Why the Argument for Austerity Took a Big Hit Yesterday

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Updated at 11:12 p.m.

In the years following the financial crisis, America has been obsessed with debt. Hurting from the crisis, consumers and businesses have been busy paying off debt, while the federal government has ramped up its borrowing through a combination of stimulus spending and lower tax revenue. And of course all this new government debt — which has reached 73% of GDP and is expected to remain roughly at that level for the next decade — has many policymakers and citizens deeply concerned, to say the least.

But exactly how concerned we ought to be over that debt level — and how radically we need to act to reduce it — remains hotly debated. Governments obviously need to be able to borrow, and nearly every government does so. But experts have reached no clear consensus over how much (relative to the size of its economy) a nation can safely borrow.

That is, no consensus had begun to emerge until the appearance in 2010 of a paper, by economists Carmen Reinhart and Kenneth Rogoff, called “Growth in the Time of Debt,” which found that countries with higher debt levels tend to grow more slowly than those with little debt. For those who tend to see the rising debt load of the U.S. as a serious problem, these findings were just the evidence needed to prove that America had to cut back on spending, and fast.

(MORE: When Will the Federal Debt Cause a Greece-Like Crisis in the U.S.?)

Tim Fernholz at Quartz does a nice job summarizing just how influential this work has been in Washington and Europe. He points to a scene, from a recent book on the federal debt by Republican Senator Tom Coburn, in which a bipartisan group of senators meet with Reinhart and Rogoff, and are obviously in agreement with their conclusion that allowing total debt/GDP to grow beyond 90% would be very dangerous indeed. As Fernholz writes:

It’s hard to get bipartisan agreement on anything in the Senate, but you can see influential legislators from both parties were listening closely to the two economists as they engaged in key debates over the economy. Even the notoriously obstreperous Coburn noted that ‘there was remarkable agreement about the severity of the problem.’

Reinhart and Rogoff have always been careful to note that just because high-debt countries have tended to grow more slowly than low-debt countries, it doesn’t mean that high debt definitively caused slow growth. Critics have pointed out, quite justifiably, that the causation could be the other way around — that slow growth causes debt. But even though Reinhart and Rogoff’s research doesn’t prove causality, it didn’t stop them from writing as if it did. And proponents of austerity took their research as solid proof that high debt levels impede growth. For instance, Paul Ryan has used Reinhart and Rogoff’s research to argue for his deficit-slashing budgets, writing, “Economists who have studied sovereign debt tell us that letting total debt rise above 90% of GDP creates a drag on economic growth and intensifies the risk of a debt-fueled economic crisis.”

(MORE: What’s Behind the Crash in the Gold Market?)

But new evidence emerged yesterday throwing Reinhart and Rogoff’s research into question. In particular, economists following in the footsteps of Reinhart and Rogoff say their conclusion is based on faulty data. Here’s the Roosevelt Institute’s Mike Konzcal on the findings:

From the beginning there have been complaints that Reinhart and Rogoff weren’t releasing the data for their results (e.g. Dean Baker). I knew of several people trying to replicate the results who were bumping into walls left and right — it couldn’t be done.

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, successfully replicate the results. After trying to replicate the Reinhart-Rogoff results and failing, they reached out to Reinhart and Rogoff, and they were willing to share their data spreadsheet. This allowed Herndon et al. to see how Reinhart and Rogoff’s data was constructed.

They find that three main issues stand out. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries.

What Herndon, Ash and Pollin find is that countries with debt loads higher than 90% of GDP actually grow an average of 2.2% per year, rather than the –0.1% found by Reinhart and Rogoff. The details of the errors are technical, but pretty embarrassing for such respected and influential research.

Reinhart and Rogoff responded to the critique yesterday afternoon — noting that despite the growth-rate discrepancy, both papers find that countries with higher debt loads grow more slowly on average — but fail to address the supposed data errors. (In fairness, the new paper just came out yesterday, and Reinhart and Rogoff deserve more time to respond thoroughly.) Nor did they address the most powerful critique of their research, namely the issue of causation. As Paul Krugman points out, we know that Japan’s high debt levels are the result of slow growth caused by a financial crisis, not the other way around. In addition, the research can’t explain why the U.K. grew so quickly after World War II, despite high debt levels.

Unfortunately, calling Reinhart and Rogoff into question doesn’t answer the fundamental question — How much debt is too much? — one way or another. We still don’t know for sure that our current debt levels aren’t an imminent threat. But if you’re looking for evidence that there will be serious consequences if we don’t cut spending immediately, Reinhart and Rogoff isn’t it.

