those after the financial crisis. And in some cases, there was no choice. Let me say that, the one interesting aspect of this is, when you have no choice and you have to do something quickly, in most cases it is actually much easier to raise taxes, because you have an immediate effect on the budget. Just ask people: Go to the cash machine of the taxpayer, and you get money out of them. To cut spending: Figure out what to cut, how to cut, how to do it. To minimize social cost takes a while. And when the time is not there, you just raise taxes. A perfect example with my own country of origin, Italy, is that in 2012, and 2011, was in a situation of being close to default on the debt because the interest rate went through the roof. There was contagion from Greece. The previous government, the [?] Silvio Berlusconi government, did not seem to have the situation under control; and a technical government was appointed with a goal of avoiding a second financial crisis in Italy. They had to do it quickly, and the only thing they could do was to raise taxes. The result was another major recession in Italy. So, sometimes the time pressure makes you make the wrong choices about which kind of austerity to do. Russ: And in a little bit, we are going to talk about that different choice between raising taxes and cutting spending as a way to close the deficit and bring about a balance and to reduce the need to borrow.
7:17Russ: But, I brought up those two examples--the sort of strategic idea of austerity versus the 'Oh, my gosh, we have to do something' view--because I think I've found it fascinating that after Greece, which got most of the attention in its crisis, a lot of people said they made a huge mistake in trying to close the deficit. They needed, in fact, to be borrowing even more. And what would you say to that claim? Guest: I think Greece is a special case. To begin with, they were growing and [?] at a rate in the first 10 years of the Euro, they were doing extremely well. It turned out that they were doing it just because they were borrowing and consuming what they were borrowing. They were even hiding their deficit--at the beginning of the financial crisis was supposed to be 3% of GDP (Gross Domestic Product); instead it was 13% of GDP. Because Greece had sort of hidden their deficit. There was major tax evasion. Productivity was not growing; it was actually declining. It was a country in complete economic disarray. Now, at that point, probably the cleanest solution would have Greece default, and call it a day. The problem was that--it was that Greece is also a very small country relative to the rest of Europe. The problem was that--well, the cynical view is that the German and the French did not want their banks to suffer from a Greek default, because German and French banks held a lot of the Greek debt. The less cynical view would be that the default in Greece would have triggered contagion in other high-debt countries, like Italy, or high deficit countries like Spain and Portugal and Ireland, that may have created a second major financial crisis, perhaps even collapse of the Euro. So, the austerity plan for Greece was, in my opinion, not credible. Nobody really believed, I think, that it would have worked [?] it was extremely large in terms of proposed cuts in terms of--it was unrealistic that they would manage to achieve those cuts. And in fact they were not. And there was a back-and-forth between do this, and the Greeks were doing 1/3rd of what they were supposed to do. They tried [?] pretend that they were doing well enough to give them even more money; and then they were doing 1/2 of what they were supposed to do. And so, going back forth. And then the worst[?] were cut from the debt. So Greece was completely mismanaged. Now, that leads to your second question: the mismanagement of Greece created panic in the markets and countries like Italy, Belgium, Portugal at some point were, the government were borrowing at 6, 7%--an interest rate of 6 or 7%. And there was a sense that if the market completely stopped believing in the ability of the sustainability of these countries' debt, particularly the debt of Italy which is really large, there would be a major, major, major disaster with the bank [?] or bank failures. And perhaps collapse of entire financial institutions of Europe. At that point, to simply say 'We need to borrow even more because we need to support the economy to grow more to get out of the recession,' it was, in my opinion, somewhat short-sighted, in the sense that to simply think about government spending more to get the economy more quickly out of a recession was in my opinion forgetting all of these other aspects, which were a problem of potential financial collapse, bank failures; and then a new and much bigger recession. So, Europe, for all this combination of reasons, European countries were forced to enter in this austerity policy probably sooner than might have been optimal. Some countries had accumulated too much debt before the financial crisis. So, they were in a situation in which they could not [?] they could not prolong morally[?] because that debt was already very high. So they entered in a phase of austerity, perhaps attached too soon than they should have. And, it seemed they were forced by these market forces, they had to do something quickly. And in some cases--not all cases--they ended up raising taxes than cutting spending. But even when you look carefully at the data, once again you find that austerity done by raising taxes has been austerity done by cutting spending. Even after the financial crisis.
