Few papers have received so much unwarranted attention as Reinhart & Rogoff’s “Growth in a time of debt”. Two years ago Robert Shiller of Yale wrote a very critical piece on the paper stating:
“if one reads their paper carefully, it is clear that Reinhart and Rogoff picked the 90% figure almost arbitrarily. They chose, without explanation, to divide debt-to-GDP ratios into the following categories: under 30%, 30-60%, 60-90%, and over 90%. And it turns out that growth rates decline in all of these categories as the debt-to-GDP ratio increases, only somewhat more in the last category.
There is also the issue of reverse causality. Debt-to-GDP ratios tend to increase for countries that are in economic trouble. If this is part of the reason that higher debt-to-GDP ratios correspond to lower economic growth, there is less reason to think that countries should avoid a higher ratio, as Keynesian theory implies that fiscal austerity would undermine, rather than boost, economic performance.”
That just scratches the surface though. My big problem with the paper was that they arbitrarily took currency issuing nations and compared them with currency using nations. For instance, the problems in Greece (who is a currency user with a foreign central bank) are far different than the problems in the USA (notice a recurring theme? Understanding the modern monetary system matters and helps you avoid crucial flaws in your thinking!). Throwing the two nations into the same data set and then coming to conclusions based on arbitrary debt/GDP ratios is absurdly misleading. In my opinion, this critical flaw in the paper renders it almost totally void of value.
But then today Mike Konczal points us to a new paper by Thomas Herndon, Michael Ash, and Robert Pollin of the University of Massachusetts that does a deep dive into the Reinhart & Rogoff paper. Konczal summarizes:
“They find that three main issues stand out. First, Reinhart and Rogoff selectively exclude years of high debt and average growth. Second, they use a debatable method to weight the countries. Third, there also appears to be a coding error that excludes high-debt and average-growth countries. All three bias in favor of their result, and without them you don’t get their controversial result.”
There it is. So next time someone cites the Reinhart and Rogoff paper just tell them they’re working from a fundamentally flawed foundation.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.