The Corner

Rogoff, Reinhart Defend Their Findings on Debt and Growth

On Monday I noted that “supporters of the president’s policies find it useful to quote Rogoff and Reinhart when advocating patience with the speed of the recovery but strive to ignore (and in some cases rabidly attack) the team’s related finding that debt-to-GDP levels over 90 percent are associated with notably weaker economic growth.” Today, Rogoff and Reinhart have published a response to their critics, most of whom had argued that R&R had gotten the causation backwards — that low growth leads to high debt, and not the other way around. Here is the meat of the team’s response:

There is little room to doubt that severe economic downturns, irrespective whether their origins was a financial crisis or not, will, in most instances, lead to higher debt/GDP levels contemporaneously and or with a lag. There is, of course, a vast literature on cyclically-adjusted fiscal deficits making exactly this point. …

A unilateral causal pattern from growth to debt, however, does not accord with the evidence. [emp. added] Public debt surges are associated with a higher incidence of debt crises. This temporal pattern is analysed in Reinhart and Rogoff (2010b) and in the accompanying country-by-country analyses cited therein. In the current context, even a cursory reading of the recent turmoil in Greece and other European countries can be importantly traced to the adverse impacts of high levels of government debt (or potentially guaranteed debt) on county risk and economic outcomes. At a very basic level, a high public debt burden implies higher future taxes (inflation is also a tax) or lower future government spending, if the government is expected to repay its debts.

There is scant evidence to suggest that high debt has little impact on growth. Kumar and Woo (2010) highlight in their cross-country findings that debt levels have negative consequences for subsequent growth, even after controlling for other standard determinants in growth equations. For emerging markets, an older literature on the debt overhang of the 1980s frequently addresses this theme.

One need look no further than the stubbornly high unemployment rates in the US and other advanced economies to be convinced how important it is to develop a better understanding of the growth prospects for the decade ahead. We have presented evidence – in a multi-country sample spanning about two centuries – suggesting that high levels of debt dampen growth. One can argue that the US can tolerate higher levels of debt than other countries without having its solvency called into question. That is probably so. (see Reinhart and Reinhart 2007). We have shown in our earlier work that a country’s credit history plays a prominent role in determining what levels of debt it can sustain without landing on a sovereign debt crisis. More to the point of this paper, however, we have no comparable evidence yet to suggest that the consequences of higher debt levels for growth will be different for the US than for other advanced economies.  [emp. added]

Total U.S. public sector debt currently stands at 117 percent of GDP. How high can we go, free-lunchers? You really want to find out the hard way?

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