12:50Russ: So, let's talk about that. So, your work focuses on many issues. But that one in particular is one I think is the most interesting. Which is that when you studied this recent episode of European countries trying to reduce their deficits, you found a very different response for the economy as a whole when those changes were done via tax increases versus spending cuts. Try to summarize the range of magnitude and the differences in the two responses. Guest: Okay. So, before the financial crisis, after the financial crisis, there were several papers that I and others had written which had found that, in a way which, in my opinion, is pretty much uncontroversial--people may disagree about the magnitude of this or that coefficient--but any unbiased observer would agree that after the financial crisis, all the episodes of austerity after then were characterized by the fact that those that were based on government spending were much less costly to absorb[?] short-run recessions than those based on tax increases. In fact, in some cases government austerity done with cut in spending [?] no cost. And in some cases, there have been also cases called expansionary austerity, namely the budget cuts, spending cuts have been associated with an increasing growth rather than declining growth. While tax-based austerity has been much more costly. And the differences are quite large. We are talking about the effect of spending-based austerity having close to zero cost on average in terms of output; and tax-based austerity having recession of 2, 3% of GDP for 2 or 3 years. So very large, very large differences. And we can return, then, to that--we can go into more detail later. Now, when the financial crisis occurs and the austerity that followed the financial market happened, there was a period in which some of the--everybody said, 'Oh, look, austerity is terrible. It is causing recession. It's a disaster. Look what's happening.' Some people drawing the conclusion that those costs were unreasonable and we should not have had austerity--and we talked about that before--and some people saying, 'Well, these are costs but they are necessary because austerity is unavoidable.' Now, when you look [?] evidence begins to accumulate and [?] of now, and you look at this recent evidence, you find once again exactly what was true, what we found before: Namely that tax-based austerity has been much more costly than spending-based austerity. And let me give you two examples. One is Italy, that I mentioned before: in the end of 2011, and 2012, they raised taxes by almost 2% of GDP, in a variety of different taxes. And Italy entered another recession; and Italy has been in a recession for, basically, almost until now, and from the beginning of the financial crisis up to now it has lost 9% of GDP per capita, roughly. While other countries were coming out of the recession in 2013 and 2014, Italy was still deep down in the recession, as it is now, to this tax [?] in 2012. The opposite example is England. When the Cameron government came into office, it announced, it implemented spending cuts, in 2011 and so--and in fact it is interesting that the IMF (International Monetary Fund) predicted a major recession for Britain. And there was quite a vocal disagreement between the British government and the IMF about the benefits and costs of their spending cuts. And in the end we discovered them not to be right; and in fact the IMF apologized publicly for having under-predicted the United Kingdom economy, who did quite well in 2012, 2013, 2014. On average they did well. They did not enter in a recession. And they reasonably well. Quite well considering that they were still suffering from the Financial Crisis [of 2008] and they had done pretty sizeable spending cuts. Russ: Did they actually cut spending? Or did they just talk about it? Guest: Well, that's a good question. There was a lot of talk about it. Say, they talked, and they announced 10, and then they did 4 rather than 10. But they certainly did something. And the deficit did go down substantially. The public debt slowed it's growth. So, they talked more than what they did. But they did do something. So, yes, there is a sense in which they--even though, I must say that incidentally--and this is actually another quite interesting point: The announcement of policies may actually have an effect on the economy as well. Russ: Fair enough. Guest: So we may need [?] that effect. But in any case, they certainly did less than what they were saying; but they did indeed do something.
18:57Russ: I just have to quote--I have to give you two quotes here. One is from Paul Krugman, in November of 2015. And the second is Paul Krugman in April of 2015. Here's the first one:
The doctrine of expansionary austerity--the proposition that cuts in government spending would actually cause higher growth despite their direct negative impact on demand, thanks to the confidence fairy--was all the rage in policy circles five years ago. But it brutally failed the reality test; instead, the evidence pointed overwhelmingly to the continued existence of something very like the old-fashioned Keynesian multiplier.
