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Debt and growth: Don't lose faith in Rogoff and Reinhart

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Revelations of highly un-Harvard-like data selection and spreadsheet incompetence by economics professors Kenneth Rogoff and Carmen Reinhart are obscuring the fact that the main premise of their research is being proven more accurate with every passing day.

The Rogoff and Reinhart brouhaha does effectively put the final nail in the coffin of one of the most widely publicized of their contentions – the 90 per cent debt-to-GDP canard. The professors had argued that economies where the ratio of public debt exceeded 90 per cent of GDP were fated to grow at less than 1 per cent a year. The foundation for this argument has now been found wanting, and it appears the professors were overreaching.

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As Josh Barro from Bloomberg clearly explains, the 90 per cent assumption is only vaguely correct. It's much more of a loose tendency than a hard-and-fast rule for policy makers. The controversy, by exposing this, will remove the rule as a weapon for narrow-minded Tea Party members and miserly Germans.

But investors should not forget that Prof. Rogoff and Prof. Reinhart's research effectively predicted the slow pace of the economic recovery. The premise of their findings – that slowdowns arising from banking crises are categorically different than all others in the postwar era – remains a vital thesis for both investors and policy makers.

As the crisis unfolded, the vast majority of Wall Street economists (Nomura's Richard Koo is a notable exception) used economic recoveries in 1990 and 2001 to predict post-2008 economic growth. Prof. Rogoff and Prof. Reinhart successfully predicted that the crisis and its aftermath would look far more like the U.S. in the 1930s, and Japan in the 1990s.

Respected fund manager and writer Barry Ritholtz called the pair's academic work 5 Historical Economic Crises and the U.S. "THE seminal paper" of the financial crisis and added, "Writing in advance of the crisis and recovery, R&R turned out to be more correct than anyone else covering the space."

The data issues and inexplicable spreadsheet errors that came to light this week have cast suspicion on the full body of the professors' work. The sins are significant and castigation is justified. But there is no excuse to ignore the significant contribution Prof. Rogoff and Prof. Reinhart have made to our understanding of financial crises, nor their prescience in predicting the current state of the U.S. economy. There are few experts who are more qualified to chart a way forward.

Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More


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