One of the most significant trends of the past several years has been austerity measures taken by governments all over the world in order to try to keep their budgets in control. Much of the support for these actions came from a 2010 paper by Ken Rogoff and Carmen Reinhart of Harvard entitled Growth in a Time of Debt. This paper claimed to have found that over the last 200 years, countries whose debt levels were above 90% of GDP experienced significantly lower growth rates than those whose debt levels were below. That conclusion certainly makes theoretical sense and fits very nicely into the modern political rhetoric. However, there is one problem: the Excel spreadsheet used contained a coding error and omitted some data that would have completely changed the conclusion if included. The results if the data was included would indicate that debt-to-GDP levels actually have no impact on growth.
That revelation certainly sparked quite an uproar in economic circles. The reason for this is twofold: Reinhart and Rogoff are two of the most respected economists in the profession today and the fact that many governments chose to take austerity measures instead of creating more stimulus through spending may have slowed down the recovery and caused irreparable damage. In fact, even the International Monetary Fund has admitted that they were wrong about underestimating the negative side effects of austerity. What’s even more fascinating about that admission is that it came before the Excel error in Reinhart and Rogoff was found!
However, as any basic economic student knows, there is a finite supply of money so debt levels do matter. Further, much of the support for austerity is still ingrained in the political system due to politics and not data. The Financial Times has a very good summary of the players, risks, and rewards of the austerity game in case you are not yet aware. Also, Japan has been doing the opposite of austerity for quite some time now and has even announced that they plan on doubling their money supply within the next year or two. Yet, the Japanese economy has been stuck in somewhat of a doldrums for the past decade with an average GDP growth rate of 0.8% since 1999.
The austerity vs stimulus debate has been going on for a long time- back since the days of Keynes and Hayek as this YouTube video shows. There’s no clear answer to this question, but there’s points to be made on both sides of the aisle. Personally, I think in today’s low interest rate environment stimulus spending and investment should be much higher- provided that there are good projects to invest in. I’d be happy to discuss and debate thoughts from the globalEDGE community in the comments below!