The second one is even more pointed:
Meanwhile, all of the economic research that allegedly supported the austerity push has been discredited. Widely touted statistical results were, it turned out, based on highly dubious assumptions and procedures--plus a few outright mistakes--and evaporated under closer scrutiny.

It is rare, in the history of economic thought, for debates to get resolved this decisively. The austerian ideology that dominated elite discourse five years ago has collapsed, to the point where hardly anyone still believes it. Hardly anyone, that is, except the coalition that still rules Britain--and most of the British media.
Is he talking about your work? Being "discredited"? Or do you think--or is there something orthogonal about that claim to your work? Is there something that--is he talking about some different aspect? Because he makes it sound like this view that cutting spending-- Guest: Well, I think Paul Krugman has rather extreme views. But more importantly, he talks about his views as if they were obviously true, and anybody who would disagree with him was obviously wrong. And he exaggerates. And that I really prefer not to go into a discussion about his quotes. But I think that the idea that the work about austerity that I and others have done has been discredited is wrong. In fact, the IMF, in 2010 wrote a rather pointed criticism about my work, in particular about two points: one, whether spending cuts were less much less costly than tax increases in terms of austerity policy. And when everything, after everything was said and done and written, even the IMF acknowledged--had to conclude that this was indeed the case: that spending cuts were much less costly than tax increases. Now, the reason that not completely clear to me they seemed to underscore this message of their own work was, if you read the published paper of this IMF research, you will conclude that they also agree with this conclusion. Which is the fundamental result about austerity, on which my work is based. So on this point, actually, I think Krugman is completely wrong. I think there is uncontroversial evidence that spending cuts are much less costly than tax increases. Russ: So-- Guest: And this point is exactly the opposite. Now, the second point is whether there are cases where spending cuts accompanied by other policies can be expansionary, and the confidence argument that he makes fun of is actually confidence, one of the many aspects; and we can elaborate on that. But I think that there are several episodes in which fiscal spending cuts have been accompanied not by a recession, but by an expansion. So, I think that those kind of statements by Krugman are trying to push a view which is respectable but they are not proven by the facts. Or at least they are not supported by research.
23:34Russ: So, let's talk about the empirical finding itself, and some of the challenges of measuring it. But I want to start with the intuition, if there is any, in the most basic Keynesian model of the role of government spending. It's not a model I'm a particular fan of, but it's the one that I think most students are taught, as undergraduates, still. Government spending, in a recession, adds to aggregate demand and stimulates through the multiplier. Cutting government spending then would be destructive to--would reduce aggregate demand and would reduce income--GDP. And at an even slightly more basic level, you could argue--you don't, but you could argue that it doesn't matter whether you have tax increases or government spending cuts. They both reduce aggregate demand and therefore in a recession they are not productive; they are harmful. And yet you find that they have very different effects. So, I want to talk about two things. We are going to start with the first. The first is going to be: Why might that be true? And the second is: How might one, how have you and your co-authors tried to actually measure that in a world where things are changing at the same time--other policies as you mentioned, reforms as well as certainly monetary policy which is one, I think, the main argument that some people make about trying to make conclusive statements about fiscal policy. So, let's start with the first. What do you think is the reason for why you get such an asymmetric effect from tax increases compared to spending cuts? Guest: The reason is the basic Keynesian model [?] is of course basic because of course Keynes is much richer than what is often referred to, how his views are expressed. But anyway, the basic Keynesian model that you summarized, spending cuts