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This Time is Different: Kenneth Rogoff

Kenneth Rogoff is the Thomas D. Cabot Professor of Public Policy and Professor of Economics at Harvard University. He was previously Economic Counsellor and Director, Research Department of the International Monetary Fund, and the Charles and Marie Robertson Professor of International Affairs at Princeton University. He received a B.A./M.A., summa cum laude, honors in Economics from Yale University, and a Ph.D. in Economics from the Massachusetts Institute of Technology. A chess prodigy, Rogoff received the highest title in chess, International Grandmaster, in 1978. His latest book is This Time is Different: Eight Centuries of Financial Folly.

The Politic: What course or person at Yale most influenced your world view?

KR: I think my greatest influence was the late professor Jim Tobin. He won a Nobel Prize, though he hadn’t received it yet when I was a graduate student, but he was very distinguished. Very simply, I was greatly influenced by his view that economics is important, that it matters, and that it can help people, but when you use the wrong economic model, it can do a lot of harm.

The Politic: Many economists have argued that the United States faces serious threats of dramatic inflation or default. You’ve talked about a 30% or higher increase in taxes. Is this politically feasible? Will it be enough to prevent inflation or some type of default?

KR: Well, right now the Federal government is taking in about 15% of GDP in taxes, and it’s spending 20-25%. The spending can come down, but not that much, and eventually the taxes will have to go up. Historically, Federal taxes have been about 20% of GDP. Given the huge deficits we’ve run, and the actual likely increase in spending to fund social programs like the health care plan, it’s hard to imagine that taxes won’t have to go up to around 23% of GDP. That would actually be a 50% increase from where we are. There are certainly substantial tax increases ahead, and I think the catalyst for them will be concern about rising interest rates on US debt.

The Politic: You’ve described the US banking system as vulnerable and a potential cause of continued domestic economic troubles. What steps need to be taking to overhaul and repair the system?

KR: The single most important change is that the government needs to put in regulations that make it much harder for financial institutions that are implicitly guaranteed by the government to borrow massive amounts at short-term levels. It would also be extremely helpful if there were a way to remove the government’s implicit guarantee with “too big to fail” banks. Unfortunately, it’s not clear that this is easy. I think we need rather radical change in our regulation system, particularly after the extremely generous bailout packages that the banks were given in the financial crisis.

The Politic: What would be the best way to remove “too big to fail”?

KR: I think putting large capital requirements on short-term borrowing would be the single most effective change that the government could make. With “too big to fail” banks, we either have to put some limits on size, as Mervyn King at the Bank of England favors, or at least have a significant tax on size, as I believe the Federal Reserve is likely to propose.

The Politic: Should central banks raise rates to thwart perceived bubbles?

KR: I think there is no question that when central banks see asset price bubbles that are accompanied by huge amounts of borrowing, that should be a blinking red light that requires close examination. Ben Bernanke and others have argued that central banks should pay attention to bubbles, but that they should treat them with regulation. I think that this is true in the first instance, but that regulation is often insufficient for many reasons. It is difficult for regulation to overcome tremendous political pressures and have a lasting effect. In cases where we see really sharp run-ups in asset prices that are fueled mainly by increasing leverage, it does make sense to raise interest rates. Economists need to come up with better models for how to calibrate how much interest rates should be raised in these situations. We don’t really have good models, and as a result, are stuck analyzing past judgments. Central banks need better rules to decide, and better frameworks for deciding how high to raise rates to lean against the wind in leverage-fueled asset bubbles.

The Politic: Based on your experience at the IMF, what are the right ways to deal with institutional corruption in the developing world? Who can fix it and how?

KR: I think there is relatively little that the outside world can do for a sovereign state that is rife with corruption. I think it is very helpful to have non-profit agencies such as Transparency International, which play a valuable role in monitoring corruption. There are steps that can be taken and George Soros had a good recommendation some years ago that basically said that Western oil companies and the like need to report their payments to local officials in oil rich countries. Europe and the United States have adopted various rules to enforce more transparency on payments made to national officials when doing business abroad. The Chinese, of course, famously have not been complying with this rule, and there’s been a lot of discussion about that. While there are limits, it’s certainly important for the United Nations, the IMF, the World Bank, and others to try to shed light on corruption. Ultimately though, a country’s own citizens have to deal with their internal corruption.

The Politic: What do you see as the future of development lending?

KR: I think that we have learned a lot of lessons and the World Bank does things much better today than it did in the past. Jeremy Bulow, who was my classmate at Yale and a big factor in my decision to go into economics, and I have written a number of papers arguing that it would be better to give developing countries outright aid than to give them loans. Development takes so many decades – we’re talking potentially 50 or 100 years – that it’s unrealistic to expect that they’ll grow so quickly as to be able to easily repay the loans.

Historically, there’s been a great deal of evergreening of development loans, and a lack of transparency about who is getting money and why. Also, because so much development aid is given in the form of loans, there’s a tendency to give too little money to the poorest countries, which obviously can’t repay loans as easily as wealthier ones. So, we’ve argued in this series of papers that we need a better system with most development aid in the form of outright grants instead of loans that need to be repaid. Even if the loans are at very low interest rates, it is still difficult for these countries to repay them. This leads to a lot of confusion about who is getting paid, how much, and why its being given, so we advocate in favor of grants.