MORE: The Real Significance of the Bitcoin Boom (and Bust)

UPDATE: Reinhart and Rogoff have issued a second, more in-depth response, here

134 comments
Innocentious
Innocentious

I find it interesting that the revised numbers basically say the same thing, That countries that have engaged in Keynesian and QE end up growing more slowly than those countries that do not have a high debt load.

People we are not talking about high tax rates and wealth redistribution. We are talking about Governments BORROWING money in order to pay for Social Programs and Military expenditures.

Most of the comments I read here are people who hate Conservatives who want to have a balanced budget and think they hate the poor. Austerity is meant to pay down debt and make good on your line of credit. Many people suggest, well just throw more money at the problem. Which is fine except this has all kinds of ramifications.

Look you never know when you are a bad debtor until people will no longer loan you money. Name one business that would not succeed if it could simply continue to have people loan it money in perpetuity? The same is true with Government. The issue with Greece and Spain is that they went too far and lost too much revenue and HAD too much debt. They HAVE to engage in austerity. What other choice do they have? They are bad debtors.

EdwardChin-Mook
EdwardChin-Mook

This is very interesting and TIME must be commended in publishing same. I would like to beg the indulgence of the author and fellow commentators to look at a matrix of Accounting and Economics, this is where I believe the ultimate answer for Austerity measures lies. During my accounting training and auditing various entities we were taught about financial accounting for Government as compared to accounting for Private Firms. Where one was more concerned about meeting BUDGETS and Reserves versus generating Profits through a mix of Cost and Management Accounting  optimizing and implementing efficiencies according to the gearing of the firm.

I am from Jamaica and we now have a debt to GDP ratio of over 130% and is currently (2013) seeking 1Billion US$ loan from the IMF. We have been experiencing negative or low (1-2) growth for "most" of the last 20 years and this conversation is timely for me as a citizen, looking to face this new debt. Which honestly I do not see the need, because we have lots of resources that could be mobilized. These resources are directly under government stewardship and tax dollars are being used to pay (very very high) interest rates on these monies, crowding out the real private sector and reducing the real parity power of the Jamaican economy to globally uncompetitive levels.  Hence existing businesses are downsizing or closing and new businesses - start ups  can not get funding to adequately gear their operations to take advantage of local, regional and international market opportunities.

An in all of this the government is increasing TAXES to pay a ballooning debt which has no "ASSETS" on our national balance sheet generating income to sustain same. Most if not all of the debt came about when the CENTRAL BANK was moping up liquidity to support a "Liberalized Exchange Rate Policy", which again had no developmental policy when the policy was changed.

Thus in concluding, I believe the absence of a clear mix of economic and accounting policies then we will always try to predict or postulate based on assumptions which will be a hit or miss no matter the size and resources of the country, first world or developing. 

 


CaliforniaTryst
CaliforniaTryst

Wrong on hyperinflation, wrong on growth through austerity measures... Wonder what they'll cook up next. 

tomkinney54
tomkinney54

That's the problem with government action to correct the economy, it's unpredictable.

econhub1
econhub1

@crobmatthews nice article. it would be nice to see an article cataloging the diversity of economists views on debt lebels

michael1_4
michael1_4

 "In the years following the financial crisis," Huh? We're still right in the middle of it. We're still in recession. What years since the financial crisis?

DBritt
DBritt

I am shocked, shocked that a paper supporting right wing ideology is based on false data.

sji5151
sji5151

Good article, except for one, really ill-advised comment.“Governments obviously need to be able to borrow, and nearly every government does so.” Our Monetarily Sovereign government does not need to borrow. 

drudown
drudown

How can anyone credibly contend that magically transmuting 20,000,000 foreign nationals into American citizens is not going to materially increase the debt of our state, federal and municipal governments?

(sigh.)

The prudence of the GOP's "no new taxes" policy in times of record corporate profits tends to show where their true loyalty lies. 

sacredh
sacredh

In other breaking news, Ayn Rand was a heartless b!tch.

MrObvious
MrObvious

We've had thousands of years of history where civilizations soak the rich and beat the poor. It's funny that we've never seen so much prosperity since the living standard increased among the middle class.

Including a record number of rich people.

But whatever - lets try the good ol' times again. It's bound to work this time around.

shepherdwong
shepherdwong

"But exactly how concerned we ought to be over that debt level — and how radically we need to act to reduce it — remains hotly debated."

