The plan, dear reader, was to dedicate this week to an exhaustive economic analysis of raisin production in the United States. I have no doubt that you would have been mesmerized by the flood of dry grape knowledge that would have assaulted you. Alas, current events being what they are we must discuss something all together less compelling.
If you're not an economist or politician you've probably never heard of Reinhart and Rogoff. In brief they are two Harvard professors who published an influential paper in 2010. The paper dealt primarily with how debt levels are related to economic growth. They concluded that when a nation's debt exceeds 90% of GDP economic growth slows dramatically (and in fact becomes negative generally). Obviously if you owe nearly as much as you earn annually and you earn less and less each year (negative growth) it becomes very difficult to ever escape the debt trap.
As it turns out a simple spreadsheet error resulted in Reinhart and Rogoff's conclusions being quite different than reality. Although debt levels are weakly negatively correlated with growth, there is no evident tipping point at a 90% debt to GDP ratio.
Now the real question is, "Why should anyone care?" After all there are certainly dozens if not hundreds of other economic papers out there with similar (though hopefully unintentional) errors. This one may be more prominent than the average but it hardly seems worthy of a great deal of attention.
To be quite honest, the error in Reinhart and Rogoff's work is not terribly significant. It is however very symbolic. As everyone knows the last several years have been difficult for the global economy. The US housing and credit crisis gave way to problems with government debt in the eurozone. Uncertainty in China is growing and governments have been trying to figure out the best way to forge through their difficulties. In the United States we opted to stimulate the economy by easing credit markets and stimulus spending. In Europe many nations decided to sharply reduce government spending in order to bring debt levels down.
The decision of many of the European nations was based upon the idea that high debt levels would halt economic growth. The exact same conclusion that Reinhart and Rogoff came to in their paper. Were the decisions of the Europeans governments based upon the data found in Reinhart and Rogoff's work? Probably at least in part, though hopefully not completely. Now that the paper has been shown to be incorrect doubt is cast upon austerity measures as a whole. Or so it would seem.
The fact is that most American economists already believed that austerity measures in Europe were not effective. There's been a gradual trickle of data from European economies showing that large reductions in government spending haven't improved much economically speaking and have often left the public worse off. Thus a paper that supports austerity tactics turning out to be inaccurate isn't really much of a surprise. After all, we can see real world data that indicates austerity doesn't seem to improve economic outlook. Compared to that data an error in a pro-austerity paper is relatively inconsequential.
However, Reinhart and Rogoff's error is an easily digestible fact for the general public. Anti-austerity economists can crow and point the finger at how wrong austerity is without having to result to time consuming activities such as modeling and data collection. Armchair politicians can knowingly cluck their tongues at dinner parties and tell their longtime right wing nemesis "I told you so." And everyone can feel very well informed because they know who Reinhart and Rogoff are now.
Ultimately not very much has changed from a week ago. Two professors are a bit embarrassed, one graduate student has earned a bit of fame, the European austerity experiments proceed apace and no one really knows any more than they did before a spreadsheet error was discovered. While the signs don't seem positive for austerity proponents, only time, not spreadsheets will tell who was right in the end.
More economics next week. Until then stay safe and rational.