Two excellent new additions to the debate over what the link is between high debt loads and growth came out in the past 24 hours.
The first is by Arindrajit Dube, “A Note on Debt, Growth and Causality”: “This note documents the timing in the relationship between the debt-to-GDP ratio and real GDP growth in advanced economies during the post World War II period using the dataset from Carmen Reinhart and Ken Rogoﬀ. I ﬁrst show that the debt ratio is more clearly associated with the 5-year past average growth rate, rather than the 5-year forward average growth rate–indicating a problem of reverse causality. Indeed, there is little evidence of a lower growth rate above the 90 percent threshold when using the 5-year forward average growth rate….non- and semi-parametric plots provide visual conﬁrmation that the relationship between debt-to-GDP ratio and growth is essentially ﬂat for debt ratios exceeding 30 percent when we (1) use forward growth rates, (2) control for past GDP growth, or both.”
This short paper formalizes a recent post Dube wrote at this blog, extending his semi-parametric analysis out to five years. It also provides all the equations, as well as some of the literature on this debate. It’s an important piece, dismantling the arguments that debt leads to lower growth.
The second is by Miles Kimball and Yichuan Wang at Quartz. “Based on economic theory, it would be surprising indeed if high levels of national debt didn’t have at least some slow, corrosive negative effect on economic growth. And we still worry about the effects of debt. But the two of us could not find even a shred of evidence in the Reinhart and Rogoff data for a negative effect of government debt on growth.”
Using different ranges (including 5-10 years out) and different techniques, Kimball and Wang can’t find any evidence for the Reinhart and Rogoff thesis that high debt loads are correlated with lower growth. It’s a remarkable post, where you can read them become surprised at what they are and are not seeing, and how they take pains to make sure they aren’t missing something.
Now where are the posts arguing the opposite? The literature hasn’t addressed this well at all. Indeed, in their recent letter to Paul Krugman, Reinhart and Rogoff argued that the “repeatedly-expressed view that slow growth causes high debt but not visa-versa, is hardly supported by the recent literature on the subject.” They suggest checking out their appendix to their New York Times piece for more info, which tells us to check out the World Economic Outlook.
But even the Outlook warns us on causation (in the paragraph immediately after the one they cite, no less): “But there are limits to empirical studies on the economic effects of debt overhangs. For example, countries that have high debt levels may have low growth for other reasons that typically are not captured in the econometric models. In fact, some studies find no causal relationship between high debt and lower growth. The October 2012 Global Financial Stability Report finds that countries with debt above 100 percent of GDP experience lower growth, but it also finds that countries with high but falling debt ratios grew faster than countries with lower but increasing debt ratios.”
Straightforward checks for casuality are missing from these previous studies. I’m not sure why, but now that people are looking at these issues with fresh eyes, it is suddenly much more difficult to make the statements about high debt leading to low growth with any certainty, much less the one that has dominated the converation during the turn to austerity after 2010.
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