Influential Harvard Paper on Debt and Growth Riddled With Critical Flaws

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The intellectual case for fiscal austerity came under fire on Tuesday when a study by academics at the University of Massachusetts found that economic growth is achievable even public debt is greater than 90 percent of GDP. The findings refute an influential 2010 pro-austerity study by Harvard economists Carmen Reinhart and Kenneth Rogoff, and renews the debate over deficit reduction policies being pursued in the eurozone and elsewhere.

The Reinhart-Rogoff paper, Growth in a Time of Debt, had argued that economic growth falls to a mean average of negative 0.1 percent when public debt is greater than 90 percent of economic output – a key finding that has been touted the intellectual underpinning of the pro-austerity argument.

However, academics from the University of Massachusetts at Amherst are challenging the very foundation of that idea, raising questions about whether such a debt threshold even exists.

The controversy stems from a new paper by Thomas Herndon, Michael Ash and Robert Pollin, economists at the University of Massachusetts, who claim that achieved a growth rate of 2.2 percent when they repeated the Reinhart-Rogoff study using the same datasets.

“Coding errors, selective exclusion of available data, and unconventional weighting of summary statistics led to serious errors that inaccurately represent the relationship between public debt and GDP growth,” said Herndon et al in their paper published on Tuesday.

The most important error, Herndon et al said, appears to be a failure to include years of data that showed Australia, Canada and New Zealand enjoying high economic growth and high debt at the same time.

Including all the years of data boosts New Zealand's average economic growth rate under high debt to 2.58 percent, from negative 7.6 percent. Given the small amount of data used in Reinhart and Rogoff's study, this has a huge impact on the overall findings.

"It's certainly a very different picture from stagnation or decline once you cross the wall at or around 90 percent" of public debt, Ash said, adding that his study “reopens the conversation about what happens at high public debt levels.”

In the United States, many politicians have pointed to Reinhart and Rogoff’s findings as justification for deficit reduction even though the economy is far below full employment.

Paul Ryan, the Republican chair of the House Budget committee who has pushed for rapid fiscal tightening in the United States, cited the Reinhart-Rogoff study as "conclusive empirical evidence that total debt exceeding 90 percent of the economy has a significant negative effect on economic growth". The current U.S. debt-to-GDP ratio is estimated at slightly over 100 percent.

Ryan’s 2014 budget, introduced earlier this year and subsequently passed by the Republican-controlled House, aims to eliminate the U.S. budget deficit over the next decade.

In Europe, Reinhart and Rogoff’s work and its derivatives have been used to justify austerity policies that have pushed the unemployment rate over 10 percent for the eurozone as a whole and above 20 percent in Greece and Spain.

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Reinhart and Rogoff said in a statement on Tuesday that they would review the criticisms but argued that there was consensus on the basic conclusion of the “association” between higher debt and slower growth.

“By the way, we are very careful in all our papers to speak of “association” and not “causality” since of course our 2009 book THIS TIME IS DIFFERENT showed that debt explodes in the immediate aftermath of financial crises,” said the Harvard professors.

The findings by Reinhart and Rogoff “have served as an intellectual bulwark in support of austerity policies,” the University of Massachusetts academics said. The fact that their results “are wrong should therefore lead us to reassess the austerity agenda.”

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