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By Dean Baker, co-director of the Center for Economic and Policy Research

There was an earthquake in the world of economic policy last week when three economists at the University of Massachusetts uncovered spreadsheets errors that provided the basis for the results of a highly influential paper by Harvard economists Carmen Reinhart and Ken Rogoff. This paper, “Growth in a Time of Debt,” which purports to show that countries see sharply slower growth when their ratio of debt to GDP exceeds 90 percent, was widely cited by people in policy positions to justify austerity measures. Political figures in the United States, the United Kingdom, and euro zone countries had frequently cited the Reinhart and Rogoff (R&R) paper in arguing for budget cuts and higher taxes.

[http://www.peri.umass.edu/236/hash/31e2ff374b6377b2ddec04deaa6388b1/publication/566/]

　However when the spreadsheet was corrected it no longer supported their case. The corrected spreadsheet did show that countries with debt levels exceeding 90 percent of GDP experienced slower GDP growth, but the gap was far smaller than in the original analysis. Given the small number of incidents where wealthy countries had seen their debt to GDP ratios exceed 90 percent, the falloff in growth in the corrected spreadsheet is not close to being statistically significant.

　Furthermore, the corrected spreadsheet actually shows a much sharper falloff in growth at very low levels of debt to GDP. Neither R&R nor anyone else has argued that debt to GDP ratios in the range of 30 percent could be harmful.

　The more important question was that R&R never distinguished cause and effect. Even if there is a relationship between high debt and slow growth it does not follow that the debt caused the slow growth. It is entirely plausible that slow growing economies are going to be ones that need large deficits to sustain growth.

　Japan is an obvious example. Japan‘s economy boomed in the 1980s, driven by bubbles in the stock and housing markets. When these bubbles burst in 1990 its growth slowed sharply. The country, which had previously run very small deficits, suddenly began to have large deficits in order to sustain growth. In the R&R story the high debt that Japan eventually built up caused slow growth, however the causation seems to be clearly in the opposite direction.

　Another University of Massachusetts economist, Arindrajit Dube, decided to directly address this issue [http://www.nextnewdeal.net/rortybomb/guest-post-reinhartrogoff-and-growth-time-debt], testing whether causation seemed to go from debt to growth or in the opposite direction. He found that there was very little evidence of causation from debt levels to growth over the next three years. However, there was very strong evidence of causation from debt levels to growth over the prior three years. In other words, it was the past history of slow growth that was leading to high debt-to-GDP ratios, not the other way around.

　The two papers from University of Massachusetts taken together demolish the case that we have any basis for thinking that higher debt levels in the ranges we are now facing will, by themselves, have any appreciable impact on growth. The notion that we face some sort of debt cliff that we risk falling over is simply not supported by the data.

　If the debt cliff argument can now be dismissed the question again arises as to whether we should have more aggressive stimulus to boost the economy. By most accounts, President Obama’s initial stimulus worked pretty much as planned. It created in the range of 2-3 million jobs. The problem was that it was not nearly large enough.

　Like the rest of the economics profession, President Obama‘s advisers badly underestimated the severity of the downturn following the collapse of the housing bubble. We actually needed a stimulus that could create 10-12 million jobs.

　The argument for additional stimulus would be the same as it was when President Obama first took office. We have millions of people who are not being employed by the private sector. The extended periods of unemployment they are experiencing is incredibly destructive to both the unemployed and their families.

　It is also an enormous waste from the standpoint of the economy as a whole. The government could be putting these people to work in productive tasks. In many cases this will be simple since we have laid off hundreds of thousands of public employees in the last three years, many of them were previously employed as teachers, fire fighters, or air traffic controllers. Putting these people back to work will have clear economic benefits.

　We can also take advantage of this downturn as an opportunity to rebuild our infrastructure. In addition to the maintenance needs that can be addressed, we can also turn to longer-term items like high speed rail where the United States lags the world. And a simple no-brainer should be retrofitting homes to make them more energy efficient. This could put to work many construction workers who are still unemployed following the collapse of the building boom.

　The argument against more spending is simply the classic argument that deficits crowd out private investment. With interest rates still near post-World War II lows, this one simply is not plausible. With the R&R work now discredited, there simply is no good reason not to go the route of greater stimulus.

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