reduces the public part of aggregate demand and increase in taxes reduces the private demand; and in fact, in the basic Keynesian model should actually be even more harmful than tax increases, because spending cuts, entire spending is cut; plus the multiplier effect. While if you raise taxes, people reduce some of their savings, so aggregate demand goes down less with tax increases. Now, there's nothing wrong with that except that there are a ton of things which are left out. When you start putting things which are left out, many other things become relevant. Even when talking only about fiscal policy. If you then add the fact that austerity plans typically are a combination of many, many policies, then the situation is even more complicated. Starting only remaining in strictly confined to fiscal policy, the Keynesian model is static, for example, or at least the simplification of Keynesian thinking is static. So, if you cut government spending today, and people think that this cut is permanent, they will think, 'Okay, in the future taxes will be lower.' So, if I expect the taxes in the future to be lower, then I can consume more today; or, even more relevant, till now that empirically [?] to say even more powerful that if you had an investor or entrepreneur and you see government spending going down and you expect your taxes to go down in the future, and then you invest in and plan for the future, considering that investment takes a while to materialize, the future matters a lot. So you may invest more because you expect taxes to go down in the future. Taxes, on the other hand, have a distortionary effect on the economy, so there is a supply side of the economy that is left out of this model; but if you raise taxes, people may want to work less, may want to invest less, because of [?] effect on investment decisions. And then there are more shadow[?] but I think important effect which have actually turned out to be important in some European countries, which are highly unionized: If government spending means reducing the growth or even the level of public sector wages, that may have an effect on the private sector wages and increase[?] profitability and investment of firms. And all of these effects have nothing to do with confidence, but in addition to this I do think that confidence is important, because we have empirical evidence suggesting that when there are spending cuts, the confidence of investors actually goes up, and the confidence of consumers goes down very little; while with tax increases, confidence of both consumers and business investors goes down quite a bit [?] countries. So confidence has played a role. And then, there are many--as I said, austerity plans are a combination of many, many other policies. So, it matters what monetary policy does. It matters that sometimes, particularly in European countries, when there is a crisis and austerity is called for, then there is a [?] opportunity to engage in other so-called structural reform [?] labor market reform and goods market reform, liberalization of various sectors, which help and that indeed has [?]. And of course monetary policy matters--[?] we are saying in a situation which monetary policy is supportive, expansionary, that helps fiscal adjustment. So, these are just the more important of many other factors which are left out from the basic Keynesian model. So I think that thinking is not that the basic Keynesian model is wrong; it is simply that they focus only on one of the many effects of fiscal policy. So, when you include the richness and the complication of the various [?], which fiscal policy may operate, then you get a picture which is much more complex. Now, on the specific issue of expansionary fiscal policy, expansionary austerity, that does not mean that nobody, including me, has ever said that cutting government spending per se is expansionary. But the notion of expansionary austerity is that in some cases, the Keynesian effect of cutting spending is small and is more than compensated by other effects which we somewhat talked about a moment ago. And, in the 1980s there has been an example in Denmark and Ireland; in the 1990s there has been an example in Canada. And in Belgium the case of--and in Finland if I remember correctly; in the case of England even in the middle[?] of the financial crisis is one example. So that's what the evidence says. And I think it is a complicated issue because many things go on at the same time. There are many interactions that are difficult to disentangle. But I think that this is what a fair reading of the evidence suggests.
