Public Debt and GDP

Is the government’s focus on austerity coming at the wrong time?

July 15, 2013
The pace of U.S. economic growth continues to lag long-run norms by a fairly wide margin, causing some to fear the government’s focus on spending restraint comes at exactly the wrong time. And rightly so.
Keynesian economics suggest an active role for government when the economy is weak. They believe austerity at the wrong time unnecessarily prolongs pain and suffering.
Data for the first quarter of 2013 shows that a decline in government spending took nearly a full point off of U.S. economic growth. Except for early 2011, you have to go back 60 years to find a two-quarter period wherein government spending declined so significantly.
And it turns out that a big part of the rationale to restrain government spending appears to be flawed.
Two Harvard economists, Carmen Reinhart and Ken Rogoff , performed an economic analysis that greatly influenced recent policy debates. They examined economies over a broad swath of history and found that public debt has a dramatic effect on economic growth after it reaches 90% of gross domestic product (GDP). Then, average annual growth rates drop dramatically, from about 3% annually to -0.1% after crossing this threshold.
With U.S. government debt quickly approaching this ceiling the correct response seemed clear: Spend less, borrow less, or risk financial catastrophe.
But some University of Massachusetts- Amherst graduate students revealed the Reinhart/Rogoff result to be flawed. Tasked with replicating an economic study to hone their analytical skills, the students collected and analyzed the data described in the Harvard study. But they couldn’t reproduce the results.
On obtaining the original data set and analysis, the students found several glaring problems, including a cell reference error that omitted several countries from the data set.
Plus, several years of post-war data from New Zealand were left out, ignoring a period in which both the country’s debt level and growth rate were high.
The new analysis produced results that were contrary to those published by the Harvard economists: Passing the 90% debt threshold doesn’t appear to cause economies to shrink. They simply grow at a marginally lower rate (“Real GDP growth rates by debt/GDP ratio”).
Nobody claims Reinhart and Rogoff purposely set out to deceive. But the flap does call to mind a quote by British economist Joan Robinson: “The purpose of studying economics is not to acquire a set of ready-made answers to economic questions but to learn how to avoid being deceived by economists.”
Economists aren’t a deceitful lot—honestly! They’re mostly interested in uncovering truth and finding what drives behaviors and how things like economies and businesses work. Yet they’re frequently asked for analyses that have important public policy implications.
It’s not clear if the revised study will cause policymakers to rethink their current focus on austerity. But one thing is clear: Whatever path they take can have profound implications for the economy, U.S. workers, and credit union operations.
MIKE SCHENK is CUNA’s vice president of economics and statistics. Contact him at 608-231-4228.