Sunday, April 28, 2013

Narrow focus on debt and deficits distracts us from the primary problems

Published in The Tennessean, Sunday, April 28, 2013 and at FORBES with archives.

by Richard J. Grant

In scientific controversies, as in political contests, the people most ignored are those who would prefer to vote for “none of the above.” In political contests, we must often take sides between the two remaining “most electable” candidates in order to minimize the damage that will ensue. But in scientific controversies we are not so constrained.

That is why this column never endorsed the 2010 study by economists Carmen Reinhart and Kenneth Rogoff that purported to find a sudden increase in “debt intolerance” in countries whose national debt levels exceeded 90 percent of GDP. The problem was not with the concept of debt intolerance, but rather with the portrayal of the 90 percent level as some sort of natural threshold beyond which economic growth rates would be severely curtailed.

Even before reading their article, it could be guessed (correctly, as it turned out) that the 90 percent threshold was more an artifact of how the data were selected and grouped rather than anything resembling a natural law. At the best of times, statistical studies of economic phenomena are exercises in economic history, not economic science. At the worst of times, working with whatever data happen to be available, they resemble a drunk looking for his keys under the lamppost. The science resides in the theory that is necessary to interpret the data.

Last week, researchers who were given access to the original data and spreadsheet used by Reinhart and Rogoff announced they had discovered calculation errors. After correction, the 90 percent threshold had disappeared. There was still a negative correlation between the size of the national debt and GDP growth, but there was no implied causal relationship or sudden change at 90 percent.

Unfortunately, all of this had played out in a political environment in which the U.S. and some state governments were running record deficits, partly in response to the recent recession. The debate over deficits grew in shrillness and crowded out discussion of the deeper problems, such as excessive government spending, overregulation, and the abuse of the powers of the Federal Reserve System.

During the past three years, the study’s conclusions were used to overstate the case for deficit reduction. With the revelation of the spreadsheet errors, some supporters of big government were giddily proclaiming victory as if they had not already been discredited before Reinhart and Rogoff entered the scene.

Those who need the assurance of statistical studies would be better served by the Rahn Curve (named after economist Richard Rahn), which shows a long-term negative relationship between the size of government expenditures as a percentage of GDP and economic growth rates. In other words, the bigger the role of government in the economy, the lower will be long-term economic growth rates.

The original theory underlying the Rahn Curve assumed that as the size of government increased from zero, supplying law and order and some basic services, economic growth rates would increase until government reached some optimal size. Government expenditures are not the only variable, so even if we had more examples of small government, we would still not be able to specify an optimal size of government expenditures, where the Rahn Curve peaks.

But what we can be sure of is that the peak of the Rahn Curve is much closer to zero than to where we are now. Instead of obsessing over debt and deficits, we should instead focus on the primary factor of government interference in the economy. If we constrain government spending, reduce the burden of regulation, and assure the value of the dollar, the national debt will cease to be a threat.

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears fortnightly on Sundays in the print and online versions of The Tennessean. He is also a regular FORBES contributor. E-mail messages received at:

Follow on Twitter @richardjgrant1

Copyright © Richard J Grant 2013

Sunday, April 14, 2013

Japan's inflation cavalry arrives too late

Published in The Tennessean, Sunday, April 14, 2013 and at FORBES with archives.

by Richard J. Grant

Throughout history, inflation’s advocates always found some reason for governments to create new money. We receive most of our incomes as money and we calculate our wealth in terms of money. When any one of us receives more money, that person rightly feels wealthier. But it does not follow that the existence of more money in general would make us all wealthier.

It is true that as we have grown wealthier, historically the quantity of money has tended to grow along with that wealth. The biggest deviations from this tendency have occurred during periods of fiat-money inflation or debasement of the coinage. In each case, the consequent monetary depreciation resulted from government officials trying to get something for nothing. The newly printed money, or the new coins minted from diluted alloy, was directed toward the special purposes of the government officials and their supporters.

The stimulus to those activities favored by the availability of the newly created money is always temporary and never without side effects. Such newly created money never enters the economy evenly. It increases demand for some goods and services relative to others and redirects resources accordingly.

The injection of new money, especially through the credit markets, will temporarily reduce interest rates. But it does not necessarily reduce people’s time preference, which means that it does not by itself make people more willing to save. Neither does the induced reduction in interest rates reflect any such spontaneous willingness.

An increase in the money supply is not the same as an increased willingness to supply capital. An expansion of credit in the present does not assure the continuous availability of such credit in the future.

When governments arbitrarily alter the general value of our currency (whether up or down), they deprive us of a reliable measure of the relative values of the goods and services that we trade. This is especially apparent when comparing the values of present goods and investments with future goods.

This makes inflation a harmful and inappropriate method to compensate for the effects of poor fiscal and regulatory policies. But this is how inflation has been used in the United States and around the world.

It is not even obvious that inflation is a good cure for a preceding deflation, though it can truncate some of the unhappy price adjustments.

Japan experienced de facto deflation from the mid-1980s through the 1990s. Since then, the yen has trended lower against gold. For the past dozen years, even though Japanese consumer prices periodically fell, the yen-gold price did not signal deflation.

During the same period, the yen trended horizontally against the US dollar with wide, but smooth, fluctuations. That trend broke during the US financial crisis. The Fed weakened the dollar and the yen moved relatively higher, surpassing a 15-year high by the end of 2010. This (relatively deflationary) uptrend continued until about September 2012 when the Japanese government very credibly signaled its intention to inflate the yen.

After a period of deflation, it can take many years for the price effects fully to work their way through the economy. A reflation of the currency, such as that indicated by the yen-gold price during the past dozen years, would remove much of the impetus for the deflation-induced price adjustments. Reflation can never put things back the way they were, because changes in relative prices would already have caused real adjustments in economic activity.

With the yen-gold price now at record highs, perhaps the Japanese government should loosely peg its exchange rate to the dollar and focus on improving its fiscal and regulatory policies.

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears fortnightly on Sundays. E-mail messages received at:

Follow on Twitter @richardjgrant1

Copyright © Richard J Grant 2013