32:33Russ: So, let's talk about the challenges of that disentanglement. Because macroeconomics suffers I think from this problem generally--that there's too many things going on; it's very hard to attribute changes to only one particular set of things. You've mentioned two of the bigger ones: reforms--structural reforms that take place at the same time; monetary policy is the other obvious one. In your work, try to give the non-technical listener a flavor for how you try to hold those things constant in a world where, not only is there more than one thing changing, but the changes themselves are often endogenous--they are not imposed from the outside; they are responses to those underlying economic variables that we are trying to measure the effects of the policy changes on those variables. So it's a very complex system. So, how in that world do you try to measure the effects of, say, austerity, or changes in spending or cut taxes? And how precise do you think those estimates are with respect to the assumptions you make? How robust are they, I should say? You have about 5 minutes, for that. So, good luck. It's a complicated question, obviously. Guest: Yeah. This is a very difficult question, of course. And there are two, I think, issues which are difficult. One is what we call reverse causality--namely, if you see the deficit-over-GDP going down, and GDP going up, you could not conclude that, think the deficit is going down therefore GDP is going up. The deficit-over-GDP may be going down simply because GDP is going up for whatever reason; and the deficit-over-GDP is going down. So it's the denominator, not the numerator, that determines the decline in the deficit-over-GDP ratio. The first issue goes at I think or covers what is a growth because of fiscal policy, fiscal policy that causes growth. And the second, is that a bunch of things going on at the same time, and how they hold those constant. So, on the first question, one, there have been many, many ways of addressing this problem. The one which I think is more useful for the case of austerity and which is the one that some work at the IMF and then some work that I've been doing is based upon is the so-called narrative approach. So that is a very time-consuming way of looking what government or international organization actually did, announced, did and then may have changed their announcement and did something else. But looking at their doctrine by saying government of Country X in Year Y decided that regardless of the state of the economy they were going to raise the tax rate of x% or cut the spending program by y%. So, you don't look at how government spending over GDP has gone, but you look at what policies have actually been implemented. 'We have cut $30 billion dollars in government salaries,' for example. So you look at the actual policy action. So, in other words you don't look at the behavior of government spending over GDP-- Russ: You are not just looking at data. You are interested in--you are calling this 'narrative,' right--you are trying to figure out what happened. Guest: It is a narrative approach--right--which is both pioneered by Romer and Romer for the United States. They looked at, they said, if you look at the tax-over-GDP ratio in the United States--in their case they were looking at the United States--you are going to get confused because the taxes-over-GDP ratio may go up or down because the GDP moves around, not because the tax rates have moved around. So they identify several episodes in the post-WWII United States in which were actual decisions of government to reduce or raise taxes, for reasons which have nothing to do with the business cycle but for other reasons. So the narrative approach has now been extended both by work done at the IMF and by work that we have been doing on many other OECD (Organization for Economic Co-operation and Development) and not only looking at taxes but also looking at spending and focusing on [?] and we are focusing on period of spending cuts and tax increases. So, the first step is to try to isolate changes in spending-over-GDP and taxes-over-GDP that come from movement in the economy from changes that come from actual policy changes. So that's one piece of the puzzle. The second piece of the puzzle is the idea that many think happen at the same time. So, take, for example, monetary