In the last three years, there has been a concerted effort by those in Washington to reduce government spending and reign in the national debt. One reason for the budget cuts? Research by two Harvard economists, Ken Rogoff and Carmen Reinhart. The pair found that when a country owes more than 90 percent of their GDP, it slides into recession.
Except Reinhart and Rogoff made a glaring mistake in the Microsoft Excel spreadsheet they used to calculate their averages. “They left off five countries. And that changed things pretty significantly,” says Tim Fernholz, a business reporter with Quartz. Instead of a mild recession, carrying that much debt means a country is probably going to have mild growth — slow, but growth all the same.
The Reinhart-Rogoff spreadsheet, via qz.com
But why did this one paper have such huge implications on budget policy? When a country is faced with recession, it has two choices — stimulus, or austerity. Pump more money into your government, grow your debt, and hope that you’re creating enough jobs along the way to work your way out of the slump. Or you can start making cuts to slow the amount of money your country will need to borrow. “In the long term, economists think that having less debt is going to be better for the economy. But if you’re coming out of a crisis, you have to make a decision then and there.”
And this was especially true with Reinhart and Rogoff’s paper. The pair met with 40 senators in 2011 and “they told them, you need to act now and that we can’t afford to spend more money to stimulate the economy.” Also reading research by the two Harvard economists were budget chairs from both parties, then Treasury Secretary Timothy Geithner, the Simpson-Bowles Commission and financial leaders in countries overseas. “When we were talking about the budget deficit and the debt in 2010, 2011 and 2012, everybody had this 90 percent threshold on their minds,” says Fernholz.
In their defense, Reinhart and Rogoff point to other studies that show high debt leads to slow growth. But Fernholz says “it’s not clear if countries that are growing slowly have high debt or if high debt causes countries to grow slowly.” The Reinhart-Rogoff research suggested causation instead of correlation.
“When politicians around the country and in fact around the world were deciding what to do to save the economy after the recession, they were reading this paper and it was scaring them,” says Fernholz. “And it was making them think, we need to cut the debt now if we want to save the economy.”
This was true, for example in the United Kingdom which quickly implemented austerity measures. The country’s economy is in bad shape today. Meanwhile, in the U.S., there was a stimulus and Congress moved slower to make budget cuts. And while the economy here isn’t exactly sparkling, both debt and unemployment are going down.
Cheers to trustworthy journalism!
Give just $7/month to get your own KaiPA glass.