Remember: Reinhart and Rogoff weren’t the only ones saying that public debt puts brakes on economic growth

by Ryan Streeter on April 25, 2013. Follow Ryan on Twitter.

The e21 editors have a nice perspective piece on the “hysteria” over the error in the Reinhart-Rogoff study on the relationship between a nation’s debt and its growth.

They write:

The irony is that now that a data error has been found, progressives wish to inflate the significance of Reinhart-Rogoff and pretend as though it was the sole basis for concern about elevated public debt levels.  This is nonsense: numerous studies found that increased levels of public debt were associated with slower growth and they generally identified a lower threshold.  The Bank for International Settlements (2011) found that debt overhang problems become aggravated once debt hits 85% of GDP.   A 2013 paper from a former Fed Governor and famous econometrician found that economies are especially vulnerable to a debt crisis when debt exceeds 80% of GDP.

Higher debt levels increase the required level of future taxation, increase the probability of a financial crisis, and reduce governments’ flexibility to deal with future crises that may emerge.  Higher expected future tax rates reduce incentives to invest today.  The probability of a fiscal crisis makes investors seek liquidity and safety rather than productive investment.

They also make another point that isn’t discussed much in the larger public debt debate:

[I]t is important to recognize that TARP did not succeed because it was a genius plan with perfect execution.  TARP succeeded because federal debt was just 36.5% of GDP at the start of 2008.  Had the U.S. entered 2008 with today’s debt level, it is not clear the federal government would have had the capacity to backstop the banking sector.  The result would have been a situation similar to the one in Europe, where the weakness of the sovereign and the banking system create a negative feedback loop that reduces credit availability and investment demand.

  • M Berend

    Good stuff