Debt and Austerity Debate and the Reinhart-Rogoff Debacle

If you are a wonkish person like me, you might be aware of a recent scandal that shook the unsavory school of thought I call neo-classical economics.

You see, two Harvard professors, Carmen Reinhart and Kenneth Rogoff published a seminal paper in 2010 to establish that there was a causal link between slow growth and indebtedness. They specifically claimed that once the debt to GDP ratio reaches 90 percent, growth actually slows down. Since both debt and growth are expressed as a percentage of GDP, one could always argue the causality in either direction: lower growth leads to higher debt vs higher debt leads to lower growth.

Theirs was the first argument in favor of a unidirectional causality. And the first one to determine a tipping point. Their work become the foundation for all the conservative demands to dismantle the social safety net and to cut government spending in order to reduce debt. At long last, here was the justification for what they have been clamoring. It was Pete Peterson's wet dream.

As a result, their work was quoted countless times in the austerity debate. Rogoff has written many op eds with strong policy conclusions encouraging spending cuts and austerity measures. His testimony before the Senate created a rare bipartisan moment of consensus about the terrible toll of high public debt.

Their reach and influence was extraordinary. Their conclusions were cited by European Commissioner Olli Rehn, by Romney's running mate Paul Ryan, by (then) Treasury Secretary Tim Geithner, by Lord Lamont, former Chancellor and adviser to the current Chancellor of the Exchequer George Osborne.

Before Reinhart and Rogoff, there was only one lonely voice, another Harvard economist, Alberto Alesina, who claimed that austerity measures lead to growth. Sadly for him and the proponents of austerity, his work was demolished and repudiated rather quickly by mainstream economists.

So when Reinhart and Rogoff emerged they became critically important in determining the outcome of the austerity debate.

There was a tiny problem. No one could reproduce their results. Many tried and failed. So their peers asked to review their data but Reinhart and Rogoff simply refused.

Fast forward to this year. A couple of professors at the University of Massachusetts at Amherst gave a special assignment to their graduate students. They were each supposed to reproduce the findings of a famous paper. When Thomas Herndon, the graduate student who picked the Reinhart Rogoff paper could not duplicate their results, he wrote to Reinhart and Rogoff, to ask for their data. Since he was a lowly graduate student, they agreed to share their spreadsheets with him.

Herndon discovered that their data contained several very significant errors. Like omitting five countries by mistake. Or assigning the same value to one bad year in New Zealand to 20 good years in Britain. Or simply excluding certain cases that did not fit with their conclusions.

Consequently, when Herndon and his two professors published their findings with corrected data, their conclusions were quite different:

They find "the average real GDP growth rate for countries carrying a public debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0.1 percent as [Reinhart-Rogoff claim]."

In other words, there was no tipping point and there was no unidirectional causality between high debt and reduced growth. In fact, other researchers discovered that there was strong evidence that the causality is reverse, i.e. low growth leads to higher debt.

What did the two neo-classical economists say?

"We are grateful to Herndon et al. for the careful attention to our original Growth in a Time of Debt AER paper and for pointing out an important correction to Figure 2 of that paper. It is sobering that such an error slipped into one of our papers despite our best efforts to be consistently careful. We will redouble our efforts to avoid such errors in the future. 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."

So an error that revises their conclusion from -0.1 percent to +2.2 percent is not relevant and does not change their central message.

Economics is a serious and respectable discipline. But neo-classical economics is an ideologically biased school, based on dubious axioms and sporting a fake scientific veneer.

And neo-classical economist never ever acknowledge that they were wrong. Ask Krugman how they destroyed valid Keynesian notions to replace them with bogus monetarist talking points.