Econintersect: Paul Krugman has two graphs in his IMF Conference paper (14th Jacques Polak Annual Research Conference, November 7-8, 2013) which can serve as an object lesson in anlysis for Harvard professors Carmen Reinhart and Kenneth Rogoff. The lesson is so simple that one would think it would be too obvious to be of note.

Krugman presents a graph from a paper by David Greenlaw, James D. Hamilton, Peter Hooper and Frederic S. Mishkin (NBER Working Paper No. 19297, August 2013) who used it in support of their argument that there is a tipping point for high sovereign debt which will result in high interest rates.

Krugman says:

Japan, at the lower right, is an outlier, but otherwise the data seem to show a clear positive relationship between debt and borrowing costs, leading – or so Greenlaw et al suggest – to a possible vicious circle of rising rates and exploding debt once debt gets beyond a critical level, probably less than 100 percent of GDP.

Krugman then presents a second graph of the same data, with the data points segregated into countries that are sovereign issuers of their own currency in one group and countries that use a currency that is issued by someone else.

Lo and behold, Japan is no longer an anomaly!

The relationship between debt and interest rates has two clearly defined different functions depending on the control point for the issuance of currency.

All the flap over spread sheet errors in the Reinhart and Rogoff studies was a minor factor. The real question is the effect on their analysis if the two types of currency regimes were recognized.

John Lounsbury

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