A telling history

2/26/2009 - If the past can tell us anything, it might be that when the U.S. financial crisis finally clears, public debt could rise more than 86 percent.

That was the grim news that economist Kenneth Rogoff delivered to a full classroom Feb. 24 at the Kellogg School. Rogoff, the Thomas D. Cabot Professor of Public Policy and a professor of economics at Harvard University, served as the chief economist and director of research at the International Monetary Fund from 2001 to 2003.

Rogoff’s figure is based on an analysis of historical data from financial crises in advanced economies since World War II and financial crises in emerging markets. If accurate, that means the U.S. will add more than $8 trillion to the more than $10 trillion U.S. debt today, Rogoff said.

Rogoff’s research on the history of financial crises is highlighted in his upcoming book, This Time is Different: Eight Centuries of Financial Folly, co-authored by Carmen Reinhart, professor at the School of Public Policy and Department of Economics at the University of Maryland.

There were many signs that trouble was brewing in the U.S. economy before the recent turmoil, Rogoff said, citing the drop in equity prices and the housing market. A few economists noted several years ago that current account deficits in the U.S. were absorbing more than 70 percent of other countries’ surpluses, which put the market at serious risk.

But that theory was not well received by many academics, including prominent economists Ben Bernanke and Alan Greenspan, who said that U.S. current account deficits were sustainable and desirable.

“There were lots of red lights blinking,” Rogoff said. “The critical assumption was that the U.S. financial system was bulletproof.”

Rogoff said the U.S. financial system was superior to other countries, but not immune to large shocks — something unaccounted for by traditional economic models. He also said that there was no accounting for the effects that pressure from regulators and politicians would have on economic policy.

“The U.S. subprime crisis [raises] the question of overly depending on macroeconomic models that assume perfect financial markets,” Rogoff said. “Having an overly dogmatic dependence on a single modeling framework in policymaking is risky.”

Rogoff is a former director of the Center for International Development at Harvard. His book, Foundations of International Macroeconomics, which he co-authored with Maurice Obstfeld, is the standard graduate text in the field worldwide, and his monthly syndicated column on global economic issues is published in 13 languages in more than 50 countries.

Rogoff’s speech was sponsored The Office of the Dean and The Center for International Economics and Development at the Kellogg School.