The University of Manchester Research
Revisiting Reinhart & Rogoff after the Crisis: A Time Series
Perspective
DOI:
10.1093/cje/bez009
Link to publication record in Manchester Research Explorer
Citation for published version (APA):
Amann, J., & Middleditch, P. (2020). Revisiting Reinhart & Rogoff after the Crisis: A Time Series Perspective.
Cambridge Journal of Economics, 44(2), 343-370. https://doi.org/10.1093/cje/bez009
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Cambridge Journal of Economics
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Download date:09. Aug. 2022
Reprint submitted to Cambridge Journal of Economics 18 May 2019
REVISITING REINHART & ROGOFF AFTER THE CRISIS:
A TIME SERIES PERSPECTIVE
Abstract(
This paper offers a straightforward and descriptive contribution to the recent and busy
debate on fiscal discipline made popular by the seminal Reinhart and Rogoff (2010) paper,
after policymakers have sought foundation and justification for a policy known as austerity
measures, following on from the sovereign debt crisis of 2010. We revisit the debate on
whether or not higher debt levels impede growth rates and offer a time series perspective
of a corrected data set and a more recent higher frequency source. We find that with further
hindsight, and from a time series perspective, there is little to no support for the view that
higher levels of debt cause reductions in economic activity. In contrast to Reinhart and
Rogoff (2010), we suggest that economic slumps tend to cause debt build-ups rather than
vice versa.
Keywords: Austerity, Macroeconomic Policy, Fiscal Policy
JEL(Classification:"E60,"E62,"E65(
(
1. Introduction(
In the aftermath of the global financial crisis we revisit the popular debate on fiscal
discipline that has become crystallised around a controversial study by Reinhart and Rogoff
(2010), the findings of which suggest that countries with higher debt/GDP ratios (of above
90%) are associated with impeded growth rates. Our contribution to this debate is a time
series analysis that makes use of a more recent and higher frequency data source, obtained
from the OECD, alongside a corrected version of the original data from Herndon et al.
(2014), responsible for previous implications that austerity measures can be implemented
to reactivate an economy experiencing a deep recession.
In contrast to the majority of the literature on the debt growth nexus, our approach
is one that makes use of a deliberately simplistic time series perspective. We provide an
exploratory and descriptive presentation of the facts, in a similar way to Reinhart et al
(2012) and some of the earlier literature surrounding the Reinhart and Rogoff (2010)
findings. We do so alongside a comprehensive debt threshold analysis which we suggest
is perfectly adequate for the purpose of providing further evidence to this busy debate,
offering an alternative view on a topic that has been the subject of wide controversy inside
and beyond the field of economics. We consider our contribution a worthy addition to the
2
literature, given that more sophisticated empirical studies have so far found inconclusive
support for the Reinhart and Rogoff (2010) ‘debt-threshold’ hypothesis and are oftentimes
confronted with severe empirical challenge. We find little to no evidence to support the
view that higher public debt levels dampen economic growth, and rather the converse case,
where depressions in output lead to higher debt, is more likely in line with other papers
that have stressed the reverse-causal nature of economic growth and public debt (Puente-
Ajovín and Sanso-Navarro, 2015; Lof and Malinen, 2014 and Irons and Bivens, 2010).
The financial crisis of 2007 brought an extraordinary slump in economic activity
and significant increases in gross government debt for many western developed economies.
Increased borrowing and the need to recapitalise financial institutions left governments
across Europe vulnerable in terms of borrowing ability, and consequently facing sovereign
debt crises. Even though the causality linkage between public debt and economic growth
is rather complex, and not yet fully understood, it is believed to be best described through
a bidirectional relationship: In conventional views, public debt build-ups through increases
in public spending, are assumed to have a positive short-run expansionary effect on
demand, but also a crowding out of capital and thus lower economic growth in the medium
to long-run.
On the other hand, low economic growth is also likely to induce higher public debt.
Given the rise in gross government debt figures across advanced nations, it is of little
surprise that scholars have tried to find an answer to the question of whether or not
economic growth can be stifled by excessive public debt. Up until the unfolding of the
financial crisis, there had been little research in this area. An influential study by Reinhart
and Rogoff (2010) found a link between public debt and economic growth with evidence
of a debt-threshold (of 90%) at which economic growth is reduced by half. This study is
not alone in the support of the debt-threshold hypothesis, see Cecchetti et al. (2011), Casni
et al. (2014), Baum et al. (2013), Woo and Kumar (2015) or Caner et al. (2010) for
examples.
In an environment of surging public debt and crumbling growth rates, international
organisations and policymakers have found their own interpretation of studies such as this
to legitimise rigorous public spending cuts, commonly referred to as austerity measures; a
term used to describe a form of fiscal discipline, and discussed in detail by Konzelmann
(2014). Whereas the effectiveness and legitimacy of austerity measures are widely
discussed in the public, economic and political arenas, the findings in Reinhart and Rogoff
(2010) have also provoked rigorous discussion in the field of applied economics, including
contradictions by Chang and Chiang (2012) and Panizza and Presbitero (2014a), and
serious technical challenges to the validity of the methodology, such as Herndon et al.
(2014), Kourtellos et al. (2013) and Minea and Parent (2012).
