Paul Krugman: Correlation, Causality, and Casuistry


And I’m back. This real life thing is getting in the way of my blogging, so maybe I should give it up.

The delay has put me behind the curve on two new entries in the Reinhart-Rogoff affair, by Arindrajit Dube and Matt O’Brien. On the other hand, it’s given me time to think about Dube’s post, which I felt I needed to do before posting myself.

Dube tries to take on the issue of whether high debt causes slow growth or vice versa. His approach is clever, comparing the power of debt as a predictor of both past and future growth, but to my taste he skips too many steps in his explanation. So let me try to fill in the gaps.

Imagine one story — the story that R-R are implicitly telling — in which countries differ in their fiscal responsibility, this leads to different levels of debt, and those countries with high debt then suffer from slow growth. In that story, debt should be a pretty good predictor of future growth. You might also expect to see some correlation between debt and past growth, because debt levels change only gradually over time, and a country with high debt now typically had high debt and hence slow growth a few years ago too. But you’d expect the relationship between debt and future growth to be stronger than the relationship between debt and past growth.

Now imagine another story, in which countries aren’t that different in fiscal responsibility, but in which some countries for whatever reason — burst bubbles, declining fertility, structural problems coming from social change or something — have slower growth than others. Very plausibly, slow growth would lead to rising debt ratios, both because of slow growth in revenues and simply because the denominator of the ratio would be smaller. In this case past debt should be strongly related to past growth. You might also expect some relationship between debt and future growth, because growth tends to be “serially correlated” — countries that grew slowly in the past tend to keep growing slowly — but that relationship should be weaker.

So Dube does the exercise, and it looks like this:

Clearly, the data look a lot more like story #2, in which slow growth causes high debt, than story #1, which is what everyone hyping Reinhart-Rogoff claimed.

And the everyone hyping Reinhart-Rogoff very much included Reinhart and Rogoff themselves. Matt O’Brien has the goods. It’s true that their papers never said outright that the relationship was causal, but they weren’t anywhere near that scrupulous in op-eds and other media presentations. And the truth is that the papers may not have stated causation flatly, but it was clearly insinuated. By trying to claim now that they never meant to imply such a thing, R-R are falling down seriously in the menschhood test.

One last thing: even if you take Dube’s forward-looking regression as a causal relationship, which you shouldn’t, notice how weak that relationship is in the relevant range. It looks as if raising debt from 50 to 150 percent of GDP, other things equal, reduces growth by around 0.1 percentage point over the next three years. This is the dreadful consequences that prevents us from doing anything about mass unemployment?

Correlation, Causality, and Casuistry –

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One Response to Paul Krugman: Correlation, Causality, and Casuistry

  1. Joao Ejarque says:

    I can see what is in this data. But surely, even though some may use RR’s paper as justification for cutting spending, the main issue must still remain. Overcoming a debt crisis by spending (as in, issuing more debt or raising more taxes) cannot be guaranteed of not doing exactly what we are seeing right now, because, after all, where do governments get the money to spend? Unless of course we are talking of using the printer. And if we are talking about using the printer, why do governments have to be involved at all? Why not just allow central banks to buy whatever assets – individual, corporate and sovereign – they want (and burn them), and leave governments to quietly get the house in order by cutting spending and making sure the budgets are under control in the future, hopefully at lower spending levels (because taxation is distortionary and big government may well exponentiate the distortions imposed on the economy). And if the ECB is to use the printer to save portugal and greece – making each and every euro holding person pay for their troubles – why not make sure that portugal and greece are run by danes or germans (to get rid of the moral hazard) for the next 20 years, since they have clearly not been able to do the job so far by themselves? Also, just to use a single point regression, perhaps the reason Ireland is doing better than portugal is that they actually cut consumption a lot more drastically (deeper recession in the short run), and now are slowly getting the benefits of putting the house in order. I know this is superficial, but it is at the same level of depth of looking at these RR pictures of debt and growth.

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