JIM O'NEILL: That Reinhart-Rogoff Paper Was Problematic Long Before Anyone Discovered A Maths Error

jim o'neill

In recent weeks, economists Carmen Reinhart and Ken Rogoff have taken a lot of heat for a computational error in their paper relating economic growth with debt-to-GDP ratios.

However, Goldman Sachs economist Jim O’Neill reiterates that the spreadsheet error isn’t even the biggest problem with the paper.

Rather, it was the suggestion that you could simply compare varying economies just using a handful of leverage ratios.

From O’Neill’s latest Viewpoints note (emphasis added):

According to a number of media reports, central bankers at the interim IMF meetings in Washington, D.C. admitted that they don’t really know what is going on in developed economies, nor the consequences of their current policies. While, no doubt, many observers will be worried about these rather frank admissions, in my view they are rather welcome. From my own education in economics, it has been clear for a long time that it is a social science, and certainly not close to a pure science. So, of course, economists shouldn’t know what is going on. They can have a degree of confidence, but one might argue that one of the reasons why the 2008-09 crisis happened could be that too many people were too confident about their knowledge of economic relationships. Anyhow, to add to the mix, there has been particular attention on the research by Kenneth Rogoff and Carmen Reinhart, published in 2010, which has been highly influential in many circles in the past three years. According to media reports, a group at the University of Massachusetts reproduced the Rogoff and Reinhart research and, using the same data set, reached very different conclusions. Rogoff and Reinhart appeared to show that countries with a public debt-to-GDP ratio of 90% or more showed persistently lower growth than other countries, and inferred that to boost growth, debt reduction was a major necessity. Perhaps somewhat more than they might have recommended, some countries and observers have used this research to justify fiscal austerity. Following the attention the Massachusetts paper has received, Rogoff and Reinhart have apparently admitted their results were not quite as strong on re-analysis of the dataset. Coming soon after an admission by the IMF that they had underestimated the negative cyclical effects of fiscal tightening, this is seen as a victory for Keynesian-biased thinkers who have obviously articulated that growth would be restrained by fiscal tightening, irrespective of potential supply- side benefits of lower public debt.

Linked to my earlier comments about economics being merely a social science, it would seem reasonably obvious that grouping countries together in terms of their debt levels and concluding that the economic consequences are the same is quite a tricky path to tread. Even to apply such arguments about balance of payments current accounts, which to some degree are more of an accounting identifying and therefore less subjective, is tricky, but countries with high debt levels usually share very little else with each other. As a result, the remedy for the debt reduction and, more importantly, economic development and growth are probably very different. I doubt that the right economic policy for Greece, for example, could be applied to Japan.

What is almost definitely the case as a result of this attention is the fact that accelerated fiscal tightening is unlikely in countries where real GDP growth continues to struggle.

Read more at GoldmanSachs.com.

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