In this study we re-visit the busy debate on the causal relationship between
economic growth and sovereign debt by offering a two-fold contribution: In Section 2, we
compartmentalise the literature using the most recent empirical contributions surrounding
the field of fiscal discipline, discussing empirically motivated work in the context of
correlation, causality, endogeneity and cross-country heterogeneity. We argue that the field
3
has yet to present a coherent framework with consistent evidence for the existence of a
‘debt-threshold’ or a strong case for a significant and negative causal link between public
debt and economic growth. In Section 3, we emphasise the need for a more careful
evaluation in the context of heterogeneity patterns and threshold effects via a simple visual
analysis of two comprehensive data sets: We employ the corrected Reinhart and Rogoff
(2010) data provided by Herndon et al. (2014) and a more recent and higher frequency
OECD data source to provide a non-parametric and descriptive evaluation of both the
potential causal link between the variables as well as the ‘debt-threshold’ hypothesis.
A key advantage of extending our analysis to encompass the higher frequency data
source is the additional ability to consider higher frequency information including intra
annual fluctuations; although one might question the usefulness of this additional measure,
given the notorious persistence in debt and growth dynamics generally. In the context of
the Reinhart and Rogoff (2010) study, the usefulness arises from the time period in
question. The OECD sample benefits from increased scope and captures a period of
increased volatility witnessed since 2009. We therefore suggest that the perspective
provided by the OECD quarterly data is an enhanced one.
The use of lower frequency data can lead to confusion over the direction of
causality, a key issue in the context of this debate over the relationship between debt and
growth. The causal relationship can appear immediate in lower frequency data, and this
may explain the conflicting findings in the debt growth nexus literature, underlining the
value of exploratory analyses such as this study. By comparing different frequencies with
varying data coverage we illustrate a robustness in our findings that holds despite some
data discrepancies across both sets.
1
Given that debt levels have risen consistently from the
beginning of the financial crisis, and for many countries surpassing the 90% mark of the
sovereign debt-to-GDP ratio, this study benefits from a longer time series perspective on
the correlation between debt levels and economic growth; one which encompasses these
crucial debt build-ups in the latter part of the OECD sample. We find consistency across
both data sets and provide particular focus and comparison of the period leading up to the
financial crisis with that of the period of global recovery, where economic activity has
returned to more normal levels.
With the benefit of the extended scope provided by the two different data sets, we
illustrate that there is little to no evidence to support for the view that higher public debt
levels dampen economic growth. Instead, our findings lend support to those who suggest a
reverse causality, where slumps in economic activity are largely responsible for increases
in public debt. This becomes obvious as debt build-ups typically proceed economic
downturns, a pattern that regularly appears, irrespective of the actual debt level. At the
same time, even though actual growth outcomes are shown to be high in volatility, median
growth rates for countries above the 90% threshold are indistinguishable from their low-
debt counterparts.
As debt levels have risen consistently from the beginning of the financial crisis, and
for many countries surpassing the 90% mark of the sovereign debt-to-GDP ratio, this study
benefits from a longer and time series perspective on the correlation between debt levels
4
and economic growth. With the benefit of extended scope and hindsight, our study finds
no clear-cut evidence in favour of the debt-threshold hypothesis. Instead, it lends support
to those who suggest a reverse causality, where slumps in economic activity are largely
responsible for increases in public debt. Consequently, we conclude that our analysis
throws serious doubt over previous findings that austerity measures might assist in the
reactivation of an economy from a deep recession.
2. Relevant(Literature(
Within the empirical literature, numerous approaches have been employed in the attempt
to shed light on the debt-growth relationship.
2
Whilst we acknowledge the wider scope of
the literature, the purpose of this study is to concentrate on the empirical post-crisis strand
which has the ‘debt-threshold’ hypothesis at its core. We argue that this particular strand
of the literature has yet to present a coherent framework with consistent evidence for the
existence of a ‘debt tipping point’ or a strong case of a significant and negative causal link
between public debt and economic growth. We show this in the preceding paragraphs using
the delineating factors of exploratory evidence, correlation and causality, endogeneity, and
cross-country heterogeneity.
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In their influential study Reinhart and Rogoff (2010) suggest a debt threshold of 90%
at which growth is reduced by half for a sample of OECD countries. More precisely, their
‘[...] main result is that whereas the link between growth and debt seems relatively weak
at ‘normal’ debt levels, median growth rates for countries with public debt over roughly
90 percent of GDP are about one percent lower than otherwise’ (Reinhart and Rogoff,
2010, p. 573). Even if it is clear that association or correlation between two variables by
no means implies a causal effect of one variable on the other, the authors are probably over
ambitious in arguing that, ‘[...] when gross external debt reaches 60 percent of GDP,
annual growth declines by about two percent; for levels of external debt in excess of 90
percent of GDP, growth rates are roughly cut in half ’ (Reinhart and Rogoff, 2010, p. 573).
The Reinhart and Rogoff (2010) paper has also sparked controversy through the
empirical replication of their study by Herndon et al. (2014) who reported that coding
errors, selective data exclusion and unconventional weighting of summary statistics lead
to an inaccurate representation of the relationship between public debt and GDP growth
for the data sampled. After correcting these deficiencies, the previously reported,
extraordinary debt threshold becomes significantly smaller, leading Herndon et al. (2014,
p. 278) to conclude that ‘policy-makers cannot defend austerity measures on the grounds
that public debt levels greater than 90% of GDP will consistently produce sharp declines
in economic growth’. Nonetheless, it would be unjust and rather convenient to hold
Reinhart and Rogoff (2010) accountable for the direction into which the public, political
or economic debate has been leaning, let alone for the economic consequence of austerity