Hotly debated exactly as soon as a Democrat was elected president, dealing with an enormous economic crisis, following reckless fiscal irresponsibility by Republican governments. To leave the political factors out of why debt is now all of a sudden "hotly debated" (mostly as an excuse to cut programs that Republicans have been trying to gut since they were begun) is journalistic malpractice.

Regardless, Econ 101 says, against the zero-bound, government borrowing is the only way to create real growth and something approaching full employment. Then, and only then, do you start worrying about debt. "The Argument for Austerity," at zero-bound earns you an "F."

jmac
jmac

What's Paul Ryan to do?  The math was never in his favor,  and now he's lost his source.  

ConlethGordon
ConlethGordon

@CornerInnGolf @TIME Apart from that tweet not making any sense, when you're telling Washington fin analysts they're wrong 2 u must b right

Innocentious
Innocentious

@DBritt 
It still supports the ideology even with the rewrite... Did you read the article?

DeweySayenoff
DeweySayenoff

@drudownHow can anyone credibly contend that magically transmuting 20,000,000 foreign nationals into American citizens is not going to materially increase the debt of our state, federal and municipal governments?

Here's how: They have to pay taxes, too.

Duh...

mantisdragon91
mantisdragon91

@sacredh And a clueless one as well. Did I forget to mention hypocritical, since she spent her last years sponging off the system she railed against.

drudown
drudown

@shepherdwong 

Concur.

As for "the case for austerity", one need look no further than Europe to see how well that "works"...

michael1_4
michael1_4

@HenryMajor @michael1_4 Really? In NJ where I live the unemployment rate is 9%. Its 7.7 in the country as a whole. In NJ housing is the lowest it has ever been. I check on housing prices all the time and it hasn't budged. Its at the bottom, the lowest. At this rate housing prices won't recover for another 20 years. So I don't really see where you're getting we're out of recession. Maybe you're a wall street guy? Well yes, for wall street guys the economy has recovered but for average working person it hasn't.

DBritt
DBritt

@C_Ryback @DBritt Not relevant.  The loan guarantee program as a whole has been a resounding success and is well under budget.  Why don't you pick on Warren Buffet for his worst market pick?  I'm sure if was terrible too.

DBritt
DBritt

@Innocentious @DBritt Their conduct falls well short of academic standards.  Beyond that, the causality questions pointed out in the article are absolutely relevant.  It doesn't support the ideology.  Austerity is a terrible economic policy in bad economic times.  The government should lower debt during good economic times and increase it during bad.  Unfortunately we've been doing the opposite, and we suffer the consequences.

drudown
drudown

@DeweySayenoff

Speaking of "duh", why don't you explain to me how granting "amnesty" to these 20,000,000+ lawbreakers does not violate the Equal Protection Clause which states that nobody should be given preferential treatment under law? What, these 20,000,000+ don't get prosecuted...but tens of millions of other "classes" of lawbreakers do? Talk about "duh".

It is void ab initio.

drudown
drudown

@DeweySayenoff @drudown 

That's funny. 

As someone in the highest 2013 tax bracket, I take exception to your misguided assertion that these low income workers are going to pay a comparable amount in taxes vs. the entitlements they require. 

Speaking of taxes, surely you do not deny the vast majority of illegal aliens do NOT get taxed for their lower-priced labor? Moreover, the vast majority send back these untaxed earning to their country of origin- so less money is circulated in OUR economy. 

Facts are facts.

drudown
drudown

@tomkinney54

LOL.

In my experience, the vast majority of our elected officials' ostensible incompetence (see, e.g., W invading a WMD-less Iraq) is the actual result of corruption. They only see what their campaign contributors pay them to see.

"Politics: n. A strife of interests masquerading as a contest of principles." - Ambrose Pierce

DBritt
DBritt

@Innocentious @DBritt I wouldn't say what you've described here is ideological.  It seems that your aims are pragmatic.  The problem I have with ideology (of any political leaning) is that it places itself above pragmatism.  I'm a fan of what works.  It seems that you are too.  However, there are numerous advocates of austerity in the US who are anti-tax ideologues with no interest in hearing data that disagree with their ideology.  I have a huge problem with that, as their efforts have led to our downgraded credit rating, a slowed recovery, and possibly to future unnecessary recession.  An important part of getting out of a debt crisis is keeping your GDP reasonably high.  Austerity will tend to move you in the other direction.  The most important thing for the US right now is jobs, not debt.  If we can't solve the first one, no way are we going to solve the second one.

