In a 2010 paper Growth in a Time of Debt and again in a book entitled This Time is Different, Harvard economists Ken Rogoff and Carmen Reinhart presented the idea that when a country’s ratio of debt to gross domestic product reaches 90% lower economic growth is on the horizon.
However, Rogoff and Reinhart made an Excel Spreadsheet Error in their work that has the economic world in a tizzy.
A new study by three researchers at the University of Massachusetts finds that Rogoff and Reinhart made several mistakes that invalidate their thesis. They made a spreadsheet error that resulted in their leaving five countries out of an all-important average of countries with higher than 90% debt-to-GDP ratios. By restoring the full average, the UMass authors say, the growth rate for countries in that range becomes 2.2%, not the -0.1% cited by Rogoff and Reinhart. That makes the average growth rate at that ratio “not dramatically different than when debt/GDP ratios are lower.”
One irony of the finding stems from the fact that the debt-to-GDP ratio always was something of a heffalump. As economist Robert Shiller pointed out in 2011, yoking the two statistics together doesn’t necessarily tell you anything useful. Debt is measured in currency, he observed; GDP is measured in currency units per year. But there’s “nothing special about using a year…. A year is the time that it takes for the Earth to orbit the sun, which, except for seasonal industries like agriculture, has no particular economic significance.”
Error Austerity Debate
CNBC picked up the story in Reinhart-Rogoff Error Sparks Austerity Debate.
Adding fuel to to an already contentious debate over whether tough austerity measures are helpful or harmful to an economy, is a new revelation that there was a mathematical error in an influential economic research study, often cited as having paved the way for fiscal policies pursued by the U.S. and Europe.
The charge was raised in a paper, released Tuesday, by an economics doctoral student and two professors at the University of Massachusetts that called into question the findings of Harvard economists Carmen Reinhart and Kenneth Rogoff’s 2010 paper “Growth in a Time of Debt,” which concluded debt over a certain level was dangerous for countries.
Reinhart and Rogoff said they made a bad calculation within an influential economic research paper in 2010, but rebut claims that the errors were made intentionally. They also stand behind the central theme of the paper that too much public debt will slow economic growth.
Krugman Chimes In
Paul Krugman chimed in with his response Reinhart-Rogoff, Continued.
I was going to post something sort of kind of defending Reinhart-Rogoff in the wake of the new revelations — not their results, which I never believed, nor their failure to carefully test their results for robustness, but rather their motives. But their response to the new critique is really, really bad. ….
Let’s step back from the politics of the debate to focus on the obvious. My friend Pater Tenebrarum on the Acting Man Blog sent this common sense analysis of the setup in an email.
Empirical studies cannot be used to settle points about economic theory. It should be obvious that deficit spending is nothing but deferred taxation. And obviously, since government spending has no concept of the categories of profit and loss, such spending is typically a mindless waste of scarce resources. No bureaucracy has any inkling of opportunity costs or consumer wishes. The spenders are saying: government bureaucrats know better how to allocate resources than the private sector. Perhaps, but certainly not in this universe.
I remind readers that by definition, government spending adds to GDP. The government can pay people to spit at the moon or dig ditches and fill them back up again and those activities will add to GDP.
Does such economic stupidity matter at 90%, 95%, or 130% of GDP?
Is it even relevant?
What does matter is the obvious. And it should be obvious that wasting money to stimulate the economy is just that: waste.
The trigger point as to when such waste matters most likely varies country to country based on factors that no excel spreadsheet can properly discern in advance.
Rogoff and Reinhart made an error. So did Krugman. At least Rogoff and Reinhart have the general idea correct: economic stupidity matters at some point, something Krugman cannot seem to grasp.
Mike “Mish” Shedlock