The Politic: Would you want microfinance lending to become an arm of the World Bank or the IMF?

KR: Microfinance is very exciting and innovative, but at the same time, a lot of its success versus traditional banking is somewhat of an illusion. One of the reasons microfinance is successful is because it’s small, and microfinance institutions have tremendous international backing and governments are very cautious about interfering with their activities or heavily taxing their money. If microfinance institutions become large, governments in the developing world will not be able to resist causing them the same problems that they do with their own banks. Microfinance thrives because of financial repression, corruption, and other problems in the developing world. As long as it’s small, it’s effective, but if it becomes large, it will run into some problems. I wouldn’t particularly favor moving it to these larger institutions. It definitely should not be a branch of the IMF, as the IMF has no real specialty in development. I think the World Bank does better by simply providing support from the outside. Microfinance is largely successful because of its outside support from institutions such as NGOs, and it is probably best left this way.

The Politic: What role does domestic debt play in countries external debt defaults?

KR: The difference between external and domestic debt, at least as Carmen Reinhart and I define it in our book This Time is Different, is that external debt is legally enforced in another jurisdiction, usually London, New York, Paris, or Tokyo, while domestic debt is enforceable in the issuing country’s courts. It has widely been believed by policy-makers and scholars that domestic debt was relatively unimportant for most emerging markets, until relatively recently.

One thing we show in our book is that this is not true. For much of history, domestic debt was large and important, even in emerging markets. When you take it into account, it helps explain why countries have seemed to default at such low levels of external debt. That’s not to say that domestic debt and external debt are necessarily the same — you can partially default on domestic debt through inflation and there are different penalties to outright default, but still, the repayments have to come from the same pool of funds. I think scholars also believed that even if there were domestic debt in emerging markets, it would be given low priority and made junior to powerful external creditors, but Reinhart and I find that this is not true and there seems to be an equal priority.

That shouldn’t be so surprising, given that domestic debt is often held by powerful domestic holders. We also show that domestic debt has played a large role in many of the great inflations that have been seen around the world. This role has been ignored by scholars and the literature on hyper-inflation for at least 50 years.

The Politic: Will the Chinese capital expenditure boom lead to an inevitable bust? If so, how severe would the consequences be for global markets?

KR: The Chinese leadership has done a magnificent job of engineering China’s growth over the past three decades, but it is extremely difficult to grow at the rate China has in an emerging market, without all the usual problems of emerging markets, and avoid a financial crisis. China will inevitably have a financial crisis and when one occurs, it will be very, very painful to the rest of the world. The United States depends on China for cash, as they fund our deficits. Developing world and emerging market countries depend on China for their commodities. China has been driving world commodity prices, and I think that more broadly, global political stability depends on China continuing to play a positive role in facilitating global peace. Any kind of destabilization in China will certainly not be welcomed, but hopefully, it won’t happen soon, though it could.

The Politic: How did you decide between becoming a professional chess player and an academic? How has your chess background affected the way you approach the world?

KR: It was a very painful choice to give up chess. I love chess very much, but I made the decision when I was in graduate school, though I’m sure I would have been happy either way. I still follow chess, but I don’t play it because I’m too addicted. Chess has been helpful in a variety of ways. Some of my work requires game theory, and while I don’t have a high-end mathematical background in game theory, I do find that my chess experience has made a lot of the concepts very intuitive. I also found chess very useful in my days at the IMF because chess disciplines you to think about what the other person is thinking. I certainly found many decisions in my policy-making life where it was important to keep that perspective.

The Politic: You’ve talked about potential United States inflation down the road. Many money managers seem to share this idea, and as a result, there has been a largely one-sided bullish trade on gold. What are your thoughts on gold?

KR: I still have my Phi Beta Kappa key from Yale. I can’t remember if it’s 18- or 21-carat gold, but I haven’t sold it yet. During the 1970s, many commodities in general did well when there was inflation. Other hedges, such as art, did well. Unfortunately, when there is generalized inflation, there are not so many ways for investors to hedge themselves, especially if the tax system is very biased. The effective tax rate in many countries, including the United States, goes up when there is inflation. That’s certainly a major reason gold has been attractive. I think also, emerging markets that have been piling up dollar reserves are seeing that the endgame to U.S. borrowing might not be pretty, and they want to diversify with gold. It’s important to remember that rich countries hold about half of their reserves in gold, whereas the typical emerging market country maybe holds 3% or 4% of its reserves in gold. Some of the price increase we’ve seen have been responses to countries like China and India increasing their gold holdings, but I don’t think the trend will continue indefinitely, unless we really do see a huge spike in inflation.

The Politic: What do you think the track record of academics moving into public policy roles is? What do you think is the best way to handle that transition?

KR: I think the track record is very good. I think academics play their most important role in changing long-run views rather than day-to-day policy. This is where academics really excel. We try to find ideas that will influence the way that people will think in 25 or 50 years, not just what they think a few days from now. Day-to-day policy is seldom influenced by radical new economic ideas. It takes many decades and a huge consensus before new ideas really come into play. So most academic research is geared toward long-term public debate rather than day-to-day decisions. That said, training in economics is extremely useful in many public policy decisions ranging from top economic advisors to the Supreme Court. I think economic training is very valuable for most citizens, but especially policy-makers.


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