The Faulty Data Behind Austerity Measures

The 2009 groundbreaking economics book This Time is Different (Princeton University Press, 2009) received numerous awards when it was first published. It was reviewed on this website. Now, it is on the chopping block. What went wrong when they seemed so right?

When academics Carmen M. Reinhart and Kenneth S. Rogoff published This Time is Different: Eight Centuries of Financial Folly, the book opened to critical acclaim and its data was used to create austerity policies. However, a new paper challenges the data used as being faulty, which would mean people around the global may have suffered needlessly from global economic manipulations.

One of the main messages of the Reinhart/Rogoff book was that too much government debt is bad. The authors used substantial data to support this claim: if government debt rises above 90% of its GDP, that country’s economy falls, on average, by one-tenth of 1% per year. This concept was also published in American Economic Review: Papers and Proceedings in a 2010 paper by the same authors entitled “Growth in a Time of Debt.”

At the time the Reinhart/Rogoff book was published in 2009, the U.S. gross debt was tottering near 90% (see below). This caused alarm. The gross debt is composed of that held by the public and the government.

U.S. debt from 1940 to 2010.

Red lines indicate the Debt Held by the Public (net public debt) and black lines indicate the Total Public Debt Outstanding (gross public debt), the difference being that the gross debt includes that held by the federal government itself. The second panel shows the two debt figures as a percentage of U.S. GDP (dollar value of U.S. economic production for that year). The top panel is deflated so every year is in 2010 dollars. From Wikipedia.

Then, last month, a paper by three upstarts, Thomas Herndon, Michael Ash and Robert Pollin of the University of Massachusetts, Amherst, challenged the Reinhardt/Rogoff data. They said they found miscalculations in the 2010 paper and that “the average real G.D.P. growth rate for countries carrying a public debt-to-G.D.P. ratio of over 90 percent is actually 2.2 percent, not —0.1 percent.”

Their paper is entitled, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff” and was published by The Political Economy Research Institute at the University of Massachusetts where the researchers work.

Reinhart and Rogoff are distinguished and respected academics, which is demonstrated by their lofty positions. Reinhart is professor of economics and director of the Center for International Economics at the University of Maryland. Rogoff is the Thomas D. Cabot professor of public policy and professor of economics at Harvard University. Until now, what they said would be held as uttered by deities. This made their conclusions in the 2009 book and 2010 paper enormously important, not only for their colleagues in economics, but, as it turns out, with politicians who used the paper to set austerity policy both here and abroad.

The Amherst re-analysis suggests that global economic manipulations adhering to the austere Reinhart/Rogoff ideas may have been overdone because they were based on faulty data. This would suggest that millions of people suffered needlessly as scarcity measures were put in place.

On the other hand, spending with abandon without some savings seems wrong-headed, too. My best conclusion is that both sets of researchers are right, even if Reinhart and Rogoff were technically wrong. We need austerity and spending to work together in an organized way going forward. As an aside, spending that creates debt can help our country rather than harm it under certain circumstances. For more on this, please see Good and Bad Debt.

Perhaps a broader and better conclusion from all this fuss is not to judge so much what went wrong in the past, but what we can do constructively in the future. This includes duplicating important research by a second and even third uninterested laboratory before it is promoted heavily. Also, recognizing more widely that retrospective research is just that and it may or may not have any relationship to events going forward.