Austerity proponent have been dealt a blow as research has shown glaring errors in the Reinhart-Rogoff “Growth in a Time of Debt” paper.
Since the start of the economic crisis, the debate over debt and deficits has featured prominently in the political discourse of the United States and Europe. Supporters of the austerity movement, such as Paul Ryan in the U.S. and Angela Merkel in Germany, frequently cited the famous Reinhart-Rogoff “Growth in a Time of Debt” paper as empirical evidence of their perspective. The Harvard economists’ 2010 study claimed that when a country’s debt rises above a threshold of 90% of GDP, its growth slows dramatically. These findings were used to justify massive budget cuts and tax increases across the Western world, despite conventional economic wisdom.
However, a recent paper by Thomas Herndon, a graduate student at the University of Massachusetts, found serious errors in the Reinhart-Rogoff study’s calculations. Essentially, the study had neglected to include substantial data points that detracted from its conclusion. Once Herndon added the omitted data, the correlation between high debt to GDP ratios and slow growth was significantly weakened. As this graph from the UMass study indicates the trend is almost nonexistent:
The question now is: what will be the real world impact of this rebuke of Reinhart-Rogoff? In the short-term, stock markets around the world rallied in part because of the news that the era of austerity might be under threat. Despite otherwise negative economic data, yields on struggling European government bonds got a much-needed reprieve. Yet, the long-term question remains: how much austerity-inspired policy will actually change as a result of these revelations?
The most vital area of impact will be on political realities in Europe. European Commission President Jose Manuel Barroso issued a statement indicating that austerity has “reached its limits.” He called for more breathing room for struggling European economies to ease their austerity regimes and allow for some growth. Paris and Madrid are especially eager for a quick fiscal boost to jump start their economies.
Chancellor Angela Merkel of Germany, widely seen as the champion of European austerity, stood her ground in the wake of the Reinhart-Rogoff revelations. Merkel’s supporters were quick to point out that her position on austerity predates the 2010 study. The Chancellor is facing increased criticism from fellow European leaders over her views, as well as opposition within Germany with an election a few months away.
In the U.S., monolithic support for spending cuts has also begun to falter. The Reinhart-Rogoff study was famously cited as the theoretical underpinning of Paul Ryan’s pro-austerity “Path to Prosperity” budget proposal. America’s own version of austerity, massive budget cuts known as sequestration, faced some high-profile backlash. For example, Congress recently came under public pressure to restore funding to the Federal Aviation Administration for air traffic control.
Yet, economists also cautioned against too overzealous of a reaction to Herndon’s findings. Despite the loss of empirical evidence from Reinhart-Rogoff, there is widespread consensus that debt and deficits are structural problems that political establishments in the West will have to deal with. It is merely the policy priority level of balancing debt reduction in relation to growth that will change as a result. The pessimistic economic outlook for Europe and the U.S. will not be changing overnight, but this revelation does open the door for new policy options to pursue.
