Dean Baker
The Exchange (Yahoo! Finance), April 17, 2013

See article on original website

Did an Excel error cost you your job? This is what people around the world should be asking after researchers at the University of Massachusetts uncovered a serious calculation mistake. The mistake was in an enormously influential paper by Carmen Reinhart and Ken Rogoff, two prominent economists, which purports to show that high levels of government debt lead to slow economic growth.

This paper has been widely cited by political figures around the world who have been pushing the case for cutting back government spending and raising taxes. House Budget Committee Chairman Paul Ryan famously cited Reinhart and Rogoff when he laid out his budget earlier this year. So have many of the politicians now pushing for cuts in Social Security and Medicare.

Reinhart and Rogoff’s work has had an extraordinary impact for an academic paper. This is why the calculation error is so important. When the error is corrected, the relationship between debt levels and economic growth is far less clear.

They are several examples of countries that have enjoyed healthy growth with debt levels far higher than the United States has now or will plausibly experience in the foreseeable future. Furthermore, the biggest falloff in growth rates in the corrected data occurs with debt levels that are way below what the United States has seen for the last three decades.

This means that if anyone wanted to use the corrected Reinhart and Rogoff paper for an argument about reducing debt levels, they should be pushing for much larger spending cuts and tax increases than anyone has put on the table. The corrected Reinhart and Rogoff paper would be telling us to kiss Social Security and Medicare goodbye completely and tighten our belts with some real tax increases.

Of course we are not hearing such calls, because the paper itself was not actually the basis for policy. Rather its finding were being used to provide cover by those who wanted to cut Social Security, Medicare and other programs that enjoy high levels of public support. It would be impossible to garner the political support needed for cuts to these programs on the merits, so the politicians pushing these cuts were happy to use the erroneous findings from Reinhart and Rogoff to advance their agenda.

The Reinhart and Rogoff paper was not used only to argue for cuts to popular social insurance programs, it was also used to argue against government efforts to boost the economy and create jobs. The opponents of these policies argued that efforts to spur the economy would prove to be counterproductive because Reinhart and Rogoff showed us that higher debt levels would mean slower growth.

Their paper was used to imply that any short-term benefit in job creation and increased growth would come with a high long-term cost. The corrected version is far less useful in making this case.

There were good reasons for not accepting the Reinhart and Rogoff results even before this error was uncovered, as many of us had argued. Most importantly there is a serious issue of the direction causation. Countries tend to have high debt levels because their economies are doing poorly.

Japan is the best example of this story. Japan had very low debt levels as its economy boomed in the 1970s and 1980s. Then its stock and housing bubbles collapsed in 1990 and threw the economy into a prolonged period of slow growth. During this period the Japanese government has run large deficits to sustain demand in a context where private sector demand was lacking due to the collapse of the bubbles that had previously supported its growth.

We can say that Japan’s weak growth in the last two decades was caused by large deficits, but this would be like saying that hospitals cause people to be sick. The direction of causation was clear: Japan’s badly troubled economy led it to run large deficits.

Reinhart and Rogoff want to find other Japans to tell us that we have to cut Social Security and other programs that people depend upon. They also want to tell us that we should abandon efforts to boost the economy and create jobs.

The uncovering of this major error in their work gives us a chance to re-examine this issue. We need a vigorous public debate over the course of economic policy. Ever since Franklin Roosevelt and the New Deal we have known how to create jobs and boost employment. We can't let the mistaken work by Reinhart, Rogoff and others stand in the way.

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