How much government debt is too much? What is the point at which the level of government debt becomes crushing as opposed to merely costly? In austerity policy circles, it is often argued that countries with debt-to-GDP ratios above 90 percent have a negative average growth rate. But earlier this month, three economists from the University of Massachusetts challenged that assertion. And in the process they undercut one of the major intellectual underpinnings of the austerity movement.
The 90-percent figure comes from an influential research paper by Harvard University economists Carmen Reinhart and Kenneth Rogoff, entitled “Growth in a Time of Debt.” In their paper, Reinhart-Rogoff complied an impressive collection of historical data on government-debt levels and proposed a set of “stylized facts” concerning the relationship between public debt and GDP growth. Reinhart-Rogoff looked at 20 “advanced economies” for the period 1946-2009.
To evaluate the data, Reinhart-Rogoff used a straightforward method and organized the country-years in four groups by public debt/GDP ratios: 0-30 percent, 30-60 percent, 60-90 percent, and greater than 90 percent. After doing so, Reinhart-Rogoff observed a non-linear relationship with effects appearing at levels of public debt around 90 percent of GDP. Countries with a debt-to-GDP ratio below 90 percent experienced relatively stable GDP growth: below 30 percent, 4.1 percent GDP growth; between 30 to 60 percent, 2.8 percent GDP growth; between 60 to 90 percent, 2.8 percent GDP growth. But countries with a debt-to-GDP ratio greater than 90 percent, according to Reinhart-Rogoff, experienced recessionary economic slumps, to the tune of -0.1 percent GDP growth.
As a result of their calculations, Reinhart-Rogoff stated that their “main result is that whereas the link between growth and debt seems relatively weak at ‘normal’ debt levels, median growth rates for countries with public debt over 90 percent of GDP are about one percent lower than otherwise; (mean) growth rates are several percent lower.”
Importantly, Reinhart-Rogoff did not (at any point in their paper) make the argument that high debt causes negative growth. The authors merely reported a correlation between high debt and negative growth. Austerity politicians, however, quickly misused the study to imply a cause-and-effect relationship. For example, in his “Path to Prosperity” budget plan, Paul Ryan stated that Reinhart-Rogoff “found conclusive empirical evidence that [debt] exceeding 90 percent of the economy has a significant negative effect on economic growth.” Similarly, the Washington Post editorial board stated that “debt-to-GDP could keep rising – and stick dangerously near the 90 percent mark that economists regard as a threat to sustainable economic growth.”
The problem with Reinhart-Rogoff, as we now know, is that its conclusions are worthless. In a new paper, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff, Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts, Amherst attempted to replicate the Reinhart-Rogoff results. After failing, they reached out to Reinhart and Rogoff, who were willing to share their data spreadsheet.
The problems with the Reinhart-Rogoff model were immediately apparent to Herndon, Ash and Pollin.
Three main issues stood out. First, Reinhart and Rogoff selectively excluded years of high debt and average growth. Although Reinhart and Rogoff had 110 years of data available for countries that had a debt-to-GDP ratio greater than 90 percent, they only used 96 of those years. In doing so, Reinhart and Rogoff selectively excluded three countries that experienced high-debt and average growth: Australia (1946-1950), New Zealand (1946-1949) and Canada (1946-1950). The effect of these exclusions is striking. Reinhart and Rogoff, for example, pointed out that New Zealand had a growth rate of -7.6 percent during the period 1950-1951. But if you include 1946-1949, the average growth rate across all those years is +2.58 percent. That is a big difference.
Second, Reinhart and Rogoff utilized a debatable method to weigh the countries. As Herndon et al. explained, “After assigning each country-year to one of four public debt/GDP groups, RR calculates the average real GDP growth for each country within that group, that is, a single average value for the country for all the years it appeared in the category.” For example, the U.K. has 19 years (1946-1964) above the 90 percent debt-to-GDP with an average 2.4 percent growth rate; the U.S. averaged -2.0 percent per year during the 4 years in their sample above 90 percent debt-to-GDP. Reinhart and Rogoff then gave these two numbers, 2.4 and -2.0, equal weight in the final calculation, despite the fact that the U.K. had 15 more data points than the U.S.
Third, Reinhart and Rogoff’s spreadsheet included a coding error that excludes high-debt and average-growth countries. As Herndon et al. noted: “A coding error in the RR working spreadsheet entirely excludes five countries, Australia, Austria, Belgium, Canada, and Denmark, from the analysis.” Reinhart-Rogoff, or more likely their research assistants, averaged the cells in lines 30 to 44 instead of lines 30 to 49, producing a “-0.3 percentage-point error in RR’s published average real GDP growth in the highest public debt/GDP category.”
As Herndon et al. pointed out, these errors have relatively small effects on the measured average GDP growth for country-years in the lower three categories. But in the over-90 percent public debt-to-GDP category, the effects of the errors are substantial. When the errors are corrected, actual average GDP growth in the high public debt category is +2.2 percent per year rather than the -0.1 percent per year that Reinhart-Rogoff published. “In other words,” Herndon et al. wrote, “with their estimate that average GDP growth in the above-90 percent public debt/GDP group is -0.1 percent, RR overstates the gap by 2.3 percentage points or a factor of nearly two and a half.”
The Herndon et al. critique eviscerates the credibility of the Reinhart-Rogoff paper, a paper that, as Paul Krugman rightly pointed out, “was surely the most influential economic analysis of recent years.” Reinhart-Rogoff was cited by key policymakers on both sides of the Atlantic as “factual evidence” and “conclusive proof” that a high debt load is necessarily bad and that austerity was a necessary policy response to avoid economic catastrophe.
But we already know that this is nonsense. The idea of expansionary fiscal austerity is a myth, a conservative fairy tale based on market fundamentalism. And even though Reinhart-Rogoff has now been thoroughly discredited, do not expect the deficit scolds to abandon their posts.
Former Vice President Dick Cheney famously said, “Reagan proved that deficits don’t matter.” Indeed, few politicians actually care about the deficit. Although the deficit is put out there as a crisis that requires an immediate solution, it is almost always used as political cover for budgetary and legislative choices that lawmakers would desire anyway.