A critique of the work of celebrated U.S. economists Carmen Reinhart and Kenneth Rogoff has called into question the accuracy of their influential conclusions on the perils of public debt, and triggered a storm in economic circles.
Profs. Rogoff and Reinhart won wide acclaim in 2009 for This Time Is Different, their heavily researched best-selling investigation of 800 years' worth of financial crises. Their influence reached deep into public policy circles, providing intellectual ballast for the tough austerity and debt reduction measures pursued most notably in Britain and imposed on the financially crippled members of the euro zone as a condition of their bailouts.
But the new study by a trio of University of Massachusetts researchers has uncovered serious flaws and omissions in the professors' work and challenges one of their key findings.
Based on their research, Profs. Rogoff and Reinhardt concluded that countries coming out of major financial recessions face years of slow, painful recovery and those with public debt in excess of 90 per cent of GDP are doomed to dramatically lower growth rates.
To no one's surprise, Nobel laureate Paul Krugman and other notable Keynesians took immediate issue with the Reinhart-Rogoff argument, warning that the middle of a crisis is no time to tackle debt stabilization. The two sides have been trading shots ever since. But now, apart from the grim economic consequences of European austerity, the critics have fresh ammunition, courtesy of the damning critique of the Reinhart-Rogoff methodology.
In attempting to replicate the duo's results, the University of Massachusetts economists – Thomas Herndon, Michael Ash and Robert Pollin – discovered "that coding errors, selective exclusion of available data and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the postwar period."
The study found that RR, as the two are often labelled, did not include data on several high-debt countries with reasonable growth in the boom years just after the Second World War. They also appear to have employed an unusual weighting method that treated one poor year of growth in a heavily indebted country the same as several years of decent growth in another high-debt economy. They also missed a whack of other data because of a spread-sheet coding error that excluded five countries, including Canada.
The UMass economists concluded that a proper calculation would have shown average real GDP growth for countries saddled with a public-debt-to-GDP ratio above 90 per cent at a respectable 2.2 per cent – not the minus 0.1 per cent produced by Profs. Reinhart and Rogoff. Which means that average growth for economies with high public debt ratios is not significantly different than the average for those with smaller debt levels.
The researchers also found, as critics have long argued, that one size doesn't fit all. The "relationship between public debt and GDP growth varies significantly by time period and country."
"We literally just received this draft comment, and will review it in due course," Profs. Reinhart and Rogoff said in a joint statement. "On a cursory look, it seems that Herndon, Ash and Pollin also find lower growth when debt is over 90 per cent. … These results are, in fact, of a similar order of magnitude to the detailed country by country results we present. ... And they are similar to estimates in much of the large and growing literature. ... However, these strong similarities are not what these authors choose to emphasize."
The critique, released Monday by the university's Political Economy Research Institute, quickly became a red-hot topic in the blogosphere and Twitter universe.
"Some of us never bought it, arguing that the observed correlation between debt and growth probably reflected reverse causation," Prof. Krugman wrote in a blog post Tuesday. "But even I never dreamed that a large part of the alleged result might reflect nothing more profound than bad arithmetic."
If the study findings can be duplicated by other researchers, the result is bound to be embarrassing.
"But the really guilty parties here are all the people who seized on a disputed research result, knowing nothing about the research, because it said what they wanted to hear," Prof. Krugman said.