policy. And suppose you are trying to make the argument that spending cuts are less costly than tax increases. How do we know that spending cuts are not accompanied by more relaxed monetary policy and tax increases by less relaxed monetary policy? And that would explain the difference. Two answers. The first one is that you can do that by various measures of trying to hold constant monetary policy; and we have tried to do that, and the IMF has tried to do that. And the answer is that if monetary policy has been indeed slightly more relaxed during spending cuts than tax increases; but not enough, it is not enough to explain the difference. And, in addition, as you also mentioned in your question, monetary policy is itself endogenous. That is, suppose I have a central bank and I see a government that is serious, is cutting spending and announces permanent spending cuts, which will lead to not raising taxes or even reducing taxes in the future. I am relaxed and I can reduce rates. If I see a government that is in a crisis, raising taxes desperately and then raising taxes again in the future because it cannot keep with spending, then I get worried, and then monetary policy has to be different because I am afraid of a crisis. So, even monetary policy is endogenous; but in any event, even forgetting this second order effect on the endogeneity of monetary policy, all the constant monetary policy in the best way you can, the difference in the effect of spending and taxation remains very strong and actually surprisingly large. Now, structural reform, labor market reform, these are clearly much more difficult to measure than monetary policy. And so, two ways of answering your question. One is to hold them constant, of course; to say there are measures--in fact we are collecting measures of structural reform. And you can hold them constant. And the results survive. So that one way of answering your question is to say, as best as we can we can hold these structural reforms constant. But then the second way is actually to embrace, rather than holding them constant to embrace them and to see: Suppose I am an adviser to a government and I tell it, especially a European government, what is the best way to do an austerity plan that is going to work and be least costly as possible? By looking at the data, we should cut spending and engage in this structural reform, because it would appear from the evidence that the combination of spending cuts and structural reform is the one that works best. So, you can try to hold them constant if you are interested in the [?] to measure as well as possible versus tax increases; or you can embrace them from the point of view of policy recommendation and saying it would appear that the best austerity is the one that is based on spending cuts and structural reform. Russ: Well, structural reforms-- Guest: They are variable--the other variable we even talk about is the exchange rate, which is also of course endogenous. And sometimes they move. And there has been some discussion whether an exchange rate devaluation has helped or not helped this or that type of adjustment. And again, exchange rates are endogenous, like everything else, so you cannot say, 'Let's hold constant the exchange rate,' because changes in government spending or taxes. But a simple look at correlation does not show that the difference between tax increases and spending cuts is explained by exchange rate movement. Which is a different statement than saying that exchange rate devaluation may in some case help. That's a different statement than, say, it's only of exchange rate movement that taxes and spending are different. Russ: So, I was just going to say, structural reform always sounds like a good thing, because we assume reform is positive. Of course, it's really changes in policy, some of which might work, some of which might not work. I think it's extremely clever, both on the monetary policy and the structural reform to argue that it may be good policy advice. It does make it harder to assess the independent impact of spending, obviously. Which you've conceded. It's not a criticism. But it's hard to know how much of it is due to spending. Obviously, even with the best empirical techniques it's challenging, and not everyone agrees with you. But you are suggesting there is something of a consensus.
