Reinhart and Rogoff might be commended on the amount of work they have put into assembling the huge database (it covers eight centuries and sixty-six countries, although the focus of the book is crises and defaults since 1800). Rather than closely studying the details of particular crises to gain an understanding of causes and consequences in order to make more general statements, their method is to aggregate particular measures and ratios across countries and over the long sweep of history to obtain data presented in “simple tables and figures” to “open new vistas for policy analysis and research.” Indeed, their book is nothing more than a large database of questionable value. The authors argue in favor of empirical investigations rather than fancy models. I agree with that. But simply having a large amount of data without much meaningful explanation is not very useful. Economic analysis and theorizing doesn’t necessarily have to be mathematical. One can use the narrative approach to explain economic events. Indeed, the narrative approach is in some cases the only way to capture the complexity of the world around us. And while Rogoff and Reinhart have rejected the mathematical modeling, they haven’t offered an alternative in the form of a narrative either. They simply have failed to do much explaining at all.
The crux of the book is that each time people think that “this time is different”, that crises cannot occur anymore or that they happen to other people in other places. True. This is exactly what Hyman Minsky was arguing more than 40 years ago. Reinhart and Rogoff don’t really explain why this perception leads to crises. Minsky, on the other hand, had an analysis of investment and of position taking in assets which led him to conclude that when people get comfortable in the existing situation they tend to overextend their balance sheets and lower the cushions of safety, which inevitably leads to fragility. A fragile financial system is then subject to a crash like the one we experienced in 2007.
The book is mostly on crises driven by government debt. Rogoff and Reinhart claim to have identified 250 sovereign external defaults and 70 defaults on domestic public debt. The problem with their “analysis”, however, is that over the past 800 years (and even over the past two centuries that are the focus of the book), institutions, approaches to monetary and fiscal policy, and exchange rate regimes have changed. For example, before the Great Depression the US was on a Gold Standard, then there was the Bretton Woods regime and finally in the last 40 years the US dollar has been a non-convertible currency. From reading the book it seems that this is not important at all. In reality the monetary regime a country operates on has major implications for government solvency. Aggregating data over different monetary regimes and different countries cannot yield any meaningful conclusions about sovereign debt and crises. It is only useful if the goal is to merely validate one’s preconceived myth about government debt being similar to private debt.
A sovereign government that operates on a non-convertible currency regime spends by issuing its own currency and as it’s the monopoly issuer of that currency, there are no financial constraints on its ability to spend. See here, here and here for more. It doesn’t need to tax or issue bonds to spend. It makes any payments that come due, including interest rate payments on its “debt” and payments of principal by crediting bank accounts meaning that operationally they are not constrained on how much they can spend. Governments operating with a non-convertible fiat currency cannot be forced to default on sovereign debt. They can choose to do so but that’s ultimately a political decision, not an economic/operational one. As far as I can tell Rogoff and Reinhart haven’t identified a single case of government default on domestic-currency denominated debt with a floating exchange rate system.
The need to balance the budget over some time period determined by the movements of celestial objects is a myth. When a country operates on a fiat monetary regime, debt and deficit limits and even bond issues for that matter are self-imposed, i.e. there are no financial constraints inherent in the fiat system that exist under a gold-standard or fixed exchange rate regime. But that superstition is seen as necessary because if everyone realizes that government is not actually financially constrained then it might spend “out of control” taking too large a percent of the nation’s resources. See here for more.
When the Great Depression hit governments didn’t know how to counteract the crisis, to solve the problem of unemployment. Further they were constrained by the Gold Standard (which the U.S. finally abandoned in 1933). Today we know exactly what to do to solve the issue of underutilization of labor resources. But unfortunately we are constrained by myths. I wonder what the economists, who propagate these myths, would say if they were in the ranks of the unemployed. Would they say that Congress should not extend unemployment benefits because it will further contribute to the deficit? Would they say that more stimulus is unsustainable? I suggest we leave them unemployed for a while. They will have more free time to do some Modern Monetary Theory reading and more “economic incentives” (i.e. lack of income to support themselves and their families) to rethink their position. Professional economists are a major impediment on the way to using our economic system for the benefit of us all. And Reinhart and Rogoff are no exception.