Bad Economics, Sovereign Debt, The Irish Mortgage Crisis And More

* Ireland apparently does not have, or almost never uses, a foreclosure process to repossess homes. Instead, involuntary bankruptcy is pretty much the exclusive means of owner occupied residence repossession - at least until this month, when a new insolvency process similar to Chapter 13 bankruptcies in the United States, was put in place. About one in eight Irish mortgages are more than ninety days overdue, mostly as a result of an economic collapse including a 50% drop in housing prices when a housing bubble there collapsed.

This stark difference from the debt collection practices of other countries with a common law legal tradition is notable.  Commentators at the BBC attributed this policy to the weighted political history of unjust evictions by absentee British overlords on the Irish consciousness.   (Source: BBC radio news broadcast heard on radio.)

* The European economy is almost certainly headed into a double dip recession (and a deep one) in the wake of the sovereign debt crisis if it isn't already there. Ireland's sovereign debt crisis has mostly been worked through, but now it has a massive private debt crisis.

The hard question is whether this will slow the not yet quite complete recovery of the U.S. from its financial crisis, or worse yet, plunge the U.S. into a double dip recession. So far, this doesn't seem to be happening because domestic demand is pushing the U.S. economy back, but it is still a serious worry.

It doesn't help that China's growth is slowing dramatically.

China and the E.U. are the two biggest non-U.S. economies in the world and import-export based revenues are important to the U.S.; on the other hand, bleak investment prospects in those countries make make the U.S. more attractive to foreign investors thereby giving the U.S. economy some private stimulus.

* The academic economic study by Carmen Reinhart and Ken Rogoff that was a main respectable justification for austerity policies in Europe and elsewhere turns out to have been deeply flawed in a manner that has created a major scandal.

The increasing consensus of informed opinion led by Krugman and others economic commentators, is that the resort to austerity measures both by U.S. states and in Europe, as well as the failure to the U.S. to take sufficiently bold stimulus measures at the federal level, has made the series of recessions that started with the U.S. financial crisis and continues into the European sovereign debt crisis, far worse.  If macroeconomists had been clear about this fact, which apart from the R&R work didn't have nearly as solid academic support, perhaps this serious misstep could have been avoided. 

Reinhart and Rogoff paper showed empircally that debt loads in excess of 90% of GDP greatly harmed long term economic growth.  But, it turns out to that they reached that conclusion based on spreadsheets that accidentally omitted key data points, mistranscribed data and because they added up the data incorrectly.  They correctly determined that austerity imposes short term pain.  But, they were wrong in concluding that the short term pain of austerity measures imposes immense penalties in terms of long term growth when economies have high public debt levels relative to their GDP.

They weren't the only economists to reach this result, but without this paper, the argument for it would have been far weaker.

If their methodology had been applied without clerical or arithmetic errors, it would have reached the opposite conclusion. The poignant question is How Much Unemployment Was Caused by Reinhart and Rogoff's Arithmetic Mistake?, by Dean Baker (via Economist's View blog):

The most important of these errors was excluding four years of growth data from New Zealand in which it was above the 90 percent debt-to-GDP threshold..., correcting this one mistake alone adds 1.5 percentage points to the average growth rate for the high debt countries. This eliminates most of the falloff in growth that R&R find from high debt levels. (HAP find several other important errors in the R&R paper, however the missing New Zealand years are the biggest part of the story.)

This is a big deal because politicians around the world have used this finding from R&R to justify austerity measures that have slowed growth and raised unemployment. In the United States many politicians have pointed to R&R's work as justification for deficit reduction even though the economy is far below full employment by any reasonable measure. In Europe, R&R's work and its derivatives have been used to justify austerity policies that have pushed the unemployment rate over 10 percent for the euro zone as a whole and above 20 percent in Greece and Spain. In other words, this is a mistake that has had enormous consequences.

This debacle has renewed the debate across a host of academic and scientific disciplines over whether published academic research should routinely include raw data and computer code, something that only rarely happens now.

It has also lead to hand wringing among economists over the sad state of empirical validation in macroeconomics and the lack of consensus in the field.

I personally believe that macroeconomics is a discipline in dire need of a transition from a narrow focus on theoretical models of monetary policy and government spending levels, in favor of a far broader descriptive orientation.

I once went so far as to take the GREs and request applications for graduate programs in economics, but did so only with trepidation because I lacked confidence in the academic discipline's serious problems (ultimately, children on the way caused me to continue practicing law instead of going to graduate school).  I was deeply dissatisfied with the quality of the scholarship in the discipline every since I took an intermediate macroeconomics class at Miami University while I was a senior in high school.

Miami University shouldn't be faulted on this score, despite the fact that the particular instructor in question wasn't very good. I considered the discipline at all, in part because of the excellent teaching I received in my honors microeconomics course the semester before from Professor Gerald E. Flueckiger (who died in 2000, far too early) and an equally able high school economics instructor my sophomore year at Talawanda High School, both of whom powerfully demonstrated the relevance and intuitive power of economic thinking and the potential breadth of the discipline even though it was rarely realized.  

The macroeconomics class I took at Miami University was typical of the discipline and graduate instruction at many institutions in macroeconomics, and a learned a lot in it about mainstream macroeconomic models even though I don't respect them very much.  We used Robert J. Barro's classic equilibrium equation market clearing model based textbook that epitomized everything that is wrong with the discipline but did so competently, albeit with a dry approach that was utterly detached from reality.  Our instructor was humorless trees for the forest kind of wonk, even worse than the textbook he taught from, who was busy fighting subdiscipline battles we were barely aware of over monetary policy in our classroom to the unseen audience of his discipinary peers.

(Full disclosure, I got in "B" in the class, but that was only because I overslept the day of the final exam and only arrived to take it a half an hour late, barely dressed, unshowered, and flustered, a reality reflected in my performance on that exam, but that didn't reflect how much I learned and absorbed from the class.)