44:21I want to challenge you in a different way. Given that--let's assume this is true, which you are confident that it is, that spending cuts reduce, have a smaller impact on output than tax increases. Does that have implications for other aspects of economic policy and economic life, given the mechanisms by which you think those changes have those effects? You talked about expectations of the future. I think one of the things about the current debates over so-called Keynesian stimulus or monetary policy is that it's very hard to know the longer-term effects, the difference between short run and permanent. A lot of people have argued that short-run changes don't have much of an effect no matter what. So, given those claims about the differences in--I should say temporary, not short-term--temporary changes have little or no effect--have you thought about the implications of that finding for other aspects of policy? Guest: Well, let me make a couple of points. One is on the temporary versus permanent effect. The conversation about austerity that we are having and the debate that is going on mostly has to do with the short-term impact of austerity policy. I think nobody would--I don't know, some extreme people may argue that you can run budget deficit and the debt growing ad infinitum. But most people would agree that sooner or later you have to bring deficit and debt under control. The question is: What are the costs of doing that in the short run? Now, in the medium and long run, eventually another result of this research that I've been doing is that fiscal adjustment based on spending cuts has been more successful at keeping debt-over-GDP ratio constant rather than spending adjustment based on tax increases. And the reason is pretty obvious: that, both in the United States and in Europe, there are various entitlement programs--Social Security, pensions--that are increasing at the rate that if you don't stop them, you are forced to raise taxes forever and ever; and that has a negative impact on the economy and on the budget. So, even talking about fiscal policy, the medium and long-run implication is not trivial, because we are talking about OECD countries with taxes-over-GDP ratios on the order of 50%. If you don't stop the growth of certain entitlements you will always be running after a moving target that is always increasing. So that is another aspect which is unrelated to the short-run output cost of austerity, but is related to a longer run expectation and reality of fiscal balance. So, that's an important implication. Regarding other variable that austerity affects, I think one very important and interesting debate is to take whether austerity, particularly austerity based on spending cuts, has a negative effect on inequality, social programs, welfare of the less wealthy, and so on. And this is of course an important question that we need to understand better. But I think that when we think about those of Keynes and Keynesian policy and so on, we should not forget that when Keynes was writing in the 1920s, government spending over GDP was a fraction of what it is today--10, 15%, and I forget the right number, but certainly a fraction of what it is today. Now, in the countries we are talking about, we have government spending over GDP about 40-60%. And the question is--and here we are not talking about cutting government spending by half. We are talking about a few percentage points of GDP, say from, I don't know--Germany is 45%, France is close to 60%--we are talking about a few percentage points. Now, are we really saying, those who are worried about inequality and so forth, are they really saying that if we reduce government spending by 3 or 4 percent of GDP, we are throwing hundreds of thousands of Europeans into poverty? I think frankly my answer is No. I think there are many ways in which you can do it without throwing people into poverty. There are lots of programs which are not means tested, [?] in which a lot of rich people receive a lot of benefits, public goods and services that are not means tested. There are a lot of things that the private sector could do even better than the public sector. So, there is a lot of room for achieving these kind of budget cuts preserving the wealth of the very poor, if that's your goal. When we talk about tax increases, we are not saying anything about the progressivity of the tax system. Taxes [?] already progressive; but if you are talking about tax cuts, nobody is saying that it should be the rich that should get tax cuts. You can have tax cuts on the middle class and not on the rich. So, the level of spending and the level of taxation per se, they say very little about [?] of consequences. And in fact, countries like in southern Europe--Greece, Italy, Portugal, Spain--who were facing the biggest problem in terms of debt and the need for austerity are also the countries that have the worst welfare systems in Europe. Namely, despite the fact that they spend not that much less than northern Europe, all the evidence shows that welfare is very poorly provided in those countries. The welfare systems are very inefficient. So, despite spending so much they are not doing a lot of good in terms of reducing inequality. And the northern European countries, who are actually more fiscally responsible, they have a large government but they are much more efficient at redistributing wealth. So, the level of spending and the level of taxes says relatively little about redistribution. So, of course, one should go much more in detail. But there's no reason why you cannot spend 4 or 5% of GDP less in European countries without--and by doing so creating an enormous increase in poverty. Or even a small increase in poverty, for that matter.
51:48Russ: So, I just want to make an aside, because I think it's important in current economic debate, as the Presidential election is moving along here in the United States. When you said you don't have to cut taxes for the rich, you cut taxes for the middle class--I think a lot of people might think, 'Well, the middle class doesn't pay a lot of taxes.' And I think that's true, relatively true, for the rich for income taxes. But a lot of people forget, we have a substantial payroll tax in the United States that's paid by any worker. And it's roughly 15%--it's 7.5% or so on each side, the worker and the employer. And most economists seem to believe that the employer's side is paid by the worker and[?] the more lower wages. So, somehow that tax burden just gets forgotten--because "That's for Social Security." But it's not. It's just another tax. It's got a name tying it to Social Security and disability payments, etc. But it just goes into the same pot. So, it's important to remember that when we think about the tax burden in the United States, you shouldn't just look at the income tax. You need to look at the income tax combined with the payroll tax. That's just an aside. Guest: Absolutely. Let me add that in fact, the tax systems even in Europe are quite different from each other. So, the word 'cutting taxes' may mean a host of different things in different countries. And in fact--but you make a very important point, which I'd like to generalize--namely that, when you talk about cutting taxes, incidentally people, increasingly people say, 'Only the rich pay taxes, and therefore cutting taxes means doing a favor for the rich.' But I think there are other ways of doing it without the perhaps corrections in the tax structure that is not necessarily the case. Russ: Yeah. My personal preference would be that we abolish the payroll tax--because I think it confuses and makes opaque what is actually happening--and raise the income tax so that we can see what's going on a little more clearly. And for a lot of reasons, I think that would be a good thing.
