No one wants greater government debt, per se, but most agree that some circumstances call for government spending to bolster the economy. But how much debt is too much? Is there a point where high government debt “overhang” is large enough to offset the benefits of government demand stimulus in a weak economy?
In 2010, economists Carmen Reinhart and Ken Rogoff (sometimes shortened to RR) released an academic paper purporting to show that while low levels of debt are relatively benign, "high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes."
Reinhart and Rogoff caution that their study only shows correlation, not causation, between high government debt and slow growth. Nevertheless, their work has been used to promote austerity measures. Numerous politicians, from the chairman of the U.S. House Budget Committee to the president of Germany’s central bank, have cited the paper as support for reduced government spending.
Reinhart and Rogoff offer little discussion of the reasons debt might dampen growth, but others cite crowding out, expectations, and the interest burden of government debt as possible reasons. We contend that government borrowing does not compete with the private market when the economy is weak, that government spending is more likely to strengthen firms and boost expectations, and that low interest rates mitigate concerns about the debt burden.
Since its publication, Reinhart and Rogoff’s work has proven difficult to replicate. Economists at the University of Massachusetts – Amherst, who were given access to Reinhart and Rogoff’s data, were only able to recreate the original results after incorporating several possible errors that lay beneath the Reinhart and Rogoff analysis. After correcting spreadsheet errors and unconventional modeling tactics, the Massachusetts paper determines that Reinhart and Rogoff’s major finding disappears; countries above the 90% debt threshold do not exhibit a growth slow-down. Unfortunately, these findings did not come to light until some time after the original work had been cited in Senate Budget Committee Testimony, the Paul Ryan Budget, and in popular articles in the Economist, Wall Street Journal, New York Times, Washington Post, Fox News, National Public Radio, and MSNBC.
Most directly, the errors undermine the 90% debt threshold identified by Reinhart and Rogoff, but the MWM perspective goes further in casting doubt on the theoretical underpinnings of any particular debt threshold that somehow signals a danger level for economic prosperity. We believe that the needs of the economy, not arbitrary thresholds, should guide government spending and tax policy. As long as an economy is producing below its potential, stimulus policies will not have negative repercussions. If the empirics upon which Reinhart and Rogoff based their argument are also faulty, then as the economists that uncovered these errors argue,
[Reinhart and Rogoffs'] findings have served as an intellectual bulwark in support of austerity politics. The fact that [their] findings are wrong should therefore lead us to reassess the austerity agenda itself in both Europe and the United States.
There are a number of places in these pages where you can find analysis that explains why the policy perspective associated with Reinhart and Rogoff does not accurately describe the effects of fiscal austerity, in the United States and elsewhere, when economies operate with substantial unemployment. In particular, we encourage readers to explore our fiscal policy pages.