Reinhart and Rogoff – the economists of austerity have got their numbers wrong but is their argument dead?

22nd April 2013


Two of the most influential economists of the age of austerity have become embroiled in a very serious argument due to a mistake in their numbers which could undermine the case for those austerity policies.

Kenneth Rogoff and Carmen Reinhart, the Harvard economists, have set what amounted to a theoretical cap on national debt after which countries are at serious risk of reducing rather than increasing growth.

Their work for ‘Growth in a time of austerity’ a paper and subsequent book suggested that increasing debt to GDP ratios above 90 per cent could cut growth by 0.1 per cent a year. The study looked at the experience of developed countries since the Second World War.

Now research from the University of Massachusetts, Amherst, suggests first that the two eminent economists left out five countries from their excel spreadsheet. The BBC reports on the story of the economics student Thomas Herndon who checked out the paper as part of an academic exercise though the BBC says rather more witheringly it was part of his homework. When he was sent the original data, he found that Australia, Austria, Belgium, Canada and Denmark had been left out. To add weight to their concerns. The Massachusetts economists – now involving Thomas Herndon, Michael Ash, and Robert Pollin have put together a working paper suggesting that the actual growth figures for those indebted countries’ growth could be as high as 2.2 per cent.

Crucially, the two economists have ‘recrunched’ the numbers and say their case still holds water. As the Guardian economics blog notes there is still much to be debated.

But will it change what has felt like something of a consensus among top leaders about austerity or is this simply going to be another chapter in the debate between the neo-Keynesians, who would cut much more slowly in the short term if at all, and the rest?

Mindful Money has trawled the web and linked to the economists with something to say to help you make up your mind on the issue.

The king of the Keynesians, Paul Krugman on his New York Times blog is on coruscating form but digs at a few other errant – in his view – economists too. He writes: “We had Alesina/Ardagna saying that austerity is actually expansionary thanks to confidence effects; Reinhart/Rogoff saying that debt has terrible effects on growth via unexplained channels. This stuff was creative, different, deeply appealing to powerful people — and dead wrong.”

On Reuters, Felix Salmon runs these interesting graphs from economist and sceptic Arindrajit Dube. The article suggests that at very low levels of debt, say 30 per cent of GDP, there appears to be a big impact on growth but generally rather than debt causing low growth, low growth may be causing the debt.

On Miles Kimball, economics professor at the University of Michigan, who has taken issue with Paul Krugman in the past for some of his work on Italy, comes to the following conclusion.

“The true statement, that we should be worried high levels of national debt might have a negative effect on growth, was mangled into the idea that a debt-to-GDP ratio of 90% is a critical threshold for the effects of debt on the economy—an idea that gained the traction it did because of Reinhart and Rogoff’s mistake,” he writes.

Rogoff and Reinhart defend their stance on the (Behind paywall). Among other things that suggest that the Massachusetts work appears to show the same pattern even with the inclusion of new data. But for the moment at least, few others are jumping to their defence.

The Baseline scenario website says that the central case around that 90 per cent figure appears to have been undermined because there is no cliff edge in terms of debt and growth.

There is clearly an investment perspective to this as well as an economic one too. It adds grist to the mill for those in the UK who would criticise the current Coalition policy stance. It may have an impact on investment decisions and could even have implications for asset allocations but not yet. But we think, for now at least, that those decisions are actually reliant on politicians and central bankers perhaps changing their mind first. For the moment, it’s about economists arguing. But it is certainly one to watch.

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