54:07Russ: But I want to turn to the issue of debt, not the deficit. We've been talking about both along the way, and people get those confused. One is a stock and one is a flow. That is, one is a particular amount at a point in time--that's debt, the national debt, that's how much do we owe at a point in time; you can answer that question. Whereas the deficit is the amount we spend above what we take in, in a particular time period--say, a fiscal year. And they are related, obviously. And you reference and many people talk about the debt-DGP ratio; that there comes a point, potentially, where that itself is so high--and we are worried about this for the reasons you were talking about a minute ago: there's demographic changes, given entitlement programs, that suggest that that ratio will get ever higher, to the point where it would be extremely difficult for the United States to continue to borrow, given that the debt would be very large. And when this kind of conversation takes place, people reference the work of Reinhart and Rogoff on the debt-to-GDP ratio. Now, some people have said that work is flawed. What I want to ask you is, two questions: Is it a serious concern in a country like the United States, that somehow we should be careful about how much we borrow, because if we continue to borrow our national debt will grow to such a point that the markets will lose confidence in the United States's ability to repay it, and we will have a crisis just because of the amount of debt we've accumulated over time? Do you think that's a reasonable worry? And if it is, how might one begin to think about when that would happen? Because a lot of people say, 'Well, everything is fine. Why are you worrying about it? We can borrow plenty more.' Guest: First of all, let me just say that Rogoff and Reinhart got really badly mistreated by the press. I think there was an error in their calculations in one particular paper, but the main message of their fantastic book and fantastic work remained solid. And I think unfortunately their mistake in the middle of this extremely heated discussion about austerity, they really received from part of the press at least really an undeserved, horrible treatment. Having said that, clearly the United States is a country that has a lot of credibility: people keep buying U.S. debt because there is a sense of security in the U.S. government that they are not going into a crisis. Interest rates for a variety of reasons are extremely low today, so borrowing is cheap. And in fact some people argue that they should borrow even more to rebuild infrastructure given that interest rates are so low; and there is some value to that idea. But I think the problem is that there are certain programs, particularly Medicare, that are exploding, Social Security and Medicare, particularly the latter. And if you read the projection of the Congressional Budget Office, it's really, really scary. So, if policies do not change, either the debt-over-GDP ratio may grow to a level that becomes unsustainable, or we don't spend on anything else other than Medicare, because Medicare is growing at an incredibly fast rate. So, something has to be done about these programs. Is there a, can it be said that if you don't do something tomorrow, in the next two years, everything is going to explode? I think the answer is No. I don't think there is--on the opposite side of those who keep saying, 'Let's borrow more, let's borrow more, because everything is fine.' Those who say, 'If we don't do something dramatic in the next couple of years, the United States is going to go bankrupt or default, is also, I think, not true, because of the credibility that the U.S. government has ever accumulated in their history. But something will need to be done. That's for sure. When the debt-over-GDP ratio reaches a point where the debt becomes unsustainable and is a problem is very hard to know. I don't think there is one number for every country. When Latin America in the 1980s got into a crisis, or even now they go into crisis, their debt-over-GDP ratio is much lower than some countries in Europe, or the United States. So, the level of the debt-over-GDP ratio, whether it is sustainable or not depends a lot on the credibility and the confidence that investors have on a particular country. And the United States has a lot of confidence on the part of investors, so the United States can sustain a very large debt without a problem of a crisis. But the dynamic, the first derivative of the debt, because of Medicare, is quite worrisome. So, without spreading terror amongst Americans, but I think they should be series of discussion by the next few Congresses about what to do. Russ: Well, one might argue that unless you spread that terror, there's not going to be any incentive for Congress to do anything about it. It's a very challenging problem of political economy. To me, it's a problem where there's no problem until it's too late. That kind of problem is not handled very well by politicians. Guest: That is--yes. From a political economy point of view, you may be absolutely right. I was talking more as an economist than as a [political economist?--Econlib Ed.]. But you may be absolutely right. I am from Italy: it's the perfect example of a country where they wait until the last moment to do things. And when things get done in the last moment, when you are against a wall, you may make a decision that is a bad optimum because you don't have the time to do the right thing. Russ: Yeah. No, I wasn't criticizing you. Guest: No, I understand. Russ: And I certainly would never suggest that economists should lie or exaggerate the fears to make sure that the politicians respond. I think that's also a mistake. But it's a fascinating problem. And the data--Japan is running almost a 300% debt-to-GDP ratio, which would seem to be unsustainable. There is a suggestion I've seen that a lot of their debt is not really debt, in the sense that there is any worry it will have to be repaid, it's held by the government--it's not as scary as it actually appears if you look at the data more carefully. But it is true, as you point out, that every country has its own level of credibility and reliability and expectations; and some countries can live with much higher ratios than others, probably without a crisis. Guest: Right. And there is also the very low interest rate that we have today in some sense is another [?] confounding factor, because now debt is cheap. It's cheap to borrow. But who knows? Probably interest rates will remain low for quite a while, but perhaps not forever. And since, again, we are not talking about the short run but medium and long run, in the medium and long run we should expect interest rates to go back to a normal situation, and when interest rates go up then the burden of the debt becomes higher, too.

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