Paging Dr. Romer; Against Reinhart/Rogoff (preliminary)

Paging Dr. Romer

We are going to start a new feature here called “Paging Dr. Romer.”  Anytime someone associated with the Obama Administration, past or present, says something that is probably wrong about the economy in 2011, we break out Christina Romer saying the correct thing in early 2009.

For instance, take this from Ezra Klein’s big Could This Time Have Be Different article (a piece we’ll cover in the next post):

“I don’t think it’s too much of an exaggeration to say that everything follows from missing the call on Reinhart-Rogoff, and I include myself in that category,” says Peter Orszag, who led the Office of Management and Budget before departing the administration to work at Citigroup. “I didn’t realize we were in a Reinhart-Rogoff situation until 2010.”

It’s not always clear what people are invoking when they bring up Reinhart-Rogoff.  The general thought is that recoveries from financial crises take a very long time.  Usually this is used, in policy debates, to mean that a financial crisis negates fiscal policy or that we can’t use fiscal or monetary policy effectively until we’ve tackled Wall Street or debts overhangs first.

Paging Dr. Romer……paging Dr. Romer……Dr. Romer located.  Here’s a transcript of Dr. Romer, March 29th, 2009, Meet the Press interview:

MR. GREGORY:  Most economists believe that until the financial system is shored up, until these distressed assets are removed from these banks’ balance sheets, stimulus won’t work and the economy won’t recover.  And yet the administration has yet to provide a detailed blueprint about how they’re going to remove these assets.  What’s taking so long and what is the plan?

DR. ROMER:  All right, so there are two things to say.  One is I don’t agree with the idea that you–that, that stimulus can’t do anything until the financial rescue is done.  I think in truth, those things go parallel.  And if you think back to the Great Depression, it’s actually–getting the real economy going was the main thing that, that helped to make–bring the banks around.

MR. GREGORY:  But didn’t FDR first shore up confidence?  The bank holiday was what he did first before he got to fiscal stimulus.

DR. ROMER:  Actually, you know, a crucial thing–when he did the bank holiday, it took the next two years to actually clean up the banks, that we actually did not get the things really cleaned up until 1935.  And that a big part of that cleanup was he managed to turn around the real economy.  We saw employment growing again, GDP growing again, and that inherently helps your financial system.

Getting people’s wages up and getting unemployment down is a great way to deal with debts.  Having median wages crash 10%, a sustained period of very high unemployment and disinflation is a good way to kill a recovery and make debt loads more unbearable.  One needs a theory of why the aftermath of a financial crisis means we have to have a period of long turmoil – and the funny part about Reinhart/Rogoff is that it doesn’t actually have a good explanation of why it should be that way.

Against Reinhart/Rogoff (preliminary)

As a placeholder for future work, here’s some others arguing against the idea that This Time It’s Different should be invoked to explain what is going on with the economy.

First, also from Ezra’s article, Joe Stiglitz gets the core of it:

Yet even among economists who admire Reinhart and Rogoff’s work, there is skepticism.  One source comes in how Reinhart and Rogoff find the economic phenomena they’re trying to study. “There’s an identification problem,” Stiglitz says. “When you have underlying problems that are deep, they will cause a financial crisis, and the crisis itself is a symptom of underlying problems.”

Next Ben Bernanke, transcript:

CHAIRMAN BERNANKE: …I thought [This Time It’s Different] was informative and as you say, it makes the point that as a historical matter, recoveries following a financial crisis tend to be slow.

What the book didn’t do is give a full explanation of why that’s the case. Part of it has to do with the problems in credit markets. My own research when I was in academia focused a good deal on the problems in credit markets on recoveries…

That said, another possible explanation for the slow recovery from financial crises might be that policy responses were not adequate. That the recapitalization of the banking system, the restoration of credit flows and the monetary fiscal policies were not sufficient to get as quick a recovery as might otherwise have been possible.

Here is Joe Gagnon:

Some have argued that economies take longer than normal to return to full employment after financial crises (Reinhart and Rogoff 2009). However, there is a wide range of growth outcomes after financial crises, and the worst outcomes tended to be associated with the poorest policy responses.

The goal of policymakers should be to learn from the past and achieve a better outcome than simply the average of past outcomes. In the current crisis, the zero bound on interest rates has been a major factor preventing monetary policymakers from doing as much as they otherwise would to speed recoveries. But, as discussed below, the zero bound is not a limit on what monetary policy can do. There is plenty of scope for further monetary stimulus.

Lopez-Salido/Nelson of the FRB suggest that their data is sensitive to how they classify the end dates of United States banking crises (h/t Arpit Gupta, paper is also source of Romer quote above):

We reconsider the connection between financial crises and economic recoveries in the postwar United States. We proceed in two steps. First, we provide a chronology of financial crises in the United States. We make the case that the postwar period prior to 2007 should be characterized as featuring three periods of financial crisis: 1973-1975, 1982-1984, and 1988-1991. This implies a substantially different postwar chronology of financial crises from that advanced by Reinhart and Rogoff (2009a, 2009b). The second step in our analysis is to reexamine economic recoveries in the wake of financial crises with this revised chronology. We find that the regularity that recoveries are systematically slower in the aftermath of financial crises does not hold for the postwar United States. The pace of the expansion after recessions seems to reflect deliberate aggregate demand policy. A weak lending outlook does not appear to pose an insurmountable obstacle to the functioning of stimulative aggregate demand policies.

We’ll expand this critique into something digestible this fall, because it appears to be the excuse for bad performance and lack of will to do anything on the economy across the political spectrum going forward.