Friday, April 19, 2013

Reinhart - Rogoff mistakes - results do not change

We have learned that some of the results from the work of Reinhard and Rogoff on government deficits are wrong. They made some errors in their excel spreadsheet calculations. The negative impact on growth from high deficits is not as bad as what their original results show. There is no excuse for that mistake; however, the general results are still the same. As debt to gdp levels reach close to 90%, you are going to get a slowdown in growth. High debt is a drag on growth. 

The theory behind this is very sound. If the size of debt to gdp is greater than 100% and the nominal rates of interest are higher than nominal growth rates, all of the growth will have to be used for funding the debt. The result is a drag on growth because the money has to be used as a payment to debt holders. The extent of the drag is an empirical question.

It should be noted that there are some large problems trying to measure these macroeconomic events. The data is limited. It is hard to work with. There are other factors going on, so it is difficult to tease out strong conclusions. There is plenty of room for disagreement on some the conclusions; however, the overall results still hold.

Does this end the austerity school of debt management? No, there is still  place for fiscal discipline however, we also need to look at whether fiscal spending has to be targeted to jump-start the economy. Keynesian counter-cycle policy is still important. The problem is not short-run policy but the structural deficits from health career and retirements which is the problem. We have to separate deficits based on capital spending in the short-run and structural changes in the longer-run.

Still, the rising debt to GDP numbers is a clear headwind that will slow trend growth. 

No comments: