A couple of years back,
to be precise in May 2010, Prof. Carmen Reinhart and Prof. Kenneth Rogoff of
Harvard University, analyzing time-series data on central government debt,
inflation and growth from 44 countries, spanning up to 200 years, published a
paper—“Growth in a Time of Debt”—stating that nations, be they developed or
developing, that had a debt to Gross Domestic Product greater than 90 per cent
are in danger of witnessing a fall in their average growth rate by about one
percentage point. They also stated: “Seldom do countries grow their way out of
debts.” Therefore, they “suggest that traditional debt management issues should
be at the forefront of public policy concerns.”
The findings of
Reinhart and Rogoff are of paramount importance to policy makers, particularly
in the context of post-global economic crisis, when countries were debating
whether to spend more to give a stimulus to their sagging economies to grow or
to observe austerity. Their findings had indeed, provided further support to
the demand for austerity made earlier by the study of Albert Alesina and Silvia
Ardagna, the validity of which was, of course, questioned in 2010 by the
findings of a study carried out by IMF.
Nevertheless, the
findings of Reinhart and Rogoff came handy to the ‘austerians’—who are known
for their strong belief that fiscal policy has no role in stimulating growth in
real GDP; wages are more flexible and likely to adjust downwards to prevent
real wage unemployment; and therefore money supply must be controlled even if
required by imposing spending cuts, to keep the inflation low—to beat the
Keynesians like Paul Krugman who have been all along demanding more of
government spending, ignoring even the widening fiscal deficit, as a
stimulation to kick-start the economy out of
recession trap and create employment.
Indeed, Keynesians
argue that in a recession, people tend to respond to the threat of fall in
employment by saving more, which means a fall in aggregate demand and a bigger
fall in GDP. It is to obviate this paradox, Keynesians advocate expansionary
fiscal policy. Yet, the so-called elite of the market economy, citing the paper
of Reinhart and Rogoff, insist that fiscal policy has no role in stimulating
growth in real GDP and hence hammer the policy makers to rein in fiscal
deficit. In the process, the policy makers of the US could not go all out in
stimulating growth and in turn employment, for at least, that is what the
Keynesians cried for during the last two years and are continuing to shout at
Federal government demanding more action for creating employment.
Interestingly, as this
tussle is on, Thomas Herndon, Michael Ash and Robert Pollin of the University
of Massachusetts came up with a publication in the first week of this month, stating that Reinhart and Rogoff
committed a simple miscalculation and data exclusion, the correction of which,
when effected, gave an altogether different result to them: the average growth
in GDP of high debt countries is not negative as claimed by the original study of
Reinhart and Rogoff, but would be 2.2 per cent. Thus, the whole understanding
of the role of expansionary fiscal deficit in stimulating growth is reversed.
Obviously, this has generated
heated debate across the countries among academicians and politicians. There
have been accusations that Reinhart and Rogoff, by virtue of “selective
exclusion” of relevant data and by “unconventional weighting of summary statistics”,
committed a serious error, though it “served as an intellectual bulwark in
support of austerity politics.” Though Reinhart and Rogoff admitted calculation
error, they have strongly disputed the accusations, stating that whatever thy
might have said to policy makers was based on their “entire experience and
knowledge of the literature, never just on our own work.”
That said, we must
admit that such omissions and commissions do happen in archival research when a
huge chunk of data is crunched by the research assistants in Excel sheets. Even
otherwise, in the field of social sciences, it is quite difficult to establish
the cause-and-effect relationships between variables, as many variables can
affect the situation, and the scope of their replicability is all the more difficult
owing to the researcher’s inability to keep all other intervening variables
constant or to control them. Secondly, seldom does any researcher from social
sciences try to replicate others’ findings.
Against this backdrop,
the effort of the graduate student of MIT, Thomas Herndon, who tried to
replicate the study of Reinhart and Rogoff, is highly laudable. Equal credit
must also be given to Reinhart and Rogoff for willingly cooperating with the
graduate student, who questioned the validity of their findings, by making the
original data they have used available to the student for further scrutiny that
resulted in the very reversal of their findings.
Now, the big question
that really matters is: What does this whole episode teach us? One answer could
be: policy makers, ignoring the basic economic theory, should not overly rely
on mindless empiricism while dealing with real-life economic situations, which
are unique by themselves. Academic studies apart, commonsense cannot be sacrificed,
for commonsense says that when economy is depressed and unemployment is rampant
all around, people resort to cutting their spending further, as a result of which
there would be a fall in the income as a whole for the economy. This leads to a
plunge in employment. This in turn perpetuates depression in the economy, as is
now being experienced by countries like Greece, Spain, Portugal and the US. So,
it calls for the governments to resort to above-normal spending to sustain the
economy till private investment flows in. In fact, government spending through
deficit financing will not in any way affect private investment, but will only
put unemployed resources to work. It thus generates additional income. This in
turn raises aggregate demand in the economy, which in turn stimulates private
investment. Once private investment starts taking effect, the economy
automatically jumps out of recession. Then, the government can withdraw from
above-normal spending and move towards reducing its fiscal deficit.
Here, it is important
to note that above-normal government spending and larger budget deficits are
not a prescription for all times. It is only when the economy is in depression that
one should undertake such off-the-beaten-track measures. Now that the
intellectual argument for austerity has lost its credibility, one hopes that
the governments, particularly of the Euro countries and the US, might do
something soon to kick the world economy out of depression.
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