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One by one, the arguments against continued austerity policies are falling. Last autumn, it was the International Monetary Fund, which reversed its prior views and stated that government stimulus helped economies during the recent fiscal crisis, while austerity policies hurt. Now a trio of University of Massachussets Amherst researchers have debunked a key piece of austerity-supporting research by highly influential Harvard economists Carmen Reinhart and Kenneth Rogoff. The intellectual case for austerity is on life support; world leaders should now have the guts to pull the plug before continued adherence to spending restraint kills their economies.
The U Mass paper takes issue with the much-quoted assertion by Rogoff and Reinhart that when a country's debt-to-GDP ratio climbs above 90 per cent, economic growth slows. In fact, by the Amherst calculations, there is no statistically significant difference in growth when debt to GDP crosses the 90 per cent threshold. Think about that: governments who have heeded warnings about excessive debt ruining their economies might very well be doing more harm than good by holding back on stimulus during a period when the world, stuck in a prolonged sluggish recovery, could actually use some.
Astonishingly, the problems in the original data stem from the fact that the Harvard academics included data from New Zealand in 1951, when the highly indebted nation sustained a steep GDP decline of 7.6 per cent – but excluded data from 1946 to 1949, when the Kiwi nation had strong growth with essentially the same debt. Given the small number of countries surveyed, the exclusion materially affected their finding, the U Mass researchers found. Apparently Mr. Rogoff and Ms. Reinhart made some other basic spreadsheet blunders as well.
The two Harvard profs will never be viewed in the same light again, although they are largely sticking to their guns. Bad ideas, unfortunately, are notoriously hard to kill. Now the question is whether policy makers will prove equally as adamant as Mr. Rogoff and Ms. Reinhart in refusing to change course. Eurocrats and British Tories have quoted the 90 per cent figure in explaining why austerity is necessary. Meanwhile, defenders of austerity – from German Chancellor Angela Merkel to finance minister Jim Flaherty and outgoing Bank of Canada/incoming Bank of England governor Mark Carney – continue to trumpet fiscal prudence as the path to growth. If they have to climb down from that assertion and contemplate a return to fiscal stimulus, they will be in the uncomfortable position of having to explain that, sorry, they threw millions of people out of work in large part because of an Excel error.