Economix Blog: With Debt Study’s Errors Confirmed, Debate on Conclusion Goes On

The Harvard economists Carmen M. Reinhart and Kenneth S. Rogoff have acknowledged that their groundbreaking 2010 study “Growth in a Time of Debt” includes statistical errors that significantly alter its results.

Three economists at the University of Massachusetts, Amherst, uncovered those errors in a bombshell paper released this week, which has prompted a huge debate in the economics blogosphere and resonated with policy makers gathered in Washington for the spring meetings of the World Bank and the International Monetary Fund. (The paper is all the talk in Foggy Bottom.)

In an e-mailed statement, Professors Reinhart and Rogoff admit their mistakes but argue that they do not change the ultimate lessons of the paper, originally published in The American Economic Review. “We are grateful to Herndon et al. for the careful attention to our original ‘Growth in a Time of Debt’ AER paper and for pointing out an important correction,” they write. “We do not, however, believe this regrettable slip affects in any significant way the central message of the paper or that in our subsequent work.”

Both the University of Massachusetts and the Harvard authors now find that countries whose debt loads are 90 percent or more of their annual economic output tend to experience slower growth than countries whose debt loads are lighter — though the effect is much smaller than previously thought.

The debate now centers on how to interpret those muddier results — and how the incorrect results influenced public policy in the post-crisis years.

The debate over interpreting the new results has centered on the thorny question of causation. Does low growth cause high debts, or do high debts cause low growth? Can the Reinhart-Rogoff data set shine any light on that question? For their part, Professors Reinhart and Rogoff do not make a causal case in their paper, though they have in subsequent public comments.

For more on this question, read Jared Bernstein, a former Obama administration economist, and Dean Baker of the left-of-center Center for Economic and Policy Research, as well as Tyler Cowen, Justin Fox and Mark Thoma.

A broader question is how influential studies like Reinhart-Rogoff were in persuading countries to adopt austerity budgeting. My sense is that for deeply indebted countries with no way to finance themselves on the international markets — Greece being the central example — the answer is that it had little to no influence.

That is because by 2010, when the Reinhart-Rogoff paper came out, Europe had already committed to austerity. Powerful policy makers including Angela Merkel and Wolfgang Schäuble of Germany as well as Jean-Claude Trichet of the European Central Bank saw fiscal consolidation as necessary, full stop. That meant countries like Greece were boxed into it.

The International Monetary Fund might have preferred a slower pace of fiscal adjustment, and in the past six months or so it has admitted that it greatly underestimated the impact that austerity budgets would have on weak economies. But in an interview, Olivier Blanchard, the fund’s chief economist, said that even if it had better understood the damage that budget cuts might cause, it probably would not have meant different policy agreements. The problem was that nobody wanted to put up any more money for countries like Greece.

“One of the unpleasant aspects of what happened is that we kept revising forecasts of growth in the euro periphery down,” he said. “Part of it, though not all of it, is due to the fact that we just underestimated the effect of fiscal consolidation.

“I don’t like to be wrong systematically,” Mr. Blanchard continued. “But if we had better forecasts, would we have had very different programs? I suspect the honest truth is that, because of financing constraints, probably only at the margin.”

A better question is what effect studies like Reinhart-Rogoff might have had in countries that elected to start the process of fiscal consolidation without much pressure from the bond markets or other external financiers.

Britain and the United States are the big question marks there. The Cameron government in Britain — over the protestations of the opposition party and the monetary fund and other groups — has slashed the country’s budget. But it still has not met its own deficit-reduction targets, because the economy has remained mired in recession and automatic spending on social programs has increased. The country still could reverse course and engage in an effort to improve growth rather than an effort to hold down its debts. But thus far it has chosen not to.

The United States has also embarked on a campaign of deficit reduction, though a more modest one. Thus far, the Obama administration and Congress have raised taxes on the wealthiest Americans and agreed to trillions in budget cuts. With the aggressive actions taken by the Federal Reserve, the economy has continued to grow — which will greatly aid the country’s fiscal situation in the long run. How important were academics like Professors Reinhart and Rogoff to that process? My sense is not very, as well, even if policy makers pushing for deficit reduction cited them.

Article source: http://economix.blogs.nytimes.com/2013/04/17/with-debt-studys-errors-confirmed-debate-on-conclusion-goes-on/?partner=rss&emc=rss