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The Reinhart-Rogoff economic policy controversy

April 18, 2013

Published in ‘New Europe’, online edition

IMG_0321Carmen Reinhart and Kenneth Rogoff are two distinguished Harvard professors of economics, mostly known to the general public for their book “This Time Is different – Eight Centuries of Financial Folly.” Rogoff was even mentioned last year as a Nobel prize candidate. On the other hand Ms. Reinhart (a refugee of Cuban-origin who arrived in USA at the age of ten), became famous for her concept of “financial repression,” a concept that has gained unexpected popularity of late due to the recent sovereign bonds’ haircuts in the eurozone.

In a 2010 academic paper “Growth in a Time of Debt,” Rogoff and Reinhart suggested that economic growth slows when government debt rises above 90 percent of the country’s GDP. The remedy for such situation is, according to the authors, a strict austerity policy. Their findings were largely cited in political debates and extensively used by politicians to justify budget cuts; in the US, Paul Ryan, the House Budget Committee Chairman, was one of the most fervent proponents of that theory.

However, a recent work by three University of Massachusetts economists — Thomas Herndon, Michael Ash, and Robert Pollin — revealed that Reinhart and Rogoff ‘s findings were based on Excel calculations! More to that, the weighing given to the results of different countries were the same for all of them. They chose to give each country’s average growth in a particular debt/GDP range the same weight, regardless of how many years the country had been in that situation. The problem is that, by changing their approach, they got a very different result: rising debts would have  a positive effect on growth – an unpleasant surprise for scholars of the monetarist school of thought.

More to that, Herndon, Ash, and Pollin found two more “weaknesses” in Reinhart-Rogoff’s study. First, several countries with high debt and yet satisfactory growth rates, such as Australia, New-Zealand, and Canada, were deliberately left  out of the study. Second, the authors had adopted an approach to sum up their data that pulled down their calculation for average  growth in periods of high debt levels.

The invalidation of the initial findings would suggest that a set of Keynesian policies would be possible, and eventually large deficits could lead to a better long term growth picture. We can just imagine the arguments that would be put into the hands of those currently fighting austerity policies in the Eurozone, as promoted by Germany and its ‘northern’ partners, and imposed upon the South of Europe. If finally confirmed, the refutation of Reinhart-Rogoff’s paper will have unusually important consequences for Europe and its heated debates, that would extend far beyond academia.

http://www.neurope.eu/article/reinhart-rogoff-economic-policy-controversy

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