What if "austerity" doesn't withstand scholarship?
For some progressives, liberals, socialists, et al, any evidence against austere budgets would be welcomed. That's why the following story has been trumpeted in left-leaning media. And they still miss some of the points. (But, that is partisanship.)
The problem is, "austerity" is defined many ways. The paper at the center of this debate suggests reducing public deficits and long-term debt by quickly cutting spending and raising taxes — a combination many reject, including me, because there are no such "quick and easy" solutions to long-term fiscal imbalances. But, lumping all theories of fiscal restraint together as "austerity" is what the media and many partisans might be expected to do.
Regardless of such generalizations, the original research paper at issue was wrong. Wrong is wrong, period, and it should cause a reexamination of the scholars' conclusions. Accuracy, even when it challenges your ideals, is what a scholar should seek.
Student Find Error in Famous 'Austerity' StudyI respect the approach Herndon took with his analysis. Unfortunately, as this article reveals, Herndon also had a bias — against austerity. It is a shame that economic research is too often ideologically driven. I fear that ideology allowed Reinhart and Rogoff to overlook their mistakes. That would be a shame; it would also be entirely normal in the field.
NEW YORK — When Thomas Herndon, a student at the University of Massachusetts Amherst's doctoral program in economics, spotted possible errors made by two eminent Harvard economists in an influential research paper, he called his girlfriend over for a second look.
As they pored over the spreadsheets Herndon had requested from Harvard's Carmen Reinhart and Kenneth Rogoff, which formed the basis for a widely quoted 2010 study, they spotted what they believed were glaring errors.
"I almost didn't believe my eyes when I saw just the basic spreadsheet error," said Herndon, 28. "I was like, am I just looking at this wrong? There has to be some other explanation. So I asked my girlfriend, 'Am I seeing this wrong?'"
When scholars trust themselves too much, they make mistakes. We tell students to check, recheck, and check again. Good advice.
In the world of economic luminaries, it doesn't get much bigger than Reinhart and Rogoff, whose work has had enormous influence in one of the biggest economic policy debates of the age.There's one problem with such quantitative certainty as "90% debt slows an economy." What if every major nation in a limited system has similar debt burdens? What if that debt is temporary? What if other factors, like quantitative easing, are also distorting markets? As readers of this blog know, I admire the Austrian School because the thinkers assumed there are no perfect models in economics — there are too many variables involved in a global economy.
Both have served at the International Monetary Fund. Reinhart was a chief economist at investment bank Bear Stearns in the 1980s, while Rogoff worked at the Federal Reserve, passing through Yale and MIT before landing at Harvard.
Their study, which found economic growth slows dramatically when a government's debt exceeds 90% of a country's annual economic output, has been cited by policymakers around the world as justification for slashing spending.
Also, that last sentence misses a major, major aspect of austerity in Europe: in addition to slashing spending, most nations also raised taxes. The "austerity" based on Reinhart and Rogoff has included tax increases that might reduce economic activity and investment. You then have government spending decreasing and private spending decreasing. Of course that will slow an economy.
But, what if you decreased government spending, lowered taxes, and encouraged private spending? That might lead to economic expansion. Austerity that assumes lower taxes — or at least simpler tax codes and lower rates raising more revenues — might result in rising GDP.
Consider Herndon's analysis:
Using the two professors' data, Herndon found that instead of a dramatic fall in growth, the decline was much milder, slowing to about 2.2%, instead of the slump to minus 0.1% that Reinhart and Rogoff predicted.Debt might not cause a recession, Herndon's revised model suggests, only a drag on growth. Better slower growth than no growth.
Now, consider a family. I've offered this example before and will likely again. Most of us live with debt, and we have a "debt-to-income" ratio that lenders (and credit scoring agencies) consider when we borrow more money. Without debt, few of us would own cars, houses, or have college degrees. The question becomes not the immediate "debt-to-income" ratio, but the likelihood of future growth that might reduce that ratio in the future.
