In advanced societies, social structure is largely experienced as a barrage of symbols. Maintenance is only as solid as the representative text and images. Recently, an important symbol went down. The Reinhart-Rogoff paper “Growth in a Time of Debt” used to show that public debt starts to curtail growth at around 90% of GDP. A grad student doing a seminar assignment showed that the data, when more properly handled, don’t, in fact, show that. The paper, as a force brandishing credibility on those who cite it, has melted away, seemingly overnight.
But I don’t think that’s the entire analysis. In fact, the Reinhart-Rogoff study (as a structure of what is deemed politically possible and impossible) has been in trouble for some time. The reason for this second post is to point out that others, in some cases months ago, expressed similar reservations about the Reinhart-Rogoff study. Only, they didn’t do it with systematic empirical re-examination, like Herndon. Instead, they relied simply on existing knowledge, theoretical sophistication, and probably intuition. And in short, that theoretical criticism, long apparent to those who wished to see it, is that if indeed there is a causal relationship between debt and growth, it is probably low growth that causes high debt. I say probably, because my sense is this has not been “definitively” shown, either. But there is theoretical inclination to make this claim, that is, again, if there is a causal relationship at all.
The important thing is that, even without Herndon’s intervention, the paper never came close to showing what its celebrators inexorably claimed, that high debt leads to reduced growth. At best, Reinhart and Rogoff showed an “association” between debt and growth. The title, then, misleads from the start, by placing “growth” as the dependent variable existing in a “time of debt.”
Anyway, all this was known years ago. Here are two examples.
First, here is Joe Wiesenthal (August, 2011), under the headline “Meet the Two Most Dangerous Economists In The World Right Now”:
America has decided: Despite unemployment above-9% and GDP growth sub-2%, the government should be focusing on reducing spending, not stimulating the economy.
Sure, the cuts aren’t all that deep in the new deficit deal, but it’s the direction and the priorities that matter.
Of course, Republican politicians in Washington don’t see cutting spending and stimulating the economy as an either/or decision. One justification for cutting spending is that it’s “pro-jobs” because it instills confidence in the private sector.
And though nobody takes the “confidence fairy” argument very seriously, pro-cutting politicians are armed with some intellectual heft: Frequently during the debate we heard politicians cite the work of economists Carmen Reinhart (University of Maryland) and Ken Rogoff (Harvard), who have argued over the last couple of years that higher public debts contribute to lower GDP growth. And, conveniently, they’ve made a big deal over this idea that a 90% debt-to-GDP ratio represents some kind of tipping point, over which growth slows fast. Their ideas are outlined in the book This Time It’s Different, which has been a huge hit.
There’s something kind of reasonable sounding about this. More debt seems bad. Reducing debt seems good. So yeah, let’s reduce our debt load, unburden the economy, and voila, growth!
Reingoff logic hasn’t just been employed in the US, of course. It’s essentially at the core of IMF economic prescriptions. Countries like Greece have been told to cut their way to lower deficits/prosperity, and they’ve wound up with both higher deficits and a weaker economy.
Fortunately, not everyone buys it.
And second, here is Robert Shiller in July 2011:
A paper written last year by Carmen Reinhart and Kenneth Rogoff, called “Growth in a Time of Debt,” has been widely quoted for its analysis of 44 countries over 200 years, which found that when government debt exceeds 90% of GDP, countries suffer slower growth, losing about one percentage point on the annual rate.
One might be misled into thinking that, because 90% sounds awfully close to 100%, awful things start happening to countries that get into such a mess. But if one reads their paper carefully, it is clear that Reinhart and Rogoff picked the 90% figure almost arbitrarily. They chose, without explanation, to divide debt-to-GDP ratios into the following categories: under 30%, 30-60%, 60-90%, and over 90%. And it turns out that growth rates decline in all of these categories as the debt-to-GDP ratio increases, only somewhat more in the last category.
There is also the issue of reverse causality. Debt-to-GDP ratios tend to increase for countries that are in economic trouble. If this is part of the reason that higher debt-to-GDP ratios correspond to lower economic growth, there is less reason to think that countries should avoid a higher ratio, as Keynesian theory implies that fiscal austerity would undermine, rather than boost, economic performance.