Home > The Economics Profession > Carmen Reinhart and M. Belen Sbrancia: basic growth theory does not explain the facts

Carmen Reinhart and M. Belen Sbrancia: basic growth theory does not explain the facts

from Merijn Knibbe

Carmen Reinhart and M. Belen Sbrancia have published an NBER study on the post World War II liquidation of government debt. It’s, in the end, a very positive article: debts can and will be resolved! And it is interesting to investigate what the multitude of data on debts, inflation, interest rates and the like tell us about orthodox economic theory. Fortunately, we do not have to investigate this ourselves, as Reinhart and Belen Sbrancia have already done this – and their results turn out to be absolutely devastating for mainstream economic thinking. Let’s quote them: 

A. Reinhart and Belen Sbrancia on basic growth theory: “Note that real interest rates were lower in a high-economic growth period of 1945 to 1980 than in the lower growth period 1981-2009; this is exactly the opposite of the prediction of a basic growth model (their note 14)”.

B. Reinhart and Belen Sbrancia on the inadequacy of growth theory and calibrated models: “Much of the literature on growth, as well as standard calibration exercises involving subjective rates of time preference assume benchmark real interest rates of three percent per annum and even higher…real ex post interest rates on government debt did not reach three percent in a single year in the United States … the incidence of “abnormally low” real interest rates is comparable for the United Kingdom and Australia …(pp. 35 – 36; 1945-1980, M.K.)”

C. Reinhart and Belen Sbrancia on how ‘soft’ liquidation of debts and restrictions on capital flows stimulated post war growth: “We show that such repression (i.e. the institutional structure of capital markets between 1945 and 1980, M.K.) helped reduce lofty amounts of public debt in many of the advanced economies in the decades following World War II and subsequently in emerging markets, where liberalisation is of more recent vintage (p. 2)”, which according to their logic  was a good thing, “as high levels of public debt appear to be associated with lower economic growth (p. 2)”

Qualifying remark: al these quotes are either preceded or followed by qualifying remarks of the “so much for reality” type. But, reading between the lines, their message is clear: so much for basic growth theory. Government debts were, are and will be risk bearing assets and surreptitious default or ‘soft restructuring’ of these assets after 1945 may have had beneficial consequences during the Golden Age of Western Prosperity between 1945-1980 (Europe: 1953-1980; see also the June 2 Krugman blog post on this: http://krugman.blogs.nytimes.com/). Any way, defaulting governments were, are and will be part of the game – for worse or, sometimes, better. In the case of Greece: no ‘firm stance’ of the ECB will be able to alter this reality.

Ex post or ex ante? A very useful part of the article is by the way the table with the timing of the liberalization of capital markets in a number of countries, which (though this requires some additional research) can be compared with the timing of banking crises in these countries (Sweden, USA, Finland, Ireland….).

Reinhart, C.M. and M. Belen Sbrancia, ‘The liquidation of government debt’, NBER working paper 16893, March 2011.

  1. Ken Zimmerman
    June 8, 2011 at 2:04 am

    Interesting. Do C. Reinhart and Belen Sbrancia attempt to provide a story that explains their findings and the conflicts with othodox economic theory?

  2. June 8, 2011 at 4:10 am

    When interest rates are, by policy, low and stable, and tax rates are progressive, discouraging get rich quick approaches, we get more real economic growth. Shocking, except if you’ve stumbled into the real world by accident.

    Or read Paul Davidson saying this sometime in the 70’s.

  3. June 8, 2011 at 12:09 pm

    A formal mathematical demonstration that the public debt follows an explosive trend is provided by the paper Society Should Never Reward Private Savings, which will be given at the 2011 ICAPE Conference and may be found at http://www.macroambiente.com.br/downloads/material_in_english/society_should_never_reward_private_savings.pdf.

  4. July 28, 2011 at 9:37 am

    Another interesting story about the role of sovereign debt in fostering financial stability in the post-war period is contained in Hyman Minsky’s _Stabilizing an Unstable Economy_ where he characterizes the period of 1945 to roughly 1965 as one in which banck were slowly shedding the accumulated load of sovereign debt from the New Deal and WWII war economy. It’s when the banks ran out of Treasury bonds that they had to start engaging in “financial innovation” in order to “make positions”. And each financial innovation led to a financial crisis. First is was Commercial Paper, then REITs, and so on.

    None of this, of course, is compatible with standard theory, but who are you going to believe? Theory or economic history?

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