At this moment, my wife and I have one car loan, my student loans, and a home loan. Together, our total debt exceeds our income — the house alone does that. What matters, to us and most other families, is that our debt servicing does not exceed a certain percentage of income. Servicing debt depends on interest rates, terms of repayment, and other factors.
For now, we can pay the loans we owe and still live a good life. If we wanted to live "debt free" it would mean not owning a house, at the very least, because we'd never save the total purchase price. But, we can and should try to pay down our debts quickly and within reason.
Nations borrow money, via bonds and other mechanisms, to invest in infrastructure and services. Right now, international interest rates are low and borrowing terms are favorable. While I believe the government should do less and spend more wisely, that is a different argument than setting a specific ratio of debt to GDP. I'm not sure we can set such an ideal ratio with models.
Again, Herndon had a bias. We should know that bias, and then consider how much it does or does not matter to this student-scholars research.
Herndon's paper began life as a replication exercise for a term paper in a graduate econometrics class. He expected to replicate Reinhart and Rogoff's results, then challenge the idea that high public debt caused growth to slow.I do believe high debt eventually causes rising interest rates, which in turn cause an inflationary spiral. But, what if your nation is the "best of the worst" among debtors? That's pretty much the reality of the United States today. We are unlikely to see inflationary pressures for a few years — though I do believe we will experience inflation at some point.
But he never got that far. Repeated failures to replicate the results roused his interest.
As the "best of the bad," our nation can keep on borrowing and spending. That's one of the arguments in favor of stimulus projects. It is an argument I reject — primarily because once government assumes a role, it seldom retreats. I've argued before on this blog, if government spent wisely… I might (and only might) trust it to spend on infrastructure. (Exhibit A: California roads and bridges are crumbling. So, the state spends money on a new high speed rail effort that goes nowhere. That's government logic at work. Politicians spend on new, shiny projects, not maintenance.)
I'd rather we reduce spending, simplify tax codes, and hope that we might, might be able to run a surplus in the future that could rebuild our infrastructure. I don't care about 90 percent debt-to-GDP or even 100 percent — what I care about is why we borrow and is there a true long-term benefit. Wasted stimulus, I can't support even if we have a 50 percent debt-to-GDP ratio, or a surplus. Spending wisely means avoid waste, no matter what some model might illustrate.
Now, we should offer some praise to Reinhart and Rogoff for doing what good researchers do: sharing their data so it can be tested. They didn't hide the data.
Herndon approached Reinhart and Rogoff earlier this year for the spreadsheets they used in their paper. The two professors provided them at the start of April, unlocking the mysteries of the data that had stumped Herndon.I wish all research data were published online and available for download. This shows why data should be shared and examined.
The response of Reinhart and Rogoff, once they learned of the problems in their model, seems inadequate to me. I hope they have a more detailed response planned, because "oops" isn't an answer.
Reinhart and Rogoff have admitted to a "coding error" in the spreadsheet that meant some countries were omitted from their calculations. But the economists denied they selectively omitted data or that they used a questionable methodology.Is this a win or loss for a particular school of economics? I cannot say. It is a win for an open scholarly process. I wish Herndon well. He has provided a valuable service by reminding us that the "great minds" of any field are fallible.
Reinhart and Rogoff, however, say their conclusion that there is a correlation between high debt and slow growth still holds.Models are, in my view, always flawed. But, welcome to economics in a quantitative world. I can't wait for the "subsequent work" from Reinhart and Rogoff. Maybe Herndon will analyze those papers, too.
"It is sobering that such an error slipped into one of our papers despite our best efforts to be consistently careful," they said in a joint statement. "We do not, however, believe this regrettable slip affects in any significant way the central message of the paper or that in our subsequent work."
Now that Herndon has ably crossed swords with some of the most eminent figures in his field, he is thinking about expanding his work into a Ph.D. thesis.