I probably don't know enough to speak intelligently on Greece, but I'm still skeptical that such intense austerity was the right answer, as that will likely put them into a deep recession.  Granted, their debt problem was much more acute.

Innocentious
Innocentious

@DBritt @Innocentious  

First if you read the original paper ( which I have and which many have not ) they indicate that a higher debt load to gdp has a correlation ( not a cause effect relationship ) Second, you are correct that the concept is to increase debt in times of 'bad' economic times, and reduce in 'good' But that would mean that you would have a stable Debt to gdp ( for the most part ) fluctuating around a center point. That is not what most nations in the west have engaged in. 

The right wing ideology for your information is  the following ( my being a proponent of 'right wing' ideology BTW Bush was NOT right wing before we get into that lol ) Create a tax rate that Government Spending will fluctuate around ( Ideally about 18% of GDP ). Then Have Government Spending dip down to 17% of GDP in times of plenty and go up to 19% of GDP in times of famine.

We typically see a trough of about 3 years and then a peak of about 4-5 years good versus bad time.

Keep a healthy bond market but attempt to limit inflation as it actually erodes purchasing power. Balance this with trade interests to keep a healthy economy.

Austerity is in response to a crisis OR an out of line debt ratio in times of plenty ( if you are still at 19% of GDP spending in a good time cut back or enter 'Austerity' )

What the paper originally was simply meant to comment on how high debt to GDP ratios seemed to accompany lower GDP growth. There may be other explanations for this ( it never should have been a -0.1% as that makes no sense simply from anecdotal evidence )

Now there is an exception to this. If you are now considered a bad debtor nation YOU MUST ENTER AUSTERITY. Just like anyone who can no longer get a loan must do so as well ( or debase your currency which Greece for instance cannot do )

What I was attempting to say in my snippet above is that the paper still with the corrections levied at it, shows correlation to countries with High debt load to GDP and low economic growth. Personally I think this is due to a few separate issues, mainly that the nation is using deficit spending rather than actual rational development in order to grow their economy. It may also show a general aspect of money entering into the ecosystem and the devaluation eating up actual growth...

Additionally I would suggest 'Austerity' is a call for making certain that your economy does not rely on Government in order to continue to grow. Government outlays in Greece were 50% of GDP before the crisis, they are now only 47% of the GDP... In the long run this will be healthier for Greece, though in the short term it bites.

Innocentious
Innocentious

@JeffSeussalias @drudown @DeweySayenoff 

So Illegal workers earned on average $39,000 a year?

That is a fairly high paying job on average for someone who is undocumented that is working here. Interesting. So what you are also suggesting is that if we removed these people from the work force we would have 3.1 Million more jobs for actual Americans?

Just curious...

Robbert5
Robbert5

@drudown@DeweySayenoff

 "As someone in the highest 2013 tax bracket,"

Stopped reading the whyne after that.  Highest tax bracket means that you are not going hungry, live comfortable in a nice house,  in a nice, safe neighborhood, good schools etc.  You are doing really well.



drudown
drudown

@Boo

Absolutely. I think ALL such tax shelters should be banned and the US should retroactively impose taxes on any Corporation or individual trying to avoid paying their fair share of taxes, i.e., despite receiving the full benefits and protections of the State.

Boo
Boo

@drudown

 are you equally outraged with big corporates like GE for not paying any tax and the rich stashing their earnings in Cayman island to avoid tax?

drudown
drudown

@JeffSeussalias @drudown @DeweySayenoff

First, estimates are not "facts". In contrast, it is a "fact" wealthy people pay the majority of US taxes (see, e.g., http://money.cnn.com/2013/03/12/news/economy/rich-taxes/index.html ).

As for the 3.1mm figure, some "estimate" there are between 20,000,000-40,000,000 illegal immigrants here in the US. 

As an aside, why should foreign nationals that violated the immigration laws receive the full Privileges and Immunities of US citizenship? Do tell. 

No US citizen can illegally immigrate to ANY other sovereign and do so. 

JeffSeussalias
JeffSeussalias

@drudown@DeweySayenoff 

so you like facts huh:

 Stephen Goss, chief actuary of the Social Security Administration estimates that 3.1 million illegal workers pay into Social Security each year. In 2010, undocumented workers and their employers paid $15 billion to Social Security with no intention of ever collecting benefits -- that year illegal workers only received $1 billion back.
http://finance.yahoo.com/blogs/daily-ticker/social-security-risk-impact-immigration-reform-124712696.html