By Dean Baker
Co-Director, Center for Economic and Policy Research, Author
The controversy continues to simmer around the Reinhart-Rogoff (RR) paper and the now famous Excel spreadsheet error that led to claim that debt-to-GDP ratios above 90 percent led to sharply lower growth rates. The University of Massachusetts paper that exposed this mistake has led many people to reconsider their earlier acceptance of the Reinhart-Rogoff 90 percent debt cliff.
While that is a positive development, the re-examination should go a step deeper and ask why anyone ever took their argument seriously in the first place. It’s not just the arithmetic on debt-to-GDP ratios that tripped up RR; it was the basic logic of their argument.
If we accept the RR thesis, something bad happens to countries when their debt-to-GDP ratio exceeds 90 percent, which causes them to experience prolonged periods of slow growth. It is difficult to see how this could possibly be the case since debt is only one side of a country’s balance sheet; countries also have assets. For there to be any actual relationship between debt and growth it would seem that it would have to be debt, net of assets, and growth.
The RR story, where they purport to find a relationship between debt and growth, would be like finding a relationship between household debt and future income, without considering whether or not they own a home. In the RR approach to family finances, a family with $200,000 in debt who rented their apartment would be viewed as being in the same situation as a family with a $200,000 mortgage on a house that is worth $500,000.
While the second family would have $300,000 in assets after deducting their mortgage, like the first family it would also have $200,000 in debt. And since RR only concern themselves with debt, both families would count as facing equal debt burdens.
It would of course be absurd to imagine that these two families are in the same situation financially. And it would be equally absurd to imagine that countries with similar debt burdens but different amounts of assets are in the same position. (more…)