The “austerity measures” currently being imposed on western nations are based on an economic theory which was created with flawed data which dramatically affects its predictive value, a student at the University of Massachusetts Amherst has shown.
The theory, developed by Carmen Reinhart, Professor of the International Financial System at Harvard Kennedy School, and Ken Rogoff, former chief economist of the International Monetary Fund, says that in a time of economic crisis, economic growth slows dramatically when the size of a country’s debt rises above 90% of Gross Domestic Product.
This is the rationale being used by most governments to institute spending cuts to reduce the national debt. The Reinhart/Rogoff paper, called “A Time of Debt” has become the manual for the “recovery” program which has seen essential services in most western nations cut to the bone.
The standing of the report’s authors has seen the conclusions unquestioned—until now.
A student at the University of Massachusetts Amherst, Thomas Herndon, was given an assignment by his professors to pick an economics paper and to replicate its results.
Herndon chose “A Time of Debt” and soon he discovered that he could, under no circumstances, recreate the predictions made in the original paper.
“My heart sank,” he was quoted as saying. “I thought I had likely made a gross error. Because I’m a student the odds were I’d made the mistake, not the well-known Harvard professors.
“I remember I had a meeting with my professor, Michael Ash, where he basically said, ‘Come on, Tom, this isn’t too hard—you just gotta go sort this out.’”
Finally, after he obtained the original data spreadsheet from Reinghart and Rogoff, he saw that the two world economists had only included 15 of the 20 countries under analysis in their key calculation (of average GDP growth in countries with high public debt).
They had left out the critically important nations of Australia, Austria, Belgium, Canada, and Denmark—which dramatically affected the outcome.
In addition, one bad year for a small country like New Zealand, was blown out of proportion because it was given the same weight as, for example, the UK’s nearly 20 years with high public debt.
New Zealand’s single year, 1951, at -8% growth is held up with the same weight as Britain’s nearly 20 years in the high public debt category at 2.5% growth.
All these results were published by Thomas Herndon and his professors on April 15. They found that high levels of debt are still correlated with lower growth—but the most spectacular results from the Reinhart and Rogoff paper disappear when all the figures are factored in.
High debt is correlated with somewhat lower growth, but the relationship is much gentler and there are lots of exceptions to the rule.
In essence, Herndon’s conclusion is that “austerity policies” are counterproductive, and that the current polices being followed by most western nation’s governments, based as they are upon factually incorrect calculations, are going to exacerbate the economic crisis, and not fix it.